Good day, ladies and gentlemen, and welcome to the Meritor second-quarter 2018 earnings conference call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Carl Anderson, Group Vice President of Finance. Sir, you may begin.

Thank you, Takeeya. Good morning, everyone, and welcome to Meritor's second-quarter 2018 earnings call. On the call today we have Jay Craig, CEO and President, and Kevin Nowlan, Senior Vice President and President of Trailers and Components, and 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 US and international copyright law and may not be rebroadcast without the express written consent of Meritor. We consider your continued participation to be your consent to our recording. Our discussion may contain forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to slide 2 for a more complete disclosure of the risks that could affect our results. To the extent we refer to any non-GAAP measures in our call, you'll find the reconciliation to GAAP in the slides on our website. Now I'll turn the call over to Jay.

Thanks, Carl, and good morning. Let's turn to slide 3. We're happy to report today strong sales and profits for the quarter. For the second fiscal quarter of 2018, we had sales of more than $1 billion, a 32% increase year-over-year. This was primarily due to higher production in all our global markets, new business wins, and favorable foreign exchange. Adjusted EBITDA margin was 11.4%, up 120 basis points year-over-year. And adjusted diluted earnings per share was up 114%. As I said, these results reflect the higher levels of production in our end markets globally. You'll see later in the presentation that we are raising our market outlook for the year in nearly every region. Even as markets are growing, we continue to gain rear axle share with our largest customers. In high markets like these, our customers know they can rely on us to meet their demand. It goes without saying, however, that at these volumes we are seeing some stress in the system. The good news is that, although incurred some premium freight and higher labor and burden costs as a result, we are still converting well and consequently are raising our guidance for the year. I attribute this to the diligent execution of our team in effectively meeting the needs of our customers while at the same time efficiently managing the supply chain complexities and incremental costs inherent at these volume levels. I am pleased to tell you that with the revenue tailwinds we expect to continue in the second half, in addition to the new business wins and other outperformance to the market, our full-year guidance has improved measurably. Kevin will give you the details, but I want to highlight that, at the top end of our adjusted EPS guidance for the year, is now higher…

Thanks, Jay, and good morning. On today's call I'll review our second-quarter financial results and our updated 2018 guidance. As you heard from Jay, we had a really strong quarter of financial performance. We saw revenue increase by $260 million, expanded adjusted EBITDA by $40 million and accelerated the progress toward achievement of our M2019 targets. Let's walk through the details by first turning to slide 8, where you'll see our second-quarter financial results compared to the prior year. Sales were $1.066 billion in the quarter, with every major region reporting stronger revenue relative to last year. In North America, Class 8 truck production was 73,000 units, up 22,000 trucks from a year ago. We believe that production levels will continue to expand for the remainder of the year due to strong net order intake in recent months. Sales in Europe were also up, primarily driven by an appreciating euro. Beyond North America and Europe, we're seeing our other major markets China, India and Brazil growing year-over-year. And while end markets are strengthening, we're also seeing the benefit of revenue outperformance globally. Driven primarily by the higher revenue, we generated adjusted EBITDA of $122 million and an 11.4% adjusted EBITDA margin. Overall we converted incremental revenue into EBITDA at the lower end of our historical range. As you can see from the chart on the right side of the slide, we are showing several discrete items that were part of the earnings walk year-over-year. First, we routinely reassess the environmental reserves required for all of our sites. As a result, we determined that we needed to accrue an incremental $8 million liability this quarter related to a legacy site. Additionally, last year you may recall that we settled a dispute with a joint venture and recorded a one-time legal charge…

[Operator Instructions]. Our first question comes from the line of Alex Potter of Piper Jaffray. Your line is now open.

Good quarter. I wanted to ask first about some of the supply chain stress you mentioned in the prepared remarks. If you could elaborate a little bit on where specifically you are feeling it, what parts of the supply chain seem to be pinch points, and then the extent to which you're able to capitalize on maybe pinch points elsewhere to win market share for yourself.

Thanks, Alex. This is Jay. Very good question. I would say, as we typically see in strong upturns like this, we're seeing it in base forgings and castings. So, not unlike the past upturns we've executed successfully on. We have some layered capacity suppliers we bring online at slightly higher cost, and that's why you see even though we're converting at what I think are strong margins, strong incrementals, they are slightly lower than we have in previous quarters just because of bringing on that incremental capacity. We actually are right now backfilling for some of our competitors. So, we've once again been asked to step in and been able to successfully do that. I don't want to understate how the whole industry feels right now, though. I think the entire industry is operating very close to capacity, which we are as well.

