WABCO Holdings Inc. Q2 2010 Earnings Call Transcript

| About: WABCO Holdings (WBC)

WABCO Holdings Inc. (NYSE:WBC)

Q2 2010 Earnings Conference Call

July 28, 2010 9:00 AM ET


Mike Thompson – VP, Strategy and IR

Jacques Esculier – CEO

Ulrich Michel – CFO


Jeff Hammond – KeyBanc Capital Markets

Robert Kosowsky – Sidoti & Company

Ted Wheeler – Buckingham Research


Good day ladies and gentlemen and welcome to the WABCO Q2 2010 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 be given at that time. If anyone should require assistance during the conference please press star and 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 Mr. Mike Thompson, Vice President, Car Business and Corporate Relations. Sir you may begin.

Mike Thompson

Thank you (Daven). Good morning everyone and welcome to WABCO’s quarterly conference call. Today we will present our second quarter 2010 results. With us this morning is Jacques Esculier, our Chairman and Chief Executive Officer and Uli Michel, our Chief Financial Officer.

Before we begin, I’ll remind you of a few things. First, 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 2010 results. Replay of this call will be available through August 28th.

Second, as shown on chart 2 of the presentation, certain forward-looking statements that we’ll make today are based on management’s good faith, expectations and belief concerning future developments. As you know actual results may differ materially from these expectations as a result of many factors, examples of which can be found in our company’s Form 10-K and quarterly reports including our second quarter 2010 report, which was filed with the SEC this morning.

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’ll now turn the call over to Jacques Esculier.

Jacques Esculier

Thanks Mike. Good morning to everybody. Well first on behalf of the WABCO folks I would tell you that I am very happy and proud to report another exceptional quarter performance for our company. But before we jump to numbers, I would like to share a few highlights with you.

Starting with the fact that for the first time in two years, market is re-firing on all cylinders, indeed when you look across the world all regions have significantly increased their level of production for commercial vehicles actually above 50% for all of them except in the US where it was only 12%. Second, during the second quarter WABCO has again outperformed the markets. Third, this second quarter results confirm our exceptional ability to transform topline growth into great profitability and fourth, our confidence in the progressive recovery of our market is actually strengthening and this results were actually in our ability to again raise our 2010 guidance.

Now looking at numbers starting with revenues, we end up the quarter with a sales of $512.3 million, up 65% excluding the impact of foreign exchange just to note upfront that its 25% below our second quarter 2008 record level. Gross profit margin actually up already at a record level of 29.3% versus 22.6% a year ago. When you look at the operating income, we reached $52.6 million versus loss last year. And we are back in the world of double-digit margin at this level, to be accurate; we ended up the quarter at 10.3%.

All this leading to a performance earnings per share of $0.63 versus a loss of $0.07 in the second quarter the performance level. Now obviously when considering the significant impact of the announcement of the European fine indemnification at $400 million, obviously the reporting EPS is going down to $5.68 of loss. We again generated very strong cash flow of $74.9 million now, when you look at the what I call the operational conversion rates, that’s excluding all the exceptional items which leads to the fine to refinance them receivables, we ended up with a conversion rate of 88%.

And again in view of the continuous improvements in the market conditions we are in a position to raise our full-year guidance as we will go in detail through that at the end of this presentation. So conclusion is our market is to definitely better across all regions and WABCO is able to fully leverage this market unwind (ph).

Turning to next page, describing the market structure and evolution, first of all as I already said we went up 65% revenues excluding exchange rates driven by a strong growth coming from our activity – the impact of the India transaction that happened I’ll remind you actually back in June 2009. So those revenues from are 10% versus the previous quarter, its led by a strong recovery in Europe and continuous strong growth in emerging markets as well as a continuous increase content per vehicle in all regions of the world.

Aftermarket which is another record level of growth 29% or 24% again excluding the impact of the India transactions. And we are back to a revenue level pre prices level. And this is obviously driven by higher fleet utilization rates and is also a confirmation that the OE growth in the manufacturing of commercial vehicles is on the move. Sales of joint venture which most represent our sales to the Meritor WABCO joint venture in the US is up 101% driven by a very strong increase in demand for traders in the US as well as preparing the supply chain for an anticipated strong growth in the second half of this year and particularly in 2011.

