Q3 2021 Westinghouse Air Brake Technologies Corp Earnings Call
Good morning, and welcome to the Wap Tech third quarter 2021 earnings conference call. All participants will be in listen only mode should you need assistance. Please signal conference specialist by pressing star key followed by zero.
After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad 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 Christine <unk>, Vice President of Investor Relations.
Please go ahead.
Thank you operator, good morning, everyone and welcome to <unk> third quarter 2021 earnings call with US today are president and CEO Rafael Santana CFO, John Olin and senior Vice President of Finance John maxillary.
Today's slide presentation, along with our earnings release and financial disclosures were posted on our website earlier today and can be accessed on the Investor Relations tab on Web Tech Corp Dot com.
Some statements, we're making are forward looking and based on our best view of the world and our business today for more detailed risks uncertainties and assumptions relating to our forward looking statements. Please see the disclosures in our earnings release and presentation.
We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics.
I will now turn the call over to Rafael.
Thanks, Christine and good morning, everyone. Joining me today is our new Chief Financial Officer, John Owen.
John is a well respected leader with broad operational and financial experience.
He is already bringing a great perspective to our business and long term strategy with a clear focus on growing shareholder value were trilled to have him on the team.
I also want to take a moment to thank Pat Dougan for his nearly 20 years of service swap deck. We're grateful for all that he has contributed to the company.
With that let's turn to slide four.
I will start with an update on our business my perspective on the quarter and our long term value framework and then John will cover the financials.
Overall, we made significant progress against our strategy and delivered a strong third quarter as noted by our sales growth adjusted margin and adjusted earnings per share each of which were up year over year.
Total sales for the quarter were $1 $9 billion.
Driven by growing demand and freight services and components, but offset by continued weakness in the North America OEM market.
Adjusted operating margin was 17% driven by strong mix and productivity ongoing lean initiatives and cost actions.
Total cash flow from operations was $244 million.
<unk> year to date cash from operations to $759 million.
<unk> $458 million a year ago.
This was a solid illustration of how the team is driving good operational performance.
Cash conversion for the year is that a 103%.
Finally, we ended third quarter with adjusted EPS of $1 14, SaaS up 20% year over year.
Today, we're also pleased to share that we have achieved our $250 million synergy run rate.
Full year earlier than expected at the time of the GE transportation acquisition.
We have consolidated and optimize our operations reduce costs to drive stronger profitability.
Accelerated lean across the enterprise and created additional capabilities in best cost countries.
We're already feeling the benefit of these efforts, which will continue to improve our competitiveness.
So overall really strong execution by the team as we continue to deliver on our long term strategy.
Shifting our focus to slide five.
Let's talk about our end market conditions in more detail.
Internationally freight activity continued to improve in the third quarter across our major markets and our order pipeline remains strong.
We expect long term revenue growth in Russia, Cif's, Brazil Africa, Asia and Australia.
Freight trends in North America weaken slightly year over year in the third quarter, not driven by lack of demand, but by global supply chain disruption that has impacted intermodal volumes and auto production.
Schumer and industrial activity continue to spur volume growth in chemicals metals and materials.
But the motive parking's continued to decline despite weaker freight traffic in the quarter we.
We expect demand for reliability productivity and fuel efficiency to continue to increase.
Racing our services business in a position of strength.
When it comes to the North America railcar built.
Demand for railcars is improving about 21% of the North American railcar fleet remains in storage.
A slight improvement from the previous quarter and in line with pre Covid levels.
As a result industry orders for new railcars are starting to improve with.
We forecast the railcar build this year will be in the neighborhood of 30000 cars.
Transitioning to the transit sector ridership remains a bit uneven and some markets.
However, infrastructure spending for green initiatives continues to be a bright spot.
Actually as governments globally churn to rail for clean safe and efficient transportation overall, the long term market drivers for passenger transport remained strong.
Shifting to slide six.
We are developing innovative solutions that address the main cost drivers for our customers, including fuel efficiency and increased velocity in the transportation sector.
Our commitment to succeed in this effort is underscored by our focus on continuing to position rail transportation as the safest and most sustainable way to move freight and people overland.
Today, we have the capability and expertise to transition diesel powered locomotives the battery power and drastically reduce emissions as we're doing with our flash drive locomotive.
We expect to extend this technology partner to a hydrogen fuel cells and help lead the industry to a zero emission rail network of the future.
And we're not stopping there.
We have extended battery technology to other areas of our business as well and.
And we are driving several technology breakthroughs to boost transit efficiency and reduce emissions and pollutants.
An example of this is our green friction technology, which drastically reduces break emissions by up to 90% in.
An incredible milestone and significantly improving the quality of the air in our metros.
We're also leading the change to create a safer and more efficient rail network.
A great example of deaths and a solution of growing interest among class one customers.
Trip Optimizer 020.
These advanced technology allows an operator to autonomously startup train from zero mph and stop it using software integrated with positive train control.
