Good day, ladies and gentlemen, and welcome to the Q2 2020 Meritor Inc. 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 may be recorded. I would now like to introduce your host for today's conference, Todd Chirillo, Senior Director of Investor Relations. You may begin.

Thank you, Jash. Good morning, everyone and welcome to Meritor's second quarter 2020 earnings call. On the call today, we have Jay Craig, CEO and President, Carl Anderson, Senior Vice President and Chief Financial Officer and Chris Villavarayan, Executive Vice President & Chief Operating Officer, all of whom will be available for questions following the call. 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 expressed written consent of Meritor. We consider your continued participation to be your consent to our recording. Our discussion may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Let me now refer you to Slide 2 for a more complete disclosure of the risks that could affect our results. To the extent we refer to any non-GAAP measures in our call, you'll find the reconciliation to GAAP in the slides on our website. Now I'll turn the call over to Jay.

Thanks Todd and good morning. I'd like to begin by expressing my thanks to all our Meritor employees for their dedication and hard work as we take on the challenges we faced today. As part of an essential business, Meritor employees remain committed to supporting the delivery of medical, food and other critical products for our communities around the world. I also want to express my thanks to the frontline workers that Meritor had the privilege to support in the fight against Covid-19. I'll now spend just a couple minutes talking about the second quarter before providing an update on the status of the business today in light of Covid-19. Let's turn to Slide 3. The company was performing extremely well before the pandemic began to impact production first in China beginning in mid-January then throughout the rest of the world beginning late in the second quarter and continuing into the third. Carl will share more detail, but here you can see the highlights from the quarter. Sales were down $285 million from last year due to lower volumes. We finished the quarter however with a 12.3% adjusted EBITDA margin, up from 12% in the same quarter of last year. That income was $240 million, up $167 million from the same period last year. This was driven by $203 million of after tax income associated with the termination of the distribution arrangement with WABCO. Our liquidity position at the end of the second quarter was $829 million. This represents approximately 20% of our trailing 12-month sales. Cash on the balance sheet was $508 million. We have access to the remaining $321 million of availability under our revolving credit facility and expect to be in compliance with our covenants under this facility for the remainder of the year. Although, it is…

Thanks, Jay, and good morning. On today's call I'll review our second quarter financial results, liquidity position, debt maturity profile and retirement related liabilities. Before I begin, I wanted to take an opportunity to express how proud I'm of our team's ability to quickly mobilize and rise to the challenges, which have been placed before us. Now, let's walk through our second quarter financial results compared to the prior year on Slide 6. Overall, sales were $871 million, down 25% from the same period last year. Sales in our commercial truck segment decreased by 33% year-over-year to $588 million. The decrease in revenue was in line with global truck market conditions as all regions saw lower production levels. The suspension of production due to COVID-19 first in China in mid-January and then late March in Europe also contributed to lower sales. In our Aftermarket, Industrial and Trailer segment sales was $319 million, down $10 million or 3% from last year. Lower sales were primarily driven by decreased volumes across the segment including the beginning impacts of COVID-19 and overall market demand, partially offset by $43 million in revenue generated from our AxleTech business. Net income from continuing operations attributable to the company was $240 million compared to $73 million in the same period last year. As Jay mentioned higher net income year-over-year was driven by $203 million of after tax income associated with the termination of the aftermarket distribution arrangement with WABCO. Adjusted EBITDA was $107 million in the second quarter of fiscal 2020 compared to $139 million in the same period last year. Adjusted EBITDA margin was 12.3% compared to 12% a year ago. The improvement in margin was largely driven by a $10 million adjustment of lower incentive compensation expense to align with the revised performance expectations due…

Thanks, Carl. Please turn to Slide 9 for our third quarter outlook. Let me highlight our assumptions, as I said it earlier segments of our operations have continued to run. We expect these businesses to contribute between 50% to 60% of our revenue during the third quarter. To restart and ramp up of our commercial truck business is not as clear, while we expect most of our plants around the world will be running in early May, there is uncertainty on timing and volume, which is driving a large range of our revenue outlook of $400 million to $500 million. Negative cash flow from operations is expected to be in the range of $150 million to $225 million. This includes the one-time impact of the unwind of our factoring programs. These programs allow us to monetize our receivables quickly after they are generated. Removing the impact of factoring, we expect negative cash flow from operations of $25 million to $50 million during the third quarter. Turning to margins, we expect to hold sequential detrimentals in the third quarter in the range of 20% to 30%. This includes additional investment required to implement new safety protocols. We were able to achieve this due to the quick and aggressive cost containment measures we have already taken. I want to emphasize that we are running the business to focus on operational cash flow in the near term. Let's move to Slide 10. As we enter the second-half of the fiscal year and restart production, we are making sure that every safety protocol is in place, including providing the necessary PPE. With the existing challenges, it obtaining large quantities of masks, gloves, cleaning supplies and disinfectants. We will first make sure that each of our plants, distribution centers and testing labs has the necessary…

[Operator Instructions] Our first question comes from Joseph Spak with RBC Capital Markets. You may proceed with your question.

