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Executives

Jacques Esculier – President, Chief Executive Officer

Jason Campbell – Vice President, Controller, Chief Financial Officer (acting)

Christian Fife – Vice President, Investor Relations

Analysts

Jerry Revich – Goldman & Sachs

Jeff Hammond – Keybanc Capital Markets

Joel Tiss – BMO Capital Markets

Steve Tusa – JP Morgan

David Baker – Robert W. Baird

WABCO Holdings Inc. (WBC) Q3 2013 Earnings Conference Call October 25, 2013 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the WABCO Q3 2013 Results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will follow at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today’s conference, Christian Fife, VP of Investor Relations and General Auditor. You may begin.

Christian Fife

Thank you, Nicole. Good morning everyone and welcome to WABCO’s quarterly conference call. Today we’ll present our third quarter 2013 results. With us this morning, we have Jacques Esculier, our Chairman and CEO, and Jason Campbell, our Vice President, Controller, and acting CFO.

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 Q3 2013 Results. A replay of this call will be available through October 31.

Also as shown on Chart 2 of the presentation, certain forward-looking statements I will make today are based on management’s good faith expectations and beliefs concerning future development. 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 the company’s Form 10-Q which was filed with the SEC this morning and in 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

Thanks, Christian. Good morning to you all, and welcome to our Q3 earnings results call. Before I go into the details of the performance summary for our third quarter, I’d like to kind of frame this quarter and put things in the perspective the market dynamics.

First of all, the third quarter, I would say that the key driver has been for WABCO a healthy organic growth reaching 13.4% that is mostly driven by our continued stability to outperform the market, also to a certain extent by some pre-buy activities in Europe ahead of the introduction of this new Euro VI emission control regulations that should happen—or that will happen, actually, by early next year. Actually, this pre-buy activity has in this quarter, in the third quarter, almost offset the normal seasonality that we see every year due to the shutdown of our OE customers’ factories during summer time.

Now looking at the fourth quarter, I would say although the market dynamics are fairly similar to what we have seen in the third quarter, so the fourth quarter for us should be basically more of the same as Q3, expecting some double-digit growth at the revenue level year-over-year with probably a slight erosion quarter-over-quarter because we expect the global market to erode by something close to 4%.

Looking now at the full year ’13, that means that we are going to end up the year at 7.5 to 8.5% of organic growth in essentially something that I would call a flattish market, meaning that we will have nicely outperformed the market this year, and that gives us a certain perspective of our initial way of looking at 2014. We’re going to spend more time later on today discussing it, but ahead of that I’d like to say that the highlight for me at this stage looking into ’14 would be continuous U.S. economic recovery. The current forecast for GDP growth in the U.S. next is above 2.5% with 2% in 2013, and if you add that to the record level of aging of the fleet, I think it is fairly compelling to believe that we will see some nice growth next year coming from the U.S.

I think the U.S. recovery also will increasingly have some positive impact on Europe that will itself see some improvement in the economic environment. We believe at this stage that the impact of the pre-buy that is going on as we speak this year will be offset more or less by, again, the benefit of this economic recovery next year in Europe, and then unfortunately we think at this stage that we could contemplate further slight erosion of markets in our emerging countries. So overall, we kind of anticipate something like a flattish market again like in 2013, but as we have seen in 2013, each region in it’s own way will continue to have a fairly kind of hectic and unpredictable dynamic.

Now jumping back to the third quarter results, we ended up the quarter with $677 million of revenues, as I said at 13.4% in organic growth, leading to a gross profit margin of 29.6% versus 30.1% last year. Performance operating come at $89.5 million, leading to 13.2% of margin compared to last year’s $76.4 million with a margin of 12.3%, generating an EPS of $1.26 per share, 24% above the $1.02 per share of last year. Free cash flow reaching over $17 million with a conversion rate of 88%, of which we returned almost $50 million to the shareholders through the repurchase of 618,000 shares, and we have narrowed the range of the guidance, as we will see later.

