Tsakos Energy Navigation Ltd (TEN) 2002 Q3 法說會逐字稿

Thank you all for standing by. I'd like to inform all parties that they will be on a listen-only mode until the question-and-answer session of this conference. The conference is being recorded at the request of Tenneco Automotive. If anyone has any objections, you may disconnect at this time.

Welcome to the Tenneco Automotive's 3rd Quarter 2002 Earnings Conference Call. I would like to now turn the call over to Mr. Jim Spangler, Vice-President of Corporate Communications. Sir, you may begin.

Thank you. Good morning and welcome to Tenneco Automotive's 3rd Quarter Earnings Conference Call. By now, you all should have received our press release and associated financial information. In a minute, I'm going to turn the call over to Mark Frissora, Tenneco Automotive's Chairman/CEO, and Mark McCollum, Our CFO.

Mark and Mark will spend about 30 minutes walking you through a detailed explanation of our 3rd quarter performance. They will then take your questions. The conference call operator will explain the process for asking a question at that time.

Please remember that we have many different audiences on the call today, and that we'll do everything possible to address all of your questions. I want to remind you that in addition to reviewing our 3rd quarter financial results, 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. At this point, I'll turn the call over to Mark Frissora. Mark?

Thanks, Jim, and good morning, everyone. Thanks for joining us this morning. Earlier today we announced 3rd quarter 2002 results. I think I best characterized the latest quarter as one of continued improvement.

As many of you know, our key objectives this year are to increase revenues and drive down costs, with the ultimate goal of reducing our debt position. In the third quarter, we increased revenues by 5%. We've taken out costs by our Genesis restructuring project, and Sic Sigma quality improvement programs. We reversed a net loss of $0.06 from last year to $0.13 of profit in the latest quarter. Most importantly, we paid down an additional $14 million in debt.

Let me give you a few more details on these achievements. In the latest quarter, consolidated revenues increased $30 million over the prior year, primarily as a result of the continued, robust production levels in North America, and higher volume in heavy-duty truck. We also had several new platform launches ramping up in our European OE ride-control business, and the broader rollout of our Monroe reflex shock, which is resulting in higher premium mix in the European replacement market.

In addition to advancing the top line, reducing operating costs and expanding lean and Sic Sigma initiatives are an ongoing priority for us. In the third quarter, we continued to implement our Genesis program for improving our manufacturing capacity and distribution productivity worldwide. This project has delivered nearly $7 million in cost-savings year-to-date, as we closed two facilities, improved the workflow at six, and reduced headcount by about 660 people.

In addition to these completed Genesis projects, we had initiated the closing of six other faculties. We have 14 additional facilities that are being reworked for improved efficiency. Genesis is on track to meet our $11 million savings goal this year. Further, our Sic Sigma program generated $5 million in savings in the third quarter, representing $13 million in savings year-to-date, slightly ahead of pace for meeting our 2002 goal of $20 million in savings from this program. Finally, we were able to maintain SGAD at exactly 12% of sales, in keeping with our goal of tighter expense controls.

We've also been successful in our initiatives to reduce total debt. In the third quarter, we extended our record of five consecutive quarters of working capital improvement. Since the beginning of the year, we produced cash flow from working capital of $69 million. Our working capital balance is down to $136 million from September 30th last year, and we have reduced working capital as a percent of sales before considering the benefit of factoring to 9.4% from 10.9% at December 31, 2001. All key working capital metrics contributed to this improvement.

We've also been controlling capital spending by redeploying idle assets, refurbishing existing machinery and purchasing used equipment. By managing working capital and capital spending, we've been able to reduce total debt by $108 million for the first nine months of 2002; an accomplishment we're exceptionally proud of.

Mark McCollum is going to go through the Sigma results with you in a few minutes. But before he does, let me give you a macro view of our operating environment, and further detail the initiatives we've undertaken to improve our position.

Let's first turn to original equipment. North American build rates and the latest SAAR numbers we've seen are at a pace of around 16.5 and 16.9 million vehicles, respectively. North American light vehicle production was up about 11% for the quarter, compared with a year ago. North American Class 8 heavy-duty truck production rates were up about 63%. According to ACT, an industry research group. Conversely, light vehicle production in Europe is estimated to be down by about 1-3% compared with the third quarter of 2001, according to the latest industry data we've seen. For Tenneco Automotive, North American business represents 54% of total revenues for the third quarter, while European operations contributed 36% to total revenues.

For our original equipment businesses worldwide, revenues for the latest three months rose 9%, compared with the third quarter of 2001. In North America, our revenues were up 15% as a result of our strong position on top-selling platforms. And our better margin (Inaudible) business continued to benefit from the Class 8 production increase that was driven by the October 1st diesel emission mandate. Our North America heavy-duty volume was up 58%, year-over-year.

Total European OE revenues were down 10%, adjusted for favorable exchange rates. A 14% increase in our ride-control business was offset by a 15% decline in our exhaust operations, as a result of lower pass-through sales and launch delays.

In the global aftermarket, total revenues declined by about 4% as the economic worldwide and a shrinking exhaust market adversely impacted replacement rates. This offset the impact of global new business, as well as a new product and stronger currency overseas.

North America aftermarket revenues declined 11% from the third quarter of 2001. This is partially due to softness in the ride-control market, resulting from the weakened economy. It also resulted from last year's addition of Sears, and its significant initial order in the third quarter of 2001.

European aftermarket revenues were up 7%, primarily as the result of global exchange rates. But our European ride-control premium mix rose 3 percentage points to 31%, due to the expanded rollout there of our Reflex premium shock.

Despite lower aftermarket revenues, we were able to maintain EBITDA margin in the global aftermarket business during the quarter, as heightened manufacturing efficiencies especially in North America are paying off.

For consolidated gross margin, we have a long-term goal of 23% that we're driving toward. We believe we'll get there through initiatives like Genesis, Sic Sigma and lean manufacturing.

