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Wabco Holdings, Inc. (NYSE:WBC)
Q3 2018 Earnings Conference Call
October 18, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. And welcome to the WABCO third quarter 2018 earnings conference call. This call is being recorded. There will be a question and answer session after the presentation. Could you please limit yourselves to one question and, if need be, a short follow-up question so that more participants can get a chance to engage with management? Thank you. At this time, for opening remarks and introductions, I would now like to turn the call over to Sean Deason, Vice President, Investor Relations and Controller. Sir, you may begin the conference.

Sean Deason -- Vice President, Investor Relations, Controller

Thank you, Chris. Good morning everyone and welcome to WABCO's quarterly conference call. Today we will present our third quarter 2018 results. With us this morning, we have Jacques Esculier, our Chairman and CEO, and Roberto Fioroni our CFO. As a reminder, this call, webcast, and presentation that we are using this morning are available on our website, www.wabco-auto.com under the heading, WABCO's Q3 2018 Results. A replay of this call will be available through October 25th.

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 -- Chairman, Chief Executive Officer

Thank you, Sean. And good morning, good afternoon to all of you. And welcome to our Q3 reporting platform. Before I jump into the details of our performance for the quarter, let me take a step back and look back at a quarter that actually was fairly rich in events and developments for the industry and obviously, also for WABCO. First, as we do every two years, the industry has gathered in Hanover Germany for this truck show that we call IAA which is the largest, most global truck show. And during the truck show, there were some salient facts. First, more than ever, it was obvious that the global industry led by all key players are decidedly embarking in the development of all technologies that will bring the industry toward this autonomous, electrified, and connected vehicle world.

And that's within this environment that WABCO, under our new banner or new brand promise of mobilizing vehicle intelligence has unveiled a remarkable, I would say impressive number of announcements of new technology breakthroughs, initiatives, and partnerships that are, actually, the seeds for medium-term to long-term, continuous outperform capabilities for our companies. And we will review those announcements in detail obviously later on in the presentation. But I can tell you that our brand was shining in the sky by, I would say, even overshining our competitors. The second thing that was very obvious is that whereas after today, all key new technologies was rooted in Europe, developed with European OEs, this new set of technologies toward this autonomous, electrified, connected vehicles is actually strongly taking roots in regions beyond Europe. I'm talking about Asia, or China in particular, or North America.

And therefore, in anticipation of these new world dynamics, as we turn the page, I believe, to the next chapter of our industry, in anticipation of all this, WABCO has reorganized its company, has moved to a new organization logic that I will describe later on. In the meantime, the market has become slightly more volatile than it has been so far this year, particularly related to those regions of the world that have been impacted or disturbed by what I would call these geopolitical decisions. And I'm talking obviously about China, Russia, and Turkey, with China by itself chopping their rate of production down by almost 30%. Now, in the meantime, the other regions, Europe, US, South America, India, have continued on their paths toward growth. And we believe that this momentum will, again, extend itself in the fourth quarter and probably in 2019 as well. But within this environment that has seen the total number of trucks and buses built globally dropping by 8.4%.

As you will see, WABCO has once again been able to outperform its market well. However, for one of those rare times since we shared with you back in 2011 this framework of our incremental margin, we have departed from the framework. Again, it's rare, but it happens. And this is due to the convergence of several distinct kind of events that we have signaled to you during our last communications. I'm talking about obviously, impact resulting from supply chain constraints, particularly in areas of the world where the industry is reaching a very high level of production. I'm talking about the continuous headwinds coming from raw material parts increase. And I'm also referring to what we already had signaled again, which is the fact that a second part of the year, particularly Q3 is seeing more engineering expenses. And Roberto will later on give you more details on that. And as it is a rare event, I guarantee you that we are all working actively to, as soon as possible, reconnect to our incremental margin framework.

Now, in the meantime also, we've been getting these headwinds. We are actually generating a fairly healthy PS growth. And that's obviously helped by a one-timer tax item that, again, Roberto will explain later. But as we talk about taxes, I think it's appropriate that I highlight the fact that we are working on some very credible projects that should have a very positive impact on our tax rate and that provide us a line of sight on a medium-term to long-term rate that could stabilize at 20% rather than jump to the 25% that we had communicated to you previously. Now, 2018, again, should close in a fairly good way, providing, again, another set of nice increases across top-line and bottom-line metrics. So, we have dated our guidance for the year.

We even upgraded our EPS guidance. And when we will share with you the first initial look at the market condition that we could, at this time, anticipate for 2019, you'll see that the markets will continue to grow across almost all regions, except for China, where we, again, expect a double-digit erosion. But overall, another good platform for WABCO to provide some further enhancement in its contribution to shareholders. Now, looking at the results, sales were up 13.4% local currency at $950 million. Performance operating income ended up at $117.1 million versus $120 last year, leading to an EPS performance of $1.78 versus $1.71 a year ago. A remarkable free cash flow of $105.7 million is resulting in a conversion rate of 112%, returning $90.2 million of it to shareholders through the repurchasing of 740,000 shares.

Moving to the next page and looking at the profile of our gross, again, 13.4%, 5.4% being purely organic, 8% driven by the US acquisitions we finalized in the later part of last year, and then some translational headwind of 2.9%. By channel our sales to the OE world went up 22%, acquisition contributing 18%. So, it was obviously driven by a market, as I said, that dropped 8% in volume year-over-year, driving by this drop of 27% in China. We strongly outperformed this key market of trader by 16% and continue to produce some very nice gross in our sales to the plus highway world. Then we have seen this quarter some erosion in our car business because of a drop in demand from General Motors in the US for its eighth line of motors, replacing the vacuum pump by other technologies. Then aftermarket was up 20%, 16% of which was contributed from acquisitions, leaving a meager, I would say 4% of organic gross. We are taking still 6% as a reference and a objective.

