Cummins Inc. (CMI) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2015 Meritor, Inc. Earnings Conference Call. My name is Tihisha [ph] and I’ll be your operator for today. At this time all participants are in listen-only mode. Later, we will facilitate a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Carl Anderson, Vice President and Treasurer. Please proceed.

Thank you, Tihisha. Good morning, everyone, and welcome to Meritor’s first quarter 2015 earnings call. On the call today, we have Ike Evans, Meritor’s Chairman and Chief Executive Officer, and Kevin Nowlan, Senior Vice President and Chief Financial Officer. The slides accompanying today’s call are available at our website, meritor.com. We’ll refer to the slides in our discussion this morning. The content of this conference call, which we are 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 do consider your continued participation to be your consent to our recording. Our discussions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to Slide 2 for a more complete disclosure of the risks that could affect our results. To the extent, we’ll refer to any non-GAAP measure in our call, you’ll find the reconciliation to GAAP in the slides on our website. Today’s presentation will be abbreviated due to our scheduled analyst event on Thursday February 5. We are looking forward to providing you with more detail at that time. If you have not received an invitation to that event and would like to participate, please contact me directly. Now, I’ll turn the call over to Ike.

Thank you, Carl, and good morning, everyone. Let’s turn to Slide 3 for a look and highlights from the first quarter. We’re pleased to report continued earnings momentum as you can see in our first quarter results. Year-over-year, we expanded our adjusted EBITDA margin by 100 basis points to 9% despite lower revenue. Incremental pricing as well as continued benefits material, labor and burden performance favorably impacted earnings. As strong demand continues in the North American Class 8 truck market, our focus on converting the incremental sales at our targeted contribution rate to management of our operating and product cost is showing in our results. We are also very excited to announce a new long-term contract with PACCAR. I’ll give you more specifics about this new business win on the next slide. As we continue to deliver strong results, the confirms are confidence in achieving the three overriding objectives of our M2016 initiative. First, with the performance we are delivering in the first quarter of 2015, our margin is now within 100% basis points over 2016 objective of 10%. Second, we’ve generated significant cash flows over the last couple of years from operations, the litigation and the sale of the non-core business, that has allowed us to reduce our net debt by nearly $500 million in just two years. And finally, we continue to drive new business wins, including the execution of the PACCAR agreement that I just mentioned, but it goes far beyond the PACCAR win. Over the past several quarters, we’ve told you about several other new business wins and long-term contracts with major OEs, including Volvo, Daimler, MAN, Ashley Cleveland, [ph] Hino, and Scania and others. We are growing our relationships with major global truck manufacturers around the world. The book of business we are building is strong, and reinforces the competitive differentiators that make Meritor unique. Our Board of Directors continues to evolve and strengthen, most recently with the addition of Lloyd Trotter, who is elected to Meritor’s Board this month. Lloyd had a successful 36-year career at GE during which time he held roles as Vice Chairman, President and CEO of GE Industrial, and Vice President of GE Manufacturing Operations. He is also a Founding Member of GenNx360 Capital Partners, a private equity firm, based in New York, that focuses on improving business operations to drive shareholder value. Lloyd’s operational background and experience in private equity will be a tremendous asset to our Board, as we manage the company for greater shareholder return. Let’s go to Slide 4 for a more detail on our new seven-year agreement with PACCAR, a global market leader in design and manufacturer of premium trucks. If you remember that about a year ago, we announced new business with DAF in South America, at the time, we viewed this as an important step in broadening our relationship with PACCAR. And now we are announcing a new long-term agreement with PACCAR. Under this agreement, Meritor will now have preferred product positioning for rear axles in North America and Australia. And in those regions, we also have enhanced optional positioning for brakes, drivelines, and front axles. As we ramp up production with PACCAR over the next couple of years, we expect this to resolve an incremental revenue of more than $150 million for our company. The bulk of this income revenue will come after 2015, although we will see some step up this year. In