It builds on trip optimizer proven performance, which has saved railroads more than 400 million gallons of fuel.
Since inception, and reduces emissions by over 500000 tons per year.
Looking forward, we will continue to advance efforts towards cleaner more energy efficient transport and will share our progress on this front as well as our broader environmental social and governance priorities in our next sustainability report, which will be <unk>.
Really it's been a couple of weeks.
Next.
Let's turn to slide seven to discuss how our Nextgen technology is helping us win in the market by covering a few recent business highlights.
In the third quarter, we secured new orders for our flex drive locomotive.
We also closed a significant order for international locomotive Cats and want a digital contract in Asia to help our customers improve asset utilization and reduce emissions.
And freight services, we won a significant long term service contract as well as an order for 100 locomotive Modernizations in North America.
Overall mods backlog remains strong and we are showing good momentum on deliveries.
In transit, we won new power collection, HVAC and service contracts in Germany, Switzerland, and the U K.
Looking ahead, we are cost at <unk> will continue to capture growth with innovative and scalable technologies that address our customers' most pressing needs.
We also will continue to control, what we can and leverage distract to combat. The current challenges that we are facing due to supply chain disruptions.
Increasing model in commodity costs and labor shortages.
He is dynamic.
Adversely impacted our third quarter results and have resulted in significant cost increases.
Across the board our team is working hard to mitigate the impact of these pressures by triggering price escalations and surcharges as well as driving operational efficiencies wherever we can we.
We anticipate that cost will continue to increase over the next few quarters.
We will continue to aggressively manage these challenges.
I will turn the call over to John now to discuss these in more detail as well as a review of the quarter segment performance and our overall financial position John Thanks.
Thanks, Raphael and good morning, everyone.
Great to be with you and I'm very excited to join the team at web check this storied company with incredible talent deep innovation and best in class differentiated technologies that is well positioned to deliver the future of real well growing shareholder value.
I look forward to meeting with many of you in the coming months.
Now turning to slide eight before getting into the financials, we would like to discuss the dynamic cost environment and supply chain challenges that we face.
During the third quarter, we experienced delays in production and deliveries of our products as well as significant increases in many key input costs.
On the revenue side, we are experiencing adverse impacts to our sales results due to shortages across many component parts, including computer chips, which are causing delays in production and customer delivery.
We believe that our enterprise revenues were the 2% to 3% lower than they would have been without the supply chain disruptions.
And that the majority of these lower revenues represent delayed sales not lost sales.
The impacts to web techs cost structure come in four areas first commodity inflation, where markets year over year or up more than 200% for steel, 94% for aluminum and roughly 40% for copper.
The second area of impact is elevated freight and logistics costs, which in many cases are up over three to four times from pre COVID-19 levels.
Third as wage inflation and labor availability, which are adversely impacting the business and finally, we are experiencing loss manufacturing efficiencies largely due to component and chip shortages.
Our costs have increased during the quarter and have impacted both our freight and transit segments.
We estimate that cost increases in the third quarter or in the range of $15 million to $20 million.
<unk> said that we expect these headwinds to intensify as the full cost of rising metals and lower manufacturing efficiencies worked their way through our inventories and purchase contracts, we anticipate cost to continue to increase over the next few quarters.
Our team is working hard to mitigate the impact of these cost pressures and supply chain disruptions by triggering price escalation clauses that are included in many of our long term contracts implementing price surcharges.
Driving operational productivity and lean initiatives and finally through higher realization of synergies.
Turning to slide nine I'll review, our third quarter results in more detail.
We had good operational and financial performance during the quarter.
Sales for the third quarter were $1 91 billion, which reflects a two 2% increase versus the prior year.
Sales were positively impacted by the continued broad based recovery, we are experiencing across much of our portfolio.
The acquisition of Northcote and favorable currency exchange.
Partially offset by continued weakness in the North America, OE locomotive market and lower year over year sales in transit.
For the quarter adjusted operating income was $325 million, which was up 10, 6% versus the prior year.
Most notably we delivered margin expansion in both those segments up one three percentage points on a consolidated basis.
Margins were aided by strong mix favorability.
Productivity and better than expected realization of synergies.
As Raphael stated during the quarter, we achieved our goal of $250 million of synergy run rate a significant milestone delivered a full year earlier than originally forecasted.
What makes this quarter's margin expansion even more impressive is the fact that our margin gains were achieved in the face of an incredibly dynamic supply chain an inflationary environment.
Looking at some of the detailed line items for the third quarter adjusted SG&A.
SG&A was $257 million, which was up $16 1 million from the prior year due to the normalization of certain expenses higher incentive compensation and employee benefit costs and the acquisition of Nord pool for the full year, we expect SG&A to be about 12.25% of sales.
Adjusted SG&A excludes $12 million of restructuring and transition expenses of which most was allocated to further optimize our European footprint.
