Good morning, ladies and gentlemen, and welcome to the Fourth Quarter 2018 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 [Operator Instructions]. As a reminder, this call will be recorded. I would now like to introduce your host for today’s conference Mr. Carl Anderson, Group Vice President of Finance. You may begin.

Thank you, Catherine. Good morning, everyone, and welcome to Meritor’s fourth quarter and full year 2018 earnings call. On the call today we have Jay Craig, CEO and President; and Kevin Nowlan, Senior Vice President and President, Trailers and Components, 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 the property of Meritor, Inc. It’s protected by US 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 webcast -- website. Now I’ll turn the call over to Jay.

Thanks, Carl. And good morning everyone. We appreciate you joining us for a look at our fourth quarter and full year 2018 results. Let’s turn to Slide 3. Let me start by saying we had another great quarter delivering on our financial and customer commitments and by all measures we also had an extraordinary year. For this, I want to recognize the Meritor team around the world. Our employees are doing a fantastic job driving excellent results in all areas of the company, particularly as we manage the challenges inherent to supporting strong markets and the volatility of material costs around the globe. The year is notable not only for financial results however, we did much more. We launched six new products for specialty linehaul, bus and coach and off-highway applications. We’ve positioned Meritor to be a leader in electric drivetrains and as part of that strategy we launched our Blue Horizon Advanced Technology brand. We successfully integrated two bolt-on acquisitions, each of which has contributed toward our revenue target for M2019. We’ve managed our business in Brazil through the severe downturn over the past several years and are happy to see volumes up almost 40% this past year as we launched new business with MAN, Mercedes Benz and Iveco. And as we remain focused on returning capital to shareholders, we bought back 4.5 million shares of common stock in fiscal '18 and are pleased to announce today that we plan to repurchase more. In 2015, we have -- since 2015 we have repurchased more than 17 million shares and significantly reduced the amount of convertible debt that was previously dilutive. In addition, we achieved our long-term leverage target of 1.5 times net debt-to-adjusted EBITDA. Overall, these actions reflect the level of performance you've come to expect from Meritor. Turning…

Thanks Jay and good morning. On today's call I'll review our full year financial results and then I'll provide you with an overview of our 2019 guidance. Overall we had an outstanding year of financial performance. We drove revenue growth of 25%, expanded adjusted EBITDA margin by 90 basis points, increase adjusted diluted earnings per share from continuing operations by 61% to $3.03 and generated $147 million of free cash flow. Let's turn to Slide 8, we’ll see our full year financial results compared to the prior year. Sales were up $831 million from last year on higher production in all of our major markets and continued revenue outperformance. Starting with end markets, in North America Class 8 truck production was 38,000 units up 30% from the prior year. Sales in Europe were also higher, driven by continued strength in the heavy and medium duty truck market. As Jay highlighted our operations in Brazil, China and India are providing additional tailwind to our sales as those regions made up about $180 million of the year over year sales increase. Revenue outperformance achieved primarily through market share increases in new business wins supplemented our sales growth and accounted for approximately $325 million or nearly 40% of the increase in sales from last year. On the right side of the slide, you can see in the line item volume, mix, performance and other we have $114 million of higher adjusted EBITDA on the $831 million revenue increase. That translates the net underlying conversion of approximately 14% which we view as a good result in market 5Bs but is particularly strong when you consider some of the headwinds we faced in 2018. For example, steel cost were significantly higher during the year much of this increase came from strong market demand and trade…

Thanks, Kevin. Let's go to Slide 14. On December 6, I hope you can join us in New York for Analyst Day. At that time, we look forward to sharing with you our new M2022 plan. I think you'll find that plan to be as aggressive that to you before and driving shareholders value but no less achievable. Before we go to Q&A, I want to recognize again the Meritor team around the world. Our employees have manage the challenges this year and the unrelenting work schedules its required with great success. This team has a remarkable dedication to meeting our commitments. From our manufacturing plants to our corporate offices we share the desire to be a leader which we demonstrated for many years now. Now let's take your questions.

Thank you. [Operator Instructions] Our first question comes from Joseph Spak with RBC Capital Markets. Your line is open.

I guess I just wanted to start on some of the outperformance stuff you reported and as a sort release of ’19. I think if we go back to analyst day last year you were looking for about $315 million of outperformance. It looks like you did a little bit better with the $325 million and then there was still if I recall correctly, like you had a gross opportunity of $625 million and you were putting in like a risk adjusted number of about $190 million to get to that $660 million. So you know now that we're a year forward I'm assuming that's not necessarily a risk adjusted or unawarded number at this point. Is that correct? like that were you able to actually execute on those opportunities that you saw in the marketplace?

