Q2 2022 Westinghouse Air Brake Technologies Corp Earnings Call

Good day and welcome to the Wap Tech second quarter 2022 earnings Conference call. All participants will be in a listen only mode should you need assistance. Please signal a conference specialist by pressing star key followed by zero.

After todays presentation, there will be an opportunity to ask questions.

I ask a question you May press Star then one on a touchtone phone.

To withdraw your question. Please press Star then two please.

Please note this event is being recorded.

I would now like to turn the conference over to Kristine Kubacki, Vice President of Investor Relations. Please go ahead. Thank you operator, good morning, everyone and welcome to <unk> second quarter 2022 earnings call.

With us today are president and CEO Rafael Santana.

F O John Owen and senior Vice President of Finance John <unk>.

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 Y Tec Corp Dotcom.

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 Raphael.

Yeah.

Thanks, Christine and good morning, everyone.

Let's move to slide four I'll start with an update on our business My perspective on the second quarter progress on our long term value framework and Dan John will cover the financials we.

We delivered a strong second quarter, which is evidenced by another quarter of adjusted margin expansion of one five percentage points and adjusted earnings per share growth of 16%.

Importantly, we continued our progress against our long term strategies as evidenced by a significant expansion in the total backlog.

We're roughly $2 billion, which was up modestly versus prior year revenue was driven by strong performance in the freight segment, but partially offset by lower year over year revenue in the transit segment, excluding foreign currency exchange consolidated revenues would have.

Grown by roughly five 5%.

Total cash flow from operations was $263 million for cash conversion of over 90%.

Total multiyear backlog was over $23 billion up $1 7 billion and excluding the headwinds from foreign exchange backlog was up $2 $3 billion from last year.

Finally, we closed two strategic acquisitions in the quarter, <unk> and Air Inc, and deployed over $100 million in share repurchases and dividends.

So all in all we had a very good quarter, we continue to invest for the future as we execute commercially and operationally with discipline and rigor and we're well positioned to continue to drive long term good all even with the uncertainty and volatility in the overall economy.

Shifting our focus to slide five.

Let's talk about our end market conditions in more details.

As we look at key metrics across our freight businesses. We are encouraged by the continued momentum in our end markets and the strong pipeline of opportunities.

North American carloads are expected to improve in the second half of the year and locomotive parking have continued to decline despite lower year to date freight traffic.

We continue to see significant opportunities and demand for new locomotives and modernizations as our customers invest in their aging fleets.

And place a greater demand on reliability productivity and fuel efficiency.

When it comes to the North American railcar build demand for railcars is increasing from what we believe are trough levels.

Railcars in storage are below pre COVID-19 levels with about 18% of the North American railcar fleet in storage.

As a result industry orders for new rail cars continue to improve and the industry outlook for 2022 is for over 40000 cars to be delivered.

Overall, we believe we have the opportunity to build significant long term momentum with growth in modernization and new locomotive sales in railcar belts and in rolling stock.

Internationally freight car activity also continues to show positive signs.

We have been growing our international fleet mid single digits on average over the last five years and we are currently executing on a strong pipeline of order opportunities.

Overall, we expect long term revenue growth in the majority of our end markets.

Finally, transitioning to the transit sector. The long term market drivers remain positive with continuing global infrastructure batting for clean safe and efficient transportation solutions. Our team is committed to driving growth across both freight and the transit segments.

Next let's turn to slide six to discuss a few recent business highlights.

We recently secured some strategic orders, including a significant agreement with Union Pacific for 600 locomotive Modernizations.

This agreement totaling more than $1 billion.

We will begin delivering next year and run over the next three years. It is the largest order for modernized locomotives and rail industry history.

The modernization will enable union Pacific to move more freight efficiently and sustainably, including our fuel efficiency improvement of up to 18%.

More than 80% increase in reliability.

College ability increase of more than 55%.

This total order will eliminate nearly 200000 tons of emission spray here roughly the equivalent of 45000 passenger cars per year.

We also closed a significant order with Canadian National for 10, new tier four locomotives, which will begin delivery in 2023 50.

<unk> 50 Modernizations.

<unk> will be equipped with our App DLA.

DLA advantage technology, which will deliver the best in class fuel and emissions reductions.

These wins build on several recent announcements we have shared with Canadian national including their purchase of the Flex drive battery electric freight locomotives and additional order for our precision dispatch system, which will help accelerate network optimization for <unk> and the entire.