Engineering expense increased from last year, we continued to invest engineering resources and current business opportunities, but more importantly, we are investing our future as an industry leader and de carbonization and digital technologies that improve safety productivity and capacity utilization.
2021 investment in technology, which includes engineering expense remains at 6% to 7% of sales.
Amortization expense was $72 $5 million.
And our adjusted effective tax rate during the quarter was 24, 8%.
Year to date adjusted effective tax rate to 25, 8%.
For the full year, we still expect.
The tax rate of about 26% excluding discrete items.
In the third quarter GAAP earnings per diluted share were <unk> 69.
And adjusted earnings per diluted share were $1 14 up 20% versus prior year.
We are pleased with our Q3 results in particular, our sales growth in the face of supply chain disruptions are margin growth in the face of sharp cost increases.
We remain diligent and proactive as we work to minimize these challenges.
Now, let's take a look at segment results on slide 10, starting with the freight segment.
Across the freight segment total sales increased four 7% from last year to $1 3 billion, primarily driven by continued strong growth in our services and component businesses.
In terms of product lines equipment sales were down five 7% year over year due to fewer locomotive deliveries this quarter versus last year and no new locomotive deliveries in North America, partially offset by strong mining sales.
This year over year performance demonstrates the resiliency of our equipment portfolio.
In line with an improved outlook for rail our services sales grew a robust 13, 6% versus last year.
Year over year sales increase was largely driven by higher aftermarket sales from our customers are modernizing their fleets.
The locomotives and the acquisition of Nord pool.
Excluding norco organic sales for the third quarter were up six 1%.
Digital electronic sales were down three 6% year over year, driven by delays in purchase decisions due to economic and cost uncertainties as well as chip shortages.
We continue to see a significant pipeline of opportunities in our digital electronics product line as customers globally focus on safety improved productivity.
We increased the capacity and utilization.
Component sales continued to show recovery and were up six seven year over year, driven by demand for railcar components.
And recovery in industrial end markets.
We remain encouraged by the continuing trend of railcars coming out of storage.
Order rates for new railcars.
And accelerated recovery across industrial end markets.
Shifting to operating income for this segment freight segment adjusted operating income was $266 million for an adjusted margin of 26% up one seven percentage points versus the prior year.
Benefit of higher volumes improved mix across our portfolio and increased synergies and productivity were partially offset by significantly higher input costs.
Finally segment backlog was $18 2 billion up $375 million from the prior quarter on the broad multi year order momentum that Raphael discussed across the segment.
Turning to slide 11 across our transit segment sales decreased two 5% year over year to $612 million.
Sales were down versus last year due in large part to supply chain issues in COVID-19 related disruptions.
This was partially offset by positive ridership trends.
Excluding near term supply chain challenges, we estimate that transit sales would have been up slightly on a year over year basis.
We believe the medium and long term outlook for this segment remains positive.
As infrastructure spending for Green initiatives continues.
Adjusted segment operating income was $77 million, which resulted in an adjusted operating margin of 12, 5% up 50 basis points versus prior year.
Across the segment, we continued to drive down costs and improve project execution, despite the volatile cost environment.
For the year, we remain committed to deliver about 100 basis points of margin improvement for the segment.
And the team continues to take aggressive action to mitigate rising costs and supply chain disruption, which will pressure the pace of near term margin improvement.
As we execute in the fourth quarter, we expect significantly improved operating margin driven by strong productivity gains improved project mix and more favorable comps versus the prior year's fourth quarter.
Finally transit segment backlog for the quarter was $3 6 billion, which was flat with the prior quarter after adjusting for the negative effect of foreign exchange.
Now, let's turn to our financial position on slide 12.
We had another strong quarter for cash generation, we generated $244 million of operating cash flow during the quarter, bringing year to date cash flow generated to over $759 million. This.
For them, it's clearly demonstrates the quality of our business portfolio.
During the quarter total capex was $23 million, bringing year to date capex to $78 $5 million in 2021, we now expect capex to be approximately $120 million. This is $20 million lower than our previous guidance as the team judiciously managing every dollar of spend.
Our adjusted net leverage ratio at the end of the third quarter was two six times and our liquidity is robust at $162 billion.
Also during the quarter, we returned capital to shareholders repurchasing $199 million of shares.
As you can see in these results our balance sheet continues to strengthen 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 to grow shareholder value.
With that I'd like to turn the call back to Raphael.
Thanks, Sean let's flip to slide 13 to discuss our updated 2021 financial guidance.
We believe that the underlying customer demand for our products and the end market momentum remains strong as John indicated we do expect continued headwinds from a more challenging sales and cost environment into the fourth quarter.
Taking into consideration this market backdrop and volatile cost environment combined with our solid performance in the first three quarters.
Are narrowing our full year revenue and earnings per share guidance.
We expect sales of $7 9 billion.
280, a $5 billion.
And adjusted EPS to be between $4 20.
$4 30 per share.
We expect cash flow conversion to remain greater than 90%, resulting in strong cash generation of about $1 billion for the full year.
