Westinghouse Air Brake Technologies Corporation (WAB) Q2 2020 Earnings Report, Transcript and Summary

Good morning and welcome to the Wabtec Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kristine Kubacki, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone and welcome to Wabtec’s second quarter 2020 earnings call. With us today are President and CEO, Rafael Santana; CFO, Pat Dugan; and President of Freight Services, Pascal Schweitzer; Senior VP 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 our Investor Relations tab on wabteccorp.com. Some statements we are 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 presentations. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics. And now, I will turn over the call to Rafael.

Thanks, Kristine and good morning everyone. We appreciate you joining us today. And I hope you and your families remain healthy and safe. Before we get started, I would like to once again thank our employees out in the field, in our factories and those working from remote locations for continuing to keep our facilities safe and operational through this pandemic. I am very proud of how our teams has responded to the challenging environment delivered for our customers and supported one another during a time when healthcare, economic and social tensions run high. And you see that reflected in our second quarter results and long-term focus. Turning to Slide 3, we had a strong execution in the second quarter despite a difficult environment. Total sales for the quarter were $1.7 billion driven largely by the international freight market and services, but offset by disruptions due to COVID in both the freight and transit end-market. Adjusted operating income was $262 million, resulting in an adjusted margin of 15.1%, which was impacted by the drop in sales across freight and transit, but somewhat offset by synergies. Cash flow from operations of $311 million was driven by strong cash conversion and good working capital performance. This allowed us to further strengthen our financial position, pay-down debt during the quarter by $300 million and increase our liquidity position by $700 million. Total multiyear backlog was over $21 billion, providing us continued visibility across freight and transit despite market conditions. And finally, we ended the quarter with adjusted EPS of $0.87, demonstrating that we are taking the steps necessary to control what we can, protect the long-term viability of the company and deliver shareholder value. With that, let’s dive into some actions underway. As you know, we remain committed to our synergy targets and we are accelerating our efforts here. We have $150 million of net synergies planned for 2020. Year-to-date, we are on plan with over $70 million in net synergies realized and we remain confident that we will deliver on the full run-rate of $250 million in synergies ahead of schedule. Of particular note, we continued the aggressive action on structural costs and lowered SG&A expense by 26% year-over-year. During second quarter, we reduced headcount by 5% and were down more than 10% year-over-year. We have also reduced our operational footprint year-over-year and we are actively driving cost reductions through lean initiatives. To-date, we have exited more than 60% of the shared service agreements from GE Transportation merger ahead of schedule. Looking ahead, the rail transportation market and impacts from the pandemic remain challenged and fluid. While we anticipate market conditions to remain somewhat mixed, as I will share with you in a moment, we believe volumes largely bottomed in the second quarter and we will see a gradual recovery. With this in mind and based on our first half results as well as based on the backlog coverage for the rest of the year, we are issuing a new outlook for the 2020 year. Pending no further lockdowns due to COVID-19 pandemic or resulting negative impacts on our business, we expect revenues in the range of $7.3 billion to $7.6 billion for the year. We will continue to adjust our variable and fixed costs to align with volume realities and we are committed to improving segment margins. We anticipate adjusted EPS to be in the range of $3.50 to $3.80 and cash conversions to be greater than 90% for the full year. This includes roughly $130 million from prior restructuring and transactions cash outflows. Cash conversion within the company’s core business is expected to be over 100%. Turning to Slide 4, I would like to discuss the market conditions and drivers we are seeing across the sector. Pascal Schweitzer, President of Freight Services will also hit on some of this in a few minutes. In both freight and transit, we are experiencing mixed conditions as economic recovery begins and commuter travel resumes. And we are carefully monitoring the ongoing impact of the virus in some regions. In North America, rail volumes had a record decline, down roughly 20% year-over-year in the second quarter. However, we have seen rail volume improve since bottoming in the second quarter. Likewise, locomotive parkings, after peaking to a record high in the second quarter, have also shown gradual improvements and we remain positive on the aftermarket sector. In terms of the North American railcar builds, a record one-thirds of the North America rail car fleet is in storage and builders are taking continued steps to slow down production lines in 2020. Industry forecasts currently indicate that the rail car build for the year will be less than 30,000 cars. Reflecting on the quarter, I want to share a couple of highlights. Internationally, rail volumes were more resilient driven largely by agriculture and mining tailwinds. International locomotive shipments were up versus last year and helped offset North America locomotives and freight car build declines, as expected. We continue to see demand for new locomotives in Russia, CIS, Brazil and Australia. Some tenders have pushed to the right due to COVID-19, but we expect this to resolve as economies have stabilized. New growth opportunities for next-gen sustainable solutions also remain strong, especially for hybrids and fuel-saving technology. We are doing some really innovative work in reducing fuel consumptions by 5% through our engine overhaul process. Pascal will share more on this in a moment. We are also currently field testing our FLXdrive locomotive, the first 100% heavy-haul battery-powered locomotive in the world operating in the hybrid [consist] [ph]. So far, we are seeing an opportunity to reduce fuel consumption for our customers by 10% to 30%. We are extending battery technology to passenger transit as well and just closed a significant deal with New York City transit to drive down their overall carbon footprint. Finally, we continue to see our digital electronics product line provide significant productivity and improve safety for our customers. Sales for the quarter were up 4% versus the prior year. Transitioning to the transit sector, the COVID-19 crisis has had a significant impact on ridership and service levels in early second quarter. Since then, particularly in Europe and Asia, ridership trends are showing a slow recovery as economies reopen. This has resulted in some positive activity internationally with new brake, new doors, and HVAC contracts in regions like Australia, Canada, India and the UK. Overall, we believe the long-term market drivers for passenger transport remain intact, especially as governments look to rail as the cleanest, safest and the most efficient mode to address the world’s public transportation challenges. Across the segment, we also continue to drive costs down. We continue to improve project execution and profitability. Lilian and the team are on track to expand margins over time while delivering over 100 basis points of improvement in 2020. With that, let’s flip to Slide 5 and I will turn things over to Pascal.

