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.

Patrick Archambault - Goldman Sachs Group Inc., Research Division Brian Arthur Johnson - Barclays Capital, Research Division Rahul Chadha - UBS Investment Bank, Research Division Robert A. Kosowsky - Sidoti & Company, LLC Irina Hodakovsky - KeyBanc Capital Markets Inc., Research Division.

Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 Meritor, Inc. Earnings Conference Call. My name is Glen, and I will be your conference moderator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr.

Carl Anderson, Vice President and Treasurer. Please proceed, sir..

Thank you, Glen. Good morning, everyone, and welcome to Meritor's Second 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 the property of Meritor, Inc. It's 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 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. Now I'll turn the call over to Ike..

Thank you, Carl, and good morning. Please turn to Slide 3. Our second fiscal quarter was characterized by solid execution as demonstrated by the financial results you see in our press release. Across the company, we're fully aligned to our M2016 and determined to achieve our targets. That determination is reflected in our performance again this quarter.

I continue to be impressed with the commitment of our leadership team and all of our employees to make Meritor a premier company for our shareholders and customers. Higher revenues combined with continued cost performance improved our EBITDA margin by 170 basis points compared to the second quarter of last year.

Total free cash flow was $9 million representing the best second quarter results since 2010. We also successfully executed several capital market transactions this quarter.

At our analyst event in February, we told you that our priorities were to maintain strong liquidity, to assess our liability structure and prudently manage our debt maturity profile. The actions we completed in the quarter support each of these priorities and ultimately provide us with greater financial flexibilities.

With regard to our outlook for the fiscal year, we're pleased to announce that we are increasing guidance for revenue and earnings. With our first half performance, combined with expected higher revenues in the second half, we've increased our guidance for both adjusted EBITDA margin and adjusted EPS.

As you know, a major element of M2016 is winning new business. On Slide 4, you'll see that we reinforced our partnership with Daimler Trucks North America this quarter by completing a new 4-year agreement. This contract represents an important partnership with a long-term customer, our largest in North America and second-largest globally.

With the agreement, we retain standard position for air drum brakes and drivelines and hold our strong optional position for front and rear axles. In addition to the DTNA agreement, we also -- we won new business with Daimler India. For this award we will supply Daimler with our MS-145 axle for its BharatBenz rigid truck.

The 145 is Meritor's highest volume axle for global applications. It was the primary axle used in North American linehaul for more than 20 years and is highly adaptable for a variety of applications. We look forward to continuing the relationship we've enjoyed for many years with Daimler and we are working together on future business opportunities.

On Slide 5 is a comparison of our sequential performance. Revenue increased $55 million to 6% quarter-over-quarter. This increase was primarily due to higher volumes across both segments in North and South America, partially offset by lower volumes in Europe as a result of the first quarter pre-buy.

Adjusted EBITDA was $78 million, up $8 million from the prior quarter. Adjusted EBITDA margin was 8.1%, an increase of 40 basis points, mainly driven by higher revenue and our continued focus on reducing costs. Adjusted income from continuing operations was $21 million, up $9 million from the first quarter.

Adjusted EPS from continuing operations was $0.22, an increase of $0.10. Free cash flow was $9 million compared to an outflow of $16 million in the prior quarter. Let's turn to Slide 6 for a revised market outlook for the fiscal year. Arrows on the chart indicate the segments where we revised our forecast.

In North America, our forecast has increased 20,000 units for a new range of 65,000 to 75,000 (sic) [ 265,000 to 275,000 ] Class 8 trucks. As you know, orders over the past 4 months have shown considerable strength year-over-year. Despite March orders being down close to 6% sequentially, they were still up more than 24% from March of last year.

The Class 8 order board is at a 22-month high at 4.9 months. As a result, OEMs are increasing production rates. Moving to China, you may remember that our revenue in the region was down approximately 40% last year.

Coming off that low base, we now expect revenue to increase 10% over the prior year, as inventories that were consumed by OEs are being replenished. However, we do remain cautious on this market.