Now, let's turn to our final slide.
Everything we've outlined today and reinforces that we have a clear strategy to accelerate long term profitable growth.
That strategy is built on our expansive installed base and deep industry expertise grounded in innovation.
Through initiatives and scalable technologies that drive value for our customers and accelerated by our lean continuous improvement culture and disciplined capital allocation.
I am proud of the strong execution by the team the third quarter, despite a challenging supply chain cost and market environment.
You are seeing their efforts and the strength of the company and our financial results.
As we go forward the rail sector is well positioned to increase share and address the critical issues facing the world's freight and logistics sector.
We will continue to lean into the strong fundamentals of this industry and our company to deliver long term profitable growth.
As we've said before <unk> holds a larger purpose to move and improve the world.
After demonstrating strong performance in the first three quarters of 'twenty one.
I'm confident that this company will continue to deliver and lead the transition to a more sustainable future with that I'll turn the call back over to Christine to begin the Q&A portion of our discussion Christine.
Thank you Raphael, we will now move onto questions, but before we view and out of consideration for others on the call.
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.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad.
Youre using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.
Our first question comes from Justin Long from Stephens You May now go ahead.
Thanks, Good morning, and John Congrats on the new role and look forward to working with you.
Good morning, Justin.
I guess to start I had a question on the revenue guidance. If we just take the low end red.
Revenue guidance it still implies a pretty significant sequential pick up in revenue in the fourth quarter I think it's around 13% of an increase sequentially to hit the low end of that guide can you just give a little bit more color about around the areas, where you see that sequential improvement and just the level of visibility.
Do you have.
So let me start there Justin.
I'll start with the pipeline of deals that continues to strengthen I mean, when you look at the impact on the quarter, it's really tied to supply chain disruption if anything versus last time, we talked.
We have a stronger pipeline. If you think about the 12 month backlog, it's up double digits versus a year ago. This is the highest backlog we've had since saw what fourth COVID-19.
<unk>.
This is our pipeline we continue to work on our convertible with you here.
Commodity demand remains silver all strong for both agriculture and mining in North America, even in the quarter demand for services and support for bulk fuel savings and reliability remains strong.
What is our running harder demand for freight car is on the rise from the forecast we had earlier.
In the year I think most important we are also continuing to build momentum on the battery electric solution with customers around the world. So.
This is not a question around demands.
I think that just meant with that the guidance for the year reflects some of that disruption, including going to the fourth quarter, which is reflected in the guidance we provided.
Okay, and secondly, I wanted to ask about margin one of the things that really stood out in the quarter was the adjusted operating margins for the freight segment. We saw a sequential decline in revenue for freight in the third quarter, but I believe the adjusted operating margins improved by over 200.
Basis points sequentially. So is there any color you can provide around that was there anything that was one time and then maybe on the cost headwinds going forward that you said would intensify any way to think about the order of magnitude around that and to pick up you expect.
Hi, Justin This is John Justman with regards to the <unk>.
<unk> also year over year margin gains were about the same year over year, one seven points on a sequential basis, two one points the driver of that and the freight organization is really the mix between the groups and mix within the groups. When you look between the group we had.
Services, which has got higher than average margin of 13, 6% and transit and the equipment down anywhere between two and a half and five 7%. So that's really the driver of both the sequential and the year over year margin improvement.
With regards to the cost side of the question.
We talked about the $15 million to $20 million and that's just in what is actually flowing through the P&L and so just to make sure that we're all straight the largest of the predominance of that costs that we're seeing on the front end as far as freight and.
I'm, sorry freight logistics costs.
Those don't flow through inventory and the hit us upfront.
So the predominance of the 15 to 20 million is in freight.
Freight costs.
The other piece of it is the materials.
As everyone knows has risen a lot as well as manufacturing inefficiencies now those get inventoried and they flow through inventory and there'll be released in the future as those products are sold if we look at what's on the balance sheet. That's at about the same amount that we saw pass through the P&L in the third quarter. So there's another 15% to <unk>.
<unk> million dollars sitting on the balance sheet that will will come and that's what we've talked about in the prepared remarks is that we would expect cost to rise in the fourth quarter in the next few quarters.
Okay. That's helpful. I appreciate the time.
Thank you.
Our next question comes from Jerry Revich from Goldman Sachs. You May now go ahead.
Yes, hi, good morning, everyone and John welcome.
Okay.
I'm wondering if you could talk about the.
<unk> business <unk> been on a really strong multiyear trajectory on that part of the portfolio can you talk about how the backlog looks and how attractive that option is for rails as they figure out there.
<unk> reduction.
The strategy longer term.
Do you anticipate a similar level of production growth for your mods business.
In 'twenty two is what you're delivering this year.
Yes, Jerry So first we did see I mean, grasping that business coming to this year I think the amount still out there on <unk>. When we think about growth I think a lot of the elements of growth chair for the mods business is more international I think it remains a robust part of the solution for our customers.