The rail industry.

Finally in transit, we won a significant order for heating ventilation and air conditioning units.

Cross Atlanta Metro system.

This quarter marks the latest win in our longstanding relationship with Stadler.

<unk> the first subway order with the car builder in the U S.

Turning to slide seven.

I wanted to briefly touch on <unk> operating system, which drives many aspects of our culture and our performance.

Starting with our people and teams addressing our customers' most critical business needs.

In developing operating plans systems and processes to deliver best in class performance.

We used this operating model to guide what we do to measure how well, we execute and to tackle where we need to improve.

One of the critical elements of our operating system is our annual strategic planning process and we are in the midst of this process right now the goal is to look at opportunities across our markets and our company and identify those areas, where we can further leverage our leadership and technology position.

Build on our extensive installed base capitalize on trends such as electrification digitalization automation and sustainable transportation, which will all create positive outcomes for our customers.

We also look to accelerate investments across the company.

Through our integration Chugach zero efforts as well as driving lean operations and continuous improvement and best in class productivity, all of which delivers long term shareholder value.

It's also a critical process in aligning our talent our products service and software investments to drive long term profitable growth.

We are confident that we're well positioned for the future and we expect to continue to deliver profitable growth ahead.

2019, this process and the Whatsapp operating system.

Have been the foundation for driving bigger strategic alignment and efficiency, especially while navigating profound volatility.

As a result, we have been able to bring the full power of <unk> to our customers while balancing the need for agility with a clear focus on strategy and execution to one the opportunities before us with that I'll turn the call over to John to review the quarter segment.

<unk> and our overall financial performance John Thanks.

Thanks, Rob and Hello, everyone turning to slide eight I will review, our second quarter results in more detail.

Another good quarter of operational and financial performance. Despite continued challenges in the supply chain currency exchange and cost increases.

Sales for the second quarter were $2, <unk> 5 billion, which reflects a one 8% increase versus the prior year for each segment sales were strong up 11, 5%, partially offset by lower year over year sales in our transit segment.

Q2 sales were negatively impacted by unfavorable currency exchange, which reduced our revenue growth in the quarter by three eight percentage points for.

For the quarter adjusted operating income was $340 million, which was up 11, 5% versus the prior year.

We delivered strong margin expansion up one five percentage points on an adjusted basis margins were aided by mix favorability increased pricing and improved productivity, partially offset by significantly higher costs.

<unk> achieve margin expansion, even in the face of rising costs and continued supply chain disruptions.

Through the first half of the year, our revenue growth, excluding foreign currency exchange in our emerging growth have been in line with our original plan and in line with the cadence, which we discussed when we issued our 2022 guidance.

As we look forward to the second half we continue to expect accelerated growth in revenue from the first half behind significantly increased locomotive deliveries and lower year over year margin percent due to unfavorable mix in our equipment sales and comparing against much higher back half margins in 2021.

More specifically, we anticipate this margin decline will be more pronounced in the third quarter than in the fourth quarter.

We continue to expect our full year margin percent will be up modestly.

In the second quarter adjusted earnings per diluted share were $1 23 up 16, 8% versus the prior year.

GAAP earnings per diluted share were <unk> 91.

Which was up 37, 9% versus the second quarter a year ago.

During the quarter, we had pretax charges of $4 million for restructuring and other onetime charges largely related to our integration two <unk> initiative to further integrate web tech operations and to drive $75 million to $90 million of run rate savings by 2025.

As Rafael noted we were very pleased with our Q2 results, especially in the face of significant foreign currency exchange headwinds and continued supply disruptions and our strong margin growth in the face of continued cost increases we remain diligent and proactive as we worked to minimize these challenges.

Turning to slide nine let's review our product lines in more detail.

Second quarter consolidated sales were up modestly at one 8% and the underlying business is performing well up five 6% excluding foreign currency exchange.

Equipment sales were up a very strong 16, 2% from last year due to higher locomotive deliveries in this quarter.

Versus last year and continued strong mining sales.

Component sales were up four 5% year over year, driven by higher OE railcar build lower number of railcars in storage and a recovery in the industrial end markets.

Did your electronic sales increased one 2% driven by a partial quarter of revenue from the strategic bolt on acquisitions have been a vision in ARINC.

We offset by ongoing chip shortages.

