ArvinMeritor Inc. F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

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ArvinMeritor Inc. (ARM) F3Q08 (Qtr End 06/30/08) Earnings Call July 29, 2008 8:00 AM ET

Executives

Terry Huch - Director of IR

Chip McClure - Chairman, CEO and President

Jay Craig - CFO

Analysts

Patrick Archambault - Goldman Sachs

Eric Selle - JPMorgan

Brian Johnson - Lehman Brothers

Himanshu Patel - JPMorgan

David Leiker - Robert W. Baird

Brandon Ferro - KeyBanc Capital Markets

Operator

Good day, everyone, and welcome to the ArvinMeritor third quarter fiscal year 2008 earnings conference. At this time to get a start, I am pleased to turn the floor over to Director of Investor Relations, Mr. Terry Huch. Please go ahead, sir.

Terry Huch

Thank you, Operator, and good morning, everyone, and welcome to ArvinMeritor's third quarter 2008 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 www.arvinmeritor.com and we will refer to the slides in our discussion this morning.

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

Let me 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.

Now I would like to turn the call over to Chip.

Chip McClure

Thank you, Terry, and good morning, everyone. Let's begin by saying how proud we are of our global team for the strong results they delivered this quarter. We believe our third quarter results tell a very clear story. Even though we are operating in one of the most challenging markets we have seen in years, we have been able to improve our earnings due to the aggressive actions we have implemented, including significantly reducing our cost, refocussing our business, improving the fundamentals of our operations, and driving a profitable growth strategy.

With a strong global leadership team, and the right focus, we are well positioned to continue executing on our goals and successfully delivering a solid performance. Over the longer-term, we believe that our diversified customer mix, global footprint, and strong product portfolio will continue to help us manage through the short-term challenges in the industry.

Before I discuss our third quarter highlights, I would like to take a moment to recognize Jim Donlon, who is becoming the ArvinInnovation CFO. Jim has been a tremendous asset to the ArvinMeritor team for over three years. We have achieved success in a difficult market, in large part, due to Jim's expertise and commitment. We wish him great things as CFO of ArvinInnovation.

At the same time, we are delighted to have Jay Craig step in as our new CFO. He is ArvinMeritor's Controller for the last two years. Jay has been an integral part of our team. We are benefitting from his knowledge of our business and his experience in the automotive industry. He has been a great help in developing many of the strategies we currently have in place. Jay will be a strong contributor to our success going forward.

Now let's turn to slides 3 and 4 which outline the highlights from the third quarter. First, we are pleased to announce that during the third quarter we earned $0.77 per share from continuing operations before special items, tripling what we earned in the same period last year. We achieved positive free cash flow of $59 million from operations net of capital expenditures for the third quarter. In the fourth quarter, we expect to report our third consecutive quarter of positive cash flow despite the fact that our top line is growing at about 20% year-over-year.

Our sales were $2 billion, up more than $340 million year-over-year due to stronger volumes, increased market share, and currencies outside of North America. Our light vehicle business was another key contributor to this growth. Although LVS sales were down slightly on a constant currency basis, this business was up in total because of its strong presence in markets outside of North America. We also saw sales improve in our commercial vehicle specialty business, including new awards for military products in the United States and off-highway products in China.

We made meaningful progress toward completing the spin-off of our Light Vehicle Systems business which announced on May 6th. I will discuss the spin-off in more details a few moments.

During the quarter, our LVS business group rolled out some exciting new technologies, including announcing a new electrically-driven chassis control system for light vehicles. LVS also expanded its engineering and technical capabilities by opening a new technical center in Brazil. We believe this business group continues to provide, that is poised for growth and success going forward.

Our CVS business success will increase its margins before special items by 120 basis points, compared to the same period last year. This was held not only by the growth in our CVA and specialty segments and through our Performance Plus cost reduction initiatives, but also achieving higher CVS sales and profits in every region of the world, compared to the third quarter last year. We continue to see improvements in our CVS organization, which is benefitting from operational improvements as well as geographic and business diversity.

We are keenly focused on the commercial vehicle business strategy to grow in areas that offer the best and most profitable opportunities, such as commercial vehicle after-market where we recently expanded our European presence by acquiring a leading remanufacturing company called Trucktechnic.

Our strong liquidity position gives us the flexibility to invest in growth businesses, such as CDA and specialty, as well as invest in our global footprint and markets that are growing. We have recently won major awards for MRAP service parts that will have a positive impact on our financial results in 2009. In addition, one of our customers announced a very large multi-year order for other tactical vehicles that will help offset lower production of MRAP vehicles in future periods.

Also, our CVS business is benefitting significantly from the booming markets in Brazil, China and India. For example, to keep up with the demand in China India, our plants Suzhou, China and Mysore, India are operating at full capacity. As a result, we are reviewing additional investments to support the strong growth in that region of the world.

Looking at the quarter overall, it is clear that we are deriving benefits from our cost cutting initiatives and growth strategy, and we are gaining market share in key business segments. We are of course proud of these accomplishments, but we are not stopping there. We will continue to evaluate our business and our needs with the same rigor as we have in the past. Over the last year, we built tremendous momentum, and we are confident that with the improvement actions we have taken, we will continue to perform well going forward.

On slide 5, you will see our outlook for 2008. As we said in our July 2nd news release, we are on track to come in at the top end of our guidance before special items of $1.40 to $1.60 for fiscal year 2008. Our Performance Plus net cost reductions of $75 million per year continue to be on track for 2008 and 2009. Although we reported strong sales in the third quarter, it was already reflected in our previous sales guidance of $7.1 billion to $7.3 billion. We are also improving our cash flow guidance by $25 million to negative $50 million to $100 million for fiscal year 2008.

