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Tenneco (NYSE:TEN)

Q2 2012 Earnings Call

July 26, 2012 9:00 am ET

Executives

Linae Golla

Gregg M. Sherrill - Executive Chairman and Chief Executive Officer

Hari N. Nair - Chief Operating Officer and Director

Kenneth R. Trammell - Chief Financial Officer and Executive Vice President

Analysts

Brian Arthur Johnson - Barclays Capital, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Michael Tuteral

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Patrick Nolan - Deutsche Bank AG, Research Division

Joseph Spak - RBC Capital Markets, LLC, Research Division

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Graham Mattison - Lazard Capital Markets LLC, Research Division

David H. Lim - Wells Fargo Securities, LLC, Research Division

Brian Sponheimer - Gabelli & Company, Inc.

Adam Brooks - Sidoti & Company, LLC

Operator

Good morning, and welcome to Tenneco's Second Quarter 2012 Earnings Release Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, please disconnect at this time. I would now like to turn the call over to Ms. Linae Golla, Executive Director, Investor Relations. Thank you. You may begin.

Linae Golla

Good morning. Earlier this morning, we issued our earnings release and related financial information. In just a bit, I will turn the call over to Gregg Sherrill, Tenneco's Chairman and CEO; Hari Nair, our Chief Operating Officer; and Ken Trammell, our Chief Financial Officer.

They will spend the first half of the call taking you through a detailed explanation of our second quarter performance. 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. The conference operator will explain the process for asking a question at that time.

Please note that our discussion today will include information on non-GAAP financial measures, all of which are reconciled with GAAP numbers in our press release attachment. The earnings release and attachments are also posted on our website.

In addition, some of our comments today will include forward-looking statements. Please keep in mind that our actual results could differ materially from those projected in any of our forward-looking statements.

With that, I will turn the call over to Gregg.

Gregg M. Sherrill

Thank you, Linae, and good morning, everyone. As you've already seen in our earnings release, we delivered strong results this quarter including revenue growth, improved profitability and good cash flow performance. Our adjusted EBIT margin improved in every segment of our business, which is especially significant given the economic challenges in some of our markets around the world.

Taking a look at the financial highlights on Slide 3, we reported record second quarter performance in a number of key metrics, including revenue, EBIT, net income, earnings per share and our leverage ratio, all of which reflect strong execution on our growth initiatives and good operational performance in all regions. We also benefited this quarter from our geographic balance. With the slowly strengthening economy in the United States and continued growth in China, our operations in these regions helped offset industrial -- industry volume declines in both Europe and in South America.

Turning first to revenue on Slide 4. Total revenue was $1.9 billion, which, after adjusting for substrate sales and currency, was a 9% increase over a year ago.

On the OE side of our business, we did an excellent job of leveraging strong production volumes in North America and China. We also increased Europe OE revenue, excluding currency, despite economic headwinds throughout the region. The increase was largely driven by the strong platform mix we have in the emission control business.

Continuing around the world, we saw lower-than-expected light and commercial vehicle volumes in South America, which impacted revenue, but conversely, strong volumes drove an increase in India, mostly on new platforms as we continue to expand in this fast-growing market.

Now turning to Slide 5 and an update on our growing commercial vehicle business. Although still very early in a 6-year growth period, our OE commercial vehicle revenue was $226 million, a 36% increase over a year ago, and representing 12% of our total revenue.

In our commercial vehicle business this quarter, we did see macroeconomic conditions negatively impacting customer schedules across North America, Europe and South America. Despite the economic uncertainty, we still expect very strong commercial vehicle revenue growth this year, although revenues will likely be closer to the first half run rate than are our forecast at the beginning of the year.

Having said that, I'm still very pleased with our program content and overall launch execution in all regions, and I believe this is positively reflected in our results this quarter.

Equally important is that our Advanced Technology solutions and global engineering and manufacturing capability continue to result in new business awards. We have an impressive list of customers, as you can see on Slide 6. And today, I'm pleased to announce new off-road business in Europe with MAN and one other unnamed customer. And in addition, we've added Tata Motors in India for on-road business.

Now turning to earnings on Slide 7. EBIT increased by $24 million or 21% year-over-year. These very strong results were driven by our strong operational performance on higher light vehicle volumes and the benefit from incremental commercial vehicle revenue. As I said upfront, we're pleased with our EBIT margin performance. With contributions from all 3 segments, adjusted EBIT as a percent of value-added revenue increased 1.4 percentage points to 9.3%.

And finally, I want to acknowledge our employees for their hard work and staying focused on our customers, which ultimately drives all our results. Our teams around the world are executing well on a number of fronts: launching new platforms, continuing to win new business, expanding in new segments and regions and managing through challenging industry conditions in certain markets.

Our employees deserve the credit, and I truly appreciate their commitment and efforts in delivering these results. And with that, I'll turn the call over to Hari.

Hari N. Nair

Thanks, Gregg. As Gregg said, we're pleased with our operational performance this quarter as we continue to execute on our growth initiatives and stayed focused on delivering profitable growth.

Turning first to North America on Slide 8. You'll see that OE revenue was up 20%, excluding substrate sales and currency. The North America team did an excellent job of leveraging higher light and commercial vehicle OE volumes. The North America aftermarket also delivered a solid quarter, with a 7% increase in revenue, driven by higher volumes and pricing in both product lines. And as expected, our aftermarket margins were in line with the historical levels.

