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Tenneco Inc (NYSE:TEN)
Q3 2019 Earnings Call
Oct 31, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning everyone and welcome to the Third Quarter 2019 Tenneco Inc. Earnings Conference Call. [Operator Instructions] Please also note that today's event is being recorded.

At this time I'd like to turn the conference call over to Linae Golla Vice President of Investor Relations. Please go ahead.

Linae Golla -- Vice President of Investor Relations

Thank you. This morning we released our third quarter 2019 earnings results and related financial information. On today's call to discuss the quarter are Brian Kesseler and Roger Wood Co-Chief Executive Officers; Jason Hollar Chief Financial Officer; and Ron Hundzinski EVP Finance. Presentation corresponding to our prepared remarks is available on the Investors section of our website. After our comments this morning there will be a question-and-answer session. Before we begin please be aware that our discussions today will include information on non-GAAP financial measures all of which are reconciled with GAAP measures in our press release attachment. Also note that all pro forma comparisons are measured at 2018 constant currency rates and include the Federal-Mogul acquisition in prior periods. We will discuss year-over-year comparisons on a pro forma basis. Unless specifically described otherwise margin refers to value-add adjusted EBITDA margin. The earnings release and attachments are available on our website. Additionally some of our comments 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.

Now I will turn it over to Roger.

Roger J. Wood -- Co-Chief Executive Officer

Thank you Linae. Good morning everyone and welcome. Please turn to page four. Tenneco delivered solid third quarter results in the face of uneven industry demand and the labor strike at General Motors. As an enterprise we generated revenue of $4.3 billion. On a constant currency and pro forma basis revenues increased 3% year-over-year and outperformed global light and commercial vehicle production. New Tenneco revenues grew 7% and DRiV revenues fell 3% compared to Q3 of 2018. Third quarter adjusted EBITDA was $387 million and adjusted EBITDA margin increased 100 basis points year-over-year on a pro forma basis to 10.9%. At the enterprise level the GM strike reduced adjusted EBITDA by $13 million and adjusted EBITDA margin by approximately 20 basis points. Excluding impact from the strike our revenue and adjusted EBITDA results were at the midpoint of our Q3 guidance. Our key business highlights during the third quarter include that we began to realize value-added revenue contribution from new China 6 light vehicle emission standards that took effect in the middle of this year. We were named 2020 Automotive News PACE award finalist for IROX 2 bearing technology.

And we continue to win advanced suspension technology and NVH business particularly on electric vehicle platforms. On page five we have provided our updated enterprise outlook for the fourth quarter and full year. Later on in today's call Ron Brian and Jason will provide more details around the outlook as it pertains to the new Tenneco and DRiV divisions specifically. Looking at the fourth quarter. Light vehicle production is expected to be lower year-over-year by 6% and the commercial truck market is showing signs of softening. In Q4 we expect enterprise revenue in the range of $3.95 billion to $4.05 billion representing a 5% year-over-year decline in constant currency at the midpoint. For the full year 2019 our enterprise total revenue guidance range is $17.25 billion to $17.35 billion flat versus 2018 on a constant currency basis. We estimate the GM strike will reduce our revenue growth by about 1% for 2019. With regards to profitability we forecast Q4 adjusted EBITDA to be in the range of $295 million to $315 million which translates to a value-added EBITDA margin of 9.4% at the midpoint.

On an enterprise basis we estimate the GM strike will negatively affect our fourth quarter adjusted EBITDA margin by approximately 70 basis points. For the full year 2019 we project adjusted EBITDA to be in the range of $1.425 billion to $1.445 billion down from prior guidance of $1.515 billion to $1.565 billion reflecting the GM strike impact as well as unfavorable demand and mix in the fourth quarter. We are improving our outlook for interest expense tax rate cash taxes and capital expenditures relative to our prior guidance. Our expectation for net debt-to-EBITDA at year-end 2019 has increased to the 3.4 to 3.5x range from our prior 3.3x expectation. Lower production volumes and less favorable business mix has reduced our adjusted EBITDA expectation and driven the increase in the ratio. We are evaluating strategic options to facilitate the separation of new Tenneco in DRiV and Brian will touch on this later. I want to thank the more than 80000 hard working Tenneco team members around the world.