In South America, we are anticipating a meaningful decline in demand expectations for the second half, resulting in a reduction to our forecast for the medium and heavy-duty truck market of 20,000 units. Our updated forecast is now for 155,000 to 165,000 medium and heavy-duty trucks.

As we moved into the second quarter, OEs built up inventory in anticipation of higher demand, but with continued economic headwinds and uncertainty, that demand is not materializing, causing OEs to decrease production and take days out of their schedules.

Inflation of approximately 6%, low GDP projections and increasing market interest rates are continuing to deteriorate consumer and business sentiment. The World Cup, which starts on June 12, is also expected across some level of production disruption, and the election in October is creating further uncertainty.

In Defense, new prime contractors will be selected for the engineering, manufacturing and design phase of the Humvee program in August or September of this year. As a result, we expect the final contract award to be in September of 2015.

The Marine Corps has established its acquisition quantity to be roughly 1,600 vehicles and has increased the acquisition price from $110,000 to $145,000 per vehicle. The JLTV program is on track with a final selection also expected in late 2015. Please turn to Slide 7.

As we watched demand increase in North America over the past 4 months, we've initiated actions to ensure we're prepared to support our customers at higher volumes. We're taking a forward-looking approach that includes global coordination and detailed market reviews with our customers.

We've improved our operating efficiency and capabilities to support our customers. We've invested in our precision forging presses and taken steps to upgrade machining and assembly operations in the United States and Mexico.

We're working with suppliers to mitigate risk associated with key commodities, and we're strategically building inventory to avoid pinch points that we've dealt with in the past. With the detailed plan we have in place, we're confident in our ability to execute well.

Our objectives are to maintain high customer satisfaction and delivery rates while converting on additional sales in line with normal levels. You will remember that in the first quarter of 2014, axle production in Western Europe was up 30% year-over-year.

Using the approach I just outlined, we successfully avoided -- we successfully achieved excellent delivery performance and managed cost for strong conversion. We expect to have the same results in North America. Now I'll turn over the call to Kevin for a more detailed review of our second quarter results.

Kevin?.

Thanks, Ike, and good morning, everyone. On today's call, I'll review our second quarter financial results and take you through our updated 2014 guidance. On Slide 8, you'll see our second quarter income statement for continuing operations compared to the prior year. Sales were $962 million in the quarter, up year-over-year by $54 million or 6%.

This increase was due to higher commercial truck production in all of our geographic regions, but most notably in North America and Europe. In addition, revenue was slightly higher in our Aftermarket & Trailer segment. Our only business that was lower on a year-over-year basis was Defense, as FMTV revenue stepped down by nearly 50%.

Gross margin increased $21 million year-over-year due to the continued execution of our M2016 initiatives.

This improvement was driven by conversion on higher revenues and continued net material, labor and burden performance, and keep in mind that this increase in gross margin was achieved despite the significant year-over-year step down in FMTV volumes. SG&A was $1 million higher in the second quarter of 2014 compared to the same period last year.

However, as we look at SG&A as a percentage of revenue, we actually experienced a slight decrease on a year-over-year basis. This is the result of our continued focus on managing the overall cost structure of the business. You should expect this disciplined approach to continue even as revenue increases.

This quarter's restructuring costs were $9 million lower than the same period a year ago. As you may recall, in the second quarter of 2013, we recognized an $11 million expense primarily for employee severance costs associated with our segment reorganization and our Asia Pacific realignment.

Earnings in our minority-owned affiliates were $9 million in the quarter, down slightly from the prior year. The decrease is primarily due to $4 million of lower earnings from our Suspensys joint venture, which was sold in July of last year and is no longer contributing to our earnings.

Interest expense was $23 million higher in the second quarter of '14 driven by the loss on debt extinguishment relating to the repurchase of our 10 5/8% notes due in 2018. You'll note that we have included an add-back of $21 million in adjusted income from continuing operations associated with this loss.

Later, I'll provide more detail on what these transactions mean for our debt maturity profile. Income tax expense increased $2 million in the second quarter of 2014. This increase was driven by higher earnings in jurisdictions where we recognized tax expense.

In addition, no tax benefit was recognized on the loss on debt extinguishment incurred during the quarter since this loss was recorded in the U.S. where we currently have a valuation allowance.

