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spk07: Good day, and thank you for standing by, and welcome to the Q2 2021 Merita, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to Todd Sherillo, the Senior Director of Investor Relations. Thank you. Please go ahead, sir.
spk02: Thank you, Felicia. Good morning, everyone, and welcome to Meritor's second quarter fiscal year 2021 earnings call. On the call today, we have Chris Villavarayan, 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 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 two 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 Chris.
spk00: Thanks, Todd. Good morning, everyone, and thank you for joining us today. Let's turn to slide three. We had strong results this quarter with $983 million in sales and adjusted EBITDA margin of 11.3%. Total company sales were up 13%, year over year, as truck demand increased in all our global markets. Free cash flow performance was excellent this quarter, coming in at $47 million. This was one of our highest second quarter cash flows since we began the end plans in 2013. Once again, the Meritor team demonstrated its ability to successfully respond to markets. Even with the sharp increase in volumes and supply chain challenges, we maintain excellent delivery and quality performance for our customers while converting increased sales to profits at expected levels. Looking at the full fiscal year, we're holding our sales, margin, and cash flow guidance despite indications that we will have one of the largest unfavorable steel impacts we've seen. In addition to higher expense in electric power train development as we ramp up production capabilities to meet the increasing demand. Carl will provide more detail, but our ability to offset these headwinds reflects the consistent strong execution you expect from us. We have a brand new electrification program to announce this quarter, in addition to an exciting new opportunity to accelerate development of our 17XE electric powertrain in Europe. And in our core business, we have recently finalized long-term agreements with two global OE customers. Please move to slide four. In the second quarter, we extended our agreement with Navistar through 2026. We're pleased to continue our longstanding relationship with Navistar as it becomes part of the Trayton family. This agreement extends our current relationship while providing opportunity for future growth in our major product categories of axles, brakes, and drivelines. We also completed a new agreement with Iveco in Europe through 2024. This includes the supply of single reduction axles and strengthens our successful business relationship between our companies. It also provides the opportunity for future growth on other product lines. With Navistar and Iveco complete, most of our long-term agreements with major customers have been renewed well past the 2022 timeframe. Moving to electrification on slide five, we are pleased to announce a new collaboration with Hexagon Purist Systems, a global leader in zero-emission e-mobility. Hexagon will integrate Meritor's 14Xe powertrain into its Class 6, Class 7 box trucks, and Class 8 6x4 vehicles starting 2021. Customers including PACCAR, AutoCar, Line Electric, Volta Trucks, and Hexagon have chosen Meritor's 14XE integrated electric powertrain. We believe this is market validation of its industry-leading performance. In early 2020, we announced an agreement with PACCAR to be the initial launch partner and supplier for the integration of the fully functional battery electric systems on the Kenworth T680 and Peterbilt 579 and 520 electric vehicles. We have begun prototype production and PACCAR is performing validation testing on its test tracks. It's very exciting for us to see these fully electric vehicles being assembled. Soon, these and many others with Meritor's preferred electric powertrain solutions will be fully operational on roads and highways. Please take a minute to view a video of this truck in motion on Meritor.com. This footage was shot last week at our Escondido, California facility. With market adoption growing for our 14XE, we're now shifting the focus to the development of the 17XE platform in Europe. Last month, we learned we were a grant recipient of the Advanced Propulsion Center in the United Kingdom. This grant will partially fund the development of Meritor 17XE. After a comprehensive, months-long nomination and consideration process, we were thrilled to be selected, along with our consortium partners, Danfoss Editron, and Electra Commercial Vehicles. This grant, totaling almost 16 million pounds, will rapidly accelerate development of this product that is designed for multiple vehicle platforms and extend our ability to offer Meritor's e-powertrain solutions for the European market. We believe demand for this product will grow because of the EU 2025 CO2 reduction targets. Stricter targets will start applying in 2030 And by 2040, all new trucks sold in Europe will need to be fossil-free to reach carbon neutrality by 2050. The 17XE is another significant step towards completing our electric powertrain portfolio. Carl will now provide more detail on our financial results.