North America adjusted EBIT increased 37% to $86 million. The main drivers were our operational performance in leveraging the stronger volumes and the benefit from commercial vehicle revenue, with excellent launch performance on all programs. I'm also pleased that our margin improved in the OE ride control business and its operational challenges are largely behind us.

As I mentioned last quarter, I can confirm that our Cozad, Nebraska, ride control plant will be closed in early August. The takeaway on North America is a strong performance with adjusted EBIT as a percent of value-add revenue increasing 1.8 percentage points to 11.8%.

Moving on to the Europe, South America and India segment on Slide 9. As everyone is well aware, Europe poses challenges in terms of the overall economic situation throughout the region, resulting in a negative impact on the automotive and commercial vehicle industries and the aftermarket. Despite declining OE light vehicle industry production, our Europe OE revenue increased 4%, excluding substrate sales and currency. The increase was driven by higher year-over-year commercial vehicle revenue and our positions on the best-selling platforms, including strong export models and with customers like Daimler, BMW and Audi.

The aftermarket in Europe remains a challenge, especially in the western and southern European markets. Revenue, excluding currency, fell 12%. Our customers have reduced inventories and pulled back on purchases in response to lower consumer demand driven by economic conditions. We are working hard to offset the declines with aggressive cost reductions and matching our production to the lower demand.

Turning to South America, the region's economy has also presented some challenges. We took actions in the quarter that partially offset the impact of an industry light vehicle production decline of 9%. Our commercial vehicle programs in Brazil with new customers are launching well, although volumes are weaker than expected.

India was a positive story this quarter. We did a good job leveraging higher volumes and benefited from the launch of new business with several global customers. Together, South America and India revenue increased 9% to $151 million, excluding substrate sales and currency.

Turning to EBIT for the Europe, South America and India segment. Adjusted EBIT declined to $34 million versus $38 million a year ago, primarily driven by $9 million in negative currency. Overall, in the face of very challenging economic conditions, we are pleased with the performance of our Europe, South America and India teams. Against powerful headwinds, adjusted EBIT as a percent of value-add revenue actually increased to 5.9% versus 5.8% last year, a very good result considering everything we faced in this segment.

Our Asia Pacific results are on Slide 10. The 13% rise in revenue, excluding substrate sales and currency, was driven by our China operations with strong OE production volumes as we continue to expand with new customers and new facilities.

Adjusted EBIT for the Asia Pacific segment was up 36% to $19 million, including $2 million in favorable currency. This increase was driven by volumes in China as we capitalize on our strong position and continue to effectively manage rapid growth in that market. We also benefited from earlier restructuring actions in Australia, as our operations are now better sized to the market, although there is further work to be done as production rates continue to be weak.

For the entire segment, adjusted EBIT as a percent of value-add revenue improved 1.7 percentage points to 9.9%.

In summary, we're doing a good job across markets with very different dynamics. I'm confident we have the right strategies in place to continue capturing all the growth before us, as well as effective plans to drive continued margin improvement. With that, I'll turn the call over to Ken.

Kenneth R. Trammell

Thanks, Hari. You can see the adjustments this quarter on Slide 12. The restructuring charge primarily relates to headcount reductions and other actions we took this quarter, mostly in South America, to adjust for the industry production declines that Hari told you.

I'll touch on the $1 million of refinancing cost in a minute. First, let's discuss taxes on Slide 13. The net tax benefit adjustment of $19 million this quarter was primarily due to the valuation allowance on our U.S. deferred tax assets.

As a result of our strong operating performance and lower interest expense, we continue to generate U.S. taxable income. Our book tax expense is benefiting from the deferred tax asset that's not currently reflected on our balance sheet.

Based on our operating performance and the outlook per vehicle production, I continue to expect that we will meet the accounting requirements to reverse this valuation allowance next quarter. Had we reversed the valuation allowance at the end of the second quarter, the net income impact would have been about $110 million.

We currently expect cash taxes for 2012 to be in the range of $90 million to $100 million.

Moving to Slide 14, let me spend just a moment on the currency impact that shows up in our results. We experienced a total of $13 million in negative year-over-year currency comparisons, driven mostly by a $6 million negative North America swing in currency transactions and the impact of translating the earnings of our European and other foreign businesses at the weaker exchange rates this year compared to 2011.

Now turning to customer changeovers on the North American aftermarket, those costs were a net $10 million lower than last year, when we completed the large AutoZone exhaust changeover.

Additionally, stock price changes caused our cost for stock-indexed compensation to be down by $7 million year-over-year.

Moving to interest on Slide 15, we incurred interest expense of $21 million in the quarter compared to $26 million in the second quarter of 2011. This quarter included the $1 million in cost we previously told you about, completing the successful refinancing we announced in March and contributing to the reduced interest expense in the quarter. We continue to expect 2012 annual interest expense of about $90 million.

Moving on to Slide 16, we generated cash from operations of $86 million in the quarter compared to $67 million generated in the year-ago quarter. The $19 million improvement was driven by higher earnings, as well as closely managing the growth and our working capital.

In the quarter, our day sales outstanding, excluding factoring, was 62 days; that's up one day from 61 days last year. Inventory days on hand was 38 days; that's up 2 days from last year. Days payable outstanding was even with the last year at 69 days.

Our capital spending is shown on Slide 17. That was $62 million this quarter, up from $47 million last year, as we continue to invest in new programs driving future growth in both light and commercial vehicles. You can see the split by segment on the slide. The majority of our spending continues to be in our OE businesses in North America and Europe, and our spending in Asia continues for new customers and new programs.