In the third quarter, total gross margin adjusted for restructuring was 21.5% compared with 21.9% a year ago. The reduction in North American aftermarket sales hindered a better gross margin performance in the recent quarter.

For the first nine months of 2002, gross margin adjusted for restructuring expenses was up 0.5% to 21.5%. Higher pass-through sales of catalytic converters negatively impacted gross margin, as this type of sale generally only earns a handling charge from the customer. If we exclude pass-through sales and restructuring costs, gross margin year-to-date was 25.7% versus 25.2% last year, driven by a higher ride-control premium mix in the aftermarket.

In the third quarter, we spent $8 million in cash related to Genesis. Year-to-date savings from Genesis are $7 million. We are on track to realize about $11 million from this program in 2002. We anticipate annualized savings of $30 million, beginning in 2004.

Finally, we continue to make notable progress on our Sic Sigma initiatives. To date, we have nine master black belt candidates, 38 certified black belts, and 92 green belts in the certification process globally.

As we've discussed previously, we have more than 800 active Sic Sigma projects underway worldwide, and the success of our Genesis and Sic Sigma projects will help drive gross margins to target levels.

Even more positive is that our Europe OE exhaust business reported an improvement in gross margin in the 2002 third quarter, compared with both the second quarter of 2002 and the third quarter of 2001. We've taken aggressive measures in the late last three months to flex down this operation in response to the lower volumes. Toward that end in the third quarter, we instituted leadership changes, we reduced our workforce by about 200 employees, and audited and subsequently changed some manufacturing processes.

This group still has some work ahead of them in terms of enhancing productivity and further reducing labor costs, but we're encouraged by the progress they're making. We expect the fourth quarter to show even greater improvement than the third quarter comparison.

In 2002, in terms of overhead spending, we're matching our goal to keep SG&A relatively flat at about 12% of revenues. For the third quarter, S G and A expenses were exactly 12% of revenues; lower than the 2001 third quarter level, despite increased spending for advertising and sales promotion in the aftermarket, as well as a larger investment in engineering. Year-to-date, SG&A was 12.2% of total revenues.

Increasing EBITDA and reducing working capital are key strategies toward generating cash to pay down debt. As of September 30, 2002, we reduced days sales outstanding, excluding factoring, to 59 days from 63 days a year ago. We brought down inventory levels on hand to 44 days from 47 days, and we increased days payable outstanding by 7 days to 68 days.

In the 2002 third quarter, cash flow from working capital was $10 million, or $29 million if you consider that we also reduced receivables factoring by $19 million in the quarter.

And there's plenty of opportunity still ahead. Based on recent benchmarking studies, we believe we have at least a $150 million opportunity over the next couple of years to further reduce working capital.

Now I want to take a couple of minutes to discuss commercial highlights before turning the call over to Mark for detailed financial review.

Tenneco Automotive's products were featured on 16 vehicle launches in the 2002 third quarter, valued at $112 million annually. We'll continue to invest in advanced technology to prepare for stricter safety and environmental regulations being mandated for 2004 and 2005 models.

Advanced technology is a competitive advantage for Tenneco Automotive, and it's an important new business driver for us. In the 2002 third quarter, we won 16 new OE business awards, valued at more than $20 million annually. Year-to-date, we've been awarded about $320 million in annual new business launched into 2005.

On the aftermarket side in North America, we added 75 new emission control SKUs to expand the breadth of our Walker and DynoMax brands. Additionally, 86 new ride-controlled SKUs were released in the 2002 third quarter.

In Europe, we added 41 new emission control part numbers, and 52 new ride-control part numbers to our product coverage. Thirty-seven of the new ride-control part numbers to our Monroe Reflex product. At the same time in Europe, we reduced inventory on hand by 20 days versus the prior year.

With that overview, I'll turn the call over to Mark McCollum for a more detailed look at our financial results.

Thanks, Mark. Let's start the business segment analysis with North American OE business.

North American OE revenues for Q3 2002 were $337 million; an increase of 15%, compared with $295 million reported in the third quarter a year earlier.

Excluding the impact of pass-through catalytic converter sales, OE revenues were up 16%. Ride-control and [inaudible] revenues were up 20% compared with the prior year, while North American exhaust revenues rose 13%. Revenues benefited from overall increased production volumes, particularly on certain GM, Ford and Damlier-Chrysler platforms, and higher-than-expected Class 8 truck revenues.

Additionally, higher pass-through sales of catalytic converters contributed to the overall improvement. Pass-through catalytic converter sales increased by 10% to $74 million.

North American aftermarket revenues for the third quarter of 2002 were $129 million; down 11% from the year-earlier period. It was a tough year-over-year comparison in part due to a large initial order recorded last year from the Sears business we won in August 2001.

Additionally, notable softness in both the ride-control and exhaust markets in the latest there months more than offset price increases of about 2%, implemented in the US and Canada, for the ride-control aftermarket products including heavy-duty.

Third quarter EBIT for total North American operations increased to $36 million, from $23 million in the third quarter a year earlier. Significantly better OE volumes, coupled with better manufacturing cost controls in both the OE and aftermarket segments drove the improvement. Substantially lower changeover costs in the latest three months versus a year ago, and the elimination of $3 million of goodwill amortization were also factors. Included in 2002's third quarter results were restructuring expenses of $1 million.

In Europe, we reported third quarter 2002 OE revenues of $219 million. Potentially flat compared to the $221 million reported a year ago. Higher currency exchange rates benefited total OE revenues by $21 million. Pass-through catalytic converter sales were down 7%, to $56 million.

Excluding pass-through sales and currency, OE exhaust revenues were down 20%. Similar to what we experienced in the second quarter, the European OE exhaust sales decreased year-over-year due to a combination of market conditions and the continuation of launch-timing issues with several of our major platforms. Such as Volkswagen's PQ 34 and Ford's C170 or Focus platforms-continuing their phase-out stage in advance of the introduction of new follow-on models in the fourth quarter or first quarter of next year.

