Q2 2021 Meritor Inc Earnings Call
Good day, and thank you for standing by and welcome to the Q2 2021 Meritor, 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 one on your telephone please be advised that today's.
<unk> conference is being recorded if you require any further assistance. Please press star Zero I would now like turn the conference over to Todd Schull reload the senior director of Investor Relations. Thank you. Please go ahead Sir.
Thank you Felicia and good morning, everyone and welcome to Meritor second quarter fiscal year 2021 earnings call on the call today, we have Chris Bill of Orion, CEO, and President and Carl Anderson, Senior Vice President and Chief Financial Officer.
The slides accompanying today's call are available at meritor dotcom well refer to the slides in our discussion this morning.
Content of this conference call, which we're recording is the property of Meritor, Inc.
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 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 and non <unk>.
It's on our website.
Now I'll turn the call over to Chris. 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.
Cash flow performance was excellent this quarter coming in at 47 million. This was one of our highest second quarter cash flow is since we began the implants 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 maintained 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 and electric powertrain 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 lateral vacation program to announce this quarter.
In addition to an exciting new opportunity to accelerate development of our 17 ex E 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 long standing relationship with Navistar as it becomes part of debt trading family.
This agreement extends our current relationship while providing opportunity for future growth in our major product categories of axles brakes and driveline. We also completed a new agreement with Iveco in Europe through 2024 day.
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 tobacco complete most of our long term agreements with major customers have been renewed well past the 2022.
Time frame.
Moving to electrification on slide five we are pleased to announce a new collaboration with hexagon purest systems, a global leader in zero emission mobility hexagon will integrate meritor 14 ex E powertrain into its class six class seven box trucks and class eight.
By Forbes vehicles, starting 2021.
Customers, including Pac car Autocar Lion electric volt, our trucks and hexagon have chosen meritor, 14th Z integrated electric powertrain. We believe this is market validation of its industry leading performance.
In early 2020, we announced an agreement with Pac car to be the initial launch partner and supplier for the integration of the fully functional battery electric systems on the Kenworth <unk> hundred 80, and Peterbilt 579, and $5 20 electric vehicles, we have begun prototype production and Packer.
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 preferreds electric powertrain solutions will be fully operation on roads and highways. Please take a minute to view a video of this truck in motion on Meritor Dot com.
This footage was shot last week at our Escondido, California facility.
With market adoption growing for our 14 ex D. We're now shifting the focus to the development of the 17 ex Z 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 17 Z.
After a comprehensive months long nomination and consideration process, we were thrilled to be selected along with our consortium partners Danfoss at a tron and electric 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 a meritor E powertrain solutions for the European market.
We believe demand for this product will grow because of the EU 2025 C. O two reduction targets stricter targets, we'll 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 17 ex E is another significant step towards completing our electric powertrain portfolio.
Carl will now provide more detail on our financial results.
Thanks, Chris and good morning on today's call I'll 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 the SEC guidance, we will no longer include non-GAAP measures the adjustment for noncash tax expense related to the use of deferred tax assets in jurisdictions with net operating loss carryforwards or tax credits. It is important to note. This is a change to our reporting metrics only as the underlying availability.
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 M 2022 planning cycle.
In the appendix we have also updated prior periods to reflect this change providing for consistent comparative.
Now, let's review the details of our financial results.
Beginning with total company revenue came in at $983 million up $112 million from the same period last year as the economies rebounded globally. We saw increased truck production in all of our markets.
Net 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 and 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 year 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 debt.
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 <unk> 68 up four 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 onetime 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 two five per cent 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-19. We were also on track for net leverage to be approximately two times this year and plan for 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 four per cent and 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 a distribution arrangement and increased incentive compensation costs, partially offset by cost reduction actions.
Before I review, our current global Mark 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 of 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 day manufacturer in the short run.
Demand, however remains high and all of our markets in particular order activity in the North America class eight market continues to be robust averaging over 40000 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 eight for an update to our fiscal year 2021 outlook.
Consistent with our market assumptions, we are holding forecasted sales to be in the range of $3 six 5% to $3 8 billion unchanged from our prior forecast.
We're also maintaining our adjusted EBITDA margin guidance steady at an expected range of $10 six to 10, 8%.
We are however, seeing steel costs continued to increase since September hot rolled coil prices have increased more than 130% and scrap prices are up nearly 100 per cent. 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 our full year headwind of $25 million to $30 million and higher steel costs up $10 million from our prior view.
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 2020. One we do have 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 in 2022.
Additionally, we are increasing our electrification spend between $5 million 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 lower interest expense expected from the bond redemption.