After adding back the debt extinguishment loss, adjusted income from continuing operations was $21 million or $0.22 per share compared to $6 million or $0.06 per share in the same period last year. Slide 9 shows second quarter sales and segment EBITDA for Commercial Truck & Industrial.

Sales in the second quarter of 2014 were $763 million, up $51 million or 7% from the same period last year. Segment EBITDA was $57 million, an increase of $20 million year-over-year.

This represents 39% upside EBITDA conversion due primarily to improved net material labor and burden performance and higher volumes across all of our commercial vehicle markets. These positives more than offset the negative mix headwind associated with the step down in our FMTV business.

Next, on Slide 10, we've summarized the Aftermarket & Trailer segment financial results. Sales were $232 million, up $8 million from last year. The increase was primarily due to higher European sales and North American pricing initiatives executed over the past year.

Segment EBITDA was $22 million in the second quarter and was flat compared to last year. The EBITDA benefit of higher revenue was offset by the loss of earnings year-over-year from our previously divested Suspensys joint venture, as well as certain inventory reserves booked in our second quarter.

Now let's move to Slide 11, which shows the sequential adjusted EBITDA walk from Q1 to Q2. Walking from the $70 million of EBITDA generated in our first quarter, we had $17 million more of EBITDA due to volume, mix and pricing. This is primarily driven by higher revenue in both segments across North and South America.

This increase was partially offset by lower revenue in Europe as production levels stepped down following the Euro 6 pre-buy that occurred during our first fiscal quarter. We also executed pricing actions in our Aftermarket & Trailer segment, which contributed sequentially to our results.

Next, you recall that in the first quarter, we recorded a $5 million accrual reduction associated with a change we made to reduce benefits provided under our long-term disability plan. This did not repeat in the second quarter, so it is a headwind in our sequential walk.

And finally, we have an all other net decrease in EBITDA of $4 million when compared to the prior quarter. This includes additional inventory accruals in our Aftermarket business, as well as the impact of the Brazilian real depreciation. Overall, this was another solid quarter for us.

We generated adjusted EBITDA of $78 million and adjusted EBITDA margin of 8.1%. We are continuing to build upon the performance we have delivered over the last several quarters and remain focused on achieving our financial objectives. Now let's turn to Slide 12. For the second quarter, total free cash flow was $9 million.

This represents a $35 million improvement over the same period last year. This increase was driven by higher adjusted earnings, lower pension contributions, lower cash interest and a decrease in restructuring payments. Working capital, including the impact of our factoring programs, negatively impacted our cash flow by $37 million in the quarter.

As we discussed on last quarter's earnings call, our first quarter cash flow was positively impacted by higher sales in Europe where we factor most of our receivables. This had the effect of accelerating the cash cycle time in Q1.

As production volumes in Europe took a step down in this quarter following the pre-buy, the first quarter cash flow benefit from factoring became a cash flow headwind for us in the second quarter.

In addition, as Ike mentioned earlier, we are continuing to build strategic inventory buffers to support an upturn in the North American market, so this had a modest impact on working capital performance in the quarter and will continue to impact us in the second half of the year.

Now let's turn to Slide 13 for a review of our liquidity and debt maturity profile. We completed several capital market transactions during the second quarter. First, we issued $225 million of 6 1/4% notes due in 2024.

The proceeds from this issuance were used, along with balance sheet cash, to call $250 million of our 10 5/8% notes due in 2018 and to pay off the remaining $41 million term loan balance. These transactions resulted in gross debt reduction of $66 million and will generate annual cash interest savings of approximately $14 million going forward.

During the second quarter, we also amended and extended our revolving credit facility. The maturity date for the revolver was extended to February 2019 and we improved the drawn pricing by 75 basis points. In addition, we increased the facility size to $499 million through April 2017.

After which time, the facility will step back down to $410 million through maturity. From a liquidity perspective, we used cash to help fund the debt repurchases I just spoke about. However, as a result of the revolver amendment, we largely offset the liquidity impact of using that cash by upsizing the revolver more than $80 million.

