Westinghouse Air Brake Technologies' (WAB) CEO Raymond Betler on Q2 2014 Results - Earnings Call Transcript

Jul.24.14 | About: Westinghouse Air (WAB)

Westinghouse Air Brake Technologies (NYSE:WAB)

Q2 2014 Earnings Call

July 24, 2014 10:00 am ET

Executives

Timothy R. Wesley - Vice President of Investor Relations and Corporate Communications

Albert J. Neupaver - Executive Chairman

Raymond T. Betler - Chief Executive Officer, President and Director

Patrick D. Dugan - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Allison Poliniak-Cusic - Wells Fargo Securities, LLC, Research Division

Scott H. Group - Wolfe Research, LLC

Samuel H. Eisner - Goldman Sachs Group Inc., Research Division

Justin Long - Stephens Inc., Research Division

Matthew S. Brooklier - Longbow Research LLC

Kristine Kubacki - Avondale Partners, LLC, Research Division

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

Liam D. Burke - Janney Montgomery Scott LLC, Research Division

Willard P. Milby - BB&T Capital Markets, Research Division

Steve Barger - KeyBanc Capital Markets Inc., Research Division

Michael J. Baudendistel - Stifel, Nicolaus & Company, Incorporated, Research Division

Operator

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.

Timothy R. Wesley

Thank you, Theresa. Good morning, everybody. Welcome to the Wabtec Second Quarter Earnings Conference Call. I'll 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'll take your questions. During the call, as always, we'll 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've set the dates for our Annual Investor Conference. This year, it's going to be held October 1 and 2 at 2 of our plants in Germany, including 1 of the Fandstan locations. And we'll 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?

Albert J. Neupaver

Thanks, 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's 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're global and they're 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 U.S. and European transit markets remain stable with the emerging markets driving growth; U.S. freight traffic will continue to grow modestly with OEM locomotive and car builds growing. So far this year, traffic -- freight traffic's up about 4%. We're assuming no major change in -- changes in foreign exchange rates. We're assuming a tax rate of about 31.5% in total for the year. It's 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're 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'd like to turn the call over to our President and CEO, Ray Betler.

Raymond T. Betler

Thanks, 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 shoe gear, 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's no product overlap; aftermarket, 30% of the sales are in the aftermarket area; it has products installed in over 100 countries; global expansion, 50% of their business is in Continental Europe, 20% in the U.K., 20% in Asia Pacific, and 10% in the U.S.

The integration process for Fandstan is already underway. It'll take time and lots of effort to complete, but we've made good progress. We visited the countries, all the country and company operations, each of the key facilities. We've talked to key management people on all the employees. We've mapped out initial plans for integrating functions such as accounting and IT, and we are beginning to introduce Wabtec's lean and sourcing activities into Fandstan.

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

Compelling markets. One of the reasons we're 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're global and they're growing. According to a UNIFE study, the worldwide adjustable rail supply market exceeds $100 billion. It has an annual growth of about 3%. Western Europe, Asia Pacific and NAFTA 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 of the markets are focused on improving safety and efficiency, and that's 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 benefits, urbanization, and energy evolution.

Let's 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 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 U.K. 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 U.S. The global installed base of freight cars is about $5.2 million. About 30% of that is found in the U.S. and about 20% in Asia Pacific.

Now if we move to Transit. Stability is still the theme of our transit markets, both in the U.S. and abroad. In the U.S. and Canada, ridership was basically flat in the first quarter, no doubt affected by weather. But in the U.K., ridership was up 7% in the most recent quarter, and in Germany, it was also slightly up. In 2013, North America 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 U.S. is also stable at about $10 billion. That's about where it's been over the past several years, and currently, there's a 2-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 bill.

Just as with freight, we're 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 it -- 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 buybacks. 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 buyback 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's four: global market expansion, aftermarket expansion, new product development and acquisitions. So let's 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 U.S. were about $350 million, just under half of the total sales versus -- about 1/3 five years ago. So we're making great progress here. We continued 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 aftermarket expansion side, sales were about $450 million in second quarter, about 60% of our total sales, and up from about $350 million 1 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 came in at about $235 million in 2013, and based on our first half 2014 numbers, we're 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've 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're pleased with the opportunities that we have in front of us.

