美國西屋制動公司 (WAB) 2014 Q2 法說會逐字稿

Good morning, and welcome to Wabtec's second-quarter earnings release.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to Tim Wesley. Mr. Wesley, please go ahead.

Thank you, Theresa. Good morning, everybody.

Welcome to Wabtec's second-quarter earnings conference call. I will introduce the people who are here with me. Our Executive Chairman, Al Neupaver; Ray Betler, our President and CEO; our CFO, Pat Dugan; and John Mastalerz, our Corporate Controller

As usual, we will make our prepared remarks and then we will take your questions. During the call, as always, we will make forward-looking statements, so please review today's press release for the appropriate disclaimers.

Before I hand it over to Al, I would like to remind you that we have set the dates for our annual investor conference. This year it is going to be held October 1 and 2, at two of our plants in Germany, including one of the Fandstan locations.

And we will be sending more details over the next week or so. But feel free to contact me in the meantime if you'd like more information. Al?

Thank you, Tim. And good morning.

We had an excellent operating performance in the second quarter, with record sales of $731 million, and record earnings of $0.91 per diluted share. Our operating margin continued to expand nicely, and was at a record 18.1%.

Cash flow from operations was strong, as we generated $111 million for the quarter. Our backlog increased during the quarter and now stands at a record $1.8 billion.

From these statistics, you, obviously, can see that the business is performing well. And that is thanks to our diversified business model, our strategic growth initiatives, and the power of our Wabtec performance system.

We are optimistic and excited about our long-term opportunities in our Freight and Transit rail markets. These markets are large, they are global, and they are growing. And we are positioned well to participate in all of them.

Today we increased our 2014 guidance. We now expect full-year earnings per diluted share to be about $3.52. This is based on a sales growth of about 15% for the year.

Our guidance assumes the following: continued modest growth in the global economy; the US and European transit markets remain stable, with the emerging markets driving growth; US Freight traffic will continue to grow modestly with OEM locomotive and car builds growing. So far this year, Freight traffic is up about 4%.

We are assuming no major changes in foreign exchange rates. We are assuming a tax rate of about 31.5% in total for the year.

It is worth noting that this guidance includes the now completed Fandstan acquisition, as did our previous guidance. As always, we will be disciplined when it comes to controlling cost, we are going to stay focused on generating cash to invest in growth opportunities, and we will always be ready to respond if market conditions change.

Now I would like to turn the call over to our President and CEO, Ray Betler.

Thank you, Al.

Near the end of the quarter, we closed on a very significant and strategic acquisition, Fandstan Electric, with annual sales of about $245 million. Fandstan makes highly engineered components, mainly pantographs and third rail shoegear; and it has strong [IP], good engineering technical capabilities, and about 60% of its business in transit, 40% in industrial and energy sectors. It meets all of our strategic criteria.

New products, there is no product overlap. After market, 30% of the sales are in the after market area.

It has products installed in over 100 countries. Global expansion, 50% of their business is in continental Europe, 20% in the UK, 20% in Asia-Pacific, and 10% in the US.

The integration process for Fandstan is already underway. It will take time and lots of effort to complete, but we have made good progress.

We visited the countries -- all the country and company operations, each at key facilities. We have talked to the key management people and all the employees. We have mapped out initial plans for integrating functions such as accounting and IT, and we are beginning to introduce Wabtec's lien and sourcing activities into Fandstan.

We continue to be confident that there are significant opportunities to improve Fandstan's margins, which are slightly lower than our current Transit margins. So, in 2014, we will see significant sales from Fandstan, but minimum earnings accretion due to the integration cost and the purchase price accounting charges. We are very confident that Fandstan will be an excellent addition to our overall portfolio.

Compelling markets. One of the reasons we are optimistic about Wabtec's future is that we are involved in a very compelling market. Our markets, mainly Freight and Passenger transit are large, they are global, and they are growing.

According to a [UNIFA] study, the worldwide addressable real supply market exceeds $100 billion. It has an annual growth of about 3%.

Western Europe, Asia-Pacific, and NAFTA that are the largest geographical markets. Rolling stock is the largest product segment, and Outsourced services is the fastest growing segment. We have opportunities in both.

All the markets are focused on improving safety and efficiency. And that is where Wabtec plays a very important role.

The markets are also compelling, because an efficient transportation system and robust infrastructure are essential to the global economies -- their growth in both developed and emerging countries. And finally, secular trends also drive investment. Awareness of environmental issues and benefit, urbanization, and energy evolution.

Let us talk about the Freight rail sector. In NAFTA, Freight rail traffic is up 4.2% so far this year, led by a 6% increase in intermodal.

OEM rolling stock deliveries this is year will be higher than in 2013. We expect approximately 65,000 freight cars, and about 1,200 locomotives to be delivered this year. That compares to 53,000 last year and about 1,000 locomotives.

Globally, Freight traffic is generally growing, with Germany and UK posting increases of 4% and 6%, respectively. As you know, we are focused on increasing our global footprint and product offerings. We see opportunities in markets that are larger than our traditional NAFTA market.

So, for example, the global installed base of locomotives is about 110,000. With about 35% of that fleet in Asia Pacific, and only about 20% in the US

The global installed base of freight cars is about 5.2 million. About 30% of that is found in the US, and about 20% in Asia-Pacific.