Now when looking at WABCO’s performance against the market evolution by region starting again with Europe. Europe production of commercial vehicles truck and bus went up 73% year-over-year which in level of 90,000 units bus (ph) compared to 52,000 a year ago. Now putting that in perspective, two years ago, Q2 2008, Europe produced 180,000 trucks, so I think again there is a lot of room for continuous growth in our region. North America we have 12% in production, we outperformed nicely at 47% for our revenues. And again North America produced in Q2 2010, 50,000 units to be compared to the peak in Q2 2006 of 159,000. So just one-third of what we produced in 2006 at the same period.

So North America continues to grow, 72%, we outperformed significantly again increasing our content per vehicle. Japan, Korea continues as well as recovered nicely 64% year-over-year, we outperformed by 4%. China is again, kind of beating its own record that was established during the last quarter. China manufactured 407,000 trucks in the second quarter to be compared to 390,000 in the Q1. Again, China, this quarter has built 53% of all commercial vehicles built around the world and we outperformed the performance by 38%. India aligned with this, strong growth, 78%, India has built 81,000 trucks during that quarter or 10% of all trucks built worldwide and we outperformed the market nicely.

So in summary, this is an outstanding quarter for our industry and WABCO was actually able to outperform all markets across the world. Now Ulrich will present to you all the details of our financial results and performance.

Ulrich Michel

Thanks Jacques. Good morning everyone and thanks again for joining us on our call. I will now walk through our financial results for the second quarter.

Turning to Chart 5, I will walk you through the details from sales to earnings per share for the second quarter, looking at both our reported and performance numbers.

Performance numbers for 2010 are adjusted to remove operation of streamlining, separation costs, the expense for the indemnification of the European Commission fine as well as discrete tax and other items. In addition, comparisons to 2009 have been adjusted for currency translation effects.

As Jacques mentioned, sales increased 64.7% in local currencies versus last year and 9.5% versus Q1 2010. This increase in sales includes price reductions to customers of 1.4%, which is slightly above Q1’s rate but still at the low end of what we are used to seeing in our business.

Gross profit increased 115.5% with an adjusted gross profit margin that has improved by 698 basis points compared to a year ago. Gross profit was driven most significantly by a higher business volume, which contributed for the $1.8 million. In addition, our productivity initiatives continue to deliver very strong results such as materials productivity of 4.4%, which is the net result of an impressive 5.8% productivity generated by our materials productivity projects and 140 basis points of commodity inflation. We also continue to deliver good conversion productivity in our factory. In Q2, we achieved a level of 5.4%, we generated significant benefits of more efficient absorption of overhead costs, which contributed nearly $24 million this quarter.

I would like to underline that WABCO’s operating system has continued to generate the necessary flexibility to adapt to fast changing market by rapidly ramping up our production volumes and effectively mitigating supply chain constraints but delivering strong productivity results.

Also this quarter, we generated $5 million in March and improvements by leveraging the exchange rate advantages of our global manufacturing footprint. While we saw reduced costs coming from the decrease in the value of the Euro in Q2 and benefited (inaudible) of $4.4 million from the revaluation of foreign currency monetary assets and liability caused by the decline of the Euro in the course the second quarter in 2010.

These improvements were partially offset by slight increases from inflation and a few other items, which altogether cost us about $1.7 million gross profit compared to the second quarter of 2009. The increase in performance, gross profit margins this quarter represents an incremental gross profit margin of 40% on our sales increases from last year. This result is in a performance gross profit margin of 29.3% this quarter, which is at a record level for the company. This is important because this is not only a record level but it was also achieved in an environment where sales volumes are still lower than when we last achieved these record levels.

As you can see, our results continue to benefit from the effectiveness of our cost reduction efforts, especially in the area of fixed costs while our productivity initiatives keep reducing our cost base.

In operating expenses, you can see an increase in the second quarter versus a year ago. As stated in our last two earnings calls, (inaudible) certain costs that we had temporarily removed in 2009. These items include annual cash flow and this is for employees, benefit from reduced working time as well as other deep cuts to our discretionary spending on marketing travel and other items at the operating expense level.

As you can see, the reinstatement of these cost items means an unfavorable variance of $7.3 million versus the second quarter a year ago. However, this remains in line with the full year estimated impact of $24 million that we had shared with your in our previous calls.

Consistent with our first quarter this year, WABCO’s second quarter performance is well above our prorated annual targets for 2010, which resulted in additional approval of $5.4 million of incentive compensation beyond target.

Inflation increased operating expenses this quarter by about $1.6 million and the consolidation of our Indian subsidiary added another $2.5 million in operating expenses compared to the second quarter in 2009. You will see that net off savings from our cost reduction efforts, we also had an increase of $7.5 million versus 2009 from new investments and other onetime items. This includes investments in new business activities, spending on strategic and intellectual property work we have done in the second quarter of 2010 and to a minor extent the lack of certain onetime favorable items record (inaudible) in the second quarter of 2009.

