Form 10K

 

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, 2004

 

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 (or for such shorter period that the registrant was required to file such report) 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 herein, 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, 2004, the aggregate market value of the voting shares held by non-affiliates of the registrant was approximately $723.8 million based on the closing price on the New York Stock Exchange for such stock.

 

As of March 10, 2005,                      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 18, 2005 are incorporated by reference into Part III of this Form 10-K.

 



TABLE OF CONTENTS

 

          Page

     PART I     

Item 1.

  

Business

   2

Item 2.

  

Properties

   10

Item 3.

  

Legal Proceedings

   11

Item 4.

  

Submission of Matters to a Vote of Security Holders

   11
    

Executive Officers of the Company

   11
     PART II     

Item 5.

  

Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Repurchases of Common Stock

   13

Item 6.

  

Selected Financial Data

   14

Item 7.

  

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

   15

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   29

Item 8.

  

Financial Statements and Supplementary Data

   30

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   30

Item 9A.

  

Controls and Procedures

   30

Item 9B.

  

Other Information

   31
     PART III     

Item 10.

  

Directors and Executive Officers of the Registrant

   31

Item 11.

  

Executive Compensation

   31

Item 12.

  

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

   31

Item 13.

  

Certain Relationships and Related Transactions

   31

Item 14.

  

Principal Accountant Fees and Services

   31
     PART IV     

Item 15.

  

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

   32

 

1


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, Pennsylvania. 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 assets and 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 about a 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. In 2004, the Company had sales of $822 million and net income of $32.4 million. Sales of aftermarket parts and services represented about 54% of total sales in 2004.

 

Management and insiders of the Company own approximately 8% of Wabtec’s outstanding shares, with the balance held by investment companies and individuals. Executive management incentive compensation focuses on earnings, cash flow, working capital and economic profit 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 outside North America account for about 22% 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 44% and about 20%, respectively, in 2004). 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, many 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

 

2


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., passenger transit 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 passenger transit vehicles, New York City is the largest passenger transit market in the U.S. Passenger transit ridership is near an all-time high, after increasing throughout the 1990s due to steady growth in the U.S. economy. Based on preliminary figures for 2004, ridership is expected to be about the same as in 2003. 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 freight related products and services in North America is 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 U.S. railroads, 2004 was a record year, with revenue ton-miles increasing about 4.9%, carloadings increasing about 2.9% and intermodal units increasing about 10.4%. 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 2004, about 1,200 new, heavy-haul locomotives were delivered, up from about 750 in 2003. In 2005, we expect the industry to deliver about 1,100 new locomotives.

 

    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 2004, about 46,300 new freight cars were delivered and about 70,000 new freight cars were ordered. We expect that about 55,000 new units will be delivered in 2005.

 

Demand for North American passenger 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. In 2005, the U.S. federal government is expected to renew legislation that provides federal funding for transportation projects. The previous legislation expired in 2004, but the government continued to provide funding at 2004 levels in the interim. 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 passenger 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 2004, we estimate that about 800 transit vehicles were delivered, about the same as in 2003. In 2005, we estimate that about 725 units will be delivered, with about 950 units estimated for 2006. The expected increase in 2006 is due to the delivery of cars to New York City, which has placed an order for 1,700 cars, including options. As a result of this order, Wabtec management expects the annual transit vehicle delivery rate to be in the range of 900 to 1,200 units through 2009.

 

    Ridership levels. Ridership on U.S. transit vehicles increased steadily from 1995 through 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. In 2004, ridership was about the same as in 2003, and the company’s revenues from aftermarket products and services increased significantly.

 

3


Business Segments and Products

 

We provide our products and services through two principal business segments, the Freight Group and the Passenger Transit Group (hereafter referred to as “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 original equipment manufacturers (OEMs) and provide aftermarket sales and services with the aftermarket accounting for about 54% of net sales. In 2004, the Freight Group accounted for 71% of our total net sales, and the Transit Group accounted for the remaining 29%. In 2004, the Freight Group generated 58% of its net sales from the aftermarket and 42% of its net sales from the OEMs and Class I railroads. The Transit Group generated 42% of its net sales from the aftermarket and 58% of its net sales from OEMs. 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 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 1,000 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 19 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

4


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 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 assemblies 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 55% 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. We currently own over 1,000 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.

 

    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.

 

5


    Experienced management team. Our management team has over 100 years of combined experience with the Company. The team implemented numerous initiatives that enabled us to manage the sharp cyclical downturn in the rail supply market in 2001 and 2002, including 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. Since 2000, the company has reduced our debt, net of cash, by approximately $500 million, lowering our percentage of net debt to book capitalization from 73% at December 31, 2000 to 15% at December 31, 2004. As a result of these initiatives, our management team has improved our cost structure, operating leverage and financial flexibility and placed us 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 aftermarket sales. Historically, aftermarket sales are less cyclical than OEM sales because a certain level of aftermarket maintenance and service work must be performed, even during an industry slowdown. Wabtec provides aftermarket parts and services for its components, but the company is seeking to expand this business with new customers such as short-line and regional railroads, or with customers who currently perform the work in-house. In this way, we expect to take advantage of the rail 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.

 

    Accelerate new product 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.

 

    Expand globally. Our net sales outside of North America totaled 22% in 2004, up from 21% in 2003, 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.

 

Backlog

 

In 2004, 54% 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

 

6


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, 2004, and December 31, 2003, and the expected year of completion are as follows.

 

    

Total
Backlog

12/31/04


   Expected Delivery

  

Total
Backlog

12/31/03


   Expected Delivery

In thousands


      2005

  

Other

Years


      2004

  

Other

Years


Freight Group

   $ 292,004    $ 233,278    $ 58,726    $ 177,963    $ 111,545    $ 66,418

Transit Group

     281,955      142,663      139,292      284,006      151,116      132,890
    

  

  

  

  

  

Total

   $ 573,959    $ 375,941    $ 198,018    $ 461,969    $ 262,661    $ 199,308
    

  

  

  

  

  

 

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, 2004, 2003, and 2002, we invested about $33.8 million, $32.9 million and $33.6 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 4.1%, 4.6% and 4.8% 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 interoperability, 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 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 1,000 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 Faiveley Transport (formerly SAB WABCO Holdings B.V.) on December 31, 1993, pursuant to which Faiveley Transport 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

 

7


resilient wheel products. SAB WABCO Holdings B.V. was a former affiliate of Wabtec, since both were owned by the same parent company in the early 1990s. The Faiveley Transport license expired December 31, 2004, 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, Europe, South Africa and India; 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 2004, about 78% of our sales were to customers in North America, but we also shipped products to more than 82 countries throughout the world. About 54% 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, General Electric Transportation Systems, Bombardier, Burlington Northern Santa Fe, Electro-Motive Division of General Motors and Amtrak accounted for 26% of our net sales in 2004. No one customer represents 10% or more of consolidated sales. We believe that we have strong relationships with all of our key customers.

 

Competition

 

We believe that we hold about a 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 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, 2004, we had 4,905 full-time employees, approximately 39% 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 2005, 2006, 2007 and 2009.

 

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.

 

8


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 our major customers during this period.

 

Environmental Matters

 

Information on environmental matters is included in Note 18 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.

 

9


Item 2. PROPERTIES

 

Facilities

 

The following table provides certain summary information about the 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    Service Center    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  
Harvey, IL    Service Center    Freight Group    Lease    19,200  
Boulder, CO    Engineering/Admin    Freight Group    Lease    3,400  
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    Sales Office    Transit Group    Lease    1,200  
Glastonbury, CT    Engineering/Admin    Corporate    Lease    2,600  
Mountaintop, PA    Vacant Land Available for Sale         Own    105 Acres  

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  
Kolkata, India    Manufacturing    Freight Group    Lease    32,000  
Tottenham, Australia    Manufacturing    Freight Group    Lease    26,900  
Schweighouse, France    Manufacturing    Freight Group    Lease    19,000  
Calgary (Alberta), Canada    Service    Freight Group    Lease    14,400  
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  

(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.

 

10


Item 3. LEGAL PROCEEDINGS

 

Information with respect to legal proceedings is included in Note 18 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

 

The following table provides information on our executive officers. They are elected periodically by our Board of Directors and serve at its discretion.

 

NAME


   Age

  

Position


William E. Kassling

   61    Chairman of the Board, President and Chief Executive Officer

Alvaro Garcia-Tunon

   52    Senior Vice President, Chief Financial Officer and Secretary

Anthony J. Carpani

   52    Vice President, Group Executive, Friction

Patrick D. Dugan

   38    Vice President and Controller

Timothy J. Logan

   51    Vice President, International

James E. McClaine

   63    Vice President, Railroad Service

Barry L. Pennypacker

   44    Vice President, Performance First

Gary P. Prasser

   47    Vice President, Group Executive, Transit

George A. Socher

   56    Vice President, Internal Audit and Taxation

Scott E. Wahlstrom

   41    Vice President, Human Resources

Timothy R. Wesley

   43    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. He was named President and Chief Executive Officer of the Company again in May 2004. Mr. Kassling was also President of the Company 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 Scientific-Atlanta, Inc. and Parker Hannifin 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, Finance of the Company from November 1999 until March 2003 and Treasurer of the Company from August 1995 until November 1999.

 

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.

 

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.

 

11


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.

 

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.

 

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.

