Westinghouse Air Brake Technologies Corporation

Good morning and welcome to Web Tech's fourth quarter 2021 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's 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 Kubacki, Vice President, Investor Relations. Please go ahead.

Thank you, Operator. Good morning, everyone, and welcome to Wabtec's fourth quarter 2021 earnings call. With us today are President and CEO Rafael Santana, CFO John Olin, and Senior Vice President of Finance, John Mestelers. 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 wabtechcorp.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. With that, I'll turn the call over to Rafael.

Thanks, Christine, and good morning, everyone. Let's move to slide four, and I'll start with an update on our business, my perspectives on the quarter, and our long-term value framework. John will then cover the financials. Overall, we achieved significant progress against our strategy, and delivered a strong fourth quarter as noted by the expansion of adjusted margins by 2.1 percentage points and adjusted earnings per share increase of over 20%. Total cash flow from operations was strong at $314 million. This takes year-to-date cash from operations to over a billion dollars, up 37% versus last year, which was a record for the company. This is a solid illustration that the team continues to drive strong operational performance and quality earnings. Cash conversion for the quarter was set 99%. Finally, we ended the year with over $22 billion of multi-year backlog, which was up $578 million in 2021. Overall, our team delivered really strong execution to finish out the year despite significant supply chain disruption and rising costs. On the back of this strong performance and our confidence about the future, I am pleased to announce that our board of directors approved a 25% increase in the quarterly dividend and reauthorized the $750 million share buyback program. Shifting our focus to slide five, Let's talk about our end market conditions in more details. Internationally, freight activity continued to grow in the fourth quarter across our major markets, and our order pipeline remains strong. We expect long-term revenue growth in the majority of our end markets. Freight trends in North America were down year over year in the fourth quarter. This was not driven by lack of demands, but largely by ongoing global supply chain disruptions. Locomotive parkings continue to decline despite weaker freight traffic in the quarter. Throughout the year, the advancements we have made in reliability, efficiency, and safety continue to drive measurable outcomes across our customers' operations. Last year, our fleet of locomotives traveled more than 1.5 billion miles in some of the world's harshest conditions. Looking ahead, we expect demand for reliability, productivity, and fuel efficiency to continue to increase, placing our services business and modernization portfolio in a position of strength. When it comes to the North American railcar build, demand for railcar is increasing. Railcars in storage are below pre-COVID levels, with about 19% of the North American fleet car in storage. As a result, industry orders for new rail cars are continuing to improve. The industry delivered just over 29,000 rail cars in 21, and the outlook for 2022 is for over 40,000 cars. Transitioning to the transit sector, ridership trends continue to be uneven in various markets. However, infrastructure spending for green initiatives continue to be a bright spot especially as governments globally invest in rail for clean, safe, and efficient transportation. Overall, the long-term market drivers for passenger transport remain strong. Next, let's turn to slide six to discuss some recent wins that are providing good momentum and visibility as we enter into 2022. Let's start with the shift to battery electric. In recent weeks, Union Pacific, announced an agreement to buy flex-drive locomotives. This comes on the heels of other strategic commitments from international customers in Canada and in Australia, all of which will leverage this next-generation technology to increase productivity, reduce fuel, and slash emissions across their operations. And in transit, WATEC was named a founding member of Europe's rail joint undertaking, which is investing nearly 1.2 billion euros to fund green rail projects. These are government-led projects focused on automation, digitization, and network optimization, areas where we can help drive innovation and technology adoption across the rail sector. I'd also highlight during the quarter, in freight services, we won a significant international long-term service contract, as well as orders for international locomotive modernizations. Overall, the modernization backlog remains strong. Throughout the fourth quarter, we delivered a record number of mods, marking a significant milestone for the team. We also want strategic digital contracts in North America to upgrade PTC hardware, along with an order for smart HPT at a class one to help our customers improve asset utilization, driving fuel efficiency and reducing emissions. Looking forward, our backlog gives us the confidence that we will drive long-term profitable growth and lead the industry in advancing its position in sustainable rail even farther. I'll turn the call here over to John to review the quarter, segment performance, and our overall financial position. John? Thanks, Rafael, and good morning, everyone.

