Tsakos Energy Navigation Limited
Q1 2017 Earnings Call Transcript

Published: 2 May 2017

[Operator:]

Thank you for standing by and welcome to Tenneco's First Quarter 2017 Earnings Release Conference Call. At this time, all participants will be in a listen-only mode until the question-and-answer session of today's conference. This call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Ms. Linae Golla. You may begin, ma'am.

[Linae Golla:]

Thank you. Good morning and welcome. This morning we released our first quarter 2017 earnings and related financial information. On our call today to take you through the results are Gregg Sherrill, Chairman and CEO; Brian Kesseler, Chief Operating Officer; and Ken Trammell, Chief Financial Officer. The slides related to our prepared comments are available on the Investors section of our website. After our comments, we will open up the call for questions. Before we begin, I need to tell you that our discussion today will include information on non-GAAP financial measures, all of which are reconciled with GAAP measures in our press release attachments. Earnings release and attachments can be found on our website. Additionally, some of our comments will include forward-looking statements. Please keep in mind that our actual results could differ materially from those projected in any of our forward-looking statements. And with that, I'll turn the call over to Gregg.

[Gregg M. Sherrill:]

Thank you, Linae, and good morning, everyone. Our performance this quarter reflects the strong balance we have across our operations with contributions from both product lines and across diverse end markets, customers, vehicle platforms and geographic regions. Having a diversified portfolio across so many dimensions is a competitive advantage and helps drive consistent results. With this balance, a consistent strategic focus and alignment around strategies for each product line, we delivered another quarter of profitable growth, giving us a good start toward achieving our goals for the year. Light vehicle industry production in the quarter strengthened versus what we anticipated earlier this year largely due to stronger production in China, India and South America. For commercial truck and off-highway combined, industry production was in line with our expectations including stronger commercial truck production and continued weakness in North American off-highway production. Against this landscape, the Tenneco team delivered another record quarter with our highest-ever first quarter revenue and record highs for EBIT, EBITDA, net income and earnings per share both reported and on an adjusted basis. Now looking first at our revenue growth on slide 5. We have a 10-year history of outpacing industry production and were off to a good start building on that trend with revenue growth of 9% in constant currency versus better-than-expected industry growth of 6%. This growth also shows good traction in both product lines with Clean Air revenue up 10% and Ride Performance up 7% compared with last year. Behind our success in growing faster than the industry are proven sustainable growth drivers. We have a strong position on light vehicle platforms globally with a strong mix of platforms and customers. We continue to have today and well into the future significant potential and regulatory-driven Clean Air content particularly in emerging markets. There is an increase in demand for our advanced suspension systems, which we're seeing in our results. And we have a strong position in the global aftermarket, which continues to be a steady contributor with outstanding growth potential ahead particularly in the Asia Pacific region. Breaking down revenue by end markets, our light vehicle revenue growth was up 11% on the strong platform mix I just mentioned. We also had a strong increase in commercial truck revenue, up 15% versus industry growth of 5%, largely driven by higher commercial truck volumes in China. Off-highway revenue was about even with the year-ago reflecting higher revenue in Europe but offset by continuing weak industry conditions in North America. And finally, global aftermarket revenue was roughly in line with last year. Now turning to slide 6 and our record high earnings. On an adjusted basis, EBIT was up 11%. Net income was up 24% and we had a 31% increase in earnings per share. All very positive results. We continued to drive profitability with a 30 basis point EBIT margin improvement at 8.8%. Again, the strong balance in our business carried through to this quarter's earnings. In the Asia Pacific and Europe and South America segments, we leveraged stronger volumes on light vehicle, commercial truck and off-highway programs and drove operational improvements. All of this drove EBIT improvement in the quarter and more than offset unfavorable mix and the timing of customer recoveries in North America. Before I hand this over to Brian, just a quick comment on antitrust. As we have previously disclosed, we are taking steps to minimize our potential exposure in the global antitrust investigation. As noted in the 8-K we filed on Friday, the European Commission notified us that they have closed their antitrust inquiry of exhaust companies. This is of course very good news. It follows the announcement in 2014 when we informed you that the United States Department of Justice granted Tenneco conditional leniency. Going forward, there is still civil litigation that must be resolved. And there are several other jurisdictions that are in less significant regions of our global operations where there are still ongoing investigations. Of course, we continue to fully cooperate in all of these investigations. In closing, I want to thank our employees for delivering another strong quarter. They consistently deliver on commitments with an intense focus on continuous improvement. Just in the last six weeks, I visited facilities in Japan, China, Belgium, Poland, Canada and here in the United States. And what always strikes me is the pride I see in Tenneco and their enthusiasm for the future. Our global team is truly the cornerstone of our success. It is aligned, executing well and continuing to move Tenneco forward. And with that, I'll turn the call over to Brian.