 

12


PART II

 

Item 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF COMMON STOCK

 

The Common Stock of the Company is listed on the New York Stock Exchange. As of March 10, 2005, there were 46,260,407 shares of Common Stock outstanding held by 948 holders of record. The high and low sales price of the shares and dividends declared per share were as follows:

 

2004


   High

   Low

   Dividends

First Quarter

   $ 17.44    $ 13.72    $ 0.01

Second Quarter

   $ 18.40    $ 13.61    $ 0.01

Third Quarter

   $ 19.19    $ 16.55    $ 0.01

Fourth Quarter

   $ 22.70    $ 18.32    $ 0.01

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

 

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 10, 2005, the Company’s Common Stock traded at $18.87 per share.

 

During the year ended December 31, 2004, there were no repurchases made by us or on our behalf or any “affiliated purchaser” of shares of our common stock registered by the Company pursuant to Section 12 of the Securities Exchange Act of 1934, as amended.

 

13


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


   2004

    2003

    2002

    2001

    2000

 

Income Statement Data

                                        

Net sales

   $ 822,018     $ 717,924     $ 696,195     $ 783,698     $ 811,178  

Gross profit

     205,164       189,450       179,471       209,926       235,662  

Operating expenses (1)

     (149,759 )     (139,636 )     (132,741 )     (152,145 )     (139,669 )

Merger and restructuring charge

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


 


 


 


 


Income from operations

   $ 55,405     $ 49,814     $ 46,730     $ 54,058     $ 77,791  
    


 


 


 


 


Interest expense, net

   $ (11,528 )   $ (11,118 )   $ (19,135 )   $ (33,501 )   $ (43,649 )

Other (expense) income, net

     (1,020 )     (3,654 )     (3,691 )     (2,130 )     3,776  

Income from continuing operations before cumulative effect of accounting change

     32,096       22,252       16,310       13,962       19,200  

Income from discontinued operations (net of tax)

     349       451       403       6,360       6,193  

(Loss) gain on sale of discontinued operations (net of tax) (2)

     —         —         (529 )     41,458       —    
    


 


 


 


 


Income before cumulative effect of accounting change

     32,445       22,703       16,184       61,780       25,393  
    


 


 


 


 


Net income (loss) (3)

   $ 32,445     $ 22,703     $ (45,479 )   $ 61,780     $ 25,393  
    


 


 


 


 


Diluted Earnings per Common Share

                                        

Income from continuing operations before cumulative effect of accounting change

   $ 0.70     $ 0.51     $ 0.37     $ 0.32     $ 0.45  

Net income (loss) (3)

   $ 0.71     $ 0.52     $ (1.04 )   $ 1.43     $ 0.59  
    


 


 


 


 


Cash dividends declared per share

   $ 0.04     $ 0.04     $ 0.04     $ 0.04     $ 0.04  
    


 


 


 


 


     As of December 31

 
     2004

    2003

    2002

    2001

    2000

 

Balance Sheet Data

                                        

Total assets

   $ 713,396     $ 656,305     $ 588,865     $ 729,952     $ 984,047  

Cash

     95,257       70,328       19,210       53,949       6,071  

Total debt

     150,107       190,225       195,151       241,870       540,197  

Shareholders’ equity

     312,426       248,293       199,262       245,271       196,371  

(1) In 2004, includes $3.2 million charge for a litigation ruling.

 

(2) In 2001, includes gain on sales of certain assets to GE Transportation Systems of $48.7 million and asset write-downs of other businesses that Wabtec decided to exit of $7.2 million.

 

(3) Includes the items noted above, as well as the following: A tax benefit of $4.9 million and $2.7 million was recorded in 2004 and 2003, respectively, primarily related to the reversal of certain items that had previously been provided for that were closed from further regulatory examination, and in 2002, a $61.7 million, net of tax, cumulative effect of accounting change for goodwill.

 

14


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 2004, about 78 percent of the Company’s revenues came from its North American operations, but Wabtec also sold products or services in 82 countries around the world.

 

Management Review of 2004 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 2004, we achieved the following:

 

    Generated cash of $65 million, more than twice net income of $32.4 million;

 

    Reduced debt, net of cash, by $65 million;

 

    Revenues increased 14.5%, as the company generated increases in both aftermarket and OEM sales, as well as international sales;

 

    Product quality, as measured by first-time pass rate, improved by 3%;

 

    Productivity increased 6%.

 

We achieved these results despite higher raw material costs, especially steel and copper, and despite the negative impact of foreign currency exchange rates, especially on the Company’s Canadian operations.

 

Freight rail industry statistics, such as carloadings and orders for new freight cars, improved in 2004. For example, carloadings grew 2.9% compared to 2003, as the freight railroads benefited from the strengthening economy in the U.S. As shown below, orders for new freight cars increased to 70,291 in 2004. As a result, the backlog of freight cars ordered was 58,677, its highest year-end level since 1998. Sales in our freight segment have demonstrated that trend. The following are quarterly freight car statistics for the past three years:

 

     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
    
  
    
     28,457    17,736     
    
  
    

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
    
  
    
     47,249    31,400     
    
  
    

 

15


     Orders

   Deliveries

   Backlog

First quarter 2004

   17,962    10,012    42,242

Second quarter 2004

   19,770    10,071    51,446

Third quarter 2004

   20,315    11,790    61,052

Fourth quarter 2004

   12,244    14,419    58,677
    
  
    
     70,291    46,292     
    
  
    

 

Source: Railway Supply Institute

 

The following is a summary of freight car, locomotive and transit car deliveries for the industry:

 

     Actual

   Forecast

     2003

   2004

   2005

Freight car

   31,400    46,292    55,000

Transit

   811    819    725

Locomotive

   759    1,235    1,100

 

Based on company estimates

 

Management is forecasting a slight increase in deliveries of freight and transit cars.

 

Carloadings and Intermodal Units Originated have grown proportionally over the past three years reflecting higher rail traffic and ultimately better opportunities for maintenance and aftermarket sales for the Company:

 

Carloadings Originated (in thousands):

 

     1st
Quarter


   2nd
Quarter


   3rd
Quarter


   4th
Quarter


   Total

2004

   4,298    4,422    4,363    4,340    17,423

2003

   4,167    4,219    4,249    4,579    17,214

2002

   4,086    4,280    4,304    4,527    17,197

 

Intermodal Units Originated (in thousands):

 

     1st
Quarter


   2nd
Quarter


   3rd
Quarter


   4th
Quarter


   Total

2004

   2,585    2,750    2,810    2,849    10,994

2003

   2,409    2,457    2,489    2,728    10,083

2002

   2,157    2,383    2,462    2,437    9,439

 

Source: Association of American Railroads—Weekly Rail Traffic

 

In 2005, we expect demand to improve due to continued strength in the freight rail and passenger transit aftermarket, as well as growth in the market for new freight cars. Looking beyond 2005, we expect to generate increases in sales and earnings from executing our four-point growth strategy (see page 5 for more details):

 

    Expand aftermarket sales;

 

    Accelerate new product development;

 

    Expand globally;

 

    Continuous improvement through lean principles.

 

In 2005 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,

 

16


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


   2004

    2003

    2002

 

Net sales

   $ 822.0     $ 717.9     $ 696.2  

Cost of sales

     (616.9 )     (528.5 )     (516.7 )
    


 


 


Gross profit

     205.1       189.4       179.5  

Selling, general and administrative expenses

     (112.6 )     (102.4 )     (93.8 )

Engineering expenses

     (33.8 )     (32.9 )     (33.6 )

Amortization expense

     (3.3 )     (4.3 )     (5.3 )
    


 


 


Total operating expenses

     (149.7 )     (139.6 )     (132.7 )
    


 


 


Income from operations

     55.4       49.8       46.8  

Interest expense, net

     (11.5 )     (11.1 )     (19.2 )

Other expense, net

     (1.0 )     (3.7 )     (3.7 )
    


 


 


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

     42.9       35.0       23.9  

Income tax expense

     (10.8 )     (12.8 )     (7.6 )
    


 


 


Income from continuing operations before cumulative effect of accounting change

     32.1       22.2       16.3  

Discontinued operations

                        

Income from discontinued operations (net of tax)

     0.3       0.5       0.4  

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

     —         —         (0.5 )
    


 


 


Income before cumulative effect of accounting change

     32.4       22.7       16.2  

Cumulative effect of accounting change for goodwill, net of tax

     —         —         (61.7 )
    


 


 


Net income (loss)

   $ 32.4     $ 22.7     $ (45.5 )
    


 


 


 

2004 COMPARED TO 2003

 

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

 

     For the year ended December 31,

 

In thousands


   2004

   2003

   Percent
Change


 

Net sales

   $ 822,018    $ 717,924    14.5 %

Income from operations

     55,405      49,814    11.2 %

Net income

     32,445      22,703    42.9 %

 

Net sales increased by 14.5% from $717.9 million in 2003 to $822 million in 2004, primarily as a result of volume increases in freight car, locomotive and transit car deliveries. Aftermarket part sales increased because of

 

17


carloadings and intermodal units originated. The Company did not realize any significant net sales improvement because of price increases or foreign exchange. Net income for 2004 was $32.4 million, or $0.71 per diluted share. Net income for 2003 was $22.7 million, or $0.52 per diluted share. This increase in net income was primarily due to increased sales and a favorable tax benefit.

