Tenneco Inc. Q2 2008 Earnings Call Transcript

Aug. 4.08 | About: Tenneco Inc. (TEN)

Tenneco Inc. (NYSE:TEN)

Q2 2008 Earnings Call

July 31, 2008 11:00 am ET

Executives

James Spangler - VP, Global Communications

Gregg Sherrill - Chairman and CEO

Ken Trammell - CFO

Analysts

Rich Kwas - Wachovia Securities

David Leiker - Robert W. Baird

Brian Johnson - Lehman Brothers

Chris Ceraso - Credit Suisse

Operator

Good morning and welcome to Tenneco's second quarter 2008 earnings release conference call. All participants have been placed on a listen-only mode, until the question-and-answer session. (Operator Instructions). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

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

James Spangler

Good morning and welcome to Tenneco's second quarter 2008 financial results conference call. Earlier this morning, we issued our press release and associated financial information. In a minute, I'll be turning the call over to Gregg Sherrill, Tenneco's Chairman and CEO, and Ken Trammell, our Chief Financial Officer. Gregg and Ken will spend about 30 minutes, taking you through a detailed explanation of our second quarter performance.

Slides related to their prepared comments are available on the financial section of Tenneco's website at www.tenneco.com. The two of them will then take your questions during the second half of our call. The conference call operator will explain the process for asking a question at that time. We will do everything possible to address all of your questions on our call today.

Now, please note that our discussion today will include information on non-GAAP financial measures, all of which are reconciled with GAAP numbers, as shown in our press release attachment. The press release and the attachment are also posted on our website. Also, in addition to reviewing our second quarter financial results, some of our comments today will include forward-looking statements. Please keep in mind that our actual results could differ materially from those projected in any of our forward-looking statements.

With that, let me turn the call over to, Gregg Sherrill. Gregg?

Gregg Sherrill

Thank you. Good morning, everyone and thanks for joining us. As everyone is well aware, the North American automotive environment is facing trying and tumultuous time. While the North America automotive industry experienced a difficult first quarter with dramatically lower production volumes, the second quarter was even more challenging with an unprecedented mix shift away from the highly profitable light truck segment.

For Tenneco, our total revenue was essentially flat as strong sales in our Europe and Asia Pacific segment offset a 17% decline in North America. Furthermore on slide 4, our Europe and Asia Pacific segment showed strong earnings improvement in the quarter, and even in North America our operating performance partially offset the volume and mix issue. All the things are in their control, our team did an outstanding job.

I really want to thank the employees at Tenneco from around the world for their perseverance and tremendous effort this year. It's easy to get distracted by all of the noise in the marketplace, but our team stayed focused and stood together to accomplish a lot and very quickly. They are an impressive group of people.

Turning back to North America, the combination of historically low levels of housing activity and consumer confidence, coupled with rising fuel prices is resulting in one of the most difficult automotive environments ever for OEMs, suppliers, and consumers alike and we don't see much evidence that would suggest a reversal in business trends any time soon. According to the latest industry information, retail demand in North America for light vehicles fell 12% in the second quarter compared to 2007 and production declined by 15%.

Moreover, the extraordinary vehicle mix shift away from pickup trucks and full frame SUVs has added to the volatility in the auto industry, because of the magnitude and the speed of the shift. As we've seen, the industry volume decline is more pronounced in the light truck segment at 23%, compared with passenger cars, which were down 4% in the second quarter.

Tenneco is the leading supplier of emission control and ride control systems for light trucks, the dominant segment of vehicle demand over the last 10 years. In the 2008 second quarter, full frame SUVs, pickup trucks, and mini vans, made up 58% of our total North American OE revenue, compared with 72% in all of 2007.

We've included our top 15 platforms, as a percent of total 2007 sales on slide 5. In North America, our earnings also were impacted as the American Axle labor strike shutdown production of two of our largest platforms, during the first two months of the quarter. And local labor strikes at GM halted assembly of their popular Malibu passenger cars for about two weeks and their strong selling crossover vehicles for more than four weeks. These are also key platforms for Tenneco.

Overall, we are looking at our business from top to bottom, flexing operations with announced production cuts and OEM plant consolidations, this is on slide 6. We've had as many as 15% of our North American hourly workforce on temporary or permanent furlough. We are focused on redeploying equipment to pay down capital expenditure needs for upcoming programs, and to more productively utilize capacity. And we're continuing to look at ways throughout the business to enhance our profitability and competitiveness.

For example, we've reduced our aftermarket sales and support staff to shore up the efficiency of our distribution channel. We are also examining our manufacturing footprint in North America, in order to better match today's lower production levels, while also planning for capacity requirements for future business. It's difficult that these actions are now, it's imperative that we position the operations for long-term success.

On slide 7, you will see that there were several factors in our favor last quarter. In an agreement with Delphi and General Motors, we acquired the ride control assets at Delphi's Kettering Ohio facility and picked up GM passenger car ride control business, which came on June 1st at full run rate contributing 12 million to our top line in the second quarter.

Additionally, new customers in the North American aftermarket provided margin upside, and our North American commercial and specialty vehicle business for ride control, showed a year-over-year revenue increase for the first time in six quarters.

