Carl D. Anderson - Meritor, Inc. Jeffrey A. Craig - Meritor, Inc. Kevin Nowlan - Meritor, Inc..

Neil A. Frohnapple - Longbow Research LLC Colin Langan - UBS Securities LLC Brian A. Johnson - Barclays Capital, Inc. Ryan Brinkman - JPMorgan Securities LLC Michael J. Baudendistel - Stifel, Nicolaus & Co., Inc..

Good day, ladies and gentlemen, and welcome to the Meritor, Incorporated Q2 2017 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. As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Carl Anderson, Vice President and Treasurer. Sir, you may begin..

Thank you, Heather. Good morning, everyone, and welcome to Meritor's second quarter 2017 earnings call. On the call today, we have Jay Craig, CEO 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 are 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 discussion may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to slide 2 for a more complete disclosure of the risks that could affect our results.

To the extent we refer to any non-GAAP measures in our call, you'll find the reconciliation to GAAP in the slides on our website. Now, I'll turn the call over to Jay..

Thanks, Carl, and good morning. On slide 3, you'll see that this was another strong quarter for us. Sales were $806 million, down slightly on lower production in the North American Class 8 truck market.

Adjusted EBITDA was up $1 million from the same quarter of last year, resulting in a margin of 10.2% despite the fact that we booked a $10 million for a legal contingency accrual in the quarter. As a result of our performance in the first half of the year and our forecast for the second half, we are increasing our guidance for the full fiscal year.

Continued operational performance combined with an expectation of higher Class 8 truck builds in North America and increased revenue in Europe gives us confidence that we will achieve full-year results at the top end of our prior outlook. Kevin will give you more color on our financial results and what we're seeing in the global end markets.

In addition to our financial results, we also had several other highlights in the second quarter driven by our focus on customers and products. As we demonstrated consistently quarter after quarter, our global team is driving improved results.

Alignment to M2019 and the drive for the success that I see in Meritor employees every day is continuing to differentiate us in the commercial vehicle business. In that regard, we are proud to tell you about three distinguished awards we recently received that are shown on slide 4.

As you know, we have a long-term relationship with Navistar that we greatly value, particularly in terms of our mutual interest to look towards the future and collaborate on designing products that meet our customers' strategic priorities. In February, Meritor was among the top 2% of Navistar's supply base to receive the Diamond Supplier Award.

We are proud to supply Navistar with a variety of products. Just last week, we announced that Meritor's 13X single-drive axle is now available to be spec'ed on Navistar trucks. The 13X designed specifically for medium-duty applications is 59 pounds lighter and 0.5% more efficient than our previous offering.

It's engineered for multiple applications, including pickup and delivery, beverage, utility, school bus, construction, and ambulance. And a few months ago, we announced that Meritor's high-performance EX+L air disc brakes are now available on International LT Series tractors. XCMG is another important customer to Meritor.

In addition to being our key joint venture partner in China, XCMG recently honored us with the excellence supplier award that recognizes its top supplier in delivery, quality, and product performance.

We look forward to further enhancing our relationship with XCMG, one of the largest construction machinery companies in the world, as the construction markets in China begin to show signs of a slight improvement, which encourages us for the rest of the year.

We also received an important industry recognition this quarter from Heavy Duty Trucking Magazine, which ranked Meritor's MFS+ Series front-steer axle as one of the top 20 products for 2017. This award honors the most innovative new products that address industry issues and help fleets improve their bottom line.

The MFS+, which we launched last February, is 85 pounds lighter than our previous offering, providing fleets with a more efficient product. We appreciate each of these significant awards and recognize that continuous improvement is necessary to meet our customers' expectations in a constantly evolving industry.

When we launched M2019, we told you we would be more aggressive in our product launch cycle than in the past, which would contribute to our revenue growth objective. We are on track to launch 20 new products across the front drivetrain, rear drivetrain, and specialty.

On slide 5, we highlighted three products that were launched in the second quarter for three different applications. The 14X HE for linehaul, the P600 tridem for heavy-haul and off-highway applications, and the MTec6 for trailers.