 

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

 

     For the year ended
December 31,


In thousands


   2004

   2003

Freight Group

   $ 587,685    $ 522,279

Transit Group

     234,333      195,645
    

  

Net sales

   $ 822,018    $ 717,924
    

  

 

Net sales. Net sales for 2004 increased $104.1 million, or 14.5%, as compared to 2003. Sales increased in both the Freight Group and the Transit Group. The Freight Group’s increased sales reflected higher sales of certain components to international markets, higher demand for pneumatic air brake components related to increased delivery of freight cars and locomotives and greater demand for friction products due to overall increased rail traffic in 2004. Industry deliveries of new freight cars for 2004 increased to 46,292 units as compared to 31,400 in 2003. The Transit Group’s increased sales were due to increased deliveries under existing contracts and higher aftermarket sales.

 

Gross profit. Gross profit increased to $205.2 million in 2004 compared to $189.5 million in 2003. Gross profit is dependent on a number of factors including pricing, sales volume and product mix. Gross profit, as a percentage of sales, was 25% compared to 26.4% in 2003. The decrease in gross profit percentage is primarily due to increased manufacturing costs because of higher raw material prices, higher medical costs for retiree health plans and the negative impact of foreign exchange rates on the Company’s Canadian operations. Other issues reducing gross profit percentage include inefficiencies relating to the closing and relocation of an electronics plant from Canada to the U.S., the establishment of a $970,000 reserve to reflect future environmental monitoring at our Boise facility, fixed asset impairment charges of $1.3 million, and the start up of low-margin rail door contracts in the Transit Group. Also, the provision for warranty expense negatively impacted gross profit having increased $4.4 million in 2004 compared to 2003. The provision for warranty expense is higher due to a combination of higher sales requiring additional reserves and charges for certain specific products. Although the warranty provision increased in 2004, warranty claims decreased resulting in an overall increase of $4.1 million in our warranty reserves. The Company is taking action to improve margins in future quarters, including price increases and ongoing initiatives to increase productivity and efficiency.

 

The following table shows our operating expenses:

 

     For the year ended December 31,

 

In thousands


   2004

   2003

   Percent
Change


 

Selling, general and administrative expenses

   $ 112,621    $ 102,398    10.0 %

Engineering expenses

     33,795      32,929    2.6 %

Amortization expense

     3,343      4,309    (22.4 )%
    

  

  

Total operating expenses

   $ 149,759    $ 139,636    7.2 %
    

  

  

 

Operating expenses. Operating expenses increased $10.1 million in 2004 as compared to 2003 including a $3.2 million unfavorable litigation ruling to GETS-GS, which the Company disagrees with and intends to continue to contest. Other costs comprising the increase include restructuring costs at the Company’s electronics unit, higher medical and insurance claims experience, foreign exchange costs and overall higher costs from inflation and sales activity. These increases were partially offset by reduced amortization expense. Amortization expense decreased due to certain intangible assets having been fully amortized.

 

18


Income from operations. Income from operations totaled $55.4 million (or 6.7% of sales) in 2004 compared with $49.8 million (or 6.9% of sales) in 2003. Higher operating income resulted from increased sales in 2004 offset by higher operating expenses.

 

Interest expense. Interest expense increased 3.7% in 2004 as compared to 2003 primarily due to the Company’s sale of senior notes in August 2003. These notes, while resulting in higher interest expense for the current year, enabled the Company to convert short-term, variable-rate debt into fixed-rate debt at an attractive long-term interest rate.

 

Other expense. The Company incurred foreign exchange losses of $1.2 million and $2.8 million, respectively, in 2004 and 2003, due to the effect of currency exchange rate changes on intercompany transactions that are non U.S. dollar denominated amounts and charged or credited to earnings.

 

Income taxes. 2004 includes a tax benefit of $4.9 million primarily related to the reversal of certain items that had previously been provided for that were closed from further regulatory examination. The effective income tax rate, not including the aforementioned tax benefit, remains unchanged and was 36.5% for 2004 and 2003. In 2004, the American Jobs Creation Act of 2004 was passed. The Company is in the process of evaluating the impact to the Company and its subsidiaries.

 

Net income. Net income for 2004 increased $9.7 million, compared with 2003. The increase was due to higher sales and the tax benefit mentioned above, partially offset by other items including the unfavorable GETS-GS litigation ruling, increased environmental reserve and higher manufacturing costs.

 

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

     49,814      46,730     6.6 %

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

 

19


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

   $ 102,398    $ 93,827    9.1 %

Engineering expenses

     32,929      33,592    (2.0 )%

Amortization expense

     4,309      5,322    (19.0 )%
    

  

  

Total operating expenses

   $ 139,636    $ 132,741    5.2 %
    

  

  

 

Operating expenses. Operating expenses increased $6.9 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 $49.8 million (or 6.9% of sales) in 2003 compared with $46.7 million (or 6.7% 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 41.9% in 2003 as compared to 2002 primarily due to a substantial decrease in debt.

 

Other expense. The Company incurred foreign exchange losses of $2.8 million and $1.2 million, respectively, in 2003 and 2002, due to the effect of currency exchange rate changes on intercompany transactions that are non U.S. dollar denominated amounts and charged or credited to earnings.

 

Income taxes. 2003 includes a tax benefit of $2.7 million primarily related to the reversal of certain items that had previously been provided for that were closed from further regulatory examination. 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.

 

Income Taxes

 

Management believes in the next three years cash outlays for income taxes will be less than income tax expense due to the utilization of NOLs and 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

 

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the deferred tax assets. In 2004, the Company has produced a $1.1 million federal net operating loss to be carried forward. A portion of the reported federal credits in the amount of $4.2 million will be realized through a carry back claim. Management believes tax planning opportunities exist in various foreign countries that will allow the Company to utilize foreign net operating loss carryforwards at an accelerated rate. 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.

 

The overall effective income tax rate includes a tax benefit of $4.9 million and $2.7 million in 2004 and 2003 respectively, which is primarily related to the reversal of certain items that had previously been provided for and that have been closed from further regulatory examination

 

Liquidity and Capital Resources

 

Liquidity is provided primarily by operating cash flow and borrowings under the Company’s unsecured credit facility 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


   2004

    2003

    2002

 

Cash provided by (used for):

                        

Operating activities

   $ 52,867     $ 55,904     $ 15,658  

Investing activities

     (17,808 )     (12,549 )     (10,817 )

Financing activities:

                        

Debt paydown

     (40,115 )     (4,949 )     (45,941 )

Other

     21,576       14,125       1,887  

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

     80,846       71,895       68,426  

 

Management utilizes EBITDA as a measure of liquidity. The following is a reconciliation of EBITDA to net cash provided by operating activities:

 

    

For the year ended

December 31,


 

In thousands


   2004

   2003

    2002

 

Net cash provided by operating activities

   $ 52,867    $ 55,904     $ 15,658  

Change in operating assets and liabilities

     2,172      563       26,925  

Change from discontinued operations

     349      344       (184 )

Change from deferred income taxes

     3,169      (8,824 )     (702 )

Interest expense

     11,528      11,118       19,135  

Income tax expense

     10,761      12,790       7,594  
    

  


 


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

   $ 80,846    $ 71,895     $ 68,426  
    

  


 


 

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 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.

 

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Operating activities. Operating cash flow in 2004 was $52.9 million as compared to $55.9 million in 2003. Net Income was approximately $9.7 million higher in 2004 than 2003. Working capital decreased, and generated operating cash, by $6.2 million, as accounts payable and accruals increased $26.1 million, offset by an increase in receivables, inventory and other current assets of $10.8 million, $5.2 million and $3.9 million, respectively. Deferred and accrued income taxes remained relatively unchanged compared to an $8.8 million decrease in 2003. The remaining use of operating cash is due to a net increase in the other assets less other liabilities in 2004.

 

Operating cash flow in 2003 was $55.9 million as compared to $15.7 million in 2002. Working capital remained relatively unchanged in 2003, as receivables and inventory increased $13.2 million, and accounts payable increased $14.1 million. Also, deferred income taxes decreased by $8.8 million in 2003.

 

During 2002, cash outlays for merger and restructuring activities was approximately $2.5 million and is 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 2004 and 2003, cash used in investing activities was $17.8 million and $12.5 million, respectively, consisting almost entirely of capital expenditures, net of disposals. In 2002 cash used in investing activities was $10.8 million. In 2002, the Company used $1.7 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 $19.3 million, $17.5 million and $14.1 million in 2004, 2003 and 2002, respectively. The majority of capital expenditures for these periods relates to upgrades to and replacement of existing equipment.

 

Financing activities. In 2004, cash used for financing activities was $18.5 million compared to cash provided by financing activities of $9.2 million in 2003.

 

During 2004, long term debt was reduced by $40.1 million. The Company also realized proceeds of $23 million from the exercise of stock options during 2004. In 2003, the Company 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, the Company issued common stock in connection with the registration and sale of stock by certain selling shareholders. The Company 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. During 2002, the Company reduced long-term debt by $45.9 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, the Company have financed the purchase of significant businesses utilizing cash flow generated from operations and amounts available under its credit facilities.

 

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The following table shows outstanding indebtedness at December 31, 2004 and 2003. The revolving credit agreement and other term loan interest rates are variable and dependent on market conditions.

