Good day, ladies and gentlemen, and welcome to the Q1 2020 Meritor Inc. earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today’s conference, Mr. Todd Chirillo, Senior Director of Investor Relations. You may begin.

Thank you, Jamie. Good morning, everyone and welcome to Meritor’s first quarter 2020 earnings call. On the call today, we have Jay Craig, CEO and President, Carl Anderson, Senior Vice President and Chief Financial Officer and Chris Villavarayan, Executive Vice President & Chief Operating Officer, all of whom will be available for questions following the call. 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’re recording, is the property of Meritor Inc., is protected by U.S. 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 Todd. Good morning, everyone and thanks for joining us today. We had a solid first quarter and have a number of highlights we would like to share with you today. Let's look at Slide 3, which provides an overview. I am especially pleased that we continue to perform well despite production volumes being down year-over-year in most of our global end markets. Adjusted EBITDA margin was 10.9% and we generated adjusted diluted earnings per share of $0.64. As markets have weakened, we have taken steps to manage cost and maintain a downside conversion of 15% which is at the lower end of our expected range of 15% to 20%. We are effectively managing what we can control considering the cyclical nature of our business and the rapid declines in virtually all of global end markets, continuing our track record of operational excellence. In the first several months of the fiscal year, we continued to execute our share repurchase program, finalized a meaningful new electrification agreement with Paccar, were added to the S&P 600 small-cap index, enhanced our technology and product portfolios and appointed Chris Villavarayan, Chief Operating Officer. As you saw in the press release announcing Chris's appointment, he has been with Meritor for 20 years in various leadership roles. In each of those positions, he has excelled and has made significant contributions toward achieving the targets we set forth both in M2016 and 2019. Global operating responsibility for both of Meritor's business segments was the next appropriate step for Chris and critical to leadership development for our team as we move forward. Notably, Meritor's electrification business is transitioning to low-volume production more quickly than we anticipated as adoption of battery electric commercial vehicles increases globally. This is demonstrated by the new business award we announced today with Paccar.…

Thanks Jay and good morning. On today's call I'll review our first quarter financial results and updated full-year guidance. Overall, as you heard from Jay, we delivered a solid start to 2020. We achieved an adjusted EBITDA margin of 10.9% and adjusted diluted earnings per share of $0.64, reflecting our ability to manage the business effectively across current end market conditions. Additionally, we remain committed to our capital allocation strategy and in the first four months of the fiscal year, we have repurchased over 10% of outstanding shares. This reflects our continued confidence in achieving and delivering on our M2022 targets. Let's walk through the details by turning to Slide 8 where you'll see our first quarter financial results compared to the prior year. Sales were $901 million in the quarter down $137 million from a year ago driven primarily by lower global truck production and lower volumes across your other businesses. This was partially offset by revenue from AxleTech, which we acquired in the fourth quarter of 2019. As anticipated we saw a significant decrease in North America Class 8 production in the first quarter. Compared to the same period last year, production was down almost 17,000 units or about 20%. Additionally in Europe, production was down approximately 18,000 units or 14% compared to the first quarter of 2019 and in India, production volumes which were down almost 40% continued to be impacted by the emission standard changeover that will occur on April 1, which requires all vehicles sold after this date to comply with the new standards. This is resulting in an industry-wide focus of reducing inventory levels prior to the changeover. Additionally, we are seeing tighter credit conditions which is also contributing to the market challenges and finally revenue from AxleTech helped to offset slowing market conditions…

Thank you. [Operator instructions] Our first question comes from Faheem Sabeiha with Longbow Research. Your line is now open.

Hi. Good morning, guys and thanks for taking my questions and Chris, congrats on the promotion. Jay you mentioned the $500 million revenue opportunity for the EV portfolio, but I was wondering what's baked into your guide this year and I guess what does the ramp look like over the next few years.

As I mentioned in my comments, the production of the Paccar work begins next year. So we're wrapping up our capabilities on the manufacturing side particularly at TransPower to deliver those vehicles beginning in 2021 and then we see them reach what we would call full production rate during 2022.

Okay. And can you talk about the revenue content of these EV systems on the Paccar trucks plus the other platforms you expect to go live on versus your contents on a diesel engine. I just want to understanding what the profitability looks like on these projects.