Finally, our geographic balance continues to deliver support and as reflected by our leading market shares in Eastern and Western Europe, South America, China, and Australia. During the quarter, our European segment generated 12% adjusted earnings growth year-over-year. Our Asia Pacific group drove adjusted earnings 40% higher than the previous year, leveraging a 19% top line expansion and improved manufacturing efficiencies. Additionally, we have a solid liquidity position.

Ken will take you through the details. But in general, on slide 8, at the end of the quarter, we had $164 million in cash, $351 million available on our revolving credit facility, and cushions against our tightest covenant of $125 million for EBITDA and $500 million for debt, and importantly we have no near-term maturities due on our outstanding debt.

With that, let's get into some of the financial details of the quarter. On slide 9, you'll see that for the quarter, North America represented 41% of total revenue and 23% of EBIT. The European segment accounted for 49% of revenue and 65% of EBIT, and the Asia Pacific region reflected 10% of revenue and 12% of total EBIT.

Turning to gross margin on slide 11, our consolidated margin in the second quarter was 16.2% compared with 17.2% one year-ago. There were $3 million of restructuring charges included in the 2008 margin and $2 million in the prior year quarter. The gross margin decline was more than accounted for by manufacturing absorption in North America resulting from the lower industry production levels, and the mix shift away from the light-trucks.

We also incurred higher raw material costs in the quarter. Steel cost increases presented a headwind of $17 million globally, but we're addressing these rising prices through concentrated efforts on cost reductions and customer recovery.

Moving on to slide 12, we reported SGA&E at 8.2% of revenue, compared with 8% of revenue for the same period last year. The increase in the SGA&E percent resulted from lower than planned revenue, $3 million of restructuring charges from a 7% staff reduction in our North American aftermarket group, as well as headcount reductions in Europe and Australia, $7 million of aftermarket changeover costs for new customers secured during the quarter and was partially offset by SG&A cost controls and reduced incentive compensation cost.

At the same time, that we are employing strict cost disciplines. We are continuing our planned investments in engineering for future programs and technologies. Now, I want to take a couple of minutes to discuss some commercial highlights on slide 13.

We launched 57 light vehicle models in the second quarter that we either, renew, refreshed, or had expanded content. We're also very pleased with our success in expanding in commercial vehicle markets for emission control after-treatment. As I've talked about before, we've won several platforms for the 2010 regulation change for on road vehicles in North America and China, and we secured after treatment business for off road applications in construction, agriculture, mining, and forestry, beginning in 2011, which reflects our ability to transfer our hot end emission control capabilities into new market segments.

As you saw yesterday, we announced that we've been awarded Caterpillar's global business for diesel engine after treatment systems. These systems will be used to meet stricter diesel emission regulations taking effect in 2011. Obviously, we are very pleased to work with Caterpillar, the world's leading manufacturer of construction and mining equipment Today the company has been awarded 37 development or production contracts globally to supply diesel after treatment technologies to meet the stricter emission regulations that take effect in various regions of the world starting in 2010.

These include 21 commercial vehicle contracts for on-road and off-road applications, 15 light vehicle contracts and one contract to meet locomotive regulations. In addition to the awarded OE business, we announced last week that we had one contracts for new or expanded after market business in North America. All of these awards are indicative of the significant amount of organic growth we're planning for over the next five years.

And with that, I'll turn the call over to Ken.

Ken Trammell

Thanks Gregg. Before I go into the business segment analysis, I'll review some of the items that affect comparability between the second quarters of 2007 and 2008 on slide 14.

Second quarter 2007 adjustments included one item, restructuring and related expenses of $2 million pre-tax or $0.03 per diluted share. Second quarter 2008 adjustments included three items. Restructuring and related expenses of $6 million pre-tax or $0.08 per diluted share, after market customer changeover cost of $7 million pre-tax or $0.09 per diluted share related to new after market business, and finally, a non cash tax expense of $13 million or $0.28 per diluted share for tax liabilities mostly related to changes in inter-company billing arrangements.

Now, turning to the North American OE results on slide 15, our revenue for the second quarter of 2008 was $516 million, down 22% compared with $661 million in the second quarter last year. Excluding substrate sales in currency, revenue was down 18%. Comparatively, North American light vehicle market production was down 15%.

Our North American OE revenue was impacted by the overall volume weakness, and more specifically by mix issues for industry production for the higher content light truck platforms fell by 23% compared with only a 4% passenger car decline as Gregg mentioned.

Our ride control revenue was down 8% compared with the prior year, much of it due to lower production including the American Axle strike, which shutdown nearly all production of the GMT, 900 where we have content on the SUVs, as well as the half ton and three quarter ton pick ups.

This was partially offset by $12 million of incremental revenue in June from the passenger car platforms we took over from Delphi as a result of the asset acquisition, we finalized at the end of May. Additionally, content on higher margin commercial vehicle platforms benefited our ride control performance in the second quarter.

According to Power Systems Research, the market class V through VIII, commercial vehicle production was down 3%. However, our ride control sales into that segment increased due to a favorable customer mix.

North American OE emission control revenue fell by 25%. Substrate sales, net of currency were 28% lower than the prior year as a result of production declines. When you exclude substrate cells and currency, North American OE emission control revenue fell 23% in the 2008 second quarter.