 

     December 31,

In thousands


   2004

   2003

Revolving credit agreement

   $ —      $ 40,000

6.875% senior notes

     150,000      150,000

Other

     107      225
    

  

Total

     150,107      190,225

Less—current portion

     —        —  
    

  

Long-term portion

   $ 150,107    $ 190,225
    

  

 

Cash balance at December 31, 2004 and 2003 was $95.3 million and $70.3 million, respectively.

 

On February 1, 2005, the Company completed the acquisition of assets of Rütgers Rail S.p.A. The acquisition was accounted for as a purchase and accordingly, the purchase price will be allocated to the respective assets and liabilities based upon their estimated fair values as of the acquisition date. Operating results will be included in the consolidated statement of operations from the acquisition date forward. The new company formed to hold the newly purchased assets of Rütgers Rail S.p.A. is named CoFren S.r.l. (“CoFren”). CoFren has become the leading manufacturer of brake shoes, disc pads and interior trim components for rail applications in Europe. The purchase price was $36.6 million in cash, and is subject to adjustment based on a calculation of net worth as defined in the Sale and Purchase agreement. The adjustment is to be completed within 90 business days of the acquisition date.

 

Refinancing Credit agreement. In January 2004, the Company refinanced 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. At December 31, 2004, the Company had available bank borrowing capacity, net of $21.9 million of letters of credit, of approximately $153.1 million, subject to certain financial covenant restrictions.

 

Refinancing 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 $40 million, $36.7 million and 2.9%, respectively for 2004. 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 our interest rate from a variable rate to a fixed rate of 3.98%. The interest rate swap agreements were terminated, for a net gain of about $200,000 in 2004 in conjunction with the $40 million repayment of the revolving credit agreement.

 

Under the Refinancing Credit Agreement, we may elect a base interest rate or an interest rate based on the London Interbank Offered Rates of Interest (“LIBOR”). The base interest 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 100 basis points.

 

The Refinancing Credit Agreement limits the Company’s ability to declare or pay cash dividends and prohibits 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.

 

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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. The Refinancing Credit Agreement includes the following covenants: a minimum interest coverage ratio of 3.0, maximum debt to cash flow ratio of 3.25 and a minimum net worth of $180 million plus 50% of consolidated net income since September 30, 2003. 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.

 

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

 

Effects of Inflation

 

In general, 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. However, higher costs of metals have reduced gross margin. Other areas of higher costs include medical benefits for active and retired employees.

 

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Contractual Obligations and Off-Balance Sheet Arrangements

 

The Company is obligated to make future payments under various contracts such as debt agreements, lease agreements and have certain contingent commitments such as debt guarantees. The Company has 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, 2004:

 

In thousands


   Total

   2005

   2006 to
2007


   2008 to
2009


   Thereafter

Operating activities:

                                  

Unconditional purchase obligations (1)

   $ —      $ —      $ —      $ —      $ —  

Long-term purchase obligations (1)

     347      347      —        —        —  

Operating leases (2)

     36,642      7,332      12,952      9,137      7,221

Estimated pension funding (3)

     —        6,826      13,858      14,659      —  

Postretirement benefit payments (4)

     —        2,408      4,997      5,241      —  

Financing activities:

                                  

Long-term debt (5)

     150,107      —        107      —        150,000

Dividends to shareholders (6)

     —        —        —        —        —  

Investing activities:

                                  

Capital projects (7)

     25,000      25,000      —        —        —  

Other:

                                  

Standby letters of credit (8)

     21,909      17,387      3,039      1,483      —  

Guarantees (9)

     1,300      —        —        —        —  
    

  

  

  

  

Total

          $ 59,300    $ 34,953    $ 30,520       
    

  

  

  

  


(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 to participants 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 to participants are expected to continue into the foreseeable future at the amounts or ranges noted. Postretirement payments are based on actuarial estimates using current assumptions for discount rates and health care costs. 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 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 2005 budget amount was approved at the February 2005 Board of Directors meeting up to $25 million.

 

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(8) The Company has $21.9 million in outstanding letters of credit for performance and bid bond purposes, which expire in various dates through 2009.

 

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

 

Obligations for operating activities. The Company has entered into $347,000 of 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 $6.1 million and $5.7 million in 2004 and 2003, respectively. Benefits paid for post retirement plans were $3.5 million and $2.1 million in 2004 and 2003, respectively.

 

Obligations for financing activities. Cash requirements for financing activities consist primarily of long-term debt repayments and dividend payments to shareholders. The Company has 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, the Company sold a subsidiary to that unit’s management team. As part of the sale, the Company guaranteed approximately $3 million of bank debt of the buyer, which was used for the purchase financing. This debt was refinanced in June 2004, and Wabtec’s guarantee was reduced to $1.3 million. Management has no reason to believe that this debt will not be repaid or refinanced.

 

The Company arranges for performance bonds to be issued by third party insurance companies to support certain long term customer contracts. At December 31, 2004, initial value of performance bonds issued on the Company’s behalf is about $150 million.

 

Obligations for investing activities. The Company typically spends approximately $15-25 million a year for capital expenditures, primarily related to facility expansion efficiency and modernization, health and safety, and environmental control. The Company expects annual capital expenditures in the future will be within this range.

 

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;

 

26


    continued 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;

 

    increases in raw material costs;

 

    successful introduction of new products;

 

    performance under material long-term contracts;

 

    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

 

27


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 Notes 2 and 18, respectively, 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.

 

The Company recognizes revenues on long-term contracts based on the percentage of completion method of accounting. The units-of-delivery method or other output-based measures, as appropriate, are used to measure the progress of individual contracts towards completion. Contract revenues and cost estimates are reviewed and revised at a minimum quarterly and adjustments are reflected in the accounting period as known. Provisions are made currently for estimated losses on uncompleted contracts. 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.

 

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 $2.4 million in 2004, $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.

 

The Company provides warranty reserves to cover expected costs from repairing or replacing products with durability, quality or workmanship issues occurring during established warranty periods. In general, reserves are provided for as a percentage of sales, based on historical experience. In addition, specific reserves are established for known warranty issues and their estimable losses.

 

Inventory is reviewed to ensure that an adequate provision is recognized for excess, slow moving and obsolete inventories. The Company compares inventory components to prior year sales history and current backlog requirements. To the extent that inventory parts exceed estimated usage and demand, a reserve is recognized to reduce the carrying value of inventory. Also, specific reserves are established for known inventory obsolescence.

 

28


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 variable-rate debt. There was no outstanding variable rate debt at December 31, 2004. After considering the effects of interest rate swaps, further described below, our variable rate debt represented 0% of total long-term debt at December 31, 2003. Management had entered into pay-fixed, receive-variable interest rate swap contracts that mitigated the impact of variable-rate debt interest rate increases. These interest rate swap contracts were terminated in 2004. In 2003, we had concluded that our swap contracts qualified for “special cash flow hedge accounting” which permitted recording the fair value of the swap and corresponding adjustment to other comprehensive income on the balance sheet (see Note 20 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report).

 

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, 2004, we had several such instruments outstanding to hedge currency rate fluctuation in 2005.

 

We entered into foreign currency forward contracts to reduce the impact of changes in currency exchange rates. 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 are for the sale of U.S. Dollars (USD) and the purchase of Canadian Dollars (CAD). As of December 31, 2004, we had forward contracts with a notional value of $59 million CAD (or $43.5 million U.S.), with an average exchange rate of $0.74 USD per $1 CAD, resulting in the recording of a current asset and an increase in comprehensive income of $3.6 million, net of tax.

 

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, 2004, approximately 66% of Wabtec’s net sales are in the United States, 10% in Canada, 2% in Mexico, and 22% in other international locations, primarily Europe. (See Note 19 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, 2003.

 

29


Recent Accounting Pronouncements

 

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.

 

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, (Inventory Costs—an Amendment of ARB No. 43, Chapter 4.” This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be recognized as current period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is currently evaluating the effect of this standard on the Company’s financial statements and results of operations.

 

SFAS No. 123 (revised 2004) “Share-Based Payment” was issued in December 2004. This standard requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. The effective date is the first interim reporting period beginning after June 15, 2005. Wabtec is currently evaluating pricing models and the transition provisions of this standard and will begin expensing stock options in the third quarter of 2005.

 

In December 2004, the FASB issued FSP No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.” FSP 109-2 provides guidance under SFAS No. 109, “Accounting for Income Taxes” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) on enterprises’ income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the impact of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions. Accordingly, provided for in FSP 109-2, the Company has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Job Act.

 

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

 

There have been no disagreements with our independent public accountants.

 

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, 2004. 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.

 

30


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, 2004, that has materially affected, or is reasonably likely to materially affect, Wabtec’s internal control over financial reporting. Management’s annual report on internal control over financial reporting and the attestation report of the registered public accounting firm are included in Part IV, Item 15 of this report.

 

Item 9B. OTHER INFORMATION

 

None.

 

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 18, 2005. The definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2004. 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.

 

31


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

   
         

Management’s Reports to Westinghouse Air Brake Technologies Corporation Shareholders

  37
         

Report of Independent Registered Public Accounting Firm

  38
         

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

  39
         

Consolidated Balance Sheets as of December 31, 2004 and 2003

  40
         

Consolidated Statements of Operations for the three years ended December 31, 2004, 2003 and 2002

  41
         

Consolidated Statements of Cash Flows for the three years ended December 31, 2004, 2003 and 2002

  42
         

Consolidated Statements of Shareholders’ Equity for the three years ended December 31, 2004, 2003 and 2002

  43
         

Notes to Consolidated Financial Statements

  44
     (2)   

Financial Statement Schedules

   
         

Schedule II—Valuation and Qualifying Accounts

  74

(b)

       

Reports on Form 8-K

   
          During the fourth quarter of 2004, the Company filed or furnished the following Current Reports on Form 8-K pertaining to the following items:    
         

(1) A report dated October 22, 2004, under Items 2.02 and 9.01, the press release, dated October 21, 2004 announcing the financial results of the Company for the quarter ended September 30, 2004.

