Carl D. Anderson - Vice President and Treasurer Ivor J. Evans - Executive Chairman, Chief Executive Officer, President and Member of Audit Committee Kevin Nowlan - Chief Financial Officer, Principal Accounting Officer and Senior Vice President.

Itay Michaeli - Citigroup Inc, Research Division Colin Langan - UBS Investment Bank, Research Division Brian Arthur Johnson - Barclays Capital, Research Division Patrick Archambault - Goldman Sachs Group Inc., Research Division Ravi Shanker - Morgan Stanley, Research Division Robert A. Kosowsky - Sidoti & Company, LLC Brett D.

Hoselton - KeyBanc Capital Markets Inc., Research Division.

Good day, ladies and gentlemen, and welcome to the Quarter 1 2014 Meritor, Inc. Earnings Conference Call. My name is Juliann, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to hand the call over to Mr. Carl Anderson, Vice President and Treasurer.

Please proceed, sir..

Thank you, Juliann. Good morning, everyone, and welcome to Meritor's first quarter 2014 earnings call. On the call today, we have Ike Evans, Meritor's Chairman, Chief Executive Officer and President; and Kevin Nowlan, Senior Vice President 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're recording, is a 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 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 refer to any non-GAAP measures 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 in New York on Thursday, February 6. We're looking forward to providing you with more detail at that time. Now I'll turn the call over to Ike..

Thank you, Carl, and good morning. Let's turn to Slide 3 for some highlights from our first fiscal quarter of this year. As you can see, performance improvement initiatives are continuing to drive financial results. We generated $12 million of adjusted net income, or $0.12 per share, in the quarter from continuing operations.

Year-over-year, we expanded our adjusted EBITDA margin by 250 basis points and had the best first quarter free cash flow performance in 4 years. We believe these results are particularly meaningful concerning the significant step down in our defense business from the same quarter last year.

We told you during our fourth quarter call that we expected the action taken in the past year to drive continued margin expansion this year even though we did not anticipate revenue growth. Our performance this quarter demonstrates that these actions are having the intended results.

We continue to execute our M2016 strategy, and I tell you I am really pleased with the progress we're making. We certainly have more work ahead of us, but first quarter results are consistent with our plan, and we're really off to a good start this year. We're also reaffirming our fiscal year guidance.

Let's turn to Slide 4 for a look at our sequential performance. Typically, we see our revenue decline in the first quarter due to seasonality from less selling days and production impacts from the holiday season. This year, however, revenue in the first quarter decreased only $2 million from the fourth quarter of last year to $907 million.

Prebuy activity in Europe and slightly stronger production in China mitigated the anticipated impact of less aftermarket sales in North America and lower truck production in South America. Adjusted EBITDA was $70 million in the first quarter, flat to the prior year, while adjusted EBITDA margin was 7.7% for the quarter.

Adjusted income from continuing operations was $12 million, up $1 million from the prior quarter. Adjusted EPS from continuing operations was $0.12, up $0.01 from the fourth quarter of last year. Total free cash flow was negative $16 million, an improvement of $30 million from the prior quarter.

Keep in mind, we prefunded $54 million of required 2014 pension contributions in the fourth quarter of last year. Excluding this prefunding, free cash flow decreased in our fiscal first quarter compared to the fourth quarter. Cash flow performance in our first fiscal quarter is typically weaker due to the normal seasonality in our business.

Please turn to Slide 5. We're encouraged with the recent developments in our defense business. With respect to our HMMWV Recap opportunity, the Marine Corps recently selected a vehicle configuration for this program. This important decision followed a competitive evaluation process of 4 different configurations.

It was determined during this process that Meritor's content meets or exceeds the Marine's performance specifications. Specifically, our content includes ProTec suspension, differentials, brakes, wheel end equipment, frame rails, drivelines, drivetrain control and central tire inflation systems.

To give you an idea of the total Marine Corps program value, the selling price of each vehicle is expected to be $110,000. At more than 6,800 units, the program value is in excess of $750 million over the course of 5 years. With significant content on each vehicle, this would be an important win for us with a meaningful portion of the $750 million.