And the 4% was mostly driven by constraint in the supply chain that obviously had to favor the OE channel to avoid any disruption in the assembly line of our customers versus the aftermarket channel. However, in the meantime, markets were growing everywhere except in Turkey, Russia, and the Middle East. Now, looking at the evolution of our truck and bus market versus our sales by region starting by Europe, production was up 3% in Europe. WABCO revenue was down 2%, still impacted by this drop in volume from the phase-out of this AMT delivered to a major year box supplier. I can tell you that actually, this program should be already finished. But the demand continues to actually exist. So, unfortunately, we will still see next year some remaining kind of drop for about $3.5 million for 2019 as forecasted at this time. In North America, production was up 9% and WABCO's revenues up 48%, of which, 35% was contributed through acquisition.

And that's, again, a very healthy 4%, driven by continuous penetration of AMT moving from 30% to 35% of the total truck and bus build as well as some market share gains in air compressors because of commerce increased penetration. South America production was up 21%. And we were up 8% more in sales. And that's, again, further penetration of AMT and a favorable mix of vehicle that favored further sales of our air compressors. Japan and Korea/Thailand went down 11% for the quarter. And we limited erosion of revenues to 3%. And that's the result of the ramp-up of a series of products and technologies around air disc brakes, electronic air suspension, and air dryers in Japan. China was down 27%, and we were down 30%. And again, we continue to face a significant headwind in the shift of ratios between the tractors and non-tractors. I remind you, tractors are used for transportation. Non-tractors are mostly used for construction.

It happens that all year long, and particularly in the third quarter, the tractors have decreased significantly more than non-tractors. Actually, tractors dropped by more than 40% and non-tractors only by 8%. And we have, unfortunately, less content, less technology on the construction equipment as compared to transportation equipment. In India, market was up 18%. WABCO was up 7% more because of further gain in market share across many different product lines.

We have to highlight also that we have 7% of outperformance in spite of a very unfavorable mix in July and August because during summer, India introduced a legislation allowing to increase the actual load on heavy-duty truck, meaning that in July August, the production was mostly favoring medium, fast trucks on which, again, we have much less technology. So, in spite of that, again, we are happy to end up in this very healthy, fast-growing market with a remarkable 7% of outperformance. So, now let Roberto bring you through the details of our financial results. Roberto?

Roberto Fioroni -- Chief Financial Officer

Thank you, Jacques. Hello, everyone. And thank you for joining WABCO's Q3 earnings call. I'm pleased to announce that despite headwinds from the global truck and bus production mentioned by Jacques, WABCO has delivered another solid quarter, comprising of double-digit revenue growth, earnings-per-share growth of approximately 4%, and a very strong conversion of net income into cash. If you turn to slide five, I will take you through the details. Our revenues grew a healthy 13.4% in local currencies with US acquisitions contributing 8%. We managed to partially mitigate headwinds related to continued capacity shortages at supplies and high material inflation pressure resulting in a gross profit of 30.3% on a performance basis. We gained $6.6 million as a result of additional volume and better absorption of our fixed costs. Our continued focus on cost efficiencies across WABCO's global value chain added a further $16.6 million in savings through material and conversion productivity.

WABCO's third-quarter gross material productivity of 3.8% was below our normal rate of about 5% as we continue to deal with supply constraints. In the third quarter, we also delivered conversion productivity of 7.7%, a very strong performance as we continue to benefit from the closure of the European factory at the end of the third quarter of last year. This benefit was partly offset by inefficiencies in WABCO's supply chain as a result of the supply capacity constraints mentioned before. Examples of these inefficiencies are emergency freights and overtime costs. Our third quarter results also includes optics investments of close to $13 million, the majority of which are related to R&D investments, accelerating in the second half of the year, as pre-empted during our Q2 earnings call in July and as mentioned earlier by Jacques. To give you some more perspective around our R&D investments, on a typical full year, we invest between 4% and 5% of revenue. In 2018, there is greater spend in the second half versus the first half.

As an example, in Q3, this ratio was 5.5% of sales. For the full year, however, we forecast to end in the middle of that range, between 4% and 5%. In the third quarter, US acquisitions contributed $60 million in performance operating income on $66 million of revenue. All of this flows through to a performance operating income of 12.8% of sales. Our third quarter US GAAP tax rate is 14.5%, while quarterly performance tax rate is 10%. Let me give you some color on the quarterly performance tax rate. Earlier this week, WABCO received notification of a bilateral arbitration settlement, resulting in a current year tax reduction related to transfer pricing adjustments of $38.3 million. The full-year tax benefit is $11.3 million, of which approximately $8.5 million impacts our third quarter performance net income. From a US GAAP perspective, the full amount will be treated as a discrete tax benefit during the three-month period ending December 31, 2018.

Remaining on the topic of taxes, we are continuing to work on other items that will further have positive impact to our tax rate, including the application for the 2013 and 2014 Belgian patent income deduction. Some of these opportunities could crystalize during the fourth quarter of this year. These opportunities have not yet been considered in today's raised EPS guidance. After exclusion of the non-performance items, our earnings per share are a healthy $1.78, up roughly 4% versus the same period last year. On a US GAAP basis, we report an EPS of $1.41. Now, let's move to slide six, and I will cover the cash flow generation for the quarter. As mentioned before, we are very satisfied with the cash generated this quarter. WABCO delivered a performance free cash flow for the quarter of $106 million, resulting in an increase of $35 million over the same period last year. The third quarter conversion of performance net income to cash of 104% keeps us well on track to deliver on our full-year commitment.