They bring their passion and commitment to work every day to find new ways to satisfy our customers grow the business improve the quality and efficiency of our processes and ultimately create value for our shareholders. Please turn to page six. In Q3 new Tenneco generated $2.1 billion of value-added revenue flat year-over-year on a constant currency basis and pro forma basis. New Tenneco slightly outperformed global light vehicle production and experienced modest growth in the CTOH and industrial business. FX was a 2% headwind to revenues on a year-over-year basis. Pro forma adjusted EBITDA grew 2% year-over-year to $245 million and adjusted EBITDA margin was 11.8% and up 50 basis points versus Q3 of 2018. The GM work stoppage reduced new Tenneco's adjusted EBITDA by $11 million in the quarter and division margin by approximately 30 basis points. In the near term we are implementing additional actions to improve the company's cost structure while also focusing on cash generation. We are in good position to realize solid content gains in China and India in 2020 and 2021.

Now I will turn it over to Ron for a review of new Tenneco segments. Ron?

Thank you Roger and good morning to everyone. We will begin our review of new Tenneco segment performance on page seven. The Clean Air segment delivered value-add revenues of $997 million down 1% year-over-year. On a constant currency basis Clean Air value-added revenues increased 1%. Regional growth was largely similar across geographies. Light vehicle revenues grew and CTOH revenues were flat. Adjusted EBITDA was $157 million and increased 5% year-over-year. Value-added adjusted EBITDA margins was 15.7% and expanded 90 basis points year-over-year the second consecutive quarter of strong margin expansion. On a constant currency basis Clean Air EBITDA contributed $9 million of EBITDA growth against $11 million increase in sales. The business benefited from volume and operation -- operating efficiencies. To help with your models Clean Air experienced the majority of the division's revenue and EBITDA impact from the GM strike and that trend should continue in Q4. Let's turn to page eight to discuss powertrain. Our chain sales were $1.08 billion in Q3 down 4% from the prior period. On a constant currency basis sales declined 2% year-over-year. Lower diesel volume in Europe demand declines in India and China and softening volume in the heavy-duty truck and industrial markets were the principal drivers of the year-over-year decline. Adjusted EBITDA measured $109 million flat with Q3 of 2018.

Adjusted EBITDA margin was 10.1% and increased 40 basis points year-over-year and benefit from better operating performance and favorable FX. On a constant currency basis powertrain adjusted EBITDA decreased $3 million year-over-year versus a negative $17 million decline in revenues representing an 18% decremental margin. Relative to initial expectations powertrain sales and profit performance moderated more than expected particularly in the second half of the quarter. Our commercial truck and industrial customers cut back on orders later in the quarter and those end markets tend to carry above-average margins relative to the powertrain segment average. On page nine we have updated new Tenneco's full year guidance and provided details on Q4. For Q4 we estimate value-added revenues to decline in the range of 8.5% to 10.5% year-over-year on a constant currency basis. Sales will approximate $1.9 billion. We anticipate $95 million of negative sales impact in the fourth quarter from the General Motors strike. We are not factoring any production recovery for the lost volume experienced. At the midpoint we expect our value-add EBITDA margin to approximate 10% in Q4 which is a 340 basis points decrease year-over-year. On a year-over-year basis our margin is being negatively affected by the GM strike and declining commercial vehicle and industrial demand. Incremental light vehicle production declines in North America apart from the labor stoppage as well a decrease in Europe also are negatively impacting our revenues. Further we expect timing of certain recoveries to extend past year-end. On the capex front we have trimmed our forecast by another $10 million relative to the prior guidance.

Now I'd like to turn it over to Brian for a review of DRiV. Brian?