2 prime contractors will be selected for the engineering, manufacturing and design phase of this project by June of this year. This phase is a new development and will ultimately lead to a final contract award in May of next year, which is a modest delay from our prior expectation.

We're working with a number of prime contractors to provide our content on their respective vehicles. We're also monitoring an additional opportunity with this program. The Army has indicated it is considering to retrofit 30% of its current HMMWV fleet. That means approximately 50,000 to 60,000 vehicles could be added to this upgrade.

This would most likely be a 20-year program with the Army. Also, this quarter, we received good news that more than 900 units have been added to the FMTV program. This additional build will now extend the program into next year. On Slide 6 is our volume outlook for the fiscal year. Overall, we're currently holding our global market forecast unchanged.

In North America, our forecast is steady at 245,000 to 255,000 Class 8 trucks. The market is solid with December being an exceptionally strong month for orders. January orders will be very important in shaping the year. For defense, I've given you an update on HMMWV Recap and FMTV. As you know, JLTV is another defense program we're closely following.

JLTV remains on schedule, with the engineering, manufacturing and development phase scheduled from August of 2012 to November of this year, with a final selection expected in late 2015. China's outlook continues to be consistent with volumes last year.

However, we experienced a stronger-than-expected first quarter, primarily in the grader and loader segments. While this is encouraging, recent economic data suggest further weakening in the region. We'll need to see another fourth -- quarter before we consider changing our forecast. India continues to be under pressure.

As we've told you, the elections in the spring will be an important event for the region. Currently, we see continued deterioration with little upside. Western Europe had a strong first quarter due to the prebuy I mentioned earlier. Our team performed well in quality and delivery with a solid contribution on incremental sales.

While economic indicators continue to point toward a modest recovery, the first quarter prebuy presents an uncertain picture for the next several quarters. In South America, we're maintaining our forecast for medium and heavy-duty truck market at 175,000 to 185,000 units.

The economy in Brazil continues to be challenging to forecast due to slower GDP growth, high inflation and a volatile currency. However, the agricultural sector has experienced record harvest, which has had a positive impact on the trucking business. Infrastructure demands also continue to be high due to the upcoming World Cup and 2016 Olympics.

Now I'll turn it over to Kevin for a more detailed review of our first quarter results..

Thanks, Ike, and good morning, everyone. On today's call, I'll review our first quarter financial results and reaffirm our 2014 guidance. On Slide 7, you'll see our first quarter income statement for continuing operations compared to the prior year. Sales of $907 million in the quarter were up year-over-year by $16 million.

The increase was due primarily to higher commercial truck production in Europe, driven by the prebuy associated with the Euro 6 regulation impact. In addition, South America revenue was higher on a year-over-year basis, as production volumes 1 year ago were still challenged following the Euro 5 emissions standards change.

These increases were partially offset by lower military revenue and continued weakness in China. Gross margin was $20 million higher year-over-year due to the continued execution of our M2016 initiative.

The gross margin improvement was primarily driven by conversion on higher revenues, execution of global pricing initiatives throughout calendar year 2013, continued net material labor and burden performance and lower structural cost resulting from actions executed largely in the second quarter of last year.

All of this was achieved in a market environment where our FMTV volumes stepped down more than 30% year-over-year. So overall, it was a solid first fiscal quarter. SG&A was $3 million lower in the first quarter of 2014 compared to the first quarter of 2013, as we continue to manage the fixed cost structure of the business.

This quarter's restructuring costs were $5 million lower than the first quarter of 2013, which had included costs associated with the actions taken 1 year ago. Earnings in our minority-owned affiliates were $8 million in the quarter, down slightly from the prior year.

This decrease was driven by the loss of earnings from the Suspensys joint venture, which was sold in July 2013. Interest expense was $2 million lower in the first quarter of 2014, driven by debt extinguishment costs of $5 million experienced in the first quarter of 2013 that did not repeat.

Income tax expense was in line with last year, despite the fact that pretax earnings improved. As we continue to expand margins and improve the financial performance of the company, we expect to drive toward a more normalized effective tax rate.

