Good day, ladies and gentlemen, and welcome to the Q3 2015 Meritor Inc. Earnings Conference Call. My name is Tia and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session. [Operator Instruction]. I'd now like to turn the call over to your host for today Carl Anderson, Vice President and Treasurer. Please proceed.

Thank you, Tia. Good morning, everyone, and welcome to Meritor's third quarter 2015 earnings call. On the call today, we have Jay Craig, CEO and President; and Kevin Nowlan, Chief Financial Officer. The slides accompanying today's call are available at 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 consider your continued participation to be your consent to our recording. Our discussion may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to Slide 2, for a more complete disclosure of the risks that could affect our results. To the extent we refer to any non-GAAP measures in our call, you'll find the reconciliation to GAAP in the slides on our Web site. Now I'll turn the call over to Jay.

Thanks Carl, and good morning everyone. I told you in April that I was confident in our ability to beat our commitments and drive enhanced value for our shareholders. Our results this quarter demonstrate the progress we are making toward our M2016 objective and provide us with increased confidence for the future. Our financial performance also demonstrates the efforts we have put in to managing labor, burden and material performance to drive expanded margins. At the same time we are growing through new contracts with important customers like PACCAR that we will talk about today. Looking at Slide 3, you will see that the quarter reflects continued strong execution, while revenues were down $70 million year-over-year primarily due to unfavorable currency headwinds. Adjusted EBITDA margins were up 120 basis points year-over-year at 9.6% for the quarter which puts our year-to-date margin at 9.5%. Adjusted EPS for the quarter also improved $0.12 from fiscal 2014 which demonstrates that our improved to margins are translating to bottom line earnings for our shareholders. In July of last year we announced $210 million share repurchase program, which was the first time we have returned value directly to the shareholders since 2000 and date. In the second quarter of the fiscal year we repurchased $31 million of securities and this quarter we repurchased another $18 million. We remained on track to complete the entire repurchase program by the end of fiscal 2016. We also refinanced and repurchased a portion of convertible notes which will help reduced the dilution impact to the number of shares outstanding going forward. Although volume headwinds outside of North America have continued to present challenges our performance throughout the year has exceeded our expectations and were attend raising our outlook for earnings and cash flow. Let's turn to Slide 4, in…

Thank you and good morning. Let's turn to Slide 6. On today's call, I'll review our third quarter financial results and then I'll take you through our revised 2015 guidance. Overall, the key takeaway you'll see from our results is that we continued to drive financial performance. Our M2016 strategies are generating improved with margins and bottom-line EPS. As a result, in the third quarter we generated adjusted EBITDA margin of 9.6% and $41 million of adjusted income from continuing operations. So, let's walk through the details on slide, where you'll see our third quarter income statement compared to the prior year. Sales were $909 million in the quarter, down $70 million or 7% year-over-year. The lower revenue was driven entirely by currency headwinds in Europe and Brazil. Without the stronger U.S dollar revenue would have been higher this year versus last year. As robust production in North America truck and other revenue increases more than offset lower production in South America and China. Gross margin as a percent of sales was 13.6%, reflecting a 90 basis point improvement over the prior year. This improvement was driven by continued material labor and burden performance and pricing actions consistent with our M2016 strategy. SG&A was $12 million higher in the third quarter compared to the prior year. The increase was due to a $20 million recovery of legal fees associated with Eaton antitrust settlement in prior-year, which did not repeat this year. Excluding this SG&A costs were actually lower by $8 million, mostly due to lower spending and variable in front of competition accruals. Restructuring costs were $9 million this quarter and were related to severance costs associated with previously announced restructuring actions taken in our South America truck business. As well as cost associated with the closure of our Newark…

Thanks Kevin. Let's turn to Slide 14. In developing M2016, we identified key issues established and communicated measurable objective aligned the organization and are successfully executing against our plan. As you know our performance metrics include margin improvement, net debt reduction and revenue growth. We are on track to achieve all three and are committed to bring in home the plan next year, but for also hard to work on our strategy for beyond 2016. Our next three year plan will put more emphasis on executing opportunities for growth in our core and adjacent markets while remaining focused on expanding our margins and driving a balanced approach to capital allocation. We look forward to providing you a detailed review of that plan in our December Analyst Day Meeting. And now, we'll open it up to your questions.