Brian J. Kesseler -- Co-Chief Executive Officer

Thanks Ron. Let's turn to results for the DRiV division on page 10. Total revenue for DRiV was down 3% in the quarter. This year-over-year constant currency comparison includes the sale of the Wipers product line and the Ohlins acquisition both of which closed during the first quarter. FX was a 3% headwind to our revenues in the third quarter. Ride Performance revenue was up 1% which outpaced industry production by 4 percentage points mainly due to advanced suspension technology content growth and higher NVH solutions revenue. In the Motorparts segment revenues were 7% lower mainly due to customer inventory reductions in North America and Europe and the impact of past channel conflict issues. On a positive note in the third quarter we began to see signs of stabilization in the North America aftermarket. Strong earnings improvement continued in the quarter. Adjusted EBITDA dollar performance was $142 million a 14% year-over-year increase and EBITDA margin was up 170 basis points on a pro forma basis to 9.7%. This improvement was driven mainly by capturing the benefits of synergy actions effective cost controls and portfolio rationalization actions in each segment. We remain ahead of schedule on synergy actions and on track to have the full earnings annual savings of $115 million in our run rate by the end of this year. For the Ride Performance business the GM strike negatively impacted EBITDA by $2 million in the third quarter. Our results this quarter highlight the diversification of DRiV's mix of aftermarket and OE product solutions with the Motorparts and Ride Performance businesses combining to deliver strong margin growth.

As shown in the graph on the top left of the page the Motorparts aftermarket segment represented more than 70% of our third quarter EBITDA. Overall the outlook for our growth drivers remain strong and we continue to deliver a unique set of technologies brands and services to satisfy our customers' needs. Some of the highlights include our Ride Performance team continues to capitalize on our advanced suspension and NVH technologies to drive new business wins particularly on electric powertrain platforms which represent a growing portion of our development work. During the third quarter we won new NVH solutions business with several large North American customers for their battery-electric programs. And both our NVH and Ride control team secured new business with a U.S.-based all-electric vehicle automaker. This is in addition to 12 incremental advanced suspension programs that we will be launching in 2020. In July we announced that our Ohlins adjustable front struts and rear shock absorbers will be offered on the new PoleStar 2 the first all-electric model from Volvo. The Ohlins team is a great addition to our portfolio. And in preparation for 2020 we've begun the work to combine our Monroe Intelligent Suspension team with the Ohlins business to create our Advanced Suspension Technologies product group. This group will be solely focused on the growth opportunities afforded by the macro trends in connectivity autonomy shared mobility and electrification and are creating unique opportunities for significant future growth and profitability. We expect the Advanced Suspension Technologies group revenues to grow double digits over the next several years on business that has already been secured. In Motorparts we continue to win new aftermarket business gaining new customers and launching new products in all regions.

In North America we are making good progress winning back the business that has been lost due to previous channel conflict. We are on track to secure roughly 25% of that lost business by the end of the year. This year we have highlighted decisions that we made related to product categories and product lines that are expected to continue improving our future financial performance. For example the Wipers product line divestiture and programs in our North America Ride Control business. The DRiV team continues to rationalize our product line portfolio region by region and category by category in both Motorparts and Ride Performance. While these decisions will likely affect our top line in the near term we fully expect meaningful sustained margin rate and cash flow performance improvement from any actions. Focusing our team's people and financial capital on fewer specific product lines in each region and business group will accelerate stronger profitable growth and is a key enabler in attaining one of our primary objectives: to deliver top-quartile performance and return on invested capital.

Now I'd like to invite Jason to take us through the Motorparts and Ride Performance segment results in a little more detail.

