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WABCO Holdings Inc. (NYSE:WBC)

Q2 2008 Earnings Call

July 30, 2008 8:00 am ET

Executives

Mike Thompson - VP, IR

Jacques Esculier - CEO

Ulrich Michel - CFO

Analysts

Jeffrey Hammond - KeyBanc Capital Markets

Steve Tusa - JPMorgan

Ted Wheeler - Buckingham Research

Martin Sankey - Neuberger Berman

Ben Falck

 

Operator

Good day and welcome to the WABCO second quarter 2008 earnings results conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. Mike Thompson, Vice President, Strategy and Investor Relations.

Mr. Thompson, Please go ahead.

Mike Thompson

 

Thank you, Teresa. Good morning everyone and welcome to WABCO's quarterly conference call. Today, we will present to you our second quarter results and then answer any questions you might have. With us this morning is Jacques Esculier, our Chief Executive Officer and Ulrich Michel, our Chief Financial Officer. Jacques will start the call with his perspectives on the quarter, and Uly will follow with more detail on our financial performance, we'll then open the lines for your questions.

Before we begin, I'd like to remind you of a few things. First, this call, webcast and the presentation that we will be using this morning are available on our website; www.wabco-auto.com under the heading WABCO second quarter results. Replay of this call will be available through Thursday, August 7.

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 concerning future developments. As you know actual results may differ materially from these expectations as a result of many factors, relevant examples of which are set forth in our company's Form 10-K and quarterly reports.

Lastly, some of our remarks contain certain non-GAAP financial measures as defined by the SEC. Reconciliations of the non-GAAP financial measures to the most comparable GAAP measure are attached as an appendix to this presentation and to our press release from this morning, both of which are posted on our website.

With that I'll turn the call over to Jacques.

Jacques Esculier

Thanks Mike, and good morning everyone, and welcome. Before we jump to actually our Q2 results, I'd like to kind of remind you that in a couple of days actually on Friday, WABCO will celebrate its first anniversary as a publicly traded independent company, and I think, today is a proper platform actually to maybe look at those last 12 months and reflect on what we have achieved so far.

We're going to do it basically using the three main areas of priorities that we've been pursuing in the last few years. One, around at our effort to improve execution across the value chain, the second one is the commitment that we made to transform WABCO that was historically more focused around its traditional markets in Europe and US and kind of expand it's reach to emerging markets.

A third one is, obviously to continue to drive technology as a major differentiator for our business. But again, going back to the way we improve our execution, continuously implementing improvement activities initiative under the umbrella, a concept of the WABCO operating system starting with our continuous deployment of the Lean Six Sigma activities across the value chain, specifically across our factories, across our key suppliers and in logistics.

That has produced some very significant results in the last 12 months. I will start with a significant improvement in the quality of our products that is very well appreciated and recognized by our customers. Actually three of them in the second quarter gave it very prestigious distinguished awards to recognize against the performance of our service level.

I'm talking about Volkswagen in Brazil, Tata in India and KAMAZ out of Russia. When we look at what it does to our profitability, actually from Q2 2007 to now, we have been able to basically lower our accrued expenses to cover warranty expenses from 1.6% to 1.2%. Obviously, improving processes across the value chain also trigger opportunities to generate productivity and when you look at the first half of the year, we have been able to generate in excess of $56 million of good productivity more than offsetting all the headwinds around inflation, commodity price increase and others.

The second thing, we're really paying a lot of attention to and that really delivers a lot of value for us is the way we develop products. We want to make our products more reliable. We also want to make the product development of our products, less expensive and also using less CapEx.

Again, I remind you and you will see again that it happens in the second quarter that we have consistently been able to maintain our CapEx below D&A, so in the last 12 months all the product development activities we have run have seen improved CapEx, significantly lower costs and better quality.

By continuously adhering to those kind of more advanced management environment, WABCO is an attractive place to grow a career for good talents. Not only to actually retain the talent we have, but also to attract some very powerful capabilities and talents from the outside who come to continuously strengthen our global leadership.

Talking about the way, we again transform our company into a company of the world into a more global company. We've seen a lot of improvement and very strong, actually improvement in distinguishing our brand as a brand of reference in all emerging markets and that is a good base to actually generate exceptional sales as we've seen India, China, Brazil, Russia, growing in the last 12 months.

I would just remind you that in 2007, we have doubled our revenue from China. Now looking back at the first half of 2008, we have driven another increase of 75% of its revenues generated by China year-over-year. In order to support this expansion in sales and revenues we obviously have to increase our capacity in those places and we have in the last 12 months inaugurated two manufacturing facilities in India and one in China and we are also further leveraging these low cost countries facilities to transfer labor intensive products from high cost countries to these places generating some good saving and productivity there as well.

Finally, we continue to develop some good strong engineering capabilities in low cost country with specifically the opening of a new software -- second software development centre in India that was opened actually during our second quarter.

Now, looking at the third, again area of focus which is continuing to bring innovation in our product development and to drive new technology, we've made enormous amount of progress as you know we are currently developing the third wave of our products and systems to equip the new wave of trucks and buses that will come out of the factories -- out of our customer's factory from 2011 to 2013.That brings a lot again, very strong innovation across the board. I would single the one breakthrough where again WABCO was the first to introduce a new technology in the area of collision mitigation. It’s a device that we introduced in the United States back in February that has already made quite a bit of good strong growth.

Finally, I would also mention something that our customers in Europe will very much appreciate. We have launched a way to simulate Electronic Stability Control on their trucks, so that they can more rapidly and certainly at much lesser expense certify all their truck configurations to be ready for the mandatory ESC device on all trucks in Europe by 2010-2011.

So looking at kind of rapidly again mentioning those things that happened in the last 12 months I would say that we have successfully brought quite a bit of success to our company, certainly to our customers and ultimately to our shareholders.

