Earnings Call Transcript - WAB Q4 2023

Operator, Operator

Good day, and welcome to the Wabtec Fourth Quarter and Year End 2023 Earnings Conference Call and Webcast. All participants will be in listen-only mode. Please note, today's 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 fourth 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 the 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, President and CEO

Thanks, Kristine, and good morning, everyone. I'll start with an update on our business, my perspectives on the quarter, our progress against our long-term value creation framework, and then John will cover the financials. We delivered a strong year with another solid quarter as evidenced by robust sales growth, margin expansion, and increased earnings and cash flow. We achieved this despite continued uncertainty in the broader economy and in the North America rail industry. Sales were $2.5 billion, which was up 9.5% versus prior year. Revenue growth was driven by strong performance from both the Freight and Transit segments. And adjusted EPS was up 18.5% from the year-ago quarter, driven by margin expansion across both segments. Total cash flow from operations for the quarter was $686 million, and total year cash flow was $1.2 billion. The 12-month backlog was $7.5 billion, up 10%, signifying continued momentum and visibility across the business into 2024, and total multi-year backlog was $22 billion. Overall, the Wabtec team delivered a strong year. Looking forward, I am encouraged by both the underlying momentum across the business, and the team's unrelenting focus on delivering for our customers. I believe Wabtec is well-positioned to drive profitable growth ahead. Our financial position remains strong. We continue to execute against our capital allocation framework to maximize shareholder value by investing for future growth and returning cash to shareholders. And as a result of our performance in 2023 and our confidence in the future of the company, our Board of Directors approved an 18% increase in the quarterly dividend and a $1 billion share buyback authorization that replaces our existing program. Shifting our focus to Slide 5, let's talk about 2024 and market expectations in more detail. While key metrics across our Freight business remain mixed, we continue to be encouraged by the strength of the business, international markets, and our robust pipeline of opportunities across geographies. North American carloads were up 2.8% in the quarter, while the active locomotive fleet was down slightly when compared to where the industry exited last year. Yet, we continue to see significant opportunities across the globe and demand for new locomotives, modernizations, and digital technologies, as our customers invest in solutions that continue to drive reliability, productivity, safety, and fuel efficiency. Looking at the North America railcar build, demand for new railcar showed growth in 2023 at approximately 45,000 cars. The industry outlook for 2024 is for about 38,000 cars to be delivered. Internationally, activity is strong across core markets such as Latin America, Australia, Africa, and Kazakhstan. Significant investments to expand and upgrade infrastructure are continuing to support our robust international orders pipeline. In mining, commodity prices and an aging fleet are supporting activity to refresh and upgrade the truck fleet. Finally, moving to the Transit sector, the megatrends of urbanization and decarbonization remain in place, driving the need for clean, safe, and efficient transportation solutions around the globe. Next, let's turn to Slide 6 to discuss a few recent business highlights. In North America, we won a multi-year order for over 200 modernizations from CSX, demonstrating customer demand for a best-in-class solution to improve productivity, while driving down fuel usage and emissions. Looking at our mining business, we are seeing continued momentum and visibility. The team signed orders totaling over $300 million in the quarter, which is up double digits versus last year. In Transit, we won a major order worth over $150 million to supply high-performance brake systems in India. These brake systems will provide improved operating performance, efficiency, and safety for a new line of 1,200 electric locomotives. Also, during the quarter, we announced our entrance into the railcar telematics market. Our innovative telematics platform will improve shipment visibility, it will increase on-time performance, and expand asset utilization to make shipping freight by rail more competitive. Finally, during December, we acquired the remaining 50% of our joint venture in Kazakhstan. This strategic acquisition enhances our manufacturing capability, both globally and in the region poised for continued long-term growth. All of this demonstrates the continued momentum across the business, the team's relentless focus on delivering for our customers, and strong pipeline of opportunities we're executing on. Wabtec is well-positioned to capture profitable growth with innovative and scalable technologies that address our customers' most pressing needs. Moving to Slide 7. Before turning it over to John, I want to briefly discuss our ability to deliver strong results through the economic cycle. Over the last four years, Wabtec has demonstrated a solid track record of managing through challenging markets and significant disruptions. We believe our favorable end markets, combined with our leading technologies and solutions, will enable us to remain resilient and more predictable. Our 12-month backlog of $7.5 billion provides significant visibility and support for growth. The 12-month backlog has consistently grown over the past four years, despite a challenging North America rail market and a volatile macroeconomy. And finally, we have consistently demonstrated our ability to execute our strategies, generate strong cash flow, deliver growth, and create value through disciplined capital allocation. Our track record of strong operating margin expansion across the business is evidence of our ability to deliver productivity, manage costs, and price for inflation. Our execution, combined with the strength of our business, leading products, and technologies, results in Wabtec being resilient through economic cycles, delivering predictable earnings and superior shareholder returns. With that, I'll turn the call over to John to review the quarter, segment results, and our overall financial performance.

