WABCO Holdings Inc. (WBC) CEO Discusses Q2 2013 Results - Earnings Call Transcript

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WABCO Holdings Inc. (NYSE:WBC)

Q2 2013 Earnings Call

July 26, 2013 9:00 a.m. ET


Christian Fife - Vice President, IR

Jacques Esculier - Chairman and CEO

Uli Michel - Chief Financial Officer


Jeff Hammond - KeyBanc Capital Markets

Joe - Robert W. Baird

Jerry Revich - Goldman Sachs

Alex Potter - Piper Jaffray

Joel Tiss - BMO Capital Markets


Good day ladies and gentlemen, and welcome to the WABCO second quarter 2013 results conference call. [Operator instructions.] I would now like to turn the call over to your host for today, Mr. Christian Fife, Vice President of Investor Relations and General Auditor. Sir, you may begin.

Christian Fife

Thank you, operator. Good morning, everyone, and welcome to WABCO’s quarterly conference call. Today, we will present our second quarter 2013 results. With us this morning is Jacques Esculier, our Chairman and CEO; and Uli Michel, our Chief Financial Officer.

As a reminder, this call, webcast, and the presentation that we are using this morning are available on our website, www.wabco-auto.com, under the heading WABCO Q2 2013 Results. Replay of this call will be available through August 1st.

Also, as shown in chart two of the presentation, certain forward-looking statements that we’ll make today are based on management’s good faith expectations and beliefs concerning future developments.

As you know, actual results may differ materially from these expectations as a result of many factors. Examples of these factors can be found in our company’s Form 10-Q, which was filed with the SEC this morning, and our quarterly reports.

Lastly, some of our remarks contain non-GAAP financial measures as defined by the SEC. Reconciliations of the non-GAAP financial measures to the most comparable GAAP measures are attached as an appendix to this presentation and to our press release from this morning, both of which are posted on our website.

I will now turn the call over to Jacques Esculier.

Jacques Esculier

Thank you, Christian. Good morning, good afternoon, ladies and gentlemen, and thank you for joining us today for this call. Before we jump to the details of the results of our second quarter, I’d like to kind of frame it and highlight two strong achievements of the quarter.

The first one is that we have raised our level of outperformance in a market that continues to be sluggish, but we are now reaching a level of outperformance that is close to our committed 8-10% range. And we are doing this through an increase in content per vehicle, through increase in our share of the market, as well as aftermarket growth that is, today, reaching over 8%.

The second highlight I would say is that we are, again, breaking a new record in performance EPS, and not by a little, by just a full $0.07, reaching $1.30 per share. So I would say all in all, it’s another strong quarter we delivered to our shareholders in a market that is still very challenging.

So now looking at the details of the performance, starting with the top line, our second quarter sales went up 6.8% in local currencies versus a year ago. Our gross profit margin ended up at 30.5% for the quarter, leading to an operating income of $91.7 million, for a margin of 13.5%, generating a performance EPS of $1.30 versus $1.19 a year ago, leading to a free cash flow of $78 million, which represents a conversion rate of 95%, by which we returned $50 million to shareholders, continuing our share buyback program. We have repurchased this quarter 722,000 of these shares. And we are in a position, as you will see later, to nicely upgrade our guidance for the full year 2013.

Turning to the following page, and again as we do every quarter, reviewing the profile and structure of our top line, starting with the fact that, again, we grew organically 6.8% this quarter versus a year ago.

As you notice, it’s exceptional, so we want to highlight it, there is no translational adjustments because the level of exchange rate between U.S. dollars and European euro was fairly stable. However, as you will see later, there is a significant headwind generated through transactional FX, because we have seen a further erosion of the Brazilian real versus the U.S. dollar. But we will go through that in more detail later on in the presentation.

Looking at the different channels for revenues, starting with the OE truck and bus, revenues are up 9% versus a year ago, and 11% sequentially versus Q1, obviously supported by this forecasted very strong rise in the number of trucks and buses built both in Europe and in the U.S. Q1 to Q2.

Aftermarket growth, as I said, was actually slightly more than 8%. Now, when we take the impact of these field campaigns that were launched a year ago, that consist of replacing with WABCO air disc brakes our competitors product at a leading European OE, because it’s starting to fade out now, actually taking it into account, our aftermarket sales would have grown 10% year over year.