As you North America, and Thats tied very much to the announcement, we made but you've got to see us talking about some announcements around the opportunity internationally for mod So thats.
That's where.
I think a larger part of that opportunity yes.
Okay terrific and then.
Terms of the international locomotive contracts I know, obviously youre not taking the commodity.
Cost risk on those multiyear projects, but do your customers.
They have the budgets to cover the significant raw material increases.
Whats, what's the process like.
Two to recover the additional costs that obviously, it's going to take time to complete those projects I think a lot of those customers are actually benefiting from that Jack So it's very much connected to it in terms of the.
The opportunities for them too.
Grow volume a lot of it is demand around bulk the elements of.
Mining, but also the elements of the.
The agribusiness and dose.
<unk> robust.
I think the forecast is positive.
We look around the world.
Going back very much to my remarks, it's not a function of a single geography, we're really seeing a pickup one different geographies.
So no issues on customers, we're writing checks.
We're facing higher steel costs in <unk>.
Multi year contracts it sounds like okay. Thank you.
And Jerry just give more color to add to a number of customer we've got multiyear contracts. So dollars already kind of provided some visibility in terms of.
Our cost escalations without process and.
Again with a lot of that most of these customers we have had a long standing relationship. So.
Gone through times like this.
Okay. Thank you.
Our next question comes from Saree <unk> with Jefferies. You May now go ahead.
Thanks for taking my questions.
Sticking on international locomotives could you just update us on what you see there where deliveries in the quarter and maybe some guidance around growth into 2022.
Sure well first I think its markets to where we're continuing to see good momentum. So when I think about the 'twenty two 'twenty three time frame I think we see.
Positive momentum, it's all around the convertibility of this pipeline into orders.
And again as I described it touches different geographies.
Elements of that so we do expect good al.
Associated to that and when we go through the 'twenty two 'twenty three time frame with regards to <unk>.
Guidance into 'twenty, two it's kind of early stages for us to really be discussing guidance at this point, but favorable demand <unk> 'twenty.
2003 timeframe.
And then can you talk to what you're seeing on the digital side and freight Comparables are a little easier this quarter, but you were still down so when do you expect this to inflect positively.
I'll start with number one efficiency productivity safety does continue to be imperatives for our customers.
We continue to see a strong commitment from them book to Bill is above one year to date we've had.
Some strong quarters looking back in terms of some of our multiyear orders.
I think internationally.
Keeping expanding our penetration.
One of the products I think I've talked about it before as PTC, it's probably an opportunity that is when I think about outside of the U S. As big as the U S opportunity. We have started to execute now PTC to three different countries outside of the U S. Now those are opportunities that it takes.
Some time.
Terms of working those through and a lot of cases, we're dealing also with governments on adopting yet but.
A very good positive progress up to this point and I think we have significant room to grow in terms of helping customers here with both of the elements of.
Driving productivity and de carbonization, which touches directly.
These products so it's going to go without the nation fuel savings at the end of today.
And then just squeeze one in Maryland.
A modeling perspective, what was the contribution of norco two sales in the quarter.
Two one percentage points.
On an enterprise wide basis.
Yeah.
Okay.
Sorry, I'm, sorry, you asked for contribution.
That was for sales.
So we benefited in overall consolidated sales because of Nordic coal by two one percentage points.
Our next question comes from Rob Wertheimer with Melius Research you May now go ahead.
Thank you.
For all the commentary on cost inflation and how it cycles through the balance sheet the P&L.
The gross market with really good so I'm just wondering if there's anything else to call out aside from the mixed factors John that you already you already talked about on gross margin and then just for clarification with the price escalators and actions that you're taking to those coincide with when that comes through or do we have a quarter of a quarter or two or whatever and then you get back to a more positive dynamic.
Yes.
Great Rob.
In terms of freight margin yes.
Sorry, certainly mix was a driver, but the productivity and the synergy that the organization is spinning out is absolutely building our margins in those areas again, we talked about the synergy piece and achieving the overall synergies a year early we're seeing some of the actual delivery of that flow through the P&L.
In the third quarter as well as the entire organization focused on productivity and integrating these companies continues to drive strong productivity.
And again that partially offset by escalating costs, so let's talk a little bit more about that and we know that the costs are up 15% to $20 million in the third quarter, we know that that's going to grow into the fourth quarter.
And when we look at how we're going to cover that.
We mentioned in the prepared remarks is we will do it through a series of price escalations pricing and price surcharges as well as a lot of hard work on accelerating productivity and kind of pushing off these cost increases as best we can.
But to your question, let's talk a little bit about the price escalators again over half the company's revenue is tied up.
<unk> locked into long term contracts. So we've got built in protection for our situation as we are experiencing now theres not a lot. There's nothing that we have to do it has already been pre determined for us on how these costs will be covered.
So the question is yes, there can be a lag.