Let's move to slide 6. We are pleased to announce that we made solid progress with our Performance Plus initiatives. In spite of rising material cost, we are on track to fully achieve our targeted goal of $75 million in cost savings in 2008. With the relentless focus on implementation late in the year, we are well positioned to see full year benefits carry into 2009. Although we are pleased with this performance, we remain focused on realizing our goal to achieve $150 million in savings by 2009, even in light of what we know is a very difficult material cost environment.

With that challenge in mind, we are launching Performance Plus Wave 2. What this essentially means is that we have refreshed, reenergized, and we are rotating our Performance Plus teams. The initial Performance Plus teams are now integrated into our businesses and operations and are driving the processes throughout the organization.

The Wave 2 teams will concentrate on generating new ideas and strategies, with a primary focus on our business in Europe. As we continue to experience industry challenges, these teams will respond by redoubling their efforts to significantly reduce costs and drive profitable growth initiatives. Since we embark on Performance Plus program, we have watched as these initiatives became part of our day-to-day performance objectives.

We are especially pleased that the Performance Plus philosophy has become part of our ArvinMeritor's DNA and culture. Performance Plus Wave 2 gives the program a boost to move us to the next level.

Let's turn to slide 7. Although some reports are showing concern about the slowing of the European heavy duty truck market, we see it as an opportunity to relieve high volume premium cost and to refocus capital expenditures on efficiency and flexibility initiatives. Although we do not expect to see the same robust pace of growth in 2008 for the remainder of 2008, and even after lowering our forecast, we still expect to see production volumes increase by 11% year-over-year. Even though we see European production volumes down by 3% in 2009, you will still be the second highest production year of all time.

Now let's turn to slide 8. As I mentioned briefly, we continue to see strong growth in our commercial vehicle after-market business which you know has traditionally been very profitable for us. In the third quarter, CVA achieved record sales volumes, exceeding its previous record for the quarter in 2006. With a keen focus on growing this profitable business, we have not slowed our acquisition or our global market expansion strategy.

As I mentioned earlier, we recently acquired Trucktechnic, a market leader in the remanufacturing and distribution of commercial vehicle disc brakes and air system components, based in Liege, Belgium. This acquisition broadens our geographic footprint, expands our product offering and deepens our existing European after-market portfolio.

Trucktechnic has an established reputation for quality, reliability and outstanding service among its customer base in Western and Eastern Europe as well as Africa and South America. We are also pleased with the progress, we made on other initiatives to expand our business.

We moved ahead quickly to integrate our North American operations with Mascot Truck Parts and the synergies, we are finding have exceeded our expectations. On March 27th, we announced a multimillion dollar supply agreement to provide remanufactured transmissions and axle carriers to Navistar Parts. We recently entered into a agreement with PACCAR's to support its Peterbilt and Kenworth dealer networks in Canada with the Mascot brand of remanufactured transmissions and axle carriers. The chart at the bottom of this slide outlines our CVA remanufacturing growth initiatives.

With the need for environmentally friendly products and the need to reduce the carbon footprint remanufacturing is growing at a fast pace. To address this trend as you can see from this slide, in Europe this year we have strengthened our remanufacturing brake business and added drivelines to the product portfolio. In North America, we improved our remanufacturing capabilities by expanding into drivetrains and adding the trailer axle product line.

Let's turn to slide 9. As part of our ongoing effort to promote products that enhance fuel economy we are constantly evaluating our technology and innovation strategy. We aim to position ourselves as the company that customers look to for lightweight and other product solutions and improve fuel economy and have a positive impact on the environment.

As you can see from this slide, we have several technologies that help us achieve this strategy. With a focus on fuel savings, we are investing in several technologies that address this need such as hybrids for commercial trucks and the tire inflation system, which delivers higher fuel economy on heavy trucks by constantly maintaining proper tire pressure. We believe this product will reduce operating costs and increase profits for truck owners by as much as $1400 per year.

Within the LVS business group, we are seeing strong demand for our smart systems product, which is an exciting area of strategic innovation. For example, our efforts to design lighter vehicles help insure that ArvinMeritor's product portfolio is ready for the shift towards improving fuel economy.

As you can see on this slide, we have several examples of lightweight LVS products including the LFI Roof, which is in production now. This new roof system replaces base sheet metal with composite materials reducing vehicle weight by as much as 10 pounds. Currently, we are producing this roof system for the Opel Corsa.

Let's now turn to slide 10. As you can see from this slide, LVS is on several of the most fuel and cost efficient vehicles in Europe. What is important here is that we are on the right platforms, especially in fuel savings as a top priority for consumers. It is also important to note that we are on some of the best selling vehicles in Europe such as the Audi Q7 and Ford Focus and we are aligned to customers, who are reporting strong earnings in the region.

Let's turn to slide 11. Since announcing the spin-off of our light vehicle systems group on May 6th, we have made great progress. As you know, we filed the initial registration document or Form 10 for our innovation on May 28th and after review by the Securities and Exchange Commission, we filed an amendment with updated information on July 28th. LVS achieved internal financial targets for the third quarter and is on track to meet financial milestones required to complete the spin.

As Jay will take you through a little bit LVS results would have been better than the third quarter of 2007, if you exclude the effects of some nonrecurring items and LVS is well positioned to achieve solid result even in a slowing economy because only 20% of its sales are with the Detroit 3 in North America. Going forward, LVS will continue to be a leading global supplier in the automotive industry. We are confident that the LVS business has a bright future.