Even after these increases, we have been able to limit the overall increase in our operating expenses to less than 50% of the sales growth, resulting in margins expansion of an additional 487 basis points versus a year ago.

So altogether, we generated operating income of $52.6 million or 10.3% of sales on a performance basis. This is a significant increase over last year’s performance, loss of $1.6 million and it has resulted in a margin expansion of 1185 basis points.

In summary, we delivered another outstanding financial performance this quarter generating a 28% incremental operating margin on our sales increase versus a year ago, excluding the effects of translation and foreign exchange.

In this quarter, you can see that equity income was $1.9 million, excluding the two minus effects (ph), the income still recorded for the former Indian joint venture in the second quarter of last year, we improved $1.4 million, which includes an improvement in earnings of $1.6 million from our North America joint venture.

As you are all aware, we recorded the charge this quarter of the indemnification of the EC fine in the amount of $400 million driving the significant loss at the reported level. As we have previously disclosed, this will be paid in the third quarter with the liquidity that WABCO already has and at the end of the second quarter.

On the reported basis, we recorded a tax expense in the amount of $12.1 million for the quarter. As we have previously explained, we will take deductions for the indemnification of the $400 million fine on our tax return. However, in the indemnifying of this entity, we still have net operating loss carryforwards from the spin offs that already have valuation allowances and so we will not be able to record any tax benefit for the fine indemnification. Therefore we still report tax expenses despite the significant loss caused by the fine indemnification.

Excluding its pre-tax items as well as other onetime items, we incurred $8.7 million of performance tax expense for the quarter. As you can see on the chart, we now believe our full year performance tax rate will be approximately 18.5%, down from the previous estimate of 20%. This improvement in our estimate drove a second quarter tax rate of approximately 17.3% in order to bring the six-month per cap rate to 18.5%. As you can see, we start to really benefit again from our supply chain structure in Europe.

Given the impact of the EC fine expense we ended the quarter with a recorded net loss of $365.4 million. After excluding the non-performance items, net income was $41.5 million. With regards to earnings per share, this translates to a loss of $5.68 on a reported basis and a profit of $0.63 on a performance basis compared to the reported loss of $0.27 and the loss of $0.07 respectively on a performance basis a year ago.

Although both the markets and our sales are still well below the peak 2008 levels, in our view the profitability that we have generated again this quarter is impressive. The second quarter was another remarkable financial performance that continues to make us confident and excited about the potential future profitability of this company.

Turning to chart six, let’s go through our cash flow for the quarter. You can see that working capital provided a benefit of $46.9 million in the quarter. As we discussed in our June 25th business update call with you, we began selling accounts receivables into our asset secularization program in the second quarter.

Based on the funding available under this program, working capital benefited from selling $74.3 million of accounts receivable into the program of which $50.5 million was the funding received as of June 30th. The remaining $23.8 million resides in a restricted cash account to be released in subsequent weeks and is presently recognized on our balance sheet as another current asset.

Outside of the benefit of selling into the secularization program, the accounts receivable balance would have otherwise grown in the quarter as we would expect in this high growth environment; however, given our continued focus on credit control and selections, we have been able to maintain our past few receivables at the low point reached in the first quarter this year.

Inventory increased by $8.4 million in which inventory turns improved from seven to eight turns this quarter. This improvement came despite the fact that we continue to invest in inventory to mitigate the impact caused by the present constraints in our supply chain. At the same time, we saw an increase in payables that were streamlined with the increase in inventory.

As you know, included in the reported net loss for the quarter is the $400 million impact from recording the indemnification of the EC fine. This was a non-cash event in the second quarter. You will see this adjustment in the operating section of the cash flow statement.

As we previously communicated, this amount will be paid in the third quarter, which you will then see as the $400 million negative impact in the next quarter’s cash flow statement.

The changes in our other assets and liabilities for the quarter represented a negative impact of $15.9 million. The most significant amount driving this negative movement is from the execution of the asset securitization program, which increased current assets by $23.8 million, partially offsetting this impact were accruals of payrolls and other people (ph) related cost as well as changes in income and value added tax items in the quarter.

As a result, net cash provided by operating activities was $89.5 million. Net cash used for capital expenditure was $14.6 million resulting in free cash flow of $74.9 million or $30.9 million excluding the $6.5 million in payments for streamlining activities and the $50.5 million benefit from selling accounts receivables in the quarter.