The 14X HE is designed to improve our axle efficiency up to 1.5%, while also reducing weight by 30 pounds over the current market-leading 14X design. Based on today's diesel prices, a fleet with 1,000 trucks equipped with the 14X HE could realize $1 million per year in fuel savings.

The P600 Series tridem axle for heavy-haul, oil field, mining and logging applications begins full production in June at our Laurinburg, North Carolina plant. High capacity, reduced fleet time, aftermarket parts availability, and Meritor's leading field service and support make us a strong competitor in this market.

And the MTec6 axle being produced in our Frankfort, Kentucky facility is now available for our trailer customers. This axle is 40 pounds lighter than the industry standard 5-inch axle, which reduces gross trailer weight to enhance fuel economy and available payload. These are three products from our pipeline that we've now launched.

Slide 6 and 7 provide a look at some of the new business we're awarded this quarter. In total, the wins on these two slides are expected to amount to just over $70 million of incremental business in 2019.

We continue to grow with strategic customers like Volvo, Daimler and PACCAR, whether through new products or the addition of existing Meritor products to applications in other regions. It was exciting to see Volvo launch its new UD Con Truck in Japan three weeks ago, which incorporates Meritor's global axle and brake platforms.

Volvo is the first OEM to offer disc brakes as a standard feature in the Japanese market, and they are depending on the proven performance of Meritor's disc brake. We are also supporting Volvo in Thailand and India. Expanding our customer base remains a focus for us, and we are having success in that area.

You can see a couple of examples of that here, with Veera Vahana, an India-based bus manufacturer and JAC Motors, a Chinese manufacturer of medium and heavy-duty trucks. And we are working hard to grow our Aftermarket business. This quarter, we earned a new private label business in Europe.

We also recently launched a new e-commerce platform called meritorpartsexpress.com, that makes it easier for U.S. and Canadian customers to shop for Meritor aftermarket parts on their computers, smartphones, and tablets.

In our components business, we have a small win this quarter, and we have a new specialty in off-highway contracts in North America for which we'll be supplying our MX-810 axle and P600 tandem.

Also, while not incremental, we recently renewed a contract with Hino in North America, resulting in a five-year extension of our current business, which includes front and rear-dressed axles for Class 6 and Class 7 vehicles. As we said, the majority of our new business is back-end loaded in M2019.

The wins on these two sides demonstrate the progress we're making to strategically grow our business in each of these areas. Now, before I turn the call over to Kevin, I wanted to make a few brief comments about the recent ruling related to our UAW Retiree Medical Benefits.

On April 20, in a 3-0 decision issued Sixth Circuit Court of Appeals, the prior lower court decision was reversed, and the court held that our collective bargaining agreements did not vest the plaintiff retirees with lifetime medical benefits.

We are encouraged by the Sixth Circuit Court's recent decision, which we believe will eventually provide us with the opportunity to amend our UAW Retiree Medical Benefit plans based on the needs of our business.

But at this point, we're still in the midst of a litigation and the plaintiffs in the case have not yet exhausted the appeal's process, which includes the potential filing for a petition for a rehearing en banc with the Sixth Circuit Court of Appeals. As a result, it's premature to speculate on the outcome.

We will remain focused on executing our strategy, which includes investing in new products and technologies that drive top line growth, improving bottom line earnings, and maintaining a disciplined approach to capital allocation. With that, I'll turn the call over to Kevin..

Thank you and good morning. Overall, we had another quarter of strong execution. We expanded margins, generated positive cash flow, and continue to make good progress toward our M2019 targets. Let's walk through the details by first turning to slide 8 where you'll see our second quarter financial results compared to the prior year.

Sales were $806 million in the quarter, down 2%. The decline in revenue was primarily driven by a lower commercial truck volume in North America. This was largely offset by increased production in Europe, India and China in addition to new business wins coming on line.

Although revenue was down slightly, we were able to expand gross margin as a percentage of sales by 30 basis points. We accomplished this by continuing to drive lower material, labor, and burden costs that helped to offset the impact of lower revenue as well as higher steel prices which were a $6 million headwind in the quarter.

