Tsakos Energy Navigation Limited
Q2 2013 Earnings Call Transcript

Published: 29 Jul 2013

[Operator:]

Good morning, and welcome to Tenneco's Second Quarter 2013 Earnings Release Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I'd like to turn the call over to Ms. Linae Golla, Executive Director, Investor Relations. Thank you. You may begin.

[Linae Golla:]

Good morning, and welcome. This morning, we issued our earnings release and related financial information. Today, Gregg Sherrill, our Chairman and CEO; Hari Nair, our Chief Operating Officer; and Ken Trammell, our Chief Financial Officer, will spend the first half of our call taking you through our quarterly results. Slides related to our prepared comments are available on the Investors section of our website at www.tenneco.com. We will then open up the call to questions. Before I turn the call over to Gregg, I need to let you know that our discussion today will include information on non-GAAP financial measures, all of which are reconciled with GAAP numbers in our press release attachments. The earnings release and attachments are posted on our website. In addition, some of our comments today 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. With that, I will turn the call over to Gregg.

[Gregg M. Sherrill:]

Thank you, Linae, and good morning, everyone. We've reached the midpoint of the year, and I'm pleased with our progress, having delivered another strong performance in the second quarter and on track for a good year. As you've already seen in our press release, we reported record high revenue, EBIT and adjusted EBIT and excellent cash performance. Our fundamental growth drivers remained strong, with the right technologies and exceptional platform, positioned globally, and an engineering and manufacturing footprint that is fueling expansion in the fastest growing markets. We leveraged these strengths this quarter to capitalize on stronger light vehicle production in several key regions and generate total revenue of $2.1 billion, which represents an 8% increase over last year and our first ever $2 billion-plus quarter. Our value-add revenue was $1.6 billion, a 6% increase over last year. A key success factor for Tenneco was the balance of our business across many dimensions, including light and commercial vehicle, OE and aftermarket, as well as vehicle platform and geographic balance. This balance serves us well and was reflected in this quarter's revenues, beginning on Slide 4. OE Light Vehicle revenue of $1.5 billion was a 10% increase compared with last year. Our light vehicle revenue this quarter was driven by the launch and ramp-up on new platforms and our strong position on top-selling vehicles, which allowed us to take advantage of higher production volumes, particularly in North America, China and South America. OE Commercial Vehicle revenue was $237 million, a 5% increase, driven by higher revenues in Europe and South America. North America commercial vehicle revenue was down year-over-year, which reflects weakness in our end markets and the impact of inventory corrections on production. Our global aftermarket revenue rose to $347 million, about a 1% increase over last year. Aftermarket revenue in North America was roughly flat, and Europe was slightly higher on stronger Ride Performance sales. Now turning to EBIT on Slide 5. Adjusted EBIT for the second quarter was $148 million, up 6% versus last year, reflecting improvement in both product divisions. Clean Air EBIT was up 15%, driven by higher light vehicle volumes in China, North America and South America, and strong operational performance, particularly in North America. In Ride Performance, we benefited from higher volumes in the Asia-Pacific segment, with overall EBIT increasing 4% year-over-year. We continue to focus on operational excellence to improve profitability, and our strong execution helped increase adjusted EBIT margin on value-added revenue to 9.4%. As I mentioned upfront, we had an outstanding cash quarter, generating $133 million in cash from operations, which was a record high for the second quarter. Our working capital performance exemplifies the disciplined approach we take to managing growth and generating cash flow. Similar to the first quarter, our overall results demonstrate our ability to take advantage of the balance across our businesses, effectively manage through uneven economic and market conditions, and execute on our strategy for profitable growth. So with that, I'll turn it over to Hari for more detail on our operations.

[Hari N. Nair:]