We continue to see improved demand for our core onboard locomotive products in our backlog and digital continues to increase.

Our services sales grew 14, 3% versus last year the year over year increase was driven by higher sales for Modernizations and the continued <unk> of locomotives to superior performance reliability and availability from our fleet continues to drive customer demand as railroads increasingly look for predictable outcomes across there.

Fleets.

Across our transit segment sales decreased 17, 5% versus the prior year to $558 million sales were down versus last year due primarily to the negative impacts of foreign currency exchange.

We believe the medium and long term outlook for this segment remains positive as infrastructure spending for green initiatives continue.

Moving to slide 10, our adjusted gross margin expanded one seven percentage points to 31, 6% driven by a richer mix of products increased pricing and strong productivity.

We offset by higher input costs and unfavorable foreign currency exchange.

Dixon pricing positively impacted our emergence mixed benefited margins as freight sales outpaced our transit sales. Additionally, higher pricing was realized for price Escalations incorporated into many of our long term contracts along with other price actions that were implemented to recover cost increases.

Raw material costs were again up significantly led by increased metal costs in dramatically higher energy costs.

Foreign currency exchange adversely impacted revenues by three eight percentage points and adversely impacted second quarter gross profits by $15 million.

Finally manufacturing costs were favorable due to productivity gains, which were largely offset by higher transportation and logistics costs.

Our team continues to execute well to mitigate the impact of these cost pressures by triggering price escalations implementing price surcharges and driving operational productivity and lean initiatives.

Now turning to slide 11 for the second quarter adjusted operating margin expanded one five percentage points versus last year, our margins benefited from higher adjusted gross profit, but were partially offset by higher operating expenses, primarily from increased investments in future technologies.

Adjusted SG&A was $257 million, which was up slightly versus prior year, but down 10 basis points as a percentage of sales to 12, 5%.

Engineering expense increase from last year. According to plan, we continue to invest engineering resources and current business opportunities, but more importantly, we are investing in our future as an industry leader in de carbonization and digital technologies that improve our customers' productivity capacity utilization in safety.

Now, let's take a look at segment results on slide 12, starting with the freight segment.

As I already discussed.

Segment sales improved for the quarter and segment adjusted operating income was $301 million for an adjusted margin of 23% up one eight percentage points versus the prior year the.

The benefits of higher sales improved mix and productivity were partially offset by higher operating expenses.

Finally segment backlog was $19 $68 billion.

Up 184 billion or up 10, 3% from the end of Q2 last year due to the significant multi year order momentum that Raphael discussed earlier.

Turning to slide 13 Transit segment sales were down 17, 5% driven by the negative effects of foreign currency exchange the exit of low margin contracts in our UK business and a late quarter manufacturing disruption caused by a cyber incident in.

In addition transit revenue continues to be adversely impacted by supply chain disruptions.

As previously announced on June 26, we detected a cyber security incident that impacted the company's network, which disproportionately affected our transit business. This disruption modestly reduced Q2 revenues and is expected to have an impact on our Q3 transit results.

Adjusted segment operating income decreased by $15 million to $58 million, which resulted in an adjusted operating margin of 10, 3% down.

<unk> 0.5 percentage points versus the prior year.

Lower absorption inefficiencies driven by the manufacturing disruption and unfavorable foreign currency exchange were partially offset by strong productivity and lower SG&A.

Transit continues to focus on driving down costs, implementing lean and improving operational efficiencies despite the volatile environment.

Finally transit segment backlog for the quarter was $3 $5 5 billion down four 4% versus a year ago.

Adjusting for the negative effect of foreign currency exchange backlog would have been up five 3%.

Now, let's turn to our financial position on slide 14.

During the quarter, we generated $263 million of operating cash flow, resulting in a cash conversion rate of 92%. This brings our year to date operating cash flow to $424 million.

Cash flow benefited from higher earnings, but was impacted by the proactive build of inventories ahead of our strong growth expectations and managing supply disruptions of critical parts.

Looking forward, we are confident that we will generate strong cash flow for the year.

Our adjusted net leverage ratio at the end of the second quarter declined to two four times and our liquidity is robust at $148 billion.

We closed on the acquisition of two digital companies be Univision and Eric.

The combined purchase price of these two businesses was $69 million.

Also during the quarter, we returned more cash to our shareholders repurchasing an additional $103 million of shares and paid dividends of $27 million.

