EXHIBIT 99.2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
In November 2001, Wabtec sold certain assets to GE Transportation Systems for
$238 million in cash. The assets sold primarily included locomotive aftermarket
products and services for which Wabtec was not the original equipment
manufacturer. The results for these businesses, along with several other small
non-core businesses that the Company has decided to exit, are classified as
discontinued operations throughout this report.
Net sales of ongoing operations decreased by 11.2% from $783.7 million in 2001
to $696.2 million in 2002. The major causes for the change were decreases in
component sales due to the continuation of the weak freight market, a downturn
in the locomotive overhaul market and the completion of a major transit contract
in the third quarter of 2002.
The results for 2002 include a $61.7 million, net of tax, write off of goodwill
in accordance with SFAS No. 142 and $126,000 of loss from discontinued
operations. The 2001 results include $47.8 million of income from discontinued
operations (including a $41.5 million gain, net of tax, on the sale of assets to
GE Transportation Systems noted above and writedown of certain businesses
classified as discontinued operations), a $9.3 million charge for asset
writedowns, a $3.7 million restructuring-related charge, a $685,000 gain on the
disposition of excess facilities, a $2 million research and development tax
credit and a $1.7 million charge for severance costs related to a 10 percent
salary workforce reduction.
MERGER AND RESTRUCTURING PLAN
In 2001, the Company completed a merger and restructuring plan with charges
totaling $71 million pre-tax, with approximately $2 million of the charge
expensed in 2001, $20 million in 2000 and $49 million in 1999. The plan involved
the elimination of duplicate facilities and excess capacity, operational
realignment and related workforce reductions, and the evaluation of certain
assets as to their perceived ongoing benefit to the Company.
As of December 31, 2002, $647,000 of the merger and restructuring charge still
remained as accrued on the balance sheet as part of other accrued liabilities.
The accrual on the balance sheet is discussed in greater detail in Note 24 of
"Notes to Consolidated Financial Statements" included in Part IV, Item 15 of
this report.
The Company began and completed a new restructuring plan for the Transit rail
business in 2001. The restructuring plan involved operational realignment and
related workforce reductions. The charges in 2001 for the restructuring plan
move totaled $2 million pre-tax. 2002 operations still included much of the cost
of integration in normal operations
The $2 million charge in 2001 included costs associated with relocating several
production operations from Chicago to Montreal, including severance costs for
approximately 103 employees.
RESULTS OF OPERATIONS
The following table sets forth Wabtec's Consolidated Statements of Operations
for the years indicated. 2002 operations included no adjustments. To enhance
comparability with results of prior periods, the 2001 adjusted column represents
the reported income statement excluding restructuring-related charges, asset
writedowns, severance costs related to a 10 percent salary workforce reduction,
research and development tax credits and the gain on the sale of excess
facilities. The 2000 adjusted column represents the reported income statement
excluding restructuring-related charges, a legal settlement charge, the
write-off of a deferred tax asset and gain on the sale of a product line.
YEAR ENDED DECEMBER 31
-----------------------------------------------------
REPORTED ADJUSTED REPORTED ADJUSTED REPORTED
In millions 2002 2001 2001 2000 2000
Net sales................................ $ 696.2 $ 783.7 $ 783.7 $ 811.2 $ 811.2
Cost of sales............................ (516.7) (573.8) (573.8) (571.5) (575.5)
-------- -------- -------- -------- --------
Gross profit............................. 179.5 209.9 209.9 239.7 235.7
Selling, general and administrative
expenses............................... (93.0) (95.0) (96.7) (94.8) (94.8)
Merger and restructuring charges......... -- -- (3.7) -- (18.2)
Engineering expenses..................... (33.6) (33.2) (33.2) (32.3) (32.3)
Asset writedowns......................... -- -- (9.3) -- --
Amortization expense..................... (5.3) (13.0) (13.0) (12.6) (12.6)
-------- -------- -------- -------- --------
Total operating expenses................. (131.9) (141.2) (155.9) (139.7) (157.9)
-------- -------- -------- -------- --------
Income from operations................... 47.6 68.7 54.0 100.0 77.8
Interest expense......................... (18.1) (33.5) (33.5) (43.7) (43.7)
Other (expense) income, net.............. (5.6) (2.8) (2.1) (0.7) 3.8
-------- -------- -------- -------- -------
Income from continuing operations before
income taxes, and cumulative effect of
accounting change...................... 23.9 32.4 18.4 55.6 37.9
Income tax expense....................... (7.6) (11.3) (4.4) (20.0) (18.7)