[Brian J. Kesseler:]

Thanks, Gregg. Good morning, everyone. Before I get into the results, I want to remind everyone that this is the first quarter when our results reflect a change in our reporting segments with India Clean Air and Ride Performance now reported as part of our Asia Pacific product line segments, having been previously reported with Europe and South America. Now turning to more detail on Clean Air and Ride Performance, keeping in mind that value-add revenues are at constant currency. Beginning with Clean Air on slides 8 and 9. Our total Clean Air revenue was up 10% powered by our light vehicle business with regulatory-driven content on strong selling platforms. In North America, Clean Air revenue was up 9%, largely driven by a 15% increase in light vehicle revenue compared with industry growth of 3%. Our growth was mainly on current platforms, which highlights our strong platform mix. Some of the vehicles driving revenue this quarter were SUVs such as the GMC Acadia, Enclave and Traverse and the Dodge Journey; pickup trucks including the Ford Super Duty and Chevy Silverado; and passenger car models such as GM's Malibu, Impala, and LaCrosse as well as the VW Jetta and Passat. We had great vehicle growth in the quarter and a slight increase in commercial truck revenue. However, weak industry conditions continued to affect our off-highway revenue with lower year-over-year volumes on those programs. Turning to the Europe and South America Clean Air segment, where revenue was up 15% with very positive contributions from both light vehicle and commercial truck and off-highway programs. Looking first at light vehicle, revenues were up 16% on growth in both regions. We had higher volumes on recently launched platforms in Europe including the Renault X82 van, Land Rover Discovery SUV and on several Jaguar models including the F-PACE crossover and the XE and XF sedans. In South America, we saw some recovery in the region with stronger volumes on our current platforms. And we benefited from the launch of new programs with FCA, GM and VW. In Europe, we had a very strong increase in off-highway revenue mainly driven by higher volumes on existing platforms with Caterpillar. And commercial truck revenue was also up slightly in the quarter which together combined for a 20% revenue increase versus last year. Finally, in the Asia Pacific Clean Air segment, revenue was up 4% driven by a 48% gain in commercial truck and off-highway revenue. The strong performance was mainly due to higher volumes on our commercial truck programs in China. India also contributed as incremental content continues to ramp up to meet the Bharat Stage IV standards. Now turning to Clean Air earnings and margin performance. Adjusted EBIT was up 7% to $119 million. Value-added adjusted EBIT margin was 11%, which was even with last year's performance. We're doing a good job leveraging higher volumes on our light vehicle platforms in the Europe and South America and Asia Pacific segments where we continue to drive greater operational efficiencies. We also benefited from strong increases in commercial truck and off-highway revenue in those segments. In North America, we continue to face weak off-highway industry conditions, which were down 15% working against the positive gains from stronger light vehicle volumes. In addition, at the beginning of the quarter, producers in South Africa took four mines out of production resulting in a sudden and unusual spike in alloy costs and created a timing issue on our contractual recoveries. We will recover these costs over the next several months and without this unusual recovery timing, we saw a sequential improvement in North American margins. So to summarize Clean Air, we had a strong light vehicle revenue growth, commercial truck and off-highway revenues were up significantly in Europe and Asia Pacific, with strong commercial truck growth in China and we continue to see weak volumes on our off-highway programs in North America. Excellent margin performance in the Europe and South America and Asia Pacific segments offset margin impact from weak off-highway volumes and the timing of alloy surcharge recoveries in North America. Concerning now the Ride Performance results in slides 10 and 11, revenue was up 7% driven by strong performances in the Europe and South America and Asia Pacific segments. In North America, Ride Performance revenue reflected stronger light vehicle growth versus last year and the impact of lower customer production on our commercial truck programs. In the after-market sales, we're 8% lower than last year, but in line with the market of our products if you take out the impact of last year's Car Quest inventory load. The Europe and South America segment had a strong quarter with revenue up 16% as we continue to see stronger light vehicle volumes on programs with VW, Jaguar Land Rover, PSA and Renault. We also had strong contributions from commercial truck programs and aftermarket Ride Performance growth in both Europe and South America. Finally, in the Asia Pacific segment, strong Ride Performance growth continued with revenue up 25%, driven by light vehicle revenue gains in China and India. In China, we had very strong volumes on current platforms including with FBW, SGM, and Fiat Chrysler. Now, turning to Ride Performance earnings and margin performance, adjusted EBIT declined 5% to $60 million and adjusted EBIT margin was 9.1%. Our lower aftermarket revenue and weak commercial truck volumes in North America worked against us this quarter with a negative impact on our overall Ride Performance margin. On the positive side, we're doing a good job leveraging strong revenue growth and driving operational efficiencies in the Asia Pacific region. So, to recap Ride Performance, we had a strong top line growth in the Europe and South America and Asia Pacific segments. The Asia Pacific team did an excellent job converting on their strong revenue growth. And Ride Performance EBIT margin was impacted by the negative revenue mix in North America. In summary, we're executing our growth plans to drive revenue growth in both product lines and our diversified profile is providing balance and helping drive consistent results. Strong performances in Europe and Asia Pacific segment and the lower corporate expense is more than offset some noise in North America and drove overall margin improvement. With that, I'll turn the call over to Ken.