In total, adjusted income from continuing operations was $12 million, or $0.12 per share, compared to an adjusted net loss from continuing operations of $11 million, or negative $0.11 per share, in the same period last year. Slide 8 shows first quarter sales and segment EBITDA for Commercial Truck & Industrial.

Sales in the first quarter of 2014 were $727 million, up $12 million from the same period last year. Segment EBITDA was $53 million, an increase of $19 million year-over-year.

This represents a 158% upside conversion, due primarily to lower net material labor and burden costs as well as pricing actions in South America to recoup part of the FX depreciation experienced in the latter part of 2013.

These positives, along with higher revenues in Europe and South America, more than offset the negative mix headwind associated with the step down in our FMTV business. Next, on Slide 9, we summarized the Aftermarket & Trailer segment financial results. Sales were $208 million, up $5 million from last year.

The increase was primarily due to a modest uptick in European aftermarket sales. Segment EBITDA was $19 million, an increase of $6 million year-over-year. The upside conversion was driven by pricing actions we executed throughout calendar year 2013. We also had lower net material, labor and burden costs.

This EBITDA performance was achieved despite the headwind of not having earnings from the Suspensys joint venture. Now let's move to Slide 10, which shows the sequential adjusted EBITDA walk from our fourth quarter of 2013 to the first quarter of 2014.

Walking from the $70 million of EBITDA generated in our fourth quarter, we had $5 million less EBITDA due to mix. Our first fiscal quarter has less selling days than our fourth quarter, which affects our aftermarket business. In addition, production levels were down in South America and our FMTV volumes took another step down sequentially.

So while we experienced a significant revenue increase in Europe driven by the Euro 6 prebuy, the benefit of that increased volume was not enough to offset lower sales from these other businesses, which typically have higher margins. The net result of this was an unfavorable net volume and mix of $5 million.

The other notable item in the quarter relates to $5 million long-term disability liability reduction. We executed a change in our long-term disability benefit plan to reduce the duration of medical benefits provided to individuals in order to be more consistent with market practices.

This cost reduction will result in real cash flow savings to the company in the coming years. Overall, this was a solid quarter for us. We believe this represents the highest reported first quarter adjusted EBITDA margin in at least 8 years. While we have more work to do, we're off to a good start for 2014. Now let's turn to Slide 11.

For the first quarter, total free cash flow was negative $16 million. This was a $90 million improvement over the same period last year, driven by higher net income and lower cash outflows for working capital.

We also benefited this quarter from an increase in factored receivables, driven by higher sales in Europe, where we factor most of these receivables, and a new short-term factoring program in Brazil. These factoring programs have the effect of accelerating the cash cycle time.

As production volumes in Europe are expected to take a step down following the prebuy, this first quarter cash flow benefit will become a cash flow headwind for us in the second quarter.

Overall, while still a negative cash flow quarter, it's important to reiterate that our first fiscal quarter traditionally is challenging due to fewer selling days and calendar year-end cutoff issues. With that in mind, this free cash flow performance represents the best first quarter results since 2010.

Next, I'd like to review and reaffirm our fiscal year 2014 outlook on Slide 12. As Ike discussed earlier, the demand assumptions are unchanged for our end markets. And as a result, we are maintaining our sales guidance of approximately $3.7 billion.

While we see the potential for upside in markets such as North America, there is still significant uncertainty in Europe relating to the full year impact of the Euro 6 prebuy, and in South America and India. As a result, we'll have a better sense as to whether we need to make adjustments following another quarter of data.

We are also maintaining our adjusted EBITDA margin guidance of approximately 7.5%, as well as our adjusted earnings per share from continuing operations guidance at $0.30 to $0.40 for 2014. Our first quarter has put us on track toward achieving these results.

However, we must keep in mind that we continue to face the sequential wind down in our high-margin FMTV business, which will continue to be a margin headwind throughout the year. Total free cash flow is still expected to be between breakeven and positive $25 million.