-------- -------- -------- -------- --------
Income from continuing operations before
cumulative effect of accounting
change................................. 16.3 21.1 14.0 35.6 19.2
Discontinued operations
Income from discontinued operations (net
of tax)................................ 0.4 6.4 6.4 6.2 6.2
Gain (loss) on sale of discontinued
operations (net of tax)................ (0.5) 41.4 41.4 -- --
-------- -------- -------- -------- --------
Income before cumulative effect of
accounting change...................... 16.2 68.9 61.8 41.8 25.4
Cumulative effect of accounting change
for goodwill, net of tax............... (61.7) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss)........................ $ (45.5) $ 68.9 $ 61.8 $ 41.8 $ 25.4
======== ======== ======== ======== ========
2002 COMPARED TO 2001
The following table sets forth the Company's net sales by business segment:
FOR THE YEAR ENDED
DECEMBER 31,
---------------------
In thousands 2002 2001
- ---------------------------------------------
Freight Group... $ 443,443 $ 490,261
Transit Group... 252,752 293,437
------------------------
Net sales..... $ 696,195 $ 783,698
========================
Net sales for 2002 decreased $87.5 million or 11.2% to $696.2 million as
compared to the prior period. Both the Freight Group and Transit Group had lower
sales. The Freight Group's decreased sales reflected lower sales of components
for new freight cars and locomotives. In 2002, industry deliveries of new
freight cars decreased to
-2-
17,736 units as compared to 34,247 in the same period in 2001 In 2002, industry
deliveries of new locomotives decreased to 940 as compared to 1,085 in the same
period in 2001. The Transit Group's decreased sales were primarily due to the
completion of a supply contract for New York City subway cars in the third
quarter of 2002.
Gross profit decreased to $179.5 million (or 25.8% of sales) in 2002 compared to
$209.9 million (or 26.8% of sales) in the same period of 2001. Gross profit is
dependent on a number of factors including pricing, sales volume and product
mix. The decrease in gross profit and margin is largely attributed to the effect
of a decrease in sales volumes (approximately $35 million in gross profit). The
resulting favorable balance is principally a result of cost reductions.
Operating expenses improved by $2.3 million in 2002 as compared to 2001 after
excluding goodwill amortization (due to the required adoption of Financial
Accounting Standard 142) of $7 million, $9.3 million for asset writedowns, $3.7
million for merger and restructuring charges and $1.7 million for severance
costs in 2001. The decrease in operating expenses was due to a decrease in
selling, general and administrative expenses.
Income from operations totaled $47.5 million in 2002 compared with $54.1 million
in 2001. Operating income would have been $75.8 million in 2001 excluding the
above adjustments shown in the prior paragraph. Lower operating income resulted
from decreased sales volumes in 2002 (see Note 21 of "Notes to Consolidated
Financial Statements" included in Part IV, Item 15 of this report).
Interest expense decreased 46.1% in 2002 as compared to 2001, primarily due to a
decrease in debt and interest rates. Debt, net of cash and equivalents, was
$175.9 million at December 31, 2002 versus $187.9 million at the end of 2001.
The Company recorded foreign exchange losses of $1.2 million and $1.7 million,
respectively, in 2002 and 2001 due to the continued strength of the dollar. Also
in 2002, the Company wrote down a facility held for sale, resulting in a $2
million charge. These items were reported as other income (expense).
The effective income tax rate for 2002 was 32% as compared to 24.2% in 2001. The
Company expects the ongoing rate to be approximately 35-36%. The 2002 rate
includes the effect of research and development and foreign tax credits
($772,000). The 2001 rate includes the effect of substantial research and
development tax credits ($2 million). Excluding these tax credits, the rate
would have been 35% in both 2002 and 2001.
2001 COMPARED TO 2000
The following table sets forth the Company's net sales by business segment:
FOR THE YEAR ENDED
DECEMBER 31,
------------------------
In thousands 2001 2000
----------- -----------
Freight Group... $ 490,261 $ 532,889
Transit Group... 293,437 278,289
----------- -----------
Net sales..... $ 783,698 $ 811,178
=========== ===========
Net sales decreased $27.5 million or 3.4% to $783.7 million in 2001 from $811.2
million in 2000. This overall decrease was primarily attributable to decreased
North American OEM freight car and locomotive component sales volumes and lower
locomotive overhauls, all within the Freight Group. Sales volumes within the
Freight Group reflected a softening OEM market for freight cars, with 34,247
freight cars delivered in 2001 compared to 55,821 in 2000. Partially offsetting
these decreases were increases in Transit Group sales, due to increased
shipments under the New York City MTA contract.