For the full year, we expect capital expenditures will be in the range of $230 million to $250 million. During the quarter, we repurchased 600,000 shares of common stock for $18 million, completing the previously-announced buyback program to offset dilution from shares awarded to employees this year.

Now let's go over debt and available liquidity on Slide 18. In June 30, debt net of cash balances was $1,185,000,000 compared to $1,133,000,000 a year ago. Our leverage ratio of 1.9x is a second quarter low. At quarter end, we had $554 million in unused borrowing capacity under our revolving credit facility and we had cash-on-hand of $181 million. Letters of credit outstanding at the end of the quarter were $44 million.

Under our European factoring programs, we sold $132 million of receivables compared to $136 million last year. In North America, we sold $60 million in the quarter compared to none at the end of last year's second quarter. So under our credit agreement, we could have sold an additional $58 million of receivables at quarter end.

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

Gregg M. Sherrill

Thank you, Ken. Well, we've reached the midpoint of the year, and I'm pleased to report that we've made good progress on growing our revenues and improving our margin performance despite challenging economic conditions that include a strengthening U.S. dollar.

Looking forward, as you can see on Slide 19, IHS Automotive is forecasting a 2% year-over-year increase in global light vehicle production in the second half of the year. With our balance across platforms and markets, we're well positioned to take advantage of the production increases, particularly in North America and China. And we'll continue working to offset the negative conditions in Europe.

On the commercial vehicle side, weakening global economic conditions are impacting production volumes, which we anticipate will continue for the remainder of the year. However, as I said, we expect very strong commercial vehicle revenue growth this year. And in addition, we're building on an already strong customer base as evidenced by the new business wins we announced today.

In regard to the North America aftermarket, Monroe and Walker hold the #1 market share positions, and we're continuing to win new customers and expand business with existing customers. We expect that our third quarter North American aftermarket revenue will be roughly the same as last year's very strong third quarter.

In the Europe aftermarket, we will continue to be aggressive in taking costs out of the business and working to match our operations with market demand, which we don't anticipate will recover this year.

But in summary, I believe we're navigating well on a complex global environment. Our growth is fueled by strong drivers, including regulatory emission control opportunities, new segments and rapid growth in markets like China, India and Thailand.

Most importantly, we're well positioned to capture these opportunities with advanced technology solutions, a global engineering and manufacturing footprint second to none, an enviable book of customers in every regions and operations that are driving stronger results. I'm pleased to say that in spite of the current economic headwinds, Tenneco is on track to deliver revenue growth, margin improvement and record earnings for the year, and our growth potential remains outstanding.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Brian Johnson.

Brian Arthur Johnson - Barclays Capital, Research Division

Brian Johnson, Barclays. Just want to go into a couple of things that surprised us. North American aftermarket revenue especially -- and then kind of put your third quarter comments in light of that and European OE. So let's start with European OE. Could you maybe elaborate a bit on what were the platforms that drove this? Was there a commercial year-over-year increase underlying this? And how should we, despite the challenged second half for European production schedules, be thinking about that going forward?

Gregg M. Sherrill

We kind of alluded to that, and Hari may want to add a little bit more color. The answer to one of your questions is, yes, there was definitely additional commercial vehicle revenue contributed in the quarter in Europe; we're talking Europe. Also, our emission control business, we have kind of told you guys, I think, all along, is a bit weighted more towards the upper end in Europe, and particularly the German manufacturers, and we're pretty strong with Audi, with Volkswagen, with Daimler.

Hari N. Nair

BMW

Gregg M. Sherrill

BMW, et cetera. So that really, I think, is the key to outpacing the market over there right now because a lot of those guys, obviously, their production has not suffered as much due to their export sales that they have.

Brian Arthur Johnson - Barclays Capital, Research Division

Right. Okay. And I assume if they're U.S. exports, then they have to have additional content over and above what the European market would have?

Gregg M. Sherrill

Not, in -- no. They're in a -- whatever their euro level is versus ours is fairly similar.

Brian Arthur Johnson - Barclays Capital, Research Division

I was just thinking on the d-size [ph] -- I was thinking like the -- or maybe you don't have content on things like the Volkswagen turbo diesels?

Gregg M. Sherrill

You're talking about diesel versus gasoline?

Brian Arthur Johnson - Barclays Capital, Research Division

Yes, yes.

Hari N. Nair

We do have content on several diesel programs, and yes, they will have slightly higher content, but on a U.S. export basis, that's not a significant thing.

Gregg M. Sherrill

Right. It's just the volume because of the just production being shipped over here.

Brian Arthur Johnson - Barclays Capital, Research Division

And then on aftermarket, several of us, people that I've talked to, have been braced for weaker North American aftermarket revenue growth after -- numerous retailers reported weak aftermarket results. What accounts for kind of slow but still year-over-year growth there? And then what's going on in the third quarter with being flat? Is this just sort of the inventory -- are we still seeing soft -- and in particular, where are your sales versus some shifted [ph] insights from the categories? What's actually moving off the shelves?

