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Tenneco Inc. (NYSE:TEN)

Q1 2009 Earnings Call

April 30, 2009 10:30 am ET

Executives

James Spangler - VP, Global Communications

Gregg Sherrill - Chairman and CEO

Ken Trammell - CFO

Analysts

Brian Johnson - Barclays Capital

Himanshu Patel - JPMorgan

Brett Hoselton - KeyBanc

Patrick Archambault - Goldman Sachs

Vincent Mierlak - Summit Securities

Mark Bishop - Boston Company

Rich Kwas - Wachovia Securities

Operator

Good morning and welcome to Tenneco’s First Quarter 2009 Earnings Release Conference Call. You will be in a listen-only mode until the question-and-answer session of today’s conference. (Operator Instructions) I just wanted to remind you that the call is being recorded, and if you have any objections you may disconnect.

I would now like to turn the call over to Mr. James Spangler, Vice President of Global Communications. Thank you sir, you may begin.

James Spangler

Good morning and welcome to Tenneco’s first quarter 2009 financial results conference call. Earlier this morning, we issued our press release and the associated financial information, and in a minute, I’ll be turning the call over to Gregg Sherrill, Tenneco’s Chairman and CEO, and Ken Trammell, our Chief Financial Officer.

Gregg and Ken will spend the first half of the call, taking you through a detailed explanation of our first quarter performance and slides related to their prepared comments are available on the financial section of Tenneco’s website at www.tenneco.com. The two of them will then take your questions during the second half of our call. The conference call operator will again explain the process for asking a question at that time, and we will do everything possible, to address all of your questions today.

Now please note that our discussion today will include information on non-GAAP financial measures, all of which are reconciled with GAAP numbers, as shown in our press release attachments. The press release and the attachments are also posted on our website. In addition to reviewing our first quarter results, 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’ll turn the call over to Gregg Sherrill. Gregg.

Gregg Sherrill

Let me begin by stating what’s undoubtedly obvious. The first quarter represented the toughest vehicle production environment for a single quarter that this industry has experienced in decade.

In North America and Europe, our two largest market regions, light vehicle production declined year-over-year by 51% and 48% respectively, as the impact of the global recession continue to drive down consumer demand, depress sales and force vehicle manufacturers to significantly curtail their outlook.

Consequently, our revenue performance reflected the realities of these external factors. For the first time in nearly five years, we generated less than $1 billion in quarterly global revenues. Last time this happened was in the third quarter of 2004, or 18 reporting periods ago.

However, in the face of this economic storm, I am pleased to report that we all set a significant portion of the impact by aggressively managing everything within our control and executing on our global cost and cash management initiatives, most of which I outlined on our last quarterly conference call.

Specifically, lower OE production volumes worldwide and manufacturing fixed cost absorption related to those volume declines, produced a negative $100 million year-over-year EBIT headwind this quarter. EBIT was also negatively impacted by $13 million in currency, but our employees worldwide fought hard to counter these conditions and we were able to offset a little more than half of this negative impact, primarily through lower SGA&E spending, restructuring, operational flexing programs, manufacturing efficiency improvements and customer recoveries.

Our earnings also benefited this quarter from a stronger mix between OE and aftermarket revenues, which typically carry higher margins. In this quarter 23% of our total revenue was from aftermarket sales, up from 17% one year ago. While gross margin in the first quarter included the benefit of customer recoveries on several commercial items, the performance is primarily a good indicator that our restructuring and other cost reduction activities are proving effective and helping to offset the unfavorable production environment.

You will see on Slide 6, gross margin was 14.5%, compared with 15% a year ago. This was our strongest gross margin performance since the second quarter of 2008 and a sequential improvement over the fourth quarter 2008, despite a 20% revenue drop in the last quarter.

One of our top priorities in this environment is liquidity. First, I want to remind everyone that we amended our senior credit facility earlier this year, which included revising the financial covenant ratios each quarter through the second quarter of 2011 to provide some cushion in complying with these ratios.

We were pleased with the support from our lenders and what we viewed is a very important step in managing through this tough environment. In spite of this environment, we made solid progress in the important area of cash by delivering on plans to generate our own liquidity, primarily through working capital improvements.

On Slide 7, you will see that we did a good job of reducing inventories and managing account receivables in a quarter, where EBITDA was down $55 million year-over-year, and cash flow from the sales of receivables was reduced by $45 million.

In the quarter, we used $81 million in cash from operations versus a $64 million usage a year ago. Cash flow from accounts receivable improved $33 million year-over-year and cash flow from inventory reductions improved $77 million compare to a year ago.

We generated $34 million in cash flow from inventory reductions versus the cash used of $43 million in the first quarter of 2008. This performance was significant, when you considered that the first quarter is when we use cash to build inventories to support OE customer platform launches and prepare for the spring selling season in the aftermarket.

Finally, we dramatically cut our capital expenditures, while continuing to make the necessary investments for future growth and we continue to make progress in eliminating all nonessential spending. As sound as our execution was within this quarter’s environment, we know challenges remain with continuing low OE production volumes worldwide.

It is more important than ever, to stay focused and continued to be aggressive in implementing targeted cost savings and cash preservation actions. We are also making sure that, we are using all of our Six Sigma and Lean Manufacturing tools to strengthen our operations and continuously improve manufacturing efficiency in our plants worldwide.

In addition to our previously announced cost reduction programs, on April 1st of this year, we implemented temporary reductions in our salaried employee cost. These plans, which will reduce global salary cost by at least 10% are tailored to each of our markets and include salary cuts and work hour reduction programs.

Our most senior level executives have taken larger salary reductions. We recognize and regret the impact of this action on our salaried workforce. Our goal is to cancel these reductions once we are comfortable that market conditions are strengthening, and a recovery is well underway.

We anticipate this action will reduce our salary cost by about $7 million in each quarter, similar to the impact of other actions we used in the first quarter such as temporary layoffs. We opted for this approach rather than another round of layoff at this time, to ensure that all critical programs are supported in the near-term, and that we have the right resources in place, as we look ahead to future growth.

