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Tenneco (NYSE:TEN)

Q1 2014 Results Earnings Conference Call

April 28, 2014, 10:00 a.m. ET

Executives

Linae Golla - Executive Director of Investor Relations

Gregg Sherrill - Chief Executive Officer

Hari Nair - Chief Operating Officer

Kenneth Trammell - Chief Financial Officer

Analysts

Ravi Shanker - Morgan Stanley

Brian Johnson - Barclays

Colin Langan - UBS

John Murphy - Bank of America Merrill Lynch

Patrick Archambault - Goldman Sachs

Joe Spak - RBC Capital Markets

Richard Kwas - Wells Fargo Securities

Ryan Brinkman - JPMorgan

Patrick Nolan - Deutsche Bank

Richard Hilgert - Morningstar

Brian Sponheimer - Gabelli & Company

Brett Hoselton - KeyBanc

Operator

Good morning, and welcome to Tenneco's first quarter earnings release conference call. [Operator Instructions]. Now, I would 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 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. With that, I will turn the call over to Gregg.

Gregg Sherrill

Thank you, Linae, and good morning everyone. On our last conference call, I summarized 2013 as a year of having made excellent progress driving profitable growth with significant upside ahead. I’m pleased to report that this positive momentum continued in the first quarter, where we did an excellent job capturing that upside with strong execution across our operations.

The first key takeaway this quarter is the strength and potential we have in both of our product lines, clean air and ride performance. Together, they are generating, in a complementary way, the profitable growth we’re seeing now and expect will continue into the future.

Additionally, underlying the distinct strategic imperatives for each product line are common foundational elements that define Tenneco as a company and which are critical to delivering strong results.

The second important takeaway is the strong balance we have across many dimensions. This balance extends across product lines, geographic regions, customers, platforms, and end markets. I’m very pleased with how all the operating segments in both the clean air and ride performance divisions contributed positively to our results this quarter as we delivered record high revenues, EBIT, adjusted EBIT, adjusted net income, and earnings per share.

Now turning to revenue, on slide four, total revenue was up 10% to more than $2 billion for the quarter, with year over year increases in both clean air and ride performance. Looking at revenue by the end markets we serve, our total OE light vehicle revenue increased 9% versus a 6% rise in industry production. Stronger light vehicle volumes in our diverse customer base, where we have content on many of the top-selling platforms globally, are driving our growth and success in outpacing the industry.

Revenue from our OE commercial truck and off-highway business increased 30% this quarter. As I’ve discussed many times, we’re in the midst of a period of high diesel regulation implementation around the world. We strategically developed our technology road map aligned with these regulations, and we’re seeing tremendous growth as a result.

This quarter’s increase was driven by incremental content to help customers meet the phase in of U.S. tier four final and Europe’s stage four off-road regulations. In addition, we benefited from the ramp up on already launched commercial truck and off-highway business, including the Scandia Euro Six program.

We’re also seeing a modest revenue contribution from China with the gradual enforcement of China National Four regulations. Our global aftermarket business also delivered a solid quarter, with revenue up 2% on year over year growth in the ride performance business in North America, Europe, and South America.

Turning now to earnings, on slide five, after adjusting for restructuring, we delivered our highest-ever first quarter EBIT of $123 million, which includes significant increases in both product divisions, with clean air up 19% and ride performance up 38%. I’m very pleased with our manufacturing performance and our sharp focus on continuously improving our operations and productivity.

That, coupled with higher revenues in each of our end markets, resulted in excellent earnings this quarter. These same factors also drove our profitability, with a 13% increase in value-added adjusted EBIT margins to 7.6%.

Before we turn to more detail on each division’s results, I want to recognize our employees for delivering another excellent quarter. Their hard work, dedication to our customers’ success, and strong strategic alignment is proving to be the right formula for growing profitably and continuing to deliver value to our shareholders.

And with that, I’ll turn the call over to Hari.

Hari Nair

Thanks, Gregg. Let me start with clean air, on slide seven. Total value add revenue was up 14% to $960 million, with every operating segment reporting higher revenue. In North America, value add revenue increased 12%, driven by our strong platform position in new and existing models, as we capitalized on higher industry light vehicle production in the quarter.

Some of the programs driving the improvement include the new Jeep Cherokee, the GM Epsilon platform, the Corvette with Tenneco’s new electronic valve, and the Ram medium and heavy duty trucks with diesel after treatment systems. Higher revenues at Caterpillar and John Deere on new content to meet tier four final regulations also contributed to growth in the quarter.

Taking a look at the clean air Europe, South America, and India segment, value add revenues also grew to 12% in the quarter. This improvement was driven by our performance in Europe, although economic conditions overall remain weak throughout the region.

The Europe results more than offset lower production volumes and relatively weak economic conditions in South America and India. In Europe, we benefited from higher light vehicle production on several strong selling platforms, including Daimler A and B class models, the VW Golf, and continued growth from several recently launched programs for Jaguar and Land Rover.