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

Patrick D. Dugan

Okay. Thanks, 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 -- in our freight car -- remaining growth in that segment is from our freight car components and our electronics businesses.

In the Transit segment, our sales increased 13%. $16 million of that increase is from acquisitions, and the remaining growth is from the transit side of our electronics business and from our U.K. and European aftermarket.

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 mentioned that the operating income was a record $132 million or about 18.1% of sales. That operating margin in the second quarter of -- the 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's a bit higher than compared to 1 year ago quarter, and that's because of the additional borrowings related to the acquisitions. Our effective tax rate for the quarter was 30.7% versus 32% 1 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 of any 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 this balance are due mainly to the acquisition of Fandstan, which contributed about $95 million of working capital, and the remaining growth is due 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. And the collection of those unbilled receivables are driven by the -- 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 billings based on projects milestones will also -- will 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 $226 million, mostly outside of the U.S. As a comparison, we had $295 million on hand at March 31. Our debt balances at June 30 were $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 miscellaneous items that we always point out. Our depreciation for the quarter was $9.2 million compared to $8.9 million in 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 5 -- $50 million, excuse me, $50 million, and that includes Fandstan.

Backlog. We have a record multiyear backlog of about $1.8 billion, which is about 7% higher than at the end of March. Included in this number was about $95 million from Fandstan. When you split up the backlog, $1.3 million (sic) [billion] is for our Transit segment and $590 million is for Freight. Our rolling 12-month backlog, which is a subset of the multiyear, was $1.2 billion, which is a 9% increase from March. When 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'm happy to turn it back to Al for his summary comments.

Albert J. Neupaver

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 or -- and we increased our EPS guidance to about $3.52 on a revenue growth of about 15%. We're 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 is taking 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.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Allison Poliniak from Wells Fargo.

Allison Poliniak-Cusic - Wells Fargo Securities, LLC, Research Division

On -- so the past few days, obviously, a lot of noise with crude by rail and the tank car safety, and electronic braking, both in Canada and the U.S., is really getting some thought. Can you just give us your thoughts on it and how we should be thinking about it? Obviously, it wouldn't be something until, let's say, 2016 or so. Just curious.

Albert J. Neupaver

Yes, Allison. It has been -- it hit the news, as you know, I think it was yesterday. And we've taken a look at what's out there. Obviously, it's way early to try to understand, really, what the final specification's going to be. And we're 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 with their proposal, and obviously, provides quite a bit of flexibility, and it's hard to really make any statements related to how it might impact Wabtec today or even 2, 3 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 some color related to ECP. Today, if you look at worldwide, there's 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's also ECPs being looked at in some of the other freight-dominant markets around the world. Some of the positive advantages of ECP is that 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're either fully engaged or fully released. And they use dynamic stopping as a way to regulate the speed of a train, especially on grades -- 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 built in to every car, therefore, you could 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's been documented and reported that there are some fuel savings related to -- 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 and the pipeline. And it also -- it gives you less in-train forces, and the forces that are created by the emergency stop, obviously, can 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 crude by rail, it's just way too early to say. So I think is always the one thing that we've stated and we state again, I mean, our reason for existence is to work on the -- in helping the railroads improve their productivity, their efficiency and safety. And I think we're one of the few companies in the world that is totally focused on that.

Allison Poliniak-Cusic - Wells Fargo Securities, LLC, Research Division

No, that's great color. And then just the second question. In terms of your outlook for the year and keeping revenue, it implies somewhat of EBIT pressure in the back half. Should I assume that a big part of that is coming from Fandstan, from the acquisition?

Raymond T. Betler

Fandstan, Allison, as we said, is going to add significant revenue for the year. But relative to the operating result, we have 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 significant impact on the result.

Operator

Our next question is from Scott Group from Wolfe Research.