Yes, Joseph you've got some of the numbers right. The $315 million we talked about was business that we had won but was not yet in the P&L and that wasn't an ‘18 number that was an ‘18 and ‘19 number. And if you look at the combination of those two columns from Analyst Day with 315 and a risk adjusted number of 145. So let's combine about another $460 million of revenue outperformance in ‘18 and ‘19. And so what we're saying is we achieved $325 million of that $460 million in ‘18. Frankly a little bit quicker than we were originally anticipating in our guidance at the midpoint suggests we'll get the balance of $135 million in 2019. So right on track for that $660 million in total revenue outperformance.

Okay, of that $315 million I guess you're right which was sort of not in the P&L over and I know presumably most of that was or the line share that was in ‘18 versus ‘19. Is that fair?

It's a mix. I think some of that still coming in ‘19 as we grow some of those new business wins that were we had won but they still might be ramping up in ‘19. So it's a mix. But I'd say the bulk of that column 315 was what we saw in 2018.

And then I guess like you know if we sort of compare and contrast again like you know your outlook for Class 8 in FY ‘19 is now higher than you thought about a year ago. So how do we think about sort of volume adjusting some of those targets.

Yes, I mean when you think of that Class 8 truck market being up. You know if you look at just 2018 what happened to the truck market going from 237,000 Class 8 trucks to 38000 Class 8 trucks. What that effectively means it's about $280 million dollars of incremental revenue from ‘17 to ’18 from the Class 8 truck market. But obviously keep in mind we grew $830 million in the year with a big chunk of that being the revenue outperformance. I think as you look at the outlook we provided at Analyst Day last year, I think the revenue was quite a bit lower than what we're now projecting for 2019. Now we're projecting $4.25 billion. I think we're a little south of $4 billion and a big piece of that is a Class 8 truck market is stronger and that's reflected in our guidance.

Okay, maybe moving to the free cash like, if I look at your guidance for ’19, it looks like a free cash flow conversion is almost 10 percentage points sort of higher than what you realized in ‘18. It sounds like maybe you're going to talk more about sort of free cash flow and the path forward at the Analyst Day but given that you've already sort of given ‘19 guidance here, I was wondering if you could just talk about what are some of the drivers of that improvement and maybe like to have an ultimate goal on sort of conversion?

In terms of what's happening in '19, fundamentally, it's that as revenue levels off, we're making less investment in working capital. So, in 2018, we had $830 million of revenue growth. Our working capital tends to run 8% to 10% or so of revenue. So, we were making those investments in working capital, particularly inventory. But as revenue levels off in '19, we no longer have the overhang of incremental working capital investment which simply means that more of the earnings flow to the bottom-line as free cash flow. And so, that's what's fundamentally happening which is a good level of free cash flow and something, in a stable environment, we'd be able to throw off as we look forward. But you're right. We'll provide more guidance and more thoughts on how we see cash flow progressing and what we do with that cash flow beyond '19 when we get to analyst day in a few weeks.

Okay. And then just real quick, on the buyback -- and it sounded like Jay, in your opening comments, you want to try to attack that fairly aggressively. Although, it doesn't look like in the guidance you're assuming much of anything in terms of excess buybacks. Maybe some to offset regular dilution. So, how should we think about you attacking or executing against that? And is it really just opportunistic? And over what time frame should we think that you execute that entire plan over?

Yes. Good question and observation, Joe. I think you're right. Implied in the guidance is all of the share buybacks we executed in 2018. But we don't have anticipation of those buybacks in our '19 guidance. Please remember that our cash flow tends to be most significant in the middle of our year, so as you get into the end of Q2, Q3, and the beginning of Q4. So, that's when we tend to execute the bulk of our buybacks. So, for the impact on EPS, it tends to be back-end loaded. We obviously view the price at which our shares are trading right now as just a great opportunity if we look at our earnings multiples and the stability of our company based on all the deleveraging we've done. And I think what places us somewhat unique in our space is we have no calls on our cash flow. We're at the debt levels we want to be. Our legacy liabilities are really pretty well taken care of and behind us. So, all this free cash flow generation can be directed toward growth or share buybacks. So, quite frankly, we're very excited with the trading levels of our stock and potentially the opportunity it provides us in the near-term. Q - Unidentified Analyst

Okay. Thanks. Congrats. And look forward to seeing you guys in a couple weeks.