   
         

(2) A report dated December 20, 2004, under Items 8.01 and 9.01, the press release, dated December 20, 2004 announcing the Company’s earnings guidance for the year ended December 31, 2004 and 2005.

   
(c)         Exhibits   Filing
Method


       2.1        Amended and Restated Agreement and Plan of Merger, as amended (originally included as Annex A to the Joint Proxy Statement/Prospectus)   5
       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   5
       4.1(a)    Indenture with the Bank of New York as Trustee dated as of August 6, 2003   12
       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   12

 

32


(c)         Exhibits   Filing
Method


       4.2        Purchase Agreement, dated July 23, 2003, by and between the Company and the initial purchasers   12
       4.3        Exchange and Registration Rights Agreement, dated August 6, 2003   12
     10.1        MotivePower Stock Option Agreement (originally included as Annex B to the Joint Proxy Statement/Prospectus)   5
     10.2        Westinghouse Air Brake Stock Option Agreement (originally included as Annex C to the Joint Proxy Statement/Prospectus)   5
     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)   5
     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)   6
     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   3
     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   4
     10.20    Westinghouse Air Brake Company 1995 Non-Employee Directors’ Fee and Stock Option Plan, as amended   6
     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

 

33


(c)         Exhibits   Filing
Method


     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   3
     10.28    Common Stock Registration Rights Agreement dated as of March 5, 1997 among the Company, Harvard, AIP and the Voting Trust   3
     10.29    1998 Employee Stock Purchase Plan   4
     10.32    Westinghouse Air Brake Technologies Corporation 2000 Stock Incentive Plan   7
     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)   8
     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)   10
     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)   10
     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    

 

34


(c)         Exhibits   Filing
Method


          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)   10
     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)   10
     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   11
     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   9
     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   13
     10.41     Sale and Purchase Agreement, by and between Rütgers Rail S.p.A. and the Company, dated August 12, 2004.   1
     10.42     Amendment Agreement dated January 28, 2005 by and among Rütgers Rail S.p.A., the Company, CoFren S.r.l. and RFPC Holding Company to the Sale and Purchase Agreement dated August 12, 2004.   1
     21          List of subsidiaries of the Company   1
     23.1        Consent of Ernst & Young 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, 2004 of the Westinghouse Air Brake Technologies Corporation Savings Plan   1

 

35



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 Annual Report on Form 10-K for the period ended December 31, 1997.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

13 Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 2003.

 

36


MANAGEMENT’S REPORTS TO WABTEC SHAREHOLDERS

 

Management’s Report on Financial Statements and Practices

 

The accompanying consolidated financial statements of Westinghouse Air Brake Technologies Corporation and subsidiaries (the “Company”) were prepared by management, which is responsible for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles and include amounts that are based on management’s best judgments and estimates. The other financial information included in the 10-K is consistent with that in the financial statements.

 

Management also recognizes its responsibility for conducting the Company’s affairs according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in key policy statements issued from time to time regarding, among other things, conduct of its business activities within the laws of host countries in which the Company operates and potentially conflicting outside business interests of its employees. The Company maintains a systematic program to assess compliance with these policies.

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment, including testing, using the criteria in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting standards. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Based on its assessment, management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria in Internal Control-Integrated Framework issued by the COSO. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

Management’s Certifications

 

The certifications of the Company’s Chief Executive Officer and Chief Financial Officer required by the Sarbanes-Oxley Act have been included in Exhibits 31 and 32 in the Company’s 10-K. In addition, in 2004, the Company’s Chief Executive Officer provided to the New York Stock Exchange the annual CEO certification regarding the Company’s compliance with the New York Stock Exchange’s corporate governance listing standards.

 

By   /s/    WILLIAM E. KASSLING        
    William E. Kassling,
Chairman of the Board,
    President, Chief Executive Officer and Director

 

By  

/s/    ALVARO GARCIA-TUNON        

    Alvaro Garcia-Tunon,
Senior Vice President,
    Chief Financial Officer and Secretary

 

37


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

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 and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the index at Item 15(a) of this Registration Statement. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 consolidated financial position of Westinghouse Air Brake Technologies Corporation and subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, 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 of 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.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Westinghouse Air Brake Technologies Corporation’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2005 expressed an unqualified opinion thereon.

 

/s/ ERNST & YOUNG LLP

 

Pittsburgh, Pennsylvania

 

March 11, 2005

 

38


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

To the Board of Directors and Shareholders of

Westinghouse Air Brake Technologies Corporation:

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Westinghouse Air Brake Technologies Corporation maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Westinghouse Air Brake Technologies Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that Westinghouse Air Brake Technologies Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Westinghouse Air Brake Technologies Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Westinghouse Air Brake Technologies Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2004 and our report dated March 11, 2005 expressed an unqualified opinion thereon.

 

/s/ ERNST & YOUNG LLP

 

Pittsburgh, Pennsylvania

 

March 11, 2005

 

39


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

     December 31,

 

In thousands, except share and par value


   2004

    2003

 
Assets                 

Current Assets

                

Cash and cash equivalents

   $ 95,257     $ 70,328  

Accounts receivable

     139,843       129,074  

Inventories

     96,992       91,809  

Deferred income taxes

     16,122       23,457  

Other

     11,359       7,424  
    


 


Total current assets

     359,573       322,092  

Property, plant and equipment

     340,948       332,619  

Accumulated depreciation

     (189,987 )     (178,780 )
    


 


Property, plant and equipment, net

     150,961       153,839  

Other Assets

                

Goodwill

     113,466       109,450  

Other intangibles, net

     39,880       37,776  

Deferred income taxes

     35,476       20,315  

Other noncurrent assets

     14,040       12,833  
    


 


Total other assets

     202,862       180,374  
    


 


Total Assets

   $ 713,396     $ 656,305  
    


 


Liabilities and Shareholders’ Equity                 

Current Liabilities

                

Accounts payable

   $ 92,189     $ 79,747  

Accrued income taxes

     3,299       126  

Customer deposits

     27,693       16,818  

Accrued compensation

     18,944       18,131  

Accrued warranty

     17,413       13,307  

Other accrued liabilities

     21,334       24,651  
    


 


Total current liabilities

     180,872       152,780  

Long-term debt

     150,107       190,225  

Reserve for postretirement and pension benefits

     43,112       39,055  

Deferred income taxes

     14,523       11,631  

Commitments and contingencies

     6,171       5,536  

Notes payable

     487       3,198  

Other long-term liabilities

     5,698       5,587  
    


 


Total liabilities

     400,970       408,012  

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 shares issued and 46,192,223 and 44,631,733 outstanding at December 31, 2004 and 2003, respectively

     662       662  

Additional paid-in capital

     286,694       282,872  

Treasury stock, at cost, 19,982,544 and 21,543,034 shares, at December 31, 2004 and 2003, respectively

     (248,021 )     (267,586 )

Retained earnings

     282,868       252,234  

Accumulated other comprehensive loss

     (9,777 )     (19,889 )
    


 


Total shareholders’ equity

     312,426       248,293  
    


 


Total Liabilities and Shareholders’ Equity

   $ 713,396     $ 656,305  
    


 


 

The accompanying notes are an integral part of these statements.

 

40


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year ended December 31,

 

In thousands, except per share data


   2004

    2003

    2002

 

Net sales

   $ 822,018     $ 717,924     $ 696,195  

Cost of sales

     (616,854 )     (528,474 )     (516,724 )
    


 


 


Gross profit

     205,164       189,450       179,471  

Selling, general and administrative expenses

     (112,621 )     (102,398 )     (93,827 )

Engineering expenses

     (33,795 )     (32,929 )     (33,592 )

Amortization expense

     (3,343 )     (4,309 )     (5,322 )
    


 


 


Total operating expenses

     (149,759 )     (139,636 )     (132,741 )

Income from operations

     55,405       49,814       46,730  

Other income and expenses

                        

Interest expense, net

     (11,528 )     (11,118 )     (19,135 )

Other expense, net

     (1,020 )     (3,654 )     (3,691 )
    


 


 


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

     42,857       35,042       23,904  

Income tax expense

     (10,761 )     (12,790 )     (7,594 )
    


 


 


Income from continuing operations before cumulative effect of accounting change

     32,096       22,252       16,310  

Discontinued operations

                        

Income from discontinued operations (net of tax)

     349       451       403  

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

     —         —         (529 )
    


 


 


Total discontinued operations

     349       451       (126 )

Income before cumulative effect of accounting change

     32,445       22,703       16,184  

Cumulative effect of accounting change for goodwill, net of tax

     —         —         (61,663 )
    


 


 


Net income (loss)

   $ 32,445     $ 22,703     $ (45,479 )
    


 


 


Earnings Per Common Share

                        

Basic

                        

Income from continuing operations before cumulative effect of accounting change

   $ 0.71     $ 0.51     $ 0.37  

Income from discontinued operations

     0.01       0.01       —    

Cumulative effect of accounting change

     —         —         (1.42 )
    


 


 


Net income (loss)

   $ 0.72     $ 0.52     $ (1.05 )
    


 


 


Diluted

                        

Income from continuing operations before cumulative effect of accounting change

   $ 0.70     $ 0.51     $ 0.37  

Income from discontinued operations

     0.01       0.01       —    

Cumulative effect of accounting change

     —         —         (1.41 )
    


 


 


Net income (loss)

   $ 0.71     $ 0.52     $ (1.04 )
    


 


 


Weighted average shares outstanding

                        

Basic

     44,993       43,538       43,291  

Diluted

     45,787       43,974       43,617  

 

The accompanying notes are an integral part of these statements.

