Overview

Meritor, Inc. (the "company" or "Meritor"), headquartered in Troy, Michigan, is a premier global supplier of a broad range of integrated systems, modules and components to original equipment manufacturers ("OEMs") and the aftermarket for the commercial vehicle, transportation and industrial sectors. The company serves commercial truck, trailer, off-highway, military, bus and coach and other industrial OEMs and certain aftermarkets. Meritor common stock is traded on the New York Stock Exchange under the ticker symbol MTOR.
Our sales for fiscal year 2012 were $4,418 million, down compared to $4,622 million in the prior year. We experienced a slowdown in sales volumes in all regions in which we operate compared to prior year volumes, other than in North America where the market remained strong. Income from continuing operations in fiscal year 2012 was $70 million, or $0.72 per diluted share, compared to $65 million, or $0.67 per diluted share, in the prior year. Net income for the year ended September 30, 2012 was $52 million compared to $63 million in the prior year. The decrease in net income is primarily due to lower sales, higher restructuring costs, charges related to remeasurement of asbestos-related liabilities and lower earnings from our unconsolidated joint ventures in South America, which were partially offset by improved gross margins, a gain associated with the sale of excess land at our facility in Cwmbran, Wales and a lower effective tax rate.

Adjusted EBITDA (see Non-GAAP Financial Measures below) for the fiscal year ended September 30, 2012 was $345 million compared to $347 million in fiscal year 2011. Our Adjusted EBITDA margin in fiscal year 2012 was 7.8 percent compared to 7.5 percent in the same period a year ago. The improvement in Adjusted EBITDA margin is due to key initiatives executed by the company during fiscal year 2012 including improved pricing and the sale of our St. Priest, France manufacturing facility, partially offset by lower sales.
On January 2, 2012, we completed the sale of our Commercial Truck manufacturing facility located in St. Priest, France to Renault Trucks SAS, an affiliate of AB Volvo. This transaction did not have a significant impact on our sales as production was absorbed by our remaining manufacturing facilities in Europe. During the first quarter of fiscal year 2012, we recognized non-cash charges of $19 million, including an asset impairment charge of $17 million for the disposal group, in connection with the then anticipated sale. In addition, other restructuring charges of approximately $5 million associated with employee headcount reduction and plant rationalization costs were recorded during fiscal year 2012.
During the second quarter of fiscal year 2012, we launched a European headcount reduction plan in response to the ongoing economic weakness and uncertainty in that region. We recognized approximately $7 million of restructuring charges associated with this plan, which was substantially complete at September 30, 2012. In addition, in November 2012, we announced a headcount reduction plan intended to reduce variable labor and other costs in response to market conditions in certain regions. Upon completion of this plan, we expect to eliminate approximately 425 hourly and salaried positions. We recognized approximately $5 million of restructuring charges associated with this action during the fourth quarter of fiscal year 2012. We also announced in November 2012 the consolidation of remanufacturing operations in our Aftermarket and Trailer segment resulting in the closure of one remanufacturing plant in Canada. Restructuring costs associated with these actions are expected to be approximately $18 million.
On November 12, 2012, we announced a revised management reporting structure resulting in two business segments: Commercial Truck & Industrial; and Aftermarket & Trailer. We will evaluate the impact of this revised reporting structure on our segment financial reporting in the first quarter of fiscal year 2013.

Cash flows provided by operating activities were $77 million in fiscal year 2012 compared to $41 million in the prior fiscal year. The increase in operating cash flows in fiscal year 2012 is due to improvements in working capital and lower usage of cash from discontinued operations compared to the prior year, which were partially offset by higher pension contributions.

Trends and Uncertainties

Production Volumes

The following table reflects estimated commercial truck production volumes for
selected original equipment (OE) markets based on available sources and
management's estimates.