Thanks, Rafael. Good morning, everyone. It is good to be with all of you today. I am Pascal Schweitzer and I am the Group President of Wabtec Freight Services. It is a roughly $2.2 billion business with operations in around 40 countries and approximately $12 billion in backlog. Roughly, 80% of our revenues are generated through multiyear contracts, including long-term service agreements, parts contract as well as multiyear modernization agreements. So in short, we are with our customers for the long haul, helping them pull freight in some of the most important logistics corridors around the world. As I have shown before, we are executing on a focused strategy to create value for our customers. This included ensuring that our fleet is performing well and running hard, that we are capturing the aftermarket with a superior product and delivering outcomes for our customers through technology upgrades and new tools. All these while constantly improving our fleet’s total lifecycle cost. Today, as railroads continue to enhance for productivity and efficiency gains, through initiatives like precision schedule railroading, for instance and in the mixed challenges brought on by the pandemic. This strategy is more relevant than ever. The second quarter, as Rafael explained, we saw significant disruption in many of the regions where we operate. Government shutdowns had an impact on our customer operations and trade volumes globally. As a result, a record number of locomotives were parked in North America. However, despite this, we continue to have a leading and increasing share of the total active fleet. And our customers continue to increasingly prioritize the dispatch of our locomotives due in large part to the performance and reliability of the fleet. I would also like to point out that in the second quarter we need to hit record performance for on-time parts delivery and despite regional disruptions and shutdowns from COVID, each of our more than 100 service locations remained open and fully operational, a huge testament to the team in the field and we see the strong illustration that we do so much more than sell parts. You see that’s reflected in the resiliency of our second quarter top line. So, while the uncertainty related to the crisis has led some railroads to delay certain investment decisions, the value of our portfolio remains. We have worked with our customers to align scheduled maintenance plans to the new market realities. And as a result, we have leveraged the full power of Wabtec to increase the scope of our work and to unlock new growth in R&D. Now looking ahead as railroads enter into recovery and the growing level of freights relying on the small number of locomotives, we expect the demand for reliability to be even greater. This will translate into more comprehensive work scopes, into more comprehensive fleet strategies, into modernization opportunities. Currently, we have more than 1,000 modernized locomotives in operation, delivering improved reliability, better fuel efficiency and overall economic performance for our customers. As our customers strategically consider their investment plans over the long-term, the value of modernizations remains very compelling. The second quarter, mods deliveries show good momentum and we continue to have visibility via our multiyear backlog. Now, on a broader international scale, where economies are starting to reopen, we are also seeing encouraging improvement in parkings and operational fleet performance. Just to give you a few examples, in Australia, rail activity has shown good momentum throughout the quarter as China resumed business following the COVID lockdown. In Kazakhstan, year-to-date car volumes are up compared with 2019. Brazil, we see a strong demand with greater dependency on agricultural products, following a record harvest. In India, while there were a significant number of locomotives parked due to the pandemic, this ultimately had little impact to our business as we shifted focus to maintenance. And as of July, all of these locomotives are back in operation. Finally, in North America, as discussed, we do expect carload volumes to continue to gradually improve and parking to progressively recover. In terms of commercial activity for the quarter, the team closed some significant long-term service agreements with Class 1s in North America as well as in Brazil and won a key order for our FDL Advantage product. Going into this product a little bit more specifically as Rafael described, we had around 10,000 FDL locomotives running globally. Any of these locomotives are approaching their second or third engine overhauls. So with these next-gen solutions, we are able to reduce the fuel consumptions by up to 5%. That means for a single locomotive burning around 200,000 gallons of fuel a year, around $25,000 in savings per year. This is an exciting first win that is opening up a multimillion dollar pipeline of opportunity for Wabtec fully in line with our strategy of technology differentiation for the installed base. Finally, I will share a few thoughts on cost management. So last year, we have reduced our headcount by roughly 10% ahead of our synergy commitment and in line with market realities. We have undertaken lean actives to drive cost out of the business, while still being able to deliver for our customers and scale up as markets recover. But to conclude, while the market remains fluid and carload volumes and parking grew significant headwinds, the freight services team had a strong operational quarter giving us confidence that our broad international portfolio, our $12 billion multiyear backlog, and our strong aftermarket rates will position us well into the future. Looking forward, you will see some fluctuations quarter-to-quarter due to the seasonality of maintenance activity due to our engine overhaul profiles and mods delivery schedules. However, the fundamentals of this business and its ability to recover post COVID remains strong. I will now turn things over to Pat to provide more color on the company’s overall second quarter performance. Pat?