Gregg M. Sherrill

We may be beginning to see what we've kind of talk about all along, which is that at some point, the aftermarket just cannot continue to grow like it was because it was really driven by a function of the OE sales crisis of '08, '09. We continue to win business, we continue to enter our [ph] market share, which is pretty high already; all of that probably has a little bit to do with the second quarter continuing upwards. But we are sort of seeing and what we're in discussions with our customers, et cetera, in the third quarter, that will likely be, like we said, roughly the same in the third quarter. But I do want to point out, the third quarter last year was a very strong quarter. It was actually higher, I believe, than last year's second quarter. Normally, the second quarter would be the strongest quarter.

Kenneth R. Trammell

That was 193 in each quarter. So that's -- normally, we would see some seasonal decline in the third quarter, and we just didn't see it last year.

Gregg M. Sherrill

I mean, my view of the aftermarket, having said all that, is still very positive. I mean, coming in the same as last year's third quarter, given everything as you've pointed out you've been hearing out there, I think is pretty positive.

Brian Arthur Johnson - Barclays Capital, Research Division

And in terms of your visibility into the end retail sales of ride control products, still would they support these -- but in the [ph] growth rate you saw 2% this quarter and the flat next quarter? For example, your former company reported a 48% decline in aftermarket battery sales.

Gregg M. Sherrill

I can't comment on that. But what we're seeing at our product lines, obviously different from their product lines, is exactly what we've pointed out here. And that, I mean, we are facing that sort of outlook right now on feedback we're getting from the market.

Operator

Our next question comes from Chris Ceraso.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Chris Ceraso from Credit Suisse. So let's see, a couple of things. Do you have volume estimates that underpin your new guidance, in particular, the CV guidance? I know you're talking about maybe 900 million instead of 1.2 billion, but can you give us some idea of where that slowdown is coming from by region?

Kenneth R. Trammell

I mean, Chris, the volume estimates -- I mean, well, we've said, I think, all along that we've built our estimates on what our customers expected to produce, and so that's the numbers that we're seeing now based on what we've seen through the first half of the year, which is a bit lower than we had anticipated on the ramp up and what they're expecting for the balance of the year. So I couldn't give you a global number that, that would equate to because it really is sort of a platform-by-platform buildup. And that is just based on what the expectations are. Like we were saying, we've seen a slowdown in Europe that's pretty significant. You've heard, I think, a number of commercial vehicle guys, especially off-road guys, talk about that slowdown in Europe. We're seeing some weakness in North America and the launch in South America, all the platforms we launched there are expected, but those are slower ramp-up there than we had anticipated earlier in the year as well. Again, I think you've seen comments -- number of folks have talked about the South American weakness. So it's moving along just fine. We're pretty happy with the launch process, the volumes are just lower than what we had originally been told to expect at the beginning of the year.

Gregg M. Sherrill

The economic challenges that clearly, everyone is seeing around the world, particularly in Europe, are simply impacting, I think, these bigger durable things a little bit more than anything else. Light vehicles, particularly in North America, are still moving along quite well, simply because they were so low at one point. There's just a lot of replacement volume going on out there. But in the commercial vehicle world, and I mean, we just wanted to signal what we're seeing right now, still very good growth for the year for us. But clearly, these economic conditions are impacting the schedules in the off-road and also in the on-road. The South America piece is probably exacerbated by the fact that last year, everyone was trying to figure out is commercial vehicles were running quite strong towards the end of the year, how much of that was underlying economic reason, how much of it was pre-buy? But certainly, there was a lot of pre-buy there. So we ramped up, but we just ramped up to a lower volume in South America than what was originally, certainly anticipated by our customers. So these things are purely a function of this economic condition. We'll give you another update in the third quarter. It's -- depending on how things are going, we could be back up a little bit or, we don't know. It's a lot of uncertainty on that thing out there. But we do know that we're going to be very, very strong year-over-year. There's no doubt about that.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

That sounds like it's a little bit in each region?

Gregg M. Sherrill

Yes, it is. You could probably categorize. Of course, Europe is probably the biggest. South America, on its own basis, is right in there, followed by North America. But it is pretty much across all regions.

Kenneth R. Trammell

And remember, the key for us is the regulated markets because if a unit is built and exported to a nonregulated markets, then obviously, the after-treatment doesn't go on it.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Right. Okay. And then if we're thinking about next year, should we think about the delta from year-to-year as opposed to the absolute number, assuming that we're just -- we've got to step down here?

Kenneth R. Trammell

Chris, I think that depends on your view of what the economy, globally, is going to look like next year. There's obviously a lot of variability around that. And so we haven't even attempted to try and do a new estimate for next year.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And just lastly, any update on the timing for commercial vehicle enforcement or emission enforcement in China?

Gregg M. Sherrill

It still seems to be holding to that July 2013.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

July 2013?

Gregg M. Sherrill

Yes. That's what's they've officially put out there. I think we mentioned that in the first quarter. And as I also said in the first quarter, we've got a lot of customers that have really fired up there prototyping and development work aimed at meeting regulations in that timeframe. Again, with my normal cautionary note, that will not go across the entirety of the country, right? It will be more in the, undoubtedly, cities in the sort of eastern regions of China. But that's what it looks like right now.

Operator

Our next question is from John Murphy.

Michael Tuteral

This is Mike Tuteral, on for John Murphy today, Bank of America Merrill Lynch. I have a few questions. I know recently, Navistar announced that they'd be changing over engine technologies, and I was just curious if this is one of the programs you added during the quarter, and if you see this as a significant opportunity for you all.

Gregg M. Sherrill

We tried to call it out. We added 2 off-road customers in Europe and 1 on-road in India. And as far as all of the work going on at Navistar right now, we're obviously going to have to defer those questions to Navistar themselves.

