Good morning, and welcome to Wabtec's Second Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would like to turn the call over to Ms. Kristine Kubacki, Vice President, Investor Relations. Please go ahead, ma'am.

Thank you, operator. Good morning, everyone, and welcome to Wabtec's Second Quarter 2023 Earnings Call. With us today are President and CEO, Rafael Santana; CFO, John Olin; and Senior Vice President of Finance, John Mastalerz. Today's slide presentation, along with our earnings release and financial disclosures were posted to our website earlier today and can be accessed on Investor Relations tab on wabteccorp.com. Some statements we're making are forward-looking and based on our best view of the world and our business today. For more detailed risks, uncertainties and assumptions related to our forward-looking statements, please see the disclosures in our earnings release and presentation. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics. I will now turn the call over to Rafael.

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 quarter, and progress against our long-term value creation framework, and then John will cover the financials. We delivered another strong quarter, evidenced by robust sales and earnings per share growth. We achieved these despite continued volatility and economic challenges. Sales were $2.41 billion, which was up 17.5% versus prior year. Revenue was driven by strong performance from both the Freight and Transit segments. Total cash flow from operations was $115 million. Overall, our financial position remained strong. We continued to execute against our capital allocation framework to maximize shareholder value by investing for the future growth, executing on the strategic M&A like our recent acquisition of L&M, and returning cash to shareholders. The 12-month backlog was $7.2 billion, up 10%, signifying growing momentum and visibility across the business. The total multiyear backlog was $22.4 billion. Overall, the Wabtec team delivered a strong second quarter, marking a good first half of 2023. Looking forward, I'm encouraged by the underlying strength and robust momentum across the business. Wabtec is well-positioned to continue driving profitable growth even amidst a challenging economy. Shifting our focus to Slide 5. Let's talk about our 2023 end market expectations for -- in more details. As we look at key metrics across our Freight business, we remain encouraged by the underlying business momentum and our robust pipeline of opportunities across geographies. North America carloads continue to be down in the quarter and locomotive parkings moved up slightly as we exited the second quarter, but better than we had anticipated as customers prioritize service and fluidity. We continue to see significant opportunities across the globe in demand for new locomotives, modernizations and digital solutions as our…

Thanks, Rafael, and hello, everyone. Turning to Slide 8, I will review our second quarter results in more detail. We delivered another strong quarter of operational and financial performance with underlying business momentum strengthening through the first half of the year. Sales for the second quarter were $2.41 billion, which reflects a 17.5% increase versus the prior year. Sales were driven by strong growth across all major product lines. For the quarter, GAAP operating income was up $48 million, driven by higher sales. Adjusted operating margin in Q2 was 16.4%, down 0.3 percentage points versus the prior year. The benefits of higher sales were offset by a less rich mix of sales between and within segments. GAAP earnings per diluted share were $1.06, an which was up 16.5% versus the second quarter a year ago. During the quarter, we had pretax charges of $10 million for restructuring which was primarily related to our Integration 2.0 initiative to further integrate Wabtec's operations and to drive $75 million to $90 million of run rate savings by 2025. In the quarter, adjusted earnings per diluted share were $1.41, up 14.6% versus the prior year. Overall, Wabtec executed a good quarter and a strong first half of 2023. We outperformed our expectations, demonstrating the underlying strength and momentum of business and as a result, we are raising our full year outlook for sales and adjusted earnings. Now turning to Slide 9. Let's review our product lines in more detail. Second quarter consolidated sales were very strong, up 17.5%. Equipment sales were up 8.9% due to higher locomotive sales this quarter versus last year's second quarter. Components sales were up 23.1% versus last year, largely driven by the higher OE railcar build and an increase in our market share due to product availability, along with…

Thanks, John. Let's flip to Slide 15 to discuss our updated 2023 financial guidance. We believe that the underlying customer demand for our products and solutions is growing across our business. Our order pipeline and 12-month backlog continued to strengthen, providing solid visibility for profitable growth for the rest of 2023 and beyond. . The team is committed to driving strong top line growth while managing costs. We are also committed to driving adjusted margin expansion in 2023 despite a so challenging macro environment. With these factors in mind, we are increasing our previous guidance. We now expect 2023 sales of $9.25 billion to $9.5 billion, up 12% from last year at the midpoint and adjusted EPS to be between $5.50 and $5.80 per share, up 16% at the midpoint. We also expect cash flow conversions to be greater than 90%. Now let's wrap up on Slide 16. As you heard today, our team delivered another strong quarter to the year despite an uncertain and volatile environment. Thanks in large part to our resilient installed base, world-class team, innovative solutions and our relentless focus on our customers. Our results remain on track for us to deliver on our 5-year outlook that we provided at our Investor Day last year, with strong item across the portfolio, increased visibility through our strengthening order pipeline, and a rigorous focus on execution Wabtec is well-positioned to drive profitable long-term growth and maximize shareholder returns. With that, I want to thank you for your time this morning. And I'll now turn the call over to Kristine to begin the Q&A portion of our discussion. Kristine?