There is another important achievement regarding the $30.9 million of free cash flow excluding streamlining and the benefit of selling accounts receivables. The $30.9 million represents an 88% conversion rate of our net income into free cash flow when excluding the expense from the EC fine indemnification.

Considering the continued growth in our business volumes before this conversion rate of 88% is a very strong result and it is in line with the conversion from last quarter. This conversion is also towards the higher end of our full year guidance for the free cash flow conversion.

Now I’d like to turn it back over to Jacques who will highlight some of the market dynamics, Jacques.

Jacques Esculier

Thank you Ulrich. Turning to page seven, we’re going to kind of update you on our view of the market dynamics across all the regions where we do business starting with Europe interesting region particularly in the later sweeps of evolution. When you look at the records (ph) book it continues to increase at a pace of 12% in the last two months.

Now there are different indicators that we are also tracking that all conversion and same conclusions starting with the orders taken by German OEs when comparing orders received during the months of June and during the months of January of this year, it’s up 50% and again, we think that it should be very well represented of all OEs across Europe.

Our order book in June compared to what we had in January is also increasing in the meantime by 48%. Now when you look at the deliveries of heavy truck in Europe again, comparing June to January of this year, it’s up 31%. So all those numbers are really kind of consolidating, I believe that the market is really gaining momentum in its recovery and that kind of lead us to again, upgrade our expectations in terms of the number of trucks and bus that will be manufactured in 2010 versus 2009; we are now expecting 50% increase year-over-year whereas we have shared with you a 40% increase a month ago.

Going to North America, recovery continues to gain momentum. There is strong recovery in the demand for freight. Actually I heard that there is even some shortage of freight capability in certain areas, which obviously would lead to an increase in the number of trucks shortly.

We have upgraded our expectations by 5% to 15% compared again to the 10% we had shared with you just a month ago.

China, as I said, has reached another peak production. However, consistent with what we have shared with you in the last two quarters, we still expect a slowdown in the manufacturing of commercial vehicles. During the second half we expect an average of 300,000 trucks per quarter in Q3, Q4 to be compared to that $400,000 that we are leaving behind in H1 Q1, Q2 and that’s due to the fact that we expect the government is going to progressively slow down the incentive package.

So we are actually as you know, the second quarter is higher than we had expected, we have great, again forecast for the number of trucks beyond 2010 compared to 2009 from 20% we had shared a month ago to 30% now.

For India the forecast is stable. We expect an increase of 40% year-over-year of all the commercial vehicles beyond again a slowdown of about 20% in the second half versus the first half.

Turning to next page, Japan and Korea again, our forecast is stable at 30% improvement year-over-year. Brazil continues to show very strong growth. We are upgrading our forecast from 35% to 40% and aftermarket is at 15% expectation increase year-over-year and we upgrade our trader expectation by 10% because we see enormous amount of momentum being built both in the US and in Europe for trader manufacturer and so we are expecting now a 50% growth year-over-year.

Going to the next page, I’m going to – like I do every quarter, update you on a few highlights around the three pillars of our strategy starting with globalization, a new series of trader axels has been launched by this company called (inaudible) in Europe in partnership with (inaudible), which I remind you is the largest trader axel manufacturer in the world and with whom we have a joint venture in China.

We equipped their axels with our added brakes, so the axels that we’ll be exporting to Europe and so through (inaudible) will be equipped with added brakes built by WABCO in China.

The second one is a continuous increase in the number of aftermarket service centers or service points. We are now at 1600 partners, up 17% year-over-year across 110 countries.

Third one is the mandate from the Brazilian government to equip starting 2013 all trucks with ABS. It will be done in two phases. In January 2013, 40% of the fleet will have to be equipped or new trucks will have to be equipped with ABS, and the remainder, the 60% remaining will have to be equipped starting in January 2014, again some very strong growth opportunities for us out there.

Last one is we are introducing obviously a revolutionary single piston, air disc brakes in the US through Meritor trailer (at source).

Going to technologies, first we are introducing a new leg to our aftermarket and services activities. We are launching a Reman solutions capability that I will go through in the page.

Second, our joint venture with Wurth, that we call WABCOWURTH, we announced a few months ago has introduced a new breakthrough product called W.EASY and it has already gained some very good momentum. We have received a lot of strong interest and good orders.

And the last one is we received a strong order from one of the key leading OE manufacturers of commercial vehicles for air disc brakes of 17 to 19 inches to equip all their trucks in the medium sized category, and the start of production is in 2013.