Now on page 4, we are jumping now to the heart of our call, start reviewing the performance level of our second quarter starting with an overview. I would kind of, start with the fact that we have broken again new records in sales, in income, and also in cash flow. Starting with sales, this is the first time we see revenues of $772.9 million at WABCO, up 33% reported or 16% in local currency as compared to last year. Revenues were driven by outperforming markets that by themselves were also growing across the world and also by further expanding our revenue base in emerging markets. Our profitability is, at the same time, actually even faster.

Operating income is up 71% as reported and when you look at it in local currency at the performance operating income level, we are up 24% leading to a margin expansion of 70 basis points, this being driven again by our continuous ability to generate solid productivity of in excess of $28 million for the second quarter as well as again, continuing to lower the cost of poor quality.

So, this led to an EPS level of $1 for the quarter, reported at [22%] year-over-year at a performance level EPS is at 113 up 66% as compared to last year, and even though, we are growing at a very high pace, 16% from second quarter. We are still about to generate a very healthy $72 million of free cash flow which is a record for us, meeting about 107% of conversion rates as compared to net income.

We also pursued our program to repurchase our shares that we actually committed for 2008 to reach $200 million. We purchased 1.2 million shares in the second quarter, as of the end of the first half; we are almost at $100 million well on our way to again meet our commitment for total year.

And because we had a pretty good first half and we feel confident for the second half of the year, we decided to raise our EPS projection by $0.21 up to 412 to 426 range, obviously Uly will give you more details on the structure of the that $0.21.

Turning to the next page, page 5, we want to give you some more details on the sales for the quarter. Starting again, with the fact that those sales went up 16% in local currencies. Fuels first by continued growth in our OE business at 19% driven by continued growth in markets across the world, in our successful global expansion in emerging markets, and also our continuous increase content per vehicle.

This quarter, our aftermarket gross is back to a double-digit level at 12%, mostly, coming actually from independent aftermarket channel. The OEs channel continues to be slightly weak. Our sales to joint ventures, which mainly consist in our sales to the North American joint venture we have with ArvinMeritor has actually slightly decreased. And this is really due and driven by the fact that the trailer market in the US is significantly down by 41% in Q2, as compared to last year. So this triggered this weakness in our sales to joint venture.

Now on the right side of the page, we compare our revenue growth to the natural truck and bus production growth in the each one of those of the regions of the world. Starting with Europe, where we have, again, our weakness in extremely strong growth in the number of trucks beyond 21% year-over-year, we are still not able to outperforming by another percent to end up at 22% revenue growth.

For North America, it's good to see that, the year-over-year growth is now positive. We haven't seen this for quite a few two quarters. We actually see the US strengthening up in the second half to probably around 25% of gross again as compared to H2, 2007, and we are able to continue to outperform the US market by 8% to end up at 11% growth, mostly driven by the continuous strong success that we have as a partner in joint venture with Cummins.

South America grew 6% in its number of trucks built, it's a little slowdown as compared to Q1, which was 24% and we outperformed it again by 5%, ending up at a gross level of 11%. Asia-Pacific, as a whole, continues to be an extremely strong source of revenue growth for us. The market went up 19%. We were able to grow 42%. Specifically in China, number of trucks built continues to be very strong, at 22% growth, and we 're able to outperform it in a very significant way, ending up again with revenue growth of 69 %.

So, and altogether, again, good strong growth, natural growth across the globe in all markets that we are able to outperform; and again, we are back to a double digit growth in aftermarket.

Now I'm going to let Ulrich give you some more details supporting all those numbers. Ulrich?

Ulrich Michel

Thanks. Good morning, everyone, and thanks, again, for participating in our earnings call.

Turning to chart six, we'll walk through the details from sales to earnings before interest and tax for the quarter, looking at both, reported and performance numbers. Performance numbers for 2008 are adjusted to remove operation streamlining and separation costs. In addition, comparisons to 2007 are adjusted for currency translation effect. As Jacques mentioned, sales rose for the quarter 16.2% in local currencies. This includes the impact of pricing pressure which was 1.9% for the quarter, once again at the low end of the range we typically see for our business, which reflects our continued efforts to delay price decreases and part material increases on to our customers.

Gross profit grew at 19.4%, which adjusted gross profit margins expanding 71 basis points compared to last year. Operating expenses expanded at a rate of 16.3% in Q2, and decreased as a percent of sales versus last year for the first half of 2008. Operating income increased 23.5% for the quarter, withed adjusted operating margins increasing by 70 basis points.

As you can see, this margin expansion was enabled by positive volume, mix and productivity benefits of more than $52 million, offsetting the approximately $38 million negative impact from price erosion, labor inflation, operating expense investments and transaction of foreign exchange.

Excluding the effects of transaction of foreign exchange, we have realized operating margin expansion of roughly 168 basis points for the quarter. Performance EBIT exceeded $93 million for the quarter, with margins expanding 54 basis points. Our EBIT was impacted by a decline…a decline in equity income of $1.7 million in local currencies from Q2 of 2007, which was due mainly to our Indian joint venture.

In summary, this was another outstanding quarter, and our results show that we continue to leverage our increased volumes and successful productivity initiatives with margin expansion versus last year.

Turning to chart seven, we see more financial information for the quarter. Our reported earnings before interest and tax was impacted by streamlining and separation-related expenses of $8.7 million for the quarter, down from $15.9 million in the same quarter of last year.

Net interest income was $400,000, as interest income more than offset $1.8 million in interest expense. We were able to achieve a performance tax rate of 21%, excluding separation and discrete tax items. This is a further reduction of more than 1% from our previous quarter and over 3% when compared to full year performance tax rate in 2007.

As a result, our reported net income for Q2 was $67 million, up 115%, versus last year. Removing streamlining, separation, and one-time industry tax items, performance net income was $75.5 million, versus $47.2 million a year ago, an increase of 60%. Furthermore, earnings per share on a reported basis was $1 while performance EPS for the quarter was $1.13 versus $0.68 a year ago, an increase of 66%.