Higher commercial truck and off-highway revenue also contributed to the clean air increase, with higher volumes and incremental content on programs with Scania, Caterpillar, John Deere, and Deutsch.

Now turning to the clean air Asia Pacific segment, which delivered 22% higher value add revenue for the quarter, strong performance in China, with revenue growth in both light vehicles and commercial trucks, was partially offset by weakness in the rest of the region.

We benefited from our strong position with China’s leading light vehicle OEMs, with higher volumes on new and existing platforms. We’re also starting to see a small increase in commercial truck revenue in China, with some movement towards increased enforcement of the emissions regulations.

Now looking at clean air earnings on slide eight, clean air adjusted EBIT increased 19% to $93 million, with improvements in each geographic segment. The main drivers were our ability to deliver strong operational performance as we converted on higher light vehicle volumes, primarily in North America, Europe, and China, and the benefit from higher commercial truck and off-highway revenue. Clean air value added adjusted EBIT margin for the quarter was 9.7% versus 9.3% a year ago.

Now let’s turn to ride performance, starting on slide 10. For the first quarter, ride performance revenue increased 7% with each of our three operating segments reporting higher revenue versus last year. In North America, revenue was up 9%. The strong overall light vehicle production environment, the benefit from recently launched content on new programs for BMW and Ford, and higher commercial truck revenue all contributed to the increase.

The Europe, South America, and India segment also delivered solid improvement this quarter, with revenues increasing 4%. In Europe, we benefited from higher aftermarket sales as well as OE light vehicle and commercial truck revenue growth. Higher aftermarket sales in South America also contribute to the increase, despite challenging economic conditions in that region.

As with clean air, China continues to drive our Asia Pacific results for our ride performance division. Revenue increased 8% in the quarter, due to stronger light vehicle production in China and our content on some of the country’s top selling models.

Turning now to ride performance EBIT, on slide 11, ride performance adjusted EBIT increased 38% to $55 million, with all reporting segments improving versus last year. The main drivers were higher volumes in our light vehicle and commercial truck business in North America and Europe, along with stronger light vehicle volumes in China.

In Europe, higher aftermarket sales and the benefit of recent restructuring actions also supported our stronger earnings performance. Ride performance adjusted EBIT margins rose to 8.5% in the first quarter, almost 2 full percentage points better than a year ago.

This significant improvement was driven by stronger volumes this quarter and also demonstrates strong focus on our product cost leadership strategic imperative. We have a lot of potential in our ride performance business, and I’m pleased to see the results of the improvements being made every day by our global team.

Before turning it over to Ken, I want to give you an update on our Europe restructuring activities. In Gijon, Spain, we are working closely with the local unions and government officials to reach a solution that will address the challenge to our restructuring plan by the employee works councils.

During the first quarter, we also announced and finalized the closure of a clean air just in time plant in Iwuy, France, and the restructuring actions are proceeding at our ride performance facility in Belgium. Overall, we remain on track with our goals for our Europe restructuring initiative.

In summary, we delivered an excellent quarter. By focusing on what we can control and constantly working to improve quality, increase efficiency, and improve costs, we’re making sustainable performance improvements. Every quarter brings its own challenges, economic climate, headwinds or tailwinds, but Tenneco’s approach remains consistent in executing on our plans for revenue growth and profitability improvement.

With that, I’ll turn it over to Ken.

Kenneth Trammell

Thanks, Hari. Turning to slide 12, in the quarter we recorded $10 million of restructuring costs in Europe, $8 million in the clean air business related to the closure of our just in time facility in Iwuy, France and $2 million for the projects underway in our ride performance business.

To date, we’ve recorded $90 million of restructuring costs related to the overall $120 million initiative. In the first quarter, we realized savings of $7 million related to these projects and are on track to reach our projected annualized savings of $60 million during 2016. Although not an adjustment, our results this quarter also included a $7 million expense for worker’s compensation reserve adjustments.

And now let’s turn to taxes and interest, on slide 13. In the first quarter, tax expense was $40 million. Before the impact of the restructuring charges on which no tax benefit was recorded, our effective tax rate was 38% in the quarter. We still expect that our effective tax rate for 2014 will be in the range of 36% to 38%, and expect to make tax payments in the range of $190 million to $210 million for the year.

Interest expense was $19 million in the quarter. That’s $1 million less than last year. For the full year, interest expense is expected to be about $80 million.

Turning to cash flow, on slide 14, cash flow used by operations was $140 million in the first quarter, compared with $92 million in the year ago quarter. That increase represents working capital investments to fund our growth.

We managed that growth very efficiently, as you can see by our key working capital days metrics. Overall, the days invested in receivables, inventory, and payables showed an improvement of two days compared to the first quarter of last year.

Days sales outstanding, excluding factoring, increased 2 days from last year to 63 days. Our inventory days on hand were 38 days, a one-day improvement from a year ago, and our days payable outstanding at the end of the quarter improved 3 days to 73 days.

