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Wabtec Corporation (NYSE:WAB)

Q2 2008 Earnings Call Transcript

July 22, 2008 10:00 am ET

Executives

Tim Wesley – VP, IR and Corporate Communications

Albert Neupaver – President and CEO

Alvaro Garcia-Tunon – SVP, CFO and Secretary

Analysts

Wendy Caplan – Wachovia

Kristine Kubacki – Avondale Partners

Art Hatfield – Morgan Keegan

John Barnes – BB&T Capital Markets

Paul Brodnar – Longbow Research

Steve Barger – KeyBanc Capital Market

Scott Blumenthal – Emerald Advisors

Operator

This is the conference call operator and welcome to the Wabtec Corporation second quarter 2008 earnings release conference call. (Operator instructions) I would like to turn the conference over to Tim Wesley, Vice-President, Investor Relations. Mr. Wesley, please go ahead.

Tim Wesley

Thank you, Andrea. Good morning everyone. Welcome to our second quarter earnings conference call today. Let me introduce the rest of the Wabtec team who are here, our President and CEO, Al Neupaver; our CFO, Alvaro Garcia-Tunon; and Pat Dugan, our Corporate Controller.

As usual, we will make some prepared remarks and then take your questions. We will make some forward-looking statements during the call. We ask that you please review today’s press release for the appropriate disclaimers. With that, I’ll turn it over to Al Neupaver, our President and CEO.

Albert Neupaver

Thanks, Tim. Good morning everyone. What I like to do is to review the second quarter results with a strategic update, take a look at our current market conditions and the outlook for the rest of the year. I’ll turn it over to Alvaro and he’ll cover the financials in a little more detail for you.

We had a record second quarter, for once again many things went right for us. In the quarter, the sales were strong with an increase of 20% to a record $390 million. We had a record earnings per share of $0.69, that’s 21% higher than a year ago quarter. Our backlog is at about $1.2 billion. This is up 3% from year-end and it really indicates a strong performance given our record sales in the quarter. These results are being driven by good progress on our strategic growth initiatives. Those initiatives are global on market expansion, new product development, aftermarket expansion, and acquisitions.

We continue to make progress on all of our strategic initiatives. In the second quarter, a little more than 40% of our sales were outside of the US. We had good growth in Europe with our friction businesses and in the UK, with our transit car refurbishment business. We also saw growth in a heat exchanges for the power generation market. Our after market service businesses in North America continues to grow as well.

We had significant activity in the corporate development area. We completed an acquisition of Poli on June 30th, just after our accounting period ended. This acquisition gives us a base to grow from in the European break equipment market. We are working to keep our pipeline filled with other opportunities.

Based on our performance and outlooks for the rest of the year, we have increased our 2008 guidance. Sales growth should be between 12% and 14%, it was just high single digit. Earnings per share of about $2.65, it was at 255. Both our freight and transit markets are expected to remain strong at a high level, with international being one of the key growth drivers for our businesses.

Keep in mind, this will be the second year in the row that our sales and earnings are forecasted to increase even as the US freight market is down. This shows the strength of our diversified business model and that our strategic initiatives are paying off and we continue to drive our margins higher through the Wabtec Performance System.

Then let’s talk about a little bit about the market conditions. Our freight rail market, so far this year, rail traffic is up; ton-miles are up 1.6%. Overall car loadings are up slightly also with gains in major commodities such as coal, chemicals and agricultural products, more than offsetting lower volumes in housing, autos, and inner model traffic. This market is driven by the economy and we will be watching this very closely.

As expected, rail car deliveries will be down this year but still at a good level. Most industry experts still expect low to mid 50,000 cars being delivered this year. The second quarter numbers are not released yet but our internal data suggest that orders and deliveries were similar to the first quarter. If that’s the case, then the backlog should be about 60,000 units, more than a year’s worth of production.

The locomotive market remains strong and our OEM builds are expected to be up in 2008.

If we are going to look at the transit market, we continue to see a strong market driven by federal funding and passenger ridership. Federal transit spending is up 6% this year to a record $10.3 billion. The current spending bill runs through September 2009. It’s likely the Congress will wait until the new president takes office next year before beginning any serious discussion about future funding levels.

Ridership continues to increase across the US. It’s up 3.3% in the first quarter after a 2% from last year, increase from last year. Setting records in cities such as Dallas and Charlotte. This growth is also driven some incremental after market growth for Wabtec.

High fuel cost and environmental concerns about emissions continue to drive growth and new investment. For example, there is new commuter rail activity in Minnesota, Utah, and New Mexico.

The international transit markets are much larger than the US and our market shares are much smaller so we expect faster growth in overseas markets.

I’ll turn it over to Alvaro who will drill down into the financial results for you.

Alvaro Garcia-Tunon

Thanks very much, Al. Good morning everyone. I’m pleased to be able to review what we felt was a very good quarter with you this morning. Highlights for the quarter includes strong sales and earnings growth, continued operating margin improvement, which is an area that is as Al mentioned that we continue to stress, a growing backlog and good progress in executing our various strategies.