In addition, we have favorable mix in our truck business, which also helped to drive higher contribution margins this quarter. As you can see from the right side of the slide, we did book a onetime $10 million legal contingency charge related to a dispute with our joint venture partner in Mexico.

We've been in litigation since 2014 with our partner over certain product manufacturing rights. The legal contingency charge reflects our best estimate of the cost to reach an agreement to resolve this issue.

We expect that this matter will be settled in the coming months, but given where we are in the discussion, we accrued this expense in the current quarter. Moving down the (13:30), we had $2 million of favorability in the line item volume, mix, performance and other.

This captures the strong operational performance and favorable mix I mentioned earlier which more than offset volume declines and the $6 million steel headwind.

Foreign exchange was a tailwind in the quarter, driven by $2 million hedge mark-to-market gains in the second quarter of this year and the corresponding $2 million mark-to-market hedge loss a year ago.

The hedge gains this year relate to foreign exchange options that protect against the strengthening Indian rupee as we have shifted some of our supply base to India over the last few years.

The hedge losses from a year ago were related to certain earnings translation hedges we had purchased to protect against the risk of a weakening euro and Swedish krona. Next, you can see that SG&A excluding the impact of the legal contingency was a $4 million tailwind this quarter, driven by lower net investments expense.

Income tax expense was $13 million in the second quarter of 2017, which translates to an effective book tax rate of 36%. Compared to last year, our tax expense was up $6 million on similar pre-tax income.

The primary driver of the higher tax expense was increased earnings in certain foreign jurisdictions particularly those in which we're not currently a cash taxpayer. However, it's important to remember that given our current tax position, this tax expense does not reflect the actual cash taxes we pay.

That's why from an adjusted income perspective, we continue to back out the noncash tax expenses associated with the utilization of our deferred tax assets. The impact of this in the second quarter was $6 million, which means that after this adjustment, our effective tax rate was 19%, in line with our expectations.

Overall, we generated adjusted EBITDA of $82 million, which resulted in a 10.2% adjusted EBITDA margin, up 30 basis points from last year. And adjusted income from continuing operations was $32 million or $0.35 per share, down $0.06 from last year. Slide 9 details second quarter sales and adjusted EBITDA for both of our reporting segments.

In our Commercial Truck & Industrial segment, sales were $620 million, down only 2% from last year despite Class 8 truck production in North America being down 20%. Segment adjusted EBITDA was $54 million, down $2 million from last year. Segment adjusted EBITDA margin for Commercial Truck & Industrial came in at 8.7%, down slightly from a year ago.

The margin decrease was driven primarily by the legal contingency charge and higher steel prices, which were almost entirely offset by material, labor, and burden performance, foreign exchange, and favorable mix. In our Aftermarket & Trailer segment, sales were $215 million, roughly flat compared to last year.

In this segment, we experienced higher aftermarket revenue, which was offset by lower trailer production as the U.S. trailer market was down 10%. Segment adjusted EBITDA was $30 million, up $2 million compared to last year. Segment adjusted EBITDA margin increased to 14.0% compared to 12.8% in the same period last year.

The margin increase was driven by favorable labor and burden performance. Turning to slide 10, total free cash flow was $21 million, very similar to what we generated last year. As part of M2019, we continue to invest in the businesses, evidenced by capital expenditures of $23 million this quarter.

In total then, we generated $44 million of operating cash flow this quarter, equal to our performance last year. This performance was consistent with our expectations and keeps us on track to deliver our full-year free cash flow guidance.

Turning to slide 11, I wanted to highlight our debt maturity profile and liquidity position as we executed a few relevant transactions this past quarter. First, we refinanced our U.S. revolver, which resulted in an increase in the facility size to $525 million and extension of the maturity to 2022, and a reduction in both drawn and undrawn pricing.

Second, we extended our €155 million Swedish factoring facility to 2020. And finally, we paid down a $6 million debt maturity in Brazil in the quarter. Under our M2019 strategy, we continue to take a balanced approach to capital allocation and are driving to have strong BB credit metrics by 2019.