Turning to chart 8, let's go through our cash flow for the quarter. As you can see, working capital decreased by approximately $8 million. This was driven by reductions in inventory and more normalized payable balance versus the lower level experienced at the end of the previous quarter.

Operating cash flow was negatively impacted by separation related payment made during the quarter. We paid indemnification liabilities of $18.5 million that we had assumed in the separation from Trane.

Next, you can see that net cash provided by operating activities was $90.8 million and net cash used in investing activities was $18.8 million. Our lean manufacturing efforts again enabled us to keep capital expenditures well below depreciation and amortization. Therefore, free cash flow was a record $72 million for the quarter. This yields to net income conversion rate of 107% for the second quarter, and combined with the Q1 results, 82% for the first half of 2008. If we exclude the impacts of separation, our conversion rate for the first half 2008 is closer to 100%.

In addition, we spent nearly $66 million repurchasing 1.4 million shares of our stock during the quarter. $60 million of which was settled during the quarter. In total, we have repurchased 4.7 million shares or 6.7% of diluted outstanding shares since our spin-off in August of last year. In Q2, we also paid dividends to shareholders in the amount of $4.6 million, yielding a total of over $70 million of cash returned to shareholders for the quarter.

On chart 9, you see first half year 2008 performance versus the same period a year ago. Sales increased by 14% in local currencies. Performance operating income has improved by 43%, and operating margin has expanded by 119 basis points. Excluding transactional effects, margins have expanded by 214 basis points, which demonstrate the operation improvements we have made by further implement our WABCO Operating System. Finally, performance earnings per share has increased by 62% for the first half of 2008.

Turning to chart 10, let's review an update of our financial projections for the year. These projections reflect our present view on second half 2008 developments in the global commercial vehicle and commodities markets. They incorporate various improvements that we have made since our last projections, and they reflect more current exchange rates. They do not include the potential impact of the EU fine.

Based on our solid progress in the first half and our expected growth in the next two quarters, we project our sales for 2008 to grow between 9% and 12% in local currencies. That confirms our prior guidance. It includes continued, but slowing growth in European truck and bus production, as already anticipated in the previous projections.

What's new is an increased softness in the trailer and specialty vehicles markets in Europe and North America, although, we still anticipate a recovery of the US and truck and bus business in the second half. We have seen strong results from our operational improvements since our last forecast. Therefore, we are confident that we can achieve increased productivity in manufacturing, sourcing and logistics and reduced cost of poor quality beyond our last projections. We should therefore be able to compensate for potential additional increases in raw material, of as much as $7 million to $8 million we are incorporating into our current projections.

EBIT margin projections are additionally impacted by the transactional foreign exchange. As compared to the exchange rate used in our previous projections, we estimate that at current exchange rates our margins are negatively impacted by 30 basis points to 40 basis points.

With an improved performance tax rate of approximately 21%, down from around 22%, higher interest income and the same number of average outstanding diluted shares of 66.6 million for the year, we now expect performance earnings per share to range from $4.12 to $4.26, up 21 cents from our prior projections.

Looking back, our performance earnings per share for the first half was $2.17. That's an actual amount. Looking ahead, our projection for performance earnings per share in the second half is $1.95 to $2.09. Again, that is based on today's projections.

Now, I'll turn it over to Jacques again for his summary. Jacques?

Jacques Esculier

Thank you, Uly. Tturning to page 11, a few elements to summarize what we just kind of reviewed today. Starting with, I think, what we can call a fairly outstanding first year of life for our company as an independent business was, I think all greens for metrics and performance indicators. We specifically for the second quarter now, we delivered again record numbers on all key measures.

We continue to successfully deploy our WABCO operating system as the engine for continuous improvement in operations across the value chain, driving again productivity, quality and obviously overall customer satisfaction. This led us to achieve a fairly significant level of improvement at our performance EPS level of $1.13, 66% of last year's.

And, again, kind of supporting our decision to upgrade and share with you our increased confidence we have in being able to deliver an overall better value our shareholders, up to a range of $4.12 to $4.26 per share, up $0.21 compared to our previous guidance.

With that, we conclude our presentation, and I would like now to open the line to answer your questions. Thank you.

Question and Answer Session

Thank you. (Operator Instructions).

We'll take our first question from Jeffrey Hammond, KeyBanc Capital Markets.

Jeffrey Hammond - KeyBanc Capital Markets

Hi, good morning, guys.

Jacques Esculier

Good morning, Jeff.

Ulrich Michel

Good morning, Jeff.

Jeffrey Hammond - KeyBanc Capital Markets

I just wanted to dig into the orders a little bit. Can you give us a sense of orders trends differentiated by region, or maybe just a capsule of what you're seeing from a European standpoint. Then maybe just address anything along the line, anything you're seeing in the way of any cancellations given some of the near-term concerns and commentary from truck OEs?

Jacques Esculier

Well, yeah. Jeff, as you see our backlog year-over-year is now up 8% , which is certainly more inline with kind of a more natural growth for the overall market, resulting probably in a very strong, continued backlog at our customers. But that is decreasing, because they received less orders than before.

So from our perspective, again, we see a continued kind of pretty good outlook for the next six to nine months, basically, because all our customers, main customers, especially in Europe still just still carry kind of backlog. What we understand from them is the slowdown in orders will progressively bring that backlog to a more normal kind of three to four months backlog.

And again, we don't see any impact right now at our backlog level, except that we have only 8% growth year-over-year compared to certainly double-digit, we have experienced in the last quarters. But nothing that would indicate, for example, that there are orders that are canceled at their level that would result into a kind of revision of short-term orders in our backlog.

So again, what I'm saying is, the visibility we have shows continued strength in the market. We don't see any sign from them that there would be a cancellation of orders, but we're aware of the fact that they take less orders today than they used to, and start to reduce a fairly of unreasonably long backlog to something that again should go back to kind of a three to four months normal level.