As Al said again, we were very optimistic about the future but recognize that we face challenges with the uncertain economy outlook, which can affect the rail industry.

Now to get to the specific numbers, sales were 20% higher than the prior year quarter and hit a record $390 million. Three quarters of this sale, which we think is more impressive, three quarters of the sale increased came from organic growth, with an incremental $15 million coming from the Ricon acquisition, which closed in early June last year.

The transit group led the way in the sales growth with a strong increase due to several factors, car refurbishment projects in the UK, some of you that were with us for our analyst meeting there saw that our UK operation and the growth it’s experiencing, friction products particularly in Europe, transit car components in North America and the Ricon acquisition, which is in the transit field as I mentioned earlier.

This is the type of broad based growth that we aim for and we like to see but the growth was not just limited to the transit group. The freight group sales were also higher than the year ago quarter. We believe this is a very good performance as our deliveries have actually been down year over year and we’ve been able to offset this lower demand for OE freight car components with growth in other areas such as heat exchangers in the power gen market. We classified heat exchangers in the freight group and international sales in general.

Margins again, one of the areas where our key focus is to drive margins, higher operating margins for particular. For the quarter, our operating margin was 14.3% versus 14.1% last year. As a percent of sales, operating expenses were lower at 13.5% versus 13.8% last year indicating the strength of our operating leverage. We think this is a good performance, given the sales growth in transit and the addition of expenses from the Ricon acquisition.

Obviously, the margin improvement is also due to our efforts to lower costs through sourcing and Lean manufacturing and increase volume, which provides operating leverage as I mentioned earlier.

Now to give you some numbers, overall, one of the areas that I think we’ve mentioned in prior phone calls, we really wanted to stress was working capital reduction and I’m pleased to be able to say that we made some progress in this area. Last quarter, working capital, not including cash was about $216 million this quarter, in spite of the increased sales, working capital is about $191 million so a significant reduction there. Receivables decreased by $2 million, inventories were about $10 million higher, but payables increased by $13 million offsetting some of that increase.

Again, we think that’s a good performance but this is a key area when you’re a leading company as we are and we think we can do better.

Cash wise at quarter-end, we had $242 million in cash up from a $175 million at March 31. Cash during the period derived from operation was $64 million. But keep in mind that just after the end of the period, we spent about $80 million on the acquisition of Poli that I referred to earlier. The balance sheet does remain in great shape. Obviously, we have plenty of capacity to invest on our growth strategies and acquisitions.

As a matter of fact, if you’ve been keeping count, you will notice that since 2005 we’ve made about five acquisitions and we financed all of them with internally generated cash flow, which we think is a very meaningful accomplishment.

To give you some of the numbers that we typically give during the phone call, depreciation for the period was $6.2 million versus $6.1 million last year, amortization stable $912,000 versus $992,000 last year and CapEx at a very modest level of about $4 million this period versus $4.9 million last year.

Another number that you are interested in and we’d like to disclose is the backlog number, which again indicates another positive indicator for the future. The rolling 12-month backlog – this is the backlog that will be executed over the next 12 months was up 18% and the total backlog remained over a billion even with the record sales quarter.

The total 12-month backlog was $690 million versus $582 million at the quarter ended 03/31/08 so that’s the first quarter of ’08 about last year and it’s up over a $100 million. The segments of the $690, a $178 was in freight versus a $180 million in the first quarter. And again, freight is not a backlog-driven business so it’s not as significant.

In transit, of $690, $512 is in transit versus $402 million in the first quarter, indicating the continued growth in transit. The multi-year backlog, in other words, the total backlog regardless of when it is going to be executed grew from $1.1 billion last quarter to $1.2 billion this quarter. Of the $1.2 billion, $221 million is in freight and $940 million is in transit.

And with that, I think that concludes my remarks and I’ll turn it back over to Al.

Albert Neupaver

Hey, thanks Alvaro. Once again, we had a strong performance with a record $0.690 record sales and a growing backlog. Most of our in markets continue to be positive, which gives us the confidence to increase our sales and earnings guidance although we are keeping an eye on the US economy.

The diversity of our business model, freight and transit, aftermarket and OEM, NAFTA and international is serving the company well. The Wabtec Performance System provides an established culture of Lean manufacturing with continues improvement. We have an experienced in dedicated management team.

And with that, we’ll be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Wendy Caplan of Wachovia. Please go ahead.

Wendy Caplan – Wachovia

Good morning.

Albert Neupaver

Good morning Wendy.

Alvaro Garcia-Tunon

Good morning, Wendy.

Wendy Caplan – Wachovia

A couple of questions about international growth, can you remind us Al or Alvaro how much of the business today is international versus US and give us the year ago comp just so I have it handy and also talk about how the international business grew this quarter and versus the US.

Albert Neupaver

Okay. International sales this quarter was a little over 40%. If you look at first quarter of ’08, it was about 44% and the second quarter of ’07 was at 39% so as a percentage of business, it’s really held pretty steady. We think there’s a tremendous amount of opportunity though, in the international arenas, being driven in both freight and transit market.