Thanks, Pascal. Turning to Slide 6, sales for the second quarter were $1.7 billion, which reflects a 22% decrease versus the prior year. The decline in year-over-year sales was mainly due to disruption across our freight and transit segments caused by the COVID-19 pandemic. For the quarter, operating income was $159 million and adjusted operating income was $262 million. That’s down 32% year-over-year, mainly driven by the lower sales and the disruption in our operations as a result of the pandemic offset somewhat by variable cost actions and the realization of our synergies. For the quarter, adjusted operating income excluded pre-tax expense of $103 million, of which $72 million was for non-cash amortization, $31 million of restructuring and transaction costs. Take a look at the Appendix D to our press release for the reconciliation of these details. Now, looking at some of these detailed line items, SG&A declined 26% year-over-year to $217 million, including $13 million of the restructuring and transaction expenses, SG&A expense benefited from structural cost actions across the business as well as the realization of synergies. Engineering expense decreased to $38 million or down 33% from last year. Engineering expense moved down with a lower volume outlook as well as some changes in project timing. And amortization expenses were $72 million. In 2020, we expect non-cash amortization expense to be about $290 million and appreciation expense of about $180 million. Second quarter, we had GAAP earnings per diluted share of $0.46 and adjusted earnings per diluted share of $0.70. Details that bridge the GAAP earnings per share to adjusted earnings per share of $0.87 can be found attached to our press release. As of June 30, our multiyear backlog was $21.4 billion. Excluding the impact of FX, backlog is flat quarter-over-quarter, a rolling 12-month backlog which is a subset of the multiyear backlog, $5.3 billion. Our backlog continues to give us and provide good visibility across both the freight and transit segments. Now, let’s take a look at those segments, the results on Slide 7. Across the Freight segment, total sales decreased 21% to $1.2 billion in the second quarter, FX negatively impacted sales by about $26 million during the quarter. In terms of product lines, equipment sales were down 37% year-over-year as a result of lower North America locomotive deliveries, which as we have discussed, often can vary quarter-to-quarter due to timing and that was offset somewhat in the second quarter by higher year-over-year international locomotive deliveries and increased mining sales. In the second half of the year, we expect locomotive deliveries to be slightly higher when compared to the first half of this year. And as you heard Pascal discuss, our services portfolio continues to show resiliency despite the OE headwinds. Despite a nearly 18% drop in North America freight volumes for the quarter, services revenues were down 8% year-over-year, a result of lower parts sales due to record locomotive parkings, but that was offset by double-digit growth in mods deliveries. We expect our parts sales to improve with a gradual recovery in freight volumes, recent timing of maintenance and overhaul work edging into the fourth quarter. Digital Electronics sales were up 4% year-over-year on higher sales of distributed power products and signaling projects. Components sales were down 30% year-over-year on lower year-over-year railcar build and declines in key industrial end markets such as oil and gas and power generation. Despite the top line headwinds, evidence of our synergies coming through as segment adjusted operating income was $229 million for an adjusted margin of 19%. Finally, the freight segment backlog was $18 billion about flat with the prior quarter. I would note again that FX negatively impacted that backlog by about $58 million. Turning to Slide 8, across our Transit segment, sales decreased 25% year-over-year to $533 million driven largely by disruptions stemming from the COVID-19 virus, but were also impacted by FX which reduced sales by an additional $18 million. OE sales were down 32% year-over-year on disruptions caused by the pandemic. During the quarter, our operations and our customers’ operations, which are primarily in Europe and Asia, were negatively impacted by government shutdowns. Aftermarket sales, which were down 18% from last year, were impacted by reduced capacity at many transit systems around the globe. However, as economies have opened up, we have seen a resumption in service, increased equipment deployed, gradual recovery and ridership in most markets. Our adjusted segment operating income was $51 million for an adjusted operating margin of 9.6%. Margin performance was impacted by the lower absorption of fixed costs in the first half of the quarter. However, we are continuing to drive improvements in the transit business and expect transit margins to increase 100 basis points for the year. Finally, the segment backlog was $3.4 billion, also about flat with last quarter. FX negatively impacted the backlog by $79 million versus the end of the first quarter. Now, let’s turn to the balance sheet and the cash flow on Slide 9. Cash flow generation during the quarter was strong at $311 million. I would note that we had about $40 million of one-time impacts due to prior year restructuring and transaction charges we had identified on our last earnings call. Our leverage ratio at the end of the second quarter was 2.7x about flat with the last quarter. But our total liquidity at the end of the second quarter, was $1.9 billion, up solidly from the $1.2 billion at the end of the first quarter and total net debt is down about $282 million. Also in July, we took proactive steps to restore a more balanced maturity profile of our debt with a successful 5-year $500 million bond offering that retired $500 million in floating rate notes due in September of 2021. Summary our balance sheet is strong, and we are confident in our ability to generate cash flow, giving us the liquidity and flexibility to execute our strategic. With that, let’s move to Slide 10. And I will turn the call back over to Rafael.

Thanks Pat. So as you heard throughout the morning and you see on this page Wabtec had a solid performance in the second quarter, despite a weak and fluid environment, a reminder that in difficult times, strong companies must learn how to adapt, find a better way and lead through change. We could not have imagined a greater stress test for our company and how it would perform in a difficult environment than the one we are seeing it today. Over the last 70 months, we have successfully managed a massive merger that doubled the size of this company we have faced into the global pandemic, in an industrial recession in one of the most difficult business cycles ever seen. Yet despite all the odds, we are performing strong and we have delivered a true testament to the team and their commitment to position this company as a stronger and more resilient Wabtec carrying into the second half of the year we would fully expect to see continued headwinds, especially given the uncertainties of COVID-19. Our leadership team remains constant and committed to manage cost and to drive profitable growth that will help us navigate these challenges. I want to personally thank each and every member of the Wabtec team. Again, for all that they are doing in the face of change your efforts are reflected in the results we shared today. With that, I will turn the call back to Kristine to begin the Q&A portion of the discussion.