As we signaled in last quarter’s call, capital expenditures increased in the quarter to $71 million from $59 million last year. The spending was primarily in preparation for launches in the clean air business to meet emissions regulations for all highway equipment in North America and Europe and for commercial trucks in China, as well as new platform wins. We still are expecting capital expenditures for the full year to be in the range of $275 million to $300 million.

Now, let’s go over debt, on slide 15. Quarter end debt net of cash balance was $1.042 billion. That’s down $83 million from the quarter end balance a year ago. Our leverage ratio of 1.4x, a first quarter record low, compares to 1.8x a year ago.

And with that, I’ll turn the call back to Gregg.

Gregg Sherrill

Thank you, Ken. In summary, we delivered an excellent first quarter and we’re off to a strong start for the year. As we’ve highlighted this morning, we have great opportunities in both clean air and ride performance, and we’re seeing our distinct strategic imperatives for each product line and strong execution driving profitable growth.

Looking ahead at the second quarter, I expect that the same positive drivers of our results will continue. The production forecasts from IHS Automotive are on slide 16, and show a 2% rise in global industry light vehicle production, which includes increases in North America, China, and India, while Europe and South America are expected to be down compared with last year.

We expect to capitalize on the stronger global production environment and outpace industry growth on the strength of our customer base globally and diverse platform mix, which includes Tenneco products on more than 300 platforms around the world.

In our commercial truck and off highway business, we have a strong customer base, the right technologies and engineering know-how, and a manufacturing footprint to support our customers globally. At the beginning of the year, we estimated that this business would show full year revenue growth between 20% and 30%. We expect our second quarter revenue will be consistent with that estimate, driven by volume and new content on programs in Europe, North America, and China.

In the global aftermarket, we expect revenue to be up slightly versus last year, driven by ride performance, with some strengthening in North America and a little better mix across customers and countries in Europe.

In closing, I’m very pleased with our performance this quarter. At Tenneco, we fully appreciate what drives our business, beginning with our commitments to our customers’ success and creating value for our shareholders.

Our employees are engaged and aligned around our clean air and ride performance strategies. We are executing well on our plans, leveraging our technology and engineering strengths, and working every day on continuous improvement in our operational performance.

And with that, we can open up the call for questions.

Question-and-Answer Session

Operator

[Operator instructions.]

Ravi Shanker, you may ask your question.

Ravi Shanker - Morgan Stanley

A couple of questions. The CV of revenues in the first quarter were towards the high end of your 20% to 30% guidance. Do you expect that range to kind of come down in the coming quarters? Or are you looking at closer to the high end of that range for the year.

Gregg Sherrill

We still think of the revenues for commercial truck and off highway will be up in the range of 20% to 30%. We had said at the beginning of the quarter we expected the first quarter to be up around 25%, so we came in slightly stronger than what our expectation was for the first quarter. But we still believe we’re in that range for the full year.

Ravi Shanker - Morgan Stanley

And as you said, the revenues were definitely a little bit higher than we expected. The margins were a little softer than we expected, though. Would you characterize the margin performance to be consistent with your expectations? Or was there something going on in the first quarter that may have dampened it a little bit?

Gregg Sherrill

I think we were extremely happy with the margins, both clean air and ride performance. So from our perspective, that was very positive in the quarter, all across the board.

Ravi Shanker - Morgan Stanley

And then just finally, can you comment on the antitrust investigation that I think you guys and some of your competitors announced during the quarter, and any update on that?

Gregg Sherrill

Clearly, we can’t comment on an ongoing investigation. We put out the release a couple of weeks ago, and the only comments I would make, which I’ve made before, is number one, here at Tenneco we run this corporation to a code of conduct and a set of values that certainly ensures compliance. And we promote the absolute highest integrity and ethics in the way we do business, and we’re fully cooperating with the authorities in this matter. And the second thing would be to say that we’re not letting it interfere whatsoever with our ongoing operational performance. So we’re focused and we’re going to stay focused.

Ravi Shanker - Morgan Stanley

And just lastly, were there any costs associated with the investigation in the quarter?

Gregg Sherrill

Ravi, the announcement we made was on March 25.

Operator

Brian Johnson, you may ask your question.

Brian Johnson - Barclays

Just wanted to talk a little bit about ride performance, particularly in the context of European aftermarket. Do you think that you’ve kind of bottomed out and are coming back in the European aftermarket? And question number two, your European restructuring, to what extent has that been focused to date on ride performance versus emissions? And are you seeing some of the benefit from that, or is it more the benefit from the selling side in terms of demand coming back?

Gregg Sherrill

I think it’s got to be a little bit of both. To answer the first question, hopefully this is not a hope, but we do think we kind of hit the bottom on the European aftermarket. You asked that question, and I’ll tell you, I think we should have seen that. You know, how slowly or quickly it comes back is still a very, very difficult thing to call, and we could bounce around a little bit still. But there are some signs that the bottom has been hit, and we’re seeing some improvements there. So the team feels good about that, as I do as well.