Our emission control sales suffered as a result of a lower year-over-year volumes on the light truck platforms. The biggest impact came from the Ford Super Duty, the GMT 900 and Dodge Ram. Only partially able to offset the decline is GM's Epsilon passenger car platform, Toyota compact wagon called Matrix, Volkswagen compact Jetta passenger car and the new Dodge Journey crossover.

Now North American after market revenue for the second quarter 2008 was $158 million, up 6% from the year earlier period. Excluding currency, revenues were up 5%. This increase was driven by $6 million of new customer orders in the quarter. As we've been able to do several times in recent years, we took advantage of some opportunities to add new customers to our business.

We added more than 10 new customers including retail and wholesale distributors for our ride control and mission control and break products. We expect all the new accounts in total add incremental revenue of about $12 million annually. When we acquire new customers, we incur a cost to remove competitive products from the shelves that was the reason for the $7 million charge we took in the quarter.

Excluding currency, ride control after market revenue was up 4% in the second quarter, and emission control after-market revenue rose 10%. Now on slide 16, second quarter EBIT for our total North American operations was $17 million, including a $1 million of unfavorable currency versus $50 million in last years second quarter.

Second quarter 2008, also included a $1 million of restructuring cost or headcount reduction in the after market and $7 million of after market changeover cost. The prior year had no adjustments. In total, adjusted EBIT for North America was $25 million, compared with $50 million last year.

In the press release, we bridged the $25 million adjusted EBIT decline for you. Let me quickly run through it again. The biggest impact was our lower OE sales and an unfavorable mix, which resulted in $27 million decrease in EBIT.

Manufacturing cost absorption due to substantial decline and overall production volumes, including the industry's union labor strikes accounted for another $12 million of the decrease. And we had a $2 million increase in depreciation expense related to capital expenditures to support the sizeable 2007 emission control platform launches.

The good news is that the higher after market volumes and the new OE platform launches added $9 million to EBIT in the quarter. Our focus on spending controls and reducing SG&A accounted for most of the remaining $7 million of EBIT contribution.

Moving onto Europe, on slide 17, we reported second quarter 2008 OE revenue of $578 million, now that's up 13% compared with $513 million we reported a year ago. Currency exchange rates favorably impacted our total European OE revenue by $70 million in the latest three months. Substrate sales, net of currency effects were down 6% over the last year. Excluding substrate sales and currency, our total European OE revenue was up 1%.

Last year, our top line benefited from alloy surcharge recovery. Since then, the price of nickel has come down considerably, as such we require less recovery from our European customers. To illustrate the impact of this, after the impact of the alloy surcharge recovery in each year, we would have reported an increase of 3% in European OE revenue, excluding currency and substrate sales in the 2008 second quarter.

European OE ride controlled revenue excluding currency increased by 9% from the 2008 second quarter, but favorable volumes on a the new Suzuki splash, Volkswagen Passat and Mercedes C-Class, both of them are electronic shock technology and the VW Golf offsetting lower volumes on the Audi A4, the Audi A6, and Renault Scenic.

Revenue from our European OE emission control unit increased 10%. Excluding currency and substrates, revenue declined 2%. Now the Nickel surcharge declined that I just mentioned affects our emission control business. If we exclude the impact of the alloy surcharge in each year, we would have reported an increase of 1% in European OE emission control revenues excluding currency, and substrate sales in the 2008 second quarter.

Volume increases in this operation, primarily came from new launches in 2007 that continued to ramp up including BMW's new one and three series and many. The new Daimler, Sprinter, and Smart models, the Ford Mondeo, the Jaguar XF, and the Volvo V70, to name just a few.

Now second quarter European after market revenue was $129 million, that's up 5% from the $124 million we recorded a year ago. This is on slide 18. When adjusted for currency, after market revenue was down 10%. The shrinking European market for exhaust replacement parts drove the decrease.

Excluding currency, ride control after market revenue was flat compared with the second quarter of 2007, while emission control after market sales excluding currency were down 10%.

Revenue from our South America and India operations on slide 19 was $108 million compared with $81 million reported in the year earlier quarter due to higher OE revenue, and an increase in South American after market revenue. Currency had an $11 million favorable impact on revenue. So excluding currency and substrate sales, revenue in South America and India combined rose 15%.

For the 2008 second quarter, total EBIT for our Europe, South America and India segment was $48 million, compared with $45 million in the second quarter of 2007. This is on slide 20. Adjusted for restructuring in each quarter, EBIT was $51 million in the latest quarter compared with $47 million in the second quarter 2007, 12% higher.

The EBIT increase was driven by OE volume increases and manufacturing efficiency improvements, as well as the lower alloy surcharges. EBIT included a $2 million currency benefit. Restructuring charges were for salaried and hourly headcount reductions in both our OE and our after market operations.

On the next slide, second quarter revenue for our Australian operations was $57 million compared with $50 million in the 2007 quarter, excluding currency and lower substrate sales, revenue rose 8%. Finally, our Asian operations reported revenue of $105 million during the second quarter of 2008, up 23% from the year earlier period.

This was driven by 23% higher sales in China, primarily related to higher volumes on existing platforms, and also to new platform launches. EBIT was $10 million versus $8 million last year in our Asia Pacific region. There were $2 million of restructuring charges taken in the late of second quarter for a 28% headcount reductions in Australia, compared with no charges last year.