Thank you, Rafael. We will now move on to questions. [Operator Instructions]. Operator, we are now ready for our first question.

[Operator Instructions]. First question will be from Justin Long from Stephens.

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

Great, Justin. This is John. Justin, when we look at the back half cadence, starting with revenue, we would expect the majority of our revenue growth to come in the third quarter versus the fourth quarter. And again, this is due to the way that the orders have come in and production is scheduled as well as we got a little lapping benefit over a slightly easier comp from a revenue standpoint. When we look at the earnings side or margin side of the equation, we would see the opposite or expect the opposite, Justin. We would expect the majority of our earnings growth our margin growth to come in the fourth quarter versus the third quarter. And that is simply because we're lapping a much easier comp in the fourth quarter of last year than we have in the third quarter.

Okay. That's very helpful. Second question I had was on the Freight Services segment. We saw some notable strength there in the second quarter. Is there a way you can help us think about the growth in that segment if you exclude mods? And then going forward, I was wondering if you could share what you're assuming for locomotive utilization. It sounds like parkings were maybe a little bit better than you thought, but we're hearing from some of the rails that locomotives are getting put into storage. So I just wanted to kind of marry those 2 trends.

Justin, you're right. So I think we'll see, especially as we go into the second half of the year, and beyond the second half, I think you'll see acceleration of growth in services. Some of that, I mean, you see it with some recent order that we announced here. So mods is a growth case continuing to us moving forward, so that continues to be a positive. When it comes down to parkings, We're seeing really active fleet staying steady side, any element of really fluctuation within the year, but the focus on services continues, and we feel very good about our fleet stamps out there providing really, I'll call, significant benefits to the customer when compared to our competitors' fleets. And that's both in terms of reliability, availability, fuel efficiency, which is a significant element here. We stand with really feel better than in average more than 5% on every single one of our platforms. So we don't expect no signs of any significant changes on that active fleet eater.

Our next question will be from Chris Wetherbee of Citi.

It's Rob on for Chris. Could you give us a sense in terms of the backlog, obviously, it increased over the 12 months sequentially. How should we think about just that conversion in '23 versus kind of '24?

Yes. I'll start just with, I feel very good about our overall backlog. I feel strong about the pipeline of opportunities that the team is working on. I think the overall underlying growth fundamentals of the business is also strong. As you said, the 12 months is up 10%. It's accelerating. Last quarter was 4.4%. The current total backlog is also healthy. So while it's down 3.5%, I look at it in conjunction with the multiyear $1 billion order that we got from Union Pacific and the auto multibillion-dollar auditor opportunities were being worked right now and with the team. So we see good momentum internationally. We see it in North America. It's positive. We're progressing, and we're continuing to grow and our pipeline supports it. In terms of the convertibility, the 12 months, already provides you a view into '24, and we continue to see strength in the pipeline.

That's helpful. And just piggyback on Justin's question. Your response you said -- I thought I heard you saying that you're expecting acceleration of services growth. So should I think about that stepping up from the roughly 14% you guys did in 2Q in the back half of the year. And maybe if you could provide a little bit more context.

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

Okay. That's helpful. And how are you thinking about services growth longer term? .

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

Next question will be from Wertheimer Melius Research.

So just to clarify on gross margin, obviously, you mentioned that you had mix headwinds between segments and within. Is mix the entire driver of the down gross margin? Or is there any price/cost or anything else to catch up still? And then was there a mix drag within Transit as a segment? .

Okay, Rob, this is John. Looking at the quarter, we came in -- margin came in 16.4%, down 0.3 percentage point. As we talked about in the earlier quarter, we expected the first half to be flat on margin. So margins were down a little bit more than we expected. The key driver of that, Rob, was the inefficiencies we're experiencing at our facility in Erie behind the strike. So that is the biggest driver. The mix we anticipated, the mix within the groups we anticipated on locomotives and mods in the original guidance. But the difference really is the inefficiencies at our facility at York -- I mean, at Erie.