Gross profit decreased to $209.9 million (or 26.8% of sales) in 2001 compared to
$235.7 million (or 29.1% of sales) in the same period of 2000. Gross margin is
dependent on a number of factors including pricing, sales volume and product
mix. The decrease in gross profit and margin is largely attributed to the effect
of a decrease in sales
-3-
volumes (approximately $11 million in gross profit). The balance is principally
a result of changes to the sales mix primarily from a drop in the Freight Group
of 8% offset by an increase in the Transit Group of 5% and overall pricing
pressures in many product lines.
Total operating expenses as a percentage of net sales were 19.9% in 2001 and
19.5% in the same period a year ago. After excluding $9.3 million for asset
writedowns, $3.7 million for merger and restructuring charges and $1.7 million
for severance costs in 2001 and $18.2 million for 2000 merger and restructuring
charges, operating expenses would have been 18% and 17.2% of net sales,
respectively. Without the above adjustments, operating expenses would have
increased $1.5 million in 2001 as compared to 2000.
Income from operations totaled $54.1 million in 2001 compared with $77.8 million
in 2000. After excluding the merger and restructuring-related charges in both
periods and the asset writedowns and severance costs in 2001 and a $2 million
legal settlement in 2000, operating income would have been $68.7 million and
$100 million in 2001 and 2000, respectively. Lower adjusted operating income
resulted from decreased sales volumes in the Freight Group and changes in
product mix (see Note 21 of "Notes to Consolidated Financial Statements"
included in Part IV, Item 15 of this report).
Interest expense decreased 23.2% to $33.5 million in 2001 from $43.6 million in
2000. Debt, net of cash and equivalents, was $187.9 million at December 31, 2001
versus $534.1 million at the end of 2000. The decrease in interest expense is
primarily due to the lower debt amount as a result of working capital management
and the sale proceeds from GETS received in November 2001 (with taxes on the
gain deferred to 2002).
In 2001, the Company recorded foreign exchange losses of $1.7 million. In
February 2000, the Company disposed of its transit electrification product line
for $5.5 million in cash and recognized a gain of $4.4 million. These items were
reported as other income (expense).
The effective income tax rate for 2001 was 24.2% as compared to 49.4% in 2000.
The 2001 rate includes the effect of substantial research and development tax
credits ($2 million). Excluding this tax credit, the rate would have been 35%.
The 2000 rate includes the effect of the one-time, non-cash write-off of the
deferred tax asset ($5.1 million) relating to the termination of the 1995
established ESOP. Excluding this effect, the rate would be 36%.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is provided primarily by operating cash flow and borrowings under the
Company's credit facilities with a consortium of commercial banks ("credit
agreement"). The following is a summary of selected cash flow information and
other relevant data.
-4-
YEAR ENDED DECEMBER 31,
-----------------------------------
In thousands 2002 2001 2000
--------- ---------- -----------
Cash provided (used) by:
Operating activities.......... $ 15,658 $ 119,097 $ 60,214
Investing activities.......... (10,817) 227,413 (21,485)
Financing activities..........
Debt paydown................ (45,941) (298,280) (28,390)
Other....................... 1,887 1,093 (9,619)
Earnings before interest, taxes,
depreciation and amortization
(EBITDA)(1)................... 67,363 132,807 120,176
- -------------------------------------------------------------------
(1) See discussion and reconciliation below.
Operating cash flow in 2002 was $15.7 million as compared to $119.1 million in
the same period a year ago. Working capital decreased $6 million in 2002, as
inventory decreased by $16 million while payables and accruals decreased by $10
million. In 2001, working capital decreased significantly primarily due to a
decrease in accounts receivable and inventory. During 2002 and 2001, cash
outlays for merger and restructuring activities were approximately $2.5 million
and $6.8 million, respectively, and are reported as a reduction to cash provided
by operating activities. Also, in 2002, $30 million was paid in taxes related to
the gain on the sale of locomotive aftermarket assets to GETS in 2001. The
operating cash flow in 2002 excluding the $30 million tax payment from 2001 was
approximately $46 million.
Cash used by investing activities was $10.8 million versus cash provided by
investing activities of $227.4 million a year ago. Adjusting the 2001 amount by
the sale of businesses to GE for $238 million, cash used by investing activities
would have been approximately $10.6 million. In 2002, 2001 and 2000, the Company
used $1.7 million, $3.7 million and $650,000, respectively, 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 $14.1 million, $20.7 million and
$23.2 million in 2002, 2001 and 2000, respectively. The majority of capital
expenditures for these periods relates to upgrades to existing equipment and
replacement of existing equipment.
