Meritor's CEO Discusses F1Q 2013 Results - Earnings Call Transcript

| About: Meritor, Inc. (MTOR)

Meritor, Inc. (NYSE:MTOR)

F1Q 2013 Earnings Conference Call

January 30, 2013; 09:00 a.m. ET


Chip McClure - Chairman, Chief Executive Officer & President

Jay Craig - Chief Financial Officer

Christy Daehnert - Director of Investor Relations


Brian Johnson - Barclays Capital

Brett Hoselton - KeyBanc Capital Markets

Timothy Denoyer - Wolfe Trahan & Co.


Good day ladies and gentlemen and welcome to the first quarter 2013 Meritor earnings conference call. My name is Taheisha and I’ll be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session (Operator Instructions).

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 Taheisha. Good morning everyone and welcome to Meritor’s first quarter of fiscal year 2013 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 expressed 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 two 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 will find the reconciliation to GAAP in the slides on our website. Before we begin, I’ll point out that today’s presentation will be slightly abbreviated due to our scheduled analyst event in New York on Tuesday, February 5. We are looking forward to providing you with more detail at that time.

Now, I’ll turn the call over to Chip.

Chip McClure

Thank you Christy and good morning everyone. Let’s turn to slide three.

I’ll start our call today by announcing three key executive appointments. I’m pleased to tell you that Jay Craig has been appointed Senior Vice President and President of Meritor’s Commercial Truck & Industrial segment. Most recently Jay was our Chief Financial Officer with additional responsibility for Treasury, Tax, Purchasing, Information Systems, Investor Relations and Communications.

Jay’s experience and success in leading each of these disciplines, as well as his operations background at GMAC and at Meritor will play an instrumental role in the turnaround of the Body Systems business prior to its sale, makes him the perfect candidate for this position.

Tim Bowes, who formerly held this position has accepted a CEO position with Transtar Industries. We wish Tim all the best in his new opportunity. Replacing Jay in his role of Chief Financial Officer is Kevin Nowlan, Meritor’s current Vice President and Controller, and he has been in that position since 2010. Prior to that Kevin also held the positions of Treasurer and Vice President of Shared Services. Prior to joining Meritor he was the Director of Capital Planning at GMAC.

I’m also pleased to tell you that Brett Penzkofer, who many of you know, will become our new Controller. Brett has held a number of financial roles since joining us in 2006. Before that he served in various finance positions at DaimlerChrysler. We have been diligent in building the bench strength of our management team and are confident these moves will continue to enhance the company’s performance.

Turning to slide flour, our financial performance in the first quarter of fiscal year 2013 was slightly below our expectations, due primarily to greater than expected weakness in our major global markets.

As we told you last quarter, the general market weaknesses we’re seeking is being driven by continued recessionary forces in Western Europe, slowing truck production volumes in North America and reduced infrastructure investment in China and India. As we review the global market outlook, you will note that Meritor’s forecasts are more conservative than others. While the markets are challenging to predict, we use all available data to forecast production in these markets as closely as possible.

Over the past several quarters we have been correct unfortunately in identifying these downward trends. To offset the volume declines we are experiencing globally and the anticipated margin impact of the FMTV program winding down in late fiscal year 2014, we have taken several aggressive steps to manage costs during the past three months.

In November, we initiated variable labor reductions. Overall we adjusted our global headcount by approximately 800 people. As we noted in our fourth quarter call, this included 50 salaried and 750 hourly workers, Commercial Truck, Aftermarket and defense facilities were affected.

Also in November we announced plans to consolidate the production operations from our remanufacturing plant in Mississauga, Ontario into our remanufacturing facility in Plainfield, Indiana by March of this year. This action resulted in the elimination of an additional 85 positions in our Canadian manufacturing facility; 65 of those positions were transferred to our Indiana facility, resulting in a significant efficiency improvement.

In January we initiated an action to reduce our fixed cost structure by eliminating approximately 200 salaried positions that included full time employees and contract workers. This restructuring action followed our November announcement indicating we revised our structure to report the future results under two segments; Commercial Truck & Industrial and Aftermarket & Trailer.

