West Pharmaceutical Services Q2 2021 Earnings Call Transcript

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Provided by Quartr
July 28, 2021

Key Takeaways

  • We delivered a strong Q2 with sales of $2.0 billion, up both sequentially and year-over-year, an adjusted operating margin of 15.2%, and adjusted EPS of $1.06, a 22% increase.
  • Operating cash flow of $223 million in Q2 (YTD $515 million vs. $229 million last year) drove cash conversion over 100%, and Wabtec now expects about $1 billion of free cash flow for the full year.
  • The company raised its full-year guidance to $7.9–8.2 billion in sales and adjusted EPS of $4.15–4.35, with cash flow conversion projected above 90%.
  • Backlog stands at a robust $21.5 billion multi-year and $4.1 billion 12-month book, with a book-to-bill ratio above 1, supported by a strengthening international locomotive pipeline.
  • Wabtec is advancing zero-emission rail through partnerships with CSX on the “0 to 0” trip optimizer and GM on battery/hydrogen fuel cell technologies, and its FlexDrive battery locomotive test achieved an 11% fuel and emissions reduction.
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Earnings Conference Call
West Pharmaceutical Services Q2 2021
00:00 / 00:00

Transcript Sections

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Operator

Good morning, and welcome to the Wabtec second quarter 2021 earnings call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key, followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch tone phone. To withdraw your question, please press star then two. 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.

Kristine Kubacki
Kristine Kubacki
VP of Investor Relations at Wabtec

Thank you, operator. Good morning everyone, and welcome to Wabtec's second quarter 2021 earnings call. With us today are President and CEO, Rafael Santana, CFO, Pat Dugan, Chief Technology Officer, Eric Gebhardt, and Senior VP of Finance, John Mastalerz. Today's slide presentation, along with our earnings release, financial disclosures were posted on our website earlier today, and they can be accessed on our investor relations tab on wabteccorp.com. Some statements we're making today 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. I will now turn the call over to Rafael.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thanks, Kristine, and good morning, everyone. Let's begin on slide four. We delivered a strong second quarter as noted by our sales growth, adjusted margin, and adjusted earnings per share, each of which were up sequentially and year-over-year. Total sales for the quarter were $2 billion, driven by growing demand in Freight Services, components, and transit, but offset by weakness in the North America OEM market. Adjusted operating margin was 15.2%, driven by ongoing lean initiatives, cost actions, and the realization of synergies. Total cash flow from operations was $223 million. This takes the year-to-date cash from operations to $515 million, versus $229 million a year ago. It's a solid illustration of how the team is driving good operational performance and focused working capital management. Cash conversion for the year is over 100%. Our year-to-date book-to-bill continues to be a positive story.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

We ended the first half of the year greater than one. We have a strong order pipeline for international locomotives. Total backlog at the end of the quarter was $21.5 billion, providing strong visibility into 2021 and beyond. Finally, we ended second quarter with adjusted EPS of $1.06, up 22% year-over-year. In the area of synergies, we're on track to achieve our full run rate of $250 million this year. We are feeling the benefits of our footprint consolidation and aggressive actions on structural cost. Overall, really strong execution by the team as we continue to deliver on our long-term strategy. I am confident that with strong execution, focused cost measures, our team's drive on productivity, and continued improvements in our end markets, we will continue to deliver long-term profitable growth.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Let's turn into slide five to discuss a few of our recent business highlights, starting with a strategic partnership we recently announced with CSX. CSX will be the first railroad to implement Wabtec's Trip Optimizer Zero-to-Zero solution, which will allow them to start a train from zero miles per hour and stop it automatically using various controls. Zero-to-Zero builds on Trip Optimizer's proven performance and is an important building block to autonomous rail and a critical component of energy management, which Eric will cover shortly. We're also partnering with them to revitalize their yard fleet through an innovative Tier 4 switcher modernization program, where we overhaul switchers to the latest Wabtec Tier 4 platform. We're working with them to modernize their locomotive fleet with our FDL Advantage engine upgrade, which delivers another 5% reduction in fuel consumption.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Some great examples of partnership and innovation at work. On the international front, commercial activity is increasing with multi-year orders in equipment, digital electronics, and transit. In the second quarter, we closed a significant order for positive train control with Rumo, and we're now implementing PTC in thee countries outside the U.S. In addition, we won a key international locomotive deal in South America and a significant transit contract with Metra in North America. Finally, when it comes to innovation and going after opportunities that can enhance our current portfolio, we announced a strategic partnership with General Motors, where we're exploring the use of battery and hydrogen fuel cell technologies to accelerate the rail industry's path to zero emission locomotives. This is an exciting space, one where strategic collaboration and investment will accelerate the path to more sustainable rail. Eric will share more on this in a moment.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

It's because of these breakthrough advancements and a commitment to innovation that Wabtec was named to Fast Company's Most Innovative Companies in 2021, in recognition of our commitment to solve some of the world's toughest challenges in the transportation sector. It's also because of our proven commitment to innovation that we're able to further strengthen our financial position the second quarter, with a successful EUR 500 million green bond offering to fund investments that will continue to advance sustainable rail. Looking forward, we are confident Wabtec will drive long-term profitable growth and lead the industry in advancing its position in sustainable rail even further. With that, I'll turn the call over to Pat, who will review the quarter and segment performance and our overall financial position.