Kenneth R. Trammell

They do want to remind you that the discussions that Navistar is having is on Big Bore Engines, which are not Tenneco's engines.

Michael Tuteral

Okay, great. The North America aftermarket seems pretty strong this quarter. I was just curious if that was due to some seasonality and if you think that will continue through the remainder of the year. I know you said the third quarter will be similar to last year, but do you see that improving through the remainder of the year?

Gregg M. Sherrill

We're -- seasonality-wise, second quarter is a pretty strong quarter for the aftermarket historically. I think I mentioned earlier last year, actually, the third quarter wound up being a bit stronger than the second quarter. That was unusual. So last year's third quarter was very strong. But what we're seeing is basically everything that we can see right now, but we're going to be somewhat in line, somewhat equal -- the same as last year.

Kenneth R. Trammell

Kind of plus or minus around that last year.

Gregg M. Sherrill

I mean it's very difficult to forecast that one specifically. But we'll be in that range of last year's third quarter, which we still view as very strong, but it also is going to be a quarter where you're not seeing these big year-over-year increases, we don't think. That has a lot to do with how strong it was last year, and the fact that we've always said, at some point, those increases have to slow down as we wrap some of these strong quarters.

Michael Tuteral

Okay, great. Just one other quick one. I know recently, there's been a lot of talk about China building up their school bus infrastructure. Is this something you could take advantage of or have an opportunity to profit from?

Gregg M. Sherrill

All of that, I would just throw that into the commercial vehicle story on China. So it will depend. Obviously, it will be positive for a volume point view on that segment of China. From our perspective, it's still going to be all about enforcement of those relations. And if they do, and if those buses were running in the regions where they're enforced, it will be a positive. But for us, it's still focused on them holding to that July date of 2013 on enforcement.

Operator

Our next question is from Peter Nesvold.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

It's Jefferies. I guess, a question on North America margins. I mean, you've sort of touched on it in different areas of the conversation. But I mean, to me, that was really the thing that jumped out here. Are you able to sort of rank prioritize what was driving that? Whether it was the mix towards aftermarket, whether it was addressing the ride control items that we've been dealing with for a couple of quarters. And then I guess trying to get a sense for whether or not I can sort of start to look at this as maybe a new baseline, or am I getting a bit ahead of myself?

Kenneth R. Trammell

So on a year-over-year basis, the margins for our aftermarket just kind of went back to historical levels. Hari said that in his discussion, which is what we told you at the end of the first quarter we expected, and that's certainly what occurred.

Gregg M. Sherrill

And the second quarter is a strong mix in the aftermarket.

Kenneth R. Trammell

It is going to be our strongest quarter; it always is historically our strongest quarter. The North American ride control business, as, again, Harry said in his comments, show a good year-over-year improvement as we get those operational challenges behind us. And we had good volume growth in the North American OE emission control business, both light vehicle and commercial vehicle. And so both of those contributed to the improvement as well.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Okay. So I mean, it doesn't sound like there's anything that's particularly one-time-ish about this particular quarter. I mean, we're not going to be up 140 basis points year-over-year every quarter in North America. But just want to make sure there wasn't anything kind of that stood out, that should -- I should kind of take out of the model as I look forward to the second half of the year.

Kenneth R. Trammell

Well, remember, Peter, that in the second quarter of last year, we had a pretty good-sized aftermarket changeover. And I referenced that, that obviously, we didn't have that same size this year. Last year was $12 million, it was $10 million less this year simply because we weren't doing one of those big changeovers like we did for AutoZone on their exhaust business last year. So that's obviously part of the contributor to the year-over-year improvement.

H. Peter Nesvold - Jefferies & Company, Inc., Research Division

Okay. And then as a follow-up, the headcount reductions in South America, were those done by the end of 2Q? And is there any order of magnitude? What kind of benefit maybe that starts to show in the second half?

Hari N. Nair

Yes, they were done by the end of Q2, but we're continuing some of those actions as we see the volumes remaining pretty soft so far this year. But we're also watching the external forecasters on the call-off [ph] schedules to remain flexible, depending on how the second half production levels turn out. But from an improvement standpoint, basically, the actions are designed to offset most of the volume decline impact on the operations. So that's what we're focused on.

Gregg M. Sherrill

South America is kind of interesting to watch right now. Because if you look at the IHS Automotive, they're forecasting a fairly strong second half for Brazil, who've just implemented some incentives, drove some pretty strong sales in June, but we're just saying, we want to be a little bit cautious there as to whether that was all pull-ahead sales in June or just exactly how it's going to go down there. But we'll react, as we have, to try to mitigate either direction. You got to be agile in Brazil at the moment.

Operator

Our next question is from Patrick Nolan.

Patrick Nolan - Deutsche Bank AG, Research Division

It's Deutsche Bank. A couple of questions. First on the commercial vehicle business, can you -- you guys are obviously doing a good job there as far as on the margins front. Can could you talk about, is there some additional costs that you've already put in place that you're actually having to overcome in the results as the revenue comes a little bit shorter of your expectations?

Gregg M. Sherrill

Yes, I would say definitely. I can't give you a percent; it's not, in the grander scheme of things, overwhelming. But certainly, there's a little bit of an absorption issue going on there because we do have installed the capacity and meet the regional demand, and it's just slow at the moment. That will all come back to us as that picks back up, but in the near term, there's a little bit of a drag there.

