Good morning and welcome to Wabtec Q1 2021 Earnings Call. All participants are in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I'd like to turn the conference call over to Miss Kristine Kubacki, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to Wabtec's first quarter 2021 earnings call. With us today are President and CEO, Rafael Santana; CFO, Pat Dugan; and Senior VP of Finance, John Mastalerz.

Thanks, Kristine, and good morning, everyone. We appreciate you joining us today. Turning to slide three, we continue to see a recovery across the global freight and transit rail markets, with North American freight volumes and equipment utilization sequentially improving in the first quarter, and investments in transit infrastructure are continuing. This directional trends along with the focus performance of our team and execution against our strategic plan are reflected in our first quarter results. Total sales for the quarter were $1.8 billion. This was largely driven by international freight markets services and a recovery in transit, but offset by continued weakness in the North America OEM market. Adjusted operating margin was 15.1%, driven by lean initiatives, cost actions and favorable mix from mining and mods. Cash conversion was strong, with cash flow from operations of $292 million. Cash generation was due in large part to good working capital management, allowing us to deliver on our financial priorities, including strategic acquisition of Nordco, which I'll touch upon more in a moment. Total multiyear backlog was $21.7 billion, up sequentially over the prior quarter, providing us better visibility into 2021 and beyond. Overall, we ended the quarter with adjusted EPS of $0.89, a strong enforcement that our teams are continuing to take the necessary steps to control what we can deliver long term growth of the company and increase shareholder value. In the area of synergies, we're on track to deliver the full run rate of $250 million in synergies this year, and we have positioned the company for long term profitable growth. In the first quarter, we exited all shared service agreements stemming from the huge transportation merger ahead of schedule. This was a tremendous execution by the team on a complex transaction.

Thanks, Rafael, and good morning everyone. We had a solid operational start to the year despite the challenges in our North America, OEM markets and ongoing disruption from the pandemic. We demonstrated our ability to deliver on synergies, generate cash flow, invest for the future, and position Wabtec for profitable growth. Turning to slide four, our view of the first quarter in more detail. Sales for the first quarter were $1.8 billion, which reflects a 5% decrease versus the prior year, driven by lower North America OE freight markets as a result of the disruption caused by the pandemic. For the quarter, operating income was $192 million, and adjusted operating income was $277 million, which was down 9% year-over-year. Adjusted operating income, excluded pre-tax expenses of $85 million, of which $70 million was for non-cash amortization and $15 million of restructuring and transaction costs related to the acquisition of Nordco, along with restructuring due to the 2021 locomotive volumes and restructuring in our UK operations. Adjusted operating margin was 60 basis points lower than the first quarter last year, but up 110 basis points from the fourth quarter. Versus last year, adjusted operating margin was impacted by under-absorption costs at our manufacturing facilities, stemming from fewer locomotive deliveries, as well as sales mix impacted from lower digital electronics and a higher level of transit sale. At March 31st, our multiyear backlog was $21.7 billion, up quarter-over-quarter, a rolling 12-month backlog, which is a subset of the multi-year, was $5.7 billion and continues to provide good visibility into the year. Looking at some of the detailed line items for the first quarter, adjusted SG&A declined to 2% year-over-year to $224 million. This was the result of cost actions during the downturn, and excludes $11 million of restructuring and transaction expenses. SG&A expense benefited from headcount reductions and the realization of synergies.

Thanks, Pat. Turning to slide eight, let's look at some of the market dynamics by segments. Overall, we're seeing a gradual recovery across most end markets as global economic activity improves. And we're continuing to monitor the evolving COVID situation in regions like India. This aligns with what you've heard from our customers, as well. While we continue to work through the trough in the North American market, where new local orders remain stagnant, we are encouraged by the sequential improvement in freight volumes and a broad recovery across the agriculture, intermodal and industrial markets. Locomotive parking after peaking to a record high in 2020 are improving as a result of increased freight traffic and demand stemming from weather disruptions during the quarter. We expect the demand for reliability and productivity to improve as railroads continue to recover. This will put us in a position of strength across our freight portfolio. When it comes to North America rail car build, rail cars are coming back into use, more than 20% of the North American rail car fleet remains in storage, but it's back to pre-COVID levels. Industry orders for new rail cars remain weak and forecast estimate the rail car build this year to be below 30,000 cars. We have a strong order pipeline internationally, and we expect long term revenue growth in several of these markets going forward. And in mining, market conditions are also improving. Transitioning to the transit sector, ridership is uneven, but recovering as economies open up. We are watching short term dynamics as the pandemic evolves in several geographies, including India and Europe. Overall, the long term market drivers for passenger transport remains strong and infrastructure spending for green initiatives continues to be a focus, especially as governments globally turn to rail for clean, safe…

Thank you, Rafael. We will now move on to questions. We are now ready for our first question.