Various contracts have different start dates some are monthly and those adjust every month's quarterly and annual so that we would expect over the next couple of quarters that we would continue to build up the revenue side of this cost equation and our track to be.
Price cost neutral to positive as we go forward the other piece of it aside from the escalator, so a little bit less than half of the overall cost increases are.
Being dealt with with pricing and price surcharges.
This has all been factored into the guidance, which we've talked about.
50 point increase.
The 50 basis point increase in margins and again.
Absorbing some of these costs and still hit the guidance that we previously put out there.
Alright, thank you.
Our next question comes from Courtney <unk> Covenant.
Jakob bonus with Morgan Stanley You May now go ahead.
Great. Thanks, guys.
If we could just maybe just follow up on the on the comments about price Escalations.
Just to be clear those will are exposed to the commodities that you specifically called out John Steele.
Steel aluminum.
Copper.
And then if we see those prices.
Eventually retract.
See the price escalation stay or would we expect pricing.
To adjust downward.
And those contracts as well as coordinated as little bit of a misnomer to call them a price escalators, because they're also priced the escalators when costs go down.
So again these are long term contracts could be many many years long. So all of this is prescribed and yes. They do cover all of those commodities as well as labor and transportation costs. So.
So we feel very good about where we're sitting in that part of the cost structure, that's backed up by those long term contracts.
Here, Yes, we do have experience with those escalators as we look at over time, the combination of dose escalation plus the productivity, we drive drive cell called positive outcomes.
<unk>.
I would want to tell you that.
Okay, Great that's helpful.
Then maybe just going back to some of the longer term wins that you called out this quarter Rafael.
Between the mods.
<unk> service agreement and trip Optimizer can you just help us right.
International local cats can you help us.
Just frame out when you would expect but the timeframe of those orders apply to and when we could expect deliveries on them and I don't think you called out any incremental zero, but just give us an update on whether youre, making traction on that product line as well.
We are making progress so I'll start there.
So mark continued announcement here as we drive convertibility, we expect especially when you think of the OE side some of those might hit us more on the 'twenty three 'twenty two timeframe, but thats why it fell to you about the 'twenty two 'twenty three positive dynamics in terms of.
What we see out there in terms of revenue good up sell with that and considering the dynamics. We still have in North America, we see the opportunity here to drive profitable growth into 'twenty two 'twenty three time frame despite a still looking at.
<unk>.
Deliveries for North America locomotives still at zero, which is the same that we've had this year.
Okay, great. Thanks, and then just lastly, one more follow up on the on the supply chain. It did sound like the $15 million to $20 million cost that you called out.
Was that a gross number or a net number and it sounded like it was mostly freight and logistics and I just want to make sure that's not covered under any of those escalation. So we should think about those costs have been.
I'm kind of more.
Substantial and harder to price out is that correct. Yeah. Good question, Courtney the $15 million to $20 million of higher cost is.
Is a gross number.
And again, when we look at our net number we are triggering some of those price escalators in the quarter and we're also got some flow arrangements, where they they get priced automatically and again the team is looking at surcharges and whatnot. If we take the other side of this equation, which is the revenue piece of this is about a little over <unk>.
Half of the $15 million to $20 million.
So we're covering about half of that through these mechanisms and again, we're on our way too.
Price.
Neutrality to positive and we would expect that in.
In the next couple of quarters that we will have some margin compression as we kind of deal with the lag.
Mainly the.
Long term contracts that have price escalators in it.
Okay, great. Thank you.
Our next question comes from Scott Group with Wolfe Research you May now go ahead.
Good morning. This is <unk> on for Scott Group first wanted to go back to the gross margins Chris.
Chris Martin is a 37% were higher than we've seen in some time is that level sustainable or how much do you would you expect that to tick down given the escalating cost that you mentioned thank you.
So first I think you'll continue to see variation quarter over quarter on margins and sales and I think for reasons. We have described before which can include timing of projects. It can include mix Andre absorption. So I'll.
Stay away from really.
Pinning us down on any specific.
Our results on at any given quarter I think the overall commitment, which John spoke to is despite of this pressure shows we've talked to you on previous earnings the.
The commitments there despite a higher risk to drive 50 basis points of improvement for the year and despite of the pressure on margins moving forward. The team is continuing to work on really upsetting dollars with some of the mechanisms.
We described.
There are certainly elements of looking at alternatives for saying that the team is looking at it and we certainly got the elements of also austerity on costs that we can add to the elements of pricing and the.
The other things that John described.
Thank you and then I know, you're not providing 2022 guidance, but can you provide some additional initial color on next year do you expect a recovery in the North American local market what about railcars. So I guess, what end markets kind of feel best and what end markets feel worst thank you.
I'll start with overall, especially when I look into 'twenty two 'twenty three time frame I think we see overall positive positivism. It certainly I think even more positive when I think about the elements of <unk>.
International I talked a little bit earlier about zero locomotives in North America.