We have reduced our working capital in Asia, following the slowdown of the China market. In other regions, we have temporarily increased our inventory to support our sales for the rest of the year. As for WABCO's strategy, we continue to return cash to our investors. And we remain on track to buy back up to $300 million during 2018. In the third quarter, we repurchased 740,000 shares at the cost of $90 million, bringing our year-to-date purchases to 1.7 million shares and $210 million. In summary, in a challenging and uncertain global market environment, amid continuing headwinds from industry supply chain constraints and raw material inflation, WABCO has successfully delivered another solid quarter by outperforming the market, delivering double-digit revenue growth in local currency, growing our performance EPS, and generating a healthy cash flow. Now, I would like to turn it over back to Jacques to give you an update on our market.

Jacques Esculier -- Chairman, Chief Executive Officer

Thank you, Roberto. And turning to page seven, I give you some pictorial description of WABCO at work at IAA. On the left side, you can have a little glance at the booth that was actually one of the most popular ones, I would say, in our space. It was described as a particularly open, contemporary, technology-driven booth. We had close to 20,000 visitors coming, converging to the WABCO world. We also showcased our electric trailer which is a new breakthrough idea in technology that we have presented to our customers and that is right now featured on this other picture of the page. And then we had, as we have every year, a particularly rich set of sessions at our test track locally in Hanover, including a session with several hundreds of our customers from Asia-Pacific. And all this, again, under this new kind of brand positioning around mobilizing vehicle intelligence, focusing on this ACE which stands for autonomous, connected, and electric.

The next page will give you a flavor of the richness of the announcement we made. First, we link to the current portfolio that will have impact in the very short term. The first two are covering progress around air disc brakes. We find a joint venture with FAW which is the leading provider and manufacturer of trucks in China, of which, by the way, we have 60%. So, we have the majority of this joint venture to build and obviously provide and support the production of FAW trucks with our single-piston air disc brakes breakthrough technology. Production should start by the tail end of '19 and generate about on an ongoing basis at least $10 million of additional revenues. And then we unveiled our fifth generation air disc brakes which, as I've shared with you before, would be the lightest, the simplest, and most cost-effective product across the industry.

Then I would also mention briefly that we have actually used this breakthrough approach that we had developed in the last years for braking systems on trucks which is these modular breaking systems covering ABS and EBS in the same world, for the simplicity of installation on assembly line. And we have migrated this concept to cover now the world of trailers. And again, it's an industry first. Now, moving into those more future technologies, starting with electric, we announced an MoU with Nidec which is the leading provider of electric motors on earth. And we will develop together a concept of electric powertrain, first for the bus world in China that will blend the control of the motor itself with the control of the braking. And that could actually bring up to 10% of energy saving versus the existing solutions. The first application that we would have which is pretty straightforward and could even generate some revenues in the coming three to four years is to equip the trailer with an electric motor and batteries.

And the tractor/trailer combination will actually be like a hybrid vehicle, meaning that when the tractor breaks, the energy will be absorbed through the trailer. And when the tractor accelerates, the trailer will actually provide traction as well. And by the way, we had an enormous amount of interest around this concept at IAA. On the autonomous driving side, we have actually unveiled a very interesting, particularly customer-friendly approach whereby we would build a platform that would be open to our customers to build their own solutions of functionated modules that would actually be connected to our world of vehicles that can be controlled and provide them access to the autonomous driving capability. So, up to level three, we do it in-house through this concept called ADOPT for Autonomous Driving Open Platform Technology.

And beyond L3 which is the real fully autonomous driving vehicles, L4, L5, we have signed an MoU toward the partnership with Baidu, leveraging their technology, particularly in the world of artificial intelligence, mapping, and so on. And we will provide by 2021, sellable solutions to provide autonomous driving capabilities to hub to hub highway users' trucks. Then, going directly to connected, we have cut a very nice agreement with RIO. RIO is the fleet management solution arm of this newly named TRATON GROUP which obviously was the former Volkswagen Truck group. And we are happy to be working together for WABCO to bring a lot of our capabilities in that area as well as announcing some further developments around our transits brand with a device that is addressing specifically the smaller fleets. Our offering was mostly aiming the larger fleets so far. We have come up with a reduced scope device that is a lot more affordable and certainly, incredibly attractive for those smaller fleets

Moving to the next page, in talking about our reorganization, first, let me remind you that the former organization logic that has prevailed up until couple of weeks ago was based on a world whereby, on one hand, all new breakthrough technologies were developed connected to the European truck manufacturers. And the very large percentage of our revenues was still generated in Europe. With what I just told you in introduction, there is a shift of our industry whereby all technologies related to autonomous electrification and connected vehicles are now strongly routine beyond Europe. In the meantime, the revenues that we generate in Europe represent now less than 40% of total revenues. So, in anticipation of these kind of dynamics of the world of the industry, we have decided to move from Europe being managed by the product business units.

Whereas the other regions were already managed by regional teams driving a P&L focusing on local customers, now the business units that we now move to business hubs will not manage Europe anymore. Europe will become a region like other regions. And the four regions will build the P&L by the way. Also, by early 2019, we will report by region by the way. And now, those business hubs will be fully focusing at not only developing new technologies connected to European customers but developing strategies around new technologies connected to all regions. And that will definitely bring us more agility, more market, and customer-centric activities and strategies even more global than we have ever been and ultimately, will make us even more capable at maintaining WABCO at the cutting edge of new technology development.