Now, if we move to Transit, stability is still the theme of our Transit markets, both in the US and abroad. In the US and Canada, ridership was basically flat in the first quarter, no doubt affected by weather. But in the UK, ridership was up 7% in the most recent quarter, and in Germany, it was also slightly up.

In 2013, North American transit car deliveries were about 1,000. Bus deliveries were about 4,500, and we expect about the same volume this year.

Transit funding in the US is also stable, at about $10 billion. That is about where it has been over the past several years, and currently there is a two year transportation bill, which expires later this year, that we expect will be extended because it doesn't appear that Congress will be interested in passing a longer-term deal.

Just as with freight, we are focused on global growth and increasing our product offerings because the markets are larger overseas than in NAFTA. We estimate the installed base, globally, of transit cars to be about 330,000, with about 5% of that base in our NAFTA market.

We continue to focus on growth and cash generation. Our priorities for allocating free cash remain the same.

First, is to fund internal growth programs, including capital expenditures. Second, acquisitions. And our third focus is to return money to shareholders through a combination of dividend and stock buy-backs.

So, in second quarter we repurchased 194,700 shares for about $14 million. That means that we still have $184 million left on our $200 million buy-back authorization. We remain focused on increasing free cash flow by managing our cost, by driving down our working capital and by controlling our capital expenditures.

Our growth strategies also remain the same, there is four: global market expansion, after market expansion, new product development, and acquisitions. So let us talk about our progress in some of these strategic areas.

Growth strategies. On the global and market expansion front, in the second quarter, sales outside the US were about $350 million. Just under half of the total sales, versus about one-third five years ago. So we are making great progress here.

We continue to expand our capabilities and market presence in various markets around the world. In particular, we have opportunities in places such as Europe, China, and South Africa.

On the after market expansion side, sales were about $450 million in second quarter, about 60% of our total sales, and up from about $350 million a year-ago quarter. This growth is due to acquisitions and also internal growth initiatives.

On the new product side, we continue to have tremendous focus on this effort also. Many internal development projects such as electronic braking, our oil-free compressors, and locomotive services area has focused our spending in this area.

And positive train control continues to be one of our major growth drivers. PTC-related sales come in at about $235 million in 2013. And based on our first-half 2014 numbers, we are on track for PTC sales growth of about 20% to 25% this year, as we continue to work with railroads and other industry suppliers to develop an interoperable system.

And as you know, railroads and transit authorities have said that meeting the December 2015 deadline for PTC is not possible, and that could lead to an extension of that deadline. We have analyzed this, and we don't believe it will have a meaningful impact on our total PTC opportunity.

Acquisitions. Our pipeline continues to be very active, and we are pleased with the opportunities that we have in front of us.

And now I would like to turn it over to Pat, who will provide some details on the financials.

Okay, thank you, Ray, and good morning to everybody. I just want to highlight certain aspects of our quarterly results in the next few minutes.

Sales for the second quarter were a record $731 million, which is 15% higher than last year. In our Freight segment, sales increased 16%. Of that increase, $24 million came from acquisitions, and the remaining growth in that segment is from our Freight Car Components and our Electronics businesses.

In the Transit segment, our sales increased 13%. [$15] million of that increase is from acquisitions, and the remaining growth is from the transit side of our Electronics business, and from our UK and European after market.

For 2014, we expect to see revenues increase in both of these segments with Freight probably growing at a little bit faster rate. When you look at other elements of the income statement, I will mention that the operating income was a record $132 million, or about 18.1% of sales.

That operating margin in the second quarter of 2013 was 17.6%. So we continue to find ways to improve.

Our interest expense for the quarter was $4.5 million, that is a bit higher than compared to a year-ago quarter, and that is because of the additional borrowings related to the acquisitions. Our effective tax rate for the quarter was 30.7% versus 32% a year ago. We expect that our annual rate will remain similar for the rest of 2014, but the quarters may vary due to the timing any of discrete tax items that may occur.

When you shift to the balance sheet, in terms of working capital, at the end of June our trade and unbilled receivables were $717 million, inventories were $482 million, and accounts payable were $397 million. Compared to March 31, 2014, the trade and unbilled receivables were $637 million, inventories were $420 million, and payables were $345 million.

The increases in these balance are due mainly to the acquisition of Fandstan, which contributed about $95 million of working capital. And the remaining growth is do you to our growth through the quarters.

An important element of AR, unbilled receivables are included in the AR balance, and they are related to long-term contracts. The collection of those unbilled receivables are driven by our projects meeting certain key milestones. As our business becomes more global, that expanded footprint affects our working capital requirements and long-term contracts, as billing is based on project milestones, will also be a big factor.

Our cash from operations had a strong result. We generated $111 million for the quarter.

Our cash on hand at June 30 was $236 million, mostly outside of the US. As a comparison, we had $295 million on hand at March 31. Our debt balances at June 30 were at $501 million, which has increased from $451 million at March 31.

Both cash and debt balances, of course, were affected by the acquisition of Fandstan during the quarter. Of the $220 million purchase price for Fandstan, about half was funded with cash on hand in foreign locations, and the other half was borrowed.

A couple of miscellaneous items that we always point out. Our depreciation for the quarter was $9.2 million compared to $8.9 million last year.

