Earnings Call Transcript - WAB Q1 2023

Operator, Operator

Good morning and welcome to the Westinghouse First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Kristine Kubacki, Vice President of Investor Relations. Please go ahead.

Kristine Kubacki, Vice President of Investor Relations

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

Rafael Santana, CEO

Thanks, Kristine. And good morning, everyone. Let’s move to Slide 4. I’ll start with an update on our business, my perspectives on the quarter and progress against our long-term value creation framework. And then John will cover the financials. We delivered a strong start to the year, which is evidenced by robust sales and earnings per share growth. We achieved this despite a volatile and uncertain macro environment. Sales were roughly $2.2 billion, which was up 14% versus prior year. Revenue was driven by strong performance across the freight and transit segments, but partially offset by unfavorable effects. Total cash flow used for operations was $25 million. Overall, our financial position remains strong. We continue to allocate capital to maximize shareholder returns by investing for future growth, executing on a strategic M&A and returning cash to shareholders. Total multi-year backlog was $22.3 billion down 2% year-over-year, and excluding the headwinds from FX, backlog was down four tenths of a percent from last year. The 12-month backlog again grew to a new high of $6.9 billion. Overall, we have a strong start to the year. The underlying strength and momentum of the business is evident. And we’re well positioned to continue to drive profitable growth, even with uncertainty and volatility in the global economy. We remain confident in our ability to execute on our rigorous operating principles as we continue to deliver for our customers and make progress against our long-term growth strategies. Shifting our focus to Slide 5, let’s talk about our 2023 end market expectations in more detail. As we look at key metrics across our freight businesses, we remain encouraged by the underlying business momentum in our robust pipeline of opportunities. North America carloads were down in the quarter, but locomotive parkings are slightly lower than the same time last year, despite lower freight traffic. We continue to see significant opportunities in demand for modernizations and new locomotives as our customers invest in solutions that continue to drive reliability, productivity and fuel efficiency. Looking at the North America railcar build, demand for rail cars continued to show strength. As a result, the industry outlook for 2023 is for 40 to 45,000 cars to be delivered. Overall, we believe we have an opportunity to continue building significant long-term momentum, with growth in modernizations in locomotive sales, in railcar builds, and in digital solutions. Internationally activity also continues to show positive signs, and we continue to grow our install base of locomotives around the world. Finally, transitioning through the transit sector, the secular drivers remain in place as the need for clean, safe and efficient transportation solutions continue to increase across the world. Next, let’s turn to slide 6, to discuss a few recent business highlights. We recently signed a strategic order for new locomotives in Brazil with VLI, which results from the growing investments in Brazil’s infrastructure to support growing rail volumes. We also secured a key order for our new Ultra class mining drive system, specifically targeted for high altitude applications. Reflecting on the resilience of the business, the strength of our balance sheet, and our ability to generate strong cash flow, Moody’s recently upgraded Wabtec’s credit rating. And finally, our team in India achieved a significant milestone by delivering 500 locomotives in a 1000 unit order to Indian railways. As one of the region’s largest rail equipment suppliers, the team has positioned Wabtec and our customers for growth for years to come. All of this demonstrates the underlying momentum in the business, the team’s relentless focus on execution and the strong pipeline of opportunities we continue to deliver on. Wabtec’s well positioned to continue to capture profitable growth with innovative and scalable technologies that address our customers’ most pressing needs. With that, I’ll turn the call over to John to review the quarter, segment results and our overall financial performance, John?