Ultimately, even when do you think about the 'twenty two 'twenty three time frame the net impact of absorption I think certainly lessen.
As we first I mean, theres a lap of the impact of <unk> 21, which is just a repeat of notebook on those this year and we see the opportunity here to allow bridge, what I'll call the increased volume.
It's really a more optimized cost structure as a result of the synergies and the cost actions that the team has driven so despite of this margin pressure. We continue on our commitment here to drive profitable growth after the longer term for the business.
Thank you.
Our next question comes from Steve Barger with Keybanc capital markets. You May now go ahead.
Hey, good morning.
I know we're early in the process for the seven megawatt battery electric locomotives, but can you talk about.
How this changes how customers are talking about equipment acquisition in coming years does this increase margin decrease OE to some extent while customers wait for this or how are they talking to you about it.
I don't think customers wait for deaths.
I think some of the things that we announced here in the quarter, it's really us continuing to build momentum in battery electric solutions, and it's with customers really around the world I think.
The importance of desk is really we do expect then we've talked to you about it on building what I'll call a solid baseline demand that actually helps us accelerate the introduction of this technology, which yield soft on the longer term profitable growth for the business. So there's not a way to show a lot more in terms of our.
<unk> on how to best integrate that into their operations. There is some discussions that happen along the lines of applying that into specific corridor, where they're able to have that dedicated fleet and fast. Some of you saw our premises out and I think what's important we're past what I'll call. The invention of this product this is really.
About buddy into revenue services, and working with customers to accelerate.
Introduction.
<unk> is that it makes sense.
And as that starts to rollout is that positive for mix for you.
Yes.
We like this product very much.
They are.
Positive efficacy in terms of.
How we look at what we introduced St. Just keep in mind, you're not now just introducing waterfall locomotive a lot of the field go Swift that locomotive upfront. So we like a lot of the dynamics on what that kind of provides in terms of value for both our customers and ourselves.
Got it and then <unk>.
John I know, it's early to talk about 'twenty, two but do you have a general view on what consolidating consolidated incremental margins should look like in a modest growth environment or better yet if you want to drill down into the two segments. How you think about incrementals.
Steve, but we're going to do is spend the next three months really refining our plans.
Absorbing the cost shock that we have now and we'll be back to you in about three months and provide a good view as to what we do believe that will happen in margins in 2022, but at this point, we feel good as we look forward.
Huge opportunity on.
'twenty two 'twenty three timeline to drive profitable growth.
Highlighted in terms of some of the specific segments I think we've been open about it in terms of all the North star.
Star for our transit business, which is really getting margins to the mid teen.
Turning to continue to drive margin improvement.
For our freight businesses as well.
Understood. Thanks.
Our next question comes from Allison <unk> with Wells Fargo. You May now go ahead.
Hi, good morning.
Just wanted to go back to the digital business, specifically, you know, obviously component and chips shortage has been well documented here is there a way to understand what that specific headwind to growth for that product category has been and then it gets rafi on your comment around you know certainly delayed but not lost sales. How do you expect that to kind of I guess south correct do you have any.
At the time when that starts just laid out for you.
Whether it's based on just the availability of those components or kind of things that youre doing to sort of attack that as well.
So let me start with the second part of your question.
When we gave the guidance with.
Associated with this year that certainly applies to what I'll call a stronger headwinds than we've had in the third quarter. When it comes down to supply chain disruptions without I mean, there is.
A series of actions being taken by the team and really proud to see the progress the team has had so.
I am not going to dissipate when dose will finish we're not I think this is a very dynamic.
Situation.
And we're really focused on things that we control and it's really tied to.
Cost austerity continued to drive productivity, making sure that we are looking at alternative sourcing and that we're acting on pricing I think those are some of the things that we're focused on on additional electronics, we eat.
Dynamics are I'm going to call moving the right direction here with the business as I looking to the book to Bill moving the right side strong opportunity here for us to grow our penetration and we have the opportunity, especially as we evolve some of these technologies, we felt quite a bit about battery electric.
Really significant the opportunity to have a much more interconnected ecosystem and that's going to drive significant value for our customers, it's going to drive combativeness for rail overall and.
We can certainly benefit from that.
Got it helpful and then John.
Decent leverage at my attack in a strong cash performance, we'd love to get your perspective on capital deployments and where you think the priority should be at this point.
Well Allison.
Number one is I would say I can't wait to get our owners' perspective on capital deployment and.
Our capital structure and I will be out in the next several months talking to a lot of them to get their feedback on.
The second thought that I have on the topic is what a great problem to have the company has done a fantastic job of becoming very consistent on delivering a.
Very strong cash conversion ratio and as we look at this quarter of $1 billion of free cash. So number one is to make sure that we maintain a strong balance sheet, which the company has and continues to strengthen that the second area. Allison is to continue to invest in the organic side of the business.
I've been here now for seven to eight weeks and I've seen a lot of capital requests and the returns are absolutely fantastic on those investments in terms of driving.