Turning to the next page and reviewing the profile of our sales, as I said, we have generated 13.4% of organic growth in local currencies, coming from a pretty strong growth through the OE channel – 17%, through increased share of market, as well as increased level of technology, i.e. content per vehicle across the globe, very strong aftermarket growth of 9%. Now if you would eliminate or take out the impact of the campaign to replace our competitor’s air disc brake that started last year but is now reaching its tail end, actually year-over-year without this campaign we would have grown above 10%, at 11%. Sales to JV went up 2% - that’s mostly our sales to our joint venture in the U.S., and that’s actually in spite of a sequential—it’s sequentially, I’m sorry, 19% up versus Q3 in spite of a lower level of production of vehicles in North America.

Now looking for each region at the growth of our revenue line as compared to the evolution of production of truck and buses in each region, starting with Europe, Europe was revenue up 21% year-over-year for production estimated to be 8% only up, so very strong, healthy outperformance there supported by increased content per vehicle, particularly related to gains in new products like air disc brakes or the continued success of our automated manual transmission technology. North America was up 10% for WABCO in a market that was 7%, again, through increase of content per vehicle, through technologies that are fast-growing in the U.S. like AMT in our collision mitigation system, OnGuard. Very strong outperformance in Brazil – we reached 44% growth in a market that grew 20%, and that’s driven by increased content per vehicle, particularly supported by the ABS mandate of 40% of the feed that was implemented in January of this year. The remaining 60%, as a reminder, will be mandated at the beginning of next year.

Japan, Korea, we also outperformed nicely by 9%, and that’s driven by a favorable vehicle mix. Demand was higher for domestic vehicles as well as higher ABS content in Korea. China was up actually a small 1%, both market growth generating 22% of revenue growth for us because we continue to increase our market share, our content per vehicle; however, there was a certain level of unfavorable mix. For whatever reason, the level of demand for value trucks is actually up significantly this quarter as compared to a year ago, and we believe it’s linked to the soon introduction of this Euro IV standards in the coming months or quarters across the country. And then finally, India, we continue to see very strong erosion of market, minor 33% with unfavorable mix leading to an underperformance of 3% for WABCO. So overall for the quarter, we outperformed our markets by a healthy 10%.

I’ll let now Jason bring you through the details of our financial performance. Jason?

Jason Campbell

Okay, thanks Jacques, and good morning everyone. I will take you through our financial results for the third quarter. Chart 5, I’ll walk you through details from sales to earnings per share. We’ll look at both reported and performance numbers. I’ll remind everyone that performance numbers are adjusted to remove operational streamlining, separation costs, as well as discrete and other tax items. We also adjust comparisons to 2012 for currency translation effects.

As Jacques just highlighted for you, we delivered strong organic sales growth in the quarter. It increased 13.4% in local currencies versus last year. Price reductions were contained to 1.1%, which is within the range of what we anticipated for the full year. Our WABCO operating system continued to power excellence and execution across our organization. In Q3, it further improved our results by driving an increase in gross profit of more than 10%. This resulted in 5.2% gross materials productivity, which as expected was partially offset by 0.2% of commodity inflation, and our factories were able to generate a strong 6% conversion productivity.

The impact of volume, mix, and better fixed cost absorption generated $21.8 million of additional gross profit, while inflation on labor costs added approximately $3.6 million to our cost of sales. This resulted in performance gross profit margin of 29.6% for this quarter.

To go through our operating expenses, we continued to invest in research and development activities to support our long-term innovation and growth strategies, which added $4.3 million to our costs, while labor inflation increased operating expense by $2.8 million in the third quarter. All in all, this resulted in a 7% increase in operating expenses versus a year ago, which represents just over 50% of our sales growth for the period. Altogether, we generated operating income of $89.5 million or 13.2% of sales on a performance basis.

This quarter, however, we were negatively impacted by $13.4 million from transactional foreign exchange effects on a year-over-year basis. Excluding this impact, our incremental operating margin was 31% on 13.4% organic sales growth, another mark of healthy profitability. After slight increases in equity income and non-controlling interest expense versus last year, we delivered performance EBIT of $91.1 million or a margin of 13.5%.