Ride-control revenues including currency rose 14%. Substantially exceeding the market raise as the result of several new platform launches, including one from Peugeot. And stronger sales on existing platforms with Ford and Renault.

Third quarter European aftermarket revenue was $86 million; a 7% increase from the $81 million reported a year ago. Excluding currency, revenues were relatively flat.

So overall, excluding currency, ride-control aftermarket revenues were up 3%, reflecting the positive impact of the rate flex introduction, while exhaust revenues were down 4%. Primarily as the result of the market decline due to the now standard use of stainless steel by OEMs. In total, Europe lost $1 million in the third quarter, compared with earnings of $9 million last year.

2002 earnings were impacted by a $2 million restructuring charge for the Genesis project. Additionally, about half of the remaining variance was due to the lower exhaust volumes, and associated manufacturing inefficiencies.

We also incurred about $2 million in additional promotion and advertising expenses in the aftermarket associated with the reflex launch. Currency benefited the quarter by only $1 million.

Our South American operations reported revenues of $24 million during the third quarter of 2002, compared with $32 million reported in the year earlier quarter, due to significant currency devaluation of both Brazil and Argentina. Excluding currency, revenues would have increased by 6%.

Third quarter revenues for the company's Australian operations rose 16%, to $31 million. A favorable exchange rate and strong market demand drove revenues as Ford, GM and Toyota released new models during the 2002 third quarter.

Finally, our Asian operations reported revenues of $30 million in the third quarter of 2002, up 86% from the year earlier, as a result of new business and increased volumes in our China exhaust operation.

EBIT for the rest of the world including South America, Australia and Asia combined, was flat, at $5 million. For the company in total, currency favorably impacted our year-over-year revenue comparisons by $22 million. The currency benefit to EBIT was only $2 million.

Depreciation and amortization was $35 million for the quarter, compared with $39 million in the prior year. The decline was related to eliminating goodwill amortization this year.

Interest expense for the third quarter 2002 was $36 million. This was down $6 million compared with the year earlier, primarily due to lower average debt levels, and to a lesser extent, lower interest rates.

It's important to point out that our current interest expense levels reflect a three-year floating-to-fixed rate swap we put into place in early 2000, while $300 million of our senior term loans were required under our senior credit agreement.

Based on current short-term interest rates, these swaps are adding about $16 million annually to our interest expense. When these swaps expire on February 4, 2003, our interest expense will decrease accordingly.

We had a net tax benefit of $2 million for the quarter, plus a benefit of $3 million last year. The third quarter of 2002 included a $2 million benefit related to a change in our estimated effective tax rate for the year. The third quarter of 2001 included a $1 million benefit on the same issue.

We also reported a $2 million benefit in the late third quarter, related to an accrual to return adjustment in a foreign jurisdiction.

Cash taxes were a $6 million outflow in the latest three months, compared with a $9 million inflow for last year's third quarter. Last year's third quarter reflected refunds of earlier overpayments, while we paid taxes in the current year. On a year-to-date basis, cash taxes have been $22 million. We now anticipated cash taxes of about $30 million for the full year.

Going forward, we expect the effective tax rate to be around 40%. However, there could be some accrual-to-return differences that may affect this rate in the fourth quarter.

Now let's talk about cash and debt. Cash on hand was $46 million on September 30th. On an overall basis, we completed the quarter with $51 million drawn on our $450 million revolving line of credit.

Including letters of credit issued under this facility, we had $339 million available on the revolver at the end of the quarter. Our total debt level decreased during the quarter by $14 million to $1.407 billion.

The senior term loans were $812 million at September 30th. As you may recall, the senior secured debt amortizes by just over $23 million a quarter. We made two senior debt principal amortization payments in the third quarter, on July 1st and September 30th totaling 47 million.

We also made an additional prepayment on the senior term loans of $16 million in September, using the cash proceeds we received in the second quarter, for the sale of our York facility in England.

By the way-on October 1st, we made an $11 million payment for some old Tenneco bonds. We have an additional amortization payment on our senior secured debt due on December 31st. For all of 2002, principal payment on our debts will total $121 million.

Cash provided before financing activities was $112 million year-to-date, versus $68 million in last year's comparable period. A $44 million increase in cash flow. The increase was driven in large part by the reimbursement in the second quarter of $30 million of platform development and launch expenses by Daimler-Chrysler. The proceeds from the sale of the York facility, I just talked about. Otherwise, higher earnings and lower cash interest pay have been offset somewhat by higher capital spending and cash taxes.

Capital spending was $34 million for the third quarter; up $7 million from $27 million a year earlier. On a year-to-date basis, capital spending was $86 million, compared with $74 million in last year's first nine months. Of the difference, $4 million was related to Project Genesis. For 2002, we now expect capital spending to run closer to $140 million.

Our worldwide factored receivables were $121 million, as of September 30th, compared with $140 million at the end of the second quarter 2002, and $144 million a year ago.

Of the $121 million outstanding this quarter, $66 million was from the US accounts receivable securitization program with Bank One, and the balance of programs with regional institutions in Europe.

The decline in factoring receivables from last year's third quarter occurred in the US and primarily was caused by consistently lower overall receivables balances, due to the implementation and subsequent growth of early payment programs with GM and Daimler-Chrysler. These programs began in June, 2001, with a $26 million impact on our accounts receivable in the third quarter of 2001. They've grown to $57 million as of September 30th, 2002. In the third quarter, these programs increased by $7 million.

Our current US factoring program is subject to renewal each year on October 31st. We are working with Bank One, the [Asian] program, to replace that existing arrangement with a long-term committed program not subject to annual renewals. We hope to have a longer-term factoring program in place before the end of the year. Bank One has extended the existing program to January 2003, as we work together with them to implement the new program.

As Mark said earlier, we are significantly exceeding our bank covenant test ratios to improve performance and debt reduction, giving us additional breathing room in these calculations, which are based on the last 12 months' results.

