Good day ladies and gentlemen, and welcome to the fourth quarter 2019 Meritor 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.

If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this call may be recorded. I would now like to introduce your host for today’s conference, Mr. Todd Chirillo, Senior Director of Investor Relations. You may begin, sir. .

Thank you Catherine. Good morning everyone and welcome to Meritor’s fourth quarter and full year 2019 earnings call. On the call today, we have Jay Craig, CEO and President, and Carl Anderson, 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., is protected by U.S. and international copyright law, and may not be rebroadcast without the express written consent of Meritor.

We consider your continued participation to be your consent to our recording. Our discussion may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to Slide 2 for a more complete disclosure of the risks that could affect our results.

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

Thanks Todd and good morning. We appreciate you joining us today for a look at our fourth quarter and full year 2019 results. Let’s go to Slide 3. Our performance this year was excellent. You can see we have consistently delivered meaningful improvement over the past three years.

Since launching M2019, revenue was up 25%, adjusted EBITDA margin has expanded by 25% or 240 basis points, and adjusted diluted EPS from continuing operations is up 140%. In a moment, I want to highlight some of our achievements during M2019, but first let me make a few comments about this past year.

We saw commercial vehicle volumes at peak levels, closing out the year at 359.000 units, up 17% year-over-year, the highest market in 13 years. Production at that level requires nothing short of highly orchestrated cross-functional and regional coordination to ensure customer requirements are fulfilled.

I am proud to say that despite the stress this level of production puts on the entire supply chain, our delivery performance was greater than 99% for the total company and our quality score was 108 parts per million. If we excluded an issue that arose in one facility this year, our quality would have been an impressive 24 parts per million.

I am pleased to tell you that we achieved an overall total recordable safety case rate of 0.59 injuries per 200,000 hours worked. This safety rate required significant diligence by all of our employees during this time frame.

In addition to the great effort required to manage the peak efficiently and convert on the increased revenue, we also completed the acquisition of AxleTech, made incredible progress in our electrified drive train offerings, and launched several new products in core and adjacent markets.

We also recently announced that Steve Beringhause, CTO of Sensata Technologies, will join our board of directors. Steve’s background and expertise in the application of advanced technology for the transportation industry make him an excellent addition. We are pleased that he has agreed to join us as we begin M2022.

Now let’s talk about the highlights of M2019 performance. On Slide 4, we scorecard our financial results against targets. We had more than $600 million in revenue outperformance or 16%, driven by new business around the world, including adjacent markets and revenue from our three most recent acquisitions.

As a result of our high performance during the peak cycle, we were also able to gain rear axle share with customers in North America. Not only did we beat our adjusted diluted EPS target, we almost exceeded it by $1 per share, increasing it by $2.23 from 2015.

You will remember this was an aggressive goal when we announced it at the end of fiscal year 2015. At that time, we said we believed an 80% improvement in adjusted EPS was the ultimate measure of success for M2019. We actually delivered 140% improvement. Our third financial target was to achieve 1.5 times net debt to adjusted EBITDA.

Excluding the financing associated with the AxleTech acquisition, we achieved 1.3 times or 1.6 times if we include it. We generated strong free cash flow over the term of the plan that reduced legacy liabilities. Let’s go to Slide 5 for a summary of our capital allocation strategy.

As I mentioned, we are now generating strong free cash flow and are returning a significant percentage to Meritor’s shareholders. During M2019, we returned $276 million of cash to shareholders through equity repurchases, which represents 56% of our free cash flow since fiscal year 2016.

That is more than double the target we established of returning 25% in that time frame. We intend to maintain an aggressive rate of share repurchases during the M2022 time frame.

We told you at analyst day last December that our cash generation and the ability to deploy that cash to drive shareholder value is a critical underpinning of our next strategy. This is where we expect to drive tremendous value for our shareholders. We will provide more detail later in the discussion.

Slide 6 provides a summary of strategic transactions. We completed three acquisitions that diversify our revenue streams to help us offset the cyclicality of the line haul markets. These acquisitions expanded our portfolio and customer base with new technology and products in off highway, severe service, and defense.

AxleTech is the most recent acquisition that we completed in July. We still expect annual run rate synergies from AxleTech to be more than $15 million by 2022. Our integration process is moving along well and our belief in the strategic value of this transaction has been reinforced in the past several months.

As you know, we sold our interest in the former Meritor WABCO joint venture in 2017 and recently announced that we have exercised our option to terminate the exclusive aftermarket distribution arrangement.

Under the terms of this agreement, WABCO will pay us between $225 million and $265 million, which provides further flexibility for capital allocation. Finally, our investment in TransPower has served as an accelerant for many of the electric programs we have with major OEMs.