John Olin, Chief Financial Officer

Thanks, Rafael, and hello, everyone. Turning to Slide 8, I will review our fourth quarter results in more detail. We finished the year with another solid quarter of operational and financial performance. Sales for the fourth quarter were $2.53 billion, which reflects a 9.5% increase versus the prior year. Sales were driven by strong growth across both the Freight and Transit segments. For the quarter, GAAP operating income was $308 million, driven by higher sales, improved gross margin, and focused cost management. Adjusted operating margin in Q4 was 17.0%, up 1.7 percentage points versus the prior year. This increase was driven by a higher gross margin of 1.2 percentage points and 0.5 percentage points of lower SG&A and engineering expenses as a percent of sales. GAAP earnings per diluted share were $1.20, which was up 39.5% versus the fourth quarter a year ago. During the quarter, we had pre-tax charges of $47 million, of which $19 million was for restructuring, which was primarily 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 addition, we are exiting some small non-strategic product lines and related assets, which generated a Q4 charge of $28 million. Finally, in the quarter, our acquisition of the remaining 50% interest in our LKZ assembly joint venture generated a gain of $35 million on our existing ownership interest. I will talk more about our progress on Integration 2.0 and portfolio optimization in more detail in a few minutes. In the quarter, adjusted earnings per diluted share were $1.54, up 18.5% versus prior year. Overall, Wabtec delivered another solid quarter, demonstrating the underlying strength of the business. Turning to Slide 9, let's review our product lines in more detail. Fourth quarter consolidated sales were up 9.5%. Equipment sales were down 19.3% from last year as higher mining sales were more than offset by lower locomotive deliveries during the quarter. Recall that second half locomotive deliveries, as planned, were significantly skewed to the third quarter. Total equipment sales for the year were up a very strong 15.8%. Component sales were up 17.4% versus last year, largely driven by the higher demand for railcar products, along with increased sales from industrial products. Sales also benefited from the acquisition of L&M earlier in the year by $32 million. Digital intelligence sales were down 6.7% from last year, which was driven by lower revenues in our North American market, partially offset by higher demand for international PTC, next-gen on-board locomotive products, and digital mining. Our services sales grew 23.9%. Sales growth was driven by significantly higher modernization deliveries. In contrast to new locomotive sales, our planned second half modernization deliveries were significantly skewed to the fourth quarter. Additionally, parts sales continued to show strength as our customers continue to recognize the superior performance, reliability, efficiency, and availability across their Wabtec locomotive fleets. Across our Transit segment, OE and aftermarket sales increased versus last year. Segment sales were up 14.3% to $728 million, reflecting execution of our growing backlog. The momentum in this segment is strong across our core markets as secular drivers such as urbanization and decarbonization accelerate the need for global investments in sustainable infrastructure. Moving to Slide 10, GAAP gross margin was 30.3%, which was up 2.0 percentage points from Q4 last year. Adjusted gross profit margin was up 1.2 percentage points, driven by higher sales, favorable price/mix, and foreign currency exchange, as well as improved productivity. Our team continues to execute well to mitigate the impact of continued cost pressures by driving operational productivity and lean initiatives. Now, turning to Slide 11. For the fourth quarter, GAAP operating margin was 12.2%, which was up 1.5 percentage points versus last year, while adjusted operating margin improved 1.7 percentage points to 17.0%. GAAP and adjusted SG&A expenses were down as a percentage of revenue as we leveraged higher sales with a strong focus on managing costs. Engineering expense was $61 million, about flat with Q4 last year. We continue to invest engineering resources and 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 segment results on Slide 12, starting with the Freight segment. As I already discussed, Freight segment sales were up 7.7% during the quarter. GAAP segment operating income was $246 million for an operating margin of 13.7%, up 1.2 percentage points versus last year. GAAP operating income includes $28 million of portfolio optimization costs. Adjusted operating income for the Freight segment was $347 million, up 22.2% versus the prior year. Adjusted operating margin in the Freight segment was up 2.3 percentage points from the prior year at 19.3%. The increase was driven by significantly higher gross margin, which benefited from higher sales, favorable price/mix, and improved productivity and absorption. At the same time, SG&A and engineering expenses were lower as a percentage of revenue. Finally, segment 12-month backlog was $5.45 billion, up 11.2% from the same period a year ago. The multi-year backlog was $17.83 billion, down 4.3% from the prior year. Both our 12-month and multi-year backlogs demonstrate good visibility into 2024 and beyond. Turning to Slide 13, Transit segment sales were up 14.3% to $728 million. When adjusting for foreign currency, Transit sales were up 9.9%. GAAP operating income was $86 million, up 36.5%. Restructuring costs related to Integration 2.0 activities were $17 million in Q4. Adjusted segment operating income was $108 million, which was up 13.7%. Adjusted operating margin of 14.9% was up 0.1 percentage points from last year, driven by the benefits of volume growth and Integration 2.0 savings. Finally, Transit segment 12-month backlog for the quarter was $2.01 billion, up 8.0% versus a year ago. The multi-year backlog was also up 9.7% to $4.17 billion. Moving to Slide 14, over the next two slides, I would like to touch on both our progress against our Integration 2.0 initiative as well as provide details on our portfolio optimization. The efforts of both these programs in 2024 will unlock greater profitability and margin expansion across the portfolio. With regards to Integration 2.0, recall that during our Investor Day in 2022, we announced a restructuring program comprised of estimated one-time expenses between $135 million and $165 million, that would yield an incremental $75 million to $90 million of run rate savings by 2025. These savings are to be achieved through a combination of actions which simplify, streamline, and consolidate parts of our operations. With program-to-date restructuring expenses of $118 million, we achieved $22 million of run rate savings as we exited 2023. We expect savings to ramp more meaningfully in 2024, and we remain on track to meet our 2025 goals. Now turning to Slide 15. As you are aware, we are very focused on driving improved shareholder value through the addition of strategic bolt-on acquisitions with accretive earnings, margins, and return on invested capital. In the second quarter of 2023, we acquired L&M, a business that is very complementary to our heat transfer portfolio and enhances our mining installed base. In the short time that we've owned this business, we are pleased with its performance, and more importantly, we are excited about its future potential for driving long-term profitable growth for Wabtec. Also, as Rafael stated, late in the fourth quarter, we acquired the remaining 50% stake of our unconsolidated LKZ assembly joint venture in Kazakhstan for $81 million net of cash received. As a result of the transaction, we recorded a $35 million non-cash gain in the quarter, which is excluded from adjusted earnings. Going forward, this business will be 100% owned by Wabtec and consolidated in our financial results. We would expect virtually no impact to sales and limited benefit to earnings in 2024. We're also announcing today the exit of some non-strategic product lines in 2024. Pruning of these product lines will improve focus in profitability while reducing manufacturing complexity. Sales from these product lines totaled about $110 million of sales in 2023 and represented a lower-than-average margin profile. The expected net exit charges of roughly $85 million are largely non-cash, of which we recognized $28 million of non-cash charges in our Q4 GAAP results. Both our progress against our Integration 2.0 initiative and the announced portfolio moves will help position Wabtec to drive multi-year margin expansion. Now, let's turn to our financial position on Slide 16. Fourth quarter cash generation was strong at $686 million, resulting in total cash from operations of $1.2 billion versus $1.04 billion in the prior year, an increase of 15.7%. Cash flow benefited from higher earnings and improved working capital. Our balance sheet and financial position continue to be strong. We ended the quarter with liquidity of $2.12 billion. And our net debt leverage ratio was 1.9 times at the end of the fourth quarter, which was favorable versus the prior year's 2.2 times debt leverage. During 2023, we invested $308 million on the strategic acquisitions of L&M and the LKZ joint venture, and returned $532 million to shareholders through share repurchases and dividends. Finally, we improved ROIC during the year by 1.2 percentage points. We continue to allocate capital in a disciplined and balanced way to maximize returns for our shareholders. Moving to Slide 17, quickly recapping the year. Overall, the team delivered a strong year for all our stakeholders. Despite macro challenges, we drove strong revenue growth, expanded our operating margins, and generated robust cash flows. The resiliency of the business and strong execution provides us with a solid foundation for profitable growth as we enter 2024. With that, I'd like to turn the call back over to Rafael to provide our 2024 financial guidance.

