Tenneco inc (TEN) Q2 2021 Earnings Call Transcript

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Tenneco inc (TEN)
Q2 2021 Earnings Call
Aug 6, 2021, 10:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to Tenneco's Second Quarter Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded.

Now I'd like to turn the call over to Mr. Rich Kwas, Vice President of Investor Relations. Please, go ahead.

Rich Kwas -- Vice President of Investor Relations

Thank you and good morning. Earlier today, we released our second quarter 2021 earnings results and related financial information. A presentation corresponding to our prepared remarks is available on the Investors section of our website.Please be aware that our discussion today will include information on non-GAAP financial measures. All of which are reconciled with GAAP measures in our press release attachments and other earnings materials. When we say EBITDA, it means adjusted EBITDA. Unless specifically described otherwise, margin refers to the value add adjusted EBITDA margin. The earnings release and other earnings materials 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.In the near-term, we are looking forward to participating in three virtual conferences, including the JPMorgan Automotive Conference on August 12, the Jefferies aftermarket conference on September 9 and the RBC Industrials Conference on September 10. We look forward to speaking with many of you.

Our agenda for today will start with CEO, Brian Kesseler, reviewing highlights from the second quarter; COO, Kevin Baird will provide more details on our enterprise and segment performance; and our CFO, Matti Masanovich, will discuss our balance sheet and updated outlook for 2021. Brian will then provide concluding remarks on our shareholder value creation priorities before we take your questions.

Now, I will turn it over to Brian. Brian?

Brian Kesseler -- Chief Executive Officer

Thanks, Rich. Good morning, everyone, and welcome. There are three key themes in results that I'd like to highlight today. First, our solid operating execution. Second, our free cash flow performance. And third, our strategies to enhance growth and shareholder value.Let's start on page four, we delivered solid results. In the second quarter, we outperformed market growth in our OE businesses, supported by strong growth in our most important geographies and favorable platform mix.Like other auto suppliers, we encountered unforeseen light vehicle production downtime for our customers and escalating raw material costs. We mitigated these headwinds to deliver revenue and EBITDA at the top end of our second quarter guidance.

We delivered in excess of 20% conversion on year-over-year volume growth, despite $100 million of temporary cost savings implemented in the prior year period. In addition, our Accelerated Plus program is generating structural cost savings that will improve margins.And we remain on track to achieve the program's $265 million in annual run-rate savings by year end. Second, our focused on increasing cash conversion through disciplined capital spending and improve working capital efficiency continues to produce results.During the quarter, we generated $116 million of free cash flow for debt service, bringing our first half free cash flow for debt service to $42 million. As a reminder, Tenneco has historically experienced negative free cash flow in the first half of the year. At quarter end, our net leverage ratio improved, to 2.9 times.

And third, remain highly focused on increasing shareholder value in the near-term, reducing our net debt, the margin expansion and lowering our capital intensity. Our Clean Air and Powertrain segments play important roles and delivering results, because of their margin and cash flow contributions.At the same time, we're investing in our motor parts and Performance Solutions segments to enhance our long-term growth profile. In motor parks, we secured new business with a variety of customers in North American and Europe, which is expected to deliver annualized revenues of $30 million on a go forward basis.In Performance Solutions, we also want to incremental battery electric vehicle business in the quarter, which Kevin will discuss in more detail, later in the call. I'm proud of the entire Tenneco team for their resolve, resiliency and commitment to achieving our business objectives.

Turning to page five, I'll walk through an overview of our second quarter of 2021 results. Second quarter total revenue was $4.6 billion, up 74% year-over-year as we lap the Q2 2020 COVID quarter, included in total revenue our pass-through substrate sales of $1.1 billion.As a reminder, substrates sales are only in our Clean Air segment. The our key manufacturer source to Catalytic Converter and Diesel Particulate Filter components that include precious metals or substrates directly from the tier two supplier.Those substrates are carried in our inventory incorporated into our emission reduction systems are passed through to the customer at cost plus a small handling fee. For the quarter both value add revenue and EBITDA came in just above the top end of our guidance.