Thanks. Good morning, everyone, and good to hear all your voices. I hope everyone is okay. I guess first question is even if we sort of look at the decrementals in this quarter ex some of the incentive benefit, it still seems like there's a step down on the decrementals into the next quarter. Is that just all sort of you know volume driven as you know sort of feeling the bigger the clients or is there anything else that could sort of help bridge that gap between the performance?

Yes. Good morning, Joe. Good to talk to you as well. Yes, as I think we look at the next quarter. One this, what we provided was a sequential look relative to the second quarter. I think when you cut through the math on a year-over-year basis it gets - it's kind of running a little bit in the low 20% range. And as far as we look specifically for the second quarter, as you pointed out we did benefit from lower incentive comps in our actuals, as well as the - in the one-time kind of tax impact that ran through EBITDA.

Okay and yes just, while I guess actually somewhat related. Obviously, sort of taking out a bunch of cost in the short-term and I guess some of that can be viewed as temporary. But as you mentioned sort of maybe new world, new era. Is there an opportunity to sort of maybe as you reevaluate make some of those temporary savings more permanent in the mid to long term as you reevaluate the cost structure?

Joe, this is Jay. Thanks, very good question. Obviously, that was what I was referring to in my comments. We think the aggressive actions we took including 40% to 50% to 60% salary reductions in a very short order allowed us the time to sit back and say what is the longer term impact of this crisis look like to Meritor. And what additional actions should we take that can allow us to be successful throughout what potentially could be a longer term downturn. So we are looking at strategies as I mentioned in my comments and beginning to execute them that. We think we'll set our cost structure on the right basis for what we would expect to see for fiscal year 2021 and beyond.

Yes. Jay, the tough one, you know sort of, I guess, plan for otherwise hope, hope over the best mentality, but as a veterinary industry, I wanted to I guess pick your brand and what you thought could it be the potential snapback ability of the market and maybe what you're sort of hearing maybe from some of the, even your customers because even - if you look at sort of typical peak to trough timing probably would have normally come to the end of sort of cycle sometime around the end of the calendar year maybe a little later. And COVID obviously made it much steeper, but even if you sort of don't return to the replacement levels next year, it seems like there could be some pretty healthy growth versus obviously a very depressed 2020. So what are – do you have any high level thoughts on that?

Well, I think it – it's, it's difficult for us to say in the near-term. And you heard the comments from our customers who have their calls, so far, they – they've been very reticent to project what the outlook looks like in future. And I think that goes for us as well. What I believe and what our team is working on is, is as you mentioned is setting up to plan for the worst and hope for the best and make sure we retain the capabilities in the company to respond to the aggressive snapback that ultimately will occur most likely in long quarters time as it always does and we're going to make certain we retain that expertise to be as successful as we have been and capturing the value on that snapback and those volumes.

Thank you. Your next question comes from Alex Potter with Piper Sandler. You may proceed with your question.

Yes. Thanks very much. Hope everybody is doing well. You mentioned that cutting back on CapEx on discretionary spending, can you just give maybe a few examples of things that you are and are not reducing spending on just trying to get a better idea of the sort of initiative that you think are sufficiently important to continue investing in even in this macro?

Sure. Good morning, Alex. I think you know me, this is Chris Villavarayan. If you look at it, for example last quarter we talked about launching our or building a new facility in Brazil where we were looking at making a significant investment. As we see the current market, we might look at for example slowing down on that investment and just really modeling out where we see the market snapback and then making decisions like that. We are very definitely proceeding with the long-term prospects for Brazil, but in the short term, we might look at slowing down our investment. Also when you think about sustaining investments through our facility imagine for markets that we're running almost 60% to 70% from where we forecast, you could look and make decisions in the short-term on what we do. However, I think one thing that, Jay, is driving that as we think of the long term strategy in terms of investment in electrification, we are not slowing down on that process and as he also mentioned in how we are running the facilities and delivering the proportion or the systems we are continuing our investments into TransPower as well as electrification for the next quarter.