Jason Hollar -- Chief Financial Officer

Thanks, Brian, turning to page 11 for a closer look at the Motor parts segment with the chart on the right showing a walk from the Q3 2018 pro forma to Q3 2019 actual. The revenue chart volume and mix were the main drivers of the results. Similar to last quarter we saw inventory adjustments with a couple of large retail customers in North America. And in EMEA overall soft market conditions continued as distribution customers reduced inventory levels mainly in Western Europe. In addition the portfolio changed as Brian mentioned and the Federal-Mogul-related channel conflict loss business impacted revenue by around 4%. Solid year-over-year margin improvement continued in the third quarter with adjusted EBITDA margin up 160 basis points to 15.2%. Earnings results were driven mainly by improved operating performance synergy achievement and effective cost control. Ride Performance segment results are on page 12. Third quarter revenue was up 1% on a constant currency pro forma basis strongly outpacing global light vehicle production that declined 3% versus last year. Light vehicle revenue was impacted by our planned program rationalization in North America and included the benefit of growth in NVH and advanced suspension technology content. Commercial truck off-highway and other revenue was up 11% and includes the addition of the Ohlins business. Ride Performance adjusted EBITDA was $42 million and adjusted EBITDA margin improved 120 basis points on a pro forma basis to 6.3% driven mainly by improved operating performance and synergy achievement. A quick update on 2 recent restructuring initiatives in Ride Performance.

We've completed the relocation of our shock manufacturing operations in China and all manufacturing processes are now under one roof. We're also on track with our footprint consolidation in North America moving from 4 manufacturing sites to 2 by the end of 2020 to help improve our cost competitiveness. I'd like to wrap up the DRiV comments with the fourth quarter and full year outlook on page 13. Starting with revenue we expect fourth quarter revenue of about $1.36 billion down 7% to 10% in constant currency including a $30 million headwind from the GM strike. In Q4 we expect continued softness in the EMEA OE and aftermarket. And the North America Ride Control program rationalization will continue to impact revenue as planned. For the full year we now anticipate revenue to be down around 5% in constant currency or to about $5.9 billion which includes an estimated currency headwind of 3%. In terms of profitability we anticipate year-over-year adjusted EBITDA margin improvement of around 50 basis points in the fourth quarter including a negative impact of 50 basis points or about $10 million from the GM strike. For the full year we are raising our margin rate guidance to the top of our previous range and expect improvement of 40 basis points year-over-year for an adjusted EBITDA margin rate of 8.5% in 2019. Finally we expect full year capex to be in the range of $240 million to $250 million which is a $10 million improvement from the prior guidance.

With that I'll turn the call over to Brian.

Brian J. Kesseler -- Co-Chief Executive Officer

Thanks Jason. Turning to page 14 let me give a few comments before we take questions. First I want to echo Roger's comments about the team members at Tenneco who come to work every day and find solutions for driving revenue managing costs and optimizing our product lines for stronger margin performance. On behalf of the entire leadership team I want to thank our team members for delivering strong results and for their continued commitment. Tenneco delivered a solid quarter one that demonstrated many of the fundamental strengths that support our long-term success. We showed strong execution through a volatile market and increased margins 100 basis points year-over-year despite the GM strike and continued industry weakness. This industry weakness is expected to continue through the end of the year and into 2020. We remain committed to improving cash flow performance and delivering a strong fourth quarter and full year. Earnings and working capital synergies continue to ramp and we continue to maintain our focus on outperforming the market and managing our cost structure against expected volatility. As an update to the status of the separation of DRiV and new Tenneco we continue to receive strong support from our investors on the logic of the separation as the business rationale remains sound.

We are creating 2 purpose-built market leaders with strategic and financial flexibility as well as operational focus to drive long-term value. And we are creating an optimal financial structure allowing each business to allocate capital based on its specific business needs. We have made significant progress on the administrative separation of the divisions and expect to be operationally ready to separate by the end of this year. In particular earnings synergy capture has been pulled forward ahead of schedule to a full run rate by the end of this year. Financial and operating system separation is nearing completion. Consistent with our original transactional plan the majority of the integration costs related to the Federal-Mogul acquisition are being incurred in 2019 and we've purposely deferred additional significant costs until the final stages of the separation. With this optimized cost management approach we believe we have incremental flexibility to properly time the separation without incurring unnecessary additional costs in advance. We continue to believe that the separation of the DRiV business is the right path to deliver enhanced shareholder value and create an environment for both businesses to be best positioned for long-term success.