We look forward to our continued collaboration as customers show increasing interest in electric drive train solutions for a range of applications. Slide 7 shows a few examples of the 21 products we have launched during M2019 for a variety of applications. Our current launch cycle is one of the most aggressive in the company’s history.

New products include front and rear axles for medium and heavy applications, line haul, construction, buses and trailers, in addition to an optimized air disc brake and a transfer case for the medium duty all-wheel drive market.

Moving to Slide 8, you see that new business accounted for 16% of our revenue outperformance, largely driven by new product offerings. We are designing and manufacturing for a wide range of applications and end markets, and our efforts to grow our business in these areas is gaining traction and will continue under M2022.

Slide 9 reflects our efforts to position the company as a market leader in electrified drive train solutions. During M2019, we introduced Blue Horizon, which consolidates Meritor’s advanced solutions under a single brand, reflecting more than 20 years of technology leadership.

In the past two years alone, we have progressed through a third generation of the 14XE and are delivering preproduction samples to major customers. We have accumulated thousands of testing miles across a range of applications and duty cycles.

We have been awarded 22 e-mobility programs and expect to deploy over 130 vehicles by the end of 2020 in addition to the electric vehicles Volkswagen in Brazil will launch over the next few years.

This program award, which we announced at the North American Commercial Vehicle Show, for 1,600 trucks will begin with the OEM’s 11-ton e-delivery truck equipped with Meritor’s 12X with e-optimized gearing and will be substituted with our 12XE electric power train as it becomes commercially available.

We also announced at NACV the introduction of two new e-axles, one for medium and the other for heavy duty applications. With the addition of these two new axles, we believe Meritor now has the most comprehensive e-axle portfolio for medium and heavy duty trucks of anyone in the world.

With that, I will turn it over to Carl for more detail on the financials. .

we delivered and achieved the second consecutive three-year strategy with M2019, and even as global markets are softening, we expect to deliver solid results in 2020, continue our investments in electrification, and aggressively deploy capital as we pivot to M2022. Now I’ll turn the call back over to Jay..

Thanks Carl. Let’s look at Slide 14. On the left side of the slide, we highlight the competencies we have demonstrated during M2019 from strategic transactions, product launches and new business awards to our exceptional operational management through the peak Class 8 cycle and global market upturn. These competencies have positioned us well for M2022.

We have shown that we have the ability to flex the organization up or down as needed to adjust for major fluctuations in production. We have diversified outside of the Class 8 line haul market in North America by growing our business in adjacent markets.

We have improved our balance sheet and set in motion a capital allocation plan that is returning value directly to our shareholders. The transformation we have undertaken since we launched M2016 has been dramatic and will allow us to effectively manage even the most negative economic environments profitably.

For example, our modeling indicates that even if the North America Class 8 market were to decline to a level of 215,000 units and Europe to 400,000 units, we would expect to generate $3.5 billion in sales and maintain a 10.5% EBITDA margin.

We also would expect to generate $120 million of free cash flow in this type of environment while maintaining our investments in increased productivity and new advanced product capabilities.

Therefore, we fully anticipate that our earnings and cash flow will ensure our ability to take advantage of future capital allocation opportunities that we have established under our M2022 plan. Let’s go to Slide 15. As Carl indicated, our adjusted EBITDA margin guidance for fiscal year 2020 is in the range of 11% to 11.2%. Our M2022 target is 12.5%.

We have demonstrated our ability to improve adjusted EBITDA margin during each of the last two plans. Through continued focus on material costs, labor and burden, along with execution of synergies from the AxleTech acquisition and additional new business wins, we expect to achieve the 12.5% adjusted EBITDA margin by 2022.

Let’s take a minute to discuss our M2022 capital allocation strategy, as shown on Slide 16. Our board of directors recently increased our current $250 million share repurchase authorization to $325 million, which we intend to fully utilize in 2020.

We have already repurchased $60 million of shares in October in addition to the $25 million executed in the fourth quarter of 2019. We are planning to repurchase another $240 million in the remainder of fiscal 2020. The adjusted diluted EPS guidance that Carl referenced for the year includes the impact of these anticipated repurchases.

Given our free cash flow expectations going forward, we also have an opportunity to utilize another $400 million for future repurchases in 2021 and 2022.

We strongly believe that we have a significant opportunity to aggressively deploy capital to take advantage of current market prices in our equity, therefore we plan to continue and in fact accelerate our commitment to share repurchases. We will execute this plan through strategically timed open market purchases.

We are also committed to strong credit profile and retaining flexibility to invest for the long term. We intend to hold leverage in a similar range through the three-year period. The company retains a significant liquidity buffer should additional investment opportunities, internal or external, present themselves over the coming years.

