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WABCO Holdings, Inc. (NYSE:WBC)

Q4 2011 Earnings Call

February 2, 2012, 9:00 a.m. ET

Executives

Jason Campbell – Director, IR

Jacques Esculier – Chairman and CEO

Ulrich Michel – CFO

Analysts

Peter Chang – Credit Suisse

Alex Potter – Piper Jaffray

Steve Tusa – JPMorgan

David Leiker – Robert W. Baird & Co.

Jeff Hammond – KeyBanc Capital Markets

Robert [Inaudible] – Sidoti & Co.

Kristine Kubacki – Avondale Partners

Operator

Good day ladies and gentlemen, and welcome to the WABCO Q4 2011 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. (Operator Instructions) As a reminder, today’s call is being recorded.

I would now like to the conference over to your host Jason Campbell, Director of Investor Relations. Sir, you may begin.

Jason Campbell

Thank you, Shannan. Good morning everyone and welcome to WABCO’s quarterly conference call. Today, we will present our fourth quarter full-year 2011 results. With us this morning is Jacques Esculier, our Chairman and CEO and Uli Michel, our Chief Financial Officer.

Before we begin I would like to 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 Q4 and full-year 2011 results. A replay of this call will be available through March 2.

Second, as shown on chart two of the presentation, certain forward-looking statements that we’ll make today are based on management’s good faith expectations and beliefs concerning future developments. As you know, actual results may differ materially from these expectations as a result of many factors, examples of which can be found in our company’s Form 10-K and quarterly report.

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 Jacque.

Jacques Esculier

Thank you, Jason. Good morning and good afternoon everybody. First I’d like to wish you all a very happy new year 2012, and let’s hope that 2012 will bring us a more peaceful and successful world.

So looking at Q4, this fourth quarter is really ending 2011 on a high note for our industry for WABCO in particular, but you know, Q4 is also setting the stage for 2012, which I would call a year of transition charged with economical uncertainty.

2012 could also be a year during which major economical challenges and issues should be addressed, and I believe resolved. Particularly looking at Europe that hopefully will take advantage of this year to conserve itself as a solid and credible period of the global economy.

So looking now at numbers, again, starting with the fourth quarter. We [inaudible] 9% in local currencies. Operating income was $90.5 million, leading to a margin of 13.5 versus 12.3 a year ago, which is driving an incremental margin of over 29%, which is kind of fairly exceptional given the single-digit growth that we have experienced this quarter.

Our EPS, performance EPS was up 20% at $1.21 per share versus $1.01 last year. Free cash flow of $52 million of which we’ve returned most of to the shareholders through the repurchase of 1.1 million shares.

Now kind of closing the full-year, we ended up with a sales revenue sales level of $2.8 billion, a 22% in local currency. Operating income ended up at $375 million for a margin of 13.4% versus 10.6% the prior year, which again corresponds to an incremental margin of 27%. Performance EPS ended up at $4.73 per share, which is almost 70% ahead of the performance level of 2010.

Free cash flow generated was $250 million for conversion rate close to 80%, out of which we returned 180 million to the repurchasing of 3.5 million shares. So overall, I think it was a very good strong year for our industry for WABCO in particular, and I think we have overall delivered great value to our shareholders.

Going to the next page, we’re going to review as usual the framework of our revenue growth for the fourth quarter, which again was up 9% at a performance level driven by a 8% growth coming from the OEM channels. Continued increase of content per vehicle, market expansion. Also our performance as we do usually.

Aftermarket channel was up 5%. We broke again the all-time record in revenue. However, and it slower than it was in the first half of the year, we think that it kind of could be pointing a finger to a disturbance largely of the continued growth in Europe truck and bus, our sales to JVs were up 29%, supporting the outstanding growth that we see and benefit from in the U.S.

Now we’re looking at the evolution of market revenues versus the dynamics of the T&B production, starting with Europe. Europe production actually slowed down to 3% year-over-year, which is actually the weakest decrease we have seen for quite a while. And actually even a little weaker than what we had expected. We’re still able to outperform that by 3% because of again increased content per vehicle in market penetration.

North America market gone up 45%, we out performed by 4%. South America going up 13%. Again a little slower than what we have prepared, even that we had planned, assumed pre-buy in view of the introduction of Euro 5 standards in 2012. And we were able outperform it by 13%. Japan/Korea still growing and doing very well for us, actually following the disaster that Japan had experienced earlier this year.

China went down 25%, but as we will see later, sequentially up versus Q3, and we were able to outperform by 6 percentage points. And India, we outperformed by 10 percentage points, multiply and consistently again up double-digits. So overall, a good strong solid fourth quarter during which we continue to see good outperformance.

The following slide kind of summarizes again the profile of revenue growths for the full-year 2011, ending up again, I think we exchange it at 28% driven by an increase of 26% through the OE channel, 8% from aftermarket, sales to JVs 30%. Looking at the different regions, overall Europe ending up at 31% additional level of production, up 3 percentage points in WABCO revenue at 34%, which strongly outperformed North America by 22%, actually ending up our revenue growth at 71% and this is greatly driven by an extremely strong growth of our compressors to support common sales growth.

South America, we outperformed by 7% to end up at the revenue gross of 23%, demand in Korea, we actually nicely outperformed, ending up with a revenue gross of 15%, mostly driven by the very strong domestic demand we have seen in Japan starting during the second quarter. And if I remind you, domestic demand is asking for trade certifications on trucks that contains quite a bit of our products and systems.