Rafael Santana, President and CEO

Thanks, John. Now, let's turn to Slide 18 to discuss our 2024 outlook and guidance. We believe that the underlying customer demand for our products and solutions continues across our business. This is the strongest order pipeline we've had since 2019. Our 12-month and multi-year backlogs, as well as our orders pipeline, continue to be strong, providing solid visibility for profitable growth ahead. The team is committed to driving top-line growth and margin expansion in 2024, despite an uncertain macroenvironment. With these factors in mind, we expect 2024 sales of $10.2 billion at the midpoint, over 5% growth versus last year, and adjusted EPS midpoint of $6.70 per share, up about 13% from last year. We also expect cash flow conversion to be greater than 90%. Looking ahead, I'm confident that Wabtec is well-positioned to drive profitable growth in 2024, which is aligned with our long-term financial framework. Now, let's wrap up on Slide 19. As you've heard today, our team delivered a solid quarter to finish out a very strong year, thanks in large part to our resilient installed base, world-class team, innovative technologies, and our continued focus on our customers. These results were in line with our long-term value creation framework. I'd like to take a moment to thank all the employees of Wabtec, whose dedication and focus on execution make these strong results possible. With solid underlying demand across the portfolio, increased visibility through our backlog, and intense focus on continuous improvement, 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 Kubacki, Vice President of Investor Relations

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

Operator, Operator

Today's first question comes from Justin Long with Stephens. Please go ahead.