Finally, around execution, we won another couple of awards that rewards the excellence in our service levels. One is from Ashok-Leyland in India and the other one is from Hino in the US.

And finally our WABCO Operating System continues to allow us to demonstrate the flexibility that is needed to adapt our supply chain to this fast changing environment, while also generating, as we said, record level of productivity both in materials as well as in our factories.

Turning to next page, a few highlights around these new opportunity that we are launching, manufacturing products. Number 1, we are leveraging obviously our brand, our reputation and capabilities to develop, manufacture and support products in the world of electronics, mechatronics as well as mechanical products and systems. And we are offering this service to both commercial vehicles and passenger cars.

And this will help our customers and ourselves as well obviously to address issues related to the fact some electronic products are pushed out of production. Also to lower our cost of warranty instead of replacing defaulted units with new units, we will be able to remanufacture. And we are actually only working for and together with OEs as well as Tier 1 suppliers.

We have engaged leading experts in our industry starting with Joe Kripli who is the President of the Automotive Part Remanufacturers Association, a very kind of well-known reputable person in this industry. We have already, since we announced it a few weeks ago, received enormous amount of favorable response from major key customers and we are in a position to open facilities in Poland and in the US in September 2010. Obviously, we will not be able to raise significant amount of revenues in 2010, but our mid-term objective is to reach $60 million of annual sales in 2014 and obviously that’s the beginning of something that we think is definitely much stronger in market opportunities.

Moving to next page where we are going to share with you our new guidance, our new elements for the guidance starting with sales. We update our bracket of sales from $1.86-1.94 billion to $1.93-2.0 billion corresponding to a growth expectation of 35% to 40%. We upgrade our operating margin by half a point from 8-9% to 8.5-9.5%, leading to an upgrade of our EPS guidance from $1.75-2.05 to a bracket of $1.95-2.20. And we maintain as we said our objective to keep this conversion rate between 80-90%. And you see on the right side, all the key elements that is again driving this upgrade. One thing that I want to highlight is that we have some unfavorable conditions in the world of raw materials in H2 versus H1, which leads to a degradation of margins by 90 basis points.

Turning to the last page, and in summary, as I said, our market is now firing on all cylinders for the first time in the last two years. And you have to keep in mind that we are still 25% below our historical level which was the pre-crisis level, which leaves obviously ample room for further growth.

WABCO is continuing to outperform the market in all regions. We also demonstrated in this last quarter, once again our powerful ability to adapt to fast market changing conditions as well as to transform nice topline growth into strong profitability.

Out market conditions continue to favor our three strategic pillars, particularly as we fully leverage on grow or expansion. And finally, you know we increased our confidence in the recovery of markets and we feel very good about raising our guidance for 2010.

So, thank you for listening, and now we are going to turn to our Q&A session. Operator?


(Operator Instructions). Yes sir, our first question comes from Jeff Hammond of KeyBanc Capital Markets.

Jeff Hammond – KeyBanc Capital Markets

Just wanted to better understand what are your assumptions and what are you hearing from European OEMs in terms of the regularly scheduled shutdowns in the third quarter, have they taken them, not taken them. And then separately, on the emerging markets, China, India, Brazil, and your expectations for a downtick in the second half, are you actually seeing them downtick production here as we move into the third quarter, or is that still perspective view?

Jacques Esculier

Okay. Well, thanks Jeff. First, well it seems that all our key customers in Europe are just following the usual pattern of shutdowns during the summer. So, it doesn’t seem that they are departing from the normal kind of schedule from that perspective.

Second, emerging markets, we are seeing some already slowdown in China. That’s why we kind of feel like again there will be a slowdown in the second half, you know, the guess we shared with you is the best guess we have. As you know, this market is completely (ripe). And so many times, from time to time, actually not only for China, for all emerging markets, we underestimated the level of production. We were always, always over-conservative. So, maybe will be again we are conservative, but at least we see some slowdown coming from that (inaudible). In India, we have seen some slowdown already in the second quarter compared to first quarter, because there was a period by preceding the introduction of this new emission regulation. And in South America right now we don’t see any slowdown because the slowdown will be expected towards the end of the year in the fourth quarter. We don’t think the government will actually lower the level of support in the economy prior to their elections. And the election, I think, is in November.

Jeff Hammond – KeyBanc Capital Markets

Okay great. And then, you know, bigger picture question on kind of margin (inaudible). If you look back, ‘03 to ‘08 or that time frame, your performance saw margins, you know, were pretty stable at 11%. And not exactly knowing what 2011 looks like from a demand standpoint. Is that a reasonable target to be looking at for 2011 to get back to kind of normal? And then as we look forward and we get back the prior peak from a demand level, what’s a long term target from a performance margin basis, you know, just based on all the structural improvements you’ve made to the business over the last year, year and a half?