Thanks, Gregg. Let's start with the Clean Air revenue, beginning on Slide 7. For the quarter, total Clean Air value-add revenue increased 9% to $918 million. Total North America value-add revenue was $415 million, a 3% increase, driven by light vehicles. Our light vehicle business, which includes our strong position on pickup truck platforms, kept pace with industry light vehicle production in North America. Aftermarket revenues are also higher year-over-year. Light vehicle revenue in the aftermarket more than offset the impact from continuing lower commercial vehicle volumes, which Gregg has already discussed. For Europe, South America and India, value-add Clean Air revenue improved 12% to $332 million. This growth was driven by higher light vehicle revenue in Europe, which included the ramp-up on some key new light vehicle platforms from Daimler and Jaguar Land Rover, as well as stronger light vehicle volumes in South America. In addition, higher commercial vehicle revenue in Europe and South America contributed to the total revenue increase. New platforms at GM and Volkswagen and higher light vehicle volumes in China helped our Asia-Pacific Clean Air segment deliver another strong performance this quarter, with value-add revenue increasing 17% to $171 million. Now looking at earnings for Clean Air. Adjusted EBIT increased 15% year-over-year to $110 million, with the Asia-Pacific and North America segments driving the improvement. In North America, Clean Air adjusted EBIT was $68 million, up 19%, due to higher light vehicle volumes, slightly higher aftermarket revenue and our strong operating performance. Adjusted EBIT for Europe, South America and India was even with a year ago at $21 million. Positive drivers included leveraging higher light vehicle volumes, including the new platforms in Europe, and higher commercial vehicle revenue in Europe and South America. EBIT this quarter also includes $3 million in unfavorable currency. The Asia-Pacific segment was also a strong driver of earnings results for the Clean Air division. Adjusted EBIT for the quarter increased 17% year-over-year to $21 million. Once again, the team did an excellent job leveraging new platforms and higher light vehicle production volumes at our plants in China. For the quarter, I'm pleased that we improved our Clean Air value-added adjusted EBIT margin to 12% versus 11.4% last year, considering the ongoing industry challenges in Europe and continued weakness in global commercial vehicle production. Now turning to Ride Performance results, starting on Slide 9. Total Ride Performance revenue was $661 million, up 2%. Taking a look at Ride Performance revenue by segment, North America revenue was roughly flat at $324 million. Stronger light vehicle volumes offset weak commercial vehicle volumes, and the aftermarket revenue held steady. In the Europe, South America and India segment, Ride Performance revenue was $281 million, up 2%. Higher light and commercial vehicle revenue in South America and higher European aftermarket revenue contributed to the improvement. While we had stronger European aftermarket Ride Performance sales this quarter, the market conditions overall remained weak. Asia-Pacific continued to be a strong contributor to our total Ride Performance revenue this quarter, with revenue up 24% to $56 million, driven by our platform positions, new programs and strong light vehicle production in China, as well as the launch of new programs in Thailand. Adjusted EBIT for the Ride Performance division was $58 million, an increase of 4% versus last year. In North America, adjusted EBIT declined $1 million year-over-year to $36 million, driven primarily by lower commercial vehicle volumes. Adjusted EBIT for Europe, South America and India was $15 million compared with $17 million last year. This included $4 million in negative currency. Positive drivers for the quarter included higher revenues in the European aftermarket, and light and commercial vehicle volumes in South America. In Asia-Pacific, higher volumes and new light vehicle platforms in China and Thailand helped the segment deliver adjusted EBIT of $7 million versus $2 million a year ago. For the quarter, our overall Ride Performance adjusted EBIT margin improved to 8.8% versus 8.7% last year. In summary, we delivered a strong quarter. We remain focused on winning and launching new business and executing our strategies for each product division, and we are committed to continuously improve our global operations. Operational excellence will always be the key driver of our success. By following our Tenneco Manufacturing System, we continue to drive standardization and continuous improvement, and ensure we are converting our top line growth to the bottom line. Finally, I'd like to add that the European cost reduction actions we announced earlier this year are on track, with no change to the expected timing, costs or savings. Now I'll turn it over to Ken.

[Kenneth R. Trammell:]

Thanks, Hari. Let me spend a minute on the $7 million in restructuring charges that we recorded this quarter. The $3 million in our Europe, South America and India Clean Air segment, and the $1 million in our Europe, South America and India Ride Performance segment, represent headcount reductions. We expect savings from these actions of more than $2 million annually. In Australia, we ended production of leaf springs, and we recorded a $1 million restructuring charge there. And finally, headcount reductions and the net impact of freezing our remaining defined-benefit pension plans resulted in a $2 million charge. Now let's turn to interest and taxes on Slide 11. Interest expense in the quarter was $20 million versus last year's $21 million. Last year included $1 million in costs to complete the retirement of our 8 1/8% bonds. Our expectation for interest expense this year continues to be around $80 million. In the second quarter, we recorded tax expense of $47 million for an effective tax rate of 39%. This is higher than last year's tax rate due to the impact of the U.S. valuation allowance last year. The second quarter rate is higher than our earlier expected effective tax rate, mostly due to unbenefited foreign losses in certain countries. Because of this, our effective tax rate for 2013 is now expected to be in the range of 36% to 38%. Additionally, we estimate cash taxes for the year will be about $110 million, and this increase is mostly due to resolution of open tax issues. Turning to Slide 12. As Gregg discussed, we generated record second quarter cash flow from operations of $133 million. That's a 55% improvement from last year's performance. Our cash flow performance in the quarter was primarily driven by improving working capital, and we were particularly successful in reducing inventory this quarter, as our key working capital metrics show. On a last 3-months basis, our days sales outstanding, excluding factoring, improved 2 days to 60 days this quarter. Inventory days on hand was 35 days, which is better by 3 days from last year's metric. And days payable outstanding was 70 days, about the same as last year. Capital expenditures were $47 million in the quarter, and that's down from $62 million last year. Our investments this quarter are primarily to support Clean Air customer programs in North America, in Europe and in China. The lower expenditures this quarter represent the timing of our capital activity, as we continue to expect capital expenditures in 2013 will be in the range of $260 million to $270 million. Now let's go over debt and available liquidity, starting on Slide 13. At June quarter end, debt net of cash balances was $1,038,000,000, an improvement of $147 million from year-ago levels. That's a result of our excellent cash performance this quarter. Our leverage ratio continues to improve, and it is at a second quarter record low of 1.6x compared to 1.9x a year ago. Now the debt balance and the leverage ratio also reflect a banking error on the last day of the quarter that reduced our revolver borrowings and increased bank overdrafts by $40 million. Without this, our debt balance would have been $40 million higher and our leverage ratio would have been 1.7x, still a second quarter record low leverage ratio. At the end of the second quarter, we had $621 million in unused borrowing capacity under our revolving credit facility. And additionally, cash on hand was $240 million, and we had the capacity to sell another $49 million of receivables. In January, our Board of Directors approved a program authorizing share repurchases of 550,000 shares of common stock to offset dilution from employee stock ownership plans. During the quarter, we repurchased 45,000 shares for $2 million. We expect to complete the repurchase program by the end of 2013. And with that, I'll turn the call back over to Gregg.