At September 30th, the leverage ratio was 4.2. It could be no more than 5.75. The fixed-charge coverage ratio was 1.29. It must be at least 0.7. The third covenant, the interest-coverage ratio, was 2.23. We needed to maintain this ratio above 1.65.

It should be noted that our ratios as of September 30, 2002, are in compliance with the increasingly more restrictive limits required to be maintained under the senior credit agreement, all the way out to the second quarter of 2004. Moreover, we can borrow the full amount of the revolver, and still be in compliance with our covenant test.

Now I'll turn the call back to Mark Frissora.

Thanks, Mark. We're pleased with the strides we've made through the first nine months of 2002. We've accomplished quite a lot toward our stated goals, and we'll continue with our emphasis on inventory management and cost control in the final quarter of the year.

As you know, our earnings in the fourth quarter are historically lower than in the second and third quarter results, reflecting the seasonal slowdown in our global aftermarket business, and the shutdown in OE production in late December.

We are using this period to intensify our focus on the Genesis restructuring project, and to capitalize on cost reduction opportunities. As we plan for 2003, there are mixed signals in the marketplace. While OE builds in North America are stronger than we anticipated in early 2002, the uncertainty about the US economy and the fact that selling rates are moving closer to production rates, indicating that vehicle demand may be stalling, gives us reason to be cautious as we look ahead.

In Europe, while we're seeing some stabilization, the economy there continues to be extremely soft. The European production estimates for 2003 suggest only about a 1% year-over-year improvement. Consequently, we continue to plan a conservative top line. At the same time, we are getting more aggressive about reducing costs and managing cash.

For that then, I held a strategy meeting with our top 130 managers last month, to reflect on our progress, share best practices, and discuss the challenges and opportunities that lie ahead for our industry and us.

We agreed that we have the strategies, tools and processes in place to maximize our global assets and succeed in these uncertain economic times. However, we're also [inaudible] that the best performing companies, regardless of the industry or size of the business, share in the ability to deliver consistently on the commitments they make. This ability is execution and discipline. Stated another way, best in class companies master the fundamentals, follow through on commitments, and remain obsessed with quality improvement.

So as we move forward with our business strategies, our team is resolved to do so with an execution and discipline focus. Take EBA for example. We've had great success these past few years in changing the decision-making behavior of our leaders by instilling an EBA mindset. We drove EBA alignment by linking a large portion of the bonus compensation for the top 800 managers worldwide to this key financial metric. As a result, we exceeded our EBA improvement target last year. Year-to-date, we've improved EBA by $28 million; exceeding our 2002 objective.

The next step is to drive EBA firmly down to the shop floor. We're going to accomplish this by having each of our plants map out the EBA improvement targets into 4-5 easy-to-understand metrics such as scrap improvement and capital expense reduction, to name a few. This should provide our plan employees a roadmap on how they and their plan directly impact the company's EBA performance. To further strengthen this alignment, we plan on linking a significant portion of our plant bonus programs to EBA improvement during 2003.

Lean manufacturing possess another opportunity. Our most recent assessment shows our lean manufacturing implementation to be only 35% across our global manufacturing footprint. By improving our execution and discipline in this area. Combined with our Sic Sigma initiative, we should drive further efficiency improvements to achieve our gross margin goals over the next 12-15 months.

We also believe based on benchmarking best-in-class companies, that we have at least another $150 million in working capital improvements available to us worldwide. We can realize most if not all of this opportunity over the next two years by executing with discipline our strategies for further reducing inventory and improving our receivables and payables performance.

In summary, we are a much stronger company today than we were a year ago. We believe that we'll continue to improve as long as we maintain our disciplined focus on cash management and drive toward flawless execution with regard to our business strategies and operating fundamentals.

With that, let's open up the call for Q and A, Operator.

Thank you, sir. At this time, we are ready to begin the question-and-answer session. If you would like to ask a question, please press star-1 on your touchtone phone. You will be announced prior to asking your question. To withdraw your question, you may press star-2. Once again, if you would like to ask a question, please press star-1 on your touch-tone phone.

Our first question comes from Monica Keeny. Please state your company name.

Morgan Stanley. I was wondering if you think there's any risk to not renewing that off-balance sheet AR facility? And the other question on that is why couldn't you have just done the one-year renewal?

I guess the first question is no. I don't see any risk to getting it renewed. We had renewed it for one year a year ago. Okay? In October. That was the extent that Bank One wanted to do at that time. We've been working with them to try to design a program that made sense for all parties.

What we've done is extended the program, not for a year, but just for a quarter. Effectively, to get this renewal done in a different way. That should be plenty of time for us to make it happen.

What in particular are they looking for? I can't go into specifics on the call. I guess the answer is basically not going to be subject to renewals going forward. It's going to be a term deal; a five-year term deal.

Are you looking to make the facility larger or the same size?

Basically, the same size.

And on the revolver, what's currently outstanding?

It was $52 million at the end of the quarter.

Do you have today's balance?

No, I don't.

Okay. Given the uncertain outlook for 2003 both in America and Europe, earnings may be difficult to improve significantly. So how do you see meeting amortization payments in 2003 and the out years?

Well you know obviously, we believe that our earnings profile will improve in certain key areas. As Mark indicated at the close, we are sort of planning next year again for a lot of top line growth. But Genesis will be substantially complete. We'll get benefits from that. The Sic Sigma program continues to benefit us. We'll be taking another swipe at S G A and E costs across the entire company, to move toward our long-term goal of getting 10% of sales.

So a combination of those things plus hopefully some improvements in the European aftermarket and getting Europe sort of back on its feet in terms of its margins, we believe will help to drive EBITDA higher.

I'd also mention as we look ahead, interest expense itself has been running much higher. As the debt comes down, so does interest expense. Not only the floating to fixed swaps go away, which is costing us about $16 million a year, but also the fact that debt will be down about $121 million year-over-year. That should drive down interest expense considerably.