Before I turn the call over to Ken, let me just reiterate my thanks to our 21,000 employees worldwide. Despite the continued sacrifices we have asked them to make, they continue to impress me with their dedication, performance, and commitment to Tenneco’s ultimate success.

With that, I’ll turn it over to Ken for a review of our numbers.

Ken Trammell

Thanks, Gregg. Slide 9 shows our financial results for the first quarter, which reflected negative production environment we faced in every major region, where we operate. Revenues and EBIT were down on lower year-over-year OE production volume and manufacturing fixed absorption related to those volume declines had a significant negative impact on earnings.

With that said, a significant portion was offset, as we continue to take up costs and flex our operations in the quarter. Before I get into the specific geographic segments, let's cover the adjustments for first quarter 2009 and 2008, which effect year-over-year comparisons and are detailed on Slide 10.

Here I want to point out, that we again took non-cash charges of $18 million, or $0.39 per diluted share primarily for the impact of not recording a tax benefit for office in the United States and certain other foreign jurisdictions. In addition, we took restructuring charges of $3 million, as part of the global restructuring initiative we announced last October.

As we previously indicated, we anticipate that our restructuring expense related to that initiative, will be about $7 million for 2009. So, you can see that, we are on track with completing these actions and as a reminder once fully implemented, we estimate this restructuring program will generate annual savings of about $50 million.

I also want to call out the impact of currency in our results this quarter. Just as it did last quarter, the global economic crisis drove some unusual changes in currency exchange rates. As a result, the strengthening US dollar negatively impacted revenue by $175 million and EBIT by $13 million.

Now turning to the North American results on Slide 11, our OE revenue was $333 million, down 39% year-over-year from $550 million. Excluding substrate sales and the impact of currency, revenue was $225 million versus $333 million in the prior year.

Our results reflect volume weakness in the quarter, with industry light vehicle production down 51% from a year ago. Additionally Class 8 commercial vehicle production was down 42% and Class 5-7 commercial vehicle production was down 47% year-over-year. Our vehicle mix improved with pickup trucks and SUVs accounting for 61% of our North American OE revenue in the quarter significantly over lower 46% in third quarter of 2008, and almost even with 64% a year ago.

Our North American aftermarket operations recorded first quarter revenues of $136 million, or $139 million excluding the currency impact, versus $133 million last year. Sales were relatively stable despite lower consumer spending in this environment.

Our North America EBIT performance is detailed on Slide 12. EBIT for North American operations was $4 million compared with $9 million a year ago. Excluding restructuring in each quarter, EBIT was $6 million versus $10 million.

As Gregg mentioned, the biggest factors impacting our results were OE production volume decline and the manufacturing fixed cost absorption associated with those declines. In North America, we significantly offset the negative impact of volumes and absorption with lower SGA&E spending, restructuring actions, improved aftermarket pricing, new business launches, more favorable mix with a greater percentage of revenue generated by the aftermarket, as well as customer recoveries. Unfavorable currency also had an impact on EBIT lowering it by $6 million.

In Europe, industry light vehicle production was down 48%, which was certainly reflected in our results. On Slide 13, OE revenue generated by our European operations was $278 million, down from $555 million a year ago. Excluding substrate sales and the impact of currency, revenue was $323 million, down 19% compared with $400 million.

Europe aftermarket revenue was $60 million, compared with $87 million a year ago. Our aftermarket revenues decline due to lower sales in both product lines and the negative impact from currency exchange rates, excluding the impact of currency, revenue was $75 million.

Our North America and India operations did a good job of offsetting lower production volumes in Brazil and Argentina. As you can see on Slide 14, revenue was $68 million, down from $94 million a year ago. The decline was primarily driven by the impact of currency and lower substrate sales, which when excluded resulted in revenue that was even with a year ago.

One Slide 15, total EBIT for Europe, South America and India was a loss of $17 million, compared with earnings of $25 million in first quarter 2008. Adjusting for restructuring charges in each quarter, EBIT was a loss of $16 million versus earnings of $28 million last year. As the North America, the low production volumes and manufacturing fixed cost absorption had the greatest impact on EBIT.

We were able to partially offset the impact of SGA&E cost reductions and the benefit of restructuring activities, some of which weren’t fully implemented until the end of the quarter due to a more complex process for working with employee work councils in Europe. We also benefited from improved aftermarket pricing and new OE platform launches, currently at a $6 million negative impact on EBIT.

Now, turning to our results in Asia, which on slide 16, we generated $67 million in revenue that’s down 25% from $90 million a year ago. Excluding the impact of substrate sales and currency, revenue was down 22% to $48 million. This decline was largely driven by OE production volume declines in China on key Tenneco-supplied GM and Volkswagen platforms.

Finally, on Slide 17, you will see that revenue from our Australian operations was $25 million, down 52% from $51 million a year ago. When you exclude substrate sales and the impact of currency, revenue was $38 million, down 15% compared to $44 million in first quarter 2008. As in other regions of the world, our results in Australia were impacted by the lower OE production volumes, with industry light vehicle production down 38% year-over-year.

EBIT in Asia Pacific this quarter was breakeven, compared with earnings of $5 million a year ago, driven by OE production declines in China and Australia are largest markets in the region. Our cost reductions and manufacturing efficiency improvements were largely offset by higher year-over-year engineering and SGA&E expenses in China, in preparation for emission control, commercial vehicle launches beginning later this year. This is on Slide 18.

Now let me run through some of the other financial results in the quarter. We continue to do a very good job of executing on our cost reduction initiatives including employee furloughs and restructuring actions, which brought down SGA&E cost by 30% to $99 million from $141 million a year ago. Because of our lower year-over-year revenues SGA&E, as a percent of sales was 10.2% compared with 9%.

On Slide 20, you will see the depreciation and amortization was $52 million for the quarter, compared with $55 million in first quarter 2008. I apologize for that brief interruption. I am not sure, where we got cutoff. So, let's start again with SGA&E.

We continue to do a very good job of executing on our cost reduction initiatives including employee furloughs and restructuring actions, which brought down SGA&E cost by 30% to $99 million from $141 million a year ago. Because of our lower year-over-year revenues SGA&E as a percent of sales was 10.2% compared with 9%.

