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Wabco Holdings, Inc. (NYSE:WBC)

Q3 2010 Earnings Call

October 29, 2010 09:00 pm ET

Executives

Mike Thompson - VP, Car systems and Corporate Relations

Jacques Esculier - Chairman & CEO

Uli Michel - CFO

Analysts

Jeff Hammond - KeyBanc Capital Markets

Robert Kosowski - Sidoti & Company

Keith Schicker - Robert W. Baird

Ted Wheeler - Buckingham Research

Martin Sankey - Neuberger Berman

Robert Kosowsky - Sidoti & Company

Operator

Good day ladies and gentlemen and welcome to the WABCO Q3 2010 results conference call. At this time, all participants are in a listen-only mode. (Operator Instructions). 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 systems and Corporate Relations. Sir you may begin.

Mike Thompson

Good morning everyone and welcome to WABCO's quarterly conference call. Today we will present our third quarter 2010 results. With us this morning is Jacques Esculier, our Chairman and CEO and Uli Michel, our Chief Financial Officer. Before we begin, I'd like remind you of a few things. First, this call, webcast and the presentation that we are using this morning are available on our website wabco-auto.com under the heading WABCO Q3 2010 results.

A replay of this call will be available through November 29th. 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 third quarter 2010 quarterly 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. Welcome to out third quarter review and discussion with you but before we jump to our facts and numbers I would like to frame the third quarter in the perspective of the markets. We have seen across the world in all regions another very strong quarter of growth in the number of trucks, traders and buses built.

Actually this third quarter is the second quarter in a row with strong growths in the manufacturer of commercial vehicle in all the regions of the world. Now from WABCO's perspective I would like to share three highlights with you. The first one is that we have again outperformed the markets. The second one is that we continue to transform this strong market growth and strong growth in revenues into outstanding profitability and the third one is that the third quarter has again added to the confidence that we are building up in the recovery of our industry and this leaves us to again update and I would even say a great guidance for the year 2010.

Now looking at the numbers starting with the top line, our third quarter sales grew by 50% in local currency to $545 million. This comes from a very strong growth in demand from our OEM customers, it also comes from a remarkable 25% increase in our revenues year-over-year in aftermarket business. This quarter is actually an all time record quarter in revenues for after markets.

Performance growth profit margin is 27.7 for the quarter, up 200 basis points from 2009 quarter three leads to an incremental gross profit margin of 33%. Our performance operating income is at $56.4 million up about $40 million versus a year ago. We ended up with a margin above 10%, actually to be accurate at 10.3% and it leads to an incremental operating margin of 22%, performance EPS at $0.71 and then a free cash flow that I would call operational free cash flow of $52.4 million after we exclude non-operational items liked (inaudible) identification and other things leading to a conversion rate of a 119% and as I said we are right now in a position to confidently raising our full year guidance for 2010.

Moving to the next page, to kind of review sales performance and market dynamics. Starting with finance, we were up as I said 50% excluding the impact of foreign exchange and when we look at it from three different channels, we generate revenues from starting with OEMs up 59% year-over-year, up 7% sequentially versus Q2 2010, obviously supported by a strong growth across all regions particularly in Europe and South America this quarter as well as continuous increase of our content per vehicle, active markets went up 25% this quarter.

Again we achieved all time record in revenues mostly coming from higher fleet utilization rate as well as obviously continued strong execution of our active market strategy. Also it's worth noting that active market is using a very good indicator for the future evolution of demands from the OE channel. Then our sales to joint venture driven mostly by our sales through our American joint venture, up 74% driven by a strong increase in demand for trader products in the US 82% as well as preparing the supply chain to support what we believe to be a strong acceleration in business activity starting in Q4 2010 extending obviously deep into 2011.

Now when we look at WABCO sales evolution in each region against evolution of the markets, starting with Europe production of trucks and bus went up 64% year-over-year or 3% sequentially versus second quarter. We went 78% and we benefited from a favorable mix between heavy trucks and medium trucks actually the growth was driven mostly in the segment of heavy trucks this quarter. Most American truck and bus built 12%, year-over-year, 2% sequentially. We went up 38% again driven by these strong growths in trailer as well as the preparation of supply chain for further growths in Q4 2011.

South America market continues to do very well, 65% growth in truck and bus built versus last year, 7% up versus the second quarter of 2010 and we outperformed nicely at 79%, Japan Korea 26% increase and we are basically aligned with the market. It's a slight erosion of 2% versus Q2. China growing still 9% year-over-year, but a decline of 25% as expected versus Q2 and we've nicely outperformed at 32% gross in revenues driven by the continuous implementation, a penetration of new technologies and new products over there. The same with India where we ended with a 55% growth for market, increase of 38% year-over-year or 8% sequentially. So very strong market and again obviously we outperformed nicely to market this quarter.

I am going to drive you through the details of our financial results. Ulrich?

Uli Michel

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

Performance numbers for the quarter are adjusted to remove operation streamlining and separation costs as well as discrete and other tax items. In addition, comparisons to 2009 have been adjusted for currency translation effects.