As far as the performance, the volume obviously helps. We’ve been struggling with that for some time now. So a little bit of incremental volume is always welcome, and relative to our cost reduction initiative, clearly most of it is aimed at the ride side of our business, and I would suggest that although we’re certainly not beginning to see all the benefits there flow through yet, there was certainly some help in the quarter from it also.

Operator

Colin Langan, you may ask your question.

Colin Langan - UBS

Clean air was up 12% in North America, which is significantly better than overall production. What were the key drivers? Were there any products in particular that drove that outperformance? Or was it mostly new business wins?

Gregg Sherrill

There were a couple of things. Hari mentioned a number of products he was walking through that are certainly selling well for us. Don’t forget that we are also in the midst of launching the additional content for tier four final on the off highway side of the commercial truck and off highway business, so that was a driver as well. So you’ve got to combine the two of those together, and that’s the growth that you saw.

Colin Langan - UBS

And how is the off highway ramp up? The rules were final January 1, but there’s credits, I believe, that sort of maybe delay its full phase in? Or have most of your customers already changed over to the technology for the final standard?

Gregg Sherrill

The answer is yes to both. Certainly there’s credits, there is still some inventory, but we’re also seeing increased deliveries, along with what we had pretty much expected when we gave the estimates of the 20% to 30% growth for the full year for commercial truck and off highway. So it’s moving along just as we pretty much expected.

Kenneth Trammell

And it is phase one of a two-year phase in, so it’s sort of one engine horsepower range that’s launching this year, and the second one next year.

Colin Langan - UBS

And how about the Scania business? Does that at full ramp at this point? Because I believe it started last quarter. Or is there more ramp up as we go through the year?

Gregg Sherrill

We would expect that to continue to show a little bit of ramp as we move through the year. I’m certain that there was some pre-buy activity and on-highway commercial trucks in Europe, plus, like you said, there’s always phase ins, credit, I think they call them bunkering instead of inventory, in the arrangements in Europe. So you know, all of that will mean that we’ll see the increase probably pick up as we move through the latter half of the year.

Colin Langan - UBS

On ride performance, in the presentation you said there was $7 million in savings associated with the restructuring. Are there additional actions coming through the year? Because the restructuring, by 2016, [unintelligible] the pace through the remainder of this year, does it continue to ramp up as well?

Gregg Sherrill

Yeah, we said in total it was $7 million. That’s obviously going to be mostly ride performance, but there’s a little bit of clean air business benefit in there as well. That’s what we realized in the quarter. We’ve said all along that we’ll begin to see some benefits this year, that pace picks up in 2015 and then we hit the run rate in 2016.

Colin Langan - UBS

So is it fair to say the $7 million kind of stays the same quarterly benefit, and then 2015 we see an uptick again?

Gregg Sherrill

Yeah, we should see a little bit more benefit than that as we move through the year, because we’re implementing activities as we move through. But yeah, like I said, we’ll see some this year, a good bit of it in 2015, and then get to the $60 million run rate in 2016.

Operator

John Murphy, you may ask your question.

John Murphy - Bank of America Merrill Lynch

First question, as we think about the ramp of commercial and off highway, and it’s kind of coming in step function this year, can you just talk about your capacity utilization in those facilities, or the facility that you have producing those products, and if there could be any potential significant ramp up in margins as that capacity is filled?

Gregg Sherrill

I don’t have the exact past utilizations here with me this morning, but we are not at full capacity, I know that. Remember, we’ve got machinery and equipment in place that was in place for tier four interim, and a good many of the engines are still being built to that, but which volumes have really not to this date materialized, because of the whole industry wide condition that we’ve discussed.

And of course, now we’re launching tier four final, which took incremental equipment for its own unique purposes. And I’m sure that we’re not up to full utilization on that. I’m certain we’re not on that. That’s ramping in. So there’s still a ways to go. I just don’t have the numbers in front of me today. We’ve given them in the past, but it’s kind of all baked into our run rate at the moment, and I don’t have it in front of me.

John Murphy - Bank of America Merrill Lynch

And then a second question on ride control. I was looking at the margin there. They were also particularly strong in the quarter. Is there any sort of governing factor that would limit upside in margins there? And what could be the factors that could drive that margin higher? I’m just trying to get an idea of how high those margins ultimately could go.

Gregg Sherrill

Well, clearly we saw some volume help in all the regions this year. So that helped, number one. Number two, you know that we’ve got a very strong focus on the [unintelligible] for that division, that’s product cost leadership. So we are heavily focused on cost around the world. And we’re one year into that effort. That’s a continuous improvement exercise, and we would expect to see that continually improve, if you will.

And then the third part, and it’s kind of still probably a little bit of a wildcard, so we don’t really count on it 100%, but it’s the degree to which we can drive further implementation of the higher technologies on the ride side. And so those three things we’re working very hard on.

And I will mention one more, because clearly in the ride business is where the bulk of the strength of our aftermarket lies, particularly in North America and Europe, and the extent to which we had continued strong volumes on the aftermarket, the shocks and the struts, is also a positive factor for us.