Thank you, Raphael. We will now move on to questions. Before we do out of consideration for others on the call, I asked you that you limit yourself to one question and one follow up question. If you have additional questions, just please rejoin the queue. With that operator, I think we’re ready to take our first question.

Thank you. [Operator Instructions] And our first question will come from Justin Long with Stephens. Please go ahead.

Thanks Good morning and congrats on the quarter.

Good morning Justin.

So maybe let’s start with the 2020 guidance. So if I look at the revenue guidance, it implies that sequentially in the second half of the year revenue should get better relative to the second quarter. As we think about just the mix implications, can you give us some color on how much of that sequential improvement in revenue you anticipate to come from freight versus transit, and then anything just on a quarterly basis that you can provide to help us think about the cadence of revenue or earnings in the back half?

Sure. Justin, let me start first with well, as we look at the backlog coverage for the ranges we have provided we feel strong about that, I think we also feel strong about the strength in the execution. We have got say a strong momentum in terms of both synergies and cost actions that we are taking I think in the second quarter we certainly saw volumes bottoming for our costumers. We think it was also when we think from operational disruptions. I think we also, to some extent have seen the worse. I don’t think we are through that; I think we have seen improvement in the transit storage at the end of the quarter point out to that with unparking of locomotives, ridership levels in the transit side have improved a bit but I think the better news there, you have got a large number of trains still operating. So I think we are continuing to see those trends. There is, of course, some volatility as we see, and as we look into the recovery, but we are seeing trends up starting at the end of the second quarter, and we continue to see that through this month of July as well. Pat I don’t know if you want to add any more specifics into it?

No, I think the one thing I would point out is that when the – when you kind of look at our information though as it becomes available, the mix of aftermarket versus OE that the decline is much more significant in the OE side kind of quarter-over-quarter and year-over-year. You see that it’s really being impacted by the disruption in the industry, in the market. And so I think to get to your question of where and how those recoveries, I think the recovery is going to be in both segments, I think you are going to see it coming back to more typical mix of businesses as the year goes along.

I think one of the things we will be watching for is really any push-outs on the decisions which regards to new projects. And I think that’s something for us to continue to monitor here as we continue to build backlog.

Okay, great. And then maybe Pat on the cadence part of that question for third and fourth quarter, do you feel like third quarter is maybe a little bit worse and then we kind of build off of that into the end of the year. Any color on that front?

Yes, just want to be careful about guidance this quarter and everything. But I think you see sort of a kind of a steady sequential improvement as we go through the rest of the year.

Okay, helpful. And as my second question, I wanted to ask about free cash flow, I know you made the comment about the cash conversion percentage this year, but anymore specific thoughts around free cash flow in 2020 and how that cash could be allocated between debt pay-down and maybe potentially even buybacks? I don’t know if that’s something you are considering at this point?

Well, couple of points. I think we have given clear guidance to cash conversion being above 90%, I think we remain committed to that. And I think we have the areas of opportunities here to act. If you look into areas like inventory, for instance, so we will continue to have strong rigor around that and we feel strong about delivering above 90% cash conversion here.

Yes. And as for the allocation, I think it’s obviously, one of the most challenging times and we want to make sure that we focus on debt repayment and then get into other uses of capital. I don’t think – I think it’s too early to really be talking about anything aggressive or we want to – but we want to remain opportunistic and that’s the way we have approached this. We are generating cash, we are meeting our goals and then we are using it to get our debt in the right kind of ratio range as we have always talked about and be opportunistic for all the other things we can do.

We remain committed to the framework we presented during the Investor Day. I mean, there is a commitment to continue to pay debt down, but we are going to be looking at opportunities here. And especially, we can see bolt-on acquisitions being I will call more available than they were maybe 6 months ago and that will make sure to evaluate that against the different options. So, we are committed to that framework we presented back at the Investor Day.

Okay, great. I really appreciate the time.

Thanks.

The next question comes from Chris Wetherbee with Citi. Please go ahead.

Yes. Hey, thanks and good morning. Maybe if you could – I was curious if you could provide a little bit more sort of color on the outlook for the second half on Freight segment. So looking through sort of equipment and components and kind of getting a sense of how we should be thinking about that revenue rebound relative to what we see in the freight market. Services and digital obviously held up fairly well. But when you think about those two pieces did those kind of move linearly with recovery and volume or how are you guys expecting that to play out in the second half?

I think I will probably point out to three things to be a really watching. Of course, the impact for both customers in operation was very significant in the second quarter. As we are going to the second half, I think, first really watching closely on the freight side, the unparking of locomotives. What I feel was North America or international, I mean, we have seen the impacts in the second quarter. And as those un-parking occurs I think we have seen that trend. It’s not linear, but I think there are some brighter spots then, but one places versus others. Especially, internationally, I’d say we see some of those brighter spots. We see democrats across some geographies and driven by well, either agriculture or specific mining. There is still some markets we’re heavily under penetrated. So I think we see a good dynamics coming from the, from some of these markets. And it is reflected also in the pipeline of what I call opportunities for equipment deals. So what if I talk about agriculture in Brazil or mining in Australia, we also continue to deliver on our contract in India. You think a country like Kazakhstan's volumes carloads, are actually up year over a year, year to date, and that’s also I think, a significant opportunity for us.