Pat Dugan
Pat Dugan
CFO at Wabtec

Thanks, Rafael. Good morning, everyone. We had solid operational and financial performance during the quarter. As markets continue to gradually recover, we demonstrated our ability to deliver on synergies, to generate strong cash flow, and to invest in the future and position Wabtec for profitable growth. Turning to slide six, I'll review the second quarter in more detail. Sales for the second quarter were $2 billion, which reflects a 16% increase versus the prior year, driven by a broad-based recovery across our portfolio, offset somewhat by lower North America OE freight markets. For the quarter, operating income was $203 million, and adjusted operating income was $306 million, which was up 17% year-over-year.

Pat Dugan
Pat Dugan
CFO at Wabtec

Adjusted operating income excluded pre-tax expenses of $103 million, of which $73 million was for non-cash amortization and $30 million for restructuring, of which the majority was for our U.K. operations and transaction costs related to the acquisition of Nordco. Adjusted operating margin was 10 basis points higher than the second quarter last year and up from the first quarter. Versus last year, adjusted operating margin benefited from higher sales and the realization of synergies. Now, looking at some of the detailed line items for the second quarter, adjusted SG&A was $254 million, which was 12.6% of sales. This was up from last year due to the normalization of certain expenses compared to the temporary cost actions taken during the depth of the pandemic a year ago. Adjusted SG&A excludes $9 million of restructuring and transaction expenses.

Pat Dugan
Pat Dugan
CFO at Wabtec

For the full year, we expect adjusted SG&A to be about 12% of sales. We will continue to aggressively manage headcount and structural costs. Engineering expense increased from last year. This was largely due to higher volume outlook for the year. Overall, our investment in technology is still expected to be about 6%-7% of sales. Amortization expense was $73 million. For 2021, we expect non-cash amortization expense to be about $290 million and depreciation expense of about $205 million. Our adjusted effective tax rate during the quarter was 25.3%, bringing our year-to-date adjusted effective tax rate to be about 26.3%. For the full year, we still expect an effective tax rate of about 26%. In the second quarter, GAAP earnings per diluted share were $0.66, and adjusted earnings per diluted share were $1.06. Now let's take a look at the segment results on slide seven.

Pat Dugan
Pat Dugan
CFO at Wabtec

Across the freight segment, total sales increased 11% from last year to $1.3 billion, primarily driven by strong growth in services and aftermarket and higher demand for components. In terms of product lines, equipment sales were down 2% year-over-year due to fewer locomotive deliveries in North America. In line with improving freight traffic, our services sales improved a solid 22% versus last year and were up 11% sequentially. The year-over-year increase was largely driven by strong modernization deliveries, higher aftermarket sales from the unparking of locomotives, and the acquisition of Nordco. I'd note the timing of mod deliveries vary from quarter-to-quarter, but we expect our services sales to improve with the gradual recovery in freight volumes. Digital electronic sales were down 2% year-over-year as orders shifted to the right in North America due to COVID disruption.

Pat Dugan
Pat Dugan
CFO at Wabtec

We had strong momentum with book-to-bill over one for the third quarter in a row. We continue to see a significant pipeline of opportunities in our digital electronics product line as customers globally focus on safety and improved productivity. Component sales were up 15% year-over-year, driven by demand for railcar components and recovery in industrial end markets. This is compared to a 19% lower railcar build year-over-year, demonstrating the diversification within our components business. We are encouraged by railcars continuing to come out of storage, higher order rates for new railcars, and the broad recovery in industrial end markets. Freight segment adjusted operating income was $247 million for an adjusted margin of 18.5%. Last year, the benefit of synergies and cost actions were offset by sales mix, as well as under-absorption due to lower locomotive deliveries.

Pat Dugan
Pat Dugan
CFO at Wabtec

We will continue to execute on our synergy plans and further improve cost to drive margin improvement. Turning to slide eight. Across our transit segment, sales increased 27% year-over-year to $680 million, driven largely by recovery in OE projects and steady aftermarket sales. OE sales were up 41% year-over-year, as the second quarter 2020 was severely impacted by disruptions stemming from the pandemic. OE sales were also up 12% sequentially, reflecting the continued momentum for investments in green infrastructure. Aftermarket sales were up about 17% from last year. We expect aftermarket sales to improve for the full year as economies continue to open and demand for transit services increase globally.

Pat Dugan
Pat Dugan
CFO at Wabtec

Adjusted segment operating income was $73 million, which was up 43% year-over-year for an adjusted operating margin of 10.8%, which is slightly down from the first quarter due to a charge for a discrete warranty adjustment of over $5 million. Across the segment, we continued to drive down cost and improve our project execution. We are committed to drive 100 basis points of margin improvement for the segment in 2021. Now turning to slide nine. We wanted to provide a more detailed look at our 12-month and multi-year backlog. We had another solid performance, with total orders for the year exceeding $4 billion, resulting in a book-to-bill for the year above one. Orders can be lumpy quarter-to-quarter, but we are encouraged to see a broad-based momentum across the portfolio.

Pat Dugan
Pat Dugan
CFO at Wabtec

Our freight segment backlog remains strong at $17.8 billion with year-to-date book-to-bill above one, driven by broad-based order activity across the portfolio. Our 12-month backlog of $4.1 billion is the highest since the third quarter of 2019, a result of improving end markets. We continue to see a robust pipeline of order opportunities, especially in international end markets. Our transit segment backlog ended the quarter at $3.7 billion, with a 12-month backlog of $1.7 billion. We did see some projects pushed to the right as a result of ongoing disruption due to the pandemic. Our outlook remains strong as sustainable infrastructure spending increases globally. Finally, at June 30th, our multiyear backlog remains strong at $21.5 billion and continues to provide increasing forward visibility. Let's turn to our financial position on slide 10. We had another solid quarter of cash generation.