Beginning today with the first quarter of fiscal year 2013, we are reporting our financial results under this new structure. As I said, we are taking aggressive actions to align the business with the demand we are forecasting in our global markets through fiscal year 2013. While we understand the impact of these actions on our workforce, we are committed to taking the necessary steps to drive greater levels of efficiency across the company. We will provide you with more details on the charges, benefits and timing associated with these restructuring actions at our analyst event on February 5.

Now, let’s turn to slide five for a year-over-year comparison of our first quarter financial performance. Revenue was $891 million in the first quarter, a decrease of $268 million or 23% from the first quarter of fiscal year 2012. This decrease was primarily driven by lower commercial truck production globally.

Adjusted EBITDA decreased $33 million in the first quarter of fiscal year 2013 to $46 million, compared to $79 million a year ago due to the significant decline in sales we experienced this quarter. However, the downside conversion on this revenue decline was limited to 12%, due in large part to the benefits associated with lower material costs and the actions we have executed during the past 12 months.

Adjusted income from continuing operations was negative $11 million, a decrease of $22 million, which also reflects the impact of lower sales and EBITDA. Adjusted earnings per share from continuing operations was negative $0.11 down from positive $0.12 in the prior year.

Free cash flow from continuing operations before restructuring was negative $91 million, down from negative $10 million in the first fiscal quarter of 2012. This decrease in free cash flow was primarily due to higher working capital this quarter.

Let’s now turn to slide six to review our forecasted commercial truck production volumes for fiscal year 2013. In North America, Class 8 orders in the first quarter were in line with internal expectations. The backlog to build ratio, which measures how long it would take truck makers to assemble all trucks ordered but not yet built is currently 3.2 months according to the ACT. This ratio appears to be trending upward, but remains weak. At this time market indicators are in line with our forecast of approximately 230,000 Class 8 units in fiscal year 2013, down approximately 22% year-over-year.

Our forecast for fiscal year 2013 in South America has improved with production projected to be relatively flat to prior year at 166,000 medium and heavy units. As you’ll remember from our last earnings call, we were previously expecting the medium and heavy-duty commercial truck market in South America to be down approximately 5% year-over-year. We believe government incentives in the region are beginning to have a positive impact.

It was announced in December that the FINAME financing program was extended through the end of 2013. Reductions in truck and bus inventories are promoting more optimistic order boards and truck inventory is back to a normal range of approximately a three-month supply.

In Western Europe we are forecasting medium and heavy-duty truck volumes to decrease in fiscal year 2013 to 368,000 units, roughly a 5% to 10% decrease year-over-year. OEMs have significantly reduced the production in the first and second quarters of fiscal year 2013, but we expect that to stabilize in the second half. Due to government incentives, a pre-buy effect is not expected in fiscal year 2013 from the Euro 6 emission change effective January 2014, as we referenced in our call last quarter.

Now let’s turn to our industrial markets update on slide seven. In China we believe the decline of the construction volumes year-over-year may be more significant than anticipated last quarter. Our opinion at this time is that any recovery in this region during fiscal year 2013 will not be meaningful.

A high level of inventory at the OEMs is impacting demand for off-highway vehicles, including cranes, loaders and other excavating equipment. Mining growth also continues to weaken due to lower levels of energy consumption and low commodity costs. While we believe the market may begin to recover late in the year, it will take a period of time for an up-tick to materialize into production for Meritor, due to the current level of vehicle inventory in the channel. Based on this data we have reduced our forecast to 190,000 units for the 2013 fiscal year, down from 200,000 units we forecasted last quarter. This represents a 10% to 15% decline year-over-year.

Since our discussion last quarter, India is showing the most significant change in market dynamics. Actions by the government to stimulate the industry are not expected to create the level of improvement we previously thought.

You will remember that we forecasted the medium and heavy-duty truck market in the region to be up approximately 4% year-over-year at 348,000 units. We are now forecasting a year-over-year decline of 15% to 20%, resulting in approximately 258,000 units in fiscal year 2013. It’s worth noting that India is currently a volatile market that is difficult to accurately forecast.

LMC, formerly J.D. Power also substantially decreased their expected industry production by approximately 20% compared to the prior forecast. There is no change to our defense business since our discussion in November. As I mentioned earlier in the call, we’ve initiated restructuring actions to help mitigate the margin impact of this decline.