The freight market really is being driven a lot by the countries that are doing a lot of mining and need freight capability and our technology. The transit market, as I said during the remarks, we’re a very small player in a very large market and we feel that there’s a lot of opportunity for growth there and one of the reasons that we are excited about are strategic acquisition of Poli.

Wendy Caplan – Wachovia

Before I asked about Poli, could you just tell us what the international business grew in the quarter and domestic as well, please?

Albert Neupaver

Okay. By group or the overall, Wendy?

Wendy Caplan – Wachovia

Overall is fine but you can do group, if you want to give me that?

Albert Neupaver

Okay. Do you have that, Al?

Alvaro Garcia-Tunon

Actually, Wendy you said you had two – we have it here we just need to add a couple of numbers. You said you had second question, if you can give us one second we’ll add it up and then we’ll do it at the conclusion of your question, how is that?

Wendy Caplan – Wachovia

That would be fine, Alvaro. Thanks. My other question was about Poli, if you could speak to us about why you think – what kind of opportunities Poli represents?

Alvaro Garcia-Tunon

Okay, there is tremendous amount a strategic rationale for the acquisition, it really expands our product line in the Europe with what you called a UIC approval of their products and that is a major hurdle that we have to overcome in order to participate in that market.

This way we do not have to develop these products on our own and then wait several years to get them approved. There key products are break disk for high speed applications and other UIC approved break valves and trend breaks. These are products that we do not offer today. Now Poli, although it’s a third in the marketplace, as far as market share behind (inaudible).

We believed that overtime we can increase that share when combined with our technology and marketing capabilities we have in our transit group. It’s going to take a few years to do that. And given the long cycle nature of transit but it will be faster than if we would try to develop our own product and in those markets.

Poli, it should add modestly to revenues in the second half. The EPS impact in ‘08 will be minimal because of purchase price accounting. We still expect it to be and it will be a greater than the first 12 months.

I think the exciting part about Poli is the fact that this European market is about five times that the market size of the US and it continues to expand because a lot that technology right now – the European technology is being exported to Asia and that again will open that market up somewhat to us.

And not only that, they also have freight products and we have not been much of a player in the freight market in Europe. So all in all we are really excited about the opportunity and I think that it is a strategic acquisition and we look forward to growth into the future but it will take a little bit of time to really get the fruits of that acquisition.

Alvaro Garcia-Tunon

And to answer your question, Wendy, quarter of year over year. Last year international sales were roughly about 125 and this quarter there are roughly about 150, 155 so more in that neighborhood Ricon added to that. Ricon had a significant presence in the UK, might say probably maybe about to $10 million on that is Ricon and the rest are organic.

Wendy Caplan – Wachovia

Okay. Thank you very much.

Alvaro Garcia-Tunon

You’re welcome.

Operator

Our next question comes for Kristine Kubacki of the Avondale Partners. Please go ahead.

Kristine Kubacki – Avondale Partners

Good morning gentlemen. How are you?

Alvaro Garcia-Tunon

Hey, Good morning. Hi, Kristine.

Kristine Kubacki – Avondale Partners

I just wanted to ask about if you could provide some outlook on going one step further on the acquisition question, on potential acquisitions in terms of pipeline and the overall attractiveness of those potential acquisitions.

Alvaro Garcia-Tunon

Our pipeline obviously is formed and we’re very active right now. We’ve got a lot of activity in different parts of the world. We really can’t comment on specific acquisition targets that we have nor their attractiveness but I will remind you that we are looking for acquisitions that are strategic to our business.

Number one, we are looking for acquisition to have certain hurdles from a financial standpoint. We think that the multiply, the upper limit on that multiple depended on how strategic it is – could be seven to eight times (inaudible). We are looking for acquisitions that are a creative in the first 12 months. Obviously we have to have – our hurdle will be in greater that our return on the capital.

And lastly, we take a look at it from an economic profit standpoint and try to make sure that its adding value to the corporation.

We are very active and I wish I could offer you more information about that activity but if will be forthcoming.

Kristine Kubacki – Avondale Partners

But your outlook hasn’t slow down in anyway?

Alvaro Garcia-Tunon

No, by no means.

Kristine Kubacki – Avondale Partners

Okay. And then, if you could give us a stand, I mean the operating margin picked up again in the quarter, I was wondering if you could – I know you’ll file this (inaudible). Is there in any sense you can give us on the operating margin transit – is transit continuing to close the gap with freight operating margin?

Alvaro Garcia-Tunon

Transit margins, as we say we’re going to be focus on that and it will show continuous improvement. It will be a small increment but it will show improvement over a year and over a quarter and freight margins, we again there we are looking for improvement. Obviously it’s a little harder to improve on the level that we have in the freight area.

Kristine Kubacki – Avondale Partners

Okay and the final one question, I was wondering on raw material pressure – is obviously a focus for everyone at this point. How do you see going forward and impacting Wabtec and how you are trying to deal with it?