[Operator Instructions]. The first question comes from the line of Brian Johnson with Barclays Capital.

Can you just give us a broad sense of your China exposure? I think it's mostly off-highway, but just want to understand and also what you're seeing in that market vis-à-vis order rates, backlog et cetera.

Brian this is Jay. That's good question. Our business today is primarily of highway construction mining with some premium bus and coach axles. I think what we're seeing as stability in the bus and coach axle business with extreme weakness in the other segments of the markets implied in our Q4 guidance is than expected further step down in Q4 compared to Q3 in that of highway and construction business and something we typically see this time of the year seasonally but we don’t expect that will see any recoveries soon in those end markets.

So that's not -- but would you say it's bouncing along the bottom or further downside?

I would say it continues to step down bit-by-bit but quite frankly it's getting to be at such low volume levels, the impact to our guidance and the overall financial impact to Meritor it's becoming relatively insignificant.

Second question, on the military side. While we wait for hopefully new awards, can you give us an update on FMTV and your expectations in the fiscal 2016?

Right now we are working with the prime contractor ash Oshkosh on this program trying to determine what production levels to expect in 2016. I think at this point we would say we don’t see values changing too much in that period compared to 2015.

And final question, how do you think about consolidation in the drive line industry? I guess a couple questions. One, do you see opportunities within the commercial and off-highway world? Do you see any potential tuck-ins? And three, what about the idea of kind of combining light vehicle axles and commercial vehicle axles in the same entity?

I can address the second question first obviously we've worked hard for a long time to become a commercial vehicle focused business and I would tell you a big part of the PACCAR wins we've had PACCAR has complemented to us, in fact I think you saw the comment about Christianson made in our Analyst Day, I'm being focused on commercial vehicles. So we're very pleased with that focus or at more importantly our customers are pleased that all of our capital and research and development goes to that area and we don’t see a lot of synergies and overlap between the two as we've evaluated that over time. But as far as expansion within the commercial vehicle business as we had look to our next three year planning cycle that is something we're considering, we are looking at growth opportunities so I mentioned in my comments in the core which would be new geographies or new customers along with newer adjacencies for we think we can provide additional value to our customers and as we look at that growth we will consider certain what I would call bolt-on acquisitions that may help us expedite that growth.

And just final question, quickly, I know I ask it every time. Any update on Meritor WABCO's participation in truck active safety, and ADAS, and can we look forward to any given that's increasing, given their braking requirements coming in, whether it's through the resale of active safety equipment or just higher spec brakes, is there any contribution we can expect over the next three years from that and, if so, how to dimension it?

We've seen very solid performance in Meritor WABCO participating obviously on the increasing value of the North America along with some increasing penetrations particularly collision avoidance systems and we're very pleased with the performance of that entity. I think it's a fairer expectation of ours it should be of our investors as we could see further penetration of those safety systems in the vehicles.

But any way the dimension the impact on your equity income or your financials?

We're not forecasting that at this point. But certainly I think you can see some of the impact through our financial segments of the impact of non-consolidated joint ventures and the increasing income we're seeing from that.

And Brain it's Kevin if you look we have filed Meritor WABCO's financial statements for last year because they were a material sub here over the last couple of years so you can actually see what our earnings are coming from that entity.

The next question comes from the line of Neil Frohnapple with Longbow Research. Please proceed.

Wanted to ask a little more on the front axle business win at PACCAR. Our channel actually picked up that your front axles were already installed on a meaningful percentage of PACCAR's production in the second quarter. So would you expect the ramp-up to greater than 50% share to be even faster than the rear axles, now that you have a standard positioning? Just really trying to get at when you would expect to hit the $40 million revenue run rate?

Neil this is Kevin. Yes you are exactly right. We did start to see the ramp up of this happen early on the year as PACCAR assets to ramp up and advance of the LTA being executed. So as we look ahead to the $40 million of revenue that we’re expecting at run rate, I would tell you we're expecting that already two-thirds of that is hitting in year 2015 and it really started already in our second fiscal quarter.

And then, Kevin, revenue from the front axle business win generate incremental EBITDA margins within your stated 15% to 20% conversion rate range you had previously provided?

We don’t give specific margin guidance on any particular program, but I think it's a fair assumption on any of our new business wins to think about it being in that general zip code. I think that's the fair way to think about it.