Jeffrey Hammond - KeyBanc Capital Markets

Okay. And then, as you look at the second half, the implied organic growth guidance is 4% to 10%. What do you think are the moving pieces or the biggest drivers of what would take it to the higher to lower end of that in the back half of the year?

Jacques Esculier

Well, I think it's very related to the macro economy factors, Jeff. I don't think it's really only related to our industry. I would say it's 4% if the GDP slowed slowdown in Europe… is kind of higher than what we had anticipated. I would say 10% is indicating that actually the GDP kind of slowdown is certainly not as big as, again, what experts anticipate. The more reasonable is probably, you know, 6, 7% gross in between.

Jeffrey Hammond - KeyBanc Capital Markets

Okay. And then --

Jacques Esculier

And also

Jeffrey Hammond - KeyBanc Capital Markets

Go ahead.

Jacques Esculier

One thing that we are observing that I just mentioned which is kind of peculiar right now is fairly significant slowdown in trailers that we have started to see in the US during Q2 and that we are starting to see in Europe, -- just right now in July, actually.

Jeffrey Hammond - KeyBanc Capital Markets

Okay, and then final two questions. If you could just update us on your best thought on timing for the EU Fine and give us your updated thoughts on JV income for the year, and I'll get back in queue?

Jacques Esculier

Yeah. I will address the Fine and let Uly address the JVs. We don't have unfortunately anything new as compared to what we had shared with you three months ago. It seems that, again, the European Union Commission is postponing the decision toward the ends of this of this year or early next year with a certain level of kind of eagerness to actually come up with the level before the end of -- they want to basically kind of recognize and close this case before the end of the year, but they're not sure they're going to be able to do it. So that's about what we have heard so far. Uly, do you want to add anything?

Ulrich Michel

No. Theoretically, it can happen every day. We know the case team is working at it, but our lawyers have the impression that it's not going to happen before the end of the summer and most likely sometime in the fourth quarter. Maybe it could even go to next year, because as we said before, it's a complex case with many parties involved.

Jeffrey Hammond - KeyBanc Capital Markets

On the JV.

Ulrich Michel

Now, on the JV, there's no change to our previous guidance on the JV income. We have it around 7, 8 million for the full year, a little bit more in the second half than in the first half. So, no change to our previous guidance there. Okay, any other questions? Jeff?

Jeffrey Hammond - KeyBanc Capital Markets

No, I'm all set. Thanks.

Ulrich Michel

Thank you. Now, we have Steve.

Operator

 

Our next question comes from Steve Tusa, JPMorgan.

Steve Tusa - JPMorgan

 

Hi. Good morning.

Jacques Esculier

Good morning.

Ulrich Michel

Good morning, Steve.

Steve Tusa - JPMorgan

So just a quick question on the raw materials. I found it interesting that you're -- continuing to maybe have less of a price down. Can you just talk about the dynamics there and may be walk us your math on how you see the second half playing out regards to price cost on raw materials ?

Jacques Esculier

Yeah. Actually, Steve, if you remember, when we came up with the last kind of revision of our guidance for the year that was in April, at that time, we had added $5 million of headwinds, mostly driven by steel. Having gone through -- one more quarter, we actually think that we have to again add another $5 million and may be even -- I would say the other $5 million is pretty solid, pretty sure. Then potentially if the economy keeps going the way it goes right now, we think we should be -- we would probably see the exposure of an additional 5. So altogether it's 10 new at the max today and 5 if we go to the low end of the gross, which means that the economy overall globally is kind of slowing down and probably giving us less pressure on commodity price.

So to summarize, we had added 5 in April when we talked to you. Today we add another 5, and if we look at the upper range of our forecast for the growth, then we would add another 5 beyond that. So it's 10 max and 5 min.

Steve Tusa - JPMorgan

And then on the price side?

Jacques Esculier

Price side -- we again kind of demonstrating 1.9 for the quarter. I mean we are still guiding in that 2 to 2.5%, but we are working very hard to contain that and specifically to work with our customers to pass through some of these price increase, especially as related to steel.

Steve Tusa - JPMorgan

Right. Okay. Then just looking at the third and the fourth quarter as you've given a very good second half detail from a growth perspective. How quickly does that step down heading into the fourth quarter? I mean, you've given a range of 4 to 10. I mean, how should we think about that, given that you really, I would think you have visibility for at least the third quarter and probably the fourth quarter with the backlog you guys have? So maybe you guys could just talk about the step down in gross you expect there?

Ulrich Michel

I mean, we would see. We don't want to get into details of quarter; but at the moment, the growth percentage is definitely higher in the third quarter. We have decent visibility. And also last year, the third quarter wasn't the strongest quarter over all. You might remember that our fourth quarter last year saw, I think, 17 or 18% of land growth. So we start from a very tough comparable already. So the growth year-over-year is definitely going to be lower the second half. We have a range of, a few percent, which is partially driven of some of the more short-term business that we have like trailer and some of the specialty vehicles, where we've seen some weakness lately, and although we say we have not seen any major constellations of truck and bus customer orders. I don't know, may be there will be some delays at the moment. I would say we're about in the middle of the range that we're giving. We might get a little bit of strengthening in the trailer and in the specialty vehicles, and maybe there will be one or the other order delays. Or no, we don’t know. But that’s kind of the assumptions we built into the forecast.

Stephen Tusa - JPMorgan

So…sorry, directionally, would you expect 3Q to be above the high end, and is there the potential for 4Q to be flat, just directionally?

Jacques Esculier

We would not…we would--.

Stephen Tusa - JPMorgan

You know, the high end of the 4 to 10?

 

Jacques Esculier

Yeah. The third…maybe not above, but more close to the higher end, and that could be the fourth quarter.