[Gregg M. Sherrill:]

Thanks, Ken. Now let's turn to the outlook for the third quarter. According to the latest IHS forecast, shown on Slide 14, global light vehicle production is expected to improve in the third quarter, rising 4% year-over-year. In Europe, the difficult economic conditions are expected to drive lower production volumes. South America production is expected to be flat year-over-year, while light vehicle volumes for North America and China are forecasted to be higher. In both our Clean Air and Ride Performance divisions, we are well positioned to benefit from light vehicle volume improvement, particularly on strong-selling models in North America and China, as well as on a number of global platforms and several large-volume programs ramping up in Europe. Turning to commercial vehicles, the global market for the second half remains relatively weak. Certain markets are seeing modest improvement in demand. However, we expect that inventory corrections will continue to impact production levels in North America. We're expecting commercial vehicle revenue for the third and fourth quarter to be roughly flat compared to the second quarter, bringing our full year revenues within the lower end of our previously announced range. As we said before, 2013 is a relatively quiet launch year for our commercial vehicle business, and any volume upside would depend on the strength and timing of a broader industry recovery. Our aftermarket business is expected to deliver a solid performance, led by steady contributions from North America. In Europe, there are some signs that conditions may be stabilizing, but as I've said before, we may be bouncing along the bottom there for the foreseeable future. In summary, Tenneco delivered another solid quarter, and I want to thank our employees around the world for their outstanding efforts in serving our customers and making Tenneco successful. Our results also reflect the balance we have across markets, platforms and geographies, with this quarter showing revenue and market share growth from new light vehicle platforms in both Europe and Asia. We are excited about Tenneco's outstanding growth opportunities, and our Clean Air and Ride Performance divisions are each focused on distinct strategies to drive revenue and improve margins. We're building on our common values and foundation of operational excellence, relentlessly driving improvements in safety, quality and cost globally. And underpinning everything is our financial strength, which is demonstrated by our continuously improving balance sheet. So with that, we'll open up the phone line to take your questions.

[Operator:]

[Operator Instructions] We have a question from Brian Johnson.

[Brian Arthur Johnson:]

I just want to talk a little bit about the commercial vehicle trends that you're seeing and also, how they might play into 2014 in effect. I know it's too early to update the guidance then. But in 2014 in U.S. off-road, we go to the tighter, I assume, higher contented levels of regulation. Where you're seeing some softness, is it in the horsepower sizes that would be affected by that? Do you expect the inventory correction to work itself through? And also, kind of within that, how dependent are you on U.S. ag versus U.S. construction as you look to that 2014 content increase?

[Gregg M. Sherrill:]

Well, we're fairly balanced, I think, between construction and ag. I don't have the exact figures in front of me. I think what we're seeing here this year, clearly, we've seen inventory corrections in North America in the first half, and now those are anticipated to continue into the second half. And that's kind of what's lowered us into the lower side of our original guidance, but still within the guidance, so we're not backing away from that. The effect that it might have on next year, I think, is way too early to tell, because it's all a volume scenario, a production volume scenario that we're talking about. And I think we'll just defer on talking about any volume outlooks until we get closer into 2014. But you also mentioned the fact that we are beginning to launch additional content towards end of this year and next year, and that, you know, is a fact, we are. As the Tier 4 final regulations come in, and that impacts both the construction and the ag sectors, we will begin to put more content on as we move into 2014. I just think it's way too early to talk about the volume expectations for 2014.