Our effective cash tax rate of approximately 15% in fiscal 'twenty, one remains unchanged and finally, we are maintaining our expectation to generate between $110 million to $125 million of free cash flow.
Overall, the team is doing a fantastic job managing through the challenges of the strong global rebound and deliver a solid glide path to end 2022, now I will turn the call back over to Chris.
Thanks, Carl let's turn to slide nine.
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 M. 2025, we will move of course, we will of course closely monitor the situation as we move closer to this day.
To ensure we can meet safely beef.
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.
Todd sorry, with our colleagues and their families. During this crisis.
I want to thank you for joining us today to review Meritor second quarter results and welcome any questions. You may have at this time.
And as a reminder to ask a question you would need to press star one again for a question that is star one and we'll pause for a moment to compile the Q&A roster.
Yeah.
And your first question comes from the line of James Picariello of Keybanc.
Hey, good morning, guys. Good morning, James Good morning.
Just within the company's reiterated guy.
Reiterated got city or you're now anticipating what was I think referred to as record commodity inflation in the back half for it not surprisingly but.
Can you help quantify what the net headwind exposure is relative to what will likely flow through you know within your recovery mechanism just to get a sense that net debt net exposure 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 a year over year about 25.
5% to 30 million dollar headwind in fiscal 'twenty one.
So if you think about the recovery mechanisms as that begins to kind of flow through that will come through but really beginning in fiscal the first part of fiscal 2022, and so all of that we would expect to be recovering around probably $20 million of that number as we go forward.
Okay.
Really helpful.
Just from an industry standpoint, focusing on the North American market for a second I mean.
Again from an industry standpoint, we're trying to get near record order levels.
This year.
Industry backlogs are also going to be at.
Or close to all time highs.
Are you seeing anything unique in terms of you know.
Builds build commitments build slot commitments for for next year at this point because it seems as though we're gonna be especially given the debt.
Temporary chip shortage impacts, which I think are also proving to be more muted.
It just seems like we're.
We're on track for a really really really strong volumes next year for sure James I'll take that so when you think about it.
It's beyond the last three months if you look at it the last six months order intake has come in at 40 or about 40 and to your point backlogs are passing of I believe 300000 and for our fiscal year right now the midpoint with the recent change is.
It's 285000 for the physical between AC TNF T R and if you look at the midpoint for next year for the heavy market. It said about 340, so to your point.
Great highs and you got to believe that Texas storms resolved.
As well as.
The fire in Japan, So it's 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 we shouldnt probe. So again, we believe Theres a strong 2022 ahead of us as well.
Got it but I can just squeeze one more in.
Within the aftermarket and industrial segment.
This quarters, the second quarter's margins was there anything within that related to the timing of price increases or.
A premium freight just any any color on.
That segment's margins 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 cost from steel that affected the aftermarket business.
Thanks.
Thank you.
Your next question comes from the line of Joseph Spak of RBC capital markets.
Thank you appreciate it.
So I.
I think you know just to maybe 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 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 decrementals are a little bit higher than normal given some of the headwinds and then you can start to get some of the recovery mechanisms back next year that reverts I think that's the right way to think about it Joe.
If you look at the six months EBITDA margin performance to date or right around 11, 4%. So if you think what our guide is up 10, 6% to 10 eight that does imply the second half margins will be about 10% on roughly the same type of revenue.
Alright.
Okay. Thank you.
You for that.
Just a bigger picture question on electrification I know you have to.
You know you're humping up in the spend again here or.
In the past when you've talked about that it's really sort of into <unk>.
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.
Can you talk at all about your ability to attach.
Other meritor products like maybe disc brakes for instance, like when you.
E axle wins like is there a pretty high.
Attach rate for Meritor, one one even when youre able to do that.
Absolutely, Joe, but I'll start with the first question first I think glad to see the backlog continuing to grow as you remember we talked about having this $500 million.
Target for electrification has our revenue pipeline, we accomplished $400 million of that with the 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 to put it in perspective of spend 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 million 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 were.
With more customers.
To your second question.
The ability to attach components, absolutely, we do see a path with brakes as primarily with brakes.
With many of the customers as an opportunity to grow the business as well.
But when you upped your electrification back office I mean, those associated price I'm, assuming are not in that so is it fair to us from that.
The other side in your backlog.
Is being benefited by the electrification wins 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 it.
The new entrants, we have a significant shortage of share.
The existing pipe.
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 it 14 ex E. For example, so we're already seeing that growth as well.
Okay.
Carl maybe just a quick one on thanks for the color on this tax rate and sort of the change in guidance I think he used to sort of point to.