Jacques Esculier

Well, Jeff, again in terms of margin, I would not be sure in numbers with you at this point. But I think we can kind of review the QLMS. Number one, this all start with gross profit margin, and again, at this level of $2 billion we’re able to reach record level of 29.3. And then it’s a question of OpEx, and what we are committed to doing is grow OpEx at a much lower pace compared to top line gross, obviously, under the assumption that if the top line gross is significant. So meaning that we should be able to keep generating some good gross at the bottomline and certain expansions in margins. Now, again, first quarter we had a kind of incremental margin at the operating margin level of 31%, second quarter is 28%, we kind of guide you toward something that will end up in that range of 25%, 26%, 28%. So, I mean, you can do the math, this is the logic that we have kind of our fund, if you were any at something like 23% at the beginning of the year, obviously there has been growth, as the top line gross was going up.

Our objective is to, again, kind of continuously to very efficiently transport top line gross into bottomline increase.


Thank you. Our next question comes from Robert Kosowsky of Sidoti & Co.

Robert Kosowsky – Sidoti & Company

Good morning.

Jacques Esculier

Hi, Bob. Good morning.

Robert Kosowsky – Sidoti & Company

Hi. How are you doing? Just have a question about contemporary vehicle around the world, because I’m just looking at the rate of lab versus estimated production. I was just wondering if you can give kind of an insight into North America, China and India. How much of that is content growth versus maybe inventory build based on a higher end, especially in North America? Can I have some thoughts on that?

Jacques Esculier

Okay, thanks. Well, Bob, it’s very hard to track these things, obviously, closely. But what I could say is when you look at numbers, almost across all regions, we see a nice double-digit increase year-over-year in content per vehicle, except in Europe where we are still growing, but I would pace it at about 5%.

So we really feel confident, again, kind of looking at it in the kind of big pictures perspective. We have such a big difference between the level of technology over trapped in Europe, and the level of technology every across the world. $3,000 of addressable market in Europe compared to $1,000 in the U.S. compared to $300 in China or India, there is room for improvement and very funky it doesn’t kind of challenge the logic to explain that the continuous increase of double-digit in the content of vehicle in those emerging markets is in logical things.

As we start seeing improvement in the safety of commercial vehicles on the road in Brazil, in China, in India where we are actually introducing ABS as well, followed by many other things that will happen to again enhance the overall performance of the vehicle in terms of fuel consumption, in terms of safety. I mean, that’s the logic that I think we’re going to see driving across all those regions for the years to come, for a lot of years to come.

Robert Kosowsky – Sidoti & Company

Okay, and even the – is there any increase in the enforcement of regulations at some point, some of the countries is kind of blank.

Jacques Esculier

Well, again, there are regulations that are kind of moving across the world. I just mentioned Brazil, we are, again, kind of going to India right now. China has come up with regulation, but the enforcement is actually fairly limited. There’s probably less than 20% of vehicles that are equipped effectively with ABS. But we’re dealing with right now with the administration in China, kind of highlight the side that ABS is only contributing to a much safer environment on their roads, and they are very sensitive to it. I think they might kind of reinforce the legislation in the coming months.

Even in Europe, we have this stability control mandate that is coming up in a few months. We have discussions going on for those kinds of automated emergency braking systems that would be introduced in 2014 in the U.S. I think at one point, these breaks will become mandatory to meet a stringent regulation on braking distance that will actually align itself with what is going on in Europe. So there are a lot of steps on the horizon that will again kind of put the level of technology up in all the different regions and it obviously increase the content per vehicle for our products and systems.

Robert Kosowsky – Sidoti & Company

Okay. And could you comment on the strength of Astro market in Europe? And maybe, I know last quarter you had a 90%, 95% utilization rate for the tracking flee, if you have financial for that? And kind of gauge of how many trucks are on the fence right now?

Jacques Esculier

Well, we continued to see, obviously, a very strong utilization in Western Europe. One thing that is new this quarter is a very strong growth in Astro market coming from Russia. So, which again, kind of, I think, is the indicator that the OE activity in Russia should come up soon because obviously there was a very strong slow down in activities in the last year. It’s very kind of interesting to see that within the framework of one quarter, we see so much in increase and demand for spare parts.