Patrick Nolan - Deutsche Bank AG, Research Division

I know you're originally expecting it to be better than the average margin. Is it fair to say that's below...

Gregg M. Sherrill

I still think it's -- Ken, what would you say? I think we're positive on the margins versus sort of -- we still do -- and definitely have a bit of an absorption issue going on there.

Kenneth R. Trammell

It's not as positive yet as it will be, I guess, is the way to put it, right? Because we've still got, like Gregg said, cost to absorb as the production ramps up. But, we're pretty happy with how the launches have gone, and everything is meeting our expectations from where we stand right now from a production standpoint.

Patrick Nolan - Deutsche Bank AG, Research Division

Can you tell us what technologies you're supplying Daimler with on the on-road side of the business in Europe, I think for the commercial vehicle business?

Hari N. Nair

The Daimler on-road business in Europe is mostly on the medium duty categories, the Acros [ph] and ACSOR models. And many of those are exported around Europe and to other regions and as well continue to operate in Europe to a lesser extent but growing on an export basis. So mostly, Euro-5 technologies, and those models are continuing to run in the production system there.

Gregg M. Sherrill

And they use liquid urea SCR system.

Hari N. Nair

Yes. And they use liquid urea SCR systems, absolutely.

Patrick Nolan - Deutsche Bank AG, Research Division

And if you guys can take just one more in. Have you seen any change in the practices of your customers on the light vehicle side of the business, particularly in Europe?

Gregg M. Sherrill

No, not really. I mean, it's -- I always have to smile a little bit because in the automotive world, pricing is obviously -- it's not an easy world, right, that we live in. But I haven't seen any change, really, in the grander scheme of things one way or the other.

Operator

Our next lesson is from Joseph Spak.

Joseph Spak - RBC Capital Markets, LLC, Research Division

It's RBC Capital Markets. A couple of things. Just getting back to the North America margin. I recognized you had the changeover benefit this year, but shouldn't we start to comp against the ride control issues that weighed the margins in the back half of last year as well?

Kenneth R. Trammell

Remember, that was on the original equipment side of the business. And it really hit us in the third quarter of last year. And as Hari said in his comments, we're seeing improvement in the OE ride control business this year, and so we do expect to continue to see improvement in the third quarter as well.

Gregg M. Sherrill

This year's comp was kind of free. The issue is flaring up in the third quarter -- on the second quarter of the comp that you just saw.

Joseph Spak - RBC Capital Markets, LLC, Research Division

Right. So there should be sort of a natural benefit there, just from that normalization.

Gregg M. Sherrill

In the third quarter, of course.

Joseph Spak - RBC Capital Markets, LLC, Research Division

Okay. And then, can you just update us on -- I know you pointed out the negative mix impact on the aftermarket. Last quarter, I think you said it was $6 million in North America; how did that progress this quarter?

Kenneth R. Trammell

Joe, exactly what we told you at the end of the quarter. What happened is what occurred, like we said, that we had our normal annual pricing increase, which took effect and moved this back to the more normal historical margins. And we didn't expect to talk about -- have to talk about mix in the aftermarket again, and that's the case.

Gregg M. Sherrill

Yes, that mix is stabilized, which is what we had anticipated. We're beginning to see that. And as we told you, it was a timing issue versus those price increases. So now, it's all behind.

Joseph Spak - RBC Capital Markets, LLC, Research Division

Okay. The 3 new wins you pointed out on commercial vehicle, are those actually incremental to what you've originally stated in the 5-year outlook? Or are these just sort of announcements, so you're able to sort of put a name to a face sort of thing?

Kenneth R. Trammell

Probably, yes to both. Remember that obviously, we are awarded the business 2 to 3 years in advance at the start of production. So when you're talking about the estimates, you're talking about toward the end of our estimates, which already have a range on them, so we're certainly still well within that range.

Joseph Spak - RBC Capital Markets, LLC, Research Division

Okay. And then just last one. I thought I heard you say that the buyback program was completed this quarter. Is that something that's going to be renewed? Or at least -- or is this the end of sort of offsetting dilution?

Kenneth R. Trammell

Yes. Remember that our goal every year is to repurchase the number of shares that are issued to employees for compensation purposes. So this year, it was roughly 600,000 shares, which is what we repurchased, as we then don't expect to issue any more shares again until next year, so as we look at that, we will again take a look at the repurchase plan for next year.

Operator

Our next question is from Patrick Archambault.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

From Goldman Sachs. 2 questions really. Number one is, you had previously said that you expected a year-on-year increase in margins, I guess calculated on value-add revenue in basically Q2 through to Q4. You obviously got that this quarter. Is that still the case, despite the fact that obviously, the ramp is maybe a little slower in the back half as per your guidance?

Gregg M. Sherrill

Yes, it's still our plan.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Okay. And I guess my second one is sort of touching on one of the questions that was asked earlier. It is interesting how you guys have seen very good comps in the aftermarket, in the face of some other manufacturers of aftermarket components being down year-on-year in North America. And I understand that that's sort of slowing at this point and going to be neutral in 3Q, but is there a different cycle to your products in terms of the replacement cycle? Or is there a market share consideration that's offsetting it, because miles driven are fairly weak? And it seems to be affecting a lot of folks negatively, but you have sort of risen above that on a revenue basis in North America in the aftermarket.