As Jacques mentioned, sales increased 49.5% in local currencies versus last year and 4% above Q2 2010. This increase in sales includes price reductions to customers of 1.6%, which is slightly below what we are anticipating on a full year basis for 2010. Gross profit increased 62.7% with an adjusted gross profit margin that has improved by 22.7 basis points compared to a year ago.

Gross profit was driven more significantly by the higher business volumes which contributed 37.8 million. Our productivity initiatives continue to deliver strong results. We generated 5.2% of productivity through our material productivity project, partially offset by 250 basis points of commodity inflation. The result was a net material for activity of 2.7% for the quarter. As we previously discussed with you on our call from last quarter, we began seeing the negative effects of higher commodity prices as early as the second quarter with visibility to further impact our margins in the second half of the year.

Consistent with this previous view we would expect to see a similar effect on commodity pricing on our fourth quarter results in comparison to the same period of 2009. We also delivered very good conversion productivity in our factory. In Q3, we achieved a level of 5.7% which matches the highest level that we have ever achieved at WABCO. We also generated significant benefit from more efficient absorption of all the head costs which contributed $17.5 million this quarter.

As you can see WABCO's operating system continues to generate the necessary flexibility to a debt to fast changing market by rapidly ramping up production volumes and effectively mitigating supply chain constraints while still delivering strong productivity results. Our global manufacturing footprint enabled us to improve margins from transaction of foreign exchange gains by $5.6 million in the third quarter of 2010 versus the third quarter in 2009 as we primarily benefited from a weaker euro.

This improvements were partially upset by slight increases from inflation and a few other items which all together cost us about 1 million of gross profit compared to the third quarter of 2009. The increase in performance gross profit margin this quarter represents an incremental gross margin of 33% on our sales increase from last year, resulting in the performance gross profit margin of 27.7% this quarter compared to 25.7% in the same period a year ago.

In operating expenses, you can see an increase in the third quarter versus a year ago. As stated in our last few earnings calls. We are bringing certain costs that we had temporarily removed in 2009. These items include annual cash bonuses 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.

The reinstatement of these cost items means an unfavorable variance of $4.2 million versus the third quarter a year ago. This remains in line with the full year estimated impact of $24 million that we had shared with you in our previous calls. Consistent with our first two quarters this year, WABCO's third quarter performance is well above our prorated annual target for 2010, which resulted in an additional accrual of $3.6 million of incentive compensation beyond target.

Inflation increased operating expenses this quarter by about $2.2 million compared to Q3 2009. You will see that net savings from our cost reduction efforts we also had an increase of 7.1 million versus 2009 from strategic investments which amount to just below $3 million and other one-time items of about $4 million which include the costs of the IAA Trade Show, legal defense of IP matters and organizational change. Even after these increases we had limited the overall increase in operating expenses to less than 50% of our sales growth resulting in margin expansion of an additional 356 basis points versus a year ago.

For all together we generated operating income of $56.4 million or 10.3% of sales on a performance basis. This is a significant increase over last year's performance of $17 million and it has resulted in a margin expansion of 583 basis points. In summary, we delivered another outstanding financial performance this quarter generating a 22% incremental operating margin on our sales increase versus a year ago excluding the effects of translation on foreign exchange.

You can see that this quarter equity income was $3.2 million which includes an improvement in earnings of 1.5 million from our North American joint venture. Additionally, the expense to minority shareholders amounted to 3.2 million this quarter largely driven by the profits of our Indian subsidiary which compared to an expense of 1.7 million in 2009.

On a reported basis, we recorded a tax expense in the amount of $10.4 million for the quarter. Excluding this pre-tax items as well as other one-time items, we incurred $9.7 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%, down ideally from our previous estimate of 18.5%. This improvement in our estimate drove a third quarter tax rate of approximately 17% in order to bring the nine-month year-to-date rate to 18%.

As you can see, we start to really benefit once again from our supply chain structure in Europe. We still had very low interest expense of $0.5 million in Q3 after payment of the fine indemnification, we would expect net interest expense to increase by about $800,000 in Q4. So, after excluding the non-performance items, net income was $47.1 million with regards to earnings per share, this translates to $0.71 on a performance basis compared with $0.19 a year ago.

We believe that the growth and margin expansion we keep generating is impressive. Furthermore it makes 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 had a net negative impact on our cash from operations in the amount of $14.3 million in the quarter, included in the amount is an 8.5 million increase in accounts receivable. As we mentioned in our previous call review, we began selling accounts receivables into our asset securitization program in the second quarter.

In September, we amended the asset securitization program to give us access to additional funding through daily settlement. As of September 30, however this required effectively a reclassification of 19.3 million to financing activities combined with $11.8 million of increased receivable balances sold into the program. The net income on Q3 operating cash flow was 7.5 million of cash outflow. Outside of the impact from the securitization program, the accounts receivable balance in the quarter would have otherwise grown into an amount that we would expect in this high growth environment.