As a result, we ended the quarter with $795 million of liquidity, only slightly below last quarter's balance. Completing these actions has allowed us to achieve greater financial flexibility and has provided us a clear runway in which we have only $170 million of funded debt coming due over the next 5 years.

In fact, 85% of our funded debt doesn't mature until 2019 and later. Next, I'll review our updated fiscal year 2014 outlook on Slide 14. We are raising our fiscal year 2014 sales guidance from approximately $3.7 billion to a range of approximately $3.75 billion to $3.8 billion.

This increased sales guidance is due to a strengthening North American Class 8 truck market, and to a lesser extent, increased revenue expectations in China. This revised sales guidance also takes into account the effect of the weaker market in Brazil.

We're also raising our adjusted EBITDA margin guidance from approximately 7.5% to approximately 7.7%. We expect better second half performance than originally planned due primarily to the revenue upside we're seeing particularly in the North American Class 8 market.

But second half performance is tempered somewhat as we manage headwinds in 2 of our higher-margin businesses, as well as modestly higher steel cost in North America. We are taking down our production forecast for South America due to the softness in the commercial vehicle demand in that region.

And in the case of our Defense business, we expect revenue to be lower by more than 50% in the second half of the year relative to the first half of the year, due to the continued step-down in FMTV production. It will be important to keep these headwinds in mind when thinking about our third and fourth quarters from an earnings perspective.

We are also raising our adjusted earnings per share from continuing operations guidance to a range of $0.50 to $0.60 for fiscal year 2014, which is an increase of $0.20 compared to our prior guidance.

This increase is driven by the expected improvements to adjusted EBITDA, as well as the benefit of lower interest cost resulting from the capital market transactions we executed. Total cash flow is still expected to be between breakeven and positive $25 million.

As the North American market continues to strengthen, we are ensuring that we are prepared for increased demand by putting strategic inventory buffers in place where necessary. This investment in working capital will position us to convert on the North American market upturn.

But even with these inventory buffers, with the first half performance, we're confident in our ability to deliver this free cash flow guidance, which would be our strongest full year free cash flow performance in 4 years. Now I'll turn the call back over to Ike to provide closing remarks on our continued forward momentum..

Thanks, Kevin. Let's turn to Slide 15. When we met with you in February, we highlighted several reasons that make Meritor a sound investment. This quarter, we made solid progress with accomplishments that further validate our investment thesis. First, we said we had a clear and simple plan to improve performance in 2016. That plan is working.

As I said earlier, we're aligned and focused on 9 objectives, and we're on track to achieve the 3 financial metrics we have established for EBITDA margin, net debt and incremental revenue. Also in the second quarter, we launched our new air disc brake program with Scania in Europe.

This business was part of the $120 million pipeline we captured last year. We have strong partnerships that we're focused on growing. We're proud of our new 4-year agreement with DTNA, which is a year longer than the last agreement, and we're ready to begin new axle business with Daimler India.

We're also working hard to build and sustain relationships with other important global players like Volvo, Navistar, MAN, DAF and Mahindra to name just a few. Our margins are improving. In the first quarter, we expanded our adjusted EBITDA margin 250 basis points year-over-year.

This quarter, margins grew by 170 basis points from the same period last year. We briefly told you our liquidity was strong and we were evaluating further action to improve the balance sheet. We did that this quarter with a series of transactions. Our cash flow is improving.

In the first quarter this year, we had the strongest first quarter free cash flow since fiscal year 2010. This quarter, we had the best second quarter results since that same year. Defense programs, including the Humvee Recap and the JLTV, continue to show good potential for Meritor.

Meritor's ProTec High Mobility Suspension successfully completed 100,000 miles of on- and off-road testing in Lockheed Martin's JLTV. This equates to about 62% of the required test miles. The transformational change in our approach to material cost management is working.

As you saw, material performance this quarter helped contribute to our favorable results. And our global operations are getting more efficient. In Europe, we achieved a 98% delivery and strong conversion during the first quarter pre-buy.

We now believe we are in an up-cycle for Class 8 trucks in North America with the best 4-month period of orders from December to March since 2006. We are ready and responding as demand increases.