Alvaro Garcia-Tunon

Obviously, raw material is of concern as you know commodity to really has peaked in the last few months. And continued to be at very high levels, the demand for these commodities on a worldwide bases as we see in the industrialization of China is causing a very difficult market situation.

I think that that in general Wabtec – we have lived through the tough times back in the ’02 to ’04 area where there was similar spike. And I think that we learned our lesson and that in general we find and we go around and ask this question as we talked to each of the divisions. How are they protected and we look at it from a number of ways, one is to make sure that we have surcharges or escalators based on our increased.

If that’s too difficult in the case of a contract, we look for other means in order to make sure that we have that particular raw material covered. I can’t say that we are a 100% covered on some of these increases because it’s always one change in a commodity that you didn’t think about. But in general, we feel that we have covered our sales fairly well when it comes raw material escalations.

Kristine Kubacki – Avondale Partners

Okay very good. Thank you very much.

Alvaro Garcia-Tunon

Thank you Christine.

Kristine Kubacki – Avondale Partners

Thank you.

Operator

Our next question comes from Art Hatfield on Morgan Keegan, please go ahead.

Art Hatfield – Morgan Keegan

Thank you. Hey, good morning everybody.

Alvaro Garcia-Tunon

Hi Art.

Art Hatfield – Morgan Keegan

Hey, Alvaro, can you tell us what the organic growth rate for revenue was in this second quarter.

Alvaro Garcia-Tunon

Yes, revenues went up quarter over quarter by about $65 million, about three quarters of that, so in to the 65 – about 45 of that was organic, Art, and the rest came from acquisition

Art Hatfield – Morgan Keegan

Okay, did you have any positive or negative impact from foreign exchange?

Alvaro Garcia-Tunon

We had, I would say a slight favorable impact from the facts. Obviously, the dollar is not at its strongest point, somewhere between $5 million to $7 million of revenues benefited from the weakening dollar.

Art Hatfield – Morgan Keegan

That’s from last year?

Alvaro Garcia-Tunon

From last year, yes.

Art Hatfield – Morgan Keegan

Is that the $5 million to $7 million – would that all fall in the like that organic number or is it a part of that –

Alvaro Garcia-Tunon

Technically yes, is in the organic number. Most of it in the organic (inaudible).

Art Hatfield – Morgan Keegan

That’s fine.

Alvaro Garcia-Tunon

One thing I should say though its affect on EBIT is relatively negligible.

Art Hatfield – Morgan Keegan

Okay.

Alvaro Garcia-Tunon

Right now we are fortunate in that – just because the way our operations are setup, we have call centers in certain countries and centers in other countries. We are in the fortunate position that we don’t have to do a whole heck of a lot of hedging because we have a natural hedge because the nature of the operations and offset each other. So it’s affect on EBIT was negligible.

Art Hatfield – Morgan Keegan

Is that a result of planning you did? I remember—what was, five or six years ago when the Canadian dollar went against you. You really got hurt there. Is that impact today as a result of planning and changes that you made from –

Alvaro Garcia-Tunon

I would basically say it’s a result of excellent planning but we have followed you. I’ll take all the credit for it.

We all know that it has happened before Al got. There’s two component of it, you’re absolutely right, part of it is a deliberate effort on our part as we saw the dollar weakening. Obviously our call centers in Canada became less competitive and we have shifted some of our calls from Canada to low resource countries.

Art Hatfield – Morgan Keegan

Okay.

Alvaro Garcia-Tunon

And that was the result of deliberative planning. The fact that we are a natural hedge position right now is the way – that’s one thing we watched basically every month and we look to see how the currencies are moving. And not anything that we could say has resolved our planning.

What we try and do is anticipate what going to be happen the markets as fast we can, plan accordingly. And if we think we need to hedge, we’ll hedge but right now like I said, we’re in a natural position.

Art Hatfield – Morgan Keegan

I know you guys though have not given guidance for next year. I know you’re not ready to talk about it. But unfortunately, we have to put estimates out there. And I want to think about hypothetical for instance.

As I look out to 2009 and I try to make assessments as to what the freight car market may look like. Just kind of broadly speaking out – what does that market need to look like for you to be able to grow earnings 10% or better next year. Can you do that if the market is flat? Can you do that at say freight car builds drop to the 40,000 level next year.

Alvaro Garcia-Tunon

Let’s first take a look at the freight markets. I think what we’ve seen are this obviously –when we are talking about freight markets, we’re talking about primarily railcar built.

Art Hatfield – Morgan Keegan

Right.

Alvaro Garcia-Tunon

And as you know only about 20% of our business is really tied to railcar build. So, what we’ve been able to do is manage our freight business by really focusing on our strategic initiatives, international markets, the after market acquisitions, market expansion. And we’ve been able to more than offset the decline that you’ll see from the previous year. I mean the previous year dropped and railcar builds in ’07. We were talking about deliveries of I think 63,000 cars and we’re talking about low 50s this year.