Moving to taxes, you’ll see that our reported U.S. GAAP tax expense for the quarter was a charge of $8 million, which included favorable discrete tax items. On a performance tax basis, we recorded an expense of $11.4 million, which now brings our year-to-date tax rate to 13.5%, which is slightly lower than the 14% we communicated last quarter. After excluding the non-performance items, you can see that our earnings per share was $1.26 for the quarter. This EPS improved by 24% versus the same period a year ago, another healthy result.

In summary for this quarter, WABCO delivered an exceptional level of organic sales growth and we continue to deliver healthy profitability.

Let’s turn to Chart 6 and I’ll take you through our cash flow for the quarter. Working capital increased by $28.4 million, driven by higher levels of business activity as well as lower accounts payable, which is mainly due to the timing of certain weekly and monthly payments. Our days sales outstanding and past dues are stable with the prior quarter, while we have seen a slight improvement in inventory turns.

Changes in assets, liabilities and other non-cash items were favorable by $16.3 million. This reflects increases from accruals where invoices were not yet received at quarter-end, as well as impacts from other payroll related items.

Net cash used for purchases of PP&E and computer software totaled $26.7 million for the quarter. This continues to support the investments required to grow globally and win new business. This led to a free cash flow of $65.3 million, or $70.1 million when excluding the streamlining and separation payments for the quarter, resulting in a conversion rate of 88% on a performance net income attributable to the company. All in all, this quarterly result brings our year-to-date conversion rate to 83%.

Finally, we continued to return cash to our shareholders through the buyback program. We purchased another 618,000 shares at a cost of $48 million this quarter. As of the end of Q3, we still have $268 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.

Now I’ll turn it back to Jacques, who will take you through our markets.

Jacques Esculier

Thanks, Jason. So turning to the following page and reviewing the evolution and dynamics of each of our markets across the globe, starting with Europe, new registrations in the first eight months of 2012 were down 8%, but when you look at Q3, it was up 3% versus last year. Production of truck and buses in the third quarter were up 4% versus a year ago, but down 4% versus Q2. It’s again seasonal but certainly much lower in terms of drop versus Q2 as it is in normal years for the third quarter, leading to a forecast of the production level in H2 of 5% above what it was in H1, and again that’s due to the pre-buy effect. We assume at this stage that the pre-buy level should be around 15 to 20,000 vehicles. It seems fairly much aligned with what we have heard from our customers so far.

2013 should end up with a market that is flattish versus 2012, and now looking ahead in 2014, as I said, we believe that the kind of impasse through the economic recovery that we are starting to see right now in this part of the world that should gain a little bit more momentum across the coming quarters should lead to a market flattish between minus s to plus 3, meaning that the economy will help offset the impact of the pre-buy activities that are happening in the second half of this year.

Moving to North America, production is up 3% versus a year ago but down 8% sequentially. We see the second half essentially flattish to the first half. We would anticipate a level of production for 2013 to be between minus 5 to minus 8%, down versus 2012. Now looking ahead in 2014, as I said, I would anticipate some growth in this market. We kind of, maybe a little conservatively here would anticipate between flat to 5%, but if it is confirmed that GDP should grow above 2.5% in the U.S. next year, I would anticipate to probably have even more of a favorable impact.

Moving to China, Q3 production is up 14% versus a year ago but down 25% sequentially versus Q2. We anticipate a decline of 20% in H2 versus H1, leading to a 2013 level of production that would be 6 to 9% up versus last year, which is an improvement in the forecast because during the last call, we had anticipated flat to 5%, so we see a little bit better growth there, mostly driven by, again, this anticipation of this Euro IV introduction in the coming months. Now looking forward to 2014, obviously as usual probably the most complex market to forecast, but I would not see any kind of breakthrough either way. The best guess would be probably flat to minus 5%.