anticipation of this significant opportunity, we’ve been executing a modest capacity strategy over the last couple of years. We’ve also worked to mitigate supply constraints and implemented various operational improvements that have increased throughput in our plans. As a result, we have capacity available to support this incremental PACCAR business while still meeting our contractual commitments with all of our other customers. We expect this additional capacity, which began to come online during 2014, will allow us to effectively service our customer base at around 300,000 Class 8 market, once you factor in anticipated share increases with PACCAR over the next couple of years. This agreement with PACCAR provides opportunities for us to grow with this global truck manufacturer as we expand future product plans. It’s an important new relationship for us with DAF and other premier truck manufacturers. We’ve worked hard to earn this business and look forward to growing it successfully. At Meritor, we are differentiating ourselves from our competitors and expanding our global customer relationships. We are doing this with a global engineering network with a tremendously talent team of commercial vehicle experts. Manufacturing capabilities around the world are efficient, advanced, and unique, a global footprint that allows us to serve our customers efficiently and timely and hands down the best customer service and support in the industry. But we can always be better, and despite the significant improvements that we made in execution, safety, quality, and delivery, we want to keep getting better. However, customers require excellence of us and we require excellence of ourselves. Please turn to Slide 5 for a wide fiscal year 2015 market outlook. Let’s take a look at North America. We believe the strength in order activity reflected most recently in December orders is a result of converging trends, including stronger economic activity, aging fleets, fuel economy, and solid fleet profitability. Indications are that the fleets have accelerated orders for 2015 requirements to reserve their places from future deliveries. Based on these factors and what we see in OE forecasted line rates, we expect the current backlog to drive strong levels of production throughout 2015 and into the beginning of 2016 as well. As a result, we are increasing our outlook for Class 8 volumes in this region by close to 5% to a range of 305,000 to 315,000. However, we are not anticipating to see a comparable pickup in our production. Daimler Truck North America has ramped up manufacturing of its Detroit axle to support its incremental demand in this peak market. While we currently are and expect to remain the majority supplier of Class 8 axles to DTNA, Detroit is producing more of its own axle to support the current cycle and heads up setting the upside opportunity arising from our increased Class 8 market outlook. As I mentioned, our new business with PACCAR in North America has begun. We will see a modest impact in this fiscal year with the bulk of the increase coming in 2016 and 2017. In other markets, Europe remains flat from our last forecast at a midpoint of 390,000 units. Economic indicators continue the fluctuating, making it difficult to forecast the timing of improvement in this region. However, we do expect currency headwinds to persist for the rest of the year, as the euro continues to depreciate versus the dollar. In South America, we have decreased our production outlook approximately 10% due to a difficult economic climate, driven by high inflation and climbing interest rates. That means that year-over-year we expect the market to be down 20%. The Brazilian currency has also weakened considerably, which is having a negative effect on revenue as well. Changes were also made for 2015 that affect the financing mechanism used for more than 70% of the truck and bus purchases in the region. Companies will now be required to make a down payment as much as 50% and the financing period is being shortened by several years. We anticipate that these changes in the financing structure of truck purchases will place further pressure on our business in Brazil. As a result, we continue to manage our cost structure appropriately. We believe that all of these incremental headwinds will drive slightly lower revenue this year. from: Let’s turn to Slide 6, please. As I mentioned, our execution is showing in our results. Year-over-year, we increased our adjusted EBITDA margin to 9% driven by pricing, labor and burden improvements, and material performance, all actions that identified a part of M2016 and we achieved this on slightly lower sales. We are confident in our ability to achieve our margin target of 10% for 2016, even though we are anticipating less help from the global market recovery than we did when we launched M2016. Our self-help strategy is working as you can see in year-over-year and sequential comparisons. With that, I’ll now turn it over to Kevin for financial details.