China we outperformed by 7%, and so did we with India. So again, overall, when you look at the full 2011 year, we nicely outperformed every region of the world.

Now I’m going let Ulrich drive you through the Q4 and full-year 2011 details of the results.

Ulrich Michel

Thanks Jacque. Good morning everyone and thanks again for joining us today. I will take you through our financial results for the fourth quarter and full-year of 2011. Turning to chart 6, I will walk through the details from sales to earnings per share for the fourth quarter.

Looking at gross, our recorded and performance numbers. Performance numbers are adjusted to remove operation streamline and separation cost, as well as recreate and other tax items. In addition, comparisons through 2010 has been adjusted for currency translation effects.

Our sales in the quarter increased 8.5% in local currency versus last year. This was 1% sequential decline in revenues from the third quarter. As you may recall from our October call with you, we had noted that our order book had decreased 4% in the month of October. As you can see, our order book has decreased 7% by the end of the fourth quarter compared to the end of September. This represents a further decline of 3% in the month of November and December of 2011.

The increasing sales were as last year includes price reductions to customers of 0.6%, which is the lowest level we have ever seen in our business. Gross profit increased 7.8%, which is adjusted for a profit margin that was 80 basis points lower than a year ago. Gross profit was driven most significantly by higher volumes which contributed $16.8 million. Our productivity initiatives continue to deliver robust results, including 5.6% through our material productivity project, partially offset by 1.6% of commodity inflation. The result was the net materials for productivity of 4% for the quarter.

Our conversion productivity for the quarter was 6.2%, which is just slightly below the record set last quarter for WABCO. Overhead absorption and other cost has a negative impact on cost of sales in the amount of $9.8 million. This resulted in the performance gross profit margin of 28.2% this quarter.

In operating expenses you can see a decrease of 1.6 million in the fourth quarter versus a year ago. Labor and other cost inflation added $1.7 million, but this was more than offset by lower incentive compensation expense in 2011 versus 2010. The reduction in operating expenses resulted in margin expansion of 151 basis points versus a year ago.

So all together we generated operating income of $90.5 million or 13.5% of sales on a performance basis, just below the record we set in the second quarter. Compared to Q4 2010, we had expanded operating margin by 133 basis points delivering a very strong 29% incremental operating profit margin on the sales increase of 9% in local currencies.

Continuing down the income statement, you can see that this quarter EBIT income was $4.1 million, which includes an improvement in earnings of $1.3 million from our North American joint venture. Additionally, the expense to minority shareholders amounted to $3.3 million this quarter, compared to an expense of 2.8 million a year ago.

Our performance EBIT this quarter was $90 million for a margin of 13.4%. Moving to taxes. You’ll see that our reports for the U.S. debt tax expense for the quarter was approximately $11 million higher than our performance tax expense. The primary driver of this difference is a $13.6 million U.S. GAAP tax reserve that we recorded in the fourth quarter, which will reverse in Q1 2012.

In December 2011, we took advantage of an opportunity to repatriate approximately $300 million of foreign earnings to the U.S. at no additional tax. In fact, the repatriation will result in the tax cash refund of approximately $7 million in 2012.

The specific rules of [inaudible] now ASC 740 however require us to record this $13.6 million tax reserve. Although, we know today that no tax rate exceed in this respect. And on the regular Set 5 rules, now ASC 450, we would not record any liability for it. I do want to make sure you are aware of all the specific set patterns that led to the recording of this reserve in Q4. Although, we know today that it will be reversed in Q1.

So all in all, this repatriation was a very favorable opportunity. It will result in a slight increase of our performance tax rate in 2012 of approximately 1.5%, mostly due to increase interest income in the U.S., but it will provide liquidity in the U.S. on top of our borrowing capacity in a very tax efficient manner.

So we finished 2011 with a lower tax rate than we had estimated when we last spoke to you. Our final full-year performance tax rate is 13.5% with the December year-to-date taxes recorded at a rate 14.5%, the true result within a rate of 10.4% for the fourth quarter, misrepresents a performance tax expense of 9.1 million for Q4.

After excluding the nonperformance item, net income was $80.7 million with regards to earnings per-share, this translate to $1.21 on the performance basis, versus $1.01 last year. In summary, we are pleased to report a quarter with further organic growth, continued margin expansion, and strong levels of profitability.

Now let’s turn to chart seven. I will walk you again through the details from sales to earnings per-share for the full-year 2011. Our sales for the year increased 22.3% in local currency versus 2010. This increase in sales includes price reductions to customer of 1%. In fact, this 1% price reduction is an all-time low for us on a full-year basis.

Gross profit increased 25.1% with a adjusted gross profit margin that has improved by 65 basis points compared to the previous year. Gross profit was driven most significantly by higher volume, which contributed $99.8 million.

Our productivity initiatives continue to drive savings throughout the year, which included 5.3% of materials productivity, partially offset by 2% of commodity inflation. The result was net material productivity of 3.3% for 2011.

Another market success is conversion productivity. We delivered a record level of conversion productivity in our factories throughout the year, finishing with annual benefit of 5.9%. We also generated significant benefits for more efficient absorption of overhead, which contributed $41.1 million for the year.

The increase in performance gross profit margin this year, represent an incremental gross margin of 32% on our sales increase from last year, resulting in a full-year performance gross profit margin of 29% compared to 28.5% a year ago.