We're not disclosing specifics on that right now but the way you could think about it is this is somewhere between prototype and low-volume production. So the prices are quite a bit higher than we would expect when it reaches full production. So even though the range we gave at our last Analyst Day of 5 to 10 times the content when we got to full production mode these particular content levels are quite a bit higher than that because we're still somewhat at the prototype stage of these volumes.

Okay. And is there any white space left in the portfolio and EV portfolio or are there other services or offerings that Meritor is maybe eyeing that would increase the EV value proposition of the customer at this point?

Absolutely. As I mentioned in the comments, really twofold, we're thrilled with our purchase of the remaining equity at TransPower. We think that integration capabilities have significant growth opportunities for us in all different types of applications, be them medium duty refuse, school buses, heavy-duty, so a lot of white space growth. But just as importantly, I discussed our intent to launch our 17Xe and 17Xe electric exile. Right now we're running with just the 14Xe and those other two actual offerings will bring us into different market segments.

Thank you and our next question comes from James Picariello with KeyBanc. Your line is now open.

So just at a high level regarding the guidance, is the generalization here that we're seeing some additional weakening across US trailers, Europe, India and you're still delivering a mid-teens on just that modest weakening in the markets that you're seeing?

James, it's Carl. I think that's right. I think if you look at the guidance, the markets we did take down are what your referenced. We're still seeing North America come in relatively consistent with what we thought previously and it's really just the capabilities and ability for us to manage the cost structure to be at that lower end of our downside conversion levels of that -- around that 15% and that's what we're really managing the company to.

Got it. And then can you just talk about what the status of your internal actions are with respect to, is the restructuring plan completely finalized now and then maybe just some other cost-our initiatives that help support the margin resilience for the year and also how are commodities trending?

You would expect James company operating in deeply cyclical environments that we do. We're constantly looking at our cost structure really with the target to try and convert if we can at the lower end of that conversion guidance that we provide of 15% to 20%. Obviously we're successful in doing that this first quarter in spite of this being a quarter of our resolve rapid ramp downs in production. While we're continuously looking at actions that we could potentially take to manage that very volatile volume environment.

Okay. And is the status of the restructuring plan is that completely finalized or do you still have some more work to do?

Again we are still -- there are of the previous restructuring plan we announced that is virtually complete, but again we continue to monitor our cost structure and if we see further declines in our market expectations, we will have to take additional cost actions but I believe we've established a track record over the last half dozen years of being very good at reacting to that very, very quickly.

Got it. Appreciate it. And then just on AxleTech and maybe I missed this, so my apologies, but what was the contribution in the quarter for AxleTech and how are you thinking about the full-year in terms of the revenue and the synergies that should be realized for AxleTech this year?

Yes, James, it’s Carl. If you look at the AxleTech revenue, we had about $43 million of revenue from AxleTech. I think what we're seeing, as it relates to the synergies expectations we’re actually kind of above our internal planning from an expectation what we -- that we're delivering on. I think the business itself, we're seeing some general softness just like you're seeing whether it's in the Highway, defense and aftermarket kind of areas of the business which is similar to what we're seeing with the rest of Meritor’s business. But I would say overall, we continue to be very pleased with the strategy and with the acquisition of the company. I think revenue is a little bit softer than what we’re originally planning, if we had the discussion six months ago, but overall, what we're very pleased with is really just the team's ability to execute on the synergy plan and where we stand at this point.

Got it, thanks guys.

Thank you. Our next question comes from Alex Potter with Piper Sandler. Your line is now open.

Hi, guys. Interested in digging in, I guess maybe a little bit more on this EV opportunity with PACCAR. I guess what I'm trying to understand is once this is in run rate production, are you primarily going to be providing them with eAxles, drivetrain components or is it going to be something that flows through TransPower, these fully electrified chassis type products? Thanks.

Okay, good question, Alex. The short answer is both. So, that's the beauty of the investment in TransPower is we truly felt that two plus two equals three or four in the Meritor products and the customer relationships we brought could be added with TransPower’s capabilities on in that they're able to provide them the full integration for an electric vehicle. So we will be working now with our wholly owned subsidiary of TransPower on providing fully integrated electric vehicles for PACCAR. And they will be composed also where we can have have Meritor components including eAxles on some of the vehicles.