Now on Slide 20, you will see the depreciation and amortization was $52 million for the quarter, compared with $55 million in first quarter 2008. The decline was primarily related to currency. In first quarter of 2009, D&A includes $1 million in restructuring expense.

Moving on to Slide 21, interest expense in the first quarter was $31 million, compared with $25 million last year, when we recorded a $5 million benefit related to marking, now terminated interest rate swaps to market. Lower LIBOR rates offset the impact of our higher borrowing spreads under our amended credit agreement.

Now on Slide 22, we recorded non-cash, cash charges in the quarter of $18 million, which I mentioned earlier. Cash taxes for the first quarter were $4 million, compared with $12 million in the prior year. As a reminder, we previously said that we expect cash taxes will be in the range of $40 million to $45 million this year.

Now, I'd like to turn to our cash and dept position. First on Slide 23, you'll see that our debt position at the end of the quarter was total debt of $1.587 billion versus $1.463 billion a year ago. Cash balances were $113 million compared with $161 million at the end of first quarter 2008 and debt net of cash balances was $1.474 billion, compared with $1.302 billion at March 31, 2008.

On Slide 24, you'll see the two financial covenants that we must meet each quarter and the revised ratios under our amended credit facility. At March 31st, our leverage ratio was 4.72, below the maximum level of 5.50. Our interest coverage ratio was 2.91, which was above the allowed minimum of 2.25.

The margin we pay on our borrowings under our Term Loan A and revolving credit facility will be LIBOR plus 500 basis points in the second quarter, as opposed to increasing to 550 basis points, since our net leverage ratio was less then 5.0 in the quarter.

Our cash flow performance is on Slide 25. We were pleased with our ability to manage cash flow this quarter given the production environment, which drove our EBIT down $55 million. In addition, we have $45 million less in cash flow from the sale of our receivables, compared to a year ago.

We used $81 million in cash from operations versus $64 million use in the first quarter last year. As Gregg already discussed, this performance was primarily driven by working capital improvements, particularly inventory reductions and managing accounts receivable.

Taking a look at the components of working capital on Slide 26, the volatility in global OE production volumes continue to have an impact on our working capital metrics in the quarter. We closely managed accounts receivables such as days sales outstanding, excluding the impact of factoring, was 51 days at March 31st.

Our significant reductions in inventory resulted in 37 inventory days on hand at the end of the quarter and we continue to tightly controlling accounts payable at the end of the quarter with days payable outstanding of 52 days.

On Slide 27, you’ll see that concurrent with amending our senior secured credit facility, we also renewed our US securitization facility in the amount of $100 million through February 22, 2010. As a reminder, our limit for securitizing receivables under our credit facility is $250 million, and we have a flexibility of using several sources to maintain the program.

We are always looking to optimize the benefits from our securitization program, and we take full advantage of $250 million, but given the current environment and low level of receivables, it’s unlikely that will add significantly until production begins to recover. Our worldwide factored receivables were $148 million as of March 31st, compared with $171 million a year ago.

Now, turning to Slide 28, which highlights the couple of key points on our liquidity. First, we completed the quarter with $270 million in unused borrowing capacity under our $680 million credit facility, with $363 million in outstanding borrowings, and $47 million in letters of credit.

Second I want to remind everyone, that our first significant debt maturity is an amortization payment of $54 million in our Term Loan A, which is not due until 2010 and our first bond maturity is not due until 2013. In regard to our North American receivables, we are participating in the US Treasury Supplier Program in order to guarantee the majority of our receivables from GM and Chrysler.

At the end of March, we had net receivables in North America due from General Motors of $72 million. GM's program is expected to commence May 1st and we are finalizing the required documentation with GM and Citigroup today. At Chrysler, everything on our end is done and Chrysler is entering our eligible receivables with Citigroup through their administrative process.

We hope to receive confirmation today if their administrative process is complete. Our receivable with Chrysler at the end of March was $16 million. We received a scheduled payment from Chrysler this morning. As a result, I estimate that our receivable from Chrysler today is about $12 million.

Slides 29 summarizes our capital spending this quarter, which was down 52% year-over-year. We spent $25 million in the quarter, compared with $52 million in the first quarter of 2008. We were able to cut all discretionary capital spending while still investing and expanding our capabilities, developing technologies and purchasing the assets necessary for future growth.

In terms of tracking our progress and holding down capital spending, we anticipate we will spend about $160 million this year, which is down almost 30% from $221 million in 2008.

Now, with that I'll turn the call back to Gregg.

Gregg Sherrill

Thanks, Ken. Looking ahead our outlook remains quite consistent with what we said earlier this year. We are still operating in the midst of the lowest OE production schedules in decades. A few encouraging signs have been the positive results from certain stimulus programs including scrappage incentives and tax incentives in countries, such as Germany, France, Italy and Brazil.

In addition, China light vehicle sales in March rose 5% year-over-year to their highest level ever, but again with significant support from the Chinese government. Some third-party experts were predicting an uptick in North America and Europe production rates at some point in the second half. However, as we have seen with the recent GM production cuts, the situation is still uncertain. Therefore we remain very cautious and continue to plan conservatively.

We will not let up on our cash generation and strict cost management initiatives. The benefits from these initiatives will build throughout the remainder of the year, particularly in our Europe segment, where these activities were not fully implemented until the end of the first quarter, due to the complexity and time it takes to get measures approved in Europe.

As an organization, we will continue working to strike the right balance between taking the actions necessary to withstand this crisis and keeping Tenneco positioned and prepare to capitalize on an eventual recovery, especially given that our growth is more a function of new content and expansion into the commercial vehicle markets than volume recovery.

At the end of this year, we have new programs launching that require higher emissions control content. This regulatory-driven business is driving our targeted investments in the technologies and capabilities, required to support these light and commercial vehicle launches that ramp up in 2010.