spk03: Thanks, Chris, and good morning. On today's call, I will review our second quarter financial results and provide an update to our fiscal year 2021 outlook. As Chris mentioned at the beginning of the call, we delivered another quarter of strong financial performance. Adjusted EBITDA margin was 11.3%, and we generated $47 million of free cash flow. Now let's review our financial results compared to the prior year on slide six. Before I continue, I want to highlight a revision we are making to our presentation of two non-GAAP measures, adjusted income from continuing operations and adjusted diluted earnings per share. To better align with SEC guidance, we will no longer include in non-GAAP measures the adjustment for non-cash tax expense related to the use of deferred tax assets in jurisdictions with net operating loss carry-forwards or tax credits. It is important to note this is a change to our reporting metrics only as the underlying availability and benefit of tax attributes to offset future taxable income has not changed. We expect to maintain an effective cash tax rate of approximately 15% through the M2022 planning cycle. In the appendix, we have also updated prior periods to reflect this change, providing for consistent comparatives. Now let's review the details of our financial results. Beginning with the total company, revenue came in at $983 million, up $112 million from the same period last year. As economies rebounded globally, we saw increased truck production in all of our markets. That income from continuing operations was $63 million, compared to $240 million last year. As a reminder, prior year results include $203 million of after-tax income related to the termination of the distribution arrangement we had with Wabco. This was partially offset by the recognition of value-added tax credits in our wholly owned Brazilian entity of $22 million, or $15 million net of tax, during the second quarter of fiscal year 2021. Adjusted EBITDA for the second quarter was $111 million, which translates to an adjusted EBITDA margin of 11.3%, a decrease of 100 basis points from the prior year. Adjusted EBITDA this quarter excludes the 22 million Brazil value-added tax credit I previously mentioned. The decrease in margin was primarily driven by an approximately $20 million impact from incentive compensation costs compared to the prior period. Keep in mind, last year we significantly reduced our incentive compensation accrual at the onset of the pandemic. Additionally, we experienced higher freight costs as compared to a year ago. This higher expense was offset by cost reduction actions executed in the second half of last year. Overall, we were pleased with our margin performance, especially given some of these cost headwinds. Adjusted diluted earnings per share was 68 cents, up 4 cents from last year, and free cash flow for the quarter was very strong at $47 million. Last year, we generated $292 million of free cash flow, which included $265 million related to our distribution agreement termination. If you adjust for the one-time impact from last year, free cash flow improved $20 million year over year. Based on our market outlook and expectations on cash flow generation going forward, we are in a position to return to a more normalized level of cash on our balance sheet. We therefore are announcing the redemption of the remaining 6.25% notes due in 2024. The $175 million principal balance will be redeemed at the call price of just over 101%, utilizing available cash on hand, which was $321 million at the end of the second quarter. Our objective of maintaining Double B credit metrics through market cycles was reinforced this past year as we were able to successfully manage through the onset of the pandemic. Upon completion of the debt repurchase, our gross debt balances will be similar to where we were pre-COVID. We are also on track for net leverage to be approximately two times this year and plan for a further step down in 2022. Now let's look at our segment results compared to the same period last year. Sales in commercial truck increased by 23%, driven by higher global truck production in all markets. Segment adjusted EBITDA for commercial truck was $73 million, up $15 million from last year. segment adjusted EBITDA margin increased to 9.4%, an increase of 20 basis points over the prior year. The increase in segment adjusted EBITDA and EBITDA margin was driven primarily by conversion on higher revenue and by cost reductions actions executed last year. This was partially offset by higher incentive compensation and freight costs. Aftermarket and industrial sales were $247 million in the second quarter, down $30 million compared to the prior year. The decrease in sales was primarily driven by the termination of our distribution arrangement, which occurred in the second quarter of fiscal year 2020. Segment-adjusted EBITDA was down $12 million compared to the second quarter of 2020, and segment-adjusted EBITDA margin decreased to 13.8%. The decreases were driven primarily by the impact from the termination of our distribution arrangement and increased incentive compensation costs, partially offset by cost reduction actions. Before I review our current global market outlook on slide seven, I want to provide an update on supply chain constraints in the markets we are closely monitoring. Global supply chains, primarily for semiconductors, have become constrained during this global production upturn. This has affected many global manufacturing industries, including commercial trucks. We are seeing some impact to production schedules as a result. In India, the current wave of the pandemic is having a significant impact on the country which could affect the ability of our OE customers and suppliers to manufacture in the short run. Demand, however, remains high in all of our markets. In particular, order activity in the North America Class VIII market continues to be robust, averaging over 40,000 units per month in our fiscal second quarter, and cancellation rates