First question comes from Jerry Revich, Goldman Sachs. Please go ahead.

Hi everyone, this is for Jerry Revich. With investments stepping up in the decarbonization product portfolio, I'm wondering if you can provide any details on the proportion of total R&D related to next generation fuel technologies?

We're continuing to step up investments there. And I think we've been clear around the 6% to 7% range of investments tied to the overall sales. We're very much committed to lead the path here to decarbonization. We're working on a number of areas with customers, those include really developing some of the elements of upgrade kits. We're working on a number of areas to introduce biofuels, renewable fuels, but taking all the way to electric. And we're also, of course, working along the lines to lead in fuel sales. And that's kind of the stairway we see on progressing through it.

Great, and then, I'm just wondering if you can comment on the pace of mods activity and sort of how that's trending in 2021, how that compares to 2020?

We've had a significant step up, healthy double digit growth, you see that reflected in the first quarter where we have significant positive from that and we believe mods will continue to be an area of growth for us. It's clearly a pathway for us to introduce, what I call, upgrades into the fleet and make them more fuel-efficient, make them safer, and more overall, just efficient.

Great, thank you.

Next question is from Justin Long of Stephens. Please go ahead.

Thanks, and good morning. I wanted to ask about the guidance. And I was curious if you could share the revenue and EPS impact that you're baking in from the Nordco acquisition this year? And if you set that acquisition aside, can you just talk from a high level about any other changes that you've made to some of the assumptions that are underlying that 2021 guidance?

Let me start and then I'll let Pat continue, but we have narrowed the guidance. We have raised the midpoints given the strong operational strikes of the year, I think in the quarter the positives include mining, executional modernizations. And so, we continue to see strong numbers around locomotives being on part and we also have the acquisition of Nordco. At the same time, Justin, we continue to see supply chain headwinds, with disruptions driven by COVID. I think most impactful is situation we currently have in India, which we're falling on, but certainly had wins when it comes to transportation costs, and commodity prices over all of that is reflected in the guidance we've provided. I'd say, overall momentum is positive. And we are continuing to see a gradual recovery across most of our end markets.

Hey, Justin. So this is Pat. We're similar to what we had disclosed when we did the earnings -- the press release on the Nordco acquisition, about $175 million of sales on an annual basis and $14 million of EBITDA for on an annual basis. So we bought it basically at the end of the first quarter, beginning of second quarter. So it kind of pro rata for the rest of the year. The EPS impact, we've talked about it, is around $0.06 for the full year. So, that's included in the guidance and gave us a lot of the confidence, obviously, to increase the bottom end of the range. Plus, some of our good performance so far ultimately where we got it today.

Okay, great. That's helpful. And secondly, I wanted to follow up, Rafael, on something you mentioned a couple times on parked locomotives. Could you give us a sense for how locomotive utilization has recently trended? And what percentage of the fleet is still in storage today? And then also, as you answer that, I'm curious what percentage of that stored fleet you feel like is actually usable, because on the rail car side we always hear that we're effectively fully utilized with, call it, mid-teens, maybe low teens percentage of that fleet and storage? So we'd love to get your thoughts around that.

So just overall, the industry is not back to pre-COVID levels yet, from just the locomotive parkings perspective, we're still good with the progress especially regarding our fleets. I think we're ahead of the overall industry, which is a positive for us, when we look at our overall fleets operating globally. So that's certainly a positive trend. So you still have a little bit, I think last from units that were part, what are called post-COVID. Now, and when you look at the unit storage part, pre-COVID, those units, it's a smaller number that can potentially be utilized in here. So I think momentum is positive, we're going to continue to watch that closely here, especially as we're going to the second half of the year. And we're especially pleased with the performance we're having with customers in terms of reliability and availability, which ultimately is really the differentiator for us to winning more share of wallet. So, positives. The last piece out mentioned, you've probably seen a number of customers are looking for, what I call, spare power available out there, including some recent announcements, I'll say the good news is, those are Wabtec locomotives, it's positive for us.

Great, that's helpful. I appreciate the time. Thank you.

Next question from Scott Group of Wolfe Research. Please go ahead.