Okay, that is very helpful. I appreciate that color. And then just a detailed question about the 12-month backlog, I just want to make sure I understand sort of what the progression has been over the last couple of quarters. So that's come down a bit, and I know FX is probably some of it I am just kind of curious, have we seen any of the sort of 12 month outlook get pushed out into the right? I think there was some comments about that maybe on the in the prepared remarks, just want to make sure I am understanding sort of what the 12-month view is, obviously, the long term is very stable. So want to make sure how we are seeing that kind of play out over the course of this sort of more immediate term?

I would say certainly, when I look at second quarter, even first quarter, I mean, I can’t say those were necessarily great in terms of all favoring a dynamic of order intake. I think when you compare first quarter, against the second quarter, and if you have to exclude FX, you will see in backlog remained flattish quarter over quarter, I think, as we look at has ahead, I mean, we are really in the business of looking for business. We are chasing every piece of opportunity that we can go after. Our strategy here is to grow the business profitably, and so we will continue to act to have a more competitive cost structure than ever before. I think, yes, we are seeing some decisions moving to the right. And I think, especially if you think about some of the dynamics in the transit side with, really despite of the fact that ridership is low, I think we are seeing a number of trains in operation. So operators are really reevaluating some of these but we think the long term fundamental is ratified, look at transit or freight remain strong. And we are seeing a commitment to actually be investing in those modes. And this is part of the solution, as we look out the world ahead in terms of driving more efficient, more productive, less emissions. And I think we sit in a good place in terms of the long term fundamentals for the business.

Okay, okay that’s helpful. I appreciate the color. Thanks very much.

Our next question comes from Allison Poliniak with Wells Fargo. Please go ahead.

Hi, guys. Good morning.

Good morning.

Good morning.

I just want to delve into Chris’ question a little bit more on the freight aftermarket piece, particularly if it relates to North America. I guess, just given the focus on the rails and in terms of increasing the rotation versus bringing equipment back. I would have thought your fleet aftermarket. I think you said it wouldn’t recover one to one, but I would think it would actually recover a little faster as a result of that. Any thoughts there? Am I thinking about that wrong?

Well, couple of comments there. Number one, I mean, we felt the impact in the second quarter in North America I mean it is brutal, right? I mean, as you look into the numbers you have heard from the Class 1s I mean we have seen volume reduction, pretty close to those numbers that you have heard I think of transactional parts. And I think some of the Class 1s alluded to, like 20% down. Yes. I mean, we did feel that directly. I think what we have also seen is from the bottoming of the volume, which fundamentally happened in the first two months of the quarter, we have seen that improvement come through. That is also being true not just for North America. We have also seen that into international markets. And we do expect recovery to happen there faster, especially as our fleets are on parked. It is all dependent on the pace in, which those fleets gets un-parked. I think we are seeing a faster rate of recovery on international markets. I think I mentioned here earlier, some of the dynamics on agribusiness mining across some of the geographies that we serve, and we are certainly seeing I see a much faster recovery, in fact, of some customers actually up year-over-year in terms of carloads in some of these geographies.

Got it. Got it. And then just want to turn to transit, in terms of the recovery in terms of U.S. versus global, I know global is a much bigger impact for you on transit, any differences that you are seeing in those markets in terms of how they are recovering or interest in investing in infrastructure going forward?

I think the recovery in terms of number one, ridership has been a little bit better in Europe, if you compare against U.S., but reality is it remains well below what I will call the pre-COVID level. So, I think the better side of it is we have seen I think number of trains in service and operations are very significant despite of the ridership being down. So, I think we can also be looking at service despite maybe a lower decline going into a faster recovery. And I think other element is, I think, as far as project scales, we haven’t seen any again cancellations or anything with regards to the impact of the share. There could be an element of things pushing to the right in terms of just project delays when customers might want equipment. I think that’s one of the elements that we are going to keep monitoring.

Great. Thanks so much. I will pass it along.

Our next question comes from Courtney Yakavonis with Morgan Stanley. Please go ahead.

Hi, great. Thanks for the question, guys. You talked a little bit about kind of the bottoming in volumes and in ridership in transit. And I appreciate kind of a lot of questions on kind of the aftermarket, but could you kind of clarify what the exit rate trends that you are seeing kind of that improvement off of the down 18% in transit aftermarket and then similarly, in the freight services side kind of how you have seen that recovery progressed so far kind of as we have gone through the quarter and the exit trends?

So, I think in terms of the exit trends, I mean, yes, we saw it going back up some of the demand in both – in terms of orders, but in terms of sales, versus the first 2 months of the quarter. I think, in specific, I’d say in transit, I think beyond that, I think we have taken significant actions in the business. Lilian and the team is really committed to continue to take the necessary cost actions and I look at a year-to-date we are 110 basis points margin improvement versus the first half of last year. I think we have talked to you about being at least 100 basis points improvement year-over-year. So, despite of what I will call a really unprecedented quarter in many ways, we are very much on track to deliver on that promise. So, still a lot of work to do, still subject to lot of disruptions, but we feel like the team is heading in the right direction here.

