Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

 

Overview

 

Headquartered in Troy, Michigan, we are a premier global supplier of a broad range of integrated systems, modules and components to OEMs and the aftermarket for the commercial vehicle, transportation and industrial sectors. We serve commercial truck, trailer, military, bus and coach, construction, 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 2016 were $3,199 million , a decrease compared to $3,505 million in the prior year. The decrease was driven by lower production in the North America Class 8 truck market and South America and the effect of foreign exchange translation particularly in Brazil and Europe, partially offset by new business wins and increasing market volumes in India.

 

Net income attributable to Meritor for fiscal year 2016 and 2015 was $573 million and $64 million, respectively. The increase in net income attributable to Meritor was primarily driven by (i) a reversal of a portion of our valuation allowance in the U.S. resulting in a non-cash income tax benefit of $438 million in the current year; (ii) a $25 million income tax benefit related to other correlated tax relief; (iii) a $55 million pension settlement loss, net of tax in the prior year and (iv) a $24 million loss on debt extinguishment recognized in the prior year.

Adjusted EBITDA (see Non-GAAP Financial Measures below) for fiscal year 2016 was $327 million compared to $334 million in fiscal year 2015 . Our Adjusted EBITDA margin (see Non-GAAP Financial Measures below) in fiscal year 2016 was 10.2 percent compared to 9.5 percent in the same period a year ago. Despite lower revenue, Adjusted EBITDA margin increased as a result of (i) strong material, labor and burden performance, which continued to lower product costs year over year; (ii) lower year-over-year steel indices, which also reduced material costs; and (iii) insurance settlements and favorable insurance recoveries related to legacy asbestos liabilities (see Note 23 of the Notes to the Condensed Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data ). These more than offset the impact of lower Class 8 production volumes in North America and unfavorable foreign currency impacts on our EBITDA margin.

Net income from continuing operations attributable to the company for fiscal years 2016 and 2015 was $577 million and $65 million , respectively. Adjusted income from continuing operations attributable to the company for fiscal years 2016 and 2015 was $151 million and $159 million , respectively. See Non-GAAP Financial Measures below.

Cash flows provided by operating activities were $204 million in fiscal year 2016 compared to cash flows provided by operating activities of $97 million in the prior fiscal year. The increase is due in part to $52 million received related to insurance settlements for recoveries for defense and indemnity costs associated with asbestos liabilities in fiscal year 2016 (see Note 23 of the Notes to the Condensed Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data ), as well as $94 million used in fiscal year 2015 to fund a voluntary buyout of our German and Canadian pension plan obligations.

Valuation Allowance (VA)

In prior years, we established valuation allowances against our U.S. net deferred tax assets and the net deferred tax assets of our 100-percent-owned subsidiaries, including those in France, U.K. and certain other countries.

During the fourth quarter of fiscal year 2016, as a result of sustained profitability in the U.S., evidenced by a recent strong earnings history, future forecasted earnings, and additional positive evidence, we determined it was more likely than not that we will be able to realize a portion of our deferred tax assets. Accordingly, we reversed a portion of the valuation allowance in the U.S. resulting in a non-cash income tax benefit of $438 million .

During the fourth quarter of fiscal year 2016, due to a three-year cumulative loss and future economic uncertainty, we concluded that a valuation allowance was required in Brazil. This resulted in a non-cash charge to income tax expense of $9 million .

We continue to maintain valuation allowances in France, U.K. and certain other jurisdictions, as we believe the negative evidence that we will be able to recover these net deferred tax assets continues to outweigh the positive evidence. If, in the future, we generate taxable income on a sustained basis in jurisdictions where we have recorded valuation allowances, our conclusion regarding the need for valuation allowances in these jurisdictions could change.

Repurchase Authorizations

In June 2014, our Board of Directors authorized the repurchase of up to $210 million of our equity and equity-linked securities (including convertible debt securities), subject to the achievement of our M2016 net debt reduction target and compliance with legal and regulatory requirements and our debt covenants. During fiscal year 2016, we repurchased 8.7 million shares of common stock for $81 million (including commission costs) and all of our $55 million outstanding principal amount 4.625 percent convertible notes at 100 percent face value of the notes. In the aggregate under this authorization, we repurchased 12.8 million shares of our common stock for $136 million (including commission costs), $19 million principal amount of our 4.0 percent convertible notes due 2027, and all of our $55 million outstanding principal amount 4.625 percent convertible notes at 100 percent of the face value of the notes (see Note 18 of the Notes to Consolidated Financial Statements). The repurchase program under the $210 million authorization was complete as of September 30, 2016.

On July 21, 2016, our Board of Directors authorized the repurchase of up to $100 million of our common stock and up to $150 million aggregate principal amount of any of our debt securities (including convertible debt securities), in each case from time to time through open market purchases, privately negotiated transactions or otherwise, until September 30, 2019, subject to compliance with legal and regulatory requirements and our debt covenants. The amounts remaining available for repurchases under these authorizations were $100 million of our common stock and $150 million of our public debt securities, in each case as of November 30, 2016.