Sales to our JVs is down 6%, mostly driven by a continued slowdown in vehicle production in North America versus last year, as well as some rationalization of inventory at our joint venture in the U.S.

Now looking at WABCO’s revenue performance versus the dynamics of market in each region, starting with Europe, you can see that WABCO has outperformed Europe again very strongly third quarter at 10%, driven mostly by an increase of our share of the market.

In North America, we outperformed by 7%, there driven by a continuous increase in content per vehicle. We have sold 60% more OnGuard collision mitigation systems this year as compared to a year ago, and we are cranking up nicely the volume of AMTs in the last quarters.

In South America, we also very strongly outperformed the market, and this is supported by the fact that we have a premium position in providing ABS systems to the market, driven by the fact that the ABS is mandated in Brazil since January 2013 for 40% of the fleet. As a reminder, the other 60% of the field will be covered by this mandate starting on the first of January, 2014.

Japan-Korea is also outperformed by 9%, and that [unintelligible] a favorable vehicle mix in Japan, whereby actually there is less vehicles exported, more domestic vehicles, with more content, as well as a higher level of EBS/ABS content in Korea.

China underperformed by 17%, and that’s due to the fact that even though we have seen a strong rise in production year over year of 36%, the market is expecting a significant slowdown in production in the third quarter versus the second quarter in the range of about 30%. So the truck and bus OEs are starting to decrease the level of inventories to align with this significant slowdown.

India continues to see erosion in its markets, and we continue to underperform because this erosion is affecting mostly the heavy multi-axle vehicles with more content.

Overall, as I said, we have been able to generate a very solid level of outperformance in a market that is still eroding and challenging.

I will let now Uli drive you through the details of our performance and financial results. Uli?

Uli Michel

Thanks, Jacques. Good morning everyone, and thank you for joining us today. I will take you through our financial results for the second quarter of 2013. Turning to chart five, I will walk through the details from sales to earnings per share for the second quarter, looking at both our reported and performance numbers.

Performance numbers are adjusted to remove operational streamlining and separation costs as well as discrete and other tax items. In addition, comparisons to 2012 have been adjusted for currency translation effects.

Our sales in the quarter increased 6.8% in local currencies versus last year. This was a 3.2% sequential increase in revenues from the first quarter. The increase in sales versus last year includes price reductions to customers of 1.1%, which brings us closer to the normal levels of our business. Our total order book has seasonally decreased by 2.9% versus the end of March.

In this environment, we were able to improve gross profit by 4.8%. Our productivity initiatives keep delivering at high levels. Materials productivity projects delivered 4.8%, which was partially offset by commodity inflation, resulting in net material productivity of 4.5% for the quarter, and a reduction of material costs by $14.3 million.

Conversion productivity was 6.2% for the quarter, saving $6.4 million in conversion costs. We are pleased to report the combined U.S. dollar amount of material and conversion productivity achieved in the second quarter represents an all-time quarterly record. The impact of volume, mix, and better fixed cost absorption generated $10.7 million of additional gross profit while inflation on labor costs added approximately $3.5 million to our cost of sales. All these items combined result in a solid performance gross profit margin of 30.5% this quarter.

In operating expenses, we continued to increase spending in research and development activities and to support our globalization strategy. This quarter, altogether by $3.1 million.

Incentive compensation expense was $5.2 million higher in Q2 2013, versus Q2 2012. Labor inflation and other costs added $2.9 million to operating expense in the second quarter. All in all, this resulted in $11 million increase in operating expense in the second quarter versus a year ago, which represents an erosion to margin of 61 basis points on a performance basis.

So, all together, we generated operating income of $91.7 million, or 13.5% of sales, on a performance basis, representing a drop of 118 basis points. These 118 basis points take into account a $12 million year over year unfavorable impact of transactional foreign exchange. You might recall that last year’s Q2 was favorably impacted by $5 million of exchange gains from our balance sheet exposures.

Absent a foreign exchange impact, our incremental operating margin was 24% on 6.8% sales growth. This performance is better than the margin framework we had provided you with.

Continuing down the income statement, you can see that this quarter equity income was $5.3 million, which is up from a year ago, primarily driven by an increase in our North America joint venture by $500,000.

The expense to minority shareholders amounted to $2.6 million this quarter, compared to the expense of $3.3 million a year ago. Our performance EBIT this quarter was $94.9 million, or a margin of 14%.