Okay, understood. Maybe a little bit more on China, too. Obviously there's strength there in off-highway and construction and infrastructure, and you touched on exports as well. I'm interested to hear the extent to which you are starting to get additional traction in the on-highway business in China. Maybe not now; I sort of doubt it was impacting the quarter, maybe I'm wrong. But have you any incremental evidence to suggest that you might be able to start capturing more revenue in that segment going forward?

Sure. Yes, another good question, Alex. We talked about China, focused on that last quarter, like we focused on Brazil this quarter. And we have had market share gains and wins in the on-highway, particularly in bus and coach, continuing with Yutong and our other bus and coach customers, in bringing forth a tool light product that we've been integrating into China, which is taking our class leading Western axles and localizing them in China to get them to the right price points. So, we're seeing good progress. And I would say on path to the plan that we set out a year or so ago to increase our penetrations in that area.

Okay. Thanks very much. Good quarter.

Our next question comes from the line of Faheem Sabeiha of Longbow Research. Your line is now open.

Congrats on a great quarter. Can you bucket the $200 million increase in your revenue outlook between higher end market growth, outperformance from new business wins and FX?

It's a mix of really those first two in particular. The markets are a big piece of the equation. As we've told you, when you look at Class 8 truck, just to put some dimension around that, taking the midpoint of our guidance of about 15,000 trucks translates to about $60 million. So what that tells you is, hey, that's a big contributor, but there's a lot of things going on as well. Brazil production going up is a meaningful increase, as well as other markets and new business wins. So it's really a mix of those things across the globe.

Okay. And then speaking of Brazil, in light of the more positive outlook in South America, can you guys tell us what your market share is in South America? I mean, you highlighted a few recent axle wins in your slide deck; I'm just wondering if there's additional share opportunity for Meritor in this market.

I think we haven't talked about specific market share, but I think we have talked about that we have a market leading position in Brazil, and continue to grow upon that with the wins that we talked about with the various OEs during this call. And that's no surprise as we localize more products into that market, like the hub reduction axle, like our medium-duty product, the 13X. We expected to get market share gains as we expand our product offerings in the local market. So, I think as we stretch our product portfolio, even though we have strong market share positions in traditional Class 8 single reduction axles, we're starting to see the increased penetration from the new product launches we have there.

Okay. And just one more question around EV. Now that we're seeing the benefit of your investment in TransPower, combined with your EV offerings with the recent Peterbilt program, is the long-term plan essentially to offer these platforms on a nationwide scale?

Actually on a global scale. We are taking the technology solutions offered by TransPower and actually rolling those out globally. So, that partnership is much broader than just California or just the US. Quite frankly, we see more demand right now globally for our eAxle than we are able to meet in this prototype phase, so we're almost allocating them to individual regions and our major strategic customers. So, that's what one of the powers we saw that investment and partnership in TransPower, they saw as well, is given that we're one of the few true global brands in commercial vehicle supplier world, we could bring enormous value to TransPower by bringing their products globally.

Okay. I'll pass it on. Thanks.

Our next question comes from the line of Joseph Spak of RBC Capital Markets. Your line is now open.

This is George Clark on for Joe. You touched on this earlier, but are you confident that you will be able to continue to drive incremental margins in that mid to high teens range throughout the rest of the year despite some of the higher industry volume? And how are you offsetting some of those inefficiencies?

Our guidance assumes right now you can see we took our revenue guidance up $200 million, and implicit in that is that we took up our conversion on that about 15%. So, we're continuing to count on our ability to convert kind of at the low end of our historic range, which tends to be what we see in these types of markets. But we manage it very closely, and we watch the potential for layered capacity costs and other inefficiencies coming in, but we're managing that very effectively, like right now. It gets more challenging as markets continue to accelerate and to grow, but we've done an effective job at managing that thus far.

Okay. And then you guys had another strong backlog quarter. Are you seeing some of these measures come on earlier than you had previously expected? Is that pulling forward from maybe 2019? What is the dynamic there?

I think by and large there's two things going on. One is we had a lot of volume, new business wins coming on that we anticipated would come on in the year 2018. We had big amounts coming on in 2018 and in 2019, and we're seeing those. Plus I think with the markets being stronger, we assume our new business wins linked generally to a more normalized market. So as markets are stronger we're getting a little bit of a tailwind on some of those new business wins as well, that they come in a little bit stronger than what we were originally planning for.

All right. Thank you very much.