I want to conclude by making a few comments about the strength of the remaining commercial vehicle business. The commercial vehicle business will continue to be a market leader in drive-train components and systems for heavy and medium duty trucks, trailers, busses, off highway commercial vehicles and government heavy duty vehicles and for the commercial vehicle aftermarket.

To-date our commercial vehicle team has made significant improvements to strengthen fundamentals and broaden our geographic footprint. They have helped make our operations increasingly lean in spite of the capacity challenges that we have experienced in Europe. As we discussed these actions are starting to show in our CVS margins.

By continuous focus on improving operations, customer pricing and terms, we believe going forward that the CVS team will deliver even better margins especially given the tremendous progress they have made in developing core competencies in manufacturing. We will continue to grow our commercial vehicle business and deliver solid performance. We look forward to the next chapter in our nearly 100 year history as a commercial vehicle focused company.

I would now like to turn the call over to Jay.

Jay Craig

Thank you, Chip. Our results for this quarter were good and I think they foreshadowed what lies ahead for ArvinMeritor in the next few chapters. Slide 12 shows our income statement for the quarter. Sales were up 21% for all the reasons, Chip mentioned. I will take you through the business unit margin explanations in a few minutes and you will see how the sales increases helped us convert at a higher rate. As a result, gross profit was up 42% from last year's third quarter and came in just short of 10% of revenue compared to 8.3% last year.

SG&A was up significantly. A portion of the increase related to half balance sheet securitization. The costs associated with these sales, which were $6 million this quarter are recognized in SG&A, whereas the costs they replaced were an interest expense. This is one of the reasons our interest expense was down from last year. Another reason for the higher SG&A cost was our decision to increase marketing efforts for commercial vehicle aftermarket.

Despite a challenging freight environment North America CVA had an all time sales record this quarter, which is a good indication that our marketing efforts are working. Lastly I will mention that our SG&A cost for the year ago period were lower due to compensation factors. It became clear during the third quarter last year that we would not meet all of our financial targets for the year. As a result, we reversed a portion of the annual variable compensation we had accrued for employees in the first half of the year. In spite of that, operating income was up 60% year-over-year to $72 million.

For continuing operations before special items income before taxes was up 132%. Our after affiliate income, interest expense and taxes income was $56 million up 211% from the third quarter of last year. I will discuss the low income tax rate on the next slide. This brought our earnings per share for continuing operations before special items to $0.77 compared to $0.25 cents in the year ago quarter.

Special items excluded from these results are shown on slide 30. They include a $4 million pretax charge for restructuring and a $6 million pretax charge for the transaction costs associated with our planned spin-off. We will continue to adjust for transaction costs in the future including some tax effects, we are expecting at the time of the spin-off, as we segregate and align the various legal entities for the two companies.

Slide 13 addresses the question what changed in taxes for this period. As you can see on the slide, a very little has changed except that we now know in which quarter certain prior year tax questions have been resolved with the IRS. As you may recall, our tax rate in the first half of the year was abnormally high. We did not belabor this point because we knew it would be abnormally low in one of the quarters in the second half. It turns out that was the third quarter.

If you looked at the quarter in isolation, we would say it included $0.17 per share of nonrecurring benefit for these items. However, relative to our guidance and our full year tax rate nothing has really changed. Our full year rate guidance has been 22% to 26% since the beginning of the year. Today, we are tightening the bottom end of the range from 22% to 23%. This rate is on our trend and is close to the normalized rate, we would expect in the medium term.

Slide 14 shows the earnings before interest, taxes and depreciation by segment. CVS earned $101 million of EBITDA, an increase of 55% over last year that corresponded to 1.2 percentage point increase in margins. LVS earned $26 million of EBITDA that was down from last year primarily because of an additional accrual for the customer issue, we discussed in our first quarter report. We increased reserves for this item by $5 million in the quarter; although we do not have a final resolution the reserved amount represents, what we expect to end up paying. We project that the cash payment will be made in the first fiscal quarter of 2009.

Net of this and a couple of other nonrecurring item shown on slide 28, the underlying business of LVS improved from both an EBITDA and cash flow perspective. Total EBITDA for ArvinMeritor was $121 million, up 42% from last year. As you can see on slide 15, EBITDA has been higher than the previous year in all three quarters of 2008 and we expect that the trend will continue in the fourth quarter as well.

As a result 12 month EBITDA has been rising quickly and we expect it will be over $400 million by the end of the fiscal year. The continuing year-over-year progress reflects significant operational improvements and major benefits derived from our Performance Plus program in both divisions.

The next slide shows how those and other factors have allowed us to expand our margins in our Commercial Vehicle Systems group compared to last year. First as Chip mentioned, CVS sales were up in every region of the world. In North America Class-8 production was up almost 20% compared to last year. Medium and heavy duty truck production in Europe was up about 30,000 units from last year and South America, Asia and specialty markets continue to be very strong for us. Trailers and medium duty trucks continue to be challenging in North America, but we posted a sales gain in the region nonetheless.

Performance Plus cost reductions continue to be a very important part of our ongoing improvement and margins. Savings from these initiatives increase CVS margins by 1.3 percentage points compared to last year.

The net impact of higher raw material prices in the quarter after considering related customer pricing was small. We have had a great deal of success in passing these costs on. We are executing our steel surcharge program as envisioned and we will continue to do so. Obviously we would like for this variance to be zero, but there are some unavoidable timing differences in some of our business lines and there are commodities other than steel that are not amenable to index surcharges.

