美國西屋制動公司 (WAB) 2007 Q2 法說會逐字稿

Hello, and welcome to the Wabtec Corporation Second Quarter 2007 Earnings Release Conference Call.

(OPERATOR INSTRUCTIONS)

For your information, this conference is being recorded. I would like to turn the conference over to Tim Wesley, vice president, Investor Relations. Mr. Wesley?

Thanks, Steve. Good morning, everyone, and welcome to Wabtec's second quarter earnings conference call. I'd like to introduce the rest of the Wabtec team who are here. Our president and CEO, Al Neupaver; our CFO, Alvaro Garcia-Tunon; and our corporate controller, Pat Dugan.

As usual, we will make some prepared remarks and then we will take your questions. Feel free to ask more than one question. We will make some forward-looking statements during the call so we do ask that you please review today's press release, as well as SEC filings for the appropriate disclaimers.

With that, let me turn the call over to Al Neupaver, out president and CEO.

Thanks, Tim. Good morning, everyone. What I'd like to do is cover our second quarter results, current market conditions and outlook, talk about our strategic growth initiatives. And then we'll have Alvaro cover our financials in a little more detail.

In the second quarter, we had very solid performance. We had a strong sales increase of 24% over last year to a record $326 million. We had a record earnings-per-share of $0.57. That's a 33% increase compared to a year ago. Our backlog remained over $1 billion. This is quite notable performance given the record sales in the quarter. And we made good progress on our strategic growth initiatives, including an acquisition during the quarter.

Based on this solid performance and current outlook, we're increasing guidance for 2007. We're now forecasting sales growth of 16% to 18%. This is up from 12% to 14%. And we expect earnings-per-share to come in at about $2.15. That's up from about $2.10.

As we look forward to the rest of the year, we expect that we'll see what is a typical seasonality in the third quarter due to the European operations and summer plant shutdowns. And then we expect the normal rebound into the fourth quarter. Obviously, there will be some revenue growth from the Ricon acquisition.

We feel well positioned to achieve our forecasts. Our core markets look good and that great backlog is starting to kick in well. Our plan is working. We have a diversified business model, OEM plus aftermarket. Actually, during the quarter, our aftermarket percentage was 58%.

We have a freight business and we have a transit business. Our freight business was 55% of our revenues compared to transit at 45%. This compared to '06 second quarter with 70% and 30%. We have a good international revenue base, 38% of our sales were outside of the U.S. And most importantly, our Wabtec performance system continues to deliver as evident by our improved operating margin.

Let's take a look at the markets. After record rail traffic in 2006, the freight rail market is slightly down in 2007. Car loadings are down 4%, intermodal traffic is off 1%, railroads, however, expect the second half to have a pick up. We will continue to monitor this trend.

The locomotive OEM [build] is slightly higher in 2007. The freight car OEM -- what we see, and most industry analysts are expecting a 60,000 to 64,000 car year. The second quarter orders had a 11,600 are slightly higher than first quarter. Second quarter deliveries come in a 16,100, slightly less than the first quarter. The backlog remains at a high level at 74,000, still more than a year's production.

I just want to remind you, only about 20% of our sales is tied directly to the freight car build. The transit market is being driven by some strong market drivers; federal fundings and passenger ridership. Federal spending is up 8% this year, and expect it to be a 6% increase next year. Ridership increased 2.9% last year. Overall transit usage is up 30% in the past decade.

High fuel cost and environmental concerns about emissions should continue to drive growth. This creates opportunities for us in several areas; commuter locomotives, components for subway cars and buses. We made good progress on our growth initiative.

From the global and market expansion, as I stated, international sales were 38% of total sales in the quarter, mainly due to growth in our UK unit, which refurbishes transit cars and our BECORIT acquisition. We're also making great progress in markets, such as Asia, South Africa and South America. And we're seeing some growth in adjacent markets, such as heat exchanges for power generation and non-rail friction applications.

If we look at our second strategy, growing the aftermarket, 58% of our sales was aftermarket in the quarter driven by our friction products, again our UK unit refurbishing cars in the UK. And we've also increased our capability at our existing service centers.

The third strategy, new product development. We continue to make progress on our ETMS System train control. As you know, the product safety plan was approved by the FRA. And the implementation on this ETMS is going forward on a route on BNSF between Fort Worth, Texas, and Kansas. We also are talking -- we have pilot programs with UP and Metra and are talking to other people about our program.

Electric braking is also moving forward with two pilot programs. One on BNFS and the other on our Norfolk Southern. And we also continue our development on an ultra-low emission locomotive. Progress is evident is all these areas, however, nothing new to announce right now.

And on the acquisition front, our pipeline is flowing as evidenced by our Ricon transaction during the quarter. I'll talk a little bit about Ricon. Ricon's a leading manufacturer of wheelchair lifts and ramps for buses. It's a nice adjacent market for us. They have about $70 million in annual sales. We've purchased Ricon for $73.5 million. It's a great strategic fit.

It complements our existing bus door business. It has a good international sales component with about 25% and there's some good aftermarket opportunities. Margins are comparable to our transit margins, with room for improvement. We have other acquisitions in the pipeline, but we will remain very selective and disciplined in our approach.

And now I'd like to turn it over to Alvaro.