Turning to the next page and now moving toward the way we see the market developing for the remainder of the year as well as some in short view of how 2019 could happen, starting with Europe, registration up to August, we're up 5%. We still expect 3% for full-year. Total production was up 3% year-over-year in total Europe, down 9% sequentially which is normal because, as you know, the third quarter is vacation time for Europe. So, normal drop sequentially. Now, for the remainder of the year, we are seeing the volume falling in that 2% to 5% up range. As we look ahead, and we consider that GDP forecasts for 2019 at this stage is still up 1.9% which is very healthy for Europe -- I remind you that this year, we had 2% with some very nice gross. So, 1.9% in our view should still fuel some potentially slightly positive gross. And that's why we are looking at an initial range in between minus two to plus three with a little bit more weight on the positive side of the range.

Moving to North America, third quarter was solid production, level up 9% year-over-year, 1% sequentially with plus eight are still being permitting in production and orders for plus eight continuing to actually really see a very, very strong trajectory. For the full year, we anticipate the production level to end up in the 12% to 16% range with stronger gross in origin, plus eight. And when we look ahead, again, supported by a forecasted GDP gross at 2.5%, which is still very healthy -- a little bit down from the 2.9% that we should see and end up within the full-year 2018. But 2.5% still justified some further gross opportunity, particularly given that the average age is still at six years and could go even further down. We would anticipate a gross between 0% to 5%. Going to China, again, dramatic drop in Q3 year-over-year as well as sequentially. And that's due to less investment infrastructure as well as reduced subsidies for those who are building and developing electric buffs during the second half.

So, we think that the production will end up in that minus 13 to minus eight range which is downgraded from the minus 10 to minus five we had shared with you three months ago. Now, looking forward, we see further erosion. GDP gross is only planned at 6.2% which I think has been one of the worse for many, many years, down from 6.6% which was already low in 2018. So, that's why we are not very optimistic for the China market next year. India, healthy 18% year-over-year, down 8% sequentially. And we see continuous momentum in the economy. GDP gross should end up at 7.3% this year. Plan 7.4% for next year with continued investment in construction infrastructures. So, this year, we see the market ending up in a healthy 23% to 28% range and a positive initial outlook in that 5% to 15% range. Going to Japan, Korea, a very strong slowdown. 11% year-over-year, 4%, sequentially. Production decline is due to actually lower demand in Japan, lower exports from Japan as well.

And a very strong slowdown in Korea. So, we think this region will end up in that minus 7% to minus 2% range. And we are looking at a fairly flattish year 2019 evolution. Brazil was up a very strong 21% this quarter versus last year. Obviously, we still have plenty of room for further recovery. We are still 50% lower than the historical peak that happened, I think, in 2011. And we will end up the year in the 20% to 25% range. For next year, we believe that, even again, the fact that GDP's planned at a healthy 2.4%, we will see some further gross. We think flat to 10%. I think we could be positively surprised as we move forward closer to '19. Aftermarket was up 4%, again, fairly disappointed. But it was due to constraint in supply chain and slowdown in some key regions. Our outlook for the full year should end up at around 5%.

And we are looking forward to reconnect in 2019 with a healthy six-plus percent growth. [inaudible] provided us with a nice gross in Q3, up 8% year-over-year with strong demand from America, European, and Europe accompanying the gross in demanded for trucks. We think that the trailer will end up in that flat to 5% range for the full year. And initially, we are looking at a market that will be flattish, potentially slightly eroding even the very high level of production we have reached this year. Moving to the next page and sharing the updates of our guidance, we have actually upgraded a little bit our sales gross forecast, moving from 13% to 16% up to a 14% to 16% range, leading to a range of $3.85 to $3.9 billion at the updated exchange rate. Performance operating margin, we moved it down slightly from 14.3% to 14.7% previously to a 14.2% to 14.4%, leading to performance EPS upgrade of $7.45 to $7.75.

And the new range would be at $7.65 to $7.85 remaining actually committed to delivery a very strong free cash flow conversion. You have on the right the buildup of the guidance versus 2017 and some updates on the assumptions that we made, particularly related to what Roberto shared with you, this one-timer that we had benefited from in Q3 that has lowered the tax rate to 17.1%. Now, to close this presentation, I would say that we have seen lately some slightly more turbulent times in terms of market dynamics and also in terms of supply chain constraints and headwinds from material. But in that environment, we have once again been able to demonstrate our fairly unique ability to continue quarter after quarter to outperform the market. And we also, in spite of all the headwinds that we mitigated to a certain extent but not to the full extent, we end up helped by this tax one-timer providing a pretty healthy, nice gross in the EPS.

Now, again, looking forward to 2019, we see a market that should be still providing gross across almost all regions except in China. And we think it's gonna be another great platform for WABCO to further outperform its market and, again, transform this top-line gross into healthy contribution to the bottom line so that we, again, actually ultimately delivery very strong and healthy value to our shareholders. So, this closes our presentation. Thank you for your attention. We open now this session to the Q&A.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you do have a question at this time, please press the * then the 1 key on your touchtone telephone. If the question has been answered or you do wish to remove yourself from the queue, please press the # key. To prevent any background noise, we ask you to please place your line on mute after your question has been stated. Again, please limit yourself to one question and, if there need be, a short follow-up question so that more participants can get a chance to engage with management. Thank you. And our first question comes from Justin Long with Stephens. Your line is now open.

Justin Long -- Stephens, Inc. -- Analyst

Thank you. Good morning. So, I know you aren't giving specific guidance on 2019 at this time. But from a high level, could you speak to your comfort level that you'll be within your 6% to 10% outperformance target and back within your incremental margin framework next year?