Moving to India, a dramatic further erosion of 33% year-over-year and down 20% sequentially versus Q2. We would see a further erosion of the market in H2 of 16% versus H1, leading to an anticipated 2013 production level 20 to 25 down versus 2012, which is really strongly worse than what we had shared with you just a quarter ago. We had kind of framed it between 7 and 12% down. And also, it’s noteworthy to kind of highlight the fact that the mix is unfavorable to us in this decline to the content per vehicle. Then looking ahead, we think we have reached kind of the bottom. We would not anticipate 2014 to see that level of further erosion. We would kind of see minus 5% to flat. GDP is planned to go back to 7%, so 2013 ending up probably around 5.9 to 6% growth.

Going to Japan and Korea, Q3 production was up 6% year-over-year and up 7% versus Q2, with again, as I said, a strong enhancement in the volume of domestic vehicles which carry more content per vehicle. Overall, H2 should end up 10% ahead of H1 in volume, leading to a year of production that would be 3 to 6% down versus 2012. Now 2014, again should be flattish to minus 5% because Japan plans to increase their consumer tax by mid of next year.

Going to Brazil, production in Q3 was up 12% year-over-year but down a strong 11% sequentially. We think that H2 will end up about 2% down versus H1 because the government incentives have been kind of progressively lowered across the year, down to zero at the end of the year. So overall, 2013, will have been a very healthy year for us over there with a growth of 19 to 20%, which is slightly better than what we had shared with a you a quarter ago. When you look at 2014, because the GDP growth is not anticipated to be that high – it’s just around 4% - we believe the market will stay fairly flattish. We know that there is some inventory build as we speak, and I don’t think we’re going to be able to sustain the level of growth we have seen in the last month.

Aftermarket – as I said, the service campaign that we started last year to replace our competitor’s air disc brake, that MAN, is now slowing down. The overall growth of aftermarket activities this year would end up at 6%. If you exclude this campaign that has basically started slowing down a couple of quarters ago, the underlying aftermarket activities would have grown 7%. When you look at 2014, we anticipate 5% growth year-over-year. Again, outside of this campaign impact which at this stage will be stopped completely, we would see an underlying 8% growth in our aftermarket activities.

Finally, trailers – production levels were up 6% versus last year, down 1% versus the last quarter. H2 should be basically flat to H1, ending up the year with volume flat to minus 3%, and our initial outlook for next year is basically flattish in that minus 2 to 3% bracket.

So still a lot of uncertainty moving forward, but that would lead to a 2014 market assumption overall that would be kind of flattish, probably resembling to a certain extent what we have seen in 2013 but with different dynamics in different regions.

Moving to the following page, as we do usually, we are going to give you the highlights of our achievements in the third quarter against the three pillars of our strategy, starting with globalization. We caught a new contract with the Gaz Group, which is Russia’s largest manufacturer of commercial vehicles. We won a position as sole supplier for braking systems and associated components for their next generation of medium duty trucks, a very promising vehicle actually, and that’s all new incremental business with series production starting in 2014. We also won a contract to supply air processing units to Mercedes Benz in Brazil starting in Q4 2014 – that’s an increase in share of market. We also further expanded our relationship with KAMAZ in Russia, supplying advanced technologies around ABS and stability control devices on their new truck platform – that’s also incremental volume.

When we look at new technologies, we were able to convince Ford Otosan to adopt our clutch compressor, breakthrough clutch compressor technology on their new platforms that will be put in production in 2015, and we launched officially our OptiDrive automated manual transmission technology in South America.

Finally, execution – we have seen the production of our first million vacuum pumps this year in Qingdao, China, which positions WABCO as a privileged supplier to the local market, leveraging actually the low cost center over there to also serve markets across the globe, particularly in the U.S. And then our WABCO operating system, as Jason reported, has generated some very strong, continued strong productivity, both in material and conversion.

Moving to the next page and updating our guidance, starting with the top line, we actually narrowed the range from 5 to 8 to 7.5 to 8.5 growth in local currencies, leading to a bracket of 2.65 to $2.675 billion at a euro-U.S. exchange rate of 1.32. Performance operating margin between 13.2 and 13.4, generating an EPS between 4.9 and 5% and maintaining our commitment to a conversion of our net profit to free cash flow between 80 and 90%. Key inputs remain about the same except, as Jason mentioned, that we plan our performance tax rate to go down from 14% to 13.5%, so confirming again, pretty good strong organic growth in a market that is not itself providing much momentum for growth.