As you can see in these results our financial position is strong and we are confident that we can continue to drive solid cash generation, giving us the liquidity and flexibility to allocate capital towards the highest return opportunities into grow shareholder value.

With that I'd like to turn the call back over to Raphael.

Thanks, Sean let's flip to slide 15 to discuss our 2022 financial guidance.

In the first quarter, we issued guidance with sales growth at the midpoint of 8%.

And EPS of $4 65.

To $5 five.

Or up roughly 14% at the midpoint, our guidance was based on improving industry momentum and strong underlying customer demand for our products with the first half behind US we continue to feel strong about our businesses and we delivered the Gastar regional plan financials. Despite.

Unplanned loss of business in Russia, and very unfavorable foreign currency exchange, we are maintaining our full year revenue and cash conversion guidance and we are tightening our full year earnings guidance to $4 70.

To $5 I am pleased with the strength and resiliency of our business and more importantly, I am extremely proud that our teams continue to deliver despite and Albert changing and challenging environment.

Now, let's wrap up on slide 16.

As you've heard today, our team delivered a strong quarter, despite a challenging and evolving environment. Thanks in large part to our resilient installed base best in class technologies, and our team's focus on our customers.

For these reasons and more we are confident that <unk> is well positioned for long term profitable growth.

Looking forward, we will mean harder into the strong fundamentals of the industry.

And while our company to extend our leadership position in rail.

To delivering innovative scalable technologies for our customers and to harness the power of our lean and continuous improvement culture with that I want to thank you for your time this morning, and I'll turn the call now over to Christine to begin the Q&A portion of our discussion Christine.

Thank you Raphael, we will now move onto your questions.

But 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.

We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone. If you are using a speakerphone. Please pick up your handset before pressing the keys. If at anytime. Your question has been addressed and you would like to withdraw your question. Please press Star then two.

At this time, we will pause momentarily to assemble our roster.

And our first question will come from Justin long with Stephens. Please go ahead.

Thanks, and good morning, good morning, Justin.

I wanted to clarify with the UN P. Order for 600 miles is included in our reported backlog and also just given that announcement and the announcement we saw earlier this year from Ines.

I guess, we got some orders from CN this quarter as well what level of growth in MA is already locked in looking into 2023, I mean could we be up by 100 units 200 units any order of magnitude just based on what you already have in the backlog for next year.

So number one yes. It is included in the backlog with not just in one thing to also keep in mind is if you think just about the backlog from a quarter over quarter impact from FX alone, it's been over $400 million year over year, it's closer to $600 million. So I think it's important to highlight that otherwise you might have.

Expected of larger increase but it is reflected second pieces.

As you described I think we have strong momentum and it's not just internationally as we have largely described before but down as we've been saying for the past 12 months I think we have a strong pipeline of opportunities that cuts across both internationally and in North America, we continue to have opportunities to grow.

Double digits in terms of the modernization demand and of course, we are coming from trough levels in terms of demand for new locomotives. So it's good to see the momentum I think.

Pipeline of opportunities that we see it on today is stronger than the one we described.

Three months ago or six months ago. So continued opportunity here to further expand our backlog.

Okay, and just to be clear that double digit growth in mod was referring to 2023 exactly I think just to add to that I think quantity and foreign things about test. This is less about.

Just 23, it's really I'd say very much aligned on how we described our five year plan.

Understood and I guess, secondly for John thinking about the guidance.

<unk> segment saw a pretty significant sequential decline in adjusted operating income can you talk about what youre, assuming for the back half and transit are we expecting to get back closer to what we saw in the first quarter from an operating income perspective, and then just anything on that.

<unk>.

Margins and earnings in <unk>, and <unk> I know you said <unk> would be worse from a margin perspective year over year, but the comp stat for so I just wanted to think about things on maybe more of an absolute basis in the next two quarters.

Well, let's start with that's a lot Justin let's start with the transit business.

Starting with revenue when we look at the overall first half we find that revenue was down about 12% and operating margins down slightly at 10th of a point. So number one is we believe that trains its ability to hold margin in the face of lower revenue speaks to its resilience and underlying earnings growth and more importantly, the decline in the first half revenue was.

Caused by a few items that don't represent the businesses underlying performance or just in the future growth potential. These items include the Berlin currency exchange.

On the first half was seven percentage points.

On a quarterly basis that was up to nine.