Looking at slide eight, we continue to believe revenue from aftermarket will remain basically flat year-over-year. North America order in-take is stable; however, Europe continues to be weak. We believe revenue in the second half will improve due to seasonality and additional selling days.

We are forecasting the Trailer business to be flat to slightly up year-over-year, although we are not quite as bullish as we were last quarter due to some softening in orders recently. At this time, we anticipate 245,000 units in fiscal year 2013, versus our prior forecast of 250,000 units, approximately a 3% increase over fiscal year 2012.

Slide nine reinforces the point that we now believe production volumes in three of our addressable markets will be weaker in fiscal year 2013 than we predicted in November. They include medium and heavy-duty truck production in Europe, medium and heavy-duty truck production in India, and construction volumes in China.

Please note that while these markets are showing more weakness than we anticipated in November, nearly all of our markets are forecasted to be down or flat year-over-year. This type of market cyclicality is typical in our industry.

Although we operate under significant uncertainty, we are confident that the proactive measures we are taking to reduce our fixed cost structure will allow us to maintain the margin improvements made over the last several years and minimized cash outflow. As always, we closely monitor all of our end markets and we’ll continue to take appropriate actions to mitigate the effects of this global weakness.

Now, I’ll turn the call over to Jay.

Jay Craig

Thanks Chip and good morning everyone. On today’s call I’ll review our first-quarter financial results and provide an update on our 2013 guidance.

On slide 10 you will see our first-quarter income statement from continuing operations compared to the prior year. Sales of $891 million in the quarter were down significantly year-over-year by $268 million or 23%. The decrease was due primarily to lower commercial truck production in all regions and a production step down in our China off-highway business.

On our last call we indicated that our revenue and EBITDA would be the lowest in our first quarter, but this level of production was still lower than our internal projections, particularly in Europe and Brazil.

Gross margin was down $23 million due to the steep decline in sales; however, gross margin as a percent of sales was slightly higher in the first quarter of 2013. The improvement is a direct result of our lower material costs and the margin enhancing actions completed last year, most notably pricing and the shrinking of our European manufacturing footprint.

SG&A was $62 million in the first quarter of 2013, almost 5% lower than the prior year, as we continue to reduce the fixed cost structure of the business.

Restructuring costs were $6 million this quarter, primarily related to two items; the announced consolidation of our remanufacturing facilities Chip mentioned earlier and the variable labor headcount reductions in the Commercial Truck & Industrial segment, in response to weaker market conditions in certain regions.

This quarter’s restructuring costs were $18 million lower than the first quarter of 2012, which included costs associated with selling our French assembly operation back to Renault. Restructuring charges are excluded from adjusted EBITDA.

Other income in the current period was zero versus $4 million earned last year when we recognized a non-operating gain, primarily related to the cash sale of our remaining interest in Gabriel India.

Earnings in minority owned affiliates were down again this quarter from the prior year by $6 million or 40%. This decrease was driven by lower earnings in our joint ventures in Mexico and Brazil due to the softer economic conditions in both markets.

Interest expense was $29 million in the first quarter of 2013, $5 million higher than the prior year. The company recently repurchased approximately $245 million of the $300 million principal amount of our convertible notes due in 2026 and recognized a $5 million loss on debt extinction.

Income tax expense was down substantially when compared to 2012, due primarily to lower earnings in jurisdictions in which we recognize tax expense such as Brazil and China. All of this resulted in an adjusted loss from continuing operations of $11 million or $0.11 per share, compared to adjusted income of $11 million or $0.12 per share in the same period last year. The decrease in 2013 was primarily associated with the impact of substantially lower revenue and the reduction in affiliate earnings.

On the next few slides, I will discuss the quarterly results for our two business segments under our new reporting structure. Slide 11 shows first quarter sales and segment EBITDA for Commercial Truck & Industrial. As I mentioned earlier, production volumes year-over-year for heavy and medium duty trucks were lower in every market we serve. The most significant year-over-year decreases were seen in Europe and Brazil. The weakening of the European market beyond our original expectations is already affecting our outlook for the remainder of the year.