Higher SG&A costs reduced CVS margins by 1.5 percentage points for the reasons I discussed earlier. When you add it all up, CVS earned 7.4% this quarter compared to 6.2% in the same quarter last year. Slide 17, charts CVS EBITDA margins against Class-8 production in North America. I think it shows pretty clearly the way we have been able to disconnect CVS margin performance from the production in this one area.

We are able to do this because of our strong presence in trucks in Europe, South America, and Asia as well as our aftermarket and specialty businesses. Our intense focus on continuing to grow our specialty and aftermarket will help keep our margin momentum going and even as we steer through some challenges in the truck markets.

The left-hand side of this chart also shows that we did not really benefit from the unprecedented production levels of the 2006 pre-buy which was in full swing during the first two quarters shown on this chart. If production volumes continue to grow moderately in 2009 as we now expect, we will be able to ramp up more efficiently providing additional lift to margins.

Now let me switch over to the Light Vehicle market. I mentioned earlier that LVS margins were up if you set aside some nonrecurring factors. Slide 18, shows that LVS EBITDA margins were 0.9 percentage point lower than the third quarter last year with the customer issue accounting for 0.8 of a point and the change in allocation methodology accounting for 0.6 point.

Looking only at operational factors you can see that Performance Plus cost savings and volume growth outside North America more than offset the impact of higher raw material prices and weaker industry volumes in North America. Total worldwide volume and mix reduced margins by only 0.4 of a point, which underscores the benefits of not relying too much on the North America market. However, it also shows that we are in a lot of the right places outside North America.

In the area of steel and other raw material costs LVS is also performing well in a tough market. The team stepped up, had some very difficult discussions and reached some very favorable outcomes. So in total, LVS EBITDA margins were 4% and would have been higher if not for the customer issue.

Slide 19, shows our free cash flow for the quarter. The short story here is that the net income was converted to cash flow, which we think is a pretty good goal for future periods. Working capital was an outflow in the period, but was significantly less sold than last year whether you include or exclude changes in securitization.

Our assets and liability were a source of cash which is a normal seasonal pattern based on timing differences between expenses and cash payments. For example accrued interest increased by $18 million in the quarter because we had a semiannual coupon payment in the fourth quarter. We also had significant accruals for the quarter in compensation, warranty and the LVS customer issue. Total free cash flow was 59 million.

Slide 20, puts that in context for the full year. As you will recall we had a large cash outflow in our first quarter reflecting seasonal patterns, a one time catch-up in accounts payable and some further acceleration to help some suppliers avoid liquidity issues. We have been able to cash flow positive in the last two quarters and expect to be positive again in the fourth fiscal quarter. That will bring us into a full year guidance range, which we are raising today to an outflow of $50 million to $100 million.

Slide 21 is just a quick reminder that we have very limited refinancing risk. Our revolving credit line is almost entirely available and does not mature until 2011. Our next significant term debt maturity is in 2012.

The next slide shows our planning assumptions for the year. The GDP growth numbers at the top of the page are actually a little higher than the last time we showed this slide, reflecting a slightly stronger growth in the second calendar quarter. However, we have colored them yellow to reflect a high degree of volatility in the assumption. We updated US light vehicle industry sales in our press release on July 2nd to a range of 14.4 million units to 14.6 million units. We have also shaded that assumption yellow recognizing that it is more likely that future revisions will be downward than upward, but again any further reduction should impact primarily 2009 results and not have any significant impact on 2008.

We were not ready to lower our light vehicle sales for Europe on July 2nd, but we have lowered them here from our previous estimate of 17.1 million units to a range of 16.6 million to 16.9 million. Again, our favorable platform mix in Europe should allow us to continue to outperform the industry.

On the Commercial Vehicle side, we updated North American Class-8 and European medium and heavy-duty truck production on July 12. We did not provide an update or the outlook on Class-5 to 7 our trailers, but the lowered ranges you see here were built into our thinking for 2008 guidance. There is one more favorable change since last time, which is an increase in MRAP awards. We expect a few hundred more vehicles to be awarded this summer at which time all funded vehicles will have been awarded.

Slide 23 shows our updated guidance for 2008. Chip already provided the highlights and you can see the details on this chart. Now I would like to spend just a moment providing some early indications on what we see for 2009. I will do this separately for CVS and LVS. We continue to expect this strong year for CVS as slide 24 shows.

As one of our customers said last week even without a pre-buy Class-8 volumes in North America should at least be able to return to replacement demand levels. That would represent an increase of at least 20% compared to this year's severely depressed production. In Europe our forecasted range of 530,000 to 550,000 trucks next year represents production that would be flat to down 5% from this year. We have listed the net effect of our lower production in Europe at zero to slightly negative, but I would lien more towards the zero side if the reduction stays in this range.

South American volumes can not get much higher than they are now. However, they still may provide some improvement because of the full year effect of the recent increases there. In Asia, we continue to see opportunities to grow our truck axle operations in India and our off highway business in China.

For military vehicles, we are not projecting a significant drop off in our profitability. It will be challenging to replace all the contribution MRAP production this year, but our specialty team is working hard to do just that. A significant portion of the awarded vehicles we showed on slide 22 will be produced in our fiscal 2009.

In addition, we have received some very nice awards for MRAP service parts and the other tactical vehicles will help us in 2009 as well. On the chart military is followed by pluses for off highway and CVA. Our profitable growth in those areas is longstanding and well documented.