 

41


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended December 31,

 

In thousands


   2004

    2003

    2002

 

Operating Activities

                        

Net income (loss)

   $ 32,445     $ 22,703     $ (45,479 )

Adjustments to reconcile net income (loss) to cash provided by operations:

                        

Cumulative effect of accounting change for goodwill, net of tax

     —         —         61,663  

Depreciation and amortization

     26,112       25,284       25,513  

Results of discontinued operations, net of tax

     (349 )     (451 )     126  

Deferred income taxes

     (3,169 )     8,824       702  

Discontinued operations

     —         107       58  

Changes in operating assets and liabilities, net of acquisitions

                        

Accounts receivable

     (14,844 )     (12,410 )     (548 )

Inventories

     (6,885 )     (796 )     17,812  

Accounts payable

     14,832       14,138       (12,814 )

Accrued income taxes

     3,713       286       (30,262 )

Accrued liabilities and customer deposits

     14,580       2,836       1,964  

Commitments and contingencies

     635       (2,032 )     (3,033 )

Other assets and liabilities

     (14,203 )     (2,585 )     (44 )
    


 


 


Net cash provided by operating activities

     52,867       55,904       15,658  

Investing Activities

                        

Purchase of property, plant and equipment

     (19,262 )     (17,470 )     (14,137 )

Proceeds from disposal of property, plant and equipment

     1,454       5,048       3,673  

Acquisitions of businesses, net of cash acquired

     —         —         (1,654 )

Cash received from disposition of discontinued operations

     —         —         1,400  

Discontinued operations

     —         (127 )     (99 )
    


 


 


Net cash used for investing activities

     (17,808 )     (12,549 )     (10,817 )

Financing Activities

                        

(Repayments) borrowings of credit agreements

     (40,000 )     (149,700 )     129,700  

Borrowings (repayments) of senior notes

     —         150,000       (175,000 )

Repayments of other borrowings

     (115 )     (5,249 )     (641 )

Stock issuance

     —         9,977       —    

Proceeds from treasury stock from stock based benefit plans

     23,387       5,899       3,695  

Cash dividends

     (1,811 )     (1,751 )     (1,808 )
    


 


 


Net cash (used for) provided by financing activities

     (18,539 )     9,176       (44,054 )

Effect of changes in currency exchange rates

     8,409       (1,413 )     4,474  
    


 


 


Increase (decrease) in cash

     24,929       51,118       (34,739 )

Cash, beginning of year

     70,328       19,210       53,949  
    


 


 


Cash, end of year

   $ 95,257     $ 70,328     $ 19,210  
    


 


 


 

The accompanying notes are an integral part of these statements.

 

42


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, 2001

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

Cash dividends ($0.04 dividend per share)

                                (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 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 )
   


                                           

Total comprehensive loss

  $ (47,896 )                                            
   


 

 

 


 


 


 


Balance, December 31, 2002

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

Cash dividends ($0.04 dividend per share)

                                (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 granted through a Rabbi Trust

                        270               (270 )        

Net income

  $ 22,703                           22,703                  

Translation adjustment

    13,962                                           13,962  

Unrealized gains on foreign exchange contracts, 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 )
   


                                           

Total comprehensive income

  $ 34,906                                              
   


 

 

 


 


 


 


Balance, December 31, 2003

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

Cash dividends ($0.04 dividend per share)

                                (1,811 )                

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

                  3,822     19,565                          

Net income

  $ 32,445                           32,445                  

Translation adjustment

    10,346                                           10,346  

Unrealized gains on foreign exchange contracts, net of $1,925 tax

    3,350                                           3,350  

Unrealized gains on derivatives designated and qualified as cash flow hedges, net of $119 tax

    207                                           207  

Additional minimum pension liability, net of $(2,178) tax

    (3,791 )                                         (3,791 )
   


                                           

Total comprehensive income

  $ 42,557                                              
   


 

 

 


 


 


 


Balance, December 31, 2004

          $ 662   $ 286,694   $ (248,021 )   $ 282,868     $ —       $ (9,777 )
           

 

 


 


 


 


 

The accompanying notes are an integral part of these statements

 

43


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 2004, about 78 percent of the Company’s revenues came from its North American operations, but Wabtec also sold products or services in 82 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 $2 million and $4.5 million as of December 31, 2004 and 2003, 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 and indefinite lived intangible assets are reviewed annually for impairment and more frequently when indicators of impairment are present. Amortizable intangible assets are reviewed for impairment when indicators of impairment are present.

 

The evaluation of impairment involves comparing the current fair value of the business to the recorded value (including goodwill). The Company uses 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

 

44


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

 

Warranty Costs Warranty costs are accrued based on management’s estimates of repair or upgrade costs per unit and historical experience. Warranty expense was $14.9 million, $10.5 million and $17.6 million for 2004, 2003 and 2002, respectively. Warranty reserves were $17.4 million and $13.3 million at December 31, 2004 and 2003, 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. The provision for income taxes includes federal, state and foreign income taxes.

 

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.

 

45


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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


   2004

   2003

   2002

 

Net income (loss)

                      

As reported

   $ 32,445    $ 22,703    $ (45,479 )

Stock based compensation under FAS123, net of tax

     1,722      2,291      2,680  
    

  

  


Pro forma

     30,723      20,412      (48,159 )

Basic earnings (loss) per share

                      

As reported

   $ 0.72    $ 0.52    $ (1.05 )

Pro forma

   $ 0.68      0.47      (1.11 )

Diluted earnings (loss) per share

                      

As reported

   $ 0.71    $ 0.52    $ (1.04 )

Pro forma

     0.67      0.46      (1.10 )

 

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,


 
     2004

    2003

    2002

 

Dividend yield

   .3 %   .3 %   .3 %

Risk-free interest rate

   4.9 %   5.2 %   5.6 %

Stock price volatility

   46.1     46.1     46.7  

Expected life (years)

   5.0     5.0     5.0  

 

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. 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. The interest rate swaps were terminated in 2004. As a result of entering into these interest rate swaps, the Company incurred $262,000 in additional interest expense in 2004.

 

The Company also entered into foreign currency forward contracts to reduce the impact of changes in currency exchange rates. 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 a net basis. All outstanding forward contracts are for the sale of U.S. Dollars (USD) and the purchase of Canadian Dollars (CAD). As of December 31, 2004, the Company had forward contracts with a notional value of

 

46


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

$59 million CAD (or $43.5 million U.S.), with an average exchange rate of $0.74 USD per $1 CAD, resulting in the recording of a current asset and an increase in comprehensive income of $3.6 million, net of tax.

 

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 $1.2 million, $2.8 million and $1.2 million for 2004, 2003 and 2002, 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 Bulletins (SABs) 101, “Revenue Recognition in Financial Statements” and 104 “Revision of Topic 13.” Revenue is recognized when products have been shipped to the respective customers, title has passed and the price for the product has been determined.

 

The Company recognizes revenues on long-term contracts based on the percentage of completion method of accounting. The units-of-delivery method or other output-based measures, as appropriate, are used to measure the progress of individual contracts towards completion. Contract revenues and cost estimates are reviewed and revised at a minimum quarterly and adjustments are reflected in the accounting period as known. Provisions are made currently for estimated losses on uncompleted contracts. 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 $5.3 million and $3.4 million at December 31, 2004 and 2003, 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 2004 and 2003. One customer, in the transit group, accounted for 11% of the Company’s consolidated net sales in 2002.

 

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, 2004, 2003 and 2002, the Company incurred costs of approximately $33.8 million, $32.9 million and $33.6 million, respectively.

 

Employees As of December 31, 2004, approximately 39% of the Company’s workforce was covered by collective bargaining agreements. These agreements are generally effective through 2005, 2006 and 2007.

 

47


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

 

Recent Accounting Pronouncements 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.

 

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs – an Amendment of ARB No. 43, Chapter 4.” This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be recognized as current period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is currently evaluating the effect of this standard on the Company’s financial statements and results of operations.

 

SFAS No. 123 (revised 2004) “Share-Based Payment” was issued in December 2004. This standard requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. The effective date is the first interim reporting period beginning after June 15, 2005. Wabtec is currently evaluating pricing models and the transition provisions of this standard and will begin expensing stock options in the third quarter of 2005.

 

In December 2004, the FASB issued FSP No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.” FSP 109-2 provides guidance under SFAS No. 109, “Accounting for Income Taxes” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) on enterprises’ income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the impact of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions. Accordingly, as provided for in FSP 109-2, the Company has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Job Act.

 

48


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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. At this time, the Company is not aware of any potential liability in connection with this sale of assets. 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. 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 had 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.

