Prepared remarks
Good morning, everyone, and welcome to Wabtec's Q2 2026 earnings call. With us today are Chairman 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. 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.
Thanks, Kyra, and good morning, everyone. We're proud of the progress we have made in the first half of the year, which is strengthening our position as a leading industrial technology company. It reflects the strength of the leadership position we continue to build across our portfolio and the continued focus of the Wabtec team to deliver for our stakeholders. With that, let's move to slide four. I'll start with an update on our business, my perspectives on the quarter, and progress against our long-term value creation framework. Then John will cover the financials. We delivered a strong first half of the year, which exceeded our expectations despite tariff headwinds, unfavorable business mix, and challenging prior year comparisons. Through disciplined execution across the organization, we achieved robust growth, expanded margins, and delivered double-digit earnings per share growth. Looking ahead to the second half, I remain encouraged by the healthy pipeline, continued demand for our core products and services, the profitable growth of our 12-month and multiyear backlogs, and our focus on driving productivity and efficiency. This momentum is evident in our Q2 operational execution and our overall financial results. Having said that, sales were $3.2 billion, which was up 17.5%. Adjusted EPS was up 22% from the year-ago quarter. Total cash flow from operations for the quarter was $441 million. Backlog remains a key strength. Twelve-month backlog was up 11% from the prior year, while the multiyear backlog exceeded $30 billion, up 42%. Our financial position remains strong. We continue to execute against our capital allocation framework and expect to continue to compound long-term value for our shareholders. Shifting our focus to slide five, let's talk about our 2026 end market expectations in more detail. While key metrics across our freight markets remain mixed, we continue to be encouraged by the overall strength and resilience of our business. We are seeing solid momentum in our international markets; the pipeline of opportunities across geographies remains strong. In North America, car load traffic was up 4% in the quarter. As a result of this growth, Wabtec's and the industry's active locomotive fleet was up compared to last year's Q2. Internationally, car loads growth during the quarter was mixed. The long-term car load growth trends continue to be robust. Significant investments to expand and upgrade infrastructure are driving our international orders pipeline. Looking at the North American railcar build, the industry forecast for new railcars is slightly up compared to the prior quarter and is now projected to be approximately 25,000 cars for 2026, which is still down 21% from 2025. Finally, turning to the transit sector, we continue to see positive underlying indicators for growth. Ridership continues to increase in key markets such as Europe and India, and we continue to see strong backlogs at car builders, supported by robust levels of public investment for fleet expansion and renewals. Now let's turn to slide six and highlight several recent business wins. During the quarter, we secured a billion-dollar order from an Australian customer, spanning locomotives, services, components, and digital solutions. This award highlights the breadth of Wabtec's capabilities and demonstrates how our integrated offerings are creating value throughout the product lifecycle. We also signed a $184 million order for Positive Train Control with Vale, strengthening our long-standing partnership and marking an important step forward in advancing rail safety, efficiency, and automation across Brazil's rail network. In transit, we were awarded a $55 million platform door order for the Grand Paris Express project. Moving to mining, our APAC team secured a $52 million order to supply drive systems for 240-ton mining trucks. Overall, these successes continue to demonstrate our leadership in the markets we serve, the strength of our pipeline, and the commitment of the Wabtec team to deliver meaningful results for our customers and stakeholders. With that, I'll turn it over to John to review the quarter, segment results, and our overall financial performance. John?