[Kenneth R. Trammell:]

Thanks, Brian, and good morning. I'll start with the first quarter adjustments affecting year-over-year comparability on slide 12. First, we recorded restructuring and related expense of $15 million for head count reduction and cost improvement initiatives, including costs for closing our Clear Air Just-In-Time plant in Ghent Belgium in response to the end of production on a customer platform. The customer expects production to end in the first quarter of 2020. Second, we recorded a pension charge of $6 million, and we made a pension contribution of $10 million in the first quarter to substantially complete the pension buyout program that we discussed last quarter. The program reduced our benefit obligation by $154 million and our unfunded pension liability by almost 50%. Additionally, under the terms of our long-term performance plan, restricted stock awards vest when an employee becomes retirement eligible. In the quarter, this resulted in a $5 million charge, which we called out because of its size. We don't expect to see a similar adjustment in future quarters. Now, let's move on to taxes on slide 13. Excluding the first quarter items, adjusted tax expense was $40 million for an effective tax rate of 29%. We continue to expect the full-year effect of tax rate in the range of 29% to 31%. This quarter, cash tax payments were $15 million and we still expect full-year cash taxes in the range of $125 million to $140 million. You can see our summary of debt and cash positions on slide 14. Interest expense this quarter of $15 million improved $3 million compared with last year as mostly due to the lower interest rate on the bonds that we refinanced in the second quarter of 2016. We expect annual interest expense of about $70 million this year. Now turning to cash flow on slide 15. Cash flow from operations improved $20 million compared with last year's first quarter. This improvement was driven by our higher earnings and cash flow from receivables, inventory and payables. Overall working capital days metrics remain strong. Day sales outstanding was up 2 days at 65 days, days inventory on hand improved 1 day at 37 days, and days payable outstanding were even with a year ago at 74 days. In addition, we made pension plan contributions of $10 million as part of the pension buyout program that I mentioned earlier. Capital investments in the quarter were $85 million for new or expanded business in North America and Europe, and increased capacity in China to support a significant launch later this year. For the full year, we expect capital expenditures between $360 million and $390 million. Now, looking at returns to shareholders in the first quarter, we repurchased 240,000 shares for $16 million. We have $384 million left on the buyback authorization that we announced in the first quarter. This quarter we also initiated a quarterly cash dividend of $0.25 per share, which was paid in March for $13 million. Lastly, the other segment which is primarily the corporate office includes lower projects specific spending compared to last year. This quarter's cost reflects spending in line with our last several quarters. All other headquarters costs including legal and incentive compensation are about flat in the quarter. With that, I'll turn the call back to Brian for our outlook comments.

[Brian J. Kesseler:]

Thanks, Ken. Now, looking at our outlook for the second quarter and full year on slide 17. Our effective and sustainable drivers continue to feel growth above the industry and we're not laying-up on anything we're doing to build strong customer partnerships, drive product and technology leadership and improve operationally. In the second quarter assuming constant currency, we expect to grow revenue by 5% and outpaced projected industry production growth by 4 percentage points. We expect this growth will reflect higher light vehicle revenues, continued strong commercial truck growth, and we expect a steady year-over-year contribution from the global aftermarket. In off-highway, we expect weak industry conditions to continue about even with last year. Today, we're also maintaining the full-year revenue guidance that we have provided in January. Assuming constant currency, we expect revenue growth of 5% which will outpace forecasted industry production growth by 4 percentage points. And in addition, we still expect annual margin improvement in 2017. As we said at our New York Investor Day in March, Tenneco was built to outperform, which begins with our proven record of profitable growth, supported by our diversified portfolio and strong global balance. We are building on this record which gives us the financial strength and flexibility to drive further investment on the business and returns to our shareholders. Since beginning cash returns in 2011, we had returned $550 million to shareholders in common stock repurchases and dividends. At the same time, we have continued to make the necessary investments to accelerate core growth with positive market trends and focused strategic objectives in both product lines. In Ride Performance, we're growing with our conventional products in Asia Pacific. We're expanding our NVH expertise and capabilities globally to fuel elastomer growth and we are capturing constant growth with our Monroe Intelligent Suspension advanced technology products. In Clean Air, the increase in the stringent emissions regulations continued to be a powerful driver for our technologies as trends can point to continued strong demand for light vehicle internal combustion engines that require a higher Clean Air content and a significant expansion in the number of regulated commercial truck and off-highway engines, particularly in emerging markets. In the aftermarket, we're extending our brand and market leadership from the Americas and Europe to China and India where we are well-positioned to capture growth in what will be the world's largest and fastest growing car parks over the next two decades. As we wrap up the first quarter, I'm encouraged by the progress we're making to achieve our goals in 2017 and beyond. I appreciate the commitment of Tenneco team members around the world who work hard every day to make our progress possible, and I'm excited about the opportunities we have to create more value for our customers and more value for our shareholders. With that, we're happy to take any questions.

[Operator:]

Thank you. We will now begin the question-and-answer session for today's conference. Speakers, our first question comes from Colin Langan of UBS. Colin, your line is now open.

[Colin Langan:]

Oh, great. Thanks for taking my question. First question is just on the other line item within the EBIT, it seemed to come down a lot year-over-year from $36 million to $26 million. Is there anything unusual or it's just unusually high last year or how should we think about that?

[Kenneth R. Trammell:]

Yeah. I mean, Colin, basically, what I said in the discussion we just had was that there were some project-specific spending in the first quarter of last year. And if you look at our trend over the last, several quarters, our first quarter this year spending is pretty much in line with that.