We're also in taxes. As we've reduced our cash taxes, that's in large part because of negotiations with a service or some other planning things that we've done. That's helped to drive it out. Certainly the settlements getting dealt with, we're hopefully that cash taxes will be lower on a year-over-year basis.

Then finally, we still have $150 million of working capital to drive, and we believe that we'll have a lot of initiatives around that next year, as well. We continue to make radical progress on that front.

If I could just add a little bit technically, as well, to what Mark said. Just reinforcing some numbers, I guess. We look at Sic Sigma to generate at least another $20 million in savings next year. Then if you look at the Genesis project, we have announced that next year we should get $25 million out of Genesis, in terms of benefit next year. It's $24 million or $25 million. I could be off $1 million, there.

Is that incremental, year-over-year?

No. Because $11 million will be this year.

Right.

So $25 million next year. You just subtract, and that would be about a $14 million incremental number. S G A and E. We finished our AOP review process with every business unit. Actually, our finalized budgets are going out this next week. When you look at S G A and E, our stated goal is to reduce our S G A and E next year another 6%. So when we look at that, we think that's an achievable plan. Those are some numbers for you to add up on how we may get EBITDA improvement next year, in addition to the working capital improvement.

Right. I guess the only thing I would note on another conference call for another large supplier, one of the things that they caution investors not to do is just add restructuring savings on to EBITDA. Because there are other things such as raw material costs, as well as potential volume drop-offs that could impact that. So would you give us the same advice?

We expect to take more out of our material costs savings next year. We're planning to take out an additional amount to what we took out last year. So net of economics, we will actually take out savings on material cost. I always caution, though, in terms of restructuring savings and everything else, there's a lot of moving pieces on income statements by business unit. Whether it's pricing issues with customers, or whether it's manufacturing efficiency issues due to the fact that you have lower volumes which were put into the plant. So yes, Monica, you're right. You always have to caution and do additive-type exercises.

Right. But raw material prices are not increasing for you?

No, they are not.

They're decreasing?

That's correct. There's no question about it.

And what kind of decrease do you see there?

I don't want to give an exact percentage right now I guess, to you. I mean we have what we built into our plan. But it's important to know that steel pricing which has been the big issue with a lot of people. Seventy-five percent of our steel prices were fixed. So we didn't even have anything floating this year. So we were able to offset any of those that weren't fixed with narrowing our supply base. So actually, material and steel prices this year and next year will be no impact on us. We actually will have an overall decrease next year on steel prices. That's due to our ability of the type of steel that we buy. It's not impacted in some cases by the tariffs. Okay?

Okay. Thank you.

Our next question comes from Jeff Skoguin. Mr. Skoguin, please state your company name.

UBS Warburg. Good morning.

Good morning.

The $300 billion book of business in the OE. Is that still in tact?

We've gotten out of the business in the last could quarters of forecasting the incremental book of business. The reason we've done that is because the OEs have frankly gotten a little bit chaotic in their planning cycles over the next three years; even this year. Launch delays, program start-ups and cancellation of programs. There's a variety of issue that make it very difficult for us to really forecast with any accuracy what the impact is of new business.

Suffice to say, we have nothing, but we see market share increases over the next couple of years. We have no deterioration of base. We do have incremental growth, but for me to say $300 or $500 million is really to me an exercise that becomes just that-an exercise. Because of all the variables in moving pieces among our 15 OE customers worldwide.

Is there any way to kind of center on an organic growth rate for 2003 for the OE markets? Any kind of ballpark you could steer us toward?

The hard part about that is in terms of what OE builds are going to be next year.

Let's assume flat. Both continents.

I don't know if I can give that.

Okay.

I don't know if I have the data to give that. Because in our planning models and all, we've been planning for a decrease.

Okay. In the aftermarket, what was the size? I assume with the Sears order, I'm sure that gave you a boost. Do you know what the revenue impact of that unfinished?

We can't answer that questions specifically. It's just because of the way we have with the Sears contract. It's confidential.

Okay.

But it was significant enough of an impact. Yes. It was a large piece of the earnings.

I'm just trying to get a handle on the trends. You know, the aftermarket had been doing better, and this market was down in North America by about 11%. Could you give us an idea of the trends per month? Is this improving as we go on? What are your expectations? I know you're not in the forecast business, but how's October doing, so far in a year-over-year basis?

Let's let Dave Gabriel answer that. He's with us today. He's our Senior VP and GM for the North American aftermarket. Dave?

Hi, Jeff.

Hi, Dave.

The way I characterize it, but I won't forecast for you in the fourth quarter. We did see some softening in the overall business in the third quarter in July and August. We're getting reports from our customers base that this is improving, which will bleed down inventories. So that's a positive sign.

Ii would tell you that the general trend we've told you about in exhaust business remains. There's a considerable amount of pressure on exhaust, in that people are not replacing their exhaust systems. That pressure continues. The ride-control business, I can tell you we have pockets that are very strong in the Southeast and the Southwest and the West. The East and the Central appear to be a little softer. But again, we're getting some positive reports from the people.

How is that globally?

I don't think I want to answer more forecasts for you right now, what the October number is, right now. We're about halfway through the month and orders are relatively steady.

Okay. Last question. Class 8 year-over-year impact on the third quarter. And then how do you see that conversing in the fourth quarter? inaudible North American OE sales? What percentage of the increase or what portion of the increase was attributable to the surge in Class 8 trucks in dollar terms, maybe?

The impact to us in the fourth quarter with the lower levels of volumes that we expect. In terms of its impact on our profitability, we expect it to be insignificant. Maybe $1 million, if I were to hazard a guess, to our profitability in the fourth quarter. That's about the impact, in terms of the lower volumes in the fourth quarter. Based on what we know today in visibility. So it's not material. It's something, but it's not that significant for us.

Mark, that's a year-over-year change?