 

Stephen Tusa - JPMorgan

Okay. We get back into what the fourth quarter is obviously. Okay, great. Thanks a lot.

Jacques Esculier

Okay. Thanks to you.

Operator

We go next to Ted Wheeler with Buckingham Research.

Ted Wheeler - Buckingham Research

Yeah. Hi, good morning.

Jacques Esculier

Hi, Ted. How are you?

Ted Wheeler - Buckingham Research

I'd say good, good. I just wonder if you could put a little more color on next year? I know you're not ready to really talk about the total, but you do have, I think, a pretty good sense of the amount of outgrowth or growth relative to the market.

Could you just give us a little color on Europe, North America, South America, Asia? What you see relative to those markets? What you think you guys can do next year?

Jacques Esculier

Well, Ted, you know, I will kind of unfortunately have to align myself with what our customers shared with you guys.

Ted Wheeler - Buckingham Research

I know. The customers are going to move with the economy. I just…I'm just interested.

Jacques Esculier

The problem, Ted, is it's very hard, because again, the key drivers of what the gross will be in 2009, I think, are not, you know, kind of controlled by our industry. It's really driven by the macro economics. What I would say is this.

And again, kind of reading what our customers see in the market, the fundamentals are there to see growth in Europe, especially in Eastern Europe, kind of staying, even one customer said that by 2015 or something, the revenues for them out of Eastern Europe would actually call, what they right now generate in Western Europe. So it indicates that there is certainly fundamentally things in place to justify and support a continuous growth in the market, right.

I think in the US, everybody is now aligned to say that it's going to grow. Now, there is no question about it. Again, the second half should see, from our perspective, something around 25% growth and it should continue, obviously, in 2009.

Asia, we don't know. China is a big question mark for us, but it's like this every quarter. In every quarter, we see more growth but its very complicated for our customers and obviously even more for us to just make any prediction. The only thing I can tell you is we're going to keep significantly outperforming the natural growth of the market over there.

So the big question for me is, the macro economics interfering or not interfering with the fundamentals of what makes Europe keep growing, in the years to come. That 's a question that obviously we try to bring elements of answers to; but right now we don't have any kind of compelling story that would end indicate any kind of a continuous strong growth or any kind of strong weakness on the horizon.

Ted Wheeler - Buckingham Research

No, I agree. It's very, very uncertain as to the markets, but I guess what you see your content being or your position relative to the market. I mean, you were up in Western Europe slightly relative to the market. Do you think that for the next year or two, you continue that pattern?

Jacques Esculier

No. Definitely, Ted. We have been able to generate that, additional level of growth for quite a few years right now and we are confident that we will continue to do so. New technologies, new products.

Again, we introduced that collision mitigation system that seems to have a pretty good success in the market right away. I mean, there are a lot of good things working for us.

Ted Wheeler - Buckingham Research

Another question on the trailer cycle. Just in your history of looking at this, what would be a normal length of cycle? Do these things last for several years? Do they last several quarters? How long do you think the trailer cycle declined?

Jacques Esculier

Well, the trailer is actually fairly closely following the truck cycles. It may be that we…that they have been in overproduction of trailers, because the weakness that we have seen in the trailer business in the US, especially was certainly exceeding the drop in the truck and bus demand.

So I think we had extremely strong years back in 2006, way actually in excess of truck and bus. So what we think is that it may be that you have an additional slowdown because of what happened in those years, which is not too long ago, actually.

But when you look at the long-term perspective again, usually those two curves, truck and bus and trailer are pretty evolving together through those cycles.

Ted Wheeler - Buckingham Research

Just one last one. The India joint venture situation, I guess, is improving, and I think I recall that it's going to be still a year or two before you expect it to get back to normal. But do you see the India joint venture business or profit improving next year ?

Ulrich Michel

In 2009, or you mean for the rest of 2008?

Ted Wheeler - Buckingham Research

No. I was thinking of next year.

Jacques Esculier

2009? Well, 2009, we're going to start kind of seeing an 'exchange' of our ownership of those two different parts.

Ted Wheeler - Buckingham Research

Right.

Jacques Esculier

So we're going to be more and more isolated from what we call the non-break part of the joint venture, as you know. That's the part that has unfortunately seen some challenges in the last couple of quarters. So I think we should progressively match the dynamics of the pure brake business in the coming months. Actually, at this time next year, we should already have the majority of this joint venture on our path to moving up to 80% of ownership of that business and having 0% left in that non-brake part of that joint venture.

Ted Wheeler - Buckingham Research

Yeah. I can't recall the numbers, but that non-joint brake issue surface, while a couple quarters ago, it was about 5 million negative swing, wasn't it?

Ulrich Michel

Yeah. We have seen a negative impact. And if I recall, the biggest part of the non-brake business is a company called TVS motors, the third largest motorcycle producer in India, and we and our joint venture partner through our [ACL] company owned 56% of this business. So it gets consolidated. They have set up a new business in Indonesia to manufacture motorcycles for the Southeast Asian market. They had startup losses there. They had some operational issues in India itself with new model introductions as well. These issues, I think that will be overcome and will improve next year.

Ted Wheeler - Buckingham Research

They are still on the numbers today; is that correct?

Ulrich Michel

Numbers today - what is also impacting them is the ability of consumer credit in India and that part I don't know. If the government keeps racing rates to keep inflation in balance and if the global financial markets do not improve, I don't know whether we'll even see a further decline in demand for motorcycles in India. That part I don't know. The impact on us will be lower.

So in summary, on the non-brake side, we do think there's going to be operational improvement. But what we do not know is how the financial markets will impact them.

Ted Wheeler - Buckingham Research

Understand. Thanks and nice performance.

Jacques Esculier

Thank you.

Ulrich Michel

Thank you.

Operator

We'll go next to Martin Sankey, Neuberger Berman.

Martin Sankey - Neuberger Berman

Hey, Good morning.

Jacques Esculier

Good morning, Martin.