In operating expenses you can see the breakdown of the increase versus 2010. We increased our spending on research and development projects by $14.9 million to support our long-term strategic initiatives around new technology and product development. We also invested in additional $5.8 million activity to support our effort in expanding our global reach.

Labor and other cost inflation accounted for $7 million of cost increases. We had limited the overall increase in operating expenses to less than one third of our sales growth, resulting in a margin expansion of an additional 225 basis points versus a year ago.

So for the full-year we generated operating income of 375.1 million or 13.4% of sales on a performance basis, which represents a margin expansion of 290 basis points over the previous year. We generated a 26.5% incremental operating margin on our sales increase versus a year ago, excluding the effect of translation of foreign exchange.

The income for Meritor investment was $16.5 million in 2011, which was mainly driven by the improvement in earnings from our North American joint venture. Additionally, the expense to minority shareholders amounted 11.2 million this year, largely driven by the profit of our Indian subsidiary.

On a reported basis, we recorded a tax expense in the amount $36.7 million for the year. Excluding this free tax item as well as other onetime items we incurred, $50.8 million of performance tax rate expense, which translated in to a rate of 13.5%.

As you can see, our full-year GAAP tax expense is approximately $4 million less than our performance tax expense. This is basically the balance of the nonperformance tax reserve recorded in Q4 in relation to the repatriation [inaudible], and several accrual reverses associated with tax audit settlements that we benefited from earlier in the year.

Interest expense was $1.7 million compared to interest expense of $2.2 million in 2010. So after excluding the nonperformance items, net income was $425.7 million with regards to earnings per-share, this translates to $4.73 on a performance basis.

In summary, this results include new record level of sales, operating income and net income for WABCO. These records are especially notable in the market are still producing new trucks and buses at levels well below the previous season.

Additionally, with this level of profitability, we delivered a return on invested capital of more than 49% for the year, which is about our previous record of 46% set in 2008.

Turning to chart eight, I will now take you through our cash flow for 2011. You can see that working capital has negative impact on our cash flow in the amount of $73 million. This amount includes an increase of $40.1 million from receivables, which is generally in line with the increase in revenue. We have been successful at managing a low level of [inaudible] throughout the year. At the end of December, we did experience a short-term spike however, because some customers did pay us a few days late, and we only received the money in the first days of 2012.

Inventory increase in the amount of 14.8 million, inventory turns remaining constant with the end of the previous year. Additionally impacting this increase in working capital was the decrease in accounts payable in the amount of $18.1 million.

The changes in other assets and liabilities of $4 million effectively represents a difference between 31 million of nonperformance net income recognized in the P&L, and $22 million of payments related to nonperformance items offset by $13 million favorable changes in all other accrual and asset provisions.

The result was a net operating cash flow of $333.2 million. Net cash used in investing activities was 105.2 million, which is currently above our reduced level of depreciation and amortization. The investment continue to support the growing region and new business we have won. Therefore, free cash flow was 228 million or $25.1 million when excluding the streamlining and separation payments made throughout the year, resulting in the conversion rate of 77% on our performance net income.

Finally, regarding the share buyback plan that we implemented back in June. We repurchased 1.1 million shares in the fourth quarter at a cost of approximately $50 million, bringing the total purchase in 2011 to 3.5 million shares, at a total cost of about $180 million. This represents approximately 5% of our total shares outstanding in May, before we began the program. For the time being, we intend to keep reserving our free cash flow back to our shareholders through this buyback program. We still have 220 million remaining under the current court authorization.

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

Jacques Esculier

Thank you, Ulrich. Turning to page nine. As usual we will address through the key regions of our world, starting with Europe. Again, very strong healthy growth in demand for commercial vehicles with registration up 36% in western Europe as compared to 2010, driving an increase overall in production by 31%, which brings actually the level of production of European truck and bus to what it was back in 2004, and obviously significantly short of the peak that we had experienced back in 2008.

Now looking at our current order book, OE book as Uli] says. It’s down 9% through the end of Q3, September. And actually, when you look at Q1, 2012 order level, as of today actually, it is about 4% below the Q1 2011 sales.

So there is a lot of uncertainty remaining in the market in [inaudible] as we kind of compile all the estimates that our customer and other come up with for the level of production in 2012. We believe that as of today, we would anticipate an erosion of up to 10 to 15% year-over-year.

Looking at North America, replacement cycles actually continues to drive growth. The average age of the fleet is now starting to decrease nicely. We see a lot more heavy-duty vehicles being sold, so the growth is more benefiting heavy-duty vehicles and medium size. In 2011, we have seen a production of 53%, which brings the level of production back to where it was in 2008. Again, about 30% short of what it was in 2006. And in 2012, we estimate it will grow another 15 to 20%.

Moving to China, fourth quarter production was down 25% year-over-year, but was sequentially 11% higher as compared to Q3. Q3 was the bottom of production in 2011. ABS penetration actually increased, almost doubled in 2011. And then for the full-year production was down 14%.

Now, again appreciating that this is the most complicated market to forecast at this point, I’ll best estimate would be that the market level should stabilize it around flat to maybe minus 10%. With a first quarter even first half strongly down versus ’11, I’ll remind you that actually the production level in the first quarter 2011, was reaching a record level of 403,000 trucks built. And we are coming out of 2011 with 292,000 trucks built in Q4. So again, Q1 would definitely be a major drop.

