Westinghouse Air Brake Technologies - Q2 2023

Transcript

Operator (participant)

Good morning, welcome to Wabtec's Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would like to turn the call over to Miss Kristine Kubacki, Vice President of Investor Relations. Please go ahead, ma'am.

Kristine Kubacki (VP of Investor Relations)

Thank you, operator. Good morning, everyone. Welcome to Wabtec's second quarter 2023 earnings call. With us today are President and CEO, Rafael Santana, CFO, John Olin, and Senior Vice President of Finance, John Mastalerz. Today's slide presentation, along with our earnings release and financial disclosures, were posted to our website earlier today and can be accessed on Investor Relations tab on wabteccorp.com.

Some statements we're making are forward-looking and based on our best view of the world and our business today. For more detailed risks, uncertainties, and assumptions related to our forward-looking statements, please see the disclosures in our earnings release and presentation. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics. I will now turn the call over to Rafael.

Rafael Santana (CEO)

Thanks, Kristine. Good morning, everyone. Let's move to slide four. I'll start with an update on our business, my perspectives on the quarter, and progress against our long-term value creation framework. John Olin will cover the financials. We delivered another strong quarter, evidenced by robust sales and earnings per share growth. We achieved these despite continued volatility and economic challenges. Sales were $2.41 billion, which was up 17.5% versus prior year.

Revenues was driven by strong performance from both the freight and transit segments. Total cash flow from operations was $115 million. Overall, our financial position remains strong. We continue to execute against our capital allocation framework to maximize shareholder value by investing for the future growth, executing on the strategic M&A, like our recent acquisition of L&M, returning cash to shareholders.

The 12-month backlog was $7.2 billion, up 10%, signifying growing momentum and visibility across the business. The total multi-year backlog was $22.4 billion. Overall, the Wabtec team delivered a strong second quarter, marking a good first half of 2023. Looking forward, I'm encouraged by the underlying strength and robust momentum across the business.

Wabtec is well positioned to continue driving profitable growth, even amidst a challenging economy. Shifting our focus to slide five, let's talk about our 2023 end market expectations for more details. As we look at key metrics across our freight business, we remain encouraged by the underlying business momentum and our robust pipeline of opportunities across geographies.

North America car loads continue to be down in the quarter, locomotive parkings moved up slightly as we exited the second quarter, but better than we had anticipated as customers prioritize service and fluidity. We continue to see significant opportunities across the globe in demand for new locomotives, modernizations, and digital solutions as our customers invest in solutions that continue to drive reliability, productivity, and fuel efficiency.

Looking at the North American rail car builds, demand for rail car continues to show growth. The industry outlook for 2023 is for about 45,000 cars to be delivered. Overall, we believe we have an opportunity to continue building significant long-term momentum with growth in modernizations, new locomotive sales, rail car builds, and digital solutions. Internationally, activity is strong in core markets such as Brazil, Australia, India, and the CIS region.

Significant investments to expand and upgrade infrastructure are supporting a very strong international order pipeline. Finally, moving to the transit sector, the mega trends remain in place, driving the need for clean, safe, and efficient transportation solutions around the globe. Let's turn to slide 6 to discuss a few recent business highlights.

In North America, we secured several key wins, including orders for 30 new locomotives, an order for 69 locomotives under our Certified Pre-Owned Program, and an order for 60 modernizations from Canadian National that closed after the end of the quarter. In Australia, we recently won a strategic order for 17 locomotives from CBH, which will support the continued growth of agricultural commodities in the region. With regards to our zero emissions portfolio, we also recently signed a strategic order with Vale for 3 FLXdrive locomotives.

These locomotives will pull the world's largest iron ore train and is expected to remove 63,000 tons of carbon, the equivalent of 14,000 passenger cars per year. In transit, we won a major order to supply passenger information systems and pantographs for up to 504 Stadler cars for Germany and Austria. Finally, during June, we completed the full-own acquisition of L&M Radiator.

This strategic acquisition will enhance Wabtec's existing heat transfer portfolio, and it will extend our install base in mining, providing a solid platform for domestic and international profitable growth. All of this demonstrates the growing momentum across the business, the team's relentless focus on delivering for our customers, and the strong pipeline of opportunities we continue to execute on. Wabtec is well positioned to continue to capture profitable growth with innovative and scalable technologies that address our customers' most pressing needs.