Pat Dugan
Pat Dugan
CFO at Wabtec

We generated $223 million of operating cash flow during the quarter, bringing year-to-date cash flow generated over $500 a billion. Our performance clearly demonstrates the quality of our business portfolio. Cash flow was driven largely by good conversion of net income and focused working capital management. During the quarter, total CapEx was $29 million. In 2021, we expect CapEx to be about $140 million. During the quarter, we successfully completed a EUR 500 million green bond offering and paid down nearly $200 million in debt during the quarter. As a result, our adjusted net leverage ratio at the end of the second quarter was 2.6 times, and our liquidity is robust at about $1.7 billion.

Pat Dugan
Pat Dugan
CFO at Wabtec

As you can see in these results, our balance sheet remains strong, and we are confident we can continue to drive solid cash generation, giving us the liquidity and flexibility to allocate capital towards the highest return opportunities and grow shareholder value. With that, I will turn the call back over to Rafael.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thanks, Pat. Shifting our focus to markets on slide 11. We are continuing to see good signs of recovery. While the trough in the OE North America market remains, we are seeing sequential improvement in freight rail volumes. Total car loads were up 3% from first quarter and up 20% year-over-year. We're also seeing strong trends in intermodal, along with a pickup in the industrial sector in areas like chemicals and metals. Locomotive parkings continue to improve due to increased freight rail traffic, and we expect demand for reliability and productivity to increase, putting our services business in a position of strength. When it comes to North America railcar builds, railcars are coming back into use and about 22% of the North American railcar fleet remains in storage, but this is encouragingly below pre-COVID levels.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

As a result, industry orders for new railcars are starting to improve, and we forecast the railcar build for this year to be about 30,000 cars. Internationally, our order pipeline remains strong, and we expect long-term revenue growth in several markets. In mining, market conditions also continue to improve. Transitioning to the transit sector, ridership remains a bit uneven in some markets, but overall, the long-term market drivers for passenger transport remain strong. Infrastructure spending for green initiatives continues to be a focus, especially as governments globally turn to rail for clean, safe, and efficient transport. Given this market backdrop, our strong performance in the first half, and our confidence in our ability to deliver, we are raising our full-year revenue and earnings per share guidance. We now expect sales of $7.9 billion-$8.2 billion. Adjusted EPS to be between $4.15 to $4.35.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

We expect cash flow conversion to remain greater than 90%, resulting in a strong cash generation of about $1 billion for the full year. Overall, positive signs of recovery, great execution by the team in the first half, and a meaningful update to our full-year view as we manage through the continued recovery. With that, I'd like to turn the call over to Eric Gebhardt.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

Thanks, Rafael. Good morning, everyone. I'm Eric Gebhardt, Chief Technology Officer for Wabtec, and I'm thrilled to be here with you to share some of the transformative advancements we're driving in the clean energy transportation sector. Turning to slide 12. As you may be aware, today, rail represents the cleanest, most energy efficient, and safest mode of moving freight and people on land. Moving 40% of freight per ton mile in the U.S. alone. Current trends indicate that freight and passenger activity will more than double by 2050 as the sector pushes for more sustainable transportation. At Wabtec, we're innovating to help our customers increase efficiency, reduce costs, and cut their overall carbon footprint through the development of low-emitting locomotive technologies, including Tier 4 locomotives running on renewable fuels and battery-electric locomotives.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

We're also pushing the boundaries into alternative fuels such as biodiesel, renewable diesel, and hydrogen, which I'll share more on in a moment. Over the last year, we built and tested in revenue operation with BNSF Railway and the California Air Resources Board, the world's first heavy-haul 100% battery-electric locomotive called FLXdrive. This locomotive, which operated in a consist between two other locomotives, had a battery capacity of 2.4 MWh and generated most of its energy from regenerative braking. At the conclusion of this rigorous three-month test that spanned 13,000 miles, the FLXdrive exceeded expectations, delivering more than an 11% average reduction in fuel consumption and greenhouse gas emissions. That's the equivalent of eliminating 6,200 gallons of diesel fuel and slashing 69 tons of CO2 emissions. It's just the beginning.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

At more than 7 MWh, which is the next version of the FLXdrive we currently have in development and expect to bring to market in 2023, we anticipate further reducing fuel consumption emissions by up to 30%. This reduction is tied to a tightly coupled system that Wabtec is driving in the marketplace that includes batteries, Trip Optimizer, power electronics, and even our braking systems that capture all the available regenerative braking energy. By owning the complete system, we can control the consist to optimize fuel burn or emissions, battery life, or speed depending on the operator's need on a specific route. Our second-generation battery-electric locomotive will operate independently and leverage General Motors' Ultium battery technology that Rafael mentioned earlier.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

It's a winning combination, where we bring our expertise in energy management and systems optimization for heavy-haul locomotives while taking full advantage of GM's advanced technologies and speed to market. In addition to these efforts, we're also reimagining the future of rail utilization, safety, and logistics optimization. Our vision is to expand the use of freight rail, enable the elimination of over 300 million tons of carbon dioxide annually across the global transportation network, reduce road congestion in our cities, and make transportation significantly safer for everyone. To put us on this path, we've installed positive train control systems and software on more than 24,000 locomotives. This technology has revolutionized rail safety in the U.S. over the last decade and helped make the rail sector more efficient and effective.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

Our next-generation systems will take efficiency even further by enabling moving block and virtual coupling instead of the traditional fixed block signaling used today, while still maintaining the most stringent safety standards. Similarly, our Trip Optimizer solution or smart cruise control system, which is installed on over 11,000 locomotives, has helped save customers more than 400 million gallons of fuel and 4.5 million tons of CO2. Together with Movement Planner, these digital solutions are revolutionizing locomotive fuel efficiency and real-time network planning. We're also helping move goods more efficiently using the existing rail network, all while reducing energy use, emissions, and waste. Looking to the future on slide 13, we will accelerate the shift to green energy solutions and bring to market a heavy-haul, zero-emission hydrogen hybrid locomotive.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