Improved profits.
Over that period of time.
And then finally is on the remainder of the cash we will look at M&A and share buybacks no differently, we will prioritize returns to the shareholders and we will continue the buybacks as we did in the third quarter. So again, a great quarter in terms of share buybacks at a $199 million.
And we'll play what makes sense in terms of strategic acquisitions.
And looked at how do we continue to drive the shareholder value of the company forward.
Perfect. Thank you so much.
Yes.
<unk>.
Our next question comes from Chris Wetherbee with Citi. You May now go ahead.
Hey, guys James on for Chris I wanted to talk about or asking about freight services revenue.
Necessarily show the seasonal step up we might normally expect just kind of wanted to understand the puts and takes around that and sort of how you should see.
So if you think about the fourth quarter is that essentially sort of a baseline to operate off of is some of that pushed out just wanted to understand the dynamics there.
Let me take that starting with freight services.
Revenues are up 13, 6% and even if we were to discount.
The acquisition of Norco, you'd still have seen a sales increase of 6% until the quarter back to some of the elements of.
We could see variation quarter to quarter and that's based on timing of project mix as well can play an element there, but this is a business that.
<unk> continues to have what I'll call Heidi match for really the elements of providing reliable power on parking of locomotives continue and demand for really a modernization. It's also out there and we're continuing to see higher after market demand.
Some of the fleets get on parts, so right dynamics now.
Nothing specific.
To highlight on the business.
Alright got it and then I guess, given the dynamics you highlight or on the on parking.
Moving into the fourth quarter and further out should we start to see essentially sequential improvement off of that.
Just like.
The math of the UN Parking's would suggest that you could see a step up off of what you have in the third quarter there.
When I look at the 'twenty two 'twenty three time frame I think the expectation yes.
And we look at an opportunity here for growing demand I'll stay away from really highlighting specifics on.
Going through the early part of next year, just based on a lot of the things that we described here for the call but.
Demand is there.
While we've seen up to this point is really disruption.
Two supply chains and.
We see.
The opportunity to continue to drive.
Our long term profitable growth for the business team is executing on the strategy and where.
We're confident about our ability to position here at the company for that long term profitable growth.
Okay got it thank you.
Our last question comes from Matt Alcott with Cowen You May now go ahead.
Good morning.
Get to see the sequential increase in the total backlog and I think a year over year both.
Total backlog and the 12 month backlog.
Kris.
But Raphael and John can you can you talk about the decrease sequentially in the 12 months backlog.
What are the reasons behind it are there.
Or deferrals.
And specifically on the transit backlog because I think this is the second quarter in a row that we see a sequential decrease in the 12 months.
Backlog Jeremy.
Sure. Matt This is John matches, Matt as we look at the 12 month backlog Youre right. It is down about $115 million or a couple percent and that is driven by transit and there are two things, which are driving that reduction one is about half of it is foreign exchange so take that right off the top the other piece on the other.
Half of it in transit is our exiting some unprofitable contracts as you remember a couple of quarters ago. The company talked about of U K restructuring.
And so these are contracts that we're exiting.
They weren't delivering the level of profits that we would expect from our transit organization. So those are the two pieces that explain the bulk of the reduction.
From the second quarter to the third quarter, but I'd also point out Matt is when you look on a year over year basis, So a year ago quarter.
12 month backlog is actually up very strong it's up over 10%.
And I'll just add we just went through our strategic planning and as I look at the elements of both transit and overall franchise, we have the opportunity here to drive profitable growth.
Got it that's very helpful.
And then.
<unk> on the it's good to see the locomotives parked locomotives decreased heading in the right direction, but if you listen to at least a couple of the railroads so far.
The active locomotive fleets have.
Declined a bit so any thoughts on that Raphael and John This is a very dynamic environment. So I'm not going to pretend to explain any movement on any specific railroads at this point, but as you look at the dynamics of demand, especially as you go into.
The 'twenty two 'twenty three time frame.
Those are largely positive.
I think we have the opportunity here too.
The benefit from that.
Got it and that Raphael. This is a question that I've been meaning to ask you on the call.
Can you just talk about the.
Trip Optimizer and <unk>.
Interoperability with <unk>.
The competition, just trying to get a gauge on if the industry has to had in one direction or another as far as software.
I think we have invested in a portfolio of solutions over time I think despite of the cycles. We that's.
Our commitment we have had which is really longer term.
Hi Tech, we have come up with a number of solutions that can benefit not just our own fleets, but can be taken into serving auto fleets. We've demonstrated the ability to do that with BTC and it's.
It's something that we're certainly looking at it it's the opportunity to take.
Take that into.
<unk> markets and auto products.
Great. Thank you very much.
Thank you.
This concludes our question and answer session I would like to turn the conference back over to Kristin <unk> K Becky for any closing remarks.
Thank you for your participation everybody. We look forward to meeting with you over the next couple of months and certainly next quarter have a great day.
Yeah.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.