Westinghouse Air Brake Technologies Corporation
Q3 2014 Earnings Call Transcript

Published: 28 Oct 2014

[Operator:]

Good morning and welcome to the Wabtec Third Quarter Earnings Release Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Tim Wesley, Vice President of Investor Relations. Please go ahead.

[Tim Wesley:]

Thanks, Bill. Good morning, everybody. Welcome to Wabtec's third quarter earnings conference call this morning. Let me introduce the other Wabtec people who are here with me

[Al Neupaver:]

Thanks, Tim. Good morning, everyone. We had an excellent operating performance in the third quarter with record sales of almost $800 million and record earnings of $0.93 per diluted share. Cash flow from operations was also strong as we generated $93 million, exceeding net income. Our backlog now stands at a record $2.18 billion. The overall business is performing well thanks to our diversified business model, our strategic growth initiatives and the power of our Wabtec Performance System. We’re optimistic and excited about the long-term opportunities in our freight and transit rail markets. These markets are large, global and growing and we are positioned well to participate in them. Today, we increased our 2014 guidance. We now expect full year earnings per diluted share to be between $3.58 and $3.62. That is based on a sales growth of about 18% for the year. We have some assumptions in our guidance; continued modest growth in the global economy; the assumption that the U.S. and European transit markets will remain stable with the emerging markets driving growth. The U.S. freight rail traffic continues to grow with OEM locomotive and car builds also growing. So far this year, freight rail traffic is up about 4%. We’re assuming no major changes in foreign exchange rates and a tax rate of about 31% to 31.5% for this year. Our guidance includes the three acquisitions we completed so far this year. As always, we will be disciplined when it comes to controlling cost. We’ll be focused on generating cash to invest in growth opportunities, and always ready to respond if market conditions change. Now I’d like to turn the call over to our President and Chief Executive Officer, Ray Betler.

[Ray Betler:]

