Tsakos Energy Navigation Limited
Q4 2013 Earnings Call Transcript

Published: 30 Jan 2014

[Operator:]

Good morning, and welcome to Tenneco's Fourth Quarter and Full Year 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, everyone, 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 part of the call taking you through our quarterly and full year results. The 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 for questions. Before we begin, 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 measures in our press release attachments. The earnings release and attachments can also be found 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. And with that, I will turn the call over to Gregg.

[Gregg M. Sherrill:]

Thank you, Linae, and good morning, everyone. Less than a year ago, we announced our long-term vision and strategic imperatives to drive profitable growth for Tenneco. This included aligning our business along product lines, Clean Air and Ride Performance, each with its own distinct strategies for success. Today, I'm pleased with how results in the fourth quarter and full year demonstrate the strength of that vision, and the alignment of our global team around our growth opportunities and improvement initiatives. In addition to having 2 strong product lines, our results reflect Tenneco's outstanding balance in terms of geographic regions, end markets, customers and vehicle platforms. Building on our positive momentum throughout the year, we finished 2013 strong, delivering record revenue and cash from operations for the fourth quarter and the full year. And excluding restructuring charges, EBIT, net income and earnings per share also reached record highs for both the quarter and the year. Beginning on Slide 4, total annual revenue increased 8% to just under $8 billion. Revenues were higher in both divisions, with Clean Air up 11% and Ride Performance up 3% versus last year. Our light vehicle business, which represented 72% of total revenues, continues to show excellent growth, rising 13% in the quarter and 8% for the full year. Our strong platform position with leading customers and higher global light vehicle volumes, particularly in China and North America, helped Tenneco outpace industry growth. Supporting our overall growth and strategically complementing our light vehicle business is the continued revenue gains in our commercial truck and off-highway business. Revenue for the quarter climbed 51%, and for the full year, 18% to reach $946 million. Despite weak overall volumes, we benefited from new content launching in advance of 2014 regulations and higher revenue in all major geographic markets. To better describe the various commercial vehicle markets that we serve, we now refer to Tenneco's non-light vehicle OE business as commercial truck, off-highway and other. As we've moved through the implementation of interim and final off-highway regulations in Europe and the U.S., we've had great success in off-highway equipment used in construction, agriculture and other industries. On the commercial truck side of the business, our growth is also aligned with the regulatory timeline, with truck business growth in South America and China, and now increasing in Europe with Euro 6 regulations and customer such as Scania. The other category would include large engine applications such as those for marine, locomotive and stationary. Now we continue to build on our impressive customer list of the world's leading commercial truck and off-highway manufacturers, and today we're happy to add several new customer names on Slide 6. In China, we can now name JND and Dalian Diesel as commercial truck customers. And in South America, we will be supplying aftertreatment systems to Iveco for programs launching in 2014. In our off-highway business, we also added Tier 4 final aftertreatment to a new engine family, which will represent significant incremental business with an existing customer. Adding further balance, the aftermarket continued its steady contribution, with revenue up 5% for the quarter and 1% for the full year. Moving onto earnings, on Slide 7, we delivered our highest ever fourth quarter adjusted EBIT of $127 million, a 35% increase versus last year. Full year adjusted EBIT rose 13% to $502 million for the year, another record. Both divisions delivered solid improvements in the quarter on stronger production volumes in most of Tenneco's markets. Ride Performance adjusted EBIT rose 70% on operational improvements, higher global aftermarket sales, the ramp-up of new programs in North America and strong light vehicle production volumes in China. Clean Air adjusted EBIT increased 17% on higher volumes and the ramp-up of new platforms in North America and China. I'm very pleased that we continue to improve profitability with significant margin improvement in the fourth quarter and full year, as we continuously work to increase efficiency and reduce costs. Our adjusted EBIT as a percent of value-added revenue increased from 6.9% to 8.1% in the fourth quarter, and from 7.8% to 8.2% for the full year. These results were driven by solid operational performance in both divisions on higher light vehicle volumes, a year-over-year increase in commercial truck and off-highway revenues and higher global aftermarket sales. Finally, I want to highlight our outstanding cash performance. Cash generated by operations rose 38% to a record high, $503 million for the year, as a result of doing a particularly good job of managing working capital. We also continued to improve our balance sheet, has reflected in a record low leverage ratio of 1.2 at the end of the year, down from 1.5 a year ago. So to sum it up, we delivered excellent results in 2013 by executing well on our growth initiatives and continuing to deliver strong operational performance. And with that, I'll turn it over to Hari for his comments.

[Hari N. Nair:]