As we discussed last quarter we continue to evaluate additional alternatives to further reduce leverage to facilitate the separation of the businesses. Our work to date has reinforced our view that we have additional paths to achieve our objective. The evaluation of several alternatives has already begun and we believe that tax friction costs are manageable in most scenarios. As Tenneco continues to execute its plan for the spinoff we intend to pursue more aggressively some of these alternatives to support our plan. Certain of these options could help mitigate the impact of challenging market conditions which if current trends were to continue would likely affect our ability to complete a separation in the midyear 2020 time range. Ultimately the timing of separation will coincide with the appropriate market conditions and we will be ready to execute a separation when those market conditions are supportive and/or a potential strategic option is executed. We will continue to provide further updates on our progress as appropriate. As always thank you for your continued interest in Tenneco and for joining us this morning.

And with that we are ready to take your questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question today comes from Armintas Sinkevicius from Morgan Stanley. Please go ahead with your question.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Great. Good morning. Thank you for taking the question. When I look at the guidance for 2019 you're reducing adjusted EBITDA by about $105 million. That includes General Motors at about $35 million. Can you help me bridge the remaining gap? Because third quarter results were in line with consensus expectations here so it implies a significant step-down in the fourth quarter and not all of it seems to be explained by General Motors.

Ronald T. Hundzinski -- Executive Vice President of Finance

Yes. Armintas, this is Ron, I would say that the -- a more significant portion of the EBITDA guidance reduction is on the new Tenneco side. So in addition to General Motors I would say on our side there's approximately another $20 million of lower CTOH and industrial. We've seen continued softness in that market. There's a little bit of EMEA light vehicle and North America is about $15 million. We have some unfavorable powertrain mix about 5 lower joint venture incomes about $5 million in FX as well. So it's a scattering of smaller amounts after General Motors and CTOH.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Okay. I got it. That's helpful. And then with regards to the strategic options to facilitate the separation any way you can help us contextualize some of the things that you're considering?

Roger J. Wood -- Co-Chief Executive Officer

I think the -- this is Roger. We can't really say too much about that right now. I think the thing to take away from this is that we introduced this in the second quarter earnings call. And since then we've been favorably impressed with the market response and the interest of those statements. So we really can't provide any more detail at this point but we will as soon as we can.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Okay. And then my last one here, with the covenants on the new Tenneco side around leverage at the timing of the spin what is your flexibility or ability to update those if you need -- in order to help facilitate the separation?

Jason Hollar -- Chief Financial Officer

Yes as you I think use the right words there. We have flexibility. But I think the primary focus that we wanted to come across in this call and this release is what Roger already highlighted and Brian in the prepared remarks. That's something that we want to spend some time on and get a better understanding of what those alternatives look like. We have other alternatives as it relates to pretty flexible current credit facility that allows us to manage through this process. And then that spin covenant that you're referencing is something that could also be addressed but it's one of many tools that we have available to us to manage through the rest of this process.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Great. Appreciate it. Thank you.

Operator

Our next question comes from Ryan Brinkman from JPMorgan. Please go ahead with your question.

Ryan Brinkman -- JPMorgan. -- Analyst

Hi, Great, thanks. I just wanted to follow up a little bit more on these multiple strategic functions to deliver and facilitate the spin. I think you'd addressed last quarter the potential for further dispositions of noncore assets. Is there any more color you can provide? I know you're not going to name businesses but on the categorization of certain assets as core or noncore what characteristics make an asset at your business today core versus noncore? And then are you able to confirm that dispositions are the only strategic options being looked at? Or could it potentially include others also?