Adjusted EBIT for Asia Pacific was $12 million versus $8 million a year-ago, a 40% increase. The EBIT benefited from volume increases in China, operational improvements and a $1 million of favorable currency. On slide 22, for the company in total. Currency favorably impacted year-over-year second quarter revenue comparisons by $115 million which translated into a $2 million benefit to total company EBIT.

Depreciation and amortization was $57 million for the quarter, compared with $50 million in the prior year. The change was primarily related to the investments we made in equipment and machinery for 2007 launches, as well as the stronger euro. For 2008, we still expect depreciation and amortization will likely be in a range of $220 to $225 million.

Moving on to slide 23, interest expense in the 2008 second quarter was $33 million including a $4 million expense related to marking the interest rate swaps to market. Last years interest expense of 40 million included a $3 million mark-to-market expense from the swaps.

The net decrease in interest expense came from lower rates on both our variable portion, our variable debt and a portion of our fixed rate debt. For 2008, our projected interest expense is expected to be roughly $120 million, excluding any mark-to-market in that.

On slide 24, we recorded $27 million tax expense in the latest three months, which includes the $13 million non-cash charge that I referred to early. In 2007 comparable quarter, we recorded a $20 million cash expense. We still expect our overall operational effective tax rate to be about 33% for 2008, this excludes the $14 million of liability adjustments that we've recorded year-to-date.

Cash taxes for the latest quarter were $12 million compared with $20 million in the prior year. We still expect our cash taxes to be in the range of $45 to $50 million for 2008.

Now let's talk about cash and debt on slide 25. On an overall basis, we completed the quarter with $287 million in borrowings and $42 million in letters of credit outstanding against our $680 million in revolving credit facilities. Accordingly, we had $351 million of unused committed borrowing capacity available at June 30th.

Our consolidated debt level was $1.492 billion at quarter end and our cash balance was at $164 million, bringing debt net of cash balances to $1.328 billion. Net debt to adjusted last 12 months EBITDA at June 30 was 2.8 times improved from 2.9 times last year.

While we remain intently focused on reducing our leverage, the [Volvo] production schedules and vehicles mix in North America in the second half of the year will make it difficult to achieve our goal of improving our net debt to adjusted EBITDA ratio to 2.2 times this year.

Now if you will turn to the next slide, we'll review our cash flow performance. Cash provided by operations in the quarter was $61 million versus $67 million a year ago.

Our working capital cash flow was about the same year-over-year. Our cash flow benefited from $45 million improvement in our securitized accounts receivable. The cash flow changes for accounts receivable and accounts payable year-over-year relate mostly to the different levels of production activity and somewhat lower days payable outstanding. We also managed the downtime that resulted from the second quarter strikes, without a significant impact on our inventories.

And finally, the change in other operating activities on the second quarter cash flow statement is mostly related to the non-cash tax charge that I explained earlier. Now day sales outstanding, excluding factoring, improved to 65 days, versus 71 days a year ago. Inventory days on hand were 42 days that's in line with last year's level.

Day's payable outstanding at 72 days in the 2008 second quarter, was consistent with our historical average, but down from 84 days a year ago, when we were ramping up a significant number of new platforms. On slide 27 at June 30th, our debt compliance leverage ratio was 2.92 it can be no more than 4.0.

The interest coverage ratio was 4.22, and we needed to maintain this ratio above 2.1 times. The cushion we've built against our tightest covenant for EBITDA is a $125 million and for debt, it's $500 million. This level of covenant performance meets our tightest covenant ratio through the maturity of our senior debt facility in 2012, and we have no ratings figures in our covenants.

On slide 28, you will see that our worldwide factored receivables were higher at $216 million as of June 30, 2008, compared with $148 million one year ago, of the amount outstanding in the latest quarter $120 million was from the US accounts receivable securitization program with the balance of the factored receivables coming from programs with regional institutions in Europe.

In November of 2007, we expanded our securitization limit by more than 60% to $250 million of receivables. The second quarter's higher limit of factored receivables is a reflection of our taking advantage of that now larger limit. So let me sum up where we stand on liquidity on slide 29.

We worked to finance Tenneco with a conservative debt profile, so we can be prepared to deal with and weather auto industry volatility. We currently have substantial room on our debt covenant ratios, and so we have available to us all of the borrowing capacity on our committed revolving credit agreements.

Last November, we were able to expand our cap on factoring receivables, and we expect to reach a level near our $250 million limit by taking advantage of additional factoring opportunities in Europe. Our first significant debt maturities are in 2010 and they total $54 million.

And at the end of June, we had $177 million of receivables from GM, Ford, and Chrysler in the United States. Of this amount $45 million was sold into the North American securitization program. While there can never be any guarantees, based on what's happening today, our liquidity is adequate to see us through these difficult times in North America.

Capital spending on slide 30, was $57 million for the second quarter compared with $33 million a year ago, as we prepare for new business including commercial vehicle on highway and off road programs, that have been awarded to us for 2010 and 2011 and to support our growth in the BRIC economies.

For 2008, we still expect capital spending will be between $200 million and $220 million. On slide 31, in terms of restructuring, we recorded $6 million of expense in the second quarter for the actions that Gregg and I have outlined.