Turning to slide seven, I'll review our fourth quarter results in more detail. We had another good quarter of operational and financial performance. Sales for the fourth quarter were $2.07 billion, which reflects a 2.4% increase versus the prior year. Sales were positively impacted by the continued broad recovery we are experiencing across our portfolio, recent pricing, and the acquisition of Nordco, partially offset by continued weakness in the North America OE locomotive market, lower year-over-year sales in transit, and unfavorable foreign currency exchange. In addition, we continue to experience adverse impacts to our sales results in both segments due to shortages across many component parts, including computer chips. which caused delays in production and customer delivery. We estimate that our enterprise revenues were 3% to 4% lower than they would have been without the supply chain disruptions, and that the majority of these lower revenues represent delayed sales versus lost sales. For the quarter, adjusted operating income was $334 million, which was up 18.0% versus the prior year. Most notably, we delivered margin expansion in both of our segments of 2.1 percentage points on a consolidated basis. Margins were aided by strong mixed favorability, realization of synergies, and improved productivity. The team achieved margin expansion across both segments, even in the face of a highly disrupted supply chain and a challenging inflationary environment. We estimate that cost headwinds adversely impacted operating margins by 20%, to $25 million during the quarter. In the fourth quarter, adjusted earnings per diluted share were $1.18, up 20.4% versus prior year. GAAP earnings per diluted share were $1.02, which was up 122% versus the fourth quarter a year ago. In addition to growth in operating margins, GAAP earnings benefited from a significantly lower tax rate. The fourth quarter 2021 gap tax rate of 17.4% was 9.2 percentage points lower than fourth quarter of 2020. This decline in tax rate was due to an election which accelerated deferred tax benefits from our merger with GE Transportation. This favorable tax benefit of $25 million is considered one time in nature and therefore not included in our adjusted effective tax rate. As Rafael noted, We are pleased with our Q4 results and particularly our sales growth in the face of supply chain disruptions and our margin growth in the face of continued cost increases. We remain diligent and proactive as we work to minimize these challenges. Turning to slide eight, let's review our product lines in more detail. Fourth quarter consolidated sales were up versus last year, driven by higher sales in the freight segment, partially offset by lower transit segment sales. Fourth quarter sales were adversely impacted by foreign currency exchange of 0.8% and supply chain disruption of 3% to 4%. Equipment sales were down 12.9% year over year due to fewer locomotive deliveries this quarter versus last year and no new locomotive deliveries in North America, partially offset by continued strong mining sales. Component sales continue to show recovery and we're up 11.8% year-over-year driven by demand for rail car components and recovery in the industrial end markets. We remain encouraged by the continuing trend of rail cars coming out of storage and higher deliveries of new rail cars. In line with an improving outlook for rail, our services sales grew 21.2% versus last year. The year-over-year increase was largely driven from a record quarter of mods deliveries the un-parking of locomotives, and the acquisition of Nordco. The superior performance, reliability, and availability of our fleet continues to drive customer demand as railroads increasingly look for predictable outcomes across their fleet. Excluding Nordco, organic sales for the fourth quarter were up 10.1%. Digital electronic sales were up 1.8% versus prior year, driven by improved demand for onboard locomotive products, largely offset by ongoing shortages of chips. Notably, our backlog in digital continues to increase. And even more importantly, we continue to see a significant pipeline of opportunities in our digital electronic product line as customers globally focus on safety, improved productivity, and increased capacity utilization. Across our transit segment, Sales decreased 5.4% versus prior year to $648 million. Sales were down versus last year due to supply chain issues, COVID-related disruptions, and the negative impacts of foreign currency exchange, which adversely impacted revenues by 2.1 percentage points. Excluding near-term supply chain challenges, we estimate that transit sales would have been up on a year-over-year basis. We believe the medium and long-term outlook for this segment remains positive as infrastructure spendings for green initiatives continue. Now, moving to slide nine, our adjusted gross margin expanded 5.7 percentage points to 31.7% driven by strong product mix, increased pricing, and favorable manufacturing costs, partially offset by higher raw material costs and unfavorable foreign currency exchange. Mix in pricing positively impacted our margins. Mix benefited margins as services sales outpaced our equipment and transit sales. Additionally, higher pricing was realized from price escalations incorporated into many of our long-term contracts along with other price actions that were implemented to recover increased costs. Raw material costs were up significantly, led by dramatically higher metals costs, including steel, aluminum, copper, and increased transportation and fuel costs. Foreign currency exchange adversely impacted revenues by 0.8% and adversely impacted fourth quarter gross margins by $5 million. Finally, manufacturing costs were positively impacted by realization of synergies and productivity gains, partially offset by exponentially higher transportation and logistic costs. Container costs continue to be significantly higher than last year. In aggregate, the continuing effects of the supply chain disruptions, higher materials, transportation and logistics, and labor costs are estimated to be $20 to $25 million higher than last year's fourth quarter. Our team continues to work 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, and driving operational productivity and lean initiatives. Turning to slide 10, for the fourth quarter, adjusted operating margin expanded 2.1 percentage points versus last year, driven by higher adjusted gross margin but partially offset by higher SG&A and engineering expenses. Adjusted SG&A was $271 million, which was up $65 million from the prior year due to the normalization of certain expenses, higher incentive compensation, and employee benefit costs, and the acquisition of Nordco. Gap SG&A includes a net benefit of $7 million, primarily of sales of a closed manufacturing facility. Engineering expense increased from last year. We continue to invest engineering resources in current business opportunities, but more importantly, We are investing in our future as an industry leader in decarbonization and digital technologies that improve our customer safety, productivity, and capacity utilization. Now let's take a look at the segment results on slide 11, starting with the freight segment. As I already discussed, freight segment sales improved for the quarter and segment-adjusted operating income was $267 million for an adjusted margin of 18.7%. up 2.4 percentage points versus the prior year. The benefits of improved productivity, realization of synergies, and mix across our portfolio were partially offset by higher net input costs. Finally, segment backlog was $18.5 billion, up $615 million from the end of last year due to the broad multi-year order momentum that Rafael discussed earlier. This year's backlog growth was driven by an unusually high number of long-term service contracts. Looking forward, we expect our service long-term orders to normalize in 2022. Turning to slide 12, transit segment sales were down 5.4% driven by supply chain disruptions and the negative effects of foreign currency exchange. Adjusted segment operating income was up $11 million to $88 million. which resulted in an adjusted operating margin of 13.6%, up a strong 2.3 percentage points versus the prior year, and up 1.1 percentage points for the full year. Across the segment, we continued to drive down costs and improve project execution, despite the volatile environment. Finally, transit segment backlog for the quarter was $3.67 billion, down slightly versus a year ago. Adjusting for the negative effect of foreign currency exchange, backlog would have been up 3.6%. Now let's turn to our financial position on slide 13. We had another strong quarter of cash generation. We generated $314 million of operating cash flow during the quarter, bringing full-year cash flow generated to over $1.07 billion. which, as Rafael noted, is a record high for the company. This performance clearly demonstrates the quality of our earnings and our business portfolio. During the quarter, total CapEx was $52 million, bringing total year CapEx to $130 million. Our adjusted net leverage ratio at the end of the fourth quarter declined 2.5 times, and our liquidity is robust at $1.67 billion. Also during the quarter, We return more cash to our shareholders, repurchasing an additional $100 million of shares, bringing the full year share repurchases to $300 million and paid dividends of $92 million. As you can see in these results, our balance sheet continues to strengthen, and we are confident that we can continue to drive solid cash generation, giving us the liquidity and flexibility to allocate capital toward the highest return opportunities and to grow shareholder value. Moving to slide 14, quickly recapping the year. Overall, the team delivered a very strong year for all our stakeholders. Despite challenging dynamics, we drove revenue growth, expanded our operating margins across both segments, and generated robust cash flow. The strong execution provides us a solid foundation and good momentum as we enter into 2022. With that, I'd like to turn the call back over to Rafael.