John Olin, CFO

Thanks, Rafael and good morning. Turning to slide 7, I’ll review our first quarter results in more detail. We started the year with another good quarter of operational and financial performance, despite continued challenges in foreign currency exchange, and still elevated input costs. Sales for the first quarter were $2.19 billion, which reflects a 13.9% increase versus the prior year. Sales were driven by very strong trade segments sales, which were up 18.5% from last year. Q1 sales were once again negatively impacted by unfavorable foreign currency exchange, which reduced our revenue growth in the quarter by 2.9 percentage points. For the quarter, GAAP operating income was up $37 million driven by higher sales. Adjusted operating margin in Q1 was 16.4%, down 0.1 percentage points versus the prior year as we had expected. The benefits of higher sales were offset by a less rich mix of sales between business groups and higher next generation product development costs. GAAP earnings per diluted share were $0.93, which was up 16.3% versus the first quarter a year ago. During the quarter, we had pretax charges of $9 million for restructuring, which was related to our integration 2.0 initiative to further integrate Wabtec’s operations and to drive $75 million to $90 million of run rate savings by 2025. In the quarter adjusted earnings per diluted share were $1.28 up 13.3% versus the prior year. Overall, Wabtec delivered another solid quarter of results demonstrating the underlying strength and momentum of the business and our ability to navigate through volatile macroeconomic conditions. Turning to slide 8, let’s review our product lines in more detail. First quarter consolidated sales were very strong, up 13.9%. Excluding foreign currency exchange, sales were up 16.8%. Equipment sales were up 43.4% from last year, due to higher locomotive sales this quarter versus last year. Component sales were up 21.8% versus last year, largely driven by higher OE railcar build and an increase in our market share due to product availability, along with increased demand for industrial products. Digital Intelligence sales were up 22.2%, which was driven by robust demand for onboard locomotive products and international PTC along with revenue contribution from the strategic bolt-on acquisitions of Beena Vision and ARINC last year. Our services sales grew 6.2% versus last year. The increase was driven by higher sales from a larger active fleet, partially offset by the timing of mods deliveries in the year. The superior performance reliability and availability of our fleet continues to drive increased customer demand for our services and solutions. Across our transit segment, sales increased 3.8% versus prior year to $628 million. Absent the impacts of foreign currency exchange, transit sales would have been up 9.6%. The momentum in this segment remains positive as secular drivers such as urbanization and decarbonization accelerate the need for investments in green infrastructure. Now moving to slide 9, as forecasted, gross profit margin was slightly lower driven by a less rich mix, unfavorable foreign currency exchange and higher manufacturing costs. Mix was unfavorable, driven by strong sales of locomotives and our equipment business. Raw material costs, while still elevated are largely flat on a year-over-year basis. Foreign Currency Exchange adversely impacted revenues by 2.9 percentage points, and adversely impacted first quarter gross profits by $14 million. Finally, manufacturing costs were positively impacted by productivity gains and higher absorption offset by higher digital development costs. Our team continues to execute well to mitigate the impact of these cost pressures by driving operational productivity and lean initiatives. Turning to slide 10, for the first quarter GAAP operating margin improved 0.2 percentage points to 12.6% while adjusted operating margin declined slightly to 16.4%. GAAP SG&A was $263 million and adjusted SG&A was $258 million, both of which were up versus prior year, but down as a percentage of sales. Engineering expense increased from last year according to plan and was flat as a percentage of sales at 2.3%. 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 customers' productivity, capacity, utilization, and safety. Now let’s take a look at the segment results on slide 11. Starting with the freight segment, as I already discussed, freight segments sales were strong for the quarter, up 18.5%. GAAP segment operating income was $227 million for an operating margin of 14.5%, up 0.2 percentage points versus last year. Segment adjusted operating income was $297 million, up 14.7% versus the prior year. Adjusted operating margin in the freight segment was 19.0%. Adjusted operating margin was down six tenths of a percentage point on a year-over-year basis. The benefits of increased sales, including fixed absorption and lower SG&A as a percentage of revenue were more than offset by unfavorable mix and higher next generation product development costs in our digital group. Finally, segment backlog was $18.4 billion down 3.5% from the end of Q1 last year. On a constant currency basis, segment backlog was down 2.3%. The year-over-year reduction in backlog was driven by lapping last year’s multi-year order for modernizations. Now turning to slide 12, transit segment sales were up 3.8% driven by higher aftermarket sales, partially offset by negative effects of foreign currency exchange. Unfavorable foreign currency exchange adversely impacted segments sales by 5.8 percentage points. GAAP operating income was $69 million up 6.2%. GAAP operating income increased as a result of higher sales, improved mix from aftermarket sales and benefits from our integration 2.0 activities, partially offset by higher restructuring costs. Adjusted segment operating income was $83 million, which was up 12.2%. This resulted in an adjusted operating margin of 13.1% up 0.8 percentage points from last year. Finally, transit segment backlog for the quarter was $4.0 billion up 6.3% versus a year ago, on a constant currency basis backlog would have been up 9.3%. Now let’s turn to our financial position on slide 13. Q1 cash used for operations was $25 million. While cash flow benefited from higher earnings, we are continuing to invest in the business’s growth, which is driving working capital higher in particular, receivables and inventory. Despite that we continue to expect greater than 90% cash conversion for the full year. Our debt leverage ratio at the end of the first quarter declined to 2.3 times versus the prior year. And our liquidity was robust at $2 billion. As Rafael mentioned, during the quarter, Moody’s upgraded our credit rating, which reflects the strength of the balance sheet and the outlook for continued strong cash flow. With the Moody’s upgrade, Wabtec is rated investment grade across all three rating agencies. And finally, we returned a significant amount of capital to our shareholders in the quarter with $209 million returned through share repurchases and dividends. As you can see in these results, our financial position is strong and we continue to allocate capital in a balanced strategy to maximize shareholder returns. With that, I’d like to turn the call back over to Rafael.

