Meritor Management Discusses Q4 2012 Results - Earnings Call Transcript

 |  About: Meritor, Inc. (MTOR)
by: SA Transcripts


Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2012 Meritor Earnings Conference Call. My name is Tahesha, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Christy Daehnert, Director of Investor Relations. Please proceed.

Christy Daehnert

Thank you, Tahesha. Good morning, everyone, and welcome to Meritor's Fourth Quarter Fiscal Year 2012 Earnings Call. On the call today we have Chip McClure, our Chairman, CEO and President; and Jay Craig, our CFO. The slides accompanying today's call are available at We'll refer to the slides in our discussion this morning.

The content of this conference call, which we're recording, is the property of Meritor, Inc. It's protected by U.S. and international copyright law and may not be rebroadcast without the express written consent of Meritor. We consider your continued participation to be your consent to our recording. Our discussion may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Let me now refer you to Slide 2 for a more complete disclosure of the risks that could affect our results. To the extent we refer to any non-GAAP measures in our call, you'll find the reconciliation to GAAP in the slides on our website.

Now, I'll turn the call over to Chip.

Charles G. McClure

Thank you, Christy, and good morning, everyone. Let me begin by saying fiscal year 2012 was a challenging year, as we faced weakened markets throughout the second half due to global economic slowdown in our sector. This softening was driven by escalating recessionary forces in Western Europe, flat and slowing truck production volumes in North America and reduced national infrastructure investment in China. In Brazil, impacts of Euro 3 inventories and sluggish Euro 5 acceptance drove a decline in truck production since January of 2012. All that said, Meritor's management team faced these challenges aggressively. Together with a strong and realistic focus on cost controls and incremental cost containment, we mitigated the impact of declining sales volumes, all while still making strategic investments to improve manufacturing processes to meet or exceed our customers' expectations.

I want to emphasize that despite the global sales challenges, our EBITDA margins increased year-over-year due to the achievement of the 6 execution actions we committed to during the fourth quarter of 2011. While global market forces are beyond our control, our management team’s focus on the drivers of profitability demonstrates our collective strength and commitment to skillfully manage turbulent global markets for the benefit of our shareholders, our customers, our employees and our communities.

Let's turn to Slide 3 for more detail on our fourth quarter and full year results. Sales for the fourth quarter 2012 were $986 million, a decline of $127 million or 11% versus the third quarter. This decrease in revenue was driven primarily by weaker end markets. Adjusted EBITDA was $79 million, down from $92 million in the prior quarter. We were able to generate our EBITDA margin of 8% despite the significant revenue headwinds we faced during the quarter. This is a testament to the hard work of all our teams around the world to carefully manage costs as volumes contracted in the second half of fiscal year 2012.

Adjusted income from continuing operations was $31 million, a $6 million decrease from third quarter. Adjusted earnings per share from continuing operations in the fourth quarter were $0.32, down from $0.38 in the prior quarter. Free cash flow from continuing operations before restructuring was $37 million, a decrease of $19 million from the third quarter. However, fourth quarter cash flow included the impact of an additional $25 million voluntary pension contribution. Jay had mentioned on our prior earnings calls that if we were able to generate sufficient positive cash flow this quarter, we'll reduce the opportunity to prefund some of our pension obligations for 2013.

For fiscal year 2012, sales ended at $4.4 billion with adjusted EBITDA of $345 million and margin of 7.8%, a measurable improvement over our 2011 margin despite declining revenue in many of our global markets. Adjusted income from continuing operations was $111 million and adjusted earnings per share from continuing operations were $1.14. Free cash flow from continuing operations before restructuring was $22 million in 2012 and included total pension contributions of $102 million. Overall, I'm pleased with the strong execution that led to increased EBITDA margins, strong free cash flow generation and increased income year-over-year in the face of global recessionary forces.

Let's turn to Slide 4. Among the highlights of our business accomplishments in the first quarter, first in India, we received a multiyear award from Daimler Commercial Vehicles for Meritor hub reduction axles. Beginning in fiscal year 2014, the axles will be produced for heavy-duty dump trucks, known as the tippers, over the next 8 years. The hub reduction axle for Daimler has been adapted for conditions in India, with 18-ton cast housings for heavy-duty mining applications.

Second, in our Trailer business, Wabash National, one of the leading producers of trailers in North America, selected Meritor trailer axles to be standard equipment on all trailers it produces. Third, in our defense business, 2 of 3 OEMs selected by the Department of Defense for the final Engineering and Manufacturing Development Phase of the JLTV program contain Meritor content. Specifically, our ProTec High Mobility Independent Suspension will be integrated into Lockheed Martin's vehicle. Meritor's wheel-end and brake components will be included in Oshkosh trucks offering. Both will advance to the next round of the Army and Marine Corps JLTV development program, which we anticipate will be concluded over the next 27 months. And finally in September, we introduced our latest and most technically advanced generation of drive axles and brakes during the commercial vehicle show in Hannover, Germany.

In the right column of this slide, you will note our team earned a number of awards and recognitions demonstrating our customer service excellence. Among them, PACCAR recognized our focus on product quality by presenting their 2011 Quality Achievement Award to 4 Meritor manufacturing facilities. The award is among the industry's most demanding due to high standards for product quality and integrity. Meritor facilities receiving this prestigious award were Newark, Ohio; Manning, South Carolina; and Laurinburg and Forest City in North Carolina. The fact that 4 of our facilities have earned the PACCAR Quality Achievement Award during each of the past 3 years is a testament to our commitment to quality.

Thomas Built Bus, a subsidiary of Daimler Truck North America and a leading producer of school buses, presented their 2012 Outstanding Supplier Silver Award to our Manning, South Carolina brake plant. The award recognizes only the best suppliers for quality, delivery and service.

The Intelligent Transportation Society of America recognized our advanced brake technology joint venture with MeritorWABCO for its OnGuard collision mitigation system. OnGuard includes collision warning with adaptive cruise control, active braking and collision mitigation to assist drivers in maintaining a safe driving distance and reducing rear-end collisions.