We're managing the process carefully to ensure we convert incremental sales at normal levels, which would reflect better performance than in previous production cycles. Overall, we're showing consistent improvements in financial performance, balance sheet management, cost structure and operational excellence.

We're also winning important new business with large global players. Raising guidance for the full year is further indication that the actions we're taking are sustainable. We are building momentum and looking forward to the second half of the year. And with that, we'll take your questions..

[Operator Instructions] And our first question comes from the line of Patrick Archambault, Goldman Sachs..

Maybe a couple of questions here. Why don't we just start off with -- on the Commercial Truck side. You had very, very strong conversion on the revenue, and I think you highlighted some of these, I guess, burden and material benefits that you put in place that are sort of paying off.

Can you speak to the sustainability of that kind of a conversion in subsequent periods kind of hitting what's implied by your guidance, and potentially if we can talk about sort of beyond 2014, that would be helpful as well. That's my first question..

Patrick, the answer is yes. But as far as specifics, Kevin, do you want to go ahead and....

Yes, sure. Patrick, it's Kevin. With respect to the sustainability, I mean, this is part of our M2016 initiative. As we look at material, labor and burden performance, we have specific objectives in that regard. In material, we're driving for 2.5% annual net material performance; in labor and burden, in the same zip code; and we're were achieving it.

We achieved it last year in '13, we're on pace to achieve it in 2014. So it's 1 of those 9 key strategies we're focused on in terms of driving that type of performance as part of M2016, and we expect to sustain that and deliver that through M2016..

Okay.

And so no kind of unusual commercial settlements or anything sort of helping the result this quarter?.

No. And I think you can see that when you look at -- it wasn't just this quarter. It was last quarter and it's been prior quarters. I mean, we continue to see that improvement in our margin, so it's not a 1 quarter phenomenon, what you're seeing. You can see it quarter-over-quarter continuing..

And I guess, just looking kind of turning forward one page in your slide deck here, Aftermarket & Trailer, can you just give us a sense of what the kind of outlook is for that? I feel like there's sort of less of an understanding, less transparency in terms of the real revenue drivers there.

So what should we be looking at to sort of gauge the opportunity there from a top line and maybe in terms of a conversion as well?.

Patrick, I'll go ahead take a pass at it, and if Kevin can add a little more color, fine. But Aftermarket is tracking to forecast and the trailer market has picked up nicely. So we feel very encouraged about both our Aftermarket and our Trailer business as well. Kevin, I don't know if you have anything you want to further....

I mean, we're definitely seeing, on a year-over-year basis, the Aftermarket business is up from a revenue perspective with truck production, and that's why we provide the U.S. truck freight ton-mile as kind of an indicator, a directional indicator as to what we expect in the Aftermarket performance from a revenue perspective.

And then from a margin perspective, Aftermarket has historically been one of our better contributing margin businesses. So we would expect to generate pretty healthy conversion as we see revenue growth there.

Now this quarter, on a year-over-year basis, that was tempered by the fact that we no longer have Suspensys helping those earnings, so that's a year-over-year headwind, and we did have some modest inventory accruals that we booked in the quarter for E&O. So -- but overall you should expect that to be one of our better converting businesses..

And then on that, like Suspensys, I should know this but this was something that wasn't consolidated and was there for helping EBITDA but not revenues, is that correct?.

Exactly right. So on a year-over-year -- so second quarter of a year ago, we generated about $4 million, $2 million of which was in the Aftermarket & Trailer segment. The other $2 million was in the Truck segment. So Aftermarket's down $2 million year-over-year, but exactly like you said, it was EBITDA with no sales..

And then just the reserves that you've taken, is that kind of a one-time thing, or are those kind of accruals that are ongoing as the revenue is picking up?.

I wouldn't call it a one-time thing. I mean, every quarter, we're assessing our inventory for excess and obsolescence to see if there are any inventory adjustments we need to make. And from time to time, we make adjustments. So it was a small amount, couple of million dollars in the quarter.

And it happens from time to time, particularly in businesses where you carry a lot of inventory to support that business like the Aftermarket business..

Okay. Last one for me.