[Brian Arthur Johnson:]

And just one more question on revenue longer-term guide. Europe light vehicle is going just tighter. As I understand it, diesel requirement is getting closer to our NOx. That's obviously good for content per diesel vehicle. But what you're thinking on how those -- that additional cost of content might affect the mix of Europe light vehicle?

[Kenneth R. Trammell:]

Brian, I think that's probably a question that is more appropriately raised with the manufacturers. We can't tell you for sure. I do believe that the incentives that drive -- the fuel cost incentives that drive diesel mix so high in Europe are not likely to change. So I don't know that, long term, there's going to be a significant change though.

[Brian Arthur Johnson:]

Okay, would it be fair to say your guidance doesn't reflect a mix deterioration?

[Gregg M. Sherrill:]

No, it wouldn't reflect that. I mean, the mix can move around quarter-to-quarter. But I think in the long term, we're not anticipating a significant shift there. That would be something -- we'd have to wait and see, but we're not anticipating that.

[Operator:]

Patrick Archambault, Goldman Sachs.

[Patrick Archambault:]

Just a couple of regional ones on commercial vehicle as well. First of all, in China, you have the announcements regarding the implementation of the national for truck engine standards. How are you viewing that opportunity? I mean, I know that earlier in the year, you had talked about kind of a phase-in when those actually came into play, and so maybe you can update us a little bit on that. And then I have a follow-up question on Brazil.

[Kenneth R. Trammell:]

So Patrick, July 1 has come and gone. There have been no official announcements that have been made about the China regulation enforcement. That being said, we do know that there are a number of cities that have announced that they intend to begin enforcement. What we have seen is that appears to be reflected mostly in municipal fleets, buses, that sort of stuff. And we have seen a small, and I emphasize small, increase in sales in China as a result of that. But really nothing official. And frankly, that is not inconsistent with what we've seen the last 2 or 3 times that the regulatory -- time that has passed before we hear anything official. That being said, we're still fairly confident that we're closer now than we ever have been. We've talked about it in the past and it hasn't changed, that the refiners are in the process of implementing what they need to do in order to provide wider availability of lower-sulfur diesel fuel. That certainly helps. We think things are heading in the right direction.

[Patrick Archambault:]

Okay. So what's your best guess? So you've got some regional pockets of compliance. But what's your best guess now on when you think you're going to get national-mandated changes?

[Kenneth R. Trammell:]

I don't know that we have any more information on that than anybody else out there does. Basically, I've given you everything we know at this point.

[Patrick Archambault:]

Okay. And let me just shift gears to Brazil. Obviously, this last quarter has been a very good one, arguably, just a product of coming back from a pre-buy. I think it was Dana that was on their call saying that the second half seemed to be a bit softer. What are you guys seeing for that region in terms of your order books from your customers over there?

[Hari N. Nair:]

This is Hari. We're not seeing any softening at this point, certainly into Q3. And early indications for Q4 continue at a fairly strong clip, fairly consistent with the first half, except for some general seasonality. So we're not seeing any slowdown at this point.

[Patrick Archambault:]

Okay, that's helpful. And if I can just ask one last accounting one. The higher tax rate guidance this year which you've laid out, is that something we should be thinking about modeling going forward, or do you ultimately think you'd go back down to sort of the statutory 35% rate?

[Kenneth R. Trammell:]

Well, again, our goal is always to reduce the rate, and the reason that it looks like it's going to be up this year is because of just the mix of where the earnings are coming from. We're not able to record a benefit for losses in certain jurisdictions, and those have increased. And it's going to depend on the economic recovery in those regions as to whether or not there's going to be an impact. So for right now, we think that range that we've given of 36% to 38% is something that we should assume is going to continue for some period of time.

[Patrick Archambault:]

Okay. And can you -- just specifically, which regions are the ones that would need to get better?

[Kenneth R. Trammell:]

It's a number of regions in -- it's India. It's some of the regions in Europe, Spain, quite a few.

[Operator:]

Joe Spak, RBC.

[Joseph Spak:]

I just wanted to focus a little bit on the North American Clean Air margins, which are incredibly strong. And I imagine you're still not getting a ton of leverage from the commercial vehicle capacity, or maybe you could give us that capacity utilization update. But I mean, I understand there's probably a mix benefit from the pickups, which, I think, you alluded to earlier. But where can those margins go? Or is this sort of mid to high teens as good as it could get in North America?