Thanks, John. Let's flip to slide 15 to discuss our 2022 financial guidance. We believe that the underlying customer demand for our products and the end market momentum remains strong across our product lines, and our backlog continues to provide visibility into 2022 and beyond. North American freight markets are expected to show growth despite another year of zero locomotive deliveries in North America. Our international pipeline remains strong and order momentum continues to build. International markets continue to be the bright spot, and we expect overall locomotive deliveries to be significantly higher versus 2021. We expect strong growth in equipment in 2022, which will create negative mix for us during the year. When it comes to North American rail car builds, rail cars are coming back into use and we expect rail car deliveries to increase. Our service business continues to benefit from demand for reliable, efficient, and available power, driving the need to modernize and refresh fleets, along with the continued unparking of locomotives. In digital electronics, our growing backlog of orders supports a return to growth in 2022. Now transitioning to transit, We expect growth as ridership continues to recover and infrastructure spending increases as governments invest in clean, safe, and efficient means of transport. We are committed to driving adjusted margin expansion in 2022, despite headwinds from supply chain disruptions, an unfavorable mix, and still challenging cost environment with higher investments in technology. The team is committed to driving strong top line growth while aggressively managing costs. With these factors in mind, we expect sales of $8.3 to $8.6 billion in adjusted EPS to be between $4.65 and $5.05 per share. We expect cash flow conversion to be greater than 90%. Now, let's turn to our next slide. Our teams remain committed to delivering long-term profitable growth. Our strategy is built on our significant stall base and deep industry expertise, grounded in innovation, breakthrough initiatives, and scalable technologies that drive value for our customers. These efforts will continue to be accelerated by our lean and continuous improvement culture and disciplined capital allocation. I'm proud of the strong execution by the team in the fourth quarter, despite a challenging environment. You are seeing their efforts in the strength of the company, our 2021 financial results, and our 2022 guidance. 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, WAPTAC's mission holds a larger purpose to move and improve the world. And after demonstrating strong performance in 2021, 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. Before we begin Q&A, I'd also like to remind everyone we will be holding our Virtual Investor Day on March 9th, beginning at 8 a.m. Eastern Time. During that discussion, we look forward to sharing more details on our long-term growth strategy and financial outlook. A detailed agenda will be released shortly. We will now move to questions. 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 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed, and you would like to withdraw your question, please press star then 2. Again, please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. The first question comes from Courtney with Morgan Stanley. Please go ahead.

Hi. Good morning, guys. Thanks for the question. You know, if you could just give us a little bit more detail on your thoughts for 2022, appreciate the sales guidance. But if you can give us, you know, any thoughts on how the growth rates should compare on freight versus transit. And then, you know, you talked about some negative mix and cost headwinds through the year. But if you can comment at all on the first half versus second half margins or incrementals, you know, since many of your peers are talking about, you know, a worse first half and specifically first quarter versus second half. Just helpful for us to frame the cadence through the year.