As we continue to generate positive free cash flow, we will be opportunistic in repurchasing debt as well as buying back common stock. The main takeaway from this slide is that we continue to maintain strong liquidity and have limited funded debt maturities over the next four years.

Turning now to slide 12, you'll see that we have revised some of our market assumptions for our fiscal year 2017. In North America, inventory levels appeared to have stabilized, while net order intake in our second quarter was up 25% sequentially and 30% year-over-year.

We are seeing the effects of this coming through our order boards right now and believe that the next couple quarters will be stronger than we were anticipating. As a result, we are increasing our Class 8 production outlook to be in a range of 205,000 to 215,000 units this year.

We are also increasing our production estimates in Europe to be in a range of 440,00 to 460,000 units, up 10,000 units from what we had previously thought. Truck registrations, replacement demand, and the current economic environment continue to have a positive effect on the demand for trucks across Europe.

In addition, certain key customers in the region are performing quite well. All of our other market assumptions are consistent with our previous expectations. Next, I'll review our fiscal year 2017 outlook on slide 13. As Jay told you, we are raising our fiscal year 2017 revenue and earnings guidance to be at the top end of our previous range.

Based on stronger U.S. and European markets and our continued success in driving new business wins into the P&L, we now expect revenue to be approximately $3.1 billion for fiscal year 2017. From an earnings perspective, we are now anticipating incremental steel headwinds of $10 million to $15 million relative to what we were previously expecting.

So, we now believe steel will be a $25 million to $30 million headwind on a full-year basis. However, the increased revenue outlook combined with continued operational performance is driving earnings higher.

That's why we're taking our guidance up with EBITDA margin of approximately 10% and adjusted diluted earnings per share from continuing operations of approximately $1.40.

While we don't provide quarterly guidance, I did want to remind you that in our third quarter last year, we had $9 million in favorable supplier and insurance recoveries that we don't expect to repeat.

So, as you think about our year-over-year performance for next quarter, you should consider that last year's results create a difficult earnings comparable. Finally, our free cash flow guidance is unchanged with a projected range of $50 million to $70 million.

Even with our projected capital expenditures of $90 million and some investment in working capital to support higher revenue outlooks, we expect our cash flow to be solid for the full year. Now, I'll turn the call back over to Jay to provide closing remarks..

Thanks, Kevin. We're very pleased with our performance this quarter and in the first half of the year. We're particularly happy to be in a position to raise our guidance for fiscal 2017. On slide 14, we wanted to highlight for you a couple of important events coming up later this year.

The new NACV Truck Show in Atlanta will be a great venue for us to showcase our products currently in production and those we will offer our customers in the future including electrified drivetrains. We hope to see you there. Then in December, we'll host our Analyst Day event in New York.

We look forward to giving you a detailed M2019 update at that time. Now, we'll take your questions..

Thank you. Our first question comes from Neil Frohnapple with Longbow Research. Your line is open..

Hi. Good morning, guys. Congrats on a great quarter..

Thank you, Neil..

Thanks..

If we exclude the $10 million in legal contingency in the quarter from Commercial Truck & Industrial, I believe you would have delivered over a 10% EBITDA margin in the quarter despite Class 8 truck production being down over 20%.

So, just curious on why the implied EBITDA margin for this segment wouldn't be higher in the back half of the year because I do believe that implied a meaningful step-down particularly in light of increasing NAFTA Class 8 production.

And I appreciate the incremental steel headwind you called out, but versus the first half of the year, I don't think that's incrementally that materially different. So, if you could just help us out with some of the puts and takes there that would be helpful..

Okay. Starting with your first point about the legal contingency, I mean, you're right, our results would have been considerably stronger if we didn't have the $10 million item in the quarter, and that would have impacted the truck segment.

Now, keep in mind, if we didn't have that $10 million item, we probably would have been trending quite a bit higher relative to our internal target. So, we probably would have had some sort of an offset in our incentive compensation accruals that would have mitigated that a little bit. But directionally, you're right.

