WABCO Holdings (WBC) Jacques Esculier on Q3 2016 Results - Earnings Call Transcript

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WABCO Holdings, Inc. (NYSE:WBC)

Q3 2016 Results Earnings Conference Call

October 20, 2016, 09:00 AM ET


Christian Fife - VP, IR and Treasurer

Jacques Esculier - Chairman and CEO

Prashanth Mahendra-Rajah - CFO


Jeffrey Hammond - KeyBanc Capital Markets, Inc.

Neil Frohnapple - Longbow Research

Jerry Revich - Goldman Sachs

Ross Gilardi - Bank of America Merrill Lynch

Robert Wertheimer - Barclays

Seth Weber - RBC Capital Markets LLC


Good morning and welcome to the WABCO Holdings Third Quarter 2016 Earnings Conference Call. This call is being recorded. There will be a question-and-answer session after the presentation. Could you please limit yourself to one question and, if need be, a short follow-up question so that more participants get a chance to engage with management. Thank you.

At this time for opening remarks and introductions, I would like to turn the call over to Christian Fife, Vice President, Investor Relations and Treasurer. Sir, you may begin your conference.

Christian Fife

Thank you, Liz, and good morning, everyone. Welcome to WABCO's quarterly conference call. Today, we'll present our third quarter 2016 results. With us this morning, we have Jacques Esculier, our Chairman and CEO; and Prashanth Mahendra-Rajah, our CFO.

As a reminder, this call, webcast and the presentation that we're using this morning are available on our website, wabco-auto.com, under the heading Q2 2016 results. A replay of this call will be available through October 27th.

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 these factors can be found in our company's Form 10-Q, 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 will now turn the call over to Jacques Esculier.

Jacques Esculier

Thanks Christian. Good morning, good afternoon to all you and welcome to our third quarter earnings call. Before I jump into the detail of our Q3 performance, I'd like to frame what happened during this quarter. And it was actually an important quarter for our industry and for WABCO because as we do every two years in September, we gathered an industry including commercial vehicle manufacturers, suppliers and customers alike and to basically discuss about new technologies, new opportunities, new value propositions and I would say that this time has been important because I would describe the entire industry converging towards a common vision around which we have sealed a pretty strong commitment and that is do drive autonomous driving through our industry as well as digitalization.

And as you would expect WABCO had more than its fair share of news announcements on the matter. Actually I'm going to spend a little time down the road today to describe the key breakthrough technologies as well as partnerships that we have unveiled during this [Indiscernible] gathering in Hanover.

Now coming back to the reality of our day-to-day business, I would kind of said that the third quarter has again emphasized the complexity and I would say complicated to predict dynamics of our market. And that's reflective obviously of an economical environment that is itself fairly complex to predict and becoming even sometimes fairly unstable even in the Western part of our world.

So, when we talk about markets, I would say that this quarter again, our industry has seen an overall erosion of demand year-over-year by in excess of 1% -- actually 1.2% to be accurate.

However, what is more affecting WABCO is that there has been a very strong erosion in the western world, which obviously carries more content per vehicle as an average and I'm talking about a loss of 25% of production levels in the U.S., 35% for the Class 8 only, which carries more content, obviously. A drop of 6% year-over-year in production level in Europe -- in Western Europe and that's the first drop in the last two years.

That was actually mitigated by a continuous strong increase in China by almost 30% year-over-year. Unfortunately China carrying still quite less content per week as compared to our western regions and we have seen for the first time in two a half years a drop in production levels in India by 13% and will explain to you why, but overall, you standard that the market was pretty much of a strong headwind this quarter. And in spite of this, WABCO has still been able to generate more than 5% topline growth, obviously, supported by our continuous ability to outperform market as well as a continuous improvement in profitability and continuing also to generate pretty health cash flow.

So, now moving to the detail of our revenues and profits, starting with revenues, as I said, we grew our topline by 5.2% in local currency year-over-year, generate a gross profit of $214 million or 31.7% of margin versus 30.9% a year ago.

With performance operating from $88.9 million with a margin of 13.2% versus a margin of 12.7% a year ago, leading to a performance EPS of $1.54 versus a $1.39 in Q3 2015. Performance free cash flow of $70 million, leading to a conversion rate of 82%, of which we returned 60.7% versus 7 million to shareholders through the repurchase of 595,000 shares and as you will later, we will update our full year guidance.

Moving to the next page and giving some color to the topline dynamics, actually as I said excluding FX impact, we grew revenues by 5.2%. By channel, it's rooted into 12% gross from our OE channel in a market that again altogether eroded a further 1.2% year-over-year and that's driven mostly by an increase of content per share per vehicle and market share.