Amortization expense was $5.1 million, compared to $5.2 million in the last year. And our capital expenditures were $12 million versus $8 million.

For the year, we expect our total CapEx to be about $50 million, and that includes Fandstan. Backlog, we have a record multi-year backlog of about $1.8 billion, which is about 7% higher at the end of March. Included in that number was about $95 million from Fandstan.

When you split up the backlog, $1.3 million is for our Transit segment, and $590 million is for Freight. Our rolling 12-month backlog, which is a subset of the multi year, was $1.2 billion which is a 9% increase from March. And you split that again, $662 million is in Transit, and $513 million for Freight.

These figures do not include about $250 million of contract options. We don't count them in backlog until our customer exercises those options.

With that, I am happy to turn it back to Al for his summary comments.

Thanks a lot, Pat, and Ray.

Once again, we had a strong performance in this last quarter; record sales, record earnings, record margins, strong cash flow, and a record backlog.

For 2014, we anticipate another record year and increase -- and we increased our EPS guidance to about $3.52 on a revenue growth of about 15%. We are happy with our strategic progress, and the long-term growth opportunities we see, as countries around the world continue to invest in freight rail, and passenger transit infrastructure.

We continue to benefit from our diverse business model and the Wabtec performance system, which provides the tools we need to generate cash and reduce cost. We have an experienced and dedicated management team that has taken advantage of our growth opportunities, and ready to respond to any changes in market conditions.

With that, we'd be more than happy to answer your questions.

(Operator Instructions.)

The first question is from Allison Poliniak from Wells Fargo.

Hi, guys, good morning. The past few days, obviously, a lot of noise accrued by rail and tank car safety in electronic braking, both in Canada and the US is really getting some thought.

Could you just give us your thoughts on it, and how we should be thinking about it? Obviously, it wouldn't be something until, I would say, 2016 or so.

Yes, Allison, it has been -- it hit the news as you know, I think it was yesterday. And we have taken a look at what is out there.

Obviously, it is way early to try to understand, really, what the final specification is going to be. We are talking about a 60-day comment period, and then they could actually extend that another 90 days for a review.

I think that the fact that the railroads are looking at being able to transport crude oil in a safer manner is critical to the industry. I think that the rules that they are proposing, obviously, provides quite a bit of flexibility. And it is hard to really make any statements related to how it might impact Wabtec today, or even two, three years down the road.

One thing I can do, and we didn't have this in our prepared remarks, but I can give you a little bit of a -- some color related to ECP. Today, if you look at worldwide, there is over 40,000 cars that are equipped with ECP around the world.

Most of the ECP adoption has been in regions such as Australia, South Africa, and the Middle East. There is also ECPs being looked at in some of the other freight dominant markets around the world.

Some of the positives, advantages of ECP is it does provide shorter stopping distances, anywhere from 40% to 60%. ECP allows graduated release.

Today, the engineer either has the brakes fully engaged or they could release them, they are either fully engaged or fully released. And they use dynamic stopping as a way to regulate the speed of a train, especially on steep grades. ECP uses less air, which means that there is -- if you needed another release in a quick period of time, there would be more air available.

It provides an opportunity for diagnostics. You have electric going to every car, therefore you can very easily put smart sensors and be able to use it to provide information about the health of the train.

It does create some fuel savings. I think that it has been documented and reported that there are some fuel savings related to that. I think in one case, it was up to almost 13% over conventional braking.

In an emergency situation, you get shorter stopping distances, you get a faster recovery time of the air pressure in the pipeline. And it also -- it gives you less in-train forces. And the forces that are create the by an emergency stop, obviously, could lead to other problems down the road.

So those are some of the advantages. It is adopted around the world. What the -- how this will be impacted by the latest discussions around -- you know, proved by rail, it is just way too early to say.

I think, as always, the one thing that we have stated and we say it again, our reason for existence is to work on the -- helping the railroads improve their productivity, their efficiency, and safety. And I think we are one of the few companies in the world that is totally focused to that.

Thank you. That is great color.

And then, just the second question, in terms of your outlook for the year and keeping revenue, it implies somewhat EBIT pressure in the back half, should I assume part of that is coming from Fandstan in the acquisition?

Fandstan, Allison, as we have said, is going to add significant revenue for the year, but relative to the operating result, we had the purchase price accounting that will offset profit opportunities. And we obviously have some integration costs associated with it.

So, it will add to our overall revenue mix and performance for the year. But you won't see signature impact on the result.

Okay, great, thank you.

Thank you.

Our next question is from Scott Groups of woeful research.

Thank you, morning guys. So, all the rails are taking up CapEx guidance for cars and locomotives, and looks like you guys raised your expectations for those markets too.

I am wondering, why keep the revenue guidance at 15%? It feels like we were already, kind of, on that run rate before Fandstan.

Is there something offsetting that is getting worse, that is going to pressure the revenue growth? Or is there upside to that 15%?

At this point, you have to look at the markets and you have to say it is good. The rail business is good right now, there is no doubt about it.

I think as we look into the second half of the year, it is easy to calculate that our revenue growth is almost all acquisitions related to Fandstan. And thus, as Ray just explained, that would have an impact on the margins because of the statements that he just made.

Are we going to see the car build and locomotive build get better in the second half? I think we are, kind of, looking at a little bit of a conservative approach on the -- on those particular market factors.