[Colin Langan:]

Got it. Okay. And then when look at North America Clean Air, how should we think about that margin going forward? I mean any quantification of this alloy impact in the quarter and when does the recovery come through? So should we see outsized in the second half of the year, is it like two quarters away? How should we think about it trending?

[Brian J. Kesseler:]

Yeah, Colin. This is Brian, as we have been talking over the last couple of quarters; we continue to expect sequential improvement on the Clean Air North America margins. The impact of the alloy charge increases was roughly $7 million in the quarter and we will continue to recover those per our contracts with our customers over the next several months, substantially being completed by the time we jump into the third quarter as we move through that quarter. I would expect us to continue to make that improvement over these next several months.

[Colin Langan:]

So we should see a big help in Q2 as you get recovering?

[Brian J. Kesseler:]

Sequentially. The costs are still there, so there's – the sequential improvement of the price recovery will be there.

[Kenneth R. Trammell:]

Yeah, I mean, Colin, just to put a fine point on it, right. The alloy surcharges ticked up and we don't see them ticking down. It's just a timing difference. Our revenues go up enough, we think, in the second quarter to cover the increase. But it'll obviously be a while before all of that comes back to us from a margin perspective. Costs come back to us in the quarter, but the surcharges are staying elevated roughly in the same area that they are now.

[Colin Langan:]

But you'll get some recovery?

[Kenneth R. Trammell:]

Yes.

[Colin Langan:]

Yeah. And then, in that same segment off-highway North America was down a lot. But I think in the release, it says it was flat globally. Is that North America specific; is that mix of your customers or what's driving the big decline within that?

[Brian J. Kesseler:]

On the off-highway, it's a regional issue. We're up in Europe and we're down in North America. They balance each other out roughly. But we're seeing and we're highlighting that those off-highway conditions in North America will continue about at the same pace that we see from first quarter into second quarter. And while we're seeing some encouraging signs globally, a lot of what our off-highway customers are seeing are right now in unregulated regions or in the aftermarket.

[Colin Langan:]

Got it. So we should continue to expect weakness in the near term in North America commercial...?

[Brian J. Kesseler:]

Yeah. In off-highway.

[Colin Langan:]

I'm sorry, North America off-highway. Okay. All right. Thank you very much for taking my questions.

[Operator:]

Thank you. Our next question comes from Brian Johnson of Barclays. Your line is now open, Brian.

[Brian A. Johnson:]

Yes. Good morning. I want to talk a little bit on Asia Pacific Clean Air China. It looked like Asia Pacific, but particularly China. In general, China production seemed to be strong in the quarter on the light vehicle side, yet, we didn't see it coming through your results. Could you maybe kind of talk about that, was it programs, platforms, are you just underleveraged to the China LV market relative to the CV market?

[Kenneth R. Trammell:]

Hi. So, Brian, on the Ride Performance side, we saw, gosh, 25% improvement in margins and that's really all light vehicles. So, obviously Ride Performance was good. The Clean Air side of the business, I think we've addressed this the last several quarters. Our strength is with the joint ventures over there, who have primarily served the sedan market and are just now moving into the crossover market. And that crossover market has been – has seen a fairly rapid market shift. So that's the primary driver there. That'll I'm sure catch up as those customers, our customers respond to the shift in the market.

[Gregg M. Sherrill:]

I certainly wouldn't say that we're biased to the commercial vehicle side in China. I mean it's very, very important to us, but light vehicles still overwhelmingly...

[Brian A. Johnson:]

Okay. Second question. Just around this European Commission. Back in February, you said you were expecting a $5 million to $7 million year-over-year increase in legal expenses. Will this reduce that run rate and is there anything in terms of – even if we haven't reserved, kind of range of liabilities that this might have released or potential liabilities?

[Kenneth R. Trammell:]

Yeah. So Brian, that's really two questions there. The first one relates to...

[Brian A. Johnson:]

Yeah.

[Kenneth R. Trammell:]

...our ongoing spending. And certainly, I think the good news out of the European Commission that we talked about that we issued the 8-K on Friday should bring the legal cost down, probably to a level that's not significant enough to talk about in the future. Obviously though, as Greg pointed out, there's still several areas that need to be resolved and no, we have no estimates of what it might ultimately cost to resolve this.

[Brian A. Johnson:]

Okay. And final question, just anything you could tell us – were there any interesting signings around or expansion of the Intelligent Suspension product lines over the last quarter?

[Brian J. Kesseler:]

We're obviously quoting a lot of programs going forward. Nothing significant that we can talk about. We're still in launch with five programs this year – four, four programs this year as we move forward.

[Brian A. Johnson:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from Joe Spak of RBC Capital Market. Joe, your line is now open.

[Joseph Spak:]

Thank you. Good morning. The first question, just to follow up on Brian's last question. So legal expense goes – becomes minimal, can you remind us what you spent in 2016 on the antitrust investigation?

[Kenneth R. Trammell:]

Well, Joe, I don't think that that was – again, we were in sort of a lull. I don't think we had a number that we talked about in 2016.