In this 12%, the small acquisitions we actually drove in -- at the beginning of the year, MICO and Laydon contributed 2.1% of that growth. Aftermarket channel was actually a 4% only this quarter. And we have been suffering headwinds coming from the Middle East, obviously related to all what is going on, particularly around oil price as well, and from Turkey because of the political instability that the country has been going through in the last month and China coming from a slowdown in the mining industry.

The channel from the joint venture went to down 35% year-over-year related to a U.S. market itself was down 25% with actually a decline in heavy-duty truck of 35%. Now looking at the evolution of our revenues versus market evolution by region, Europe production levels was 2%, 6% in Western Europe, and up 32% actually in Eastern Europe Russia. And we outperformed the market by 4% by continuing to benefit from market share gains in air disc brakes in AMT as well as the ABS content.

North America, again, our revenues went down 35% in a market that market down 25%. South America we nicely outperformed and ended up with a revenue of plus 19% in the market that took another dive of 8% year-over-year and that's due to the launch of new products taking market share over there as well as benefiting from favorable vehicle mix.

Japan, Thailand, Korea, we outperformed by 6% in a market that eroded severely this third quarter due to Korea and that's related to favorable customer mix and more domestic production in Japan than exports to Southeast Asia that has more content per vehicle.

China was up very healthy 28% and we outperformed the market this quarter by 20%, driven by more share of the ABS market as well as feeding the new mandate for light and medium-sized trucks.

And finally India, that actually took a pretty serious dive of 13% year-over-year. We still see a very healthy outperformance continuing to be supported by the introduction of the ABS mandate in Q4 of last year.

So, overall, still a very strong level of contribution from our outperformance to the topline. Then I'm going to let Prashanth drive you through the detail of our financial results. Prashanth?

Prashanth Mahendra-Rajah

Thank you, Jacques. Good morning everyone. Overall, Q3 was a good quarter. Year-over-year performance operating income grew 10% on a sales growth of 5%, while truck and bus production was down by 1.2%. Cash flow from operations was $81 million and reflects a high conversion of our net income. Year-to-date our performance to cash flow conversion is running at 97%.

If we can turn to slide five, I'll walk you through the details. And as usual, I will focus on of the performance numbers. As a reminder, these are adjusted to exclude items that may cloud the underlying operating results such as separation and streamlining items, acquisition-related costs, and related or exceptional tax items.

Revenue growth of 5% in the quarter translated into a healthy performance gross profit margin of 31.7%, slightly up from last quarter and 80 bps above the prior year. Our operating income on a performance basis was 13.2% of sales and at constant FX; it was up $8 million year-over-year. Transactional FX contributed $5.2 million. So, excluding this impact, we delivered incremental margin for the quarter at 9% and around 13% year-to-date with an organic growth of 5%.

Productivity results were very strong, almost near record levels. Gross material productivity is 5.4% for the quarter, contributing $14 million. Conversion productivity of 7.1% in our factories generated savings of $7 million.

We stopped production in our Netherlands manufacturing facility mid-quarter. Some of these benefits flow through conversion productivity and contributed roughly 1 million out of the 7 and we would expect to see that continue to increase in Q4.

In Q3, our OpEx on a performance basis increased by $7.8 million year-over-year and is in line with the prior quarter spend. Investments in R&D and front-end contributed $5, million and the consolidation of MICO and Laydon added another $2.5 million.

The equity income from our joint venture was $6.4 million, which is down by $3.1 million year-over-year, mirroring the 35% reduction in North America and heavy-duty production.

Our performance tax rate improved versus the previously guided rate by 120 basis points to 15.8. Coincidentally, the quarterly rate is close to last year. Our full year U.S. GAAP tax rate is 33% or 19% excluding discrete. We'll cover tax in more detail in the further slide.

So, after excluding the non-performance items, you can see that our earnings per share is a $1.54 for the quarter, or $1.48 at the previously guided tax rate. On a U.S. GAAP basis, we reported a $1.76, which represents a gain of a $1.09 versus prior year.

Recall that in 2015, Q3 EPS included a $40 million restructuring charge driven by our intention to cease manufacturing in two European facilities.

And if we can now turn to slide six, I'll update you on our tax outlook. As you may recall from our pervious earnings calls, we advised you that the European Commission decided that a long-standing tax incentive program in Belgium was considered state aid and deemed illegal. Thus in the first quarter 2016, we booked a tax liability of $86 million related to the benefits that we had received over the past four years from this program.

We also mentioned that in March, Belgium appealed the European Commission state aid decision and now in September, we have separately filed our appeal. At our last earnings call, we noted that subsequent to the close of Q2, we had successfully obtained from the Belgium Finance Ministry approval to participate in a tax incentive program referred to as a patent income deduction or PID. The impact of which was noted in our guidance, but not in our Q2 results. This benefit is now reflective in the P&L.