Great. Good morning, everyone, and thanks, Al. I'm pleased to discuss with you this morning what we felt what was a good quarter.Like Al said, we posted solid sales and earnings growth and good company-wide operating margin improvement. Also I think we made significant progress on our strategic initiatives and it shows in the growth that we were able to post.

And this is the result of executing our internal growth strategy and -- which includes -- and with acquisitions as well, both internal growth and accusations. So overall we're pleased with the quarter. And we remain optimistic about the future. To discuss specific numbers, sales were up about 25% higher than last year. And they hit a record $326 million. About 60% of this was due to organic growth. The rest was due to a little of FX and some acquisitions.

The sales increase was due mainly to higher sales from the [CAT] car refurbishment projects in the UK that Al referred to earlier; our commuter locomotives in North America, the backlog of which has increased, and I think you're pretty familiar with; and two acquisitions on a comparable basis, BECORIT and Ricon.

In essence, we've really been able to offset the lower demand for OEM freight car components with growth in these areas as well as some areas, including heat exchangers in the power generation market. And that's why I emphasize that we're really executing our growth strategy because this is all part of it.

Margins, as we said before -- and I know you're focused on -- we're focused on driving margins higher as well, with particular attention on the operating margin because of the effect of mix on gross margin lines.

Operating margins for the quarter -- operating margins for the fourth quarter was 14.1%. And this compared to 13.5% last year and 13.4% in the first quarter of '07, so a nice pick up from the first quarter. This improvement was due to our efforts to lower costs through sourcing in Lee Manufacturing.

I think you're all pretty familiar with our Wabtec performance system, and increased volume obviously, which provides operating leverage. Operating expenses also contributed to his improvement in operating margin because we've really been able to hold those at bay as we increase our results.

Operating expenses increased $3.4 million from last year, but $2.8 million of that was from the three acquisitions that we made since the first quarter. And also when you compare to the first quarter of this year, SG&A was basically flat even though the Ricon acquisition added about $500,000 of SG&A. So, again, we feel relatively pleased that we've managing to hold the line on SG&A.

To summarize some of the account balances that we normally get questions about and hopefully get that out of the way early. Working capital -- we've had a year-to-day increase of about $47 million, with about $14 million of this due to acquisitions. The balance of that is due to really increased inventory and receivables to handle the increased volume, as well as the fact that we had significant prepayments in the prior year and we're starting to utilize those as we start to executive on the contracts.

The balances though -- the receivable balance has increased by approximately -- and again, I'll emphasize approximately -- $24 million from last year. About $9 million of this was due to Ricon. The rest was internal. Inventories increased by about $40 million from last year. And about $14 million of that was due from Ricon. Payables increased by about $17 million. And $9 million of this was due to Ricon.

Working capital is about 20% of sales. And we still continue to believe that's one area that we'll emphasize going forward as a lean company. With a lean company, you always think you can do better. But we think we can particularly do better on working capital management. And we'll continue to emphasis that going forward.

The cash balance was $140 million -- about $140 million at June 30. Obviously, after spending the amount, the $73.5 million on Ricon that Al mentioned earlier, debt was still the same as before, at about $150 million. And the balance sheet still remains, I think, very, very solid. And we still have plenty of availability to execute whatever we need for our growth strategy.

During the quarter we bought back about $5 million worth of stock. The board had originally authorized about $50 million and we're about half way there in the stock repurchase program. We bought about 25 million back. A few other miscellaneous items -- depreciation for the quarter was $6.1 million, versus $5.2 million last year.

Amortization is $1.1 million, versus about $850,000 last year. And CapEx is another area where we're spending what we need to spend, but we try and be thrifty. And even with the expanded size, our CapEx is very stable, very flat. This quarter it was about $5.1 million, versus $5.6 million last year. And again, that includes a few acquisitions that require CapEx as well.

Some more numbers -- I think is about the last page here. But again, we typically get questions on these. The rolling 12-month backlog increased by 10% compared to the first quarter, even with the strong sales that we managed to post. The backlog, what we call the rolling 12-month backlog, which is what we'll execute hopefully during the next year, during the next 12 months, the total amount of $586 million.

In the freight segment, that's about $172 million. And in transit, that's about $414 million. And the multi-year backlog, the total backlog of firm orders, the total is just a little bit in excess of $1 billion. It's about $1.05 billion. Freight constitutes about 25% of that, $235 million. And transit is $813 million.

Hopefully, I didn't go too fast and then you were able to get those. But if anybody would need to get those repeated, we'll be happy to it.

And with that, I'll turn it back over to Al.

Okay, thanks, Alvaro. In summary, we've had a strong performance, with a record $0.57 quarter and record sales. Our end markets are generally positive, which gives us confidence to increase our sales and earnings guidance.

The diversity of our business model is really paying off. Freight and transit, the aftermarket, the OEM, NAFTA versus international sales is serving the company well. The Wabtec performance system is providing the culture of lean manufacturing. And we have a very experienced and dedicated management team.

With that, we'll take questions. Steve, do you want to poll for questions? And again, we'll certainly entertain multiple questions from anybody who has them.

Okay, thank you.

(OPERATOR INSTRUCTIONS)

And our first question comes from Jim Lucas with Janney Montgomery Scott.