Our DSO and past dues remain at historically low level. Inventory increased by $23.8 million whereby turns improved this quarter. As we mentioned last quarter, the high growth environment that the commercial vehicle industry has experienced in recent months has put various constraints on the supply chain. In order to help mitigate any impact of these constraints we continue to invest in inventory for those areas where we see risks. Our payables were increased in the quarter by $18 million, also reflecting the impact from increased growth in our business.

As we previously communicated, we paid the EC fine indemnification in the third quarter in the amount of €326 million translating to an amount of roughly $437 million on the date of payment to the commission which took place towards the end of September. This amount contracts with the $400 million translated at the rate of the date of the EC announcement and assessment in June. The development of the foreign exchange translation seeks the assessment of the client had no impact though on our overall financial position because we used €230 million of cash previously invested in short-term euro deposits and borrowed €96 million in Europe under our revolving credit facility.

The changes in another assets and liabilities had no significant net impact in the quarter. As a result net operating cash flow was a negative 381.7 million for the quarter. Net cash used in investing activities was 12.1 million which included $3 million in proceeds from the disposal of our Utah facility that we had announced in our original streamlining program in 2008.

The resulting free cash flow was a negative 393.8 million or a positive $52.4 million when excluding the payment of the fine indemnification, the net streamlining payments and the effects of the asset securitization program. This $52.4 million represents a 119% conversion rate of our net income into free cash flow. Considering the continued growth in business volume this level of conversion is a very strong result.

I would also like to draw your attention to another significant fact. Looking at our current financial performance, our return on invested capital excluding goodwill and pension is close to 40% which is at the pre-crisis levels again. This is a good proof of the efficient way of our WABCO operating systems optimization of uses of cash. Now I would like to turn it back over to Jacques who will highlight some of the market dynamics.

Jacques Esculier

So turning to page seven. Like we do every quarter, we are going to share with you some of our observation and forecast for the market evolution in each of the regions of the world, start with Europe. Actually Europe continues to do well for us. Our order book actually keeps increasing, we have seen an increase of 9% in the last three months. We see an increasing number of orders for trucks and buses, both from European customers as well as for export markets or together we now see the evolution year-over-year of the European markets grow to 55% which is 5% of what had shared with you three months ago.

That's 2010 compared to 2009 and actually when you look at those 55%. Again as kind of said it before 30% of this 55 is really driven by the fact that a year go the industry was trying to get rid of a very fat inventory of finished good representing about 72,000 trucks and now that this inventory has been depleted at the beginning of this year, this impact is gone and that truck drives itself in the 30% increase of reduction to align with demand.

The second part of 25% covers increase in demand. We see about 1/3rd of it coming from European demand actually registration for the third quarter are up 14% year-over-year and the other 2/3rds of this 25% comes from increase in demand from exports. Looking forward to 2011, we anticipate a continuous growth year-over-year in the range of about 15%, that's initial kind of view of the world that we have today.

Moving to North America, strong kind elements pushing for a continuous increase in demand for commercial vehicles, the freight demand is up. We see strong orders from export markets. Overall we think that the industry will produce about 15% truck and bus more as compared to 2009 for this year.

Now looking at 2011 and giving an initial estimate. We think that this market will really take off, starting in Q4 by about 40% year-over-year. Now to put that in perspective, when you look at the number of heavy truck, heavy duty truck ordered in 2010 versus 2009, the number of orders is up 40%. The number of orders year-over-year is up 24%, so I think it frames nicely the fact that in the very short term, we will see a significant increase in the number of trucks and bus built.

Going to China, Q1 and Q2 have seen each of them 400,000 trucks built over there and anticipated the demand for truck has gone down in the third quarter and 300,000 trucks were built there. We expect Q4 to be flat to Q3 actually and this is due as we had anticipated to the fact that the government has slowed down on stimulus packages and it has an impact on demand for construction vehicles.

Overall for 2010, we expect the truck and bus production rate to go up by 35% as compared to 2009 and that's 5% higher than what we had shared with you a quarter ago. Now looking to 2011, even though the Chinese market is as you know the most complex environment for us to forecast, if we have to give an estimate today we would say it's going to stay flat to maybe slight erosion of around 5%.

Going to India, Q3 truck and bus production was up very significantly actually even 9% sequentially versus Q2 and this is due to the fact that on the 1st of October there is introduction of a new legislation on emission control. So there was a pre-buy effect in Q3. Now for the full year we anticipate the truck and bus growth to be at 50% versus 2009 which is up10% from what we had shared with you three months ago. Now the fourth quarter will be sequentially down 15% from Q3 again because of this pre-buy. Now anticipating 2011, initial estimate would be for this market to continue to grow at double digit between 10% to 15% a year.