Jacques Esculier -- Chairman, Chief Executive Officer

Well, I would say, Justin, it's the framework that we are taking as a reference and that we have taken for now more than seven years. So, that's the one we're gonna be anchoring ourself. I'm sorry that it's -- we are not in a position because we are far from having finalized all the elements that would be necessary to assemble our budget for next year. So, I can't really give you a wise answer. The only thing I can tell you is we will obviously work very hard to reconnect with the incremental margin model and continue to nicely outperform the market moving forward. Now, by the way, we don't know yet about material price. We believe that we will have some relief that should be giving us some tailwind versus this year. We, again, would anticipate that the supply chain constraints will end up fading out. We thought it would fade out faster when we talked to each other in July. We thought that during the second half we would see less impact.

And we actually still see much less than we had before but still see a fairly significant kind of headwind there. And ultimately, the logic will call for capacity to be added at suppliers. And obviously, those suppliers maybe being back to a more normal relationship, particularly as related to those productivity programs that is fueling our material productivity line. As you know, we end up this quarter with a mature productivity that is lower than we have been used to. And again, we are really looking forward to rebuilding this productivity beyond the 5% that we have seen consistently in the past.

Justin Long -- Stephens, Inc. -- Analyst

Okay. Thanks. And secondly, I wanted to ask about China because that seems to be a focus right now. You've previously spoken about Chinese production eventually normalizing around a million units. So, there's market risk clearly, but at the same time, you seem more optimistic about the content opportunity in China as they become more of a technology leader. When you put it all together and you balance the market risk with the content opportunity, what do you think that means for Chinese revenue over the longer term? Is the content opportunity enough to keep your Chinese revenue flat to up over a longer-term five-year planning period?

Jacques Esculier -- Chairman, Chief Executive Officer

Justin, that's the thesis. And I'm absolutely still completely adhering to this approach which is, I would say, wise in recognizing that the level of production today is probably still excessive, given the fact that there has been some artificial -- maybe a strong word -- but artificial influx of funds to help the construction world. But more important because at the end of the day, the reliability and durability of trucks will increase. And as you keep your trucks longer, you will need less replacement.

And that will automatically impact the volume. But we think that, again, the need for additional technologies -- and we know, for example, that AMT, that air disc brakes and many of these -- EBS rather than ABS, ABS which is gonna be a mandate on coaches starting next year that will probably invade the space in the following two-three years. Those are very strong pillars of additional content which, in my opinion, will absolutely more than offset this natural potential erosion of the demand for those vehicles in that region of the world. So, I'm still incredibly enthusiastic about what's ahead in China.

Justin Long -- Stephens, Inc. -- Analyst

Great. That's really helpful. Thanks for the time today.

Operator

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

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Hey. So, just back on the supply chain constraints, are you seeing any sequential improvement as you go into fourth quarter that that is abating? And as you talk to your suppliers, how confident are you that these are normalized by beginning of '19?

Jacques Esculier -- Chairman, Chief Executive Officer

Yeah, Jeff. Very important question. And there are several elements in what we call supply chain constraints. First, let's address this raw material price increase. Indeed, we're gonna be dragged to pay a price increase of about 1.5% year-over-year up to the end of the year because we have seen already some easing in the area, particularly of aluminum. However, you know that there is always a delay between what the raw material price does and how it impacts and when it impacts WABCO because that's the setup with our suppliers. So, we, unfortunately, will not benefit from that tailwind but probably in the early part of next year. So, that's one. The second one is really related to all the additional costs. And I'm talking about express freight, particularly for incoming goods from our suppliers because that has been the driving factor of the way that this whole situation has driven.

That should ease up as the capacity of suppliers is starting to really build up and catch up. And then the third part is, again, what I was mentioning before related to the mature productivity level that has dropped below our historical levels because it's very hard in this kind of environment to ask for suppliers to focus on projects to lower their cost and obviously pass it through to us. But we believe, again, it will come back. And we are working actively at that. But we have to refuel the pipeline of initiative activities that will continue to drive those mature productivity up to 5%. And that may take a few months because the pipeline right now has obviously lowered in activities. We have to reprime it. We are focusing enormous amount of attention and energy particularly within the new organization structure where we have this focus on the European region that is still providing an enormous amount of that percentage of opportunity. So, that should be allowing us to reconnect to that 5% I would say fairly rapidly in the coming month.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Okay. That's helpful, Jacques. And then just on Europe, it looks like you fully anniversaried this AMT supplier change. So, with that anniversaried, how should we think about outgrowth going forward in Europe? Thanks.

Jacques Esculier -- Chairman, Chief Executive Officer

Yeah. What happened is actually, we are -- the demand that we had considered or anticipated to stop for those order products that we are actually continuing to deliver and will continue to deliver next year, this is lingering a little bit further and longer than we had anticipated. And that's why it does impact our ability to outperform this year. And it will again. When we look at the forecast that we are provided with in 2019 by these manufacturers, it seems that we could have another $3.5 million of tail end impact for next year which is not comfortable. In the meantime, there are all kinds of activities here and there that should fuel a meager -- because our performance in Europe has never been gigantic. But I would still think that we could produce this 2% to 3% outperformance on an ongoing basis.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Thank you.

Operator

And our next question comes from Alex Potter with Piper Jaffray. Your line is now open.