Moving to India, we end up the year with fourth quarter production up 12%, and 13% for the full-year. India is still attracting a lot of interest from global OE manufacturers that are currently building up production over there. We estimate that because of the economical issues that India had to face, particularly related to inflationary pressure, the level of production may be suffering some in 2012, and our estimate would be limited to a flat to up 5%.

Turning to page 10. Looking at Japan/Korea, again Q4 brought a healthy 17% growth year-over-year. OE sequentially up 5% from Q3. Japan has a production level back to where it was prior to the earlier 2011 disaster. So all together the production in 2011 was up 3% and we believe that we’re going to see continue growth, mostly driven by Japan that will generate another 10 to 15% growth in 2012.

Going to Brazil, Q4 production was up 12, 15%, but it was 11% down from Q3. Overall for the year, the market generated another very healthy 16% growth, after the 54% growth we had experienced in 2010. We believe that there may be some erosion in 2012, particularly during the first half. So all together for the year we best mention today is that the market could be down 10 to 15%.

Aftermarkets, Q4 had seen the aftermarket revenues reach, again, a new record, up 5% year-over-year, but because it is slightly lower than what we have been experiencing the last quarters and years, we believe that it could kind of support the fiery of certain slowdown of truck and bus production, ahead of Europe. Again, nothing close to what we had experienced though back in 2008, 2009.

In 2011, for the full-year, aftermarket grew 8% and we expect 2012 to drive another 5 to 8% growth.

Finally, looking at trailers. Production in fourth quarter was up 16% in Europe, but if you include [inaudible] actually went down for the first time, sequentially 8% versus Q3. Which again, kind of adds to these indicators that could point finger to a slowdown of truck and bus activity in Europe. Overall for the year, trailer production was up 22% and we expect the global production to be flat to down 5% in 2012, with Europe a little further down, 5 to 10%.

Next page as we do every quarter, we’re going to kind of summarize the highlights of our three-tiered strategies starting with globalization. Actually our OptiDrive, as you know, had been ordered by Ashok Leyland. We are very happy that he has been actually introduced in their new city bus during the India show. It’s a very strong highlight for us, and we are very proud of it. And then we have introduced an innovative technology in drive around control for leading engine maker in Brazil that will help them with the Euro5 emission standards.

In terms of our new technologies and products, we added a second large OE customer in Europe for our breakthrough cutchable compressor, which I remind you could save up to 2 to 3% fuel for longhaul truck. We have also sold – we have been the first company actually to sell in better Cruise Control system to Yutong, which is the world’s largest manufacturer of buses in China. And serious production should start this year during the first quarter. And then we have been obviously healthy quarter to get a pretty prestigious award for the agricultural trailer, highlighting the safety of their braking system.

Executions, reporting 7 top supplier awards that we are very proud in China from very, very prestigious customers, among which CNHTC and FAW, obviously we continue support and predictive performance of WABCO in that market. And then finally WABCO operating system, as we said has continued healthy growth material productivity and a record level of conversion productivity of 5.9% in our factories.

Turning to the following page, we are giving you our first guidance for the year 2012 that kind of summarizes the impact of all the market issues that we have, again kind of established in the last couple of pages. Starting with the sales growth between the growing of 2% of revenues to an increase of 3% of revenue at equal exchange rates, which translates in sale in a range of 2.57 to $2.71 billion as we take a exchange rate of $1.3 per euro. We estimate operating performance of operating margin in between 12.8 and 13.8%, leading to a performance EPS in the range of 4.3 to 4.8%, maintaining as usual our free cash flow conversion in the 80 to 90% range.

So the inputs and assumptions for this model, is that we obviously continue to nicely outperform the markets. We maintain our price erosion at about a percent. We do not face about 1.5 to 2% material cost inflation next year. We assume that our productivity levels are in line with what we have seen in the past. The performance tax rate as we said has increased from 15.5 to 16.5, 1.5% of which is actually related to the repatriation that we benefited from this year. And the other half being related to the fact that the portion of our revenues in Europe is decreasing, and a level of [inaudible] shares at 65.5 million.

So in this guidance I would say the top line is in the context of macro uncertainty, but WABCO company is actually ready to adapt and flex.

So in summary, I would say that WABCO is really ready to face 2012 in full benefit of whatever we’re going to see ahead. When you look at WABCO over the years, I think we have built a company that has proven resilience in face of strong market challenges. The company has also actually demonstrated a lot of flexibility as we fully took advantage and benefited from that strong revenue growth that we have experienced in the last two years. So I would say in summary, that WABCO has proven resilience in that time and we are really flexing, like know tomorrow in good times. And that’s who we are and we’re ready to face 2012 as the year of transition, with still a lot of uncertainty in the economy.

We’ll be in the meantime continuing to invest, to be ready for the next wave of sustainable growth that I think we should see starting as early as 2013, or maybe even earlier. Again, the European issue is being resolved in the coming months. So thank you, and I would like to open the session for Q&A now.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Peter Chang with Credit Suisse. You may begin.

Peter Chang – Credit Suisse

Hi, good morning, Jacques, Uli and Jason, and congratulations on a great 2011. My question is around the content per vehicle story of by geography. Are there any material differences in ’12 versus ’11? I mean, you’ve talked about market share gains in Brazil. I know there was a stability control mandate in Europe in late ’11, but given, you know, you took down your European – your Europe guide and your China guide, yet you can maintain flat revs. I mean, it sounds like the rest of your story is intact. But to the extent that you can comment on the content per vehicle penetration difference by geography, that would be great.