Driven by our diversified balanced portfolio value add revenue was $3.5 billion up 68% year-over-year excluding the impact of foreign currency exchange rates, this comparison favorably the second quarter industry like vehicle production growth of 49%.

The scale of diversity our portfolio is a differentiator for Tenneco.The value add revenue split by product application shows that just over 50% of our business is generated from aftermarket and commercial truck off highway and industrial applications.Taking that a step further, by adding the light vehicle portion of our Performance Solutions business, 64% of our revenue this quarter is unrelated to OE light vehicle ICE technologies.

Our constant dollar value at revenue performance was very strong in all markets and includes 81% growth in light vehicles, 91% growth in commercial truck off-highway and industrial, and 43% growth in aftermarket and OE service. This diversity extends geographically as well with North America and Europe each around 40% and China had 13% of our value-add revenue.

We delivered adjusted EBITDA of $356 million resulted in a margin rate of 10.2%. The strength of our end market, product, and regional mix and the team's strong profit conversion on that additional volume drove outperformance in the quarter. The outperformance extended to free cash flow generation and net debt reduction. We delivered seasonally better first half cash flow for debt service and ended the quarter with a net leverage ratio of 2.9 times, a 1.4 times improvement since the end of 2020. Available liquidity remains strong at $2.2 billion as of June 30th.To sum it up, our portfolio continues to enable strong earnings performance and cash flow generation for net leverage reduction.

I'll now turn it over to Kevin for a view of the enterprise and segment performance. Kevin?

Kevin Baird -- Chief Operating Officer

Thanks Brian. I'll start on page seven with our Enterprise Performance. Another benefit of our diversified portfolio is our favorable OE platform mix in North America, where around 85% of our light vehicle revenue is weighted toward SUVs, CUVs, and pickups enabling us to outperform market growth in the quarter.In the aftermarket, our motor parts segment grew 10% sequentially from Q1 to Q2. And while the second quarter is historically the strongest quarter of the year in the aftermarket, that is twice the sequential growth rate that we realized back in 2019.As Brian mentioned, the team executed well and we experienced strong EBITDA conversion on the higher volumes. Of note, our performance in the quarter includes an approximate $15 million benefit from a material cost driven inventory revaluation that will reverse into cost of goods sold in the third quarter.

Solid contribution from our Accelerate Plus program and other continuous improvement initiatives were able to personally offset last year's temporary cost actions and continuing supply chain disruptions in cost challenges. Overall, we showed solid execution in an uneven light vehicle production environment.Let's turn to our motor parts business performance on page eight. Second quarter aftermarket revenue was $794 million, up 39% year-over-year on a constant currency basis.

The strong order book we saw at the end of the first quarter continued through the second quarter. Also in the quarter, we secured roughly $30 million of annualized new business in North American Europe, which has begun to contribute to our base. We continue to focus on growth initiatives in China, including expanding our share of our leading brands with key distribution customers, developing 35 new customers covering 12 cities and conducting product training sessions for technicians.

Adjusted EBITDA for the quarter was $118 million, up of year-over-year and sequentially. Margin was 14.9%, up 220 basis points compared to the prior year, as we saw strong profit conversion on increased volume and mix. The sequential growth in North American revenue, our largest region, supported the improved margin performance in the quarter.Please turn to our Performance Solution segment on page nine. Second quarter revenue was up 81% in constant currency to $715 million with very strong growth across all markets. Light vehicle product applications were up 80%, commercial truck off-highway and industrial was up 147%, and aftermarket and OE service applications were up 45% year-over-year.

As a reminder, product lines in this segment are agnostic to the powertrain technology in a vehicle include a broad offering of highly engineered products and solutions to our customers. For example, during this quarter, our ohlins branded product with the advanced suspension technology business was selected as a Exclusive Shock Absorber for the NASCAR Cup Series Next Gen car.In addition, ASD further strengthened this relationship with an important strategic growth partner in Europe, and also launched production of advanced suspension programs on two electric SUV platforms; one in Europe and one in China.