Art Hatfield – Morgan Keegan

Right.

Alvaro Garcia-Tunon

And in ’06, it was 74,000. So, we’ve been able to manage our freight business and look at other areas to grow. We would like to be able to continue to do that into ‘09 and we see no reason.

As far as what that railcar builds is going to be, probably your guess is as good as mine or any of the experts, but I don’t see that particular number particularly going up. And I think it would drip down, if anything.

More importantly is the ton-miles and utilization of freight line. And even in a recessionary period, as we’re in right now, it’s a good business to be in. The freight markets the ton-miles is up 1.6%.

When you look at what it cost to move a product, just between the truck and a train, there’s an advertisement. And I’ve read this number placement (inaudible). He has the advertisement – you can move a ton of freight, 436 miles in a gallon of diesel fuel.

I mean, that’s compelling when you think about the utilization of the freight line. So, I think it’s a good market to be in and I think the price of oil is not about to be retracting anytime soon. So, I think that market is a good market. We look at transit, we know we’re in about halfway or a little more in halfway through the spending bills just here in North America. And that bill continues to through September of 2009. And the spending will continue on and they all come out with another bill and again, ridership is up and it’s being driven by the price of oil and that’s a good market.

You look at the opportunity globally that we have internationally, those markets in transit is so much larger. And I talked a little bit about the freight market. And we continue to improve.

Our goal has always to have double digits earnings through the business cycle on average. And we know that we are tied to some sickly products. And it’s really the burden we have to really prepare for that and be planning for ’09 and 2010 right now.

We just went through our strategic planning processes and each of those businesses are required to take a look at that and come up with a plan. And that’s how we’re approaching at this point. I hope I did answer your question.

Art Hatfield – Morgan Keegan

Yes, I know. So, you got the strategic planning process. I mean, do you care to give us guidance for next year.

Alvaro Garcia-Tunon

I would love to – MOFE.

Art Hatfield – Morgan Keegan

Kidding aside, I guess – yeah what I’m hearing from you then is that you don’t necessarily feel handcuffed to that business. It is what it is. It’s cyclical but you feel comfortable in your ability to plan for that any and inevitable downturn which we’ve seen in the last couple of years. And you’ve successfully done that but even if we see further downturn in that business, you feel good about your ability to at least have a good opportunity to still grow earnings despite that.

Albert Neupaver

I think you placed the brutal facts of the business you’re in and then we plan around it. Does that mean that we’re always going to be able to overcome any of the turns? I can’t say that within a year.

Art Hatfield – Morgan Keegan

I understand that but you just don’t feel completely handcuffed to that line of business and –

Albert Neupaver

We used phrase early along. We were not going to ride the rails.

Art Hatfield – Morgan Keegan

Right.

Albert Neupaver

And we’re going to control our futures the best we can. It’s a good business to be in right now, the railroad.

Art Hatfield – Morgan Keegan

Do you see any other opportunities outside the rail business as things have softened and maybe there are some areas in the industrial community where maybe some smaller mom and pop type operations, don’t have access to capital anymore where they can even just maintain their business or even grow it. Do you see opportunities to move in areas where some voids maybe –

Albert Neupaver

We have expanded our corporate development group to where now we have four dedicated people in that particular area. Two years ago, we had zero and some of that effort is being afforded at exploring exactly what you’re saying, is looking for alternatives, adjacencies in the marketplace. We continue to evaluate opportunities. We are going to be selective. We are going to take our time and we are going to make sure there are good additions to the Wabtec team.

Art Hatfield – Morgan Keegan

Just one last one. The stocks had done extremely well. You guys have shown a very, very strong capability to grow. I think given what you put together in the last few years, I don’t know that we would have seen this kind of earnings generation given the downturn that we have seen the last couple of years. If you still have the same makeup as you had last cycle, has the board or has the company been approached about possibly selling the company? Has anybody shown any interest in Wabtec?

Albert Neupaver

We really can’t even, I can’t even comment.

Art Hatfield – Morgan Keegan

You can’t fault me for trying though.

Albert Neupaver

You tried about three different ways to get us to the same thing that we shouldn’t. Actually, to one of your earlier questions, I was going to add. Right now, when I first joined Wabtec, I think probably OE was about 55% of our sales. I think right now, it is about 40% of our sales. Just for this quarter, I think aftermarket was 59% and the OE was 41%.

So, I would suggest that if you are trying to get a measure where Wabtec is going to go, I think revenue on ton-miles and car loading are just as critical, really even more so than just freight car builds. And ton-miles tend to be relatively steady because we have shifted a large portion of – not shifted, but what we’ve done is we’ve grown the aftermarket and we continue to grow the aftermarket. And that’s the key area of emphasis.

Within freight, we have things like friction that are totally dependent on traffic, repairs, services, parts, all those are totally dependent on traffic. And I would suggest that really a better indicator than freight car builds is ton-miles and car loadings because of the impact to our aftermarket.

Art Hatfield – Morgan Keegan

Thanks. I know one of these days you will answer one of my questions.