In recognition of our growing remanufacturing business, ReMaTecNews, an international news magazine for remanufacturers, presented Meritor its 2012 Remanufacturer of the Year award. ReMaTec cited Meritor is taking remanufacturing to a new level of sophistication and product excellence. Our remanufacturing operations encompass 5 sites in 5 countries and a substantial portfolio of drivetrain and wheel-end components.

Turning to Slide 5. We continue to invest in innovation to sustain our leadership in drive axles and brakes. Many of our product innovations were showcased at the commercial truck show in Hannover in September. Our 17X axle was well received for the single-reduction European axle market. It is the industry's lightest axle system in the 13-ton class with improved ratios to meet upcoming emissions regulations. Our ELSA brakes were also well received in Hannover. They offer the attributes of improved performance and reduced weight together with improved durability, resulting in a lower cost of ownership for both the European and North American markets.

In India, our MS 04 series axle offers a wide range of applications for the minibus, truck and off-highway vehicle markets. As a fully dressed axle, the MS 04 series offers an optimal combination of efficiency, durability and mobility. And finally, Meritor's innovative SMARTandem offers attractive weight savings with an estimated 2% improvement in fuel efficiency. The 6x2 configuration features 1 drive axle and a nondrive tag axle. This configuration reduces friction while delivering a weight savings of 400 pounds.

Turning to Slide 6. You'll note our business success was driven by outstanding execution by our Meritor team. As discussed earlier, despite revenue headwinds, Meritor's fiscal year 2012 EBITDA margin increased. This performance was driven by a number of well-executed actions at the end of 2011 and the beginning of fiscal year 2012. Among those actions, our North American Commercial Truck team secured an improved pricing structure more closely aligned to the Meritor value proposition. To further improve manufacturing efficiencies in Europe, our team completed a rationalization of our European manufacturing footprint to reduce fixed costs while maintaining the appropriate level of capacity to meet future increases and demand as economies in that region recover. We executed aggressive material cost recovery initiatives with our customers to mitigate the impact of rising global commodity costs.

In the fourth quarter of fiscal year 2011, we successfully completed the exit of our European Trailer business. In North America, our defense team managed to return our production back to peak levels without issue. This allowed us to serve our nation's vital tactical-wheeled vehicle programs with seamless consistency. And at the end of fiscal year 2011, we also initiated a program to trim our executive ranks.

Turning to Slide 7. We took the following actions in 2012 to maintain our strong liquidity position. First, we amended and extended our $515 million revolving credit facility from 2014 to 2017, inclusive of a $100 million term loan. In addition, we entered into a new $100 million U.S. securitization facility expiring in June of 2015. This new facility provides higher advanced rates and reduced pricing from the facility it replaced. We also were pleased to receive rating upgrades from S&P, which is further evidence of our strong liquidity and improving credit profile.

Let's now turn to Slide 8 to review our 2013 forecasted production volumes for the 3 geographic regions of the Commercial Truck segment. In the upper left, we provided our fiscal year 2013 North American industry forecast for medium- and heavy-duty truck volumes. Today, we believe the softening observed in the industry during the fourth quarter of fiscal year 2012 will continue into 2013.

Our forecast for 2013 combined volumes is approximately 420,000 units. This includes a forecast of 230,000 Class 8 trucks and 190,000 Class 5-7 trucks. This market softening is based on an assessment of the dealer inventory levels nearing all-time highs and an OEM backlog-to-build ratio of less than 4 months.

In South America, the softening we experienced in 2012 following the emissions change in January has stabilized. But we believe we'll remain at this level for the first half of our fiscal year with limited visibility for near-term recovery. Our fiscal year 2013 forecast for medium- and heavy-duty trucks reflects this outlook, where we expect 159,000 units of production, down about 5% from prior year.

In Western Europe, we are forecasting the medium- and heavy-duty truck industry volumes to decrease in fiscal year 2013 to 370,000 units. This represents a 5% decrease over fiscal year 2012 industry volumes. The decline is expected to continue throughout the fiscal year due to prolonged economic headwinds, coupled with no anticipated prebuy demand from Euro 6 emission changes that will be effective in January 2014.

Now let's turn to our Industrial segment market update on Slide 9. Our Industrial forecasts for fiscal year 2013 are mixed. In China, the reduction of infrastructure spending and higher levels of dealer inventory continued to impact the production of cranes, loaders and other excavating equipment. As a result, inventory corrections are expected to continue for the next several quarters. While the government has announced programs to support increased infrastructure spending, we have not seen any favorable impact of these actions to date. Consequently, we are forecasting fiscal year 2013 off-highway production to be down 8% to 10% from 2012 levels.

Turning to India. We are forecasting a small increase of approximately 4% in medium- and heavy-duty truck production from 335,000 units in fiscal year 2012 to 348,000 units in fiscal year 2013. The forecasted increase is due to the anticipated positive impact of government stimulus focused on investment in the country's infrastructure.

Within our defense business, our Caiman production ends in the first fiscal quarter of 2013 with no additional sales forecast beyond that point. Also FMTV production decreases significantly in 2013. We expect production to step down almost 30% year-over-year as this program ultimately concludes in late 2014.

As you know, this is a significant mix impact that will place pressure on our EBITDA margins in fiscal year 2013 and beyond. As I will address on upcoming slides, we are already beginning aggressive actions to operate in this new environment of reduced defense spending and to mitigate the impact of this loss margin.

But first, let's turn to Slide 10 to review the Aftermarket & Trailer segment. We expect our global Aftermarket business to be roughly flat, driven by softening market conditions in our core markets throughout the world. Unless we see a significant increase in economic activity in our core markets, we do not expect measurable growth in this business.

Moving to Trailer. Our forecasted industry production in North America is expected to improve by 5% in fiscal year 2013 to 250,000 units. Orders and build rates remain healthy to date. Order boards have been filling at a rate consistent with typical seasonality and cancellation rates remain very low.

Overall, we are seeing most of our markets in all 3 segments down in 2013, especially in the last calendar quarter of 2012, which is our first fiscal quarter. However, we are optimistic about markets in the back half of the year as we will show in upcoming slides.