Looking at battery electric vehicle and hybrid business awards across the five Performance Solutions business units, in the first half of the year, we won 52 new programs, 26 of which were awarded in the second quarter. Overall in 2021, we are launching 21, the EV or hybrid program with annualized revenue of greater than $160 million. And importantly, over the third of our new business pipeline and nearly a third of our year-to-date awarded business is battery electric vehicle or hybrid.Adjusted EBITDA of $42 million in the second quarter increased $76 million year-over-year for a margin of 5.9%. The business delivered good profit conversion on a higher revenue and we expect to improve margin performance from the current level in the near term.

On page 10, you can see Clean Air's results. Clean Air value-add revenues were $943 million growing 76% year-over-year, excluding foreign currency effects. Light vehicle value-add revenue expanded 72% and OE service increased 84%. Clean Air's commercial truck and off-highway value-add revenues grew 87% year-over-year.China commercial truck and off-highway revenues doubled compared to the second quarter of 2020 boosted by the ongoing adoption of China 6 emission standards. Strong volume recovery in North American and Europe also supported the segment's value added revenue growth, commercial truck, off-highway and industrial made up 26% of the segments value add revenues in the second quarter compared to 19% for all of 2020.

Adjusted EBITDA was $146 million, compared to $38 million in the prior year period. Value add adjusted EBITDA margin was 15.5%, representing an 810 basis point increase compared to the prior year period. Solid conversion on the significant volume increase and the increased commercial vehicle revenue mix were the main drivers of the margin improvement.The summary of Powertrain's performance is on Page 11. At constant currency, revenues increased 81%, compared to the second quarter of 2020. Light vehicle revenues increased 94% year-over-year, benefiting from the significant volume recovery in North America and Europe, where the business has its highest content applications.

Commercial truck, off-highway and industrial sales increased 76% year-over-year, recovery in the developed markets was the key contributor to the growth. OE service revenues increased 57%. Adjusted EBITDA was $102 million in the second quarter, compared to a $28 million EBITDA loss in last year's quarter. Adjusted EBITDA margin was 9.7%.We delivered good operating conversion on the higher volume, supported by restructuring benefits, as well as increased JV income, all driving the year-over-year improvement.

I'll now turn the call to Matti to discuss our balance sheet and guidance.

Matti Masanovich -- Chief Financial Officer

Thanks, Kevin. I'll begin my comments on Page 13. At the end of the second quarter, our net leverage ratio was 2.9 times, which represented a 1.4 times improvement from our year-end ratio. The elimination of our second quarter 2020 EBITDA from our trailing fourth quarter EBITDA helped reduce our net leverage ratio.Additionally, our positive free cash flow performance in the second quarter boosted the reduction. As Brian said, we delivered $116 million of free cash flow for debt service in the second quarter, bringing our year-to-date total to $42 million. Our continued focus on net working capital efficiency and reducing capital expenditure intensity is driving higher free cash flow.

Our liquidity was $2.2 billion at the end of the quarter and included over $700 million of cash on hand. We have no significant near-term debt maturities, and our revolver had no balance drawn at quarter end. Our revolving credit facility and term loan A mature in September of 2023. We remain opportunistic, regarding our future refinancing needs.

Page 14, shows our updated 2021 guidance and expectations for the second half of 2021. We increased our fiscal year 2021 value-added revenue guidance to a range of $13.8 billion to $14.1 billion, which compares to our prior range of $13.5 billion to $14 billion. At the midpoint, the adjusted represents an increase of $200 million versus the prior outlook.

The projected increase in revenue is driven by material cost recovery in the second half in the form of higher prices, offset partially by lower light vehicle production relative to our initial expectation for the second half of the year. Our updated full year global light vehicle production estimate at midpoint is 78.5 million units, down from our prior assumption of 80 million units. On a year-over-year basis, our updated production assumption implies an 11% year-over-year decline in second half light vehicle unit production.

Relative to HIS, we are more conservative in Europe and North America, our top two markets for light vehicle revenues, because of the ongoing uncertainty around semiconductor availability. We have seen incremental production downtime in both regions in July and August. We are planning for global light vehicle production to decline sequentially from the second quarter to the third quarter, followed by some recovery in the fourth quarter.