Finally as a summary, I would say that we are just about to close another year in a global market environment that is fairly sluggish with fairly hectic and unexpected trends across all regions of our world, for each region in their own way and for their own reasons. But in that kind of environment, I’m very proud that we have been able to still generate a pretty healthy outperformance level, generating some good strong organic growth for WABCO. And when we kind of look forward to next year with very, very preliminary, as we do usually at this time of the year, very preliminary kind of outlook, it seems that 2014 will resemble what happened in 2013, meaning fairly flattish market overall but with different dynamics across the regions. Again, I believe the U.S. economy pulling demand in that part of the world also probably having positive impact on Europe and progressively, I think, taking the lead in helping the overall global economy to take a path on improvement.

That concludes our presentation, and I’d like to now open the session for your questions.

Question and Answer Session

Operator

[Operator instructions]

Our first question comes from the line of Jerry Revich of Goldman & Sachs. Your line is now open.

Jerry Revich – Goldman & Sachs

Hi, good morning and good afternoon everyone. I’m wondering, Jacques, if we could just talk about the cost reduction opportunities you’re targeting over the next 12 to 18 months and how does that compare to what we’ve seen you deliver over the past year, both the magnitude and just the overall direction of the savings. What are you targeting next?

Jacques Esculier

Well Jerry, I don’t think there is any kind of breakthrough activities. It’s kind of maintaining the focus on efficiency of cost, first through the supply chain by continuing to produce those very high levels. I think not many companies in our space are generating that kind of productivity in material and across our factories, and that’s really a major pillar of our logic and of our financial performance. Also, obviously being very kind of careful and mindful in the way we invest in our OPEX to obviously support the enhancement of our globalization and technology paths, but being careful trying to contain it to something that we had kind of indicated to be about half of the top line growth.

So it’s kind of more of the same rigor and performance and success that we are kind of anticipating for next year along those lines.

Jerry Revich – Goldman & Sachs

Okay. In terms of the opportunity on the vacuum pumps as we get the auto OEMs moving closer to rolling out the gasoline direct injection engines, can you just give us a timing update and how is the production ramp looking, when will we see that really start to impact and benefit your business?

Jacques Esculier

Well, right now as I said, we have obviously kind of cranked up production pretty strongly this year. Right now, we believe it to be at about 30% of what the peak demand will be coming from General Motors, and that will kind of continuously add volume to what we have today up until 2015, about.

Jerry Revich – Goldman & Sachs

Okay. And lastly, really good performance in aftermarket. Excluding the field campaign, can you just give a sense for which regions are really stronger than others and what’s driving that acceleration in your mind this year versus what we’ve seen over the past couple?

Jacques Esculier

Well as we kind of share with you fairly regularly, aftermarket for us is a major focus of our strategy. First, it’s profitable, nicely profitable; second, it’s not as cyclical, so this is an area of the business that we really put a lot of focus at growing, and we have in the last years launched a lot of initiatives across the board to sell more parts in more places of the world as well as we are starting to build up some nice services to the fleet across the world. I would say what you see there is basically the result of all those strategies being kind of grown and resources being nicely allocated to support that growth, and that’s something we obviously want to continue to do in the coming years.

Jerry Revich – Goldman & Sachs

Okay, thank you very much.

Operator

Thank you. Our next question comes from the line of Jeff Hammond of Keybanc Capital Markets. Your line is now open.

Jeff Hammond – Keybanc Capital Markets

Hey, good morning guys. Just kind of a fine tune question, 3Q to 4Q, it just seems like seasonally and maybe year-end push on pre-buy, you’d be up more meaningfully sequentially. Is it just simply China-India as the offset, or what are the moving pieces there?

Jacques Esculier

Well what we see, Jeff, right now ahead is obviously still some incremental progress in Europe because we think that the pre-buy is probably fairly stable, Q3 to Q4, but you still have that seasonality impact behind the pre-buy, so we should see Europe up in demand versus Q3. What would really penalize this whole thing would be North America, that we see sequentially down kind of 7, 8% quarter-over-quarter, and South America potentially as much as 30% down sequentially. Then as you said, China could go down another—whatever, 5, 6, 7%.