Next, Performance Plus will continue to improve our cost base in 2009 compared to 2008. The many actions we have implemented in the second half of the year will give us a lot of momentum and Wave 2 will help us keep the pipeline full of high value ideas to improve our profitability.

Raw material costs provide a headwind, but I think we have proven that we have an effective strategy to minimize the impact on our income statement. In total, 2009 will be a very good year for CVS with a little help from the market it could be a great year.

In the light vehicle industry environment maybe somewhat more challenging than the commercial vehicle industry in Europe and North America, but LVS still expects higher results than this year also. In the US, production and sales are expected to remain at this year's low levels. In Europe we currently expect a 5% decrease in light vehicle sales in 2009, which will be a negative for LVS. However, there is a lot of regional and segment variability in Europe and the mix of platforms and regions we sell to is an important mitigant.

For South America LVS is anticipating for the same thing as CVS is hoping for, continuation of current high industry levels for all of 2009. In Asia LVS's growth plans are aggressive and well developed. The relationships with Cherry and Hyundai in the region will ramp up meaningfully over the next few quarters. Cost savings that have been accomplished through Performance Plus will help results also. As will future productivity programs that LVS is currently working on.

We have talked about our plans to close facilities in high cost regions, such as our Roofs facility in Frankfurt, Germany and backfill them with production and more cost competitive zones. Some of those actions are underway right now which will help LVS in 2009. We also expect material, labor and burden savings to continue to outstrip customer price downs.

LVS has been particularly effective in controlling plant operating costs and that momentum will carry forward into next year. Again, raw material costs will be a challenge, but the team has proven it knows how to deal with that issue. That is our last slide.

If I could summarize the quarter I would say that the cost reductions and excellent business diversity are allowing us to restore this company to acceptable levels of profitability. Even while our end markets are very difficult, we are controlling our own destiny and we are poised to benefit when the skies start to clear up. At this point we would be happy to take your questions.

Question-and-Answer Session

Operator

Gentlemen, thank you. (Operator Instructions). We will take our first question from Patrick Archambault from Goldman Sachs.

Patrick Archambault - Goldman Sachs

Hi, good morning.

Chip McClure

Good morning Patrick.

Patrick Archambault - Goldman Sachs

Yes. I think you touched on it in slide 24, but can you give us a sense of what declines you would start to need in Europe before really you start to see margins start to compress there. It sounds like the capacity constraints have made; it is such that at least the first, the drop off in the first few units might actually be positive for margins. Would you just give us a little color as to what the sensitivity might be on that on the downside?

Chip McClure

Sure. That is a good question Patrick. As you know, a year ago we really struggled with some that, there was a lot of premium cost. So as we look at that even with what is factored in there right now. I think it will actually put it into more of a reasonable phase as far as trying to reduce the premium cost, and as we have indicated we have been putting additional capacity in place.

So as we look at the volume productions that are actually in our plans and what Jay laid out for both the balance of this year and going forward into 2009. I think that clearly should help us, unless there is a significant drop off, and again you have got two different markets there, you have got Western Europe and you have got Eastern Europe. Western Europe, I think is where a lot of softness is being seen.

We continue as do our customers see strong growth in the Eastern European part of it. So as we see it right now I think, as you indicated right up front that with the softness as we see it in Western Europe will actually help reduce premium cost both for the balance of this year and more importantly going into 2009.

Jay Craig

I think Patrick the only thing I would also add is that, to meet some of the additional capacity requirements that we are asked to by our customers we have not added additional facilities or significant additional headcount. So that if the volumes come in slightly lower than people anticipate it should not require a lot of significant restructuring costs.

Patrick Archambault - Goldman Sachs

Okay, great. On the US side, can you just remind us what you estimate replacement demand is for North America?

Chip McClure

Well, we are looking at replacement demand in North America is probably in the 240,000 to 250,000 range for next fiscal year.

Patrick Archambault - Goldman Sachs

Okay, great. Finally, can you quantify the compensation portion of the expense that was in SG&A for this quarter and give us a sense, is that a one time issue or is that something that maybe extended into fourth quarter as well?

Jay Craig

I do not think we are prepared to give a specific quantification of it at this time. I would say it was one of the largest components in the year-over-year comparisons of SG&A. Just to give a little more color other than that, were in my remarks earlier. If you recall last year at this time the performance of the business was suffering, so we had a release of the expected incentive compensation payments.

Obviously this year we are performing quite well, so those incentive compensation payments are expected to be made. So the comparative swing is quite large. In the fourth quarter we do not expect that to have as significant impact. It may have a slight impact. However, overall we expect SG&A to get back to more normal trends and be more consistent on a quarter-over-quarter period comparison.

Patrick Archambault - Goldman Sachs

Okay, thanks, that is helpful. Then last just on raw materials, it sounds like there was a gap between recoveries and gross costs for this quarter. Can you give us a sense as to what your expectations are for the year on that and if you see yourself offsetting, most of your gross costs through customer recoveries, or as I think you have said in the past or if there may be some, some probability that you might actually have to take a little bit of extra expense on that item?

Chip McClure

Let me try to show that Patrick, and then I will let Jay weigh in a little bit. Obviously as we indicated earlier we have been working with our customers to make sure there is a pass-through. I think as you look at the absolute size of it, given the huge headwinds that exist out there, I think it is a reflection of the fact that we have indeed been able to work with our customers to look at that pass-through going forward. As Jay indicated some of it is a timing issue you look at. Quite frankly some of it is non-steel related type of material costs that are not as easy to index that way. I think it is safe to say that as we look at the steel program we have been successful in working with our customers to do that.