Thanks, Al. One of the reasons we’re optimistic about Wabtec’s future is that we’re involved in very compelling markets. Those markets, mainly freight rail and passenger transit, are large, global and growing. According to a UNIFE study, the worldwide adjustable rail market exceeds $100 billion with an annual growth of about 3%. One common theme around the world is that customers are focusing on improving safety, productivity and efficiency and Wabtec plays an important role in all of those efforts. The markets are also compelling because an efficient transit system and transportation network and robust infrastructure are essential to global economic growth in both developed and emerging countries. Also driving global investment are secular trends in urbanization, energy evolution and increased environmental awareness. In NAFTA on the freight rail side, freight traffic is up 4.2% so far this year. It’s led by an increase of 5.7% in intermodal. OEM rolling stock deliveries this year are strong. We expect more than 1,200 locomotives to be delivered compared to 1,000 last year. The freight car market continues to be strong with third quarter deliveries up about 18,000, orders of 43,000, which puts the backlog at about 124,000, another record high. Full year delivery should hit in excess of 67,000. Globally freight traffic is somewhat mixed. In Brazil, MRS had a record first half with traffic up 8%. India saw growth of about 5% while traffic decreased about 1% in Russia, Germany was up about 1.5%, UK was down about 2%. As you know, we’re focused on increasing our global footprint in our product offerings where we see opportunities in markets that are larger than our traditional NAFTA model. The global installed base of locomotives exceeds 100,000. The global installed base of freight cars is more than 5 million with about 75% of those vehicles being outside of NAFTA. On the transit side, stability is still the theme both in the U.S. and abroad. In the U.S. and Canada ridership was up slightly in second quarter, in the UK ridership was up 3.7%, in the most recent quarter in Germany it was also slightly up. This year we’re expecting North America transit car deliveries to be about 1,000 and bus deliveries about 4,500. Both numbers are about the same as 2013. Transit funding in the U.S. is also stable at about 10 billion and that’s where it's been for the past several years. The current two-year transportation bill expired recently, but it was extended a few months as expected. Congress doesn’t seem to be focused or interested on long-term funding bill right now. Just as with freight, we’re focused on global growth and increasing our product offerings because the markets for transit are larger than NAFTA globally. We estimate that the global installed base of transit cars is around 300,000 with about 95% of those vehicles outside of NAFTA. Now let’s focus on growth and cash generation. Our priorities for allocating free cash remain the same, to fund internal growth including CapEx, to focus on acquisitions, to return money to shareholders through a combination of dividends and stock buybacks. In the third quarter we repurchased 124,600 shares for about $10 million. So we have about $175 million left on our 200 million buyback authorization. We remain focused on increasing free cash flow by managing cost, driving down working capital and controlling our capital expenditures. Our corporate growth strategies remain the same, global and market expansion, aftermarket expansion, new product development and technologies and acquisitions. So let’s talk about our progress in these areas. On the global and market expansion side, in the third quarter sales outside the U.S. were 416 million, a little more than half of our total sales and about one third of our sales five years ago. We continue to expand our capabilities and our market presence in various markets around the world. During the quarter we won a signaling project with a new customer in Brazil. We continue to have opportunities in places like Europe, China, India and South Africa. The common denominator in these markets is an ongoing need for transportation infrastructure, investment and maintenance. On the aftermarket expansion side, overall, our aftermarket sales were 497 million in the third quarter. That’s about 60% of our total sales and up from 358 million a year ago. This growth is due to acquisitions and also internal growth initiatives. Regarding new products, we continue to have tremendous focus in this area and it's driving much of our internal development projects for new technologies. Train control has certainly been one of several growth drivers and their sales came in at about 235 million in 2013 based. On our year-to-date numbers, we remain on track for PTC sales of about 25% this year as we continue to work with railroads and other industries to develop an interoperable solution. On the acquisition side, our pipeline continues to be very active and we’re pleased with the opportunities we’re reviewing. During the third quarter we closed on two acquisitions Dia-Frag and C2CE. So I would like to brief you a minute on those. Dia-Frag is based in Brazil and has revenues of about $45 million. It expands our friction product offerings in the niche market, motorcycle, brake pads and other highly differentiated products with a strong intellectual property content and technology. Dia-Frag also offers margins that are better than our corporate average and the company has a large installed base which provides recurring aftermarket revenue. Dia-Frag also offers us the potential to manufacture other products within their facilities for the Brazilian and South American market. C2CE, it's a company based in Australia and offers revenues of about 35 million. It provides turnkey train control signaling and communications solutions for us in that part of the world which include design, project management and installation. Those are very complementary capabilities with our Xorail business in Jacksonville. C2CE serves as a regional market provider. It allows us to address the Australian and South East Asia market. Those markets are large and growing and C2CE has a good installed base with strong customers like Rio Tinto and Queensland Rail. C2CE also has an excellent management team and technical staff with significant breadth and depth of experience in train control solutions. So we’re very confident in these companies along with Fandstan and we know that they'll be an excellent addition to our overall portfolio. Now, I’d like to turn it over to Pat Dugan for more details on the numbers.

[Pat Dugan:]