Rafael Santana, CEO

Thanks, John. Let’s flip to slide 14 to discuss our 2023 financial guidance. We believe that the underlying customer demand for our products and solutions remains strong across our product lines and our backlog continues to provide good visibility into 2023 and beyond. The team is committed to driving strong top line growth while managing costs. We’re also committed to driving adjusted margin expansion in 2023 despite FX volatility and our still challenging cost environment and continued supply chain disruptions. With these factors in mind, we are reiterating our previous guidance; we continue to expect 2023 sales of $8.7 billion to $9 billion and adjusted EPS to be between $5.15 and $5.55 per share. We also expect cash flow conversion to be greater than 90%. Now, let’s wrap up on slide 15. As you heard today, our team delivered a strong start to the year despite a challenging and volatile environment, thanks in large part to our resilient installed base, world-class team, innovative solutions and our relentless focus on our customers. Our results remain on track for us to deliver on our five-year outlook that we provided at our investor day last year, with strong momentum across the portfolio, increased visibility through our multiyear backlog and rigorous focus on execution. Wabtec is well-positioned to drive profitable long-term growth and maximize shareholder returns. With that, I want to thank you for your time this morning. I’ll turn the call over to Kristine to begin the Q&A portion of our discussion, Kristine?

Kristine Kubacki, Vice President of Investor Relations

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

Operator, Operator

Our first question will come from Justin Long of Stephens. Please go ahead.

Justin Long, Analyst

Thanks. And good morning.

Rafael Santana, CEO

Good morning, Justin.

Justin Long, Analyst

I was wondering if you could help us think through the assumption in your guidance for North American locomotive utilization over the rest of the year. What percentage of the locomotive fleet are you assuming gets parked by the end of 2023? And as we think about your sensitivity to that, is there any way you could speak to the percentage of your freight services revenue that’s transaction-based that would be impacted by that trend?

Rafael Santana, CEO

So Justin, I’ll start with a strong quarter. We finished with a strong pipeline of opportunities. And I think we continue to add on some really important options here for multiyear orders. As you look into the quarter specifically, I would say revenues were a bit higher. A piece of that was the alleviation of the supply chain. But the other one was really a piece of what I’ll call, locomotive parkings being actually a positive. So there were lower parkings than we had for last year. That’s not what we planned for the year. The plan for the year was to have locomotive parkings be up. So with that, we do expect that to be more amplified in the second half of the year. For the first half, I think we will continue to be positive. I think ultimately, a lot of that’s going to depend on the improvement of both velocity and dwell times. And that’s, I think, ultimately going to be determinant. I don’t want to speculate; I think we feel very strong about the dynamics of the year based on the backlog that we have. The convertibility really is high for the year. At this point, we moved into a new high from the 12-month backlog. So we feel confident about our ability to deliver on the guidance that we provided at this point.

Justin Long, Analyst

Okay. Great. And on the percentage of your freight services business that’s tied – it’s more transaction-based. John, is there any color on that you could provide?

John Olin, CFO

Well, out of the $2.5 billion, a good $2 billion of it is tied to the service contracts, right? And if the locomotives are running, we’re earning and if they’re parked, we don’t. So we don’t provide, Justin, the amount in our forecast. But as Rafael had mentioned, on a full-year basis, we expected the parkings to grow, be up, which would be a headwind to revenue. What we saw in the first quarter was a slight reduction. So again, a little bit of a benefit. And that drove a little bit more revenue than what we expected in the quarter. But on a full-year basis, Justin, we would expect to get to that target or even a little bit higher. And the reason I say a little bit higher is that, if you remember last quarter, we talked about our assumption on carloads, and that was for flat. And coming out of the first quarter, flat doesn’t feel likely now given the fact that carloads were down 3.6%. So that could amplify a little bit of the parking. But Justin, to answer your question specifically, we don’t provide that number. But we’ve got 16,000 of them running in North America and the fewer that run, a little less that we get in revenue.