you: As a result, we generated adjusted EBITDA margin of 9% and $35 million of adjusted income from continuing operations in the first quarter. Both of these are good results for us. So let’s walk through the detail by first turning to Slide 7, where you will see our first quarter income statement for continuing operations compared to the prior year. Sales were $879 million in the quarter, down $21 million, or 2% year-over-year. The decrease is primarily driven by lower commercial truck production in Europe and South America, as well as lower revenue from our defense business. Sales were also negatively impacted by $30 million in the quarter, due to the weaker euro and Brazilian real. The decrease in sales was partially offset by higher sales in North America, as the Class 8 tuck market continue to strengthen. Gross margin increased $10 million year-over-year due to pricing and material labor and burden performance. Keep in mind that this increase in gross margin was achieved despite the year-over-year step down in revenue. SG&A was $6 million higher in the first quarter of 2015 compared to the same period last year. The increase is primarily due to a $5 million long-term disability accrual reduction, which occurred last year and did not repeat. Interest expense was $19 million in the first quarter of 2015 compared to $27 million in the same period last year. The decrease was driven by the capital market transactions we executed that reduced our gross debt balances by $171 million and lowered our cost of debt. In addition, interest expense was favorably impacted by $2 million, due to interest earned on the refund of a judicial deposit in Brazil, which will not repeat going forward. Income tax expense was $7 million in the first quarter of 2015, representing a decrease of $4 million compared to the prior year, despite the fact that pre-tax income was higher this year. As I mentioned during the fourth quarter call, in many jurisdictions, including the U.S. and most of Western Europe, we previously established valuation allowances against our deferred tax assets. As we generate positive earnings in these jurisdictions, we will recognize the minimal tax expense as long as these valuation allowances exist. Our effective tax rate of approximately 18% this quarter is a reflection of the fact that we are beginning to generate earnings in certain of these jurisdictions. All of that totals up to adjusted income from continuing operations of $35 million, or $0.35 per diluted share. Slide 8 shows first quarter sales and segment EBITDA for commercial truck and industrial. Sales were $703 million, down $24 million, or 3% from the same period last year. In Europe, the Euro 6 pre-buy favorably impacted sales a year ago. In addition, we saw lower production in South America in defense and experienced approximately $30 million of FX headwinds in the segment, due to the weakening euro and Brazilian real. These revenue headwinds were partially offset by higher sales in North America, as the Class 8 truck market continue to strengthen. Segment EBITDA was $56 million, an increase of $3 million year-over-year. Continued execution of M2016 initiatives, including pricing and reduced product in operating costs, as well as the conversion on higher sales in North America more than offset the unfavorable impact of lower defense revenue, lower commercial vehicle demand in South America and FX. Next on Slide 9, we’ve summarized the Aftermarket and Trailer segment financial results. Sales were $208 million, up $6 million from last year, mostly coming from our aftermarket and trailer businesses in North America. Segment EBITDA was $25 million, up $4 million compared to last year. The increase is driven by conversion on the slightly higher sales and pricing actions executed last year. Now, let’s move to Slide 10, which shows the sequential adjusted EBITDA walk starting from the $80 million earned in the fourth quarter of 2014. First, you will recall that last quarter, we incurred both the $20 million charge associated with the remeasurement of our asbestos liabilities and the $15 million benefit related to the curtailment of our U.S. retiree medical plan at year end. Both of these items were discreet to the fourth quarter and did not repeat. The net impact of volume mix and pricing was flat for the quarter, even though volumes were down significantly on a sequential basis. Our first fiscal quarter has selling days, which affects our aftermarket business. In addition, production levels were down in South America as that market continues to show further signs of softening and the bid in North America as well as industry production was a little lower than in Q4. We were able to offset the lower volume through global pricing. Next, we experienced $23 million foreign currency headwind on sales, which negatively impacted EBITDA by $5 million, primarily associated with the continued appreciation of the U.S. dollar relative to the euro and the real. Finally, we had an all other net decrease in EBITDA of $1 million. This includes around $3 million of one-time favorable items that provided the benefit to our result this quarter. Overall, this was a very solid quarter for us. Despite declining revenue, our strong execution presented a corresponding decline in adjusted EBITDA. The result was adjusted EBITDA of $79 million and adjusted EBITDA margin of 9%, which means, we were able to successfully manage downside conversion to only 2%. Now, let’s turn to Slide 11. For the first quarter, total free cash flow was negative $21 million, compared to negative $16 million in the prior year. In the first quarter, we typically make our variable incentive compensation payments related to prior year performance, and this year’s payments were higher than the prior year’s payments. These payments are included in the line item called other on the slide. Aside from incentive compensation payments, our first quarter is also typically affected by seasonal trends, including fewer selling days and calendar year-end cut off issues which often impact the timing of receivables collections. Despite this, we continue to be on track to generate $100 million in cash flow this year. Next, I’ll review our updated fiscal year 2015 outlook on Slide 12. Based on the demand assumptions I highlighted on Slide 5, we have lowered our fiscal year 2015 sales guidance to approximately $3.7 billion. As noted on that earlier slide, we are seeing FX headwinds in Brazil and Europe, which is impacting our revenue outlook. You can see our new currency assumptions reflected on the slide here. In addition, lower production expectations in South America and China are further reducing our revenue expectations. And while the North America Class 8 market is up a bit, as we mentioned, we don’t expect to see that translate to increased revenue for us, as the increased revenue opportunity is being offset by DTNA supporting that ramp-up with increased internal axle production. Despite the decreased revenue outlook, we expect to achieve an adjusted EBITDA margin of approximately 9% compared to our previous guidance of a range of 8.8% to 9%. We expect to drive this margin result primarily through our continued strong execution of our M2016 initiatives. We’re maintaining our adjusted earnings per share guidance from continuing operations in the range of $1.20 to $1.30 for fiscal year 2015. The impact of lower revenue, slightly higher margin guidance, and the mix of earnings between tax-paying and non-tax-paying jurisdictions is driving very little impact on our bottom line earnings outlook. Our effective income tax rate guidance also remains unchanged at approximately 20% for fiscal year 2015. Although cash taxes might drop a bit with the revised mix of earnings, that drop isn’t going to move the needle meaningfully on our effective tax rate. And finally, as I said earlier, we continue to expect free cash flow to be approximately $100 million for 2015, which means, we’re expecting back to back years of cash flow at or above that level. Now, I’ll turn the call back over to Ike, to provide closing remarks.