And then just one final one. Aftermarket and trailer segment EBITDA margins, very impressive in the quarter and up year-over-year again. That sounds like it was primarily driven due to continued execution of the M2016 initiatives. But you do have a tough comp in the fourth quarter versus last year. Do you guys think you can exceed last year's margin, given the momentum you built for the segment?

I don't think we're prepared to give specific margin guidance on each segment in the quarter, but I think if you look the last four quarters in a row now we've generated 12% to 14% EBITDA margins in that segment and that's not an accident. I think the 14% numbers that you saw on a couple of quarters had someone timers in there and as you think about the 13% or 13.3% we generated in the quarter which really didn't have any real type of one timers that's probably more of which you should expect of the run rate of this business at the current revenue level.

The next question comes from the line of Patrick Archambault with Goldman Sachs. Please proceed.

Just following up on that last question firstly, what was -- sorry, you said there was some one-off items that impacted the fourth quarter last year in trailer. Can you just remind us of what those were?

Well I guess I was speaking to like the 14% we generated a quarter ago where we had some of those FX tailwinds the one-time foreign exchange hedges that generated some gains, so I think we've had a couple of guidance drove us with 14% numbers, but I think you should expect something in that 13% zip code is about the right margin for the business right now.

And the liability true-up, I guess in September, can you tell us a little bit more about that? Is that something that you've kind of factored in a base amount, and you're being a little cautious because you don't know what the variance is, or how specifically are you -- because I'm not familiar with that particular issue?

I mean if you look at the last couple of quarters, we have seen some liability true-up happen to us at yearend particularly around some of our legacy liabilities. And unfortunately last year we saw a pretty meaningful step up in our legacy liability although we saw some big upsets to that as well. So as we think about our forecast for Q4, we are assuming a few million dollars of potential liability adjustments as part of our planning process, but it remains to be seeing what the actual valuations are going to come in at.

And what are -- is that like interest rate or discount rate-driven, or what kind of factors affect that?

I mean for example last year when we had some of our asbestos exposure, it really related to the forecast of our tenured liability based on actual experience that we were incurring in the current year. So as we just looked ahead we're being cautious I think and assuming that there is some risk that we could have a few million dollar of true-up probably nothing material like we saw last year given where we sit today. But the potential exit that there could be a few million dollars and that's what we planned for thus for in our guidance.

And last one from me, I guess all my questions are on accounting liability things, but just the German annuity that you are pouring some funding into, can you just remind us what are the tax implications and the earnings implications of funding that plan with that annuity?

So obviously we've issued that and we're using some cash on the balance sheet to basically fund that transaction. I think as you look at the impact of this on a going forward basis beside from the fact that we'll have bit of interest expense for the portion of that it uses debt we'll see an EBITDA improvement heading into next year probably in the $2.5 million to $3 million range. So that would be a partial offset to the interest expense that we're seeing. And then I think as we -- as I mentioned in my remarks, we'll have a non-cash charge that will take associated with some of the actuarial true-up that we have to flush through the P&L that will be a one-time non-cash charge that we will take. And then finally one thing that we'll be cognizant enough and we're not sure the impact yet as we take away that headwind of the German liability and the cost of that liability going forward, it has the potential to impact the way we look at our valuation allowances in Germany in terms of assessing the positive and negative evidence of whether or not we need to reverse the valuation allowances there and can start using those tax attributes that remains to be seen.

But if there's not really a cash tax shield from funding that thing like there would be in the U.S., right?

Correct.

And then so -- and then you have said, and you said it again today, well, multiple times, I think, that you're going to likely write up your deferred tax assets. So we should think of modeling something closer to the statutory rate next year onwards, is that kind of a safe modeling assumption, in the absence of more detail?

I don’t think we said that anything is likely. We're still assessing the positive and negative evidence. We've had obviously here a couple of quarters of positive earnings in the U.S. and certain jurisdictions in Western Europe, if those trends continue, if the potential exist that we could some of those assets being reversed or those valuation allowances being reversed, later this year or into some time in 2016 and I think we'll be prepared to give you that guidance at the end of the quarter when we get into the November earnings call.

The next question comes from line of Colin Langan with UBS. Please proceed.