 

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


   2004

   2003

   2002

Net sales

   $ —      $ 6,593    $ 11,158

Income before income taxes

     550      710      593

Income tax expense

     201      259      190

Income from discontinued operations

   $ 349    $ 451    $ 403

 

4. SUPPLEMENTAL CASH FLOW DISCLOSURES

 

    

For the year ended

December 31,


 

In thousands


   2004

   2003

    2002

 

Interest paid during the year

   $ 13,203    $ 6,478     $ 18,111  

Income taxes paid during the year

     7,376      8,185       34,452  

Business acquisitions:

                       

Fair value of assets acquired

   $ —      $ —       $ 1,654  

Liabilities assumed

     —        —         —    
    

  


 


Cash paid

     —        —         1,654  

Less cash acquired

     —        —         —    
    

  


 


Net cash paid

   $ —      $ —       $ 1,654  
    

  


 


Noncash investing and financing activities:

                       

Notes payable

   $ —      $ 3,198     $ —    

Deferred compensation

     —        270       268  

Treasury stock

     —        (270 )     (268 )

 

49


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

5. MERGERS AND ACQUISITIONS

 

The Company made the following acquisitions in 2002 and 2005:

 

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. This acquisition was accounted for under the purchase method. Accordingly, the results of operations of the 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 $664,000 and was allocated to goodwill. Effective January 1, 2002, goodwill was no longer amortized upon adoption of SFAS No. 142.

 

ii) On February 1, 2005, the Company completed the acquisition of assets of Rütgers Rail S.p.A. The acquisition was accounted for as a purchase and accordingly, the purchase price will be allocated to the respective assets and liabilities based upon their estimated fair values as of the acquisition date. Operating results will be included in the consolidated statement of operations from the acquisition date forward. The new company formed to hold the newly purchased assets of Rütgers Rail S.p.A. is named CoFren S.r.l. (“CoFren”). CoFren has become the leading manufacturer of brake shoes, disc pads and interior trim components for rail applications in Europe. The purchase price was $36.6 million in cash. The purchase price is subject to adjustment based on a calculation of net worth as defined in the Sale and Purchase agreement. The adjustment is to be completed within 90 business days of the acquisition date.

 

6. INVENTORY

 

The components of inventory, net of reserves, were:

 

     December 31,

In thousands


   2004

   2003

Raw materials

   $ 34,280    $ 28,711

Work-in-process

     45,628      45,559

Finished goods

     17,084      17,539
    

  

Total inventory

   $ 96,992    $ 91,809
    

  

 

7. PROPERTY, PLANT & EQUIPMENT

 

The major classes of depreciable assets are as follows:

 

     December 31,

 

In thousands


   2004

    2003

 

Machinery and equipment

   $ 248,808     $ 249,604  

Buildings and improvements

     85,676       76,290  

Land and improvements

     6,153       6,435  

Locomotive leased fleet

     311       290  
    


 


PP&E

     340,948       332,619  

Less: accumulated depreciation

     (189,987 )     (178,780 )
    


 


Total

   $ 150,961     $ 153,839  
    


 


 

50


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 $22.8 million, $21 million and $20.2 million for 2004, 2003 and 2002, respectively. During 2004, the Company wrote down $1.3 million of various assets, a portion of which were subsequently sold in 2005.

 

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 are 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 discounted cash flow analysis and market multiples based upon historical and projected financial information. The Company also performed the required impairment test in 2004 and 2003, which resulted in no additional impairment charge. Goodwill still remaining on the balance sheet is $113.5 million and $109.5 million at December 31, 2004 and 2003, respectively.

 

As of December 31, 2004 and 2003, the Company’s trademarks had a net carrying amount of $19.6 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


   2004

   2003

Patents and other, net of accumulated amortization of $22,459 and $21,053

   $ 11,269    $ 13,675

Covenants not to compete, net of accumulated amortization of $8,263 and $9,437

     61      137

Intangible pension asset

     8,987      4,401
    

  

Total

   $ 20,317    $ 18,213
    

  

 

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 $2.4 million, $3.4 million and $4 million for the years ended December 31, 2004, 2003, and 2002, respectively. Amortization expense for the five succeeding years is as follows (in thousands):

 

2005

   $ 2,303

2006

   $ 2,053

2007

   $ 1,957

2008

   $ 1,921

2009

   $ 1,766

 

51


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The change in the carrying amount of goodwill by segment for the year ended December 31, 2004 is as follows:

 

In thousands


   Freight
Group


   Transit
Group


   Total

Balance at December 31, 2003

     92,570      16,880      109,450

Foreign currency impact

     2,364      1,652      4,016
    

  

  

Balance at December 31, 2004

   $ 94,934    $ 18,532    $ 113,466
    

  

  

 

9. LONG-TERM DEBT

 

Long-term debt consisted of the following:

 

     December 31,

In thousands


   2004

   2003

Revolving credit agreement

   $ —      $ 40,000

6.875% Senior notes

     150,000      150,000

Other

     107      225
    

  

Total

   $ 150,107    $ 190,225

Less—current portion

     —        —  
    

  

Long-term portion

   $ 150,107    $ 190,225
    

  

 

Refinancing Credit Agreement

 

In January 2004, the Company refinanced 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. At December 31, 2004, the Company’s available bank borrowing capacity, net of $21.9 million of letters of credit, was approximately $153.1 million, subject to certain financial covenant restrictions.

 

Refinancing 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 $40 million, $36.7 million and 2.9%, respectively for 2004. 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 were terminated in 2004 in conjunction with the $40 million repayment of the revolving credit agreement.

 

Under the Refinancing Credit Agreement, the Company may elect a base interest rate or an interest rate based on the London Interbank Offered Rates of Interest (“LIBOR”). The base interest 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 100 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

 

52


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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,

 

Scheduled principal repayments of outstanding loan balances required as of December 31, 2004 are as follows:

 

In thousands


    

2005

   $ —  

2006

     107

2007

     —  

2008

     —  

2009

     —  

Future years

     150,000
    

Total

   $ 150,107

 

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.

 

10. EMPLOYEE BENEFIT PLANS

 

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

 

In addition to providing pension benefits, the Company has provided certain unfunded postretirement health care and life insurance benefits for a portion of North American employees. In January 1995 the postretirement health care and life insurance benefits for U.S. 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.

 

53


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company uses a December 31 measurement date for the U.S. and Canadian plans. The U.K. plan uses an October 31 measurement date.

 

Obligations and Funded Status

 

     For the years ended December 31,

 
     Pension Plans

    Postretirement Plans

 

In thousands


   2004

    2003

    2004

    2003

 

Defined Benefit Plans

                                

Change in projected benefit obligation

                                

Obligation at beginning of year

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

Service cost

     (2,721 )     (2,425 )     (583 )     (330 )

Interest cost

     (7,161 )     (6,474 )     (1,975 )     (1,715 )

Participant contributions

     (528 )     (401 )     —         —    

Plan amendment

     (2,418 )     —         18,416       —    

Actuarial loss

     (9,827 )     (7,361 )     (35,261 )     (5,495 )

Benefits paid

     6,074       5,666       3,631       2,150  

Expenses paid

     71       372       —         —    

Effect of currency rate changes

     (6,025 )     (9,743 )     (451 )     —    
    


 


 


 


Obligation at end of year

   $ (135,652 )   $ (113,117 )   $ (45,313 )   $ (29,090 )
    


 


 


 


Change in plan assets

                                

Fair value of plan assets at beginning of year

   $ 86,581     $ 67,600       —         —    

Actual gain on plan assets

     6,380       11,834       —         —    

Employer contribution

     12,677       5,554       —         —    

Participant contributions

     528       401       —         —    

Benefits paid

     (6,074 )     (5,666 )     —         —    

Administrative expenses

     (548 )     (1,081 )     —         —    

Effect of currency rate changes

     4,884       7,939       —         —    
    


 


 


 


Fair value of plan assets at end of year

   $ 104,428     $ 86,581       —         —    
    


 


 


 


Funded status

                                

Funded status at year end

   $ (31,224 )   $ (26,536 )     (45,313 )     (29,090 )

Unrecognized net actuarial loss

     40,823       29,213       40,847       8,961  

Unrecognized prior service cost (credit)

     6,485       4,237       (16,423 )     22  

Unrecognized transition obligation

     3,458       3,084       —         194  

Effect of currency exchange rates

     —         1,399       —         —    
    


 


 


 


Prepaid (accrued) benefit cost

   $ 19,542     $ 11,397     $ (20,889 )   $ (19,913 )
    


 


 


 


Amounts recognized in the statement of financial position include:

                                

Prepaid pension cost

   $ 411     $ 323     $ —       $ —    

Reserve for postretirement and pension benefits

     (21,640 )     (19,142 )     (20,889 )     (19,913 )

Intangible asset

     8,987       4,401       —         —    

Accumulated other comprehensive loss

     31,784       25,815       —         —    
    


 


 


 


Prepaid (accrued) benefit cost

   $ 19,542     $ 11,397     $ (20,889 )   $ (19,913 )
    


 


 


 


 

The projected benefit obligation for all defined benefit pension plans was $135.7 million and $113.1 million at December 31, 2004 and 2003, respectively.

 

54


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The accumulated benefit obligation for all defined benefit pension plans was $126.1 million and $106.2 million at December 31, 2004 and 2003, respectively.