Martin Sankey - Neuberger Berman

Congratulations on some good work on the tax rate, could you tell us, what's going into that tax rate reduction, and is there further progress to be made?

Ulrich Michel

This 1% reduction you're seeing now is the combination of implementing tax planning measures that we had, and of the geographical distribution of our profits. As we told you, we have ideas to reduce our tax rate further. We are constantly working at it. But the governments aren't sleeping either. They're constantly working on ways to make sure that they get -- what they see fair share of the profit. We told you that some of our tax holidays are expiring and so at the moment the 21 is what we would cling to.

Martin Sankey - Neuberger Berman

Okay, and that would be for 2008 and 2009?

Ulrich Michel

Yes. That's not considering the EU fine.

Martin Sankey - Neuberger Berman

Right.

Ulrich Michel

Without the EU fine on our normal operating basis, yes.

Martin Sankey - Neuberger Berman

Okay. Now since you bring up the subject, suppose a potential EU fine would not be tax deductible to you?

Ulrich Michel

We would claim it as a deduction on our tax return. We would also claim the interest resulting from additional or less cash or more debt in Europe on our tax return. But from an accounting point of view, you will not see a benefit, because it happens in a jurisdiction where we already have net operating loss carry-forwards that we have evaluation reserve again.

Martin Sankey - Neuberger Berman

Okay. I do not understand the mechanics behind the ability to deduct the fine because my understanding is usually EU fines are not tax deductible.

Ulrich Michel

Belgium is a bit of an exception here.

Martin Sankey - Neuberger Berman

Okay. A good domicile that.

Ulrich Michel

So I mean, it would certainly be an argument how much will be deductible and so on; but, we have our position on this.

Martin Sankey - Neuberger Berman

Okay. On a second subject, the share repurchase. From what it looks like, you are tactically moving the program, so that you are repurchasing 50 million a quarter to get to the $200 million budget by year-end?

Ulrich Michel

Yes.

Martin Sankey - Neuberger Berman

Is there any temptation to accelerate the share repurchase given where the stock price is?

Ulrich Michel

The temptation is there, yes. But I think we laid out our liquidity plans for you. We've made the commitment for the $200 million, and I think we'll stick to the $200 million full year.

Martin Sankey - Neuberger Berman

Okay, and lastly, I know I'm probably beating a dead horse here, but can you point to any changes in the OEM production schedules by your European customers for the second half?

Ulrich Michel

Changes compared to?

Martin Sankey - Neuberger Berman

Compared to, let's say, what they were communicating to you earlier this year for their second-half production intentions?

Ulrich Michel

We already said we hadn't seen any major change in orders placed with us. There's always one or the other that moves things a little bit, but I would say nothing major that we have seen from our European truck OEs so far.

Martin Sankey - Neuberger Berman

Okay, and I guess, lastly, you've won a number of quality awards from truck OEMs all over the world, but the most interesting I found was the Russian quality award, and could you talk to us about how truck production is increasing in the eastern block as well as your ability to penetrate that market, and what that implication might be for that on your revenues?

Ulrich Michel

Well, Russia is actually a very strong market for us, because we provide them with a lot of those more advanced devices, like ABS, for example, and there is a trend right now to improve the level of technology built in those trucks, because the threat that we have already discussed, I think, with you last quarter is that, Scania,, DAF and Mercedes and others are actually sharing the information that they will establish grounds over there and deliver kind of European star trucks over there. So truck manufacturers like KAMAZ need to upgrade their technology, so they become competitive against the newcomers.

We obviously are supporting them in doing that, and that becomes a pretty strong growth opportunity for us, all right? Again, we are already delivering the bulk of their ABS parts and systems, and we are working hard at growing that beyond what it is today. So the market by itself actually for the year is actually supposed to grow at about 5% rate year-over-year. It represents about close to 175,000 trucks.

But again, with the limitation margin, talking about number of trucks is always difficult, because it's always very hard to reconcile that across the different companies talking about number of trucks. But from our perspective we see at least some kind of a 5% growth year-over-year in the number of trucks; but certainly more in content per vehicle.

Martin Sankey - Neuberger Berman

Okay. So does Russia, for example have the potential to become a meaningful fraction of your business?

Jacques Esculier

 

Oh, certainly. That number of trucks -- you look at Camas. I think Camas represents about 85,000 trucks. If you start equating them with the kind of content that we could expect in coming years, if they want to again upgrade to something that looks like the technologies that those guys are bringing from Western Europe, that represents a significant amount of opportunities for us.

Martin Sankey - Neuberger Berman

Okay. Thank you. I'll get back in queue.

Jacques Esculier

Okay, thanks Martin.

Operator

(Operator Instructions). We'll go next to [Ben Falck].

Ben Falck

Hey, how are you doing?

Jacques Esculier

Hi Ben.

Ben Falck

Just coming onto the question on Europe we kind of alluded to that earlier. Today we saw MAN of Europe, orders down 23% earlier. A couple days ago we saw Volvo, Scania, Daimler, orders all down like 40 to 50% in Europe, about 35% down in Eastern Europe. I guess the question is when does this kind of 40 to 50% kind of decline that we see in the two quarters and now start to impact your sales growth? What's the kind of the lag there? Is that kind of Q4, or is that kind of next year, is the first question?

The second question is just, in terms of the -- I might have missed this on the presentation; in terms of the $0.21 raise, how much of that -- if you could just break that down simply, how much of that is operational, and how much of that is FX and tax? Thanks very much.

Jacques Esculier

Okay. Well, first the impact on us -- actually again referring to what our customers, how our customers see the slowdown in orders, which has obviously a direct impact on us and the way for us to answer your question. We have seen, in the last two or three quarters, a level of backlog that is unheard of in our industry, up to 12 months.

What our customers are saying right now is things are progressively going back in orders, and what they call kind of the normal environment is that three to four months backlog, which is what we have been experiencing with them for obviously quite a few years.