Cash used for financing activities was $44.1 million in 2002 versus $297.2
million in 2001. During 2002, the Company reduced long-term debt by $45.9
million. During 2001, the Company reduced long-term debt by $298.3 million. The
Company repaid $175 million of senior notes in the third quarter of 2002 to take
advantage of lower interest rates on the Company's revolving credit agreement.
Historically, the Company has financed the purchase of significant businesses
utilizing cash flow generated from operations and amounts available under its
credit facilities.
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.
-5-
EBITDA is derived from the statements of income as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------
Net income (loss)......................... $(45,479) $ 61,780 $ 25,393 $ 36,623 $ 73,851
Cumulative effect of accounting change for
goodwill, net of tax.................... 61,663 -- -- -- --
Income tax expense........................ 7,594 4,465 18,718 20,887 31,908
Interest expense.......................... 18,072 33,501 43,649 44,109 38,228
Depreciation and Amortization............. $ 25,513 33,061 32,416 33,292 30,245
-------- -------- -------- -------- ---------
EBITDA(1)................................. $ 67,363 $132,807 $120,176 $134,911 $ 174,232
- ---------------------------------------------------------------------------------------------------
(1) EBITDA, as presented above, includes the following items:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------
Income from discontinued operations, net
of tax.................................. $ 403 $ 6,360 $ 6,193 $ 13,439 $ 15,444
Gain (loss) on sale of discontinued
operations, net of tax.................. (529) 41,458 -- -- --
Other income (expense), net............... (5,558) (2,130) 3,776 428 11,223
-------- ------- ------- -------- --------
$ (5,684) $45,688 $ 9,969 $ 13,867 $ 26,667
- --------------------------------------------------------------------------------------------------
The following table sets forth the Company's outstanding indebtedness at
December 31, 2002 and 2001. The revolving credit note and other term loan
interest rates are variable and dependent on market conditions.
YEAR ENDED
DECEMBER 31,
------------------------
2002 2001
- -------------------------------------------------------
In thousands
Revolving credit
agreement due 2004........ $ 189,700 $ 60,000
9.375% Senior notes......... -- 175,000
5.5% Industrial revenue
bond due 2008............. 4,909 5,556
Other....................... 542 1,314
----------- -----------
Total..................... 195,151 241,870
Less -- current portion... 833 782
----------- -----------
Long-term portion......... $ 194,318 $ 241,088
- -------------------------------------------------------
-6-
Credit Agreement
In November 1999, Wabtec refinanced the then existing unsecured MotivePower
credit agreement with a consortium of commercial banks. This unsecured credit
agreement currently provides a $275 million five-year revolving credit facility
expiring in November 2004 and a 364-day $95 million convertible revolving credit
facility maturing in November 2004, with an annual renewal in November 2003. In
November 2001, the Company and the banks negotiated a reduction in the 364-day
facility from $213 million to $100 million, as a result of the $208 million, net
of tax, cash proceeds from the sale of locomotive businesses to GE. In November
2002, the Company negotiated a further reduction in the 364-day facility from
$100 million to $95 million. At December 31, 2002, the Company had available
bank borrowing capacity, net of letters of credit, of approximately $159
million.
Under the credit agreement, the Company may elect a base rate, an interest rate
based on the London Interbank Offered Rates of Interest ("LIBOR"), a cost of
funds rate and a bid rate. The base rate is the greater of LaSalle Bank National
Association's prime rate or the federal funds effective rate plus 0.5% per
annum. The LIBOR rate is based on LIBOR plus a margin that ranges from 87.5 to
200 basis points depending on the Company's consolidated total indebtedness to
cash flow ratios. The current margin is 150 basis points. The cost of funds rate
is a fluctuating interest rate based on LaSalle Bank National Association's then
cost of funds. Under the bid rate option, any participating bank may propose the
interest rate at which it will lend funds, which rate may either be a fixed rate
or a floating rate based on LIBOR.
The credit agreement limits 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 credit agreement contains
various other covenants and restrictions including the following limitations:
incurrence of additional indebtedness; mergers, consolidations and sales of
assets and acquisitions; additional liens; sale and leasebacks; permissible
investments, loans and advances; certain debt payments; capital expenditures;
and imposes a minimum interest expense coverage ratio and a maximum debt to cash
flow ratio.
The credit agreement contains customary events of default, including payment
defaults, failure of representations or warranties to be true in any material
respect, covenant defaults, defaults with respect to other indebtedness of the
Company, bankruptcy, certain judgments against the Company, ERISA defaults and
"change of control" of the Company.