Thanks, Rafael, and hello, everyone. Turning to slide seven, I'll review our results in more detail. Our Q2 results came in better than expected, driven by stronger revenue growth and increased operating margin expansion. As we discussed in our last call, we expected the quarter's revenue growth to be similar to Q1's results. Q2 revenue growth came in stronger than Q1, driven by a combination of a couple things. First, we had favorable timing of shipments, and second, we experienced incremental flow business revenue. We also expected our margin expansion to be similar to Q1. In actuality, our operating margin expansion also came in favorable to Q1's results. This was driven by better-than-expected product mix and our continued focus on productivity and efficiency with programs such as Integration 3.0. Having said that, sales for the Q2 were $3.18 billion, which reflects a 17.5% increase versus the prior year, with strong contributions from both the freight and transit segments. Excluding the impact of currency, Q2 sales were up 16.6%. For the quarter, GAAP operating income was $600 million, which was up 27.1% versus the prior year. The increase was predominantly driven by higher sales, improved gross margin, and lapping prior year's transaction costs resulting from our recent acquisitions. Adjusted operating margin for Q2 was 21.9%, up 0.8 percentage points versus the prior year. This improvement was achieved despite tariff-related headwinds, unfavorable mix, and tough year-over-year comps. GAAP earnings per diluted share was $2.33, which was up 18.9% versus the year-ago quarter. During the quarter, we had net pre-tax charges of $6 million for purchase accounting charges and transaction costs associated with our recent acquisitions. In the quarter, adjusted earnings per diluted share was $2.76, up 21.6% versus the prior year. Overall, the quarter reflects the strength of our execution, the resilience of our business, and solid momentum as we move through the year. For the second half, we expect year-over-year revenue growth to temper as we lap the inclusion of Inspection Technologies in the prior year period. We also expect the majority of our margin expansion for the year to occur in the back half of the year. Our H2 margins are expected to benefit from, first, tempering year-over-year tariff impacts as we begin to lap 2025 tariff increases. Next, increasing productivity momentum from our Integration 3.0 and portfolio optimization initiatives. Finally, lapping more moderate prior year margin growth. When we look at the cadence of growth between the third and the fourth quarters, we expect revenue growth to be slightly higher in Q3 versus Q4. On the margin side, we anticipate the opposite dynamic. We expect a meaningful acceleration in margin growth in Q4, with Q3's performance generally consistent with the margin growth rates delivered in the first half of the year. Now turning to slide eight, let's review our product lines performance in more detail. Q2 consolidated sales were up 17.5%. Equipment sales were up 35% from last year's Q2. This was driven by higher locomotive deliveries and increased mining sales. Our services group drove strong core services sales growth in the quarter, which was offset by lower modernization deliveries, as we expected. Looking ahead, we expect modernization deliveries to grow in the second half of the year, returning services to growth in the back half. That said, we continue to expect full-year services revenue to be down due to the lower number of modernization deliveries that were shipped in the first half when compared to the prior year. Consequently, as modernization deliveries ramp up in the back half, we would expect equipment revenue growth to remain positive, but at a very moderate pace versus the 43% growth achieved in the first half. Component sales were down 0.7% versus last year due to the industry's decline in the North American rail car build and due to lower revenue from our portfolio optimization efforts, partially offset by increased industrial product sales. Digital intelligence sales were up 88.5% from last year. This was driven by contributions from the Inspection Technologies and Frauscher acquisitions. In our transit segment, sales were up 18.9%, driven by the Dellner acquisition and growth across our products and services businesses. Foreign currency exchange had a favorable impact on sales in the quarter of 1.3 percentage points. Moving to slide nine, GAAP gross margin was 36.5%, which was up 1.8 percentage points from Q2 last year. Adjusted gross margin was up 1.9 percentage points during the quarter. GAAP operating margin was 18.9%, which was up 1.5 percentage points versus last year. Adjusted operating margin improved 0.8 percentage points to 21.9%. Operating margin was positively impacted by cost recovery from contractual price escalation, increased productivity, and integration savings, partially offset by rising manufacturing costs, higher year-over-year tariffs, and unfavorable mix. Adjusted and GAAP SG&A expenses were higher year-over-year, due largely to the SG&A expense associated with our acquisitions. Engineering expense was $70 million, $20 million higher than Q2 last year, primarily due to acquisitions. We continue to invest in engineering resources and current business opportunities, but