[Joseph Spak:]

Okay. So, it's more in 2015 when you're spending that?

[Kenneth R. Trammell:]

That's right.

[Joseph Spak:]

When it first came out. Okay.

[Kenneth R. Trammell:]

Exactly.

[Joseph Spak:]

Thanks. Then, European off-highway up 20%. Is there a way to disaggregate that between sort of what the customer does and sort of how much is just – I know you had some new business you won there, and then I guess the third bucket would be just increased content on the volume from the regulations?

[Kenneth R. Trammell:]

It's primary volume driven Joe, because the content was fully and ramped in by regulations ended or the change in regulations was completed in 2015. So middle of 2016 the content was pretty much ramped in. So it's really volume.

[Joseph Spak:]

Okay.

[Kenneth R. Trammell:]

Obviously, we've got several customers over there and they had a good first quarter. We'll have to see how the trends that will go for the rest of the year on the off-highway business over there.

[Joseph Spak:]

And is that more ag or construction driven, would you say?

[Kenneth R. Trammell:]

Since we build for an engine, I couldn't tell you for sure, because the same engines go into both ag and construction.

[Joseph Spak:]

Okay. And the last question, I noticed that the buyback, the total dollar amount was that a little bit of the lower level versus what you've done in the past couple of quarters. I mean, how much of that is a function of where the stock is or the quarterly timing of the cash flow. I know 1Q is a little bit seasonally weaker or is it perhaps because you initiated the dividend; you're sort of splitting the returns between those two methodologies now or is there something else?

[Kenneth R. Trammell:]

Yeah. I mean, so Joe, when we announced the new $400 million repurchase program, we did say that we would seek to be opportunistic on our purchases, so I wouldn't expect to see the same amount every quarter as we go forward, but I think the last point you made is key. The total returns to shareholders this quarter, first quarter of this year were $29 million substantially in excess of what we did in the first quarter of last year.

[Joseph Spak:]

Yeah. Okay. Thanks a lot, guys.

[Operator:]

Thank you. The next question comes from Rich Kwas of Wells Fargo. Your line is now open.

[Richard M. Kwas:]

Hi. Good morning, everyone.

[Gregg M. Sherrill:]

Good morning.

[Kenneth R. Trammell:]

Good morning.

[Richard M. Kwas:]

On the Ride Performance in North America, I think you talked about commercial vehicle being a headwind to margin, so I imagine you probably had that factored in given trends. On the aftermarket side, was there something unique there that hurt margin, hurt leverage there more so than expected or was that just the Car Quest you expected and it was just Car Quest and the comp going against that?

[Brian J. Kesseler:]

Yeah. It was – a lot of that was the Car Quest comp year-on-year in the first quarter. Our sales are in line with the market as we're looking at our overall customer base. So it's – we're okay with where we're at. Obviously we'd always like that business to be better.

[Richard M. Kwas:]

All right. So, Brian you wouldn't call out anything on that?

[Brian J. Kesseler:]

No.

[Richard M. Kwas:]

Okay. And then as we think – when do you fully comp against Car Quest? It'd be this quarter or next quarter?

[Brian J. Kesseler:]

We're done now, so...

[Richard M. Kwas:]

Done. Okay.

[Brian J. Kesseler:]

Last year first quarter was the last load.

[Richard M. Kwas:]

Okay. So when we think that there'll be better leverage, all else equal, as we move forward here within that?

[Brian J. Kesseler:]

That'll be the goal.

[Richard M. Kwas:]

Okay. All right. And then just on diesel – so, I know it's a smaller piece of your revenue mix relative to, I think, the perception out there, but anything we should think about in terms of the shift given some of the declines here in the first quarter and the assumption and it's maybe going to be worse than expected going forward at least relative to what the market had embedded? As we think – I know you have regulations and some of that come from a content standpoint helping you going forward, but any kind of rule of thumb we should think about in terms of a percent decrease in diesel and what that means for your content in Europe and Western Europe?

[Brian J. Kesseler:]

Yeah. The way we think about it, Rich, is we're ambivalent mostly. We'll see the shifts as they come around, but we're not seeing any significant shift in our revenue profile. And again, this is primarily a Europe Clean Air discussion.

[Kenneth R. Trammell:]

Yeah. And Rich, just to remind you, right? I mean we've said for past several quarters now that we don't anticipate seeing a quarter when we'll have to talk about the diesel mix as being a problem for us. Like you said, it's 6% or 7% of our global revenue, the diesel light vehicle business. And whatever trend that kind of develops over the next few years, I don't expect that to be a significant headwind for us.

[Richard M. Kwas:]

Okay. All right. That's helpful. And then last one from me on the corporate expense side. Ken, should we think that this dollar rate here in the first quarter is the right number to think about as we move forward? I know you talked about with the first quarter was kind of in line sequentially, but anything you'd point out there?

[Kenneth R. Trammell:]

Yeah. I mean, Rich, I think that's – you've really hit the key point there. If you sort of looked over the last several quarters, indeed the last few years, right, our average has been sort of around plus or minus where we are clearly, always some volatility driven by what happens in the incentive compensation and things like that. But, yeah, I think whatever I was trying to point out in the comments was that we're in line with where we have been for the last several quarters and indeed in the last few years.