Good morning, everybody. Our sales for the second quarter were a record $797 million, which is 26% higher than a year ago quarter. Of this increase, about half was from organic growth and half from acquisitions. That remains consistent with our long-term expectation. In the Freight segment, our sales increased 33% or about 112 million. Only 29 million of that increase was from acquisitions. Therefore, the majority of the growth was organic from locomotive and freight car components, electronics and radiator, heat exchanger businesses. The transit segment sales increased 18% or about 53 million. 57 million increase was from acquisitions, so we’re essentially flat organically amongst all the other businesses. And the reason for that is that we had completed certain locomotive projects in prior quarters which contributed revenues. Adjusting for these projects, the organic revenue in the segment would have been up about 35 million or about 14%. Operating income for the quarter was a record 136 million or 17.1% of sales. As expected, that operating margin is slightly lower than prior quarters mainly due to the acquisition of Fandstan earlier in the year. During our second quarter call, you might remember that we said that Fandstan will contribute significant revenues in the second half of the year, but minimal earnings mostly due to expenses from purchase price accounting and from integration. In addition, its historical margins are currently lower than our transit margins. Now that we've had Fandstan in the fold for a few months, we’re confident that we can increase margins overtime and we continue to expect our corporate operating margin to improve over the long-term as well. Interest expense for the quarter was 4.6 million or about 800,000 higher than a year ago quarter and that’s because of increased borrowings for our acquisition program. Our tax rate for the quarter was 31.3% versus 29.2% in the year ago quarter. In the prior year we had a benefit from a tax law change in the UK. We expect our annual rate to be about 31% to 31.5% in 2014, but the quarters will vary due to timings of any discrete tax items. Working capital at September 30, 2014, we had a trade and unbilled receivables were around 715 million, inventories were 489 million and accounts payable were 389 million. At June 30th of this year, trade and unbilled receivables were 717 million, inventories were 482 million and payables were 397 million. As we discussed is prior quarters, our unbilled receivables are related to our portfolio of long-term contracts. By hitting certain project milestones, we’re able to bill for that work, so it would shift from unbilled receivables to trade receivables and be collected. During the quarter, we reduced that number from 252 million to 240 million and we expect to make further progress by year end. In the quarter, the company generated 93 million of cash from operations which we feel is a strong result. So far this year we’ve produced 231 million of cash from operations, which is a nine-month measure, and when you compare that to the prior year, for the full year results we generated about the same amount in 2012 and 2013. Cash on hand at September 30th was 213 million, mostly held outside of the U.S. We had 226 million on hand at June 30th. And our debt balances at September 30th were 522 million, which increased from 501 million at June 30th due in part to the acquisitions of Dia-Frag and C2CE. Couple of miscellaneous items we always point out. Our depreciation expense for the quarter was 10.3 million compared to 8.2 million in last year’s quarter. Our amortization expense was 6.7 million compared to 3.9 million in last year’s quarter. That’s up because of PPA and amortization from the acquisitions. CapEx was 13 million versus 9 million in the last year’s quarter. So far year-to-date our capital expenditures were 31 million and that’s compared to a budget of roughly $50 million. And backlog information. At the end of the third quarter, we had a record multiyear backlog of $2.18 billion. We split that in our segments; transit backlog was 1.3 billion and freight 886 million; the increase from the second quarter, about half gained from acquisitions and half gained from contracts for locomotive overhauls, freight car components and singling projects; a rolling 12 month backlog which is a subset of the multiyear backlog was 1.4 billion and you split that again; 641 million for transit and 736 million for freight. I’ll point out that the total backlog figures that we just quoted do not include about 220 million of contract options. We don’t count them in backlog until a customer actually exercises the options. With that report, I'll turn it over back to Al.

[Al Neupaver:]

Thanks, Pat. Once again we had a strong performance in the third quarter with record sales and earnings, strong cash flow and a record backlog. We expect to close out 2014 with another record year and we’ve increased our EPS guidance from $3.58 to $3.62 on revenue growth of about 18%. We are happy with our strategic progress and our 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 extremely dedicated management team that has taken advantage of our growth opportunities and ready to respond to any changes in market conditions. With that, we’ll be more than happy to answer your questions.

[Operator:]

We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Allison Poliniak with Wells Fargo.

[Allison Poliniak:]

The global growth strategy, you continue to execute well there. Can you maybe discuss areas or regions that you think you are gaining the greatest traction, maybe better than expected and then maybe conversely areas that you feel you're still a bit challenged in?

[Al Neupaver:]