Turning to slide seven, I'd like to highlight how Wabtec will provide efficient solutions for our customers by driving their productivity, reducing fuel consumption, and improving safety, while leading the decarbonization of rail across the industry. Wabtec is uniquely positioned to shape a more sustainable future for rail by inventing and developing technologies that provide customers with adaptable and efficient solutions to meet their carbon reduction goals, while providing strong investment returns to our customers, given improved reliability, haulage ability, and fuel efficiency. Ultimately, we will help lead the industry towards a zero emissions rail network. We have already started laying that path to get there through new locomotives, modernizations, with advancements in utilizing renewable and biofuels, leading in battery electric applications, investing in hydrogen technology, and providing a wide range of digital solutions.

With that, I'll turn the call over to John to review the quarter, segment results, and our overall financial performance. John?

John Olin (CFO)

Thanks, Rafael, hello, everyone. Turning to slide eight, I will review our second quarter results in more detail. We delivered another strong quarter of operational and financial performance, with underlying business momentum strengthening through the first half of the year. Sales for the second quarter were $2.41 billion, which reflects a 17.5% increase versus the prior year. Sales were driven by strong growth across all major product lines. For the quarter, GAAP operating income was up $48 million, driven by higher sales. Adjusted operating margin in Q2 was 16.4%, down 0.3 percentage points versus the prior year. The benefits of higher sales were offset by a less rich mix of sales between and within segments.

GAAP earnings per diluted share were $1.06, which was up 16.5% versus the second quarter a year ago. During the quarter, we had pre-tax charges of $10 million for restructuring, which was primarily related to our Integration 2.0 initiative to further integrate Wabtec's operations and to drive $75 million-$90 million of run rate savings by 2025.

In the quarter, adjusted earnings per diluted share were $1.41, up 14.6% versus the prior year. Overall, Wabtec executed a good quarter and a strong first half of 2023. We outperformed our expectations, demonstrating the underlying strength and momentum of the business, as a result, we are raising our full year outlook for sales and adjusted earnings. Turning to slide nine. Let's review our product lines in more detail.

Second quarter consolidated sales were very strong, up 17.5%. Equipment sales were up 8.9% due to higher locomotive sales this quarter versus last year's second quarter. Component sales were up 23.1% versus last year, largely driven by the higher OE rail car build and an increase in our market share due to product availability, along with increased demand for industrial products. We also closed the strategic acquisition of L&M late in the quarter, which did not have an impact on component sales during the quarter. Digital intelligence sales were up 18.9%, which was driven by robust demand for onboard locomotive products and international PTC, along with revenue contribution from the acquisitions in Q2 of last year. Our services sales grew 13.9%.

Sales growth was driven by higher sales from increased modernization deliveries and increased part sales. Our customers continue to recognize the superior performance, reliability, efficiency, and availability across their Wabtec locomotive fleets. Across our transit segment, OE and aftermarket sales significantly increased versus last year. Segment sales were up 25.3% to $699 million. The momentum in this segment is strong across our core markets as secular drivers, such as urbanization and decarbonization, accelerate the need for investments in sustainable infrastructure. Moving to slide 10, as forecasted, gross profit margin was slightly lower, driven by a less rich mix and higher manufacturing costs. Mix was unfavorable, driven by strong sales from the transit segment and higher sales of new locomotives and modernizations within the freight segment. Raw material costs, while still elevated, were largely flat on a year-over-year basis.

Foreign currency exchange was unfavorable to sales by $7 million or 0.3 percentage points, and it reduced our second quarter gross profits by $2 million. Finally, manufacturing costs were positively impacted by favorable fixed cost absorption, more than offset by manufacturing inefficiencies at our Erie facility in June. Our team continues to execute well to mitigate the impact of continued cost pressures by driving operational productivity and lean initiatives. Turning to slide 11, for the second quarter, GAAP operating margin was 12.9%, which was flat versus last year, while adjusted operating margin declined 0.3 percentage points to 16.4%. GAAP SG&A was $285 million, and adjusted SG&A was $283 million, both of which were up versus the prior year, but down significantly as a percentage of sales.

Engineering expense increased from last year according to plan, yet was down 0.2 percentage points as a percentage of sales at 2.2%. We continue to invest engineering resources in current business opportunities, but more importantly, we are investing in our future as the leader in decarbonization and digital technologies that improve our customers' productivity, capacity, utilization, and safety. Let's take a look at the segment results on slide 12, starting with the Freight segment.

As I already discussed, Freight segment sales were strong for the quarter, up 14.6%. GAAP segment operating income was $271 million, for an operating margin of 15.9%, up 0.2 percentage points versus last year. Adjusted operating income for the Freight segment was $346 million, up 15% versus the prior year.

Adjusted operating margin in the Freight Segment was flat with prior year at 20.3%. The benefits of increased sales, including fixed cost absorption and lower SG&A as a percentage of revenue, were offset by unfavorable mix from higher sales of international locos and modernizations, as well as non-recurring expenses from our labor negotiations in Erie.