Justin Long, Analyst

Thanks, and good morning.

Rafael Santana, President and CEO

Good morning, Justin.

Justin Long, Analyst

So, maybe to start with a question on Freight margins, if you look at the fourth quarter, we saw a decline relative to the third quarter, despite mix looking like it got better. Equipment sales were down a lot sequentially, services revenue was up a lot sequentially. So, can you talk about what drove that pressure kind of quarter-to-quarter in Freight margins, and what you're anticipating for the progression of Freight margins as we look at the 2024 guide?

John Olin, Chief Financial Officer

Yes. Justin, this is John. I probably wouldn't characterize it as pressure between the third and the fourth quarter. A lot of that is just seasonality of our overall margin structure. We've talked about the back-half margins versus year ago being the strongest in the back half and even stronger in the fourth quarter, and that's exactly what we saw with the fourth quarter, company margins being up 1.7%, but when we dig down a little bit deeper into that and we look at the Freight segment, they were up 2.3 percentage points. So, again, we feel real good about those margins that we did deliver in the fourth quarter in the Freight segment. When we look forward, we've talked about on the overall guidance, you've seen the guidance, and we would expect both our Freight and Transit segments to grow revenue as well as margin in 2024.

Justin Long, Analyst

Okay. Great. That's helpful. And I guess as a follow-up, I know we can see some lumpiness in the business on a quarterly basis because of mix and the timing of deliveries, similar to what we saw here in the fourth quarter. So, as we think about the 2024 guidance, is there anything you can share on the expected quarterly cadence of revenue and earnings?

John Olin, Chief Financial Officer

Let's discuss the quarterly performance. Any given quarter can be influenced by just a few locomotives. The key takeaway is that we anticipate revenue and operating margins to increase in 2024 compared to 2023, consistent with our long-term growth strategy. Specifically, we expect stronger revenue growth in the first half of 2024 compared to the second half, along with slightly higher margin growth in the first half as well. The factors affecting this timing are primarily related to volume, which depends on the schedule of locomotive and modification deliveries, along with comparison to the higher margins we experienced in the second half of 2023.

Justin Long, Analyst

Okay. Great. I'll leave it at that. Thanks for the time.

Rafael Santana, President and CEO

Thanks.

John Olin, Chief Financial Officer

Thanks, Justin.

Operator, Operator

Thank you. And our next question today comes from Matt Elkott with TD Cowen. Please go ahead.

Matt Elkott, Analyst

Sorry about that. Good morning, everyone. Can you guys give us some more insight on the 5% revenue growth at the midpoint, price versus volume? Are there any acquisitions baked in? I also ask because your backlog is 10% higher, and your revenue growth is 5%. Last year you did 16% revenue growth. Is it just a function of comps being more difficult for revenue this year?

Rafael Santana, President and CEO

Matt, a couple of things. First, the fundamentals for the business are strong. We have the coverage. We have the orders to execute here. The portfolio is well-positioned to provide customers with fairly a significant payback. Fleets are old. And we're still coming out of a trough in terms of customers' investments, India fleets. There's also significant drivers globally. International, as you've heard, is very strong, which drives demand not just on the locomotive front, but if you think about mining, transit, digital and the overall freight. Emissions, as you know, emission regulation is a tailwind for us. We have continued to expand our visibility with really improved backlog coverage, which goes beyond '24, and that really positions us well to deliver ahead of our long-term guidance. With that being said, our guidance takes into consideration a number of factors. If you think about '24, you still have North America carloads continues to be on the low end. We expect parkings to continue to go up, and freight car build is actually down. With that, our approach has consistently ensured really a strong say/do ratio with results ahead of our commitments, and we continue to be committed to overdeliver.

Matt Elkott, Analyst

That's helpful, Rafael. As my follow-up question, are the headwinds you mentioned the reason why the organic Freight revenue contribution to growth in the fourth quarter was lower than in the third quarter and essentially the lowest in the past couple of years, if I'm calculating correctly? Do you anticipate that trend will continue to decline in 2024?

John Olin, Chief Financial Officer

I'm sorry, Matt. I'm not sure I completely understand the question. Can you repeat the driver of...

Matt Elkott, Analyst

Yeah, John. Like the $92 million organic Freight revenue contribution in the fourth quarter, if I look back over the last two years, it's the lowest number we've seen from organic Freight revenue. Is that a function of the headwinds in the North American rail market? And do you expect it to continue to trend downwards?