Let's now turn to Slide 11. As I indicated at the onset, Meritor recognizes it cannot control geopolitical economic forces that impact our markets. However, our management team continues to implement the aggressive actions required to adapt to the rapidly changing environment in which we conduct business. As we've already reviewed, we successfully implemented many margin-enhancing actions in 2012. While we are disappointed that markets continue to be soft in most of our major regions of operation, we are moving aggressively to address our cost structure and adapt to this changing environment.

Similar to our response to previous significant changes in economic activity, we have reacted quickly by adjusting variable labor costs due to weaker markets in Brazil, Europe, the U.S. and China. These actions will reduce our workforce by approximately 800 people. This includes 50 salaried and 750 production workers, of which 350 are contract and temp personnel. Cost savings associated with these actions should be evident by the second fiscal quarter of 2013.

Within our Aftermarket segment, we are taking actions to consolidate our remanufacturing activities through the closure of our operation in Mississauga, Ontario and the consolidation of our North American remanufacturing operations into a center of excellence in Plainfield, Indiana. In addition, we are making structural cost reductions to respond to the expected medium-term decline in the defense business and the impact to us. Recognizing our near-term declining military volume and the related contraction in the Industrial segment in total, we are rationalizing our business segments from 3 to 2 going forward. We wish to emphasize that the rationalization of our business segments is a long-term structural change to the organization and not just a short-term tactical action taken in response to current market conditions.

The expected financial benefit of these structural cost reduction actions together with other initiatives are expected to be significant to substantially mitigate the loss margin associated with the FMTV program. We'll provide you the details of these actions during our Analyst Day on February 5. At that time, we will review with you in detail both the short-term actions reviewed today and the longer-term structural changes and how they position the organization going forward.

These actions are not easy. They're extremely difficult for us and our employee base, but unfortunately are necessary given the economic conditions we faced. I want to take the opportunity to thank the leadership team here for their attention and focus on the next phase of implementation. We must execute these actions so that we don't lose the financial benefit of all the hard work the team have put forth over the past year to improve EBITDA margins in 2012. We can't lose the positive momentum achieved even with these challenging market conditions.

Now I'll turn the call over to Jay as he walks through the more detailed financial review.

Jeffrey A. Craig

Thanks, Chip, and good morning, everyone. On today's call, I will provide a review of our fourth quarter and full year results, as well as our guidance for 2013.

Slide 12 compares our actual results for fiscal year 2012 to the revised outlook we provided on August 1. Sales for the year were just over $4.4 billion, which was in line with our outlook as the third quarter weakness experienced in Brazil and China continued through the fourth quarter. In addition, we saw fourth quarter weakness in North America across the segments, which drove us to the lower end of our sales guidance range.

We delivered an adjusted EBITDA margin of 7.8% or $345 million, which was at the midpoint of our range. Given the global market contraction that frankly was far from what we were expecting at the beginning of the year, I'm extremely pleased with this performance. Our margin was 30 basis points better than last year despite there being over $200 million less in revenue. We view our ability to overcome these revenue headwinds and improve our margins as an impressive achievement.

We've laid out very challenging goals for this organization a year ago. And every quarter, we updated the external investment community as we made progress on achieving those goals. We executed this plan and I can't emphasize enough, this was no easy task. We had tough discussions and negotiations with our customers in many cases, but the team delivered. We recognized that our work isn't over to achieve our long-term margin objectives we established for ourselves. But I do want to recognize the tremendous accomplishments of this team in 2012. Unfortunately, the global economic downturn has somewhat overshadowed the meaningful improvements we've made to the core profit generation capability of the company.

2012 adjusted income from continuing operations was $111 million, just above the high end of our guidance. And we earned $1.14 in adjusted earnings per share from continuing operations in 2012, again at the high end of our range. Free cash flow from continuing operations before restructuring was $22 million. As Chip mentioned earlier, this amount includes total pension contributions in 2012 of $102 million, of which $25 million was voluntary. Our effective tax rate came in essentially on plan at just over 40%.

Overall, we delivered solid financial results in 2012 and the strong execution of our teams around the world helped to offset the revenue headwinds we experienced in nearly every international end market we serve. We are better positioned today than we were a year ago in so many respects, and that should also allow us to capitalize on the eventual rebound in the global markets.

On Slide 13, you will see our fourth quarter income statement from continuing operations. We also included a similar slide for the full year 2012 in the appendix for your convenience. Sales of $986 million in the fourth quarter were down $231 million year-over-year or 19% due to Commercial Truck production in all regions, continued pressure on production in our China off-highway and India on-highway businesses and the softness of the Aftermarket. Gross margin was roughly flat year-over-year, even with the significantly lower sales resulting in gross margin as a percent of sales expanding by 180 basis points. This is a reflection of the fact that we have been able to sustain the financial benefit of the 6 execution items we implemented in the fourth quarter of fiscal year 2011 and the early part of 2012.

SG&A of $80 million was much higher in the fourth quarter of 2012 versus the same period in 2011. This was related to a onetime, noncash year-end valuation adjustment to our estimated asbestos liabilities totaling $18 million, substantially related to legacy Rockwell plants. In working with our actuaries, we determined that the experience data was now consistent enough to enable us to make a 10-year estimate of this viability versus the 4-year period we were limited to previously. This 10-year period is also consistent with the period over which we evaluate our other pool of asbestos liabilities in the dormant legacy Maremont subsidiary.

Although the impact of this change on ongoing future expense is expected to be immaterial, these actuarial valuations are inherently dependent on many assumptions related to an environment that is continually changing. Because of the onetime nature of this change in estimation period, we have excluded the financial impact from adjusted EBITDA and are treating it as an adjustment to our earnings. This is consistent with our treatment of that $16 million gain on sale of property during the third quarter. Excluding this charge, SG&A would have been slightly lower than the fourth quarter of last year.

Restructuring costs were $9 million in the fourth quarter of 2012, of which $3 million was associated with the European salary headcount reduction program we announced 2 quarters ago affecting the Commercial Truck segment. We also incurred $5 million in the current quarter related to a recently approved restructuring plan for additional headcount reductions, primarily in the Commercial Truck segment in response to weaker market conditions in certain regions. We have also announced the closure of 1 remanufacturing plant in Canada. Remaining costs under this program are expected to be approximately $13 million and substantially incurred in 2013. The asbestos liability remeasurement and restructuring charges are both excluded from adjusted EBITDA.