With the solid Q1 cash flow performance, we feel confident about our ability to deliver such a result, which would be our strongest full year free cash flow since 2010. Now I'll turn the call back over to Ike to wrap up and discuss our continued focus on M2016..

Thank you, Kevin. If you'll please turn to Slide 13. In our fourth quarter call in November, we provided you with detail on each element of our M2016 plan. Let me briefly summarize the highlights for you again because this plan is the roadmap to the financial results we have committed to achieving in 2016.

The 3 financial targets we've established for M2016 address margin performance, net debt reduction and revenue. We intend to achieve a 10% margin for the full fiscal year 2016 through performance initiatives, incremental business wins and some market recovery. As we said previously, our cash flow breakeven is around 7% to 7.5%.

We intend to drive performance that far exceeds this breakeven point so that we can consistently generate strong free cash flow. Last fiscal year, we reduced net debt by $216 million, which puts us more than halfway to our goal of $400 million. We're off to a good start but have more to do. We also reported $120 million of new business last year.

We'll continue to scorecard ourselves annually against our target of a $500 million per year run rate, and we'll continue to tell you about new business we're winning around the world. M2016 has 9 specific initiatives that we believe will improve the performance of our business, resulting in achieving the financial targets that I just mentioned.

In the first quarter of this year, we exceeded our operational targets in safety, quality, delivery and cost. Through continued execution of Lean concepts in our plants, we're taking the Meritor production system to a higher level in an effort to further improve our operational performance.

We're making solid progress toward completing contracts with major customers. As we discuss our partnerships with these customers and others around the world, we're working closely with each one to ensure our product strategy is closely aligned with theirs.

We're designing new features and enhancement to help our customers achieve their goals in safety, efficiency, performance and application coverage. We're confident in our ability to organically grow this business as we continue to engineer commercial drivetrain products that enhance mobility and maximize vehicle uptimes through superior engineering.

Our products offer better performance at lighter weights for increased payloads and higher operating efficiencies. We're also actively pursuing various strategic approaches to reduce material cost, and we're seeing the results. Working capital is another area that we've targeted for improvement.

We believe there's an opportunity to increase our inventory turns over the next few years. Overall, we're on track to meet our M2016 objectives. We've focused our resources onto the fine set of initiatives that we believe will lead to the achievement of the financial targets that we've detailed for you. We have momentum. We're celebrating our wins.

We're challenging ourselves to do even more. We look forward to seeing you at Analyst Day in New York on February 6 for a more detailed discussion. Now we'll take your questions, and thank you..

[Operator Instructions] Your first question comes from the line of Itay Michaeli from Citigroup..

I was hoping we could talk a little bit about, just if you could help us out on the cadence of margins throughout the rest of the year. I know -- because typically Q1 is, as you mentioned, fewer production days. Your margin did come in above your full year range. You did mention some of the sequential FMTV headwinds.

Hoping you can maybe quantify those, maybe just walk us through a little how we should think about the margin cadence in the next couple of quarters roughly..

We're not going to give specific guidance on a quarterly basis, but I can tell you the way to think about it. Obviously, we had a good quarter here at 7.7% margin. A couple of the headwinds that you should keep in mind as we think about sequentially going into Q2 and beyond.

One is we obviously had this one-time benefit from long-term disability, which was an execution item to reduce our cost structure. But that's not going to be an item that recurs in the next couple of quarters. Second is we do have continued step down in the FMTV business sequentially over the next few quarters.

So you should expect that to be a headwind. And third, there is some risk related to the Brazil FX. I mean, even if you look at where that was yesterday, trading at $2.44, that's even a depreciation versus where we were at the end of the year.

So while we won't give sequential guidance, you can expect that some of those things are impacting us as we think about hitting our full year 7.5% guidance..

Sure, that's helpful. Then on the fiscal '16 targets on revenue, I know you didn't provide a new revenue scorecard like last quarter. Maybe you could talk about the overall quoting booking environment that's out there, just your overall level of confidence today to achieve the $500 million target..

Yes, we're not going to scorecard ourselves quarter-to-quarter on that. Obviously, we provided in our year-end call our scorecard in terms of having already generated bookings of $120 million on a run rate basis, and $110 million of which is going to hit in 2016.