So overall net-net, we kind of see a global market that would potentially be down 3, 4%, and that’s why I’m saying year-over-year, I feel good that we should have double-digit growth on the top line of our P&L, but sequentially probably maybe slightly lower.

Jeff Hammond – Keybanc Capital Markets

Okay. And then clearly this year—I mean, pretty mixed markets, kind of flat, and you’re putting up 8% core growth, and great job on the outgrowth. As you look at programs coming into the pipeline, share, and kind of your outgrowth funnel, how should we think about outgrowth into ’14 on, again, kind of another flat year?

Jacques Esculier

Well again, I just don’t want to really talk too much about our top line at this stage, as I kind of push back every year at this same time in the year, because we haven’t yet finalized and we are not close to finalizing the commitment for next year. Our budget is still very much open and under work. But you know, that’s what I said, Jeff – I think 2014, for me, we will outperform. At what level, I don’t know; but obviously my objective would still be to kind of hang my hat on that 88% type of thing, but I cannot commit to it yet because I don’t have enough information to support it. But to me, the logic for 2014 would kind of resemble what we have seen in 2013 so far.

Jeff Hammond – Keybanc Capital Markets

Okay, thanks. I’m jump back in queue.

Operator

Thank you. Our next question comes from the line of Joel Tiss of BMO. Your line is now open.

Joel Tiss – BMO Capital Markets

Hi guys, how’s it going? I wonder if you could give us a sense – since you made sort of the big blanket announcement a couple of months ago that you can outperform end markets by 5 to 7% for the next five years, there have been a whole bunch of new product wins. Would those new product wins add to that 5 to 7%, or would it be more out in the future? Can you just give us a sense of how some of these new products flow into the next couple of years and maybe how big some of them are?

Jacques Esculier

Yes. Joel, first our commitment was more in the 8 to 10%, which obviously answers your other question. For sure, everything is in there because 8 to 10% is obviously a pretty challenging kind of level to reach. For us, this kind of outperformance is, as you may remember, structured around different things. One is our ability to continue to globalize and bring our existing technologies to emerging markets; two, to continue to feed mature markets with new technologies; and three, to obviously continue to drive aftermarket as well as our core business. This whole thing still kind of continues to support the logic that we shared with you a few years ago, and for me it’s still the objective that I keep for the company.

Joel Tiss – BMO Capital Markets

Okay. And then can you just talk about the $275 million roughly, the rebate, the timing of when you think you might get that and what the plans are for that plus your excess cash?

Jacques Esculier

Yes. Around that, a few things – number one, we are very proud to have recovered basically two-thirds of a fine that we had really kind of felt as excessive when it was imposed on us back in 2010, so two-thirds of it, we are getting it back, so we won this appeal. However, the Commission has the possibility to appeal, but only on matters of law, meaning that they cannot reverse the conclusion of the appeal. What they can challenge is the way those conclusions have been translated into the $271 million, or €203 million. So it’s a very narrow opportunity for the Commission to challenge the decision and appeal, but they have an ability to do it and we have to wait until we see whether they do or do not appeal, and if they do appeal, on what grounds and what kind of space it would cover of that €203 million in order to recognize them, because that’s the rules of GAAP – you know, recognition. Jason can, if you are interested, can emphasize a little bit more on that. So that should take place in Q4 as we get the result of the decision from the Commission.

In the meantime, we will receive the cash momentarily – actually, we should even receive it today. That’s what we were told, but if it’s not today, it’s in the very next coming days. Then what are we going to do with the cash? I can tell you that obviously I have not had a discussion with the board since we were told that we would receive those $271 million back, so I cannot commit myself to anything; but objective would be certainly to return that to shareholders one way or another. As I always share with you, we have some ideas and opportunities for acquisitions or we could kind of return it more directly to shareholders, but again that’s a decision that is right now to be discussed and validated by our board of directors, and our next board meeting is early next week.