For 2008, we now expect restructuring costs may run higher than our earlier estimate of $25 million, reflecting necessary actions to adjust operations to the declining North American production environment, as well as our normal restructuring initiatives that come about as a result of successful Lean and Six Sigma programs.

We'll give you more details about those as actions occur. Now, I will turn the call back to, Gregg.

Gregg Sherrill

Okay. Thank you, Ken. Our expectation is for the North American economic environment to continue to be weak and for the automotive market in this region to remain under stress through the second half of 2008. In Europe, although economic indicators are weakening, light vehicle production so far continues at a steady pace.

Global Insight's recent forecast on slide 32 projects second half 2008 production to be up 2% year-over-year, with Western Europe's estimated 1% decline being fully offset by Eastern Europe's 9% expansion. Production in South America and India is expected to grow 9% and 19% respectively in the second half.

Our European segment continues to drive operating efficiencies to expand margins. This strength overseas helps to counter some of the North American obstacles we're facing. Global Insight's second half estimate for China calls for 16% increase in production.

However, as consumers deal with rising inflation including increasing fuel costs and the recent earthquake, we expect to see some moderation in China's growth rate. Evidence of this is already occurring, as two of our major OEMs there have reduced their production schedules in July.

Moving onto slide 33, we've looked over our global OE revenue guidance for 2008 and 2009, and of course our assumptions at the beginning of the year are drastically different from where they are today. And the North American production environment is still extremely volatile.

With an ongoing stream of customer shift changes, plant down time, and restructuring announcements, it's still difficult to predict, what might occur over the next 5 months and in the next year. Because things are quickly and dramatically changing in North America, our January OE revenue guidance is no longer applicable.

While our year-to-date OE revenue is up approximately $100 million year-over-year, with all of the volatility in the market, we won't attempt to update the revenue guidance at this point, as the data would probably prove unreliable. Our expectations are also tampered by record breaking commodity inflation, this is on slide 34.

Rising alloy surcharges for chrome in North America and soaring carbon steel prices worldwide are having a greater impact on cost and those foreseen at the beginning of 2008. While we have substantial protection for much of the current steel inflation due to our annual contracts, we do have some shorter term contracts and renewals that occurred during the course of the year.

As such, we are now forecasting 2008 steel cost increases of approximately $50 million to $60 million, versus our earlier estimate of $40 million. As in previous years, we will offset these cost increases through our cost reduction efforts, after market pricing, and OE customer price recoveries.

As current contract expire, and we move into 2009, we're expecting an even more significant acceleration of these costs. As I'm sure everyone in the industry agrees, it is imperative that these costs must be passed on to the market and discussions on this topic are already underway with our customers.

In the second half of 2008 and into 2009, you will also see us take further restructuring actions. In fact, earlier this week, we reduced North American salaried headcount by roughly 75 people across different business units and different apartments. And as Kim mentioned, we are taking a hard look at our North American manufacturing footprint to not only ensure we have the appropriate capacity for the forecasted lower light truck production mix, but also to support the significant growth opportunities coming on in the next few years.

Cost reductions and productivity improvements are important focuses for us. As such, we have aggressive internal savings targets that will service well in the current environment and should position us to fully realize our higher margin incremental new business as the economy recovers. As we manage for the short-term challenges, we're not in anyway losing focus of our long-term prospects.

We continue to execute on our growth strategy, and to invest in new technologies and new markets that will play an important role in our future. Our future that is as promising as ever. Regulation driven opportunities to gain share in adjacent markets like commercial vehicle will be a significant driver of our growth over the next 5 years. The new off road business award from Caterpillar is indicative of this trend. We're still confident in our projection of 11% to 13% compounded annual revenue growth through 2012, even after adjusting for the change in production volumes in light vehicle mix in North America.

If you look at the components of the growth on slide 35, the majority comes from our emission control business, where environmental regulations are mandating additional after treatment content to reduce pollution from nearly ever type of vehicle with an internal combustion engine. These regulations are being instituted around the world.

If you further feel back the layers of our growth goal, you'll see that more than half will come from the commercial vehicle segment, both on highway and off road. The environmental regulations over the next five years are concentrated in the diesel agreement and therefore, will impact commercial vehicles much more than light vehicles.

The second biggest contributor to our expansion will come from the rapidly growing BRIC economies. We have multiple facilities in Brazil, Russia, India, and China, and are investing in additional capacity to meet the growing demands of our expanding customer base there. It's evident that the near-term is going to be challenging, where we have new market opportunities launching, as soon as the later part of 2009 that will help offset the effects of the current North American mixture.

And with that we can open the call for questions.

Question-and-Answer Session

Operator

Our first question today is from Rich Kwas, you may ask your question and please state your company name.

Rich Kwas - Wachovia Securities

Good morning, Wachovia.

Gregg Sherrill

Good morning.

Ken Trammell

Good morning, Rich.

Rich Kwas - Wachovia Securities

Gregg, could you give us a little better profile, your European mix in relation to size of the vehicles, are you more weighted to smaller vehicles or larger vehicles over there and how do you expect the trend to shape up over the second half of the year aside from what you've given here in the presentation?

Gregg Sherrill

I'm not sure, I'm prepared to give you the full details of the mix in Europe. I mean, Europe the market itself is a very strong B, C, a little bit of D segment. B and C is the big with C probably being the predominant size platform in Europe. And I would suggest that if I did come up with the details, it's probably going to mirror what that market looks like pretty closely.

