Good day and welcome to the Wabtec Second Quarter 2022 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Kristine Kubacki, Vice President, Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone and welcome to Wabtec's second quarter 2022 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 on our website earlier today and can be accessed on the 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 relating 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.

Thanks, Kristine, and good morning, everyone. Let's move to Slide 4. I'll start with an update on our business, my perspectives on the second quarter, progress on our long-term value framework, and then John will cover the financials. We delivered a strong second quarter, which is evidenced by another quarter of adjusted margin expansion of 1.5 percentage points and adjusted earnings per share growth of 16%. More importantly, we continued our progress against our long-term strategies, as evidenced by a significant expansion in the total backlog. Sales were roughly $2 billion, which was up modestly versus prior year. Revenue was driven by strong performance in the freight segment, but partially offset by lower year-over-year revenue in the transit segment. Excluding foreign currency exchange, consolidated revenues would have grown by roughly 5.5%. Total cash flow from operations was $263 million for a cash conversion of over 90%. Total multiyear backlog was over $23 billion, up $1.7 billion and excluding the headwinds from foreign exchange backlog was up $2.3 billion from last year. Finally, we closed two strategic acquisitions in the quarter, Beena Vision and ARINC and deployed over $100 million in share repurchases and dividends. So, all in all, we had a very good quarter. We continue to invest for the future as we execute commercially and operationally with discipline and rigor. And we're well-positioned to continue to drive long-term growth even with uncertainty and volatility in the overall economy. Shifting our focus to Slide 5. Let's talk about our end-market conditions in more details. As we look at key metrics across our freight businesses, we are encouraged by the continued momentum in our end-markets and the strong pipeline of opportunities. North America carloads are expected to improve in the second half of the year, and locomotive parkings have continued to…

Thanks, Rafael, and hello, everyone. Turning to Slide 8, I will review our second quarter results in more detail. We had another good quarter of operational and financial performance despite continued challenges in the supply chain, currency exchange and cost increases. Sales for the second quarter were $2.05 billion, which reflects a 1.8% increase versus the prior year. Freight segment sales were strong, up 11.5%, partially offset by lower year-over-year sales in our Transit segment. Q2 sales were negatively impacted by unfavorable currency exchange, which reduced our revenue growth in the quarter by 3.8 percentage points. For the quarter, adjusted operating income was $340 million, which was up 11.5% versus the prior year. We delivered strong margin expansion, up 1.5 percentage points on an adjusted basis. Margins were aided by mix favorability, increased pricing and improved productivity, partially offset by significantly higher costs. The team achieved margin expansion even in the face of rising costs and continued supply chain disruptions. Through the first half of the year, our revenue growth excluding foreign currency exchange, and our margin growth have been in line with our original plan and in line with the cadence which we discussed when we issued our 2022 guidance. As we look forward to the second half, we continue to expect accelerated growth in revenue from the first half behind significantly increased locomotive deliveries and lower year-over-year margin percent due to unfavorable mix in our equipment sales and comparing against much higher back half margins in 2021. More specifically, we anticipate this margin decline will be more pronounced in the third quarter than in the fourth quarter. We continue to expect our full year margin percent will be up modestly. In the second quarter, adjusted earnings per diluted share were $1.23, up 16.0% versus the prior year. GAAP…

Thanks, John. Let's flip to Slide 15 to discuss our 2022 financial guidance. In the first quarter, we issued guidance with sales growth at the midpoint of 8% and EPS of $4.65 to $5.05 or up roughly 14% at the midpoint. Our guidance was based on improving industry momentum, and strong underlying customer demand for our products. With the first half behind us, we continue to feel strong about our businesses and we delivered against our regional planned financials despite unplanned loss of business in Russia, and very unfavorable foreign currency exchange. We are maintaining our full year revenue and cash conversion guidance and we are tightening our full year earnings guidance to $4.70 to $5. I am pleased with the strength and resiliency of our business. And more importantly, I'm extremely proud that our teams continue to deliver despite an ever changing and challenging environment. Now, let's wrap up on Slide 16. As you've heard today, our team delivered a strong quarter despite a challenging and evolving environment, thanks in large part to our resilient installed base, best-in-class technologies and our teams focus on our customers. For these reasons and more, we are confident that Wabtec is well-positioned for long-term profitable growth. Looking forward, we will lean further into the strong fundamentals of the industry, and of our company to extend our leadership position in rail to deliver innovative, scalable technologies for our customers, and to harness the power of our lean and continuous improvement culture. With that, I want to thank you for your time this morning. And I'll turn the call now over to Kristine to begin the Q&A portion of our discussion. Kristine?