Rafael Santana, President and CEO

So, let me just be clear here. Our backlog is strong. We feel good about it. The pipeline of opportunities shows it, as I said, the strongest pipeline we've looked at in the last five years. And despite some of the dynamics here, we just described to you in North America with carloads, and so forth, we're continuing to see really customers investing for cost, investing for reliability, and we continue to see both an element of growth both for us in North America and international. You're going to have variation here, as John described, quarter-to-quarter, but we're continuing to look at profitable growth as we go in '24, and most importantly, I think we've got a stronger element of international here that really provides us visibility now into '25, '26, and '27.

Matt Elkott, Analyst

Got it. Thanks, Rafael. Thanks, John.

Rafael Santana, President and CEO

Thank you.

Operator, Operator

Thank you. And our next question comes from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich, Analyst

Yes. Hi. Good morning, everyone.

Rafael Santana, President and CEO

Hi, Jerry.

Jerry Revich, Analyst

Hi, Rafael, I'm wondering if you could provide an update on how your customers are approaching the discussions with California regarding sub-Tier 4 locomotives in the fleet. How do you see the regulatory process and timeline developing? Is this influencing customer preference for new locomotives versus modifications that wouldn't meet the new CARB-proposed standards? Can you discuss the current trends and the timeline you anticipate for clarity within the industry?

Rafael Santana, President and CEO

Yes. So, Jerry, last November, CARB petitioned the EPA for a waiver and supports for regulation for in-use locomotives. EPA has not responded to California's waiver request, and the ruling became effective beginning of this year. On one hand, I'd say the outcome of the rule remains fluid, but we are technically very well-positioned to support our customers here for all outcomes. We have the best-in-class products, lowest fuel consumption, lowest emission, best reliability, best availability, and regardless of further regulation what I'll tell you the good news is, our entire installed base will be able to burn bio and renewable fuels. But what's more exciting to me is, our newer fleets, they will ultimately go beyond bio and renewable fuel. We firmly believe we can bridge customers here to their ultimate near-zero emission goals. We are aggressively testing alternative fuels, hydrogen being part of that mix in our newer internal combustion engines, and with really an eye towards enabling customer sustainability journey, and in parallel, we're integrating batteries, and ultimately hybrid systems into our fleet. So, we have not incorporated regulatory change into our guidance. So, that would be a tailwind for us.

Jerry Revich, Analyst

Super. And then, can I just ask, you've been very clear on the cash flow from operations conversion rate at over 90%. The CapEx that we're seeing at 2% of sales, is that the run rate that we should be thinking about, John? Are there any ebbs and flows as we think about what total net income to free cash flow conversion should be like over the next couple of years depending on your CapEx plan?

John Olin, Chief Financial Officer

So, when we look off over the rest of our investment horizon that we came out with a couple of years ago, we would expect 2% range of CapEx over that entire period of time.

Jerry Revich, Analyst

That's clear. All right. Thank you.

Operator, Operator

Thank you. And our next question today comes from Rob Wertheimer with Melius Research. Please go ahead.

Rob Wertheimer, Analyst

Thank you. Similar to Jerry's question, it seems you received a strong order for modifications from CSX. Could you provide some insight into the total number of modifications for 2023 and what that order signifies in context? Additionally, even setting California aside, how much are your North American customers considering new locomotives in light of their climate goals and maintaining an aging fleet? Do you believe it's feasible for them to meet their climate objectives with just modifications? Any thoughts on the current situation regarding modifications and the outlook for new locomotives would be appreciated. Thank you.

Rafael Santana, President and CEO

Hey, Rob. Our customers invest for returns at the end of the day. So, it just really comes down to making sure as they look into their fleets, they've got really the opportunity here to continue to drive costs down, to drive reliability up, and improve service levels, and I think that continues. When I look at that investment, of course, we're coming from trough levels here in the past. We have growth coming into '23. We have still significant growth in '24, and the recent order that you just referred to, it just gives us greater visibility into really continue to grow market. I think we still have, I think, an opportunity to grow here as we get closer here to what I'll call average replacement rates with really the older fleets we've had. I think some of the elements on what customers decide to invest in could be shaped here certainly by regulation, but most importantly, I think it's going to get shaped by some of the elements of technology that we're introducing, that allows faster payback, a greater payback, and greater flexibility to really, I'll call, ultimately bridge customers here into a lower emissions environment, and that's how we look at it.

Operator, Operator

All right. Thank you. And our next question today comes from Scott Group with Wolfe Research. Please go ahead.

Scott Group, Analyst

Hey, thanks. Good morning. So, within the...

Rafael Santana, President and CEO

Good morning, Scott.

Scott Group, Analyst

Good morning. Within the revenue guidance, just directionally, are you guys expecting better Freight or Transit growth? And when you just think about all the moving pieces with your growth, how should we think about mix as a tailwind or not this year?

John Olin, Chief Financial Officer

Thank you for the question, Scott. Looking at our five business groups for 2024, we anticipate that equipment will be the fastest growing segment, as Rafael mentioned previously. Additionally, we expect both mods and locos combined to grow at a rate exceeding our average midpoint revenue growth, which may result in some mix headwinds in 2024. I've indicated before that there are two types of mix: good mix and bad mix, and this situation reflects a good mix. As we adjust our offerings in the market, we are creating assets that will generate revenue for us over many years. Overall, we are optimistic about our progress, although we do expect some mix headwinds ahead.