I think we are going to provide you a little bit more color at Analyst Day next week on some of the things that we think drive or help us achieve the targets as it relates to that $500 million run rate revenue target..

I might add to Kevin's point, we have a very robust pipeline that we think is very viable and we continue to work that aggressively..

That's great to hear. And just lastly, on the FMTV, the incremental vehicles into fiscal '15.

Any way to help us quantify the impact to you from that extension?.

Yes, I think the way to think about it is next year, we were thinking that we would have no FMTV revenue. I think you should think about those 900-plus vehicles, I think it's 949 vehicles or so, as being about 30% of the volume that we would experience in FMTV in '14. So '15 volume in that regard would be about 30% of '14..

Our next question comes from the line of Colin Langan from UBS..

Just a follow-up on the earlier question on the FMTV.

What kind of sequential headwinds are we facing? I mean, is it -- any color on the percent down over the next few quarters?.

Well, I think, as you know, we were about to -- we were going to lose all of our volume this year. So this is potential upside..

And you should think about it as you go through the course of the year, we're down about 30% year-over-year Q1. But on a full year basis, we're going to be down about 55%. So I think that should just help you see that there are more step downs coming sequentially as we head into Q2 and Q3..

Okay, that's very helpful. And any color on how Brazil is trending? Are orders there still stable? I mean -- because I think there has been some....

It's very difficult to forecast what's going on in Brazil. It's just been, for the reasons we outlined, it's been difficult. I mean, we -- GDP and inflation remain a concern. But the inventory levels are -- the good news, inventory levels are stabilizing. The FINAME program has been extended to this calendar year. So those are positives.

But consumer confidence is weak. And so it's just very uncertain. But we're pretty confident that the 175,000 to 185,000 medium and heavy-duty trucks is probably a fairly realistic outlook..

And then keep in mind, from a Meritor-specific perspective, we did have that new business win with DAF, which should help our revenue as we go throughout the year relative to -- in increasing share, you can think about it relative to the overall market there..

Okay, that makes sense.

And any update on the Eaton litigation? I mean, is the last date it's set to go to trial on June 23, or are there any additional updates?.

Well, the District Court ruled in favor of Meritor and against Eaton on a set of pretrial motions. And we had a pretrial scheduling conference, and the judge tentatively set a date for June 23. Eaton has asked for additional time for more discovery.

And she has said that she will consider that and get back to us and determine whether she is going to hold the June 23 date, which would probably be an 8-day trial. But either way, we expect a trial date this year, whether it be June 23 or a little later in the year. But there should be a trial this year..

Okay.

And just one last question on -- any color on the size of the factoring benefit in the quarter to your cash flow?.

Yes, I mean, you could see the factoring was -- the good news coming through the factoring line was about $81 million. Now as you think about that -- and that's driven by Europe, where we had a big uptick in volume sequentially, driven by the prebuy activity.

And we also had a new factoring program in Brazil, it's a short-term program that we had put in place. As you think about that from a headwind perspective going forward, I would think about it as being roughly half of that balance, maybe a little bit more of half of that balance being a sequential headwind as we go into Q2..

Our next question comes from the line of Brian Johnson from Barclays..

A couple of questions. First, on the litigation. Your General Counsel just retired or left the company.

Does that -- is that -- could you just kind of comment on that and how that kind of fits into the broader litigation picture?.

Sure, Brian. Vernon had shared with us his plans to retire in the next several years. And was expected to leave. Vernon has been a valued member of our team. But we were opportunistic and found a great replacement. And as you probably know, finding good outside -- excellent [ph] counsel and corporate secretary can be difficult.

So we decided to go ahead and proceed with that. We will be making an announcement shortly in that regard. And Vernon has also continued to -- continue in a consulting role with us for this next year. We do not see any impact at all to the Eaton suit. Kevin and I and Vernon have actually teamed this with outside counsel.

We've had the same outside counsel for 7.5 years. So we don't -- there's no impact here at all, Brian..