For the second half of the year, we are planning commercial truck off-highway and industrial volumes to decline from the first half levels, but still show growth year-over-year. Also, our aftermarket volume is typically done in the second half of the year versus the first half, and our guidance assumes that seasonality.We are reconfirming our 2021 full year adjusted EBITDA guidance of $1.4 billion at the midpoint and narrowed the range to $1.36 billion to $1.44 billion. At the midpoint, our updated guidance represents an adjusted EBITDA margin of 10%. Our updated guidance includes over $250 million of material cost recoveries via higher price in the second half, which comes in at zero margin.

Our commodity price escalators are on a lag and we have begun to recover higher commodity costs absorbed in the first half of the year, because the recoveries benefit our sales at zero margin. It has a dilutive effect of approximately 40 basis points on the overall margin in the second half of 2021 and a 20 basis points dilution for the full year.We expect the third quarter to have lower margins in the fourth quarter, as the material recoveries are weighted to the fourth quarter. With the expected continued escalation of material costs, we anticipate the recovery lag will extend into the first half of 2022. As a reminder, our third quarter year-over-year EBITDA comparison includes $50 million of temporary cost savings that do not recur this year. For the full year, we continue to expect year-over-year savings of $110 million from our Accelerate+ cost reduction program.

We expect your net debt to fall below $4.2 billion at year end consistent with our prior guidance. We have lowered our guidance for capital expenditures to a range of $425 million to $475 million, down $25 million from our prior outlook. Our forecast for cash taxes remains the same at $140 million to $160 million.Before turning the call back to Brian, I want to emphasize that we are more conservative than current IHS projections for the second half of the year, and feel confident about our ability to execute our plan. Industry light vehicle inventories are at all time lows and underlying consumer demand is solid. As the automotive industry is existing supply constraints, unwind in coming quarters. The current industry landscape bodes well for us to deliver top line growth and enhanced profitability and cash flow in 2022 and beyond.

I'll now turn the call back to Brian for concluding remarks.

Brian Kesseler -- Chief Executive Officer

Thanks, Matti. Turning to page 15, we'll close with a summary of our key priorities to enhance shareholder value. With our focus on driving continued operating performance improvement and strengthening our balance sheet. We're delivering higher free cash flow for debt service and it is yielding tangible results. We see this as the key component to unlocking significant near term shareholder value creation potential.

As we have indicated, the Clean Air and Powertrain businesses are our cash engines that will help fund our net debt reduction targets and support investments, and the target growth areas of our portfolio. Going forward, our capital allocation priorities remain consistent. First, funding organic growth and cost competitiveness; second, reducing our net debt; and third, after reaching our midterm net leverage ratio target of 1.5 to two times evaluating strategic investments in motor parts and performance solutions advanced technologies.

From a long term value creation perspective, our motor parts and performance solutions markets possess favorable macro trends in the evolving mobility landscape. And we expect our planned investments in these segments to drive above market growth. In our Clean Air and Powertrain segments, we see new business and incremental content opportunities available globally that can boost each segments commercial truck, off-highway and industrial mix of revenues to 50% before the decade is out.

The combined potential of the market out growth in our growth engines and a revenue mix shift in our cash engines have a starting revenue from OE light vehicle IC product lines to be less than 20% by the end of this decade.In closing, we believe the combination of better operating performance, a stronger balance sheet, and consistent above market growth opportunities in our core growth platforms is a compelling case to increase long term shareholder value. The Tenneco team's performance in the last four quarters should serve as strong evidence that our company is capable of consistently delivering on our commitments.We remain committed to the disciplined execution required to deliver our core objectives in the coming quarters and years.

On behalf of the entire leadership team, I'd like to thank more than 73,000 Tenneco team members around the world for their commitment and resilience and for taking care of each other and working to keep our facilities operating safely. We're proud of the high level of service they delivered to our customers, as they continue to drive improvements in our business performance.