                                                          Year Ended September 30,
                                                2012        2011      2010      2009      2008
Estimated Commercial Truck production (in
thousands):
North America, Heavy-Duty Trucks               296           224       147       129       194
North America, Medium-Duty Trucks              182           159       114       101       171
Western Europe, Heavy- and Medium-Duty
Trucks                                         389           405       265       252       562
South America, Heavy- and Medium- Duty
Trucks                                         168           204       174       118       161

We expect production volumes in North America and Europe to soften compared to the levels experienced in fiscal year 2012. Beginning in second quarter of fiscal year 2012, production volumes in South America declined significantly as the industry transitioned to tighter emission standard requirements for commercial vehicles. The recovery of production volumes has been slower than previously expected and we expect production volumes in South America to remain at such low levels during the first half of fiscal year 2013, with a modest improvement in the second half of fiscal year 2013. Production volumes in the Asia-Pacific region, more specifically China and India, have decreased compared to levels experienced in fiscal year 2011, and there is no certainty as to when these volumes will return to the levels previously experienced.

Sales for our primary military program were at their peak during the fourth quarter of fiscal year 2012. This program is expected to wind down over the next two years beginning in fiscal year 2013. We are working to secure our participation in new military programs with various OEMs. However, failure to secure new military contracts could have a longer-term negative impact to the company. In addition, even if sales of our military programs do return to historic levels, the levels of profitability on these sales could be lower than what we have recognized in recent periods. Industry-Wide Issues
Our business continues to address a number of other challenging industry-wide issues including the following:
• Uncertainty around the global market outlook;

• Volatility in price and availability of steel, components and other commodities;

• Disruptions in the financial markets and their impact on the availability and cost of credit;

• Higher energy and transportation costs;

• Impact of currency exchange rate volatility;

• Consolidation and globalization of OEMs and their suppliers; and

• Significant pension and retiree medical health care costs.

Other
Other significant factors that could affect our results and liquidity in fiscal year 2013 include:
• Significant contract awards or losses of existing contracts or failure to negotiate acceptable terms in contract renewal negotiations;

• Ability to manage possible adverse effects on our European operations, or financing arrangements related thereto, in the event one or more countries exit the European monetary union;

• Ability to work with our customers to manage rapidly changing production volumes;

• Ability to recover and timing of recovery of steel price and other cost increases from our customers;

• Any unplanned extended shutdowns or production interruptions by us, our customers or our suppliers;

• A significant deterioration or slowdown in economic activity in the key markets in which we operate;

• Higher than planned price reductions to our customers;

• Potential price increases from our suppliers;

• Additional restructuring actions and the timing and recognition of restructuring charges;

• Higher than planned warranty expenses, including the outcome of known or potential recall campaigns;

• Our ability to implement planned productivity, cost reduction, and other margin improvement initiatives; and

• Restrictive government actions by foreign countries (such as restrictions on transfer of funds and trade protection measures, including export duties and quotas and customs duties and tariffs).

NON-GAAP FINANCIAL MEASURES

In addition to the results reported in accordance with accounting principles generally accepted in the United States (GAAP), we have provided information regarding non-GAAP financial measures. These non-GAAP financial measures include Adjusted income (loss) from continuing operations and Adjusted diluted earnings
(loss) per share from continuing operations, Adjusted EBITDA, Adjusted EBITDA margin, Free cash flow and Free cash flow from continuing operations before restructuring payments.

Adjusted income (loss) from continuing operations and Adjusted diluted earnings
(loss) per share from continuing operations are defined as reported income or loss from continuing operations and reported diluted earnings or loss per share from continuing operations before restructuring expenses, asset impairment charges and other special items as determined by management. Adjusted EBITDA is defined as income (loss) from continuing operations before interest, income taxes, depreciation and amortization, non-controlling interests in consolidated joint ventures, loss on sale of receivables, restructuring expenses, asset impairment charges and other special items as determined by management. Adjusted EBITDA margin is defined as Adjusted EBITDA divided by consolidated sales. Free cash flow is defined as cash flows provided by (used for) operating activities less capital expenditures.

Management believes Adjusted EBITDA and Adjusted income (loss) from continuing operations are meaningful measures of performance as they are commonly utilized by management and investors to analyze ongoing operating performance and entity valuation. Management, the investment community and banking institutions routinely use Adjusted EBITDA and Adjusted EBITDA margin, together with other measures, to measure operating performance in our industry. Further, management uses Adjusted EBITDA for planning and forecasting future periods. In addition, we use Segment EBITDA as the primary basis to evaluate the performance of each of our reportable segments. Management believes that Free cash flow is useful in analyzing our ability to service and repay debt.