Scott H. Group - Wolfe Research, LLC

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'm wondering, why keep the revenue guidance at 15%? It feels like we're already kind of on that run rate before Fandstan. Is there something offsetting that's getting worse that's going to pressure the revenue growth? Or is there upside to that 15%?

Albert J. Neupaver

At this point, you have to look at the markets and you got to say, it's good. The rail business is good right now. There's no doubt about it. And I think that as we look into the second half of the year, it's easy to calculate that our revenue growth is almost all acquisitions related to Fandstan, and thus, as Ray just explained, that, 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're 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's always a little hard to predict. So yes, things are good in the marketplace right now. There's no doubt about it.

Scott H. Group - Wolfe Research, LLC

Okay. That makes sense. In terms of the margins, I think the negative mix of Fandstan for the rest of '14 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?" Or is there a level where you say, "You know what, this is as good as it can get?" Or does a 20% margin number, at some point in the future, not seem unrealistic?

Albert J. Neupaver

I can tell you -- and I'd like Ray to answer this as well, but I could tell you that you will never hear me make the statement that we can't get better. And 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're looking at adding this as the -- one of those areas that we focus on year-to-year that would give us incremental improvement. I think there's always room for improvement. I think that it also can be driven just by the -- 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's always room for improvement. And Ray, maybe you can talk a little bit about this cost-of-quality initiative that you started that I am super impressed with.

Raymond T. Betler

Yes. So 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've talked before about corporate counsels that we have in place that address every key business process area. There's 8 of those now. We just put 1 in place for project management. But quality counsel has put a, basically, a metric process in place where we measure total cost of poor 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're going to put a target in place. We've 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 lean process. And it focused on pricing. We're going to add incrementally to that objective, that requirement and include an improvement on cost of poor quality for every business next year. So that's not the only initiative, but it's an example of the initiatives that we have in place across the corporation.

Scott H. Group - Wolfe Research, LLC

That's good, Scott. And just last question, just a follow-up on the ECP brakes. Can you just remind us -- and I think we understand you guys have the patent. Are there competitors with similar patents on the ECP brakes? And what's your latest estimate on the revenue per car for you guys? Because it does feel like it's coming in Canada and, who knows, maybe in the U.S.

Albert J. Neupaver

Yes. Right now, there's 2 suppliers of electronic controlled pneumatic braking: ourselves and New York Air Brake, which is a U.S. division of Knorr, which is our competitor in Germany. It's privately held. The ECP, when you look at what the costs are for an EP -- ECP system, it's 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 2 different parts: There's a service part and there's an emergency part to the brake. And there's a pipe bracket that combine these 2. You -- 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 brake and only use ECP. So that's an option. You could also take an existing brake and add a pipe bracket as well as ECP to it. So it's a range of costs that really could be a few thousand up to $7,000 or $8000 to outfit a railcar. You also have to have -- in order to work, you have to outfit the locomotive with compatibility with the particular cars. And that adds another cost to the particular implementation.

Operator

Our next question is from Sam Eisner from Goldman Sachs.

Samuel H. Eisner - Goldman Sachs Group Inc., Research Division

Just going to the comments on cash flow. I think through the first half of the year, operating cash flow was about $137 million -- $140 million versus about $45 million last year. So just curious what's driving the strength in cash flow for this year.

Patrick D. Dugan

The second quarter -- this is Pat, by the way. The second quarter was particularly strong. We -- 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, it -- we explained that does drive up some of the working capital elements. But it's, obviously, acquired through the deal. The combination of all those things gave us a really good "cash flow from operations" result in Q2. And in Q1 and then in the first half of 2013, you had projects and revenue growth that were really driving up working capital.

Samuel H. Eisner - Goldman Sachs Group Inc., Research Division

Understood. And then just to follow up on that. I mean, is the expectation for this year that free cash will be in excess of net income? I know that the last 2 years, we haven't reached that bogey. So just curious how you guys are thinking about that.

Patrick D. Dugan

Yes, it's always been our goal -- our stated goal. And we plan to execute...