Okay. And then just on the synergy targets, obviously, you mentioned that you feel confident that you can get over the $150 million net by the end of this year. I think you have talked about some of those synergies being volume related. So, maybe can you just comment on your confidence is that because you are seeing that volume improve or are you seeing maybe faster footprint reduction than you were anticipating? And then if you can talk at all about maybe the upside to that $250 million since you have mentioned that you will achieve that earlier than you had previously anticipated?

Yes, we are certainly – I’d say number one reason for that is we do have a pipeline of synergies that’s greater than the one that we have provided. So, we are continuing to work on those and they are critical in order to offset any I’ll call downside that we could experience along the way. So, we are not giving necessarily any considerations on volume growth at this point as being able to accelerate that. But I think we have got good momentum there. And I think we continue to have opportunity here to provide I will call better news in terms of accelerating synergies as we progress this year and into next year.

Okay, great. Thank you.

The next question is from Ken Hoexter with Bank of America/Merrill Lynch. Please go ahead.

Hey, good morning. Pat, maybe just continue on the margin commentary there, what are your thoughts on freight margins now that you have fully integrated with GE and lapping year-over-year. You are in the upper-teens, but maybe just help us think about what happens as asset sales come back online, should we see a mix change do you expect that to move back into the 20 should it stay at this level, maybe just your general thoughts as the mix shifts with business mix?

Sure. I mean, when you kind of look at the impacts you have freight car builds that are really at very historically low levels you have North America locos and in the impact of that markets on our business, as those volumes come back on, we have we obviously get really good margins on the on the freight car build and we get good margins on the locomotive builds, on OE and the absorption that comes along with that. So I think that you could see the business and the margins for that freight segment improve with the higher volume It certainly makes sense. The other aspect of this would be digital electronics and, the investment that our customers will make in the growth in that in that revenue area will also provide really good margins for the segment.

So it’s not like digital has higher margins because of less asset intensity. So therefore, it’s peakish now and with more assets, it would be pressured you see as the physical assets come back and improving in that margin, just as you get more fixed cost coverage just to clarify on that?

Yes, exactly. I think fixed costs coverage is a big part of it, but I think it’s, also it those are those are good product lines for us and they deliver a lot of value for our customers and I think that is the overall volumes recover and we get industry improve. I think that you will see the margins get back to more historical than typical levels.

Right. And then for my follow-up, Pascal, you say obviously freight did well in the in holding up in the background can you talk about the mix of contract services versus equipment in the backlog itself in terms of what was added and maybe your thoughts on domestic versus international as well?

Look, you want to think about I just want to be a little careful, I don’t think we’ve kind of broken out like each of the, the component, the product line revenue into its backlog and everything. Obviously, we talk in general about the revenue mix in the services, as about half of it comes under the MSA agreements, which is an element of both kind of labor service and parts and other activity. You have mods in there and you have part sales in there. So those are those are basically the rule of thumb that we have been talking about in terms of how to look at that, that product line revenue. And I think the orders that we have come in, kind of hold with that with that mix. It is not absolute every quarter but when you look over a longer period, a year or more, you are going to see your order intake be pretty consistent with that mix of revenue.

And maybe to your question about…

North America back to the international, I mean, what we see is that North America, we have seen these big impact from parking. Now, if you look at the active fleet today, Wabtec locomotives really represent the majority of the fleet that is running today. So this is an effect that is mitigating with high parking number. And the locomotives that are running are running really hard. So in terms of megawatt hour miles per locomotive we have really seen a strong increase, together with the implementation of precision scheduled railroading So which is one thing that is accelerating scheduled maintenance, that is putting more focus on reliability and which is good for services international Rafael discussed it. I mean, Australia is strong, Brazil is strong Kazakhstan, Egypt, many of our big international markets have remained strong. And in terms of in terms of mods with the great work that our supply chain team has been doing to keep our factories open, we have been able to stick to our delivery schedules, and to have a strong quarter as well. So these are really the three building blocks that that can explain this performance, I would say.

I think if you look at the last few years we have continued to see an increase in terms of the percent of our fleets running when compared to our competitors, whether if I look at North America or global markets. I think that’s an ongoing trend.

Thank you so much. Appreciate the time and thoughts.

The next question comes from Matt Elkott with Cowen. Please go ahead.

Good morning. Thank you. So, back at the Analyst Day, you guys provided a chart showing the installed base distribution for locomotives. And based on the age profile of the T4 locomotives, it would appear that some of them may be rolling off warranty in the next couple of years. First of all, is that – if that makes sense? If so, would that be a positive for aftermarket revenue on those locomotives?

Yes, yes, that’s true. Now keep in mind, I mean, this is a big fleet right, we are talking about 23,000 assets as we presented. I think we have a favorable age distribution. The average age of this fleet is only 13 years, which is a pretty young fleet that is going to keep running for a number of years. You have some of the older fleets that are running less you have some of fleets that are coming off warranty, especially internationally. And so you have a number of effects coming together. But true, we have some locomotives coming off warranty and these locomotives start generating service revenue.

And then service revenue, that doesn’t make it into the backlog number, does it, that you have published at $12 billion?

Not necessary, it depends on the contractual coverage that we have for these units.