Thank you, Rafael. We will now move on to questions. But before we do and out of considerations for others on the call, I ask 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.

And our first question will come from Justin Long with Stephens. Please go ahead.

Thanks, and good morning.

Good morning, Justin.

I wanted to clarify, was the UNP order for 600 MODs included in the reported backlog, and also just given that announcement and the announcement we saw earlier this year from NS, and I guess we got some orders from CN this quarter as well. What level of growth in MOD is already locked in looking into 2023? I mean, could we be up 100 units, 200 units any order of magnitude just based on what you already have in the backlog for next year?

Yes. So number one, yes, it is included in the backlog. And with that, just one thing to also keep in mind is if you think just about the backlog from a quarter-over-quarter impact from FX alone, it's been over $400 million, year-over-year, it's closer to $600 million. So I think it's important to highlight that, otherwise, you might have expected a larger increase, but it is reflected. Second piece is, as you described, I think we have strong momentum. And it's not just internationally as we have largely described before. But as we've been saying for the past 12 months, I think we have a strong pipeline of opportunities that cuts across both internationally and in North America. We continue to have, I would say, opportunities to grow double digits in terms of the modernization demand and of course, we are coming from trough levels in terms of demand for renewable commodities. So it's good to see the momentum. I think the pipeline of opportunities that we see it on today is stronger than the one we described 3 months ago, or six months ago. So continued opportunity here to further expand our backlog.

Okay. And just to be clear that double-digit growth in MODs was referring to 2023?

Exactly. And I think just to add to that, I think one of the important things about this -- this is less about just '23. It's really, I'd say very much aligned on how we described our 5-year plan.

Understood. And I guess, secondly, for John, thinking about the guidance, so the Transit segment saw a pretty significant sequential decline in adjusted operating income. Can you talk about what you're assuming for the back half in Transit? Are we expecting to get back closer to what we saw in the first quarter from an operating income perspective? And then just anything on the cadence of margins and earnings in 3Q and 4Q? I know you said 3Q would be worse from a margin perspective year-over-year, but the comp is tougher. So I just wanted to think about things on maybe more of an absolute basis in the next two quarters.

Well, let's start with -- that's a lot, Justin. Let's start with the Transit business. Starting with revenue, when we look at the overall first half, we find that revenue was down about 12% and operating margins down slightly at tenths of a point. So number one is we believe that Transit's ability to hold margin in the face of lower revenue speaks to its resilience and underlying earnings growth. And more importantly, the decline in the first half revenue was caused by a few items that don't represent the businesses underlying performance or just in the future growth risk potential. These items include the foreign currency exchange, which in the first half was 7 percentage points. And on a quarterly basis, it was up to 9. We talked about in the first quarter the exit of the low margin U.K business that continues into the second quarter. We will not continue beyond it. Now we're lapping the full exit of that. And then finally, the manufacturing disruption we had from the cyber incident, which reduced revenue roughly 5% in the Transit business, and that incident largely hit the Transit business. But excluding these items, Justin, the underlying business is up modestly. As we look to Q3, we do continue to expect headwinds on Transit revenue because of foreign currency, and certainly some spillover of the cyber incident. When we look at the overall margin piece, that's been really driven by a lot lower absorption in the second quarter as well as some of the inefficiencies due to the cyber event. In the back half, we don't provide guidance for the back half. But with that, on Transit -- but with that, Justin, I'll transit into your next question, which is on the cadence. As we've talked about, this year…

Okay, that's very helpful. Thanks, John.