Albert J. Neupaver

We expect to do that.

Patrick D. Dugan

Yes.

Samuel H. Eisner - Goldman Sachs Group Inc., Research Division

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're basically implying $280 million or $290 million. Curious what you're seeing in the marketplace from a PTC standpoint. And then what is the expectation, potentially, for 2015 on PTC?

Raymond T. Betler

I think that PTC, Sam, is -- what we're seeing in marketplace is, to some extent, probably people trying to do their best to meet the deadline. Even though people have announced that they're 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 make-up, catch-up that is a result of the suspension that existed because of the Native Indian burial grounds that's resolved, and people are probably trying to do some catch-up there. So I think, overall, it's a healthy situation, and it's going to continue into 2015.

Samuel H. Eisner - Goldman Sachs Group Inc., Research Division

Great. And then just lastly on the nonrail business, there wasn't a lot of commentary on that on your prepared remarks. Just curious how that business is faring. 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 there would be helpful.

Albert J. Neupaver

Well, it actually is improving as we go forward. We're seeing a lot more activity out of our customers in that particular area, especially when you look at the heat exchanger business. It is tied to the oil and gas exploration, the frac-ing business. That is really coming back very strong for us. And that's globally. 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.

Operator

Our next question is from Justin Long of Stephens.

Justin Long - Stephens Inc., Research Division

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 prebuy and then a headwind in 2015 if builds are a little bit weaker? What's the best way to think about that?

Albert J. Neupaver

As we view it right now, there could be a prebuy. I think that if you go back in time, you step back 18 months, 2 years ago, many of the Class 1 railroads are saying they weren't going to need locomotives for a number of years. Obviously, that's changed because of the pressures they're seeing. Velocities went down, the demand's gone up and the economy, 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. Some of that are prebuy, and I know there's some 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 rebuilds or overhauls? That's some of the things we'll see. The one thing I 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 prebuy. The other thing that's happened on the Tier 4 -- maybe, Ray, you could comment about what business we've seen from the need to supply Tier 4 motors in some of the specialty markets.

Raymond T. Betler

Yes. I think, Justin, we're going to -- we're well positioned to address the Tier 4 opportunities. As a matter of fact, we have a group of people meet with one of the locomotive builders today just on that topic. So we've done a lot of work to prequalify our equipment, heat exchangers for instance, and respond to those opportunities. We've mentioned before that we also will likely be the first Tier 4-compliant commuter or locomotive provider in NAFTA with our gold transit opportunities. So both in the rail sector and outside of the rail sector, we've done our work to position ourselves and have qualified our products. So we'll be able to support and respond to our customers' needs as it's related to that regulation.

Justin Long - Stephens Inc., Research Division

Great, and that's 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?

Albert J. Neupaver

We have no accurate projection in '15. So we won't really provide you one. I think that the rate of the locomotive build, as we see it, is pretty constant right now. So I would think that second half's going to be very similar to the first half. But I wouldn't make a forecast into '15 yet.

Justin Long - Stephens Inc., Research Division

Okay, great. And last question. As you're looking at M&A opportunities, have you seen any major changes to valuation multiples in the market? I know if you go back historically, the average EBITDA multiple you've paid, especially on a post-synergy basis, is pretty impressive. I'm just curious if you still think you can get deals done around that historical multiple you've paid.

Albert J. Neupaver

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's an upward push on pricing. We will remain disciplined in our approach, and the relative price we pay, obviously, has to reflect what the market is and is directly -- can be directly correlative to how strongly we feel it's a strategic fit.

Operator

Our next question is from Matt Brooklier from Longbow Research.

Matthew S. Brooklier - Longbow Research LLC

Just curious if you have the number for PTC revenue contribution for second quarter.

Albert J. Neupaver

Yes. It was $74 million. About $74 million.

Matthew S. Brooklier - Longbow Research LLC

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

Albert J. Neupaver

It's staying pretty consistent what we've seen in the past with about 50% in Freight, 25% in Transit and about 25% in international. We'll 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 projections, that's pretty accurate.