Moving through the next chart, traveling all the way to Japan, Korea where we see the truck and bus production fairly stable at about 62,000 to 63,000 units per quarter. In the fourth quarter, we see a slight erosion in Japan after some pre-buy effect in Q3 again due to again a legislation introduced in Q4 compensated by a slight increase in demand from Korea. Overall at the end of the year we are seeing this market having progress by about 35% versus 2009 which is 5% more than what we had anticipated three months ago.

Now looking at the horizon, we see an initial estimate of flat to about 5% increase in 2011 versus 2010. Brazil continues to be a strong growth story. The government has decided to maintain the stimulus package until the end of the year. So it has really helped the third quarter. It will continue to help the fourth quarter. However, the fourth quarter should be lower than the third quarter because there are some vacations planned in December.

As I remind you, it's going to be the hottest summer time over there. However altogether for the year we expect the market to have progressed by 50% versus 2009 which is 10% more than what we had anticipated during our last call and we think this market will continue to grow. However the first half of the year, we believe will actually come down because the government stimulus will end at the end of this year, so that we will have a negative impact on the first half of the year that will be compensated by a strong growth in the second half fueled by a pre-buy because of the introduction of new legislation in early 2012.

After market, as we said we have seen a very strong increase in Q3. We are now in a position to upgrade our expectation for the full year to 20% from 15 that we had shared with you three months ago. 2011 we kind of see the growth going back to normal at about 10% sales growth year-over-year and again as we said it's a indicator that comfort us in the fact that we should see continuous growth in demand for our trucks and buses particularly in Europe and North America moving forward.

And then the last element of our market is trailer, which has seen another significant improvement in Q3 versus last year at 65%. Our Q3 is however flat at this point to Q2 and that's the seasonal effect. The market is again expected overall to have generated a 60% increase year-over-year versus '09 which is 10% more than we shared with you three months ago and again looking at 2011, we would anticipate at this stage that it could grow as far as another 20% because it's going grow probably in line with the market in the US and in Europe.

Moving to page 9. Again, as usual we give you the highlights of our achievements around the three periods of our strategy starting with globalization. We have expended the contractual relationship, we have signed to actually sell our OptiDrive automated manual transmission to Ashok Leyland for their heavy duty truck, that was a few months ago and we have extended that contract to cover now their medium duty trucks as well as their buses.

We signed a five-year extension of our supply agreement with Cummins to provide them with compressors for their engines in trucks and buses delivered in 190 countries and we expanded our long-term agreement with Iveco to add some air processing units that we are going to start delivering to them in 2011 and that's new business for WABCO.

In terms of new technologies and products as you know we had in September, we attended the bi-annual IAA fair trade show for our commercial vehicle which is the largest trade fair for our industry in the world and that was obviously the privileged platform to rollout 10 new products and technologies among which I would mention our on broadcast technology. This is today the industry's first system to comply with European unions expected regulation to make these autonomous emergency braking system mandatory on trucks built starting in November 2013.

We also won of couple of awards, the first is the 2010 Telematics Awards. That's for the technology that we rolled out to equip trailers with a system that we call Trailer Guard and the second one is a prestigious Trailer Innovation Award that kind of recognizes the suite of technologies and innovations that we have packaged into what we call the intelligent trailer program for again our trailer customers in Europe and in the US.

And lastly along the execution or our strategy our WABCO operating system as we said continues to provide very strong results both in material productivity as well as continuing to reach record level of conversion productivity in our factories. Turning to page 10, we are sharing here with you our upgraded guidance for 2010.

Starting with the topline, we are actually seeing now the growths in revenues moving from the 35 to 40% bracket to 46 to 47 range. Our performance operating margin moving from 8.5 to 9.5 to a bracket of 9.7 to 10, leading to a performance EPS estimate from 195 to 220 to a range of 247 to $257 per share and maintaining an objective for a strong conversion of our free cash flow of 80 to 90%.

Now we are as you know not sharing quarterly guidance, however there is only one quarter left which is I one to avoid the you the deduction of those numbers and we provide you with the protection that the first quarter, we start in the range of 35 to 40% year-over-year performance operating margin of 9 to 10% and performance EPS of $0.62 to $0.72.

Finally moving to page 11, kind of summarizing this quarter, again very strong quarter for the market. Even stronger for WABCO with a double-digit growth in all regions and this is another strong step in the recovery of our industry. WABCO continues to outperform the markets. We have achieved a very healthy $0.71 for performance EPS. We have seen a strong conversion of net income to free cash flow and we continue to build up the confidence in our market and that resulted in raising the full year 2010 guidance.

And then we think our market continues to be and will continue in 2011 to be a steady platform for growth for our business obviously under the assumption that we will not see any destructive macroeconomic development. So this concludes our presentation and we open now obviously to questions and comments.

Question-and-Answer Session

Operator

Our first question comes from Jeff Hammond of KeyBanc Capital Markets

Jeff Hammond - KeyBanc Capital Markets

Just on the fourth quarter guidance, it looks you are at the midpoint looking at 11% sequential improvement versus 3Q and the guide kind of implies on an earnings basis flat to down and I understand there is some moving pieces, but help me understand why earnings aren't up sequentially more in line with sequential sales improvement?