Okay. And in terms of M2016, I guess, a couple of questions. How much of the low-hanging fruit has been harvested and kind of where does it go going forward? And kind of second, probably more for Kevin, is kind of on a sequential basis, it sort of looked like a wash, you had a little volume pricing.

How do we kind of judge sequentially the impact of M2016? It looked good year-over-year, but sequentially, and it gets to that low-hanging fruit question, harder to see..

Well, regarding to the low-hanging fruit, as far as margin performance, we feel very comfortable in our abilities to deliver our material net cost reductions. In fact, if you look at what we've identified and what we have to go get this year, it's very, very small.

We're very confident we've demonstrated it in last year, as well as far as labor and burden improvement, and we're well on track through the first quarter this year in both labor and burden and material performance.

So we're very confident, at this point in time, that we can continue with the Meritor Lean production system and continuous improvement, that the opportunity still exists.

We have a -- and we also have not only, on our revenue side, a very aggressive pipeline, we have also identified a very solid pipeline of opportunities on the material and labor and burden front as well..

And I think another thing to keep in mind, Brian, is that as you look at this year, we obviously ended last year with a full year EBITDA margin of 7.1%. We're guiding to flat revenue this year and margin uptick to 7.5%. And that's despite 2 pretty significant headwinds, 1 being the FMTV stepping down 55%.

And I think we've given different data points over time which can help you kind of dimension the potential impact of that. And second, keep in mind, we don't have Suspensys anymore. So we've lost those JV earnings.

And the combination of those 2 things are being overcome or overwhelmed by the performance that we're generating right now to allow us to generate improved margins. So as you think sequentially as we go forward toward M2016, those headwinds start to go away. Suspensys won't be a headwind again in '15.

And FMTV, while it's got another step down coming, it's not going to be the same magnitude of headwind for the next 2 years. So as long as we continue to execute on the performance we have, we're going to start to see that performance flow to the bottom line without those same types of offsets we have here in '14..

I was just going to say, if you'll recall, when I first came, I made an assessment regarding M2016 that this plan was doable and that we have the right management team to execute it, and nothing has changed in that regard. And you can see by the results that it's working..

Our next question comes from the line of Patrick Archambault from Goldman Sachs..

Yes, a couple of questions from me. First is, I know you have upcoming contract negotiations with Daimler and Volvo.

Can you kind of give us a sense on the timing of that, and it's probably still early, but should we be viewing those as opportunities, or how easy is it to dimension the importance of those things to your profit outlook that you've outlined in 2016?.

Speaking specifically about Daimler, we're in a process of finalizing our contract renewal with them. We view them, clearly, as a strategic customer. And when we're in a position to make an announcement, we will do so. But we're very encouraged about our progress. Similarly, we're very encouraged about the discussions that we've had with Volvo.

And we're not in a position to make any announcement in that regard. But we're encouraged with the discussions that we've had to date..

Okay. And just on the -- some of the volume outlook.

I mean, could I get just a general idea of, like, based on what you've seen with one additional quarter since you outlined your plan and your guidance for this year, what has come in, like what regions do you have more confidence in, what regions do you have less? I mean, I guess, within that, I'd be specifically interested in Europe, which you haven't really had a question on yet.

With the prebuy, how much of what you've seen is really just pure prebuy? How much of what you've seen is actual activity picking up, and in first quarter, based on the kind of visibility of the order book, how difficult do you think that could be? So maybe just a couple of questions surrounding the volume outlook as it stands now..

I would say the greatest uncertainty at this point in time is in North America. The December, Class 8 orders were very strong at 31,000 plus. So January will be -- we're really looking at this month orders critically. So, hopefully, there could be some upside there, we're not sure, but we'll have to watch that closely.

The prebuy in Europe clearly helped the first quarter, and it kind of clouds the remaining 3 quarters. But maybe, Kevin, do you want to....

Yes, I mean, I think you characterized it right. If you think about -- if your question's really where the risks and opportunities relative to the guidance that we're giving right now, I think North America is the one where there is the potential for upside, but we're not prepared to call that yet because it's just based on a month of orders.