Kenneth R. Trammell

Well, with that, I mean, remember that part of the year-over-year increase that you saw was volume. And then a part of it, also, as we said earlier, was pricing. So certainly, there is -- part of our improvement is just being able to put more pricing through, which is what we had planned to do and what we have said before we do on an annual basis. And we continue to pick up a little bit of market share. And remember, we're already in the 60% plus range on ride control. And so that market share continues to improve, but obviously, it's improving at a slow pace. So it's a combination of all those things. From a cycle standpoint, I don't know that there is a cycle difference. Clearly, on the ride control side, they degrade slowly over time. It takes people longer to notice, so I guess the longer they hold their cars, the more likely they are to replace their shocks.

Operator

Our next question is from Graham Mattison.

Graham Mattison - Lazard Capital Markets LLC, Research Division

Lazard Capital Markets. Just a follow-up question on the aftermarket. Last quarter, you had some very strong conviction in terms of the state of that market and the outlook for it. Has there been any change since the last quarter, or I guess, what's your outlook for it as you compare it before?

Gregg M. Sherrill

No, not really. I don't think so. I mean, it's still -- what our conviction was that we're absolutely going to continue maintaining and growing our market share here in North America, that it's strong business, that we weren't going to allow the mix thing to interfere more than that one quarter, and it didn't. And our stand about the third quarter, and again, I want to reiterate, it's still going to be pretty strong third quarter since last year was so strong. We've said all along that the aftermarket cannot continue, ad infinitum, going at the pace it has been. That that was a function of the aging fleet, and all of that is a result of such low sales for several years. But that's going to catch up with us. Maybe the third quarter is the first indication of that. It's kind of hard to say because again, we're confident with the strong third quarter last year. But overall, yes, we're still very pleased with our aftermarket business and very positive about it going forward.

Graham Mattison - Lazard Capital Markets LLC, Research Division

All right, great. And then on the commercial vehicle side, the delays you're seeing, are these more coming from your off-road customers versus on-road? And then if you look out into 2013, which on-road or versus off-road is more of a concern or a factor in your expectations there?

Gregg M. Sherrill

I think we're kind of seeing it a bit across the board, both. Clearly, most of our business that we've been launching here in the last year or so has been off-road. But I think we're seeing them both. Brazil is definitely on-road, it's not off-road, they're not even regulated down there, so -- for the off-road.

Operator

[Operator Instructions] Our next question is from Rich Kwas.

David H. Lim - Wells Fargo Securities, LLC, Research Division

This is David Lim for Rich Kwas, Wells Fargo Securities. We saw your SG&A rates come down on year-over-year and it's pretty impressive. Is there a little more detail behind that? Could it be some FX translation there?

Kenneth R. Trammell

Certainly, there's FX on the European costs, simply because the euro is weaker clearly on that, but that would also reflect itself on the revenues as well. You've got, like I talked about earlier, the lower changeover cost in the North American aftermarket because a good bit of that, which we've pointed out last year, went through selling expense. And that should be about -- I'm sorry, I'd also want to point out, we had the change in the stock price, and I mentioned this in the discussion as well, obviously gave us a year-over-year benefit of about $7 million. Last year was a $2 million expense; this year was a $5 million benefit just because of the variability in the stock price.

David H. Lim - Wells Fargo Securities, LLC, Research Division

So it's a $7 million swing?

Kenneth R. Trammell

That's right.

David H. Lim - Wells Fargo Securities, LLC, Research Division

And on that, is that SG&A rate sustainable going into the Q3 and Q4? Or should that sort of tick back up a little bit in the successive quarters of the second half?

Kenneth R. Trammell

Certainly, depending on -- the stock price will depend on what happens with the stock as we kind of move forward. We don't personally believe that it will -- should go up, but that -- kind of take that out, and yes, I think we're in pretty good shape. But there's always some seasonality in our SG&A because of the support of the aftermarket. So generally speaking, the aftermarket should be high in the second and third quarter and then tail off a bit in the fourth quarter.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Got you. Now on EBIT margin in the rest of the world, very strong. Is there some more detail there? Maybe launch cost or come in [ph] rolling off. Can you elaborate on that a little more?

Hari N. Nair

No. Nothing specific that stands out. We are continuing to adjust our operations to the market environment. I think we've all talked about our outlook for rest of the world. China will continue to grow year-over-year, although at a slower rate. And Europe outlook, I think, is fairly well established in terms of the second half, where we continue to adapt to the market. So nothing, no standout items. We expect to continue to follow the operational model to the market environment in all those regions.

Gregg M. Sherrill

I would just add that China's absorption is sort of slowly improving because we've been telling you guys about some pretty heavy investments going on there over the last several quarters. We've still got investments going on there, but that was kind of an extreme case there for a while, so those volumes are beginning to catch up as well.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Okay. And then on the new wins when it comes to commercial vehicle, the MAN and the Tata, you guys have an idea or can you share of when these programs will launch, or sort of give us an idea of would it be 2 years from now, 3 years from now?

Hari N. Nair

Roughly, middle -- early, I said it's Q2 2014 timeframe. The Tata program likely to be a little bit earlier, but in Europe, it will be towards the second quarter of 2014.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Now when normally you guys get an award or after you win the bid, does it take about a year or 2 in order for you guys to launch on that program?

Hari N. Nair

At least 2 to 3 years in advance of the start of production.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Got you. I mean, but relative to that, how sooner can you do something like that? Can you, like, move up the launch date or compress the launch schedule to a year possibly?