Thank you.

Our next question will come from Chris Wetherbee with Citi. Please go ahead.

Hey, thanks. Good morning, guys. This is Eli Winski on for Chris. So …

Good morning.

… maybe -- good morning. So I just want to go to the revenue segment for a second, in Freight. So I understand that equipment growth will look really strong. Is that where the focus is right now in growth within freight? And I understand that MODs are doing well, but maybe on the Components and just Digital Electronics, like how should we be thinking about some of the revenue growth in those two areas as well?

Well, if you take about the quarter per se, it's certainly lab, not just by equipment. You see it on the services side as well. If you think about components, we do expect to continue to gain momentum there as you're coming from the trough, and we do expect that the number of freight cars shipped will be about 40,000. So that's a positive too. I think the other elements, which is on Digital Electronics, we expect strong second half in terms of sales. And certainly when you look at backlog dynamics, it's certainly reflected in both in terms of the Digital Electronics business and the Component business both with book-to-bill above 1.

Okay, great. That makes sense. Thanks, Rafael. And then, John, I appreciate the help on the cost and the margin. But I feel like there's been a lot of talk about just FX. And just maybe can you help us clarify what the specific impact of FX was in this quarter? And how does it compare to last year? I just want to understand like how that impacted each of the segments and on the full business, and then what that looks like year-over-year?

Great. Good question. So let's start with what's driving it. The euro is driving it. The U.S. dollar strengthened dramatically, as you know, against the euro. And if we look at the average euro a year ago, it was at 120. And in the second quarter that we just exited it's at 107. So it's about 12% strengthening against the dollar. What this does is it translates into our revenue, which on a consolidated basis, was down $76 million. And if you look at that, in terms of a percentage of growth, that was 3.8 percentage points of growth that kind of went away because of currency. That was much more predominant when you look at our Transit business. It was $60 million that hit Transit and just shy of 9 percentage points decline in revenue do to it. Now as we lose -- move to the earnings impact, it's considerably less than the impact on revenue and that's a result of the company's natural hedges and the way we're manufacturing and a lot of that being locally. Gross profit in the quarter was down $15 million due to unfavorable foreign currency exchange, and then operating income was only down $4 million.

Okay, got it. Thank you.

Thank you.

Our next question will come from Matt Elkott with Cowen. Please go ahead.

Good morning. Thank you. Would love to hear an update on the performance of the FLXdrive and any possible issues that still need to be worked out? Also, any update on the number and cadence of deliveries over the next few years would be appreciated? I know you guys have been taking orders from several railroads over the past year or so. So any insight into when deliveries might kick in over the next few years would be helpful.

So let me start with the second half of your question, I'll go down into the FLXdrive question. I think on the pipeline of deals, we really have relevant opportunities across key geographies at this point. I think volume dynamics continue to be a positive in Kazakhstan. We have a number of projects under discussion in Asia and Australia. We continue to follow up specific projects in Africa that are tied to commodity exports. In Brazil, I think despite of the drop in carloads year-to-date, there's significant opportunities tied to renew concessions, and mining is also a positive in that context. I think in North America, despite of carloads being down for the first half, we continue to see growing demand for modernization and new locomotives. And that's, again, driving efficiency and reliability, with a direct impact to the operating ratio of our customers and bringing certainly enormous impact to their ESG targets as well. So when we look at the cadence moving forward, I think we certainly feel we're very well-positioned to deliver 5-year guidance that we provided at our Investor Day. We certainly feel stronger about it now than we did 3 months ago and then we did 6 months ago. And that's very much aligned to, I think, the pipeline of opportunities we've started to describe over a year ago. On the FLXdrive comment there is we continue to see interests from customers out there. We are continuing discussions, and you're going to see that moving through other geographies. And I think that's very much aligned how we see the evolution here and, you're going to see also permutations of that product going to not just full battery electric, but also hybrid as we've also described on previous calls.

Got it. And then just anything -- is everything going as expected as far as the testing and the performance of the FLXdrive, Rafael?