Matthew S. Brooklier - Longbow Research LLC

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 the end of '15 and that mandate deadline, if that starts to get pushed out, and the marketplace is more comfortable with not making that potential deadline?

Raymond T. Betler

Yes. I think, people are trying in earnest, Matt, to do everything they can to come as close to the deadline as possible. You have several Class 1s that are running pilot tests right now, field tests with PTC-equipped segments of their railroad. So what we see are -- everybody is doing their best, I think, to try to implement PTC and respond to the mandate, and we're doing our best to support -- the testing that's being done on the railroads, thus far, has gone well. So I think you're going to continue to see significant progress over the next couple years.

Operator

Our next question is from Kristine Kubacki from Avondale Partners.

Kristine Kubacki - Avondale Partners, LLC, Research Division

I just wanted to try to -- not to beat a dead horse on this ECP, but just wanted talk a little bit about the opportunity there. Reading through the document that they put out yesterday, it's pretty lengthy, I know, but the government estimates that it's going to be between $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's new or retrofit. Do those numbers sound about right to you? And can I infer that what's your exposure to both the locomotive retrofit as well as the car?

Albert J. Neupaver

Yes, Kristine. There's 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 the, what we call, the overlay? Are we talking about new cars? Are we talking about taking an existing car and upgrading it? So it's 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's other technologies that are involved in what they're talking about in getting enhanced braking. Utilizing distributive power gives you some of the benefits that you would get from the 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 the middle of a train, and thus, you've got braking being generated and promulgated from the front and to 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's really premature, without knowing exactly what option's going to happen and what some of the pluses and minuses are to get overly -- I'd hate to get down the road on a potential that really is very iffy at this point. So what I thought best to do was just try to explain at least our view what we think the advantages are and how we see the market. We've been very encouraged about the adoption as well as the performance of this technology on a global basis. So I don't know if -- I apologize for not totally answering your question, but I just feel it's a little premature.

Kristine Kubacki - Avondale Partners, LLC, Research Division

I was going to say, you're not giving me the answer I wanted, Al. I'll try again later. Just a quick question on the ...

Albert J. Neupaver

[indiscernible]

Kristine Kubacki - Avondale Partners, LLC, Research Division

All right. A question on the highway bill. Obviously, we're probably kicking the can down the road. Is there any watchouts or any behavior we're seeing, changes on any -- on particularly any transit projects here in the near future?

Raymond T. Betler

No. Kristine, it's pretty much the same as it's been over the last several years. The people that run these transit authorities seem to be pretty resilient and use this kind of behavior. And they find 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. The 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's a little bit unfortunate. Sure, it's difficult to manage a business without knowing where your funding is coming from, but they've managed to do it pretty well.

Kristine Kubacki - Avondale Partners, LLC, Research Division

That's 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 still out there. And can your remind us how much that is? And I assume that's part of the option that was mentioned earlier.

Albert J. Neupaver

Yes. Right now, we think that the program will actually be turning the project over to the customer, probably early in 2015, at least first half. Right now, we've got one section of railroad that is running with our assistance in what we would call a pilot program. We're working on implementing it on another section of the railroad. The option, I think, is going to be delayed. That's worth probably another $80 million because of the demand for iron ore driven by the growth in China. It will happen some point, but right now, it's not on the table to be implemented immediately. That could change depending on -- keep in mind that this wasn't done because of the mandate. It wasn't done because of, actually, safety reasons. This was done for productivity. They had a older signaling system, and they wanted to go to the state-of-the-art signaling system. And so they're 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're going to do. But right now, that is off to table, as far as I'm -- as far as I understand.

Operator

Our next question is from Art Hatfield from Raymond James.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

Obviously, I'm going to ask some of the same questions, but it's all I got for you today. On the 40,000 cars globally that are equipped with ECP, what percent of those are equipped with Wabtec systems?

Albert J. Neupaver

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.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

Well, and that's my next question. Are you constricted based on your product to only selling in full-unit train?