Brazil is a different story as Chip reviewed earlier. The market seems to be recovering earlier than projected, which is helping to slightly offset Europe’s decline. We had some tough comparables year-over-year in Brazil due to the small pre-buy before January 2012, emissions change from Euro 3 to Euro 5. As a result our production in the first quarter of last year was very strong, but much lower in the following four quarters, including the first quarter of this fiscal year.

While production is on an upward trend, the impact of the industry transition to Euro 5 emission standards last January, and the overall weakness in the Brazilian economy, resulted in lower production for us in our first quarter of 2013. Again, we are feeling much better about the outlook in this particular region, but we expect it will take some time for the production to ramp back up to levels seen in years past.

Sales in the first quarter of 2013 were $715 million, down $260 million from the same period last year. Segment EBITDA was $34 million, a decrease of $27 million year-over-year. The decrease in EBITDA and significantly lower sales or what we call downside conversion was limited to 10% for the segment. This was due primarily to lower material costs and the actions executed in 2012, most notably pricing and the shrinking of our European manufacturing footprint. These margin-enhancing actions largely offset the revenue headwinds previously discussed, including weaker affiliate earnings from our joint ventures in Brazil and Mexico.

Next on slide 12 we summarized the Aftermarket & Trailer segment financial results. Based on our revision to the operating structure of the business, this segment no longer includes the financial results of South America and Asia Pacific aftermarket, as that has now been consolidated into Commercial Truck & Industrial segment results. The prior period has also been restated to reflect this reporting change. This equates to about $80 million of annual revenue that is now reported in the Commercial Truck & Industrial segment.

Sales were $203 million, $15 million lower year-over-year. The decrease was primarily due to lower aftermarket sales in North America. Segment EBITDA was $13 million, a decrease of $4 million year-over-year, but downside conversion was approximately 26%, which is fairly consistent for this business, especially since the affiliate earnings in our trailer joint venture in Brazil were down, which has a direct impact on our EBITDA, with no corresponding impact on sales.

Moving to slide 13, I will summarize our sequential performance and then provide greater detail for our adjusted EBITDA on slide 14. Sales in the first quarter of 2013 were $891 million, a decline of $95 million or approximately 10% from the fourth quarter. This decrease in revenue was primarily due to weaker sales in North America truck, FMTV and aftermarket.

Adjusted EBITDA was $46 million, down from $79 million in the prior quarter. This decrease of $33 million quarter-over-quarter was driven by the significant decline in revenue. Adjusted income from continuing operations was a negative $11 million, a $42 million decrease from the fourth quarter. Adjusted earnings per share from continuing operations in the first quarter were negative $0.11, down from the $0.32 in the prior quarter, also due to weaker sales and EBITDA.

Free cash flow from continuing operations before restructuring was negative $91 million, a decrease of $128 million quarter-over-quarter, primarily driven by lower earnings and higher working capital.

Now let’s move to slide 14, which shows a sequential adjusted EBITDA lock from our fourth fiscal quarter of 2012 to the first quarter of 2013. Walking from the $79 million of EBITDA generated in our fourth quarter, we had $30 million less EBITDA due to volume and mix, which was by far the most significant impact to us in the first quarter.

The sequential reduction in sales was primarily seen in North America truck, aftermarket and FMTV. The negative mix was associated with FMTV, as our production took a step down of over 30% sequentially. We expected this in our internal planning and we are forecasting to maintain roughly this level for the next two quarters with another significant step down in our fourth quarter of 2013.

Next we saw lower EBITDA, versus the prior quarter of $2 million, related to net material costs. We have reported favorable material costs in recent quarters, partially driven by modestly declining steel prices. While we are still seeing reductions in material costs, we have contractual pass-through mechanisms with our large OE customers, under which we flow through the benefits of the reductions and index steel costs.

If you remember, there is a pass-through or recovery lag of about one quarter on average with our customers in North America. These pass-through mechanisms are now catching up with those declining steel prices, requiring that we pass-through those reduced costs to our customers through lower prices.