[Richard M. Kwas:]

Okay. All right. Thank you.

[Operator:]

Thank you. Our next question comes from David Tamberrino of Goldman Sachs. Your line is now open.

[David Tamberrino:]

Great. Good morning and thank you for taking our questions. I know it's a little early in the year and there's clearly a lot of uncertainty with regard to light vehicle production as well as commercial truck and off-highway volumes, but I do want to dig a little bit into the cadence of organic growth and really constant currency is a – if you think about this, in the first quarter, 9%; second quarter looking at 5%, about a 200-basis-point headwind on FX. But if we extrapolate to the back half of the year, it really implies a much slower rate for 2H 2017 from a organic growth standpoint. Is there anything that we should be conscientious of that's making it a tougher comp for you in that back half of the year, or is it more of just conservatism given it's the first quarter of the year and again, there's a lot of uncertainty?

[Brian J. Kesseler:]

Well, if you take a look at the way we've been talking over the last several quarters about that revenue outlook, it's all in relation to the production rates. And so, if you look at the IHS data, it looks that the year-on-year production rate is coming down. So, we're still forecasting to be 4% above the industry production rates. So, as those flex, we would expect to maintain that 4% outpace as we go on. If you look at that IHS projection out in Q3 and Q4, that's coming down on a year-on-year comparator.

[Kenneth R. Trammell:]

Yeah, so David, it's not the organic growth in excess of production, it's simply what's happening with our markets in the latter half of the 2017 production year.

[David Tamberrino:]

Got it. And that's very helpful. And just on the off-highway side, I mean, when you think about that business and where you are, how far away do you feel your customers may be from seeing potentially a rebound within the business, albeit regionally or customer specific or if you feel like that's probably still 6 months to 12 months away from this point?

[Brian J. Kesseler:]

Well, we've tried to get out predicting when the commercial truck or the off-highway business is going to back. Some encouraging signs if you listen to some of our customers' dialogue over the last several weeks. And the agriculture, the gas and oil, and the construction are big factors for us. Having seen those coming back quite yet in the regulated regions, but there are at least some encouraging signs and reversals of overall market with some of our larger customers in this space.

[Kenneth R. Trammell:]

That being said, I can point out that our production schedules aren't showing a significant increase in the next several quarters yet. We're just looking for signs like you are.

[David Tamberrino:]

Got it. Yeah, we're paying attention on all the same ones. All right. Thank you for the time this morning. Appreciate it.

[Brian J. Kesseler:]

Thank you.

[Operator:]

Thank you. Our next question comes from Ryan Brinkman of JPMorgan. Your line is now open, Ryan.

[Ryan Brinkman:]

Thanks for taking my question. First one just on contribution margin. It seems that when you sort of exclude the foreign currency and concentrate only on the value-add revenue at substrate, that incremental margin was maybe roughly 13% or so in the quarter. And then you discussed the regions with regard to timing of alloy recoveries, et cetera. Now, what would you consider though to be sort of a normal contribution for you on value-add organic revenue? And then how do expect your incrementals to track in the balance of the year?

[Kenneth R. Trammell:]

So we actually don't give earnings guidance. But I would point you to the numbers that we've delivered for the last several years. We've averaged somewhere in the mid-teens. But whenever I say that; I always point out too, obviously, that mix has a big impact on that, launch loads, everything else. So if you look at it on an individual quarter basis, it's been somewhere as probably mid single digits as high as mid-20%. But the average of mid-teens right around that – what you saw here in the first quarter is probably not a bad assumption to make on a go-forward basis.

[Ryan Brinkman:]

Okay, that's helpful. And then just the last question and it's on the aftermarket in China. Is it a pretty small business, which is why maybe you discussed the trend in slide 10 in the aftermarket in North America, in Europe and South America but not Asia Pacific? And I was just thinking with the growth in China production expected to slow relative to in the past, which would be a headwind for other suppliers with little or no aftermarket exposure. Presumably, the fleet age in that country should at some point increase a lot and that could be a sizeable opportunity for you guys. Can you just sort of frame that business for us, the size of it, your relative position within it and then how investors should think about it going forward?

[Brian J. Kesseler:]

Well, today, for us it's a relatively small business. And some of the market factors that are driving that is the average age of the fleet there right now. It's about four and a half years. But - [Technical Difficulty] (38

[Operator:]

The speaker line has now been reconnected.

[Linae Golla:]

Thank you, Dale. Can you hear us now?

[Operator:]

Yes, ma'am.

[Linae Golla:]

Wonderful. Well, I think we were -

[Brian J. Kesseler:]

We were with Ryan Brinkman on -

[Linae Golla:]

Ryan, are you on the line?

[Ryan Brinkman:]

I am, yes.

[Linae Golla:]

Wonderful. Let's try this again. How far did you hear us?

[Ryan Brinkman:]

You'd started to answer saying the size of the market in China was relatively small from the aftermarket perspective and then it cut off.

[Brian J. Kesseler:]

Okay.