We have a clear roadmap to get there, one that de-risks across the path with batteries as a focal point across the entire spectrum, and one that is already underway with FLXdrive. Our vision is to leverage battery technology while burning hydrogen in the internal combustion engine, similar to what we're doing today with natural gas in Florida. This step is a retrofittable approach where we can take 80%-90% of the energy content and make it hydrogen, driving a dramatic drop in emissions. In parallel, we will develop a hydrogen fuel cell locomotive and ruggedize the fuel cells so they can operate in a harsh rail environment. GM's hydrogen capabilities give us an advantage here as well. Their HYDROTEC hydrogen fuel cell power cubes are compact and easy to package and can be used in a wide range of applications, including locomotives. Our vision is clear.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

To have an operation fully decarbonize trains utilizing battery-electric and hydrogen technology. The recent partnerships we announced with Carnegie Mellon University, the nation's leading university in artificial intelligence and robotics, and Genesee & Wyoming, the nation's largest short line and regional freight railroad, put us on a path to do just that. By working together, we believe the transition to a more utilized, efficient, and zero-emission rail network is absolutely within reach, and we're committed to helping the industry get there. With that, Rafael, I turn it back over to you.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thanks, Eric. A great example of how we're driving breakthrough technology investments in scalable and sustainable products that will position Wabtec and the industry for long-term profitable growth. Let's turn to our final slide. Everything we've outlined today reinforces our strategy to accelerate long-term profitable growth. That strategy is based on our expansive installed base, deep expertise, innovation in breakthrough initiatives and scalable technologies, rigorous operations, continuous improvement culture, and disciplined capital allocation. I'm proud of the strong execution by the team in the second quarter, despite a still challenging environment. As we go forward, we will continue to lean into the strong fundamentals of the company to execute on synergies, drive margin expansion, generate strong cash flow, and deliver long-term profitable growth. As we've said before, Wabtec's mission holds a larger purpose: to move and improve the world.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

After demonstrating strong performance in the first half of 2021, I'm confident that the company will continue to deliver and lead the transition to a more sustainable future. We look forward to sharing more on the company, technologies, and our long-term vision in the fourth quarter when we plan to host an investor day. More information on this will be shared shortly. With that, I'll turn the call back over to Kristine to begin the Q&A portion of our discussion.

Kristine Kubacki
Kristine Kubacki
VP of Investor Relations at Wabtec

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

Operator

We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please take up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question today comes from Justin Long with Stephens.

Justin Long
Justin Long
Analyst at Stephens

Thanks, and good morning.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Good morning.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

Good morning, Justin.

Justin Long
Justin Long
Analyst at Stephens

I'll start with one on the guidance. Could you share how much of the guidance raise was a function of the second quarter beating your expectations versus a change in second half expectations? Maybe as you answer that, I got the impression last quarter that in 2Q, we'd have a little bit of a dip in terms of locomotive deliveries and mods, and then we'd see a re-acceleration in the back half. Just curious if that's still the right cadence to be thinking about.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Yeah. Justin, I'll start with the second quarter. I think the team has been able to really overcome, I think, some of the headwinds that we had referred to in terms of supply chain, and there are some significant challenges in India. I think we've executed better than what we had expected, which is good. Helps us de-risk any elements of the second half of the year. Really, we feel like we're very much on track to continued margin expansion into the second half of the year. I think some of the guidance change really reflects, I think, an improved environment ahead. I think we've certainly seen that with, I'll call a number of our end markets. Certainly internationally, we're continuing to see unparking locomotives and freight cars.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

You look at freight cars, the numbers we're looking at it for now in the year are better than what we have guided earlier on.

Justin Long
Justin Long
Analyst at Stephens

Okay. Thinking about the international locomotive market, so you've noted orders have picked up here recently. It sounds like the pipeline is strengthening as well. Any way you could give us an update on your expectations for international locomotive deliveries this year, the level of visibility you have into next year, just to help us think through that pickup.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Sure. Like you said, our pipeline of deals continues to strengthen. You will continue to see the backlog expansion. This is the highest backlog we've had since second quarter, and we have a stronger pipeline that we're working on. We've had a number of significant international equipment deals that are under negotiation, and you're starting to see some of those convert. First one you saw was here in South America, but we've got some of those really cutting across. We see it in Asia, specific in Australia, Russia, CIS. To a large extent, I would say tied to commodity exports that have really strengthened for some of our key customers, with growing demand in mining. Internationally, that's really, I think, something that's playing out across.

Justin Long
Justin Long
Analyst at Stephens

Okay. I'll leave it there. I appreciate the time.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Kristine Kubacki
Kristine Kubacki
VP of Investor Relations at Wabtec

Thank you.

Operator

Our next question comes from Saree Boroditsky with Jefferies.

Saree Boroditsky
Saree Boroditsky
Analyst at Jefferies

Hi. Thanks for taking my questions. Could you just talk a little bit about the freight margin performance? You saw a pickup in some of the higher, what I would think is higher margin categories such as services versus locomotives, but then margins decline year-over-year. What is the key driver there, and what do you need to show margin improvement? How are you thinking about getting back to 2019 levels? Thank you.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Well, first, let me just start with, you're going to see margin expansion into the year across both segments. I think we've been very specific with regards to transit. That doesn't change. As you go into the second half of the year, we expect over 50 basis points of margin improvement versus the first half of the year. With that, I want to highlight you will continue to see variation on specific quarters. Those are tied to timing of projects. They could be associated with mix. If you look at it year-over-year, certainly transit's growing faster than the rest of the portfolio. Within transit, certainly OE is growing at much faster rate. There's also elements of how under absorption plays along the year. As we look at it, there's an element of sometimes locomotive deliveries versus what the build plan is for the year.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Overall, committed to really deliver on margin improvements for the year and better than what we guided early in the year.