Justin Long, Analyst

Understood. And as a follow-up, John, you were helpful last quarter in helping us think through the quarterly cadence that’s baked into the guidance in terms of both revenue and operating margins. Just curious if you have any updated thoughts as we look out the rest of the year based on what’s coming in the backlog mix, etcetera?

John Olin, CFO

Yes, great question, Justin. Last time, we discussed both margin and revenue. Regarding margin, we stated that we expect it to grow on an annual basis in accordance with our long-term plans, with this growth anticipated in the latter half of the year. Therefore, we expect the margin in the first half to remain flat. Currently, year-over-year, we are down about 0.1%. We feel positive about our position compared to our plan, which brings us to revenue. Previously, we mentioned that revenue would grow more significantly in the first half compared to the second. We experienced strong revenue growth in the first quarter, which surpassed our expectations, as Rafael noted. When putting our plan together, we based it on the fourth quarter. Excluding currency effects, the fourth quarter saw a 15.7% increase, and we anticipated some tempering in the following period. However, we experienced a slight acceleration, resulting in a 16.8% increase ex-currency. This revenue difference has some components pulled from the second half. This was influenced by three factors. First, our assumption about supply disruptions was somewhat more front-loaded than expected, which contributed to increased revenue. Second, our forecast on parking showed a decline instead of an increase, affecting our revenue expectations. Lastly, our Components group managed to gain market share. We are still confident in our carload build of 40 to 45. Thanks to our investments in working capital and inventory, we were able to capture additional market share due to availability. However, we anticipate that many of these dynamics will reverse in the latter half of the year. Overall, from a revenue perspective, we are aligned with our expectations, with a slight boost in the first quarter that will likely balance out over the next three quarters.

Justin Long, Analyst

Okay. Got it. Congrats on the quarter.

John Olin, CFO

Thank you.

Operator, Operator

The next question comes from Allison Poliniak of Wells Fargo. Please go ahead.

Allison Poliniak, Analyst

Hi, good morning. Just wanted to go back to the services piece. John, I think you made a comment that there was some impact timing of mod deliveries this quarter. Could you give a little color there on how we should think about it through the balance of the year?

John Olin, CFO

Yes. So when we looked at the full year, and we talked about the last couple of quarters that we expect our mods to be up double digits on the year. But when we look at the quarter, Allison, actually mods were down a fair amount in the first quarter. And that’s nothing to get excited about. That’s the way it was planned. And we’ll have still that double-digit growth by the end of the year. So that’s the cadence that we’re referring to. I think where it comes in to be important, Allison, is when you look at the fourth quarter, mix was a big driver of that unfavorability. And at that time, we had talked about both locomotives and mods being up quite significantly driving that. In the first quarter, mix is unfavorable, but not to the same extent that we saw in the fourth quarter, because we had a little bit of offset and the mods being down in the quarter. And we also saw strong growth, as you saw in our equipment group, with regards to the locomotives.

Allison Poliniak, Analyst

Perfect. On the digital side, there has been really strong growth. I know it's about 10% on an organic basis. Is some of that growth a result of a catch-up now that the supply chain is easing, particularly for electronic components? Or is this growth in line with your expectations? Should we consider this as the number to focus on for the remainder of the year for Digital?

John Olin, CFO

There was a little bit of catch-up in the computer chips. I wouldn’t say a lot. And again, the first time we started to see the computer chip market ease was in the fourth quarter. And so we saw a little bit more easing. But not a huge portion of it, Allison, but a bit of it.

Rafael Santana, CEO

Allison, I’ll just add that the progress we made over the last two years has positioned the business well in terms of backlog. Some of these were multiyear agreements, so our backlog coverage is actually better than it was a year ago. The team remains highly focused on ensuring we drive convertibility into 2023; we still have some work to do on that.

Allison Poliniak, Analyst

Great. Thanks for the color.

Operator, Operator

The next question comes from Scott Group of Wolfe Research. Please go ahead.

Ivan Yi, Analyst

This is Ivan Yi on for Scott Group. First, following the Norfolk derailment in East Palestine, what potential regulatory initiatives could Wabtec benefit from? And I know Wab does not manufacture the hot bearing detectors. But are you seeing any uptick in orders for other detection systems? Can you get into the hot box market? Thank you.