All right, thanks. Good morning, guys.

Good morning, Jim.

Good morning, Jim.

Alvaro, thank you for all those numbers.

Well, we get questions about them so we're just trying to accommodate as much as we can. You're very welcome.

So perhaps next question, segment margins, but let's not be too greedy here.

There you go.

But, no, in all serious, thank you for that. It's very helpful from a transparency standpoint. Al, good you give us an update with regards to the integration side of the acquisition, given that acquisitions are going to become increasing a more important part of the story here. Supposedly, the balance sheet will support that. Any color you can provide on the integration? Just let us know how that is going in terms of building that as a core competency.

Okay, yes, Jim, as you said, acquisition is an important part of our growth strategy. And to date, since I've been on board, we've had three excellent acquisitions. And the company had one the previous year.

The two acquisitions that we did at the end of last are totally integrated into the company right now. They're running as separate divisions. They've already been indoctrinated to lean manufacturing principles. They're performing, in both cases, in excess of what our plan was, especially our BECORIT operation in Germany. They have done a tremendous job from a performance standpoint that have exceeded our expectations.

We're in the process right now of integrating Ricon. And that process is going extremely well. Our approach is to get our team -- we spend probably as much time on due-diligence review as we do integration review and vice-versa. We have weekly meetings with every functional group responsible to report their progress.

We have a very detailed checklist of items that we need to complete, fully integrate from IT, to communications, to HR issues. We always try to focus on, I think, some of the soft items as well as the financial issues that you need to deal with when you integrate a company. And I'm very happy to report that all three right now are looking extremely good.

And I'm really impressed with out team's capability of doing this. This was not, I think, a competency that we hit home over the last few years because we hadn't done a lot of acquisitions. But bringing Mark Cox on board has been a real plus from the corporate development. And the rest of functional groups have really stepped up in getting involved with acquisitions. And I think it's a learning process, but they're doing an excellent job.

Okay, thanks. That's very helpful. And internally, what was international, the percent of sales. Can you give a little bit of color on what you're seeing in the international markets?

Our international sales -- sales outside of the U.S. was 38% for the quarter. I think that's about the same about that we had in the previous quarter.

What we're seeing internationally, there's a lot of interest and opportunity in the emerging markets. When I talk about emerging markets -- India, China, Russia. We started operations in South Africa this quarter. We started manufacturing some friction products. We'll be moving other products into that market. We're seeing a lot more interest in the freight side of things in the European market.

We're really -- I think that definitely a large opportunity area for us. We're well established in a few places. In other places, we're not. And I think the opportunity is very good for us. Just in the transit area, the market in Europe, which we do not play heavily in, is five times the size of the North America market, as is.

And that's about the same size as if you looked at China and the rest of Asia as a transit market. So these opportunities are quite large and we're making good progress in most of those areas.

All right, great. Thank you very much.

Thank you, Jim.

Your next question comes from Scott Blumenthal from Emerald Advisors.

Good morning, Al, Alvaro, Tim.

Good morning, Scott. How are you doing?

Good morning, Scott.

Hi, Scott.

Hey, can you talk a little bit about -- I see the gross margin where we struggled a little bit there. Can you talk about gross margins and material costs and what you're seeing there, how things went during the quarter?

Okay, I'll start out and maybe Alvaro can add in. If you look at gross margins, second quarter '06 was 29.4%. And second quarter '07 is 27.9%. First quarter was 27.5%. Keep in mind, when we talk about the mix change, last year. Second quarter, we had 70% freight and 30% transit. This quarter, we have 55% freight and 45% transit.

Now, what we were able to do is -- obviously, that has an impact because, I think, historically our margins are better in freight than they are in transit. And we've really been able to manage that not only on that line by improving our margins in transit, which we did in the quarter again, but we also are managing the SG&A, or where you look at the total operating expenses.

Operating expenses as a percent of sale, s compared to second quarter '06 was 15.9%. We're at 13.8% in this quarter. So we're leveraging that volume. We're driving cost reductions through our Wabtec performance system and sourcing efforts. And I think the real telling story is that we were able drive that operating margin up to 14.1% as compared to the second quarter 13.5% and last year -- or last year was 13.5% and the first quarter 13.4%. So I think we're managing it well.

We're a company that believes in lean manufacturing concepts, continuous improvement. And we want to continuously improve on those margins. But I think the biggest impact on that gross margin, to get back to your original questions, is really that mix impact.

I don't know if Al -- you want to --?

No. I can't really add much to that, to be honest with you. You've covered all the bases.

Yes, we've come to learn to expect the operating margin performance. And when we look at the gross margin, I appreciate you reminding me that transit is traditionally a little bit lower than freight.

I think you mentioned, I think, two or three times -- Alvaro mentioned it once, you mentioned it a couple of time -- the heat exchanger business, which is kind of a little bit of a diversification effort. Can you tell us what the -- would you be able to give us a little bit of color as to the scale significance of that business as related to the overall business at this point? Because it does seem to be growth and it does seem to be mentioned more?

Okay, yes, Scott. If you look at the heat exchanger business, we view the importance of it is the fact that it really is an execution of a strategy. And when we talk about global and market expansion, there's a different meaning to global and market.