Jacques Esculier

That's really good question. Jeff what we see right now looking at Q4, obviously Q4 would show just short of $50 million of increase in revenues which will sequentially provide us with about $0.16, additional cents at the EPS level driven by this additional volume. However there are a few things that you said that kind of happens here and there and a few of those happened this quarter. There is first what we called, what I would overall call seasonal routine activities.

That thing that happened during fourth quarter usually and everything related to seasonal vacations as compared to third quarter for example. The third quarter usually sees a lot of vacations taken and certainly more than in this first quarter then there is everything related to the physical inventory revaluation that we do in the first quarter and there is a slight additional investment in OpEx all together. Then we have about, in that we present $0.11. Then there is interest increase quarter-over-quarter.

Again all that is compared to Q3. About $0.01, we said about $800,000, its about $0.01 after tax and then we had improved the tax-rate for the year in Q3 and we had to catch up for the first two quarters so that represents basically $0.02 to $0.03 itself. Right, so when we kind of look at it, yes there is the logic of our incremental margin and over that we drive $0.16 additional as compared to Q3 but then we can take out quite a bit of those things because of order, the reason that I listed and that's why we think that our role is going to be more or less at December level, at the EPS level.

Jeff Hammond - KeyBanc Capital Markets

If I kind of wait for your growth rates or production growth rates that you put into the presentation, it kind of gets me to low teens production growth on a weighted average. How would you think about market out growth in to '11 just given the wins you've had and how content per vehicle is moving?

Jacques Esculier

I don't want to talk about AOP because we have not really locked it in yet. So I don't really want to kind of guide on 2011 performance and you know that's why we wanted to basically kind of frame it as we kind of ourselves talked about how we see the market evolving. Now I would say very rapidly at the top line, I think we will continue to outperform markets the way we have kind of discussed it with you guys over the years but I would say 2 to 3% something like this.

Jeff Hammond - KeyBanc Capital Markets

Okay, great. And then just final question. When you came out of the spin in 2007, the focus from a free cash flow prospective was to add a little leverage, buy back stock, pay a dividend, and we have had this period around the fine where we were just collecting cash, and now that's behind us. So, just wanted to refresh on that issue. How is management and the board thinking about capital allocation and free cash flow use today? And how is that the same or different versus pre collecting cash for the fine?

Jacques Esculier

Yes, another really slick question Jeff. Obviously we would certainly not accumulate cash on our balance sheet. This is not a good way to drive wealth for our shareholders. However I kind of mentioned several times before, in the last three years we just could not drive any acquisition activity because we have to conserve cash to pay the fine. There are a few opportunities that we right now are kind of unlocking in the pipeline. And I think in the coming months, we want to leave our self the opportunity to drive some acquisition activities.

And that would be the first priority for me to realize this cash because I think it's probably help the force to keep kind of increasing our parameter in terms of global reach, in terms of technologies. Nothing transformation on as I have said before, but think that nicely complements and supports our growth for the future. Then obviously depending on the amount of acquisition we are successfully driving, whatever would be left we will differently kind of make decisions and there are a few things, three things that we can look at, number one is look at the leverage that we have at this point.

Right now we think of reasonable leverage, however, the economy moving forward is not as solid as we wish it would be. And obviously we don't want to enter any kind of new potential recessive environment with a stretched balance sheet. So I want to have until the economy looks little more certain, I want to have a fairly conservative approach on the leverage and the other thing is obviously all depending again on the marked cash left, we will definitely look at the best way to return it to the shareholders under the form of dividends or buy backs of both.

Operator

Thank you ladies and gentlemen. (Operator Instructions). Our next question comes from Robert Kosowsky of Sidoti & Company.

Robert Kosowski - Sidoti & Company

It looks like SG&A was actually the lowest of 2010, our operating expenses the lowest of 2010. What's the reason for this decline despite revenue being so much stronger than the first and second quarter?

Jacques Esculier

Its what we have said, it's the seasonal impact of vacation. In Europe typically people take may be two to three weeks of vacation in the third quarter and in the other three quarters it maybe one week

Robert Kosowski - Sidoti & Company

Okay.

Jacques Esculier

Okay and for our us one week of vacation is worth close to $4 million, if everybody takes it in SG&A.

Robert Kosowski - Sidoti & Company

4 million for one week.

Jacques Esculier

That's one week of payroll maintenance sheet for us.

Robert Kosowski - Sidoti & Company

Per person?

Jacques Esculier

For all the people in SG&A and product development.

Robert Kosowski - Sidoti & Company

Okay and can you talk a little bit about raw material purchasing and kind of what you are seeing out there? Did you see any material shortages in some of the components you are buying? I know you said you bought inventory ahead of time. But other steps you may have done to mitigate that and kind of what your outlook is for 2011 with regards to material availability and inflation?