In addition to the tax benefits related to the current year 2016, we were also able to claim a PID benefit for 2015. In Belgium the tax returns are due in September, thus we were able to include the PID program in our 2015 tax return. This had the effect of reversing $17 million of the $86 million claw back that we had accrued in Q1. This 2015 PID benefit will also reinstate some of our Belgian tax losses and we'll be able to utilize them against our 2016 profits.

If we now look out over the next few years, we continue to face uncertainty. We will formalize July 2017 guidance when we announce our full year results in February, but we want to give you a preview today.

While we see a path to the mid-teens rate in 2017, this will require a formal approval of the Belgian tax authorities that the PID program can be applied retroactively for 2013 and 2014.

We expect to start discussions with the authorities regarding this in Q4. If we are unable to obtain approval, the 2017 effective tax rate is likely to be high teens to low 20s. And as we look beyond 2017, we would expect our effective tax rate in the medium term to also be high teens to low 20s, but with increased upward pressure on the tax rate over time as countries adopt and implement depth related legislation.

If we can move on to slide seven, I'll cover the cash flow generation for the quarter. Excluding streamlining and acquisition-related payments, our performance free cash flow for the quarter is at $70 million, which represents the conversion rate of 82% of performance net income.

We had a temporary $7 million buildup inventory due to a service campaign tied to faulty components manufactured by a third-party supplier. We're working with our supplier and their insurer for the full recovery of the costs associated with the campaign. More details on this can be found in our quarterly filing.

Though our share buyback program, we repurchased 595,000 shares at a cost of $61 million. And as noted on the slide, subsequent to the quarter, we raised just $0.5 billion dollars of senior unsecured notes at an attractive 1.1%, which further demonstrates our investment-grade profile.

With this additional debt, we maintain a strong balance sheet flexibility, a well-balanced debt profile in terms of currencies and ternaries close to zero net cash and ample interest coverage at 25 times.

Let me now turn it back over to Jacques who will provide an update on our view of the markets.

Jacques Esculier

Thank you, Prashanth and turning to page eight, we're going to go through all our different global markets one after the other as we do usually starting with Europe.

Registration in Western Europe as of the end of August was up very healthy 16% and actually 18% in the months of August itself. However, the industry and our self are expecting the year end registration number to be up only 9%, meaning that from now on till the end of the year we will see a negative comparison year-over-year in terms of registration numbers.

Leading to a truck and bus production, for the third quarter down 2%, again, 6% for Western Europe and up healthy 30%-plus in Russia and down 15% versus Q2. When we look at year end, we believe that the production level will end up flat to 4% and there is no change to what we shared with you three months ago.

With a very, very, very initial outlook for the production levels next year, we would say that Europe is a complex region to predict now. GDP is supposed to still be a 1.3% up versus 1.6% this year. Aging of the fleet has actually not changed here at a record level high at 7.7 years.

Next year Russia will have probably a positive GDP growth over 1%, which is a major change in trend versus the last years. So, all this would favor a continuous growth of the demand.

However, there are some headwinds that appear on the horizon including by the way the fact that Brexit will start kind of moving on the past probably that will be finalizing 2018, but starting potentially disturb the economy.

And those kind of forces actually lead us to believe that we could see most probably a slight further increase, but unfortunately the negative forces may also push the bar down to a slight erosion, so that's why we ended up with this minus 2% to plus 3% for the moment

Moving to the U.S., production down severely 25%, heavy-duty down 35%, and further 15% versus the previous quarter. Inventory levels at dealers is still very high at around 60,000 trucks that is potentially in excess of 15,000 to 20,000 beyond the normal level of inventory and that will penalize not only the fourth quarter, but probably next year's production levels.

Now, when we look at the prediction for the year end levels for 2016, we believe it's going to end up in the range of minus 15 to minus 20 with flattish 5 to 7 Class vehicles, meaning that the Class 8 would end up at basically minus 30% for the year.

When we look ahead, again, a complex kind of equation to result to predict what will happen 2017. One would predict that GDP growth is going to grow to 2.2% and actually it has gone down to 1.6 this year. Way down actually from the initial anticipation we expressed early in the year. So, potentially a certain support from the economy.

However, there is this excess inventory that appears to be burn out and we believe that the economy would probably stabilize the market, maybe with slight growth, but given the burden of this inventory, we probably will end up into negative territories and that's why we take a guess -- initial guess of minus 3% to minus 8% range.

China was up a healthy 28%, however, down sequentially versus the previous quarter. And we have seen some pretty positive initiatives from the governments in addition to their investments into construction of infrastructure. The government in July has issued a new regulation that actually is revamping regulation that was pretty old, back in 2006 or something that limits the loading of trucks on the road and the dimensions of the vehicles.