Finally, in regards to the General Motors and Chrysler situations, like everyone, we are following developments very closely. Obviously, this is a very fluid situation and to say anything more at this time would really be speculative. To emphasize, what Ken mentioned earlier, we are participating in US Treasury Supplier Program, which provides guarantees for most of our North American receivable exposure with GM and Chrysler.

In closing, let me reiterate, what I said last quarter. We are working each day to generate and preserve cash and improve our operations with greater efficiencies, while also relentlessly serving our customers with leading technologies, quality products and outstanding service to help ensure their success and ours.

With that we can open the call up to questions.

Question-And-Answer Session

Operator

(Operator Instructions). The first question is from Brian Johnson. Please state your company name.

Brian Johnson - Barclays Capital

Could you kind of recap for us some of the cost reduction numbers, the targets, and how those are spread across the geographies, and then where the timing is on those going forward?

It looks like if you said about half of the $100 million EBIT headwind was offset, that’s about $55 million of cost reduction in 1Q. Is that about right, and how is that split and I know you’re not done yet, but what can we look to going forward?

Ken Trammell

Brian from a cost reduction standpoint, I guess if you look at the SGA&E side of the mix, we were down about 30% compared to first quarter of last year in our total expense for SGA&E. That is a combination of restructuring activities that we’ve taken, the extraordinary efforts that our employees have put out to make sure we cut every dime of discretionary spending that we just absolutely don’t have to spend, and then the employee furloughs and other activities that Gregg talked about that we implemented in the first quarter.

We would look to continue to see significant SGA&E and cost savings as we move through the rest of the year and then, would remind you that the salary rollback that we talked about implementing on April 1st, we expect the same place until we begin to see recovery. So, that is a bit fluid. When recovery happens, we would expect to restore salaries back to where they were.

Brian Johnson - Barclays Capital

How about on the production cost side? Some of the other players with active in Europe like Borg Warner have moved to flexible work weeks. Can you quantify what the cost reduction was in Europe or alternatively what kind of decremental margins you're looking to in that segment?

Gregg Sherrill

I don’t know that I could quantify on this morning, but we have taking those exact same types of actions that you just mentioned, negotiated with our labor unions over there. Some of those were implemented in the first quarter. Some of them are now going into effect significantly in Germany and Belgium, where our bigger operations are, but I don’t know Ken that we could actually quantify those this morning.

Ken Trammell

Yes, I don’t have a quantification for you. I can tell you. I mean, obviously the volume hit us pretty hard in Europe in the first quarter because it takes longer to get some of the actions moving in Europe. We didn’t see as much of a benefit in the first quarter, as we would expect to see in the second quarter.

So, certainly pending the outcome on production in Europe through the rest of the quarter, we hope to see an improvement in the decremental amount. Second quarter should look better than the first quarter.

Gregg Sherrill

I have to say that, we're pretty happy with the cooperation we're getting in Europe. There is no question about that.

Brian Johnson - Barclays Capital

On the European revenue side, the scrappage program suddenly we hope will be stabilized in production going forward. What are you seeing in terms of mix, in terms of gas versus diesel and the impact on your OE emissions business from those types of programs?

Gregg Sherrill

I don’t know that there was a significant gas versus diesel mix change. Clearly and it has been reported, a great deal of our significant part of the sales will resulting from the scrappage programs have been in smaller vehicles. I think it just kind of a function of the times right now, and whether that mix begins to mature back later on or not it’s just too early to say, but I think there has been something of a shift towards smaller vehicles.

Brian Johnson - Barclays Capital

So, with that headwind, looking at page 13, production was down 45%. Ex-currency and substrate, your revenue was down 19%. Is that roll-on of some backlog? Is that a mix that was position to what was being produced and selling in the market?

Gregg Sherrill

It’s a combination really of probably two or three things, Brian. It certainly, there is always platform that launch every quarter. We got a bit revenue; I won’t say it a lot (inaudible) related to platform launches.

Our platform mix versus the total market based on what was produced in the quarter and then on our ride control side, it’s get still a mix, but we've got pretty strong mix because of the computerized electronic shock. That particular piece of our business has held in, I'd say; probably better than everything else in Europe at this point.

Brian Johnson - Barclays Capital

The electronic shocks are used even in the smaller vehicles?

Gregg Sherrill

They’re not on the smaller vehicles, but we've been launching on those very quickly, very recently and on the vehicles that they are on, the take rate is continue to run pretty nicely.

Operator

The next question is from Himanshu Patel from JPMorgan.

Himanshu Patel - JPMorgan

Hi, I had a question on just the margins in North America and Europe. You were profitable in North America this quarter, if we just were to assume that industry production volumes were to stay stable at this level. Is it fair to say the NAFTA should remain in the black going forward?

Ken Trammell

Himanshu, certainly there is no guarantees, but that's would be what our expectation is. I mean, looking at North America, one of the things that really helped us in this quarter, beyond all the cost reduction efforts, was the aftermarket mix, with that aftermarket mix moving up, that certainly helped the EBIT margins and if you'll recall, traditionally the second quarter is our strongest aftermarket quarter. So, we think we’ll continue to get a lift from the aftermarket into the second quarter.

Himanshu Patel - JPMorgan

Okay and then, on that same line of thinking, is that how you’re setting up your European business as well? Once all of the savings from the restructuring in Europe are implemented at current production levels, can that business be in the black as well?

Gregg Sherrill

Europe is probably a little bit more difficult for us to assess on that line right now, Himanshu. There will be improvements in Europe, as all of these cost reductions roll through. That one took a little more time and remember the Europe drop in volume came later than the drop in volume in North America as well, right? So, we’ve had some time to really shore up North America and Europe really took the big hits in the fourth quarter and then even worse in the first quarter.

So, I don’t know that I’d want to just quantify that really this morning. We’re definitely going to see some improving performance in Europe, as a result of cost reductions that are now in effect if you will. That we are not fully in effect in the first quarter and it does remain to be seen exactly how mix and things like that are going to shake out in Europe.

One last thing, I’d say in Europe is, we’re not seeing quite the same level of aftermarket performance from a market point of view. I mean, it is not come back quite as strong as that in North America and again, if that were to come back with a stronger, that would also be some positive for us, but it has not as of this time, like North America has.