Rafael Santana, CEO

A couple of comments there. First, we’re not going to comment on the accident per se. But if you think about rail safety, I think this is a top priority for both us and for our customers. I think similarly to what we do in efficiency or carbon emissions, we continue to partner with customers to further improve rail safety, rail productivity, emissions. We are working with a number of customers on technologies that help really further detect and anticipate any failure of systems or subsystems, and that’s continued to be a part of opportunities we have to continue to always drive continuous improvement in the space.

Ivan Yi, Analyst

Thank you. And just on a follow-up, can you discuss the M&A market? In what areas or regions are you most actively looking right now for any potential acquisitions? Thank you.

Rafael Santana, CEO

Well, when we think of inorganic growth, we’re continuing to explore bolt-on acquisitions. To some extent, we will continue to be opportunistic here. This needs to really ultimately drive higher ROIC and faster profitable growth for the business. With that being said, I think our focus continues to be very much on driving organic growth for a lot of the investments that we’re doing on technology. We believe that will continue to drive momentum in terms of the opportunities we have here in the combination of modernizations and new locomotive sales. And with that, we continue to see opportunities to return value to shareholders. Our Board recently renewed the authorization for $750 million in buybacks. And with that, we continue to be committed to pay down that.

Ivan Yi, Analyst

Thank you.

Operator, Operator

The next question comes from Rob Wertheimer of Melius Research. Please go ahead.

Robert Wertheimer, Analyst

Thank you. Good morning everybody. I had two questions on international freight. And one was just on locomotives. Is there any shift in trend there? Or is strength just normal variability in production and delivery? And then second, I wonder, kind of a bigger picture question, if you could just give us a state of the market PTC and digital, in general, across international freight? And what the runway looks like there?

Rafael Santana, CEO

We continue to see a strong pipeline of deals and good momentum both internationally and in North America. Our team is focused on converting orders. Internationally, in regions like Brazil, Kazakhstan, Africa, and Australia, we have several projects under discussion. In North America, there are further opportunities to enhance productivity and efficiency by upgrading an aging fleet. This is likely the best visibility we’ve had in the past couple of years, especially for the next three years. We believe we can maintain our momentum toward achieving the five-year guidance we shared last year. Regarding PTC and international expansion, we are continuing to deploy PTC in additional international markets, which is a significant opportunity as we upgrade systems. This momentum supports innovation and the development of next-generation products that will enhance efficiency and productivity for our customers. Additionally, trends in Transit remain positive, and the overall fundamentals of the business appear strong.

Robert Wertheimer, Analyst

Thank you. And one follow-up, if I may. I mean that’s a fairly bullish statement. The North American locomotive kind of pipeline of potential orders, etcetera. Do you have any characterization of what’s driving that? You mentioned the old fleet; we all definitely know that’s there. You guys have done a ton with efficiency, and I think your Tier 4 is more efficient. So maybe that makes the economics easier. Just any color commentary from the conversations you’re having, and I’ll stop there. Thank you.

Rafael Santana, CEO

A significant part of this is focused on enhancing efficiency. Consider how trains currently rely on three or four locomotives; the goal is to reduce that number to two or three locomotives for the same task. The locomotives we are delivering now utilize less fuel, which presents numerous advantages. They also demonstrate greater reliability, contributing to improved efficiency. This improvement creates opportunities to further enhance operations. We are actively investing in technologies to expedite this process, and we see continual opportunities in this area.

John Olin, CFO

Rob, our customers usually experience a mid-double-digit return or internal rate of return on their investment in either new or upgraded units. The return is generally slightly higher for new units, but both options offer strong mid-double-digit returns. This provides them with a significant economic incentive.

Operator, Operator

The next question comes from Saree Boroditsky of Jefferies. Please go ahead.

Saree Boroditsky, Analyst

Thanks for taking my question. Just first, a follow-up on the derailment question. There’s been some talk about shorter train lanes in response to this. Have you heard anything from a legislative perspective? And how do you think about that impacting your business?

Rafael Santana, CEO

We’re continuing to work with our customers and other stakeholders in the industry to continue to support improvement. And there’s always a sense of continuous improvement, despite rail being the most sustainable way of moving things over land. I mentioned here some other technologies that we’ve been working with customers that could anticipate, once again, a failure at various equipment, including not just thermal, but also vibration and other technologies here that allow us to be more predictive on rail. So we see an opportunity here to continue to drive, I’ll call it, innovation in the space. And with that, I think we have a set of solutions that can continue to help customers drive efficiency, productivity, emissions and rail safety.