Thanks, Gregg. Looking first to the Clean Air division fourth quarter results, starting on Slide 9. Total value-add revenue was up 20% to $952 million. Revenue in all geographic segments was higher versus last year due to several consistent drivers. First, stronger light vehicle production volumes. Second, Tenneco's ability to leverage our position on top-selling platforms. And third, higher year-over-year revenues in commercial truck and off-highway, as well as in the aftermarket. In North America, industry light vehicle production improved and we benefited from our customer and platform balance with higher volumes on current and new programs. Some examples include Chrysler model such as the 200, Dodge Avenger, Jeep Cherokee, the Ram three-quarter-ton trucks with new aftertreatment content and the GM Lambda and Global Epsilon platforms. Additionally, pick up volumes remained strong during the quarter. Commercial truck and off-highway revenue also increased on higher revenues with Caterpillar and John Deere. And the North America aftermarket also had higher year-over-year revenue. Turning now to the Clean Air Europe, South America and India segment. The overall production environment in Europe remains relatively weak, and the industry continues to face significant overcapacity issues. Having said that, in the fourth quarter, light vehicle production volumes improved slightly in Europe, which drove an increase in revenue versus a year ago. We benefited from higher volumes on large platforms with Daimler and Volkswagen, and the continued ramp-up of recently launched programs for Jaguar and Land Rover. Commercial truck and off-highway revenue also contributed to the Clean Air increase, with higher revenues in all regions. And Clean Air aftermarket sales were roughly flat versus last year for this segment. Now taking a look at the Asia-Pacific segment for Clean Air. China continues to drive revenue gains, with higher light vehicle volumes and a number of new programs on strong selling models. We also benefited from higher commercial truck revenues versus last year, as we are slowly beginning to see an increase in commercial trucks with aftertreatment content. Increasingly, cities in China are beginning to implement emissions regulations, supported by the greater availability of low sulfur diesel fuel. Now looking at earnings for Clean Air, on Slide 11. Clean Air adjusted EBIT increased 17% to $97 million, with improvements in each segment. The main drivers were our ability to effectively leverage higher light vehicle volumes, primarily in North America and China, and the benefit from higher commercial truck and off-highway revenue while delivering consistent strong operational performance. Clean Air value-add adjusted EBIT margin for the quarter was 10.2%. Fourth quarter 2013 margin includes higher engineering investments for future customer programs, primarily in North America. For the full year, we improved value-add adjusted EBIT margin to 10.6%. Now let's turn to Ride Performance, starting on Slide 12. For the fourth quarter, Ride Performance total revenue rose 8%, with every segment reporting higher revenue versus last year. In North America, the production environment remains strong. Higher light vehicle volumes and our recently launched content on new programs for BMW and Nissan, new elastomer content on the Ram and Ford pickups, higher commercial truck revenue and higher aftermarket sales, all contributed to increased revenue in the quarter. Now turning to the Europe, South America and India segment. Our balance helped deliver revenue growth despite challenging economic conditions across Europe, with relatively weak light vehicle production and industry overcapacity issues. Revenues in the quarter increased mainly on higher Europe commercial truck revenue and higher aftermarket sales in Europe and South America. In the Asia-Pacific segment, Ride Performance revenue growth continued in the quarter, driven by stronger light vehicle production in China and our content on some of the region's top-selling models. Now looking at Ride Performance EBIT on Slide 14. Ride Performance adjusted EBIT increased 70% to $51 million in the fourth quarter, with improvements in each segment. The main drivers were operational cost improvements, higher light vehicle volumes in North America and China, new program launches in North America, higher global aftermarket sales and higher commercial truck volumes in Europe and North America on programs with Ride Performance content. Ride Performance adjusted EBIT margin improved to 8.3% in the fourth quarter, 3 full percentage points better than a year ago. Underpinning our success this quarter and throughout the year was strong global alignment around our Clean Air and Ride Performance strategic imperatives and continued focus on operational excellence, including flawless launches and standardizing our manufacturing processes through the Tenneco Manufacturing System; executing on our previously announced restructuring activities in Europe where the process is continuing according to plan; continuing emphasis on controlling our cost drivers; and improving our safety and quality performance. In 2013, we achieved a record low total case rate for safety and recorded our best ever PPM quality metric. These important metrics help strengthen our operational performance, improve customer satisfaction and support employee engagement. To summarize, the results this quarter and for the year reflect our unwavering focus on continuously improving every aspect of our business to drive even greater success for Tenneco. With that, I'll turn it over to Ken.

[Kenneth R. Trammell:]

Thanks, Hari. On Slide 16, we recorded $8 million of restructuring cost in Europe. $5 million of that was in the Ride Performance business and $3 million was in the Clean Air business. As we first discussed last January, we expect the European cost reduction initiatives to generate $60 million in annual savings by 2016, with related costs of about $120 million, of which we had announced $80 million by the end of 2013. Separately, we recorded $1 million in restructuring and related costs this quarter as part of exiting the distribution of aftermarket exhaust products in Australia. Now let's turn to taxes and interest on Slide 17. Tax expense for the quarter was $33 million and included $1 million of tax benefit on restructuring charges and $3 million of tax adjustments related to prior year estimates. Before these benefits, our fourth quarter tax expense was $37 million, resulting in an effective tax rate of 35% this quarter and 36% for the full year. We expect that our effective tax rate for 2014 will be in the range of 36% to 38%. In 2013, we made cash tax payments of $109 million, up $29 million from 2012, due to higher taxable earnings. In 2014, we expect cash tax payments will increase significantly as we will have fully utilized our U.S. net operating loss. As a result of that and continuing profitable business growth, we expect cash taxes in 2014 will be between $190 million and $210 million. Interest expense was $20 million in the fourth quarter compared to $21 million last year. And for the full year, interest expense was $80 million, and we expect to incur about the same level of interest expense in 2014. Turning to cash flow on Slide 18. We generated cash from operations of $412 million in the fourth quarter. That's an increase of 72% from the year-ago quarter. As Gregg highlighted, we did an excellent job managing working capital this quarter, as shown in our key working capital days metrics. Days sales outstanding, excluding factoring, improved 3 days from last year to 53 days. Our inventory days on hand were 35 days, an improvement of 6 days from a year ago. And our days payable outstanding at the end of the quarter were even with last year's metric at 72 days. Capital expenditures in the quarter were $91 million compared to $77 million in the fourth quarter last year. The increased fourth quarter spending was primarily to prepare for launches, including those that need upcoming emission regulations for off-highway equipment in North America and in Europe and for commercial trucks in China. For the full year, capital expenditures were $254 million, down slightly from 2012's $263 million. As we discussed last quarter, the timing of some of our investments was deferred into 2014 due to launch requirements. That change in timing, plus spending for upcoming launches, will result in expected capital spending in 2014 in the range of $275 million to $300 million. I would like to point out 2 other items in the cash flow statement in the quarter on Slide 19. We completed our 2013 share repurchase program by purchasing an additional 130,000 shares for $7 million in the fourth quarter, bringing the total shares repurchased in 2013 to 550,000 shares for $27 million. Earlier this month, our Board of Directors approved a plan to repurchase up to 400,000 shares during 2014 to offset dilution from employee stock ownership plans. Additionally, during the fourth quarter, we completed both stages of the transaction we told you about on our last earnings call to acquire the partner's remaining ownership in our Dalian, China joint venture. Now let's go over debt on Slide 20. At quarter end, debt net of cash balances was $822 million, an improvement of $135 million from last year end. As a result of our excellent earnings and cash performance, our leverage ratio improved to 1.2x compared to 1.5x a year ago. And with that, I'll turn the call back to Gregg.