Thank you. Our next question comes from Neil Frohnapple with Buckingham Research. Your line's open.

Hi. This is Joe Nolan on for Neil. Congrats on a great quarter. I know that you guys said that you almost completely offset steel cost in the quarter. But I was just wondering what that headwind was on a year-over-year basis.

Yes. On a full-year basis when we look at '18 versus '17, we almost entirely offset it. When you look Q4 to Q4, we did have a little bit of a headwind. Call it about $2 million or so. And sequentially, even going from Q3 to Q4 because we've seen steel cost ramping up in the back half our fiscal year. We also saw a sequential headwind probably of $4-ish million going from Q3 to Q4. But full-year '18 versus '17, the way steel moved and our recovery mechanisms kicked in, it was a push.

Got it. And then what is embedded in the fiscal year '19 EBITDA guidance for steel cost headwind?

Yes. The assumption is that we're going to be burying the cost of the movements that we saw in steel in the season, the back half of our fiscal year. And as you know, our recovery mechanisms in our OE contracts work on a lag. So, we'll have a little bit of a lag that creates a headwind from a steel perspective. Call it high-single-digit millions of steel cost on a year-over-year basis which is embedded in our guidance that we provided.

Okay. And then can you just talk about the success of the mid-year price increase within the aftermarket business? And did that benefit margins at all in the fiscal year fourth quarter?

Sure. I think we have been successful in executing the price increases we planned for. I think you see that on the fourth quarter results of our aftermarket group. We're achieving the objectives we set out for this year to return that business to more normalized margins. And we're very pleased with the run rate of the profitability of that business going into 2019.

Okay. That's it for me. I'll pass it on. Thank you.

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

Hi, guys. Good morning. This is Jason Stulgrair on for Brian Johnson. I was just hoping to ask about the margins in the quarter. I guess I'll follow up from the previous question. The margins in aftermarket and industrial above 14%. It sounds like that's largely the effect of price increases. And you guys would expect that run rate to continue into 2014. So, just wanted to confirm that wasn't necessarily a one-time timing issue and that was a more structural change in that business.

No, you're correct. If you look at the full year, what we saw in the aftermarket business is we were incurring certain costs, freight costs, steel costs, other costs throughout the entirety of the year. And we didn't execute pricing actions to mitigate the bulk of those cost increases until Q4. So, we generated a Q4 margin in that segment of 14.7% which is obviously higher than what the full-year margin for the segment was. And there is nothing unusual about that. It's the fact that we're now recovering the cost that we were seeing throughout the year. So, as we head into '19, our expectation is we'll see a typical dip in Q1 as we normally do in the segment because that's the seasonal low point for aftermarket with fewer selling days in the quarter. But as we look at the last nine months or the last three quarters of the year, that we're expecting aftermarket industrial margins to be well north of 14% for each of those quarters going forward.

Okay. Yes. Terrific. And then I guess just moving to commercial truck and trailer, margins were a little lower in the quarter on top of strong volume. And I know you guys called out material and freight headwinds in both segments in the press release. And so, obviously, higher material and freight comes with growth. But was there anything that surprised you in the quarter like premium freights or spends of inefficiencies that surprised you for efficiency of growth?

Yes. I guess a couple things. When you look at the truck segment that you're talking about, truck and trailer, if you're looking at Q4 to Q4 as opposed to the full-year which is what our press release was focused on -- but Q4 to Q4, I'd say there are really three things. One is we do have currency impacting the business right now. The US dollar has gotten stronger in the last few months. You can see just on a year-over-year basis versus the Reais. The Reais depreciated almost 25%. The Swedish Krona's depreciated quite a bit. So, Q4 to Q4, we saw headwinds from that. Don't forget we also had the Meritor WABCO business that a year ago, we owned, and we no longer own. That's worth about 90 basis points to that segment in Q4 numbers. And then we did incur some premium costs as we were delivering on the strong markets and the peak markets that we're seeing. And as Jay mentioned in his remarks, we're investing in some supplier capacity, making some modest supplier capacity investments to be able to mitigate the costs as we look ahead.

Yes. Jason, I'd just add to that. One part of your question I think was were we surprised by that. I'd say quite the opposite. What we saw -- and you saw this in us being able to realize many of the M2019 revenue grains earlier than we anticipated -- we saw an opportunity to really lock in those market share and revenue gains. And so, we purposely incurred some premiums, bringing on some new suppliers to bring that volume in. And with the site investments we'll make in those suppliers, we're already seeing those premiums abate. And we should see them virtually disappear by the first calendar quarter or second fiscal quarter. The payback on those investments was a matter of months. And we just felt it was a great opportunity to lock in additional market share and still be able to hit both our near-term and mid-term financial commitments.