Talked about in the first quarter the exit of the low margin.

K business that continues into the second quarter.

Not continue beyond now we're lapping the full exit of that and then finally, the manufacturing disruption we had from the cyber incident, which reduced revenue roughly 5%.

In the transit business in that incident, largely hit the transit business, but excluding these items just in the underlying business is up modestly as we look to Q3.

We do continue to expect headwinds on transit revenue.

Because of foreign currency and certainly some spillover of the cyber incident.

When we look at the overall margin piece, that's been really driven by lower absorption in the second quarter as well as some of the inefficiencies due to the cyber event in.

In the back half, we don't provide guidance for the back half, but with that eye on transit with the adjusted all transit into your next question, which is on the cadence.

As we've talked about.

This year in the cadence we've talked about really the story of two halves. The first half we would expect moderate growth in ex currency, we were up a little over 5% in the first half and we also talked about stronger year over year earnings.

Sorry margin growth in the first half and we were up about one four percentage points on the half so that really played out exactly as we had planned.

We look to the back half, we said that the back half would be more pressured on merchant growth and actually we said that it would be lower on a year over year basis.

That would be driven by much higher revenue, that's coming from our equipment group.

And the delivery of of locomotives predominantly in the back half.

So now if we look at the back half and push that back a little bit better and talk about the cadence between quarters, we would expect the third quarter and the fourth quarter to be up significantly in revenue, but a little bit more on the third quarter than the fourth quarter and with regards to operating margin. We would expect the margin percent in the third quarter.

To be less.

Less than.

What we experienced in the fourth quarter.

Okay. That's very helpful. Thanks, John .

Thank you.

Our next question will come from Chris Wetherbee with Citi. Please go ahead.

Hey, Thanks. Good morning, guys. This is Ely looking on for Chris. So maybe morning. So I just wanted to go to.

Revenue segments for a second freight so.

I understand that equipment growth will look really strong is that where the focus is right now in growth within freight and I understand that moms are doing well, but but maybe on the components and just digital electronics side like how should we be thinking about some of the revenue growth in those two areas as well.

Well, if you think about the quarter per se, it's certainly a lab.

Not just buy equipment do you see it.

On the services side as well.

If you think about the components we.

We do expect to continue to gain momentum there as you are coming from the trough and we do expect.

The number of freight car ships will be above 40000. So that's a positive too I think the order element, which is on digital electronics.

We expect strong second half.

In terms of sales.

Certainly when you look at.

Backlog dynamics.

It's certainly reflected in bulk in terms of the digital electronics business and the component business Paul Quip.

Book to Bill above one.

Okay, great that makes sense, thanks, Raphael and John I appreciate the help on the cost and the margin, but I feel like there's been a lot of talk about just FX and just maybe can you help us clarify what the specific impact of FX was in this quarter and how does it compare to last year I just want to understand like.

How that impacted segment on the <unk>.

Full business and then what that looks like year over year, great. Good question, So let's start with what's driving it.

ROE is driving it but the U S dollar strengthened dramatically as you know against the Euro and if we look at the average year over a year ago was at $1 20 and in the second quarter that we just exited is at 107, so above 12% strengthening against the dollar with this does this translates into a revenue which on a consolidated basis was down <unk> <unk>.

$76 million and if you look at that Liana in terms of a percentage of growth that was three eight percentage points of growth that kind of went away because of currency that was much more predominant when you look at our.

Our transit business. It was 60 million that hit transit and just shy of nine percentage points.

Decline in revenue do it.

Now as we move to the earnings impact it's considerably less than the impact on revenue and that's a result of the company's natural hedges and the way we're manufacturing in a lot of that being locally gross profit in the quarter was down $15 million.

Due to an unfavorable foreign currency exchange and then operating income was only down $4 million.

Okay got it thank you.

Thank you.

Our next question will come from Matt Alcott with Cowen. Please go ahead.

Good morning, Thank you I would love to hear an update on the performance of the flex drive and any possible issues that still need to be worked out also any update on the number and cadence of deliveries over the next few years would be appreciated I know you guys have been taking orders from several railroads over the past year or so.

So any <unk>.

Insight into when deliveries might kick in over the next few years would be helpful.

So let me start with the second half of your question I'll go down into the Flash drive question.

The pipeline of deals so we really have ralph fence opportunities across key geographies at this point.