Okay, thanks, I guess I mean the reason I asked the question is I think you may agree or maybe not, with that. But eventually presumably once electric vehicle penetration reaches a certain threshold, the truck manufacturers themselves are going to have to decide what they view as core and what they're going to rely on the supply chain for. And I got to believe that at some point, they'll take some of that content and do it internally. Maybe that's not the case in the sort of quasi prototype space but I don't know what's your view on when you think the OEMs said on that line differently?

No, I think as we've spoken before we couldn't agree with you more, that's fine. We've taken what we've labeled an open architecture model towards our work primarily out of TransPower, where we work very closely with our OE’s development teams and work with them on what capabilities they will eventually want to in-source. And as we've mentioned specifically, as an example, we're looking forward to them in sourcing the battery sourcing and battery management systems. We're doing that right now. But we expect that they will integrate that over time because they have actually greater scale for purchasing of those. But offsetting that decline in revenue on that end will be two different items on the other side, coming up which is one are eAxles which were developing and getting to full run rate production will begin to be placed on more vehicles with significantly more content than a traditional axle. And then secondarily, there will be a segment of the market that won't have the scale that will be able to execute all the integration services. So we will be providing those as our technology is proven.

Interesting. Okay, very good. That that makes good sense. I was wondering then outside of electrification, some of the other maybe more slightly more near-term growth initiatives that you've spoken about recently, thinking about things like off-highway precision gearing, maybe medium duty truck share disc brakes, pretty sure I'm omitting a couple more here as well. But if you could maybe just rank order those opportunities based on your recent experience, which ones are doing better than plan in line with plan and maybe some that are performing below expectations?

What I'm going to do is, is like Chris, I wanted him to speak about this breaking opportunities, because we take they are significant, but obviously the biggest opportunity we have during this planning period through 2022 is the successful integration of AxleTech and making sure we garner all of those costs and revenue synergies, particularly as we focus on the off-highway military opportunities there. But I would Chris to also speak about the disc braking side.

Thanks, Jay and good morning, Alex. I think when you think about M22 and our target is $300 million of revenue. And as you look at our presentation, we talked about seven new products, and the one right in the middle is the disc brake, our single piston disc brake that we’re launching. As we announced over a year-ago, we have a standard agreement on air disc brakes with Daimler. And we're looking as one customer and as we're growing here in the future, we plan to take this globally and grow the disc brakes. So the disc brake business is a considerable part of our growth strategy going forward.

Great, very good, thanks a lot guys.

Thank you.

Thank you. Our next question comes from Brian Johnson with Barclays. Your line is now open.

Great, I both have kind of outlook kind of housekeeping question and then a more strategic question. In terms of just and I know you have hit in this before, but the commercial truck downside conversion was very strong at 15%. I was particularly struck by the how gross margins held in which would seem to imply that perhaps you're managing detrimentals on the SG&A OpEx side. Could you maybe talk about that or in particular with the gross margin get better, was there a commodity tailwind there?

Yes, Brian it’s Carl, I think you're right on the gross margin, what we did see is we did see some benefit from steel in the quarter, kind of similar in line what we talked about back in November as far as outlook for the full-year. So I would say steel was probably a mid single digit million tailwind for us in the quarter. We also had a pretty significant improvement in cost as it relates to labor and burden in the quarter as well as really managing kind of our freight expenses well. So it's really, it was a combination of all of those items which were all around kind of the same type of magnitude for the quarter in which we saw which helped really drive the improvement in gross margin for us.

Okay, second question around what are you seeing in kind of the mid truck market in North America that gives you some greater confidence in both how it’s held up and then how it's going to look over the coming year?

Well, right now in terms of the market, I think we're in line with where we see, let's call it the external rating agencies coming in ACT and FTR between 240 to 250. And then on top of that, as I look at the line rates that we're seeing from our customers, I believe all those three are actually boxing in very closely. So we're quite comfortable with what we see going forward. Maybe your question on with respect to new trucks and where we see that going in the future, I think trucks are becoming far more efficient as we see. And obviously, we've seen over the last two years and with the path of electrification diesels got to get even more efficient. So I think that's one place where we've really play strongly. And so I think it's equally important because if you think about our high efficiency axles that we've launched recently as well as you know, the axles that we have coming, Jay talked about the new vocational axle, we really believe that the efficiency gain will drive it and I just want to clarify one point also on the forecast, it's 245,000 to 255,000.