Finally, segment multi-year backlog was $18.3 billion, down 6.8% from the end of Q2 last year, while the 12-month backlog was $5.3 billion, up 10.3% over the same period. The 12-month backlog continues to show momentum beyond 2023. Conversely, the year-over-year reduction in the backlog was driven by lapping last year's significant multi-year order from Union Pacific for over $1 billion of modernizations. Now turning to slide 13.

Transit segment sales were up 25.3%, driven by strong OE and aftermarket sales. GAAP operating income was $66 million, up 32.0%. GAAP operating income increased as a result of higher sales and benefits from our Integration 2.0 activities, partially offset by higher restructuring costs. Adjusted segment operating income was $76 million, which was up 31.0%.

This resulted in adjusted operating margin of 11.1%, up 0.8 percentage point from last year. Finally, Transit segment multi-year backlog for the quarter was $4.1 billion, up 15.4% versus a year ago. Now let's turn to our financial position on slide 14. Q2 cash from operations was $115 million.

While cash flow benefited from higher earnings, we are continuing to invest in the business's growth, which is driving working capital higher, in particular, receivables and inventory. Despite that, we continue to drive toward a greater than 90% cash conversion for the full year. Our debt leverage ratio was 2.4x at the end of the second quarter, which was flat versus prior year, primarily due to the acquisition of L&M. We look forward, we have a $250 million senior note at 4.38% coming due in August. We intend to roll that debt into our delayed draw term facility. I'd like to spend just a moment on providing some additional color on L&M. Rafael mentioned, during the quarter, we completed the bolt-on acquisition of L&M.

This strategic acquisition will extend and complement our portfolio of premium heat transfer solutions in mining. We purchased L&M for $223 million in cash, and the business is expected to have calendar year 2023 sales of about $130 million. Finally, we returned $105 million of capital back to shareholders in the quarter through share repurchases and dividends. As you can see in these results, our financial position is strong, and we continue to allocate capital in a balanced strategy to maximize shareholder returns. With that, I'd like to turn the call back over to Rafael.

Rafael Santana (CEO)

Thanks, John. Let's flip to slide 15 to discuss our updated 2023 financial guidance. We believe that the underlying customer demand for our products and solutions is growing across our business. Our order pipeline and 12-month backlog continue to strengthen, providing solid visibility for profitable growth for the rest of 2023 and beyond.

The team is committed to driving strong top-line growth while managing costs. We are also committed to driving adjusted margin expansion in 2023, despite a still challenging macro environment. With these factors in mind, we are increasing our previous guidance. We now expect 2023 sales of $9 and a quarter billion to $9 and a half billion, up 12% from last year at the midpoint. Adjusted EPS to be between $5.50 and $5.80 per share, up 16% at the midpoint.

We also expect cash flow conversions to be greater than 90%. Let's wrap up on slide 16. As you heard today, our team delivered another strong quarter to the year, despite an uncertain and volatile environment. Thanks in large part to our resilient installed base, world-class team, innovative solutions, and our relentless focus on our customers. Our results remain on track for us to deliver on our 5-year outlook that we provided at our Investor Day last year.

With strong momentum across the portfolio, increased visibility through our strengthening order pipeline, and a rigorous focus on execution, Wabtec is well positioned to drive profitable long-term growth and maximize shareholder returns. With that, I want to thank you for your time this morning, and I'll now turn the call over to Kristine to begin the Q&A portion of our discussion. Kristine?

Kristine Kubacki (VP of Investor Relations)

Thank you, Rafael. We will now move on to questions. Before we do, and out of consideration for others on the call, I ask you that you limit yourself to one question and one follow-up question. If you have additional questions, please rejoin the queue. Operator, we are now ready for our first question.

Operator (participant)

Thank you. We'll now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press two. This time, we'll pause momentarily to assemble the roster. First question will be from Justin Long of Stephens. Please go ahead.

Justin Long (Managing Director of Equity Research)

Thanks, and good morning.

Rafael Santana (CEO)

Good morning, Justin.

Justin Long (Managing Director of Equity Research)

Based on the updated full year guidance, I was wondering if you could share how you're expecting third quarter and fourth quarter to look on a relative basis. Do you think they'll look similar from a revenue and earnings perspective? I just wanted to better understand the cadence that you're anticipating when you think about the timing of deliveries, mix, or anything else we should be mindful of in the back half.

Rafael Santana (CEO)

Great, Justin. This is John. Justin, when we look at the back half cadence, you know, starting with revenue, we would expect the majority of our revenue growth to come in the third quarter versus the fourth quarter. Again, this is due to the way the orders have come in and production is scheduled, as well as we got a slight little, a little lapping benefit over a slightly easier comp from a revenue standpoint. We look at the earnings side or margin side of the equation, we would see the opposite, or expect the opposite, Justin.