Our next question comes from the line of Neil Frohnapple of Buckingham Research Group. Your line is now open.

Jay, as you mentioned, you have a chance of achieving the M2019 EPS target one year earlier, which is very impressive. But could you just talk about your confidence level in achieving the target next year in FY19, given how strong FY18 is coming in from a global market outlook standpoint? And even if NAFTA Class 8 truck is down in FY19, sort of your ability to still achieve that?

Well, thanks, Neil. That's a good question and obviously something we look at very closely as well. Because like M2016, these aren't point of time targets. This is transformational for the Company and we plan to grow on those achievements. It's a little early to talk about 2019 guidance, but obviously the significant number of new business wins we think will serve as a measurable dampener to any market downturn we see. And also, as Kevin just mentioned, we tend to convert at lower levels during peaks because of bringing on layered capacity and incurring some premiums. So as those markets step down, we could see further expansion of our conversion metrics as we're able to more aggressively manage those stepped-up costs during peak markets.

Okay, that's helpful. And then the incremental environmental reserve of $8 million in the quarter related to a legacy site. You would have delivered a 12.2% EBITDA margin in the quarter if that did not occur. And I know these things can be unpredictable, but do you feel like the $8 million is more one time and there won't be additional cost related to this in the back half of the year?

Again, Neil, we highlighted that. That's one-time cost. It's difficult with some of these sites to say will we ever have another dollar of investment. I wouldn't go that far. But I think the actions that we accrued for that we're in the midst of taking, our very aggressive clean-up of the site, that we think will hopefully put this behind us. And so, we've taken a more aggressive approach towards this particular site to try and put that liability behind us.

Okay. And then one last one. I mean, just given where the stock is trading, can you just talk about the thought process of buying back your own stock versus doing additional bolt-on acquisitions? And you did buy back some shares in the quarter, but just given the increase again in the free cash flow outlook, could you potentially do more buybacks than previously anticipated with the stock trading significantly below intrinsic value?

Absolutely. I mean, we're going to be opportunistic and balanced as it relates to deployment of our capital from here on out through 2019. We anticipate obviously generating more free cash flow over the balance of the year and you can anticipate we'll expect to have strong free cash flow again in 2019. We will look at bolt-on acquisition opportunities that make sense for us and we'll look at continuing to be opportunistic in the market, just as we were in the second quarter repurchasing 1.4 million shares. So we'll be balanced and opportunistic.

Okay, great. Thanks so much.

Our next question comes from the line of Mike Baudendistel of Stifel. Your line is now open.

Just wanted to ask you on this all-electric program with Peterbilt, is there more Meritor content on those all-electric trucks versus a similar piece of equipment that are diesel?

At this point in time I would say is fairly neutral. As our eAxle comes online and gets through the prototype stage we'll actually be running one of those on a school bus application by the end of this month. I think the expectation is if that product proves out to be as efficient as we believe it will be, I think we could start to see that eAxle replace some of the components on the vehicle, because it allows for much more battery capacity than the architecture that we're moving forward with on those Peterbilt vehicles right now.

Got it. And then I just also wanted to ask you on this acquired assets of the AA Gear & Manufacturing, does that play into the EV strategy at all? Because I remember from your investor day that part of the additional content on some EVs would be the additional gearing near the wheel end. Is that - does that play into that - the thought process on the acquired assets there?

Very insightful question, Mike, because of one of the capabilities AA Gear brings us is precision ground gears, which we think there'll be increasing demand for in an electric environment. Because those ground gears are quieter in operation and, obviously with the elimination of the noise from the internal combustion engine, the vehicle becomes much more sensitive to other components and the noise they generate. So, we are very excited about that capability as well. But I would say overall it's just clearly right in line with the strategy we laid out for M2019 in our components business. And we like Fabco's acquisition, like the investment in TransPower, hopefully you can see that our acquisitions are very logical and connected to our strategy.

Got it. Makes sense. And then just wanted to ask you one last one on China. You increased the guidance there and I think a lot have with sort of the fast start to China. Does it also include a thought that the Chinese market is going to slow down in the back half of the year? Or is it because it's less relevant to you because you do more off-highway in China?

I would say it's somewhat less relevant to us because we're more heavily weighted towards the off-highway.

Got it. Thanks very much.

Our next question comes from the line of Brian Johnson of Barclays. Your line is now open.