Yes, it is. We are certainly paying a lot of attention and working very closely not just with our customers, but also with suppliers in that context and making sure that we continue to progress with all the elements of that and special with regards to the battery. And as you know, we have a partnership here established with GM, and we're working very closely with them in order to make sure we continue to progress in that direction.

Got it. Just one quick follow-up, Rafael. You mentioned mining. We've seen some slight guidance reductions on CapEx from some of the miners this earnings season. Nothing big. I mean, I guess, end-market demand continues to be solid. But given the slight CapEx reductions and the lower commodity prices, are you guys concerned about the Mining segment beyond this year? I know your outlook for this year is positive, but what about 2023?

I think that can certainly be an element of, I'm just going to call, the cycle moving forward. We are working very closely with customers and with Komatsu in that regard. We see solid opportunities ahead, and we will continue to make sure we are balancing that with auto in the business. I think there's a lot of positive news here in terms of what we could be seeing in terms of opportunities for the rail side. So solid. No concerns for the year. We will continue to work closely here with customers to understand demand into '23 and beyond.

Great. Thank you very much.

Thank you.

Our next question will come from Scott Group with Wolfe Research. Please go ahead.

Yes, good morning. This is Ivan Yi on for Scott.

Good morning.

Good morning. First, can you discuss the rough margin percentages on these locomotive modifications -- modernizations? And how does that compare relative to margins on new locomotives?

Yes, Ivan, we don't provide specific margins, obviously. But when we look at MODs versus new, the way to think about it is that certainly the revenue is somewhat lower on a MOD than a new. However, the margin is somewhat higher on a MOD than a new.

Great. That's helpful. And secondly, what has been the impact of poor rail service on the pace of loco on parkings? And also, have you started having any initial conversations with the rails about buying any new locomotives? Thank you.

So true. Thanks. Of course, I think the services have -- as you look at least into the past several months, have translated into unparking of locomotives. That -- I mean, as you look forward, it's got to be balanced with carloads being a bit more positive here in the second half of the year. So I think that's part of balance. When you think about investment on new locomotives, it's part of the construct and the dialogue that we have with North American customers. You see that as part of the announcement of some purchases of Tier 4 units this past quarter. And this is very much part of the dialogue. It's going to depend in some of the solutions in order to solve for some of the productivity and efficiency, while we are convinced that there is an opportunity here to invest and drive both reliability and efficiencies from the existing fleet very much aligned with the opportunity here to improve operating ratios and also aligned to driving, I think, significant elements of the decarbonization targets that were laid out there.

Thank you.

Thank you.

Our next question will come from Rob Wertheimer with Melius Research. Please go ahead.

Thank you and good morning, everybody.

Good morning, Rob.

My question is a little bit on the bigger picture on inflation margin. You guys have had really solid margin performance, perhaps without as much at least backward-looking cycle and revenue support as some other end-markets. I'm curious if -- I mean, when you look at your supply chain and you look at your costs, is there any wave of inflation coming that you have not yet dealt with? Maybe you could just give sort of a general outlook on how the inflationary cost pressures in your supply chain, your backlog and your outlook compared with your forward looking ability of the price? Thank you.

Okay, Rob. The inflation that you're referring to came in an initial wave of higher costs in the third quarter of last year. And it takes a while for that to roll through our inventory, right? And we saw cost build and rise in the third, fourth and first quarter of this year. And we did have and see another cost shock at a much smaller level than what we saw in the third quarter, and that was due to the war in Ukraine. So as some of that rolls through, we would expect cost to rise a little bit from the first cost shock. Now having said that, we are seeing some tempering of costs out there, right? Metals are had a good quarter. They're down, but they're still at historic highs and up on a year-over-year basis. But tempering, we feel good about that. In terms of the logistics costs, we are continuing to see very high cost of transportation and logistics, in particular, in containers coming from Asia, but they've tempered slightly as well. So -- all this is going to take time to get through our P&L, but we would expect costs in the third quarter to be up a bit from what we are seeing here in the second quarter.