Himanshu Patel - JPMorgan

Just coming back to aftermarket market in North America, I noticed the stabilization there. Can you just characterize the sort of monthly pattern, what’s been going on there from January through April? Have you seen actually growth in the business in the latter part of the quarter versus being down in the first part or was it pretty steady-Eddy throughout the whole quarter?

Gregg Sherrill

I think March and April were certainly better than January and February, but remember, there is some normal seasonality there as well. I think the important thing that we're really saying this morning about the North American aftermarket is, our outlook there is, for it to be, sales-wise relatively stable to last year, which anything that’s relatively stable relative to last year right now, is good news for us.

Himanshu Patel - JPMorgan

Gregg, how do you view the impact on the North American aftermarket business from any potential scrappage program?

Gregg Sherrill

I don’t know again that in the real short-term, we’d see anything. I think that over a longer term, again that’s going to be having an effect, but its kind of the same (inaudible). I've already said about the aftermarket is very tough to sort out the seasonality from what's impacting what.

You do have to kind of look at it over a longer term. If we implement a fairly aggressive scrappage thing in over the longer term that’s going to pull some of the older vehicles off the road. It could have an impact. I wouldn’t expect it to be in this year though so to speak. I don’t know that you could sort it out.

Ken Trammell

I’m answering the other thing, we got to point out. I think most of the scrappage program discussions have been vehicles 10 years and older and really our prime target market, especially in the ride control side, is those vehicles like in the 5 to 10 year range. So, it will have some impact, but I think it will be a bit muted because we operate the premium end of the aftermarket that tends to be, you know, those vehicles that are 10 years of age and under.

Himanshu Patel - JPMorgan

Just one housekeeping, can the amended leverage and coverage ratios, they start stepping back down in the fourth quarter. Is that right?

Ken Trammell

That’s right

Operator

The next question is from Brett Hoselton from KeyBanc.

Brett Hoselton - KeyBanc

Two different thoughts, or two different questions here. Accounts receivables, securitization, you know that you've got about $148 million of availability, if I remember correctly here. Do you have the receivables to actually utilize that?

Ken Trammell

That's the reason we have the availability right now. Because the receivables are down then we have not been able to add to the level of securitized receivable and kind of like we said in speech. Brett, as soon as we see productions start to recover, we will expect to be able to bring that back up, but at this point, a low level (inaudible) obviously having impact on our ability to fully utilize the $250 million that’s available.

Brett Hoselton - KeyBanc

Now as you utilize the US Treasury Program and are you using just a guaranteed portion of it or you actually factoring?

Gregg Sherrill

Yes, just a guarantee. So, we are looking at right now.

Brett Hoselton - KeyBanc

How does that affect the account receivable securitization here in North America? In other words, do you lose any liquidity, do you have to pull GM and Chrysler out and then put it over into, I mean, how does it have any impact?

Gregg Sherrill

The Chrysler receivables have been and eligible since we redid this deal back in January. So, there is really no impact from Chrysler fees. We will have to pull our capital, the GM receivables, out and I think at the end of March, we've probably sold about 6 million of GM receivables into the program. So, that that have an impact and there is probably an impact on the ratios were in the program as well. As we've looked at it, we are pretty comfortable from liquidity standpoint that’s not a significant hit.

Brett Hoselton - KeyBanc

If think about the commodities impact on your business, as you move forward, nickel pricing seems to be coming down fairly substantially and then steel, it seems like it could be a tailwind here. Do you see commodity is being a tailwind in 2009? Do you see it being a significant tailwind in 2009? You quantify that?

Gregg Sherrill

Not so sure, I’d say significant. Going forward, I think there is certainly some moderating factors there. If you look at the first quarter, it was essentially neutral for us. Net-net our materials really had no impact here.

Ken Trammell

Remember that to on the nickel question that you were asking, Brett that we have pretty pass-through arrangement that doesn’t give us a lag, which means that as it was going up, we didn’t suffer a huge debt, but that means it is going down, we are not looking for a benefit.

Brett Hoselton - KeyBanc

Okay and then switching over to the restructuring, I guess I was a little surprised, that your restructuring costs appear to have come down year-over-year. I mean $4 million in the first quarter of last year, $3 million in the first quarter of this year. It would seem as though that would actually be up. How should I think about that in terms of your restructuring efforts? Does that suggest that, you’ve got most of restructuring behind you, and therefore there is going to be a minimal benefit, as you move into the second quarter and third quarter?

Ken Trammell

Remember that we took a pretty substantial charge in the fourth quarter for the actions that we announced at the end of October and we have continued to utilize and to spend against that restructuring, the first quarter charges for those items that belong, just from an accounting perspective in the first quarter related to that $58 million and remember too that we made an announcement that we would delay for purposes of making sure we managed our cash appropriately, some of the activities that we had initially talked about undertaking one of the plant closure. So, as that, assuming that the economy continues to show some improvement, we would expect to put that plant closure back in at some point in the future.

Brett Hoselton - KeyBanc

Then as we think about the competitive landscape, is there any opportunity here to pickup some additional business in terms of resourcing of product in the near-term from weaker competitors and then longer term, as you look at what you’re bidding on and so forth, are you in that market share gainer at this point in time?

Gregg Sherrill

Yeah, I’d say, based on what we’re seeing out over the next two or three years, the business that we’ve either booked or that we feel very strongly that all the indications are, we're going to book it, that we would be a market share gainer and a big chunk keep in mind as well. So, growing in light vehicles continues, but a big chunk of the growth also just due to these diesel regulations is going to be over on the commercial vehicles segment as well and that’s where it new market being created. So, you're really not taking market share from anyone there.

Brett Hoselton - KeyBanc

Well, and in the short-term is there any possibility if you get some takeover business in the short-term from possibly weak end competitors?

Gregg Sherrill

I would never say there is not a possibility there, but so far I think everyone is really trying to manage through this thing from what we're seeing without disruptions to that type. I mean we will certainly be prepared to, if any of our customers were to come to us, but as of this point we're really not seeing any movement like that.