The other thing that plays into our look in the second half, we typically get a little bit of seasonality in the third quarter. And that is always a little hard to predict.

So yes, things are good in the marketplace right now. There is no doubt about it.

Okay, that makes sense. In terms of the margins, I think the negative mix of Fandstan for the rest of 2014 makes sense.

But, Al, I know you guys talk about continuous margin improvement, but is there a point where you say: You know what, I don't think this is a business that can do a 20% operating margin. Is there a level where you say: This is as good as it can get? Or does that 20% margin number at some point in the future not seem unrealistic?

I can tell you, and I would like Ray to answer this as well; but I can tell you, that you will never hear me make the statement that we can't get better. As a matter of fact, one of the initiatives that Ray and the management team has come up with in the last year, is that we really had not focused on the cost of poor quality.

And now, we are looking at adding interest to one of those areas that we focus on year to year, that would give us incremental improvement. I think there is always room for improvement. I think that it also can be driven just by how you look at your strategy related to your acquisition program.

Are we going to be looking for businesses that are accretive or dilutive when it comes to margins? So I think there is always room for improvement.

Ray, maybe you can talk a little bit about this cost of quality initiative that you started, that I am super impressed with.

So, yes, Scott, I agree 100% with Al. Our focus is simply on continuing to improve in every area of the business, which hopefully leads to profitability improvement.

And we have talked before about corporate councils that we have in place that address every key business process area. There is eight of those now, we just put one in place for project management.

But, Quality Council has put a -- basically, a metric process in place where we measure total cost support quality. We always had quality metrics, obviously, but this is a more robust, comprehensive measurement process that tries to really identify and itemize every specific contributor to poor quality cost.

So why do we want to address poor quality cost? Because those are opportunities to bring money to the bottom line. And it also represents significant opportunities to do a better job in the customer service and customer satisfaction area.

So we are going to put a target in place. We talked about 2% improvement year on year, as one of our requirements in the budget process.

That 2% focused on strategic sourcing, it focused on our lien process, and it focused on pricing. We are going to add incrementally to that objective, that requirement and include an improvement on cost support quality for every business next year.

So that is not the only initiative, but it is an example of the initiatives that we have in place across the Corporation.

That is good stuff. And just, last question, to follow up on the ECP brakes.

Can you just remind us -- I think, we understand you guys have the patent. Are there competitors with similar patents on the ECP brakes, and what is your latest estimate on the revenue per car for you guys? Because it does feel like it is coming to Canada, and, who knows, maybe in the US.

Yes, right now there is two suppliers of electronic control pneumatic braking. Ourselves and New York Air Brake, which is a US division of Knorr, which is our competitor in Germany, it is privately held.

The ECP, when you look at what the costs are for an ECP system, it is really pretty variable on what you order. We offer what is called an overlay ECP.

Now, an overlay system allows you to operate that brake valve in a conventional manner or in an electronic manner. You also have the option of putting on a brake -- the brakes are made up of two different parts.

There is a service part, and there is an emergency part to the break. And there is a pipe racket that combine these two.

If you put on ECP, and you wanted to give up the option to use it conventionally, you could eliminate the service portion of the break and only use ECP. So that is an option.

You could also take an existing brake and add a pipe racket as well as ECP to it. So it is a range of cost that, really, could be a few thousand dollars, up to $7,000 or $8,000 to outfit a rail car.

You also have to have -- in order to work, you have to outfit the locomotive with the compatibility with the particular cars. And that adds another cost to particular implementation.

That is good color. Thank you, guys. Appreciate it.

Thank you.

Our next question is from Sam Eisner from Goldman Sachs.

Good morning, everyone.

Good morning, Sam.

Going through the comments on cash flow, I think for the first half of the year, operating cash flow was about $137 million, $140 million versus about $45 last year. So just curious, what is driving the strength in cash flow for this year?

The second quarter -- this is Pat by the way -- the second quarter was particularly strong. Our earnings were good for the quarter. Our working capital remained fairly stable compared to our sales growth.

And so -- and then the acquisition of Fandstan, we explained that does drive up some of the working capital elements, but it is obviously acquired through the deal. The combination of all those things gave us a really good cash flow from operations result in Q2. In Q1 and in the first half of 2013, you had projects and revenue growth that were really driving up working capital.

Understood. And then just a follow-up on that, is the expectation for this year that free cash will be in excess of net income?

I know in last two years, we haven't reached that bogey. So, I am just curious how you guys are thinking about that.

Well, that -- that has always been our goal, our stated goal, and we plan to execute it.

We expect to do that.

Understood. And then on PTC, it seems as though you guys are updating your expectations for PTC for 2014.

I believe, last quarter was only about $275 million, or $270 million for that matter. So, just curious why you are basically implying $280 or $290.

Curious, what you are seeing in the marketplace from a PTC standpoint? And then, what is the expectation, potentially for 2015 on PTC?

PTC, Sam is -- what we are seeing in the marketplace is, to some extent, probably, people trying to do their best to meet the deadline. Even though people have announced that they are not going to be able to do that, I think people are trying, in earnest, to do the best they can to expedite PTC implementation where possible.

I think you also have some makeup, catch-up, that is a result of the suspension that existed because of the Native Indian burial grounds. That is resolved, and people are probably trying to do some catch-up there.