Rich Kwas - Wachovia Securities

And then in Europe, you showed solid performance there, I mean, do you still expect to see margin expansion going forward in 2008, 2009? Do you still think there is substantial opportunity that you've talked about in the past?

Gregg Sherrill

Yeah, we do. We still believe we are going to see some margin expansion in Europe. I mean, it's a function of again launching new programs that we believe are at very solid margins, as well as the ongoing operating efficiencies that we're driving for over there.

Rich Kwas - Wachovia Securities

Okay. And then, finally when you look at next year, do you plan to update OEM revenue in January again or '09 and then into '10? Is that kind of the plan right now?

Gregg Sherrill

Yeah, that's exactly what the plan is Rich.

Kenneth Trammell

Yeah Rich, and we do it once a year, and so we intend to go ahead and do that again in January, so we can get some new guidance.

Rich Kwas - Wachovia Securities

Okay. And then, in terms of the restructuring in North America, how much of that do you expect -- I know you said that you expect additional announcements over the course of this year and potentially into 2009, do you think that the bulk of that will be done this year heading into '09, how much do you expect in 2009?

Gregg Sherrill

I'm going to say that they will certainly start this year but could carry over into 2009 as well.

Kenneth Trammell

Richard it's part, we're in somewhat of a different position, because then other companies in the auto supply industries simply because of the fact that we've got a balance the growth that comes with this commercial vehicle business here, just almost around the corner with where the capacity needs need to be for the light vehicle business right now. So we're intently working trying to make sure we factor both of those pieces into that simultaneous equation, so to speak.

Gregg Sherrill

Yeah, that's a very good point. The whole footprint analysis is encompassing not only the light vehicle mix shift of trucks that we're seeing clearly right now, but also the growth particularly in commercial vehicles that we've got planned out there in the 2010 timeframe. So we want to make sure we wind up optimized for all of that.

Rich Kwas - Wachovia Securities

And then, are you flexible with regards to the -- between the light vehicle capacity and the commercial capacity and how can, are you able to switch pretty easily if, given what's happening on a light vehicle side, so that you could kind of minimize the use of CapEx?

Gregg Sherrill

Yeah, there is a lot of capital equipment that is very flexible. I mean, it all has to be re-tooled, but that's okay. I mean, typically the customers own our tooling any ways, but the basic capital machinery itself is definitely flexible and can be retooled for the other business.

Kenneth Trammell

Until our benders and welders and things like that, that like Gregg said is really tooling, that determines what kind of vehicle it services rather than the equipment sold.

Gregg Sherrill

And it is also safe to say that that in turn helps to mitigate capital expenditures required for some of that growth.

Rich Kwas - Wachovia Securities

Okay, great. Thank you.

Operator

Thank you. David Leiker you may ask your question and please state your company name.

David Leiker - Robert W. Baird

Hey, David Leiker at Baird, how're you guys doing?

Ken Trammell

Good morning.

Gregg Sherrill

Good morning, David.

David Leiker - Robert W. Baird

Couple of things, just kind of following up on something here in Europe -- what kind of presence or exposure do you have to vehicle that are being built and sold in Eastern Europe?

Ken Trammell

Vehicles that are built and sold?

David Leiker - Robert W. Baird

Built in Eastern Europe or built in Western Europe and sold in Eastern Europe?

Gregg Sherrill

Well, again, I think if you look at it, we've got a pretty broad exposure to both regions, Eastern and Western Europe. Obviously, we sell to an OE manufacturing plant that in turn manufactures platforms in any given plant, whether it's in Western or Eastern Europe and those vehicles are then sold in many cases in both Eastern and Western Europe, as well as export to other regions of the world. But I would say we're pretty well distributed across the whole, both Western and Eastern Europe. There is not a real mix concern there for us, I don't think at all.

Ken Trammell

Yeah, I mean you'll remember we started moving a lot of our manufacturing to Eastern Europe, early this decade because that's where lot of the lease were moving their manufacturing, so we got about 30% of our manufacturing capacity in the Eastern Europe, 30% of our European capacity in Eastern Europe today.

David Leiker - Robert W. Baird

Okay.

Ken Trammell

Like Gregg said there is certainly sort of, you might call it a cross border flow of completed vehicles. We've got a very good match against the market there.

Gregg Sherrill

And I am not sure, whether you're counting Russia in Eastern Europe or not, David. But we're expanding our presence in Russia. And, I only said that because it depends on who you are talking to as to whether they do.

David Leiker - Robert W. Baird

Yes, I know.

Gregg Sherrill

But we're expanding our presence there and that market is becoming quite significant as everyone knows.

David Leiker - Robert W. Baird

Yes, that's for sure.

Gregg Sherrill

Right.

David Leiker - Robert W. Baird

And, when you launched all of these new truck programs over the last 18 months or so did you put up new buildings for that, or did that go into existing capacity?

Gregg Sherrill

No, that went into existing plant footprint.

Ken Trammell

Yes, the only exception was that the Tundra where we opened just-in-time assembly plant in San Antonio and Indiana for those.

David Leiker - Robert W. Baird

Yeah, and are those plants dedicated to those platforms or?