And finally we have an all other decrease in EBITDA when comparing to the prior quarter of $1 million, resulting in adjusted EBITDA of $46 million in our first quarter. This includes $6 million of improvement relative to the fourth quarter, related to a value-added tax contingency charge associated with certain aftermarket sales transactions trued up in the fourth quarter that did not repeat in the first. The favorability was more than offset by a combination of several negative factors, including foreign exchange and lower earnings from our minority owned joint ventures.

While our year-over-year downside conversion on lower sales was 12% this quarter, our sequential downside conversion was about 35%, which is much higher than the typical 15% to 20% we told you to expect in changes from revenue.

The past two quarters we reported a decline in sales, but were able to minimize that downside conversion to 10% or better. Unfortunately, this quarter we saw significant mix impacts resulting from the decreases in FMTV and Aftermarket, two of our most profitable businesses that we were unable to offset in the quarter. However, the January 8 restructuring announcement and resulting reduction of 200 salaried positions should have a measurable impact going forward, even on this trough level of revenue.

The benefit of the recent reductions announced in January was intended to substantially mitigate the margin impact of lost FMTV production occurring at the end of the fiscal year 2014. Our proactive response to these reductions will now help us partially offset the profit impact to the revenue headwinds that continue to impact our business in 2013, which as we mentioned are below what we originally projected.

Slide 15 summarizes our income tax expense for the first quarter of 2013. Our effective tax rate on income not subject to valuation allowances was 28%. Our total effective tax rate was negative 167%, as the loss in jurisdictions with valuation allowances more than offset income just mentioned.

In 2013, we do expect the majority of our income will be in regions with no valuation allowances, therefore we’ll be moving to a directional guidance on income tax expense for 2013, versus using an effective tax rate that isn’t very meaningful, and I’ll discuss this in a few slides.

Now, let’s turn to slide 16. For the first quarter free cash flow from continuing operations before restructuring was negative $91 million, $81 million lower than the same period last year. This was driven primarily by higher networking capital, including the decrease in factory.

With volumes declining so rapidly the last couple of quarters, we have been unable to drive inventory down fast enough. We manage inventory down to be in line with current production requirements, but this is a process that takes time, especially as production has continued to decline rapidly for several quarters in a row.

In addition, we did intentionally build selected inventory banks in the United States, to mitigate the risk of a potential dockworker strike that was avoided, and in Brazil to prepare for the ramp-up in production occurring this quarter. Total free cash flow for the first quarter of 2013 was a negative $106 million, $86 million lower than last year, primarily due to the reasons just mentioned.

Next I’d like to review our fiscal year 2013 outlook on slide 17. As Chip discussed earlier, the demand assumptions for many of our key end markets in 2013 are much weaker than we hoped, and have taken another step down from when we last spoke in November.

As a result, we now expect sales in fiscal year 2013 to be approximately $3.8 billion, down around $600 million from 2012 and $200 million lower than we were expecting in November. Our revenue outlook is based on our market assumptions that Chip outlined on slides six through nine.

Last quarter when providing our initial 2013 guidance, I stressed the significant volatility in many of our addressable markets and that volatility continues to be a net negative, especially in Europe, China and now India. However, even with our revised revenue assumption for 2013, we still expect to earn an adjusted EBITDA margin of approximately 7%.

When we gave the 2013 guidance during our November call, we stated that the benefit of the business segment rationalization formalized on January 8 was not included in this guidance.

Further with $4 billion of revenue, we expected to adjust the 7% margin up after we had quantified the restructuring benefit at our February Analyst Day. We now expect these savings, which begin in our second quarter to offset the EBITDA margin impact of $200 million of less revenue. The full impact of the cost reductions will be discussed next week as we committed back in November.

We are also maintaining our adjusted earnings per share from continuing operations at $0.25 to $0.35 for 2013. Free cash flow from continuing operations before restructuring is expected to be slightly negative, down from our original projection of about breakeven.

Now, let’s turn to slide 18 for a wrap-up with some of our key planning assumptions. 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, but still investing to drive operational efficiency and productivity improvements.

Interest expense is now expected to be in the range of $95 million to $105 million, higher than our original guidance due to the new convertible debt transaction recently executed. Cash interest payments are unchanged at $75 million to $85 million and cash income taxes are now expected to range from $45 million to $55 million for 2013, as our production outlook for China and India have come down.