John Murphy - Bank of America Merrill Lynch

So it would be fair to say net of pricing, that there is potential for some real material upside in the margins on ride control, and that’s what you’re really targeting?

Gregg Sherrill

Yeah, we’re working very hard on that.

John Murphy - Bank of America Merrill Lynch

And then just lastly, on slide 16, when you were talking about your volume expectations. Europe only up 1% for FY14, and we’re hearing a lot of other suppliers getting a little bit more constructive on Europe, obviously with the caveat that Eastern Europe could be at risk for some of the obvious factors. What are you guys seeing there? Is there something that you’re seeing as far as the order book or anything in the markets that’s kind of tempering your expectations relative to other folks? Or is it just conservatism?

Gregg Sherrill

Actually, those are really not even our numbers. They’re exactly what IHS Automotive is forecasting for Europe. Because unless we think we see something that’s a distinct error out of that macro forecasting business, then we’re giving you what their view of the world is for the quarter.

John Murphy - Bank of America Merrill Lynch

So there’s nothing distinctly negative you’ve seen in the order books, or anything like that? It’s kind of what you’ve been…

Gregg Sherrill

I’m saying that Tenneco would have adjusted one way or the other.

Operator

Patrick Archambault, you may ask your question.

Patrick Archambault - Goldman Sachs

Piggybacking on that last question, the delta from up 7 to minus 1 does seem a bit extreme, at least from what you’re seeing in terms of your order book. I understand the rationale for getting out of the forecasting business, but are you seeing that much of a slowdown? Or is that something that when it comes to pass is likely to be sort of higher?

Gregg Sherrill

We’re not seeing, I think, any shift in schedules, nothing that concerns us, nothing that changes our outlook that we really talked to you about at the end of last quarter. Remember, these are year over year comparisons as well, so I’m not sitting here with the map in front of me to tell me the degree to which 1% down year over year in the second quarter relates to the run rate of the first quarter, to be honest with you. But we’re not seeing any downturn in schedules that makes us nervous or anything.

Patrick Archambault - Goldman Sachs

Just one other regional question. South America has obviously been a big sore spot. You have that as down 26%. I don’t believe you have a lot, if anything, in Venezuela, but can you give us a broad idea of what your exposure is in Brazil and Argentina?

Gregg Sherrill

Our business in South America is predominantly in Brazil and Argentina. We don’t manufacture anything in any of the other regions. And you mentioned Venezuela. Our exposure there really relates to aftermarket parts that are sold through a distributor who distributes in that region. So really not a lot of exposure to Venezuela. What you’re seeing in the estimates for the second quarter there, with IHS saying 26% down for light vehicle is just reflective of what’s going on mostly in the Brazilian and Argentinean economy right now.

Patrick Archambault - Goldman Sachs

And of course we don’t overlay commercial vehicles on the forecast here, but can you remind us as we think about Brazil for you guys, I think you’ve launched on some fairly significant programs there. Are you still seeing content growth that’s offsetting whatever potential decline in commercial vehicle builds you’re seeing this year? Just remind us sort of what the content growth versus volume exposure is there.

Gregg Sherrill

The content growth in Brazil is pretty much in place. So going forward, until such time they might implement any increased regulation, but that’s not in the near term. So it’s pretty much where are the markets going at this point, from a volume perspective.

Patrick Archambault - Goldman Sachs

And if I can just push that a little further, expectations seem to be all over the place for the commercial vehicle market. How are you guys thinking about it for this coming year?

Gregg Sherrill

For the next quarter, at any rate, I think we see a pretty much flat year over year market.

Kenneth Trammell

Flat to probably down a little bit. The economy there in Brazil in particular is going to have an impact, and it’s a little bit weak right now.

Operator

Joe Spak, you may ask your question.

Joe Spak - RBC Capital Markets

Maybe we could just quickly head back to ride control. Gregg, if I take all your comments and even backing out the $7 million of worker’s comp expense you mentioned in the quarter, and then the fact that the restructuring run rate still seems like it could double, we’re talking about a margin level in the double digit range. And that’s before some of the other stuff you talked about. So what would be some of the potential offsets to that as we think about that business going forward?

Gregg Sherrill

Any inflationary pressure would offset, but we’re not really seeing anything huge right now. Certainly, from a margin point of view, it would be an offset. We would certainly expect to offset that. We will deal with the normal pricing environment, and I’m not sure there’s anything out of the ordinary there. I don’t see anything coming out of the ordinary. And other than that, as long as the macro stays reasonably positive and the volumes hold, it should be a pretty good story.

Joe Spak - RBC Capital Markets

And in clean air, you talked a little bit about this last quarter, and I think you alluded to it even earlier today, about there may be some development costs for tier four final. So as that volume ramps, but also some of those costs subside, is your expectation that the incremental margin improves as we move throughout the year in that business?

Gregg Sherrill

Well, presuming we see some volume uptick. Because we do still have some absorption issues on that business, because still, industry wide volumes are still at a somewhat low state, if you will. And to the extent that we see some recovery there, which we’re just not making the call on right now at all, that would be a big help in helping the margins start to move a little bit as well, from an absorption point of view.