Scott Group, Analyst

Okay, helpful. I just want to clarify about the modifications side. Have we seen the same consistent double-digit growth in modifications this year as we have in recent years? Also, do you have any updates on the battery locomotive and the timing for the first delivery? Thank you.

John Olin, Chief Financial Officer

With regards to the mods, we tend to look at one or the other, mods and new. If we look at combined mods and new in the year, we said they'd be up double digit, and they were in 2023. As we look forward as I had just mentioned, we do expect them to grow faster than the average, those combined, to grow faster than the average.

Rafael Santana, President and CEO

So, strong growth here going to '24, and, Scott, with greater visibility ahead. On your question on battery electric, we're continuing to make progress here. In the fourth quarter, as you know, we unveiled the first heavy-haul battery electric locomotive with over 7 megawatts of power. These units will start running this year in Australia. And on that, I think fuel continues to be one of the biggest costs for customers. There's a continued focus here on driving efficiency. We've got a number of pilots and demo projects, and while we do not expect broad adoption of these, there's going to be some really key opportunities here that we're ready to work on and support customers on.

Scott Group, Analyst

Thank you.

Rafael Santana, President and CEO

Thank you.

Operator, Operator

And our next question today comes from Allison Poliniak with Wells Fargo. Please go ahead.

Allison Poliniak, Analyst

Hi. Good morning.

Rafael Santana, President and CEO

Good morning, Allison.

Allison Poliniak, Analyst

Could you provide more details on the digital intelligence aspect of your business, especially in North America? It appears that growth in this area has been somewhat slower. Are companies delaying investments for cyclical reasons? Do the long-term drivers still remain intact? Any insights on this in the near term would be appreciated. Thank you.

Rafael Santana, President and CEO

Yes. So number one, I think during the quarter, I think in one side, while we saw higher demand from international, when you think about PTC, on-board locomotive, digital mine, we saw really a softer demand here, which is continuing with US, driven by really discretionary OpEx and the commuter signaling business. What I'd say is the pipeline of opportunities remains strong, driven primarily by international and also by digital mining solutions. I'd say recurring revenues in short-term convertibility continues to be a focus area for the group. But I think what's more exciting here, something we announced in the fourth quarter, which is really tied to us entering the railcar telematics market. We are creating a platform here with proven technology, and this is a market of 1.6 million freight cars. It is a multi-billion dollar opportunity for us, one that we will be providing real-time data to railcar, and tank car owners. And opportunities like this will keep propelling growth and profitable growth for this business.

Allison Poliniak, Analyst

Got it. And then, on the cost optimization, could you maybe give us any color on how we should think about run rate exiting 2024? And then, was that portfolio pruning part of that? Is that incremental? Just any color there. Thanks.

John Olin, Chief Financial Officer

Yeah, Allison. This is John. So, they're separate. Integration 2.0, we couldn't be more pleased with the performance of that. And, to-date, most of the investment is behind us, and most of the savings are in front of us. So, as we exited 2023, we had a run rate of $22 million. And as we exit 2025, the run rate that we will exit at will be $75 million to $90 million. So, over the next two years, we would expect a significant ramp in moving from $22 million to the $75 million to $90 million, and it will probably be somewhat equal as we ramp from here to on the exit period.

Allison Poliniak, Analyst

Great. Thank you.

Rafael Santana, President and CEO

Thank you.

Operator, Operator

And our next question today comes from Ken Hoexter with Bank of America. Please go ahead.

Ken Hoexter, Analyst

Great. Good morning. Rafael and John, could you discuss the differences between international and domestic product types? Additionally, please help us understand the margin variations or mix challenges as one grows compared to the other, within your 5% growth forecast.

Rafael Santana, President and CEO

When considering the revenue side, I mentioned a stronger international pipeline, which indicates significant growth prospects internationally, particularly beyond 2024. We have a robust pipeline of deals, some of which were signed last year, and we expect a portion of these to convert into backlog this year, highlighting the long-term strength of our business. In terms of specific margins, this is driven on a project-by-project basis, as John explained. There are still some headwinds linked to the rate at which we are growing both the new locomotive business and the modifications business, which is growing faster than the overall company.

Ken Hoexter, Analyst

So, maybe we can delve into that for a quick one from my follow-up, just the backlog conversion. It looks like the backlog is building up maybe double-digit rates, right? Freight is up 11%, Transit up 8%. Just wondering, is that a good signal, a read-through for that revenue growth? I mean, you're targeting 5%. The backlog is growing there double digit. How do we reconcile the two? Where's there a loss, I guess, in the conversion?