Adjusted income (loss) from continuing operations and Adjusted diluted earnings
(loss) per share from continuing operations and Adjusted EBITDA should not be considered a substitute for the reported results prepared in accordance with GAAP and should not be considered as an alternative to net income as an indicator of our operating performance or to cash flows as a measure of liquidity. Free cash flow should not be considered a substitute for cash provided by (used for) operating activities, or other cash flow statement data prepared in accordance with GAAP, or as a measure of financial position or liquidity. In addition, these non-GAAP cash flow measures do not reflect cash used to service debt or cash received from the divestitures of businesses or sales of other assets and thus do not reflect funds available for investment or other discretionary uses. These non-GAAP financial measures, as determined and presented by the company, may not be comparable to related or similarly titled measures reported by other companies. Set forth below are reconciliations of these non-GAAP financial measures to the most directly comparable financial measures calculated in accordance with GAAP.

Adjusted income from continuing operations and Adjusted diluted earnings per share are reconciled to income from continuing operations and diluted earnings per share below (in millions, except per share amounts).

                                                Year Ended September 30,
                                              2012          2011       2010
Adjusted income from continuing
operations                                 $    111       $   82     $   18
Restructuring costs                             (39 )        (22 )       (6 )
Gain on sale of property                         16            -          -
Asbestos-related liability remeasurement        (18 )          -          -
Gain on settlement of note receivable             -            5          6
Loss on debt extinguishment                       -            -        (13 )
Income tax benefit                                -            -          9
Income from continuing operations          $     70       $   65     $   14
Adjusted diluted earnings per share from
continuing operations                      $   1.14       $ 0.85     $ 0.21
Impact of adjustments on diluted earnings
per share                                     (0.42 )      (0.18 )    (0.05 )
Diluted earnings per share from continuing
operations                                 $   0.72       $ 0.67     $ 0.16

Free cash flow and Free cash flow from continuing operations before restructuring payments are reconciled to cash flows provided by operating activities below (in millions).

                                                        Year Ended September 30,
                                                      2012           2011       2010
Cash provided by operating activities -
continuing operations                              $     89       $     98     $ 147
Capital expenditures - continuing operations            (89 )         (105 )     (55 )
Free cash flow - continuing operations                    -             (7 )      92
Cash provided by (used for) operating activities -
discontinued operations                                 (12 )          (57 )      64
Capital expenditures - discontinued operations            -             (6 )     (34 )
Free cash flow - discontinued operations                (12 )          (63 )      30
Free cash flow - total company                     $    (12 )     $    (70 )   $ 122
Free cash flow - continuing operations             $      -       $     (7 )   $  92
Restructuring payments - continuing operations           22             13        14
Free cash flow from continuing operations
before restructuring payments                      $     22       $      6     $ 106

Adjusted EBITDA is reconciled to net income attributable to Meritor, Inc. in "Results of Operations" below.

Results of Operations

The following is a summary of our financial results for the last three fiscal years.