We would expect the majority of our earnings growth, our margin growth, to come in the fourth quarter versus the third quarter, and that is simply because we're lapping a much easier comp in the fourth quarter of last year than we have in the third quarter.

Justin Long (Managing Director of Equity Research)

Okay, that's very helpful. Second question I had was on the freight services segment. We saw some notable strength there in the second quarter. Is there a way you can help us think about the growth in that segment if you exclude mods? You know, going forward, I was wondering if you could share what you're assuming for locomotive utilization. It sounds like parkings were maybe a little bit better than you thought, but we're hearing from some of the rails that locomotives are getting put into storage, so I just wanted to kind of marry those two trends.

Rafael Santana (CEO)

Justin, you're right. I think we'll see, especially as we go into the second half of the year and just beyond the second half, I think you'll see acceleration of growth in services. Some of that, I mean, you see it with some of the recent order that we announced here. Mods is a growth case, continuing to us, moving forward. That continues to be a positive.

When it comes down to parkings, we're seeing really the active fleet staying steady, besides any elements of really fluctuation within the year. The focus on services continues, and we feel very good about our fleet stats out there, providing really, I'll call, significant benefits to the customer when compared to our competitors' fleets.

That's both in terms of reliability, availability, fuel efficiency, which is a, a significant element here. We stand with, really, fuel, better than, in average, more than 5% on every single one of our platforms. We don't expect no signs of any significant changes on that, the active fleet either.

Justin Long (Managing Director of Equity Research)

Okay. Thanks for the time, and congrats on the quarter.

Rafael Santana (CEO)

Thank you.

Operator (participant)

Thank you. Our next question will be from Christian Wetherbee of Citi. Please go ahead.

Speaker 12

Hey, good morning, guys. It's Rob on for Chris.

Rafael Santana (CEO)

Good morning.

Speaker 12

Could you give us a sense in, in terms of the backlog? Obviously, it increased over the 12 months sequentially. How should we think about just that conversion in, in 2023 versus kind of 2024?

Rafael Santana (CEO)

Okay. I'm gonna start just with, I feel very good about our overall backlog. I feel strong about the pipeline of opportunities that the team is working on. I think the overall underlying growth fundamentals of the business is also strong. As you said, the 12 months is up 10%. It's accelerating. Last quarter was up for 4.4%.

The current total backlog is also healthy. While it's down 3.5%, I look at it in conjunction with the multi-year billion-dollar order that we got from Union Pacific, and the other multi-billion dollar order opportunities were being worked right now with the team. We see good momentum internationally. We see it in North America. It's positive, we're progressing and we're continuing to grow, and our pipeline supports it.

In terms of the convertibility, the 12 month already provides you a view into 2024, and we continue to see strength in the pipeline.

Speaker 12

That's helpful. Just to piggyback on, on Justin's question, your response, I thought I heard you saying that you're expecting an acceleration of services growth. Should I think about that stepping up from the roughly 14% you guys did in, in 2Q in the back half of the year? Maybe you could provide a little bit more context.

Rafael Santana (CEO)

First half versus second half of the year. That's where I made the comment.

Speaker 12

Okay, that's helpful. How are you thinking about services growth, longer term?

Rafael Santana (CEO)

It continues. I mean, as you saw, I think the demand for a lot of the solutions we have there continues to be robust. We have an opportunity to modernize a significant part of the fleet out there. I think customers are really looking into it. You see based on the announcement we just made yesterday, when you're looking at 18% fuel savings, 40% improvement on reliability, 55% on pulling power, those are significant numbers that are really compelling in terms of driving, not just the quality of the service you're providing to your customers, but reducing your costs. I think these are some of the fundamentals we'll continue to build on growth for the modernization of the fleet and demand for new units as well.

Speaker 12

Appreciate the time.

Rafael Santana (CEO)

Thanks, Rob.

Operator (participant)

Thank you. Next question will be from Robert Wertheimer, Melius Research. Please go ahead.

Robert Wertheimer (Founding Partner and the Director of Research)

Thank you. Just to clarify on gross margin, obviously, you mentioned that you had mix headwinds between segments from within. Is mix the entire driver of the down gross margin, or is there any price cost or anything else to catch up still? Was there a mix drag within transit as a segment?

John Olin (CFO)

Okay, Rob, this is John. Looking at the quarter, we came in, margin came in at 16.4%, down 3 tenths of a percentage point. As we talked about in the earlier quarter, we expected the first half to be flat on margin. Margins were down a little bit more than we expected.