Yes, I mean, you – you have MSAs that are out there depending on the customer and the fleet and their own decision. There might be a contract agreement that’s in place. But you could also have customers be doing some of the maintenance on their own with just our parts or somewhere in the middle, it’s really – it’s not something as you can kind of paint broad-brush over everybody, it can be a little bit different. And that’s why I always go back to the kind of the mixer of the service revenue for the product line.

So there is about what $600 million, which is more transactional, which is orders you get on the Gulf, so you might not be seeing those on the backlog to your point out of the total $2.2 billion that make up the bridge.

Got it. That makes sense. And speaking of question that may be in that gray area and it’s somewhat hard to answer, I was just wondering, if we can gauge what percentage of your international backlog maybe for customers that are government-backed entities, federal government backed entities versus state level versus private companies, I know that you probably don’t have that specific breakout, but any color would be helpful?

Exactly. We don’t really have that breakdown like you described, but I mean we can certainly look into that and try to get back to you with at least some color around it.

Yes, I would just add – I mean just as like a rule of thumb or something that just to consider. I mean, a lot of our especially in the freight side, our contracts are backed with bank guarantees and other financing that’s in place. And when you get on the transit side, especially on the OE markets, where you have the big backlog, those are typically supported with government funding. And often that funding has been in place for years and because they – because the contract was awarded years ago. So, that’s just kind of a thing to consider.

So, that’s one side on the equipment and maybe on the service side they will very often be sold if a services contract on the top of that, because they want to make sure ultimately they maintain the locomotives running and there is an element of continued training to the operators. And what we often see is our fleets running, especially in those remote locations as we support the customers throughout the life of the locomotives.

Yes. To look, I mean, internationally, we can pretty often without the proper service we both end up with a brand new fleet of locomotives that is stranded after a few years only we really try to stay close, we have our customers over the entire life of the – over the entire life of the locomotive. We have more than 160 service locations all around the world. So, adding local presence and being able to bring engineering support whether physically or with remote diagnostics is having keeping parts locally is really important for us internationally.

So we are very interconnected with our customers to the point that in a lot of places, we manage the inventory associated with parts coming in and ultimately making sure we guarantee the availability and reliability of those assets. So we feel very much upfront on any of those changes.

Great. Very helpful. Thank you very much.

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

Good morning, everyone. Rafael I am wondering, I’m wondering if you could talk about how your MSA is performed in the quarter obviously, really strong services results. Sounds like mods help. But can you talk about the MSA performance in particular and, I believe you get Higher revenue opportunities post PSR adoption and I am wondering, are you starting to see that hitting the sweet spot, if you will? Can you? Can you just expand around those points?

Okay. So I’ll just start with the second quarter. I mean, of course, the trends were not great there. I mean we saw a decline in some of these items. And I think I mentioned about parts I mean we also saw pressure on the MSA I mean units not just not running as much as they were. But once again, I think as you start seeing the on parking take place, I think we are seeing those trends as early as of June and continuing to July to move in the right direction. And I think we are seeing a good pattern from this point of view. But I think though one thing I want to highlight to you here is we are working with customers to make sure that they have got ultimately, I think the most efficient the most reliable locomotives out there. And these presents to us opportunities to overhaul to modernize and to ultimately also equip them, so they can run a lot of the things you have heard from the Class 1s, how do I run longer trains? How do I get to a more fuel efficiency for those locomotives, and we got to make sure that we are combative does we do that but things like distributed power with LOCOTROL, LXA, Trip optimizer. These are some of the technologies that will enable that and these are in fact, proven technologies that align very well with PSR. And all the efficiency, railroads want to drive and I think, again, very much connected with a lot of the story you hear from Pascal on the services side, and one area that we continue to see opportunity here to grow our installed days and to help customers with a great paybacks.

Okay. And then, a follow-up on mods, Pat, I think you mentioned in your prepared remarks. You had double digit growth, to hit the type of outperformance that you had in services versus trade volumes in the quarter, you would see mods, shipments would have to be up, you know, 30% to 40% year over year to drive the level of performance that we saw for you folks in the quarter and I am wondering if you can comment on what’s the equity level like for adding mods to backlog? Are you able to essentially maintain the mods backlog as we hopefully see improving Freight conditions entering 21

Yes, so the mods are, they are in the backlog year over year, essentially, we continue to execute on orders received and, it would have been in 2019. And according to the schedule, that are customers and have worked with us on establishing so there is a certain amount of quarter to quarter variability it will come with those mods orders as we execute it sometimes it’s, to look at it and say this is going to be linear or whatever, or have a trend there, you really have to look at a bigger picture, a bigger number of quarters or a year to date, kind of kind of numbers. So it just so happens in the second quarter that backlog is more staggered in compared to last year. When you talk about order intake for mods going forward I mean, it’s, I think that there is a lot of interest in our customers to continue to, to use this mod approach to leverage especially in their PSR strategy and, and their fleet and their fleet strategy. Pascal if there is anything you want to add to that?