Hey, thanks, good morning. Just going back to the guidance here. So it looks like you're assuming the second half is about 30% higher than the first half of the year from an earnings standpoint, give or take, and we don't typically see that level of seasonality. Can you just help us understand what's driving such a big ramp in the second half of the year?

Scott, I think consistent with initial forecasts we have for 2021, we have more growth weighted to the second half of the year. I think in that regard, we're continuing to see sequential improvements in the first quarter. If you think about your orders to book to bill, it's increased to 1.2, some of these are multiyear orders, while there's an impact in 2021, the impact goes beyond 2021. I think our pipeline of deals has continued to strengthen, so I think there's just good momentum coming out of a tough year being last year and we have also good progress quarter today. Our 12 month rolling backlog is up about 3.5%, and we've got good momentum and to focus really on convertibility of our pipeline of orders into this year and building forward. I think just start with regards to second quarter May day is -- we -- as previously discussed, I think we've got some elements of volatility, especially tied to COVID disruptions. We think those are contained very much into the quarter. But that's the situation we'll continue to monitor, especially with regards to India, which is important market for us.

Okay, just a follow up there. So is the second half more about transit or freight or domestic versus international? Just some additional color would be great.

I think international markets continue to be robust, if you think about it, just in terms of sales, we've grown our business more internationally than in the US. So I think largely the North American market is going to be tied to the continued on parking of locomotives. Internationally, I think growth has been, call it, more robust in some ways, the team is very much focused on convertibility, we've got some very foreign opportunities around the OE side that teams working to convert between here second and third quarter. So, those are critical elements of continuing to build profitable growth.

Would you say international is back at pre-COVID levels?

I'd say largely, when you think about the services from ; Scott, I think there's room for a lot more momentum forward. And if you think about it, on how much of our business was, let's say, last year, international versus now, it's gained about five basis points in terms of momentum there. So you think about it, we're probably at a rate close to 65% in the first quarter with international. So that gives you a sense of our both the strength there, but the weakness in North America.

Okay, thank you. Appreciate it.

Next question is from Chris Wetherbee of Citi. Please go ahead.

Hey, thanks. Good morning. I wanted to ask you about freight and maybe how we can think about in the context of that ramp in the second half of the year, how do you think about sort of incremental margins in that business? I know you have the synergies that you're working through, but fixed costs absorption, obviously, has been one of the challenges for you as the volume and revenue dynamic has been more challenging over the course of the last several quarters. So is that something where we could see potentially somewhat large snapback as we move into the second half of the year?

Let me answer in two ways. Number one, we are committed to improve margins on both the freight and the transit side. On the transit side, I think we've been more clear in terms of what we expect that to be. And the team is certainly working towards striving 100 base points, we expect improvement on the freight side, we're working through some of those dynamics here, taking the necessary actions. When it comes to the OE sides, there's probably really not much opportunity in terms of really gaining volume for the year, but there's certainly opportunity when it comes to the services side. And we also have mining really improving overall. So mining is also a positive here for us into the year. So that's just maybe the way to think about it.

Yes, Chris, what I keep reminding everybody is at quarter to quarter, there can be some margin impact from the timing of projects and the type of deliveries. But what you really need to look at the full year margin, and we talked about a transit improvement explicitly for the full company, at least a 40 basis point improvement in overall margin as we progress through the year, that's being driven by a combination of synergies being achieved, of the volumes coming back, offset a little bit by some cost and absorption items and normalization of our other costs in SG&A. But that overall improvement really is a year view and a full year view and should be considered.

Okay, that's helpful. I appreciate that. And then, just picking up on the synergy comment, obviously you have a target for this year. As you think beyond 2021, what do you think the opportunity is? Obviously, you've had the combined company now for a period of time, had the opportunity to kind of go through and see what the opportunities are? And obviously, it's been a challenging macro backdrop, to say the least. As we go into 2022 and maybe get on more firmer footing, can you give us a sense of what you think the potential sort of bigger-picture synergy opportunities might be?

I think I'll qualify those beyond this year last about synergies. I think we're really working hard to make sure that we progress with a lean culture approach. And I think there is a lot to be done there. I think we've started in a number of key and critical sites. And think more in terms of how we think about productivity gains, how we can change some of the work around really rationalizing our footprint, doing more, I think some of you think about acquisition of Nordco. I think it provides us a good opportunity to expand internationally and utilize that footprint of customers and a volume recovery will also be positive in that regard. So it's all around productivity, efficiency, really lean mindsets, and make sure that we drive productivity.