And the government has decided to enforce it strongly this time, which will actually have a very positive impact, particularly during the fourth quarter as they have as of early September forbidden wide trailers and trucks to use roads carrying, for example, two rows of cars at the same time, and now they can only carry one line of car, like in every other country and that will trigger some additional demand for Q4 and that's also most probably a positive vector for growth next year.

However, in the meantime, there is a very strong slowdown that will be continuing severely next year in real estate and as well industrial activities. So, this year, we actually increased our prediction. We were plus 5% to plus 10% three months ago, now we push it to plus 10% to plus 15% for full year 2016. And initial guess for 2017, again, would kind of call for a fairly flattish market with a possibility that it flushes right or left to plus 5% or minus 5%.

India was, again, down 13% for the first time in two and a half years year-over-year and seasonally down 20% versus Q2 and that's due mainly to the over optimism of the industry in the first half that has actually ended up in dealing some stocks at the end of June and that has been kind of consumed during the third quarter with very significant slowdown in production levels.

So, we have to unfortunately revise our whole prediction from 15%, 20% to a range of 7% to 12%. We had also anticipated starting in the Q3, but mostly in Q4, that there would be a pre-buy effect ahead of the implementation of a EUFOR-like mandate by the end of first quarter next year.

It happens that the government decided that by April next year, they will revise and actually decrease the local taxes, the GST, and the GST will be decreased by basically about 7% to 8%, which is exactly corresponding to the price increase of the truck due to this EUFOR implementation. So, overall, there is no more incentive for fleets to pre-buy. So, that's why, again, we have revised our forecast for the full year.

Now, looking ahead in 2017, we still believe that India will benefit from healthy GDP growth and we believe the level of production will continue to grow obviously at a slower rate, but between 0 to 5%.

Moping to next page, Japan, Korea production down 11% in -- during the third quarter, driven by a drop of 31% in production in Korea alone, because of the severe impact on their exports to Russia and Middle East.

For the full year, we predict that the production level in Korea, Japan including the Japanese manufacturing of trucks in Southeast Asia would end up between minus 2% to minus 7%. For next year, we basically predict a flattish market minus 3% to plus 2%.

Then Brazil, third quarter, another erosion of 8% year-over-year, down 4% sequentially. However, due to some breakthrough in the resolving their political issue potentially, we think that there are some indicators right now that the country could potentially reverse the trend and start kind of pass on economic recovery.

For 2016, however, we unfortunately have to revise our previous forecast that was flat to minus 10% to minus 10% to minus 15%. But we think that 2017 this time was a GDP growth that is for the first time in quite a few years would be positive. We think we could see some real solid change in trend and we predict that this point flat to plus 10%.

Aftermarket, as I said, Q3 up 4% year-over-year. We continue to see a very strong demand through the independent aftermarket channel. However, very much offset by weak markets in Middle East and in China as well as weal demands through the OES channel.

For the full year, we predict about 6% of growth for the aftermarket and initial outlook for next year with this report 7% anticipation growth. Trailers Q3 was down to pretty strong 9% year-over-year and 10% sequentially and that's driven by North America and China, but China building a lot of -- actually trailers for the North American market.

So, for the full year, we see the outlook flat to minus 5%, again, severely impacted by North America, contracting China. For next to accompany a fairly sluggish market, we think that trailer would to lag at minus 5% to minus10%.

Moving now to the next slide that kind of will introduce the key announcement we made at this IAA Tradeshow. I will start with the first chart that gives you today the vision that we have been driving for quite a few years on our path towards automation and autonomous driving ultimately. And here you have some key functionalities and technologies that we already sale and offer to our markets.

The following slide which is very much alike will give you actually the in blue -- in the blue color, will give you all the different technologies, partnership, and resulting functionalities that were announced at IAA, starting with this OnGuardMAX, which is the of addition of OnGuard Active, the premium collision mitigation system in the market. OnGuardMAX was allowed to apply the full braking power on stationary object, which is not the case right now on OnGuard Active.

We have announced this on CD very clever leader-based single sensor to cover 180 degrees on the side of the truck to identify pedestrians and cyclists in a city environment. This is a unique breakthrough technology.

Then we announced a partnership again with the Peloton that allows us to access platooning. In the U.S., Peloton is a company, it’s a start-up from the Silicon Valley that is ahead in actually developing and providing a solution for platooning.

Then we have an agreement -- a partnership with Mobileye to bring to the world of commercial vehicles their camera system equipped with the latest chip and then we have announced a initial agreements, an MOU with a tier-1 large Asian automotive supplier leveraging their actually very, very attractive steering solution for commercial vehicle and integrating the steering into an active steering world that will be connected to our control world adding the lateral control of the truck to the longitude control we already cover, very important step.