Brett Hoselton - KeyBanc

Ken final question, I’m surmising that there is a potential ramp up in revenue. New business growth in 2010 will probably outpace that of 2008-2009. I could be wrong there, but that’s my assumption. How do I think about the cash, the CapEx associated with that versus you're current availability. So, I mean is that going to put a significant strain on your liquidity.

Ken Trammell

Well certainly, the 2010 launches we're getting ready for now as we speak. So some of the spending that you're seeing is making sure that we're ready for those 2010 launches.

Gregg Sherrill

That’s within this $160 million outlook we've given.

Ken Trammell

Right. So, we're managing our cash and our spending and our liquidity in a manner to make sure, Brett that we don’t put all these us on liquidity that together.

Operator

The next question is from Patrick Archambault from Goldman Sachs.

Patrick Archambault - Goldman Sachs

Actually, just wanted to follow-up on Brett's question there. Have you had to -- I mean, just given the significant ramp up that you're seeing. Have you had to pull back on any contracts that you had originally been awarded just given your cash constrains. So, are you finding you can, sort of find the way to pretty much fund all the business that you had won?

Gregg Sherrill

No. We have not pulled back on anything. So, we have found a way to get there and that's our intention going forward as well.

Patrick Archambault - Goldman Sachs

And to put it into perspective, can you give us a sense of what commercial vehicles are now as a percentage of sales and maybe what you would expect them to be by the time, let say these contracts ramp up by 2011, I guess.

Gregg Sherrill

For 2008, commercial vehicle was probably in the 6% range, maybe slightly up.

Ken Trammell

And that was mostly right control in elastomer business.

Gregg Sherrill

We've really had the international truck and engine emission control business in 2008 and then some in Europe on emission control. But it's mostly the ride control side. Because it's difficult to get a handle on what production volumes are expected to be in the future, as you recall that we've pulled back on all the guidance we had given, but if I sort of refer back to where we were, if we go back that sort of a more normalized production environment.

We had anticipated that by the 2012, 2013 timeframe, commercial vehicles were probably somewhere between 25% to 30% of our revenue base versus that 6% today. However, production comes out in that timeframe will ultimately determine what that is. But at the end of the day, I think that should at least give you an idea that we expect to grow fairly significantly over the next few years.

Patrick Archambault - Goldman Sachs

I mean, just follow-up on that, can you give us a sense of, you mentioned that you had grown share basically, or gained share just in that [putting] activity. What is it that has allowed you to break into that commercial emissions business and kind of displays, I guess a lot of incumbents like [Donaldson and Nelson fleet car], that sort of thing. Can you give us a sense of what it was that has been your competitive advantage here for that?

Gregg Sherrill

In one sense, you have to remember that as these regulations have come on, it has created for that market new applications, things that no one’s had to produce before. And most of the technology for the emission control systems that those regulations are driven is coming out of the light vehicle segment. It just never was there for the commercial vehicle segment since they did not fall under any of those regulations.

And then as far as where we see our competitor in this, we have been highly focused. We talked about this at length; it’s one of our pillars we think; it’s where it all starts is, we have a very clear technology roadmap lined up with those global regulations, and we believe that we are bringing to market products that are absolutely as competitive as anyone’s in the world. And we think that these wins are evidence of that. And we are still focused on that technology roadmap as well.

I mean, there have certainly been some things in the out years that we pulled back out as we conserve spending, but if you look at anything that’s on the regulatory timeline, required to meet those regulations, we’re still working very diligently on those to ensure that we stay as competitive as possible. And again, I think it’s speaking to those capabilities, these wins that we’ve had.

Patrick Archambault - Goldman Sachs

Okay, thanks. And one on your, on slide 28, you might have covered this, but I didn’t quite get it in time. I think the 72 million receivables from GM and I guess the updated $12 million from Chrysler. Are those gross receivables that, the insurance that you have purchased through the treasury program will help sort of diminish or is that sort of numbers that are kind of net of that insurance policy, representing just your net exposure. How do I interpret this?

Ken Trammell

Those are our receivables. So, we haven’t taken into account the treasury program and just a quick comment on the treasury program. Its still, probably situation is that gets defined, source of parts and where parts are produced and delivered and everything else as to which ones treasury is going to cover, what we expect that a substantial portion of those will be covered by the program.

But also there was a statement that was in the Obama administration information that came out 30 days ago. Of course it feels like 6 years ago, but 30 days ago when they talked about the viability of GM and Chrysler, where the administration actually said the vast majority of the trade at GM and at Chrysler will carry through the process will be fully paid.

So, we're looking at the treasury program as, if you want to call it belt and suspenders, when you add that on to the fact that all critical vendors should be paid in order to continue to order parts, plus the statement that was made by the Obama administration as to keep it in pretty good shape.

Patrick Archambault - Goldman Sachs

Got you okay. One other one, just can you remind us what the outlook for raw materials is this year? I guess you said it was neutral in the first quarter. I take it that, you probably have a number of your contracts settled now. Can you give us an indication? Is that going to sort of hold that neutral for the rest of the year or might you actually get some benefits there.

Ken Trammell

I think, that’s what we said on the fourth quarter call was that, we didn't really expect to see much of a headwind or tailwind on materials on an overall basis in 2009. And there's really nothing that has changed from that.

Operator

The next question is from Vincent Mierlak. Please state your company name.

Vincent Mierlak - Summit Securities

Yes, good morning. I am with Summit Securities. I was just wondering if you would give us a sense of the magnitude of the benefit you received from the customer recoveries in the gross margin.

Ken Trammell

In terms of the gross margin, we had negotiated recovery of some materials cost we incurred in 2008, so its costs that ran through our income statement in 2008 that we finally got resolution of in the first quarter of 2009. That was probably in the $2 million to $3 million range.

Operator

The next question is from Chris Ceraso. Please state your company name.

Unidentified Analyst

Hi. This is Joe on for Chris, Credit Suisse. So I guess, customer recovery was pretty small in North America. It points to a really good performance there. Can you break out for us the aftermarket business versus the OE business there in terms of profitability in anyway, so that we can kind of walk to the second quarter with the decremental margin?