I think, overall, it is a healthy situation. And it is going to continue in into 2015.

Great. And then just lastly, on the non-rail business, there wasn't a lot of commentary on that on your prepared remarks. Just curious how that business is fairing.

I believe it's about 15% of the total Company. So just curious how you guys are seeing that.

Is there accelerating through the back half of the year? How was it in the first half of the year? Just any kind of comments, that would be helpful.

It actually is improving as we go forward. We are seeing a lot more activity out of our customers in that particular area, especially when we look at the heat exchanger business.

It is tied to the oil and gas expiration, the fracking business. That is really coming back very strong for us. And that is global.

And we also, as you know, about 40 -- I think about 40% of Fandstan is really outside of the rail business. And focused primarily on seaports, as well as energy as well. So we should continue to see growth in our industrial businesses.

Great. Thank you so much.

Thank you.

Thank you.

Our next question is Justin Long of Stephens. Please go ahead.

Hey, guys, good morning, and congratulations on the quarter.

Thank you.

Hey, Justin.

So, we have the tier 4 locomotive requirements on the horizon. And I was wondering if you could talk about how you expect that to impact your business over the next year or so.

Could this be a near-term tailwind due to a pre-buy, and then a headwind in 2015 as builds are a little bit weaker? What is the best way to think about that?

As we view it right now, there could be a pre-buy. If you go back in time, step back 18 months, two years ago, many of the Class I railroads were saying they weren't going to need locomotives for a number of years.

Obviously, that has changed because of the pressures they are seeing, velocities went down, the demand has gone up, and the economy and the volumes for the railroads, as we stated earlier, are very good. So I think there was a natural need for locomotives that they hadn't anticipated.

Is some of that a pre-buy? And I know that there is stuff in print related to one of the suppliers being ready to supply a Tier 4 compliant locomotive.

Will that have an impact? Will there be more attention given to rebuild or overhauls? That is some of the things we will see.

The one thing can tell you is, the demand for locomotives internationally is very strong right now. And that really would offset some, if not all of the potential pre-buy.

The other thing that has happened on the Tier 4, maybe Ray, you could comment about what business we have seen from the need to supply Tier 4 motors in some of the specialty markets. Yes, I think, Justin, we are well-positioned to adjust to Tier 4 opportunities. As a matter of fact, we have a group of people meet with one of our locomotive builders today just on that topic. So we have done a lot of work to pre-qualify our equipment, the heat exchangers, for instance, and respond to those opportunities.

We have mentioned before, that we also will likely be the first Tier 4-compliant commuter, locomotive provider in NAFTA with our GO Transit opportunities. So both in the rail sector and outside of the rail sector, we have done our work to position ourselves and have qualified our products. So we will be able to support and respond to our customers' needs as it is related to that regulation.

Great. And that is helpful.

And as a follow-up to that question, if you look at the 1,200 North American locomotive builds expected this year, what portion of that are you expecting in the second half, and do you have a projection -- an industry projection on 2015 right now?

We have no accurate projection in 2015. So we won't really provide you one.

I think that the rate of the locomotive builds as we see it is pretty constant right now. So I would think that the second half is going to be very similar to the first half. But I wouldn't make a forecast into 2015 yet.

Okay, great. And last question, as you are looking at M&A opportunities, you have seen any major changes to valuation multiples in the market?

I know if you go back historically, the average EBITDA multiple you have paid, especially on a post-syngergy basis, is pretty impressive. I am just curious if you still think you can get deals done around that historical multiple you have paid?

I guess there is one word for the M&A market rate today, and that word would be hot. And whenever that market is hot, obviously, there is an upward push on pricing.

We will remained disciplined in our approach. And the relative price we pay, obviously, has to reflect what the market is, and is directly correlated to how strongly we feel it is a strategic fit.

Okay, great. Thank you for the time. I appreciate it.

Thank you.

Our next question is from Matt Brooklier from Longbow Research.

Hey, thank you, good morning. Just curious if you have the number for PTC revenue contribution for the second quarter.

Yes, it was $74 million. About $74 million.

Okay, and how did that break up roughly between the Freight and the Transit business?

It is staying pretty consistent to what we have seen in the past, with about 50% in Freight, 25% in Transit, and about 25% international. We will probably see as we wind down on the MRS program, probably that number would -- that percentage will start declining into 2015. But right now, as our projection, that is pretty accurate.

Okay. And then I think per Ray's commentary on PTC, it sounds like the -- I guess the pickup in growth expectations for this year is partially due to a little bit of delay in the marketplace, with respect to getting PTC installed.

And now that we have this pickup, is there a fear though, that we play catch-up and then, potentially, you could see a slowing of spend if, you know, the end of 2015 in that mandate deadline, if that starts to get pushed out and the marketplace is more comfortable with not making that potential deadline?

Yes, I think people are trying in earnest not to do everything they can to come as close to the deadline as possible. You have several Class Is that are running pilot tests right now, field tests with PTC-equipped segments of their railroads.

So what we see are -- everybody is doing their best, I think, to try to implement PTC and respond to the mandate, and we are doing our best to support them. The testing that is being done on the railroads, thus far, has gone well. So, I think, you are going to continue to see significant progress over the next couple years.

Okay. Appreciate the color. Thank you.