Hi, Courtney. Thanks so much for the question. Let me start with top line growth at 8%. When we think about 22, we have stronger coverage than we had last year. So that's a positive. We're continuing to invest in the business with engineering up as a percent of sales. We like the momentum on how we're progressing with the deal pipeline. We do have had wins from inflation. We are going very much through a transition in terms of costs coming in while our teams are working on both elements of pricing, but also continuing to manage costs. I think mix is a relevant element, especially with equipment really growing at a faster rate than the rest of the company. Our teams are focused on driving what I call profitable growth into 22 and beyond, and with EPS growing at double digits. You asked a little bit about the dynamics between first half of the year and second half of the year. We would say revenues relatively similar to what you saw last year with maybe a couple points higher in the second half of the year. Profitability on the other way around, you should think about profitability a bit higher in the first half of the year versus the second half, and that's really driven by, again, the mix as we have deliveries of what I call new locomotives into the second half of the year.

Okay, great. That's helpful. And then, you know, I think you mentioned a couple times about your record mods deliveries this year. And if you can just, you know, comment on your thoughts for mods. I think you had also mentioned, you know, services should grow next year, but just how much visibility you have there and how we should be thinking about that specific driver within freight.

Courtney, strong results on that side. We had also, I think, very strong orders last year. And those are multi-year orders. I think in the fourth quarter in specific, we're continuing to pick up momentum internationally on that, which I think provides a significant opportunity for us to continue growth. So that business line is growing in 22. And we see the opportunity to continue to grow beyond that. There's just a significant opportunity for us to modernize units, really drive, I think, a lot of the technology that we've developed with companies fuel and automation and demand is out there.

Okay, thank you.

Thanks.

The next question comes from Justin Long with Stevens. Please go ahead.

Thanks and good morning. Morning. I wanted to circle back to the supply chain impact. I know you've called that out the last couple of quarters in terms of how it's impacted revenue. It sounds like at some point there will be a catch-up. I think, John, you said some of that revenue was delayed, not lost. So I'm curious if you could give us a little bit more color on what's getting baked into the 2022 guidance in terms of the supply chain headwinds and maybe a catch-up at some point.

Thanks, Justin. Yeah, as we've discussed, and taking it back to the third quarter, we certainly had a a drag on revenue because of the supply chain disruptions of three to four and I'm sorry in two to three percentage points and that increased in the fourth quarter. As we look forward into next year, we've incorporated a catch-up into the guidance that we have and would look that to be hopefully over the next couple quarters. It's very difficult to tell. We see parts of the supply chain improving and other parts getting a little bit worse. And it's kind of spread out beyond just the material piece, the labor with Omicron. So we expect there to be some impact, certainly in the first quarter. And we'll just have to see how things work out over the next few quarters.

Justin, I'd like to add the following. I mean, just in the fourth quarter and this transition here between fourth quarter and first, we saw record absenteeism in the business, something we hadn't seen before. And, well, needless to say, some of the continuation of some of the supply delays. But that has ultimately just delayed revenues. And in that case, for the fourth quarter, was over $70 million. We're past that peak. And we have a strong team who's executed well. And we're seeing that coming through in the first quarter.

Okay, so maybe just to clarify, if I run the math on the third and fourth quarter, it looks like the revenue headwind was somewhere in the range of $100 million to $140 million, and your guidance is assuming that you kind of catch up that revenue here in the first half, but maybe with some offset in the first quarter from headwinds?

Yeah, Justin, they're not necessarily additive, right? It affected us in the third quarter, took revenue down, In the fourth quarter, as we exited, a way to look at it more is it was three to four percentage points. At the midpoint, that's around $72 million. So we're looking year over year, not sequentially from quarter to quarter. So we would expect to pick up a fair portion of the majority of that $72 million that we believe we were short at the end of the year.

Got it. Okay. That makes sense. And then from a cost perspective, you know, you called out the 20 to 25 million of increased costs here in the fourth quarter. I'm assuming that's a gross number. Can you maybe talk about how that number trends going into 2022 and maybe what the net number looks like when you include some of the mitigating actions?

Sure, Justin. Let's take the two pieces and start with the gross cost. And you're absolutely right. The $20 to $25 million is a gross cost. And again, let me take you back to the third quarter at the time this all started. And we had higher costs, which were predominantly on the transportation side, but called out the fact that coming behind that on the material side was a lot of costs that were getting caught up in inventory and that they would release over time. And at that time, we had $15 to $20 million of costs. We said it would rise. And indeed, it did in the fourth quarter. It grew to $20 to $25. But we also saw that piece coming behind us in inventory grow, which we expected. So as we look forward, Justin, we would expect costs to continue to grow over the next few quarters, certainly in the first half of the year. And as you pointed out, there's two sides of this equation. And so that takes us to the other side in the cost recovery or the pricing side of it. Again, taking you back to the third quarter, at that time, we said about half of the higher costs of 15 to 20 million were being recaptured in terms of pricing. We also talked a little bit about our uniqueness in that the majority of our revenues are tied up in long-term contracts, and they have price escalators in them. So we feel very confident. that that pricing will come. These have been in contracts for decades and very tried and true. But they will come over a period of time. And they typically, while some are monthly, most of them are annual. And they'll tick at the anniversary dates. And that'll happen throughout the four quarters after the third quarter or throughout the next year. And what we saw in the fourth quarter is exactly what we would have expected, is that price recovery has increased from the 50% into the fourth quarter, and we will expect to see that to continue to increase over the next few quarters as we lap those anniversary dates in our contracts with our customers.