Other income was down $6 million from the prior year as we recognized a $5 million nonoperating gain on the settlement of a currency hedge in last year's fourth quarter that did not repeat in 2012. Earnings in our minority owned affiliates were down over 40% or $8 million year-over-year. This decrease was driven almost entirely by lower earnings from our brake and trailer affiliates in South America, due to the continued effect of the emissions change this past January and softening economic conditions in the region.

Interest expense of $23 million was in line with the fourth quarter of 2011 and has been fairly consistent for several quarters. Our effective tax rate was 58% for the quarter, which is higher than what we consider a more normalized rate. I will review the fourth quarter and 2012 fiscal year tax rate in more detail later in the presentation.

We earned $0.32 per share of adjusted income from continuing operations compared to $0.45 in the same period last year. The decrease was primarily associated with the reduction in affiliate earnings and the 2011 nonoperating gain that didn't repeat again this year, as discussed earlier. On the next few slides, I will discuss the quarterly results for our 3 business segments.

Slide 14 shows fourth quarter sales and segment EBITDA for Commercial Truck. Production volumes for heavy- and medium-duty trucks were lower in all 3 regions, North America, Europe and South America, relative to the fourth quarter of 2011. The most significant year-over-year decrease was seen in Brazil as we have yet to see any real recovery in our revenue. While our production levels have stabilized, the impact of the industry transition to Euro 5 emission standards this past January and the overall economic downturn continued to impact our production.

Despite these significantly lower sales, segment EBITDA margin increased to 7.9% compared to 6.4% in the prior year. The increase in margin reflects the benefit of the pricing and European footprint -- profit movement actions completed at the beginning of our second quarter. In addition, we have seen meaningful material performance in this segment year-over-year. These margin-enhancing actions more than offset the South America headwinds previously discussed, including weaker affiliate earnings from our brake joint venture in that region.

Now let's turn to Slide 15 to review the Industrial segment results. Fourth quarter sales were $222 million, a decrease of $47 million or 17% year-over-year. The decrease is primarily due to lower sales in China and India. Despite the lower sales, the Industrial segment EBITDA margin increased slightly to 6.8% in the fourth quarter of 2012. The impact of lower sales in the Asia Pacific region was more than offset by improved sales mix as our FMTV production increased in the fourth quarter of 2012 versus the same period last year.

Next, on Slide 16, we've summarized the Aftermarket & Trailer segment financial results. Sales were $248 million, $26 million lower year-over-year. The decrease was primarily due to lower Aftermarket sales in Europe and North America. Segment EBITDA decreased $12 million, driven primarily by 2 items, downside conversion on lower sales and a $6 million charge related to a value-added tax contingency associated with certain sales transactions, which is expected to be nonrecurring.

Now let's move to Slide 17, which shows the sequential adjusted EBITDA walk from our third fiscal quarter of 2012 to the fourth. Starting with the $92 million of EBITDA generated in our third quarter, we then reduced that by $15 million due to volume, mix and pricing, the most significant of these being volume as sales decreased sequentially. But this was offset slightly by positive pricing in our Aftermarket business.

Next, we've identified a $9 million improvement in EBITDA versus the prior quarter due to reductions in material costs, including improvements in our freight expenses in the fourth quarter. The next item on the block is the charge for $6 million related to a value-added tax contingency incurred in our Aftermarket business that I just discussed on the previous slide. We don't expect this to be recurring, but this did negatively impact our EBITDA in the fourth quarter. That leaves an all other decrease in EBITDA, when comparing to the prior quarter, of $1 million, yielding adjusted EBITDA of $79 million in the fourth quarter with an 8% margin. We are very pleased with this performance given the continued revenue headwinds. We are able to manage the downside conversion by proactively managing our cost structure, as volumes have pulled back and maintained the benefits of our 6 execution actions from earlier in the year, another testament to the effectiveness of our teams globally.

Slide 18 summarizes our income tax expense for the fourth quarter and fiscal year 2012. As I stated earlier on the call, our effective tax rate was 58% in the fourth quarter, as no tax benefit was recognized on the $18 million onetime charge related to the remeasurement of asbestos liabilities. For the year, our effective tax rate was 41%, in line with our expectations.

Now let's turn to Slide 19. For the fourth quarter, free cash flow from continuing operations, before restructuring, was $37 million, $10 million higher than the same period last year. Lower earnings and higher pension contributions in 2012 were more than offset by outstanding working capital performance and reductions in capital spending dictated by market dynamics.

Total free cash flow for the fourth quarter of 2012 was $31 million, $8 million higher than the fourth quarter of the prior year, primarily due to the reasons just mentioned. And remember, the fourth quarter and full year 2012 figures include a $25 million voluntary pension contribution that Chip mentioned earlier.

For the full fiscal year, free cash flow from continuing operations before restructuring was $22 million, $16 million higher than 2011. Again, our improvements in working capital and decreases in capital expenditures more than offset the significant increases in our pension contributions. Total free cash flow for 2012 was a negative $12 million, an improvement of $58 million. Reduction in cash required by our discontinued operations, off slightly by higher restructuring cash payments in 2012, partially led to the improvement year-over-year along with the other items just discussed.

Slide 20 describes our current pension and retiree medical status. As of September 30, 2012, our U.S. and global pension plans were $529 million underfunded compared to $557 million underfunded at the end of fiscal year 2011. The underfunded position improved over the last 12 months as our asset returns exceeded our planning assumptions and we made sizable contributions to our global plans. Unfortunately, discount rates moved against us, which negatively impacted our reported funded status. In the U.S., we saw the discount rate at the end of September 2012 drop to 4.2%, down significantly from 4.9% seen at the end of 2011. But even with the significant declines in discount rates, our global pension funded status improved as our discount rate hedging strategies cushioned the negative impact of declining rates.

For fiscal year 2013, we expect global pension expense to be 0. This is due to better-than-expected investment returns and significant contributions made in 2012, partially offset by the lower discount rate I just spoke of. In 2013, we will be winding up and annuitizing one of our significant Canadian pension plans as required under Canadian pension rules and regulations. The expected onetime settlement costs related to this windup are not included in our pension expense assumptions.