Albert J. Neupaver

No, that's 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 a 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 the conventional way without paying the extra money. So you -- it could be used on either train. It's just that it would have the ECP capability.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

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

Albert J. Neupaver

I don't know.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

Okay. That's fair enough. Just looking at the quarter and the operating margin. I 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 were there certain things in the quarter that really helped that quarter specifically?

Albert J. Neupaver

I think, quarter 2 is pretty representative of this. And keep in mind, we had about almost $18 million of Fandstan. And with the PPA and the other thing, I doubt if it contributed any margin whatsoever. So -- and we typically have these onetime pluses and minuses that we try not to -- they're 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?

Patrick D. Dugan

No. I don't think there was anything worth really noting that's unusual from quarter-to-quarter. I mean, it's an improvement over the first quarter of '14 and an improvement over the quarter of '13. So I think it's a good operating margin.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

Last question, and I appreciate your comments about your desire to continue to grow margin. 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? I -- 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's just not an opportunity that we can generate a return on?"

Raymond T. Betler

Art, I don't -- I'm trying to think of opportunities we can generate a return on. There's almost no area, certainly, that we're working on purposefully that doesn't, in one way or another, impact our ability to improve our margins or improve our overall profitability. So...

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

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

Raymond T. Betler

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 equipment, they're made on product development programs, they're made on acquisitions, and we have plenty of those. We have plenty examples of that -- where we've gone through, assessed various opportunities because it comes down to management capacity and resource capacity. And there's many places where we've made decisions not to do things and prioritized better opportunities over those. But there's no areas that I'm aware of that we have made decisions to go ahead that we don't have opportunities for margin improvement.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

So -- 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?

Albert J. Neupaver

[indiscernible] we have them every month. Probably every day, we do something that we aren't totally pleased with. 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 2 of which were not performing where it should've been. And part of that presentations was lessons learned. It's part of the culture. It's part of continuous improvement. And that -- those really become the opportunities. Those are the things that you have to do because the next time you're in that same situation, you got to be able to approve it. And I think our team realizes it. And when you put an up-and-coming executive that wants to impress someone, he's got to explain to the Board of Directors why we didn't hit the numbers we were supposed to hit. It has a meaningful impact on culture.

Raymond T. Betler

And Art, I know we've talked to you before about restructuring programs we've 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'll 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're difficult. They're not easy discussions. You're 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.

Arthur W. Hatfield - Raymond James & Associates, Inc., Research Division

I actually was just trying to get educated, and I hope -- I've got some other companies I hope are listening to what to you were saying there.

Operator

Our next question is from Liam Burke from Janney Capital Markets.

Liam D. Burke - Janney Montgomery Scott LLC, Research Division

Ray, near term, you saw nice traffic volume and CapEx numbers from the rails. Long term, you've got safety and fuel-efficiency issues. Is there anything that you saw in the first half of the year you see going forward that's giving you any kind of caution or concern?

Raymond T. Betler

I'm always concerned, Liam. But no. I think that we're very fortunate. It's a blessing to be in this situation we're in right now relative to the market. It comes down to our ability to perform.

Liam D. Burke - Janney Montgomery Scott LLC, Research Division

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

Patrick D. Dugan

I do. Hold on.

Albert J. Neupaver

First half.

Patrick D. Dugan

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

Operator

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

Willard P. Milby - BB&T Capital Markets, Research Division

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

Patrick D. Dugan

Yes. 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 that for -- the run rate for going forward would be about $75 million.

Willard P. Milby - BB&T Capital Markets, Research Division

All right. Also, just looking at gross margin, I think 30.7% is a high watermark over the past couple years. And historically, you've been moving it up the past 2 or 3 years. And I was wondering if you could give us a sense of what's behind this growth or improvement, rather.

Patrick D. Dugan

So I think that 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're, 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 of those things contribute to us getting the gross margin over 30% and our operating margin at 18%.

Willard P. Milby - BB&T Capital Markets, Research Division

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

Albert J. Neupaver

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

Operator

Our next question is from Steve Barger from KeyBanc.