more importantly, we are investing in our future as a leading industrial technology company focused on improving our customers' fuel efficiency, labor productivity, capacity utilization, and safety. Let's take a look at segment results on slide 10, starting with the Freight segment. As I already discussed, Freight segment sales were up a strong 16.9%. GAAP segment operating income was $504 million, driving an operating margin of 22.5%, up 0.9 percentage points versus last year. Adjusted operating income for the Freight segment was $579 million, up 20.6% versus the prior year. Adjusted operating margin in the Freight segment was 25.8%, up 0.8 percentage points from the prior year. The increase was driven by higher gross margin of 1.7 percentage points, partially offset by an increase of 0.9 percentage points in our operating expense, expressed as a percentage of revenue. The key driver of this is due to the mix of higher gross margin businesses as a result of our acquisitions of Inspection Technologies and Frauscher, and our continuous focus on productivity and efficiency. Finally, the Freight segment's 12-month backlog was $6.64 billion. Our 12-month backlog was up 10.2%, while the multi-year backlog of $25.33 billion was up 47.8%. Turning to slide 11. Transit segment sales were up 18.9% at $936 million. When adjusting for foreign currency, transit sales were up 17.7%. GAAP operating income was $146 million, which reflected the quarter's robust revenue growth and operating margin expansion. These strong results were partially offset by $20 million of purchase accounting charges and non-cash amortization expenses, which were primarily associated with the acquisition of Dellner in Q1. Adjusted segment operating income was $166 million. Adjusted operating income as a percent of revenue was 17.7%, up 2.5 percentage points from prior year, with the underlying momentum of the business and the Dellner acquisition serving as key contributors to this quarter's margin expansion. Finally, Transit segment 12-month backlog for the quarter was $2.5 billion; our 12-month backlog was up 14.5%, while the multi-year backlog was up 19.4%. Let's turn to our financial position on slide 12. Our Q2 cash flow generation was $441 million, resulting in a cash conversion of 82%. Our balance sheet and financial position continue to be very strong, as evidenced by, first, our liquidity position, which ended the quarter over $2 billion, and our net debt leverage ratio, which ended the quarter at 2.2x. Our leverage ratio remained in our stated range of 2.0–2.5x, even after funding the purchase of Dellner during Q1 for approximately $1 billion, and repurchasing $457 million of our shares in the first half. We continue to allocate capital in a disciplined way to maximize returns with an expectation of compounding our earnings for our shareholders. During the quarter, we repurchased $215 million of our shares and paid $53 million in dividends. With that, I'd like to turn the call over to Rafael to talk about our 2026 financial guidance.
Thanks, John. Now let's turn to slide 13 to discuss our 2026 outlook and guidance. Overall, the team delivered a strong Q2 with operational results ahead of our expectations. Importantly, we continue to see underlying demand for our products and solutions across the business. That demand is reflected in a strong pipeline, and both our 12-month and multi-year backlogs provide clear visibility into profitable growth ahead. With that backdrop, we are increasing our full-year guidance. We now expect 2026 revenue of approximately $12.5 billion at the midpoint, up 11.5% from last year, which is an increase of one percentage point versus our prior guidance. We also now expect adjusted EPS to be in the range of $10.60 to $10.90, up 20% at the midpoint. Now let's wrap up on slide 14. As you heard today, our team continues to execute against our value creation framework and our five-year outlook. The strength of our performance is driven by our resilient install base, world-class team, innovative technologies, and our customer-focused approach. We are also encouraged by the integration and early performance of our recent acquisitions, which are strengthening our portfolios and expanding our total addressable markets for future growth. Overall, I believe Wabtec is uniquely positioned as a leading industrial technology company. With a strong foundation, a talented global team, and significant opportunities ahead, we are well-positioned to deliver profitable growth and continue to compound shareholder value over time. With that, I want to thank you for your time this morning, and I'll now turn the call over to Kyra to begin the Q&A portion of our discussion. Kyra?
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 are now ready for our first question.
Questions and answers
Our first question comes from Ken Hoexter with Bank of America. Please go ahead.
Hey, great. Good morning, and congrats on raising the outlook. Rafael or John, maybe you noted kind of the mixed carload outlook on a global basis, some wins on international, Australia in particular. Maybe thoughts on sustaining the 12-month backlog at that near one-time book-to-bill. Are you seeing — Rafael, just give an update on what you're seeing out in the market in terms of keeping that progress going on the orders?