I think volume dynamics continue to be a positive in Kazakhstan, we have a number of projects under discussion in Asia and Australia. We continue to follow up specific projects in Africa that are tied to commodity exports in Brazil, I think despite of the drop in carloads year to date theres significant opportunity to start to renew concessions.

And mining is also a positive in that context.

In North America, despite of carloads being down for the first half we continue to see growing demand for modernization and new locomotives and.

That's again driving efficiency and reliability with a direct impact to the operating ratio of our customers and bringing certainly enormous impact to dairy yesterday targets as well.

When we look at the cadence moving forward I think.

We certainly feel like we're very well positioned to deliver five year guidance that we provided at our Investor day, we certainly feel stronger about it now than we did three months ago, and then we did six months ago.

That's very much aligned to.

The pipeline of opportunities with starting to describe over a year ago.

On the flagstone comments.

Comments there is so we continue to see.

The interest from customers out there, we're continuing discussions and youre going to see that moving to all other geographies.

I think that's very much aligned with how we are.

Let's see the evolution here and Youre going to see also a permutations of that product's going to not just full battery electric but also hybrid as we've also described on previous calls.

Got it and then just.

Anything.

Things go as expected as far as the testing and the performance of the Flex drive Raphael.

Yes. It is we're certainly paying a lot of attention and working very closely not just with our customers, but also with suppliers in that context, and making sure that we continue to progress with all of the elements of that special with regards to the battery and <unk>.

As you know we have a.

Partnership established with GM, and we're working very close with them in order to make.

Make sure we continue to progress in that direction.

Got it just one quick follow up Raphael you mentioned mining.

We've seen some slight guidance reductions on capex from some of the.

Minors this earning season.

Nothing nothing big I mean, I guess.

End market demand continues to be solid, but given the slight capex reductions and the lower commodity prices are you guys concerned about the mining segment.

Beyond this year I know your outlook for this year is positive, but what about 2023.

I think that can certainly be an element of just going to call out the cycle moving forward.

We are working very closely with customers sharing with komatsu in that regard, we see solid opportunities ahead, and we will continue to.

Make sure we are.

Balancing that with auto <unk> in the business I think there's a lot of positive news here in terms of what we could be.

Saying in terms of opportunity for the rail side so.

Solid no concerns for the year, we will continue to work closely here with customers to understand demand.

'twenty three and beyond.

Great. Thank you very much thank you.

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

Yes. Good morning. This is <unk> on for Scott Good morning.

Good morning, first can you discuss the rough margin percentages on these locomotive modifications modernizations and how does that compare relative to margins on new locomotives.

Yes.

Ill provide specific margins, obviously, but when we look at.

Mods versus new the way to think about it is that certainly the revenue is somewhat lower on a <unk> than a new however, the margin is somewhat higher on <unk> than a new.

Great. That's helpful and secondly, what has been the impact of poor rail service on the pace of logo on parking.

And also have you started having any initial conversations with the rails about buying any new locomotives. Thank you.

Sure. Thanks of course, I think our services.

As you look at least into the past several months south translate into on parking of locomotives.

And as you look forward, it's going to be balanced with carloads being a bit more positive here in the second half of the year. So I think thats.

Part of balance when you think about investment on new locomotives.

It's part of the construct and the dialogue that we have.

With North American customers, you'll see that as a part of the announcement of some purchases of tier four units.

This past quarter and this is very much part of the dialogue, it's going to depend some of the solutions in order to solve for some of the productivity and efficiency. While we are on desk as that there is an opportunity here to invest and drive both reliability and efficiencies from the existing fleet.

Very much aligned with the opportunities here to improve operating ratios and also aligned.

Two driving I think significant elements of decarbonization targets that were laid out there.

Thank you.

Thank you.

Our next question will come from Rob Wertheimer with Melius Research. Please go ahead.

Thank you and good morning, everybody.

Good morning, Rob.

My question is a little bit on the bigger picture on inflation margin you guys had really solid margin performance.

Perhaps without as much at least awkward booking cycle in revenue support as some other end markets.

I'm curious if I mean, when you look at your supply chain. If you look at your cost is there any way above inflation coming that you have not yet dealt with.

Maybe you can just give sort of a general outlook on how the inflationary cost pressures and your and your supply chain your backlog in your.

Your outlook compare with your.

Forward looking ability to price. Thank you.

Okay Rob.