Okay. Very good. That's helpful. I was wondering if you could comment also on the supply chain risk, you know not all companies end up having this sort of balance sheet that you guys have. I'm thinking particularly of risks that you see upstream potentially for smaller suppliers. You know is this going to be an issue, you have solvency risk concerns for any of the suppliers that you rely on.

Good question, Alex. And we're using the same playbook that we put in place during the 2008-2009 recession where we immediately put up a multi-discipline team together including finance, purchasing, supply chain, manufacturing expertise to do much more active monitoring of suppliers, particularly those who we think do not have the balance sheets that may provide them enough liquidity through this time period. So far, we have not seen any disruptions, but we're monitoring it extremely closely and that playbook that we did execute in 2008-2009 was very successful for us. Included in that is engagement of outside experts that we can send in to the suppliers to assist them with operational and financial challenges that we've already locked those same experts into agreements if they are necessary.

Interesting. Okay. That's good to hear. I – one thing, obviously this, this WABCO infusion was, was well timed. Can you update me us on the ongoing relationship with WABCO, if there is any I think – what is the relationship between the two companies going forward? Have you essentially severed all historical relationships now going forward or not?

Yes. We have a much smaller relationship here through our aftermarket business as a distributor for certain products. But it, it, I, I don't want to misrepresent it, it's a fraction of what the business was previously. And those expected revenues are embedded in our outlook for the third quarter.

Okay. Very good. Last question. I know that you had historically looked at some of these smaller sorts of mom and pop machine, machine shop type operation to support aftermarket gearing and off highway. That always struck me as sort of an interesting business. I don't know I guess maybe two questions. First, do you want to continue building that part of the business through acquisition of these little companies? And question number two is, do you think COVID-19 will potentially present you with the opportunities to do that?

That's a very good question, Alex. I think it gets around the broader question as obviously there will be M&A opportunities that present themselves through this crisis for people who maybe don't operate as well or have the financial wherewithal to withstand the downturn. At this point in time, we are focused to make certain that our company operates successfully as it's currently configured. And we like the growth prospects of the company in areas like electrification, like our recent off highway acquisition of AxleTech, so we didn't see a burning need to add bolt-on acquisitions at this time. Now as we come out of the crisis, if there is just some incredible opportunity on the landscape and we see our revenues growing during that time period we may revisit at that time.

Thank you. Our next question comes from Brian Johnson with Barclays. You may proceed with your question.

Hi, Jay, and good morning. This is Jason Stuhldreher on for Brian. And just first question on margins maybe first in the Commercial Truck space. In the past we've talked about sort of layered capacity giving you the ability to sort of flex that debt, the footprint the direct labor footprint given with the variations in Commercial Truck. Just curious I mean in the margins that we saw this quarter, which I frankly thought were pretty good. Did any of those benefits from offloading that layer capacity or did that layer capacity pretty much already hit bottom by last quarter. And then similarly on Aftermarket, Industrial and Trailer. I was also impressed by the margins this quarter was thinking the AxleTech acquisition would be a little bit dilutive is that not the case sort of now?

Good questions. This is Carl Anderson. Just on your first question as relates to Commercial Truck, as we look at those layered capacity cost for the most part those have pretty much been eliminated in the second quarter. We did have some that pretty much been eliminated in the second quarter. We did have some that carried a little bit in the first quarter. And as we go forward as we're kind of back in ramp up mode depending on the supply chains, you could see a little bit maybe some incremental cost kind of coming in over the next couple of quarters, but nowhere near where we were running last year with a high truck markets kind of at that point. And then as relates to your aftermarket question. I think the AxleTech business, I think; we're very pleased with the amount of synergies we've been able to achieve as it relates to that. One thing that's running a little bit softer than initial plan is just overall revenue for that business. And so I think the margins aren't exactly where we want them to be currently, but as you know over time as revenue begins hopefully at some point pick up, I think we're going to be in good position with an acquisition in that business.

And just adding to Carl's comment, I think one of the benefits we got with also the layered capacity costs coming down is also a benefit from not seeing the premium freight costs associated with all of that. So we have seen some benefit both from the layered capacity as well as the premium freight. And I think in terms of the overall cost of purchase components versus our own internal cost there's also the benefit that we're seeing from that as well.