Alex Potter -- Piper Jaffray -- Analyst

Hi, guys. So, I wanted to talk about the incremental margins again. I think obviously up until now, most of the focus has been on some of these cyclical issues. So, we've got supply chain constraints and raw materials and all of those things. And I think that's one thing. And clearly, cyclical issues tend to fade over time. I want to just be clear that there has been no structural change because obviously, the company's been buying other companies, right? You had the Meritor joint venture acquisition, then Off-Highway. There was Sheppard. All of those companies potentially have a different cost structure than what WABCO historically had. And then there's also these R&D pressures now that we have with electrified vehicle and autonomous vehicles. And so, I just wanna make sure that none of those structural changes, either within the industry or within the company itself are potentially driving some of the incremental margin headwinds and the potential change in the framework going forward.

Jacques Esculier -- Chairman, Chief Executive Officer

Very good question, Alex. And I appreciate your approach. Well, I would say first of all, no. Acquisitions have not fundamentally changed. And this is not a major root cause of this kind of departure, again, away from the incremental margin framework. I would tell you that Sheppard didn't know probably how to start material productivity up to its acquisition by WABCO. And it will take a little while to build the momentum that we want all our areas of the company to work under. But it's not a major driver at all. The size of what it represent is not material. But there is more opportunity there than right now headwind. What I would say is, again, when you look at things, those two poles of issues that I mentioned are really where the problem is anchored. One is the inefficiencies in the way we operate, having to pay excessive express freight as well as having lost some of the normal flow of material productivity coming from our suppliers. And I'm not saying that those are easy to resolve.

When you're stuck in those kind of situations, you need to work hard, as we are obviously being helped by some leveling of activities in the market and at suppliers in terms of adding capacity to resolve them. But those are not insurmountable structural issues. Those are issues that you have to very, very seriously and decidedly address. But I don't see why we would not be able to resolve them in the coming months. Now, I can't tell you, "By this month, we're gonna have resolved them," because again, it's a lot of dynamics and a lot of situations that, for some of them, it's not completely under our control. But I'm saying it's something that departs from the logic of where this industry should be operating on an ongoing basis. It's an exceptionally stressed and constrained environment. And that will ease up at one point. In the meantime, we are taking very significant actions ourself to help the mitigation be accelerated.

Alex Potter -- Piper Jaffray -- Analyst

Okay. Very good. Last question on air disc brakes in China. I'm interested to hear what the thinking process was behind addressing that market with a joint venture as opposed to doing it in a wholly owned subsidiary and the extent to which this would end up limiting your ability to sell to other OEMs. If you're making air disc brakes with First Auto, with FAW, could you sell brakes from that joint venture to other OEMs? Or would they be reluctant to support buying something from your competitor?

Jacques Esculier -- Chairman, Chief Executive Officer

Good question, Alex. Actually, let me reassure you. We do have actually right now three sources of air disc brakes capability: one which is still ongoing which is this pool of capability linked to a full axle manufacturing that's in the southern part of China, one that is anchored into our own facility which is wholly owned, and one that is actually linked to, again, one of two major leaders of this industry in China. Well, it happens that, as you know, the dynamics of this market at least as well as I do, there are some complicated discussions in business models over there that don't exist to the same extent, to a similar extent in our world. But you want to position yourself strongly at FAW.

The joint venture is a necessary step. And actually, the good thing is we are conforming it. The great thing is we have a particularly healthy, solid relationship with FAW. The CEO of the company was at our booth. And we have had several very positive meetings in the last year. And what I'm saying is I think as a healthy move, a very positive move for WABCO -- obviously, it would have been even better if we could have done it on our own, not having to share 40% of the result of this company. But you know what? That's the way it is. That's a fact of life. And we have to comply with it. And I'm very happy that WABCO was the clear winner in the competition around this opportunity.

Alex Potter -- Piper Jaffray -- Analyst

Interesting. Thanks, Jacques. I appreciate it.

Operator

And our next question comes David Leiker with Baird. Your line is now open.

Erin -- Baird -- Analyst

Hi. This is Erin --

[Crosstalk]

Erin -- Baird -- Analyst

-- on for David. So, my question for you is with the aftermarket business and your guidance for that business to reaccelerate to approximately 6% gross next year, what is driving that business, considering you still have supply chain constraints ongoing at this point?

Jacques Esculier -- Chairman, Chief Executive Officer

 

First of all, again, we should anticipate and credibly think that this supply chain constraint will ease up. And we are seeing actually some easing up as we speak. So, that's one. Second, as you know, we have always, for many, many years, focused at developing this channel because it's, we know, more profitable source of revenues and profit. So, we have focused a lot on expanding the network, reaching into markets that historically were not properly addressed, in developing an extremely interesting, actually avant-garde digitalization of the way we sell, address, communicate, connect to the world of customers in that area of the business. And then, as part of the aftermarket, we also cover today this world of fleet management solution which, as you know, offers an amazing level of opportunity, not only in Europe but across the world. And we are well-positioned in this region.

And we are also very rapidly establishing very, very strong roots in China and India through the different initiatives that I have shared with you before. So, all this for me is pointing finger to a credible, continuous gross of this business at 86%. Again, we launched the percent this year. There were some not only, unfortunately, issues with the supply chain, but there were, in some key markets, some unfortunate headwinds that were imposed artificially by what is going on in the world of geopolitics. But again, I would anticipate that, at this point, it is a very credible kind of improvement to see this rate from 5% going back to 6% plus for next year.

Erin -- Baird -- Analyst

Great. Thanks for taking my question.

Operator

And our next question comes from Seth Weber with RBC Capital Markets. Your line is now open.