The inflation that you are referring to came in an initial wave of higher costs in the third quarter of last year and it takes a while for that to roll through our inventory right and we saw cost build and rise in the third fourth and first quarter of.

This year and we did have an another cost shock at a much smaller level than what we saw in the third quarter and that was due to the war in Ukraine.

So as some of that rolls through we would expect cost to rise a little bit from.

Through the first cost shock.

Now having said that we are seeing some tempering of cost out there right metals are we had a good quarter they are down, but they're still at historic highs and up on a year over year basis, but temporary and we feel good about that.

In terms of the.

Logistics cost we are continuing to see very high cost of transportation and logistics in particular in containers coming from Asia, but they've tempered slightly as well so.

All of this is going to take time to get through our P&L, but we would expect costs in the third quarter to be up a bit from what we're seeing here in the second quarter.

I'll just close saying we're.

We're committed to grow margins forward.

Could and will have significant variation sometimes quarter to quarter I think this especially given the mix.

With much higher growth value and equipment. There is also the elements of what John spoke about in terms of.

Inflation with the specific for the second half of the year I just want to emphasize here how big the mix in fact is in specific in the third quarter. If you think about it where we have over a third of our shipments of new work them out is happening in the third quarter. So I couldnt highlighting some of the elements of mix and variation that got that.

We can see from that on quarter over quarter.

Okay. Thank you.

Thanks, Rob.

Our next question will come from Saree <unk> with Jefferies. Please go ahead.

Hi, Good morning, just following on your last comment you're talking about a third of the locomotive shipments happen in third quarter could you quantify how much of a mix headwind do you expect on margins just from these locomotive shipments.

No.

We can't quantify that series just just the overall concept that while we have strong margins in our equipment business.

Lower than the average and as Raphael had mentioned will have a significant revenue growth driven by that and that will pull over a pull down the margin. It's something that we planned on all year long and we are expecting and again, that's why we've talked about in the back half that our margins on a year over year basis.

This will be.

Lower than.

Year ago, but on a full year basis, our margins will be up modestly as we've as we've discussed.

Just to reemphasize that for the year, we expect results very much aligned to the guidance. We provided in February of this year and all we described on previous earnings calls. So it's all about higher margins in the first half of the year higher volume the second half with a significant element of mix coming in.

Got it and then you talked I think about the opportunity for 500 miles per year, just given the recent orders.

We are executing on this opportunity.

Incremental today, so just in line with your outlook, we have not provided any specific guidance with regards to our total number of months'. So we certainly see opportunity to continue to expand on that and I think we've been clear about that on previous calls so the opportunities there. It's certainly reflected in the pipeline.

And youre seeing that being realized us backlog continues to grow.

Hey, Thanks for taking my questions.

Our next question will come from Nathan <unk> with Bank of America. Please go ahead.

Hey, good morning team.

Morning.

Yes.

Thank you.

Yeah.

Just a quick question on the cyber attack.

Yeah.

And sort of the.

<unk> impacts.

On operations would you mind, maybe getting a little bit more detail on how this affected.

Both quarterly operations as well as the same margins.

Okay just.

In terms of the second quarter I think John said it was about 5% in the third quarter, we expect transit 5% transit.

And the specific we would expect that to be less in the third quarter.

We don't ex fact impact for the year and that's part of why we've reaffirmed guidance at this point.

Got you. Thank you so much and then also just John on your comments regarding supply chain challenges.

We've seen some incremental debottlenecking for the auto sector.

For your digital electronics are you witnessing anything similar.

Similar there is there sort of signs of incremental improvement.

And as we look for.

The first quarter to second quarter, we don't see any improvement. The good news is that don't feel that's getting worse unfortunate news is we don't feel is getting better as well and again as Rafael had mentioned earlier, that's certainly a big impact on our first half revenues with digital.

Chips are hard to come by we're not seeing.

A change from the first quarter and we're hopeful as we move forward just a couple of comments on the digital orders grew double digits last year book to Bill for this year is very positive it's the highest between our businesses year to date.

A multiyear agreement and we expect the second half.

<unk> sales second half in the year and with that John mentioned chip shortages have had any impact for the business.

Got it thanks, Brian .

Thank you.

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

Yes.

Good morning, everyone. Good morning Gerry.

I'm wondering if you folks can talk about.

Your capacity.

For for Mods, how quickly you can ramp up considering the.