 

The aggregate projected benefit obligation and fair value of plan assets for the pension plans with benefit obligations in excess of plan assets were $135.7 million and $104.4 million, respectively, as of December 31, 2004; and $113.1 million and $86.6 million, respectively, as of December 31, 2003. The aggregate accumulated benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets were $122 million and $100.2 million, respectively, as of December 31, 2004; and $70.2 million and $49.6 million, respectively, as of December 31, 2003.

 

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

 

In thousands


   2004

    2003

 

U.S. plan

   $ 7,782     $ 1,539  

Canadian plans

     12,043       10,103  

U.K. plan

     (282 )     (245 )
    


 


Prepaid (accrued) benefit cost

   $ 19,543     $ 11,397  

 

Components of Net Periodic Benefit Costs

 

     Pension Plans

    Postretirement Plans

In thousands


   2004

    2003

    2002

    2004

   2003

   2002

Service cost

   $ 2,721     $ 2,425     $ 2,658     $ 583    $ 330    $ 232

Interest cost

     7,161       6,474       6,008       1,975      1,715      1,447

Expected return on plan assets

     (6,949 )     (6,576 )     (6,591 )     —        —        —  

Net amortization/deferrals

     2,525       1,406       617       1,990      489      19
    


 


 


 

  

  

Net periodic benefit cost

   $ 5,458     $ 3,729     $ 2,692     $ 4,548    $ 2,534    $ 1,698
    


 


 


 

  

  

 

An increase in the minimum pension liability resulted in a charge to shareholders’ equity, net of tax, of $3.8 million in 2004 and $2.8 million in 2003.

 

Assumptions

 

Weighted average assumptions used to determine benefit obligations are as follows:

 

     Pension Plans

    Postretirement Plans

 
     2004

    2003

    2004

    2003

 

Discount rate

   5.89 %   6.25 %   6 %   6.25 %

Rate of compensation increase

   3.41 %   3.79 %   NA     NA  

 

The discount rate is based on settling the pension obligation with high grade, high yield corporate bonds, and the rate of compensation increase is based on actual experience.

 

Weighted average assumptions used to determine the net periodic benefit costs are as follows:

 

     Pension Plans

    Postretirement Plans

 
     2004

    2003

    2002

    2004

    2003

    2002

 

Discount rate

   6.25 %   6.57 %   6.75 %   6.25 %   6.25 %   6.75 %

Expected long-term rate of return

   7.62 %   7.44 %   8.25 %   NA     NA     NA  

Rate of compensation increase

   3.79 %   4 %   4 %   NA     NA     NA  

 

55


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The expected return on plan assets is based on historical performance as well as expected future rates of return on plan assets considering the current investment portfolio mix and the long-term investment strategy.

 

The assumed health care cost trend rate grades from an initial rate of 9.06% to an ultimate rate of 5% in six 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 $441,000 for 2005, and increase the service and interest cost components of the accumulated postretirement benefit obligation by approximately $6.7 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 $351,000 for 2005, and decrease the accumulated postretirement benefit obligation by approximately $5.5 million.

 

Pension Plan Assets

 

The composition of all plan assets consists primarily of equities, corporate bonds, governmental notes and temporary investments. This Plan’s asset allocations at the respective measurement dates for 2004 by asset category are as follows:

 

Asset Category


   %

 

Equity securities

   61 %

Debt securities

   34 %

Other, including cash equivalents

   5 %
    

Total

   100 %
    

 

Investment policies are determined by the respective Plan’s Pension Committee and set forth in its Investment Policy. Pursuant to the Investment Policy for the U.S., the investment strategy is to use passive index funds managed by the Bank of New York. The target asset allocation and composite benchmarks for U.S. plans 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 is evaluating allocation policies for its plans in Canada and the U.K.

 

Cash Flows

 

The Company’s funding methods are based on governmental requirements and differ from those methods 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 $9.7 million to the pension plan during 2005 and expects this level of funding to continue in future periods. Rebalancing of the asset allocation occurs on a quarterly basis.

 

56


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Benefit payments expected to be paid to plan participants are as follows:

 

In thousands


   Pension
benefits


   Post-
retirement
benefits


Year ended December 31,

             

2005

   $ 6,826    $ 2,408

2006

     6,725      2,478

2007

     7,133      2,519

2008

     7,244      2,579

2009

     7,415      2,662

2010 through 2014

     42,893      13,197
    

  

Total

   $ 78,236    $ 25,843
    

  

 

In May 2004, the FASB issued FSP 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (FSP FAS 106-2). This Act was signed into law by the President on December 8, 2003 and introduces a prescription drug benefit plan under Medicare Part D as well as a federal subsidy to sponsors of retiree health benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. FSP 106-2 provides guidance on how companies should account for the impact of the Act on their postretirement health care plans. To encourage employers to retain or provide postretirement drug benefits, beginning in 2006 the federal government will provide non-taxable subsidy payments to employers that sponsor prescription drug benefits to retirees that are actuarially equivalent to the Medicare benefit. FSP 106-2 is effective for interim or annual financial statements beginning after June 15, 2004. The adoption of FSP 106-2 did not have a significant impact on the Company’s financial position or results of operations.

 

Defined Contribution Plans

 

The Company also participates in certain 401(k) and multiemployer pension plans. Costs recognized under these plans are summarized as follows:

 

     For the year ended
December 31,


In thousands


   2004

   2003

   2002

Multi-employer pension and health & welfare plans

   $ 571    $ 1,531    $ 1,310

401(k) savings and other defined contribution plans

     5,707      6,828      6,929
    

  

  

Total

   $ 6,278    $ 8,359    $ 8,239
    

  

  

 

The 401(k) savings plan is a participant directed defined contribution plan that holds shares of the Company’s stock. At December 31, 2004 and 2003, the plan held on behalf of its participants about 695,000 shares with a market value of $14.8 million, and 776,000 shares with a market value of $13.2 million, respectively.

 

Additionally, the Company has stock option based benefit and other plans further described in Note 13.

 

11. INCOME TAXES

 

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

 

57


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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


   2004

   2003

    2002

Domestic

   $ 29,852    $ 35,470     $ 12,226

Foreign

     13,005      (428 )     11,678
    

  


 

Income from continuing operations

   $ 42,857    $ 35,042     $ 23,904
    

  


 

 

No provision has been made for U.S., state, or additional foreign taxes related to undistributed earnings of $57 million of foreign subsidiaries which have been or are intended to be permanently re-invested.

 

The 2004 Jobs Creation Act and FSP 109-2 state that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for applying SFAS No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions. Accordingly as provided for in FSP 109-2, the Company has not adjusted its tax expense or deferred tax liability to reflect repatriation provisions of the 2004 Jobs Creation Act.

 

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


   2004

    2003

    2002

 

Current taxes

                        

Federal

   $ (8,676 )   $ 763     $ 609  

State

     714       1,470       (2,421 )

Foreign

     3,723       1,993       2,876  
    


 


 


     $ (4,239 )   $ 4,226     $ 1,064  

Deferred taxes

                        

Federal

     13,796       11,525       (14,788 )

State

     (284 )     821       (4,364 )

Foreign

     1,689       (3,522 )     (2,716 )
    


 


 


       15,201       8,824       (21,868 )
    


 


 


Total provision (credit)

   $ 10,962     $ 13,050     $ (20,804 )
    


 


 


 

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

 

    

For the year ended

December 31,


 

In thousands


   2004

   2003

   2002

 

Continuing operations

     10,761    $ 12,790    $ 7,594  

Income (loss) from discontinued operations—

     201      260      (59 )

Cumulative effect of accounting change for goodwill

     —        —        (28,339 )
    

  

  


Total provision (credit)

   $ 10,962    $ 13,050    $ (20,804 )
    

  

  


 

58


WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

A reconciliation of the United States federal statutory income tax rate to the effective income tax rate on continuing operations for the years ended December 31 is provided below:

 

     For the year ended
December 31,


 

In thousands


   2004

    2003

    2002

 

U. S. federal statutory rate

   35.0 %   35.0 %   35.0 %

State taxes

   0.2     2.4     3.6  

Adjustment to prior year matters

   (11.4 )   (7.6 )   —    

Change in valuation allowance

   0.8     7.4     —    

Deferred rate/balance adjustment

   2.7     2.7     —    

Foreign

   0.2     1.5     0.3  

Foreign tax credits

   —       (2.5 )   (2.1 )

Research and development credit

   (2.3 )   (2.4 )   (3.3 )

Other, net

   (0.1 )   —       (1.7 )
    

 

 

Effective rate

   25.1 %   36.5 %   31.8 %
    

 

 

 

The overall effective income tax rate includes a tax benefit of $4.9 million and $2.7 million in 2004 and 2003 respectively, which is primarily related to the reversal of certain items that had previously been provided for and that have been closed from further regulatory examination.

 

Deferred income taxes result from temporary differences in the recognition of income and expense for financial and income tax reporting purposes. These deferred income taxes will be recognized as future tax benefits or costs when the temporary differences reverse.

 

Components of deferred tax assets and (liabilities) were as follows:

 

     December 31,

 

In thousands


   2004

    2003

 

Deferred income tax assets (liabilities):

                

Accrued expenses and reserves

   $ 5,637     $ 4,342  

Deferred comp/employee benefits

     6,054       4,439  

Pension

     18,737       15,491  

Inventory

     3,805       4,388  

Warranty reserve

     3,301       3,224  

Restructuring reserve