[Gregg M. Sherrill:]

Thank you, Ken. In summary, it was a great quarter and a great year. We made excellent progress driving profitable growth in both our Clean Air and Ride Performance divisions, and we continue to see significant upside ahead. Now looking at the latest third party forecast on Slide 21, global light vehicle production in the first quarter is expected to rise 6% in the regions where Tenneco operates, including increases in North America, Europe and China, while production is forecasted to decline in India and South America. As we have demonstrated, our strong position with light vehicle customers globally, will help us successfully capitalize in this production environment. In our commercial truck and off-highway business, we expect revenues in the first quarter to be about 20% higher than last year. This includes new content to meet more stringent off-highway emissions requirements, beginning this year in North America and Europe, and higher China revenues as we gradually see more implementation of existing emissions regulations. In the first quarter, we expect the global aftermarket to be essentially flat compared with strong levels from a year ago. Now turning to our revenue guidance for the full year on Slide 23. We expect our total OE revenue for 2014 will grow in the range of 7% to 11%, including revenue growth in both light vehicle and our commercial truck and off-highway business. We expect our light vehicle revenue growth to outpace overall global industry production as volumes increase and we capitalize on our strong platform position with leading global customers. According to IHS forecast, global light vehicle production is expected to increase 5% year-over-year in the markets where we operate. We also expect to benefit from new platform launches, as well as the ramp-up on recently launched light vehicle platforms, such as the 2014 North American car and truck of the year, the Chevy Corvette and the Silverado pickup, both of which featured Tenneco content. In commercial truck and off-highway, we anticipate strong year-over-year revenue growth between 20% and 30% for 2014. Even though volumes are expected to be relatively flat overall in Tenneco's commercial and off-highway businesses, we expect a number of factors will fuel our growth, including the initial phase-in of U.S. Tier 4 final and Europe Stage 4 regulations, which will add incremental content on off-road equipment programs; additional growth as customers, such as Scania, ramp up on recently launched Euro 6 programs; and in China, we expect a gradual increase in revenue from commercial trucks as more cities implement diesel emission regulations and low sulfur fuel becomes more widely available. Finally, our global aftermarket is expected to continue its steady performance, driven by our market-leading positions and the power of our brands. Looking further ahead, we expect significant OE revenue improvement to continue. In fact, our book business has grown in the past year. And over the next 5 years, we anticipate average annual OE revenue growth of about 10%, supported by the same drivers we discussed with many of you at our Investor Day in New York, last February. In our core light vehicle business, incremental content and our outstanding geographic balance and platform position with leading global customers will allow Tenneco to outpace global industry production. Increasingly stringent emissions regulations will create technology-driven growth opportunities in light vehicle and commercial truck and off-highway equipment. Our strong, diverse and growing book of business with industry-leading commercial truck and off-highway manufactures offer cyclical upside as the various markets recover, and we have significant incremental growth opportunity in large engines, as emission regulations expand to marine, locomotive and stationary applications. We're excited about the opportunities before us, confident in our strategies to capture growth and laser-focused on driving improved profitability. Finally, let me recognize the 26,000 Tenneco employees around the world who deliver our results every day while building towards this bright future. Thank you, all, for your efforts in 2013 and the great work underway in 2014. And with that, we can open up the call for your questions.

[Operator:]

[Operator Instructions] Our first question or comment comes from Brian Johnson from Barclays.

[Brian Arthur Johnson:]

Could you maybe comment on the kind of strength we saw in aftermarket this quarter in ride control, which both, and at least versus our [indiscernible] revenue and EBIT? And whether this was just a catch-up or whether -- and we could expect this to moderate or this is the type of performance with the seasonality we ought to expect going forward?

[Kenneth R. Trammell:]

Brian, I don't know if we saw anything particularly unusual with the aftermarket business. I mean, like we've said, sort of for several years, it is -- the aftermarket business in general, which includes Ride Performance, is a business that's not growing very fast around GDP or maybe a little bit below. But the Ride Performance business in particular, with the strength of the Monroe brand, continues to do well. We continue to win some new customers, we've done that here, as well as particularly in Europe recently. And we're pretty happy to see some stabilization like we've talked about for the last several quarters in the Europe aftermarket. I don't think there's anything particularly unusual. And like Gregg said in sort of his closing comments there, we expect next year the aftermarket will continue to be steady, I don't know if we'll see a lot of growth. But it's at a very strong level right now, and we're pretty happy with what's going on there.

[Gregg M. Sherrill:]

I think one of the key points there, is that it has been at a pretty strong level now for several years. And yes, there's one quarter and maybe a little bit stronger next quarter, around that strong sort of median, if you will, a little bit less. But we're really pleased with it, obviously. We expect it to kind of stay where it's at and grow moderately over time based on the market share gains we have and the power of that brand, as Ken said. But I wouldn't overreact to one single quarter's point, I guess, is what I would say.