The size of the Union Pacific order compared to your production to date.

An update on how youre thinking about capacity for.

That line of business.

It would be helpful and also Raphael if you could comment on your.

Assessment of using mods to reach essentially the greenhouse gas reduction targets for for other rails. How optimistic are you on others, taking a similar approach.

Yeah, Jerry first in terms of the manufacturing footprint to deliver on these orders and more we certainly feel strong about having that capacity and.

We certainly have the manufacturing capacity to do that but it's about more than that is making sure that we're continuing to work very closely with our customers suppliers and that process. So we can ultimately anticipate demand certainly lead times. When you look at a couple of years ago have extended and I think a big piece has been really.

Making sure that we're close to customers. So we could anticipate demand and you see to some extent some of that.

<unk> certainly has impacted our inventory numbers as part of that but that's.

Thats a piece of it when it comes to our model I think that continues to be a very positive story.

It's really part of a dialogue that varies customer by customer in terms of the solutions.

We see some significant opportunities for customers to actually be working on being more productive and in some cases means reducing the number of locomotives that poll.

A certain number of cars and that house translating to also applying some of the fuel solutions that we've described we see opportunity to continue to expand on that I think what's what's important here is we see that part of really a growing multiyear backlog. This is I think less about what 23, it's going to be.

Its backflow the comments I made which is really tied to the five year plan that we described it.

Feel like we're very well positioned to deliver on that five year guidance that we provided at our Investor Day last March despite of all them macroeconomic uncertainties out there.

And speaking of the uncertainties you.

Folks pointed out to the Russia headwind.

Looking at your freight results in the quarter, it's tough to pinpoint which lines of business. The Russia headwind played out and obviously organic growth would have been stronger without it can you talk about which lines of business.

The exit impacted the most.

In the quarter within frame.

You'll certainly freights, probably a combination of equipment.

Services, that's where we really saw the bulk of that impact.

And there was a full five points.

You anticipated at Investor day on a consolidated basis.

Sure that would be 2%. So the revenues that we had in 2021.

We're about 2% of our sales.

Two months for the year.

As we described as 5% we can have variation again quarter to quarter.

But.

That's that's about the magnitude of what we expected for the year.

Thank you.

Our next question will come from Dylan coming with Morgan Stanley . Please go ahead.

Great. Good morning, Thanks for the question.

Just wanted to go back Rafael to one of your comments on the park logo Count I think we understand why that's kind of been moving lower through the year right and so reflective of the service issues the class one level.

From our perspective, it seems like more of the class one they're shifting their tone around potential partners in the back half I guess my question is in your view it frames traffic does start to more fundamentally will begin next year right. That's reflective of the service issues, but more reflective of actual declines in rail demand is your view of the class ones actually can park more fleet or would you say that the service issues are more supportive.

It's kind of a structurally higher active fleet.

I think the element of park answers not just going to be a function of service improvement, but also what Carlos do in that period.

I think that that's something that we'll continue to watch and work.

Very closely.

Part of that I think what's what's a positive I think it's a lot of the underlying investment that you see in terms of really guaranteeing fleet reliability ultimately driving efficiency.

Across the fleet and I think we continue to see momentum there. So if that comes counterbalanced with any elements of a potential parking's I think thats a.

<unk>, where we are.

We still see and we will be working closely with our customers in that regard.

Okay. That's helpful. Thank you and then maybe just a question on the back half margin related issues are headwinds as it relates to international deliveries I guess I was wondering longer term do you have scope to structurally improve the margin profile of those international local delivery is because I think given your commentary on the pipeline rate. It feels like volume should be accelerating next year and into 'twenty four as well so just curious.

So this is more of a recurring issue or if you feel like you can actually start getting a better level of incremental margin on those international deliveries going forward.

So that's actually a positive and it's something that we've been able to is to ultimately drive as delivered margins battered now sold margins something that we track very closely.

And the business. So there is certainly continued opportunity there and I think the RFP is just making sure that we are.

Continue to expand on graph on some of these markets, where we've really had.

But really I'll call it the best in class products to work with customers and we.

We see some good momentum there.

Okay, great. Thank you.

<unk>.

This concludes our question and answer session I would like to turn the conference back over to Kristine Kubacki for any closing remarks. Thank.

Thank you operator, and I'd like to thank everybody for their participation today and we look forward to speaking with you next quarter Goodbye.

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