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

I do. We're continuing to first make progress on battery electric. I think that order is a great example of that. We're developing a supply chain around it to make sure that we make really the overall product reliable first deliveries are happening next year. We're continuing to work actively with customers, both in North America and internationally. . There is demand out there to further expand the use of the technology. We're working with customers to really make sure that we pace as we step into it. Fuel continues to, of course, be a significant element of cost for our customers. I think there is a really significant opportunity for us to continue to grow that, and we're going to pace it as we grow into different geographies. That's I think the exciting piece. It's not a demand around one specific customer or one specific segment. I think we have an opportunity to apply that battery concept also in conjunction with, what we call, not just a hybrid product, but hybrid systems as well. I recently came back from Europe and there's, I'll call it, significant opportunity for us there as well.

Our next question will be from Saree Boroditsky from Jefferies.

This is James on for Saree. So I wanted to touch on Integration 2.0. So can you provide an update on how Integration 2.0 is progressing? And how should we think about cost savings into 2024?

Great, James. So as we've talked out, when we announced Integration 2.0 a little bit over a year ago that we would invest $155 million to $165 million and expect ongoing savings of $75 million to $90 million. We're off to a great start as we talked about at the end of the '22 investment was a little bit ahead of schedule, which is a good thing. And as we ended last year, we were at run rate savings of $5 million. In the 6 months that we've had this year, we've over doubled that, and the trajectory will continue through the remainder of 2023, and add to a fair amount of our incremental margin in the back half as well as through 2024 as we head up to that $75 million to $90 million run rate in 2025.

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

I'll start with, over the last 2 years, we have successfully reached an agreement with all of our union and nonunion side. So we're working on collaboration. We remain committed to the workforce with that, We remain optimistic that we can reach an agreement here in a timely manner. From a financial perspective, plan to realize for a variety of outcomes and contingencies here and we do not mistake any impact to the full year revenue. .

Our next question will be from Allison Poliniak of Wells Fargo.

A quick question on the outlook. Your 5% revenue growth at 5% earnings growth. So it really implies sort of lack of leverage on that revenue. Is that just simply a mix situation that's driving that? Just any -- if you could walk us through that.

Allison, you're talking about within the quarter?

No, for the full year, the guidance raised nice revenue guidance raise, but EPS really just in line with that revenue guide, just implies the lower incrementals. I just want to understand if that's just purely mix, if there's something else within that that's driving sort of a lack of incrementals there. .

Sure, Allison. So yes, we're thrilled to be able to raise our revenue guidance from the midpoint of up 6% to up 12%. And driven by the underlying momentum that we've experienced, right? And that's continued from the back half of last year into the -- through the first half of this year. When we look at the earnings guide, it was up from a midpoint of 5.65% or up 10% to up 16%. So what we're seeing is a couple of things. You're not seeing the increase in revenue coming through in earnings. And Allison, that's for 3 reasons. One is in the first quarter, we had some additional investment in our next-generation technology. for our PDS software that's dispatch software. And so that's a onetime event that kind of will bring the earnings down on a full year basis. The second driver of that is the strike in Erie. That does have costs. Rafael mentioned, we don't expect any impact on revenue for the year, but it does have a cost. And we had cost in that in the first -- in the second quarter, but we'll also have some costs in the third quarter. So that's included in that as well, again, more on the onetime side. And the third area is higher interest cost. As you can see in the quarter, interest was up about 25% to $11 million. We would expect interest to be higher in the back half as well. partly behind the L&M acquisition, but also the refinancing of some debt that we've got come and do. So Allison, when you take those 3 things that's the difference between the growth rate of revenue and the growth rate of earnings.

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

So a couple of points here, Allison. First. I mean, as you saw, I mean, we had significant order buildup in the last 2 years has positioned the business really well. from a backlog perspective. A good chunk of that was drilling international orders, somewhere my year agreements. As you go more international, it's a bit more lumpy. So we would expect that to play out over the different quarters. But -- and the auto comment I would make no different than the previous years. we need to really drive convertibility into the shorter-term orders that continue to deliver on the year results. But backlog coverage is better than we've had before. We like the fundamentals of the business, but would it not to be lumpy.

Our next question will be from Scott Group of Wolfe Research.

It's Ivan Yi on for Scott. First of all, your revenue guidance updated to $9.4 billion at the midpoint implies a 12% increase in total sales this year. How much of that 12% increase is volume versus how much of that is price?

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

Perfect. And secondly, can you provide some background on the pace of absolute locomotive modernizations, meaning how many mods did you do in '22? What are you're expecting in '23? And can you talk about '24? And then lastly, what is the timing of the 60 mods for CN?