Moving to taxes, you’ll see that our reported U.S. GAAP tax expense for the quarter was $9.7 million, reflecting the net result of taxes on earnings in profitable jurisdictions, partially offset by fully valued net operating losses, an accrual release due to settlement of a foreign tax audit, and certain foreign tax planning.

Excluding discrete tax items, our performance tax expense was $12.3 million, which reflects a year to date true up to our revised performance tax rate of now 14% for the full year, driven primarily by higher profits in Europe.

After excluding the nonperformance items, net income attributable to the company was $82.4 million. With regards to earnings per share, this translates to $1.30 on a performance basis, a new quarterly record. In summary, we are extremely pleased with the levels of profitability for the quarter.

Turning to chart six, I will now take you through our cash flow for the second quarter of 2013. You can see that working capital increased by $5.1 million in the second quarter. This increase is entirely driven by the increase in business activity. Our days sales outstanding, past dues, inventory turns, and days of supply all improved versus March.

Change in assets, liabilities, and other noncash items were unfavorable by $10.5 million. This is reflective of a multitude of items. The predominant driver this quarter is an increase in Chinese notes receivable due to the sequential quarterly improvement of business activity in China.

All this resulted in a net operating cash flow of $92.1 million. Net cash used for purchases of property, plant, equipment, and computer software totaled $20.6 million for the quarter.

We continue to support the growing regions and new business we have won with increased investment. Therefore, free cash flow was $71.5 million, or $78 million when excluding the streamlining and separation payments made throughout the quarter, resulting in a conversion rate of 95%, on our performance net income attributable to the company of $82.4 million.

Under the share buyback plan that we implemented back in June 2011, we repurchased another 722,000 shares in the second quarter at a cost of $50 million. As of the end of Q2, we still have $390 million left under our existing buyback authorization. For the time being, we intend to keep returning free cash flow back to our shareholders through this buyback program.

Overall, we are pleased that in these uncertain market conditions we continue to generate strong free cash flow and can use this to enhance shareholder value through the share buyback.

I now would like to turn it back over to Jacques, who will highlight the current market dynamics. Jacques?

Jacques Esculier

Thank you, Uli. Turning to page seven, and looking at the evolution of our market as forecasted for the next third quarter in the different regions of our world, starting with Europe, we just got this morning the results of registration for Western European trucks. It’s down 5.8%, leading to an 11% erosion of registration in Western Europe for the first six months of this year versus, obviously, a year ago.

When we look now at Q2 itself, production level was down 4% year over year, but up a very healthy 16% versus Q1, which was actually even beyond what we had forecasted at that time.

Now, looking ahead, the next half of 2013 is planned to provide us with an additional 5% increase versus the first half, mostly driven by a raised assumption of the impact of a pre-buy effect. During the last quarter, we had anticipated 10,000 trucks. Again, today, we kind of see most probably 15,000 to 20,000 trucks being part of this pre-buy.

And all together, for the full year 2013, our outlook will go from 0 to minus 3, the way it was presented to you three months ago, to minus 2 to plus 2 today.

Moving to North America, our production in the second quarter was down 5% year over year, but up a very strong 21% versus Q1. And when we look at H2, we see it fairly flattish versus H1, leading to a production outlook which is similar to what we had previously shared with you in the range of minus 5% to minus 10%. I think there is still some potential upside if the economy continues to grow in that part of the world.

Moving all the way to China, second quarter production was up 36% year over year, and up 15% versus Q1. However, looking to the next two quarters, we think they’re going to be down all together 30% versus the first half. But because the second quarter was much stronger than what we had anticipated, we see the overall 2013 level flat to plus 5% at the end of the year versus 0 to minus 5% that we had previously forecasted three months ago.

India, production level was down a further 11% versus 2012 second quarter and down sequentially 1% versus Q1. We still forecast an improvement in the second half versus the first half. However, given the continuous weakness of the market, we degraded our forecast and outlook from 0 to minus 5 to minus 5 to minus 12 range, and this because of a continuously weak economic environment out there.

Turning to page eight and moving to Japan-Korea, production for those two areas was down 10% versus a year ago, but up 5% versus Q1. As I said, there is a stronger decline for export vehicles in Japan as compared to domestic, which is favorable to our content per vehicle. For the second half we see it still 10% above the first half, leading to a production outlook which is still unchanged compared to the last forecast we shared with you, minus 3 to minus 8 range.