I think overall you're correct, we are making great progress when you look at our international expansion with a third of our business outside of the U.S. just a few years ago and today we’re over 50% of our business. If you look at freight and transit individually, our freight sales, 43% were outside of the U.S., where in transit it was up around 65%. So, one of the areas that I think we continue to make progress in is transit. As we explained to you all over time that we’re a small player in a large market in both the European and the Asian areas. So we continue to focus on those areas and I think our acquisitions that we’ve targeted have helped that transition as well. When you look from a location globally where are we getting a better footing, I think it’s -- I would almost say almost everywhere else and I don’t know of an area that we’re not making progress in. We actually have entered some transit orders in Russia that was a target market for us. We’re getting a larger position in Europe. We have opportunities that we think that we’re going to be able to take advantage of in South Africa. If you look at the freight markets in Brazil and Australia, we continue to make progress and gain market share and continue to offer new products in those areas. Even with the shutdown of -- not the shutdown, but the slowdown in China, we still see a lot of activity in the infrastructure area. I think one of the things that Ray mentioned that is extremely important is that we did get another, not a large, but a small signaling project from a new customer in Brazil. I think that’s a great sign that our efforts at MRS are being noticed and I think that that hopefully will give us the momentum to continue its growth in that area as well as Australia after our acquisition with C2CE. So, I think internationally, we expect to continue to grow and we’re making progress around the world.

[Allison Poliniak:]

And then Pat, I just want to clarify. I think you said transit organic adjusting for the locomotive was up 14%. Was that the right number?

[Pat Dugan:]

That’s right. Yes, so we had -- if you go a year ago quarter, we had a couple of projects that are now completed. So if you were to compare the sales, we would end up with about $35 million in improvements and that’s about 14%.

[Allison Poliniak:]

And what’s driving that? It sounds like you had sort of flat funding. I mean is it your execution outside the U.S. that’s driving that organic higher?

[Ray Betler:]

So the order sales are large in the new locomotive area and they're lumpy. There's not continuous orders in the transit commuter market. So we had a couple of large orders, one in New York City that we finished out, one in NBTA that we're about to finish out. So we’re going to deliver all those locomotives this year. So it’s really the unique size of the orders in this area. But I think what your question was, where is the strength coming from transit globally and the answer is globally. We’re getting -- we’re having some success in new markets that we have been working on for years.

[Operator:]

Our next question comes from Justin Long with Stephens.

[Justin Long:]

I wanted to ask first about the organic growth profile of the business. Just given the tightness in the North American freight rail market, PTC, what you’re seeing globally, do you believe the organic growth rate that you’re seeing in the business today is sustainable? How do you look out over the next several quarters?

[Al Neupaver:]

We’ve said in the past and I think that this will continue to hold true, we think that organically we could grow our businesses mid single-digit rate. And if we want to sustain the top-line growth that we’ve experienced over the last five to 10 years, we'll then have to supplement that with acquisitions as well. Realizing that when we look at these acquisitions, we’re trying to make sure that we have acquisitions that are strategic. By strategic means means that we could grow and we can improve that profitability. So I think that when we put together our strategic plan, which we just presented to the Board just last month, we feel that we could very well hit that target of at least mid-single digits internal growth into the planning period.

[Justin Long:]

And as a second question, it’s obviously been a very good year for PTC and the related revenue growth, but I wanted to get an update on your early expectations for 2015. Do you think that PTC related revenue can continue to increase next year just based on your current contracts and the discussions you’re having with customers?

[Al Neupaver:]

Without really talking about 2015, because we’re right in the middle of our planning process for our budget Ray and his team are putting that together. I may just -- maybe Ray if you want to give an update on -- there was a nice report that we saw that was put out by the Association of American Railroads that kind of gives a summary on where they’re at and I think that will give you an indication on what you might see into the future.

[Ray Betler:]

So Justin, for '15 we feel pretty good about '15 and the reason is if you look at the report that Al has referenced and Tim can send it to you, it basically says that about 50% of the spend has been executed today, so that's 4 billion out of 8 billion. About 50% of locomotives have been equipped either fully or partially, about a third of the wayside equipment. So there is still a significant amount of revenue opportunity for the base business. And again, as we have elaborated several times, there will be follow-on opportunities associated with the aftermarket and enhancement. So there is still a lot of work to do. The railroads are working very hard to install and develop the qualification process and submit their safety cases. They’re all in different states of accomplishment there and we feel pretty good about '15.

[Justin Long:]

I’ll sneak one last one in kind of along those lines. One of the items that was brought up at the Investor Day was the potential to integrate new productivity related products into the PTC on-board technology in an effort to leverage that system. Could you provide some more color on what some of those products might look like and maybe a realistic timeframe for starting to make progress on that opportunity?