We would have had a considerably stronger quarter both on an overall basis as well as in the Commercial Truck & Industrial segment. As it relates to looking forward, steel prices have escalated even in the quarter. If you look at scrap, for instance, it's up almost 50% sequentially from last quarter to this quarter.

And if you look at a lot of the other indices around the globe, they're up anywhere from 10% to 30%. So, we have seen sequential step-ups in the indices, which is higher than what we were anticipating a quarter ago.

So, we are looking now at the back half having a bigger headwind from steel in the range of $10 million to $15 million incremental to what we are previously expecting. But we are expecting to overcome that with a stronger revenue and a stronger performance.

And so, if you cut through the math of what we're saying from a guidance perspective, through six months, we're at 9.7%. In the back half of the year, we're effectively guiding to something in that 10.2%, 10.3% range even with that steel headwind coming into the P&L..

Okay. That's helpful. And then just want to ask a bigger picture question. I mean, it's been almost a year-and-a-half, I believe, since you launched M2019, and it certainly will require some significant earnings growth in 2018 and 2019 versus the guidance for this year.

So, maybe, Jay, can you just talk about your confidence still in hitting the EPS target of $2.84 and whether any of the key buckets within the earnings bridge are performing better than are worse than expected.

And again, look, I believe expectations are that North America truck should be up a lot in 2018, so that will certainly help close the gaps, but just curious more from an aspect of things at Meritor if you control. And certainly, it does sound like you guys are launching new products on schedule, but any more color there would be helpful..

Sure. Yeah, I still have a high degree of confidence of achieving targets we set out for M2019. I think there are some areas where we seem to be overperforming to-date, and that's on the cost improvement side. I think we're seeing a little higher cost reductions than we anticipated and our planning cycles on material and labor and burden.

I think we're very pleased particularly this quarter with the new business wins of $70 million. So, we're starting to see our initiatives take hold in almost all markets around the world, as I mentioned significant new business wins not only here in North America but in Japan and in India and in Europe.

So, I think we're starting to see the fruits from the investments we're making in new products that are targeted at specific markets. And also, the global market recoveries are falling right in line I think with what our market expectations are for the end of that planning cycle.

So, overall, I think we still remain very confident of achieving the targets, and everything so far has fallen within what we expected when we set the plan up..

Great. Thanks very much. I'll pass it on..

Thank you. And our next question comes from Colin Langan with UBS. Your line is open..

Great. Thanks for taking my question. In your commentary, you mentioned the legal settlement.

Can you just remind us if you do get that reversed, how much of a benefit in terms of reduction of OPEB that would be? And any color on how long it might take to get through the final review?.

Well, I think it's probably premature, Colin, for us to speculate what the benefits could be until we get a final mandate from the courts that allows us to start to consider what the adjustments to the benefits could be.

Just for your recollection, at the end of the year, we sat with a total liability of $447 million, and the annual cash and expense charge for that is about $30 million a year. Now, how much of potential benefit we could achieve from the ruling, again, it's too premature for us to speculate on that until we get the final ruling.

As far as timing, the current appeal process could be resolved in any wide range of timeframes, anywhere from a couple of weeks to many months, upwards of six to seven months, depending on how the appeals court wants to proceed with an appeal from the UAW. And we'll obviously keep people updated as the issues transpire out of the courts..

And that $447 million, is that everything – does that include different sub-segments of retirees or is the $447 million all the UAW related that's under (28:23)?.

Of the $447 million, about 95% or maybe about $430 million is U.S.-related. And I'd say the bulk of that, almost the entirety of that is really related to UAW. Now, the portion of that that's subject to the actual litigation itself is less than half of that number at the moment.

We're hopeful that once the court resolves the issues and hopefully rules in our favor that it will give us the opportunity to reassess all of those retiree healthcare benefits in the U.S..

Okay. Very helpful.

And then in terms of the commodity exposure, can you remind us if you have any hedging or indexing mechanism that you get some of those $25 million, $30 million back? I mean, do you get recovery on that eventually or is it on a lag?.