[Kenneth R. Trammell:]

So in the second quarter, certainly, pickup trucks are selling well. I should point out that production wasn't quite as strong for pickup trucks as for passenger cars in North America in the quarter. I think pass car was up around 6%, and pickups are up around 4%. So yes, we're certainly getting some benefit from that. But I think you're seeing also the impact from a production standpoint of some of the launches of the new product that's going on in the pickup truck segment.

[Joseph Spak:]

Okay. And on the 55% capacity utilization that you pointed to in the past in the commercial vehicles there, I would imagine, given the levels close to what it was in the first quarter, that's still fairly accurate?

[Gregg M. Sherrill:]

It's within the margin of error being exactly what we told you basically in the first quarter. Commercial vehicles minus those 3/4 tons, which are counted in the light vehicle segment, were down a little bit year-over-year from a production point of view. So that still represents considerable opportunity with any recovery there.

[Joseph Spak:]

Okay. And then the Asia-Pac Ride Performance, I think you called out some new launches, but meaningful improvement. I mean, is it fair to assume that could be a double-digit margin business as you start to leverage some of the investments you've made over in that region?

[Kenneth R. Trammell:]

I think we've talked about the margins in Asia-Pacific, in China, in particular, as being margins we're very happy with. And our goal is to maintain the strong margins. I think it's difficult to assume that we'll continue to expand those margins in the near term, but certainly, maintaining strong margins is our goal.

[Joseph Spak:]

Okay. And one last quick one. We've heard some conflicting commentary about whether there's actually a Euro VI pre-buy going on, on the commercial vehicle side in Europe. Do you have any color on that, or what are you guys seeing?

[Kenneth R. Trammell:]

I think we did see -- have seen just a little bit of a pickup in terms of production in on-road commercial vehicles in Europe. Whether or not that constitutes a pre-buy or whether it constitutes a little bit of recovery or just what Gregg's talked about before, bouncing up and down along the bottom in Europe, I think if anybody knows the answer, they probably have a crystal ball that none of us -- none of the rest of us can see.

[Gregg M. Sherrill:]

Yes. Europe is pretty hard to discern because there are so many things negatively impacting it, right? And to me, it makes sense that there is some level of pre-buy going on. And we've seen those same comments out there that I'm sure you're referring to. But just the degree to which it's impacting versus just the general overall economic conditions, that's hard to sort out right now.

[Operator:]

Rich Kwas, Wells Fargo.

[David H. Lim:]

David Lim for Rich. Just a couple of questions. We noticed -- I mean, we noticed that your value-add performance in North America was faster than the overall North America sales increase, but it was -- but in Europe and Asia, it was the other way around. Can you just put a little color around that? Is it just the mix of business that you guys are doing, or was there something else that was going on in the quarter?

[Kenneth R. Trammell:]

So David, is your question just going to overall value-add revenues in the different regions?

[David H. Lim:]

Yes, yes, exactly. So I mean, value-add revenues, it seems like the pace of increase was faster than revenues in North America, just in general.

[Kenneth R. Trammell:]

So actually, David, we may be miscommunicating, because what we see, and you probably should go back and take a look, what we see is, in North America, we roughly matched the pace of light vehicle production in the quarter. And that was driven by the fact, like I said earlier, that pickup trucks, which is our strength, didn't actually grow as fast as passenger cars. So we feel pretty good about matching that pace in North America, sort of given that mix was not necessarily in our favor in the quarter. In Europe, with some production that we have from new launches, and I think Hari emphasized this in his numbers, we actually grew a good bit faster in value-add revenues than the European production rates as a whole did, so we feel pretty good about that as well. And similarly, in Asia-Pac, particularly in China, we grew faster there than the light vehicle production rates did as well.

[David H. Lim:]

Oh, I'm sorry. I guess I miscommunicated here. What we noticed is that, like in Europe, you guys are growing, on overall net sales basis, on the Clean Air division, 18%, and your value-add went up only 12%. And we were -- I was just wondering if you could sort of explain the delta there, because in North America, your revenues -- your North American Clean Air went up 2% and your value-add went up 3%. So I just wanted to sort of understand the difference between the regions and what may have driven that difference.

[Kenneth R. Trammell:]

Okay. So David, that's just the mix of the substrate content. Higher hot-in [ph] content, which we're launching in Europe, obviously drives a greater substrate mix.

[Operator:]

Brett Hoselton, KeyBanc.

[Brett D. Hoselton:]

Let's see. I wanted to talk just, first of all, about commercial vehicle revenue outlook. And into the second half, I mean, I've got a pretty good sense of the visibility in the light vehicle segment. But on the commercial vehicle segment, as you look into your second half, how much visibility do you have into production? Therefore, how much confidence do you have that you're going to be able to achieve that $900 million number for the full year?