Jacques Esculier

Like everybody had on strike now in I think in the industrial world. We are faced with some kind of complication in the supply chain that affects a few areas; I would say mostly electronic components, plastics and in some areas actually casting of aluminum and that's mostly driven by some shortage of capacity for casting and machining operation. And very frankly, in addition to the pure inflation of the raw material, it costs us about $3.5 million of additional cost for us to which you have to add a few $100 million of airfreight because again we have succeeded as not of being one of those suppliers that would disturb the production line of customers. So it's a little bit of a stress sometimes, but again we have so far complied with the commitment for our deliveries, we have maintained a decent delivery rate and but it costed us some money.

Now moving forward, again I don't want to share anything with you related to 2011 at this stage because I think it would be unfair while we don't have enough information. What I would say is really this. If you would freeze, the quest of commodities as we anticipate to see them at the end of 2010 which means another year-over-year for the quarter is about growth 2% increase in 2009 versus 2010. If you would take this and you would say okay, we freeze it for 2011, it would represent about 1-1.5% of further increase in commodity cost. And now anything that would be increase beyond what it will be at the end of 2010 obviously will come in addition to it.

Robert Kosowski - Sidoti & Company

And that's because I guess a lot of the inflation was back half loaded in 2010. So you're…

Jacques Esculier

Exactly, exactly. As I remind you, the first quarter year-over-year, we actually had seen a little kind of tailwind. The second quarter I think it was 1.6%, the third quarter was 2.5 and the fourth I think is 2.2 or something like this, that's headwind. 2, 3, 4 is all headwind.

Robert Kosowski - Sidoti & Company

Okay, fair enough.

Jacques Esculier

The first one was a tail wind.

Robert Kosowski - Sidoti & Company

Okay, then one other question. Would you expect it to see higher incremental margins this year given the presumably easy efficiencies of Europe going back up in production as much as it did?

Jacques Esculier

This year you mean?

Robert Kosowski - Sidoti & Company

Yes, this year in 2010. Given that Europe came back so strong, would you have expected to see incremental margins above 33% the goal that you have.

Jacques Esculier

No, for 2010 roughly we had shared with you were kind of we would up kind of just short of 25% at the incremental operating margin right?

Robert Kosowski - Sidoti & Company

Yes

Jacques Esculier

Yes, that's why we are looking at it. Now what we also said is the way we framed it and that's the way we have shared with you guys we say give us top line growth of 15% to 20% and I think we could see a incremental operating margin of 25% to 30%.

Robert Kosowski - Sidoti & Company

And then I don't know if you will be able to answer this question, but how do we get more comfortable with your forecasting ability with regard to guidance?

Jacques Esculier

Well I am just asking our customers to be more accurate in their forecast is going to help because the top line is really driving a lot of unguided force right now in 2009, it was negative unguided. Now it's positive unguided because we are obviously trying to push our supply chain, but there is still a little bit of anxiety.

Operator

Thank you our next question comes from David Leiker from Robert W. Baird.

Keith Schicker - Robert W. Baird

If I look at the operating expenses, how should I think about a growth rate in those expenses over time or kind of a trend growth rate as we revert to a more normalized level of market growth in 2010 after the strong growth and 2011 after the strong growth in 2010?

Jacques Esculier

At this quarter I think we have a operating expense of 17.5% type of wrench. We have continuously kind of coming down where I shared about 22% if I remember for the full year. I mean first quarter was more in the 19%. So we are 17.5. I am sure that we continue to obviously drive OpEx at a much lower paid as compared to topline and very frankly I think that 17.5 is still accepted for us, but we have to drive minimum of OpEx to cover engineering activities and what not and what I said in 2009 which was that we didn't want to deplete OpEx and certainly decreased engineering costs beyond a certain point is true.

We need to drive a minimum amount of activity of just make sure that we secure the pipeline of innovation or in technology as well as obviously continue to expand globally and fuel the global growth. So yes we will keep increasing OpEx, we cannot freeze OpEx at this point, but we will end the commitment we have, we will keep increasing it at a much slower pace as compared to the top line.

So that's what I would say Keith.

Keith Schicker - Robert W. Baird

If I look at the greenhouse gas emissions and fuel economy requirements for trucks that were proposed in North America, I understand that's not one of your primary markets, but you do have some technologies that do help to meet those standards. Beyond automated manual transmissions and beyond the air compressor with the clutch on it, is there any other opportunities that you see to help others meet those standard and can that potentially drive additional growth for you and penetration into the North American market?

Jacques Esculier

Well again there are couple of things, we can help this two consumption and you mentioned two technologies, you could also kind of mention the electronic air processing unit that could be at one point offering opportunities in the US, it has not yet. But there is also the opportunity for us to highlight the saving on weight and that's kind to earliest great strategy that will allow us to introduce a disc brake that is lighter, nicely lighter as compared to competition. And we also have the time monitoring kind of a device that have to drive it continuously, maintain the pressure in the tire at the right pressure and that saves a lot of fuel. So and other things, obviously I can't share with you at this point because it is a little bit longer term, but we really want to be a strong contributor in normally North America across the world for each region to progress as day one to make their commercial vehicles cleaner.