We do. It's on a lag in terms of our recovery from customers. So, as we're seeing an increase right now in steel prices, that increase is starting to come through from the supply base to us. And then we have pass-through mechanisms with our OE customers around the globe that allow us to pass those back to them, generally on about a six month or so lag.

So, some of the potential offset to that, we won't see in the current fiscal year. It will slide into next year..

Okay. And are all your contracts under pass-through? Any percent that protects that or....

I mean, the overwhelming bulk of our OE contracts and relationships are governed in practice by contract with these recovery mechanisms, so yes..

Got it. Okay.

And then lastly, the one-time, the $10 million legal charge in the quarter, why is that not sort of pulled out as a onetime charge?.

Well, consistent with some of our recent practice, we've been absorbing the positives and minuses in our P&L. So, even last year, just two quarters ago, we had a $10 million favorable legal litigation settlement related to asbestos, for instance, and we didn't adjust that out.

And so, as we look at it, in terms of maintaining consistency with recent practice, what we saw even in the last year, we thought it appropriate to just keep that in the baseline results and just absorb it and outperform and hit our results even with that headwind..

Great. Thank you very much..

Thank you. And our next question comes from Brian Johnson with Barclays. Your line is open..

Yes. A few follow-up questions.

First, with the litigation, since the Sixth Circuit has already ruled, are you talking about either a potential en banc appeal or requesting that it go back to the Supreme Court?.

I think the first step, Brian, is an en banc appeal..

Okay..

We should (31:05) to UAW's intention here most likely before the end of the week. But they're asking for an en banc appeal, but that's the first step in the process..

Okay. Second question, there certainly been some tweets out of Tesla on all-electric semi trucks, as well as your partner Volvo AB is piloting some hybrid electric long-haul trucks.

Setting aside the debate on where it makes sense, where it doesn't make sense, but if you just think of the potential Meritor content on a hybrid electric truck and then on a electric truck, maybe differentiated between long-haul and in-town delivery, how would you see that evolving?.

Well, great question, Brian. This area I'm spending quite a bit of time on having our electrification team, in fact, is reported directly to me.

And so, I think on the Class 8 linehaul, what we're seeing is much of the industry is looking at solutions that are prior to the drive axle, probably with the exception of Nikola and Tesla, which are looking at wheel-end applications.

Where there is wheel-end applications, we've been deeply involved in many of those, as you know, with Nikola in developing independent suspension solutions really out of our military applications derived from those applications to help them with those designs.

Where it is prior to the drive axle, so many of them are a series or parallel hybrid applications coming through the transmission and replacing that transmission. It still uses a traditional drive axle, but in fact, as you may recall a number of years ago, we've been updating this product ever since.

We had a series in parallel hybrid solution that Walmart was running on a Navistar vehicle. So, a lot of the OEs are looking to us for some design expertise there as well..

Okay. And just maybe – you mentioned military, and I know you always discuss this at the annual meeting. We certainly have a new administration, not much happened to defense budget in the continuing resolution.

But just where do you think discussions are vis-à-vis the various land vehicle programs that you are involved with, could be involved with, could be accelerated, and how do you see that shaping up?.

I think the timing is still unclear. But obviously, the next one appears to be on the road map is the recapitalization of the FMTV fleet, which we are involved with some customers on and looking at providing certain products and either varying levels of content.

And then we expect shortly after that the HMMWV recap will be revisited, which we, again, have potential for significant content..

Okay. Thank you..

Thank you, Brian..

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

Great. Thanks for taking my question. And thanks for the update on the Sixth Circuit decision. Most of my questions there have been answered. But I thought to ask what your understanding or your council's understanding is of the likelihood of success on the UAW's part in the appeals process. I think it's quite low, but I thought to ask..

Very difficult for us to speculate on that. I think we obviously asked that question, and as a client of our firm, we've remained – for our legal firm we've remained bullish on that but very difficult for us to speculate. As you know, this is a highly politicized issue.