Thank you.

Our next question is from Kristen Kubacki from Avondale Partners. Please go ahead.

Hey, good morning guys. I just wanted to try to -- not to beat a dead horse on this ECP, but I just wanted to talk a little bit about the opportunity there.

Reading through the documents that they put out yesterday, it is pretty lengthy, I know; but, the government estimates that it is going to be about $50,000 and $79,000 for a locomotive to be implemented with ECP, and then about $3,000 to $5,000 per car, depending on whether it is new or retrofit. Do those numbers sound about right to you? And could I infer that -- what is your exposure to both the locomotive retrofit as well as the car?

Yes, there is so many variables, as I tried to explain earlier, as to are you going to equip it with a ECP-only product, are you going to have what we call: the overlay? Are we talking about new cars? Are we talking about taking an existing car and upgrading it?

So, it is really hard to put a number and try to say if they chose option 1, which I think one of the option 1 included the 9/16-inch thick steel with ECP; but, you got to realize there are other technologies involved in what they are talking about, in getting enhanced braking. Utilizing distributive power gives you some of the benefits that you would get from ECP. Probably not the full benefits, but some of it.

What is meant by distributive power, is they, literally, take locomotives and put it in middle of the train. And thus, you have got braking being generated and promulgated from the front and, say, the middle of the train to the back, and communicating with the end-of-train device. So you could get quite a few of those benefits that exist.

So, I think, it is really premature without knowing exactly what option is going to happen and what some of the pluses and minuses are, to get overly -- I would hate to get down the road on a potential that really is very iffy at this point. So, what I thought best to do, is just try to, you know, explain at least our view, what we think the advantages are and how we see the market.

We have been very encouraged about the adoption as well as the performance of technology on a global basis. I apologize for not totally answering your question, but I just feel it is a little premature.

I was going to say, you are not giving me the answer I wanted, Al.

(Laughter)

I will try again later. Just a quick question on the --

(Laughter)

A question on the highway bill, obviously we are probably kicking the can down the road. Is there any watch-outs or any behavior we are seeing, changes on any -- particularly, on any transit projects here in the near future?

No, Kristine, it is pretty much the same as it has been over the last several years. The people that run these transit authorities seem to be pretty resilient and used to this kind of behavior, and they have found a way to continue to manage, operate, and also to manage the capital equipment requirements for new projects.

So we really haven't seen anything. The pipeline is good, projects that are underway have not been stalled, and the new projects are coming to the market.

So we really haven't seen any disruption. It is a little bit unfortunate.

I am sure it is difficult to manage a business without knowing where your funding is coming from. But they have managed to do it pretty well.

That is great color. I appreciate that.

And just one final question, on the PTC side, can you remind us, is Brazil MRS, is that completed? And I assume that option is it still out there.

Can you remind us how much that is? And I assume that was part of the option that was mentioned earlier.

Yes, right now, we think that the program -- we will actually be turning the project over to the customer probably early in 2015. At least the first half.

Right now, we have got one section of the railroad that is running with our assistance and what we would call a pilot program. We are working on implementing it on another section of the railroad.

The option, I think, is going to be delayed. And that is worth probably another $80 million because of the demand of iron ore driven by the growth of China. It will happen at some point, but right now it is not on the table to be implemented immediately.

That could change depending on -- keep in mind, this wasn't done because of a mandate, it wasn't done because of, actually, safety reasons. This was done for productivity.

They had an older signalling system, and they want to go to the state of the art signalling system. So they are really doing it for productivity reasons.

And I think if they see the end result, once this thing is up and running without the minor glitches that we have, you don't know what they are going to do. But right now, that is off the table, as far as I understand.

Okay. That is helpful. I will call you later Tim, on the ECP.

(Laughter)

Okay.

Our next question is from Art Hatfield from Raymond James. Please go ahead.

Morning, thank you guys. Obviously, I am going to ask some of the same questions, but it is all I got for you it today.

(Laughter)

On the 40,000 cars globally that are equipped with ECP, what percent of those are equipped with Wabtec systems?

I would -- I don't know the exact number. But I would think that we probably have more share. And most of them are overlay.

And that is my next question. Are you constricted, based on your product, to only selling in full-unit trains?

No. That is what I was trying to explain.

You could actually -- first of all, you could sell a brake valve that has the pipe bracket, which allows for single-car automatic testing, and you could put an ECP valve on that -- the overlay one, which you could either have it operate using electronic signals or pneumatic signals -- which means it would work in a conventional way, but you are paying the extra money. So it could be used on either train, it is just that it would have the ECP capability.

Got it. And going back to that market share, not the -- I don't want to push on something you may not know off the top of your head, but when you say a larger market share, would you think it is closer to 60% or 90% share?

I don't know.

Okay, fair enough. Fair enough.

And just looking at the quarter and the operating margin, I you know you discussed this earlier, and I appreciate your comments about the impact from Fandstan. But excluding -- if you hadn't acquired Fandstan, would it be fair to say that Q2 would be representative of what you could do from a margin standpoint for the rest of the year, or was there certain things in the quarter that really helped that quarter specifically?

I think quarter two is pretty representative of us. And keep in mind, we had about -- almost $18 million of Fandstan. And, you know, with the PTA and the thing, I doubt if it contributed any margin whatsoever.