[Al Neupaver:]

I think that progress has already been made on a lot of that. I think you’ll see that the railroads are using not necessarily autopilot but throttle control and a similar mechanism is cruise control so that they can maximize their fuel efficiencies. There is also products that are related to planning on where some of these trains are moved, when they’re moved and how they’re moved, I think efficiencies related to sensor technology that would monitor the health of a particular locomotive. There are probably a myriad of enhancements that are being looked at and worked on, some of which are already being implemented. Are these going to deliver $8 billion of savings? No. But now that the railroads, the class ones and other railroads are going to have a computer on-board, it’s critical that we’re talking about how do we better utilize that computer to help with the productivity, efficiency and safety of the railroad and that’s exactly what we’re doing. Ray and the team are out there talking to the various railroads exactly about that and trying to pick the easier ones first and we’ll continue to work on this as we go forward.

[Operator:]

The next question comes from Scott Group with Wolfe Research.

[Scott Group:]

So, just want to follow up on the PTC question. How much of the revenue this year includes some aftermarket opportunity? And is there -- when do you think the aftermarket starts coming? And any way to put some context on how big that could be, is the first part on PTC? And then any update on how far along you are on the transit side with PTC?

[Al Neupaver:]

Okay. First question is related to, has the aftermarket really kicked in. And as you define aftermarket, the answer to that is, not extensively. I think that we have some service agreements that fall in that category, but we’re really focused right now on, especially in the U.S., on getting the pilots running, the field testing done. And once all this equipment has been commissioned, I think that’s when you start turning over to more of the aftermarket. We’re closer to that with our MRS project down in Brazil where we should be able to get some aftermarket business in 2015. Your second question was related to where do we stand on the transit. Up to this point we’ve announced five or six transit authorities that we have contracts with. That’s out of a potential 21. Those contracts we announced, you could go back and add them up, it’s probably $150 million to $170 million. So, that will give you an indication of where that is. It’s hard to predict the size of the projects because in some cases we may be the program manager or maybe a turnkey, in other cases we may just be supplying the on-board computer. So, I think that gives you a fair indication about where we’re at in the transit PTC. I think also in the transit arena, the aftermarket and service portion probably is a good opportunity as well, because most of those organizations do not have a large signaling department or people that are capable of maintaining that system going forward.

[Scott Group:]

We hear from freight rail, locomotives are really really tight. What’s your -- how do you think about the locomotive market entering next year? Do you have a better relationship with one versus the other OEM on that side? Does that matter if one of the OEMs is leaving the market? How do you think about how is Wabtec positioned with this tight locomotive market?

[Al Neupaver:]

We work very hard to have a good relationship with all potential customers. And I think the market right now because of the requirement of Tier 4 requirements on which one of the producers is now offering a product and my understanding is that they have a good backlog that goes out a couple of years related to that. But you must keep in mind that the locomotive market is not just for the U.S., there is a lot of locomotives being sold worldwide. And I think both the major U.S. producers are taking advantage of that international market trends that although we’re not sure we haven’t really looked to 2015 to the point where we could talk about it, but we think that the demand for locomotives is going to continue as long as the economy continues to push and there is demands. I think that there might be a tightness of availability, but I don’t see a big drop coming in '15 because of the regulation change as long as the economy keeps the demand up.

[Scott Group:]

Just last question maybe for Pat or Al or whoever on the margin side. So the margins were down, year-over-year operating margins, and yet the Fandstan mix impact. Should we think that the next three quarters have a similar cosmetic margin pressure or is it -- are there enough other things going on in the business or improvements coming in Fandstan where we can start to see margin expansion again in a quarter or two?

[Ray Betler:]

What happened in the third quarter when you look at all the acquisitions together, we had less than a 10% contribution margin from those increase in sales where the rest of the business was really operating where it should be. Some of that are just price accounting that is one time. Those onetime charges usually flow out between six to nine months and a little tail but not much of an impact. So I would think there would be some impact going into the first quarter of 2015. But also though after about three to six months we expect some of our synergies start kicking in as well to hopefully offset that.