Can you just remind us the percent of sales that you have today in China and how they're structured? I believe they're through joint ventures, just so I understand the earnings?

Yes, in China I mean you look a year ago our China earnings were-- our revenue was about 150 million of revenues to down 35% this year was same. We're going to be in $100 million zip code. That’s predominantly conducted through a 60-40 joint venture where we own 60% and our JV partner own 40%. There's two JVs there, but the bigger of the two is with XCMG.

And then regarding the PACCAR win, can you give a sense of how your capacity is today to handle that, because market's pretty strong in North America. What kind of capacity are you running at and are there going to be any challenges with all the new wins coming on line?

I think, we feel confident meeting what we estimate as the demand currently in North America with current penetration we see including the incremental business with PACCAR. I would say we wouldn't commit to that type of business without having some surety that we could deliver on that without incurring additional expediting costs or other costs and just as importantly that we should expect PACCAR wanted to do some due diligence on that before committing to us. So I think all of us feel very comfortable where we are at and I think it's displayed in the actual quarter performance you are not seeing premium costs impact our ability for match the ramp up in volumes in North America.

Can you remind us on the pensions, the impact, the mortality when we measure at yearend?

Yes, this is Kevin when we first started looking at this a year ago and look at the Society of Actuaries tables, as they were published in the exposure draft. We model that through our liabilities and thought the impact would be about $124 million on our liability however as we-- as the final rules about how to apply the tables were published we realized we are able to apply some of our actual experience to modify the base line tables that were provided by the Society Actuaries. So in the end our experience defers from that, that was published by the Society of Actuaries. The end result for U.S., we think is going to be less than a $25 million impact on our liability at the end of the year versus the 124, so we thought about a year ago in this time. So less than 25 million we think at this point.

And lastly, any update on your M2016, $500 million sales target? Where do you stand now with the recent win?

We will update that in November but this win the $40 million PACCAR business win is incremental to what you have seeing before.

The next question comes from the line of Kristine Kubacki with Avondale Partners. Please proceed.

I know you guys look at fiscal year a little bit different, but want to talk a little about the North American market, and obviously we're at very high levels. Where do you see that going, in terms of are we at peak? There's a lot of debate in the market. And would it be a bad thing to kind of come down from these really, really high levels? It sounds like you're not incurring any premium cost, kudos to you, but would it be a little bit more comfortable for you if the market cooled off just a little bit in North America next year?

Well, as I mentioned in my comments is a typically foresee this high volume level continuing through the calendar year, that we have discuss previously through this calendar year. Certainly we have to start to see orders pick up a bit for to continued this, these very strong levels through next fiscal year but will be providing our details outlook next quarter in conjunction with our guidance for fiscal '16. As far as whether it's a good thing, it cools off to that as you commented and I did-- we are able to perform very, very well at these volumes. I think we have because of the make-up of our hourly work force with a meaningful percentage being contract labors. We are able to flex sound quiet effectively, so I think this is pretty broad range where this market can be very profitable for us. So if it comes down a bit certainly we will miss those volumes. I wouldn't mislead you but I think we'd still have very profitable business in North America.

And then kind of the same question in Europe, but kind of the reverse of, as it -- it seems like it's a little bit more slower ramping there, but are there any things as we watch out in that market, as it seems like things continue to get better over there, are you anywhere near how you think about operationally ramping up there? Are there any challenges as that market continues to accelerate?

I think we feel good about Brazil we did have a pre-buyer little of year ago now that we actually hit it very well on it and we lost it about one quarter but again its very few if any premium cost can be had its deal with that our response of that spike volumes. Right now I think what you are saying in that market is just for slowly building confidence and increased orders, so it looks like it could be a slow ramp up which obviously we could respond to very effectively. And also we're just very pleased with the profitability as far as European business overall.

That concludes today's Q&A session I'd now like to turn the call back over to Carl for any closing remarks.

This is Jay Craig. I just want to thank everyone for joining the call and for your continued interest in Meritor and more importantly I want to thank to Meritor employees just for their efforts this quarter and delivering outstanding results for our investors. Our results in the third quarter are really testimony but our focus on execution and revenue growth is working, we're committed to delivering increased shareholder value by driving margin improvement and reducing debt and positioning our core businesses for profitable growth. I look forward to either seeing you before the next quarter or speaking to you next quarter. Thank you.