The key driver of that, Rob, was the inefficiencies we're experiencing at our facility in Erie, behind the strike. That is the biggest driver. The mix we anticipated, the mix within the groups, we anticipated in locomotives and mods in the original guidance, but the difference really is the inefficiencies at our facility at York. At Erie.

Robert Wertheimer (Founding Partner and the Director of Research)

Erie. Perfect. Okay, got it. Then if I can ask a different one, on hybrid electric, you know, the win in mining, the biggest iron ore train in the world. I don't know what the size of that market is and what your expectation for the pace of testing, validation, you know, and potential future orders may be. I wonder if you have any comments you can make.

Rafael Santana (CEO)

I do. We're continuing to first make progress on battery or electric. I think that order is a great example of that. We're developing a supply chain around it to make sure that we make really the overall product reliable. First deliveries are happening next year. We're continuing to work actively with customers both in North America and internationally.

There is demand out there to further expand the use of the technology. We're working with customers to really make sure that we pace as we step into it. Fuel continues to, of course, be a significant element of cost for our customers. I think there is a really significant opportunity for us to continue to grow that, and we're gonna pace it as we grow into different geographies.

That's, I think, the exciting piece. It's not a demand around one specific customer or one specific segment. I think we have an opportunity to to apply that battery concept also in conjunction with what I'll call, not just a hybrid product, but hybrid systems as well. I recently came back from Europe, there's I'll call a significant opportunity for us there as well.

Robert Wertheimer (Founding Partner and the Director of Research)

Perfect. Thank you.

Operator (participant)

Thank you. Our next question will be from Saree Boroditsky of Jefferies. Please go ahead.

Speaker 13

Good morning. This is James on for Saree. Thanks for taking the questions today. I wanted to touch on Integration 2.0. Can you provide an update on how Integration 2.0 is progressing, and how should we think about cost savings into 2024?

John Olin (CFO)

Great, James. As we talked about, when we announced Integration 2.0, a little bit over a year ago, that we would invest $135 million-$165 million and expect ongoing savings of $75 million-$90 million. We're off to a great start. As we talked about at the end of 2022, investment was a little bit ahead of schedule, which is a good thing. As we ended last year, we were at run rate savings of $5 million. The six months that we've had this year, we've over doubled that, the trajectory will continue through the remainder of 2023.

add to a fair amount of our incremental margin in 20 in the back half, as well as through 2024, as we head up to that $75 million-$90 million run rate in 2025.

Speaker 13

Great, that's helpful. Just following up on the Erie plant strike. Can you provide, like, a little bit more detail on the strike and how that is affecting the production schedule, like revenue mix, given that the facility was more focused on, like, components, like customized locomotive for international and electric locomotives?

John Olin (CFO)

I'll start with, over the last two years, we have successfully reached an agreement with all of our union and non-union sites. We're working in collaboration. We remain committed to the workforce. With that, we remain optimistic that we can reach an agreement here in a timely manner. From a financial perspective, I'd say with plan two, really for a variety of outcomes and contingencies here, and we do not anticipate any impact to the full year revenue.

Speaker 13

Great, thank you.

Operator (participant)

Thank you. Our next question will be from Allison Poliniak of Wells Fargo. Please go ahead.

Allison Poliniak (Senior Equity Analyst)

Hi, good morning.

John Olin (CFO)

Good morning.

Allison Poliniak (Senior Equity Analyst)

Just a quick question on the, the outlook. You know, you have 5% revenue growth, but 5% earnings growth, so it really implies sort of lack of leverage on that revenue. Is that just simply a mix situation that's driving that? Just if you could walk us through that. Thanks.

John Olin (CFO)

Allison, you're talking about within the quarter?

Allison Poliniak (Senior Equity Analyst)

No, for the full year, the guidance raise. You know, nice revenue guidance raise, but EPS really just in line with that revenue guide, just implies the lower incrementals. Just wanna understand if that's just purely mixed, if there's something else within that, that's driving sort of that lack of incrementals there?

John Olin (CFO)

Sure, Allison. So yeah, we're thrilled to be able to raise our revenue guidance. Went from a midpoint of up 6% to up 12%, and driven by the underlying momentum that we've experienced, right? That's continued from the back half of last year into the through the first half of this year. When we look at the earnings guide, it was up from a midpoint of $5.65 or up 10% to up 16%.

What we're seeing is a couple of things. You're not seeing the full increase in revenue coming through in earnings. Allison, that's for three reasons. One is, in the first quarter, we had some additional investment in our next generation technology for our PDS software, that's Precision the Dispatch Software.