Credit agreement borrowings bear variable interest rates indexed to the indexes
described above. The maximum credit agreement borrowings, average credit
agreement borrowings and weighted-average contractual interest rate on credit
agreement borrowings was $217.7 million, $133.7 million and 3.31%, respectively
for 2002. 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, 2002, the notional value
of interest rate swaps outstanding totaled $60 million and effectively changed
the Company's interest rate from a variable rate to a fixed rate of 8.7%. The
interest rate swap agreements mature in June 2003. The Company is exposed to
credit risk in the event of nonperformance by the counterparties. However, since
only the cash interest payments are exchanged, exposure is significantly less
than the notional amount. The counterparties are large financial institutions
and the Company does not anticipate nonperformance.
9 3/8% Senior Notes
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 are collectively, the "Notes"). The 1999 Notes were issued at a
premium resulting in an effective rate of 8.5%. The terms of the 1995 Notes and
the 1999 Notes were substantially the same, and the 1995 Notes and the 1999
Notes were issued pursuant to indentures that were substantially the same. The
Notes were redeemed at par (face) on July 8, 2002 through the use of cash on
hand and additional borrowings under the credit agreement. See Note 25 of "Notes
to Consolidated Financial Statements" included in Part IV, Item 15 of this
report.
-7-
Industrial Revenue Bond
In July 1998, a subsidiary of the Company entered into a 10 -year $7.5 million
debt obligation that bears an interest rate of 5.5% and is payable in monthly
principal and interest installments. The proceeds of the bond provided financing
for the purchase of a building used in the Company's operations.
Principal repayments of outstanding loan balances are due at various intervals
until maturity. See Note 9 of "Notes to Consolidated Financial Statements"
included in Part IV, Item 15 of this report.
The Company believes, based on current levels of operations and forecasted
earnings, cash flow and liquidity will be sufficient to fund its working capital
and capital equipment needs as well as meeting the debt service requirements. If
the Company's sources of funds were to fail to satisfy the Company's cash
requirements, the Company may need to refinance its 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. The Company currently expects to refinance and replace its existing bank
facility at least twelve months prior to its November 2004 expiration.
EFFECTS OF INFLATION
General price inflation has not had a material impact on the Company's results
of operations. Some of the Company's labor contracts contain negotiated salary
and benefit increases and others contain cost of living adjustment clauses,
which would cause the Company's cost to automatically increase if inflation were
to become significant.
CONVERSION TO THE EURO CURRENCY
On January 1, 1999, certain members of the European Union established fixed
conversion rates between their existing currencies and the European Union's
common currency (the "Euro"). The Company conducts business in member countries.
The transition period for the introduction of the Euro is from January 1, 1999
through June 30, 2002. The transition to the Euro has not had a material impact
on its operations or financial results.
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 services in the freight and passenger rail industry;
-- consolidations in the rail industry;
-- demand for our products and services;
-8-
-- continued outsourcing by our customers;
-- demand for freight cars, locomotives, passenger transit cars and buses;
-- industry demand for faster and more efficient braking equipment;
-- fluctuations in interest rates;
Operating Factors
-- supply disruptions;
-- technical difficulties;
-- changes in operating conditions and costs;
-- successful introduction of new products;
-- labor relations;
-- completion and integration of additional acquisitions;
-- 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;
-- governmental funding for some of our customers;
-- political developments and laws and regulations, such as forced
divestiture of assets, restrictions on production, imports or exports,
price controls, tax increases and retroactive tax claims, expropriation
of property, cancellation of contract rights, and environmental
regulations; and
Transaction or Commercial Factors
-- the outcome of negotiations with partners, governments, suppliers,
customers or others.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
CRITICAL ACCOUNTING POLICIES
The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make judgments, estimates
and assumptions regarding uncertainties that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses. Areas of uncertainty that require
judgments, estimates and assumptions include the accounting for derivatives,
environmental matters, the testing of goodwill and other intangibles for
impairment, proceeds on assets
-9-
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 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.
In 2002, Wabtec 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 recognized
was $5.3 million in 2002, $13 million in 2001 and $12.6 million in 2000.
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). 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 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.
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.
The recent declines in equity markets and interest rates have had a negative
impact on Wabtec's pension plan liability and fair value of plan assets. As a
result, the accumulated benefit obligation exceeded the fair value of plan
assets at the end of 2002, which resulted in a $7.1 million, net of tax, charge
to other comprehensive loss in the fourth quarter.
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.
-10-