Jacques Esculier

Okay, good morning, Peter. Actually, there are a lot of things, and it’s very hard to establish a list, but having said that, obviously, the increase penetration in [inaudible] brakes that started in the later part of last year, you know, I remind you that for the first year, we were at 10% market share, we go to 50% market share now and maybe even higher. There are a few, you know, products that we have gained against complication in Europe, in South America. Again, I would not list them here.

So what I’m saying, Peter, is the logic of continued outperformance of the market is intact. Now, as I said, you know, several times, because we don’t have a, you know, a very hefty growth and actually we may experience some contraction in the markets in like Europe that would affect these 8 to 10% brackets. So the outperformance that you see today therefore may be slightly below that bracket for next year, but not really significantly below.

Peter Chang – Credit Suisse

Great, that’s great color. And you mentioned the air-disc brake market share gains, but in North America, have you been approached by any major OEMs for air-disc brake opportunities? There’s a pretty well publicized news out there that one of you competitors is struggling with some brake issues and I just wanted to know if that is an opportunity for you? Then I’ll get back in queue.

Jacques Esculier

Yes, and Peter, we are in discussions with manufacturers in the U.S. and as we have actually shared with you previously, we have already [inaudible]. In fact, one of the very key manufacturers in the U.S. So they are very, very strong discussions and I’ll still be recognizing that the penetration of air-disc brakes is extremely limited.

And just as a procedures, it’s not an [inaudible] brake issue from what I understand that right now is affecting the market, it’s, I think, a braking system issue. But anyway, that’s not our so I don’t want to comment on that.

Peter Chang – Credit Suisse

Got you, okay, great. Thank you very much for taking my questions.

Jacques Esculier

Thanks, Peter.

Operator

Thank you. Our next question comes from Alex Potter with Piper Jaffray. You may begin.

Alex Potter – Piper Jaffray

Hi, guys. Thanks for taking my question here. I guess a couple questions, first around gross margin. Can you just basically comment on any and all of the different factors that could potentially impact gross margin? I know that you – it seems that you’ve been giving away less price for instance. Is that something that you regard as sustainable? You know, past utilization, what some of the mix shifts might be here over the next year as we’re looking forward to try to see what sort of impacts we might have qualitatively on gross margin?

Jacques Esculier

Well, I actually, as you say, it’s a mixed bag of a lot of parameters that all converge to ultimately, you know, influencing and in this case, positive influencing gross margin. You’re right, our assumption is that we will maintain fairly low price erosion and that’s a – that, again, is probably sectional in the history of WABCO. It’s also obviously maintaining, as Uli shared with you, a very strong level of productivity both in material in our factories and it’s, you know, mixed issues. It’s all kinds of things that basically kind of altogether converge to this estimate.

Alex Potter – Piper Jaffray

Okay, great. I was wondering if you could comment a little bit on China just with regard to the increase in content per vehicle there and what the outlook is there. Is there any – I guess, incremental evidence that ABS regulations are starting to actually drive increased content per vehicle? I know that it happened here over the last couple quarters. Is that something that you see continuing or has progress there kind of leveled off?

Jacques Esculier

Well, very complicated to say. Actually, you know, as I said, we have kind of doubled our penetration for ABS. We believe that, you know, segment of the market where [inaudible], there’s still room for the market to align with the regulation. I think there is probably 10% of the market we estimate that is not yet aligned with the regulation. You know, [inaudible] just for 30% of the market that should be [inaudible], we think that there is probably about 20% fully equipped right now.

So that’s – that first link of opportunity, and then as we said before, unfortunately, we don’t have much more kind of timing information to share with you, but the rest of the market was ultimately had to kind of adopt ABS as well, but we don’t exactly when.

So it’s an opportunity that is still on the horizon, probably not reachable in 2012, but it’s going to happen.

Alex Potter – Piper Jaffray

Okay, very good. I’ll jump back in queue. Thanks.

Operator

Thank you. Our next question comes from Steve Tusa with JPMorgan. You may begin.

Steve Tusa – JPMorgan

Hey, guys. Good morning.

Jacques Esculier

Good morning, Steve.

Steve Tusa – JPMorgan

Just a question on the margins and just the guidance. First of all, what is the impact of FX on those margins? That’s the first question. And then the second question really is, as we think about these, you know, decremental margins, how much of a bottom-up build, you know, do you have in there, you know, because it seems like it’s essentially the same time of decremental that you have, you know, an incremental and is there any concern around moving parts within the geography so you know, is Europe more profitable than China versus the U.S.? Maybe you could talk about those dynamics and what the downside risk you see in those margins.

Jacques Esculier

Well, Steve, first off, FX, I think from the 1.4 to the 1.29, we could say there’s probably 40 basis points right …

Ulrich Michel

That’s what we’ve proven through March.

Jacques Esculier

Forty basis points of March improvement [inaudible] different [inaudible]. We reviewed the rates at the end of December which is our plan and our guidance. And the difference between these rates and the average rates of 2011, which, you know, are reflected in our P&L should help our March to the tune of 40 basis points but it might hurt our income translation. So net-net, it is a hurt – I think it [inaudible] .