Albert Neupaver

Long after we are retired.

Art Hatfield – Morgan Keegan

Thank you.

Albert Neupaver

Thanks a lot, Art.

Operator

Thank you. Our next question comes from John Barnes of BB&T Capital Markets. Please go ahead.

John Barnes – BB&T Capital Markets

Hi, good morning, guys.

Albert Neupaver

Good morning, John.

John Barnes – BB&T Capital Markets

Can you talk about the contracts that you have in place now in your backlog? Do you have a feel for what percentage of those are fixed price. And of those, if you do have fixed price, are you having any success at trying to re-negotiate steel coverage provisions of some kind or is that what you were talking about? Just having to do other things to negate the higher cost of steel?

Albert Neupaver

In review of the contracts and we’ve really gone through these, some of the older ones that probably date back. Some of these contracts were probably ‘04, late ’03-‘04 and some of the transit contracts. Some of those, there is some slight exposure. A lot of those times, we really tied up our suppliers but they really have been pressing us hard so there is this pull and tug all over the place.

The new contract, we are very conscious of the issues related to material inflations and if we don’t have an absolute surcharge, we have some type of a color that we put on the percentage change of each of the commodities that would require a re-negotiation of the price.

So, we have been pretty disciplined in that. We do have some legacy contracts that we live with in those cases, we do other things. We look at opportunistic buy and they do have to carry some inventory to cover it but we know the exposure and we limit the exposure that we have.

John Barnes – BB&T Capital Markets

All right, and as you break it down, the fixed price contracts that you do have in place, do they tend to be more on the transit side than the freight side?

Alvaro Garcia-Tunon

Definitely, our backlog in freight just does not really go much beyond 12 months as a few but not much.

Albert Neupaver

I think in total, if you look at freight, of the total backlog, I think close to 90% is less than 12 months 80-90%. So it’s almost all in transit.

And in those cases, in a lot of those cases, material is not a large percentage of the final price as well. So, it’s not a huge exposure.

John Barnes – BB&T Capital Markets

Okay. And then with the rising commodity prices, I know the funding is still out there, there’s still money to be spent on infrastructure and that type of thing but have you seen any of your customer base begin to pull back orders a little bit or bid activity a little bit with the thought, “Hey, we can’t get as much for our dollar today as we could a year ago. Maybe we are better off waiting” or is this the type of asset that you really can’t wait on and so you really have been seeing that the commodity price increase really affects your styles or marketing effort.

Albert Neupaver

Yes, it really hasn’t had much effect but there is a little more to the story. If you look the transit businesses, 80% of the funding is federal funding. And that particular funding is really on infrastructure and capital expenditures generally. And then you have to match with 20% from local funding. Where the transit authorities are really being intense is on the operating cost because of the rise in fuel cost and some of the labor cost that they have and what you’ve actually seen is that the Congress is starting to try to help them out.

I think that within the month of June, you saw one of the house committees approved, I think it might have been close to billion dollars a year for the next two years to help them on the operating cost of the business. And that’s where they are really getting cramped and you read a lot about – they could be providing more services but they don’t have the money to do it. Our particular product is really tied to that 80% federal funding that is used for infrastructure, rolling stock, locomotives and that type of thing. Okay?

John Barnes – BB&T Capital Markets

Yes, and then on the acquisition front, a couple of quarters ago, when you guys were asked about acquisitions, for a couple of quarters there, you just said, “Hey, there’s nothing we can do right now, evaluation multiples are just too high.” Now that you’ve done one and can you give us an idea? Have multiples come in and Al said you have got a pretty full pipeline of potential acquisition opportunities, with this one, it just kind of popped up. It was more of an anomaly and where do you stand in terms of – Are you ready to pull the trigger if the purchase price is right and are you ready to pull the trigger on multiple acquisitions? Can you integrate multiple acquisitions at one time?

Alvaro Garcia-Tunon

Yes. Our activity is if you go, I mean we went almost a year without acquisition and during that timeframe, we had a lot of activity and we really set the ground work for a lot of opportunities in some of the international platforms that we think are important and we continue to work in that area. We really can’t comment on the specifics of any activity but we remain busy. We feel that we are ready to be opportunistic when we feel that we have the right acquisitions on the table in front of us and we will be cautious. We are going to take our time. We are going to make sure we understand it but I think acquisitions has been and will continue to be an important part of our growth strategy.

John Barnes – BB&T Capital Markets

Okay. Very good. Thanks for your time, guys. Nice quarter.

Alvaro Garcia-Tunon

Thanks, thank you John.

Operator

Thank you. Our next question comes from Paul Bodner of Longbow Research. Please go ahead.

Paul Bodner – Longbow Research

Yes, good morning, gentlemen. Thanks. One quick question because last time you had updated us on ECP and ETMS and just kind of what sales looks like in the quarter. I know it’s a long process but are you going to further update on that?

Albert Neupaver

It is a long process. I had a full head of hair when we started it.

Alvaro Garcia-Tunon

Black hair.