And then, we typically have these one-time pluses and minuses that we try not to -- they are small, and we don't spend a lot of time on them, normally, unless they make an impact. So, we had a typical plus and minus type quarter, I think. Pat, was there anything out of the ordinary?

No, I don't think there was anything worth really noting that is unusual from quarter to quarter, I mean, It is an improvement over the first quarter of 2014 and improvement over the quarter of 2013. I think it is a good operating margin.

Last question, and I appreciate your comments about your desire to continue to grow margins. But, what do you do as a Company to prohibit yourself from -- with that mindset, to going after cost opportunities that don't generate the returns necessary?

Given the culture that you have about continuous improvement, and I think Ray alluded to this in some of his comments, related to this earlier. But what kind of things do you have in place that say: Look, that is just not an opportunity that we can generate a return on?

Art, I don't -- I am trying to think of opportunities we can't get a rate of return on. There is almost no area, certainly, that we are working on purposefully, that doesn't in one way or another impact our ability to improve our margins, or improve our overall profitability.

I get that, right now. Obviously, you have been able to evaluate and -- but, in the future, what do you have in place that says: Look, as opposed to spending 20 bases of margin -- we don't want to spend 20 basis points in margin to get a 10 basis point improvement --

Well, we have a pretty rigorous business case assessment process that we go through to just make those kind of decisions. Those kind of decisions are made on capital climate, they are made on product development programs, they are made on acquisitions, and we have plenty of those.

We have plenty examples of where we have gone through -- assessed various opportunities. 'Cause it comes down to management capacity and resource capacity.

And there is many places where we have made decisions not to do things and prioritized better opportunities over those. But there is no areas that I am aware of that we have made decisions to go ahead that we don't have opportunities for margin improvement.

And that being the case now, have you ever had something in the past that it didn't work out the way you had hoped, and what do you do in that instance, if you had one, to kind of cut the program off?

We have them every month. Probably every day we do something that we aren't totally pleased with.

Okay.

And the biggest thing we do is, one, we do look in the mirror and face the brutal facts about things. And we work awful hard about lessons learned.

As a matter of fact, we had a Board meeting just yesterday, and a couple of the group execs had to stand up and explain. We reviewed major cost initiatives with the Board.

And we, basically, showed two of which were not performing where it should have been. And part of that presentation was lessons learned.

It is part of the culture, it is part of continuous improvement. And those really become the opportunities. Those are the things that you have to do, because the next time you are in that same situation, you have got to be able to improve it.

And I think our team realizes it. And when you put an up-and-coming executive that wants to impress someone, he has got to explain to the Board of Directors why we didn't hit the numbers he was supposed to hit. It has a meaningful impact on our culture.

So, Art, I know we have talked to you before about restructuring programs we have had in place. So, maybe more specifically, to answer your question, if we see problems in business units -- every business unit isn't great, Al has told you, we have some business units that are much better than others. Which means that some are much worse than others.

So we will put restructuring programs in place. And again, we have a very rigorous process and expectations for the group execs and business leaders to deliver on those restructuring programs. And they are difficult, they are not easy discussions.

You know, you are talking about cutting people, cutting capital costs, certainly any variable costs, we can take out discretionary costs. So we do that on a regular basis.

Thank you for that. I actually was just trying to get educated. And I hope -- I have got some other companies I hope were listening to what you were saying there.

(Laughter)

Thanks, Art.

Our next question is from Liam Burke from Janney Capital Markets. Please go ahead.

Yes, thank you. Ray, near term you saw nice traffic volume and CapEx numbers from the rails.

Long term, you have got safety and fuel efficiency issues. Is there anything that you saw in the first half of the year or that you see going forward that is giving you any caution or concern?

I am always concerned, Liam.

That's fair.

I think we are very fortunate. It is a blessing to be in a situation we are in right now, relative to the market. It comes down to our ability to perform.

Okay. And, Pat, do you have a first half CapEx number?

I do. Hold on. First half, so year-to-date number for CapEx would be about $18 million.

Great. Thank you very much.

Thank you, Liam.

Our next question is from Willard Milby from BB&T Capital Markets. Please go ahead.

Good morning, everyone.

Morning.

First off, I was hoping you could give us a sense of where SG&A was going to fall on Q3 and Q4 now that Fandstan's deal is done.

Our SG&A for the current quarter was roughly $73 million. And in that quarter, we had some deal expense, and we only had a partial Fandstan. So we think the run rate for going forward would be about $75 million.

All right, thank you. Also, just looking at gross margin, I think 30.7% is a high water mark over the past couple of years.

Historically, you have been moving it up the past two or three years. And I was wondering if you could give us a sense of what is behind this growth, or improvement, rather.

I think it goes back to a lot of the same conversation we had about operating margin and our drive to push costs out of our business units. We are, obviously, having some good growth in our Freight segment, which tends to have a little bit better margin than our Transit market. So, I think all those things contribute to us getting the gross margin over 30% and our operating margin at 18%.

All right, great. And I think you mentioned that you expected Freight growth to outpace Transit for the remainder of this year. Was that for the remainder of this year, or into 2015 as well?

We won't give any guidance on 2015 just yet.

Okay. All right. Thank you for the time.

Thank you.

Thank you.

Our next question is from Steve Barger from KeyBanc.