Then secondarily as we indicated is part of our Performance Plus Wave 2. First of all we demonstrated in the third quarter, we know how to do it, we are doing that together with our customers and obviously have an obligation from a cost reduction internally. However, as we indicated by kicking off Wave 2 Performance Plus we also recognize that these headwinds are going to continue. We recognize the need in addition to working with customers to pass-through the increases is define ways to offset the costs and so we are actually doing it on both sides.

Patrick Archambault - Goldman Sachs

Okay, great. Thank you very much.

Chip McClure

You are welcome.

Operator

Next we will hear from Eric Selle with JP Morgan.

Eric Selle - JPMorgan

Hello, can you hear me.

Chip McClure

Good morning.

Eric Selle - JPMorgan

Good morning. I was caught off guard. Going through your balance sheet what was your off balance sheet factorings total at the end of the quarter. I think it was around 482 at the end of the March quarter?

Jay Craig

Yes, it was $491 million at the end of this quarter.

Eric Selle - JPMorgan

Okay. So basically you are really seeing some of that net debt roll off because of working capital. As you look into the fourth quarter are we going to continue to see some of that working capital as a source or should that reverse?

Jay Craig

As far as the factoring programs themselves we see them remaining relatively consistent, although sometimes they fluctuate with the customer receivable balances as you would expect. Again, just to remind folks, the vast majority of those factoring programs are customer sponsored. So, they are related directly to primarily European customers that we have, but they do fluctuate with the receivable balances.

Eric Selle - JPMorgan

Then the on balance sheet working capital what trend should we look for in the fourth quarter on that?

Chip McClure

Working capital should improve in the Q4. Again Q3 is traditionally our strongest sales quarter and does require a fairly large investment in working capital. We are quite proud that that investment this year was significantly below what we invested last year, which was due in large part to our aggressive improvement in our receivable collection activities. However, we tend to see the fourth quarter come down as our sales volume comes down in that quarter.

Eric Selle - JPMorgan

Great, thanks a lot for your time.

Operator

(Operator Instructions) We will hear next from Brian Johnson at Lehman Brothers.

Brian Johnson - Lehman Brothers

Yes, couple of questions. In the Performance Plus Wave 2 few questions. Is this evenly split between LVS and CVS in terms of the costs it is going after?

Jay Craig

Well, as a matter of fact what we have done is, as we have indicated in the past a lot of that was based on percent of sales it will be about one-third or two-thirds.

Brian Johnson - Lehman Brothers

Yes. I mean split by sales, which seem to roughly if my calculation is right look like it was about $20 million of Performance Plus in CVS this quarter out of the 428.

Jay Craig

You are directionally correct.

Brian Johnson - Lehman Brothers

In addition to the cost savings given the issues around working capital, are you doing anything operationally around working capital as part of this Wave?

Chip McClure

Oh, absolutely. When you look at it on the inventory side of it we are very much looking at that both Carsten Reinhardt and his team, and Phil Martens and his team are very much looking at that. We track that the same way we track the other parts of that.

Thoroughly we are looking to do and we have talked about that in several previous calls an area that we have looked at within ArvinMeritor production systems within the area of lien manufacturing and that type of thing is obviously we continue to lien our plans. We see opportunities to reduce inventory and at the same time with our suppliers, we are looking at working with them to get different terms there. So, yes, we do see that within the operations.

Brian Johnson - Lehman Brothers

Do you have a target for inventory days or overall cast cycle days for '09 that you could share?

Chip McClure

Actually I can not share here. Obviously as you look at it, it is different across the platform quite frankly between OE and aftermarkets. We have got different demand needs there. We have also got to factor in as part of what we are looking is our total inventory throughout the pipeline depending where things are sourced too. So, I just giving one number, obviously we are looking at it as year-over-year improvement. It really is different based on whether it is an aftermarket OE customer and where it is located in the world.

Brian Johnson - Lehman Brothers

Do you have a gap like you did in Performance Plus the best-in-class that you would like to close?

Chip McClure

Yes. As we look at that we continue, as part of our continuous improvement culture because we want to continue to identify where the gaps are. Literally if you will facility by facility and then put action plans in place within those facilities to make sure we can close that gap.

Brian Johnson - Lehman Brothers

In terms of days gap, I mean, length of the magnitude?

Chip McClure

No. As I said before Brian, as I look at it, it is really is facility-by-facility and market-by-market.

Brian Johnson - Lehman Brothers

Okay. Then on the off-highway ex the MRAP, when you look at your expectations going forward to next year are you looking really at the market or are you looking at your participation in those market share?

Jay Craig

As far as, off-highway.

Brian Johnson - Lehman Brothers

Yes.

Jay Craig

Yes. As you look at Brian, as you know, we have had a very strong position off-highway in Asia Pacific. Our plant, Suzhou, China, I was just there a couple of week ago is literally going 24/7 and as I indicated in my comments, we need to look at how we can increase that capacity there. As you know, we just announced the fact that we are reentering the off-highway market here in North America, South America, Europe and Africa.

So, as I look at that I continue to see strong market demand in the market we have been serving for the last number of years being China in particular and secondarily probably other parts of Asia Pacific, as they continue to build infrastructure. I think as importantly as we reenter these markets and I will tell you the response from our customers in these markets of the Americas, Europe and Africa have been very positive. I see that increase going forward as we continue to reenter these markets.

