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Meritor (NYSE:MTOR)
Q4 2019 Earnings Call
Nov 13, 2019, 9:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good day, ladies and gentlemen, and welcome to the fourth-quarter 2019 Meritor earnings conference call. [Operator instructions] As a reminder this call may be recorded. I would now like to introduce your host for today's conference, Mr. Todd Chirillo, senior director of investor relations.

You may begin, sir.

Todd Chirillo -- Senior Director of Investor Relations

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. 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.

Jay Craig -- Chief Executive Officer and President

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% and 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 drivetrain 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 liability.

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 drivetrain 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 drivetrain 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 to 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 OEMs 11-ton e-Delivery truck, equipped with Meritor's 12X with e-optimized gearing and will be substituted with our 12XE electric powertrain as it becomes commercially available. We also announced at NACV the introduction of two new eAxles, 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 eAxle 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.

Carl Anderson -- Senior Vice President and Chief Financial Officer

Thanks, Jay, and good morning. On today's call, I'll review our 2019 financial performance, along with our fourth-quarter segment results. I will then provide you with an overview of our fiscal-year 2020 guidance. Overall, we had another outstanding year of financial performance, and we successfully completed our M2019 plan that we committed to almost four years ago.

In the last year of the plan, we expanded adjusted EBITDA margin by 60 basis points, increased adjusted diluted earnings per share from continuing operations to $3.82, generated $153 million of free cash flow and deployed over 60% of our free cash flow to repurchase $95 million of common stock. Let's turn to Slide 10, where you'll see our full-year financial results compared to the prior year. Sales were up $210 million from last year, driven by higher North America truck production, increased aftermarket industrial and trailer volumes across North America and continued revenue outperformance. From a segment perspective, we saw the largest increase in revenue from our aftermarket, industrial and trailer segment, which was up $137 million from the prior year.

We benefited from a strong all-wheel drive market, the launch of the first-ever gear-driven transfer case for Navistar and a 7% increase in trailer production. The commercial truck segment was up $80 million in revenue. In North America, Class 8 truck production was up 17% from the prior year. We also saw a strong demand in medium duty, increasing almost 10% to 288,000 units, driven by demand for last-mile deliveries.

In fact, our revenue since 2017 in North America truck has grown by over 50%, compared to growth of 35% for the combined heavy- and medium-duty market. We were, however, negatively impacted by lower sales in both India and China. In India, the pending implementation of a new emission standards significantly impacted sales in the back half of the year. And in China, we have seen a slowdown in the economy, which significantly impacted sales in our fourth quarter.

For the full year, China's revenue was $165 million, down 18% from our expectations when we started the year. The overall increase in revenue was partially offset by an approximately $100 million unfavorable foreign exchange translation impact as the U.S. dollar strengthened against most major currencies. Moving to the right side of the slide, you can see on the line labeled volume, performance, mix and other, we had $51 million of higher adjusted EBITDA on $306 million of revenue increase.

That translates to net underlying conversion of approximately 17%, which we view as a very good result in markets like these as we were faced with higher layer capacity and net steel costs, as well as other inefficiencies, primarily in the North America truck market. Additionally, as we compare 2019 results to the previous year, we had a onetime $9 million environmental charge related to a legacy site, which occurred in 2018 and did not repeat. And given the FX headwinds in the year, adjusted EBITDA was negatively impacted by $14 million. These items provide the walk to our adjusted EBITDA of $520 million and adjusted EBITDA margin of 11.9%.

In the table on the left, you can see that our operating performance drove an increase in adjusted income from continuing operations to $330 million or $3.82 of adjusted diluted earnings per share. In addition to the higher overall adjusted EBITDA generated this year, we also had a lower tax expense. Our effective tax rate was approximately 9%, which is lower than the 13% rate we saw last year as we benefited from a higher percentage of earnings coming from jurisdictions which have net operating losses or tax credits to offset taxable income. And finally, due to our continued focus on capital allocation, we had approximately 5 million less diluted average common shares outstanding, which drove about $0.20 of adjusted diluted EPS.