Thanks, Kevin. Let’s turn to Slide 13. Before we conclude our comments, I want to reiterate that we are on track to achieve all three of our M2016 metrics. By the end of fiscal 2014, we had already reduced net debt, including retirement benefit liabilities by close to $500 million, achieving our target two years early. Despite the revenue headwinds we referenced today, primarily in Europe and South America, we remain confident in achieving our 10% adjusted EBITDA margin target in 2016. And we remain on track to achieve incremental book revenue of $500 million per year at run rate. In fact, with the PACCAR win we announced today, we’re more than halfway to achieving our $500 million run rate revenue target. We’ll share more detail on our performance against these goals next week at Analyst Day. And with that, we’ll take your questions.

Thank you. [Operator Instructions] Your first question will come from the line of Brian Johnson from Barclays. Please proceed.

Good morning, team.

Good morning.

Good morning, Brian.

Look forward to seeing you next week. I want to just get a little bit more color on PACCAR. Could you maybe tell us if I or a fleet buyer is going to a PACCAR showroom earlier this calendar year, what would I be offered in terms of rear axles and other drivetrains? Where would Meritor have been in that option book, if at all, and then where are you going forward? And then kind of second, leading into that, is that $150 million in annual run rate, life of the contract measure and so forth?

If you were to walk in and talk to a fleet, you would find that the Meritor axel would be listed as the preferred axel. And the 100 - to answer your other question on the revenue, that’s a $150 million annually.

Okay. But earlier in the year, if I went in last year to a fleet, would I even have the option…?

You would have the - Brian you would have had the option, but our competitor would have been listed as standard.

Okay. So you are moving from standard from optional to preferred for rear axle…

Yes, let me - yes, Brian, at that point, I mean, there are specific axles that we’re talking about. And in particular as we talk about the preferred option, we’re really talking about a 46K axle, and there - there’s technically not a real standard position in the data book. The standard positions are around the 40K axles. And so, as you look at the 46K axle, which is a meaningful piece of the business, the rear axle business, we are the preferred option, which means, we are lower priced in the data book this year going forward.

And what do you think was going on - why do you think you won this business, how competitive was it? What was the feedback from the customer on why they made this change?

The feedback from PACCAR and you need to ask them specifically, but they view us as a long-term partner, they can support them from a product, quality, and delivery standpoint. And matter of fact, at the Analyst Day, you will see Jay Craig is with Bob Christensen, and you will see a testimonial almost from Bob Christensen talking about why they picked us.

And in terms of capacity, is it - how are you freeing up capacity, is it adding extra shifts, is it improving flow rates through Six Sigma, any bump outs?

It’s all of that. We have had some capital investment. It’s been modest and it’s been within the 2% that we’ve targeted. And there is still some, a little bit of modest, it’s not much to go that will finish this year. We’ve really as far as our operational excellence, we’ve been working on quality throughput and then had some real opportunities there. And we’ve also worked with our supply place to mitigate the constraints there. So if you look at it from a standpoint of our guidance this year of 305 to 315, we will - we’ve stated we were at 300, we probably can support, because we had two 80,000 quarters that we have successfully converted that would take us to 320, but when PACCAR was fully up to speed we would be back to a 300 Class 8 market.

Okay. And this trend with Detroit Diesel - last question, kind of, how much of an offset is insourcing to the market share gains you are making in PACCAR and is this more of a - is this permanent shift at that customer, or could it happen with other customers, or is it more a question of a customer, kind of, adding peak loading capacity?

Right, we’ve seen Detroit ramp up to support this peak market, and it has had the effect that we’re talking about. But they are a valued and important customer. They are our largest customer in North America. I mean, we just signed a long-term agreement with DTNA last year that runs through 2017. And the bottom line is that, they and we expect to remain the majority supplier of their Class 8 axles going forward.

Okay, great. Thank you. Looking forward to seeing you next week.

Thanks, Brian.

Your next question will come from the line of Colin Langan from UBS. Please proceed.

Yes, just - thanks for taking my questions. Can you just clarify in terms of, I think you mentioned that you are preferred on certain axles, so any color in terms of the PACCAR business. Are you preferred in the majority of the trucks that they are selling, or is this just a subset and any color there on the relative size…?

The preferred option is really focused on the 46K, which is, it’s not the majority of the business, but it’s a meaningful piece of the business.

Okay. Thank you for the clarification. Any color on how we should think about the rest of the year? If we look at the annualized pace, you are at around $1.40, but you didn’t take your guidance up. What factors kind of mitigate the earnings growth through the rest of the year that we should be thinking about as we model things out?

I mean one of the things to keep in mind is that, as I mentioned in my remarks on the sequential walk, there was about $3 million of, I’ll call them one-time favorable items just a few $1 million items that we don’t expect to repeat. So if you flowed that through the EPS, if you backed that out effectively on a going forward basis, your annualized run rate wouldn’t be as high as what you’re suggesting there. So I think that’s something to keep in mind.