Steve Tusa – JPMorgan

[Inaudible] or when it gets dark and meaningful. Total sales were down 5%, what would you expect to kind of delever at? You know, should we think about that as a 50% rate? I mean, just to get idea of where to kind of pinpoint the, you know, anchor or expectations?

Ulrich Michel

I think I would say, you know, it is the ultimate increase we had back in 2009 where 23% obviously, you know, increase [inaudible] from this because that’s probably not [inaudible] that anybody at that time would think anything. Less would increase the decremental margin, you know, accordingly. We don’t have a model yet for 5%.

Jacques Esculier

And Steve, frankly speaking, we don’t – it also depends on what we think the future beyond this decline will hold. If were to – we’ve got to mow through, you know, maybe a 5 to 10% decline in the second half of ’12, with a visibility of a returned growth soon after, we would probably not cut as deep and just say, okay, we’re confident it will come back, we will keep our investments at the pace and we will keep our basic [inaudible] in place. If we were to think, you know, or lose confidence in the return to growth and maybe think that 5% decline would be followed by a – even a steeper decline later, we would, of course, cut the loss deeper in our infrastructure and in the investments we’re making. So you know, at this point, I don’t think we can give you a clear answer to your question.

Steve Tusa – JPMorgan

Right, okay. Either way, I think that’s good color. Thanks a lot and good luck this year.

Jacques Esculier

And I think it’s fair to say in the range that we’ve given you, I would say in the guidance, in the normal revenue with no major changes to our infrastructure and our investments because you’re absolutely saying, you know, the incremental, decremental are not a big difference. This is because we assume we keep our planned investments in product development and so on throughout the year with this range.

Steve Tusa – JPMorgan

Great, okay. Thanks.

Operator

Thank you. Our next question comes from David Leiker with Baird. You may begin.

David Leiker – Robert W. Baird & Co.

Hi, good morning. [Inaudible] on the line for David. I'm just wondering on your level of outperformance last April you expected a level 8 to 10% above your market. Given where your production estimates globally is, it sounds like flat to downsize while you organic growth assumption are this year. I’m just wondering why does that level change on 2012? Is it a reaction by your customers looking at their industries and seeing potential declines that they might maybe delay installation of your product on their equipment?

Ulrich Michel

Well, Jon, what are you – what’s driving the topline assumption, again, it’s definitely not an indication of our estimate for [inaudible] to continue to outperform the market, but rather, you know, kind of a certain assumption on markets and market resolution, particularly in Europe. You know, we had kind of [inaudible] minus 5 to minus 10. Right now we spend more into the minus 10 to minus 13. However, still being kind of ready to flex any direction particularly in the direction of seeing the market that is more fair, more than what we had anticipated.

Jacques Esculier

I would think it’s going to go much cheaper. I think it could go – [inaudible] better, but again, when you kind of consider everything today, we believe 10 to 15% is where the center of gravity of the expectation is right now.

David Leiker – Robert W. Baird & Co.

Is your expectation over the long term to outperform the global truck industry is still at the 8 to 10% level?

Jacques Esculier

Yes, yes. And actually, you know, 2011 we were just basically at 8%. You know, in fact, the only thing, again as I’ve shared with you guys before in an environment where the market is actually, you know, not moving or even slightly eroding, [inaudible] the level of our performance for a couple of reasons, one of them being that there’s destocking from customers because the need – they don’t need to spend that level of inventory to support a lower level of production. And second, usually when the market comes down, there is a [inaudible], usually the number of heavy trucks – duty trucks goes down faster than medium-sized trucks.

David Leiker – Robert W. Baird & Co.

Okay, that’s helpful. I just want to follow back on the braking quality issues with one of your competitors in North America and I think you went over the difference. I’m just wondering you know, a braking system is a fairly well-branded product. I’d imagine the truck customers, or the buyer rather, is going to know whether they’re buying a WABCO system or a BENDEX system and I’m just wondering if in your – In any previous experience that has kind of an overhang effect on the sales of a particular brand where maybe [inaudible] the benefits?

Jacques Esculier

Well, you know, Joe, it’s an unfortunate things, I certainly would not comment on it. What I would say is those things happen and I certainly would not point a finger to my competitor in any way, shape or form at this point to blame him for anything. I don’t even have the details of what happened so if you don’t mind, I will not comment any further on that.

David Leiker – Robert W. Baird & Co.

That’s understandable. And then just one quick last one. There’s a lot of press releases coming from Diamler and Volvo bringing their manuals over from Europe and coming to North America with an automated transmission product . When we see those releases, can we basically assume that’s your product because I’m not aware of another suppler that can automate a basic manual like that, like you guys are able to?

Jacques Esculier

Yes, sure. Absolutely. There is only one ABS on those two brands and [inaudible].

David Leiker – Robert W. Baird & Co.

All right.

Jacques Esculier

[Inaudible] and impact on pricing people can get on a [inaudible] activity ahead of production of [inaudible]. And your second question was, I’m sorry?

David Leiker – Robert W. Baird & Co.

About potentially pent-up demand and how in ’13 and later this year, how you’re thinking about the average age of the European fleet because it’s obviously older in the U.S. so how do you guys think about the average age of the U.S. and the European fleet and potential for pent-up demand given [inaudible] the last few years?

Jacques Esculier

Well, obviously if the product of trucks decreases in the next – this year in 2012, then the average age will go up a tick. And then it would correct itself later on, you know. Like what we have seen in the U.S. that was a much more significant level of [inaudible].