We want to expand our products obviously on a global basis, which is, I think, easy to understand. But market expansion is taking our existing products, our existing competencies and finding ways to grow in other markets. And what's important about that is it adds to that diversity. It gets us away from the cyclicality. The brutal fact of this industry is it's cyclical. And this one major success story.

We were sable to take our heat exchangers that were developed for locomotives in a very demanding rugged application and we found other applications for this product. And it's in the power generation market. And the reason why it's applicable there is that in that locomotive -- they go to pretty high temperatures. And our units are designed to operate at higher temperatures. The power generation market needs to these higher temperatures to try to minimize the emissions. So that's the reference to it.

Now the magnitude of it -- [freight] today, that division is probably about 8% of total revenue. And we actually sell more outside of the rail industry than we sell in the rail industry. And really, I think that it's not so much the magnitude of that, but it's the concept that we want to continue to look for opportunities to expand from a market-expansion standpoint with our competencies and technologies.

Do heat exchangers fall in the freight or the transit segment? Freight, correct?

Generally, freight.

Okay.

Yes, we classify those as freight because the unit that manufacturers them, their rail sells are predominantly freight. So we put them in the segment, correct.

How large a world-wide market is the market for heat exchangers? And is that going to be something -- I've heard other companies that I follow mention that as a wildly growing and very robust market. Is that going to be something that you might focus on in the future as an acquisition target?

I can't comment on the specific acquisition targets other than to tell you that it is attractive. It is a very large market. However, we would be really focused on niche areas. A lot of the heat exchanger markets, if you look at the gigantic size of it, these are not of interest to us because they would not be differentiated or add -- we could add a lot of value. So we're really looking for other niche applications. And we would not -- we'd obviously be interested in opportunities in that area.

Okay, great. And, Al, could you just, if you're able to, give us an idea as to what you're doing right now to specifically target kind of non-friction rail applications in the European market. I know that we're pretty heavily dependent on friction there. And just what you see as far as the acquisition or the available of non-friction rail-related European opportunities.

Okay, Scott, our friction product is truly that business. It's run by Tony Carpani for us. It's truly a very global business. We actually manufacture on five continents. We have sales in -- they showed me a list this week -- countries that I'm not sure I knew exactly where they were at. So this is a truly global business. And we've been doing quite well in growing that business just in the last few years.

Now, we have a great technology. Again, we -- to give you an example, our break shoes, actually were pads, center pads, that were used on the train that broke the speed record in France just, I guess, about two months ago. We are at the leading technology of friction products.

Now, one of the -- attractiveness of the BECORIT company when we acquired it was that there was -- about 10% or 15% of their business was non-rail friction, which has given us an introduction and some ideas on areas that we could find more niche applications on a global basis. And we are working from a strategic standpoint to identify those applications, those niche areas, and try to grow that non-rail friction product on a global basis.

Actually, I think was Scott was asking as well is -- I guess, maybe even two parts, non-rail friction as well as non-friction rail. In other words, how can we expand in Europe outside of friction?

Did I get that right, Scott?

It must have been my Spanish.

Well, I can do this is Spanish too. But, again, in non-friction rail, the markets there are very similar to North America and they're leading competitors. And our strategy is really two-fold. One is to establish bases in each country, which I think we've managed to do in the UK, in Italy, in Germany, so forth, that we can use to sell auxiliary products.

We've done that, I think, very well in Australia. We started with [Futura], our friction subsidiary there. And now we have a related company that really dwarfs Futura in terms of sells of other products in Australia, using Futura as a base originally.

And that's part of our strategy in Europe, is to basically nibble at niche markets and expand where we can. And then obviously be alert to other opportunities that may arise where we can expand in a more meaningful way.

Well, that's terrific. Thank you both. Thank you all for a terrific quarter. And Al, if you want to visit any of those places that you can't find, let me know. I'd be happy to go with you.

Thanks, Scott. You realize we have Pakistan in there. We have Afghanistan. We have Namibia

We've got a lot of places over there.

(Inaudible) Namibia. The other two I'd be willing to take a shot at.

Okay.

Our next question comes from Steve Berger from Key Bank.

Good morning, gentlemen.

Good morning, Steve.

Steve, welcome.

Welcome.

Thanks. I'm looking forward to working with you.

Likewise.

You had a solid quarter. You took revenue growth guidance up by 4%. But EPS guidance only increased a nickel, or about 2%. And I don't understand -- I mean, I don't have the history contextually of how you've dealt with guidance in the past. But are you being conservative here, or is that due to mix, or are there margin headwinds that won't offset operating leverage? Or how should I think about that relationship.

I think we're being a bit conservative. But also, part of this revenue growth that we'll see will come from the acquisition of Ricon. Ricon in the second half, although it will have revenue contribution, because of purchase price accounting, we don't expect it to have much impact on the profitability.

Okay, that makes sense. So on a -- excluding acquisitions, do you expect similar operating margin increases on a year-over-year basis that we saw this quarter?

We are a lean manufacturing company with continuous improvement as our goal in life. When we get up in the morning and look in the mirror, we're asking ourselves how can we continually improve. And our goal is to do that.

And without studying any specific goals, we really feel that we can continue to improve our operations through apply these principles by sourcing better, by moving product to low-cost platforms to leverage this volume growth that we're going to get from the backlog.