We are currently planning to contribute $73 million to the global pension plans in 2013, a decrease of $29 million year-over-year, as we prefunded $25 million of contributions in our fourth quarter of 2012. The amounts in 2013 include an estimated $5 million to $7 million of contributions related to the Canadian pension plan windup I just mentioned.

OPEB expense was $42 million in 2012, and we expect a slight decrease in 2013 to $41 million. This level has been fairly consistent over the past few years and benefit payments continue to approximate the expense running through the income statement. In 2013, we'll expect ongoing OPEB benefit payments of $40 million.

Next, I'd like to review our fiscal year 2013 outlook on Slide 21. As Chip discussed earlier, the demand assumptions for many of our key markets in 2013 are much weaker than we hoped, particularly in the global commercial truck and China off-highway markets. We also expect to see a significant drop in our FMTV production, as that program winds down over the next couple of years. As a result, we expect sales in fiscal year 2013 to be approximately $4 billion, down around $400 million from 2012 and much lower than we were expecting about 6 months ago. Our revenue outlook is based on our market assumptions that Chip outlined on Slides 8 through 10.

Similar to last quarter, I want to stress that there is still significant volatility in many of the markets we serve, especially in North America, China and Brazil. But this is our best look today based upon our detailed bottoms-up forecast and input from our customers. Given our revenue assumption for 2013, we expect to earn an adjusted EBITDA margin of approximately 7%. Adjusted earnings per share from continuing operations is expected to be $0.25 to $0.35, reflecting lower pretax earnings and a higher effective tax rate.

Free cash flow from continuing operations before restructuring is expected to be about breakeven, with the decrease in earnings largely offset by lower pension contributions and capital expenditures. Our effective tax rate for fiscal year 2013 is forecasted to be around 50%, with a higher rate at the beginning of the year and reductions in that rate expected with each quarter as we progress through 2013. We expect the higher effective rate primarily due to the decline in revenue and earnings in our North American and European Commercial Truck businesses and our military business. As you recall, because we have a valuation allowance in these jurisdictions, we do not get a tax benefit when earnings decline.

Now let's turn to Slide 22. While we are not providing quarterly guidance, I did want to take the opportunity to comment on the volatility we anticipate in 2013 and the effect we think it will have on the quarterly timing of revenue in some of our businesses. Chip already reviewed the markets earlier in the presentation, but I wanted to expand on that further. There is a lot of data and commentary out there on the North American truck market. And while we do not believe fundamentals, we do believe that fundamentals continue to be positive, Class 8 orders have pulled back over the past couple of quarters and many fleets remain on the sidelines. We were encouraged by the October net orders, however, it remains uncertain when they will translate into builds and if that trend will continue or even strengthen.

For now, we are forecasting a step-down in our first quarter with increases each quarter as we move through 2013. We don't expect to get back to production levels we had in our fourth quarter of 2012 until sometime during the second half of the year. Europe overall remains an area of concern as it seems there are more indications the economy will weaken further before getting better. The fourth fiscal quarter for this business is always the weakest because of the summer shutdowns. So we do expect a small uptick in the first quarter. Revenue should then remain flat until our third quarter, with the seasonal falloff again in the fourth. Keep in mind we are expecting 2013 to again be weaker than 2012, which had already stepped down 10% from 2011. So overall, we are expecting revenue to remain weak in Europe, which also carries over to our Aftermarket business.

In Brazil, we think the market is going to bump along where it has been since January with no real revenue increase until our third fiscal quarter. While we have seen some pickup in order activity over the last couple of weeks, it is unclear if this is an indication of a recovery. As of now, we aren't seeing a meaningful impact of the government incentives on our business. Historically, these incentives have driven demand increases, so we were hopeful and continue to closely monitor our order patterns there.

Until we see a significant shift in momentum, we don't feel comfortable forecasting a recovery any sooner than the May-June period of 2013. For China, there is still too much inventory in the channel for construction equipment. So we think production will remain at this depressed level for a few more months and begin to increase as we get into our second fiscal quarter. But even then, we are still expecting volume to be below 2012 levels.

Next, I want to talk about our military revenue even though it is not on the slide. For FMTV shipments, Chip already mentioned the year-over-year decline of 30%. This step-down will be felt even in our first quarter. We are forecasting shipments to be modestly stronger in the first half of the year than in the second half, as production schedules start to ramp down towards the eventual end of the program in late 2014. For the Caiman program, we will have production only in the first fiscal quarter. So total military sales will be the strongest in the first quarter, then step down slightly in the second with payment production completed, and finally, will decline modestly from there as FMTV starts to drop off a bit more later in the year.

Finally, we always want to remind everyone that our quarter typically -- that our first quarter typically has the least amount of selling days out of the entire fiscal year. That holds true for 2013 with 5 fewer selling days in Q1 versus the fourth quarter of 2012. This is mostly due to the seasonality associated with holidays around the globe in December. So as you think about our full year guidance, you should expect that the first quarter will be our most challenging quarter of the year from a revenue and margin perspective.

Please turn to Slide 23 for a review of some of our key planning assumptions for fiscal year 2013. Capital expenditures are expected to be in the range of $65 million to $75 million as we continue to manage investments in line with market dynamics, while continuing to invest to drive operational efficiency and productivity improvements in our manufacturing facilities. Interest expense is expected to be in the range of $90 million to $100 million, in line with 2012. Cash interest payments are expected to be $75 million to $85 million, down slightly from 2012. We expect to pay cash taxes in the range of $50 million to $60 million in 2013.

And finally, with the announcement this week of the rationalization of our business segments and the additional actions Chip described that are under development, it is premature for us to provide an estimate of restructuring cash at this time. We plan on providing detailed information on this topic at our Analyst Day on February 5.

Now I will turn the call back over to Chip, where he will wrap up with a summary of our 2013 priorities.

Charles G. McClure

Thank you, Jay. Let's turn to Slide 24. I wish to stress that our fourth quarter financial results were solid and in line with our expectations. Despite weakening sales volumes driven by stressed market conditions outside the U.S., we were able to maintain improved adjusted EBITDA margin year-over-year through cost controls and continued manufacturing efficiency improvements. This performance was driven by the focus, the attention and the flexibility of our management team to deliver on our commitments.