Thank you for taking the time to join us today. Operator, we will now answer any questions.

Questions and Answers:

Operator

We'll now begin the question-and-answer session. [Operator Instructions] First question comes from Ryan Brinkman of JPMorgan. Please go ahead.

Ryan Brinkman -- JPMorgan -- Analyst

Hi, thanks for taking my questions. Could you maybe talk a bit more about the drivers of the continued stronger growth of our market in both the light and commercial vehicle off highway and industrial end markets? And how much of this roughly could be attributable to some of the segment mix changes were seen as a result of that semiconductor shortage situation with for example, automakers, preferencing allocation of scarce chips toward more profitable trucks and SUVs, which you tend to supply more into than passenger cars versus how much might be driven more by backlog revenue, conquest wins or regulatory driven content gains? Thanks.

Brian Kesseler -- Chief Executive Officer

Yes, so if I start with the light vehicle Ryan, I would say our portfolio mix in North America is over 85% indexed to light truck SUV, CUV. And with those platforms really being the primary profit drivers for our customers. It's obvious they've prioritized those when the semiconductors are available. So, I think that's helped us. Obviously, we continue to pick up business in some of our different business lines across the board. So that always helps.

From a commercial truck off-highway industrial standpoint, very strong off highway, year over year that we see, and the commercial truck was stronger, primarily North America and in Europe. And from a content perspective, China 6 and Bharat 6 for clean air business is really helping us kind of outperform the market in those two regions that are still catching up on the regulatory requirements for emissions.

Ryan Brinkman -- JPMorgan -- Analyst

Okay. Great. Thanks. And then, I see that you're delivering faster than expected, driven more by the faster than expected improvement in EBITDA, given that free cash flow for you guys tends to be more back end loaded in the year, right? So as the cash does come in, in 3Q and I think historically you've been weighted even more to 4Q, should we be expecting the next stage of the leverage to come in the form of debt paid down in the back half? And is it more the term loan A that you continue to chip away at, or does your comment, I think about being opportunistic about future financing needs suggest something maybe different, what's the next step with regard to the balance sheet?

Matti Masanovich -- Chief Financial Officer

Yeah. So I think we mentioned -- it's Matti speaking, Ryan. We'll be optimistic, like we have been, we've done two refinancings over the last six months and we'll continue to look at the market and refinance when it's open, and when it looks good for us to enter the market. We do have September 2023, we've got the term loan A and revolver that mature, and so we will need to go to market over the course of the next year at some point to refinance that.

I'd say that we are back-half loaded. As we pay that, if we do pay down debt, it would go against the term loan A. That's a fact. And we'll make that decision as we get there. We are seeing choppiness as I alluded to, in my comments in July and August with chip supply. And so we are seeing a volatile market, and so I think we'd want to get through that volatility, make sure we've got the right construct in place, and then we would look to pay down debt. But that is essentially our power management growth company.

Brian Kesseler -- Chief Executive Officer

Yeah, Ryan, if I could, I just add to that a little bit, and really pick up on Matti's comments in the presentation. I think everybody's a bit surprised at the lower production numbers that were kind of being counted on. As we mentioned, we were planning about 80 million units in the light vehicle, global build for the year, we've lowered that now based on what we see and what we are hearing from our customers.

But I think as those supply chain constraints get worked out over the next three, four quarters, there's pent up demand, all time low inventories, and that revenue comes back here, we're obviously poised to execute that that will come back stronger. We anticipate and the conversion on Apple drive margins, which will help the leverage ratio and drive cash also.

So we're, we're looking forward to the supply constraints getting solved once and for all. But I do think it's probably going to be second half. And that's what we're hearing more and more of our customers, NOT that this current downtime is going to go, it should get better from what we hear, but I don't know if it'll be completely resolved until mid-year 2022.

Ryan Brinkman -- JPMorgan -- Analyst

Okay, thanks. And last question with regard to the comment on slide 15, about evaluating strategic acquisitions versus return to shareholders, is this different versus prior when I think you were maybe more solely focused on debt pay down in order to consummate a separation of the drive business, if you were to consider pivoting toward acquisitions, or even return of capital to shareholders, a luxury option you didn't have previously? You know, what does that imply about your desire or not to continue to pursue a separation of the businesses.