Okay, that's great. You're shifting gears a little bit to end markets. Given your broad exposure to rail car components -- and we know that there are some challenges in that market. What are your customers saying about 2007 and 2008? Are you sensing a -- have we reached an inflection point relative to sentiment or are they still in a wait-and-see kind of mode?

And this is rail car you're talking about, is that correct?

Correct. Yes.

The rail car market -- you're hearing a different story from who -- depending on who you talk to. If you look at the rail car builders that are making tank cars or covered hoppers, they feel pretty good. They have a nice backlog. If you look at the make up of the backlog, it's about -- that's what's really driving it.

It's probably 60%, 70% of the backlog of those two products. Where the fleet, if you look at the fleet, it's about 50% in those two areas. So if the specific rail car builders making those products -- I think they're feeling, not necessarily bullish, but they're definitely happy about what they see in the future.

If, for example, if you're specialized in an area other than those and don't have those capabilities, I think we're seeing a little different story and some concerns. Although, it was nice to see that non-ethanol rail car percentage actually had a little better performance in this incoming order than in the last quarter. You see a little bit more non-ethanol. And the ethanol-related ones are the tank car and the covered hoppers.

Right.

That was positive. We saw a little pick up in the coal cars and the intermodal.

Okay, great. Moving onto BECORIT, it sounds like that acquisition was a very solid addition. But at I was looking at the web site, I noticed that they also make breaking products for wind turbines. And I'm sure that's a smaller business for you. But is there an opportunity to expand that into the U.S., given the strong growth rates that we're seeing here. And have you gotten any inquiries for that business?

Yes. And that's a little of when I misunderstood Scott's question, that's the tangent I was taking actually -- was the attractiveness of that business was we had non-rail applications. And I thought that's what Scott's question was.

But that is a nice area for us. The one thing you'll find though, you're seeing that expansion using wind power as a means of generating electricity throughout the world. But the technology is still being driven a lot by the European technology.

We have some aftermarket opportunities in half the countries, but the rest of the world is really -- where you get the OEM business is in Europe. And we're well established on that. We are seeing a lot of OEM business in that area and part of that non-rail business we're excited business.

So are you saying that the breaking technology on European wind turbines is different than what we see domestically?

No, I think it's the same. It just that they're building the components for it.

Oh, I see. I see.

They're the actually technology of the engine itself with the turbine.

Aren't some of the adjacencies higher margin than the rail business itself, for instance, these turbine break pads?

Well, one thing good about adjacencies is that you can be selective. And we're really looking for higher-margin products when we go any ways away from our core technology.

So typically the adjacencies would be higher margins?

That's correct.

Okay, thanks very much. I'm looking forward to it.

Thank you, Steve.

Great.

Our next question comes from Brannon Cook from J.P. Morgan.

Good morning.

Good morning.

Good morning.

Good morning.

And welcome to you too, Brannon.

Thank you. You guys talked about locomotive OEM build being a bit stronger in '07 than in '06, even as we're seeing rail car demand be down a bit year-over-year. Could you provide a little more color on what's driving that growth in locomotive OEM build?

Well, there's two things. One, I'm happy to report, it's our own locomotive build grade is up. And that's being driven primarily by commuter locomotives.

But secondly, a lot of the locomotives that are being built buy General Electric and EMD, they have some great international demand right now. So that's part of the reason why you're seeing -- although the North America locomotive market is still Okay, as far as demand from the class ones.

And you feel that there's pretty strong replacement demand for the newer locomotives in that market, looking out?

Yes, yes.

Okay. And then a question transit margins. I guess you don't break that out in the release. Obviously, you're having a bit of a mix shift as you're growing the transit more quickly than the typical freight business. And it seems like you guys talked about that being an area where there's substantial margin improvement potential as you look out.

Could you give a little more color on what you're doing in that business? You're always looking to improve margins, but specifically what you're doing in transit to try to improve margins as we look out here.

Yes, our margin improvement approach with the transit business is very similar to what we'd do with any business. And one of the things that does help is we're leveraging the volume. With that good volume, you get some improvement.

We're taking a look at our manufacturing base and we're determining what's the best location to produce. What is the low-cost platform to produce some of these products? And we've actually moved some our manufacturing base that we had to lower-cost platforms. We're looking at out sourcing. In many of the cases, we're way to vertically integrating, doing things that I think we could leverage by going outside.

We apply -- in each of these plans, we had our general manager, Kaizan, where we bring in all of the general managers of the company one of the operations. And this year just happened to be -- because of that focus, we went to our Spartanburg operation, which is where we make our transit components.

And we did a week-long Kaizan of looking at the operation and looking at ways to improve the quality, looking at ways to improve the productivity and efficiency of the plant. And not just from manufacturing, we also looked at some of the -- how could we lean out some of the function areas and finance and other areas.

So we've applying what we call -- that is the Wabtec performance system, to find ways to continually improve. And we made good progress in this quarter in the transit area.

And -- this is a follow up question on the transit margins. Is your ramping up revenues here growing quickly, obviously supplemented by the acquisition growth? Is it a bit more challenging to try to manage that as you're ramping up here or does that actually provide some leverage opportunity?