Operator

Our next question comes from Ted Wheeler of Buckingham Research.

Ted Wheeler - Buckingham Research

I wanted to circle back if I could on the content issue. Maybe focus on China particularly and India, Brazil and Japan, sort of the developing economies. There's a lot of volatility in the content for the outgrowth that you exhibit, but it is pretty powerful. It seems to be much higher than that 2% to 3%. I wondered if you can just kind of give us a look at to what might be a more sustainable number in those markets?

Jacques Esculier

Yes, you are right. It's sequential, so there are technology that we introduced, but unfortunately you introduced them only once. Now the penetration is obviously progressing year-over-year, I don't want to go into the discussion of 2011 if you don't mind beyond what I just said. The only thing I can say is yes, there is continuous opportunities for us to further penetrate the emerging markets with technologies that we have developed in this part of the world and again these (inaudible) Clayton contract is again a nice kind of proof of it.

Content per vehicle is progressing but to be fair, as much as I wish we could put a AMT on every truck in China, the penetration is not as fast as one could anticipate at this point. It's going to be probably take time for those kind of high tech thing to generate a huge amount of additional sale that could have an impact in terms of content per vehicle at the overall top line of WABCO.

So there are a lot of things that we are planning, a lot of things that we are generating locally nice incremental sales, but again to just hit the top line of WABCO, 2% of the top line of WABCO is already (inaudible) to 3%, so Ted to kind of make in clean and clear what we have been doing so far and proving to you is what we would continue to do in future in the terms of bringing new technologies to emerging markets as well as by the way introducing, continuing to introduce new things to European market. As I remind you we are introducing the stability control at the end of next year to Europe. We are introducing the AEBS, this autonomous emergency braking system in 2013-14 and of 13, early 14. So that will still provide some nice opportunities in our traditional markets as well.

Ted Wheeler - Buckingham Research

Is there also a mix issue in, say, China? Where just the percentage of trucks that carry the higher-value product is fairly low, and isn't it reasonable to expect that will continue to work its way higher?

Jacques Esculier

It's going to continue for different reasons. First begin as I said you look at an AMT system for example. It takes time to switch the market to this and very frankly I think we are doing some incredibly interesting things right now to kind of convince the market overall that AMT is a very valuable thing to have on a truck. And that's for the domestic market. Also I think that increasingly the Chinese manufacturers will be willing to include more advanced technologies as they kind of export more trucks across the world to compete against our more traditional global OE players.

So for exports as well as again as we kind of mature the market towards those new technologies progressively I think these all things supports again a continuous increase of content per vehicle in those countries.

Ted Wheeler - Buckingham Research

Well we have a little more granularity on this issue, in subsequent earnings call? I mean, when you get to look at '11, will you kind of break this out a little bit more?

Jacques Esculier

Yes, we have to be careful there because there are a lot of very proprietary data here that obviously we can't openly share like this, but we can certainly mention a few things. A few technologies that we see being introduced because it's kind of public data, but we can't give you obviously accurate numbers on the number of items we sell and the increase year-over-year and those kinds of things because that becomes pretty confidential obviously.

And another thing by the way Ted that we have to all recognize is this way of legislation that mandates ABS in the future. India is just going through it, you have Brazil coming. China has gone through it back in 2005 but it's still not implemented. The penetration is still below 20%. So there is still a huge potential even with ABS.

Operator

Thank you. Our next question comes from Steve Tusa of JPMorgan.

Unidentified Analyst

This [Drew Pearson] in for Steve this morning. Just quickly, on just to revisit FX, I know year-to-date, the way your footprint is set up with the weaker euro, you have been able to kind of minimize the fall through of the bottom line on FX. Is that still in place given kind of the moves we've seen in the last month or so in currency? Can you just kind of re-update us on that issue?

Ulrich Michael

Yes I will. You know we have exposure to several currencies. Of course we do business in all the major countries of the world. So we have exposure to all of these currencies but our biggest exposures are between the euro and the US dollar. And since we still generate the majority of our income in Europe, a strong euro helps us when we report earnings in dollars by translating the euro income into more dollars.

On the other hand, we are still a net exporter out of Europe mainly to the US. You have seen these sales through our joint venture, the biggest chunk of the sales go to our North American joint venture Marathon WABCO kind of see this market and at this point, that's basically the only input we have. I hope we're going to be a little bit richer as we progress into developing the AOP over there and obviously as we again present the AOP and share the guidance we view in February of course we have been an exposure to the exchange rates on the margins.

So if you assume we sell may be $13 million to $14 million worth of products from Europe to North America and we have 10% moving into the exchange rate and you can see formally on our operating income eroded which again explains also this thing of operating margins but we'll make it up with the translation of our income in Europe.