Steve Barger - KeyBanc Capital Markets Inc., Research Division

I'm going to try one more margin question. Ray, I thought your comments on cost of quality were great. You guys have been very effective at driving operating margin expansion over the past couple of years. You averaged about 120 basis points in '11, '12 and '13. So 2 questions: First, how -- can you quantify how much of that came from the Wabtec improvement system versus how much came from mix tailwinds like PTC or anything else that may have been a positive for you?

Albert J. Neupaver

Let me just help with that a little bit because Ray's looking at me and saying, "I don't know." I don't think we have an exact number.

Patrick D. Dugan

Yes.

Albert J. Neupaver

But what I can tell you, when we put together a budget goal for a division, they'll put together action items that add up to around 2% improvement. There's a certain percentage that's related to WPS and average about 25% of that -- the 75% of that number is related to Wabtec Performance System. Now how much gets to the bottom line is very difficult to measure. I mean, we identify programs and give you that amount of savings. Does it all get there? Does half? But what normally happens on that 2% goal, only about 0.5% improvement ends up at the end of the day. So if you look at it from a target standpoint, we're 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're also the first to admit that good mix hides everything. It has problems, and it's 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 basis. 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's really, really difficult to quantify.

Steve Barger - KeyBanc Capital Markets Inc., Research Division

Got it. Well -- and so I'll 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 give you a net positive but somewhere below 2% in terms of where you're targeting?

Albert J. Neupaver

I think it's on a divisional basis. Division comes in and they'll manage their own projects. What you hope to always do is push down this culture to the lowest-possible level and our ability to manage now because of the -- just the size of the company. We have individual reviews with the division, but that division may be made up of 4, 5 plants where they've got to drive that priority deployment all the way down to the lowest common denominator.

Steve Barger - KeyBanc Capital Markets Inc., Research Division

Got it. And then last question. Ray and Al, you guys have a lot on your plate with the Fandstan integration that's 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 6 months [ph] or 1 year from now, in terms of how you see your plan of attack proceeding?

Raymond T. Betler

As far as acquisition, Steve, we have acquisitions right behind the one we'd just completed. So there's an -- 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 are specific targets that we've prioritized -- certainly, opportunities to continue to expand our Transit business are interesting to us. So those are the areas that we're focused on today, and we're making good progress in those.

Steve Barger - KeyBanc Capital Markets Inc., Research Division

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 or bolt on?

Raymond T. Betler

Yes. 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's something that I think we shared with you, we started working on 4, 5 years ago. So certainly, to benefit -- to be able to acquire a company that hits all of our corporate strategic objectives, has operations in 7 continents, the size that Fandstan is, was a significant accomplishment. But we don't anticipate that everyone's going to be like that nor do we neglect the strategic ones that are smaller.

Operator

Our next question is from Mike Baudendistel from Stifel.

Michael J. Baudendistel - Stifel, Nicolaus & Company, Incorporated, Research Division

I just wanted to ask a question on locomotive repair and rebuilds. One of the Class 1s this week was talking about rebuilding older locomotives in order to make up for some of the volume gains and some of the service disruptions. Have you seen any big pickup in those types of activity?

Raymond T. Betler

Yes. We have opportunities, certainly, Mike, for overhauls. There's -- some of our customers have focused on addressing the Tier 4 requirement that way. So you know that that's good business for us, is the overhaul business as well as the new OEM business on locomotive sector. MotivePower does complete overhauls. We do subsystem overhauls in many of our businesses, and we have a global services business with 1/2 dozen major service shops throughout North America. So yes, we've seen some of it, and we've continued to pursue it.

Michael J. Baudendistel - Stifel, Nicolaus & Company, Incorporated, Research Division

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?

Albert J. Neupaver

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

Operator

[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.

Albert J. Neupaver

No. 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'll also be visiting BECORIT division, which makes friction products for worldwide market. Thank you.

Raymond T. Betler

Thank you.

Operator

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

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