Okay, and then finally the PACCAR obviously prototype to look in its early days but then you talked about some things like battery management, how are you thinking about the software that would span across managing the flow from the battery, the flow through the power electronics, and then the actual control, the motors itself, is that something where you're whether it's some of the acquisitions you made, you're writing the software, or are you basically providing the hardware and the OEM partners doing the software?

Very good question, Brian. I mean, that's why the TransPower investment and now the acquisition of the remaining equity was so critical, TransPower provides supervisory controls to the software in that area, that makes the whole system run including instrumentation on the vehicle, breaking all the other supervisory controls. They also provide the battery management controls that determine the energy rate of energy flow and the utilization of energy. So we do have software and software engineers at TransPower. In addition, we've ramped up within Meritor, our software engineering capability just to manage the features in the eAxle because that eAxle obviously containing motor components, cooling components requires a lot of software system intellectual properties. So we have an entire software team here in our Troy research center that's focused on the software on the eAxle as well.

And as part of that, are you getting close loop data out of vehicles on the road that would allow you to refine the algorithms and control algorithms?

Yes, we welcome any of our investors or analysts to come visit TransPower in San Diego and you can ride on the test vehicles with me and see how they operate. We have thousands and thousands of test miles on these vehicles right now.

And any plan once those get on the road to continue to harvest the data, I’m thinking here of last night and?

Yes, continuously. Sorry for misunderstanding your question. But yes, it’s true.

Yes, I know, I'm thinking of the advantage the Tesla has in terms of getting for its BMS and control systems?

Correct, although I think as we heard in a previous question, it is our expectation with the large OEs that they will start to take control of management of some of that data as well. And we're very open and working with them to enable them to do that.

Okay, thank you.

Thank you, Brian.

Thank you. And our next question comes from Ryan Brinkman with JPMorgan. Your line is now open.

Hi, thanks for taking my question. Clearly you have accelerated the share repurchases here, which as you've mentioned before, provides flexibility toward meeting those longer-term targets in a wider variety of macro scenarios. I'm curious though, just given that only $100 million remains whether you intend to pursue another authorization or what your plans might be after the current authorization is completed?

Good morning, Ryan. It's Carl, I think you're absolutely right, we have $100 million left to go which the board has authorized us. And we've been in the first four months pretty aggressive in the share repurchases. We did signal last quarter that we have an opportunity in front of us over the next couple of years is related to what we're generating in free cash flow to repurchase up to potentially another 400 million of shares. And so I think our approach will be we'd like to fully execute and complete the existing program. But I would believe that once we do that, we'll be in a position to seek further authorization, especially where the stock is currently trading.

Okay, great. Thanks. And then just on Slide 8 regarding that catch all volume mix performance, other category driver of EBITDA, I know you'd call it out your decremental track for the lower end of your targeted range, which indicates solid performance within that category. But are you just able to maybe disaggregate that bucket a little bit, what is electrification investment running within this category? And how are you thinking about the impact of performance or electrification investment for the full fiscal year?

Yes, I think Ryan as we look at the quarter specifically, electrification really was roughly flat on a year-over-year basis at least in the first quarter, we do expect that to continue to ramp-up for the rest of this fiscal year. And I think what we were talking about, probably up about $10 million or so from a year-ago. So overall as it relates about that line item itself, when you kind of do the math is about 13% downside conversion with all the components but as we go forward, we do see this pickup and ramp up in electrification spend especially with the success we've had with the new PACCAR win as well as with the TransPower acquisition.

Okay, great. Just lastly from me regarding that new facility in Brazil, there's been some reticence to invest more capital in light vehicle capacity in that region on the part of suppliers. Can you just maybe talk a little bit? Why you're excited about this? Is it a case of increased localization, which helps to offset currency risk? Or also, I heard you say that it was a significant cost savings move. So maybe it's replacing some older, more expensive capacity anymore how to think about that would be helpful, thanks.