That's a one-time event that kind of will bring the earnings down on a full year basis. The second driver of that is the strike at Erie, right? That does have costs. Rafael had mentioned, we don't expect any impact on revenue for the year, but it does have a cost. We had cost in that in the first and the second quarter, but we'll also have some cost in the third quarter. That's included in that as well. Again, more on the one-time side. The third area is higher interest costs. As you can see in the quarter, interest was up about 25% to $11 million.

We would expect interest to be higher in the back half as well, partly behind the L&M acquisition, but also the refinancing of some debt that we've got coming due. Allison, when you take those three things, that's the difference between the growth rate of revenue and the growth rate of earnings.

Allison Poliniak (Senior Equity Analyst)

Great, that's very helpful. On the digital side, if I recall, it's always been more, I would say, cyclically sensitive, and it doesn't seem to be exhibiting that sort of same trend. Is it sort of a change in how your, your customers are approaching that product? Is it sort of the investment that you've done that they can gain maybe even more efficiencies than they did in prior cycles, so they're pushing through that investment? Just trying to you know, understand sort of how, why it broke that sort of cyclical or just trying to use an exhibit.

John Olin (CFO)

A couple of points here, Allison. First, I mean, as you saw, I mean, we have significant order build-ups in the last two years, has positioned the business really well from a backlog perspective. A good chunk of that was really international orders, some were multi-year agreements. As you go more international, it's a bit more lumpy, we would expect that to play out over the different quarters. The other comment I would make, no different than the previous years, we need to really drive convertibility into the year. Shorter-term orders that continue to deliver on the year results. Backlog coverage is better than we've had before. We like the fundamentals of the business, we would expect to be lumpy.

Allison Poliniak (Senior Equity Analyst)

Perfect. Thank you.

Operator (participant)

Thank you. Our next question will be from Scott Group of Wolfe Research. Please go ahead.

Ivan Yi (Director and Equity Research Analyst)

Yes, good morning. This is Ivan Yi for Scott. First of all, your revenue guidance updated to $9.4 billion at the midpoint implies a 12% increase in total sales this year. How much of that 12% increase is volume versus how much of that is price? Thank you.

John Olin (CFO)

We would look at price on a full year basis to be in the 1%-2% range.

Ivan Yi (Director and Equity Research Analyst)

Perfect. Thank you. Secondly, can you provide some background on the pace of absolute locomotive modernizations? Meaning, how many mods did you do in 2022? What are you expecting in 2023, and can you talk about 2024? Lastly, what is the timing of the 60 mods for CN? Thank you very much.

John Olin (CFO)

I think without getting into any specifics of 2024, of course, it's kind of early for that. We expect growing momentum on the modernization portfolio. You see that, I think, the order you just asked about, the CN, it's part of that, and we see that growth momentum not just going to 2023, we see that momentum going into really 2024 and beyond. Just good backlog.

Ivan Yi (Director and Equity Research Analyst)

Thank you very much.

Operator (participant)

Thank you. Our next question will be from Jerry Revich of Goldman Sachs. Please go ahead.

Jerry Revich (Managing Director)

Yes. Hi, good morning, everyone.

Rafael Santana (CEO)

Good morning, Jerry.

Jerry Revich (Managing Director)

Rafael, John, I'm wondering if you could just talk about in transit, you know, you've had really strong bookings for three quarters now, the top line inflection this quarter. You know, are we at a point where, you know, this business has earned the right to grow, and we could see, you know, more substantial pickup in top line now that the margins are where you need them be? In other words, is there more runway, based on the bookings and the performance this quarter for the momentum to continue in transit?

Rafael Santana (CEO)

I think, Jerry, first, the fundamentals for the business remain strong. I think despite of a more competitive environment, I look at our book-to-bill ratio is over one. The 12-month backlog's up 9%, the multi-year is up double digits. I'll tell you, while we are pleased with the progress, there's significant work ahead of us, to simplify the footprint, to further improve and sustain margins.

We're gonna have variation quarter to quarter, but the mandate's there, and the team is executing on extending margins. We feel we're building competitiveness in the business, so we ultimately drive profitable growth. It feels good from that perspective. We're gonna continue to drive that there. We continue to have opportunities.

Jerry Revich (Managing Director)

This point where we're putting up north of 20% top line growth, it sounds like the, based on the backlog, that should continue into the back half.

Rafael Santana (CEO)

The backlog's strong, but we're also overlapping what I'll call easy comps, from last year. If you think about, just the top line, if you remember, some of the disruptions we had associated with, not just supply chain, but we also had, at that point, a cyber incident.