Brian Johnson - Lehman Brothers

Okay, thanks.

Jay Craig

Okay. Thank you, Brian.

Operator

Our next question will come from Himanshu Patel with JP Morgan.

Himanshu Patel - JPMorgan

Hi, can you hear me.

Chip McClure

Yes indeed. Good morning, Himanshu.

Himanshu Patel - JPMorgan

Good mornin. Just a couple of questions, can you give us an update on the state of recovery discussions on raw materials with the OEM's particularly on the light vehicle side just directionally speaking have they gotten anymore constructive or is it as difficult as it was before.

Chip McClure

Well let me first of all say that when you look at any request for material price increases the discussions are difficult. I will tell you that as I look at that and as we indicated in our comments and as you look at the both the margin improvement and as importantly the small size of the material cost as a factor, I think sufficed to say that yes, we have been able to be successful both in the LVS and CVS side to do that.

I think the difference this time from time stats is because it was such a rapid increase in the raw material cost that I do not think there is any question in anybody's mind that these material costs are real. So, although they are difficult discussions I would certainly say that it made the discussions easier. I am really talking both LVS and CVS and any questions specifically LVS, I will tell you really on both sides I think, because of the fact that it was recognized by everybody that the material costs starting with raw material are indeed real.

Himanshu Patel - JPMorgan

Okay. Then we have heard some grumblings about from other suppliers about freight costs becoming a big issue particularly inbound freight costs. Well first of all was that a material issue for you this quarter and in particular I am wondering how that affects the profitability of your CVA business.

Jay Craig

Himanshu, it was a fairly significant issue. We are tracking that at a very detailed level. As we look through our recoveries from customers, we are not solely focused just on steel; we are focused on all the commodity cost increases including the rising cost of transportation. So, but we are also through the Performance Plus initiative one of the particular individual initiatives was focused particularly at better freight management, which we have seen significant reductions overall in our freight cost even with the rising cost of fuel and the pass-through effect of that on our cost. Overall, we have seen a net-net dramatic improvement in freight cost.

Himanshu Patel - JPMorgan

Okay. I want to go back to an earlier question I think. I mean, clearly Europe is a very big portion of the LVS business and also material portion of CVS. I am just wondering your preliminary '09 outlook look relatively benign on Europe. I am just wondering what is developing your thoughts there, is it that, is it a simpler saying that the bottlenecks in Europe are material enough on the CVS side that if you had maybe a 5% volume decline you would be agonistic to that from a profit perspective or are you just saying that the incoming data is not that bad yet and therefore you are not willing to be so concerned on the European top line?

Chip McClure

Well, let me start and then I will let Jay weigh in. When you look at I think you touched on some of that in the CVS side as far as the bottlenecks, as the volumes more normalized that helps to reduce the premium cost for that. Secondly, as I indicated in my comments, when you look at the platforms along with LVS, they continue to be very strong sellers in the market. So, those are two positives.

The third positive is the fact that we do continue to see the strength in Eastern Europe side. So, the real weakness I think everybody is focused on is in Western Europe. Quite frankly, we are seeing some of that too. So, it is when you look at it on balance the market, continue strong in Eastern Europe with weakness in various markets in Western Europe but then offset, as I would have indicated on the CVS side with bottlenecks and then on the LVS side with the platforms we are on.

Jay Craig

Add a couple of comments I think on the CVS side we are seeing fairly divergent set of opinions from the OE customers and what their expectations are next year for European volume. I think our course of action is we are planning for I would not say the worst, but for lower volumes and I think the best example I can give of that is the Performance Plus Wave 2 Program that Chip mentioned we are focusing heavily in Europe on the cost reduction side. So, it is a big part of Wave 2 just to hedge our best-to-bet, if the volumes end up softer.

Chip McClure

Okay, thank you.

Operator

Our next question will come from David Leiker at Robert W. Baird.

David Leiker - Robert W. Baird

Good morning

Chip McClure

Good morning, David.

David Leiker - Robert W. Baird

Looking at first Craig on the SG&A line can you talk about interest and marketing cost as being two of the big drivers relative to what we saw in the first two quarters, can you quantify those at all?

Jay Craig

Sure. I think what I mentioned was the cost of factoring, which was included in SG&A or sale of receivables as compared that mix of borrowing as compared to traditional interest costs from debt. That impact gross for the quarter was approximately $6 million. The CVA marketing investment was approximately $3 to $4 million. Then there was a fairly large component related to this incentive compensation change year-over-year. So that was the dimensioning the various components.

David Leiker - Robert W. Baird

Sequentially the compensation went to that large of an issue, right?

Jay Craig

I am sorry, could you…?

David Leiker - Robert W. Baird

Relative to first and second quarter, the comp is not that big of an issue, is it?

Jay Craig

No. It really impacted us this quarter and we expect the impact in the fourth quarter to be lower.

David Leiker - Robert W. Baird

Okay. Then, these other two are the factoring, the marketing obviously continues. Is this a new level in terms of these factoring costs for you or is that something one-time going on there unusual?

Jay Craig

Again, the factoring tends to vary with receivables and as we see the reduction in working capital in the fourth quarter. I think we should expect to see that cost decline. As far as the mix between our bowings, between year-over-year comparisons I think you should expect that the factoring costs will be higher as a percentage of a mix compared to interest costs as we changed our bowing strategy. As far as sequentially quarter-over-quarter, we may see that go down slightly as our investment in working capital declines.