Gregg M. Sherrill

It can be. It depends on the product, on the state of our capacity, et cetera, but it's possible.

Operator

Our next question is from Brian Sponheimer.

Brian Sponheimer - Gabelli & Company, Inc.

Gabelli & Company. Just I wanted to go back to this Navistar issue. Can -- you touched on the fact that Navistar's after-treatment is going to go on a Big Bore Engine, and you basically alluded to the fact that that's not really your -- Should I be thinking that's not in your core competency as a company and that you wouldn't be eligible to provide that after-treatment, or...

Gregg M. Sherrill

No. that's not what we meant at all. We do Big Bore Engines around the world.

Brian Sponheimer - Gabelli & Company, Inc.

Exactly.

Gregg M. Sherrill

That's not the issue. All we're stating is Navistar obviously is working their way through. The program they're working their way through on is the Big Bore Engine, which we do not currently have. That's just a statement of fact. We have their medium-duty stuff. I mean, nothing to do with capabilities, et cetera.

Kenneth R. Trammell

Brian, remember, we do engines much larger than that for guys like Cat and Deere.

Brian Sponheimer - Gabelli & Company, Inc.

That's why the comment -- that's a question, that's all. And also thinking about China, as we look into next year, as you think you're looking at a July enforcement, do you currently have any emission control content on any commercial vehicles in China? We're thinking that there might be some sort of pre-buy ahead of the purchase of vehicles with liquid after-treatment?

Gregg M. Sherrill

We do have some SCR systems running around China. I can't to tell you exactly, which customers today. They would be in that list that we've got. Not all of them, but some of them are already basically running fleets, if you will, that's more of that than anything right now. So we're gaining experience; we do ship at a fairly low volume in China today. The list of customers we've given you are those that we've got either in production, as I just described, or development, we're very heavily going on. So we're prepared to go when those enforcements are determined, but there is some being shipped today.

Brian Sponheimer - Gabelli & Company, Inc.

Okay. And not to belabor any point on the aftermarket, but I'm just trying to draw a line between the 2. This morning, Monro Muffler And Brake came out with comps down 15% for exhaust and down 12% for front-end and shocks. You're obviously talking about a more muted back half for your own aftermarket. But given the declines that some of the end customers are seeing, is there any difference in channel that we should be thinking about, maybe on the dealer's side doing a little bit better, where you're seeing better than that down, low double-digit.

Kenneth R. Trammell

I couldn't speak specifically to Monro Muffler And Brake. They are a Tenneco customer. They do sell -- I know they sell Monroe shocks. I'm not sure if they do exhaust, but they're certainly a customer. But, as you know, our mix goes all the way from the traditional WDs through the retailers to guys like NAPA. So we've got probably a broader group than what you'd be looking at for just one specific installer like Monro Muffler And Brake.

Operator

Our final question today is from Adam Brooks.

Adam Brooks - Sidoti & Company, LLC

Just a few quick questions here. Can you talk a little bit about ER&D. You have a lot of launches coming up. It looks like it was down about 20% year-over-year. Is this kind of a one quarter blip, or is this a fair run rate based on a seasonal basis for the rest of the year?

Kenneth R. Trammell

Well, the engineering, research and development line on the income statement obviously varies, both with our expenses as well as when recoveries come in from customers. So there's always some variability, up or down. But I think what we've said is that if you look over the sort of the sweep with the last few years, it's been around 2% of revenues, and we expect it to stay, again, over time, around that 2%.

Adam Brooks - Sidoti & Company, LLC

Okay. And just a quick question. Can you talk a little bit about what your content would look on let's call it a nat gas car versus the gasoline or diesel. I know it's a small portion right now, but if that picks up, maybe what the content difference would look like?

Kenneth R. Trammell

There is a lot of uncertainty around the exact sort of format that those engines would take, right? If it's simply natural gas like you see on a Honda Civic, it's probably closer to the gasoline and the diesel content. Some of the engines that have been discussed for the commercial vehicle, specifically because of the significant increase and torque that you need, would be diesel-ignited natural gas, which has something much closer to a diesel-type after-treatment than it does gasoline. So I think it's going to depend a large extent on what ultimately happens if those engines do become more prevalent.

Adam Brooks - Sidoti & Company, LLC

Okay. And lastly, can you maybe give us a number for utilization rates in China right now?

Gregg M. Sherrill

That's a little bit complicated. Obviously, I mentioned earlier, we've put in a lot of capacity here in the last several quarters, couple of years, in anticipation of all the new programs that we're launching over there. And clearly, that ramp is progressing. I mentioned earlier, absorption is improving. It was planned capacity, it's not anything other than that, and I think our results kind of bear that out. But I couldn't tell you exactly where that utilization rate stands today in China.

Operator

Thank you. I would now like to turn the call back over to the speakers for any closing comments.

Linae Golla

Thank you. This concludes our call. An audio replay will be available on our website at tenneco.com in just about an hour. You can access the recording by telephone. In North America, you can reach the playback at (800) 841-8609. For those outside North America, the number is (402) 280-9935. This call-in information is also found in our press release. If you are an analyst or an investor with additional questions, please follow-up with me at (847) 482-5162. Reporters with additional questions can contact Bill Dawson, our Executive Director of Global Communications, at (847) 482-5807. Thank you for joining us today.

Operator

Thank you. This does conclude today's conference. Thank you very much for joining. Please disconnect at this time.

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