Saree Boroditsky, Analyst

And then maybe just a follow-up. Could you provide an update on how integration 2.0 is progressing? And maybe any segment-level benefits for this year?

John Olin, CFO

Sure, Saree. Integration 2.0, as we exited 2022, the spending was a little bit higher than what we had anticipated. So that is very good. It means we’ll get to the savings quicker. But looking at that launching spot, Saree, after one year, we spent $46 million. A lot of that noncash, but took a $46 million charge. And with that, we returned $5 million of savings. And as we move into the next couple of years, we would expect that $5 million of savings to grow to $75 million to $90 million on a run rate basis by 2025. So we expect a fair ramp as we go forward with that. And we saw some of that certainly in the first quarter. When we look about the segments, most of the spending, and you said a majority of the spending, as well as the savings are going to accrue to the transit group. There is a fair amount in the freight side, but a little bit overshared in terms of our investment and opportunity for consolidation in transit. And again, when you look at the margins in the first quarter, we were up 0.8 points year-over-year. Some of that was certainly driven by those savings on the investments that we made in 2021 beginning to turn and pay off.

Saree Boroditsky, Analyst

Appreciate the color. Would it be possible to provide any numbers around what you would expect for savings for this year and maybe for 2024?

John Olin, CFO

No. In terms of the spending, we would expect it to be a little bit north of what we spent last year of the $46 million. In terms of savings, again, Saree, we’ve got three years to ramp up from $5 million to, call it, $80 million to $85 million at the midpoint. So it’s pretty significant, and it will continue to build over that period of time. So a little bit more in 2024 than in 2023.

Saree Boroditsky, Analyst

Okay, appreciate the color. Thanks for taking my questions.

Operator, Operator

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

Jerry Revich, Analyst

Yes, hi good morning everyone. I’m wondering if we could just talk about the Wabtec products that could potentially improve the safety around and not only the incident that we spoke about on this call, but a range of other less severe accidents. What does the addressable market look like, Rafael, if we were to say, let’s leverage Wabtec’s products to improve safety and outcomes across the industry? Obviously, different paths to get there, but what is that addressable market if we were to move in that direction that’s favorable to Wabtec’s product portfolio?

Rafael Santana, CEO

Jerry, I think it’s, number one, it’s a significant opportunity that we have. A lot of it resides into a lot of the elements that we described as automation, which comes down to really driving what I call a more seamless operation that will improve both the elements of efficiency, but that will also drive opportunities here to continue to capitalize on safety and other elements of that. And some of it comes down to potential introduction of new projects and new products and technologies, such as products that allow the detection in anticipation of failure, whether that’s at the locomotive level, or whether that’s at train level, that’s a piece of it. The other one is the integration of some of these systems. You’re well aware of our Trip Optimizer, which is a product that we have largely deployed not just in North America, but internationally as well. The combination of that with PTC and some other elements really allow you to fundamentally operate a train largely with what we would call an autopilot. So those are some of the things that we have an opportunity here to continue to drive with customers. And we’re at different stages on that, depending on the complexity of networks around various parts of the world. And we’re seeing really an opportunity here to drive larger adoption. I mentioned here, PTC internationally. I mean we’ve gone with PTC now not just into Brazil, but we did it in Africa. We’re expanding into Asia, and that’s another area where we expect that to go into. We’ve got opportunities to share with wayside monitoring as well. And those are some of the things that we’re currently either in the process of installing or discussing with customers in North America. It’s a significant opportunity.

Jerry Revich, Analyst

And Rafael, really interesting comment around the combination of locomotive and broader system technologies. Maybe just to put a finer point on that. The 16,000 locomotive installed base, what proportion would you estimate of that installed base that you folks have, has that combination of Trip Optimizer plus is on network with PTC to drive that level of automation? How significant on a good chunk is that out of the existing installed base?

Rafael Santana, CEO

Jerry, it’s very high, right? I mean if you think about PTC, it’s really deployed across the entire installed base, whether it’s Wabtec locomotives or any other compatible locomotive that’s running out there. When it comes to Trip Optimizer, that’s more, I’ll call, really been largely deployed at the Wabtec locomotives. So that’s an area of an opportunity that we would have here to continue to expand on that. And with that, I mean, there is the evolution of some of the products that we’ve talked to you guys before, such as 0 to 0, which really amplifies a lot of the elements of automating the entire trip. And with that, the continued automation of some of these systems. The Shimoda systems, that really operate at a network level. So helping the railroads both dispatch trains, but really ultimately manage the network. Things like Movement Planner, which allow you to really, in a very fast mode, be able to redefine the operations and dispatches you’re going to be doing along the day.