Okay. Ken, in terms of demand and backlog conversion, we're seeing improved demand in the year, and we're converting a strong pipeline into multi-year backlog and higher margins. You certainly see that globally. You saw that strong win we had in Australia in Q2. We continue to have opportunities of size, and you're going to see a couple of those coming in the second half of the year, so strong from that perspective. On the execution front, I'd say we're continuing to drive better execution, and that's really coming with improved margins, and that's driven by productivity gains and the progress on simplification, Integration 3.0. Despite the headwinds we still face with inflationary pressures, still managing through tariffs, and chip shortages with impacts to electronics, I think the other item to highlight is the acquisitions, which continue to perform very well in the early days. Overall, it's been a stronger year with our teams delivering ahead of plan in support of long-term guidance. John, you might want to comment more on the specifics of the quarter.
When we look at Q2, Ken, revenue was ahead of expectations as well as earnings. Revenue was driven by a couple things. Number one, on a more sustainable basis, we saw our flow businesses accelerate, and that is on the freight side. As you pointed out, Ken, partially driven by the improvement in carloads, which has driven higher year-over-year locomotives and operations during the quarter. We also saw some strength in the aftermarket in our transit business. The other piece of our revenue in Q2 was some timing on shipments. We did see some pull forward from the back half into Q2. Also, as we talked about in Q1, we had lower organic growth earlier; we saw some push-outs that landed in Q2 as well. Overall, very strong revenue growth at 17.5% with organic growth up 8.5%. When you shift to the earnings side of it — and going back to revenue — the piece that is really more sustainable on the flow business, we've looked at that and forecasted it forward, and that growth is expected to continue in the second and the third and the fourth quarters at largely the same rate. That has resulted in us raising our overall revenue guidance by $110 million or a full percentage point on the year. Now we're sitting at a midpoint of 11.5%. On the other side is earnings. We did see earnings come in a bit more than what we had expected, and a fair amount of that was driven by two things. Number one is on the revenue: flow revenue typically comes at a higher margin, and we saw that reflected in favorable mix in that aspect. Overall, mix was still unfavorable, but less unfavorable than what we had anticipated. The other area is our integration and productivity came in stronger; we're making really good progress on Integration 3.0. With that, we extended that benefit over the back half, and that drove the increase in EPS guidance of $0.30 to $10.75 at the midpoint.
Hey, John, if I can just get a follow-up there. You mentioned 3.0. Can you talk about how much cost savings were realized? It sounds like maybe the message you're trying to give from margins into Q3 from Q2 based on the run-up you gave us.
Yeah. Ken, as you know, in Q1 we raised our guidance by $15 million on Integration 3.0. We saw the momentum and the timing of these projects at that time, and we've seen that convert certainly in Q2. We would expect from our original thoughts on the year that Integration 3.0 is going to deliver more benefit over the year. Again, that is part of that increase in the EPS guidance of $0.30.
Thanks, John.
Our next question comes from Scott Group with Wolfe Research. Please go ahead.
Hey, thanks. Good morning. If I look, the 12-month backlog's up 11%, the total backlog's up 42% year-over-year. I think that's the biggest spread we've ever seen between the two. I'm trying to understand what's the timing for that multi-year backlog to start converting to revenue? Ultimately, we had high single-digit organic growth in Q2. Is that sustainable?
Well, sure, thanks. I'll start with the total backlog. This is very strong coverage, Scott, to your point. That's how we run the business: make sure that we have that coverage. It's probably the strongest coverage we've had, and some of the multi-year backlog calls over really a multitude of years. That's very good and really strengthens our position to deliver on the long-term guidance we provide. In terms of the 12-month backlog, I think that number really supports the mid-single-digit growth of 5%–6% that we've described for the year. You have to extract from that some of the nuances associated with especially the acquisitions we've done. John, I don't know if you want to add to that.
Yeah. Scott, you had mentioned organic growth in Q2. When you look at our overall growth of 17.5%, the easy way to look at this is half of it, about 8.5%, is driven by the year-over-year impact of acquisitions. The other half of it, about 8.5%, is driven by organic growth. That's certainly an acceleration from what we saw in Q1. If you remember, Q1 organic growth was up 2.3% based on timing of shipments as well as the write-down of a digital project. I think the best way to look at organic growth is to look at it on an H1 basis that takes care of some timing nuances; on that basis, we're up 5.5%. We feel good about that. When you look at the 12-month backlog as an indicator, if you take out acquisitions and currencies and more normalize that, we are in that range of mid-single digits. We see that continuing in the back half of the year, given the strength that we're seeing in particular of our flow business.
