Tsakos Energy Navigation Ltd (TEN) 2021 Q2 法說會逐字稿

Good morning, and welcome to Tenneco's Second Quarter Conference Call. (Operator Instructions) 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.

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 attachment and other earnings materials. When we say EBITDA, it means adjusted EBITDA. Unless specifically described otherwise, margin refers to 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 3 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 the 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?

Thanks, Rich. Good morning, everyone, and welcome. There are 3 key themes in our 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 4. 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 from our customers and escalating raw material costs. We've mitigated these headwinds to deliver revenue and EBITDA at the top end of our second quarter guidance.

We delivered an 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 Accelerate+ 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 focus on increasing cash conversion through disciplined capital spending and improved working capital efficiency continues to yield 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 2.9x.

And third, we remain highly focused on increasing shareholder value in the near term by reducing our net debt via margin expansion and lowering our capital intensity. Our Clean Air and Powertrain segments play important roles in delivering results because of their margin and cash flow contributions.

At the same time, we are investing in our Motorparts and Performance Solutions segments to enhance our long-term growth profile. In Motorparts, we secured new business with a variety of customers in North America and Europe, which is expected to deliver annualized revenues of $30 million on a go-forward basis.

In Performance Solutions, we also won 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 the resolve, resiliency and commitment to achieving our business objectives.

Turning to Page 5. I'll walk through an overview of our second quarter 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 are pass-through substrate sales of $1.1 billion. As a reminder, the substrate sales are only in our Clean Air segment. The OE manufacturers source the catalytic converter and diesel particulate filter components that include precious metals or substrates directly from the Tier 2 supplier. Those substrates are carried in our inventory, incorporated into our emission reduction systems and 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 compares favorably to second quarter industry light vehicle production growth of 49%. The scale and diversity of our portfolio is a differentiator for Tenneco. The value-add revenue split by product applications 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-add revenue performance is 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, resulting 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 our 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 2.9x, a 1.4x improvement since the end of 2020. Available liquidity remained strong at $2.2 billion as of June 30.

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 review of the enterprise and segment performance. Kevin?

Thanks, Brian. I'll start on Page 7 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 towards SUVs, CUVs and pickups, enabling us to outperform market growth in the quarter.

In the aftermarket, our Motorparts 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+ program and other continuous improvement initiatives were able to partially offset last year's temporary cost actions and continuing supply chain disruptions and cost challenges. Overall, we showed solid execution in an uneven light vehicle production environment.

Let's turn to our Motorparts business performance on Page 8. 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 America and 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 both 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 America revenue, our largest region, supported the improved margin performance in the quarter.

Please turn to our Performance Solutions segment on Page 9. 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 and include a broad offering of highly engineered products and solutions to our customers. For example, during this quarter, our Öhlins branded product with the advanced suspension technology business was selected as an Exclusive Shock Absorber for the NASCAR Cup Series Next Gen Car. In addition, ASD further strengthened its relationship with an important strategic growth partner in Europe and also launched production of advanced suspension programs on 2 electric SUV platforms, one in Europe and one in China.

Looking at battery electric vehicle and hybrid business awards across the 5 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 BEV or hybrid programs with annualized revenue of greater than $160 million, and importantly, over 1/3 of our new business pipeline and nearly 1/3 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 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 America and Europe also supported the segment's value-add revenue growth. Commercial truck, off-highway and industrial made up 26% of the segment's 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.

A 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.

Thanks, Kevin. I'll begin my comments on Page 13.

At the end of the second quarter, our net leverage ratio was 2.9x, which represented a 1.4x improvement from our year-end ratio. The elimination of our second quarter 2020 EBITDA from our trailing 4-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 IHS, we are more conservative in Europe and North America, our top 2 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 down 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 0 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 0 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 point dilution for the full year. We expect the third quarter to have lower margin than the fourth quarter as the material recoveries are weighted to the fourth quarter.

With the expected continued escalation 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 our 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's existing supply constraints unwind in coming quarters, the current industry landscape bodes well for us to deliver top line growth and enhance profitability and cash flow in 2022 and beyond. I'll now turn the call back to Brian for concluding remarks.

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 are 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 and will help fund our net debt reduction targets and support investments in 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 mid-term net leverage ratio target of 1.5 to 2x, evaluating strategic investments in Motorparts and Performance Solutions advanced technologies.

From a long-term value creation perspective, our Motorparts 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 segment's commercial truck, off-highway and industrial mix of revenues to 50% before the decade is out. The combined potential of the market outgrowth in our growth engines and the 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 the last 4 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 the 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 deliver 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.

(Operator Instructions) First question comes from Ryan Brinkman of JPMorgan.

Could you maybe talk a bit more about the drivers of the continued stronger growth over market in both the light and commercial vehicle, off-highway and industrial end markets? I mean how much of this roughly could be attributable to some of the segment mix changes we're seeing as a result of the semiconductor shortage situation with, for example, automakers preference in 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?

Yes. So I'd start with the light vehicle, Ryan. I would say our portfolio mix in North America is over 85% indexed to light trucks, SUVs, CUVs. And with those platforms really being 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'll 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 VI for our Clean Air business is really helping us kind of outperform the market in those 2 regions that are still catching up on the regulatory requirements for emissions.

Okay. Great. And then I see that you're delevering 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 delevering to come in the form of debt pay down in the back half? And is it more the Term Loan A that you'd continue to chip away at? Or does your comment, I think, about being opportunistic about future financing needs suggest something may be different? What's the next step with regard to the balance sheet?

Yes. So I think we mentioned -- it's Matti speaking, Ryan. The -- we'll be opportunistic like we have been. We've done 2 refinancings over the last 6 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 23. 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 debt -- 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 so that is essentially how we're managing the growth company.