But I would say the average age of the fleet in Europe right now, obviously suffered in 2009. I think [inaudible] was the growth that you see the last couple of years is probably recovering nicely. Again, it depends what’s going to happen in 2012.

But you know, not as much as [inaudible] in the U.S. The U.S. is huge pent-up demand in the U.S. accumulated during those years since 2006. And we haven’t seen such an environment in Europe.

David Leiker – Robert W. Baird & Co.

Okay, thank you.

Operator

Thank you. Our next question comes from Jeff Hammond with Keybanc Capital. You may begin.

Jeff Hammond – Keybanc Capital Markets

Hey, good morning, guys. Just – and maybe I missed this because I think maybe, Uli, you mentioned a down five front half, but just – I know you don’t give guidance, but it sounds like Europe may be challenged more in the front half, you know, Brazil, you know, timing from the pre-buy overhang and then China kind of ramping through the year. I mean, is 1Q kind of the low water point and how should we think about growth maybe first half versus second half with the content of kid of that flat guidance range?

Ulrich Michel

Well, Jeff, I don’t think we’re going to be [inaudible] from our normal [inaudible] on the timing. The only thing I can tell you – I mean, you got it, you got, you know, the main pieces. Europe, you know, we are starting a little slow. South America, we really see a – probably a significant dive in the first quarter. China, by the fact that last year product had reached its peak at 43,000, we won’t see a significant up so I’ll let you write the rest of the story. But you know, again, I wouldn’t go any further than that in commenting, if you don’t mind.

Jeff Hammond – Keybanc Capital Markets

Okay. And then just, you know, you mentioned the down to 15, Europe and you talked to some customers. What’s the range of production levels for Europe that you’re hearing from your customers? Is it all within the 10 to 15 or is there still, you know, more optimism by some?

Jacques Esculier

No, there’s a couple that are more specific and a couple that are maybe in need of [inaudible], maybe a little bit beyond where we are at this point. So that’s why I think it’s kind of a deepened average.

Jeff Hammond – Keybanc Capital Markets

Okay, that’s helpful. And then just kind of running through your ranges and your business mix, it seems like within your guidance, the market outgrowth assumption is kind of more in the 4 to 5 range. Is that a fair assumption?

Jacques Esculier

I would really put it much higher even.

Jeff Hammond – Keybanc Capital Markets

You think it’s a little bit higher than the 4 to 5?

Jacques Esculier

That’s what I would say.

Jeff Hammond – Keybanc Capital Markets

Okay. And then just on China, I mean, is it just – it seems like 4Q ramped in line with how you thought. I mean, what’s driving the more cautious view there or the change in the guidance?

Jacques Esculier

Well, you know, that…

Jeff Hammond – Keybanc Capital Markets

I mean, is that just simply a visibility issue or…

Jacques Esculier

Well, you know, this is kind of [inaudible] that we have had from discussing with customers and whatnot. I would say that if I don’t feel comfortable with predicting Europe, I would feel particularly uncomfortable forecasting China. But you know, they had been, as you know, some breaches in the [inaudible] and the economy over there. They have their own problems. Obviously, the European slowdown, that impacted a significant portion of the EP. You know, there was an effort to fight against inflation that has decreased the number of construction trucks. So all those things together kind of could lead to the logic that we could see further erosions up to down 10% next year. But again, I’m ready to be proven wrong. I’m happy to be proven wrong.

Ulrich Michel

Jeff, also keep in mind what Jacques said. The first quarter in 2011 had 403,000 trucks being built in China. At the moment, they’re around 280,000. If it stays at the current level, then it’s a decline by 10%. It’s minus 10. At 290, it’s minus 10.

Jacques Esculier

[Inaudible] which is the fourth quarter, you say that minus 5%. All right, so that’s kind of the assumption for there. But again, with a limited level of conviction.

Jeff Hammond – Keybanc Capital Markets

Okay. And then final, just on – just give me a sense of how you think, you know, it seems like if you run your range of guidance and your 80 to 90% free cash flow target you’re running in the 250 million free cash flow range for ’12. I mean, how do we think about priorities? Does that enable you to kind of clean up this buyback in ’12? Maybe just address acquisition pipeline and any kind of updated thoughts on initiating a dividend.

Jacques Esculier

We – to tell the truth, buyback is not on the radar screen at this point, Jeff, as a way to return cash, but we did kind of continue to pursue the buyback. I think it’s a good thing for shareholders. I do believe that it’s the right time to buy, the right [inaudible] to buy WABCO stock. Also as we keep telling you, we keep kind of scanning the market for good opportunities for acquisitions and we’ll see.

Jeff Hammond – Keybanc Capital Markets

Any idea on buyback to continue to use all the cash generation to buyback stock absent deals and not lever the balance sheet?

Ulrich Michel

Yes, what we just keep saying is at this point we want to maintain this rule that we say that we return the cash we generate through whatever channel whether it’s buybacks or if we find an acquisition obviously that would be in Europe most probably.

Jeff Hammond – Keybanc Capital Markets

Okay. Great. Thanks, guys.

Operator

Thank you. Our next question comes from Robert [Inaudible] with Sidoti. You may begin.

Robert [Inaudible] – Sidoti & Co.