Joe Spak - RBC Capital Markets

And then last one, Asia Pacific clean are was at least stronger than we thought, and I think you started talking about a little bit better numbers out of China. I was wondering if you could just update us on what you’re seeing. We’re starting to hear of a potential ramp in the inflection for enforcement in China in the second half of this year. Wanted to get your thoughts. And then maybe also just it would be helpful, if you’re able to provide it, of the 277 commercial vehicles in specialty OE, can you give us just, percentagewise, a breakout between the different regions, how that fell this quarter?

Kenneth Trammell

We really don’t break that out. I mean, it’s still a fairly small piece of our business, so we’re just giving you the number in total. We are seeing, in China, like we’ve said for the last quarter or two, that there is some push for increased enforcement, and deliveries did pick up, although still at a very modest level. We would expect that it will be volatile this year. The enforcement mechanisms, enforcement decisions, are not yet clear to everyone, so we may see some quarters when it’s up, and some quarters when it’s not quite as strong. We did see a nice pick up in the first quarter, so we’re encouraged, but it’s still a bit of a wait and see in China. It’s happening like we said. We think the installation rate will be low at first and then will ramp over the course of a number of years.

Gregg Sherrill

The good news about China, it is modest right now, but the good news is that we are talking in the present tense about commercial vehicle volumes increasing. Our schedules have increased, as opposed to some expectation, given this or given that, out in the future. And as Ken said, that does not necessarily mean that there just will be this steady ramp in the full blown implementation in China.

So we still see China coming along modestly. It’s positive, it’s good news. The revenues are coming in as we’ve described. But overall, we still see the full year, when we take everything into account, that OE revenue growth in that range that we gave you, the overall 20% to 30%. And we got off to a good start with them right at that 30%.

So we’ll see how it goes as we go forward. And if there’s any major shifts in that positively or negatively, obviously we’d be talking about it in the future.

Joe Spak - RBC Capital Markets

I know you can’t talk about the antitrust. Is there any thought given to how maybe some higher legal expenses will be treated going forward? Or are those going to be called out on a quarterly basis as they’re incurred?

Kenneth Trammell

We actually don’t expect to, but if you’re sort of thinking about the expenses, this is a very rough estimate, but maybe an increase somewhere in the range of $3 million to $5 million a quarter for the next two or three quarters. And probably we’ll begin to ramp down a little bit after that.

Operator

Rich Kwas, you may ask your question.

Richard Kwas - Wells Fargo Securities

Just a follow up on that. Ken, that $3 million to $5 million, so we should model that? It’s not going to be called out as part of restructuring per se? I want to be clear on that.

Kenneth Trammell

No, I don’t see how we could call that part of restructuring.

Richard Kwas - Wells Fargo Securities

So we include it in the numbers, okay. Just on Brazil, I know, Gregg, you talked about flat to down on volume for Q2. Within the guide, the 20 to 30, has the expectation for the full year come in a bit relative to what you thought back in January, in terms of volume specifically?

Gregg Sherrill

Are you talking about just South America, or overall?

Richard Kwas - Wells Fargo Securities

Just Brazil. Because I know that’s a growing piece of your overall commercial footprint.

Gregg Sherrill

No, I think Brazil in the first quarter was pretty much what we expected.

Richard Kwas - Wells Fargo Securities

My question is, essentially, 20 to 30, you did 30 in the first quarter. I know you said you’re comfortable with the 20 to 30, but essentially is there more cushion in there, because there’s more uncertainty in South America, because there’s just a lot of things going on down there?

Gregg Sherrill

No, I wouldn’t say that there’s full cushion in South America. You know, we said 20 to 30. It’s not going to be a perfect percent. Obviously, increase every quarter, depending on what happened last year as well, which I’m not even looking backwards at it right now for the second, third, and fourth quarter.

But overall, I haven’t seen anything through the first quarter other than a slight positive. And it’s pretty slight, really. We expected the first quarter to be on the high end of that 20 to 30, and it came in right at the high end. But anything that would change that 20% to 30% [unintelligible] forecast right now. We’ve got one quarter behind us that’s positive, we’ve got a second quarter coming up that looks like it’s going to be right in that range as well, so that’s where we see it coming, and we feel very good about it.

I don’t see any region right now that I’m overly nervous about. I could worry about weakness in Brazil, but I don’t think that will take us out of the range. We could worry about maybe China slowing down before it speeds up again, but I can’t pin that one down right now either. I just think overall, with all the moving pieces, they’re pretty much on our expectation in the first quarter, and we’re seeing them pretty much on our expectation right now for the second quarter.

Richard Kwas - Wells Fargo Securities

And then on North American aftermarket, I know you’re seeing a little bit better volume growth for the second quarter on a year over year basis, but with the winter we’ve had here in North America, and this is your seasonally strongest quarter for that business, what are you seeing from your customers on a point of sale basis? Any kind of pickup because of winter activity being so harsh and favorable impact on the aftermarket volumes?