Brian Kesseler -- Chief Executive Officer

Yes. So I think what you have to take that in context because they're in priority order. And so when we talk about our available capital to allocate, we first go to funding our organic growth fund this secured business that we that we are receiving, making sure that we do the restructuring to continue to be competitive in the marketplace. And that isn't that paid out.

The only time will drift into strategic acquisitions is once we can reach our mid-term target of 1.5 time to two times on our leverage ratio. We've been slightly optimistic, if a smaller opportunity came up to bolster motor parts or bolster the right -- or the right businesses, the advanced suspension technology businesses in the portfolio. But we're solely focused right now on that reduction, because we see that as really the best near-term potential to drive significant shareholder value.

Ryan Brinkman -- JPMorgan -- Analyst

Very helpful. Thank you.

Brian Kesseler -- Chief Executive Officer

Thank you.

Operator

Thank you. And the next question is from Colin Langan of Wells Fargo. Please go ahead.

Colin Langan -- Wells Fargo -- Analyst

Yes. Thanks for taking my question. Just looking at the outlook, it looks like I think roughly 80 basis points of EBITDA margin, declines are expected in the second half. I think you mentioned 40 of that is commodity rate related. I mean, what is the rest of the weakness? They are decrementals on lower sales? Are there other factors that we should be thinking about? And to the second,

Brian Kesseler -- Chief Executive Officer

We call it a couple of factors, there's clearly sales are going to often lower the back half to the front half, and so the decremental on sales that will come through on our overall call our normalized decremental margin that we've discussed in the past. And then there's also the $15 million, we've talked to the Q2 inventory rebound is going to flow into the third quarter primarily.

Matti Masanovich -- Chief Financial Officer

And on the 40 basis points on material cost of -- revenue coming in at zero margin.

Brian Kesseler -- Chief Executive Officer

Yes.

Colin Langan -- Wells Fargo -- Analyst

Okay. And what was the outlook originally for commodities and what is it kind of looking like now you mentioned 20 was the -- is the full year headwind.

Brian Kesseler -- Chief Executive Officer

Yes, the outlook was -- obviously much smaller than this, I will say Colin you haven't kicked around in the industry for 25 or so years. You know, there's always those commodity increases for specific commodities you hear about steel or polypropylene or other commodities over the years. I can tell you for me, this is the first time I've seen almost every commodity we have going up double-digits or more year-over-year and then we get the luxury of kicking in free costs are, kind of way, way elevated from a year-over-year basis.

So we plan nowhere near that. And so our commercial teams and our business line and customer teams are hard at work offsetting those with cost savings objectives, honestly, but then the recoveries for the commodities. I will tell you this -- these commodity cost increases can't stop at one point in the supply chain, and it's not going to sit on our doorstep. So we are absolutely committed and having the necessary conversations with our customers to make sure it works into our price.

Colin Langan -- Wells Fargo -- Analyst

And how do we think about that into next year. Do you actually maybe start getting those recoveries or the hit we have this year just continues through. Any thought

Brian Kesseler -- Chief Executive Officer

So mechanically, if you think about a lag we've talked about a quarter or a little bit longer lag in general on average, we see that coming through. But that just catches us up, right. So if you want to talk about margin expansion opportunities, it really doesn't start moving the other way until these commodities drop-off, because we'll get the lag on the other side, where we will keep the price and it'll be at a lower cost. So it's a matter of keeping the margins until these commodities start to come down. And then over time, based on our agreements, they would come back out. Does that makes sense?

Colin Langan -- Wells Fargo -- Analyst

No, that makes sense. And just lastly, I missed the comments on your you had a lot of wins on some bad platforms. Can you just remind me what you're referring to on that?

Brian Kesseler -- Chief Executive Officer

Well, mostly we're talking about performance solutions overall. And there's 52 new wins on battery electric vehicle. This year 26, which we've seen in the first half. First the second That's comments, Kevin. That comment is for battery electric vehicles and hybrids.