Moving to the last slide, we look forward to the future as we ramp up for M2022. In every area of the company, we are executing well due to the talented dedication we have around the world. I want to recognize our employees in every region of the world for their role in what Meritor has become.

Each one of our 9,000 employees is responsible for our success. We also have excellent relationships with our customers, suppliers and investors.

Over the past month, our management team has worked with one of our largest long-term shareholders, Glenview Capital, who has provided input on our capital allocation plans which are fully aligned with our M2022 strategy.

We appreciate the support and feedback from them and all of our long term owners as we drive performance for our customers, opportunities for our employees, and value for our shareholders. Now let’s take your questions. .

[Operator instructions] Our first question comes from James Picariello with Keybanc Capital Markets. Your line is open..

Hey, good morning guys. .

Morning James..

Just digging in on commercial truck and the expectations around the decremental margins for the year, this fourth quarter decrementals came in as promised - you know, solidly at 10%. It does sound like you plan to almost double your electrification spend.

Just wondering the cadence of the year and maybe just the timing on the electrification spend, if there is any lumpiness there..

Yes James, it’s Carl. Good morning. I think as it relates to electrification, I think as you look at the planned spending on that, it’s relatively ratable each quarter as we go forward in 2020.

Then in the commercial truck segment, if you look at where the margin performance and some of the tailwinds we had in the fourth quarter as it related to lower steel costs as well as freight cost and layer capacity costs, that will be offset by obviously just the lower revenue volumes as well as we go forward..

Got it. Then thinking about your other segment, the decrementals in this fourth quarter were pretty elevated. Just wondering what might be one-time related or what’s the favorable offset into next year related to the AxleTech synergy pull-through, and just your thoughts again on decrementals for that segment as we think about next year..

Yes James, if you look at the performance and margin, actually it’s all really attributable to AxleTech, so if you were to strip out the AxleTech revenue, margin performance would have been very similar on a year-over-year basis within the quarter.

As we said in the prepared remarks, we think AxleTech, we’re right in the process of continuing to execute on the various synergies that we outlined previously, and we fully expect as we get out of the first quarter that that will be more in line with our expectations as we get into Q2 and beyond..

What was the AxleTech contribution, revenue contribution in the quarter?.

It was right around $30 million..

Okay, thanks guys..

Thanks James..

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

Hi, this is Jason Stuhldreher on for Brian. Going to the guidance quickly, if I look at the revenue guidance, end markets are guided for a little more conservative potentially than third party estimates, which I think is fine.

I guess I was looking at any potential for revenue outperformance in 2020, and I know the key tenets of the M2022 plan was some pretty significant, at least $300 million or so of revenue outperformance driven by new wins.

Just wondering if we’re seeing any of that in that global markets bucket, or if the cadence of that outperformance is maybe a little more back end weighted..

Thanks for the question, Jason. This is Jay. I think first of all, we’re seeing the full year benefit of AxleTech revenue, which again we included in our new revenue targets, so you’re seeing that benefit flow through.

I think we are expecting some significant downturns around the globe, and I know that’s difficult at times for people analyzing us from outside the company because of how global we are.

We’re also looking to hold the vast majority of our North American Class 8 penetration increase at or above 7 out of 10 trucks now running on our axles in the Class 8 market, so we’re continuing to see revenue outperformance but these step-downs in some of our markets, particularly in China off-highway, some of our contractual return obligations for declining steel prices and productivity, tamped down that a bit, but we’re still continuing to bring on new business that’s increasing penetration as well..

Okay, that’s helpful.

Then just secondly, as we think about steel costs next year, which I know was guided to be a tailwind and is sort of within that first bucket you mentioned, offset by lower layer capacity costs, steel costs, just wondering if you can help us--you know, if we assume the indices and the prices stay flat from here, I was wondering if you could help us with maybe the cadence of the steel tailwinds next year, because I know it’s a little complicated with any sort of escalation clauses and pass-through clauses you have with customers.

So, should we assume tailwinds are sort of evenly spread throughout the quarters next year, or is there any strange cadence we should be aware of?.

I think on steel, most of it will be in the first half as we expect kind of the tailwinds from that. As we’ve assessed it, it’s probably high-single-digit millions is what our expectations is for the tailwind in 2020 as you compare to ’19..

Okay, understood. Thanks a lot..

[Operator Instructions]. One moment while questions queue up. I’m showing no further questions at this time. I’d like to turn the call back to Mr. Todd Chirillo for any closing remarks..

Thank you. This concludes our fourth quarter call. Please reach out to me directly if you have any questions. Thank you very much for joining. .

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