This is Steven Hempel on for Brian Johnson. Just wanted to drill down a little bit on the long-term comp structure as part of the M2022 plans, longer-term comp plans here. Obviously the 2017 plan was focused really on EBITDA margins, which you guys did a great job of achieving. 2018 plan shifted more towards EPS and then the 2019 plan added an above market growth aspect to it, as well as leverage. Just thinking about kind of where we're at from a cycle perspective and where your margins are at currently, and then obviously the shift to electrified products and eAxles, how we should be thinking about the comp structure at a high level. I understand you can't disclose what they will be, but just strategically as we think about where we're at from a cycle perspective, what additional potential metrics might you be looking at? ROIC, free cash flow, et cetera, above market growth? I'll leave it at that.

Sure. Well, first of all, I think our long-term comp structure is very clear in its alignment to the strategies, as you just articulated. Senior executive management gets compensated on hitting those three financial targets embedded in M2019, as we did on the M2016. As we spoke in the previous quarter, we're in the midst of developing the M2022 strategy and we expect to roll that out at an Analyst Day this December. And we will once again that strategy will result in defined financial metrics that we will set for the Company over that three-year period. And then our long-term incentive plans will then again be locked into those achievement of those metrics. Now, to determine those metrics, we're doing a lot of research. We've done a very detailed shareholder survey over the last few months, both on the buy side and sell side, and we're taking all of that input to develop what those metrics will be, that we're hearing will drive the most significant return on shareholder value. So, we're a little early to talk about specifically what they'll be, but just know that the input you've given is being heard, filtered down, and then we'll develop those metrics.

Good. That's great to hear. I believe that's fairly thorough relative to some other companies in our coverage particularly. But anyhow - so just want to shift gears here over to the PACCAR EV tests here. Obviously good to see some progress there and some announcements on that front. Is PACCAR working with other Tier 1 suppliers for these eAxles and electrified products? Or is Meritor going to be the exclusive supplier there moving forward?

I think like all OEs, they have some projects with different customers. I know they have one particular project, I believe it's with Cummins and their system. I think the announcement we made today is certainly one on the largest block orders, if not the largest. But as you would expect in a rapidly evolving market right now, like I would do if I were running an OE, they are placing their bets with different providers right now. But I think clearly Meritor has established itself as one of the leaders in the future of that technology, which is our goal. And for example, we were asked to present - I was asked to present just Tuesday as the keynote speaker at the ACT Expo. No great complement to my great speaking skills, but more about how Meritor has been recognized as a thought leader in electrification, and they wanted to hear what Meritor's plans are for the future.

Okay. And then just to follow on that, how should we be thinking about the North American and EU European bus market? Obviously you look at China, that's - from an electrified standpoint, that's been the first market to move over to eAxles. Just wondering how quickly we can start seeing some announcements on the North American/European bus market.

As I've stated previously, I think that's one of the markets globally you're going to see move the quickest and most aggressively. There were some very interesting applications out at ACT Expo this week, even on the airport shuttle vans and buses, moving fully electric. I think that the requirements on cities to meet clean-air requirements are going to drive the bus sector much more quickly potentially than any other sector.

Okay, so safe to assume that Meritor is - there's projects and whatnot in the pipeline?

Yes. I feel very pleased with where we are positioned in our pipeline on different bus projects throughout the globe.

Got it. And just really quickly on the ramp up on RD&E here to support new business, particularly around electrification. I believe the expectation for 2018 here was roughly half of the $12 million increase was due to increased R&D, so to speak. How should we be thinking about that ramp into 2019 and beyond?

I think it's premature at the moment to comment on 2019, but I would say as you look first half to second half, there is a little bit of an incremental step up in the electrification investment that's embedded within our guidance.

Got it. And if I could just squeeze in one quick one. AA Gear & Manufacturing acquisition, Cat and CNH, like those two customers, obviously. Were those customers previously for Meritor? And I guess strategically this acquisition kind of, did this get you kind of above market growth, so to speak, more quickly, getting to the extent that Cat and CNH wasn't a customer to Meritor?

Well, I think to answer the second half of your question, yes. We believe so, that this will work towards getting us the above market growth. Caterpillar and CNH were small customers of ours in components, but this significantly expands our penetration. Obviously IVECO is a subsidiary of CNH, and we supply all the single reduction truck axles for them in Europe. But this moves us aggressively into the construction, ag, off-highway space for components.

Got it, great. Thanks for taking my questions.

Thank you. Ladies and gentlemen, this concludes today's question-and-answer session. I would like to turn the conference back over to Carl Anderson for closing remarks.

Thank you, Takeeya. This does conclude our Meritor second-quarter earnings call and we thank you for your participation.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.