Gregg Sherrill

The JIT facilities which are quite small, yes they are dedicated only in the sense they're dedicated to their mother assembly plant, if you will. I mean they could also produce, if someone put something else into that vehicle assembly plant, we could also produce for that product line from there.

David Leiker - Robert W. Baird

Okay. Can you, on the Caterpillar contract, can you give us some sort of scale of what kind of content you have on the vehicle like that?

Gregg Sherrill

We're not really prepared to go into that today. We've made the initial announcement, and we're working on a range of technologies with Caterpillar on what will be required for the off road requirements that all begin out in 2011. So there's a little bit of time there, and as we can we'll update you guys on that.

David Leiker - Robert W. Baird

Is it bigger, I mean, is there more content on that than on our commercial truck?

Gregg Sherrill

I mean, the answer to that is yes. I mean they're just bigger machines.

David Leiker - Robert W. Baird

Yeah.

Ken Trammell

And the duty cycle was different. But if you're feeling about the regulations, David in 2011 it will first address particular matter much like the 2007 regulations did for the on road vehicles.

David Leiker - Robert W. Baird

Okay.

Ken Trammell

And then in 2014, it's the NOx emissions, again like the 2010 regulation changes for the on road.

David Leiker - Robert W. Baird

Okay, and then the last thing here, what's your, I think you say your average content, and I know it's hard to do this, because there's a range of it is like, I want to say it was like $600 or $700 or so, is it in a passenger vehicle?

Ken Trammell

I don’t know, if we've never actually given an average. We did have some examples that we have been giving for a while about the difference between a gas engine vehicle and a diesel engine vehicle. And I think for 2007, like a gas engine this is a V-8 light truck in the US. It is probably somewhere in the 300, I am sorry, the 2007 around, gas engine around $575 a unit, and for a diesel engine in 2007 around $800 a unit. Now that is an old estimate, but that at least gives you a feel for the difference between gas and diesel.

David Leiker - Robert W. Baird

And just follow up on that, how does that step down to a six cylinder and a four cylinder?

Ken Trammell

It's probably going to be relatively speaking related to the displacement. So if you've got a five liter versus a four liter engine. Assume that, there's going to be somewhere in that range percentage change in the content. And a lot of that obviously, is going to be on the precious metals requirements for that.

Gregg Sherrill

And that's just a rule of thumb, it can vary platform-to-platform.

David Leiker - Robert W. Baird

Okay, great. Thank you very much, and I think that the slides are great.

Gregg Sherrill

Well, thanks, David.

Ken Trammell

Thanks, David.

Operator

Thank you. Brian Johnson, you may ask your question, and please state your company name.

Brian Johnson - Lehman Brothers

Lehman Brothers, Brian Johnson. Good morning, Gregg and--.

Gregg Sherrill

Morning, Brian.

Brian Johnson - Lehman Brothers

Okay. I mean, in terms of the move to adjacent market, when we think about that 11 to 13% OE growth number and think back to January when diesel prices at the leader, at the pump were close to those of gas. Is your thinking evolved in terms of the percent of that that's going to come from commercial off highway and stationary?

Gregg Sherrill

Not really, it hasn't changed dramatically. I'm trying to even think of the things that have moved so rapidly. We have now completely tested that forecast against the new revised lower permanent, as everyone's calling it, mix shift of light trucks. We did not include any increase in diesel penetration in light vehicle whatsoever in that outlook, of course, on the commercial vehicle arena there is no penetration issue. It's all diesel to begin with.

So it was always a major part, literally the 50% we're talking about growth. And there have been a few things that we've seen that have helped. The recent regulation changes for example, on rail that have tended to pull some of the retrofit requirements for rail ahead, certainly helped to offset some in there too.

So those were minor tweaks. Those are the types of things I would expect us to be doing continuously as we test what's going on in that regulatory world and how it would impact our growth projections.

Brian Johnson - Lehman Brothers

Okay. And do you have a rough CPV number following up on the last questions for how we should be thinking about commercial?

Gregg Sherrill

No. We really can't give it to you right now. I mean, some of these, if you just think about it, particularly the off road machines, each one of them is quite a bit different. I mean there's a whole myriad out there, types of machines and sizes et cetera. So we're really not prepared to do that at this point.

Ken Trammell

And Brian because the duty cycles for those are different from on road, they're going to require different types of technologies. And in fact different machines may use different technologies to address the same regulation. So that was going to be even more complicated than the on road.

Brian Johnson - Lehman Brothers

And last kind of strategic question. Who do you see as the main competitors in this segment, and then what is the Tenneco kind of key factor for success vis-à-vis that entrenched competition?

Gregg Sherrill

I think we see the same competition there as we see basically in the light vehicle segment. Recall that there is really not been any requirements for any of this after-treatment products in the commercial vehicle arena until now and going forward. So they are really looking down into the light vehicle segment for people with that technology, because technology is transferable, we've said that many times, it's very scalable. So there is really no current incumbents because there is no product really in that segment, so it's the same group that we face-off with pretty much around the world today.

Kenneth Trammell

And what, Brian, I think your question was, what strategically gives us, we think an advantage, and it's what Gregg said, it's our diesel technology. It's been a focus in Europe for years. We did a pretty good job of transferring that to North America for the 2007 regulation change and obviously, as we continue to advance the technology, we think we'll be pretty successful on the commercial vehicle offer segment as well.