Actually the OE business for us in Russia this quarter was actually up 22%. We look at a gross of 20%, 22 % for the full year, the first quarter was slow. So we showed some good momentum going on there. But Western Europe, I think, the utilization rate is still kind of very close or even at probably the full utilization rate, which probably in Europe, would be around 95%.


(Operator Instructions) Our next question comes from Ted Wheeler of Buckingham Research.

Ted Wheeler – Buckingham Research

Hi. Good morning.

Jacques Esculier

Good morning, Ted.

Ted Wheeler – Buckingham Research

I echo, a nice quarter. Glad to have the phone in the room here. You mentioned that interest expense were hold at current levels. I just kind of – you are paying out a fair amount of cash here. Could you just run through that? I think…

Jacques Esculier

Ted, what we meant is that the forecasted expense that’s pending into our guidance is that the current interest rate levels. Of course we had forecasted, as we said in our last call, about $800,000 less income or more expense versus the last forecast. But all we wanted to say with this is that at current interest rate levels and if interest rates go up or down, of course, our interest expense would go up or down a bit.

Ted Wheeler – Buckingham Research

Okay, thanks. And one other point I saw on the release, you referred to some supply chain inefficiencies. You didn’t highlight them, so I guess they are not meaningful. But I wondered if you could comment on them and if these inefficiencies are going to increase or decrease? Or how that plays out?

Jacques Esculier

Well, what we’re referring to get is actually ease out manufacturing at sites are able to flex and integrate this huge growth in demand. It’s not through across all the supply chain and all suppliers. I think across the automotive industry, there is a recognition that the supply base is actually lacking the flexibility and really being stretched to deliver all the different components and products that are necessary to assemble those products that are going to other Tier 1 suppliers.

I think that’s where it kind of sometimes stretches a little bit of things that forces us to spend higher money on air freighting, I mean, there are some crazy things going on here to just, at the end of the day, to avoid any disruption in the assembly of trucks and buses at our suppliers and traders. I can mention things that happen. We had actually excluded the BSL (ph) that created a huge shortage for plastics across the industry. We had another factory that exploded in Thailand that was delivering electronic boards for the industry. We have this kind of things happening because those are running on full capacity, and we have to compensate for it. We have to luckily find ways to kind of generate an alternative and again (ph) so that’s the kind of discrepancy that we are referring to – –

Ted Wheeler – Buckingham Research

Just recalling a couple of years ago, you kind of bulk out some expenses, it sounded similar and, I guess, they’re not at that level. But it occurs (ph) two years ago, maybe two years ago or three years ago.

Jacques Esculier

Not exactly, it began – remember that two years ago, we wear ourselves stretching our own capacity which is not the to do. We have built the flexibility to grow in our assembly capability and machine capability in-house. And the problem is really more with the suppliers at this point.

Ted Wheeler – Buckingham Research

Okay, and so we should think about this as an ongoing problem, guess you’re having problem there with the growth.

Jacques Esculier

Well, it’s not the same (ph) problem we are getting with, believe me (ph), but again the ultimate objective is to shield our customers from these issues. It’s not something that is only affecting WABCOWÜRTH (ph) but it cuts across the entire automotive industry and obviously when we deal with our peers, we all, kind of, face the same challenge. But, again, progress will make things to go back to order, people will embrace the capacity that is necessary to support the labor that we’re going to reach.

Ted Wheeler – Buckingham Research

And, lastly, you mentioned the escalating inflation in commodities built into your guidance now, will those increases something you can offset with the lag of next year or these are just cost you’re going to be absorbing.

Jacques Esculier

Well, we are increasingly be trying to include closure in our contracts with customers that would at least share or maybe completely offset the movements in the price of commodities, but as I have shared with you time and time again we are in an industry that kind of, traditionally, doesn’t do this. It’s a new practice. We are solid with steel, actually, because we don’t have the more erratic behavior in the last two years and we have been successful in good cases to share the burden with our customers but it would take a long time before it’s going to become a common practice across the board.


Our next question comes from Jeff Hammond of KeyBanc Capital Markets.

Jeff Hammond – KeyBanc Capital Markets

I just want to understand your assumption better. What are you assuming for the euro (ph), in the back half of the year? The $1.28 is a full-year assumption, but how are – –

Jacques Esculier

The way we spilt the guidance, we’d use $1.23 for the second half of the year. It’s basically the balance sheet at the end of June.

Jeff Hammond – KeyBanc Capital Markets

Before I just do the math on your revenue guidance in total versus your cost in currency, it looks like $110 million to $115 FX had won in the back half, is that the right way to look at it? That just seems higher even relative to the $1.23 euro.