[Operator:]

Our next question or comment comes from Patrick Nolan from Deutsche Bank.

[Patrick Nolan:]

Gregg, first, can you just touch on your expectations what value-added margins will look like, assuming this kind of 7% to 11% OEM revenue growth next year?

[Gregg M. Sherrill:]

I mean our goal, I know it's unchanged, is to overtime continue to improve our value-added margins. Kind of like I said last year, I'm not going to say that every individual quarter might hit it because we have a little seasonality to the business. We'll have higher engineering investments for future growth in given quarters versus whatever that revenue may turn out to be. But over the course of the year, our goal would be to continue to drive improvement.

[Patrick Nolan:]

And if you -- and it seems like you chose to not disclose the kind of the 5-year revenue outlook for CV, like you've done in the past? Can you just help us think about are the goals the same, as far as where you think that business can get as far as a percent of your overall OEM revenue? Or if that come down a bit, given volumes becoming a little bit weaker there and you've done better on the LV side?

[Gregg M. Sherrill:]

I think what we're seeing there is -- first up, the simple answer to your question is those commercial revenue growths can easily hit those percentages that we've given you. What we're seeing here is, is -- and I said it in my remarks, the content, the business we're booking only continues to increase, actually, in the past year, right? That was built into all of those numbers. I think all we're saying, by giving you as clear as we can, what we're seeing in our total OE revenue growth for one year and sort of that 10% CAGR look out over the next 5 years, is kind of pulling back on getting out of the business of trying to forecast the timing of cyclical swings in the market out there, right? Given that market comes back, and when it does, we can go above the trend line that we've given you. If those cycles come down, we'll go below it a little bit. But the overall trajectory is still -- I don't think it's really changed. The overall trajectory is unchanged. And that's what we're trying to say by that 10% CAGR number, the average annual year-over-year growth rate there. And we feel really good. We feel really good about where we're at. And I think all I'm saying is, I'm kind of at least in 2, 3, 4 and 5 years out time frames, getting out of the business of forecasting cyclical movements in the markets.

[Patrick Nolan:]

That makes sense. If I could just sneak in just one more. Can you just refresh us, given the volatility we've seen in some of the Latin America markets, just what your overall exposure as a percent of revenue to South America today?

[Kenneth R. Trammell:]

Patrick, I don't know that we've disclosed South America separately. I'd have to go check honestly and look into 10-K and see if it's there. But, I mean, we've got a pretty good presence in Brazil and Argentina. We do expect that light vehicle production will be down in South America this year. Not significantly, I think, in the order of 6% or so. We do expect that commercial vehicle will be up a little bit, commercial truck. It's the on-road commercial truck business that is regulated down there. That will be up just slightly, again, based on kind of what our customers are telling us down there. So what we will see, a little bit of change in that market, but it -- then [indiscernible] can be a significant driver for the company overall.

[Gregg M. Sherrill:]

And it kind of nets out within that overall production increase at 6%. It's included in that.

[Operator:]

Our next question or comment is from Rich Kwas from Wells Fargo.

[Richard Michael Kwas:]

Just following up on that last point with the South American piece, and maybe some of the other emerging economies. What have you baked in, in terms of currency for the rest for 2014? There's been a lot of volatility with some of these markets, and how much cushion, if at all, have you put in with regards to currency fluctuation?

[Kenneth R. Trammell:]

Rich, we're -- since we're not very good at currency forecasting, we defaulted to fairly recent currency rates. So it's whatever everything was trading at the euro, obviously, will be the biggest driver, and that was at 1 33. The others are relatively where they've been for the last, up 2, 3 months there.

[Richard Michael Kwas:]

Okay, so the recent volatility in some of these currencies, let's say, the last week or 2, or 3 weeks or so, that wouldn't be factored in?

[Gregg M. Sherrill:]

No. Not in these. No.

[Richard Michael Kwas:]

That's helpful. And then, Gregg, in terms of the longer term on -- within that 10% CAGR, you talked about light vehicle outperformance, and you had very strong performance this quarter with a number of launches that helped, but is there a way to quantify the outperformance versus light vehicle production over the next few years, the expectation, is it a function of, you need to grow 1 or 2 points above light vehicle production or anything different than that?

[Gregg M. Sherrill:]

No, I think it's-- we're seeing is pretty much what our historical record has been. And that's on the order of 1% to 2% above.

[Richard Michael Kwas:]

Okay, and then on the CV side in the quarter, in the fourth quarter, did you benefit in Europe and North America? And I know the on-road piece was pretty small for you in North America, but in Europe, did you get any benefit from prebuy?

[Kenneth R. Trammell:]

There was probably a little bit of a pickup there, Rich. But remember that, for 2013, our primary exposure there is on a handful of Daimler platforms. So again, like we've said, it's not that significant.

[Richard Michael Kwas:]

Okay, so it wasn't a big driver of the upgrowth in the fourth quarter for CV? Okay.

[Kenneth R. Trammell:]

Not on the commercial truck.

[Gregg M. Sherrill:]

The upcoming sort of boost we'll get in Europe on road, if you will, on highway, is the Scania business, that's launched and beginning to ramp up Euro 6, because that's an all new customer for us.

[Kenneth R. Trammell:]

And Rich, there was a pickup in off-highway production in the fourth quarter, both in North America and Europe. And our visibility is a little bit limited to what the inventory looks like there, but that may have been a bit of build ahead of the regulation change for 2014.

[Richard Michael Kwas:]

Right, right. So there was -- so -- but there's not really a way to quantify that, but you did feel like you got some benefit?

[Kenneth R. Trammell:]

No, there's not a way to quantify it, but we've -- try to adjust for it in on our expectations for 2014.