Saree Boroditsky
Saree Boroditsky
Analyst at Jefferies

Great. Thanks for that color. You could talk a little bit about what you're seeing on the digital side. You talked about some projects on PTC outside the U.S. Maybe just help us think about what's the global opportunity for PTC generally, and then when would you expect digital to get back to 2019 levels?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Yeah. Well, two things. I'll start with, our customers continue to be focused on efficiency, productivity, and safety, which is what digital's all about. We continue to see a strong commitment there. Our book-to-bill was strong in the past three quarters, well above one. As you mentioned, I think we've seen significant progress internationally on expanding our penetration. A good example is PTC, as you mentioned. We're now executing it in three different countries outside the U.S. We've got a number of other countries where we're discussing the opportunity. I think one of the things I would highlight about the business, this has been largely, as you look in the past, transactional business. If the locomotive order dropped, you would see really pressure to revenues on our digital electronic segment. Our teams continue to take steps to further drive what I call recurring revenues in the business.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

We expect some of these multi-year orders to continue. I think a big chunk of the focus for this year is to drive convertibility for the business and improve the forecast for the year. Largely committed. This is a significant element of how we're also going to do this energy transition with battery-electric. It really comes down to having a strong portfolio that allows you for really strong energy management on the consist. Very overall positive. I think we're still working on convertibility for a year at this point.

Saree Boroditsky
Saree Boroditsky
Analyst at Jefferies

Great. Thanks for taking my questions.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Saree Boroditsky
Saree Boroditsky
Analyst at Jefferies

Thanks.

Operator

Our next question comes from Rob Wertheimer with Melius Research.

Rob Wertheimer
Rob Wertheimer
Analyst at Melius Research

Thanks. Good morning, everybody.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Good morning, Rob.

Rob Wertheimer
Rob Wertheimer
Analyst at Melius Research

I had a small one. What was the issue with the restructuring in transit? I think it was $23 million. I apologize if I missed this in the prepared remarks. I thought you were more or less past some of that. My bigger question is, there's a bit of a perception out there that all the efficiencies in rail means locomotives are less needed in the future. We don't share that, but it's out there. I love the overview of the efficiencies you're bringing with a variety of technologies to the market, and I'm just curious what the reaction or the conversations are like with your rail customers on the efficiency driving upgrades to new as opposed to just mods. Thank you.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Let me start and I'll pass it on to Pat on the specifics of the restructuring. When we look at where we are in rail, I think the demand for more reliable power continues to be there. We continue to see improvement in terms of the unparkings. I think those were largely tied to the dynamics you saw over last a couple of years, not just in terms of car loads, but also in terms of PSR. I think that's largely in. When we look at moving forward, I think the focus on both reliability of the fleet, that's a significant positive for us when you look at our services business. The other element is the continued focus from customers now on really making sure that you're getting more productivity, and I think that will tie very well with some of the solutions that we have out there.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

That's right, fuel savings. We've talked about the FDL Advantage. There's also, I think, significant elements in terms of upgrades that we can continue to drive. You heard about us implementing the Tier 4 engine with CSX. This is something that we can apply not only to our platform, but to other platforms out there as well. We're really excited about the opportunity here on this energy transition with battery-electric. We are currently responding to a number of questions coming from requests for quotes and requests for information from customers, not just in North America, around the world. We see battery here as a significant element of how you really renew some of the fleets, driving value for customers and driving value for ourselves. I think we're really building off on a positive momentum here ahead of us.

Pat Dugan
Pat Dugan
CFO at Wabtec

To talk about the restructuring, we've talked about this in the past. It's specific to our U.K. operations, where we're seeing some of larger projects wind down and conclude. We're looking at all of our footprint in the U.K. and consolidating operations. There is an element of impairment and other severance that comes through in that number. The majority of that restructuring is non-cash. There's just a lumpiness here in the second quarter. I would tell you that when you look at the full year, we still expect our restructuring to be less than it was a year ago. We also expect that restructuring is going to continue as we drive that margin improvement for our transit segment. We are consolidating footprints, taking steps to improve our productivity, and improve margin overall. There'll still be more in the future, but down year-over-year.

Rob Wertheimer
Rob Wertheimer
Analyst at Melius Research

Thanks.

Operator

Our next question comes from Scott Group with Wolfe Research.

Scott Group
Scott Group
Analyst at Wolfe Research

Hey, thanks. Good morning, guys.

Pat Dugan
Pat Dugan
CFO at Wabtec

Good morning, Scott.

Scott Group
Scott Group
Analyst at Wolfe Research

I want to just come back to the margin outlook for a second, because when we look at the new revenue guidance and earnings guidance, it looks like it implies the margin, implied margins have come down a little bit from the prior guidance, and just want to get your sense on why that is and maybe why we're not seeing just better leverage on the sales upside. Is it just mix or is there anything else going on? Thank you.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Scott Group, I'll really go back to what I said. You're going to see margin expansion going through the second half of the year by more than 50 basis points versus the first half. If you look at the original guidance we had given for the year, we're going to be seeing margins expanding better than that original guidance was. I think there's always going to be, again, elements of variation in the quarter, as I had highlighted, in terms of timing of projects. Mix can also be an element here, especially as you think about the speed of growth here on the transit segment versus the freight segment. As you look into some of the other elements, even as G&A, we're consistent with the 12% we had guided earlier in the year. Very much committed and executing to the $250 million of synergies that we have talked about.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

We expect to deliver those earlier in the second half of the year than later. I think the other positives, we're moving forward into what I call a second phase of Integration 2.0, which a lot of it is really tied to a continuous improvement culture, and that will continue to drive up productivity. We are committed to continue to drive profitable growth with improved margins going to next year as well.