[Kenneth R. Trammell:]

The – it'll be (38

[Brian J. Kesseler:]

Now that I got a practice on it. So the market for us right now is relatively small. The average age of the vehicle in that car park is about four and a half years. By 2025, it'll be the largest car park in the world. Average age will move to about 8.5 years estimated. The sweet spot for our replacement rates is about year six to year nine. So it'll be right in the middle of the sweet spot. What we're doing today is making the necessary investments in distributor development, manufacturing locations, supply chain enablement, the brand reinforcement, all of which are formulas for success that have led us to market-leading positions in the Americas and in EMEA. So we're really, really bullish on the market there. And we're making the right investments right now to capture that growth as it comes over the next five to seven years.

[Ryan Brinkman:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from Rod Lache from Deutsche Bank. Your line is now open, Rod.

[Rod Lache:]

Thank you. We were disconnected a little bit earlier. I was hoping to just clarify one or two things and I apologize if this is repetitive. But first, just based on the production schedules that you see in the North American off-highway business, could you talk a little bit about as we sit – at the current view, when the comps start to level out? Just give us a sense of what you're expecting going forward.

[Kenneth R. Trammell:]

Rod, I don't think we're seeing much in the production schedules in North America that would indicate anything other than some continued weakness.

[Rod Lache:]

Okay.

[Kenneth R. Trammell:]

That changes, we'll certainly be the first to celebrate it. Maybe the second, but -

[Rod Lache:]

Similar declines going forward to what we're seeing right now?

[Gregg M. Sherrill:]

Leveling out. A bit of leveling.

[Kenneth R. Trammell:]

Yeah, it should sort of level out on a quarter-over-quarter basis. I think that the first quarter was a little stronger last year, so the comp is a little more difficult.

[Gregg M. Sherrill:]

Right.

[Rod Lache:]

Okay. So the year-over-year declines moderate as you go out over the next couple quarters if it's still down. Is that correct?

[Kenneth R. Trammell:]

I would -

[Brian J. Kesseler:]

That's right.

[Kenneth R. Trammell:]

Yeah, I think you're right.

[Rod Lache:]

Okay, all right. And secondly, just to clarify – I didn't quite understand this earlier. Should we be expecting that alloy surcharge of $7 million to reverse, in other words, a retroactive recovery or are you still experiencing a headwind as far as the alloys are concerned that moderates going forward?

[Brian J. Kesseler:]

What we've been seeing for the first quarter and coming into the second quarter is the alloy surcharges are bumping around in the same range that we saw a spike coming into the first quarter. What we're seeing is a lag in the recovery. And so that recovery will come over the next several months. So the costs to us are staying relatively constant now. The price will come in now for that recovery, but we'll have a lag there for a while.

[Kenneth R. Trammell:]

So, Rod, we don't expect a continued headwind on margins in the second quarter. But it's not like there's a retroactive catch-up that's a tailwind either, just to be clear.

[Rod Lache:]

Got it, all right. That's very clear. Thank you.

[Operator:]

Thank you. Our next question comes from Brian Sponheimer of Gabelli. Your line is now open.

[Brian C. Sponheimer:]

Hi. Good morning, everyone.

[Gregg M. Sherrill:]

Good morning.

[Brian J. Kesseler:]

Good morning.

[Kenneth R. Trammell:]

Good morning.

[Brian C. Sponheimer:]

Just on the North American light vehicle market, maybe your conversations with your customer base about build schedules. How much is going into build inventory ahead of some plant shutdowns for the back half of the year relative to just meeting demand in the marketplace right now?

[Kenneth R. Trammell:]

Yeah, Brian. I don't know that we're seeing anything other than what's showing up in IHS. Nothing specific as it relates to building inventory.

[Brian C. Sponheimer:]

All right. You may have mentioned this. North American commercial vehicle, can you talk about the pockets of where you're seeing growth? Is it vocational Class 8? Is it more on the medium side?

[Kenneth R. Trammell:]

We were actually down on an overall basis in the first quarter. The off-highway was the biggest driver. A little bit of a pickup on the Ride Performance side on commercial truck, I think, but nothing significant there.

[Brian J. Kesseler:]

Yeah, and medium duty is where we're seeing on a year-on-year basis mostly because of some of the launches that happened last year.

[Brian C. Sponheimer:]

Okay. And then just to put a bow on this recovery issue. If cost is constant here on out; at some point, there will be a time at which the costs stop and then there will be a period where you'll be getting recoveries in the couple – two or three weeks or months thereafter?

[Brian J. Kesseler:]

Yes.

[Brian C. Sponheimer:]

Okay.

[Brian J. Kesseler:]

That's -

[Brian C. Sponheimer:]

All right. Thank you.

[Operator:]

Thank you. Moving on, our next question comes from Matt Stover of Susquehanna. Your line is now open.

[Matthew Stover:]

Thank you very much. Most have been addressed. I did have one question or two actually. The first one is, in Europe, in the Clean Air business, there's a really nice margin improvement. And I'm wondering if you could just kind of give us anymore detail about what drove that in the quarter.

[Brian J. Kesseler:]

Well, we saw a couple of things working for us. The off-highway came back online, so our utilization of our capacity there helped our margins. Light vehicle continued to be a strength on a year-over-year comparison. And commercial truck was a nice contributor, not huge. But overall, I would say our European Clean Air team continues to drive the operational efficiencies to continuous improvement to the cost structure and continues to do a nice job.