It's providing us good leverage opportunity. We've got a good manufacturing team in place. And they've really stepped up to meet this increased demand. As you know, that's one of the concerns that people have. And we had that, knowing last year what the backlog looked like and what this year's demands were going to be.

And when we did our budget, planned, and our strategic planning sessions with the divisions, we spent a lot time trying to anticipate these demands. And I think the divisions and the team have really stepped us to perform quite well, considering this kind of growth and specific divisions.

And one thing I'd like to emphasize, Brannon, that at the end, bottom line, we really are one company. It's not like, by definition, an acquisition in the transit arena's going to provide more operating leverage, more of a chance to improve margins necessarily than the one in the freight. One of the ways we would improve margins, by sourcing.

I mean, we have one sourcing operation that serves the entire company. We have one QPS operation, again, a source of improvement that serves the entire company. So what we're trying to do obviously is layer on strategic acquisitions that we buy to meet our criteria and then utilize our tool chest of QPS sourcing, et cetera, et cetera, to improve them. But we do that regardless of whether it's transit or freight.

Okay, that's helpful color. And finally, just on the acquisition pipeline, you mentioned that, as we look out here, obviously you don't want to talk too much about this, but should be think about acquisition sizes in line with about Ricon and with more an emphasis on international and transit-type acquisition opportunities, or is kind of everything on the table here?

I think the best way to classify it is what you stated last, everything's on the table. You have to be opportunistic with acquisitions, although it's good to target the specific areas. But if they're not for sell, they're not for sell. And as you know, the acquisition arena is pretty hot. There's a lot of money out there. So we have to be very disciplined. We have to be -- we've got to make sure we do the right thing and that's what we're doing. We're going to approach this and make sure that we do it in a disciplined manner.

Okay, great. Thanks for the time. Nice quarter, guys.

Thank you, Brannon.

Thank you.

You're next question comes from Lawrence Casse from M Partners.

Good morning, guys.

Good morning, Lawrence.

Good morning.

Hi. Question on the lower-mission switcher locomotives, which you mentioned at the beginning. And we've heard some other companies mentioned in terms of developing product that's going to meet the Tier 3 EPA requirements that are coming out. You mentioned that there's some R&D work going on there. Could we see some new product announcements in that area in the next 12 months?

Lawrence, right now we are in the last stages of development for a multi-engine ULEL, ultra-low emissions locomotive. And we hope that here in the near future we'll be able to announce the completion of that development work. And that is a nice market right now. There's a lot of activity in that market. And there are some people who are producing units and supplying that area. And we hope to be in a position to do that as well in the near future.

Well, presumably, given your manufacturing capacity, you'd be able to produce it more efficiently than some of the competitors would if you could meet those same emission criteria.

Well, we have a great team at our Boise operation where we manufacture our locomotives. And they're doing a great job. As you know, they really ramped up quite a bit there for locomotives for the commuter area. And they've always been in the switcher arena and have served that market for a lot of years. So we're excited about that opportunity.

Okay, good. And I may have missed this. I came in a little late. Did you break out the operating margins in the two segments?

No, but you're probably the fifth person that asked for that.

Okay.

If you look at this quarter -- and we'll put that out in the queue here in two weeks -- but generally what we've worked on is improving the transit margins. And we were successful in doing that in the quarter.

Okay, good. Of your international business, approximately what percentage of that is the UK and Europe? And what I'm thinking of is the effect of the lower U.S. dollar against the pound and the euro?

Yes. Well, it's in terms of our international sales basically that -- and we watch this very carefully obviously as part of our overall hedging strategy. But the U.S. dollar has basically weakened against all the currencies -- all the countries that we operate in. For example, Australia -- I would just limit to just the euro and the pound, but it's weakened proportionately in Australia. It's weakened proportionately in the UK, as you noted, and obviously in the euro as well.

I think we mentioned that about $5 million of the increased in sales is basically due to translation from these countries where now obviously the sales are worth more. And that gives you a little rough idea, I think, of the magnitude of what we have.

We do export -- to add to that -- we do have an export competent from our NAFTA manufacturing plants. But in a lot of cases, especially in Europe, most of that is actually manufactured and done in the local currency, especially the UK. We have a large facility there were we refurbish transit cars as well as some locomotives. So that business is really in the local currency. And Europe as well, we have the manufacturing bases.

Okay. And when we look at the decline in freight volumes, should we think of the break replacement cycle as a linear relationship so, if you have a 4% decline in freight volumes, you would see a 4% decline in break replacements? Or is it more complicated than that?

I assume, Lawrence, you're talking about break shoes from the friction standpoint?

Yes.

Yes. Generally, if volume's down, they're going to replacing less break shoes. As we advance the technology to produce break breaks, that will lower that cycle. However, what we do try to do is come with technology that is going to allow for some level of differentiation in the marketplace.

And just to add a little bit to that, for the first half of the year, even though you're right, freight traffic has dropped, we haven't really seen that much of an effect of an effect on, at least domestic, break shoe business yet.

And I think part of that is due to -- because the railroads expect freight traffic to pick up in the second half of the year. And I think they're cut their ordering rates relatively steady. We haven't seen any dramatic change from where we were before. We haven't seen a pick up, but we certainly haven't seen any kind of decrease to speak of.