Jerry Revich (Managing Director)

In freight, really impressive performance in service, in an environment where freight volumes have obviously not been very good. Can you just talk about for your service business ex mods, what are some factors that are contributing to the performance? If all of the year-over-year, so growth is driven by mods, that would be a pretty dramatic ramp. It feels like the core business is doing pretty well, ex mods, given the gap versus freight volumes. I'm wondering if you just comment on that, if you, if you don't mind, Rafael.

Rafael Santana (CEO)

Fleet is active. It's running hard, right? If I look at it in the different markets we serve, start with Kazakhstan or Australia, I think there's just a strong demand out there when you look at the pipeline of opportunities. I think those things are ultimately connected. In North America, where you could have expected that change in the active fleet, I think it's holding strong. It's again, back to the focus on both services, and I think we stand with a significant advantage in our fleet in terms of fuel savings, in terms of haulage capability and reliability, and that's really critical to our customers right now.

Jerry Revich (Managing Director)

Thanks.

Rafael Santana (CEO)

Thank you.

Operator (participant)

Thank you. Our next question will be from Steve Barger, KeyBanc Capital Markets. Please go ahead.

Steve Barger (Managing Director and Equity Research Analyst)

Thanks. Good morning.

Rafael Santana (CEO)

Good morning.

Steve Barger (Managing Director and Equity Research Analyst)

Can you talk about the margin profile for new business you're booking relative to the margin profile in the next 12-month backlog? Then just generally, is new business looking higher margin than old business?

Rafael Santana (CEO)

Yeah, Steve, this is John. Absolutely. You know, we, we've watched our margins, come up over the last couple of years. That is a function of bringing in, better orders at higher profit. As we look forward, to the backlog we've talked about, we feel great about it overall, not only from a standpoint of the revenue it will drive in the future, but also from a, a profitability standpoint. It's booked at a higher, margin than, we've seen in the past.

Steve Barger (Managing Director and Equity Research Analyst)

Got it. Thanks. Total backlog has contracted. I know it's not much, but it's been a couple of quarters now. When you think about the size of the new deals you're signing and the pipeline versus what's scheduled to come out of backlog in the back half, would you expect it to continue contracting this year?

Rafael Santana (CEO)

Steve, what I'll tell you is the following: Yes, the total backlog is down. It's gonna be lumpy as we have those, I'll call them, multi-billion dollar deals. We've got more than a couple of those being worked right now, that could drive some lumpiness. I think our focus here is making sure that we've got the convertibility moving forward.

Of course, as you look into the convertibility, 12 months, 18 months and 24 months. We track that, and we feel very strong about that. It's really in the pipeline of the deals that we're working on, and we're continuing to grow that, and it's really supported by our pipeline.

Steve Barger (Managing Director and Equity Research Analyst)

Got it. Thank you.

Operator (participant)

Thank you. Our next question will be from Adam Uhlman of Bank of America. Please go ahead.

Adam Uhlman (Equity Research Analyst)

Hey, thanks for taking my question. Adam Uhlman on for Ken Hoexter. We've covered a lot. Maybe just to touch on the M&A pipeline, is there anything you can share broadly about verticals or geographies of interest in this space?

Rafael Santana (CEO)

... of course, I mean, we're not going to go into any of the specifics here. We are continuing to explore bolt-on acquisitions. We're gonna be very opportunistic here. They'll be strategic, they'll drive a higher ROIC, ultimately, accelerate profitable growth for Wabtec and increase shareholder value. I think L&M is really a great example of that. We're active, really, trying to make sure that we find those opportunities.

Adam Uhlman (Equity Research Analyst)

Thank you. Then, maybe just going over to transit. You've mentioned a mid-teens margin target in the past. Just maybe give us a sense of, you know, how we are trending there versus initial expectations. Any view over the next coming years, maybe if that could be achieved earlier than initially thought? Thanks.

Rafael Santana (CEO)

I'll maybe start, and I'll pass it on to John. I think, we're continuing the mandate. We feel strong about it. Pascal and the team are working on really, continuing that trajectory. It's never steady and precise. There's always some bumps along the way, but we feel strong about continuing to drive the simplification on that business, improving the competitiveness and a lot of opportunities here.

John Olin (CFO)

As I mentioned earlier on the question on Integration 2.0, right? We're going to see that continue to ramp. The majority of the benefit will accrue to our transit group. We feel great about the consolidation, the integration that's happening there, and the results that it's starting to spin. Part of the benefit we saw in margin growth in transit in the quarter was due to Integration 2.0.

The other question with regards to the backlog. As we continue to bring in volume in the backlog, we're very focused on making sure that it is coming in at a higher margin, we are focused on bringing in good, profitable business versus revenue in the transit group.