[Matthew Stover:]

Were there any recoveries in there, Brian?

[Brian J. Kesseler:]

Not really, no.

[Matthew Stover:]

Okay. And then the second question is to follow onto that aftermarket in China. You're building that out right now. Is there a point at which as you begin to think about the acceleration in that market, where the costs that you need to put in place to ensure future success become a burden in margin or is that something that you can pace as you go along?

[Brian J. Kesseler:]

Right now, we would expect it to do what we're doing today, which is pace as we go along. As the revenue comes, we continue to make the right investments. We're happy with the progress we're making from the investments from the people side, from the distributor side, from the brand equity building side. So right now, we think we could do a pay as you go.

[Matthew Stover:]

Okay, thanks.

[Operator:]

Thank you. Our last question in queue comes from John Sykes of Nomura. John, your line is now open.

[John Sykes:]

Yeah. Just going back to China, you had mentioned you're pretty well-positioned in Ride Performance with the JVs. If the government does something different there to favor some of the local players, how much of an impact would that have? And I guess, do you expect that to happen?

[Brian J. Kesseler:]

Well, we're pretty well-positioned with the JV partners that we have on both product lines, Clean Air and Ride Performance. And our JV partners are normally well-positioned relationship-wise with the local players. But obviously, we're weighted strongly to the joint ventures, the global joint ventures as they're established. We're hearing the same things that the market's hearing. But when we're talking to our JV partners, we're not hearing drastic moves. But one would continue to anticipate that there'll be some consolidation over the long haul. And we'll make sure we're well-positioned for that.

[John Sykes:]

Would it be fair to say that that market is going to get more competitive price-wise, product-wise? It seems like the non-JV local players are developing a pretty good product now to compete.

[Brian J. Kesseler:]

As the technology continues to evolve and have to be – bring to market for our emissions technology and the Ride Performance technology, we would expect to see actually some consolidation in the supply base on both sides of our products. But it's a competitive marketplace now. And our team does a nice job with answering the market and bringing the solutions for the market. In certain segments, the requirements aren't as stringent from a durability perspective. So that's why you see inside our strategic plan documents that we have to have very specific solutions for the China market. And that's what's led to a lot of the ability for us to have success there today.

[Gregg M. Sherrill:]

I would throw one more thing in regarding sort of the sense of your question. The big car company JVs are with these national companies and we're not seeing anything where China is making a move that would ultimately sort of damage those guys. The competition with the private guys sure is there and they are improving. I'll grant you that. And it's not like we don't have any business with those guys. We certainly do have some. But I'm not seeing a big shift, if that's kind of the sense of your question, in the way this whole thing is going to balance out from the big national company JVs to the private sort of guys.

[John Sykes:]

Yeah, okay.

[Gregg M. Sherrill:]

We're watching, but I don't see it right now.

[John Sykes:]

And you don't see those players getting too involved in the North American market where they might be significantly competitive, right?

[Gregg M. Sherrill:]

When you say those players, you're talking about the private guys?

[John Sykes:]

Like (49

[Gregg M. Sherrill:]

Yeah.

[John Sykes:]

Yeah.

[Gregg M. Sherrill:]

Not yet, we don't. Certainly, they still got to come a long (49

[John Sykes:]

Just one other question. I think it comes up quite a bit, but I'll ask it again. So you're BB+ S&P, I think Ba2 Moody's. Just with your performance, the cash flows, the low level of leverage, it seems you should be getting pretty close to IG. Can you give us some insight in terms of what the rating agencies are telling you?

[Kenneth R. Trammell:]

So we've basically said the same thing for the last probably half a decade on the ratings. And that's that our goal is to have a very strong balance sheet. We really look more at how our investors, both on the bond and the equity side, treat Tenneco. And I would say that we're certainly enjoying the benefits of our strong balance sheet. As you know, we were able to refinance last year at 5%. So we look more at what the market says rather than what the rating agencies say. Those tend to be sticky ratings and they're especially sticky when you're an auto supplier. So the investment grade rating is not the focus. It's really how we manage the balance sheet and manage returns to shareholders that we focus on.

[John Sykes:]

No, I appreciate that. But it has an impact on the bond price eventually. But I realize you're not managing the company to that. But it seems like you stack up pretty well against all the guys that are IG. So -

[Brian J. Kesseler:]

We would agree.

[John Sykes:]

Yeah, okay. Thank you.

[Brian J. Kesseler:]

Thank you.

[John Sykes:]

Yeah.

[Operator:]

Thank you. And that concludes our question-and-answer session for today's call. At this point, I would like to turn the call back over to Ms. Linae Golla for her closing remarks.

[Linae Golla:]

Thank you, Dale. So this does conclude our call. An audio replay will be available on our website in about an hour. You can also access a recording of this call via telephone. In North America, you may reach the playback at 800-937-4851. For those outside North America, the number is 203-369-3401. The playback information is found in our press release. Thank you for joining us today.

[Operator:]

Thank you. That concludes today's conference. Thank you for your participation. You may disconnect at this time.