I will just close saying that, I mean, we are committed to grow margins forward. We could and will have significant variation sometimes quarter-to-quarter. I think this is especially given the mix with much higher growth in equipment. There's also the elements of what John spoke about in terms of inflation. With specific for the second half of the year, I just want to emphasize here how big the mix impact is. And specific in the third quarter, if you think about it, we are -- we have over a third of our shipments of new locomotives happening in the third quarter. So I couldn't highlight enough some of the elements of mix and variation that we can see from that on quarter-over-quarter.

Okay. Thank you.

Thanks.

Thanks, Rob.

Our next question will come from Saree Boroditsky with Jefferies. Please go ahead.

Hi. Good morning. Just building on your last comment. You talked about a third of the locomotive shipments happened in the third quarter. Could you quantify how much of the mix headwind do you expect on margins just from these locomotive shipments?

We can't quantify that, Saree. Just the overall concept that while we have strong margins and our equipment business are lower than the average. And as Rafael had mentioned, we will have a significant revenue growth driven by that, and that will pull over -- pull down the margin. It's something that we planned on all year long, and we are expecting. And again, that's why we've talked about in the back half that our margins on a year-over-year basis will be lower than a year ago. But on a full year basis, our margins will be up modestly as we've discussed.

I will just reemphasize that for the year, we expect results very much aligned to the guidance we provided in February this year and how we described on previous earnings calls. So it's all about higher margins in the first half of the year, higher volume in the second half, with a significant element of mix coming in.

Got it. And then you've previously talked to think about the opportunity for 500 MODs per year. Just given the recent orders, how are you executing on this opportunity? And are these orders incremental to this or just in line with your outlook?

We have not provided any specific guidance with regards to a total number of MODs. So we certainly see opportunity to continue to expand on that. And I think we've been clear about that on previous calls. So the opportunity is there. It's certainly reflected in the pipeline, and you are seeing that being realized as backlog continues to grow.

Okay. Thanks for taking my questions.

Our next question will come from Nathan Ho with Bank of America. Please go ahead.

Hi. Good morning, team.

Good morning.

Thanks again . Just a quick question on the cyber attack and sort of the 3Q impact on operations. Would you mind maybe giving a little bit more detail on how this affected both quarterly operations as well as same margins? Thanks.

Okay. Just in terms of the second quarter, I think John said it, it was about 5% in the third quarter.

5% in Transit.

5% Transit, in specific. We would expect that to be less in the third quarter. We don't expect impact for the year, and that's part of why we've reaffirmed guidance at this point.

Got you. Thank you so much. And also just, John, on your comments regarding supply chain challenges. I mean we've seen some incremental debottlenecking for the auto sector. Are you -- for your Digital Electronics, are you witnessing anything similar there? Is there sort of signs of incremental improvement?

Nathan, as we look from first quarter to second quarter, we don't see any improvement. The good news is I don't feel it's getting worse. The unfortunate news is we don't feel it's getting better as well. And again, as Rafael had mentioned earlier, that's certainly a big impact on our first half revenues with digital. But chips are hard to come by. We are not seeing a change from the first quarter, and we're hopeful as we move forward.

Just a couple of comments on the Digital. I mean, orders grew double digits last year. Book-to-bill for this year is very positive. It's the highest between our businesses year-to-date. So a number of multiyear agreement. We expect the second half strong sales second half of the year. And with that, as John mentioned, chip shortages have had an impact for the business.

Got it. Thanks .

Thank you.

Our next question will come from Jerry Revich with Goldman Sachs. Please go ahead.

Yes, hi. Good morning, everyone.

Good morning, Jerry.

I'm wondering if you folks can talk about your capacity for MODs, how quickly you can ramp up considering the size of the Union Pacific order compared to your production to date? An update on how you're thinking about capacity for that line of business would be helpful. And also, Rafael, if you could comment on your assessment of using MODs to essentially the greenhouse gas reduction targets for other rails? How optimistic are you on others taking a similar approach?