Brazil, production level was up a very strong 49% year over year, and still another 14% versus Q1. However, given the weakness of the economy and the continuous erosion of the support from the government, from an incentive program standpoint, we still think the second half will be about 20-25% lower than the first half.

Overall, for the production outlook, we actually increased it by 5% as compared to what we had shared with you during our last call, ending up in the range of 15-20%.

Moving throughout the market, again, as I said, the campaign to replace our competitors air disc brakes at a leading OE in Europe is starting to slowdown in Q2, and will progressively fade out across the remainder of the year. Today, the outlook for aftermarket is raised from 5% to 6%. Now, excluding the impact of the campaign altogether in 2012, 2013, we would be left with an outlook of the remaining aftermarket business of 7%.

Finally, trailer [world], down 6% year over year and up 6% versus Q1. We see H2 flat to H1 in volumes and our production outlook remains the same, flat to minus 5%. So we are, at the end, still in a fairly hesitant and sluggish market that I would even continue to call capricious.

Moving to the next page, and kind of sharing with you achievements along the three pillars of our strategy, starting with globalization, we opened our new and first factory in Russia, in the [Ural] region. And this is actually the 20th plant that WABCO has opened in 10 countries across four continents. This factory is aimed at supporting a local truck maker, UralAZ, which is part of the GAZ Group, which is Russia’s largest maker of commercial vehicles.

We entered into an agreement with Agrale, which is a local manufacturer of trucks and buses in South America, based in Brazil and Argentina, for the supply of hydraulic ABS systems. And finally, we are the first and still only company as of today to have received a license from the Chinese government to remanufacture air compressors for the local markets over there.

Looking at new technologies, I’d like to share with you the results of a study published by NHTSA relating to a study conducted by the University of Michigan using WABCO’s OnGuard collision mitigation system and recognizing the strong value of this product to lower the level of accidents and fatalities on the road.

And finally, we entered into series production of the 12-volt version of our new, automated manual transmission to support Daimler Trucks in North America.

And then finally, on the execution pillar, I would like to share with you that we received a quality excellence award from Hino Motors in the U.S., being, as you all know, a division of Toyota. And that recognized our performance of zero defects per million parts throughout 2012 as well as a perfect on-time delivery level of 100% for that year.

We also received a very prestigious quality award from PACCAR, which is the top [unintelligible] for supplying the DAF Company in the Netherlands. And then as Uli said, we have reached very strong levels of productivity for the quarter that all together, in dollar terms, represents an all-time record, again kind of supporting the efficiency and strength of our overall operating system.

Turning to the next page, I’d like to share with you the update and upgraded guidance. Starting with the top line, sales growth will end up in the 5-8% range, coming from 3-7%. It’s here interesting to notice that this upgrade in the sales growth level is not driven by changes in the markets, because if you kind of go back and summarize all the movements and changes we have made in the forecast of the different markets, it actually results in a flattish market overall globally for WABCO.

The increase is really driven by enhancements of our performance level, again through further gains in market share, through further increases in aftermarket growth year over year, as well as enhanced content per vehicle in the different regions we serve. That drives to a reported sales of $2.625 billion to $2.7 billion. We also upgraded, in parallel, our performance operating margin to the 13% to 13.5% range, overall leading to a performance EPS nicely increased to a level of $4.70 per share to $5 per share, still maintaining our commitment of a free cash flow conversion in the 80-90%.

We have, on the right side, as you can notice, updated and upgraded our key assumptions, starting with price erosion. We used to aim at a range of 1% to 1.5% erosion that we kind of frame to 1.1% to 1.3%. Raw material inflation was anticipated in the range of 0.5% to 1%. We think it’s going to be actually about half a point of material cost.

Performance tax rate used to be kind of 15%. We believe we can be at 14% at the end of this year. So that’s, again, the assumptions sustaining and accompanying the upgrade of our guidance.

Turning to the last page, and as a summary, overall for this quarter, we have enhanced our ability to continuously outperform our market, which, by the way, in parallel, is not itself really seeing any improvement. Still very sluggish and uncertain.

We also continue to deliver very strong productivity at record levels, leading to another record quarterly performance EPS at $1.30, and still delivering an extremely strong conversion rate of 95% through a continuous discipline in the management of our cash flow.