Okay. Great. And then just one more if I could. On the 2019 revenue target of $4.25 billion, obviously, it increased from 2018. But as I look at the end markets that you guys are forecasting, the increase in revenue target from where you guys were at investor day which, as you guys alluded to, was just under $4 billion to now is like a 7%-8% increase. But with end-markets like Class 8 trucks and Class 57 trucks in North America increased around the 20% range from investor day, it just seems like some of us might have been expecting a stronger 2019 number given where you guys ended up with your end-markets. So, are there any other puts and takes there? Is that pricing? Is it FX that we should be considering?

Well, I guess a couple things. One is keep in mind the Class 8 truck market going up from where we were in 2017 to even this year is worth $280 million. And we increased our revenue this year $830 million. So, while the truck market is stronger, that wouldn't drive something that's hundreds and hundreds of millions of dollars higher. It's $280 million higher year-over-year. And you're seeing that in our guidance. But we are also seeing then an FX headwind as we head into 2019 of about $100 million. And you can see that with the strengthening US dollar against most of the European currencies, the Chinese currencies, the Brazilian Reais. So, it's really across the board that we're seeing that revenue headwind.

Okay. That's it for me. Congrats on finishing up a great fiscal '18, guys. Thank you.

Thank you. [Operator Instructions]. Our next question comes from Faheem Sabeiha with Longbow Research. Your line is open.

Congrats on a great quarter. I was just sticking to the revenue outlook for next year. Wondering if you can provide a little commentary around your aftermarket industrial business. And it seems like that $50 million sales increase is primarily coming from the Class 8 market. Just wondering if you can provide some thoughts as far as what the guide implies for the aftermarket industrial business.

Effectively, that's right. The bulk of the market increase we're talking about is really Class 8. And if you do the math based on the guidance we've given before, every 5,000 Class 8 trucks translates to about $20 million of revenue. So, it's a little bit more than $40 million associated with the Class 8 truck market. So, it's the bulk of the increase.

Okay. And then your production outlook for North America Class 8 seemed a little conservative given where the industry's backlog sits today. Is your initial production guide based on current delivery schedules that's being communicated by your customers? Do you guys not have much confidence in the order or it's past the first half of calendar '19? Just any thoughts around there would be great.

Yes. I think our outlook is very consistent with the market services of ACT and FCR if you look at those in the first part of our year. I think we have a little uncertainty as compared to them in Q4. And that's not really based on current production outlook from the OE customers. It's really just looking forward. And I think we are a little more conservative in our outlook in our fiscal Q4 just given how long this upturn has lasted so far. So, obviously, we'll see how that Q4 turns out. But that's really the main difference.

Okay. And you guys talked a little about the material cost for next year. I'm just wondering what else is embedded in your incremental margin. It looks like it's gonna be at the high end of your typical range. Just any sort of commentary around freight costs and pricing. That would be great.

Hi. You're right. The implicit guidance we have there is that it's about 20% incremental conversion on a year-over-year basis. I mentioned that steel is a headwind in the single-digit millions of dollars. Remember, in our 2018 results you saw on the walk we did from '17 to '18, we did have a one-time environmental remediation reserve that we booked. So, as you look on a year-over-year basis, that should be a tailwind on the causal going '18 to '19. But when you net all the puts and takes out, it means that we're probably converting on normal incremental revenue growth in that 15% to 20%, probably closer to the 15% range with all the puts and takes.

Okay. And just one last question. Regarding your braking business, as the market shifts to the single-piston air brakes, which, from what I understand, have lower payback periods over the next few years, just wondering if these next-gen disc brakes would be a net neutral or loss from a content standpoint versus the brakes that are --

Well, yes. Good question. The content on single-piston disc brakes is still markedly higher than a drum brake. It's less than our dual-piston brake which is currently being specked. But I think what we're seeing is you can expect configurations on trucks that they most likely will have dual-piston on the front axles and potentially single-piston on the two rear axles. So, overall, compared to the drum brake content, there's significantly increased content in that configuration.

Thank you. And I'm showing no further questions at this time. I would like to turn the call back to Mr. Carl Anderson for any further remarks.

Thank you, Catherine. We thank you for your participation on today's call. And if you have any further questions, please feel free to reach out to me directly. Thank you.

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.