Joel Tiss – BMO Capital Markets

Okay, thank you very much.

Operator

Thank you. Our next question comes from the line of Steve Tusa of JP Morgan. Your line is now open.

Steve Tusa – JP Morgan

Hi guys. So lots of good color. Any changes—you guys had really good incremental margin this quarter. Any change to that kind of framework that you guys have talked about? I think it’s been high teens incrementals on less than 10% growth, and then 20 to 25% incrementals on greater than 10% growth. Is the cost structure kind of normalized? Is there stuff you have to add back going forward to sustain this rate of market growth that changes those incremental margin dynamics?

Jacques Esculier

No, Steve. Quite frankly, I really want to stick to this model, which is already challenging for us, obviously as it would be for many companies. So I don’t think that it would be the right thing for us to upgrade this model. I would want to stick to it as a management objective, and when we can do better than, that’s great; but sometimes we may not do as well, and that’s obviously--. So overall average, this is kind of, I think, a reasonable framework to keep working towards.

Steve Tusa – JP Morgan

Okay, helpful. And then on the Brazil front, you guys are calling for, it looks like, a flattish market for next year. I think there’s been a lot of noise around that marketplace in the last several months, and there are some that believe it’s going to be down next year. Can you maybe comment on what you’re seeing down there?

Jacques Esculier

Yes, when you look at the level of demand, actually, it’s still not back to what it was, the level of production before the pre-buy in 2011. But the economy is certainly not as flourishing as it used to be at that time, so that’s why I want to stay prudent. GDP growth next year is still at 4% but obviously less than what it was before. I think to be excessively pessimistic may not be at this time, in my own mind, the best way to kind of think about this market for 2014, but I was informed that there is some inventory build-up as we speak. That’s why we see a potential strong decrease in Q4 versus Q3.

So again, Steve, we don’t know. I think the next coming weeks will be very important for us to kind of be in a better position to maybe refine those forecasts for countries like China or Brazil that are complicated at this point to really understand.

Steve Tusa – JP Morgan

Right. And in China, I guess is that more—what are you watching there? Are you watching your markets on the ground? Are you watching degree of what the management or government there does around property markets and interest rates and things like that? Are you watching more macro or are you watching more micro stuff for China?

Jacques Esculier

Well I think experience shows that even if you kind of look at all these parameters, it’s always hard to really predict the market, particularly on the quarter-to-quarter basis. Now for the full year, what we kind of feel is yes, they will still be something above 8% in GDP growth next year probably, and that would logically drive at one point to an improvement in the level of commercial vehicles you build, but there is less investment in construction. But we also have the impact of the excess of trucks that were built in the years 2010, 2011, but there is also apparently—there are certain kinds of pre-buy activity right now ahead of what seems to be announced to be a strong kind of push to implement that Euro IV emission control regulation by early next year.

So all this confusion for us is very complicated to measure in terms of it’s impact on the market. That’s why right now the best thing we could say is probably nothing really positive but nothing drastically negative either, and that’s we kind of said minus 5 to zero, not being able to say anything better at this point.

Steve Tusa – JP Morgan

Yes, that’s a lot of buts. I appreciate the color. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Dave Baker with Baird. Your line is now open.

David Baker – Robert W. Baird

Good morning, how are you all doing? I want to follow up on a couple of questions that have been here. Jacques, as we look at this long-term growth above your end markets, it seems like the aftermarket piece of it is growing faster than what it has. Is that faster than what you have embedded in that overall assumption?

Jacques Esculier

No. Actually when we described that 8 to 10%, David, we assumed the aftermarket to stay in that 8 to 10% growth itself. So right now, we are actually within that kind of range, and obviously when the market is depressed, particularly in Europe, there is always a certain impact, much lower than on OE, obviously, but there is certain cyclicality in aftermarket as well. So that’s why it has been kind of a little slower than in the last couple of years, but I think we are rebuilding the momentum that supports this 8 to 10% objective.

David Baker – Robert W. Baird

Great. And then if we could splice the aftermarket just a bit, how is Europe itself performing within that part of your business?