We’re able to upgrade our guidance. We continue our share buyback programs, and I can tell you at this time that WABCO is today more than ever ready to grab and benefit from any market uptick.

So this is the end of the presentation, but before I turn it to a Q&A session, I would like to briefly touch on another item that we reported today in our 8-K filing. After 10 years spent with WABCO, first as we were an American standard company and then as we grew as a public company, our CFO, Uli Michel, has resigned from his position to take on a new challenge with another company, which is in a very different sector.

I would like to take this opportunity to recognize Uli’s dedication and commitment and contribution as a senior leader of our business, and thank him for his support. We particularly appreciate how he has guided WABCO’s financial controls and management reporting, successfully supporting our business growth and global expansion.

Uli’s efforts have also contributed to WABCO establishing a strong reputation with our external stakeholders and investors, and we are very excited for Uli as he takes on this new opportunity, and we wish him every success.

We have, obviously, already initiated a search for his replacement, and Uli will stay with us until October 11 of this year. Uli can also leave us with the reassurance that his team, the finest team at WABCO, is actually well-positioned to continue to support our business as we move forward on our successful path.

And now I would like to let Uli say a few words. Thank you.

Uli Michel

Thank you for the kind words, and for the complimentary tone. I would like to thank WABCO for the many rich opportunities that I have had during the last decade to grow and gain experience. It has been an immense pleasure to work in such a dynamic and exciting company.

I would also like to thank Jacques personally and the finest team here at WABCO for creating with me the financial environment on which WABCO’s reputation with our investor community is built on.

I have every confidence that the WABCO team will continue to deliver and execute along the strategic path that we have laid out to deliver value to our shareholders. All the growth drivers are solidly in place and the WABCO operating system is delivering better results than ever.

My resignation is an entirely personal decision that simply presents me with a compelling opportunity to push myself in a new direction in another, completely unrelated, industry.

Last but not least, I would like to thank you, our shareholders, and the analyst community, for the confidence you have placed in me and the successful relationship that you have established with the team. I wish everyone continued success with WABCO.

Now, I would suggest that we open the call, or the microphone, for questions. What do you say, Jacques?

Jacques Esculier

Okay, thank you, Uli. So, operator, could you please switch to the Q&A session?

Question-and-Answer Session


[Operator instructions.] Our first question comes from the line of Jeff Hammond of KeyBanc Capital Markets. Your line is open. Please go ahead.

Jeffrey Hammond - KeyBanc Capital Markets

Just to be clear on Europe, Jacques, would you attribute all of your improvement and your assumptions to what’s a little bit of a higher pre-buy? Or are you seeing some signs of underlying fundamental improvement in Europe? And maybe just comment on the aftermarket dynamic in Europe specifically?

Jacques Esculier

We don’t really know yet. I think we have more customers right now convinced that the impact of the pre-buy will actually be stronger than anticipated originally at the end of this quarter as compared to last quarter. So I believe this will have an impact overall in this outlook for the second half of the year.

To be fair, I don’t think that there are really compelling arguments that would sustain the kind of belief that the economy overall would improve in the second half of the year, even though there are some articles, as you know, probably floating around through the press today, that things seem to be slightly better.

And obviously any improvement in the overall economic environment is more than welcome for us, and we will know how to leverage it completely.

I would say in our forecast right now, we have more limited it to kind of purely increase our assumption around the pre-buy.

Jeffrey Hammond - KeyBanc Capital Markets

And along those lines, what are your customers telling you about summer shutdowns? Are they taking shorter shutdowns because of some of this increased activity?

Jacques Esculier

No, actually, the message we have received from each customer right now is actually showing that the pattern is a very normal pattern, and doesn’t really kind of demonstrate any need to increase production beyond the normal schedule.

Jeffrey Hammond - KeyBanc Capital Markets

And just back to aftermarket, are you kind of indicating that the aftermarket growth was more a function of your outgrowth? Or is there some kind of underpinnings of some macro improvement in that aftermarket data?

Jacques Esculier

Well, it’s hard to analyze aftermarket. What I can say is, we always kind of said that a good way to anticipate what could happen in the OE world with obviously all limitations that are necessary to maintain here, there are two things.