So, those are the key technologies and activities that we have announced, which, again, we present enormous amount of grounds for us to rollout very attractive new functionality and new value proposition to the market in the coming years on our pass through autonomous driving.

The next page actually as we do every quarter kind of list the key achievements along the three pillars of our strategy, most of them have already been addressed in the last couple of slides. I would just add to it the announcement by CNHTC of their launching of the Safest Intelligent Heavy-Duty Truck in China. It happens that CNHTC rely uniquely on our technology across our portfolio.

We also received in Asia from Daimler Truck a very attractive award of being named -- nominated as Elite Level Partner Suppliers. And then we also received a very, very prestigious award from Daimler Truck North America, we're nominated Masters of Quality Supplier. And then we got for the seventh year in a row, this Platinum Supplier Award from Wabash National, a leading manufacturer of trailers in the United States. And then related to productivity, a kind of recap what Prashanth has been describing to you previously.

Turning to next page, we're going to go through the update and upgrade actually of the guidance. Even though we brought the midpoint of our sales gross range down 0.5% to recognize the further headwinds that we have just described coming from demand out there, so we end in the range of 7.5% to 8.5% or $2.83 billion, with a performance margin between 13.5% to 13.8%, we upgrade our performance EPS midpoints to $5.80 with a range of $5.75 to $5.85 with a free cash flow conversion still in excess of 90%.

And on the right side, you will find all the key assumption as we share with them with you every quarter.

And as a summary last page, another quarter of topline growth -- solid topline growth supported by a very good level of continuous outperformance of a market that is in itself very sluggish and actually still eroding.

Generating also additional profitability at the bottom-line as Prashanth has -- went through that with you. And a very healthy conversion cash flow which is year-to-date at 97%. We have tightened our guidance and actually upgraded our midpoints of EPS guidance and we continue obviously to return cash to shareholders through the buyback program.

That ends up our presentation and we will open now this session for questions. Thank you.

Question-and-Answer Session


[Operator Instructions]

Thank you. Our first question comes from Justin Long with Stephens. Your line is now open.

Unidentified Analyst

Good morning and congrats on the quarter. This is actually Brian calling on for Justin. Okay. So, I wanted to ask about the stability control mandate that becomes effective in the U.S. next year, could you just talk about your competitive positioning to lock down some of that business?

And also do you think you'll see a meaningful impact from this on your financials in 2017?

Jacques Esculier

Yes. Thank you, Brian. Well, stability control will be mandated at midyear next year. Stability control will be linked to braking system, meaning that we will have the market of those customers to which we deliver braking system, meaning a pretty decent share of the market, obviously and that will feed the outperformance -- the list of opportunities that we see in the outperformance for next year. So, yes, it’s a good addition to our topline revenue for next year.

Unidentified Analyst

Great. That's helpful. Thanks for time.

Jacques Esculier

Thank you.


Our next question comes from Jeff Hammond, KeyBanc Capital. Your line is now open.

Jeffrey Hammond

Hey, good morning guys.

Jacques Esculier

Good morning.

Prashanth Mahendra-Rajah

Good morning. How are you?

Jeffrey Hammond

Just wanted to hit on the incremental margin and kind of how you're feeling about it relative to the growth? It seems just a little bit light and as we look into 2017 given your initial growth outlook, how you’re thinking about our incremental margins?

Prashanth Mahendra-Rajah

So, Jeff, I'd remind you that in our Q1 call, we indicated that -- or our guidance call, we indicated that incremental margin this year was going to be under a bit more pressure driven by two items; one, we were starting to see more acceleration of our air disc brakes business, which on OE side is a little less profitable until the aftermarket kicks in.

And then also with the mandate on the ABS in India, that was just the pricing that comes along with that was going to make this year a little more tough.

As we think about next year, we should be wrapping -- lapping the India activities this year where we think we're going to have a little bit of a challenge next year and probably not unusual for both companies is the German bond continues to fall in its interest rates and that's going to have an impact on our pension.

So, we haven’t got the numbers on that yet, but in our filings, we do tell you where we are today in terms of what assumptions we've used on the interest rate. You can look at the market and see that the 10-year bond is fairly low, I think it actually be negative.

So, when that rolls through our pension obligation, it's going to put some significant headwinds against the framework, but until our actuaries finish their magic, we're not going to know the full impact of that.

Jeffrey Hammond

Okay. And then it looks like aftermarket is decent in Europe, but slow in a number of other markets. And again, maybe, what you think is driving some of that in these other markets outside I guess North America, which has been obviously weak.