Can you just -- any update on discussions with Volvo?.

Patrick, as you know, our contract expires this fall in October. We are encouraged with our discussions, but we don't have any announcements to make at this time. I think that if you step back, the good news from both Volvo and our perspective is that we both see long-term value in our relationship.

And I think it's fair to say that we see a path forward, but I don't really have any more than that at this point in time..

Your next question comes from the line of Brian Johnson, Barclays Capital..

Just want to start in the CB [ph] division by asking a little bit more color on the impact of Brazil, Venezuela or other countries in South America.

What was the drag there, if any? What does it look like going forward? And then where -- if there was a drag, where were the key offsets and kind of -- and maybe just gives us some color on how you're managing that situation as it kind of went through the quarter?.

Brian, it's Kevin.

Are you referring to FX related or something broader?.

Or are you talking the economy?.

FX inflation, weak economies, government in Venezuela that's on the -- following the Fidel Castro model, just the whole collection of [indiscernible]..

Okay. So before Kevin answers, the good news is we're not in Venezuela, so we don't have an issue with FX coming out of Venezuela.

But Kevin?.

Yes. I mean, that's exactly right. We don't have any Venezuelan exposure, so from a market perspective or an FX perspective, there is 0 exposure that we have to that market. From a Brazilian perspective, obviously, it's an important business for us. I think it was about $450 million in revenue last year and we have had some FX headwinds there.

I mean, for the quarter, the Brazilian real was about 2.35. Keep in mind, a year ago it was about 2. So on a year-over-year basis, that's impacted us quarter-to-quarter, Q2 to Q2, about $22 million in revenue, the Brazil real, and about $5 million or so in EBITDA.

But sequentially, it didn't have a big impact on us even though there was some depreciation, maybe about $4 million of revenue in the quarter. The good news is we're offsetting that with performance, so you're not seeing that pop as a real big bad news item that's not being offset by other things like volume, mix, pricing and performance..

Okay. And then secondly, anything you can update us on the Eaton litigation and kind of timeline for that? We know there's a court date currently scheduled for June 23..

That date is still a good date, and we expect the trial to last 8 days as we've communicated before. But really don't have any more to update than that, Brian..

Okay. And then final kind of question.

As you kind of look at the margin progress here, as well as in your guide, and you're kind of thinking about M2016, to what extent would you ascribe the margin improvement to, a, revenue just showed up better than you expected due to cyclical factors? Or versus, b, we executed better and had revenue been, say, a bit lower or -- where would it have been [ph], I think Ike will kind of recognize this as a question has boss back at Emerson would've asked.

That is, are you actually operating better or did you just get some -- something from tailwind?.

Brian, we are operating more efficiently across the globe, our material and burden and labor cost reduction initiatives are bottom lining, and it was all part of M2016 that we would -- in difficult markets, that we would improve our EBITDA margins.

But Kevin, you want to add a little more to that?.

Yes, I will. I mean, as you look at 2014, I mean, the primary reason why we're taking up our guidance is obviously driven by revenue but our ability to execute on converting on that revenue. And we're guiding to a range on revenue and we're guiding to approximately margin.

But if you just kind of do the math on some of the midpoints, it would imply a high-teens conversion on that revenue, which is showing that the cost performance initiatives that we are executing are sticking and that we're able to convert successfully on the incremental revenue we're seeing. And we would expect that to continue..

Your next question comes from the line of Colin Langan, UBS..

This is Rahul Chadha on behalf of Colin. I just want to understand, it seems like in the first half, the margins have been pretty strong, 7.7% in Q1, 8.1% in Q2.

So why does your full year guidance only stop at 7.7%? Is there room to go above or is it just being conservative?.

Yes. I mean, I think there's a couple of headwinds that we need to keep in mind as we look at the second half of the year. The first starting with kind of markets and the mix impact of that.

We obviously have South America where we're taking down our guidance on the second half of the year with that market coming down quite a bit, so that's impacted the way we think about the second half versus what we were thinking before.

Second is, our military business, which is another high-margin business for us, is down 50% in the second half of the year versus the first half of the year. Big mix impact for us there. And finally, in the North American market, with the upturn, we have seen steel indices increase on a year-over-year basis.