John Olin, CFO

Yes, this is the first quarter after six consecutive quarters of rapidly increasing costs of goods sold compared to a year ago. Costs remained stable compared to the previous year, but I don’t want anyone to think that costs are acceptable. They are still very high. This is the first quarter in six without a rise in costs. It’s hard to predict what the next quarter will be like. We have our forecasts, but various factors affecting costs are moving in different directions. Metal costs have decreased significantly; they rose sharply from the second quarter of 2021 through the invasion and into the second quarter of 2022, but they have been declining since then, which is positive. Transportation costs are similar, both in terms of fuel and container prices, and those are also improving. However, it takes time for these changes to impact our inventory. On the downside, labor costs continue to rise, and we cannot overlook general inflation; everything is becoming more expensive, with the CPI up 5% in March. These factors all influence our cost structure. Additionally, about 60% of our revenue comes from long-term contracts, many of which include cost escalators. If costs decrease, that will also impact the escalators. We keep a close watch on everything. Our primary goal, which we have pursued since the beginning of this situation seven quarters ago, is to maintain a balance between price and costs, which we achieved in the second quarter of last year and have sustained for the past four quarters. We expect to continue maintaining this balance throughout 2023.

Jerry Revich, Analyst

Super. I appreciate it. Thank you.

John Olin, CFO

Thank you, Jerry.

Operator, Operator

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

Unidentified Analyst, Analyst

Thanks for the introduction. This is Nathan speaking on behalf of Ken. Congratulations on a strong quarter. I want to follow up on Justin’s question regarding the quarterly cadence. I've noticed a positive impact from international orders in the first quarter, and based on your previous guidance, it seemed like the first half would be weighted that way. Could you provide the breakdown between the first and second quarters regarding the impact on equipment? Additionally, I've observed that even though the 12-month backlog has increased, this marks the third consecutive quarter of a decline in the total backlog. Is this simply due to the assumed commodity escalators? Could you also share your outlook on demand and the sales pipeline? Thank you.

Rafael Santana, CEO

Let me start with the second half of the question, and then I’ll pass it on to John to address the first one. On the second one, if you look at it, in the first half of last year, we had some very significant multiyear orders. So orders that really supported not just 2023, 2024, and 2025, and those were modernizations that we signed with Class 1s in the U.S. You don’t have the repeat of that this year. But this is, as I said before, the best visibility we had in terms of our ability to drive momentum towards 2023, 2024, and 2025. And I think the 12-month backlog is just a realization of the solid backlog we have to drive 2023 and now stepping into 2024 as well as part of that. With regards to the first part, John?

John Olin, CFO

Yes, in terms of our quarterly schedule, all of our equipment is under long-term contracts. We had a contract that was expected to be significant in the latter half of 2022 and in the first half of this year. This is related to the mix. We experienced an unfavorable mix in the latter half of last year, and we are seeing the same in the first quarter. We anticipate that the equipment group's elevated growth will transition into the second quarter. While we do not disclose specific growth figures from equipment, it is important to note that this level of delivery was planned for four quarters. We expect to see revenue decrease in the second half, just as it increased in the first half of last year. Additionally, the mix will also influence and enhance some of the improved margins in the second half of this year.

Unidentified Analyst, Analyst

Got it. Great, that’s very clear. Thank you so much.

Operator, Operator

The next question comes from Matt Elkott of TD Cowen. Please go ahead.

Matthew Elkott, Analyst

Good morning. The increase in the 12-month backlog, how much of it is due to delivery dates for some existing orders maybe being moved up, maybe because manufacturing disruptions are easing? If that’s a factor at all versus actual new order additions?

John Olin, CFO

Matt, when we look at it, there can be orders that move this quarter to that quarter just like our overall volumes. Over time, it’s nothing significant in the numbers. We saw a 4.4% increase in the 12 months, and ex currency was about 5.5% up. But any driver of the supply disruptions, a lot of that would have been baked in over the last seven quarters, right? And we’re seeing a little bit of release of that, but nothing of great significance on a number of that magnitude.

Matthew Elkott, Analyst

It's good to hear that. John, you mentioned the margin dynamics for freight. It's encouraging to see that freight margin remained strong despite significant equipment growth. If we assume a mix similar to last year’s first quarter and exclude the technology costs you mentioned, what would the margin have been instead of 19%?