First of all, as you know, we keep kind of adding sources of new revenue. I’m talking about remanufacturing activities and talking about this diagnostic system and whatnot. So all those activities by themselves, they’re there to kind of bear some good fruit for us. Also, geographical penetration, the aftermarket revenues actually growing quite nicely beyond Europe.

So I don’t have, yet, very refined analysis that would allow us to kind of see what products, what region, whatnot. I would take it as good news, actually, very frankly. And we are pretty happy when we get good news from the market. But I still would take it with a certain level of caution.


Our next question comes from the line of David Leiker of Robert W. Baird. Your line is open. Please go ahead.

Joe - Robert W. Baird

Hi, this is actually Joe on the line for David. Just wanted to say, with the sales growth, the OE sales growth, in Europe, which was pretty strong this quarter, you said there were some share gains. Is there a way to maybe talk about specific products, a segment of the market’s customers, that’s driving the share improvements?

Jacques Esculier

I would say that we have gained some share at one customer against our competitor. A couple of competitors, actually. We continue to really see nice penetration of our air disc brakes, actually, in terms of share of the customer where we launched it a couple of years ago. And we have, again, kind of gained some share at another customer in Europe with some mechanical systems around air management. I cannot be more accurate than that, unfortunately.

Joe - Robert W. Baird

With the issues the competitor faced in air disc brakes that you’re helping out with on the aftermarket side, is that beginning to kind of carry through in quoting activities with new customers, with maybe the OEMs second guessing a decision to maybe use the competitor instead of WABCO?

Jacques Esculier

I would rather not comment on this situation here, but I would let you pull the conclusions of the situation yourself. But obviously it’s helping us more than our competitors.

Joe - Robert W. Baird

Okay. Switching gears to the margin, in thinking about incremental margins, you’ve delivered pretty strong productivity gains for several quarters while volumes and market volumes have been declining. I would think that on a more efficient manufacturing system and now you’re in a position to have higher volumes running through that your incremental EBIT contribution should be wider than the typical ranges you targeted and talked about eight quarters ago, before you accrued these gains? Is that a fair assessment? Or is there some offset that actually dilutes what I’m thinking about?

Jacques Esculier

If I may, I think the targets and the ranges that we have shared with you are pretty aggressive, and hard to reach already, if you don’t mind. And actually, to be fair, you’re right. This quarter we had 24% incremental margin, excluding some items that Uli has listed on the 6.8% top line growth, which was, again, kind of outperforming our guidance ranges. But, you know, those ranges are already very aggressive. So I would really want to maintain it as a framework, which is, I think, an extremely healthy framework for us to continue to meet in the future growth. I don’t think we are at a point at all to upgrade those numbers.

Uli Michel

Other issue to keep in mind, at the relatively low levels of growth we had, you know, it’s $43 million top line growth, it doesn’t take much to make the percentage a little bit higher or lower. So on the longer term, stick to the margins that we gave you.

Joe - Robert W. Baird

No, that’s certainly already a very healthy range. The last one for me is just looking at the equity income line, a 16% sales decline but income was up year over year. Is that more indicative of the product mix in the business, maybe looking at what Meritor WABCO did this quarter, and maybe pointing to OnGuard being more software intensive, so that carries a better margin?

Jacques Esculier

The 16% drop we see in revenues is driven by, again, kind of accompanying a market that is continuing to erode year over year. But more important, there was a deliberate kind of decrease of the level of inventory of our parts at this joint venture Meritor-WABCO. So that impacted us this quarter.

Joe - Robert W. Baird

Okay, but then the actual JV earnings were up year over year.

Jacques Esculier

The sales of the JV to the end market is actually outperforming the market still. But here you’re looking at the sales of WABCO to the JV. So, again, the sales of the JV to the end market is still outperforming the market, but we are underperforming because there is a rationalization of inventories as well as a further erosion of the market demand in sales.


Our next question comes from the line of Jerry Revich of Goldman Sachs. Your line is open. Please go ahead.

Jerry Revich - Goldman Sachs

Jacques, can you talk about the opportunities in China now that national [four] engine regulations are being implemented. Presumably you’ve got more opportunities for the semiautomatic transmissions. Once that happens, is that right? And can you just step us through how you see the timing of enforcement actions playing out beyond the 30 cities that have implemented the regulations thus far?