And then, again, how does that frame kind of the confidence level in that 7% initial look in the 2017? And then I'll get back in queue. Thanks.

Jacques Esculier

Yes, Jeff, this year again, we gave few regions and it's not new to this quarter. We have already mentioned them before that we're lagging in aftermarket growth and dynamics. And in industry that continues to default on growth, actually there's nothing surprising that the aftermarket level in market demand is not very active, meaning that our growth is mainly driven by market share gains or activities like the launching of these new brands. We're profoundly kind of involved into digitalizing the connection between WABCO and its aftermarket customers, which makes it easier, more convenient, and attracts further demand for our products.

So, all those initiatives -- our view is creating this positive growth, but I would say the market itself is fairly sluggish, overall, particularly in some regions like Middle East, Turkey obviously with what's going on or what has been going actually in last month.

And then China, because we used to have a pretty strong anchoring into the world of mining over there and that has declined severely as well. But when we look on the horizon, given the momentum of those initiatives continuing to build up, also related to the fleet management solution activities that we now start kind growing into territories beyond Europe, particularly in Asia, we think at this point, and again it's early in the process, I must admit we have not come yet to the budget loop and cycle, but 7% doesn't seem unrealistic.


Our next question comes from Neil Frohnapple with Longbow Research. Your line is now open.

Neil Frohnapple

Hi, good morning.

Jacques Esculier

Hi Neil.

Neil Frohnapple

Regarding Europe, can you provide more granularity on what drove the 6% estimated production decline in Western Europe in the quarter? And just any detail you can provide on how the quarter progressed? Just wondering if you saw a drop in September and that's kind of give a new pause for the fourth quarter, so fourth quarter more difficult comparisons.

Jacques Esculier

The fourth quarter will be basically also negative territories year-over-year not quarter-over-quarter. The third quarter is always historically weak because vacation time for Europeans is precious, So, obviously, the level will be up in the fourth quarter and in the third quarter, we see mostly a major impact from Turkey that has drop production due to pre-buy -- former pre-buy of the introduction of Euro 6 [ph] in their area as well as -- again, the impact of what happened during the last three months, politically.

And that's chromatic because it's basically a 44% drop and Turkey is an important center of production abroad. So, this Euro 6 pre-buy that has now the negative impact plus the political situation drive this 44% drop and that basically is a major driver of the 6% drop overall for the region.

Neil Frohnapple

Okay, that's helpful Jacques. And then could you talk a little bit more about what you're seeing for Brazil. Are you seeing any sequential improvements in orders that could start leading to higher production off a very low base that gives you confidence and your more constructive outlook for the industry?

Jacques Esculier

Yes. We see actually when you look at the number of trucks, we were at the 20 -- actually it was 20,020, we ended up third quarter at 21,000. We think it will go up sequentially kind of 10%. Q4 would be pretty strong compared to Q3 at 10% already up, because we see some -- already some kind of signs of increased demand, which is nothing astonishing because you read the papers, the economy overall is starting to show some signals -- or at least a change of trend and potentially a slight recovery already.

So I'm not surprised and I would say that we would expect this to continue in the coming year and I think it's going to -- if the recovery is consolidated on its paths in the coming months, then I think we could see in Brazil, in the next couple of years what we just witnessed in India, meaning a very good source of market growth.


Our next question comes from the line of David Leiker with Baird. Your line is now open.

Jacques Esculier

Hi David.

Unidentified Analyst

Hi, this is actually [Indiscernible] for David.

Jacques Esculier

Okay, good morning. How are you?

Unidentified Analyst

Hi, Jacques, I'm well. I'm wondering if you could talk a bit about outgrowth expectations into next year and may be less about the backlog contribution because I'm sure it's maybe too early, but when you think about the individual end markets and the fact like the east of Europe might be stronger than the west of Europe as a mix example, do some of those mixed items and the regional variances may be dilute your rate of outgrowth next year?

Jacques Esculier

Well, obviously the trucks are built in Russia do not carry as much content per vehicle. So, fair enough, when you see growth in the region was less content per vehicle, it's less favorable to the outperformance.

But we have as we do every year a fairly long list of things that will keep feeding this pipeline for outperformance. We will continue to gain share in air disc brakes, particularly in the U.S. We believe that at Daimler, with our agreement with this Henriksen [ph] and we will also gain share in Europe at Volvo on the medium-sized truck air disc brakes. We will have -- obviously as we have announced before, regain the EBS share of market that we had lost quite a few years ago, meaning an increase from 60% of the market currently to a 100%.

Then we're also gaining market share on the ABS front at Daimler because basically next year we’re going to have everything and they were historically ABS markets that we did not process, one is Europe and there is a medium-size truck that has quite a bit of ABS equipment on it.