So the way I interpret that is and the way I kind of hear what they're saying is that they are not really concerned right now. I think the concern would start if they would see their backlog coming down significantly below that 3 to 4 months and stay on a low level of orders.

But that's not what they're saying, and that's not what at least we have read in what they shared with you guys in the last days, right? So from my perspective, as long as there is no kind of order cancellation which doesn't seem to happen, right now, at least at a big scale. If there is a continuous meltdown of that backlog not below that kind of, 3 to 4 months threshold, well, we should be back to a more normal growth of kind of 7, 8% that we have experienced in the past years.

Certainly not, this kind of significant double digit growth that we have experienced again lately. So, our customers don't seem to be overly concerned and meaning that I'm not overly concerned either. But obviously you don't know what can happen to the economical environment.

Ben Falck

Okay. But just as a follow-up. I mean, if you're not concerned about obviously customers seeing a 40% to 50% orders declining are you saying that that kind of significant drop-off for the last quarter, or two quarters now has nothing to do, or very little to do with the European slowdown? You think it's more to do with the long order backlogs? Is that kind of what you are saying?

Jacques Esculier

Again, what I think is shared by our customers is that, and I think we can compare that. Somebody who wants to place an order today, in an environment where the economy is obviously kind of uncertain, to say the least, right? Why would he kind of rush to put an order for a truck that would only be delivered six to nine months down the road.

I would say the guy probably waits another 3 or 4 months to see where the economy is going, and then kind of put that order…kind of send that order to our customers for delivery that is three to four months afterwards.

Again, that seems to be reasonable. Now we're not saying I'm not concerned. It would be maybe excessive, because I'm concerned, like everybody else because of the uncertainty. We don't know really where the whole thing is going. So far there is no indication that there is a major drop on the on the horizon.

But obviously, if there is a significant slowdown on the GDP in Europe, that would have an impact on our industry, like basically many other industries around us.

Ben Falck

And what about your orders, are they kind of there into in the 40% to 50% drop-off as well, or is that…

Jacques Esculier

Our orders are not kind of as clean and clear as ordering a truck or whatever. The metrics that we are sharing with you is the level of our backlog and its evolution year-over-year, and what we kind of showed today is that our backlog has increased by 8% this quarter. We have been seeing double-digit increase in the last few quarters.

So it's a slowdown, but it's still at 8% growth, so it's not an alarming slowdown viewed from our standpoint.

Ben Falck

Does that nevertheless imply that orders are negative for you?

Ulrich Michel

The intake versus last year is slightly negative. We've taken year-to-date $27 million at equal exchange rate, less orders than last year's year-to-date, which is not really alarmingly down.

Ben Falck

That's very clear.

Ulrich Michel

If you consider that last year, all of our customers saw this exception of growth, and our visibility also went out many more months than we had it before from our customers.

Ben Falck

Okay. Perfect. Just my final question as I asked earlier, just how did the $0.21 cents raise, how much of that is underlying operations and how much is tax and FX?

Ulrich Michel

Tax is about $0.05, FX is another $5 cents. Then we told you that on commodities versus the last projections we gave between Q2 and the rest of the year. We see maybe $5 million to $10 million more commodity, which at the midpoint would be about $0.09 negative, and then the rest of the improvement is between our operational improvements we've made along productivity and some changes in our interest forecast and so on.

Ben Falck

Perfect, all right. Thank you.

Ulrich Michel

Okay, thanks.

Operator

You have a follow-up question from Jeff Hammond, KeyBanc Capital Markets.

Jeff Hammond - KeyBanc Capital Markets

Hey guys. A couple follow-up questions, if you could just provide a little more color to the comment continued weakness in the OES channel, is that supply constraints, or is there some demand weakness there? Maybe just a little more color and what you think happens there on a go forward basis?

Jacques Esculier

First of all, I don't think we can see a sustainable situation where IM is growing at double-digit and OES is growing at a slower level, especially because again when you hear our customers talking about their aftermarket activities, it doesn't seem that they are slowing down.

We had identified at the end of the first quarter, when we first realized that the OES channel was not as active and fast in growth, we had talked to them and realized that they had accumulated some inventory at the end of last year that they wanted to deplete.

Now, we obviously are continuously talking to them right now, and my feeling is, if IM keeps going at that rate, OES will have to, kind of, at one point start coming back to a very comparable level of growth.

Jeff Hammond - KeyBanc Capital Markets

Okay. Great.

Jacques Esculier

Jeff, what I'm saying is, you talk to all of them, I mean Scania, DAF particularly discuss their aftermarket arm, and they both mentioned that it was nicely growing for them. So if they repair trucks, they need parts and they need our parts.

Jeff Hammond - KeyBanc Capital Markets

Okay. Great. So maybe some lift there on a go-forward basis.

Jacques Esculier

Yeah.

Jeff Hammond - KeyBanc Capital Markets

I'm just looking at the Q1 '08 over '07 and some of the drivers of margin expansion, and then I look at it for 2Q, and it seems like the one of the notable differences is this OpEx and other component, which was a $12 million headwind this quarter. Can you just … was there anything one-time in there, or, was it just an easy compare? Maybe just help me what goes into that and what was the big delta?

Ulrich Michel

The increase versus 2007 in the second quarter?

Jeff Hammond - KeyBanc Capital Markets

Yeah, the 11.9 delta.

Ulrich Michel

The biggest factor of this is performance based compensation. We have more people on a performance base compensation now. You've seen in our proxies and in the 8-Ks that performance target percentages have been changed for a good part of our management team, and our performance is also very good, better than last year at this time of the year.

The other driver is PD, product development. We've invested over $3 million more in product development than you see inflation, on our labor costs, which is about $3 million, and then we had a bit of a hit from the accelerated vesting from the Trane options. You might remember that many of our employees still have Trane options from the times we were part of American standard, and they also got accelerated vesting now with the (inaudible) takeover, but that's only about a $0.5 million and the rest is just investments in our infrastructure for sales in this facility, quality and so on.