I think there are other regions, though, Europe, as Ike alluded to, South America and India, where I think there's continued risk in those relative to our guidance. I think still too early to tell at this point. And I think once we get one more quarter of data, we'll have a pretty good idea of where those markets are more likely to shake out.

But at this point, that where the real risk and opportunity is..

Okay, that's helpful. And I guess just one clarification.

The 10% EBITDA margin and the revenue target for 2016, you were able to -- do you still feel that you'd be able to achieve those things even in the absence of some major wins to replace FMTV? And I guess, on the back of that question, it seems like there are a lot of irons in the fire, so to speak, on military.

And should those be considered maybe upside opportunities to that target?.

Yes it's -- I mean, the way we think about it is we feel really good about our ability to deliver 1.5 to 2 points of margin expansion, absent any volume changes from where we are today.

And then the volume, which is a combination of new business wins that -- some of which we've already executed on, as well as the market recovery, those are the things that would get us the rest of the way to 10%.

So right now, as we think about it, there is a little bit of dependence that we have on the markets and the new business wins, but the bulk of the margin expansion that we're driving toward right now is based on underlying execution and performance. So we expect we'd get to 8.5% or 9% without any volume help..

But Patrick, as you look at our pipeline, we are not dependent upon any single program. We had -- the pipeline is very robust. And I would view -- I would look at the defense as some of the newest opportunity that presented themselves as just opportunity..

Our next question comes from the line of Ravi Shanker, Morgan Stanley..

A quick question on Latin America, long term. We've heard from -- on the light vehicle side, from a lot of the OEM suppliers, obviously, addressing the volatility and the lack of visibility in the region, and some of them even maybe downgrading their priorities in that region.

Just want to get a sense of how you guys think of the Latin American market long term? And do you feel like your business is rightsized and nimble enough to deal with the volatility there?.

Well, to answer your question, we remain very bullish in South America on the long term. And yes, we think we have the cost structure to weather where we are today. But we're winning new business as we speak, and we've announced that with MAN and Phevos. So we are very bullish on particularly Brazil and Latin America..

Got it. And just one housekeeping question. You commented earlier on the potential cadence of earnings through the year.

What about cash flow? Do you expect that to be fairly back-end loaded in getting up to that 0 to $25 million? Or do you think it's going to be fairly stable through many quarters?.

It's -- normally, our stronger cash flow quarters tend to be the third and the fourth fiscal quarter. And I think you should think of that being no different this year. Because we do, as we come into Q2 here, we do have that factoring headwind I mentioned in Europe as those volumes come down following the prebuy and that factoring benefit unwinds.

So I think you should expect that Q3 and Q4 will be the stronger quarters of the year from a cash flow perspective, but still in line with putting us on full year targets for 0 to $25 million of positive total free cash flow..

Our next question comes from the line of Robert Kosowsky from Sidoti..

Just looking at the balance sheet. It looks like the inventory turns have been turning down over the past 6 months -- 6 quarters or so, and your operations are supposedly getting better.

And a, do I have my math right on inventory turns coming in? And why is that decelerating when the operations are getting better, material side especially? And what should we look for as -- when is the turn going to happen in inventory turns, and when are you going to get some of this shining through?.

You're correct that the quarter was not as strong on inventory turns as we'd like. We've identified what we need to do. We have not changed on where we think we can go long term -- longer term, which we think we can get to 10 turns. But Kevin, I don't know whether you want to add a little more color..

Yes, I'll give a little color, because that's right. I mean, Q1 is down from where we were in Q4. If you look year-over-year, just looking where we ended '13 versus where we ended '12, actually, our inventory turns are flat. Now we would have liked to have seen some improvement, but we didn't.

Now as you look at a year-over-year basis, Q1 to Q1, actually, our inventory turns improved.

And the reason they are down, though, on a sequential basis, is we tend to have some inventory build that we have in the first quarter as we prepare for aftermarket spring selling season coming up and some of the other volume preparation we do, as we have production shutdown in December, we need to be ready for the early part of the second fiscal quarter.