Yes, I would just add to that is, we've tried to be very disciplined about how we look at synergies and communicate that, because it was such a big part of the strategic rationale putting the companies together, but truthfully, the DNA of the company has always been about productivity gains, lean initiatives, all the things that Rafael just referred to, so we just continuously look at how we can improve margin going into future years.

Largely, if you think about our sites, there has been a focus here today, especially in 15 of them. We got to expand that to really drive broader impact in terms of productivity moving forward.

Okay, that's helpful. Thanks for the time. Appreciate it.

Thank you. Next question is from Allison Poliniak of Wells Fargo, please go ahead.

Hi, good morning. Just turning to the digital side, you know, kind of like your comments suggested an incredibly active market and the guidance for flattish growth, it certainly leads to that as well. Could you maybe help us understand the progression of digital through the year to get to that flattish? I mean, it sounds like it's going to be a significantly stronger second half for you. Is this something where the time from order to I would say implementation is pretty short, that gives you that comfort here?

So Allison, I think we continue to see a strong commitment here from customers. We certainly saw that internationally. Our book-to-bill was strong on both fourth quarter of last year and first quarter this year. So that just provides back into what I just said. But customers, when you look at last year, they pushed out some of those investments due to COVID. With that being said both efficiency, productivity and safety remain an imperative. We expect those multi-year awards to continue. The team is very focused on compatibility for the year at this point. So with the strong book-to-bill we saw some of that impact beyond this year. So really a lot of focus on convertibility for this year at this point, we're continuing to invest in the business that business will continue to provide long term growth for us. I think there is more an element here of delay and keep in mind also the element of locomotives shipments. Whenever ship locomotives into North America that goes with the significant number what I call digital software and hardware. So with that drop, we're not seeing that. So that's another element of being packed that I just want to highlight.

Got it. Thank you. And then just on the lines of locomotives, the flex drive, you know, that you completed the test in revenue service. You mentioned some interest in the locomotive, you know, how should we think about those in terms of the quality, the inquiries. Is something that, you know, could be revenue generating and sort of ‘22 whereas of more of a ‘23 timeframe for you?

Allison, interest is strong, we have proposals outs. That would not be an impact for next year specifically, but we expect a battery electric to be part of long term growth with the company. And so we see a number of areas where that could be applied. So we're having some strong discussions with customers. And this really combines with a strong focus from the ESG side. And I think the flash drive is very unique product to address these challenges. So I do expect that momentum to continue and we're working with customers and the number of pilots out there.

Great, thank you.

Thank you. The next question is from Matt Alcott of Cowen. Please go ahead.

Good morning. Thank you. So I think you're a backlog you're total backlog increased by $80 million sequentially from December. But your 12 month backlog increased by about $186 million. So I was wondering if there was some pull forward from the out years or if he has had any cancellations in the years that were more than offset by new orders for the next 12 month if that makes any sense?

We let me start with the end part of your question. So we have not had cancellations. Yet, I think we're continuing to see momentum on both segments, where it fits freight and whether it fits transits. Of course, there's an element of projects into our business, which can lead to some lumpiness on quarter-by-quarter, but momentum is good. We see that with the book-to-build in quarter today. So we've also had, I think, a good momentum to continue on that trend; that's kind of that.

Yes, so I would also there's an element of FX that impacted the backlog number. And, you know, if you imagine that our international operations are more multiyear projects, and the International impact of those can be spread out over a longer period of time. And we have foreign exchange hurt, our backlog number by about $170 million. And so I think that FX impact is more overly weighted into the full number, not the 12 month number.

That's helpful. And then just for my second question. It's been over a year now, since the beginning of the pandemic. And there were a lot of concerns about the long term prospects of transit, patent referral. Now, you know, do you have any more clarity from your conversations with customers about a potential secular shift in transit long term?

We're seeing both customers and governments very committed to transit overall. So with that, just reiterating no cancellations of orders received projects. So moving forwards, you see very much systems continue to operate. And that's shown in the resilience of our service numbers. On the top of that, I think we're continuing to see just transit part of the solution in terms of how you de-carbonize things moving forward, I think there's a number of improvements being thought through but strong fundamentals for that business moving forward.

Thank you very much.

Thank you.

Thank you. Next question from Ari Rosa, Bank of America. Please, go ahead.

Yes, hi. Good morning. So, you've mentioned COVID impacts in India and obviously, we're seeing regrettable surge in cases there. Maybe you could go into a little more detail around kind of what you're seeing there, what you think the potential impacts could be? And if you've had any discussions with customers there? I know, India has been a big focus area in terms of the growth. Do you see that kind of shifting the timeline there or the prospects?