[Richard Michael Kwas:]

Okay, that's helpful. And last quick one, on the $60 million of savings from the restructuring, is there -- have you -- could you share with us what you've gotten so far? I know that's the run rate looking out in the future, but is there a way to say what impacted '13?

[Kenneth R. Trammell:]

Yes, it's still been fairly small in 2013. I don't have a number off the top of my head, but it's certainly in the single digits. We're expecting it to begin to ramp up this year. We ceased production in our plant in Spain in the fourth quarter, so we'll start to see a little of benefit as we move into 2014 there. But the bulk of it is really going to come in 2015, and then we'll finish up in 2016 and get the run rate.

[Operator:]

Our next question or comment comes from Ravi Shanker from Morgan Stanley.

[Ravi Shanker:]

So within the new CV segment, can you give us the breakup of the 3 subsegments so that's commercial vehicles, off-highway and the other within that.

[Gregg M. Sherrill:]

For us, it's not a new segment. It's -- we just...

[Ravi Shanker:]

Okay the renamed segment?

[Gregg M. Sherrill:]

Yes. I mean, we just try to clarify what all is in there. Because we intended to the best use of the word commercial vehicle, which sort of in the industry out there, it means a bunch of on-road trucks, right? And if you -- again, our emissions business is driven by that regulatory timeline. We've had this really great success in the off-road side and so all we thought was let's clarify when we use to talk about commercial vehicle, what do we mean? We mean on highway trucks, #1, commercial trucks. #2, we mean this off-road equipment. You can think Deere, Caterpillar, Deutsch, tractors, bulldozers that sort of thing, right? And then thirdly, the category which we was calling other right now, that's where we include what we call the really large engine business that has applications in marine, stationary, locomotive, okay?

[Ravi Shanker:]

Quite so safe to say the new segment is -- so the segment is predominantly on-road CV?

[Gregg M. Sherrill:]

No, actually because of where the regulations have been recently it's more of the off-road equipment.

[Kenneth R. Trammell:]

Ravi, if you...

[Gregg M. Sherrill:]

By the way, that's a little bit regional, because again, you have to follow that timeline. In North American and Europe, a lot of the growth has come in equipment, off-road equipment, right? In South America, with the regulations change for trucks we had a great success there. That was commercial trucks, on-road. We've also, in Europe, had some success recently with on-road, picking up some business with Scania for their Euro 6 requirements. And China is all commercial truck. It's not the off-road stuff. So you got to study those regulations region by region, which we kind of lay out, I think pretty clearly for everyone. And all we're saying is when we're talking commercial, we mean all of that. And it's certainly region by region different what that mix of business is.

[Kenneth R. Trammell:]

And Ravi, if you a look at Page 6 of the $950 million out of the roughly $8 billion in revenue we had, that's what's in the commercial truck and off-highway business. And that is -- we show you the customers and whether they serve the commercial truck of the off-highway business on Page 6, so that will help you with that.

[Ravi Shanker:]

Got it. And on the margins, you said that you're goal is to improve margins in the coming years, obviously. But do you think we'll see that more on the gross margin line or SG&A or where is that going to come, or both?

[Kenneth R. Trammell:]

Yes. So Ravi, I mean clearly, we'll continue to work on margins, right? And when we talk about improving margins, we do talk about the value-add EBIT line. All right? Because we got to take the substrate components out. Those are pass-through. And it’s a value-add EBIT line we expect to continue to improve that, now we'll continue to work on the gross margins as well and we will, as best we can, continue to leverage the SG&A piece. Now there may be some both ups and downs on SG&A, as well as engineering. In fact, you saw, in the fourth quarter, we had an increase in engineering expense in our Clean Air business as we're getting ready for some big launches coming up over the course of the next year or 2 in that business as well. So we will continue to work on both, but you'll see it kind of coming through best I think at the value-add EBIT margin line.

[Ravi Shanker:]

Got it. And just finally, your cash flow performance is great in the quarter. Is that a new normal or would any timing related gain is there? And also does this strength in the quarter kind of make you revisit your priorities for use of cash?

[Kenneth R. Trammell:]

So Ravi, we have a fairly seasonal working capital business in the fourth quarter. It's always the best quarter, that's when quite honestly revenues begin to decline in the aftermarket, and therefore, we're collecting receivables that we built up earlier in the year. We're also adjusting inventories in the aftermarket to what's happening with the seasonality. And because there is downtime on our original equipment build rates at the end of the quarter, we're collecting more cash then we're putting back in there as well. So the seasonality of the business is no different than we've seen before. We did see very good performance this year in the fourth quarter, in particular, on things like inventory. But I should point out that inventory days on hand 35 days is basically the same spot where we were 2 years ago. We're just getting back from inventory that we had had to put into the business during 2012.

[Ravi Shanker:]

Got it. And do you see yourself kind of maybe looking a little more at upping the size of the buyback or something just given the strength of the cash flow recently?

[Kenneth R. Trammell:]

So Ravi, we've tried to be hopefully very clear on what our goals are, both near term and long term in terms of deploying our cash. Net debt-to-EBITDA leverage ratio of about 1x is key. That's driven off the fact that we want to make sure we're prepared to not have to go back to the banks the next time there's a downturn. We got amendments before, we can certainly do it again, but not our favorite thing to do. So we certainly want to make sure we don't have to go back to the banks and ask them to continue operating the company in the event there's another downturn. So we need to get the 1x before it opens up the opportunity to start thinking about that. We've certainly made a lot of progress, but we're not there yet.

[Operator:]

Our next question or comment comes from Joe Spak from RBC Capital Markets.