Mid teens with the way you sort of adjusted so should we model something more like 20 per cent and in the outer years now given given the change well I think it's Joe to that point, it's 15% definitely through 2022, I think once you start getting past 'twenty. Two you got to 'twenty three 'twenty four it could begin to moderately step ups.
So probably not too far off with that assumption.
Thanks very much thank you.
Your next question comes from the line of Ryan Brinkman of J P. Morgan.
Hi, Good morning, this bad from onboard JP Morgan for Ryan and I. Thank you for taking my question I just have two questions. The first one what is your view on the impact of higher labor cost to monogenetic production started to come back.
On a sad note how are you seeing freight costs progressing through the rest of the year I know what someone.
Aftermarket last week said something about the freight costs could be two or three times higher than day seeing right now so how much impact from margin.
Do you expect this headwind and and what are some backyard. They can be used to offset the impact. Thank you.
Absolutely. So let me start with the first question specific to labor, it's a red hot market out there as you could 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 piece being strong in consumer spending.
No.
In essence, we were able to drive that.
That some of that.
Recoveries specific to that with some of our customers. However on top of that it's really about operational performance, that'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 costs to your point, whether its on ocean or internal as well and for those elements. What we are again doing is trying to offset a lot of that with.
With mature I would sorry with material performance than operational performance, but on top of that we also look at working with our customers as well.
I'm sorry to ask so this is Larry Kaufman everything auto do you factor in the guidance right.
Yes, it is yes and to add to our Chris said as we look Eric 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 the what we're seeing is kind of just the basic run rate with cost today is all factored into ours.
Items.
Thank you. Thank you very helpful and my second question is on the on that.
The RV business. So the RV demand has been very strong the last few months and just Nick morning, and RV dealer up there our adjusted EBITDAR guidance at materially can you talk about the opportunity for growth in this area of the business and I think last quarter. You mentioned, some you mentioned something about an.
And suspension with wheels and motors for RV. Then if you can please just give any update on that thank you. So absolutely. So the industrial specialty and off highway markets are incredibly important for US. This is why we did the axle tech and <unk> acquisitions, two years ago, and so where we are.
The fruits of those acquisitions as we think through 2022 and our as we look at our revenue pipeline growth. When we think about the core business and as we have talked about exceeding our revenue targets for 'twenty. Two it's a lot of it is coming in our industrial defense and specialty business in its prime 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 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 electric platform that acquires accomplishes the same thing as well for the RV space.
Thank you so much for taking my question.
Your next question comes from the line of boost channel platform.
Hey, Good morning. This is Matt My Alaska entrepreneurs Chen.
Good morning, Matt.
Good morning, with regards to higher freight costs.
You mentioned one of the mitigating things that Youre doing is working with customers any additional color, we can get around there and how those conversations might be going.
Sure I think when we at this point, we are working with customers that we have agreements in certain regions.
And as you could imagine they are hard agreements and day, they take a while to work through and it's a it's a discussion that we are working through and we are seeing the benefits in some areas.
Thanks, a lot.
Thank you.
And your next question comes from the line of each day Mccalley LCD.
Good morning, everybody just two quick ones from me first just talk about.
But housekeeping.
Capex and it looks like it's still kind of running below.
The full year and I think I think the original plan for the cumulative Capex through 2022 was about 475 million standard curious whether youre seeing efficiency there if that's just.
Timing.
Good morning, Utah, 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.
Great that's helpful color.
Adjusted to the prior questions, but just as we think about that bridge from the second half margins to get to the 2022 targets. I think you mentioned some of the recoveries on steel, but you just maybe walk us through some of the bigger kind of puts and takes in terms of what at least at least somewhat from the headwinds.
Today, there are contractually go into kind of reverse next year, particularly on the steel side.
The biggest thing we're seeing when you really boil it down is really on steel so as I referenced the $25 million to $30 million headwind is really a second half story for us so while freight costs, what we've talked about or have an increase in our elevated from kind of what they have been historically our material performance in some of our operational performance.
Its items have been able to offset that so there's true stories deal and if you were to simply adjust for the steel of $25 million to $30 million.
Our margins would be very similar to what they are here in the first the first and second quarter.
Got it perfect. That's very helpful. Thanks. Thank you.
And there are no further questions at this time and I'll turn the call back over to Todd.
Great. Thank you and thank you everyone for joining our call. The day. If you have any questions. Please feel free to reach out to me directly. Thank you and have a great day.
And this concludes today's conference call. Thank you for participating you may now disconnect.
Yeah.
Yeah.