Well it's a year-over-year volume change of about 19% [inaudible] on the revenues. Yes.

Yes. $1 million would be just based on what we had as a forecast. Then what the new level at the dollar grade is. So it should impact going forward from a current level of profitability.

All right. Just to clarify the 19% revenue declines you're expecting in the fourth quarter. What's the basis from?

That 19% I quoted is the third quarter increase year-over-year.

Due to heavy trucks? Right. I thought it was a [inaudible] said earlier.

$65 million.

Sixty-three percent's Class 8? Or 19 is Class 8?

That's a reverse. In terms of our revenue, Class 8 was up 19% year-over-year.

Okay.

I think that as one of your questions.

I guess the follow-up question than would be in the opening remarks you'd said that Class [8] production was up 63%. Why are you guys are only up 19% in Class [8]?

We're looking it up. I'm sorry. I quoted you wrong. It is 58% year-over-year in increase. That was our heavy-duty volume.

Okay.

63% was the total market.

Okay. The 58% in terms of dollar terms? I'm just trying to get an idea of what revenue's like.

I don't have that. Typically our heavy-duty revenues as a percent of our North American OE volume runs unfinished. Just look at North American OE volumes. It's typically around 10% of that total volume. So we don't have the exact number here. [inaudible] break that out.

So that helps. That helps.

Okay.

Thank you.

Yes.

Thank you. Our next question comes from David Bitterman. Mr. Bitterman, please state your company name.

Yes. Deutschbank. Good morning. Keep it simple this time around. Mark Frissora, could you give us a sense on the gross margin line? My sense is that despite the numbers being pretty solid, you might be a little bit disappointed relative to sort of upward momentum on the gross margins.

Can you talk a little bit about the pricing environment, both in OE and aftermarket and what your take is on sort of normalized gross margin for you guys?

Yes. On a normalized basis, we excluding pass-through sales. I said excluding. I meant to say including pass-through sales. Our goal is to get to 23%.

The issue for us right now in getting there in terms of pricing pressure in the aftermarket. It's always there, but it hasn't been an issue for us, because of our launching of new products and the fact that we've been convincing people that the premium mix is the way that they can increase their gross margins at the retail level. Or even at WD level. We haven't had really any more significant price pressure there.

In the OE area, you always have the constant pressure on pricing. But in fact in North America, we certainly haven't seen that or any more pricing pressure than we've historically had. The same thing is true in Europe. Pricing pressure in terms of our planning on what price [inaudible] we actually have to give is essentially flat on a year-over-year basis.

Our biggest issue on the gross margin line, frankly, was our exhaust business in Europe. It's a big piece of the European pie for us. That exhaust OE business on a normalized basis is a $700 million business. It's over half of Europe; it's 2/3 of Europe for us.

What's happened in that business is what we called the perfect storm the last couple quarters. The expiring programs have dwindled down to nothing, and the replacement programs are like a two-quarter lag. So we've had a 20% volume hold on a year-over-year basis.

As you know, it's very difficult to flex down quickly on that volume [inaudible] in Europe, because of the Worker Council issue. So what we've had to do is work with the Worker Council. We developed a six-month plan. We've got the first couple months out. We've got 200 people out. We have significantly more coming out in the fourth quarter. By the first quarter of next year, I think that business will be operating on all cylinders.

We'll have increased volumes, fewer workers, more productivity and a better execution of Lean and Genesis. Genesis, right now, is being completed in that emission-control business unit. So it had a whole lot of combination factors.

Our gross margin hole in the company is something you can almost focus on. That's where it occurred. That's where we didn't' get the improvement we were anticipating. The good news is it's on the mend. We expect to have it fixed in the next couple quarters.

Very good. And Mark, a second question. It seems I kind of have this issue with the press, these days. They seem to be sort of selectively picking on industries and picking on guys like the supply base. So as a result concerns about a sort of onslaught from the OEs.

Most of the suppliers we talked to said yes, it's always out there but it's not necessarily getting any worse. And in fact, there's some teaming going on with the OEs. Is that sort of how you would describe your business?

Absolutely. I just had a dinner with the top 20 suppliers of General Motors. For example Rig, Wagner and Bow. We've got a top supplier dinner going too, with Ford. Everyone's saying the same thing. We're in this together. This is a partnership.

This frankly is, I'd say, a more positive environment than we had a year ago, in terms of how management at the OEs feels about the supply base. So if anything, there's more of a spirit of cooperation in that we're in this together versus " we versus they" kind of attitude.

Just to echo what you've heard, that's absolutely the case. Again, when we look at pricing pressure, the only thing that we're doing now with the OEs ore aggressively, and that the OEs are doing more aggressively as well, is something we call total cost takeout, with VAVE type activity. Value Analysis and Value Engineering. Together, we jointly take costs out of the product with both of our engineering organizations. That's become much more aggressive, and the OEs have devoted more resources to that.

That's a win-win. We can save in the cost reduction, and so do they. So there has been more emphasis on that, and that's been more helpful to both parties.

Thanks, Mark.

Thank you. Our next question comes from Mr. Kirk Ludky. Mr. Ludky, you may ask your question. Please state your company name.

JP Morgan. Hello, everyone.

Hello.

I was hoping to complete the bridge to 2003 earnings. I guess Genesis, one of the Marks mentioned that it would be $11 million in 2002 and $25 in 2003. I think that earlier in the presentation, you mentioned how much you'd get from Sic Sigma this year. I think it's $20 million next year. What is it this year?

It's $20 million this year.

$20 million this year. What do you think you'll get next year?

We're planning on $20 million.

Okay. So year-over-year's different in Europe?

[inaudible] for incremental projects.

Okay.

Okay? It's not a one-time thing. It's a continuous improvement process that goes after incremental savings. So when we talk about the $20 million, it's incremental.

In 2002?

And 2003 as well. So each year it's incremental.

Right. But if you're bridging from 2002 to 2003, it'd be a zero?