Scott Group
Scott Group
Analyst at Wolfe Research

Okay. You talked about locos getting unparked. Maybe can you just talk, how many locos were unparked in the second quarter, what your outlook is for the back half of the year, what's the revenue opportunity for you from each loco getting unparked?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Scott, I think the best way to answer you there is just we're looking to the second half. I think we expect here certainly a continued rebound at a gradual pace. Of course, when you compare the piece year-over-year, they become a little more challenging. I think the good news is, when you look at the fleet that's running out there, you're really looking for reliability and availability. Those locomotives are running harder than they were before. Even though if you look at the overall fleet, you're not necessarily back to pre-COVID levels. I think we are positioned well here with the newer fleets. Fleets that really provide, I'll call the best reliability for customers, which is certainly needed right now when you look at improving service levels ahead. I wouldn't speculate in terms of the levels of unparking.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

This is an active dialogue we have with customers, and it involves not just the elements of unparking. It involves a strategy around modernizations, new locomotives. It's a broader equation than just tied to unparking of existing fleets, which will potentially come with sometimes penalties tied to reliability of the overall system.

Scott Group
Scott Group
Analyst at Wolfe Research

Okay. Thank you, guys. Appreciate it.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Operator

Our next question comes from Jerry Revich with Goldman Sachs.

Jerry Revich
Jerry Revich
Analyst at Goldman Sachs

Yes, hi. Good morning, everyone.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Good morning, Jerry.

Jerry Revich
Jerry Revich
Analyst at Goldman Sachs

Rafael, can you talk about the mod pipeline and where it stands today? Nice to see the really strong deliveries in the quarter where you had the tough comp from a year ago. I'm wondering what's the backlog look like, what's the pipeline and level of activity overall?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Jerry, mods was a significant step up this year versus last year. That helped us, I'd say, partially offset even some of the elements of new locomotive deliveries. We look at moving forward, I think good momentum there. If you think about the things that we're bringing to market that allows us to even upgrade some of the existing fleets with better fuel efficiency, some of the elements of automation. We see that as a trend continuing, certainly going to next year. I think there's an element here of just the step up in growth we saw year-over-year. I do not expect that necessarily be the same going to next year. Mods does have a significant opportunity for us. As you look at internationally as well, it's been a significant element of discussions with international customers, too.

Jerry Revich
Jerry Revich
Analyst at Goldman Sachs

Very interesting. On the international locomotive pipeline, can you help us put a finer point on the timing and magnitude of project opportunities? If you can, comment on whether they're from countries where you have existing operations versus areas where you might need to build assembly capacity. Thanks.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Sure. I think that's really a part of, I think, the good dynamics we're seeing. Those are countries that we largely operate in. We have strong relationships with customers, and we see that momentum there picking up. I'm not going to speculate here with specific elements of when some of those orders convert, but what I'll tell you, as I look into the framework for what I call a 2022, 2023 timeframe, that's certainly a positive and there's good momentum. I'm just not going to speculate in the elements of exactly when orders get finalized. The momentum's there, pipeline's stronger, and we feel positive about growth in the international market moving forward.

Jerry Revich
Jerry Revich
Analyst at Goldman Sachs

Rafael, just to clarify, 2022, 2023 timeframe, is that when you expect to deliver the locomotives or when you expect the firm orders?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

No, we expect the firm orders this year, so that's more of an element of delivery as you look into the future. That's why I don't want to speculate how much it goes into the specifics of next year or 2023, but it's a positive as I look at it, and those are units that we'll largely be building in that timeframe.

Jerry Revich
Jerry Revich
Analyst at Goldman Sachs

Terrific. Thank you.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Operator

Our next question comes from Allison Poliniak with Wells Fargo.

Allison Poliniak
Allison Poliniak
Analyst at Wells Fargo

Hi. Good morning. I just want to go back to the digital businesses for you. Obviously, it sounds like a lot of momentum's building back sort of post this COVID lull. I guess one question, you had mentioned the thought behind building that recurring revenue. How big is that as a percentage of digital today? I think as you entered this year, you were expecting digital to be flat. Is that still the case with the momentum really impacting next year, more importantly? Any thoughts there?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Allison, when you look at the recurring revenue, I go back a couple years ago, this was in the teens. I look at it today, it's above 20%. I think the team continuing to work on that regard. I think just more recurring revenues as a function of that. I think some of the challenges tied to the year is really getting orders that you can convert in the year. I think we still have some challenge in the year in terms of increasing the revenue in any significant manner. It feels very positive in terms of the multi-year orders we've been able to get for the past three quarters. Our book-to-bill has been well above 1. I think that translates into growth for the business going to next year and beyond.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

I think we've often talked about growing two to three times faster on that segment, and that's a story that doesn't change. As you look into also the other comment I made with regards to battery-electric, that's such a critical portfolio in terms of how you manage a consist. I think you'll have the opportunity to hear more on it, but I think you will need that portfolio with Trip Optimizer, with Zero-to-Zero to ultimately make sure that you're really taking advantage of improved fuel savings moving forward.