[Joseph Spak:]

Maybe just a follow-up on that last comment. You are 1.2x now. If you just look at the midpoint of your revenue growth and assume a pretty good incremental margin, and I recognize and appreciate that you guys said cash taxes are higher. But it does seem like you get to 1x or maybe even a little bit better by the end of next year. So is that something you'll update us on through the year as we get closer to that target? What the capital allocation plans are?

[Kenneth R. Trammell:]

Yes. I mean, Joe, I think you hit a couple of key things to take into account, right? I think that cash flow in 2014 will certainly be a little bit more challenged than 2013. A, we've got growth and we'll require working capital investments to fund the growth. B, CapEx is going to be up $275 million to $300 million next year compared to the $254 million we had this year. And then the cash taxes will be up fairly significantly. So we won't make as much progress in 2014 from a cash flow perspective as we did in 2013. That being said, certainly, we want to get to 1x. We do have a seasonal business, which means that, that leverage ratio grows in the interim quarters and then comes back down when we get to the end of the fourth quarter. Certainly, there is a possibility we get there by the end of 2014, but with investments we want to make, it may not be until sometime in 2015. Nevertheless, we're still committed to that capital allocation that we've included in our investor presentation for probably the last 2 or 3 years. And in that order, which means that when we get there, that the option certainly opens up to look at share buybacks and dividends. But it doesn't mean that it's automatic when the first quarter we talk about 1x.

[Joseph Spak:]

Okay, great. And then I Just want to go back to something you said earlier, Ken, and in the past, you talked about how we could be in a little bit of a period where maybe the incremental margin on the Clean Air side aren't as strong because of some of the investment for the next stage of regulations, you talked about higher engineering this quarter. For instance, it does seem like the incrementals were a little bit low, is that something that maybe should per -- or at least below the third quarter, is that something that maybe persists here in the beginning of the year and then start to improve a little bit as we exit '14?

[Kenneth R. Trammell:]

Yes, I think so. I mean kind of like we talked about in the third quarter call, as we're launching the new business, we're certainly putting in the investment both the personnel, as well as the equipment to be able to build the content for the NOx emissions requirements. And so we will work into that as those customers begin to ramp up their production during 2014. So we should see that start to pick up from as we sort of move through the year.

[Gregg M. Sherrill:]

I'm not assuming here looking exactly at regulatory timeline, but for example, in 2013, as we said at the beginning of last year, it was a relatively quiet year for regulatory change, right? We were ramping into a lot stuff that have changed the year before and early in the year. This year, there's some more change. As you lead into that, that's where the engineering investments start coming in. There's a change in the content with those Tier 4, final, in particular, in the stage 4 being Europe that are causing a higher level of engineering at this point in time. And that kind of rolls, right? So it kind of ebbs and flows, depending on where the next significant regulatory content is being engineered into their product. And so, we're kind of seeing that right now and you saw it in the quarter. And then that should kind of ebb away, pending what else is coming out there, right? Again overall, the whole thing is you get it launched, you get it ramped up, then you start getting the revenue in the base, and our margins start should, like we said, the goal is to improve those, it's just -- we're not going to say quarter, every single quarter because of this ebb and flow of incremental engineering investment.

[Joseph Spak:]

Okay. One last question, if I can. I appreciate the sort of flat volume commentary on commercial vehicle off-highway. Is there any additional texture you can provide within that, is AG expected to be down, maybe construction up a little bit, that sort of next to flat.

[Kenneth R. Trammell:]

Well, to be honest with you we look at it customer by customer. When we build an aftertreatment system for an engine, we can't tell you which market they're going to put it into. But generally speaking, most of our customers are right around flat. One may be up a little bit, another may be down a little bit. And it's different regionally as well. I mentioned, for example, that there's a little bit of expectation that we'll see some increase in Brazil commercial truck business.

[Gregg M. Sherrill:]

That's the on-highway.

[Kenneth R. Trammell:]

That's the on-highway business. In China, although production rates are expected to be down in China for commercial truck, because we're seeing some gradual increase in the implementation of the standards, our revenues in China will grow in 2014.

[Operator:]

Our next question or comment is from Matt Stover from Guggenheim.

[Matthew T. Stover:]

I just had to kind to follow on the question of incremental margin, and I'm wondering if you could quantify the value of the increase in RD&E in Clean Air? And sort of on the other side of what was maybe a little lower incremental margin in Clean Air, you had significant -- significantly more positive performance in Ride Performance business and I'm wondering how we should think about that into '14, given your outlook for the market, as well as the impact of actions that you've taken?

[Kenneth R. Trammell:]

Yes. I'll give you that. If you look on the income statement Matt, for the quarter, we saw about a $9 million increase in engineering expense, and that was predominately associated with what's going on in the Clean Air business. Okay, and then your other question was regarding Ride Performance margin improvements, and I think Hari covered it fairly well. We've seen volume improvement, which is great because we're seeing a little bit of increase on the fixed cost base, we've already got there. We've also seen operational cost improvements. That business has been working hard on some of the strategies we talked about at the beginning of the year, and so we've made some pretty good progress on it. We'll continue to work on it, but this quarter was obviously a very strong quarter for improvement. I don't know that I would assume that it continues to improve at this rate in the future, but certainly, we're happy to see that come in right now.

[Gregg M. Sherrill:]

Yes. Now you want see Ride improvement just right. I mean that was obviously -- but that was -- it's kind of the historical line in the fourth quarter, with some of the sales revenues and new programs launching et cetera, but I do want to emphasize what I'm very pleased with, over the last year, we got organized into these 2 product divisions. We got really focused on each individual business, and I -- you guys heard me hammering away even a year ago on focus, focus, focus on these businesses. And I think that has helped put what is going to be a little bit more sustainable focus on the cost side and the operational side of that Ride Performance business. And I do expect to see that to continue to improve. Again, Ken is absolutely right. That's not the driver of that entire increase. As I said, the stars aligned. We have some good programs launched and all that. But I do want to stress what I think is very positive underlying that business is that focus in operational improvement.