No.

No.

It'd be $20 million incremental in 2003. Okay? In other words, you've got 800 projects. Some of those are coming in this year. And we expect to get incrementally this year $20 million in cost savings from Sic Sigma. Starting January 1st, 2003 through December 31st, we'll get another $20 million incrementally.

Okay. That's a lot of money. And then raw material you said would be down this year? Do you want to quantify?

Yes. Let me give you some just technical on that, as well. Two percent of our purchases today are sourced from low-cost countries. We're moving up to 30% for the next 12 months. We've already got sourcing agreements in place. So low-cost countries obviously give you a much better advantage in terms of high-quality products there, on stamping and things that we do traditionally on both the Monroe product line and the exhaust product line.

We have a lot of stamp work. In some cases, we're outsourcing that. In other cases, when we look at the acquisition of steel, again we have a big opportunity to leverage worldwide some of our sourcing agreements with steel suppliers. In some cases again, we haven't sourced steel from lower-cost countries. At the same time, we're protected on pricing through 2003, on key different types of steel.

Some of our steel that we purchase basically has nothing to do with tariffs. That's the reason why we're able to get a lot of the cost reduction net of economics out of our current supply base. It's not necessarily holding our suppliers hostage; it's just a better sourcing strategy in terms of moving into low-cost countries.

I'm kind of surprised to hear that. That's good news. I think earlier you passed on quantifying that.

Yes. We're passing on it as well, right now.

What you didn't mention in your bridge, I thought I might bring up. It's a pretty big number. It's the shift in mix to premium ride-control products. I'm curious if you think that will be a contributor to 2003.

Certainly in the European mix shift. It's going on right now. But yes, in the aftermarket in Europe. We expect more significant premium mix shift in North America to give you a comparison.

Right now, Dave, I believe our premium mix in North America is what?

Low 40s.

Low 40s. So it's [inaudible] 42%. It used to be 24-25% a couple of years ago. In Europe, it was around the same number-around 24-25%. It's now up to 31 or 32%.

Hari Nair is on the phone. He's in Europe. Hari, is it like 31 or 32% right now?

Mark, it's right between. It's almost 32%. It's 31.8%, to be precise.

Okay. And we expect it to get up around 40% next year. So that obviously on the ride-control side of our business is selling a stick for $22-23 versus the low end of our pricing strategy, which is $12-13. So you're getting $10 more a stick for a premium shock than you would for a standard or low-end version that we sell. If we improve that mix, it obviously improves our profitability.

The other thing that you didn't mention was this S G and E focus. We're moving to a shared services concept by region in this country in this company. We've got two reasons. Europe and North America. We're moving to that concept. Plus the business units are getting much more productive in terms of S G and E expense. So we'll look at that. If it's a six percent improvement next year, it's a number we think is achievable. So that's our goal. I think that would yield from obviously [inaudible] improvement, as well.

So back to the mix issue, going from 32% to 40% is what kind of number in EBITDA?

We can't answer that. A little bit too precise. I appreciate the question, but no.

I think on the last call, there was a $30 million number thrown out there. I'm not sure we're talking about the same change. But it was a move from 35-40% with a $30 million EBITDA impact. Is that still the right range?

I don't think we've ever given numbers like that.

Okay. Maybe my notes were [unfinished].

Maybe what you're considering is an overall of North America in aftermarket on the year-over-year basis. They've improved their profitability considerably. Premium mix is one element of that, but they've also been fairly disciplined in terms of managing their S G and E in growing share, overall.

Okay. So it doesn't sound like it's that big. The impact.

It's not a number that we have.

Okay. And then the last of the bridge that I expected you to mention but you didn't was just normalizing this European exhaust business. I know in the second quarter you said it impacted your earnings by $10-15 million. It sounded like this quarter, it was about $4 million.

That's about right.

So is that $15-20 million if you get that business right size?

I'd say that's exactly right. Yes.

Okay. Any other things in the bridge that we should consider? Or is that pretty much the business?

I'd say that's pretty much it.

Okay.

In broad strokes.

Okay. And then you mentioned taxes. I thought you were not a taxpayer next year. Does that give a shelter?

We're not in the US. We have a fairly substantial NOL in the US. But we do pay foreign taxes. And so when you look at our $30 million of cash taxes that we're forecasting this year, that's all foreign-related. Canada, Mexico, Spain and I think a little bit of Belgium.

Obviously, one of the big things that we work on is trying to minimize those foreign taxes by trying to shift some of that NOL or at least the cost that drives it around. We have all of our interest expense in the US legal entities, because that's where our debt structure lies, but only about 40-45% of the earnings.

Okay. How much of $150 million of working capital do you think you'll get next year?

I'd say based on reasonable goals. Our goal this year was about $50 million. We'll probably be about $50 million next year, as well. [inaudible] target.

Then last question. After sales. I know you're closing a lot of facilities over there. They had a surprisingly large book value. I was curious if you plan to sell any of those.

We're going to be aggressively looking to shed assets, if it makes sense. I mean there's nothing on the radar screen. There's nothing I can say to you that we're going to get a big gain. But clearly there may be some open space that will hopefully we'll continue to market.

Great. Thank you.

Thank you.

Thank you. Our next question comes from Jim Schulmann. Mr. Schulmann, please ask your question and state your company name.

Goldwater Capital. Just want to circle back on the raw material and the steel costs. It's my understanding the North American steel was pretty well covered by long-term contracts into 2003. But the European side's similar contracts run out at the end of 2002. I just don't quite understand how you can on a quick basis sheer down the prices to protect yourself in the early stages of 2003. I just wanted to confirm that what I sensed was correct to start with. Then if you can elaborate a little bit me on how you're going to be able to implement this.

The other thing was are you going to be readily able to substitute exempt steel for non-exempt steel?

Let me go through it real quick. I'll do it by continent. In North America, 74% of the North American steel spend is protected under firm pricing contracts through 2003. And 87% of the steel types and grades are exempt from the Section 201 tariffs.