[Gregg M. Sherrill:]

These are just based on indications we are getting from our customers. I mean, it's as confident as we can really be, I think, on the light vehicle side as well. Hard schedules certainly don't carry us all the way through to the end of the year. They're out there just a few weeks, as they are in the light vehicle side. But it's still based on forward planning and what our customers basically are signaling us that they're ready for. I don't see the confidence being a great deal different between the 2. And that's where we stand right now, and we're feeling reasonably good about it. I mean, there are obviously some things out there that can change it up or down, but we feel as good about the one as the other at the moment.

[Brett D. Hoselton:]

And as you think about 2014 and beyond, outside of production and expectations, do you see any particular material reason for -- reason for material change in terms of your longer-term expectations, whether it be additional contract wins or some production or -- excuse me, launch delays or anything along those lines?

[Kenneth R. Trammell:]

Not aware of any launch delays at this point. We've given you the list of customers that we've won, and that list hasn't changed. And the content requirements to meet the regulations hasn't changed. So really, I think you said it best, Brett. The primary variable, as it has been for quite a while, is the level of production.

[Brett D. Hoselton:]

And then switching gears, just on the European aftermarket, that's been a bit of a headwind here. It appears as though at least you've got one quarter where you've done a little bit better here. As you think about Europe on the aftermarket side, not necessarily the light vehicle side but just the aftermarket side, would you characterize it as stabilizing in your opinion? Or is it just kind of too early to call at this point, in your view?

[Gregg M. Sherrill:]

I think we've said that it seems to be stabilizing somewhat. But I've used this term several quarters in a row now, kind of bouncing along the bottom. So what I mean by that, I'm not just trying to be cute, is that you may see a tick-up one quarter followed by a tick-down the next quarter, but it's still overall within the sort of lower realm of where we've seen it for a couple of quarters. So I think it's -- I don't see it getting materially worse in some sort of a trend fashion, or even materially better. We're just going to see a quarter maybe or 2 where it appears to be up, and then it may be back down again. If we can discern a trend in all that at some point, we'll certainly kind of change our outlook on it. But that's what we're seeing right now, and that's kind of the reports we get from our customers over there.

[Operator:]

Brian Sponheimer, Gabelli & Company.

[Brian Sponheimer:]

Just a few questions here. One, in the past, it's been a quality problem for you when you've had a big rise in your stock, your stock price. Share comp wasn't an issue in the quarter. Have you guys done anything as far as regarding compensation to maybe smooth out what your share comp expense would be?

[Kenneth R. Trammell:]

No, Brian. I mean, we've talked about it and sort of given you the guidance that around $120 million-and-change in our overall market cap is about $1 million in EBIT. That hasn't changed. We had a bit of a tailwind last year and a headwind this year, but that's all just incorporated in the numbers. There's other puts and takes that occur. But yes, at the end of the day, that's there, and the arrangements, the stock-indexed compensation arrangements haven't changed.

[Brian Sponheimer:]

Okay, all right. Now within the operations, what's preventing, maybe other than volume, Europe, South America and India on the Ride Performance side from getting closer to those North American margins? Is it a mix issue?

[Kenneth R. Trammell:]

So certainly, the volume is the biggest driver right now, I think, Brian, is the best way to put it. Also, to be honest, the aftermarket is a bigger piece of the total in North America than it is in Europe, because Europe has been challenged for quite a while. And that also helps the margins in North America compared to Europe.

[Gregg M. Sherrill:]

There are also some mix effects on platforms. European platforms are simply smaller. And our Ride Performance business probably has a little bit more of a lower -- or smaller platform, I should say, mix versus the large platforms. Clean Air is kind of the other way around in Europe.

[Brian Sponheimer:]

Understood. And just one final one. Just talking about some of the inventory corrections that you still need to see in the North American commercial vehicle market. On a quarter-over-quarter basis, Gregg, how much better or worse is it than maybe you saw after the end of the first quarter and maybe what you expected?

[Gregg M. Sherrill:]

First off, we saw -- I think it's pretty much, at least in the second quarter, what we did expect, okay? So no surprise with the numbers in the second quarter, really, at all. I think we were indicating back in the first quarter that we believed that some of those inventory corrections would start slowing, if not ending, somewhere in the second half, and now they seem to be extending themselves. That's what we are seeing. So we're going to continue to see a little bit of a headwind there, primarily impacting the North American numbers, as we've said in this call. So the second quarter, I think, was right on expectations and probably, the second half's a little bit disappointing.

[Brian Sponheimer:]

Is this -- I'm sorry to take up so much time. Is this a one customer issue, or is this pretty broad within the industry?

[Gregg M. Sherrill:]

It's primarily within one customer.

[Operator:]

Patrick Nolan, Deutsche Bank.