No, I mean, number one, I think if you look at the service number for the quarter, it was not 100% a mod story, right? As we explained, we had a difficult situation in North America due to parking. However, a big portion of our fleet kept running internationally. We saw some strong performance. And then we had a strong mod quarter in terms of deliveries. Now looking forward for mods, I mean, we believe that this is a big opportunity for the railroads, which is fully in line with their strategy, as Rafael said around longer trains, more reliable trains, better economic performance, we have analyzed the fleet in a lot of detail and we have the opportunity to deliver big outcomes and to our customers. So, we are talking about 50% increase in power eligibility, reliability improvement by more than 50%, 10% fuel efficiency improvement, the addition of all our suite of digital solutions, Trip Optimizer, LOCOTROL, LXA. And all this, when you combine it together we believe that this is turning into a very attractive investment proposition for the railroad. Now for them in the end it’s a question of capital allocation and they decide. I mean we will count to show them the value of our product and we believe that there is a big opportunity to create value for the railroads and for Wabtec at the same time. You can and you will see big swings between mods and so what I’ll call new locomotive volumes quarter-over-quarter. Just keep in mind, the same facilities, they are doing the mods or doing the new units and of course, we tend to profile those to make sure mean we are driving good productivity at our plants. So, there could be some significant changes on quarter-over-quarter numbers. I think the seasonality – the seasonality effect is important and you have mods, you have service, you have scheduled, you have unscheduled maintenance, you have the overall profile. There is a seasonality impact and then you will see some ups and downs there.

Okay. Appreciate the discussion and congratulations on the strong quarter. Thanks, everyone.

Thank you.

Our next question will be from Steve Barger with KeyBanc Capital Markets. Please go ahead.

Hey, thanks. Good morning. Just a couple of quick ones. For the Digital business increase of 4%, was more of that recurring revenue from existing customers or you have been able to convert new customers looking for efficiency in 2Q?

Can you repeat that?

You broke up a little bit. Steve, can you say it again?

Yes, sorry. The digital business increase of 4% more recurring customers or were you converting new customers?

I think we have – a lot of it’s associated with I will call existing customers. We have the opportunity here to grow our installed base on some products that are still under-penetrated. I think I mentioned here, LXA as a product. So I mean, we still have an installed base that’s relatively small when I look at the potential of this product. And it’s a key product, especially as railroads look at making longer trains. I think there is some elements here of auto products like Smart HPT that will also enable customers to get significant fuel savings as they run those longer trains, so more with existing products and existing customers. I think one of the big opportunities we have is to expand that share growth and really into the international market. I think we have got some earlier adopters in places like Brazil, in places like Kazakhstan, but we can still be doing a lot into some modern geographies.

So that was my next question. The digital business is much more North America and less penetrated in international?

Exactly.

And just last one, one quick clarification, Slide 8 says you expect to drive margin improvement in transit through the rest of the year. Does that mean sequential improvement by quarter or is that relative to what you put up last year?

I think, again, what we said last year was we are going to drive at least 100 basis points margin improvement year-over-year. And we certainly have actions that support more than that. And I think my commentary earlier was you look at the first half of the year, we are very much on track to do so and actions will continue. It’s less about the event. I will call the improvement year-over-year, but making sure that we will continue to drive momentum to, well, get to our entitlement. So I want to see continued momentum there.

Understood. Thank you.

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

Hey, thanks for the time, guys. A couple quick ones for you first Pat. So typically third quarter just normal seasonality is lower than third than second quarter, does that sort of normal seasonality apply this year and then maybe just bigger picture when I look at the guidance, showed a faster improvement in revenue growth off the bottom than earnings growth? Maybe just some thoughts there on sort of the mixer or margins as revenue starts recovering? Thank you.

Yes. So the seasonality we kind of find that to be a little bit challenging and a little bit, not typical year to year when you would consider all that we have gone through the easy one to point to is the timing of some of our freight services business, we would see a lot of strength of that in the in the third quarter. And then in the my earlier remarks prior March, I kind of mentioned that we see some of that edging out into the fourth quarter. And I think that that’s, from what we can tell what our customers we think that that’s going to have an impact. I think you also look at that was always a kind of a positive seasonality in Q3 you also had some negative impact of shutdowns and plant slowdowns in the in the summer months in Q3. We are seeing that being a little bit moderated. So I think that the expectation for us in Q3. getting back to normal and next year. and I your point about, about kind of revenue growth outpacing the earnings growth. I think that’s a little bit related to the sales mix timing, we, we certainly will see some kind of return to normal and some of our engineering costs and, SG&A being, more consistent with the higher revenues. And I think that will have an impact on our margins a little bit in the second half of the year.

Okay, thank you. Just last one, if I go back to the beginning of the year, you were talking about $900 million of cash from ops. It looks like the net income guidance is down around $200 million from January. So should we assume a similar sort of $200 million decline in cash flow from operations or is there reasons why it can be better than that?

Well, I think you got a, obviously consider the impact of net income In lower volumes on the cash flow, but, the areas of confidence in cash flow and opportunities to do better, really starts with the ability to work with our working capital to reduce our working capital with a lower volumes, turn that into a source of cash, obviously, the cash, the cost savings initiatives that we put in place. And, we continue to execute on some of the tools, the balance sheet tools and the supply chain tools that we replaced from exiting the GE transaction. So all those things I think lead to a lot of confidence in our cash flow generation for the rest of the year.

Okay, great. Thank you, guys. Appreciate the time.

Thank you.

Ladies and gentlemen, 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 everyone for your participation. I will turn the call over to Rafael for a quick few comments.

Hey, just one of the most disruptive quarters for us ever with really an impact for both customers and operations, Wabtec employees have been absolutely amazing in their response, and I just want to thank them for the hard work and dedication to keep serving our customers and running our company. Well. Thank you.

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