Okay, so gross costs probably go up sequentially in the first quarter, but do you think net costs go down?

Gross costs will certainly go up in the first quarter. And we'll also see the pricing go up. Not saying anything about the net cost. So the timing of what comes through, it's just a little bit harder to tell because the timing of what comes through the balance sheet are off of inventory.

Got it. I appreciate the time. Thanks.

Thank you, Justin.

The next question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Yes, hi. Good morning, everyone. Good morning, Jerry. Rafael, can you expand on your comments on the battery electric locomotive order trend? Sounds like you're getting test units in place. I'm wondering, can you just quantify the orders that you've seen to date and what level of order opportunities do you see for those products over the course of this year?

Jerry, I think strong progress here. We're continuing to work closely with customers, and this is an area where we are a leader and will continue to be in that space. We're continuing that dialogue. We've had a number of orders announced now, more recently in North America, but we've had orders in Canada and in Australia. There's really conversations continuing with customers in other geographies, so the pipeline, it's continued to build up, and we're confident about that. When you think about the deliveries here, they're mostly into the 24 timeframe, and that's, I think, when you're going to be seeing more of that. With that, I mean, we're excited to see some of the evolution of the technologies and a lot of the elements of what we consider today in terms of power density, in terms of what's possible. We see growth in that power density, and combining that with really the digital portfolio we have, we feel like we're uniquely positioned to really do energy management and drive significant value for customers. in terms of the results they get from this technology.

And Raphael, just order of magnitude, you know, you've had initial orders, I think, in the tens range. Are we talking about potential hundreds of orders in 2022? Or can you just frame for us just the order of magnitude, please?

Yeah. I think if you look at the announcements, there's about 20 at this point. But I think a lot of it is tied to customer testing that technology into their specific operations. Jerry, we're not going to be commenting on specific numbers around disorders, but we're picking up. If you think about when we really started to talk about this, this is reality. It's got application in a variety of areas for customers and will ultimately help them drive not just the fuel expense down, that will ultimately also help them meet the decarbonization goals, which most of them have put out there.

Okay, I appreciate the discussion. Thanks. Thank you.

The next question comes from Scott Group with Wolf Research. Please go ahead.

Hey, thanks. Good morning, guys. Just want to follow up on a couple things. Rafael, your comments about first half or second half, the year-over-year, was that a year-over-year comment about Better year-over-year earnings growth in first half than second half and better year-over-year revenue growth in second half than first half?

Yeah, it was a comparison between first half and second half. Sorry, Scott.

But you're talking year-over-year, correct?

Yes.

Okay, great. And then I guess I want – John, you had a comment about maybe something unusual in the backlog, if you could just – I wasn't sure what you meant. And then, Raphael, you were talking about a big increase in international locos. Can we just put some directional numbers on where international locos were last year, where you think they're going to be this year?

Okay. Scott, so in the prepared remarks, we talked a little bit about the backlog. We're very pleased overall with the growth that we're seeing. Just wanted to point out that in 2021, we had a strong level of orders coming in on pretty long-term multi-year orders on the service side. And while we expect backlogs to continue to grow into the future, we'll see a little bit of normalization in some of those long-term contracts because we picked up a lot of them from some of our largest carriers in 2021.

Scott, let me add the following. When you look at how we finished last year, 12-month backlog, growing double digits, But really, I think what's most important here is providing higher conversion into 22 versus what we had a year ago. So, stepping into the elements of the guidance we've provided, we certainly have higher confidence based on that backlog conversion that we have moving forward. We talked about equipment growth, which it's really tied to international locomotive orders, largely concentrated in the second half of the year, especially in the fourth quarter. And those were the comments that I made earlier associated with mix and the elements of higher margins in the first half of 22 versus second half of 22.

And just so if there's a lot in fourth quarter, should we think that there's going to be good momentum on international going into 23?

Scott, that's certainly what we're continuing to work on building on that momentum. I talked about a strong pipeline there, so it's all about convertibility, making sure we continue to drive convertibility. But as I look across the various geographies, the momentum is there. So it's not a single geography. It's really I'll call a number of different elements driving that discussion with customers.

Thank you, guys. Appreciate it.

Thanks.

The next question comes from Rob Wertheimer with Milius Research. Please go ahead.