remain very low. Overall, as we assess all of the pluses and minuses, We are keeping our global production outlook unchanged as we balance strong global demand with potential supply chain constraints. Let's turn to slide 8 for an update to our fiscal year 2021 outlook. Consistent with our market assumptions, we are holding forecasted sales to be in a range of $3.65 to $3.8 billion, unchanged from our prior forecast. We are also maintaining our adjusted EBITDA margin guidance steady at an expected range of 10.6 to 10.8%. We are, however, seeing steel costs continue to increase. Since September, hot-rolled coil prices have increased more than 130%, and scrap prices are up nearly 100%. The price movement in steel has been the most severe and rapid increase we have seen over the past 10 years. As a result, we now anticipate a full-year headwind of $25 to $30 million in higher steel costs, up $10 million from our prior review. Most of this impact will be felt in our third fiscal quarter as prices begin to reset with our steel suppliers. While this is a significant headwind in 2021, we do have a pass-through mechanism in place with our customers, which are typically on a three- to six-month lag. We expect to see most of this recovery beginning in early fiscal year 2022. Additionally, we are increasing our electrification spend between $5 to $10 million from our prior guidance as we continue to respond to this growing opportunity. While we are experiencing these higher costs, we expect to be able to offset most of these increases through continued operational performance. Our purchasing team has done an excellent job in driving material performance savings, and we continue to see the benefits from cost reduction actions executed last year. Moving to adjusted diluted earnings per share, our outlook for 2021 is now in the range of $2.15 to $2.30. This reflects the impact from the adjustment for non-cash taxes as well as the lower interest expense expected from the bond redemption. Our effective cash tax rate of approximately 15% in fiscal 21 remains unchanged. And finally, we are maintaining our expectation to generate between $110 to $125 million of free cash flow. Overall, the team is doing a fantastic job managing through the challenges of this strong global rebound and deliver a solid glide path to M2022. Now, I will turn the call back over to Chris.
spk00: Thanks, Carl. Let's turn to Slide 9. While it is difficult to schedule events with certainty, we're planning to hold our Analyst Day in person this year in New York. More details will be provided in the coming months. At that time, we will present M2025. We will, of course, closely monitor the situation as we move closer to this date to ensure we can meet safely. Before we close, I would like to express our concern for the serious situation occurring in India as the pandemic worsens. Our team in the region has taken actions to help employees and the community through care centers, vaccination and mobile testing facilities, and we plan to do more. Our thoughts are with our colleagues and their families during this crisis. Again, I want to thank you for joining us today to review Meritor's second quarter results and welcome any questions you may have at this time.
spk07: And as a reminder, to ask a question, you will need to press star 1. Again, for questions, that is star 1. And we'll pause for a moment to compile the Q&A roster. And your first question comes from the line of James Ticcarella of KeyBank.
spk04: James Ticcarella Hey, good morning, guys.
spk00: James Ticcarella Good morning, James. Good morning.
spk04: Just within the company's reiterated guide for the year, you're now anticipating, you know, what was, I think, referred to as record commodity inflation in the back half, right? Not surprisingly. But can you help quantify, you know, what the net headwind exposure is relative to, you know, what will likely flow through, you know, within your recovery mechanism, just to get a sense of that net exposure? Sure.
spk03: Sure. James, it's Carl. Good morning. As it relates to steel prices, which is the really primary driver for us, we do expect it to be year-over-year about 25 to $30 million headwind in fiscal 21. So, if you think about the recovery mechanisms as that begins to kind of flow through, that will come through really beginning in fiscal, the first part of fiscal 2022. And so of that, we would expect to be recovering around probably $20 million of that number as we go forward.
spk04: Okay. That's really helpful. Just from an industry standpoint, you know, focusing on the North American market for a second, I mean, you know, again, from an industry standpoint, we're trying to get near record order levels this year. You know, the industry backlogs are also going to be, you know, at or close to all-time highs. Are you seeing anything unique in terms of, you know, build commitments, build slot commitments for next year at this point? It just seems as though we're going to be, especially given the temporary chip shortage impacts, which I think are also proven to be more muted, just seems like, you know, we're on track for really, really strong volumes next year.
spk00: For sure, James, I'll take that. So when you think about it, you know, this you know, it's beyond the last three months. If you look at it, it's the last six months order intake has come in at 40 or above 40. And to your point, you know, backlogs are passing, I believe, 300,000. And for our fiscal year right now, the midpoint with the recent change is, you know, it's 285,000 for the fiscal between ACT and FTR. And if you look at the midpoint for next year for the heavy market, it's at about 340. So to your point, great highs. And you've got to believe the Texas storms resolved as well as the fire in Japan. So the chip shortage will get resolved here shortly or will improve shortly. We do believe there is impact through the next couple of quarters, but it eventually should improve. So again, we believe there's a strong 2022 ahead of us as well.