And then there is Brazil, we historically did not deliver ABD to Daimler, Brazil before and this next year we start. And then more AMT in Daimler as previously mentioned, stability control being regulated next year. We have little bit more ABS in China, and on and on.

So, there's a list of things that as usual will support a outperformance level that I think will be solid. I can't give you any number yet because it will also very much depend on the market level.

You know that this year we have been heavily penalized by the construction of the U.S. market, which was obviously one of the market with the highest level of content per vehicle.

So, we are not ending up the year as good as we thought we would even though we have executed all the different levers, but the market has been providing headwind. So, it's very hard at this point to predict what level of outperformance we could expect from next year. But, again, we have a lot of initiative and opportunities to support it.

Unidentified Analyst

That's great detail. I'll leave it there. Thank you.

Jacques Esculier

Thank you.


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

Jacques Esculier

Good morning Jerry.

Jerry Revich

Hi, Good morning and good afternoon, everyone. Jack, I’m wondering if you could talk about what you’re seeing in your aftermarket business in Europe and how that varies by country, any trends that are emerging post to Brexit road [ph] that are notable or if you have some more visibility based on the OE or to respect some terms of what you’re shipping and into production any color there would be helpful.

Jacques Esculier

No. It is very hard to read by country. Now if we look specifically on U.K. because there is this Brexit issue that goes beyond aftermarket actually. The production of the U.K. is basically 15% of the Western demand, so it's not gigantic. We are actually seeing the demand slightly eroding, but nothing dramatic. I mean nobody could guess with this type of movement in the market that there is a Brexit behind it because it’s not to descale [ph] what people would have expected Brexit to do. So for the moment we don't see anything very drastic or dramatic.

I don't think there is any specific country where big swings or surprises happened, again except for Turkey that I again mentioned before. Now we take a lot of initiatives again as I said to regardless of what the market does continue to outperform and drive growth in this important region for aftermarket.

As I said we launched earlier this year this new brand for VIA that is very successfully penetrating the dealer channels because it does offer a very attractive alternative to private brand coming from outside the region that were at much lower price but also lower quality and for VIA is at a very attractive price but guaranteeing WABCO quality.

We also -- as I said kind of rollout this initiative to digitalize our world of aftermarket interface with all the different customers and channels. And all this in my own view will continue to feed nice growth moving ahead. But again, not being able at this time to very much predict what will happen in the aftermarket overall demand.

Jerry Revich

Okay. Thank you for the color. And Prashant, you mentioned the margin mix of new product sales this year obviously EVA positive and returns positive but lower margins. How would you characterize the margin profile of a new products that will be entering the fold for your folks in 2017? Should we calibrating some more way to what we saw in '16 or if the profile is different?

Prashanth Mahendra-Rajah

Jerry, important clarification that it’s left around new products as around product mix, so the margin profile for our product is -- worth facing with this year if the mix of those products with Air Disc Brakes being a bit lower on the upfront side than some of our other products. So that what’s causing little bit of pressure. As we go into next year, we would for the right set of product mix I think we would continue to be able to hold the margin profile and I wouldn’t expect that we would be further deterioration.

Jerry Revich



Our next question comes from Ross Gilardi with Bank of America Merrill Lynch. Your line is now open.

Ross Gilardi

Good morning. I just wanted to -- make sure I understood what you’re saying about Europe and maybe I’ve got my geographies to confused because are you attributing the 6% decline in Western Europe truck and bus production for Turkey?

Jacques Esculier

You know there are two regions in our structure one is called Western Europe and the other one is called Eastern Europe. In that structure for us Turkey is not yet Russia. So for that structure we selected Turkey to be part of Western Europe and Turkey is an important center of production particularly for customers like Daimler or AMN [ph], which are kind of Western Europe customers. So we consider them as Western Europe.

What we call Eastern Europe is actually beyond the border of Poland and Ukraine. It’s really Russia and the Belarus Russia that’s what we call Eastern Europe. And what we are seeing is minus 6% in Western Europe that is impacted by Turkey and actually 32% in Eastern Europe which is really more driven by Russian and Belarusian.

Ross Gilardi

Okay. I mean if you strip out Turkey I mean is Western Europe actually still probably up year-on-year?

Jacques Esculier

Western Europe is up in demand. As I said the registration of trucks is very high. It’s 16% year-to-date will end up 9% however its mitigated by a very strong pressure of -10% on the exports and the export represent 20 plus percent of the manufacturing and that’s export mostly to Middle East to some Asian country. So Western Europe in terms of truck deals is scattering Western Europe demand but also exports to other parts of the world including again Middle East, Africa, Asia, Far East and all that. And that’s down 10% so that’s kind of against reports the further erosion of the peers not demand for trucks in Europe.