Okay, that’s very helpful. And any color on - this is the first quarter with the new Volvo contract, any color now that has sort of passed on how much that maybe helped in the new contract or any framework there?

We can’t really comment on that. We did get pricing with our OEs across all regions as well as our aftermarket business as well. But really not in a position disclosed specific details about that contract I would reiterate again that, we’re really pleased that we’re able to reach the agreement with Volvo that allows us to continue to provide them with their products for the foreseeable future.

Okay. All right. Thank you very much.

Your next question will come from the line of Patrick Archambault from Goldman Sachs. Please proceed.

Good morning. Thanks a lot for taking my question. I guess just - I dialed in a bit late and I might have missed the detail, but just the interplay between kind of the ramp-up for DTNA that you mentioned as well as PACCAR, and I guess the impact on margins that it’s having. Could you just get kind of get into a little bit more detail on that just because I felt we went through it fast, I wasn’t quite sure of what the impact was of all those pieces put together.

Okay, Patrick, I’ll - this is Kevin, I’ll take that. Very simply the way to think about it is that we’ve taken our full-year North American truck market up - guidance up about 5%. We think that 5% increase in market is effectively being offset from a revenue perspective by DTNA ramping up its internal production to support the peak market. So I think we are seeing effectively that upset opportunity being offset by some of the ramp up the DTNA has done. In terms of the PACCAR business, the bulk of the PACCAR ramp-up is going to happen after 2015, it will happen in 2016 and 2017. We are seeing some of that ramp-up this year, but it’s already factored into the guidance. We were on the verge of executing this contract back when we first gave guidance for the full-year, so we were already contemplating that in the guidance.

And I’m sorry, like the DTNA ramping up internally that would be negative for you, why exactly?

Because effectively they are ramping up internal axle production, so they have a vertically integrated supplier. We provide the majority of the Class 8 axles and we continue to do so today, but they ramped up such that effectively our penetration on the rear axles with them has gone down as a result.

And is that just kind of a timing item, or is that sort of a permanent shift that they’ve kind of resourced some of the stuff you have had?

Patrick, we just signed just last year a four-year agreement and with Daimler that positions us as a majority of - supplier for the majority of their axles, and we expect that to be the case going forward as well.

Okay. But - sorry, just a little bit on this more though, it sounds like in exchange for a price, they might have insourced some of it, right? Is that kind of a fair way to think about it?

No.

I don’t know that I would go that far, Patrick, other than to say, we’ve seen them clearly ramp-up their internal axle production capability to support the peak market here. And beyond that that’s probably all I would say at the moment, but we expect to continue to provide the majority of axles as we’re doing today on the Class 8 business.

Okay. That’s helpful, thanks. And just on Brazil, did you - did I hear you say that your - I don’t have the comps of the South American numbers you have on page 5 or Slide 5, but did I - I think you had said that was down 20%, so that’s fiscal 2015 over fiscal 2014, is that correct? And then, I guess, maybe just a little bit more on that, I get it that you have the FINAME financing rates that have gone up in the down payment and all of that fun stuff. But I mean, on a calendar basis, production was down 50% in Brazil or the high 40s% at least last year. So one would have thought it was at least an easy comp. So I guess, maybe, just help me understand a little bit better what’s going on there, if you don’t mind.

Well, on a year-over-year basis, 2014 production was down only about 12% in 2014 versus 2013. As we look ahead to this year, we’re expecting it to be down another 20% on top of that. I mean, if you look at Q1 alone, sequentially going from Q4 to Q1 the market is down - production is down over 20%. You look on a year-over-year basis 2014 to 2015 is down little over 30%. The market we’re seeing right now in Brazil, where we are looking at about 130,000 market is approaching the levels that we saw back in 2009. The good news is, we’re still profitable in that market and we expect to play in that business longer-term. But we’re approaching levels that we haven’t seen since the recession five or six years ago.

Interesting. I guess, maybe, some of that is the fiscal conversion, and I suppose you also potentially have a different market than what ANFAVEA reports, is that the difference? Because on a calendar basis, they have production down, kind of high 40s%, but so - maybe we can take that offline, but…

Yes, we can talk about that offline, but ANFAVEA we’re looking at from them that we’re seeing the exact same numbers that they are.

Okay. All right. We will reconcile that offline. Thanks a lot, guys.

Okay.

Thank you, Patrick.

Your next question will come from the line of Brett Hoselton from KeyBank Capital Markets. Please proceed.

Good morning, gentlemen.

Good morning.

Good morning, Brett.