spk04: Got it. If I could just squeeze one more in. Within the aftermarket and industrial segment, you know, this quarter's, the second quarter's margins, was there anything, you know, within that related to, you know, the timing of price increases or, you know, excessive premium freight, just, you know, any color on that segment's margins?
spk03: Yeah, James, it was really just driven by a couple of factors. One was we did see some higher freight costs in the second quarter as well as a little bit higher costs from steel that affected the aftermarket business. Thank you.
spk07: Our next question comes from the line of Joseph Speck of RBC Capital Markets.
spk06: Thank you. I appreciate it. So I think, you know, just to maybe sort of get a little better sense for some of the costs you talked about, Carl, in the back half, I think if we look at the guidance, it still implies on a year-over-year basis about 20% incrementals. But I think that seems to be maybe some of the base period in the math, because is it fair to assume that sequentially we should see maybe detrimentals a little bit higher than normal, given some of the headwinds, and then as you start to get some of those recovery mechanisms back next year, that reverts?
spk03: I think that's the right way to think about it, Joe. If you look at the six months EBITDA margin performance to date, we're right around 11.4%. So if you think what our guide is of 10.6 to 10.8, that does imply, you know, the second half margins will be about 10% on roughly the same type of revenue. Right.
spk06: Okay. Thank you for that. Just a bigger, bigger question on electrification. I know you have to, you know, you're upping the spend again here. In the past, when you've talked about that, it's really sort of been to, you know, support programs that you think are sooner rather than later. So maybe if you could just sort of confirm again that that increase of five to 10 is for that. And then somewhat related on electrification, can you talk at all about your ability to attach other Meritor products, like maybe disc brakes, for instance, like when you get the axle wins, like is there a pretty high attach rate for Meritor when you're able to do that?
spk00: Absolutely, Joe, but I'll start with the first question. First, I think, you know, glad to see the backlog continuing to grow. As you remember, you know, we talked about having this $500 million target for electrification as our revenue pipeline. We accomplished $400 million of that at the last quarter, and so with this announcement with Hexagon, we've taken a chunk of that, so we continue to see the growth. And, you know, to put it in perspective of spend here, You know, if you go back to 2019, we spent about $12 million. Last year we spent $21 million, and this year we're moving it up to $35 to $40 million. So we're almost doubling it per year, and it's primarily because of the wins, and it's essentially application and testing of our products as it wins with more customers. To your second question, the ability to attach components, Absolutely. We do see a path with brakes, primarily with brakes, with many of the customers as an opportunity to grow business as well.
spk06: But when you up your electrification backlog, I mean, those associated products are not in that. So is it fair to assume that the other side of your backlog is being benefited too by the electrification ones?
spk00: It is on, let's call it, everybody that is, let's call it, new entrants coming into the market. So when you think about the new entrants, we have a significant share of the existing traditional business. So it is on the new business. But you also have to take into account, when you think about electrification, always remember it's five times and up to five times content on a 14XE, for example. So we're already seeing... that growth as well.
spk06: Okay. Carl, maybe just a quick one on thanks for the color on the tax rate and sort of the change in guidance. I think you used to sort of point to, you know, mid-teens with the way you sort of adjusted. So should we model something more like 20% in the other years now given the change?
spk03: Well, I think it's, Joe, to that point, it's 15% definitely through 2022. I think once you start getting past 22, you go out to 23, 24, it could begin to moderately step up. So you're probably not too far off with that assumption. Okay.
spk06: Thanks very much.
spk03: Thank you.
spk07: Your next question comes from Nalina Ryan Brinkman of J.P. Morgan.
spk01: Hi, good morning. This is Ben Phuong for J.B. Morgan, for Ryan, and thank you for taking my question. I just have two questions. The first one is, what is your view on the impact of higher labor costs to margin as production starts to come back? And on the same note, how are you seeing freight costs progressing through the rest of the year? I know someone in aftermarket last week said something about the freight costs could be two or three times higher than they're seeing right now. So how much impact to margin Do you expect this headwind, and what are some factors that can be used to offset the impact? Thank you.