Jacques Esculier

First half or headwind compared to last year?

Jeff Hammond – KeyBanc Capital Markets

Last year.

Jacques Esculier

$1.45, since you’re above the number, for FX for last year in the second half so it is quite a headwind, yes.

Ulrich Michel

When you take our guidance and compare each two revenues to which one revenue, I think the upper end of the guidance kind of shows the 3 ½% increase at key port exchange (ph) rate. The lower end is a minor 3.5% . So meaning that the mid range of our guidance is flat revenues excluding extend rate, H2 versus H1.

Jeff Hammond – KeyBanc Capital Markets

And you know it’s about a billion (ph) this half year at mid price, right?

Jacques Esculier

We had $1.45 in the second half last year, we’re not forecasting $1.23, and we say 90% of our sales are outside of the U.S. dollar. So it’s not the full impact because what we’re seeing now, really, is more a euro weakness rather than a dollar franc. So, not all our sales are impacted. The euro fell by about 60%, maybe a little bit more in the second half of the year with the growth we’ve seen. So I think it’s not so hard to get to the number you mentioned, Jeff.

Jeff Hammond – KeyBanc Capital Markets

Just looking at the margin, the moving pieces margin, I guess, first half, the second half. Clearly a raw material dynamic is a big piece. But, I guess, as the FX plays through, shouldn’t that be margin accretive? Shouldn’t you have lower transaction cost?

Jacques Esculier

That is big thing in our forecast but you also have to keep in mind, as I’ve mentioned, we had a big gain in the second quarter, almost $5 million, just from the movement of the exchange rate. We have on our no concurrency books, we have for example dollars (ph) on euro book. We have zero liabilities on yen or redeem (ph) book. So if the euro weakens, we have a gain in the second quarter in our P&L which you cannot review without seeing the second part again.

So this is the one time you pay (ph). Other than that, we’re pretty, pretty well hedged that is for the second half between our translation and our transaction of the exposure between the euro and most currency but we are exposed to the short-term movement, where we headed from our balance sheet where we had a nice gain in the second quarter which you will not see in the second half. And then, if you rather think we are still – - we have two factories in China. We grow that on stream where you would see a big (ph) carry-over in costs in the second half versus the first half of the year. Then there’s franc (ph) you know we said at full year maybe $1.7 or it will be better. And we have $1.2 in the first quarter, $1.4 the second quarter. We’ve been delaying price increases as much as we can throughout the year but we had to give it at some point. So if you add all these up, I think, you can see where the margin design is coming from.

Jeff Hammond – KeyBanc Capital Markets

An then separately and maybe you haven’t had a board meeting since the fine came up. I’m just wondering, in the balance sheet you’d still pose for fine and you’re going to be in pretty good shape and certainly the cash flow is continuous to be in process, how has the philosophy changed or not change in terms of cap of the deployment, to want to carry versus one when you first flown out.

Jacques Esculier

I just said we haven’t yet talked to the Board about it and presented our view of the war but I would retrade on June 25, meaning that the kind of leverage we have right now, seems to be accurate but we are generating cash and what we said is we are kind of company reviewing some opportunities for both on acquisitions and things like this. What I can say is we will not kind of need a lot of cash sitting on our balance sheet. When were on it we’re going to have to that cash into our valued share holders, the only thing is again we don’t want to be your verdict (ph) we’ve been leveraging this business even the fact that there is still uncertainty in the economy and we don’t want to be in cordon city (ph) situation where we would have some liquidity problems in case, again, the market crashes into something like this. Again, I think, we would have right now a good solid kind of leverage but be assured that we will not let cash accumulate in very unreasonable manners if we’ll not be using it for either purposes . But again we still not hold our board a good discussions and a good kind of presentation from us on that.


Our final question comes from Robert Kosowsky of Sidoti & Company.

Robert Kosowsky – Sidoti & Company

I was wondering about the about euro 6 (ph) regulation that’s supposed to come out and that’s 2013 and whether or not there could be potentially a pre-buy in 2012 and maybe kind of hit that back after 2011.

Jacques Esculier

I don’t know what I can share with you is that usually in Europe you don’t have much of a free bite. We have seen a lot of introduction of new technologies driven by regulations and the impact on the cyclicality of demand is actually very minimal as compared to what you see in the U.S. So probably you would see some but again I would not expect the kind of swing fits you see on the other side of the DX90.

That closes our conference call today and thank you again for your attention. I’ll talk to you in the quarter, thanks. Bye-bye.


Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may all now disconnect. Thank you and have a nice day.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


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