Jeff Hammond - KeyBanc Capital Markets

Okay. That's helpful. Thanks, guys.

Ulrich Michel

Thanks, Jeff.

Jacques Esculier

Thanks, Jeff.

Operator

We have a follow-up question from Steve Tusa, JPMorgan.

Steve Tusa - JPMorgan

Hi, sorry, just two quick ones. Just the margin dynamics in the second half, I would assume they move somewhat with volumes, but there was lumpiness on last year's margins. So a year-over-year basis, the comps look kind of funny. Can you just talk about how you got to your annual target of our third, fourth quarter.

Ulrich Michel

Yeah, Steve you're talking H1 to H2, or H2 to H2.

Steve Tusa - JPMorgan

I'm talking about within H2, third quarter to fourth quarter, so just the dynamics which is higher, which is lower.

Jacques Esculier

Yeah. We're not commenting on this.

Ulrich Michel

Yeah. We're not kind of guiding by quarter, Steve. So, we don't really want to kind of start moving into a quarter-to-quarter comparison ahead of us.

Steve Tusa - JPMorgan

Okay. One more question. When you look out to 2000, or 2009, 2010, with all the contract wins and the growth in Asia, et, cetera, everything that's going on outside just European truck builds, should we look at this year as how much that gauge as to how much of that content as well as the geographic expansion can help you guys grow in excess of whatever European truck builds are, or are there dynamics that help you more or less? How should we think about that going forward?

Ulrich Michel

Well, I think, what we said for quite a few years overall is that our gross was kind of 2% to 3% ahead of the natural growth of the market overall, kind of gives and takes of countries and whatnot.

Obviously, we see more growth through additional content per vehicle in emerging markets than we do in Europe, even though we have still demonstrated for quite a while that we are systematically able to get another point or two on top of the natural growth of the market in Europe.

But we took kind of an average view of the world saying 2% to 3% should kind of cover what the weighted average world is for us.

Steve Tusa - JPMorgan

Maybe you think with the US maybe bouncing a little bit off the bottom with China gaining more critical mass and the after market continuing to accelerate that, next year you would be maybe a little higher than your historical average?

Jacques Esculier

Obviously, the faster we grow with the US, especially again as we keep benefiting from that growth through Cummings, the more revenue will generate in and Asia and specifically in countries like China or India, where content per vehicle is certainly kind of gaining momentum.

The more overall, we 're going to have an increased level of growth as compared to the natural growth of the number of trucks and buses built.

Steve Tusa - JPMorgan

Right.

Jacques Esculier

But I can't share with you any kind of projections for 2009, 2010 at this time.

Steve Tusa - JPMorgan

Yeah. That's fine. Thanks a lot.

Jacques Esculier

Okay. Thanks.

Operator

We go to Martin Sankey, Neuberger Berman.

Martin Sankey- Neuberger Berman

Thank you, just a couple of quick questions. One there was a mention in your presentation that the there was an $18.5 million payment to train, and you also mentioned accelerated investing of Trane options due to the (inaudible) merger. Does the merger trigger any changes in the separation agreement that you have with them that we should be aware of or trigger any actions for payments, or relief of obligations?

Jacques Esculier

No. Not I'm aware of, no.

Martin Sankey- Neuberger Berman

Okay.

Jacques Esculier

We're obligated towards the purchase of B&K. We're obligated toward (inaudible) instead of Trane, and there's really no change in the mutual indemnifications and so on.

Martin Sankey- Neuberger Berman

Okay. Then I have a second question following up on the question that … regarding the European order decline. So do you have any … the history of cycles in the trucking industry, is that when the backlogs start to blow now, there's double ordering by dealers and other end users in order to obtain trucks on a more timely basis?

Do you have any feel from your vantage point as a component supplier as to how much there may be in the OEM backlogs and the order, how much the order decline is reflecting some of the double order booking coming out?

Jacques Esculier

Yeah, Martin, that's a concern that actually was triggered back in January and that we took very seriously because obviously it could have threatened the integrity of our forecast at that time. So what we did is two things.

Number one, we talked to our customers, who just kind of confirmed that there was no such thing and they really didn't believe that it would be a factor affecting the integrity of the forecast.

The second thing we did to our aftermarket channels, we went and interviewed … I think it was about 50 fleets, important fleets in Europe, and it was an extremely negligible part of them who just said that they may have utilized that thing. But what I'm saying is you can consider actually our 50, probably 50, just said, no way. We just don't double order. We have been talking about this with again customers. We keep updating each other, and very frankly, again it doesn't seem to be very important factor.

Now we are two quarters later, right? Because we have six months behind us since we started to hear this kind of potential issues, and very frankly, Martin, we have not seen any kind of significant or any reduction in our backlog for the year 2008. All right. Whereby if … actually it would have been true that a lot of customers would have gone through double ordering to obtain trucks in a more timely manner. At one point they would have basically pulled one out of two orders and that would have been obviously affecting the level of orders that we would have seen from our customers and the level of number of trucks built in this year.

Martin Sankey- Neuberger Berman

I'm just thinking that maybe what's starting the hit in the last months or two.

Jacques Esculier

Again, Martin not that we know of, we have never heard anything like this from our customers or from fleet.

Martin Sankey- Neuberger Berman

Okay. Thanks for the very helpful reply.

Jacques Esculier

Okay. Thanks, Martin.

Operator

Ladies and gentlemen, that does conclude the question-and-answer session today. At this time, I will turn the conference back to Mr. Esculier for additional and closing remarks.

Jacques Esculier

Well, just wanting to thank you all for participating, and just wishing you a wonderful summer, and see you in three months. Thank you. Bye-bye.

Operator

That does conclude today's conference. Thank you for your participation. You may disconnect at this time.

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