Thanks. You know, it seems like you have really solid progress on flex drive during the quarter. Just a quick question on that. Does that, when you see those orders, and I know it's early, do they tend to drag in orders for other power units? You know, I know it's a system that could probably operate with a lot of equipment ages, but nonetheless, do they tend to sort of see the potential to drag in other locals with it. And then just one other one, if I may, just put both on at once. Any comments on transit demand, transit systems, you know, across U.S. and Europe, how they're, you know, doing with maintenance versus schedule, if there's any sort of comeback demand in the coming years? Thank you.

Well, two things. On battery electric first. I think customers are really taking those units into operation to really test on their own realities. And I think some of these customers are having parallel discussions in terms of increased demand and demand for new locomotives. And that's a reality in a variety of geographies that are traditional to us, and that's interesting. where also I base some of my comments on a strong pipeline. What if I think about Kazakhstan, Australia, or Brazil? I think that's part of the dialogue. On transit and transit guidance in specific, we expect offline growth more in the low single digits for this year. And the team is really committed to continue to drive profitable growth in the transit business. as we continue to work there. I think we continue to have opportunities to invest overall on making what I'll call WAPTEC businesses more efficient. And a big chunk of that is really really looking at our footprints. And with that being said, we're continuing to work through the dynamics of what John highlighted earlier, pricing, inflation, and supply chain disruptions. So you could see some variation quarter to quarter, but we see really progress in 22 driving a profitable growth.

Okay, thank you.

The next question comes from Alison Poliniak with Wells Fargo. Please go ahead.

Hi, good morning. I want to stay on that transit topic in terms of margin. You know, the margin performance was incredibly strong, you know, kind of what we would have viewed the prior peak to be. I guess one, you know, is this sort of the new step up for there or, you know, is this one of those, you know, businesses, again, similar to freight that the equipment growth that you would anticipate in the coming years given that the funding could be a headwind from a mixed perspective as we think of transit? Just trying to think of that business going forward.

Hi, Allison. This is John. Number one, we're very pleased with the fourth quarter margin results, which were up 2.3 percentage points. But beyond that, they were up 1.1 points on a full year basis. And if you go back the last four years, we've been up about 400 basis points. So we couldn't be more pleased with what we're seeing from the transit group. But zeroing in on your question, Allison, in the fourth quarter, the margin was driven by three areas. Number one was mix within transit with strong. Now, this can go both ways, right? So I wouldn't say that that is structural, but it did benefit us in the quarter. The other two are. The second area, and we talked about this in the third quarter, and it has been a focus of transits for the last couple of years, is really working on higher, more profitable contracts. And each quarter that goes by, we're seeing that take hold. And we're seeing it reflected in our margins. And we do believe that is certainly structural going forward. And then the other piece, of course, which is also that way, is their focus on productivity and integration. They've done an absolutely fantastic job of driving productivity, whether it has been continuous improvement on the day-to-day things or integrating within the transit organization and integration with the broader web tech company. Very pleased with that, and we expect them to continue to drive their margins forward in the future.

Got it. Thank you. That's helpful. And I just want to go back to freight. I hate to beat this up, but I know the sales and equipment is going to increase, and that's certainly a positive thing in the back half of the year. Is there a way to think about the mixed headwind, I guess, within the back half? And then also, obviously, freight. The backlog has certainly improved. You know, is there some mixed element there that we should be thinking of? I know the contracts and mods have increased as well. I'm just trying to balance out equipment versus some of the other businesses that are improving as well.

Yeah, Allison, this is John. I'll take the question on the freight mix in 2022. So, you know, it is going to be a bit of a drag on overall margin growth, but I wouldn't call it a headwind as such. Um, anytime that we can put an installed base out there, that's going to be for the next 20 or 30 years, um, to me is a, is a tremendous positive. And, um, we will sell year over year, a big increase as we believe we hit the trough and locomotive sales in 2021, um, of locomotives as well as mining equipment. Um, so with that, the fact is, is that while freight, I'm sorry, equipment has, um, strong margins, um, they're, they're on the lower side of the five groups that we have. and they will grow a fair amount faster than the rest of the groups in 2022, as Rafael pointed out, particularly in the back half. And so that, yes, there will be a headwind with regards to margins, but we'll have those assets out there that will continue to service and modernize and put digital equipment as well as the component and replacement parts. So we feel great about that mixed unfavorability going into 2022.

Got it. And then just the backlog as well, you know, how is, are we thinking a similar situation where that equipment backlog is increasing so that mix, you know, will, I don't, to your point, it's good growth longer term, but from a margin perspective, sort of a drag on margins as we sort of look out into the back half and into 23 based on the backlog today?

Well, I think kind of going back to the previous comment, as we launch from 2021, We took on a lot of long-term service contracts in that mix. So those, we feel very good about the profitability going forward. And we also improved our, increased our mix of international or of our locomotive orders that we'll see being delivered next year. So I would say that the margin that we're seeing as we exit the year in terms of overall margin is pretty balanced.

I think there's an element here to be considered just on quarter over quarter and specific variations you might have there. But the dynamics, as you've heard, are very favorable in terms of demand for mods. I think digital also, I think, really turn it into a growth story coming to the year and as we progress forward.