I guess first, just kind of a broad kind of overarching question here. Over the past 10 or 15 years that I have covered the company, you guys have gone through a number of cycles. As that cycle has ramped up and we’ve seen a fairly material ramp-up in Class 8 orders here recently and obviously you are raising your expectations here. In the past the leverage that a lot of us anticipated you might get or benefit from as a result of the higher sales has been offset by premium freight costs over time and that sort of thing, and therefore, you haven’t necessarily gotten to the 10% target that you had hoped to achieve and so forth. So my question is, how do you think about or how have things changed at Meritor this cycle versus prior cycles that that give you confidence that you will be able to achieve these higher margins as that cycle lifts?

We’ll, I think, we’ve given guidance before that we thought we could convert incremental revenue in the 15% to 20% range. And I think the answer Brett, is we’ve been doing it. We have just come out two 80,000 quarters. And we did successfully convert at the 15% to 20%. Now, some of it has been better throughput as we talked about before and we’ve expanded our supply base. There has been - it’s not a single one action, it’s probably 10 or 15, if you were to sit and list them all. But I think the proof is proof is, is in the pudding of what we’ve been doing, that we’ve successfully been doing it for the last four, five quarters.

And then as you think about the additional 100 basis points of margin expansion as you move into 2016, can you talk about or quantify or bucket the primary drivers of that and then just kind of give us a flavor of your confidence level in being able to achieve that?

And I think as we look ahead to 2016, we are emboldened by the fact that we are already jumping out of the gate here in the first quarter of 2015 at 9% on revenue that’s not even at $900 million. So we feel pretty good about the starting point as we look ahead toward 2016. So as we look towards 2016, we are expecting a mix of continued performance like we’ve been demonstrating the last couple of years combined with some revenue help. I mean, at the end of the day, we have a mix of things that we are looking for next year. And as we said publicly, we expect that we need to be at about $4.2 billion of revenue to be able to achieve 10% target. Now jumping off of $3.7 billion, how do you get from $3.7 billion to $4.2 billion? It’s too early to call what the markets are going to look like next year. But we know that with the new business wins that we generated, including the PACCAR win that we announced here today, that’s going to contribute a couple of $100 million incrementally between 2015 and 2016, which means then end market recovery we are still looking for $300 million or so of help. That said, this company is determined on executing toward hitting its 10% margin targets, but that’s kind of the flight path there.

I think to add a little more to that, it’s basically our self-help. In 2016, the elegance of it is in its simplicity and the focus that we’ve done around the initiatives to support the overarching objectives.

The 80,000 unit run rate that you experienced here, about 320,000 units, what happens in the event that the market moves up maybe another 10% or so to north of 350,000 units? How does that affect the business model, the margin profile, and so forth?

Right now, we don’t think that is probably the case, Brett, and we’re in a position where we are supporting our contractual agreements with our customers. So I mean, I don’t see the market for the foreseeable future doing that. But right now, we are not going to chase capacity around the world above and beyond what we’ve committed to.

And I think when we look back to the last time we were approaching these types of levels in 2012, we saw or observed that there were constraints across the global supply base. And so seeing the market get to that type of level like you mentioned, 350,000, I don’t think we think it’s really achievable given the broader supply base in this industry. And so, as Ike mentioned, we are not going to chase that capacity by investing - installing new capacity to support that. But we don’t see the market going there. We think the order activity we are seeing, frankly, just strengthens our outlook for 2015 and probably carries us into 2016 as well a little bit.

Excellent. Ike, Kevin, thank you very much, gentlemen.

Thank you.

Thank you.

Your next question will come from the line of Robert Kosowsky from Sidoti. Please proceed.

Good morning, guys how are you doing?

How are you, Robert.

Good morning, Robert.

Doing, right. Just going back to the Detroit axle, DTNA, I guess, shift in production, is this something that was contemplated when you came up with the most recent agreement? Meaning that if they are ramping up production right now, it might be tacking into some inefficiencies that you might have in your own production environment. So this is something that was contemplated going into that agreement a couple of years ago?

I can’t necessarily answer what DTNA was thinking at the time. I just know what we’ve agreed to in the contract. And it was just signed last year, and the contract is that, we will be the majority supplier of DTNA’s axles going forward.

So, I mean, it’s is structured in a way that it gives DTNA the incentive to keep business with us. But DTNA has had that - had their vertical capability for an extended period of time that we continue to be the majority supplier of axles for an extended period of time. So the way the agreement is structured, our expectation of that relationship is that, it will continue to be operate the way it has, which is we will be the majority supplier. But, again, I think DTNA has used this as an opportunity to invest in some capacity from the axle side to support the peak market here.

The way Kevin explained it, we are just missing a little bit of the upside here, that’s the bottom line.

Okay. And would this - if you had gotten this upside, would you have incurred, I guess, inefficiencies because it would have been - the market would have been going above what you were, I guess, capacitized for?