Jacques Esculier

Jerry, this implementation of Euro 4 is fairly hectic, actually, as you know. It has been a very complicated kind of path so far, and they have been kind of enforcing this now in very few cities. For us, I think it first kind of created a certain level of pre-buy, and that’s why the first half is significantly stronger than the second half.

Most probably one of the reasons being that people have bought Euro 3 trucks ahead of whatever will happen in the second half of 2013, which was still fairly uncertain, at least from my standpoint. So now we are seeing this minus 30% decrease in the second half.

In terms of content per vehicle, we are not really selling things in the world of exhaust systems, and so we should not directly benefit from this upgrade of their standards. AMT actually is not necessarily mandated as part of Euro 4. It’s obviously helping overall to save some fuel, but I think the argument and the value it represents is more kind of strictly limited to, you know, ease of drive and some fuel consumption, not as part of this shift from Euro 3 to Euro 4. The engine manufacturers and obviously exhaust designs will take care of that shift by themselves.

So, now, this being said, we continue to obviously put a lot of efforts into raising the level of interest for AMT in China. They’re still lower than what we had anticipated. It’s taking more time. It’s kind of what happened in the U.S. You know, in the U.S., it took the industry quite a while to get the market to buy into the value of AMT. Now we have cracked the ice, and obviously the level of interest is rising very rapidly. We do whatever we can to put [unintelligible] quicker in China. At this level, though, I can admit that we still don’t have huge volumes over there.

Jerry Revich - Goldman Sachs

And in Europe, obviously you’ve been successful with some share gains, as you pointed out. What’s the full run rate? Presumably you didn’t get a full quarter of production on more OEM platforms that you run the business on that you outlined in the slides. I guess what kind of outperformance should we expect over the next couple of quarters as your sales to new customers ramps following the share gains?

Jacques Esculier

I would not answer a question like this. It’s kind of complicated and detailed. But what I would tell you is when we look at Q3, Q4, we see our outperformance levels staying actually pretty close or even slightly better than what it was during this quarter. And that covers, obviously, the gain in the share of market that we have seen in Q2 as well as some further gains in content per vehicle and whatnot. But that’s all I would say.

Jerry Revich - Goldman Sachs

And in the U.S. obviously Navistar is in the midst of the transition. Can you just give us an update on what proportion of their platforms WABCO’s now the standard offering? And based on the timing, at which point do you expect that to drive your outperformance? Can we get that in the back half of the year? Or is that more of a 2014 event?

Jacques Esculier

I think it’s going to probably trigger more in the coming quarters. We are a little bit behind in terms of kind of being moved on those platforms because at least we are kind of advised that engineering is more focused on engine issues and upgrades right now than they are at homologating our braking systems across all their platforms. But obviously the commitment is there. We shared the view that we had won these positions a couple of quarters ago. But it’s getting, actually, implemented slower than we had anticipated, again because obviously Navistar has some priorities right now for their engineers.

So what I’m saying is I think we should expect positive impact more in the coming quarters than just now.


Our next question comes from the line of Alex Potter of Piper Jaffray. Your line is open. Please go ahead.

Alex Potter - Piper Jaffray

You had mentioned that you’re seeing some aftermarket growth in areas outside of Europe. Could you focus specifically on which geographies you’re starting to get penetration on there?

Jacques Esculier

I’m sorry, Alex, I’m not equipped to go in that level of refinement and detail at this point. So I think it’s probably across many regions. I don’t have the details by region at this point. But you can be sure that Europe is one, because given the importance of Europe for this business, Europe is increasing. But I don’t know in detail about how much each other region has contributed to this overall increase.

Alex Potter - Piper Jaffray

Then just shifting over, just in general to content gains, if you could rank, I guess, maybe the top three or four contributors. Obviously it sounds like AMT in North America is the big contributor. Maybe OnGuard, ABS in Brazil. If you could just kind of highlight which areas you think over the next 12 months have the biggest opportunity to make a financial impact.

Jacques Esculier

I think you kind of mentioned most of the key dealers of our content per vehicle increase. I would mention that Brazil would provide further opportunities next year, because, again, not even half of the fleet has been equipped so far this year.

Another one that could be interesting is the further mandate that we are seeing implemented in China starting in October of 2013. And then another step in 2014 that will end up covering up to 70% of the volume of the Chinese trucks. I’ll remind you right now we are in the 30-plus percent, so we would basically double the coverage of that fleet, and of that production.