Colin Langan -- Wells Fargo -- Analyst

Okay, all right. Thanks for taking my questions.

Brian Kesseler -- Chief Executive Officer

Thanks, Colin.

Operator

Thank you. Next question is from Bret Jordan of Jefferies. Please go ahead.

Bret Jordan -- Jefferies -- Analyst

Hey, good morning, guys.

Brian Kesseler -- Chief Executive Officer

Good morning, Bret.

Bret Jordan -- Jefferies -- Analyst

Could you talk a little bit about what you're seeing in the aftermarket point-of-sale data? I mean, you called out, seasonal Q3 typically down from Q2, but could you talk about what you're seeing maybe as far as inventory clearing the channel and what you might expect, you know, sort of relative to average from a reorder standpoint?

Brian Kesseler -- Chief Executive Officer

If you recall, we our customers had very good Q2 and we were on a bit of a lag and had a good strong order book come jumping into Q2. And so we saw that continue to hold through the quarter. So I think the inventory positions are pretty well, normally situated. But we are seeing a continued kind of strong POS center and our customers pretty much all seven of our categories appear to be holding for now with the prior year in Q3. And some are little up, some a little down, but it overall and pretty good step. So right now, we see the aftermarket continue to benefit from vehicle miles travelled returning to '19 levels, which is good to see, when you think about miles travelled to work is still down substantially.

So we're seeing that do well. And then our categories, especially here in North America, coming into '19, vehicles in operation from six years old to 13 years old that we serve primarily as kind of our sweet spot. There's actually a growth of 3% CAGR from '20 to '23 that reverses the decline from the prior three years. So holding up very well I think.

Bret Jordan -- Jefferies -- Analyst

Okay, great. And then you're forecasting a global production number this year below IHS, did you say what you're forecasting for next year? And it sounds like the production issues last through the middle of the year for sure. But do you have a feeling for you know how 22 months back off on a full year basis against 21?

Brian Kesseler -- Chief Executive Officer

Yes. I mean, obviously, we would hope would be higher. But I think this is so uncertain and we get so many different conflicting messages around with semiconductor capacity strength is going to go but you know we were at 80 million coming and jumping into the year which was conservative to IHS for 78.5 and a half now at its midpoint were conservative to IHS, that's primarily North America and Europe. And, even with evidence of the uncertainty is even the two big announcements this year -- this week in North America, where they've reversed course pretty quickly on their plans related to the semiconductor issued. So, I think it's way too early to call what '22 is.

But as Matti said, there's some good -- continues to be pent up demand, inventories are lower, so it should bode well for the industry. But we just got to get confidence that the capacity constraint gets lifted.

Bret Jordan -- Jefferies -- Analyst

Out of that you know the markets $90 million approximately $95 million yet so they're well up from where they're at this year?

Matti Masanovich -- Chief Financial Officer

I'm not sure I'd be that optimistic. But it was just because of the continuing issues in the end of the second half that we're hearing.

Bret Jordan -- Jefferies -- Analyst

Okay, great. And then one final question, I guess on slide 13, obviously, debt reduction and is the number one priority, but I wasn't quite clear that the top priority of acquisition versus potential spinning of the aftermarket business, did one of those sort of supersede the other?

Kevin Baird -- Chief Operating Officer

I think as we move through and move our debt with leverage ratio down to that one-and-a-half to two times target, that's where the best opportunities begin to present themselves for options. For sure, the option that we will choose is the one that we see as driving the best long-term shareholder value for our shareholders. And so if the spin was the right way, then we would look at that, if that acquisition was the right way, we'd look at that and listen if taking a part of the business out of the portfolio where the right decision we would do that. So right now, we're solely focused on driving margin expansion, and cash flow conversion on that margin, to get that down to really open up a broad window of opportunities for us.

Bret Jordan -- Jefferies -- Analyst

Great. Thank you.

Operator

[Operator Instruction] Next question is from Joseph Spak, RBC Capital. Please go ahead.