Yes. Jerry, first, in terms of the manufacturing footprint to deliver on these orders and more, we certainly feel strong about having that capacity. And we certainly have the manufacturing capacity to do that, but it's about more than that. It's making sure that we're continuing to work very closely with our customers, suppliers in that process, so we can ultimately anticipate demand. Certainly, lead times, when you look at a couple of years ago, have extended. And I think a big piece has been really making sure that we were close to customers so we could anticipate demand. And you see, to some extent, some of that certainly has impacted our inventory numbers as part of that, but that's a piece of it. When it comes to MODs, I think that continues to be a very positive story, and it's really part of a dialogue that varies customer by customer in terms of the solutions. I think we see some significant opportunities for customers to actually be working on being more productive. And in some cases, means reducing the number of locomotives that pull a certain number of cars, and that has translated into also applying some of the fuel solutions that we've described. And we see opportunity to continue to expand on that. I think what's important here is we see that part of really a growing multiyear backlog. This is I think less about what '23 is going to be. It's back to the comment I made, which is really tied to the 5-year plan that we described. And we feel like we are very well-positioned to deliver on that 5-year guidance that we provided at our Investor Day last March despite of all the macroeconomic uncertainties out there.

And speaking of the uncertainties, you folks pointed out the Russia headwind. And looking at your freight results in the quarter, it's tough to pinpoint which lines of business the Russia headwind played out and obviously, organic growth would have been stronger without it. Can you talk about which lines of business the exit impacted the most in the quarter within Freight?

Certainly, Freight, probably the combination of equipment and services. That's where we really saw the bulk of that impact.

And Rafael, was the full 5 points that you anticipated at Investor Day on a consolidated basis?

Jerry, that would be 2%. So the revenues that we had in 2021 were about 2% of our sales.

Super. Thank you.

But for the year, as we've described, I mean, it's 5%. We can have variation again quarter-to-quarter, but that's about the magnitude of what we expected for the year.

Thank you.

Our next question will come from Dillon Cumming with Morgan Stanley. Please go ahead.

Great. Good morning. Thanks for the question.

Good morning.

Just wanted to go back, Rafael, to one of your comments on the Park local account. I think we understand why that's kind of moving lower through the year, right, and it's reflective of the service issues at the Class 1 level. I guess from our perceptive, it seems like more of the Class 1s are shifting their tone around potential parkings in the back half. So I guess my question is, in your view, if freight traffic does start to more fundamentally weaken next year, right, that reflects those service issues but more reflective of actual declines in rail demand? Is your view that the Class 1s actually can park more fleet? Or would you say the service issues are more supportive of kind of a structurally higher active fleet?

I think the element of parking is not just going to be a function of service improvement, but also what carloads do in that period. So I think that's something that we will continue to watch and work very closely as part of that. And I think what's a positive, I think it's a lot of the underlying investment that you see in terms of really guaranteeing fleet reliability, ultimately driving efficiency across the fleet. And I think we continue to see momentum there. So if that comes counterbalanced with any elements of potential parking, I think that's a story we still see and we will be working closely with our customers in that regard.

Okay. That's helpful. Thank you. And then maybe just a question on the back half margin-related issues or headwinds as it relates to international deliveries. I guess I was wondering, longer term, do you have scope to structurally improve the margin profile of those international deliveries? Because I think given your commentary on the pipeline, right, it feels like volume should be accelerating next year and into '24 as well. So just curious if this is more of a recurring issue? Or if you feel like you can actually start getting a better level of incremental margin on those international deliveries going forward?

So that's actually a positive, and it's something that we've been able to is to ultimately drive as-delivered margins better than now sold margins, something that we track very closely in the business. So there's certainly continued opportunity there. And I think the other piece is making sure that we are continuing to expand on growth on some of these markets where we've really had really, I will call the best-in-class products to work with customers, and we see some good momentum there.

Okay, great. Thank you.

Thanks.

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

Thank you, operator. And I'd like to thank everybody for their participation today, and we look forward to speaking with you next quarter. Goodbye.

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