In 2013, our team will demonstrate this same resolve. Our priorities will be to: maintain flexibility in uncertain market and successfully execute as global markets recover; remain focused on rigorous cost management; continue to implement appropriate balance sheet strategies; and continue to invest in new product developments and maintain market and technology leadership positions. Again, we'll review these strategies and actions in greater detail during our Analyst Day on February 5. Now I'd like to open it up to questions. Operator?

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Brian Johnson from Barclays.

Steven Hempel - Barclays Capital, Research Division

It's actually Steven Hempel on for Brian Johnson. I just had a question around the litigation with Eaton. Could you provide just an update on that litigation, the expected dollar amount, as well as the possible timing of the trial date?

Charles G. McClure

Well first, I can't give you -- this is Chip. And I can't give an update on the dollar amount, but let me just for the audience just to let you know that back on September 28, the Third Circuit court did find in favor of Meritor, supporting the jury's finding that Eaton had engaged in anticompetitive conduct and actually remanded the case back to district court for further proceedings on damages. Eaton did appeal that. And on the 26th of October, so just last month, the circuit -- Third Circuit court did deny Eaton's petition for a rehearing on this. And so at this point, it looks like it's going to be remanded back to district court for proceeding on damages. There is some initial contact starting even later this month, but really can set timing at this point. But it has been remanded back to district court for damages and expected to proceed that way.

Steven Hempel - Barclays Capital, Research Division

Okay. And then just a follow-up in terms of looking out to 2013 revenues here. On Slide 22, it looks like you're expecting obviously the back half to be a little more revenue back end-loaded. Is this the way you guys are looking at revenue for 2013, to be more back end-loaded? And then if you could just sort of hit on the margins as well. I understand we've got some puts and takes with lower FMTV production. If you could possibly try and bucket the revenue and margins into China off-highway, military and commercial vehicle, that'd be kind of helpful.

Jeffrey A. Craig

Sure. Steven, this is Jay Craig. Using Chart 22 -- and I don't think this is too dissimilar what you're hearing from others in the industry. The one thing to remember is given our September 30 fiscal year, as you look at our first quarter, which is the fourth calendar quarter, I think we, and most of the industry, are looking at -- looking for that to be fairly weak around the globe in all commercial truck markets and in the Chinese construction market. We think there's a lot of positives later in the year, whether it be the runoff of the Euro 5 engines in Brazil and the effect of the stimulus actions that have been taken in that economy, the benefit of the stimulus actions in China on our sector and off-highway that we think will benefit us in the second half of the year. We think the fundamentals in the North American truck market are very strong, and we view the recent declines up until October orders in order activity to really be temporary and that the long-term dynamics are very strong. And improving, given the improvement housing market in the U.S., which should drive additional demand as well. I think the most difficult one for us to call is Europe. There is an emissions change coming at the end of 2013, the beginning of '14. Our hope was that would provide at least a floor to the demand in Europe. So far we are not seeing that. We're still seeing a slight step-down. But we're hopeful as we get towards the back half of the calendar year that, that looming emissions change could provide some order activity as we go through that market. Now as far as the impact on our margins, I think it generally flows with the volume puts and takes that I just walked through. Other than a couple of specifics, we tend to get higher margin expansion within Brazil recovers because of some of our unconsolidated joint ventures in that market. Also China tends to be a higher-margin region for us. And then offset by some declining -- continued declining volume in FMTV. But as Chip spoke to, we're already looking through with the rationalization of our business segments. We're looking to take some very significant cost reduction actions in anticipation of the runoff of the FMTV program. And as we'll walk through in our Analyst Day in February, I think you can anticipate we should start to receive the benefit of those actions in our margin towards the latter half of the year.

Steven Hempel - Barclays Capital, Research Division

Okay. Perfect. And just one quick follow-up here. I'm just trying to bucket the China off-highway, military and commercial vehicle. Obviously, we're looking at 2013 volumes down $400 million. I was just wondering if you could try and roughly break out the reduction. Is it roughly equally split between those 3 segments in China off-highway, military and commercial? Or is it more geared towards military?

Jeffrey A. Craig

I would say it's -- I think we're not providing those details today within the segment. But obviously, the China off-highway market has stepped down very significantly. And as Chip mentioned, FMTV volumes this year are coming in 2013. We expect to be about 30% lower than 2012.

Charles G. McClure

Yes. Steven, just to add to that. I think if you look at the China off-highway very quickly, that has been soft in China for a period of time. So that has actually been carried for the last couple of quarters in 2012. And then the military step-down, as you look at it, really is beginning this fiscal year just from a timing point of view.


Your next question comes from the line of Graham Mattison from Lazard Capital Markets.

Graham Mattison - Lazard Capital Markets LLC, Research Division

Just a question. On the -- in the past, you'd said that you needed about $5.2 billion to get a 10% EBITDA margin. Given the changes that you've made in the cost adjustments, can you give us a sense of what type of revenue you need to get back to that 8% to 9% level or even to the 10% level now?

Jeffrey A. Craig

I think obviously, we've taken out a lot of fixed cost on the business. I think our thought is it's measurably lower than that number. I think as we get to February 5, we'll probably give you some indication of where we think that point may be as we talk through the details to the rationalization program of going from 3 to 2 segments. But I think you can expect it's measurably lower than the $5.2 billion we gave guidance to you before.

Graham Mattison - Lazard Capital Markets LLC, Research Division

All right. Great. And then just looking at South America, what's underpinning your expectations for the May-June pickup? Is it the run through the Euro 3 inventory? Or is there something else behind that we should be thinking of?