Seth Weber -- RBC Capital Markets -- Analyst

Hey. Good morning, everybody. Hi. Good morning. I wanted to go back to in your prepared comments, the mention about the auto, the passenger business. I think you talked about it being lower with some changes to the TM. Can you just remind us how big the auto business is for WABCO today and maybe just frame what you're thinking about for autos for WABCO for next year, whether you think that'll be up or down next year?

Jacques Esculier -- Chairman, Chief Executive Officer

Yeah. The revenues represent about 6%. And as you know, we are present in two segments. One is vacuum pump. The other is this electronic control air suspension that we sell to luxury cars, SUVs, and others. We are a leader or one of the two key leaders in the second market. We are a strong player but not a leader in the more the vacuum pumps. Now, the world of vacuum pumps is fading out in certain western world manufacturers, replaced by some other devices. And I must admit that I'm not a real specialist in telling you by what. Actually, if I know something, it's not something we have in our portfolio. But what we are doing right now is actively compensating this drop in sales at GM in particular with opportunities that we have worked and actually succeeded with in India and China because the impact of GM is larger.

But it's mitigated by gross in China and India where we believe there is still some good momentum to be gained. As you know, this is an opportunistic segment of our portfolio. We'll not invest huge amount of monies to, again, create new technologies, breakthrough technologies to replace vacuum pumps. We have much better use of our funds to support all these ambitions we have in the world of commercial vehicles. We do maintain obviously the technology that we have which is a different setting from others in vacuum pump. We do have if I remember, 2% to 3% of fuel saving because our vacuum pumps are more efficient than others. But we will not, again, follow the trend and follow the industry into these new technologies. But for the moment, it's really contained at some very needing auto manufacturers.

Seth Weber -- RBC Capital Markets -- Analyst

Okay. So, on a net basis, you think auto could be neutral to you next year?

Jacques Esculier -- Chairman, Chief Executive Officer

Well, I don't know yet. I hope so because if it's an opportunistic segment, obviously, you don't want to have this kind of element of your portfolio to start providing headwinds. So, this is the promise that we are trying to support. But I can't tell you yet. Given all the elements that are still converging to support our budget development, I can't tell you where we're gonna end up next year. But we'll really update you, obviously, as we know more about it.

Seth Weber -- RBC Capital Markets -- Analyst

Okay. And then maybe just a question for Roberto. Do you think that the engineering expense for next year would be above a 5% of revenue level? Or do you think it's back in your traditional 4% to 5% range?

Roberto Fioroni -- Chief Financial Officer

No, Seth because this year is also gonna be in the 4% to 5% range. It's just that the third quarter saw a peak. And next year, we expect to be within that range as well.

Seth Weber -- RBC Capital Markets -- Analyst

Okay. Thank you very much, guys.

Operator

And our next question comes from Larry De Maria with William Blair. Your line is now open.

Larry De Maria -- William Blair -- Analyst

Hi. Thanks, guys. Good morning. Good afternoon, everybody. First, just a clarification. You said medium- to long-term 20% sustainable performance tax rate is what you're hoping for. Should we be penciling that in for 2019 as a best guess for right now?

Jacques Esculier -- Chairman, Chief Executive Officer

I think it could be appropriate.

Larry De Maria -- William Blair -- Analyst

Okay. Perfect. We'll do that then. Thanks. And --

Jacques Esculier -- Chairman, Chief Executive Officer

Sorry. It's just a first indication. We don't have yet -- it's not an announcement. It's not a commitment. It's just sharing with you that we are driving some activities, some things at WABCO. And those things will have an impact on our tax rate. And that's why we can't anticipate because we have consistently shared with you that our medium- to long-term tax rate would stabilize at 25%. What I want to tell you is be ready for us to come back and tell you that actually, this 25% is now a 20%.

Larry De Maria -- William Blair -- Analyst

Understood. Okay. Thank you. And then Jacques, just maybe a little bit more big picture. You talked about electrification, autonomous, connected. Obviously, where the industry's going and where WABCO's going. Do you expect these things to fundamentally change your revenue composition and your margin profile in two to three years from now? And related to that, your principal competitor just went public. Are they doing all the same things? Do you expect their behavior to change? And how do you see them evolving as now that they're a public company and as maybe the competition stays the same? But just curious how you're keeping an eye on them as it's interrelated to these new technologies moving forward. And I'll leave it there. Thank you.

Jacques Esculier -- Chairman, Chief Executive Officer

Yeah. Thank you, Larry. Well, the first that I'm gonna of the question -- this set of technologies will not significantly impact our revenues in the coming two to three years. We continue to make progress in the world of ADAS which is the first levels, L1, L2, of autonomous driving that has five levels. The more advanced capabilities I think would take some additional time to really heat the top-line. So, we are still obviously relying on the core activities of WABCO that are really addressing these overall vehicle dynamics control. We have put in place something that is incredibly powerful and unique which is an amazing leadership in braking control systems, steering that we are connecting to the braking and stability control. And then we have this pillar around connectivity, fleet management solutions, telematics, and all this. So, that's the role of WABCO that is essential as you migrate into this new space of ACE that we call A-C-E.

And we will be up on top of this. Now, the core of WABCO will stay around these very fundamental capabilities. But the core of WABCO will expand to encompass some of the technologies that enable autonomous driving through partnerships like Baidu. Baidu would give us access to -- again, they're very rich and capable artificial intelligence capabilities, mapping, and others. But we will add to it. And that's where we will see but in a few years. The first, again, application with Baidu is planned for 2021, not before. And I don't know at that time what momentum we would gain in the first year.