Allison Poliniak
Allison Poliniak
Analyst at Wells Fargo

Great. That's helpful. You made a comment about projects being pushed to the right a little bit more, too, in general. We've heard that, I would say, across manufacturing complex. Do you feel like people are getting a better handle on where you're seeing more conversion on time as we enter the back half? Or does this feel like it's going to be an ongoing situation where it could continue to get pushed into maybe next year, even?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Mike, again, as we look into the year, we feel confident. Otherwise, we wouldn't have raised the guidance overall. As we look into the dynamics going to next year, it really points out to a profitable growth year for us. I think the elements here of projects, whether if you talk about transit, whether if you talk about freight. In transit, we see largely authorities and governments committed to invest in the transit system, that continues. We haven't really seen, again, any cancellations or anything like that. If anything, I think there is opportunity for growing momentum there, especially as we look at a number of stimulus packages going across. On freight, my comment here, sometimes more on the elements of the timing of orders. Certainly, I'd say requires more, I think, negotiations than some of the elements of North America, positive momentum forward.

Allison Poliniak
Allison Poliniak
Analyst at Wells Fargo

Perfect. Thanks, I'll pass it along.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Operator

Our next question comes from Matt Elkott with Cowen.

Matt Elkott
Matt Elkott
Analyst at Cowen

Good morning. Thank you. On the synergies front, I think most of your synergies have been on the cost side from the deal so far. That's understandable given that you guys inherited a backlog from GE. As you take in more new orders, are you finding opportunities on the revenue synergy front?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Yes, we are, and it's really one that goes into various areas. I'll start with transit. I think some of the relationships that we've had with the broader company, it is allowing us to grow our share into some markets that traditionally we would not be as present. I think that's a positive and we are seeing the opportunity here to be early on projects, to be specced in, and to really work on what I'll call a category of products that we're able to supply into transit. It's certainly true also for a number of regions. Whether if I think about Eastern Europe, whether if I think about Russia and CIS, those are areas that traditionally we've had a very strong footprint, strong relationships with customers, and you see that as a function of opportunities for us to grow transit faster and more profitably as well.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

On the freight side, I think some of those, we've talked about it in the past. There's certainly an opportunity for us to continue to do that. A piece of that is us also looking at taking advantage of competitors' platforms and being able to implement some of the elements of mods and things like that, which were capabilities that we brought with a merger of the company. You'll see more of that and opportunities for us to be expanding our solutions into other competitive platforms.

Matt Elkott
Matt Elkott
Analyst at Cowen

Got it. Rafael, do you think that Wabtec legacy content in new locomotive orders should be higher than pre-deal for new orders?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

The answer is yes, it should, and especially as you look at new platforms that we're launching. We're certainly taking advantage of a lot of this, I'll call core technologies that really ultimately guarantee the value for the customer. If you think about the core, we call them vital organs. I think that has expanded and those platforms largely will reflect that. It's a growing penetration of our products into these future platforms.

Matt Elkott
Matt Elkott
Analyst at Cowen

Got it. Just one, my second question on the infrastructure bill. Sorry if I missed any comments there you made, but as you know, the $560 billion infrastructure bill took a step forward yesterday. I think there's about $100 billion for rail and public transit. Can you talk about any potential benefits for you guys from this?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Well, the sector will benefit from the bill. This is a positive for Wabtec. I think there's a couple opportunities here on both fronts. I think certainly in transit, I think we'll see some of that reflected in terms of some of the opportunities we have. Also on the freight side, as we talk about some of the technology development, those are some of the discussions that continue in terms of really government support to accelerate some of the elements of decarbonization and efficiency for our customers. We see it largely as positive news and something that will benefit rail and will benefit us.

Matt Elkott
Matt Elkott
Analyst at Cowen

Great. Thank you.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Operator

Our next question comes from Steve Barger with KeyBanc Capital Markets.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Hey, thanks. Rafael, you brought up how things can be lumpy quarter-to-quarter. Should we be thinking 4Q sees the typical step-up in revenue and EPS from 3Q, or can you just talk about back half cadence?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

I'd be thinking about sequential improvements as you go into the second half of the year. There is, of course, an element, sometimes a seasonality between third and fourth quarter. Traditionally, you would've seen third quarter, I'm going to call especially stronger with some of the elements of the mix. I'll call sequential improvement.

Pat Dugan
Pat Dugan
CFO at Wabtec

Yeah, I think if you go back, we're still seeing some disruption, a little bit in the normal seasonality because of everybody coming off of COVID. If you go back to 2019 and even before, you would see third quarter was really usually strong in the freight services side. It kind of ties to our customer's maintenance cycle and when they do things. Meanwhile, in the fourth quarter, there's usually some strength in the transit aftermarket business. All those things kind of play out here in the second half of the year. I think we have a lot of confidence in what the second half will look like. I'm still looking at sequential improvement, but considering those things might be coming back in more normal situations.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Just so I understand, sequential improvement meaning three Q better than two Q and four Q better than three Q this year?

Pat Dugan
Pat Dugan
CFO at Wabtec

That's our expectation, yeah.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Okay. Got it.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

From an EPS perspective, yeah.

Pat Dugan
Pat Dugan
CFO at Wabtec

Yeah, from an EPS perspective, correct.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Sure. If I model out to the midpoint of your guide, I get mid-15% range operating margin, which gives about a low 20% incremental for the year. Can you tell us what the impact of mix or unusual items were this year in terms of margin impact relative to your original thinking? Just remind us how we should think about incremental margin going forward in an environment where you can drive high single-digit growth.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

I'll emphasize the element that we will expand margins this year, and we'll continue to expand as we go into next year. I think it would be worth taking some time offline with you, just walking through some of these elements as mix certainly plays out through, especially the element here of the year per se. That's variation on quarter-over-quarter. I think again, 50 basis points margin improvement going into the second half of the year. We're going to be better than the 50 basis points. Pat could also add that.