So overall, I think we'd like to see our performance improving. But as you look at the year-over-year metrics, we have seen some improvements. So I'm not sure I would agree that sequentially, we're seeing it get worse and worse. I think it's been stable, really, as I look Q4 to Q4 of last year and then Q1 to Q1 as well, it's a little bit up..

But having said that, it is one of our initiatives, and we're committed to improving our inventory turns. So....

And is the 10x turn goal concurrent with M2016, is that end of the year then?.

Yes..

Okay.

Then otherwise, the -- I guess, in Brazil, are the DAF business and the new exposure you have to MAN, are those at full run rates right now or do those step up over the course of the year?.

They step up over time..

The DAF one is happening right now, and the MAN-Phevos program starts several years out. It's not one that's in production right now..

It's a modest revenue in '16..

Okay. Then finally, how are you thinking about China. Because you seem kind of cautiously encouraged, I guess, by what you're seeing in some product lines.

CAT seemed like they're a little bit constructive as well, but obviously, there's a lot of negative headlines in the newspaper, so I'm wondering what you think about the China big June quarter season..

Well, we successfully completed the consolidation of our operations, and we saw really nice margin improvement. We've got the right cost structure. Grader and loader segments did show some signs of improvement. But overall, look at the mining segment, it's at depressed levels. And there's still some inventory out there for cranes.

So we are, as we said in the call earlier, let's wait another quarter, and we'll come back to you on that one. Right now, we're kind of seeing it as flat..

Your next question comes from the line of Brett Hoselton from KeyBanc..

Kind of following on with some of the questions that Patrick asked. This is just clarification on my part.

My understanding is that roughly, I think, 150 to 200 basis points of the M2016 margin expansion is due to a combination of some execution on your part but also some pricing, which I think feeds into the idea that you're negotiating with Daimler and Volvo, and so on and so forth.

Can you do 2 things here? One, can you just give us the timing as to the contracts, Daimler and Volvo, when is the expiration? Just remind us there.

And then, secondly, am I correct in my impression that you seem to feel pretty good about how those contract negotiations are going with respect to your M2016 targets?.

First of all, one of the pricing actions, Brett, is with our aftermarket. And we are achieving that. As far as Daimler is concerned, we're really excited about the discussions that we're having with them. And we'll -- to be announced at a later date. We are actively engaged in productive discussions with Volvo.

The Volvo contract expires in Europe at the end of this year. So -- but in all cases, these are strategic customers for us. And we are engaged and involved and the discussions, at this point in time, are all positive..

And keep in mind, I think one of the things we've said is as you think about this OE contract renewals, it doesn't mean there are meaningful price movements in all of those contracts. I think we're focused on a couple in particular that we feel like are maybe underpriced.

And so I don't think you should have an expectation necessarily that every OE contract necessarily translates to some sort of significant step up in price. The other question you asked there about Daimler. The contract actually expired December 31.

But as you can imagine, with the strategic relationship that we have with Daimler, we continue to supply Daimler, and we continue to have a constructive relationship and hope to have something to talk about in the near future..

Okay. And then, secondly, and again, Patrick asked this question, but I just didn't quite understand the answer. You outlined a number of military opportunities here on Page #5.

And as we think about the $500 million target, how much is baked into that?.

The -- there's -- the HMMWV is in our pipeline. And as I said, we didn't discount any of the programs in that pipeline, but we've discounted the total. So we're not dependent on any particular program. I mean, we could not get HMMWV and still be okay with the incremental revenue growth that we're talking about.

We're just encouraged about where we are with HMMWV right now because of -- with the selection of the -- where the Marine Corps is in their process..

And then as it relates to the FMTV, I mean, it's -- the extension of the program into '15 is nice, but that doesn't help us on a run rate basis. So that volume, you're not going to see us count that towards the $500 million of revenue.

But the HMMWV is one of those programs that we're focused on among a lot of others as we drive toward the $500 million..

You have no questions at this time. I would now like to turn the call over to Mr. Carl Anderson for closing remarks..

Thank you for your participation in today's call, and this concludes our first quarter earnings call. Thank you..

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day..