[Operator:]

Our next question or comment is from Brett Hoselton from KeyBanc.

[Brett D. Hoselton:]

Okay. So just to follow with Matt's question on the incremental -- on the Clean Air side, the contribution margins, if I were to kind of reak out the contribution margins with, and add back in $9 million in RD&E that was just the contribution margins would be kind of around 10% on the Clean Air side versus 6%, which is what you reported. And then on total revenues, I'm looking at it on total revenues not so at value-added revenue. I guess my question is, do you have any sense, Ken, as to what you might anticipate value-added margins or contribution margins, depending on how you want to look at, might look like as you kind of move out into the year #2 or year #3 from where we're currently at after we get past this period of additional engineering expense?

[Kenneth R. Trammell:]

Yes. I mean Brett, as you know, we don't give earnings guidance. So I don't have a percentage to give you. But certainly, I think you've seen it half in several times before where we make additional investments. We've done it in the past in China, we're doing it right now for engineering purposes and Clean Air. And then as we built the revenue, the margins start to come back in. Over time, we will be probably sort of where we have been historically, but it won't be smooth every quarter.

[Gregg M. Sherrill:]

I think, where are we? 10.2 in the quarter on Clean Air? I'm sitting here very pleased with that for the quarter. I mean the engineering is there, it's there for the right reason. We also wouldn't show an engineering begin ramping up on launching, if you will, some of this Tier 4 final stuff. So you got incremental up in the cost of goods sold as well. Manufacturing guys going in, being trained, the volumes are still low, the revenues are still low on that portion of the business. That's just that ebb and flows as you launch and then ramp up and start absorbing all that, right? Is still up for the year, that's what I keep kind of hammering away on. And our goal is to make it up for the next year as well.

[Brett D. Hoselton:]

And as I think about that RD&E expense, how do we think about it over the next, let's say several quarters, is it simply going to be choppy depending on the launches? Is there some sort of a step function change downwards, because we're in a period of particularly heavy launches today, but 2 or 3 quarters from now it starts to step down again, how do we think about the trajectory of that?

[Kenneth R. Trammell:]

I mean, so Brett, we're going to continue to make investments in engineering expense. There is certainly what we're talking about right now for near-term launches, but a lot of the strategy that we talked about a year ago involves a solid knowledge in core sciences. We want to be the go-to company for our customers from an engineering standpoint for handling Clean Air. And we'll continue to make those investments. And those are going to continue to come in. So I don't know that there's going to be a lot of ebb and flow, I mean there's always changes, timing of customer recoveries and everything else. But we -- that's an important part of the growth story of the business.

[Gregg M. Sherrill:]

We're not talking about anything new here. This has been running for several years. I mean, so I am not sitting here with 3 or 4 years’ worth of quarterly detail in front of me, but I do want you to think that this quarter engineering expenses were a little higher, fine. There'll be another quarters there were as well and they will be going forward vis-à-vis the revenues, right? As you go through this launch cadences and the ramp cadences and all of that. But the overall trajectory, the overall, if you start looking at a broader based on a year, you go back to look at history, I don't think we're talking about anything really new here.

[Brett D. Hoselton:]

I would agree. The second question I have for you. As you think about your revenue guidance in '14 and your revenue guidance over the next 5 years, obviously, you've trimmed it down a little bit here. It doesn't sound like you're seeing any content headwinds, sounds like you're actually adding content adding new customer, and so on and so forth. I see light vehicle production estimates generally being revised upwards. So it seems like the primary driver of the reduction is entirely on the commercial off-highway and other production side of things. Is that a correct assessment? Or are there other factors driving the...

[Gregg M. Sherrill:]

No, no. I think that's pretty good assessment. As we said before, we are continuing to build our book business. That you can -- that as much a commercial vehicle statement as anything. In fact, it was primarily a commercial vehicle statement, although light vehicle continues to build as well. And as I said earlier, all I'm trying to do is get out of thinking I know what the market cycles are going to be 3, 4 and 5 years out, because I don't, and neither does anyone, right? So there the only change would be, if you look at 2014 last year, whatever it was, right, I'm sure we have baked in there some improvements in commercial vehicle volumes that we're not kind of seeing as overall flattish, right? That market -- I keep stressing, of course, it's going to go back. That's the definition of a cyclical market, and it has been down and it still is right now. But there's only volume differences due to these cycles that we're in this -- stop trying to forecast, at least 2, 3, 4 or 5 years out. Obviously, we're giving a revenue forecast for the next year. And quite frankly, when we look back, our 1 year out forecast has actually been pretty good over the last 5 years. We've missed 1 year, I'll admit that. Total revenue, 2012.

[Kenneth R. Trammell:]

And again that was volume on commercial truck and off-highway that drove it. So...

[Gregg M. Sherrill:]

The bottom line of your answer is, the content we continue to build and be pleased with, and we're just -- we'll be really happy when those cycles come back.

[Operator:]

Our next question or comment comes from Brian Sponheimer from Gabelli & Company.

[Brian Sponheimer:]

Most of what I wanted to ask was asked already, but just 2 quick questions. Any benefit that you may be expecting in Ride Performance in North America from a miserable winter or potholes et cetera.

[Kenneth R. Trammell:]

So Gregg has always said, if we need water to sell sharks, we don't need sales guys. But it certainly doesn't hurt. We will see it's been, obviously, one of the roughest winters we've had in quite a while. And certainly, we would hope to see a benefit, but at this point, I think it's probably a little bit early to call it, for sure.