Gregg Sherrill

I think that’s part of why we’re seeing the second quarter’s going to be up. Again, some strong numbers last year. You know, clearly this year there was an impact in the regions that were so harshly hit in the January and February timeframe. But what we’re seeing are indications that roads did get tore up, and sales should be pretty strong in those regions. Remember, it wasn’t a countrywide event, but certainly the big population regions of the Northeast, the upper Midwest, etc. should be pretty strong in the second quarter.

Richard Kwas - Wells Fargo Securities

Okay, so that’s embedded in this outlook that you’ve provided today, or some of that?

Gregg Sherrill

Yes.

Operator

Ryan Brinkman, you may ask your question.

Ryan Brinkman - JPMorgan

With regard to your, I think you said record, low net leverage ratio of 1.4x, this is now lower than the 1.6x average for the 15 parts suppliers we cover. Do you continue to target 1.0x, I think you unveiled that back in February 2013? If so, what benefits from the 1x leverage do you think that you get, whether related to lower cost of debt or sometimes suppliers talk about better [unintelligible] with Japanese automakers, etc.? And how do you weigh that against the benefits of [accretion] associated with a buyback?

Gregg Sherrill

The 1x is set based on making sure that the company is well-positioned to work through any normal economic downturn. It’s obviously a very cyclical business and as we grow into the commercial truck and off highway, that’s even more cyclical. So that 1x is honestly based on making sure that within our debt covenants, which are 3.5x net debt to EBITDA, we’re well-positioned not to have to seek a bank amendment during the next downturn. So that’s the 1x. We’ve also been very clear that once we are consistently at that 1x level, that gives us the opportunity to look at further returns to shareholders.

Ryan Brinkman - JPMorgan

And then just on incremental margins in the quarter, it looks like about 14%, at least by my metrics, kind of a $26 million increase in adjusted EBITDA on like $187 million of higher value add revenue. So is this roughly how you would expect the incrementals to maybe track for the remainder of the year? And if so, how does that compare to what you think your normalized incremental margins are kind of longer term?

Kenneth Trammell

You know, Ryan, since we don’t give earnings guidance, I obviously can’t give you a direct answer to your question. But if you look back historically, we’ve certainly seen volatility in incremental margins depending on where we are in the cycle, and what happens in a number of other situations. But I would say we probably averaged somewhere in midteens, plus or minus maybe a little bit. But it does go both up and down from a quarterly basis.

Ryan Brinkman - JPMorgan

And is there any reason to think that that might structurally improve relative to the history, just because of the greater focus on the commercial truck and off highway markets, potentially?

Gregg Sherrill

We’ve pointed out certainly that commercial truck and off highway is accretive to our corporate average margins. Don’t forget that the aftermarket, which won’t grow as fast as the OE, would offset just a bit of that. But certainly as we continue to move into commercial truck and off highway, we would hope that would continue to drive some margin improvement for us.

Ryan Brinkman - JPMorgan

I tend to ask this every quarter, and there’s usually not a lot of intraquarter updates, but any progress to report or in regards to getting more business, non-light or commercial vehicles? So, you know, some of your analysts [unintelligible] you’ve talked about locomotive, you’ve talked about stationary power, marine power, etc. Where do you think the company is headed with regard to that?

Gregg Sherrill

We still see those very positively. We’re just not up to a point where, just the overall timing of our regulatory and where the customers are at, that there’s anything to announce. But you know, we’ve got a lot of effort going, a lot of development projects underway, and we still view it as positive growth potential going forward.

Operator

Patrick Nolan, you may ask your question.

Patrick Nolan - Deutsche Bank

I just had one follow up detail question for Ken. We saw both R&D and SG&A up a bit as a percentage of sales and in absolute dollars for the quarter. More looking at the percent of sales increase, is that what we should be thinking for the year? So you had like the 20 basis point increase in R&D as a percentage of sales and I think it was about 10 for SG&A. Is that what we should be thinking as far as an increase for the full year?

Kenneth Trammell

I think if you looked on an adjusted basis, that percent is fairly consistent plus or minus, but fairly consistent with the last several quarters. On the SG&A side, certainly you’ve got just sort of normal increases that happen based on inflation and that sort of stuff. You’ve also got slightly higher incentive compensation for employees this quarter compared to first quarter of last year. So that’s just sort of normal business activity.

On the engineering side, there’s some spending for upcoming platforms and also some timing related to customer recoveries. So that, as usual, will go up and down.

Patrick Nolan - Deutsche Bank

And was the $7 million worker’s comp accrual that you referred to earlier in SG&A, or COGS?

Kenneth Trammell

In cost of sales.

Operator

Richard Hilgert, you may ask your question.

Richard Hilgert - Morningstar

I realize Asia Pacific isn’t as much of the total as your other regions are, but I noticed this quarter that the ride performance division, the EBITDA margin value add revenue basis, really maintained the same level, slightly above 15%, as the fourth quarter. But then you look at the clean air division and the first quarter always seems to be the seasonal low in terms of margin. And I thought that that might have something to do with the seasonal low that we see in China volume in the first quarter, because of the way their holidays fall over there.