Albert Neupaver

Black hair. ECP is working at electronic controlled pneumatic braking. It’s an important opportunity for us. What you have is you have two pilot programs with a 3rd pilot program with another railroad coming on in the next month or so. These pilot programs are being – they are trying to prove up the technology to make sure that they get the fuel savings and they get the efficiencies and the cycle times that they need.

The opportunity for electronic controlled pneumatic braking is primarily on what they call unit trains that go back and forth from the same two places and that makes up 20% to 25% of the fleet out there. So, it’s a huge opportunity when you consider about $4,000 per car in order to upgrade and there is about a billion three cars. So you could see the opportunity. We expect that opportunity to start rolling out.

The test on pilot programs will run another 12 months in minimum and from that time on, there will be a gradual roll out of that technology if it’s proven as we expect it be. As far as electronic or positive train control, we have our pilot, which was proven and the product safety plan approved at BNSF. They are in a commercialization phase of the program for an overlay system.

We are working with two other major railroads on a vital ETMS system and those pilots, we should actually have equipment up and running in early 2009. It will take a good year to submit what is called again the product safety plan for the FRA. Once it is submitted and approved, then commercialization should follow that. That will be a slower and a smaller – it will take much more time but in addition, it’s a little bit of a smaller market. It’s more in the $400 million area if it was implemented across half of the locomotives out there, where the ECP is about a billion-dollar market opportunity with other player being involved and that’s New York Air Brake.

Paul Bodner – Longbow Research

Okay. Any (inaudible) on ECP? I mean, internationally, how’s that is going –, I believe you (inaudible) in Australia and also and in South Africa?

Albert Neupaver

Yes, they are running really well. The Australian ECP has been out there since 2004. There is one train running in South Africa and it will be, that’s running without any problem at all and they are seeing the benefits in both locations.

Paul Bodner – Longbow Research

Any further opportunities on that, along those lines?

Albert Neupaver

I think in those countries, especially the mining countries where they used the unit trains, again, point A to point B, the problem gets in is when you have to mix cars, you can’t do it. The whole train has to be ECP or not ECP and as you know, freight cars could be pulled by different companies across the country. So, it is with these unit trains that I think we first targeted with this technology.

Paul Bodner – Longbow Research

Can you also back off for the year on margins. I may never see it was round up in raw material prices. I mean, can we expect them to hold at the current rate or from the current quarter in the 14.3% operating margin there or did you expect that to pull back some…

Albert Neupaver

Yes, we always get fluctuations quarter to quarter, but keep in mind, continuous improvement is what we really count on here. We are not looking for the big bang. We are looking to improve ourselves week-on-week, day-on-day, month-on-month, quarter-on-quarter.

Paul Bodner – Longbow Research

Okay. Thanks a lot.

Albert Neupaver

Thank you.

Operator

Thank you. Our next question is from Steve Barger of KeyBanc Capital Market. Please go ahead.

Steve Barger – KeyBanc Capital Market

Good morning.

Albert Neupaver

Good morning, Steve.

Steve Barger – KeyBanc Capital Market

You said the $45 million of the $65 million increase in revenue was organic? Can you talk about price versus volume?

Albert Neupaver

I would think that we got very little of that as priced small percentage, single digit if less –

Steve Barger – KeyBanc Capital Market

Okay, are you internally talking about raising prices to capture cost or you’re not seeing the need to do that yet?

Albert Neupaver

I think price increase – normally we’re able to deal with commodity increases, which is the surcharges but we don’t consider that a price increase. We’re discovering our cost. Normally, it affects your margins because you don’t get the incremental margin on –

Steve Barger – KeyBanc Capital Market

Right.

Albert Neupaver

Where we have the – products that are much more differentiated than other products. Obviously, pricing is important and we will continue to be very aggressive in getting pricing where we can.

Steve Barger – KeyBanc Capital Market

Okay. When thinking about the 10% freight growth, did that come more from freight car components themselves or locomotive parts or heat exchangers? Can you talk about where the real strength was in the quarter?

Albert Neupaver

Yes, there was some strength in primarily aftermarket, international market, and heat exchanges, so all three probably an equal contributor to that growth.

Steve Barger – KeyBanc Capital Market

Okay, and are you seeing any pull forward from customers who might be anticipating higher prices? Are they worried about input cost?

Albert Neupaver

I think that they’re all worried about cost. I think, especially in the railcar area where it was probably the analysis of some fixed car contracts that make it very difficult. So, as I said earlier, this is – you’re being pulled in both directions. You’re trying to recover and it depends on how much leverage that and buyer has a purchaser as on you. So, I’m seeing a lot of pull from all directions when it comes to commodity pricing.

Steve Barger – KeyBanc Capital Market

Okay, one last question. Over the past couple of years, you’ve typically had a little bit higher EPS in the back half than in the front. This year, the guidance says we’re a $1.30 about in the back half versus a $1.35. Should we read anything into that or can you talk about any specific concerns you’re seeing by product line or region in the back half?