Rafael Santana, President and CEO

There are a few points to consider. We will experience variations from quarter to quarter. Over the last four quarters, we have seen both low-single digit and double-digit performances. We expect to see more of this variation. Our approach to running the business includes ensuring we have convertibility planned out for 12 to 18 months, which involves considering the lead times associated with our products. It's important to have that coverage in place. Specifically for 2024, there are aspects of coverage needed, particularly for the flow products, that must be executed throughout the year. Additionally, with a decline in freight car builds, there are factors that will unfold over the year. Overall, we are confident in both our coverage and our ability to continue driving profitable growth with the current pipeline.

Ken Hoexter, Analyst

Thanks, Rafael.

Rafael Santana, President and CEO

Thank you.

Operator, Operator

And our next question comes from Angel Castillo with Morgan Stanley. Please go ahead.

Angel Castillo, Analyst

Hi, good morning. Thanks for taking my question. I want to expand on that a bit and look at the longer term. As you consider your book-to-bill for 2024, specifically regarding new locomotives, how do you see that evolving? It seems like deliveries will increase throughout the year. Based on your discussions with customers, what are your thoughts on this for the year in terms of being above or below one? Any additional insights you can provide would be appreciated.

John Olin, Chief Financial Officer

Angel, on average, we expect our book-to-bill to be over 1 because we anticipate continued growth in the mid-single digits for the foreseeable future. However, some of these orders can fluctuate at times, and many are multi-year contracts, so we do not provide specific guidance on our forward-looking book-to-bill expectations. Nevertheless, we certainly expect it to remain above 1 over time.

Angel Castillo, Analyst

Got it. Could you quantify the impact of the portfolio divestitures or pruning on EPS within the guidance? Also, are there any additional pruning opportunities you foresee?

John Olin, Chief Financial Officer

When we examine portfolio optimization, our primary focus is on overall company profitability, and Integration 2.0 is contributing to that. Additionally, we are closely assessing the portfolio and identifying product lines that are not meeting our expected profitability or value. As a result, we are planning to eliminate about $110 million in revenue. It's important to note that this revenue will not be present in 2024, which contributes to some headwinds on our overall guidance midpoint. To address your question, this pertains to very low margin or no margin products. Consequently, it will not negatively affect our profitability moving forward, but it will lower our revenue, which may lead to slightly increased upward pressure on our margin percentage.

Angel Castillo, Analyst

Very helpful. Thank you.

Operator, Operator

And our next question today comes from Saree Boroditsky with Jefferies. Please go ahead.

Saree Boroditsky, Analyst

Thanks for fitting me in. So, you announced the $1 billion in share buyback authorization. Can you just talk about how you're thinking about using the cash flow this year between repurchases and M&A, the expected timeline for completing this authorization, and if any of this is baked into your EPS guidance for the year?

John Olin, Chief Financial Officer

So, Saree, number one is in terms of capital allocation, we are on track to do what we've done in 2023. Again, we couldn't be more pleased with the balance that we had in 2023 when you look at the free cash of about $900 million, operating cash of $1.2 billion, it would sound pretty split between M&A and share repurchases. When we look forward, as you know, we will prioritize M&A over share repurchases as long as we have good strategic bolt-on M&A. And if not, we will return excess cash to our shareholders in the form of share repurchases. In relationship to the authorization, it replaced the old authorization that we had. So, we've got the ability to spend up to a $1 billion in share repurchases. And again, that will be determined throughout the year as far as what we have in M&A opportunities.

Saree Boroditsky, Analyst

But is it fair to say that any additional share buybacks this year is not included in your EPS guidance?

John Olin, Chief Financial Officer

Our guidance includes all of our business aspects as well as the use of cash in 2024.

Saree Boroditsky, Analyst

Okay. So, it does include share buybacks?

John Olin, Chief Financial Officer

Share buybacks, M&A, or the use of that cash, yes.

Saree Boroditsky, Analyst

Okay. And then, for next question, I know you're hesitant to kind of put a number on Freight margin performance for this year, but maybe comment on incremental margins in Freight, because I think you should have easier comps with the absence of the strike, you have higher volumes, and you're exiting lower-margin products. So, what can we think about for incremental Freight margins this year?

John Olin, Chief Financial Officer

Overall, we can see the direction we're heading regarding incremental margins for the entire company. Freight will definitely play a significant role, but we also anticipate margin growth in the Transit segment. We are overcoming the effects of the strike we experienced, which is reflected in our overall guidance. When we evaluate the margins, we are observing positive productivity and absorption, along with the advantages from Integration 2.0 and the portfolio optimization mentioned. However, we will face some challenges due to an unfavorable mix.

Saree Boroditsky, Analyst

Great. Thanks for taking my question.

John Olin, Chief Financial Officer

Thank you.

Operator, Operator

Thank you. And our next question today comes from Chris Wetherbee with Citigroup. Please go ahead.