Brian J. Kesseler -- Co-Chief Executive Officer

Yes, this is Brian, I think the spectrum of opportunities is pretty wide. We'll always look at core noncore assets or business lines just as a matter of course. So I wouldn't call that as special. Anything that's core is something we believe has good long-term growth prospects contribute well to the scale of the business and kind of match up with the macro trends. From a spectrum of opportunities or alternatives there are several some bigger than others and some that could come to fruition as a one action or a combination of a couple of actions, so obviously as you understand it's difficult for us to be able to put any context around that as we are in the middle of a bunch of different evaluations.

Roger J. Wood -- Co-Chief Executive Officer

Ryan this is Roger. Maybe I could just build on what Brian had said and complement what he said. We said at the second quarter earnings call when we introduced this that we were going to make sure that we didn't do anything to hurt either 1 of these 2 businesses. So we are going to look at the parts of the portfolio that don't necessarily fit. But -- and as Brian said some are quite large and some maybe not so large. But at the end of the day both of these businesses are going to be good robust businesses going forward.

Ryan Brinkman -- JPMorgan. -- Analyst

Okay. And then I know you expect to be separated of course. But is there an updated view you could provide on the puts and takes for pro forma combined company free cash flow in 2020 versus 2019? I'm not sure with what granularity you want to discuss the outlook for earnings in 2020 versus 2019. But are you able to help at least with the latest in terms of the moving pieces relative to restructuring costs combination and separation costs including tax and working capital and advisory costs? And is there a higher level a targeted conversion of EBITDA into free cash flow that you have for the business over time? And how much potential is there for that to inflect next year?

Jason Hollar -- Chief Financial Officer

Sure. Yes. This is Jason. When we think about the total transaction cost we went through that in some additional detail on the last call. I would say not much has changed since then which we is at that time highlighted a couple of hundred million dollars roughly $200 million of transaction costs this year and about half that is expected from next year. As was highlighted in the opening remarks we are doing what we can to postpone as much of that until later end of the process so that we can work through all these alternatives and just ensure that we are not spending any money that could be needless depending upon what those alternatives and outcomes look like. So with that said I do see that $200 million being probably a little heavy for this year. I think we will underspend that. But then depending upon the outcome it could be then pushed off into some part of 2020. But I think that overall aggregate number it's probably about right.

The other elements of free cash flow for 2020, that we've highlighted is that relative to 2019 we would expect capex and restructuring to be lower by $50 million to $100 million. And we highlighted the fairly significant amount of restructuring especially in the DRiV side that's happening this year related to our China plant move -- or China plant relocation and our North America Ride footprint consolidation. And then of course there's a carryover. Whatever synergies are not included in 2019 we expect a low of the run rate to be in place this year but there's a carryover effect that goes into 2020. And those elements can lead you down a path of a couple of hundred-million-dollar improvement in free cash flow year-over-year. But certainly we need to see where the industry is going to shake out and get a better understanding of revenue and volume. And we will provide that in the guidance elements to 2020 in the next call.

Roger J. Wood -- Co-Chief Executive Officer

Yes there's really 2 other things maybe I could add on to Jason's comments. One the majority of more transaction cost advisory fee cost is really going to be tied to the decision on separation. So it's going to be highly variable to whenever that decision is made and we go execute one. Two the other thing on some of the strategic alternatives and I mentioned it in the prepared remarks with the work we've done the tax friction cost on the majority of the alternatives we are looking at right now is very manageable. And so we are pleased with that from the ability to increase our flexibility. So I hope that gives you what you need.

Ryan Brinkman -- JPMorgan. -- Analyst

Yes, very helpful. Thank you.

Operator

And ladies and gentlemen at this time I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

Linae Golla -- Vice President of Investor Relations

So I think that does conclude the call. Thank you everyone for joining us.

Operator

[Operator Closing Remarks]

Duration: 33 minutes

Call participants:

Linae Golla -- Vice President of Investor Relations

Roger J. Wood -- Co-Chief Executive Officer

Brian J. Kesseler -- Co-Chief Executive Officer

Jason Hollar -- Chief Financial Officer

Ronald T. Hundzinski -- Executive Vice President of Finance

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Ryan Brinkman -- JPMorgan. -- Analyst

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