[Brian Sponheimer:]

I guess beyond that, staying in Ride Performance, any expectations or any potential business wins as advance factors in that the Carquest and Worldpac acquisition?

[Kenneth R. Trammell:]

Yes. I mean, it certainly has they did add and some of our other customers have bought businesses, it's benefited us. There's a cost to that associated with that, and that's the changeover cost that we've talked about before. So if there's something that's significant that comes up from that perspective, we'll certainly give you a heads-up about it. But I mean certainly, well we expect to continue to win market share as that continues to move along.

[Brian Sponheimer:]

And Ken, just housekeeping. Pension underfunding at year end.

[Kenneth R. Trammell:]

So I haven't seen the final actuarial numbers. We're certainly a lot better. Like most companies, we've been chasing the discount rate down, and that reversed in 2013. And we had obviously very good performance with the pension assets as well. I just don't know what the net numbers are going to be, but the 10-K will be out here in 2 or 3 weeks, and that will get you the exact number.

[Brian Sponheimer:]

All right. If you're in a situation where that potentially gets to an overfunded number, I think you probably have to get to about 1 15%. would you look to annuitize that?

[Kenneth R. Trammell:]

Yes. I mean, Brian, we're certainly still in an underfunded position. So I want to make sure that I'm clear on that one. We're just a lot closer to funded than we've been in the past. We'd like to get out of the pension management business, whether that is an annuity or something different, we haven't made any decisions yet. But remember that we've frozen most of our defined-benefit plans really around the globe, and we're certainly working our way out of it. But it'll take a while we get there. So it's not a near-term opportunity for us, I don't think.

[Operator:]

Our next question or comment for us from Richard Hilgert from Morningstar.

[Richard J. Hilgert:]

On the substrate percent of revenue, I noticed it's not a huge increase, but as a percent of revenue, it is going up from 27% to 28%. Just curious, that's not cost of the material that's driving that, that's just the greater number of substrates for admission unit, correct?

[Kenneth R. Trammell:]

Yes, Richard. It's the mix. You're exactly right.

[Richard J. Hilgert:]

Okay. Also, there's been quite a bit of discussion about the engineering expense. I'm not concerned about whether the expense is going to be owners in 2014 or not. The basis of my question here is just to get to how your thinking is for the way that Tenneco develops intellectual property going forward? And was just wondering on the engineering expense, was some of that may be to develop new product, new technologies that you're investing in for the future besides just doing the daily blocking and tackling on the engineering side for your customers?

[Gregg M. Sherrill:]

I think what you saw in the fourth quarter was what I call a little bit more the variable side of engineering. It's not the underlying R&D that didn't really change I don't think in the quarter, per se. So it's more that variable piece, that's more launch, content design driven due to the timing of customer programs out there.

[Richard J. Hilgert:]

Okay. Good. And one last one, please. I was curious with -- we still keep hearing about natural gas, we're also hearing about increases in biomass for diesel fuel. And it would seem to me that no matter which one the commercial vehicle industry might tend to use a little bit more than what it has in the past, your actual value-add should probably be about the same. The only difference might be whether or not there is catalytic converters involved. Is that the correct way to look at those 2 alternatives?

[Kenneth R. Trammell:]

Yes, so I mean, Richard, the natural gas, let me see if I can answer your question by explaining it this way. A natural gas engine has a content, the cost to clean it up for the emissions regulation is probably somewhere between a gasoline engine and a diesel engine. That being said, depending on the type of natural gas engine that you're talking about, it can even vary within that. If it's just a straight natural gas engine like you see in a passenger car or a light pickup truck, that's probably a little bit closer to the gasoline side. If it is a diesel ignited natural gas engine, in other words, what will be required to get greater torque that you need in a larger commercial vehicle, that's going to have higher content, because that still has diesel emissions that come through the tailpipe. It runs from what we understand, I think probably around 10% diesel, 90% natural gas. And so consequently, that's going to have a variable number. So it is going to vary depending on the technology the customer uses. But that is something that we're on top of and have been providing content for natural gas engines for a while now.

[Richard J. Hilgert:]

Right. My thinking was just trying to understand how this -- if it becomes a greater part on the commercial vehicle side, if it becomes a greater part of the revenue, which -- I'm not expecting a wholesale move into either one of these in the next couple of years, but just trying to understand the way that the margins work if the value-add is about the same, but the total revenue generated from that type of business is lower because of the nonvalue-add side is different. Then, we could expect to see a shift in or an improvement in margin. Is that the way to think about it, or is it the opposite of that?

[Kenneth R. Trammell:]

It varies with the technology that's required to clean it up. So we'd certainly rather do a diesel-ignited natural gas than a natural gas, but we'd rather do natural gas than gasoline. And our preferences is complete diesel, if you're talking about total value-add.

[Gregg M. Sherrill:]

But if you're talking about just the total margin, including the substrates, obviously, any shift in the percentage substrate going lower improves that overall margin. That's why we focus on the value-add, that way we stay close to the fluctuations and the precious metal stuff.

[Richard J. Hilgert:]

Okay. And there's no change or difference in system that would have to be used on a low biomass diesel engine and a diesel engine that's equipped to handle this new 20% level?

[Kenneth R. Trammell:]

I don't know the direct answer to your question, Richard. But if you're burning hydrocarbons, it is just a matter of physics. There's always something that comes out of the tailpipe, that's going to require [indiscernible].

[Operator:]

And I'm currently showing no further questions or comments at this time.

[Linae Golla:]

Thank you. This concludes our call. An audio replay will be available on our website in about 1 hour. You can also access the recording of this call by telephone. In North America, you may reach the playback at [phone]. For those outside North America, the number is [phone]. This playback information is also found in our press release. If you're an analyst or 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:]

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