So our exposure is obviously very limited.

Right.

The rest of Tenneco's steel pricing right now through 2002 is 100% protected. Overall, 82% of the steel we purchase worldwide is protected through 2002. So you kind of stated that.

Steel prices in Europe have been increasing. That's just overall in the marketplace. Overall in the marketplace in Europe, we've seen a 20% increase. Not us personally, but overall in the market.

We've got steel contracts in place and see no negative impact in 2002. In 2003, to mitigate any increases, we're planning supply-base reductions. Reductions can eliminate 30-40% of our current hot-rolled and cold-rolled steel suppliers, and possibly bring in one or two new ones. Ultimately they share the one or two new ones' more volume.

We're also researching substitution of exempt steel grades for the various hot-rolled and cold-rolled items that we currently purchase. We're implementing the Tier 2 supply program that will be introduced by year-end 2002. It allows us to manage and control the stamping supplier steel procurement, while at the same time increasing our [inaudible] and leverage for negotiating purposes.

So I could give it a lot more detail if you want. But the bottom line is, we're very, very positive next year that we'll have material price reductions net of economics, including on steel. So including steel as one of our commodities. Understand that steel as a percent of our overall commodities purchases, may be 30% roughly. Okay? So there are other commodities besides steel that we're procuring that steel represents of our spend, roughly 30-35%.

And these substitute steel products will allow you to maintain at least the same level of quality, I presume?

Absolutely.

Okay. Different subject. With your amended bank agreement, and if things are a little soft, or if things in Europe take a little longer, do you think you've got enough cushion going into those next year when they commence tightening?

Oh, yes. In fact, one of Mark's points earlier was that with the cushion we have just through the first three quarters of next year, that cushion effect would take us through 2004 second quarter. Even if we in effect had a fully withdrawn revolver. At our current operating level, we could probably just borrow another $500,000 worth of debt.

Right.

We have about $85 million of EBITDA cushion.

Thank you.

Yes.

Thank you. Once again, if you would like to ask a question, please press star-1 on your touch-tone phone.

We have a question from Mr. Ron Tadross. Mr. Tadross, please ask your question and state your company name.

Hi. This is actually Nick with Bank of America. How are you?

Good. How are you, Ron?

All right. Would you be able to talk about the status of your potential plan and any strategies you might have on this next year?

It's very hard to understand. Could you repeat the question? We could barely hear it. Sorry.

Ron? Can you repeat the question, please?

He has removed himself from the queue.

I think he was on a cell phone.

I think what he was asking was about pensions. Maybe we could just sort of give a little bit of information about that. I know it's a broad question.

At the end of 2001, in our disclosures in the footnotes, the footnotes reflected in our pension plan that the funded status was about $113 million under funded. Across all of our global pension plans.

Of the $113 million of under funded status, only $77 million of that relate to funded plans. The rest of that balance relate to plans that we don't have any kind of funding requirement on. Such as, there's a supplemental retirement plan in the US. Germany is another big one, as well.

Of the $77 million in the funded plans, $52 million of that relates to the US pension plans; for hourly and salaried plans which we have the most restrictions around. The other plans relate to the UK and Canada.

In the US, now, the accounting requirement itself reflects that there's a $52 million under funding. The ARISA funding status of that is dramatically different. In fact at the end of 2001, where the ARISA-funded status said that we are under funded, actuary liability was only $17 million.

As a result, in 2002, our required cash contribution into the US pension plan was only about $12 million. While we like other companies have been impacted by the reduction in the stock market, our actuary rate at the end of September was looking at the market at about one of its lowest points. We'll also be looking at lower discount rates as the result of the falling interest rates. Other companies will.

In terms of our cash requirements for next year and the funding status under ARISA calculation guidelines, we expect that our funding requirements will be basically the same as they were in 2002 in 2003 and 2004. And 2004. That's exactly right. And 2004. Based on our calculations, today.

Clearly you know the accounting costs will probably go up next year. We don't have those exact numbers; we're still working on them. But the cash costs will not. It's not going to be a significant drain on our liquidity as a result of the changes.

The accounting changes are much more dramatic than the ARISA actuarial calculation changes, because the ARISA calculations don't take into consideration to the same extent the dramatic swings of the stock market, in terms of the valuation of the assets that are in the plans.

So the cash requirement is going to be significantly less. When Mark talked about the overall reductions in S G A and E for next year, those are including some projections that include our accounting costs related to pensions and other posted benefits.

Our last question comes from Brumilla Peters. Ms. Peters, you may ask your question. Please state your company name.

My question has been answered. Thank you.

Thank you.

We do have one more question from Mr. David Bitterman. Please state your company.

Yes. Good morning. It's David Bitterman at Deutschbank. Mark, I just wanted to ask a quick follow-up. Mark McCollum. You described the pension contribution as a cash contribution. I just wanted to make sure that I heard you right.

That's exactly right. We are making cash contributions into our US salary retirement plans.

Okay. Very good. Thanks, Mark. I just wanted to be sure.

Thank you. At this time, we are showing no further questions.

Thank you. This concludes our call. As a reminder, an audio replay of this is available on our website, www.Tenneco-Automotive.com. You can also access a taped playback of this call by telephone. If you're located in North America, you can reach the playback toll-free by calling 888.568.0422. If you're located outside of North America, the playback can be reached by dialing 402.539.7957. The passcode is 8400.

The taped playback should be available by 1 pm Eastern today, and access to the playback will be available through 5 pm Eastern a week from today, Tuesday, October 29th. This dial-in information can also be found at the end of our earnings news release.

Should you have any additional questions, please feel free to follow up with Leslie Hunziker, our Director of Investor Relations, or with Jane Oakstrander, our Director of External Communications.

Leslie can be reached at 847.482.5042. Jane can be reached at 847.482.5607. Thank you again and have a good day.