Jacques Esculier

I think Europe—you know, Europe represents, as you know, a significant percentage of that revenue, so you would never see 8 to 10% growth in aftermarket without seeing Europe contributing greatly to it. The services that we’re talking about are for the moment very much focused on Europe, but with some actually nice growth in other areas of the world. The problem is nice growth out of not much is still not a huge contributor to the overall equation.

So aftermarket activities in Europe are basically growing at the pace that is kind of aligned with what we declare for the global market, I would say.

David Baker – Robert W. Baird

And then one more item on that particular topic – this growth and acceleration in growth in particular, is that market share? Is it putting more product through your channel? Can you characterize exactly what some of those elements are that are driving that growth?

Jacques Esculier

Yes, I think, David, we put some color to it as I was kind of crossing all the different regions. They are both, actually. We are gaining share in market in Europe. We have gained share in market in Brazil. We have gained share in market in Russia. We continue to grab some share in Asia. We also obviously have introduced ABS in Brazil, which is a major piece of that outperformance over there. We continue to enhance our volumes of collision mitigation systems and leverage this automated manual transmission fast penetration in the U.S., because basically it’s all ours for Volvo, the mandate that Volvo—or probably not the mandate, they have put it as a standard on all their trucks over there.

So it’s kind of a little bit of both, depending on which region, but basically at this time we are firing on all those cylinders to support that outperformance.

David Baker – Robert W. Baird

Great. And then the last item, if we could talk about the transactional currency impact here and talk a little bit about exactly what that is and what’s driving that for you.

Jason Campbell

David, if you remember, when we started the year, we highlighted that the Japanese yen was much bigger of an exposure for us now, so that’s kind of carried itself through the year with a negative impact, and actually probably a little bit more than what we anticipated. But you’ve also noticed that the Brazilian real in recent months has also moved quite a bit, and we are sourcing quite a few parts from Europe, for example, that go into our products in Brazil and that are sold in the real currency, so that’s been an additional negative to us recently. And then the Indian rupee is another similar situation where you’re sourcing in one currency, manufacturing the product and then selling it into another currency.

So versus the start of the year, what’s gotten worse is the yen is probably a little worse than we anticipated, but we’ve also added the impact from the real and the rupee.

David Baker – Robert W. Baird

Okay, and then do you have plans to localize production to help offset and hedge some of these currency risks?

Jacques Esculier

You know, there is always a push to localize because it’s not comfortable to have those type of exposures; however, it would be unreasonable, David, to localize anything in Japan given the fact that you have China just next door, which obviously is providing the level of performance and quality that is absolutely aligned with the expectations from our customers in Japan. We are kind of progressively localizing more and more to Brazil, but again it’s always an equation of investment and returns on investment. When the volume justifies it, we do not hesitate and we do localize, particularly by the way because our OEs are demanding that we localize because they themselves have to prove to kind of utilize local suppliers, local manufactured products in order to escape some tax burden. But when the volume is not sufficient and the investment is high, then I would say we just keep exporting from Europe.

And you know that WABCO has a pretty extensive network of facilities across the world, so we have already kind of localized a significant portion of what is utilized locally in each region of the world, except for Japan because Japan really frankly from the economic standpoint doesn’t make sense. It’s not a center of production that would kind of be logically added to our existing network.

But what we are kind of contemplating is to set up more capacity in the U.S., for example, and bring to the U.S. a lot more manufacturing capacity as compared to the past to support this nice growing business that we are building over there in addition to the expansion of the market. We expect some nice outperformance in the coming years there, so that’s something that we are right now contemplating for the coming years.

David Baker – Robert W. Baird

Okay, great. Thank you very much.

Operator

We are showing no further questions at this time. I would now like to turn the call back over to Jacques for any further remarks.

Jacques Esculier

Well thank you for your attendance and looking forward to meeting you across these quarters if we happen to meet during these experiences in the coming weeks where I’m going to be in the U.S. meeting some of you. Otherwise, I wish you a wonderful year-end and talk to you next year. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s call. You may all disconnect. Have a great day, everyone.

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