David Leiker - Robert W. Baird

Okay. Over the course of your going through your slides, several times Chip you made comments that gaining share. Can you give us some thoughts in terms of where you are seeing the greatest share gains?

Chip McClure

Well, as I indicate some of that is in the off highway side. As I indicated first of all we have had a very strong position in Asia Pacific and that market continues to be strong and see growth there. As we re-enter off highway side, we see some of that there. That is going forwards into the future. As I look at it currently a lot of that is in the CVA side and I think we indicated in the last earnings call that when we look at both Europe and in South America on CVA, we see growth. If I look at it currently a lot of the market share opportunity we are seeing is in CVA both Europe and South America. If I then look on the LVS side, and I would refer you back to my slides that shows some of the platforms, obviously we blend, add successfully on some of the platforms I think have shown share gain within the LVS phase.

David Leiker - Robert W. Baird

Okay, great. On the Performance Plus, you have done a great job here and on a run rate, you are ahead of what your targets are, is there a point in time that you raise that $150 million target for 09?

Jay Craig

Well, as we said at this point, we are recognizing that there is headwind with material cost side of that, so for us to do that right now what we have said is we are recognizing the reality that is going on in the marketplace. So at this point no, we are not prepared to raise that, but obviously as part of our commitment or if you will recommitment to those targets in '09, we want to put those things in place to make sure we are doing that, obviously we stayed with the focus on Europe. The other thing I should mention clearly is on these things we are very volume dependant, so depending what the volumes do will dictate our reflection there.

David Leiker - Robert W. Baird

The last thing here is in the commercial vehicle business, the contribution margin here looks pretty nice, it is obviously being held back somewhat by steel. Do you think your normal level there now with where you need to be or is there still some upset on the contribution margin?

Jay Craig

Well, obviously as we have said I think what we would like to do is look for more on the upside part of that. If you notice although we are showing North America up year-over-year, suffice it to say last year at this time for this quarter, the North American mark was pretty much bottomed out. So, as we look at the North American rebound into '09, we do expect that we will show margin improvement from there.

David Leiker - Robert W. Baird

I am understanding your raw material in Europe weakening a little bit that somewhere down the road you could hit a 10% margin in that business?

Jay Craig

Again, our long-term goal, as we stated previously can be mentioned in a couple different manners. One is to have a return on equity that would be top quartile and the way we look at that, that would require us to have EBITDA margins above 10%. So it would be 10% to 12%. So that is what we are focused on as the long-term goal. We are certainly very pleased with the progress and the trend, particularly given the external forces that we are faced with right now, but we are focused on a long-term goal of 10% to 12% EBITDA margin.

David Leiker - Robert W. Baird

Great, thank you very much.

Operator

(Operator Instructions) We will go now to Brandon Ferro with KeyBanc Capital Markets.

Brandon Ferro - KeyBanc Capital Markets

Good morning, everybody.

Chip McClure

Good morning, Brandon.

Brandon Ferro - KeyBanc Capital Markets

Can you give us a sense of what your largest non-steel commodity buys are, maybe which ones are more or less minimal to index pass-through and maybe a total dollar exposure?

Jay Craig

Certainly one of the largest ones would be fuel, which we talked about in transportation cost, and we are tracking that as well very closely and our discussions with customers include changes in that cost as well. Other ones would be aluminum and copper on the LVS side, but there are much smaller risks, but primarily it is deal. I mean, if we look at the largest single component of our products, that is the main area and it is the main component and is the main area of focus for us on the recovery discussion.

Chip McClure

I should mention Brandon, the second point. Some of those do have indexes in place and I think we talked earlier about the fact that on the fuel side, we are indeed having discussions with customers on that as we speak.

Brandon Ferro - KeyBanc Capital Markets

Okay. Also on Performance Plus, Wave 2, relative to the first Wave, can you remind us what the restructuring, non-restructuring is of that 75 million, meaning more or less cash spend on the second Wave versus the first?

Chip McClure

I think we expect it to be relatively consistent, although for this year our estimate of restructuring is lower than our initial estimate was. Certainly we will be looking closely as we come off the 2009 peak. We may have some capacity rationalization here in North America. We will be updating that as we get further into the Wave 2 program.

Brandon Ferro - KeyBanc Capital Markets

Okay. Concerning Western Europe, some of your CVS facilities, can you give us a sense of maybe where utilization levels might stand now and where you see that coming down to potentially as volumes come down?

Chip McClure

Well, first of all, as Jay had mentioned, even with some softening we are seeing in Western Europe, these are existing facilities we have. As we have mentioned in some previous earnings calls, within these existing facilities, the first thing we did was put in as part of our ArvinMeritor Production System additional lien activities which actually indicated significant improvement in throughput on the existing equipment. So that was phase 1.

Phase 2 is we have in constant with our customers made some capital commitments to put additional capacity in place which is beginning to come on line in the second half of this year and those within existing facilities. So those two things are taking place right now. As Jay had indicated, even with the, you know, if there is softening for the second half of this year, which we do envision, which still shows the year-over-year increase, and with 3% softening next year year-over-year, we still feel that the capacity that we have either had in place and made more efficient or the additional capacity we put in place, we do look to that being fully utilized going forward.

Brandon Ferro - KeyBanc Capital Markets

We have reached the top of the hour so we are going to have to end the call now. I would like to thank everybody for their participation.

Operator

Ladies and gentlemen, this does conclude ArvinMeritor's third quarter fiscal year 2008 Earnings Call. We thank you all for your participation today. You may now disconnect your lines, and have a great day.

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