All of these items allowed us to exceed our M2019 target of $2.84 of adjusted earnings per share by almost a full dollar. Additionally, on a GAAP basis, we recognized approximately $8 million related to restructuring. This was primarily driven by costs incurred as a result of the $20 million restructuring plan announced in September to reduce hourly and salary headcount globally in anticipation of market declines. We expect the remainder of the restructuring costs to be incurred in fiscal-year 2020.

We also recognized a $9 million charge to impair certain customer relationship intangible assets related to the AA Gear business we acquired last year. And finally, we generated $153 million of free cash flow in 2019. This is inclusive of the $50 million cash contribution we made as part of the bankruptcy reorganization for the nonoperating entity Maremont that was completed in July. Exclusive of this transaction, we generated $203 million of free cash flow, a $56 million increase from the prior year.

Slide 11 details our fourth-quarter sales and adjusted EBITDA for our reporting segments. In our commercial truck segment, sales were $728 million, down 11% from last year. The decrease in sales was driven by lower production in India, Europe and China. While segment adjusted EBITDA was $69 million, down 7%, our segment adjusted EBITDA margin for commercial truck increased 40 basis points over the same period last year.

As we previously discussed, higher costs associated with record markets in North America began to abate in the third quarter, and this quarter's results continued this trend. The increase in segment adjusted EBITDA margin was driven by lower net steel, premium and freight costs and material performance, which more than offset the impact from lower revenue. In our aftermarket, trailer and industrial segment, sales were $341 million, up 11% from the same period last year. This was driven by the inclusion of revenue from AxleTech.

Segment adjusted EBITDA was $44 million, up $2 million compared to last year. Segment adjusted EBITDA margin decreased by 80 basis points compared to the same period last year, primarily due to the consolidation of AxleTech. We expect this acquisition to be decretive to margins through the end of the calendar year as certain targeted synergies, primarily from the elimination of cost overlap, have not yet been fully realized. Next, I'll review our fiscal-year 2020 market outlook on Slide 12.

In the North America Class 8 market, we are projecting production levels between 240,000 to 250,000 units. Fundamentally, this is due to continued lower order intake over the past several quarters, combined with higher current dealer inventory, which is driving a step down we are seeing for production in 2020. As we look to our other markets, we anticipate that Europe will be in the range of 450,000 to 460,000 units, down approximately 6% from last year. Overall, economic conditions are pointing to a modest slowdown in 2020, following several years of strong truck markets in Europe.

Moving to India, we are seeing the continued impact of the transition to the BS6 emission standard, along with continued liquidity constraints in the credit market. Ahead of the April 1, 2020, deadline when all new vehicles registered must comply with the new regulations, we expect significant headwinds impacting the first half of our fiscal year compared to the prior year. The impact of BS6 should abate in the second half of our fiscal year as we pass the implementation deadline. Overall, for the full year, we believe the market will contract and be in the range of 330,000 to 350,000 trucks, down approximately 17% from last year.

Also, while we have not included China on our outlook slide, I did want to briefly discuss this market. As I mentioned earlier, we have seen a significant economic slowdown in the region, which is impacting the off-highway market where we compete. As a result, we expect our sales in China to be down approximately 35%, which is between $55 million and $65 million from the previous fiscal year. On Slide 13, I'll review our financial outlook for fiscal-year 2020.

Our forecast for sales is expected to be in the range of $3.7 billion to $3.8 billion. We are projecting most of our markets to be lower in 2020. The call-out box to the right walks through this number from our 2019 actuals. We expect lower global markets to reduce revenue between $625 million to $725 million.

We are also seeing continued headwinds from foreign exchange, which we estimate to be in the range of $50 million to $75 million. Additionally, we anticipate terminating the WABCO aftermarket distribution agreement in the second quarter of our fiscal year, resulting in approximately a $75 million revenue headwind in the second half of the year. Offsetting the impact of global markets and the WABCO distribution transaction will be a full year of revenue from AxleTech. Moving back to the table on the left, we forecast that our adjusted EBITDA margin will be in the range of 11% to 11.2%.

As you can see in the call-out box, we expect our operating performance, lower net steel prices and layer capacity costs to significantly offset declining markets. Additionally, we expect an approximately 20-basis-point impact from the termination of the WABCO aftermarket distribution agreement. We are also planning to double our investment in electrification in 2020 given the significant opportunities we are seeing in the market. This does result in a 30-basis-point margin impact as compared to last year.