Yes, excellent, Ryan. This is Chris Villavarayan. I'll take that one. So I think you hit on two points that we've been in Brazil for several years, actually over 50 years. And our current location is landlocked, and we're unable to grow from that site. And the Brazilian market, as you could imagine, and you have seen through many of our quarters is a very important market for Meritor. And so we made the decision many years ago to make a long-term commitment here and we've been working on deciding a new facility here for over 10 years. And so with the market continuing to strengthen and we've seen it strengthened over the last four to five years are our thoughts are we need a new facility, we’ll add more capacity and drive local content to your point also bring us closer to our customers and also drive the best-in-class cost. It provides us yet another opportunity, have to build a new facility that's more modernized and then continues to drive our cost position. So it is one of the largest as Jay pointed out, cost reduction opportunities in our M22 plan.

Great, it’s very helpful. Thanks a lot.

Thank you.

Thank you. Our next question comes from Joseph Spak with RBC Capital Markets. Your line is now open.

Thanks, everyone. I guess first just on the aftermarket industrial trailer segment, so margins are down. You called out in some of the integration. You lowered your trailer outlook but then the synergies ran through the year. Like what do we expect margins for the year, for the whole year in that segment to be now like, can they be fired? Or should we sort of start modeling them down now given some of the incremental headwinds?

Yes, I think, Joe what we are seeing, we definitely see a margin increase in kind of from the current run rate that we finished the first quarter in. The one thing to take into account is just the overall just general softness we're seeing across the segment, obviously, we talked trailers, but also with the industrial and off-highway parts of the business and aftermarket itself that we're seeing here in North America. We're just seeing some general softness, but our expectations, as you know, we don't give a number specifically for the year by this segment, but we definitely see that margin increasing progressing throughout the year.

Driven by the synergies ramping on?

Yes.

Okay, Jay the TransPower full acquisition, not a surprise, I think you've sort of hinted or indicated this could be possible. But you've also been working very closely with them to-date. So like, just what specifically does sort of the full ownership allow you to do now that you weren't able to do before?

Well, I think it's just overall the statement to the employee base there of how importantly are to Meritor. I think we're the perfect home for them. And what we've found in the period that we've had an investment in TransPower is those benefits are even greater than we originally estimated. And we each bring different skill sets. Obviously Meritor has over 100 year history of production for the commercial vehicle industry. And we can assist TransPower as they're moving from this low volume prototype stage to production stage. And we actually have a Head of Production that resides in San Diego and has for many months now. That's an executive of Meritor that is running the production floor. And TransPower brings to us the development expertise in this particular area and jump starts us as a full vehicle integrator. So I think overall, it's been a perfect marriage, the employees at TransPower that I meet are just thrilled to be part of Meritor. So I think it's just a natural progression.

Okay, and then lastly from me, with the appointment of Chris to COO, very exciting and I appreciate Chris, all Chris's sort of comments and look forward to talking more with him. But you've also like been an operating story and operating at a very high level for some time. So what specifically did you see that led you to believe that now is the right time to have that role? And I guess I mean this in the most respectful way possible, but is there any element of succession planning in this decision as well?

Well, to be honest, there's always elements of succession planning whenever anybody gets promoted. But I'm not saying that in any time in the foreseeable future, I see stepping away from the company. It's really twofold. Chris has really been my partner in time on the operating side. I was reading through my prepared remarks, almost everything related to the operating side of the product side. I would say Chris has either led or we've jointly led. So I think a lot of it is recognition of Chris’s importance to the business. But secondarily also, as I've mentioned, the rate of the ramp-up of the electrification business has been much happened much more quickly than any of us anticipated. And those capital allocation decisions and other critical decisions around that business have really ended up flowing to my desk as you would expect, and I think it's the right time just for me to get more directly involved with that and make sure we're all aligned on those different decision points we have we encountered.

Great, I really appreciate that color. Thank you.

Okay, thank you.

Thanks Joe.

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Todd Chirillo for any closing remarks.

Thank you for joining our call today. Please reach out to me directly, if you have any questions. Thank you and have a good day.

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