So on the bottom line; we don't add much of an exposure there. Now that again, there's a few other currency payers that are more important ones for us other than (inaudible) Riyal where we have both the exposures against transaction because we sell from Europe to brazil and we sell from brazil to US a little bit and then of course we have income in Brazil. Another important exposure of course is today Indian Rupee. We have (inaudible) business in India which is too mighty more of their profitable business. So when there would be strength versus the dollar, we benefit from it because our rupee income translates into more dollars.

From a transactional basis we do not have that much exposure yet. And then we have the RMB and the euro and the dollar but unfortunately the RMB is not moving much to the dollar. So I would say on the big exposure which is dollar euro, we're pretty well hedged on the net income basis and if you look at the baskets of all the other since we have so many different currencies, most of the time at least over a few quarters, the net impact is also not very big.

Unidentified Analyst

Okay. Great. Thanks, and then finally just moving to China, I appreciate the dynamics on how that's a hard market to forecast and I understand the comments about exiting the year out of a lower run rate, and the difficult comp's. But what else are you guys looking at, whether it's a macro view or what you are hearing from customers in terms of getting to that flat to downsize forecast? Just a little more color. Thanks.

Ulrich Michael

Again, very funky of China particularly is very complicated for us to even gather a clear vision from our customers. Our customers are used to basically not really having much of a forecast for the full next following year. They know they are in a fairly complicated market, complicated to forecast at least. And you know it's not like in other places of the world where they would to a certain extent share a certain feeling on what's ahead. In China it doesn't work that way.

So we really kind of looked at it ourselves kind of saying where we, WEBCO see would this market and at this point that's basically the only input we have. I hope we are going to be a little richer as we progress into developing the AOP over there and obviously as we again the present the AOP and share the guidance with you in February but this point unfortunately we don't have much more than that.

Operator

Our final question comes from Martin Sankey of Neuberger Berman.

Martin Sankey - Neuberger Berman

Okay. I would like to focus in on a couple of dynamics for 2011 that aren't market, but rather on the cost side. First, we've seen discount rates come back and drop significantly. What impact does that have on pension expense for WABCO in 2011? What kind of headwind does that generate?

Jacques Esculier

What do you mean with discount rates, you mean interest rates or…

Martin Sankey - Neuberger Berman

Well the discount rate on the projected benefit liability and the impact on your pension accrual for next year

Jacques Esculier

I mean look we haven't recalculated but as you know, the majority of our pensions are unfunded in Europe, so there is an impact on it that would potentially increase with discount the future liability at a lower rate; it makes the higher liability now. But I have to share what I have seen so far for this year's data there is not much of an impact with the new interest rate, just few calculations or initial calculation on some of the plans we have here. So, I really can't give you a good answer, I think just mechanically that's a good increase for liability.

Martin Sankey - Neuberger Berman

Okay. My next question has to do with the tax rate. I understand that we're now in a regime where you would expect the tax rate to be in the 20% range, but during the third quarter, there was some laws passed in the United States in which, there were tax provisions affecting international company taxation. Is that going to have an effect on the tax rate of WABCO going forward? Anything that we should be aware of?

Ulrich Michael

First thing is we're currently at around 18% and from all I know and for all we certainly do now, it would also be my best guess for next year at this point. We look at the US legislation future that is either United States or people would expect to be enacted and we do not see it as a significant impact on our tax rate.

Martin Sankey - Neuberger Berman

Okay. Thanks. And lastly, interest expense. Now that we have the EU fine in the book, so to speak, as well as the fact that you are using asset-backed securities on receivables, would the fourth quarter interest expense level be a good gauge to look at the 2011 or is there a new dynamic we should be aware of?

Ulrich Michael

It depends upon of course the interest rates, if you assume the same rate. Then I would say Q3 come down a little bit next year because we're probably pay down some of our debt in the course of next year. Otherwise, the difference of course what we do is we do an execution and we might have to borrow a bit more money for it, then it will increase, but I would say everything else being equal, the data I gave you for Q4 is probably a good starting point and I assume that it is going to retch you down in the course of the next year to I don't probably maybe half a million or so.

I think as long we keep our asset securitization program in place, there is minimum expense associated to it. Also there is a certain expense, the repayment on our 800 million facility that will stay in place and certain minimum will stay.

Operator

And we have a question from Mr. Robert Kosowsky of Sidoti & Company.

Robert Kosowsky - Sidoti & Company

What are your current thoughts about the European trucking industry with respect to freight volume and rate? The kind of the overall gauge of the health over there?

Jacques Esculier

For when? 2011?

Robert Kosowsky - Sidoti & Company

No, just right now, how we're looking at the end of October and November, the strength you have seen from the volumes and I guess pricing?

Jacques Esculier

Robert we are not in a position right now to answer that question specifically for the remaining of this year. What we hear from customers, it continuous to actually kind of support a need for more trucks, but I don't have any number to share with you at this point.

Operator

There are no further questions, sir.

Jacques Esculier

Okay, thanks so that closes our discussion on the third quarter and as we will not talk to each other before the beginning of next year. I would like to take this opportunity to wish you a wonderful yearend and a very happy Christmas holiday. Thank you

Operator

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

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