So, I think there are a lot of puts and takes in the courts that we can't always control. So, we'll just have to wait and see and continue to perform on our current plan and just hope that the ruling is upheld..

Okay. Thanks. And then just a question on the outlook. It looks like you're raising your guidance for most items although FCF didn't tick up. I was just curious what the puts and takes are there this year relative to....

Is this on (35:32) cash flow, Ryan?.

Yes. Yeah..

I think the primary issue is like how we dealt with the last upturn in North America that we experienced, we preemptively built inventory banks (35:42) to make certain that we responded to (35:46) uptakes and order demand.

And so, we've taken that same strategic approach this time because we think it builds enormous long-term franchise value for Meritor in the last upturn. And so, we are beginning to build some targeted strategic inventory bank (36:07) so that's why we're not expecting the cash flow performance to near term mirror the uptick in earnings and revenue..

Okay. Great. And then just lastly from me, there was that earlier question about the electrification of commercial vehicle drivetrains. You've talked before about the 14X HE (36:24) axle which has the potential to improve the payback period of truck and bus hybrid systems.

How far along in development would you say that this product is, this axle is? And then are you coming to the point now where you can begin to quote it out to commercial vehicle manufacturers and whether or not you are that far along? Are you able to sort of gauge initial customer interest?.

Well, we're having many meetings with potential customers and integrators.

In fact, earlier this week, I was out in Silicon Valley meeting with a few electrification integrators who were very interested in the product because of the packaging it allows the vehicle manufacturers to put more battery capacity compared to some of the current designs that they're looking at deploying.

We will have a prototype at the NACV Show here in September, and we are in preliminary discussions, I would say, with most of our OE customers and some new partners about potentially launching that axle..

Very interesting. Thank you..

Thank you..

Thank you. And our next question comes from the line of Mike Baudendistel with Stifel. Your line is open..

Thank you. You called out in your press release that increasing your share of the aftermarket is one of your strategies.

Could you just sort of explain how you expect to do that at a high level?.

Sure. What we've done is we've looked for categories where we believe we have a stronger right to play, for example, some gearing and drivetrain categories, for example, and looked at filling out our portfolio in those areas and launching new products and also looking at improving our delivery and distribution network.

So, we're evaluating whether we – and are beginning to launch the execution of some new warehouse and delivery sites so we can shorten the speed to market in terms of delivery of product. We also, as I mentioned on the call, updated our website and our online capabilities to be much more user friendly.

And as I mentioned on the call, we're starting to see these very focused efforts begin to generate revenue in line with our M2019 objectives..

Sounds good. And I also wanted to ask you, if you had thoughts on the trajectory of the OEMs, production rates, as we go throughout the calendar year.

Do you expect the second half to tail off at all or just sort of accelerate from the second quarter?.

I think we're expecting – I mean, what we're seeing right now is production levels in the current quarter are ramping up, and we're expecting to see that through at least the balance of our fiscal year. So, we're seeing a strong uptick here in the third quarter that we're now sitting in..

Sounds good. And just wanted to ask you one on China, I know it's not too big of a part of your revenue business, but there is some conflicting things we've heard from other companies here.

And do you think the sort of surging activity sort of early this year was more of a first or second quarter event and do you think it's sustainable through the end of the year? (39:52).

Well, frankly, I think it's been sustained longer than our initial expectation, so we're seeing the housing construction market remain strong, for example, which is driving XCMG's revenues and also pulling demand on our axle products.

What we're also very encouraged long term is that the market seems to be moving up to that mid-tier more rapidly than we may have expected on the on-highway products, which is, if you recall, in our M2019 strategy, is a significant component bringing our on-highway drive axles to that market.

So, we're also very encouraged with the long-term prospects in that market for us..

Great. Thanks very much..

Thank you..

Thank you. And that ends our Q&A session. I'd like to turn the call back over to Carl Anderson, Vice President and Treasurer, for closing remarks..

Thank you, Heather. This does conclude our second quarter earnings call. If you have any follow-up questions, please feel free to reach out to me directly. And again, we thank you for your participation..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you all may disconnect. Everyone, have a great day..