Our next question comes from Robert Wertheimer with Barclays. Your line is now open.

Robert Wertheimer

Oh, gosh. I think you just answered Jacques. So effectively the gap between your full year registrations expected up 9 in Europe and production kind of up to at the point is like a couple of points from the exports. But I think you said 20% of market the exports are down and that’s couple of points and Turkey is couple of points. I’m just trying to put those two things.

Jacques Esculier

Yes, you have -- also I think 10% of the market is buses and buses is also eroding 2%. Then you have 10% of erosion on these exports. And the rest is really registration of Western Europe. So you make the equation is to work out through that numbers.

Robert Wertheimer

Perfect. And then, is it true then that the OEMs are expecting or you are expecting registrations to be weaker in 4Q. Is that expectation based on market or is it conservative look because obviously, it’s been stronger than a lot of expected throughout the year in Western Europe registrations.

Jacques Esculier

First, it’s an industry kind of wide prediction and it’s down year-over-year and again I think it’s about 3%, 3-4-5% if I remember but going from 16% year-to-date end of August to 9% you made the calculation yourself and its slight erosion year-over-year. And obviously, sequentially it also kind of sees a drop between Q2 and Q3 because of seasonality Q3 is always weaker because of vacation. Q4 is actually a little up versus Q3. It’s not another drop of Q4 versus Q3. Q4 is slightly up versus Q3, but down versus Q4 last year.

Robert Wertheimer

Perfect. Thank you. If I may -- obviously, you guys have done -- your partners and you have done great in AMT in North America and that’s presumably a headwind is long haul truck in such gets cut faster than the total truck market or even total Class 8. Do you think you’re seeing the full effect of that headwind in 3Q or is an incremental mix headwind in other words your under go-to-market by little bit more as you go into 4Q in 2017. That’s just been headwind we’ve anticipated, and also it's slow there or not?

Jacques Esculier

No, I think we’re going to see the headwind for probably little while until the inventories -- the inventory of truck is Class 8 almost only. And you need to burn that whatever 20000 truck of heavy duty before you’re going to sort heavy duty – to start seeing heavy duty up again in production levels and that will obviously prevent the AMT volumes to go up as well accordingly. Right now AMT penetration is about 40 plus, almost 45%. So, there's still some way to go. And right now it has been disrupted by exactly what you're saying, the fact that the Class 8 has retracted severely this year. As Class 8 stabilizes and starts hopefully by year end next year or midyear next year into 2018 to rebuilt itself, then AMT will further kind of provide momentum for our outperformance.

Liz, I think we're going to be able to take one more question and then we need to call it.


One last comes from the line of Seth Weber with RBC Capital Markets. Your line is now open.

Seth Weber

Hey, good morning everybody. Thanks for extending the call here. Maybe if you could just touch on the debt issuance that you referenced, I saw the 8-K this morning, and is that just being opportunistic or how should we think about that? Are you expanding your M&A pipeline a little bit? Should we think about more aggressive share repurchase here going forward perhaps? Thank you.

Prashanth Mahendra-Rajah

I would say opportunistic and prudent. Opportunistic and that we are at an incredible interest rate environment now globally. We issued our first debt last year and I think in hindsight we probably caught the bottom of the market from a U.S. standpoint in terms of rates and spread and we issued this instrument in euros and we're borrowing basically for a decade at 1% which you have to believe is going to be very close to the bottom as well.

So, opportunistic in that standpoint, prudent and just mixing our exposure between different tenors, between currencies and between in mix of variable and fixed.

Seth Weber

And is there anything you can talk about the M&A pipeline? I mean are you spending more time there? You've done a couple of deals recently?

Prashanth Mahendra-Rajah

I'll let Jacques take the question on M&A, but also before I got to finish, the debt issuance also help support our commitment to buyback program.

Seth Weber

Okay. Sorry I -- sorry to interrupt you.

Prashanth Mahendra-Rajah

No worries. So, I'll let Jacques talk about the pipeline.

Jacques Esculier

Yes, M&A pipeline, I mean as usual as we have several targets and activities. Obviously the pipeline and this broadening of our space and horizons on that path towards autonomous driving will kind of force us to establish partnership and potentially sometimes acquire and digitalization.

We're still very ambitious on our plans to bring this value proposition and value vector I would say to connect more to the fleets globally. So, there are lot of good things kind of under study, but as usual, we're prudent conservative and certainly don't want to degraded the overall quality of our franchise.


And that concludes today's question-and-answer session. I'd like to turn the call back to Mr. Esculier for closing remarks.

Jacques Esculier

Yes, thank you, Liz, and thank you all for attending this call and wish you a very successful quarter and year end. And we'll talk to you in next January. Thank you.

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