So I think we're not get into any specifics of '24. Of course, it's sort of early for that. We expect growing momentum modernization portfolio. And you see that. I think the order you just asked about CN. It's part of that, and we see that growth momentum much as going to '23. We see that momentum going into really '24 and beyond. So just a good backlog. .

Our next question will be from Jerry Revich of Goldman Sachs.

Rafael and John, I'm wondering if you could just talk about in Transit, you've had really strong bookings for 3 quarters now, The top line inflection this quarter. Are we at a point where this business has earned the right to grow, and we could see more substantial pickup in top line now that the margins are where you need them be? In other words, is there more runway based on the bookings and the performance this quarter for the momentum to continue in Transit?

Jerry, first, the fundamentals for the business remain strong. I think despite of a more competitive environment, I look at our book-to-bill ratios over 1, The 12-month backlog is up 9%. The multiyear is up double digits. But I'll tell you, while we are pleased with the progress, there's significant work ahead of us to simplify the footprint to further improve and sustain margins. We're going to have variation quarter-to-quarter but the mandates there, and the team is executing on expanding margins. And we feel we're building competitiveness in the business. So we ultimately drive profitable growth. So it feels good from that perspective. And we're going to continue to drive that there. We continue to have opportunities.

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

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

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

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

Our next question will be from Steve Barger, KeyBanc Capital Markets.

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

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

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

Steve, I'll tell you use [indiscernible]. Yes, the total backlog is down. It's going to be lumpy as we have those, I'll call multibillion-dollar deals. We've got more than a couple of those being worked right now, so that could drive some lumpiness. I think our focus here is making sure that we've got the convertibility moving forward. And of course, as you look into the convertibility 12 months, 18 months and 24 months. So we track that, and we feel very strong about that. And it's really in the pipeline of the deals that we're working on, and we're continuing to grow that and it's really supported by our pipeline. .

Our next question will be from [indiscernible] of Bank of America.

[Indiscernible] on for Ken Hoexter. We've covered a lot. Maybe just to touch on the M&A pipeline. Is there anything you can share broadly about verticals or geographies of interest in this space?

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

And then maybe just going over to Transit. You've mentioned a mid-teens margin target in the past. Just -- maybe give us a sense of how we are trending there versus initial expectations? Any view over the next coming years? Maybe that could be achieved earlier than initially thought.

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

Yes. And as I mentioned earlier on the question on Integration 2.0, right? We're going to see that continue to ramp. The majority of the benefit will accrue to our Transit group. So we feel great about consolidation and the integration that's happening here and the results that it's starting to spin. And part of the benefit we saw in margin growth in Transit in the quarter was due to Integration 2.0. And the other one is, the other question with regards to the backlog. We continue to bring in volume in the backlog, we're very focused on making sure that it is coming in at a higher margin. And we are focused on bringing in good, profitable business versus revenue in the Transit Group.

Our next question will be from Matt Elkott, TD Cowen.

On the 69 certified preowned locomotives, do you guys foresee any similar opportunities going forward? And if you can provide some insight maybe on to like the revenue and margin profiles of those locomotives, if not on an absolute basis, at least kind of relative to mods?

I'm not going to get into the specifics of that program. But what I'll tell you, that program provides a significant opportunity for us to, number one, as we think about our products, it's how we cascade those products down. So they're not just on core mainline, we often focus a lot of the dialogue here around 16,000 locomotives that we got running out there. There's a number of auto locomotives running in short lines in yards, and we see an opportunity to cascade that fleet down antiquated with a fleet that's more efficient, it causes less emissions, able to pull more. So a lot of those same fundamentals. And I think that's where we look at building and it provides, again, a significant strength for our Services business as there will be a pull there in terms of providing spare parts and things like that. So really excited about gaining momentum on that front, sure.

And Rafael, also it sounds like this is not that you guys have done actively to any meaningful extent in the past and it's kind of a fairly new area for you, these certified preowned units.

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

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

I would say that -- I would say not. There'll be a little bit in there, but not to the extent to drive the overall guidance, Matt. It's the underlying momentum we've talked about for the last year continues to come at us and the backlog continues to fill. It'll be more of an impact on the future growth as we look to '24 and beyond.

Exactly.

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

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

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

And if I missed it, did you guys say what the purpose of those? These are just diesel locomotives for replacement? Or is there a technology element?

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

Next question will be from Steve Barger, KeyBanc Capital Markets.

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

They are absolutely included in our revised guidance, Steve?

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

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

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