All right. Got it. Okay, very helpful color. And then just I guess more broadly as we think about the electrification opportunity, Jay, I think you've mentioned, the team has mentioned how pivotal of a year 2020 we're shaping out to be in terms of the awards activity pipeline that was going to be coming here in the next few quarters. Just curious if that pipeline is still full or if that is – if the industry is basically push that out 8 to 12 months as we deal with the current situation?

Yes. It's a very good question, Jason. Obviously, I think it's a question on the industry spend where this will be viewed as something that can be deferred to preserve capital. But so far all of the programs we're associated with particularly the largest program, the PACCAR program, it remains on schedule. I've had technical updates with the PACCAR team recently. Our products are performing extremely well and so we see no sign that our customers not too dissimilar from us are not continuing to prioritize that spend. And as Chris mentioned in one of his comments, this is one area with all the cost reductions we've made both on the CapEx and expense side. We are retaining our investments in electrification and we continually continue to respond to active code opportunities and still look at this year to be a very big year for us.

Thank you. Our next question comes from Ryan Brinkman with JPMorgan. You may proceed with your question.

Hi, good morning. Thanks for taking my question. Is there anything that you can relate about customer order books in the back half of the calendar year after lockdowns are presumably lifted? I'm sure their visibility is also low, but when you look across your various customers and your various end markets you know commercial and highway, off-highway, specialty trailer et cetera, are there notable differences and how you expect these end markets to bounce back or hold up.

And maybe I'll take this one Ryan, just you know as you can see that we're not giving much guidance beyond the next quarter. Again, it's from the perspective that we are seeing from our customers as well. But at a very high level, let's just break it down into maybe the three areas. And if you think about aftermarket and we've looked through last quarter as well as you know what we're seeing at least in the short-term window, aftermarket is obviously holding well you know when you think about 75% of the products that we use to travel by truck. The aftermarket seems to be holding strong. We see a slight weakening but nothing that's dramatic in the near future. Moving to the specialty defense of highway space. As I think Carl pointed out, we have noticed, you know, we did notice at the back end of that order board was getting weaker, we could say maybe about 20%, 30% but nothing of significance obviously consistent demand on that side and we got to see how that plays out. The truck market is obviously the big one as we see the customers coming up in April or late April and early May, that's where we're going to probably see what the real order boards come in. So, we – all the customers will be up of you know as we see most will be up as up May 4. So that would be probably a good time to see a perspective. But then breaking it up by region maybe I'll just address in that way China, you know as, as you all of you know I think we've seen a quick V and markets are back now whether that will hold up is all based on stimulus. And then India and South America are still under a pretty hard shut down and so time will tell how those two markets will come up. But in those two markets, inventories were low as you know with the FX. And the other two markets have addressed previously, I think we just have to see where our customers come back at.

Okay. Thanks. You know those are helpful rundown. Just lastly from me, why are you it looks like unwinding some of your factoring facilities. Can you remind us, was that something that was previously planned you know prior to your mention in that March 25 release? And does it relate to the various Volvo facilities mentioned in the K or the US one with P&C that I think has a covenant attached. I'm just asking because it would seem maintaining the facilities might help bolster liquidity in the current environment or am I missing something? Thanks.

Yes. Good morning, Ryan. It's Carl. Good question. You know I think that the factoring unwind is really – it's really that's a function of having a lot lower sales especially - really in Europe where we are utilizers of the supply chain financing program. So it's - if the unwind is just more, it's more natural because we're not able to sell receivables in normal course because the sales are a lot lower. The real impact is just because you have a timing mismatch as far as obviously the payables need to kind of run off in the working capital perspective. And you are unable to sell new receivables. So yes, it is consistent with what we kind of provided back in the March 25, March 25th 8-K that we put out as well.

Our next question comes from James Picariello with KeyBanc. You may proceed with your questions.

Hey. Good morning, guys. Just regarding your covenant, the total priority debt over, over trailing EBITDA, I mean it seems very encouraging how the EBITDA is calculated; you just to clarify this include the gain on the WABCO aftermarket sale now. Is that right? And then, has there been any change on that point? And then just based on your third quarter outlook that outlook clearly be the most challenged environment, is it safe to assume that the Meritor can now avoid any covenant breach over the next 12-months? Thanks, Jay and Carl.

Yes. Thanks, James. Yes. I mean I think what you're seeing from the WABCO income, yes, it is included in the trailing 12-month calculation. And so as I was highlighting that we're kind of carry through for the next really four quarters as well as we look to calculate the overall compliance to EBITDA. So as we look at what's in front of us not only third quarter but for the rest of this year, our expectation is we will not have any issues with our debt covenant and we feel that coupled with the overall liquidity of the company. So with the amount of cash on hand I think we're in a pretty good spot to be able to manage the current environment.