Good afternoon, guys. How are you? Just a quick question. If I look back at Q2, it looks like you’re operating expenses are down like $18 million. What are some major buckets that you cost out of and how did you just generally do this and how much more flexibility do you see in that line item?

Jacques Esculier

Well, Rob, I’d be surprised if you can compare them at equal exchange rates. You’d be very flat in calculating this.

Robert [Inaudible] – Sidoti & Co.

Any kind of like…

Ulrich Michel

It would have quite an impact on the effect. But with our operating expenses, there is seasonality in them, you know, Q3 is the time of vacation typically, you know, then we do have different timing on co-payments we received from our customers from product development activity. You know, we do sometimes have bigger efforts in development and more outside services in one quarter than another. So you know, I don’t think it’s very beneficial to look at it in a sequential quarter over quarter. I think we gave you the elements on the year-over-year change we invested in. You can kind of [inaudible] range from the guidance we gave you on next year. We told you we want to keep investing, right, so I think, you know, you have the elements.

Robert [Inaudible] – Sidoti & Co.

Okay, so maybe you see like R&D up maybe OpEx flat to down a little bit? Or SG&A down a little bit?

Ulrich Michel

You’re getting into the details of it now. [Inaudible].

Jacques Esculier

I mean, OpEx will be up.

Ulrich Michel

We said we want to keep investing in our product development and global [inaudible] and this implies a bit of an increase next year in OpEx.

Robert [Inaudible] – Sidoti & Co.

Okay, and then I might have missed this on the call but what’s the status on the remanufacturing business ramping up in the aftermarket side?

Jacques Esculier

Actually, you’re right, good question. The last quarter didn’t see much of a difference versus the Q3, so it’s slower than anticipated. 2012 has to be a breakthrough year for this.

Robert [Inaudible] – Sidoti & Co.

Okay, so that supports the growth you see.

Jacques Esculier

Yes. That supports the growth and we also support the bottom line as well.

Robert [Inaudible] – Sidoti & Co.

Okay, and finally, Uli, just a mechanical question on the cash generation in the buybacks. Can you explain how that works with regards to where the cash generated and tax is on the repatriating it back to the U.S. and what that means for your tax rate?

Ulrich Michel

Well, we said this earlier. We have repatriated $300 million in December of 2011. It’s not all detached yet back to the U.S. at the moment. [Inaudible] a note between the U.S. and the foreign procedure rate, so this is now up to us to bring the cash back next year to be used also for the buyback program. It comes with a bit of [inaudible] in the expense next year. We estimated it at 1.5%, which is – you do the math, is around $5 million. But we do receive a cash tax refund of about $7 million when we bring the cash back to the U.S. So from an income point of view and what you see in our P&L, we said it would increase our rate about 1.5% next year, specifically as long as it’s interest bearing note between the U.S. and Europe outstanding and [inaudible] moving forward [inaudible] overtime. And the rest of the tax rate is the geographic change, but you know, this is a very efficient way for us to bring cash back to the U.S. at the end, no additional tax cost even a refund on taxes.

Robert [Inaudible] – Sidoti & Co.

Okay, that’s helpful. And finaly, one other question, what percent of the workforce is temporary right now?

Jacques Esculier

We – yeah, quite a bit. We have more than 30% in Europe and we have even more outside of Europe. So we are loaded with a lot of flexibility.

Robert [Inaudible] – Sidoti & Co.

Thank you very much. Good luck with 2012, guys.

Operator

(Operator instructions). Our next question comes from Kristine Kubacki with Avondale Partners. You may begin.

Kristine Kubacki – Avondale Partners

Good morning. Thank you for talking my question. My question, I’m just trying to compare a little bit about the differences in the cycles, and in your view, are the Euroean OEMs matching production much more quickly to the order trends than they did in the last downturn? And then you know, is that also a sign that inventories may be more lean and that we could see a more – a better ramp if the market stabilizes in the second half of the year kind of versus where we were into the last downturn?

Jacques Esculier

Absolutely. I think [inaudible] and that’s back in the end of 2008, as we ended up that year with a huge inventory because the street denied the fact that demand was significantly dropping. As we obviously maintained the confused data was our customers. I see them continuously, you know, revising their production rate adapting to the market, even one customer is actually committed to maintaining an eight-week lead time to be on trucks. So they don’t want to have any more inventory than just this 8-week lead time and it forces them to flex their production as the demand changes. So again, I don’t – we don’t hear inventory issues right now. I don’t believe there would be much of it even if the market comes down percentage wise.

Kristine Kubacki – Avondale Partners

That’s very helpful. Thank you. And then my next question is just on the aftermarket side, can I infer that your view that you’re expecting growth, that inventories are relatively lean there as well and that utilization, even in Europe is fairly good despite maybe the pullback on the new equipment side?

Jacques Esculier

Yes. There were, I think there had been some correction of inventories in the later part of 2011 as the market was probably in some kind of a slowdown. I don’t think we should see any further recognition of inventory expected here. That’s – but again, the 5 to 8% that we are coming up with is something that should accompany an erosion of market demand of production by that 10 to 15%.

Kristine Kubacki – Avondale Partners

Very good. Thank you very much. I appreciate the time.

Operator

Thank you. I’m showing no further questions in queue. I would not like to turn the conference back over to Jacques Esculier for closing remarks.

Jacques Esculier

Okay, I want to thank you for being with us today and we’ll talk to you in the quarter. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation and have a wonderful day.

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