Albert Neupaver

I don’t think you ought to read into that at all. Other than typically, we see some seasonality in the third quarter. We have plans to shut down. We’re more of international than we were in the past. I think that has an impact.

We’ve also seen that increase in business – the volume increase and each, the next two quarters get increasingly more difficult as to comparison basis. So, I don’t think you ought to read anything into those numbers.

Steve Barger – KeyBanc Capital Market

All right, very good. Thank you.

Albert Neupaver

Thank you.

Operator

Thank you. Our next question comes from Scott Blumenthal of Emerald Advisors.

Scott Blumenthal – Emerald Advisors

Good morning, gentlemen. Congratulations on the quarter.

Albert Neupaver

Thanks, Scott.

Alvaro Garcia-Tunon

Good morning, Scott.

Scott Blumenthal – Emerald Advisors

Have you seen – we’re not used to, as North Americans, $4 a gallon gas prices. Have you seen a market pick up in interest for more fuel efficient locomotives as of recently?

Albert Neupaver

Yes, without a doubt. I think every class – one right now is working on programs that help. That’s part of the – we talk about Wabtec being one of the few companies in the world that could really change the technology of the industry when it comes to efficiency productivity. That’s exactly what ECP and ETMS – actually give you that opportunity to do so. So, we’re really pushing hard to get our technology and implement it and part of that technology, especially the positive train control, is with that on-board computer when tied with some kind of autopilot or gas optimizer or fuel optimizer, it could result in some major benefits.

Also, keep in mind that from a standpoint of our own locomotive business, our thrust on our commuter locomotive has been fuel efficiencies and that were things that we were pushing four or five years ago. And the introduction to our low emissions locomotive used in the yard is obviously more fuel efficient. I think the fuel efficiency on our commuter locomotive was 35% improvement over previous commuter locomotives.

Scott Blumenthal – Emerald Advisors

Okay. Have you been able to, Al or is the thrust to –

Albert Neupaver

One of the things, Scott, I was just thinking about to answer that question. I also read a statistic that – I couldn’t go out and verify this but this was stated by the – Ed Hamberger of the AAR that if he moved just 10% of the freight from trucks to freight rail, we would save 1 billion gallons of fuel in a year. That’s the kind of statistics that really excites you about the rail industry. I apologized for interrupting you.

Scott Blumenthal – Emerald Advisors

Oh, no. That’s okay. That’s helpful. Is there an initiative then at Wabtec to package all of these fuel-efficient and low-emissions offerings into one kind of a green offering and market that to rails? You talked about positive train control. You’ve talked about ETMS. We’ve got low-emissions locomotive. If you put all of these things together, there is a very compelling package to offer – total package to offer to rails not only in efficiency and cost savings within in environment.

Albert Neupaver

No question and we have an open position in marketing here, Scott.

Scott Blumenthal – Emerald Advisors

And it’s not all far commute for me.

Alvaro Garcia-Tunon

Hey, there you go.

Albert Neupaver

These are some of the discussions we’ve had during our strategic planning sessions. It was amazing how different divisions come in with this green approach. And some of the thoughts that you really talked about and putting it all together, is a package – it’s a unique and it’s a good idea.

Scott Blumenthal – Emerald Advisors

Thank you.

Alvaro Garcia-Tunon

Scott, just to add, this is trivial but just to give you an indication where we’re going when we were doing the strategic plans for our Friction Unit. They were even talking about a green break shoe that it’s totally recyclable and decomposable and they think that’s something that would have appeal to the railroads worldwide. So, I think everybody’s moving in that direction and we’re not going to be left behind. We think we can participate.

Scott Blumenthal – Emerald Advisors

Okay and I guess my last one – Thanks, Alvaro. Is the weak dollar, are you starting to see or have you seen interest from other geographies locals, that you wouldn’t normally have seen looking for products that are priced in dollars and maybe wanting to source U.S.-based goods where they traditionally wouldn’t have been interested?

Albert Neupaver

Yes, obviously it makes us more competitive on our export product and we’ve seen that almost globally. So, it has had some of the positive effect on our international business.

Alvaro Garcia-Tunon

And again, the key for some of our products is you have to be approved before you could sell. You have to be homologated and approved by the specific rail unit or the governing authority of that territory and that’s really one of the advantages of Poli. We do get products that have been approved and now, we can start supplying some of that content through low resource countries. So the Poli acquisition fits right in with being able to do what you just said.

Scott Blumenthal – Emerald Advisors

Okay. Well, thank you and congratulations again.

Albert Neupaver

Thanks, Scott.

Alvaro Garcia-Tunon

Thanks, Scott.

Operator

Thank you. (Operator instructions) Gentlemen, we have no further questions at this time.

Albert Neupaver

Okay, thanks a lot

Alvaro Garcia-Tunon

Thanks, Andrea.

Albert Neupaver

Bye-bye.

Operator

This concludes today’s Wabtec conference call. Thank you very much for participating. You may now disconnect.

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Source: Wabtec Corporation Q2 2008 Earnings Call Transcript
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