Okay, great. Thank you.

Thank you, Lawrence.

Our next question comes from Wendy Caplan from Wachovia.

Thank you, good morning.

Good morning, Wendy.

Good morning.

Good morning.

First, a quick clarification. You're about 215 outlook includes the $0.05 related to the Canadian restructuring. So excluding this restructuring, you're view would be about 220, right?

That's exactly right, Wendy.

Okay. Just wanted to be sure.

Right.

International or domestic, where are we seeing better growth on a core basis?

I would see it's about equal right now, Wendy, if you include NAFTA as domestic.

Right.

Because we are seeing some nice Canadian business, especially at GO Transit in Toronto. But it's about equal. Our UK unit is doing extremely well, as is our Australian operations. As you know, mining is going bonkers in Australia. And we're seeing the impact of that as well. And these emerging markets give us some opportunity as well.

Wendy Caplan. Okay. And order of magnitude, transit or freight margin, which is expanding faster? And as a follow up directionally, what are you assuming for each in the second half of the year? Our margins are improving obviously because it has a lower base and there's more room for improvement in the transit area. And as far as the freight is concerned, we're working to improve that, but it's at a pretty high level, so the incremental change is going to be smaller as far as improvement as we go forward. But we still have the goal to continue to improve those margins.

As we look forward, we would think that we should see more of the same because we're a continuous improvement company and we want to continue that trend to improve our margin over time. Now, quarter-to-quarter, there's going to be fluctuations, whether it be mixed or a specific one-time issue or a problem here. But in general, over time, our goal is to maintain double-digits earnings and to improve those margins going forward.

Okay. And finally, assuming the midpoint of your 16% to 18% revenue growth outlook implies low-single digit core growth, given that you had somewhere in the mid-teen organic revenue growth in Q2. Should be assume that you're just being conservative in your second-half view?

There is some conservatism obviously. And we have built in some of the Ricon acquisition into the revenue numbers. But if you look at a quarter-to-quarter comparison, the fourth quarter last year, we really did the ramp up. I think our sales was close to $300 million. I think it was, like, 294.

294.

So it gets to be a tougher comparison as we go quarter-to-quarter. What we do expect is some seasonability, as a said earlier, and really a rebound in the fourth quarter. And that assumes -- the things we worry about is obviously the global economy and things like that. But that's how we view it right now.

Okay. And if we were, 12 months from now, given what you know about your backlog that we don't know, would we assume that the mix of freight and transit flip-flops by then?

I don't know if it'll flip-flop, but I tell you that this mix right now -- I was kind of surprised at the end of the quarter when we really looked at it - 55/45. And we might see a little bit more drift toward a 50/50, but I don't think it's totally flip-flop.

Okay. And again, aftermarket versus OEM, should we expect to see the aftermarket increase or stay at this kind of high 58% level?

I would think, long-term, we're going to be in the 50% range on average, 50/50. I think that if you take a look, we've actually been trending a little higher in the aftermarket. And a lot of that has to do with the growth at our UK location. And we have expanded our capabilities at our service centers. And they've done a great job of bringing in new products -- one of them being heat exchanges.

So, yes, we might be more trending more toward an aftermarket. And that is a stated strategy. I mean, we want to grow that aftermarket but obviously -- you're installed base is so important to sustain that aftermarket portion, let alone current bases. So we don't lose focus on that.

And really, in regard to both of those last two questions, Wendy, acquisitions are going to somewhat of an impact. For example, Ricon doesn't have much of aftermarket visit. That's mostly [OE]. That's one of the attractions of it, to be honest, that we think, over time, we can combine that with our other businesses, which are very active in the aftermarket and growth that area. But initially, we won't.

The same with the transit freight. I mean, Ricon will add about $70 million worth of sales to transit. But that's not really an indication of an organic change.

Wendy Caplan. Okay, that's fair. And Alvaro, since I've got you on the phone. Okay, I've got another phone call, I've got to go.

A quick question on your balance sheet. Conceivably, given your cash generation, one could make the case that it's too good. Can you speak to...

You will never get Bill Kassling to admit that our cash generation is too good. You should know better than that.

Al, can you speak to sort of the cash-deployment question in terms of capital deployment question. What are the priorities at this point and what should we expect going forward?

I don't think there's been any real change in our cash deployment strategy. Obviously, we're still very focus on cash. We think the generation of cash is very important to us because it basically allows us to execute our growth strategy.

In terms of use, we think, and particularly with the renewed emphasis that we've placed on it now, that a successful acquisition strategy in the end will lead to the best use of cash long-term for our shareholders.

If you look at the additional earnings that we can generate with an acquisition versus, let's say, a stock buy-back -- the equivalent effect of a stock buy-back, the benefits of an acquisition are really compelling.

So again, we tend continue to place emphasis on a strong cash generation. And the primary goal for right now will to continue our disciplined approach to making acquisitions. And if we find at the end that we still have excess capacity, then we'll consider other alternatives.

We also feel -- just to add to that -- and I agree totally. But we also want to employ some of that cash for internal development. We think that we have a lot of opportunity. And some of this new product development, we continue to invest in electronic-controlled pneumatics and the electronic train control, positive train control.