And that could provide us with some very, very nice future growth opportunities in ABS in China, with, again, the limitation that the implementation of the mandate could take some time. So it may take another two to three years to really kind of grow to the full 70%. But I think it’s going to fuel outperformance for quite a few quarters.

Otherwise, we continue to obviously put efforts into penetrating China and India. In particular with AMT, we see some very interesting initiatives and opportunities in India for our OptiDrive product. And as I said before, we continue to push hard at growing the presence and adoption of OptiDrive in China as well. And then you have a lot of bits and pieces across many other technologies. AMT, as I said, 60% up year over year, continues to really drive a superb success story for us in the U.S.

And it’s also started to kind of take root in Asia, actually, and was, I think, a very nice opportunity. We have delivered some of those adaptive cruise control systems to Yutong, which is the largest bus manufacturer in the world, which is in China.

So many other opportunities kind of as usual.

Alex Potter - Piper Jaffray

I guess one other one. If you could talk about pricing in general. It sounds like your expectations for pricing in the back half are a little bit better than what you originally had thought. They’re certainly a lot better than what they would have been several years ago. Just wondering if you can comment on the sustainability of those sort of expectations looking out over the next couple of years. Do you think this is a sustainable scenario that we’re in, now expecting 1-1.5% maybe price erosion every year?

Jacques Esculier

Actually 1-1.3% I still think is overly aggressive. I think it’s not really sustainable in the longer term. The industry is really putting more pressure on pricing because of eroding markets, because of raising competition. I shared with you that my objective would be to maintain price erosion in the long term between 1.5% to 2%.

Now, how fast would we kind of see this level? I don’t know. Obviously we’re going to do whatever we can to minimize price erosion quarter after quarter. We were, again, this quarter able to do it. We think we can contain it below 1.3% for the full year. We’re going to try hard to contain it further in 2014. But I don’t think it’s something that we could sustain for the long term.


Our next question comes from the line of Joel Tiss of BMO Capital Markets. Your line is open. Please go ahead.

Joel Tiss - BMO Capital Markets

One clarification. In the 10-Q, you have two different numbers for the amount of receivables that you sold in the first half of the year. Maybe I’m just a little confused. It says in one sentence that you sold $381 million in the first half of 2013, and then later it says $77 million.

Jacques Esculier

$77 million is the outstanding amount. Maybe that’s what you confused. The $381 million is the total amount that we have sold over the six-month period year to date. And the outstanding amount is the $77 million.

Joel Tiss - BMO Capital Markets

And then two things I wanted to ask about. One is a chance for a hangover in Europe in 2014, and I’m not asking for guidance, just sort of like the color around it. And second would be about acquisitions. If you can just talk about how does that fit into the priorities with all of the aggressive share repurchase that you guys are doing.

Uli Michel

You want to answer the one on the hangover? I think the question gears towards, with the pre-buy this year, what would it do for next year.

Jacques Esculier

Obviously, Joel, whatever we sell this year ahead of the market need and demand, we would be penalized during the first quarter, first half of next year, with it. So we would see less volume most probably in Q1.

So there’s no creation of demand here. It’s just a shift from borrowing demand from Q1 2014 and putting it into the second half of 2013. So to be fair, I’m not welcoming any pre-buy at all, because it’s disturbing for the supply chain, and it doesn’t create more volume.

But you know what? We don’t have a choice. And we’re going to have to follow the market wherever they bring us. And the second part…

Uli Michel

Was on M&A activities, how we prioritize this versus our buyback.

Jacques Esculier

We continue to kind of balance and optimize the way we return cash to shareholders, and kind of glancing at the opportunities that we continuously analyze through our pipeline versus the buyback of our shares. So we continuously make the decision quarter after quarter. So far it has been in favor of buying back our company, our shares.

But I told you this several times, we have good, solid opportunities in the pipeline. We continue to analyze them, and as I told you, I think, we could come up with an opportunity in the future. Maybe not that far in the future. But again, nothing kind of decided or finalized yet.


And that does conclude our Q&A session for today. I’d like to turn the conference back over to Mr. Jacques Esculier for any closing remarks.

Jacques Esculier

Well, again, thank you for your attendance today and your continued interest in WABCO. And I wish you a great summer, and I’ll talk to you at the end of October. Thank you.

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