Okay. Yes. That's great to hear. And then just on that factor receivable the previous question, can that reverse partially by as early as the fourth quarter?

Yes. That's exactly right. And so that's how we're characterizing it. There is, we'll call it a one-time impact at a sales levels dropped significantly based on the lower production volume. But as the fourth quarter, if there is some pick up and production kind of comes back, you will see the cash benefits at that point in time.

Got it. And then it sounds as though you guys were not stepping off the accelerator in terms of future EV investment for this year. But just in terms of CapEx is a good starting point and assumption of maybe a similar level of your CapEx as a percentage of sales for this year-

I think that's early -

Or early to be?

That's a good way to think about. I think the last quarter that we had a guided about $115 million of CapEx. So it's probably closer in the $80 million, $85 million range at this point as we think for the remainder – for the full year. So that kind of around 3% is probably the right way to think about it.

Got it. And then my apologies if I missed this, did you mention the AxleTech contribution in the quarter, so just wondering on that point and then how the synergies are trending, does the current environment accelerate or maybe delay the synergy pull through.

No. I would say on the synergy side in AxleTech, we're coming in right on plan and actually we're looking and we feel very good with all the actions that we have been able to take since we acquired the company last year. You know there is a reference, obviously, we are seeing some softness in overall just revenue levels, specifically in the off-highway market, as well as in aftermarket. So overall the margin performance is still probably not where we want it to be, but a lot of that now is driven more on the revenue side as opposed to any of the cost actions that we've taken to date.

And what about the just the revenue contribution in the quarter.

Yes, it was about $43 million, so very consistent with what we saw in the first quarter as well.

Thank you. Our next question comes from Faheem Sabeiha with Longbow Research. You may proceed with your question.

Hi, good morning. Thanks for taking my question. I appreciate the guidance you are able to provide for FY 3Q and the additional color regarding the revenue breakdown but can you provide a little more color around Aftermarket, Industrial, and Trailer, I mean, then imply the sizable hit, and I know first talk about aftermarket coming down a little, just wondering if most of that's in Trailer or equally across all three parts of that business.

Good morning, Faheem. You know I think one of the things that's in there is the impact from the WABCO, agreement being, our distribution agreement being terminated and so prior to the crisis that was a probably a book of business about a $115 million. So you are seeing a headwind now in this quarter that we're in as well and that will continue on as we kind of go forward. So a significant piece of that really relates to that particular business.

Okay. And how much are you baking in from AxleTech acquisition in 3Q?

Well, again I would say, we've not kind of given line by line guidance on the revenue, but I would just say the first two quarters that we've seen this year in AxleTech has been running a little bit north of $40 million of revenue. And I would expect - we don't expect probably some little bit further softness for a period of time for that business.

Okay and then you commented a little on the visibility in the back half of the year, but as far as 3Q, I mean, you guys provided a pretty wide band and I'm just curious if that's based solely on orders received thus far as truck production restarts or if there could be some upside later in the quarter?

I think it's really almost entirely based on the lack of visibility on the OE manufacturing side. So if you take the business that your questions, Carl, you were just discussing the aftermarket business and Industrial that represents roughly a 50% of our expected revenue in that guidance. So if you took the remaining revenue, we have almost a 50% range of aftermath on the truck OE business. And I think that's very consistent with what we're hearing from our customers both in our private discussions and what you've heard them discussed publicly as they've released their earnings. It's just - it's a very opaque visibility window right now and after this quarter. And so that's why we put as wide range on revenue as we did. But understand this revenue estimate was important for us internally as well because it gave us the markers on which we have to manage the business to achieve our objectives of having the operating cash outflow be a very limited amount.

Yes. Okay. And as far as the 20% to 30% sequential downside earnings convergence, I mean, is that going to be balanced between commercial truck in aftermarket, industrial and trailer to one of those segments will look a little weaker?

I don't think where we're providing that level of guidance just given the volatility, I mentioned on the revenue outlook. But what I would make note of is included in that downside sequential guidance is the incremental cost of providing the safety materials that we need to ramp up our production such as masks, face shields, sanitary products, positional cleaning. So there is some incremental cost that's being incurred right now that's outside our norms in running the business.

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Todd Chirillo for any further remarks.

Thank you for joining our second quarter 2020 conference call. Please reach out to me directly with any questions. 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.