Okay, that's helpful. One follow-up: your comment about the pace of margin suggests Q4 we see some really strong year-over-year margin improvement. Is that a good way to think about what 2027 could look like, that exit rate?
I would say looking at the half is more indicative. Let's talk about why we're expecting what we're expecting. We're expecting the majority of our margin growth to be in Q4. Why is Q4 expected to be up more? First, a year ago in Q4 we had very strong cash flow and cash conversion that was just shy of 300%. As I think you also know, our comp plans and focus on cash across the organization are embedded in both short-term and long-term comp plans; that drove a higher expense than we had anticipated last year. Second, our transit business had level-loaded some production a year ago and moved forward some benefit into Q2 and Q3, which resulted in weaker margins in transit in Q4 due to manufacturing inefficiencies as we rebalanced. We're lapping those two things that are not going to repeat this year. The other piece is tariffs. Our tariff expense is going to be relatively even between quarters this year; the comparable is very different. In Q3 last year we had very little tariff expense; Q4 last year we saw a large rise in tariff expense. That headwind in Q4 is going to drop significantly in comparison to last year. Between the confluence of those factors, we expect our Q4 to be up more than we would typically expect in a quarter with regard to margin growth.
Okay. Super helpful. Thank you, guys.
Thank you.
Our next question comes from Angel Castillo with Morgan Stanley. Please go ahead.
Hi, good morning, and thanks for taking my questions. I wanted to start on components. Could you unpack that a little more? You still have rail cars down, even though the outlook has improved a little, but the 1% decline is notable. You've talked about flow and mentioned industrials. Can you quantify how much the flow business has improved? How much is rail car OE down? On the industrials part, how is that progressing, particularly the data center portion of your components business? What are you seeing in demand there, and how is your strategy changing or evolving based on that demand?
Always a lot in components, Angel. I'll start and let John dive into some details. As we described, we saw North American freight volumes strengthening. With that, we saw more demand for parts and fleets being unparked. We've seen continued strength in the transit backlog. Specifically for components, despite the lower freight car build, our teams have continued to adjust operations to align with that volume. They've driven significant cost discipline and margin improvement for the business. We are continuing to see strong demand in industrial applications. That is particularly visible in heat exchangers, which go into power generation demand, and that's a positive for us.
Specifically, Angel, components were down seven-tenths of a percentage point. Over the last six quarters, we've really been bouncing around flat. The team has been absorbing a significant downstroke due to rail car business, which is about 60% of overall revenue. Another piece this year is the exit of some non-strategic business and revenue. The team is fighting from a cost standpoint and market share and offsetting as much as they can, and we are getting some help on the industrial side. We're not seeing a big shift in the industrial side over the last six quarters; it's up on a small basis and benefiting from some data center work. It's a small base but enough to largely offset what we're seeing from rail cars being down. We hope that rail car demand turns in 2027; early forecasts suggest that, but we expect a couple more quarters where rail cars are down in the 20% range.
Got it. That's very helpful. As a follow-up, could you unpack the data center portion of power generation separately from heat exchangers? How is that progressing versus any potential equipment demand, and how is your strategy evolving to target that market?
Angel, on the positive side, heat exchangers are a tailwind and are a significant offset to pressures on the freight car side. Regarding engines, our engines are built for very demanding applications and are exceptional for reliability and fuel efficiency. For data centers, a large portion is connected to backup power-only applications, for which our engines are generally not the most competitive solution. We are selectively looking into power generation opportunities where emission restrictions favor our solutions. This is a niche segment, and to date we've had only very nominal sales in that space.
Very helpful. Thank you.
Our next question comes from Bascome Majors with Stephens. Please go ahead.
Good morning, and thanks for taking my questions. I wanted to revisit the EVO Advantage modernization program. You reported quite a bit of orders earlier this year in that space. Can you give us an update on how the product is resonating with the Class I railroads in North America, where you are on the ramp-up of actual delivery, where you think you'll be at a run rate into next year, and how the pipeline compares to the backlog? Big picture, how do you expect that to evolve as the product gains traction?