Is there something else going on in that margin number? Was there some pricing or something in the first quarter, or is volume that much of a difference that the low for the year is going to be equal to the high of the previous year for the ride performance EBITDA margin?

Kenneth Trammell

Really nothing unusual in the margins there. Certainly, China is the biggest driver, but don’t forget that we’ve got other businesses that are in the Asia Pacific region, Australia, Thailand, which is seeing some obviously volume challenges with the political situation there. Japan and Korea are all in there. We’re still in ramp up phase in Japan on the off highway business [unintelligible].

Richard Hilgert - Morningstar

And then the severe weather that we did have over the winter, and especially in the first quarter, throughout the Midwest, and we saw the OEMs talk about some of the logistical arrangements that they had to make because of the bad weather, were there any premium logistics costs for you that might have affected any margin in the first quarter?

Kenneth Trammell

You know, somewhere, there undoubtedly was, but it would have been noise in the system for us. It wouldn’t have been significant.

Operator

Brian Sponheimer, you may ask your question.

Brian Sponheimer - Gabelli & Company

I guess a longer term question on substation of precious metals within clean air. Any opportunities that you’re seeing and any issues regarding the sourcing of some of your precious metals at this point?

Gregg Sherrill

No. I mean, first off, we don’t source those, if you’ll recall. Our customers do. And then they basically source them themselves, and we manage them on this pass through basis. So the question would probably be a little bit more appropriate to them from a sourcing point of view.

As far as substitution point of view is concerned, it goes into that all the time. There’s still no real significant trend that would move us anywhere in the near future away from the precious metal coated type converters that we use today.

Operator

And the last question comes from Brett Hoselton. You may ask your question.

Brett Hoselton - KeyBanc

First of all, the restructuring. You’ve talked about $60 million of savings by 2016. How do we think about how that progresses as we move through ’14 and ’15, and then into ’16?

Gregg Sherrill

We talked about that just a little bit earlier. We’ve got about $7 million of savings in the quarter. We’ve said that for the balance of the year we’ll continue to see some incremental savings, but most of the business benefits will come in in 2015, and then we’ll reach the run rate in 2016. We just haven’t given specific numbers.

Brett Hoselton - KeyBanc

If commercial vehicle revenue is up 30% in the first quarter, up roughly 30% in the second quarter, then what might be the reason that it might not be up 30% in the third and fourth quarters?

Gregg Sherrill

Certainly there’s going to be both pluses and minuses. We’re seeing, like we said a little bit earlier, the 25% was the guidance we gave for the first quarter, so we were just a little bit stronger than that. We still think the 20% to 30% is the right number for the full year. We talked a little bit earlier about the fact that we’re expecting that we’ll probably see a little bit of volatility in deliveries in China.

And we also talked a little bit earlier about the fact that we’re seeing a bit of potential weakness in South America, just because of the economic situation in Brazil. So there’s both pluses and minuses. We still think that range, 20% to 30%, is the right number for the full year.

Brett Hoselton - KeyBanc

As I think about 2015, and if I recall, your revenue guidance that you provided a while ago, February 2013, assuming things haven’t changed dramatically, it looks like your partial vehicle revenue is going to accelerate fairly significantly in 2015. I calculated up 50% in 2015. And that’s, again, based on your February 2013 guidance. Obviously that’s a while ago, so things may have changed. But it seems like your commercial vehicle revenue is going to accelerate, which is going to be accretive to your margins.

It seems like you’re going to get some incremental restructuring benefits of a fairly significant amount into 2015, which all seems to suggest that the contribution margins might actually accelerate or be better in 2015 than they are even in 2014. Are there other factors that might be headwinds that we should be considering?

Kenneth Trammell

There’s always certainly other factors. There’s material costs and everything else that happens year in and year out. On the 2015 numbers, I do want to point out that we did not update that, so that’s obviously old information. I can’t tell you what that would be for 2015. We will update that at the end of the year this year.

There is, of course, the implementation of the second phase of the tier four final. The higher horsepower engines are this year, the medium horsepower engines are next year. So that will certainly ramp in for 2015 on the commercial truck and off highway business. Certainly hoping that we see some continued ramp in China as well.

Since we don’t give margin guidance, there’s not I’m going to answer directly, but you certainly hit on the things that we’re working on. We’re working very hard on our ride performance, our product cost leadership. Part of that is encompassed in the restructuring activities we’re undertaking in Europe. And we are certainly going to continue to work on our clean air margins as we ramp in the additional content for these new regulations.

Linae Golla

Thank you, and this concludes our call. An audio replay will be available on our website in about an hour. You can also access a recording of this call by telephone. In North America, you may reach the callback at 866-430-8796. For those outside North America, the number is 203-369-0942. 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 847-482-5162. And reporters with additional questions can contact Bill Dawson at 847-482-5807. Thank you for joining us today.

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