Brian Johnson - Lehman Brothers

You are saying, who is ever turning out to be mufflers, and the tail pipes on big rigs now is not really a competitor going forward, it's more of the M corps and the others that you faced off with in the past?

Gregg Sherrill

Well, they can certainly be a competitor for that cold end piece of it, depending on how they source it okay. But for the higher technology hot end piece, the true after-treatment side of it, that's pretty much the same group as you just mentioned that are or I just mentioned in the light vehicle segment.

Kenneth Trammell

On the off road side, the manufacturers too have tended to be more vertically integrated than light vehicle manufacturers have been and so for example, Caterpillar in addressing 2007 regulation change that they had to deal with on road was handling that themselves rather than an outsourcing.

Brian Johnson - Lehman Brothers

And you know they talked about a trend to outsourcing in that industry.

Gregg Sherrill

I don't know that I've heard anybody talk about it. The only thing then, I guess I would say that we've seen a lot of opportunity. CAT is the one we've been able to announce but we won other contracts for off road as well so. I don’t know if you call it a trend but it at least look good for us.

Operator

(Operator Instructions). Our next question is from Chris Ceraso, you may ask your question and please state your company name.

Chris Ceraso - Credit Suisse

Thanks, good morning, Credit Suisse.

Gregg Sherrill

Good morning Chris.

Kenneth Trammell

Hi, Chris.

Chris Ceraso - Credit Suisse

You guys have been talking for a while now about the opportunity in the off road business. Have you come any closer to sizing that or framing what the potential opportunity is in terms of total industry revenue is for off highway after-treatment?

Gregg Sherrill

Yeah, we're going to try to do that for you in the future. I don't think we're prepared this morning. Again, it is a very complicated segment. A lot of these builders are also shipping engines not only into what you think of as off road, the construction equipment that we all see along side of the highway, or the forming and mining equipment and all that stuff. But they also sell those same engine application into marine, locomotive, industrial, stationary, a lot of different segments. And so, yes, we are coming much closer to sizing that market, but I would rather still take a path on at this morning and as we really get it firmed up, we're going to get that information out to you.

Chris Ceraso - Credit Suisse

Okay. If I have the numbers right, it looks like the total company operating margin was down about 80 basis points year-to-year. Do you think if we look at the second half, the year-to-year change will be about that magnitude or will it be better or will it be worse, how should we think about the profit hit in the second half?

Kenneth Trammell

You know Chris, I think it'll be hard to get you on answer because of what we're seeing in the North American market right now, I mean the same reason that we decided that we were going to try and update our only revenue guidance. Certainly if you look at the production decline, I don’t think anybody is expecting second half production to get better than the first half, even the strikes in the first half. On the other hand we are working very hard to try and offset as much of that as we can, including some of these restructurings that we announced today.

Gregg Sherrill

You know part of the problem with that is every customer is kind of taking his own approach right now in the short term is to how they are taking adjusting their volumes downward. Some are pulling shifts off, which still leaves you stumbling on a steady stable lower production. Others are just taking complete down time for several months and we really don’t even think all those announcements are probably through coming. That’s the volatility that we have seen. So that makes that just very difficult.

Chris Ceraso - Credit Suisse

So tough to frame, but it sounds like if anything, you'd be hard pressed to see the year-to-year margin comp get better in the second half than it was in second quarter. Is that fair?

Gregg Sherrill

Yeah. We are working real hard to offset the problems in North America, so yeah I think that’s probably a fair assumption.

Chris Ceraso - Credit Suisse

Okay. Last one, you mentioned the steel headwind. You changed your expectations to 50 to 60 up from 40, based on what you have got in the pipeline in terms of contracts and when they turn over, can you take a stab at the 2009 headwind, is that a 100 million, is it--?

Gregg Sherrill

No we can't really do that right now. We are in full negotiations both with the supply base looking forward, as well as our customers on as I said we are already engaged with them on 2009, but it would not be possible to frame that magnitude right now.

And I think as everyone has been talking about it. It is something that’s clear, its an industry wide problem. So the magnitudes are pretty much what I think everyone is seeing, but it's just impossible for us to really give you a figure right now.

Chris Ceraso - Credit Suisse

Okay. I'm sorry, just one more, the folks that are on furlough, are they paid any portion of their normal wage or no?

Kenneth Trammell

No. On temporary furlough, they don’t get any normal wage. We do continue to pay medical benefits. Once one of our employees has been out for more than two to three months, then their medical benefits also cease.

Chris Ceraso - Credit Suisse

Okay. Thank you very much.

Operator

Thank you. (Operator Instructions)

James Spangler

Okay. This concludes our call. An audio replay of this will be available on our website, www.tenaco.com. You may also access recording over the telephone. If you are located in North America, you may reach the playback at 800-294-0991. For those outside North America, the dial-in number is 402-220-9753. The playback will be available about one hour from now.

This call-in information can also be found in our news release. If you are an analyst or an investor with additional questions, please follow-up with Leslie Hunziker, our Executive Director of Investor Relation at 847-482-5042. Financial reporters may contact Jane Ostrander, Executive Director of Communication at 847-482-5607. Thank you for taking part in our conference call. And have a good day.

Operator

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

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