Unidentified Analyst, Analyst

Hey, thank you, operator, and good morning, everyone. This is Rob on for Chris. If I could dig a little bit further into Integration 2.0, it looks like on a run-rate basis, exiting 2024, more than double the savings. Can you give us a sense of the cadence you're expecting to realize that run rate throughout '24?

John Olin, Chief Financial Officer

Yeah. We wouldn't expect any unusual aspect of that. There's numerous projects that make up Integration 2.0, and most of them have all been executed. And now it is just different levels as the savings start to drive forward. So, for purposes of modeling, probably more straight line is more accurate than any other way to look at them, that build.

Unidentified Analyst, Analyst

That's really helpful. To follow up on Justin's question about the timing of earnings and revenue growth, could you provide more detail on the percentage of revenue expected in the first half compared to the second half? It's clear that the first half will have a heavier weight, but...

John Olin, Chief Financial Officer

Yeah, we would just expect revenue growth to be higher in the first half than in the second half, again, largely how we have some of our delivery of the high-ticket items planned. But, again, whenever you move a few locomotives from one period to the other, or deliveries a little bit ahead or behind, it's hard to get too fine-tuned on that. So, suffice to say that the first-half revenue growth will be a little bit higher than the second half.

Unidentified Analyst, Analyst

Understood. Appreciate the color.

Operator, Operator

Thank you. And our next question comes from Bascome Majors with Susquehanna. Please go ahead.

Bascome Majors, Analyst

You talked about a roughly neutral volume environment for North American rail. How much would that have to deteriorate to start to meaningfully impact your service revenue on the locomotive contracts?

Rafael Santana, President and CEO

What we described was that carloads are somewhat muted for the year, which has been factored into our guidance. However, I believe the ongoing opportunities for customers to invest for returns are more than compensating for this. This involves enhancing productivity, reducing costs, and in some instances, replacing three units with two. These factors are still in play, not just for 2024, as shown by the recent orders we've received. From a fleet perspective, service levels have remained stable, and we expect to continue facing favorable market dynamics in North America.

Bascome Majors, Analyst

And moving to international, on the buyout in Kazakhstan, you talked about not much 2024 impact from that. As you look out longer term, is the deal structured in a way where all of the benefits from any of this $2 billion-plus of MOUs converting to orders would accrue to Wabtec? And just longer term, when could that become a meaningful contributor to your overall profit profile? Thank you.

John Olin, Chief Financial Officer

I would consider the LKZ venture as an assembly joint venture. It doesn't affect our overall revenue growth or expansion into the CIS region. Instead, it enhances our supply chain. Many components we were handling through the joint venture involved kits produced with parts sourced globally. The joint venture primarily focused on assembly. Now, we have complete control over the operational supply chain in a region we anticipate will experience significant growth in the future.

Rafael Santana, President and CEO

We anticipate significant growth in 2024 and 2025, and we have the opportunity to use our manufacturing capabilities to export beyond Kazakhstan, which is a crucial aspect for us. Additionally, we have seen very strong returns.

Operator, Operator

Thank you. And our next question comes from Steve Barger with KeyBanc Capital Markets. Please go ahead.

Steve Barger, Analyst

Hey. Thanks. John, you said equipment will be the fastest growing group, but if I'm remembering right, that category is pretty evenly split between locomotive and mining, marine, and drilling. Are you thinking locomotive outgrows the industrial products, or do you expect more equal growth from those kind of two categories?

John Olin, Chief Financial Officer

Yeah. We don't break it out specifically, Steve, but when we look at 2024, our equipment group, we expect good growth out of both locomotives as well as mining equipment.

Steve Barger, Analyst

Got it. Thanks. So, similar growth rates, no big variance between the two?

Rafael Santana, President and CEO

Steve, it's, I think, a challenge here. Might have, again, variation as we go through it, but they're strong. They're strong, both strong, and a lot of it really internationally driven and beyond '24.

Steve Barger, Analyst

Got it. And for Transit, you're coming off a tough comp, but really the best growth in years. And with equipment and services on the Freight side outgrowing consolidated guidance, does that mean Freight is more like high-single digit for the year and Transit low-single digit?

Rafael Santana, President and CEO

We won't get into the specifics or guiding for Transit or for Freight. What I'll tell you, on Transit, the fundamentals for the business continue to be strong, book-to-bill ratio closed over 1 for the year. While we are pleased with the progress, we continue to do significant work here to simplify the footprint. This business will deliver on margin expansion in '24. Integration 2.0 is a significant contributor to that. But we will continue to have variation quarter-to-quarter, driven by really mix and timing of project.

Operator, Operator

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Kristine Kubacki for any closing remarks.

Kristine Kubacki, Vice President of Investor Relations

Thank you, Rocco, and thank you, everyone, for your participation today. We look forward to speaking with you next quarter.

Operator, Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.