Thank you. We've seen continued progress with the EVO Advantage program, which we announced in Q1. We got our first order in North America in Q2, consistent with expectations. We see that as an opportunity to continue momentum refreshing our install base globally, especially in North America, providing more value to customers through fuel efficiency and driving better outcomes for them. We are expanding the value we bring on fuel efficiency and widening our competitive advantage. It's early days, but positive.
You said first order in Q2. Just to be clear, the $1.3 billion in orders you received later last year was not for the EVO Advantage. The order conversion for this product is still mostly ahead, correct?
Exactly. That's correct.
Our next question comes from Rob Wertheimer with Melius Research. Please go ahead.
Thanks. Rafael, you touched on fuel savings. Given global uncertainty around diesel, could you remind us of the fuel economy savings on modernizations and new builds? How do your customers react — do they wait for elevated prices, park older locos and run newer ones, or does a diesel spike impact your business now?
Let me start high level. Rail is much more efficient at moving goods than road, which is favorable to our overall business. In North America, some freight movement has shifted into rail, and that translated into more visibility in our flow businesses, especially freight parts. We have not yet seen any shift in demand for modernizations or new units tied directly to fuel prices; demand has remained consistent with prior descriptions. Higher fuel prices are generally positive for the overall business.
Perfect. Then one more: are people still doing mods on older FDLs or waiting for EVO to be exciting?
Yes, they are. Keep in mind this is not just North America; international demand matters too. These programs drive roughly a 5%+ advantage on fuel, so the returns for customers are significant but customer-dependent based on application and fleet operations. It's early days for EVO mods, but it's good to see the first order in Q2.
Our next question comes from Ben Mohr with Citigroup. Please go ahead.
Hi. Good morning. Congrats on the quarter and the raise. Regarding the revenue-related backlog: your midpoint revenue guide raise of 1% — can you help parse how much of that is related to rail volume strength in North America in Q2 that could help generate non-backlog revenue? Your Q2 organic revenue was up 8.5%. You're guiding H2 organic revenue closer to mid-single digits. How much are you embedding continued rail volume strength to generate non-backlog revenue in the H2? Are you assuming the up 4% carloads persist, or is it more conservative?
The revenue raise of $110 million is largely driven by the flow business. About 30% of our business is flow and 70% is backed by long-term agreements. The growth we saw is coming from that flow business. For the half, carloads were up just shy of 3% on the half and 4% in Q2. We've looked at that and held the Q2 level throughout the back half in our planning. Looking at the revenue behind us driven by the flow business in Q2 and adding a similar run rate in H2 delivers the $110 million additional benefit.
I appreciate that. Also, congrats on the $1 billion Australia order. Has that entered into your Q2 backlog?
Yes, it has.
Related to that, are you still optimistic about potential orders from regions you've mentioned previously — Australia, East Asia, Uzbekistan, Mongolia, Pakistan, Brazil, parts of Africa — in upcoming quarters where you're still in one- to two-year negotiations?
Very much. We've been talking about Australia for several quarters and it materialized. International deals can take longer, but we feel strong about more than a couple of significant deals happening in the second half. They're meaningful and part of the pipeline that remains strong, providing increasing coverage as we look ahead.
Fantastic. Thanks for the time and insights.
Our next question comes from Steve Barger with KeyBanc Capital Markets. Please go ahead.
Hello. Good morning. This is Christian Zyla on for Steve Barger. Can you give us a sense of the current breakdown of the backlog for freight? Is it primarily equipment and services, or does it look more like the product mix for freight? Which category are you seeing the most growth in the backlog?
Christian, the backlog is predominantly equipment, which has longer lead times. The flow business doesn't typically fall into the 12- or multi-year backlog because it's more of a turn product. About 70% of our revenue falls into that backlog category, either 12-month or multi-year, and it's predominantly longer lead-time equipment.
Got it. That makes sense. Second question: on the international opportunities and the regions you talked about, are you starting to see deeper penetration for the digital offering internationally, or is it still mainly core equipment, mods, service, etc.?