That's why I said all those ACE kind of activities for me are more medium- to long-term seeds that you plant, and you will nurture to really fill up the pipeline of our performance because once all the trucks in the world will have an EBS, an air disc brake, not several air disc brakes, AMTs and what not, this very fundamental, unique, organic gross pipeline that we have, then we have to plan today to, again, plant the seeds for those new technologies to keep feeding that pipeline and continue to allow WABCO to outperform its market. That's what is going on right now. So, we have today. We benefit today from this very powerful pipeline and organic growth opportunities. When you look at the profile of the mandates around the world, whether its stability control that will be mandated in more break countries, whether you're even thinking about ABS being now mandated in China -- India is talking about it. The US is talking about it.

You're talking about the side detection of pedestrians and side things that could be mandated as early as 2021 in Europe. There's plenty of things that will feed the traditional organic gross. Again, we're talking about building the organic gross beyond that or, actually, at least in the medium-term, not the short-term. Now, the second question, I'm telling you I have enough of managing one company. It's very hard for me to anticipate what our competitors will do in terms of managing their relationship, information flow, presentation to the street. I would just only encourage you, like we will, to obviously monitor what's going on on that side. And I'm just welcoming them to the dynamics that we have now established in the last 11 years and that allows us to, I think, be fairly transparent and fairly efficient at sharing information that allows you guys to forecast and position WABCO in your portfolio.

Larry De Maria -- William Blair -- Analyst

Okay. Understood. Thanks. And good luck.

Operator

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

Jerry Revich -- Goldman Sachs -- Analyst

Hi. Good morning. Good afternoon, everyone. Good morning. I'm wondering if you could talk about a little bit more the change in organizational structure, Jacques, that you pointed out and why the transition at this point in time and what are some near-term opportunities that you'd like to execute toward by making the shift and any changes in performance metrics that you're looking for your direct reports as a result. Can you just say more about that transition, please?

Jacques Esculier -- Chairman, Chief Executive Officer

Yeah. When you think about it Jerry, our BU leaders that we're driving the destiny of our products were also managing Europe because, again, that was their territories to connect with those customers to identify technology evolution, strategies and technologies for the future and all this. Now that the evolution of those technology breakthrough will root itself beyond Europe, there will still be a lot of activities in Europe but very frantic. When you look at autonomous driving, at electrification, you will know that we could call even China ahead of Europe. Then those people cannot manage the P&L for Europe in addition to driving the global strategy now of how the new technologies will evolve connected to all the different regions. So, we want to pull those people out of the European management, create a very focused team around Europe that will manage the day-to-day P&L activity and connectivity to customers and then extract those product people that we call product hubs.

Why do we use the word hubs which is not a very conventional word in the world of HR and organization structure? But I want to send a very strong signal that those people are now becoming very global platforms, that they are not driving on their own or only connected to their European peers, to develop strategies. They are the hub connecting to all regions to take inputs from all customers to optimize the strategy of our products moving forward. It's a very precious move that obviously was actually not relevant before. Before, the model that we had had since 2005, actually, has proven to drive pretty strong wealth and health across our business evolution. But we believe that with this kind of positioning that we see, evolution that we contemplate in the different regions, I think it's absolutely necessary, as we always do, to anticipate what's next and adapt ourself to again position WABCO as the winner, as the leader in taking advantage of all those opportunities ahead.

Now, in terms of metrics, obviously, we're gonna have a team. We have a team built around [inaudible] with the full P&L of Europe, with the full set of metrics that one would expect to describe customer satisfaction, customer gross, and obviously, ultimately, all the different elements of the service level we provide to customers as well as the P&L elements.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. And Jacques, to switch gears, in terms of outgrowth, so a big contribution in the Americas from AMT for you folks this year. As we think about the outgrowth opportunities over the course of the next 12 to 18 months out of all of the products that you folks have moving forward, where are you most optimistic on most significant outgrowth drivers when we think of the entire WABCO portfolio as we think about the next 12 to 18 months?

Jacques Esculier -- Chairman, Chief Executive Officer

Well, we are still gaining momentum in air disc brakes. I think that probably could be the leading product lines to drive our performance in that region of the world. We are still at 60% of penetration for AMT in the heavy-duty truck world. I said 35%. That's the full population of trucks. 60% is heavy-duty because, for the moment, we really address only the heavy-duty. So, there is still room beyond that 60% to move up. Europe is much higher in penetration. And then the big question mark is what about medium-sized trucks? We know that the Dunbar is migrating their technology, their powertrains for medium-sized trucks. I don't know where in discussion, but decision is definitely not being said whether they will call for our technologies to help them in that segment in the United States. But if they do, then it would create another set of momentum for gross and penetration there.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Thank you.

[Crosstalk]

Jacques Esculier -- Chairman, Chief Executive Officer

Go ahead.

Operator

This does conclude today's question and answer session. I would now like to turn the call back to Jacques Esculier for any further remarks.

Jacques Esculier -- Chairman, Chief Executive Officer

Okay. Well, thank you all for attending this call. And we're looking forward to closing this year in a strong way and looking forward to interface with you again at the beginning of next year. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. And everyone, have a great day.

Duration: 78 minutes

Call participants:

Sean Deason -- Vice President, Investor Relations, Controller

Jacques Esculier -- Chairman, Chief Executive Officer

Roberto Fioroni -- Chief Financial Officer

Justin Long -- Stephens, Inc. -- Analyst

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Alex Potter -- Piper Jaffray -- Analyst

Erin -- Baird -- Analyst

Seth Weber -- RBC Capital Markets -- Analyst

Larry De Maria -- William Blair -- Analyst

Jerry Revich -- Goldman Sachs -- Analyst

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