As you look at bar and hot-rolled, I mean, you're seeing up about 7% or 8% on a year-over-year basis, we saw the indices peak in January. And so that's going to have an impact on us in the back half of the year.

And even though we have recovery mechanisms, those recovery mechanisms, as you recall, are on a lag, and so we're not likely to get the recovery on those until early in '15. So those are the things, as you think about why second half is implicitly guided to something lower than first half.

Those are the headwinds that we're seeing and to keep in mind..

That's very helpful. And then one question on the Military business.

Any update on potential wins which were in the pipeline or in the near-term?.

There's 2. Humvee timing, we expect 2 contractors to be selected for the EMD, or the Engineering Manufacturing Design phase. That should occur late August or September of this year, and we expect the final contract to be awarded a year from now -- a year from September 2015. And the JLTV is, we expect that selection to be late 2015.

And as I mentioned in my comments, we're performing well on the test phase with Lockheed Martin..

And could you remind us, was any of this baked in the $0.5 billion incremental revenue target in M2016?.

Yes. I mean, those initiatives, along with a number of other initiatives, are baked into the M2016 target. But keep in mind, we have a pipeline that far exceeds the $500 million target we're driving for. We embed all of the initiatives that we're working toward and then we put a discount factor on that, kind of a macro-level discount.

And there's no single award that would -- that if we didn't win, would cause us to miss that target. So while those are important programs to hitting $500 million, we're not dependent on any one program to hit the $500 million..

Your next question comes from the line of Robert Kosowsky, Sidoti..

Just a quick question on China.

Was this a -- I guess more clarification, was this a restocking that you saw there, or are we're just seeing demands at the point where it's mirroring end-user demand? And also any thoughts about growth in excess of the market, either on-highway or off-highway?.

No, you got it right, Robert. It was restocking. It's a replenishment of inventories at this point in time. And obviously, as I mentioned, we're coming off a weak comparison. So we're not declaring victory as far as the Chinese market, but we are seeing some increase orders to replenish inventory..

Okay. And then secondly, SG&A has been under pressure for quite a few years now. You've done a really good job on just driving that lower.

And if we do have some -- little bit better cyclical end markets over the next few years, would you expect to see an inflationary growth rate in SG&A, or is it still going to be a source of like an absolute dollar attrition?.

No, we expect to be able to, as we increase revenues, to be able to leverage our functional spend. It's something that we pay attention to, we work hard on it. And obviously as we win new businesses we may have a few incremental increases. But overall, we expect to be able to leverage our functional spend going forward..

Okay.

Would you expect growth in absolute dollars?.

There could be some incremental dollar growth. But as far as rate, we should expect to be able to see that being leveraged. And you saw that, by the way, in the sequential walk from last quarter to this quarter as well..

Your next question comes from the line of Irina Hodakovsky from KeyBanc Capital Markets..

Brett had to sign off, I'm representing Brett Hoselton. A quick question for you. As we move into the third quarter, your comparisons become much more difficult.

I'm trying to understand how you can -- I know you don't provide guidance on a quarterly basis, but if you can maybe directionally guide us into what we can expect from your end markets?.

We're not giving specific guidance, obviously, on each of the last 2 quarters. You can do some of the math, though, and look at what our guidance is implying about the second half of the year, and obviously, it's implying that our margins are going to be down. So you're absolutely right when you look at Q3.

Q3 is a difficult comp for us given that we generated 8.8% EBITDA margin in that quarter. But again, keep in mind we do have some headwinds heading into the second half of the year that I spoke of earlier that'll hit us over the course of the next 2 quarters.

I talked about how we took down our guidance in South America, FMTV stepping down and the modest increase in steel economics that we're seeing in North America..

[Operator Instructions] At this time, we have no further questions. I will now turn the call over to Mr. Carl Anderson for closing remarks..

Thank you, Glen. Thank you for your participation on today's call. For any follow-up questions, please feel free to reach out to me directly. And with that, this concludes Meritor's Second Quarter 2014 Earnings Call. Thank you..

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect, and have a great day..