We are seeing meaningful advancements internationally in technology, automation, and digital offerings. You saw our win on PTC 2.0; that's becoming a vital element of running railroads internationally. Combined with our Zero-to-Zero strategy, that brings advantages to customers. We're also advancing EVO Advantage and hybrid battery programs. These elements are driving significant opportunities for digital and technology penetration internationally.
Great. Thank you.
Our next question comes from Harrison Bauer with SIG. Please go ahead.
Great. Thanks for taking my questions. As you've implemented some of your tariff mitigation actions, have any of those changes proven structurally beneficial enough that they're likely to remain permanent regardless of how tariff policy evolves? Specifically regarding sourcing, localization, supplier diversification, and stickiness of pricing processes.
Thanks, Harrison. Some actions have proven beneficial and may remain, and some are awaiting further implementation depending on tariff stability. We have a four-point plan to minimize tariff impact, including working with the supply chain. Where possible we've moved products from higher-tariff areas to lower-tariff areas in the U.S. Many of these moves require investment to relocate production, so further changes depend on stability in tariff rates. Yes, some moves have been good and will remain in place if rates change again.
Okay, great. Maybe a follow-up on mix: within your long-term margin framework, can you help us understand the relative contributions from operational improvements, mix, and synergies from acquisitions? How much is natural maturation of the install base toward higher-margin aftermarket and digital revenue contributing to steady freight margin expansion over time?
Harrison, in the long term, we would expect some mix headwind as we grow mods and locals faster than average, but there's good mix and bad mix. The modernizations are good mix because they generate service revenue for decades. We've talked about roughly 350+ basis points of margin expansion over the long term. About two-thirds of that is expected to come from productivity: everyday productivity, lean, integration programs, and portfolio optimization. The remaining third comes from adding more value through pricing recovery and innovation. Most of our revenue, about 60%, has long-term contracts with price escalators, which helps recover inflation. Innovation and selectivity, especially in transit, will drive the remainder of margin expansion.
Thanks.
Our next question comes from Jerry Revich with Wells Fargo. Please go ahead.
Hi, good morning, everybody. Nice quarter. Rafael, on service: as we've seen these good freight volumes this year, has your service business picked up steam? Are you looking for the pure service part to accelerate? Regarding mods and the product lifecycle transition from FDL to EVO, are we thinking about mods being down again in 2027 versus 2026 given that transition? Can you calibrate that lifecycle?
Jerry, we've seen benefit from the flow business tied to volume growth and unparked locomotives. It's early to comment on 2027 specifically. Upside could come from customers continuing to unpark units and sustaining those levels. Productivity from Integration 3.0 could materialize faster and add upside. On the risk side, we remain mindful of inflationary pressures, chip shortages affecting electronics, the North American railcar build, and tariff-related changes. Execution remains a key variable. So far, the environment has been positive.
Okay, super. On transit, nice margin performance. Out of the legacy business excluding the acquisition, where are we in terms of the proportion of backlog that's at your target margin levels? Is it fair to think about margins in backlog as higher than what's flowing through to sales this year?
On transit, we've made great progress. Teams continue to drive productivity and simplify operating footprints. We see a clear path toward the high-teen margin performance we've described. Mix was a positive for the quarter, and the Dellner acquisition is performing well in the early days and is on track to deliver synergies. Overall dynamics are positive and ahead of plan.
Yep. Thanks.
Our next question comes from Tami Zakaria with JPMorgan. Please go ahead.
Hey, good morning, congrats on impressive results. Double-clicking on freight traffic: North America freight traffic accelerated notably in the quarter. What factors drove that — specific industries or broad-based? Do you believe this is sustainable going forward? Any color would be helpful.
Tami, we are seeing movement into rail tied to several factors: dynamics in the truck market, higher fuel prices, persistent driver shortages, and better service in rail. Those dynamics have contributed to positive results in Q2. We'll continue to watch whether customers sustain unparked fleets; that would be a source of upside. So far, it has not translated into a change in demand for mods or new units in North America; demand remains consistent with prior descriptions.
Understood. Thank you.
Thank you.
Thank you.
This concludes our question and answer session. I would like to turn the call back over to Kyra Yates for any closing remarks.
Thank you, and thank you everyone for your participation today. We look forward to speaking with you again next quarter.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.