[Operator:]

The next question comes from Arthur Hatfield with Raymond James.

[Arthur Hatfield:]

If I could kind of follow-up on that a little bit, based on kind of how I'm modeling fourth quarter due to your guidance that you gave for the rest of the year. I am kind of coming up with an SG&A number for the year that is growing a little bit above 20%. And I understand that could move around based on what actually happens with Q4. But I can’t even recollect, but it appears that that’s the first time that that’s going to outpace revenue growth in a very long time. And I understand that PPA is probably having an impact there. I know you don't want to get too much in the detail on '15, but should we think about that SG&A kind of flattening from here now that you have got these acquisitions installed or is there opportunity to reduce that number as we go forward?

[Ray Betler:]

We are always going to be doing acquisitions, so that isn’t going to slow down. But I think Pat has taken a good look at the SG&A, engineering and amortization and maybe Pat you can address that.

[Pat Dugan:]

Right. So if you look at the SG&A, we're roughly for the quarter 88 million. We have some acquisition cost and some other that when you take a full quarter it might increase that a little bit, but some other onetime expenses that are more related to PPA and professional fees. And so I think our run rate is going to end up being in the range of 85 million to 86 million per quarter for SG&A.

[Arthur Hatfield:]

And that’s exclusive of any further acquisitions I would assume?

[Pat Dugan:]

That’s right. And then when you look at engineering, I think our engineering is going to be relatively flat for the quarter. And then our amortization expense is a little high. We have some onetime acquisition amortization in there and that’s going to then be offset by ongoing amortization of intangibles and other cost. So I think the best number for your model would be somewhere around $5.8 million to $6 million.

[Arthur Hatfield:]

Also just as I think -- I have been trying to figure this out and I don’t know if my numbers are right because I am not going to share. But when I think about the acquisitions that you've made this year, and let’s just assume that there is no growth to the companies after you acquired them for that first 12 months, kind of how much acquisition revenue do you already have embedded for 2015?

[Al Neupaver:]

The only thing I would recommend you do is go back to the announcements related to each of the acquisitions and relatively when they were acquired. I think you could get a pretty good feel from that.

[Arthur Hatfield:]

Okay. So you are basically telling me my numbers are probably right?

[Al Neupaver:]

I did not say that. I don’t know your numbers.

[Arthur Hatfield:]

That’s why I asked you, Al. And did you guys say how much of a detrimental impact Fandstan had on margins in the quarter?

[Al Neupaver:]

The only I have mentioned is that the contribution margin related to all the acquisitions was 10%.

[Operator:]

The next question comes from Liam Burke with Wunderlich Securities.

[Liam Burke:]

Al, you talked about lots of opportunity on the transport side. You've had a fair amount of runway being the third player -- roughly the third player in the market. Are you seeing any competitive pushback here?

[Al Neupaver:]

Obviously our competitors are very aware of our presence in the marketplace. We have got excellent competitors and we have been in some tough battles along the way. And keep in mind that one of the things that we really like about the rail market is the barriers to entry. And just as we are able to protect our base pretty good, they do a good job of protecting their base as well. So as we do make progress, the one thing that you could be assured is that you've got to earn your ability to keep it. But if you do a good job, there is barriers for others to enter. So we do see some tough competition there.

[Liam Burke:]

And with the tight locomotive market you announced or you mentioned a servicing contract on the locomotives heading the backlog. Do you need to beef up that area of the business or invest any additional funds there?

[Al Neupaver:]

We have received some orders that -- the railroads have some choices on whether or not they buy locomotives or they could actually take and repower or upgrade their existing locomotives as long. As long as they improve, they don't have to reach Tier 4, but they do have to improve on the emissions. And some of the railroads are doing that and we're taking advantage of that. In order to take advantage of that, we do not need to spend any capital at all. We have the capability at our locomotive plant out in Boise, Idaho as well as we've put in -- I think we’ve established three if not four -- how many, Ray?