As I mentioned earlier, we are no longer providing an estimate for our 2013 effective tax rate, but we do expect income tax expense to approximate the low end of the cash tax guidance. As we discussed on our November call, we will provide you with details of the cost reduction actions and corresponding restructuring cash guidance for 2013 at our Analyst Day on February 5.

Now, I’ll turn the call back over to Chip, where he will summarize Meritor’s 2013 priorities.

Chip McClure

Thank you Jay. Let’s turn to slide 19. As highlighted this year, we are challenged with significant volume pressures. As such, we are closely managing and taking actions associated with each of the priorities we identified this fiscal year. We are adjusting our global work force as needed to align with market demands in each region.

Earlier in the call we noted several restructuring actions that we executed in the first quarter and early in the second quarter of this fiscal year. As we see our markets start to rebound like in South America, we remain focused on execution. This includes managing capacity, pricing for value, investing intelligently and maintaining high levels of quality, safety and delivery. We will remain focused on rigorous cost management and will take necessary actions to ensure we are managing the business at an optimal level.

We continue to implement appropriate balance sheet strategies such as the successful convertible transaction we completed in the first quarter of this fiscal year. We’ll hear more about these strategies from our Treasurer, Carl Anderson, next week in New York, and we are working hard to maintain our leading market share positions in all regions of the world.

We are committed to developing new technologies and products, specifically in the areas of safety, fuel economy and environmental, and we will prioritize those that provide high value to our customers, including drivers, owner operators, fleets and OE’s that work in global applications and enhance our margin.

We look forward to seeing you at our analyst event in New York on February 5.

Now, we’ll take your questions.

Question-and-Answer Session


Thank you. (Operator Instructions). Your first question comes from the line of Brian Johnson from Barclays. Please proceed.

Brian Johnson - Barclays Capital

Yes. Just want to go through and just sort of at a higher level, it sounds like when you talk through the sequential decline and just where you landed this quarter, that FMTV and military was roughly where you expect. I wanted to just -- one, was FMTV and military roughly where you can expect it and is the miss versus consensus, anything just maybe us getting the cadence wrong?

Two, was vis-à-vis your expectations, was this mainly a volume gain impact in the quarter? And then three, where do you stand on rolling through contractual adjustments, price increases and other reengineering efforts and their ability to offset some of these volume pressures?

Jay Craig

Sure. Thanks Brian, this is Jay Craig. I will answer the questions sequentially. You are correct and as far as our expectations for revenue, I think FMTV as I mentioned in my comments, came in where we expected. I think the markets that came in a bit shorter than we expected were primarily in Europe, North American aftermarket and in India. So those markets came in weaker than we expected.

I think particularly in Europe and India, those markets have been very difficult to call for us, as well as I believe everyone in our industry as I have interacted with them and read their comments publicly. So I think that’s where as we looked at it sequentially from Q4 to Q1, where the adjustments were.

As far as volume and how we react to that, obviously there is a big impact from our equity earnings and JVs. Also those come through pretty heavily as we see volumes movements in North America and Brazil, and then as we look at the contractual price downs, we usually see the largest impact of those in our first quarter. Some of our contracts, particularly outside the U.S. still have some annual provisions in them, so they tend to be heaviest, the adjustments for those in our first fiscal quarter and we expect it to abate somewhat as the year goes on.

As far as how we react to it, we had a very good quarter operationally in terms of the reducing material costs where we can control that. We actually are on our expectations, which were quite aggressive for that for the year. And also in our labor and burden improvements in our plants, are actually on are very, what we thought were aggressive planning assumptions.

And then as both Chip and I mentioned in our comments, the actions taken on January 8 should help us significantly in reducing SG&A and fixed costs, so we do see our ability to expand margins sequentially benefiting quite significantly from those actions.

Brian Johnson - Barclays Capital

Okay, and in terms of the equity income, can you just maybe recap if we kind of compare the $9 million this quarter to the $15 million a year ago, sort of what the major sources of change were?