We don’t think so because, in fact, as we - as Ike talked about earlier, the capacity that we were installing over the last couple of years to support the PACCAR business that we were anticipating winning and ramping up. That capacity really started to come online last year. And so it happened to coincide with this type of the market, which is why we were able to actually support the 80,000 quarter that we saw back in Q4. And so, as the market hit that type of level with the types of penetrations we’ve experienced in the past with DTNA, we absolutely could have supported it. Now, once the PACCAR business comes fully up to speed over the next couple of years, our capacity will be constrained back to the levels that it was before. So I think the fact is, we could support an 80,000 market right now, because the capacity is there to support it until the PACCAR business completely ramps up.

Okay, I understand that. And then secondly, obviously there is weakness in Brazil and China on the construction side. I’m wondering do you see any signs of hope in those markets, and specifically there was some talk earlier this month about a Chinese infrastructure stimulus plan coming out. Do you give any credence to that?

Well, the Brazilian market is - obviously has its own issues, and we don’t see much recovery this year. Hopefully we’ll start to see some recovery next year, and as Kevin implied, we like the Brazilian market. We have strong relationships with our customers. We are profitable at the levels that it is today, so I mean, we’re very much committed to the Brazilian market. The China market is anybody’s guess, and if - obviously if there is additional infrastructure spending, we’ll obviously have the opportunity to take advantage of that.

Okay. Do you think there is a good likelihood that a plan goes through, or do you have any kind of idea as to whether or not the reality of that happening?

I just don’t know, to be honest.

All right. Thank you very much, and good luck.

Thank you.

Your next question will come from the line of Alex Potter from Piper Jaffray. Please proceed.

Hi, guys. One thing that you had mentioned pretty consistently both in the aftermarket and in the new equipment segment was this impact on pricing. Can you just, I guess, flush out a little bit more what specifically you are being able to increase pricing on and why?

This is Kevin, I’ll take that. From an aftermarket perspective over the last number of years, we’ve consistently launched or executed pricing actions generally in the second fiscal quarter of the year. And, in fact, we’ve executed pricing again in this current quarter in the aftermarket business. So that’s been a pretty consistent trend for, at least, five or six years. On the OE side, it’s been more opportunistic as opportunities arise with different markets or different OEs. And so, as we look at the commercial truck and industrial segment in the quarter, we saw a number of different geographies and a number of different customers in which we had some pricing actions that went into effect.

Okay. And presumably that’s, I guess, related to the fact that right now, say, in North America, we are getting somewhere in the neighborhood of peakish order run rates. So the - I guess, the supply chain is somewhat constrained and you have more leverage to be able to request pricing increases?

No, not - I mean, the countries in which we are under an LTA, if that LTA is still in effect and continuing, the pricing is already contractually locked in. So there aren’t - there generally aren’t mechanisms when you are in the middle of an LTA to change the pricing, unless you are launching new products or providing new features. It’s really things that happen when either an LTA comes up for renewal or when you have, you are operating on a spot basis in certain markets, those are the types of opportunities.

Okay. So it has nothing to do with supply constraints in the supply chain?

No it does not, yes.

That’s correct.

Okay. And then shifting over to margins, obviously nice margins in aftermarket, how sustainable do you think they are going forward?

Very. I mean, we don’t see - as a matter of fact the pricing opportunities we’ve got are not this is necessarily just price per say. They are value-added services that we’ve been in - product availability, 24-hour service. We are doing things that our customers put a value on and they are willing to pay for it. So the margins that we see are very sustainable.

And I think we alluded to that last quarter as well. I think our Q4 margin was a little bit high. We were at a higher revenue level because we have seasonal - seasonality in the business that takes revenue down this quarter, but we also had some one-time favorability that was helping the results last quarter. And we indicated that we thought a normalized run rate at that type of revenue was a little bit north of this, and with revenue coming down a little bit in the quarter, this is right in line with our expectations. So I think, we do believe this to be sustainable as we go forward.

Okay, very good. And then the last question also on aftermarket, but specifically on Europe. I was wondering if you could kind of dive in there, I don’t know if you have sort of visibility on what Europe’s aftermarket specifically is doing by maybe region or sub-region within Europe, but is there any way that you can draw some insights out of those aftermarket trends that help inform your view of the new truck market?

Well, the aftermarket distribution channel in Europe is very much different than it is in this country. It’s basically through the OEMs as opposed to - in the North American market, it goes through OEMs and distribution. I guess, the biggest impact to us in Europe is Russia. We have considerable revenue in Russia, and Russia obviously is uncertain at this point in time.

Okay. And no specific aftermarket trends up or down in Russia that would lead you to believe that things are getting better or worse there?