                                                               Year Ended September 30,
                                                       2012                2011              2010
                                                       (in millions, except per share amounts)
Sales:
Commercial Truck                                 $        2,717       $      2,806       $    1,960
Industrial                                                1,001              1,113              951
Aftermarket & Trailer                                     1,011              1,020              909
Intersegment Sales                                         (311 )             (317 )           (290 )
SALES                                            $        4,418       $      4,622       $    3,530
SEGMENT EBITDA:
Commercial Truck                                 $          190       $        171       $       85
Industrial                                                   68                 74               94
Aftermarket & Trailer                                        93                113               83
SEGMENT EBITDA                                              351                358              262
    Unallocated legacy and corporate costs, net
(1)                                                          (6 )              (11 )             (2 )
ADJUSTED EBITDA                                             345                347              260
Interest expense, net                                       (95 )              (95 )           (106 )
Provision for income taxes                                  (56 )              (77 )            (48 )
Depreciation and amortization                               (63 )              (66 )            (69 )
Restructuring costs                                         (39 )              (22 )             (6 )
Loss on sale of receivables                                  (9 )              (10 )             (3 )
Gain on sale of property                                     16                  -                -
Asbestos-related liability remeasurement                    (18 )                -                -
Other, net                                                    -                  5                -
Noncontrolling interests                                    (11 )              (17 )            (14 )
INCOME FROM CONTINUING OPERATIONS, attributable
to Meritor, Inc.                                             70                 65               14
LOSS FROM DISCONTINUED OPERATIONS, net of tax,
attributable to Meritor, Inc.                               (18 )               (2 )             (2 )
NET INCOME attributable to Meritor, Inc.         $           52       $         63       $       12
DILUTED EARNINGS (LOSS) PER SHARE, attributable
to Meritor, Inc.
Continuing operations                            $         0.72       $       0.67       $     0.16
Discontinued operations                                   (0.18 )            (0.02 )          (0.02 )
Diluted earnings per share                       $         0.54       $       0.65       $     0.14
DILUTED AVERAGE COMMON SHARES OUTSTANDING                  97.2               96.9             87.6

(1) Unallocated legacy and corporate costs, net represents items that are not directly related to our business segments. These costs primarily include pension and retiree medical costs associated with recently sold businesses and other legacy costs for environmental and product liability. In fiscal year 2010, we recognized approximately $7 million of income as a result of the pension curtailment triggered by the freeze of our U.K. pension plan, of which $6 million is included in unallocated legacy and corporate costs, net.

Fiscal Year 2012 Compared to Fiscal Year 2011
Sales
The following table reflects total company and business segment sales for fiscal
years 2012 and 2011. The reconciliation is intended to reflect the trend in
business segment sales and to illustrate the impact that changes in foreign
currency exchange rates, volumes and other factors had on sales (in millions).
Business segment sales include intersegment sales (in millions).
                                                                      Dollar Change Due To
                                               Dollar       %                         Volume
                        2012        2011       Change    Change      Currency        / Other
Sales:
Commercial Truck      $ 2,717     $ 2,806     $  (89 )     (3 )%   $     (123 )     $     34
Industrial              1,001       1,113       (112 )    (10 )%          (24 )          (88 )
Aftermarket & Trailer   1,011       1,020         (9 )     (1 )%          (23 )           14
Intersegment Sales       (311 )      (317 )        6       (2 )%           21            (15 )
TOTAL SALES           $ 4,418     $ 4,622     $ (204 )     (4 )%   $     (149 )     $    (55 )

Commercial Truck sales were $2,717 million in fiscal year 2012, down 3 percent from fiscal year 2011. The effects of foreign currency exchange rates decreased sales by $123 million compared to prior year. North American industry-wide production volumes for heavy- and medium-duty trucks increased by approximately 25 percent in fiscal year 2012 as compared to the prior year. However, the increase in sales in North America associated with the higher production volumes was substantially offset by lower sales in South America and Europe as industry-wide production volumes in these regions decreased by approximately 18 percent and 4 percent, respectively, compared to the same period in the prior year. In South America, the industry transitioned to tighter emission standard requirements for commercial vehicles resulting in lower production volumes beginning in our second quarter of fiscal year 2012. The recovery of production volumes in South America has been slower than previously expected, and we expect these production volumes to be lower in the first half of fiscal year 2013 compared to the first half of fiscal year 2012.
Industrial sales were $1,001 million in fiscal year 2012, down from $1,113 million in fiscal year 2011. The decrease in sales was due to lower sales in the Asia-Pacific region, primarily China and India, and lower sales from Caiman and other non-FMTV defense programs as compared to the same period in the prior year, partially offset by higher sales in our FMTV defense program.
Aftermarket & Trailer sales were $1,011 million in fiscal year 2012, slightly down from $1,020 million in fiscal year 2012. The decrease in sales is primarily due to the impact of foreign currency translation, which decreased sales by $23 million compared to the prior year. Excluding the effects of foreign currency, sales increased by $14 million primarily due to higher sales of aftermarket and trailer products in North America, partially offset by lower sales of aftermarket products in Europe.
Cost of Sales and Gross Profit
Cost of sales primarily represents materials, labor and overhead production costs associated with the company's products and production facilities. Cost of sales for the fiscal year 2012 was $3,933 million compared to $4,146 million in the prior year. The decrease in costs of sales is primarily due to lower sales, which decreased by 4 percent, and the lower fixed costs resulting from the rationalization of our European manufacturing footprint as well as improvements in our operations. Total cost of sales was approximately 89.0 percent of sales in fiscal year 2012 compared to 89.7 percent in the prior year.
The following table summarizes significant factors contributing to the changes in costs of sales for the fiscal year 2012 compared to prior year (in millions):