Jay Craig

Yes, the major sources of change would be as you would expect in Brazil and the U.S. So they would be our two JV’s with the Randons in the Brazilian market, one in the breaking area and one in trailers, and then obviously the Meritor Wabco JV and our Mexican JV, Sisamex. So those are the big JV’s with probably a lesser extent of an impact from our Indian JV, AAL and our Chinese JV was roughly flat.

Brian Johnson - Barclays Capital

Okay, so when you think about sequential or year-over-year incremental margins, because that’s a significant driver, how should we think about kind of teasing that out when we think about the volume effect on EBITDA?

Jay Craig

The earnings tend to move pretty well correspondently to the movement in markets. So our expectation as you can see from our guidance is that for example the Brazilian market strengthened sequentially throughout the year. So I think we expect and you should expect that the two JV’s in Brazil and performance should improve throughout the year as well.

That is also our assumption in North America Truck, the strengthening in the back half of the year, so you should expect our JV’s there to perform more strongly as the year progresses.

Brian Johnson - Barclays Capital

Okay, thanks.

Jay Craig

Thank you.


Your next question comes from the line of Brett Hoselton from KeyBanc Capital Markets. Please proceed.

Brett Hoselton - KeyBanc Capital Markets

Good morning.

Jay Craig

Good morning Brett.

Brett Hoselton - KeyBanc Capital Markets

Let’s see here. Yes, just kind of tailing onto Brian’s question, maybe kind of taking it from a little bit different tact, I guess my first question is cadence of sales through the remainder of the year. If I take $3.8 billion divided by 4, I get $950 million. Obviously you are at $890 million for this quarter and so the expectation seems to be that your sales are going to improve as you move through the year. So can you talk a little bit about the cadence of production and the cadence of sales as you move through the year?

Jay Craig

Brett, this is Jay again and good morning. I think if you recall in our fourth quarter, we showed a four-panel chart that showed for the key markets what our volume expectations were by quarter, represented by lines in those charts. We will be updating that for our Analyst Day on Tuesday and showing that to the audience on that day.

But just as a preview for that, I think we expect that as we move to the second quarter, the revenue should be fairly similar to this quarter and then a recovery in the third and fourth quarter, driven primarily by three main markets, North America, South America and the aftermarket.

We expect that China and India will roughly be flat for the year and I would add, that’s really the biggest change to our guidance from what we are speaking about today as compared to November.

As you may recall, we expected a recovery particularly in China in the back half of our fiscal year, but we have kind of now flat-lined our expectations for the rest of the year and I think you are seeing out in the marketplace people having great difficulty forecasting how the Chinese construction market will perform for the rest of the year and so we thought it best to drive the business on the assumption that it’s just flat for the rest of the year and push the business internally based on those assumptions.

Brett Hoselton - KeyBanc Capital Markets

Thank you. And then from a margin standpoint, similar question. Obviously reporting adjusted EBITDA margins of 5.2% in the first quarter to get to 7% for the year, you have to track out the remainder of the year at 7.6 % and so how should we think about the cadence of margins?

It sounds like restructuring is going to play a fairly large role. That is going to have a partial impact on the second quarter and then it sounds like your sales are going to be higher in the third and the fourth quarters. So it sounds like maybe we see kind of a sequential increase in margins as we move from the first to the second to the third and into the fourth quarter.

Jay Craig

Yes, I think there’s a couple of big things and we’ll walk you through in detail that next week, actually. It will be Kevin Nolan walking through that and you will see really two big impacts; the one you mentioned being the restructuring. It was very, very significant, that restructuring.

As you may recall, we expect it to offset the entire margin loss for the difference between our margin on FMTV and our Commercial Truck products, so a very significant restructuring. We’ll walk through the details of that on Tuesday and the expected quarterization of that. We’ll give a rough idea of how that plays out.

The other big move unrelated to volume as we have previewed earlier is we implemented fairly significant pricing actions in our aftermarket business on January 1. Those have a little bit of a lag effect, as you would expect. Our customers react to knowing that and tend to pre-buy a little and then we tend to see the benefit of that begin towards the end of January and then carry on through the year. So those are two of the biggest movers of our margin, independent of volume.

Brett Hoselton - KeyBanc Capital Markets

Thank you very much.

Jay Craig

Thank you Brett.


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

Timothy Denoyer - Wolfe Trahan & Co.