Gregg Sherrill

Joe, I mean, as you know we do not break up the profitability of our OE and our aftermarket business. It's important for our profitability in both of those businesses that information stays internal.

Unidentified Analyst

Right. So, is there any way you can walk us to the second quarter, thinking about sort of the decremental margin then on the OE side of the business as these production cuts come in from GM?

Ken Trammell

I guess, might be misunderstand your questions. You were talking about Europe, but you asked about the GM production cuts, which are North America.

Unidentified Analyst

No, I’m not asked about Europe; I’m just trying to get a feel for how North America held up so well relative to Europe. It looks like the decremental margin in Europe year-over-year was some high double-digit percentage. At the same time in North America, your possibility was essentially unchanged on revenues that were down some 40%, 50%.

Ken Trammell

I think probably several things we had to cover; remember that in the first quarter of 2008, profitability was down in North America, driven to a large extent by the American Axle strike. So, when you’re comparing first quarter 2008 in North America to first quarter 2009, you’re already starting from somewhat of a lower base.

Secondly, remember that first quarter of 2008 in Europe was a very strong production quarter. So, there is certainly just an overall environment difference between the two. Moreover, like Gregg and I talked about during the call, we were able to implement restructuring action in North America in 2008, driven first of all by the fact that the production declined earlier in 2008 in North America, and second by the fact that we’re able to get that done quicker in North America and then like I said, the volume really hit Europe strong in the fourth quarter and then even stronger in the first quarter. So, it just takes a little bit longer to respond.

Unidentified Analyst

Right, okay, that’s helpful and then on the tax rate, did you call out the inability to recognize a tax benefit in North America or in the United States or is that some kind of catch up that you did there with that $18 million?

Ken Trammell

That $18 million is almost all if not all related to not being able to benefit the US net operating loss. There is a little bit of foreign jurisdiction, but of that $18 million I think $16 million relates to the US.

Unidentified Analyst

Okay and then on the debt covenants to step down at the end of the year, is that the net debt to EBITDA covenant, and do you have the level that steps down to?

Ken Trammell

That’s the leverage ratio and you know what I didn’t bring the levels with me, but they are in our 10-K.

Operator

(Operator Instructions) The next question is from Mark Bishop. Please state your company name.

Mark Bishop - Boston Company

Boston Company. I just, I’m a little unclear on the cost cuts. I know you cut a lot of costs over all, some of which I think were manufacturing and I think you originally had a plan of cutting SG&A, I don’t if it was SG&A or if it was overall costs like $58 million or something like that and I missed the number that you gave on the call here like, its only $7 million of that shown up this year.

So, that’s my, my question is how much is of the plan that you announced before this call. How much of the prior cost that you talked about, which I think were $58 million, how much of that is already done and shown in Q1 fully and then secondly, when does the rest come in and then on top of that, well, then I'll go from there.

Ken Trammell

Okay. Mark let me try and clarify for you. In the fourth quarter of last year we announced that we were implementing a restructuring program that was designed to both address our cost of sales, in other words the manufacturing cost as well as SG&A. So there is a reduction force on a global basis.

We also announced that we were closing some plants and we said that the benefit of that we expected once fully implemented would be $58 million on an annualized basis, of which we anticipated we would be able to achieve $50 million in 2009. So, if you look at it, we are already fairly close to run rate. So, while I don't have a breakout of how much of the total cost savings related to that particular program, you can assume we've gotten pretty close to the run rate of the $50 million in the first quarter.

Secondly, we have programs to simply not spend much right, every employee on a global basis is watching every dime, and we've got significant benefits that are showing up from that. We had employee furlough programs in the first quarter and what we said, we replaced those furlough programs beginning April 1st, with a global salary rollback that we anticipated is about $7 million on a quarterly basis and I think that's what the $7 million comes from. So, I hopefully got kind of frames for you in different pieces of what we are talking about in terms cost reductions.

Mark Bishop - Boston Company

Okay. So, you had some global furlough programs in Q1 and that was now replaced by the $7 million per quarter salary cuts. How much did you benefit from the furlough program in Q1? So, where just there a net change in cost from that switch?

Gregg Sherrill

It actually works out pretty close. It was $6 million to $7 millions bucks, I think in the first quarter. If you'll recall, we came out of Christmas with practically all of North America to shutdown, everything was down and so we reacted very quickly with furlough programs and so we were not only flexing our operations if you will, we were literally flexing our salaried staff, because of the extremely low levels, particularly in January that we all faced and what we realized is, as you just cannot continue that over the long haul, which is why we put into place. We believe there is a much more equitable way of addressing it; there is more an equity of sacrifice across the whole base and it’s much less disruptive going forward literally to just getting the work done, if you will.

So, we put the one in place very quickly in reacting to hard flexing. The other thing that I’d mention too, so far the overall cost efforts in the company that I’m not sure have come out or not, but with our plants operationally week in and week out we are flexing very hard to production volume levels.

I mean, we’re still in a situation, where we got plants up and down and parts of plants down all the time. The whole industry is operating at a fraction of its capacity and of course there we still have much more flexibility here in North America than we do some of the other regions of the world, but we have gained a lot of flexibility in Europe and other regions through the negotiations we’ve done. So, that’s a much improved situation from an ability to control cost than we’ve ever had in the past.

Mark Bishop - Boston Company

All right. Let me just see if I got that. So, most of the prior cost cuts are in; the salary cut thing is kind of neutral really, but you further go-forward cost savings that you could get would be from getting some employee cost concessions in Europe, which you are happy are progressing, and maybe some further flexibility to what close down some more production or something? Is that right, or I mean, how big potential additional cost saves could you possibly you’re looking at going forward?

Ken Trammell

Mark, I think you pretty much got it sorted out. There will be some additional savings, as we continue to roll in the initiatives that didn’t have full effect in the quarter. I don’t have a quantification to give you.

Gregg Sherrill

That’s primarily Europe.