spk00: Absolutely. So let me start with the first question specific to labor. It's a red-hot market out there. As you can see with the first question, there's significant drive and demand for the product, and I think it's running right through the economy, GDP being strong and consumer spending. In essence, we're able to drive some of that recovery specific to that with some of our customers. However, on top of that, it's really about operational performance. It's driving incremental operational performance, whether it's labor and burden and how we look at our lines or whether it's how we look at material opportunities. So that's how we drive that savings to offset labor. Specific to freight, we're seeing about three times more freight in terms of cost, to your point, whether it's on ocean or internal as well. And for those elements, what we are again doing is trying to offset a lot of that with material performance and operational performance. But on top of that, we also look at working with our customers as well.
spk01: And I'm sorry to ask, so this freight cost and everything already factor in the guidance, right?
spk03: Correct. Yes, it is, yes. And to add to what Chris said, you know, as we look at just overall freight costs, in our first quarter we did experience probably higher premium costs associated with the rapid increase in production that we saw in the first quarter. But what we're seeing is kind of just the basic run rate with costs today is all factored into our guidance.
spk01: Thank you. Thank you. Very helpful. And my second question is on the RV business. So the RV demand has been very strong in the last few months. And just this morning, an RV dealer up there, they're addressing even their guidance materially. Can you talk about the opportunity for growth in this area of the business? And I think last quarter, you mentioned something about independent suspension. with wheels and motors for RVs. And if you can please just give any update on that.
spk00: Thank you. Absolutely. So the industrial specialty and off-highway markets are incredibly important for us. This is why we did the Axel Tech and Fabco acquisitions two years ago. And so we are seeing the fruits of those acquisitions as we think through 2022 and as we look at our revenue pipeline growth. When we think about the core business and us, we have talked about exceeding our revenue targets for 22. A lot of it is coming in our industrial defense and specialty business, and a lot of it's driven by this. So we are seeing that growth. Again, last quarter we talked about developing an independent suspension for this market, and it is going into production this year, and it will be in run rate next year. And then second is we're also developing a similar system on the electric side. So we're looking at an electric platform that acquires, accomplishes the same thing as well for the RV space.
spk01: Thank you so much for taking my question.
spk00: Sure.
spk07: Your next question comes from the line of Bruce Chan of Stifle.
spk08: Hey, good morning. This is Matt Mylask on for Bruce Chan.
spk03: Good morning, Matt.
spk08: morning. With regards to higher freight costs, you mentioned one of the mitigating things that you're doing is working with customers. Any additional color we can get around there and how those conversations might be going?
spk00: Sure. I think at this point, we're working with customers that we have agreements in certain regions. And as you could imagine, they are hard agreements and they take a while to work through. And it's a discussion that we are working through, and we are seeing the benefits in some areas.
spk08: Thanks a lot. Thank you.
spk07: And your next question comes from the line of Itay McKelly of Citi.
spk05: Good morning, everybody. Just two quick ones for me. First, just a little bit of housekeeping on CapEx. I mean, it looks like it's still kind of running maybe below the full year. And I think the original plan for the cumulative CapEx through 2022 was about $475 million. Just curious whether you're seeing efficiency there or if that's just some timing.
spk03: Good morning, Itai. It's more timing. For the first six months, we had about $25 million of CapEx. We are planning for about $70 million of CapEx the last six months of the year. So part of it was Production came back pretty quickly, as you recall, in our first fiscal quarter, and I think some of the programs we are just beginning to kind of ramp back up here this quarter as well as in the fourth quarter for us.
spk05: Great. That's helpful, Carl. I think you kind of addressed it to the prior questions, but just as we think about that bridge from the second half margins to to to the twenty twenty two target i think you mentioned some of the recoveries on steel but you should be walk us through some of the bigger kind of puts and takes in terms of what at least at least some of the headwinds you're facing today that are contractually uh... you're going to kind of reverse uh... next year particularly on the other steel side and uh... you've had the biggest thing which
spk03: seen when you really boil it down is really on steel so as I referenced the that 25 to 30 million dollar headwind is really a second half story for us so while freight costs what we've talked about are have increased and are elevated from kind of what they have been historically our material performance and some of our operational performance items have been able to offset that so the true story is steel and if you were to simply adjust for the steel of 25 to 30 million our margins would be very similar to what they are here in the first and second quarter.
spk05: Got it. Perfect. That's very helpful. Thanks.
spk03: Thank you.
spk07: And there are no further questions at this time, and I'll turn the call back over to Todd Sherillo.
spk02: Great. Thank you. And thank you, everyone, for joining our call today. If you have any questions, please feel free to reach out to me directly. Thank you, and have a great day.
spk07: And this concludes today's conference call. Thank you for participating. You may now disconnect.
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