Rafael Santana, CEO

Well, let me start here because I think the first thing is we will have significant variation, as John mentioned here, in terms of quarter-to-quarter. And some of it, it’s mix. I mean, John just told you here how we saw very significant growth on the delivery of new locomotives. But mods was significantly down in the quarter. We’ve got project specifics. We’ve got investments when it comes down to specialty R&D, which we continue to drive. And those will have variation quarter-to-quarter. And we’ve got still some of the elements of cost dynamics playing in. So I’d just be careful with some of those assumptions on how they play quarter-to-quarter as it will be bumpy from that perspective, but we feel very well about making sure that we deliver on the guidance we’ve provided.

John Olin, CFO

I would add that we are providing our outlook in halves because things can fluctuate between quarters. This aligns with what we anticipated and the guidance we've given. There are always various factors at play each quarter, but everything is in accordance with our expectations. We are confident about our margin performance as we enter the first quarter.

Matthew Elkott, Analyst

Got it. And John, you mentioned you haven’t taken market share in components. Is there any way you can update us on your average content now in railcars, both freight and transit and locomotives? And I guess, have you guys been realizing the revenue synergies one would expect now that you’ve worked through the locomotive backlog you inherited from GE, and are now taking orders as both the equipment manufacturer and the component supplier?

John Olin, CFO

Yes. We don’t provide that number. Actually, Matt, I don’t know the number, but we don’t provide it as well. So the other one, yes, we are seeing the opportunities. And as time goes on, in terms of the group working better and as equipment is selling products, we’re pulling as many things that we make across the board onto these things. So yes, we’re seeing strong revenue synergies in terms of, again, all of our products working in unison with one another to deliver the best locomotive we can to our customers.

Rafael Santana, CEO

Matt, if you go back to some of the comments we made earlier on, those who are around, I’ll call it, to translate to today, about $7,000 of content in a freight car that we would see on average. We have had the opportunity here to, as John described, win share. And that was largely due to some of the investments we did in inventory and the ability to ultimately be able to serve customers in that context. We do see an opportunity here, and we’ll continue to drive, I’ll call it, really entitlement and share into the products that we sell, especially as we go here into these battery electric locomotives, the opportunity to have a lot more content as we drive the integration of the system. And that speaks not just to the brakes but speaks to various other parts, including heat exchangers and things like that into the system. So I think we’re going to continue to see us driving share up. It’s a slow play game as you got to really work with customers that have fleets with auto systems deployed. And we got to make sure that we’re putting up also the services to be able to support them through that process. But it’s not an opportunity for growth for us and how we’ve been executing on it.

Matthew Elkott, Analyst

That’s a helpful number, Rafael, the 7,000 average. The maximum opportunity, my understanding is it’s closer to like 25,000 or 30,000. Is that true?

Rafael Santana, CEO

It will depend on the type of freight car. That’s why we provide that average number. However, it’s important to note that this figure is specific to freight cars and differs when considering locomotives.

Matthew Elkott, Analyst

Right. And transit is way, way higher, right?

Rafael Santana, CEO

It is higher. Again, it speaks to the various, I’ll call, critical systems that we have that sell out to doors, HVAC systems, call platters, brake systems, and so forth.

Matthew Elkott, Analyst

Okay. And just one final thing, Rafael. I think I might be overanalyzing this, but you mentioned that the underlying business fundamentals strengthened in the quarter. Was that specifically in reference to the strong results you achieved in the quarter or something else?

Rafael Santana, CEO

When I mentioned this in the context of transit, I was referring specifically to the comments I made. Overall, we observe this trend across the business. In transit, the underlying fundamentals are strong, with the book-to-bill ratio and the 12-month backlog increasing by over 5%, and even the multiyear backlog rising by over 9% on a constant currency basis. We are still seeing significant strength in the pipeline of opportunities. Similarly, in the Freight segment, we observe a comparable situation. The order question we received previously was mainly due to some multi-billion dollar contracts we secured in the first half of the year, particularly related to the modernization efforts with Union Pacific and NS.

Matthew Elkott, Analyst

Perfect. Thank you very much.

Operator, Operator

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

Kristine Kubacki, Vice President of Investor Relations

Thank you, Andrea. Thank you, everyone, for your participation today. We look forward to speaking with you again next quarter.

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation, and you may now disconnect.