                                      Cost of Sales
Fiscal year ended September 30, 2011 $       4,146
Volume, mix and other, net                     (79 )
Foreign exchange                              (134 )
Fiscal year ended September 30, 2012 $       3,933

Changes in the components of cost of sales year over year are summarized as follows (in millions):

Lower material costs             $ (147 )
Lower labor and overhead costs      (65 )
Other                                (1 )
Total decrease in costs of sales $ (213 )

Material costs represent the majority of our cost of sales and include raw materials, composed primarily of steel and purchased components. Material costs for the fiscal year 2012 decreased by approximately $147 million compared to last year, primarily as a result of lower sales.
Labor and overhead costs decreased by $65 million compared to the prior fiscal year. The decrease was primarily due to lower sales compared to the prior year. In addition, savings associated with the rationalization of our European manufacturing operations, including the sale of the St. Priest, France facility, as well as continuous improvement initiatives contributed to the decrease in labor and overhead costs.
As a result of the above, gross profit for the fiscal year 2012 was $485 million compared to $476 million in 2011. Gross margins increased to 11.0 percent for fiscal year 2012 compared to 10.3 percent in the prior year. Other Income Statement Items
Selling, general and administrative expenses (SG&A) for the fiscal years 2012 and 2011 are summarized as follows (in millions):

                                   2012                          2011                    Increase (Decrease)
SG&A                       Amount       % of sales       Amount       % of sales
Loss on sale of
receivables             $        9          0.2 %     $       10          0.2 %     $       (1 )                -
Short- and long-term
variable compensation           23          0.6 %             27          0.6 %             (4 )                -
Charge for legal
contingency                      6          0.1 %              -            - %              6            0.1 pts
Asbestos-related
liability remeasurement         18          0.4 %              -            - %             18            0.4 pts
All other SG&A                 229          5.2 %            241          5.2 %            (12 )                -
Total SG&A              $      285          6.5 %     $      278          6.0 %     $        7            0.5 pts

Included in selling, general and administrative expenses in fiscal year 2012 are $6 million of charges for a legal contingency. In fiscal year 2012, the company recognized an $18 million charge associated with the valuation and remeasurement of asbestos-related liabilities (see Critical Accounting Policies below). All other SG&A represents normal selling, general and administrative expenses.
Restructuring costs of $39 million were recognized during the fiscal year ended September 30, 2012 compared to $22 million in the prior year. Restructuring costs in the fiscal year 2012 include $24 million recognized in our Commercial Truck segment in connection with the January 2012 sale of our St. Priest, France manufacturing facility to Renault Trucks SAS. These costs included non-cash charges of $19 million recognized in the first quarter of fiscal year 2012, of which $17 million relate to impairments of assets held for sale at December 31, 2011. In addition, in fiscal year 2012, we recognized $5 million of costs associated with employee headcount reductions and facility rationalization actions. During the second quarter of fiscal year 2012, we approved a European headcount reduction plan in response to the ongoing economic weakness and uncertainty in that region and recognized approximately $7 million of restructuring costs associated with this plan in fiscal year 2012. During the fourth quarter of fiscal year 2012, we recognized approximately $5 million of costs associated with employee headcount reductions. The remaining restructuring costs recognized during the fiscal year 2012 were primarily associated with the company's previously announced executive headcount reduction. In fiscal year 2011, we recognized $16 million of restructuring charges primarily associated with employee headcount reductions at our St. Priest, France manufacturing . . .