Well, so first, no really chuffed in terms of the prospects as you look term. In fact, if you think about freight volumes in India, it's actually positive year to-date. So just give your perspective. This is really more tied to disruptions associated with lockdown, certainly impacting our suppliers, sub-suppliers, our customers as well. We're following up that closely to this point. We see it more as an impact, potentially to the quarter. But we'll continue to monitor and take the necessary actions here and we'll report on any relevant changes.

Got it, understood. Very helpful. And then just if we could return to kind of the North American market, maybe you could give your latest thoughts on where we are in terms of emerging from a cycle, compared to past cycles. How do things look in terms of the timeline? Do you think by 2022, 2023, we could get back to kind of a more normalized rate of demand from customers? Or do you see this kind of lingering for longer?

It's good to see the momentum here. We're walking into the first half of the year. We are working with customers closely and watching on that momentum towards the second half of the year, which I think will be determinant in terms of how customers will think about their fleet strategies, which will include contributing modernizations are certainly opportunities here for parts as they continue to consider on parking of units and new locomotives is also going to be part of the discussions with customers. So, I see that largely as a second half discussion based on concerning momentum for the first half of the year.

Between locomotives and rail cars, do you typically see one piece of that business lead the other?

I think it tends to be connected, but just could be just tied to the levels of parking. If you think about freight cars, we're already back to pre-COVID levels. If you think from an overall locomotive fleet, we're not yet back to pre-COVID level. So, there could be some elements of delays there, which are sometimes really driven by just think about velocity and dwell times in the network, which ultimately could be determinant factors on these.

Got it. Great. Thank you for time.

Thanks.

Thank you. Next question comes from Saree Boroditsky at Jefferies. Please, go ahead.

Hi, thanks for taking the question. Locomotives were down almost 6% in the quarter and you know this is largely due to North American shipments. You've been positive on the long-term view of international locomotives. But just for clarity, were international locomotive also down in the quarter? And should they decline for the full year?

I think we're seeing more of growth opportunities when I think about the international markets. So, to your point, I think largely the impacts here in the quarter was driven by a drop by 50% on those. I think if you look at specially our equipment business, I think you've got to keep in mind that some of that we've been able to offset by really double-digit growth in mining. So that's being a positive and I think even more significant growth in our mods business. So, there's opportunities there.

So, Saree, just said specific to your question about the variance year-over-year is that we had a large number of international loco shipments in Q1 of 2020, specific to the Middle East. I think we've talked about this at various time. So we had an overweighting of the of the locos in the first quarter of last year versus this year. But our full year locomotive phasing for international purposes are going to be largely the same as for the full year.

And we've got long-term orders there tied to some key markets, which includes India, includes Brazil, includes Kazakhstan. So that's the audit I'll keep in mind.

Great. And then could you just provide a little bit more color on free margins? You've done a great job realizing synergies that are obviously being impacted by under absorption. When do you think you'd get back to 2019-levels? And what revenue do you need for that?

I think I don't know that we've talked about any kind of breakeven or kind of contribution margin impact. I think the way to look at it is that last year, the decremental margin on the lower volume was in the low 20% range. I think that you would imagine, you would expect that we would have a similar kind of impact with volume recovering. But you always have to consider the mix in the timing, and projects, how that volume comes back? Obviously services and parts and modernizations really are -- and digital electronics tend to be positive mix. Some of the OE elements of this can be below the company average. Ultimately, what we're focused on is that as we talked about earlier on the call, is that we're achieving synergies, driving lean initiatives, productivity gains and all the normal, continuous improvement-type activity that Wabtec has always focused on.

We're committed to improve margins across Wabtec and that includes on both segments for this year and that's really what we're driving forward going to next year as well.

Okay, but just given that service parts and modern digital are all positive to the margin mix, and you have synergies, is it fair to say that you should be able to reach 2019 margins on a lower revenue base?

I think at this point, to give that kind of guidance in when we would get to back to 2019 margin is a little early. But we're committed to that driving that margin up. I think that it's early in 2021 and we see a lot of really good things happening with the volume recovery and I think we've considered that in the guidance for the year.

Okay. Thanks for taking my questions.

Thank you.

Thanks.

This concludes our question-and-answer session. I'd now like to turn the conference back over to Ms. Kristine Kubacki. Please go ahead.

Thank you, Nick. Thank you for everyone's participation today. We look forward to speaking with you next quarter. Everyone, have a great day.

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