Ken Trammell

We will continue to focus on, but if you look at what we achieved in the first quarter with SGA&E just as a good proxy down 30%, I think that gives you an idea of what's available to us to continue to save money on a go quarter basis.

Gregg Sherrill

The only other thing I want to mention, not to confuse them, but just to say we continue, its going very hard on what I would call you, on going productivity, efficiency improvements across a global manufacturing base out there, which can, every year really substantial and we will continue to work on those.

Mark Bishop - Boston Company

Those are kind of normal productivity things.

Gregg Sherrill

They're little more normal, but I tell you in times like this you work even harder on them.

Mark Bishop - Boston Company

Okay and then I have a little confused, as to what your leverage ratio is, when you said that the maximum is 5.5, and you're like 4.7 or something. What is that the leverage? What is the ratio?

Ken Trammell

Mark that’s defined for you, I think pretty well in the 10-K, but if I can summarize for you its net debt to EBITDA.

Mark Bishop - Boston Company

Because, okay, is it last four quarters of EBITDA?

Ken Trammell

Yes.

Mark Bishop - Boston Company

It is. So, the hope would be that you continue to stay in compliance with the 5.5 maximum?

Ken Trammell

Mark, again you'll have to take a look at what's in the 10-K because when we change the invented ratios those are going to change on a quarterly basis given what's expected from a production perspective, but yeah our intension is clearly is to continue to maintain compliance with the ratio.

Gregg Sherrill

So, the required covenant ratio changes through the year.

Mark Bishop - Boston Company

So, the allowed ratios go up through the year, as some old higher quarters fall off?

Gregg Sherrill

Yes, they go up in the second-third quarter, I think and then back down in the fourth.

Mark Bishop - Boston Company

All right, great and that’s in your 10-K, is that?

Ken Trammell

It’s defined for you in the 10-K I think in a pretty good level.

Operator

The last question comes from Rich Kwas. Please state your company name.

Rich Kwas - Wachovia Securities

Hi, Good morning, Wachovia. Just two questions, on the Tier 2 and Tier 3 supplier base, what costs in cash did it incur in the quarter to support your Tier 2s and 3s, and what’s your expectation for the year?

Gregg Sherrill

Again, I am not sure. I am prepared to quantify that right now. Let me just answer it a little bit qualitatively for you, Rich. We have got a very diligent process employees globally, obviously monitoring our supply base. Keep in mind too that a good chunk of our buy is steel, coming from some pretty big players as well as substrates again coming from some pretty big players.

So, you cannot take that out because those, certainly to date, have not been at risk. But it still leaves an important supply base out there, Tier 2s that we are watching very, very close. We have a process for monitoring them. Our global supply chain management team tracks them. We have seen, I think a total of three where we've had to take actions to either re-force or pull some product, and we've had no destruction whatsoever from those three suppliers. I will say that, there is a handful others out there where we’ve probably improved terms a little bit just to help them out, but it’s not a big amount, it’s not significant at all.

Ken Trammell

I don't have a quantification of the number for you, Rich, but it is a very small number in terms of where we have made changes on terms and to get in terms of our cost for resourcing, because we've been able to do that literally overnight (inaudible).

Rich Kwas - Wachovia Securities

Gregg, in terms of your European restructuring, when is that going to be complete? When do you hit full run rate? Will it be Q2 or will that seep into Q3?

Gregg Sherrill

I think most of it’s ending Q2. I’m looking at Ken to get confirmation of that, but I believe I’m accurate there, right?

Ken Trammell

I would say we should get pretty close to full run rate in Q2 despite a little bit that leaks over into Q3, but (inaudible) pretty close.

Rich Kwas - Wachovia Securities

How should we think longer term about overall production levels, and in terms of operating margin, you’re going to be adding a lot of commercial business that should be its higher margin business, but if you think that the light vehicle business, is there a production run rate in North America that would get you back to what you would consider a normalized EBIT margin in the light vehicle business?

Ken Trammell

I’d say, it’s tough to answer for sure Rick, because sort of underlying that question is what the mix is. You got to just look at North America, first quarter last year, the light trucks and SUVs were 64% of our revenue; that dropped all the way to 46% in the third quarter of 2008, and it’s back up to around 61% in the first quarter of this year. So, that’s going to have as big an impact potentially as certainly what the overall production volumes are.

Gregg Sherrill

Remember that as we go forward, as we see any of our facilities becoming available to us, I’m talking about capital equipment is more than anything else. Those are being diverted over to support these launch and just help us to minimize our CapEx spending.

Rich Kwas - Wachovia Securities

Right, I guess is it fair to say, could you get back to an EBIT margin in North America and Europe at a lower production level? I realized you just mentioned mix as a factor, but let’s just assume mix this stable from here on out or relatively stable. I mean, has your bogie come in lower with all this cost reductions?

Gregg Sherrill

Yes. That one is easy to answer. Certainly, we don't need the full blown production recovery to come back to those levels. I mean I can't, I'm not going to say exactly where that point is shifted to and it's a little bit complex because it does balance out with the other growth we've got going on, but clearly its lower.

Rich Kwas - Wachovia Securities

Okay and I mean, can I think of it as meaningfully lower than the, let's just say 2007 first half of 2008 production run rates?

Ken Trammell

I think that's, it certainty does that's a pretty good assumption to make. I don't even sort of say first half of 2008 was already down fairly significantly because of the American Axle strike.

James Spangler

This concludes our call. An audio replay of this will be available on our website. Again the address is www.tenneco.com and you can access that recording also over the telephone. If you are located in North America, you can reach the playback at 866-501-7040. For those of you outside North America, the dial-in is 203-369-1843.

The playback will be available about one hour from now. And the call-in information, I just provided you as you can find in our press release. If you are an analyst or investor with additional questions, please follow up with Jane Ostrander, our Executive Director of Global Communications at 847-482-4607.

Financial reporters can contact me with additional questions and I can be reached at 847-482-5810 and again, I want to thank you for taking part of our conference call today.

Operator

That concludes today’s conference. You may disconnect at this time.

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Source: Tenneco Inc. Q1 2009 Earnings Call Transcript
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