Charles G. McClure

Graham, this is Chip. And if you look at it, one is, similar to what we have in North America, the age of the fleet is 1 driver that way. Second, you had to -- as you move from Euro 3 to Euro 5, you have to have access to ultra-low sulfur fuel, which outside of the urban areas, was not present out in the rural areas during the middle part of this calendar year. So that kind of slowed it down that way. So as you look at it, I think those are a couple of drivers, as you look at it, that as we look to anticipate kind of that pickup that way. The third thing that the Brazilian government has done very effectively in past is they've actually provided incentives, whether on the tax side or their interest rates that they refer to as FINAME, that have helped to kind of do that. The government has stepped up to do some of that. And right now, that -- but again, we haven't seen the effect. And again, I think part of that is driven by the lack of our access to fuel and some of that. I'll also tell you a fourth factor is again Brazil is more global and tied probably to some of the slowdown even seen in China. So there's been some macroeconomic things taking place that way. But having said all that, you then kind of look fast-forward. There's some shorter-term things like with the World Cup and some -- World Cup and the Olympics coming there, which will be a short-term infrastructure build. And then long-term -- longer-term, as you look at the presence of oil and natural gas that are drivers that way. So that's why we've kind of back end-loaded it, but do envision that as you go out into the second and third quarters of next calendar year.


Your next question comes from the line of Patrick Archambault from Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Two regional questions for you, and then one on just margins. First on, in Europe, in the statement you said earlier that you're not factoring in any kind of a prebuy due to the change in regulations into next year, is that something that you're factoring in just so you have a fairly cautious and easily defendable expectation underpinning your numbers? Or is that really the feedback that you've gotten from customers that you've spoken to in the region? And then secondly on the demand side. Can you tell us is there a mix impact in your North America business on the truck side from Navistar? Clearly, with the transition at the 13-liter, the expectation is that they're going to lose some share, and they're a pretty big customer for you. So maybe you could touch on those 2 things and have a follow-up on margins.

Jeffrey A. Craig

Patrick, this is Jay Craig. I think in Europe, what we are cautioned by is that in the U.S., if you recall, the most recent recession offset any benefit of an expected prebuy back in 2010. So we have seen a similar condition occur. And so I think that's really the issue that we see why we're a bit cautious in Europe. It's just -- and I think that is consistent with our largest customer, Volvo. If you read some of their latest earnings announcements and through our discussions with them, they are starting to have that same caution as well. And then I'm sorry, if I could just have you repeat the question on margins, that would be helpful.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Well, I didn't ask yet. Actually I just wanted to find out whether Navistar was an issue in terms of how you're looking at North America was the kind of the second part of the question, just given the transition of the 13-liter engine next year, which could potentially affect their share, and they're a big customer.

Jeffrey A. Craig

Well, we have seen, I think, as you're reading, some fairly material market share shifts in North America. But I think as we've always stated, I think the great benefit we have with our current business model is we are standard vision [ph] effectively on 3 of the 4 OEs. And the 3 have large fleet exposure. So I think you can even -- if you box our revenues to what we performed this year in North America as compared to the industry, you can see we've had very little impact to that market share shift. So we just continue to work closely with all 3 of our customers and try and support their success as best as we can.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Okay, great. And then just quickly on margins, if I may. I believe your guidance implies a decremental of about 15%, which is pretty good, just given the extent of the revenue decline that you're forecasting. And also just in the context of having a mixed headwind from slower Industrial -- or military rather. So is what's going on there really just kind of digging deep into more restructuring actions in Slide 11? Or is there anything else that I'm not sort of factoring in there as we think about that number?

Jeffrey A. Craig

Just a few things. I think obviously, the adjustments to the fixed costs that we continue to make just recognize the realities of government spending in our markets. I think it's had a very significant favorable impact. I think our team has done a great job of staying ahead of those issues. I mean remember, FMTV doesn't go away for almost 2 years. But we're almost 24 months ahead of time taking the actions necessary to adjust to that environment. And also, though, we've seen some great benefits from the price increases we've put in last year. The closure of our Saint Priest facility in Europe and we're getting the fourth quarter benefit of that. We only got 3 quarters of it last year. And also we've had some great material performance out of our purchasing team. We're really getting on stride, getting our stride and affecting material cost reductions that are not just related to just the index [ph] reduction.

Charles G. McClure

Patrick, this is Chip. And hopefully, what we demonstrated in the last 4 to 5 quarters is the fact that we do respond proactively as opposed to reactively to what we see in the market conditions. And to kind of reinforce what Jay said, the FMTV doesn't really wind down for another 2 years. But we're trying to do that proactively at this point. And that is part of what you're seeing as you look at that kind of margin walk going forward. And hopefully, the last 4 to 5 quarters have demonstrated our team's ability to be able to do that.


Your next question comes from the line of Tim Denoyer from Wolfe Trahan.

Timothy J. Denoyer - Wolfe Trahan & Co.

If I could ask the margin/Navistar question in a little bit of a different way. With their Garland facility closing in, I guess, the near-term, can you give us a sense of -- if that's going to have any sort of outsized impact on margins in the fiscal first quarter or fiscal second quarter and maybe that margin impact recedes through the year? And from a logistical standpoint and/or materials cost, could there be any efficiencies there as you adjust to that?

Jeffrey A. Craig

Tim, this is Jay. Good question. We are studying that impact. Obviously, we serve Navistar's Mexican facility, which is expected to be the significant beneficiary of that transition of production out of both our joint venture in Mexico and our wholly owned operation. So we do have local production to serve their needs. So I don't think we're as concerned about the logistics cost as we are just kind of the legal structure of some of those earnings going through our joint venture in Mexico. And we're still analyzing that. But I think you can take away that in our guidance we've anticipated the impacts of that change that should occur later in our fiscal year.

Timothy J. Denoyer - Wolfe Trahan & Co.

Okay. And another follow-up on Brazil. It did seem like a lot of that European OEMs were fairly constructive on orders in the quarter and we started to see at least October sales looked a little bit better. I was wondering, I guess, why you're not seeing a pickup until, I guess calendar second quarter. I think maybe perhaps it was [indiscernible] who actually said that some of the current incentives would require delivery during the calendar first quarter of the year. And I'm just wondering, obviously, there's always a lot of uncertainty around Brazilian incentives and when they'll be extended, but yes.

Jeffrey A. Craig

This is Jay. [ph] We're reading the same things you are and we're having conversations with our customers in Brazil. And I think the overall impression of that market is mixed. I think you're seeing some people see the increase in October registrations to be a very positive sign as are we. But we just are a bit cautious whether that is the signal that there's a long-term recovery coming in the market. And the other item to keep in consideration that I mentioned earlier in the Q&A is because of our September 30th fiscal year, our first fiscal quarter ends here in December. And even for the people seeing the market, I think, on the more favorable side, they expect that benefit in the new calendar year. So that there's a little bit of mix and match on fiscal versus calendar year relative to our guidance.