Adam Uhlman (Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. Our next question will be from Matt Elkott, Cowen. Please go ahead.

Matt Elkott (Director and Senior Equity Research Analyst)

Good morning. On the 69 Certified Pre-Owned locomotives, do you guys foresee any similar opportunities going forward? If you can provide some insight maybe onto, like, the revenue and, and margin profiles of those locomotives, if not on an absolute basis, at least kind of relative to mods.

Rafael Santana (CEO)

I, I'm not going to get into the specifics of that program, but what I'll tell you, that program provides a significant opportunity for us to, number one, as we think about our products, it's how we cascade down those products down. They're not just on core mainline. We often focus a lot of the dialogue here around the 16,000 locomotives that we got running out there.

There's a number of other locomotives running in short lines, in yards, and we see an opportunity to cascade that fleet down and cascade it with a fleet that's more efficient. It causes less emissions, able to pull more. A lot of those same fundamentals, and I think that's where we look at building, and it provides, again, a significant strength for our services business. As there will be a pull there in terms of providing spare parts and things like that. Really excited about gaining momentum on that front, too.

Matt Elkott (Director and Senior Equity Research Analyst)

Rafael, it sounds like this is not something that you guys have done, actively, you know, to any meaningful extent in the past, and it's kind of a fairly new area for you, these Certified Pre-Owned units?

Rafael Santana (CEO)

I'd say we've done some of that, for the class ones, especially bringing, what I'll call, older Dash 9 and modernizing those into, AC technology. I think it's the first time we do F side with like, short lines, and I think there is a significant opportunity there. You're right about that.

Matt Elkott (Director and Senior Equity Research Analyst)

Okay. are these, is the guidance raised partly in part because of this order that you got? I think you got it last month.

John Olin (CFO)

I would say not. There'd be a little bit in there, but not to the extent to drive the overall guidance, Matt. It's the underlying, you know, momentum we've talked about for the last year, continues to come at us, and the backlog continues to fill. It'll be more of an impact on the future growth, as we look to 2024 and beyond.

Rafael Santana (CEO)

Exactly.

Matt Elkott (Director and Senior Equity Research Analyst)

Got it. Just one question on the 30 new local orders in North America. You called them strategic. Can you tell us what that means? You know, given the fact that, you know, it's good to see new orders starting to come back in North America over the past year or so, what does that mean to the new build versus mod mix for next year?

Rafael Santana (CEO)

I think it just validates what we've been saying. I mean, in some cases, customers will look at modernizations as a better solution for some of the fleet dynamics they've got. In some other cases, it's gonna come with really new locomotives. We see both active, and I think the fact that you continue to see that, I think that's really a positive in terms of the dynamics that we're looking in to the North America market. There is really commitment to continue to drive service, to invest in the fleets that are really, at this stage, at the oldest levels in at least a couple of decades. Good opportunity here.

John Olin (CFO)

Matt, from a financial standpoint, we're pretty indifferent, whether it's a modernization or a new, right? We've talked about new comes with a higher revenue and modernizations with a higher margin. Overall, we're pretty indifferent. As long as they're Wabtec locomotives, we're good.

Matt Elkott (Director and Senior Equity Research Analyst)

If I missed it, did you guys say what the purpose of those were? These are just diesel locomotives for replacement, or is there a technology angle?

Rafael Santana (CEO)

I think there's both. I mean, there's certainly a technology element here, and they're going to be used to really pull freight more efficiently out there.

Matt Elkott (Director and Senior Equity Research Analyst)

Great. Thank you so much, Rafael. Thanks, John.

Rafael Santana (CEO)

Thank you, Matt.

John Olin (CFO)

Thank you.

Operator (participant)

Thank you. Next question will be from Steve Barger, KeyBanc Capital Markets. Please go ahead.

Steve Barger (Managing Director and Equity Research Analyst)

Thank you. just a quick clarification. I think you said the Erie situation could be a swing factor in the back half, but I also thought I heard you say that it would be one time. Can you clarify if expected costs from that are included or excluded in the back half EPS range?

John Olin (CFO)

They are absolutely included in our revised guidance, Steve.

Steve Barger (Managing Director and Equity Research Analyst)

Included. Got it. Okay. Thank you.

John Olin (CFO)

Absolutely.

Operator (participant)

Thank you. That concludes our question and answer session. I'd like to turn the call back over to Ms. Kristine Kubacki for closing remarks. Please go ahead.

Kristine Kubacki (VP of Investor Relations)

Thank you, operator, and thank you everyone for your time today. We appreciate it, and we look forward to talking with you next quarter. Goodbye.

Operator (participant)

Conference now concluded. Thank you for attending today's presentation. You may now disconnect.