We talked earlier about the ultra-low emissions locomotive. These are investments we want to continue to make. So I think it's a balanced approach. As we know our growth -- half of it we expect we can get internally. And we want to invest in that as well.

Thanks very much.

Thank you.

Our next question comes from Jim Lucas from Janney Montgomery Scott.

Yes, one quick follow up. Last year, your OM Kaizan focused on Boise on a commuter locomotive. Could you give us a report card of your goals going into that and where you stand currently?

Yes, I'd be happy to, Jim. This is, I think, a good example and a great story. We went into that Kaizan, which was September of '06. And the goal was we knew that we were going to have an increased demand on our locomotive business and we purposely selected the Boise operation to go out. And we knew what our capacity was at that time in making commuter locomotives.

The primary focus of that Kaizan was that we'd go in -- and at that point, we were making one locomotive every two weeks. And the goal was we need to make one a week. And I'm happy to report that we're at that one-a-week capacity right now. And it didn't happen over night.

We didn't go out there and waive a magic wand and us heroes reported. The real results were driven by the people on the floor in the operation there. It was just the focus that we helped apply it through that Kaizan. And they have that capacity that's available to them right now. So it was a very successful approach. A similar type of decision about going into the transit area. We knew we were going to be ramping up on some projects there, so.

Okay, thank you. Just one of those that needed a report card.

Well, I appreciate the question.

And your next question comes from Art Hatfield from Morgan Keegan.

Oh, I thought my phone was broken.

Art?

How are you?

We thought you missed the call.

No, no, I've been here tapping star-one for an hour. Maybe -- I don't know. I probably don't have any good questions, so that's why -- he knows that. Quick question, Al. I'm getting increasingly concerned about the direction of the freight car market and what kind of impact that can have on you guys.

I heard your comments earlier about what some of the tank car guys are saying. But we've heard in the last couple of days that lease rates on ethanol equipment are coming in and that there's a building excess capacity in that market. And considering that half the backlog is related to that market, we're fearful that we may see some cancellations coming up.

That are leads me to say that, with all that said, the industry built about 75,000 cars last year, probably 10,000 less this year. We could be seeing a number of 50,000 builds next year. If that happens, what can you do? And what have you done? And you've done a good job, so far, mitigating. We've seen small declines year-over-year in the build. But haw else can you do to further mitigate a reduction in the freight car market.

Okay. I think the first question is maybe our view of what we're seeing -- and obviously, if you take a look at the backlog for rail cars, it's obvious it really favors the ethanol production and the covered hoppers and the tank cars. That makes up almost -- I think I said 60% or 70%, it's probably even closer to 70%.

Right.

Where if you look at their percentage in the fleet, it's 50%. It's 50% if you add those two together. So there's a large, I think, backlog in those two areas. And I think anytime you have that, when you have a market driver like ethanol -- and I really am not an expert in that are. And I think everyone of us have read a little bit about is it boom or bust. And I'm not sure where that will lead. I do know that the people in those areas feel pretty good about that.

Again, the second thing about that backlog is that, what was nice as far as orders this time -- we saw open top-hoppers for steel. We say some coal aluminum cars order this time. And we got some intermodal cars. So I think that was a plot. That's the perspective of that particular marketplace.

I think the thing that we like to emphasize and make sure that everybody understands, only about 20% of our business is tied to that rail car build. We still see our diverse is our biggest strength -- locomotives, our transit business, OEM versus aftermarket, our global expansion opportunities.

And what we have to do is be in position, if that did. And everyone has seen the charts where car builds have gone from 75,000 to 70,000. That's the reason for our thrust to be a diverse company. We have to be prepared for that. And we have strategic sessions where we talk about what can we do, where would we go to get the other volume. And I think our strategic model addresses that.

Let me ask you, though, a question regarding that. This last second quarter, there was 16,000 deliveries, so roughly 16,000 builds. In theory, if that number were to, say, drop to 8,000 in a given quarter -- I'm just throwing a number out. Let's say that happened in fourth quarter. When does that impact your business? Would it be a third quarter event or a fourth quarter event?

It's probably going to follow the next quarter. It's about a quarter behind.

So you agree, Alvaro and Tim?

Yes, the impact is relatively quickly. I mean, a lot of this stuff is just in time. And obviously the typical building would like to have a little bit of a base back but (inaudible)

But they have a backlog as well. (Inaudible) It won't slow out the quarter now more than that, no.

But it would be more consequential to what the industry's doing, is what you're saying?

I'm not sure what you're talking about.

I'm saying that, if the industry went from 16,000 to 8,000 --

Deliveries?

-- in the fourth quarter relative to the third quarter, it would impact your business in the fourth quarter, correct?

If would impact it -- if the deliveries in the fourth quarter when from 16,000 to 8,000, it would see some impact in the fourth quarter, if that's when it happened. And it would flow over into the first quarter.

Okay. Okay. So -- (inaudible)

We wouldn't see it all immediately.

Okay. Okay, that's what I'm trying to get at, figuring on if it's a leading or a lagging effect for you all.

I understand.

Okay. That's all I've got. Thank a lot. That was helpful.

Okay.

At this time, we have no further questions in the queue.

Okay, well, thank you very much. And we look forward to talking to you again in October.

Thanks, everyone.

If not sooner.