[Patrick Nolan:]

Two questions. First, on the SG&A performance in the quarter, it was a really low percentage of sales, about 5% of sales, which, given the equity comp headwind, was a really strong performance. Can you help us? How do we think about where SG&A to sales should be falling out on a full year basis? And is this -- was there anything extraordinary in there in the quarter?

[Kenneth R. Trammell:]

The second quarter is always the strongest in terms of percent of sales because that's when our revenue is the highest. I'll be honest. I think probably, the best way to look at it is on a last 12-months basis. If you look at SG&A, I mean, that includes, like we've talked about, stock-indexed compensation, both up and down, other incentive compensation, a number of different -- timing of selling programs in the aftermarket. So if you look at the last 12 months, 2012, we were 7.5%; 2013, we're 7.4% on a last 12-months basis. So we're roughly the same. There's just some seasonality associated with that percentage in the second quarter.

[Patrick Nolan:]

And Gregg, you've previously talked about the expected value-add margins to improve on a full year basis. We were roughly flat in Q1, and we had a 10-basis-point increase in Q2. Are we still expecting, on a full year basis, to see an improvement in value-added margins?

[Gregg M. Sherrill:]

That's still our expectation. We said it was going to be kind of a quarter-by-quarter fight, and I think you've seen that through 2 quarters now. Again, we don't have, like we did last year, an overall steady climb in the commercial vehicle side, because we're just kind of depending on the volumes this year. We're not launching anything, really, to speak of. But we continue to drive operational improvements. We'll see how the mix things come out, but that's still our expectation.

[Operator:]

Ravi Shanker, Morgan Stanley.

[Ravi Shanker:]

If I can just follow up on the SG&A question. So you're saying there was nothing unusual in the quarter that caused the SG&A to be lower as a percentage of revenues. It was mostly a revenue thing. So looking forward, we should model that as like a 5.8% to 6% of revenue number?

[Kenneth R. Trammell:]

So again, Ravi, just to reemphasize what I said, the second quarter is always the lowest percentage because our revenues are the highest. Again, if you sort of look at SGA&E as a percent of sales over the last 12 months, just doing a comparison year-over-year, June of 2012 LTM was 7.5%. This year, we're slightly better at 7.4%. So again, there's nothing unusual to point out. I think it's better to look at it over a full 12 months because that takes the seasonality out.

[Gregg M. Sherrill:]

Yes, we would not look at the second quarter as a significant trend, not as a percent of sales, because we're still investing in engineering programs, et cetera.

[Kenneth R. Trammell:]

Right.

[Ravi Shanker:]

Got it. Understood. And if I can just ask about North American aftermarket. What do you think the medium-term outlook looks like there? Because there's some talk that with the new car sales increasing, that's going to have an impact on the, obviously, the age of cars on the road and how some of the oldest cars are taken out. I don't think that's a sweet spot of where you are at, but if you can talk about the medium-term trends in the aftermarket, that would be great.

[Gregg M. Sherrill:]

I don't think we're really seeing a significant effect at this point in time. Again, we would wait for probably even a good 3 or 4 quarters seeing where the OE sales go before you'd start even making a call on something like that. So I don't see any significant near-term type effect.

[Kenneth R. Trammell:]

Yes, the average age of vehicle still is pretty high. And remember, the sweet spot I think you mentioned for us is sort of those vehicles that are in the 5- to 10-year range because we're premium-mixed. And that age of vehicle still seems to be being brought in for replacement. Again, it's just solid, steady performance. We're not seeing an increase or decrease to a large extent one way or the other.

[Operator:]

Andrea Durbin, Rainier Investment Management.

[Andrea Lynn Durbin:]

My questions have been answered.

[Operator:]

Ryan Brinkman, JPMorgan.

[Ryan Brinkman:]

You mentioned in the prepared remarks that there was no change to the timing or the cost or the savings of the European restructuring plan. Is this more of a function of just not having any news to report, or does it reflect the tentative stabilization over there? Obviously, visibility is very low. But Ford management recently said, I think, that with the recent improvement, that they're now confident that their announced restructuring plans are sufficient. So I'm curious if what you're seeing on the ground over there gives you more confidence that you would not need to invest in further restructuring actions in the region.

[Gregg M. Sherrill:]

Our comment had really nothing to do with an outlook on how the European market may or may not move. It was simply our previously-announced European cost reduction plan. I think it was in the first quarter, losing track of time here. All we were doing was giving you an update. We can't really be specific right now, because we're working our way through all of the required legalities in Europe. As soon as we can, we've said we'll be specific on the actions. But we just wanted to let everyone know what was there. It's on track. We haven't changed any of the timing. We just can't be more specific right now. But it's all about that singular program. It doesn't reflect what our forward plans might be, which we just will continue to monitor that whole situation for any future potential actions.