Perfect. Thank you.

The next question comes from Ken Hexter with Bank of America. Please go ahead.

Hey, good morning, Rafael and John. You have a pretty big range in terms of the EPS. Just maybe talk about your assumptions on the upside downside. Is that makes an impact on costs? And in the past within that, you kind of had 100 basis point margin improvement target for each segment. Does that still hold for 22 or not necessarily given some of the margin variations? Thanks.

Let me start and I'll let John compliment here. Number one, I think the range is very consistent with what we've done for past years. So I'll just start there. The second thing I would want to highlight is we continue our focus on really driving profitability forward. It's about driving profitable growth in 22 and beyond. And I speak on both segments as well. I mean, we are going through a transition here. As I described, there could be variation quarter to quarter, but this is really what we're going after.

Yeah, Ken, when we look at our EPS guidance of 465 to 505 with a midpoint of 485, represents 14% year-over-year growth on a midpoint of 8% volume growth. We feel very good about the construct of our P&L guidance. and the leverage that we'll get as we cascade down through it. When you look at the core drivers of that is on the positive side is the productivity and synergies that we expect, which we feel very good about. Also, the absorption, the fixed cost absorption that will be a tailwind to us in 2022. Those being somewhat offset by the costs that we talked about. So until we get to price cost equilibrium, there will be a headwind on our costs. largely in the first half, and then the mix piece, which will be somewhat of a headwind, but I'm very positive in terms of why that's happening. SG&A, as we've talked about, will be lower as a percent of revenue, and we'll continue to invest in technology, and that takes us through the P&L. So we feel very good about the range that we have, and we certainly feel good about 2022.

Just to clarify, though, John, in the past, the 100 basis point margin was for last year, right? It's not a continued 100 basis points on each segment, or was that multi-year in terms of each segment?

No, no. That was last year. To achieve that, we got nine-tenths out of freight and 1.1 points of margin growth out of transit. Now, when we look to 2022, what we do expect, Ken, is that operating margin percent will be up on a year-over-year basis. but we're not calling a percent.

Perfect. Thanks for that. And then just to go back to the FlexDrive for a second, Rafael, when you start thinking about the testing of this, how long until you start thinking this starts getting mass deliveries in terms of really getting implemented and driving? Obviously, as you mentioned, every company seems to be talking about ESG and the benefits and really counting on the locomotive to get to their multi-year targets. So Maybe talk us through the progress from electric and then maybe eventually hydrogen, whatever the next steps are to get the pulling capacity on over-the-road type of next-gen locomotives.

Let me start with the battery electric, which we're happy with really the testing that we did of the technology. It gives us the confidence to really move forward with customers here today. and ultimately work on a product that really solves for them in terms of their reliability expectations and driving a lot of the value that you described in terms of not just fuel decarbonization, ultimately better operating ratio. But we're working with customers on a variety of solutions. I'm glad you touched alternative fuels, which is a significant element of that. One of the things that we're certainly proud is when you look at the engines that equip our locomotives there, they tend to be at least 4 to 6.6. more efficient than the competitors' locomotives. So I'll just start there. But that's at the engine level. When you go to the locomotive level, you step it up another one to two points. And by the time you add really the digital portfolio we have, you're really getting to a double-digit arena here. And that scenario will continue to step up. And if you think about biofuels and you just add on the top of that the opportunity to make sure that ultimately you're driving decarbonization in the most efficient way. So we feel strong about these elements, and they were built really over time, and we continue to really invest and continuing to find solutions to operate, install, base, and stay ahead of the game here. There are other alternative technologies that are being looked at. I think we talked last year about hydrogen and fuel cell technology, things that we're doing in partnerships. So there's really a number of things that we're looking at it. We're working very closely with customers ultimately through that process. And some of this will play longer term, as we have described in the fuel cell side. And there's a lot to be validated there. But in terms of alternative fuels, we think that could play shorter term and we feel strong about, well, leading on that front as well.

Great. Thanks, Rafael. Thanks, John. Appreciate the insights.

Thank you.

The next question comes from Chris Weatherby with Citigroup. Please go ahead.

Hey, guys. James on for Chris. Wanted to ask about services revenue within freight. Seems to have stepped up in the quarter. Just wanted to know how much of that was essentially a new run rate, seasonal, or just basically a catch-up from 3Q. Just trying to figure out how we should think about that going into 22.

James, this is John. The services revenue was up 21.2% in the quarter. If you take away Nordco, we were up 10.1%. And that's really what we've been running largely throughout the year and have had a good year and we expect growth momentum to continue into 2022 in our services group.

Got it. And then if we're also just thinking about the end parkings going into 22 as well, what have you seen sort of year to date and is there a certain level of improvement in locomotive on parkings that you've built into the guidance throughout the year?

When we looked at the last six months, we've seen on parking to continue. When you look at the specific dynamics on the first quarter here, I think certainly the weather conditions have been really quite disruptive. So that actually has also driven what I'll call demand for the services business as our customers are investing on that fleet. And if you think about the elements of how the network has slowed down, that will also be an element of potentially driving on parkings here and more freight cars online. So positive from that perspective.