Overall, our downside conversion, even including the increased investments in electrification and termination of the distribution agreement, is approximately 16%, which is well within our typical downside conversion rate of 15% to 20%. Moving to adjusted diluted earnings per share, we expect 2020 to be in the range of $2.75 to $2.85, which does include the impact of our share repurchase plan that Jay will discuss coming up. Additionally, we expect an adjusted effective tax rate of around 15%, consistent with the M2022 planning guidance we've previously provided. Finally, we expect to generate $165 million to $175 million of free cash flow, an increase of $10 million to $20 million from last year.

This increase will be driven by the onetime funding of the Maremont Trust not repeating in 2020 and improvements in working capital due to market normalization. Based on this, we expect to achieve our M2022 target of 75% free cash flow conversion in the first year of our new three-year plan. From a financial perspective, the bottom line is this. 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.

Jay Craig -- Chief Executive Officer and President

Thanks, Carl. Let's look at Slide 14. On the left side of the slide, we highlight the competencies we've 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 and increase productivity in 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 cost, labor and burden, along with the 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 and 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 a 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.

Questions & Answers:


[Operator instructions] And our first question comes from James Picariello with KeyBanc Capital Markets. Your line is open.

James Picariello -- KeyBanc Capital Markets -- Analyst

Hey, good morning, guys.

Jay Craig -- Chief Executive Officer and President

Morning, James.

James Picariello -- KeyBanc Capital Markets -- Analyst

Just digging in on commercial truck and the expectations around the decremental margins for the year. This fourth quarter, decrementals came in as promised, solidly at 10%. It does sound like you plan to almost double your electrification spend. So just wondering, the cadence of the year? And maybe just the timing on the electrification spend, if there is any lumpiness there?

Carl Anderson -- Senior Vice President and Chief Financial Officer

Yes, James, it's Carl. Yes, 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 you kind of go forward in 2020. And then in the commercial truck segment, if you look at kind of 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 costs and layer capacity costs, that will be offset by, obviously, just kind of the lower revenue volumes, as well as we kind of go forward.

James Picariello -- KeyBanc Capital Markets -- Analyst

Got it. And then thinking about your other segment, the decrementals in this fourth quarter were pretty elevated. Just wondering what might be onetime 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?

Carl Anderson -- Senior Vice President and Chief Financial Officer

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. So 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 us to kind of get out, out of the first quarter, that that will be more in line with our expectations as we get into Q2 and beyond.

James Picariello -- KeyBanc Capital Markets -- Analyst

And what was the AxleTech contribution -- revenue contribution in the quarter?

Carl Anderson -- Senior Vice President and Chief Financial Officer

It was right around $30 million.

James Picariello -- KeyBanc Capital Markets -- Analyst

OK. Thanks, guys.

Carl Anderson -- Senior Vice President and Chief Financial Officer

Thanks, James.


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

Jason Stuhldreher -- Barclays Capital -- Analyst

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 the -- any potential for revenue outperformance in 2020. And I know sort of a key tenant of the M22 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?

Jay Craig -- Chief Executive Officer and President

Well, I think -- 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 the -- 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 seven out of 10 trucks now running 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.

Jason Stuhldreher -- Barclays Capital -- Analyst

OK. That's helpful. And 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 could help us -- 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 I mean 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?

Carl Anderson -- Senior Vice President and Chief Financial Officer

I think on steel, most of that will be in the first half as we expect kind of the tailwinds from that. It's probably -- 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.

Jason Stuhldreher -- Barclays Capital -- Analyst

OK. Understood. Thanks a lot.


Thank you. [Operator instructions] And 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.

Todd Chirillo -- Senior Director of Investor Relations

Great. 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.


[Operator signoff]

Duration: 39 minutes

Call participants:

Todd Chirillo -- Senior Director of Investor Relations

Jay Craig -- Chief Executive Officer and President

Carl Anderson -- Senior Vice President and Chief Financial Officer

James Picariello -- KeyBanc Capital Markets -- Analyst

Jason Stuhldreher -- Barclays Capital -- Analyst

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