[Ray Betler:]

Three, currently.

[Al Neupaver:]

Yeah. Three current locomotive overhaul service centers around the country.

[Operator:]

The next question comes from Scott Blumenthal with Emerald Advisors.

[Scott Blumenthal:]

Al, the business showed very, very strong organic growth. I think we all have a good idea as to the pulse of domestic rail activity and the freight railcar business is strong with record backlogs. Can you maybe discuss some of the other business and markets that were particularly strong and contributed to the organic growth?

[Al Neupaver:]

I'll pass it on to Ray here.

[Ray Betler:]

In general across the board we have new product development that we’re introducing, Scott, throughout the worldwide market. We have a lot of examples that add, on the transit side, new brake systems, new calipers, new disks, new electronics that’s generated -- resulted in incremental revenue and future orders. On the locomotive side Al just talked about Tier 4 heat exchangers, we have developed for that application on the new locomotives for NAFTA. Locomotives internationally we have new products that we’re selling as complete brake systems. There is incremental growth organically through some of the acquisitions, Fandstan in particular has new technologies that they’re introducing that’s contributed to organic growth. So both on the freight and the transit side and a part of it is the diversified international markets that we have focused on and that focus has been both in product development and in certification. There is a tremendous effort in cost that’s required to participate in these international markets. And we, again slowly, shortly, incrementally are focused on getting that product certified so that we can sell into these international markets. Al mentioned Russia, Russia is a good example. We were on platform for locomotives in Kazakhstan. We took those products and we focused, like changes needed to be made in Russia and made those changes and over the last two years have gotten certification for a whole plethora of products in Russia. So those are some examples that I can give you.

[Scott Blumenthal:]

Ray, you did bring up the heat exchanger business. Obviously there are multiple applications for those things and you’ve been benefiting recently from some of the strength in the oil and gas business. Wondering if the recent downturn in oil prices concerns you and if you've heard anything either directly or anecdotally from some of the customers that maybe give you a little bit of concern there?

[Ray Betler:]

I would say in general, we are pleased, but are concerned about everything. So there is a lot of speculation about what’s going to happen on a micro and a macro basis in terms of changing oil prices. But we haven’t seen an impact at this point. And I think in general the heat exchanger business, both on power generation side as well as on the locomotive side, has been really good for us this year and we anticipate growth next year.

[Scott Blumenthal:]

And one last one if I may. Al mentioned the signaling project with a new customer in Brazil. I’m assuming that the new customer is separate from the MRS project which was the PTC project and I was also wondering if that represented the bulk of the -- or a larger portion of the backlog growth sequentially.

[Al Neupaver:]

As I said, it’s not a large order. It’s just an important order because it gives is more creditability in the marketplace.

[Operator:]

Our next question comes from Greg Halter with Great Lakes Review.

[Greg Halter:]

Relative to Scott’s question, that signal project, that I presume is a PTC project, correct?

[Al Neupaver:]

Yes.

[Greg Halter:]

And just one other housekeeping. Do you have the equity number at the end of the quarter?

[Pat Dugan:]

Yes. It’s 1,789,609.

[Greg Halter:]

I know you guys are big in WPS, so that’s good to hear. Actually that answers what I had. Thanks.

[Operator:]

Our next question comes from Samuel Eisner with Goldman Sachs.

[Samuel Eisner:]

Just to start off here, it looks like gross margin was up about 120 bps year-on-year and was definitely ahead of our expectations here. So it’s continuing to inch up. I’m just curious what specifically is driving that. Is that mix, is that WPS? Just want to understand again just on the gross margin line what’s driving that.

[Al Neupaver:]

Okay. I think some of it is mix. That’s a term we’re not allowed to use internally, because that’s usually an excuse not a plus. But I think the other thing is we continue to drive our margins through our Wabtec Performance System. I think Ray and the team have done a tremendous job staying focused on increasing the productivity efficiency, getting advantages from sourcing. He started a new initiative on cost quality. I think that’s what's driving it. There's only so much leverage that you have on your SG&A and operating cost. So, that’s the reason you’re seeing and hopefully we’ll be able to continue that.