Charles G. McClure

And just to reinforce, Tim, we have seen obviously, as you've indicated the last couple of weeks, that kind of uptick and it's probably a little too early to call it that way. But as Jay said, we are getting through the first quarter already, so it's really in the second and third quarter. But as we met with a lot of our customers both there and also at the Hannover truck show, there is optimism as you look at it going into 2013 because of the fuel availability and also the government's actions that they're taking to stimulate these moves. So we certainly feel it is going to occur, it's just a matter of the timing of when it does occur.

Timothy J. Denoyer - Wolfe Trahan & Co.

Okay. And then one more quick one on Wabash. I'm guessing, even though you weren't standard on Wabash trailers prior to this recent contract win, that you still had a pretty decent percentage of their production just from customer spec-ing activity. Can you give us a sense of sort of what the incremental increase...

Charles G. McClure

Now first of all, Tim, your statement is fairly correct. I mean, we were a fairly large supplier to them prior to having standard position. So it's more just kind of a reaffirmation by our customers through long-term commitment on that. But I think your statement is that so. So there is some incremental increase that way, but a lot of that was already reflected in the sales we were getting prior to having standard positions. So it's more a recognition of both our customers and our customers' customer support for our products in the trailers.

Timothy J. Denoyer - Wolfe Trahan & Co.

Okay. Any sense of -- are you going from 30% of their production up to 80%? Or is it something smaller than that? Or can you maybe have any...

Jeffrey A. Craig

I think, Tim, our plan is on February 5 at our Analyst Day, we're going to be providing a little more detail on all the wins we've had the prior 12 months and what we think the potential impacts are on increase in market share or revenue.


Your next question comes from the line of Robert Kosowsky from Sidoti.

Robert A. Kosowsky - Sidoti & Company, LLC

I was wondering on this Eaton lawsuit. Is this the final appeal that they can do? Or can they still take that to the Supreme Court?

Charles G. McClure

Yes. They can still take it to the Supreme Court if decide to do that. But at this point, it appears like the activity is taking place at the district court as far as where it's been remanded back to circuit court. So yes, there is still that one final ability if they want to go to the Supreme Court. But at least at this point, as I kind of indicated, discussions are already starting back at the district court level, so expect it that way.

Robert A. Kosowsky - Sidoti & Company, LLC

So that's a positive indicator that it might not escalate, but you still don't fully know yet?

Charles G. McClure

Still don't know. But yes, I would view that as positive. And obviously, the actions in the last couple of months we view as positive, too.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. Then do you need to share any these benefits when you do get some renumeration with your former JV partner? And is this going to be taxed at all?

Charles G. McClure

The answer is yes. This was done jointly with our partner, so it would be done that way.

Jeffrey A. Craig

Obviously, we have very significant NOLs in the U.S., so we -- the tax charge for us would be very de minimis.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. But should we assume like a 50-50 split with the JV partner?

Jeffrey A. Craig

I don't think we've disclosed -- obviously, there's compensation to our attorneys. There's compensation to the partner. We haven't disclosed the arrangements we have with those parties.

Charles G. McClure

And Robert, the other thing I'd also mention, back to the Supreme Court appeal, and I am by no means a legal expert. But my understanding is that they really do accept very few appeals to go to Supreme Court. So I feel pretty good that from a circuit court, being remanded back to district court.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. But you're not ready to give any kind of guidance as to how much the split would be with...

Jeffrey A. Craig

No. Obviously, gain contingencies would be great. But we're operating the business as if it's 0. And any benefit of that would just go towards our long-term goals of deleveraging the balance sheet. So that's how we’re treating it.

Robert A. Kosowsky - Sidoti & Company, LLC

And then 2 other kind of free cash flow questions. I guess first off on CapEx for next year. What programs did you pull back on? And are you taking advantage of any of the cyclical weakness to rebuild any machines? Or do you think everything is okay for the next upturn?

Jeffrey A. Craig

We think the guidance we gave for next year is above our ongoing depreciation and amortization. So I wouldn't think of it -- I would think of the last few years as being fairly heavy investment periods, and we're really getting more back to normal than the opposite. So I don't think -- as we've looked at the plan, we feel like we're significantly constraining capital investments that we think are required to keep to increase our margin and increase productivity.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. So all production capacity looks to be okay if you do get an uptick in volume. There's not going to be any kind of rebuild situation like we had last year.

Jeffrey A. Craig

We think better than ever, we -- obviously, we have some operational hiccups almost 2 years ago now. But we have been operating in an extremely volatile environment very effectively for almost 2 years now. So I think we are very confident in our ability to...

Charles G. McClure

And as a small microcosm that I indicated with this ramp-up on the FMTV, the military program, which we were able to do. And again, as both our internal production and with our suppliers, I think we clearly demonstrated the ability to kind of manage that ramp-up very effectively.

Robert A. Kosowsky - Sidoti & Company, LLC

Okay. That's helpful. And then finally for free cash flow for next year, do you see free cash flow being an outflow in the beginning of like this next quarter and the quarter after just based upon the securitizations still come down with volumes? Or do you see inventories...

Jeffrey A. Craig

That's a good question, Rob. I think as you typically see with us, the first quarter is usually an outflow. I don't think we anticipate anything that will change that pattern. And it has to do with obviously Europe, we intend to see some securitization outflow from the volume shifts in the first quarter, the holiday period. As I've mentioned before, some of -- a lot of our customers are calendar year end. Some of those payments seemed to arrive a day or 2 after the end of the calendar year. So we tend to see an outflow in the first fiscal quarter, but that's all incorporated in our annual guidance.


Ladies and gentlemen, we have come to the end of our Q&A session. I would now like to turn the conference back over to Ms. Christy Daehnert for any closing remarks.

Christy Daehnert

Thank you for your time and attention on today's call. Please feel free to follow up with me directly with any additional questions you may have. And that concludes today's call.


Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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