Hi. If I could just actually start with a quick follow-up on the aftermarket comment on pricing. So would you expect aftermarket sales to take a little bit of a hit sequentially going from 1Q to 2Q?

Jay Craig

We think any negative impact from that pricing will be more than offset in the traditional spring selling season we see for brake replacement. So we think that impact will overwhelm any negative impact from pricing.

In addition, you should remember there’s obviously more selling days in our second fiscal quarter, the first calendar quarter, than in our first quarter, because of the Christmas holiday and those time periods. So I think those two impacts should more than over compensate for any negative reduction in volumes due to the pricing change.

Timothy Denoyer - Wolfe Trahan & Co.

Okay, thanks. And a couple of just questions around -- I guess related questions around cash flow materials in Brazil. With the inventory ending the quarter a little bit ahead of where it seems like you’d like, do you expect that to become a tailwind to cash flow over the next couple of quarters, a little bit more than normal, and then I guess on a related note…

Jay Craig

I’m sorry, Tim. I guess I would say this phrase, it’s better. We are driving the organization very hard and the team is working very hard at getting the inventory out. In their defense, when you get this enormous volatility of customers pulling weeks of production very late in the planning process, inventory can get backed up, particularly as you come through a holiday period, because we tend to build inventory in anticipating of ramping production backup beginning in January. And so in defense of our material handling team, it is a very challenging environment for them when it hit.

Now, and there were also the two major impacts that I mentioned, that I don’t want to underestimate. We did take some defensive actions, knowing that there could have been a dock strike and a large part of our raw materials and our semi-finished materials come from overseas, with long supply lines and we wanted to make sure those weren’t disrupted if there was a dock strike, and we did purposefully build some inventory in Brazil in anticipation of the ramp-up we are seeing, so we are happy we did that.

So we are very focused on that. We do expect that the inventory reduction throughout the year should become a net benefit to our working capital sequentially throughout the remainder of the year.

Timothy Denoyer - Wolfe Trahan & Co.

Thanks, and then a couple of sort of related follow-ups on that. Will materials costs become a little bit of a tailwind to margins, I mean in terms of relative to what materials costs are in that inventory and with the fuel costs that you are seeing or does the backup of inventory sort of mute the benefit from raw materials?

Jay Craig

We will walk you through in detail the purchasing and the expected material cost benefits on Tuesday as well. We continue to have some contractual price refund mechanisms in subsequent quarters, although somewhat more muted than we see in the first quarter as I mentioned earlier. But we are really making very, very good progress on our aggressive material cost reduction efforts and we’ll be walking people through that on Tuesday. So I think we could see it as a tailwind for the rest of the year.

Timothy Denoyer - Wolfe Trahan & Co.

And if I could sneak one more in for Chip, I mean do you see any impact from the announcement recently with Volvo taking a stake in Dongfang? Does that have any opportunities or risks to your business?

Chip McClure

I think it’s just an indication of what I’ll call more the globalization of the market in China. Obviously you continue to look at it. There’s consolidation and there’s also globalization, both of which is taking place in China and I think Volvo and Dongfang are doing that.

Volvo has been and will continue to be and we are looking forward to continuing to be an important customer to us on a global basis. We currently support Volvo in many markets around the world, both here in North America, Europe and in parts of Asia that way. So we are following like the others. But I think so to answer your question, I don’t see an impact that way.

What I do see it is, more in a macro level, but it’s just an indication of the globalization of the truck market in China and what I would envision over time is similar to what we saw in automotive is, will there be some consolidation within the production capacity there at some point in the future? So just more of a step on a macro level. On a micro sense Volvo continues to be an important customer to us and just, we’ll continue to support them.

Timothy Denoyer - Wolfe Trahan & Co.

Great, thanks very much.

Chip McClure

Great, thank you.


Ladies and gentlemen, that concludes the Q&A portion of the conference. I would now like to turn the conference back over to Christy Daehnert for closing remarks.

Christy Daehnert

Thank you for your attention on today’s call. For any follow-up questions, please reach out to me directly, and that concludes today’s call.


Ladies and gentlemen, thank you for your participation. You may now disconnect. Have a great day.

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