Got it. And then just two smaller ones. Just wanted to understand how you're thinking about the buyback in terms of the time frame. And I think there was a benefit from other income in the quarter, just understanding how to think about that going into 22. Thank you.

Yeah, we couldn't be more thrilled. The board had two approvals at our recent board meeting. One is to up the dividend by 25%, and the other is reauthorizing $750 million of share repurchases. The other thing I'm happy to point out is that back half the year we purchased $300 million. We don't provide guidance going forward on what our share repurchases are, but when we look at the overall capital allocation opportunities that we have, You know, we kind of waterfall that from making sure that we build our balance sheet and strengthen that, protect the dividend, and invest in our business. And Rafael just talked about that and some of the technology investments that we're making. Then with the cash that's left over from that, we are largely looking at what opportunities there are in M&A activity for a creative, strategic, bolt-on type M&A work. And at the end of the day, when there's excess cash, we are committed to returning that to our shareholders through share repurchases.

I'll just emphasize that we're really committed to drive the higher return on investment to our shareholders. And I'd compliment we're committed to certainly investment grade and continue to work the discipline that you've seen from us through that process.

Thank you.

The next question comes from Matt Elcott with Cowan. Please go ahead.

Good morning. Thank you, Raphael. Just to follow up on your discussion of the different new technologies on locomotives earlier, were you suggesting that all these, you know, battery electric hydrogen, biodiesel, RNG technologies, can coexist in the network long term, or do you think that the industry will have to coalesce behind one or two technologies?

So, a couple comments there. Number one, I'll start with just the elements of modernizing the fleet. I think that's one of the things that our customers look at that's probably top of mind, and that's to a large extent tied not just to the mods business, but it's also tied to investment in Tier 4 and the newest technologies we have there. If you were to ask me what's second on that, I think alternative fuels, specifically with biofuels, that's another key element, and that's why it's very little alcohol or limited change in terms of how they operate in that context. And as I got to highlight here, the elements of what we got in the digital portfolio, which is continuing to equip those fleets with those capabilities, that will drive significant, I'll call it fuel reduction, and ultimately good outcomes for the customers. When I think about the next technology, I think battery is something that's really being tested. I think there is the opportunity here to have a real application of that in terms of certain routes and specific customers. When you talk about mixing, all of that, I think there's a significant degree of sensitiveness around mixing different technologies and different fuels because that would turn into a significant challenge. So ultimately, I think you're going to see evolutionary progress here. There could be an element of really hybrid locomotives. And as you step into some of this new technology, I think what's most important is the leadership role we've had on testing those and working them with customers. But there could be an element of some of these being adopted faster with some customers that might have a more simplified logistics than we have in North America, for instance.

Got it. So it sounds like maybe you're suggesting that there will be experimentation with different technologies in the near to intermediate term, and maybe we'll have a number of bridge technologies that will take us to a more kind of unified system in the long term. We're talking like a decade or longer.

You got it. I think it's going to be more evolutionary as we look into the next couple of years before you get to really a transformational step.

Got it. And then my follow-up to that is what do you think this will do? How do you think this kind of fluid and uncertain future as far as new technology is? will do to the class one's mindset as far as ordering locomotives? Is it going to limit their orders to just basic replacement demand when they absolutely have to because no one really knows what the locomotive of the future is? And then once we know, there will be a massive replacement cycle, or do you think the railroads will just go on as they have the past?

So that should not because, I mean, to a large extent, these are technologies that you can apply to existing fleet and upgrade the fleet. So you can work on that transition. So some of the technologies we're talking about, what if I start with alternative fuels? I mean, that's the thing you'll apply on the existing fleet. If you think about all the testing we're doing on batteries, ultimately that leads to potentially considering a hybridization of locomotives. So next thing, as you're thinking about mods, you could be connecting batteries into that mod and drive that fuel efficiency moving forward. Again, back to my comments on evolutionary versus revolutionary, and you've got to be very sensitive to the elements of operations and how you make sure you don't disrupt any of the elements that exist there today, especially start switching fuels. If you go into hydrogen, for instance, I think we certainly have experience with LNG, and that drives a much more significant change in the overall infrastructure.

Got it. And just one final quick question. Sorry if I missed it, but did you guys say anything about the elevated geopolitical risk in and around Ukraine and then previously a couple of months ago with the turbulence in Kazakhstan and if it's had any, if it's caused you any concerns about your business over there?

We certainly, these are important parts of our portfolio. Let me start first with Russia in specific. While it's an important part of our portfolio and we're, I'll say, certainly concerned about the situation, with that being said, Russia accounts for less than 5% of our business. If you think about Kazakhstan, yes, we follow that very closely. We have a significant operation there with employees, but there's really minimum disruption as we went through that process, and we continue to operate strongly there.

Thank you very much.

Thank you.

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

Thank you, operator. Thank you everyone for joining us. We look forward to talking to you over the quarter and certainly next quarter. Thank you.

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