[Ryan Brinkman:]

Okay, got it. And then is there any progress that you can report during the quarter with regards to those non-light vehicle and non-commercial vehicle opportunities you've been talking about? So are you winning any locomotive, marine or stationary power contracts? Would you say you feel any better or worse about those opportunities relative to when you talked with us at the Analyst Day in February?

[Gregg M. Sherrill:]

Yes, I don't think our confidence has changed at all. We're still working with those customers. Those regulations are still just a little bit further out, and we can't really make any comments because of our customers and how they like to not talk about those things too early on. But really, no change from what we talked to you about earlier in the year.

[Ryan Brinkman:]

Okay. And then I guess last question, more of a bigger picture question because there's probably a lot of moving pieces. But just on the incremental margins, I see that your value-add revenues rose by $94 million, and your EBIT was up by $9 million, for roughly 10% conversion. Obviously, it was a very good quarter, better than expected. But typically, the conversion is higher than that. Do you still target something like 20%-plus conversion? What would you say are the biggest headwinds that caused the incrementals to track less than the more typical 20%-plus? And how do you see those headwinds trending over time?

[Kenneth R. Trammell:]

Thanks, Ryan. So we haven't given guidance on what the incrementals would look like. We have, in the past, experienced something in sort of the mid-teens, but that varies pretty significantly. Some quarters have been higher, some are lower. It depends on the mix of where the volume changes are, and we've certainly seen that mix be widely dispersed, I guess, you would say, in this quarter, both ups and downs. And so that -- all of that is going to affect the quarter-to-quarter performance. But over the longer term, like has Gregg said, our goal is to continue to incrementally improve margins. We just haven't given any guidance on what that percentage sort of conversion rate ought to be.

[Operator:]

Our last question comes from Richard Hilgert, Morningstar.

[Richard J. Hilgert:]

I just wanted to know a couple of things about Europe. We've heard from a supplier, as well as a manufacturer over there, that there was some inventory building going on in the second quarter. Is that something that concerns you for the second half? And also, I was wondering if you could talk a little bit about what the cadence of your production was during the quarter. Was it pretty steady-state, or was it on-again, off-again?

[Gregg M. Sherrill:]

Well, let me take the forward look. I mean, we are expecting Europe production to be down a little bit in the second half, okay? So I'm -- how that is being impacted by inventory, I'm sure it's taking into account inventory as well as demand levels and, as I said, we do expect it to be down a little bit going forward. As far as the cadence, Hari, I don't know if you have any information on that during this last quarter. I'm not aware of if we've given up and down times. It's more...

[Hari N. Nair:]

No, we aren't -- we didn't experience any significant ups or downs, somewhat different by product line, but fairly steady directionally.

[Richard J. Hilgert:]

Okay. I also heard from other companies so far this earnings season that they were also having difficulty utilizing tax assets in certain countries. And I was curious to know, what's going on with the tax situation over there that you couldn't benefit from the losses in the tax situation?

[Kenneth R. Trammell:]

So Richard, it obviously varies by taxing jurisdiction. You may recall that in the third quarter of last year, we recorded a valuation allowance in Spain. That was obviously driven by the fact that the European economy in general is difficult and Spain, in particular, is more difficult. There are other regions where we're in a growth mode. And because we don't have yet a history of profitable income, from an accounting perspective, we just can't yet record the benefit from the losses that we're incurring there.

[Richard J. Hilgert:]

Okay. Last question on South America, where production was up 22%, on your Slide 14 from IHS. Realizing that it seems like new volume growth is slowing down there, with production being up that much in the quarter, that seems kind of like a mismatch. Can you put a little more color on what's going on with production down there?

[Kenneth R. Trammell:]

I think last year, certainly, the first half of the year, Brazil and Argentina, in particular, were seeing some economic weakness, and you've seen a little bit of recovery from that. Production rates were higher in Q2 year-over-year, and we're expecting Q3 to be roughly flat.

[Gregg M. Sherrill:]

I think it was just a relatively easy comparison.

[Kenneth R. Trammell:]

Yes, that's a good way to put it.

[Richard J. Hilgert:]

Okay, easy comparison. So it's not one particular manufacturer with a new set of models or anything like that going on?

[Gregg M. Sherrill:]

No.

[Operator:]

I show no further questions.

[Linae Golla:]

Well, thank you. This concludes our call. An audio replay will be available on our website in about an hour. You can also access recording by telephone. In North America, you may reach the playback at [phone]. For those outside North America, the number is [phone]. This call-in information is also found in our press release. If you are an analyst or an investor with additional questions, please follow up with me at [phone]. Reporters with additional questions can contact Bill Dawson, Executive Director of Global Communications, at [phone]. Thank you for joining us today.

[Operator:]

This concludes today's conference call. Thank you for participating. You may disconnect at this time.