Pat Dugan
Pat Dugan
CFO at Wabtec

Yeah, I understand your math. I think you just want to factor in the full year impact and that you're going to have some variation quarte-to-quarter. We don't give quarterly guidance on margin percentages, but really focus on the full year and the impact of all the cost and productivity savings and synergy savings, as well as sales mix and how that would impact us.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Yeah, that's really the motivation of the question, is thinking about annuals on a go-forward basis. Which is to say, if we're in an environment where you can drive high single-digit growth in the future, and as you think about your backlog mix, can you do better than a low 20% incremental for a full year?

Rafael Santana
Rafael Santana
President and CEO at Wabtec

The short answer is, in terms of incrementals, yes, we expect that.

Pat Dugan
Pat Dugan
CFO at Wabtec

Yeah.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Got it.

Pat Dugan
Pat Dugan
CFO at Wabtec

I think the volumes, and I think we demonstrated it on the variations in the past, and with the increasing revenue and absorption, you get those kind of contribution margins you're talking about.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

I know we're late in the call. Can I ask a quick one for Eric? If there's someone behind me, I'll just jump out of queue.

Pat Dugan
Pat Dugan
CFO at Wabtec

Yeah.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Go ahead. Please.

Pat Dugan
Pat Dugan
CFO at Wabtec

Ask the question.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Okay. Yeah. Slide 13 is great for showing us the technology progression to carbon zero locomotives. I know you're inventing a lot of this, so it's hard to predict timing, but any best guess on timing for battery electric lead and then hydrogen? Are we talking five years, 10 years?

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

When we look at the battery-electric coming off the successful testing that we did out in California, we're already in the process of quoting the battery-electric and should be shipping in 2023, is kind of the timeframe we're looking at there. That's be getting after 2023, and that will come lead capability. What I mean by the lead capability is that it won't have to run in a consist between two diesel-electric. You can have multiple battery-electric working together at that point. We're very proud of moving forward on that. The hydrogen will lag by a couple of years behind that. There's more invention happening in the hydrogen. When you look at what we're doing with GM right now, that's accelerating us both on the batteries as well as the hydrogen side there.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

Then I think one of the key points also is that we're also developing all the elements around it. It's the system that really works together. The battery system working with the power conversion, working with Trip Optimizer to optimize all of that, and even the braking, working the braking in there so that you can capture as much energy as possible. That's how we get to the 30% emissions and 30% fuel improvement.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

If I'm hearing you right, it sounds like you expect a hydrogen freight locomotive in this decade.

Eric Gebhardt
Eric Gebhardt
CTO at Wabtec

Yes. In the next few years.

Steve Barger
Steve Barger
Analyst at KeyBanc Capital Markets

Great. All right, thanks.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Thank you.

Operator

Our next question comes from Chris Wetherbee with Citigroup.

James Romaine
James Romaine
Analyst at Citigroup

Hi, guys. James Romaine again on for Chris. I think you had talked about 50 basis points of margin expansion in the back half. I was wondering if you could talk about your expectation for margin expansion in the back half for freight, and then understanding how much of that might be due to mix or the flow through synergies or anything else.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

When you think about margin expansion, we have not broken that out on freight. We haven't guided that specifically. But for transit, we have guided to 100 basis points, and we continue to be on that track. That's part of that guidance. That includes continuing to expand transit margins year over year by more than 100 basis points for this year. On freight, we've also, I think, been very clear about margin expansion there too. I think the 50 basis points was more to really make sure we give a framework of how we expect margins to grow into the second half of the year with greater than 50 basis points overall expansion when you look at the segments combined.

James Romaine
James Romaine
Analyst at Citigroup

Got it. Then there was a stark improvement in services revenue. I think you've called out the unparking of equipment had a lot to do with it. I'm just kind of wondering, could you give us an understanding of sort of what the business is running at in July so far, or maybe in June, with the amount of unparking and equipment that's come out of storage so far, then just maybe sort of understand how, what essentially, as activity picks up, do you expect sort of the services revenue to accelerate through the back half?

Pat Dugan
Pat Dugan
CFO at Wabtec

The unparkings, really haven't commented on anything specifically. We see these locomotives coming back into service. It very much correlates exactly with the overall freight traffic for North America. Really not something to comment on in July or anything like that, as you asked. We just see this trend to continue, and it gives us a lot of confidence and a lot of visibility as to the strength of what's going to happen with our freight services business.

Rafael Santana
Rafael Santana
President and CEO at Wabtec

Maybe just to add on, in terms of rebounds, we expect more of a gradual pace here into the second half of the year. The comps are again, different. I think one of the things that we're seeing is a stronger demand for reliable power. The newer locomotives are running, I'm going to call, harder, so more megawatt hours. That's what I think largely drives a continuation of some of the dynamics you see in services. We see stronger services ahead, not necessarily as low down, going to the second half.

James Romaine
James Romaine
Analyst at Citigroup

Got it. Thank you.

Operator

This will conclude our question and answer session. I'd like to turn the call back over to Kristine Kubacki for any closing remarks.

Kristine Kubacki
Kristine Kubacki
VP of Investor Relations at Wabtec

Thank you, Hailey. Thank you to everyone's participation today. We look forward to talking with you and speaking with you through the quarter. Thank you. Have a great day.

Operator

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

Analysts
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