Joseph Spak -- RBC Capital -- Analyst

Good morning, everyone. I guess first question related sort of more clarification I want to understand like when you show these bridges, like you're showing some pretty good incremental margins on supply chain issues, inflationary pressures, etc. That's in the operating performance?

Kevin Baird -- Chief Operating Officer

Yes.

Joseph Spak -- RBC Capital -- Analyst

Okay. So, like I think some of those conversion numbers involve extra sort of like 30% or certainly high-20s, which I believe is above what you guys have done historically, right. Now, maybe part of this is the comp period, but how should we think about the ability to convert on volume going forward?

Kevin Baird -- Chief Operating Officer

So generally, the way you should think about us on average is incremental volume should convert in the low-20s. And then incremental EBIT should convert the cash for debt reduction in the mid-20s is probably the simplest way to think through it.

Joseph Spak -- RBC Capital -- Analyst

Okay. So the better performances this quarter has some like base period math?

Kevin Baird -- Chief Operating Officer

Well, we had a obviously major downtime, so last year, so that drives the percentages up pretty significantly.

Joseph Spak -- RBC Capital -- Analyst

Yeah. Okay. And then, I know in your outlook, you mentioned CTOH, down in the second half, versus first half. I know you don't get great visibility there, but I am curious to hear if you have any insight, because I think today that's been a market that has been less impacted, certainly by the by the semi-issue? So, are you seeing some more of an impact here in the back half? Is that what sort of the reason for that for some of that caution?

And then, if we think about, CTOHI down 2H versus 1H and it seems like light vehicle is maybe more flattish half over half. I guess, it sort of really depends. I think, exactly the sort of the quarter came in. But does that also -- does that mix also sort of drives some of the margin pressure that you alluded to, half over half.

Brian Kesseler -- Chief Executive Officer

Yeah. Generally, our commercial truck off-highway and industrial business is better than our average. And so, that's sequentially -- our sequential move down, still get up year-over-year. And sequentially, it's like 5%, primarily the commercial truck.

We're starting to hear some favorable signs out of our off-highway, kind of, getting on stage set up, hope maybe in the back half of this year, in fourth quarter. But we should be -- we should pretty well be set up. But we're being conservative. Listen, we're rooting for high light vehicle production and rooting for higher commercial truck off-highway. So -- but we're just not counting on it in our business plan.

Joseph Spak -- RBC Capital -- Analyst

Okay. Final one. I'm going to go back to Ryan's question before on the different options. Like in the past, you've sort of talked about looking at assets you own, that makes sense. And you're trying to monetize that and use that cash in other means. It does seem like -- certainly, versus a year ago and I think even maybe yours is sort of six months ago, the M&A market has loosened up a little bit. So I'm not going to sort of, sort of, pick, you can't tell us if anything's on Horizon. But, I mean, maybe you could sort of categorize, sort, of the pace of-that you're having around investitures.

Brian Kesseler -- Chief Executive Officer

Yeah. I think as we look -- we've got numerous scenarios that we review constantly to drive shareholder value, and both in the near and the short term. If the right opportunities present themselves, we'll go execute on. But right now what we see from a strategic value of our cash engines is, they're just that, they're really driving our debt reduction and funding the core growth.

But over time, those -- that strategic value will shift. And we'll make another call. So we're not eliminating any options. But we're also going to make sure we stay focused on what we see is a pretty solid continued performance in a volatile market. So we'll be opportunistic when it makes sense, but we'll always go through that lens of long term shareholder value creation. Any other question?

Operator

[Operator Closing Remarks].

Duration: 43 minutes

Call participants:

Rich Kwas -- Vice President of Investor Relations

Brian Kesseler -- Chief Executive Officer

Kevin Baird -- Chief Operating Officer

Matti Masanovich -- Chief Financial Officer

Ryan Brinkman -- JPMorgan -- Analyst

Colin Langan -- Wells Fargo -- Analyst

Bret Jordan -- Jefferies -- Analyst

Joseph Spak -- RBC Capital -- Analyst

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