I am going to try one more margin question. Ray, I thought your comments on cost equality were great.

You guys have been very effective at driving operating margin expansion over the last couple of years. You averaged about 120 basis points in 2011, 2012, and 2013.

So, two questions. First, Al, can you quantify how much of that came from the Wabtec improvement system versus how much came from mixed tail winds like PTC or anything else that may have been positive for you?

Let me just help with that a little bit. I don't think we have an exact number.

But what I can tell you, when we put together a budget goal for a division, they will put together action items that add up to around 2% improvement. There is a certain percentage that is related to WPF.

In average, about 25% of that -- 75% of that number is related to Wabtec performance systems. Now how much gets to the bottom line is very difficult to measure.

We identify programs that give you that amount of savings, did it all get there? Does half? But what normally happens in that 2% goal, only about a half percent improvement ends up at the end of the day.

So, if you look at it from a target standpoint, you know, we are probably saying anywhere from 25% to 35%, 40% of our improvement could be driven by Wabtec performance system at the end of the day. But we are also the first to admit that good mix hides everything.

(Laughter)

It hides problems, and it is very difficult to sit here and say that we actually delivered all that. But I must tell you that we do calculate the savings on a specific item bases, we call it priority deployment. And it's what drives individual calculations for their incentive on achieving those particular individual increases.

So there is some accountability to it. But it is really, really difficult to quantify.

Got it. And so, I will follow up with the 2%.

I think the comment was targeting 2% annual improvement. Is that on a consolidated basis or is that specific projects as you go through the budgeting process that gives you a net positive, but somewhere below 2%, in terms of where you are targeting?

It is on a divisional basis. A division comes in, and they will manage their own projects, which you hope to always do, is push down this culture to the lowest possible level.

And our ability to manage now, because of, just, the size of the Company, we have individual reviews with the division. But that division may be made up of four or five plants where they have got to drive that priority deployment to the lowest common denominator.

Got it. And then last question, Ray, and Al, I know you guys have a lot on your plate with the Fandstan integration that is coming up.

But, for Ray specifically, as you look around the world at all the untapped opportunities that you guys see, what are the first couple of things that you may want to attack in terms of expanding market share, improving profitability? You talked about sourcing initiatives. Maybe just, where are you six months or a year from now, in terms of how you see your plan of attack proceeding?

As far as acquisitions, Steve, we have acquisitions right behind the one we just completed. So there is a very active pipeline in place.

Mark Cox, the head of our Corporate Development group is working 24 hours a day on those things, and is making great progress. Our focus, we would love to continue to grow our Electronics business, to grow our Friction business.

So from an acquisition point of view, there is specific targets that we have prioritized. Certainly, opportunities to continue to expand our Transit business are interesting to us.

So those are the areas that we are focused on today. And we are making good progress in those.

Well, since you have that poor guy working 24 hours a day, has he found deals of the same size as Fandstan? Or are they more like some of the other deals that you did earlier in 2013 that were more -- smaller, and built on?

We have a whole mix of opportunities. So the smaller ones have to be more strategic, the larger ones, if they fit our strategy -- we were fortunate to find Fandstan on one hand; but, it is something that, I think we shared with you, we started working on four or five years ago.

So, certainly, to benefit, to be able to acquire a company that hits all of our Corporate strategic objectives, has operations in seven continents, the size that Fandstan is, was a significant accomplishment. But, we don't anticipate that everyone is going to be like that, nor do we neglect the strategic ones that are smaller.

Gotcha. Thank you so much for the time.

Okay, you are welcome. Thank you, Steve.

Our next question is from Mike Baudendistel from Stifel. Please go ahead.

Thank you. I just wanted to ask a question on locomotive repair and rebuilds.

One of the Class Is this week was talking about rebuilding older locomotives in order to make up for some of the volume gains and service disruptions. Have you seen any big pickups in those types of activities?

We have opportunities, certainly, Mike, for overhauls. Some of our customers have focused on addressing the Tier 4 requirement that way.

So, you know, that is good business for us, is the overhaul business, as well as the now OEM business on the locomotive sector. MotivePower does complete overhauls, we do subsystem overhauls in many of our businesses, and we have a Global Services business with a half dozen major service shops throughout North America.

So yes, we have seen some of it. And we have continued to pursue it.

Good. And one last one, on the proposed regulations yesterday, I mean, there was really a lot that didn't have -- a lot in there that didn't have a lot to do with the brakes, things like better valves, top fitting protection, et cetera Do you envision yourself competing for any of those other safety-related features?

We -- the only thing that we would see on the overhaul if they are to overhaul a particular rail car, tank car, they may decide to upgrade some of the other things. But we are not involved in the -- with the overhaul or the valves, we are not involved, nor the thickness. So I don't see anything other than possibly the braking systems or anything else they might do in conjunction with, but not necessarily anything discussed.

Great, thanks very much.

Thank you.

Thank you.

(Operator Instructions. )

This concludes our question and answer session. I would like to turn the conference back over to Mr. Neupaver for any closing remarks.

Thank you very much, and we look forward to talking to you again at the end of the third quarter. And we really would like to see you before that at our investor conference over in Germany at our Fandstan Stemmann plant. We will also be visiting the Becorit division which makes friction products for the worldwide market. Thank you.

Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.