[Samuel Eisner:]

And then transitioning to the backlog here, I think if our numbers are right, orders increased sequentially in freight over $300 million, transit is up over almost nearly $200 million. So, I mean can you maybe breakdown what the real drivers are of that significant quarter-on-quarter order strength?

[Al Neupaver:]

Sam, we've got to admit there's -- we were not totally complete analyzing the Fandstan backlog at the end of the second quarter when we fine tune that backlog that contributed to the part of the difference between second and third quarter. If you take that into account, that backlog about 50% to 55% of the backlog gain is from acquisitions, the balance was internal orders from which we talked about, freight car components, the locomotive overhaul. And I think that we feel that the internal growth rate is about 13%. We did some work on it.

[Pat Dugan:]

Yeah. Even if you adjust, I think it was about 100 million that the second quarter backlog was light. And even if you adjust for that, the third quarter backlog was still up by 13% over the second quarter. That's still a pretty strong increase.

[Samuel Eisner:]

I guess I can follow up offline regarding the actual numbers here. And then just lastly thinking about the railcar cycle, you mentioned that 67,000 expectation for 2014, initial view of the 2015, up, down, sideways, how are you thinking about that?

[Al Neupaver:]

Well, I think that again we’re in our planning process right now for next year. I know in my nine years in the industry I’ve never seen a backlog at 124,000, that's the only thing I could tell you. But there is capacity constraints, especially on certain types of cars that we’re aware of, especially tank cars which makes up 50% of the backlog.

[Operator:]

The next question comes from Matt Brooklier with Longbow Research.

[Matt Brooklier:]

So wanted to follow up on PTC, if I could. Do you have total PTC revenue contribution for third quarter and how that broke up between freight and transit?

[Al Neupaver:]

We think the sales were around 75 million and it’s still hanging in there, about half is freight, about 25% is transit and 25% international. So it is still around those percentages.

[Matt Brooklier:]

And I think, Ray earlier on the call talked to kind of the upper end of PTC growth, revenue growth, the range that you had provided at the end of second quarter. Just trying to get a feel for or A, confirm that and B, get a feel for why potentially you have more conviction in that bigger number.

[Ray Betler:]

Maybe I didn’t articulate it properly, Matt. But it was up 25% growth this year over last year.

[Matt Brooklier:]

Okay.

[Ray Betler:]

Is that what you’re asking?

[Matt Brooklier:]

Yeah. I think that the former range -- I’m probably getting a little bit too nitpicky here. But the former range was like 20% to 25% growth for this year and you talked to that 25% number. So I was just curious if...

[Al Neupaver:]

The reason for the range is that a lot of the orders right now -- and I think we might have explained this in the past – are tied to field testing and the field testing continues. If it’s moved up and there is no issues, you tend to see more orders than you would if there is – if they come in with an issue or when it gets slowed down for any reason. So, that was the reason for our conservatism and projecting last quarter.

[Ray Betler:]

And the other issue that Al mentioned, Matt, is the transit authorities continue struggle with this funding issue. So we can’t predict when they’re going to receive their funding and release order. So, we’re involved with all the transit authorities at various stages of business development. But a lot of their spending decisions are dependent on funding.

[Matt Brooklier:]

And then this new signaling contract in Brazil that it sounds like it is a PTC work. Are you able to provide a little bit more color on that contract, who potentially you are doing the work for? How much this could grow or maybe you're a little bit -- you are not able to give that color at this point?

[Al Neupaver:]

We are not able to give the color any further than basically what we say and it is PTC related work. And it’s a new customer and it’s a small amount. But the important thing is we are getting looks from other people and that’s one of the things we have talked about in the past. We just wanted to give you an indication of it. But we are not capable of saying anything else at this point.

[Operator:]

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Tim Wesley for any closing remarks.

[Tim Wesley:]

Okay. Thanks, everybody. We will talk to you at the end of February when we have our fourth quarter report. Have a great day.

[Al Neupaver:]

Thank you.

[Operator:]

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