Well, I think just generally with the issues that we’ve seen in the Russian market it has impacted that piece of the business. It’s not a majority of our business by any means, but it’s still a meaningful piece of that business. So that has been impacted a little bit. And I think, the softness we’ve seen overall in the European market, it’s had a similar impact on the aftermarket business as well, even putting Russia side.

Okay, very good. Thanks, guys.

Your next question will come from the line of Ryan Brinkman from JPMorgan. Please proceed.

This is [indiscernible] on behalf of Ryan. Thanks for taking our questions. So the first question I have, I was just trying to get to what has really changed since you last issued guidance, and revenues looks softer on that front, but you are able to execute the stronger net higher margins. So wondering is this just a function of pulling in more cost sales in the business, or are you contemplating more pricing actions going forward in the future quarters, which is driving higher margins? What’s really helping you drive that higher margin and the slightly softer revenue outlook for this year?

I would say by and large, it’s the performance of the business. I don’t think, it’s necessarily anything incremental beyond our expectations from a pricing perspective. I think it’s just a lot of the cost initiatives are taking hold and sticking. We obviously, as I mentioned, had a few million dollars of one-time favorable items in the quarter about $3 million that we hadn’t necessarily planned for. So it’s a simple DOS around the top end of the guidance that we had previously given.

Just a follow-up there, is there an X number that you’ve quoted us to be cost save that you expect in this year incrementally over the last year?

We haven’t. I think the best way to dimension that, you can look at the sequential walks that we provide every quarter, and if you add up the components and think about what that means from a material labor and burden perspective, I think you can get in the ZIP code of what we expect to say. It’s part of our M2016 initiative. We are driving for generating reduced material costs of about 2.5% of controllable spend and about 2.6% on the labor and burden side. Those are our targets, and we achieved those last year. So the combination of those things might give you a little bit of color.

Okay, great. And just more on the housekeeping side, you mentioned some one-time items benefiting your margin this quarter. Were they primarily on the aftermarket and trailer segment? I mean, I’m just trying to get at whether the 12% margin there is sustainable, or was that benefiting from some one-off items this quarter, which don’t really carry forward?

No, it was - I would say, it’s wasn’t really related to aftermarket in particular. So there are no real discrete items. There were some accrual reversals that impacted both segments, and there were a couple discrete items more on the truck side, I would say.

So it’s fair to assume that the aftermarket and trailer segment margins are sustainable in the quarters going forward?

Yes.

Okay. Good. Thanks for taking my questions. Thank you.

Your next question will come from the line of Kristine Kubacki from Avondale Partners. Please proceed.

Hey, good morning, guys.

Good morning.

Not to beat a dead horse a little bit, but I’m a little confused, I guess, on the DTNA when you say a majority supplier. It was my understanding and I may have this completely wrong, but that as they spec out their most popular evolution package that you have to have their supplied axles. And I guess, and then I guess, when you say majority supplier to them, are you talking as a third-party supplier? And then, I guess, how do you monitor if, in fact, how you maintain a majority market share if, indeed to spec in the evolution package you have to have at Daimler axle?

Well, I will let Kevin to take it in a little more detail, but keep in mind that the fleets spec the products that they want, now they - DTNA offers the Detroit package, but the fleets can request a Meritor axle on that drivetrain if they choose. So it’s just not that that - that’s one of the potential offerings, but it is just one of the potential offerings.

And don’t forget, I think Detroit axle is standard for Daimler. It has been for a long time, yet we command a majority of the Class 8 rear axle supply for Daimler and continue to do so today. So it’s exactly as I described, the fleets can specify, which axles they would like on their vehicles and more often than not they select a Meritor axle on the Class 8.

Okay. And then just - and that’s helpful and something we haven’t talked about in a little bit. But you are still the preferred supplier for Navistar as well, correct?

We are standard position, yes.

Yes.

Okay. And that’s helpful. And then one last question, in terms of the PACCAR ramp up, how can we think about that? Is it going to take two years to ramp-up, and then I guess, how - with your traditional market share being a preferred supplier, where do you think you get to, is it 50%, is it 80% over time?

A couple of points there, I think we’ll see the majority of the income on this new contract in our income statement by the end of next year. So we would expect to see the bulk of the ramp-up happen by the end of 2016. In terms of where that puts us from a penetration perspective, we’ll talk a little bit more about that at Analyst Day next week.

Okay. That’s very helpful. I look forward to seeing you guys there. Thank you.

Right, thank you.

Okay, thank you.

Ladies and gentlemen, that will be the last question of the call. I would now like to turn the conference back over to Mr. Carl Anderson for closing remarks.

Thank you. We do appreciate your participation in today’s call. As a reminder, we are hosting our Analyst Day event next week on February 5, that we hope to see you there. This concludes our first quarter 2015 earnings call. Thank you.