Yes. Ryan, if I could, I'd 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 kind of get worked out over the next 3, 4 quarters, there's pent-up demand, all-time low inventories. And as that revenue comes back, we're obviously poised to execute that. That will come back stronger, we anticipate. And the conversion on that will drive margins, which will help the leverage ratio and drive cash also. So 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 will be completely resolved until mid-year 2022.

Okay. 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, what does that imply about your desire or not to continue to pursue a separation of the businesses?

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 and fund the secured business that we are receiving, making sure that we do the restructuring to continue to be competitive in the marketplace. And then it's net paid out. The only time we'll drift into strategic acquisitions is once we get -- reach our mid-term target of 1.5 to 2x on our leverage ratio.

We'd be slightly optimistic if a smaller opportunity came up to bolster Motorparts or bolster the right businesses, the advanced suspension technology businesses in the portfolio. But we're solely focused right now on debt reduction because we see that as really the best near-term potential to drive significant shareholder value.

And the next question is from Colin Langan of Wells Fargo.

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 related. I mean what is the rest of the weakness? Is that just decrements on lower sales? Or are there other factors that we should be thinking about into the second...

We call that a couple of factors. Clearly, sales are going to be off the lower in the back half than the front half. And so there'll be a decremental on sale, and that will come through what I'll call our normalized decremental margin that we've discussed in the past. And then there's also the $15 million. We talked about Q2, inventory rebound is going to flow into the third quarter. That's primarily the...

And then the 40 basis points on material cost -- your revenue coming in at 0 margin.

Yes.

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?

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. 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 kicking in. Freight 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, obviously, 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.

And I mean how do we think about that into next year? I mean do you actually maybe start getting those recoveries or the hit we have this year just continues through? Any thoughts?

Well, so mechanically, if you think about a lag, we've talked about a quarter, 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 it's -- we'll keep the price and it will 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?

Okay. Yes, that makes sense. And then just lastly, I missed the comments on your -- you had a lot of wins on some BEV platforms. Can you just remind me what your referring to on that?

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 quarter -- second quarter.

Yes, sorry, in the second quarter.

Sorry. The comments -- Kevin, that comment is for battery electric vehicles and hybrids.

Next question is from Bret Jordan from Jefferies.

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 sort of relative to average from a reorder standpoint?

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 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 at our customers, pretty much all 7 of our categories are -- appear to be holding now -- with prior year in Q3 and some a little up, some a little down, but overall in pretty good stead. So right now, we see the aftermarket continue to benefit from vehicle miles traveled returning to '19 levels, which is good to see, when you think about miles travel 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, the vehicles in operation from 6 years old to 13 years old that we serve primarily as kind of our sweet spot. There's actually a growth of about 3% CAGR from '20 to '23 that reverses the decline from the prior 3 years. So holding up pretty well, I think.

Okay. Great. And then you're forecasting a global production ever 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 how '22 might stack up on a full year basis against '21?

Not yet. I mean, obviously, we would hope it would be higher. But I think this is so uncertain and we get so many different conflicting messages around where the semiconductor capacity constraint is going to go. But we were at 80 million coming and jumping into the year, which was conservative to IHS or 78.5 million now at its midpoint, were conservative to IHS. That's primarily North America and Europe. And even with evidence of the uncertainties, even the 2 big announcements this year, this week in North America, where they've reversed course pretty quickly on their plans related to the semiconductor issue.

So I think it's -- I think it's too -- way too early to call what '22 is. But as Matti said, there's some good -- there 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.

I mean IHS is part of that, the market is 90 million, approximately 90 million units. So they're well up from where they're at this year at 82 million. I'm not sure I'd be that optimistic, but just because the continuing issues into the second half that we're hearing.

Okay. Great. And then one final question. I guess, on Slide 15, obviously, debt reduction is the #1 priority. But I wasn't quite clear, the top -- the priority of acquisition versus potential standing of the aftermarket business, did one of those sort of supersede the other?

No. I think as we move through and move our debt leverage ratio down to that 1.5 to 2x 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 is the right way, we'd look at that. And listen, if taking a part of the business out of the portfolio were the right decision, we do that. So right now, we're solely focused on driving margin expansion and cash flow conversion on that margin to get that debt down to really open up a broad window of opportunities for us.

(Operator Instructions) Next question is from Joseph Spak, RBC Capital.

I guess the first question, really sort of more clarification, I want to understand, like when you show these bridges, like you're showing some pretty good incremental margins on the product mix, supply chain issues, inflationary pressures, et cetera, that's in the operating performance?

Yes.

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

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 to cash for debt reduction in the mid-20s is probably the simplest way is to think through it.

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

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

Yes. Yes. 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 to date, that's been a market that has been less impacted strongly by the semi issue. So are you seeing some more of an impact here in the back half? Is that what's sort of the reason for that -- for some of that caution? And then if we think about CTOH down 2H versus 1H, and it seems like light vehicle is maybe more flattish half over half, I guess, it sort of really depends how you think exactly the sort of the quarter came in. But does that also -- does that mix also sort of drive some of the margin pressure that you alluded to half over half?

Yes. Generally, our commercial truck off-highway industrial business is better than our average. And so that sequentially -- our sequential move down -- still get up year-over-year. And sequentially, it's like 5%, primarily in the commercial truck. We're starting to hear some favorable signs out of our off highway, kind of getting staged and set up, maybe in the back half of this -- this year in the fourth quarter, but we should pretty well be set up. But we're being conservative. So we're rooting for a higher light vehicle production, rooting for a higher commercial truck off-highway. So -- but we're just not counting on it in our business plan.

Okay. Final one, I'm going back to Ryan's question before on different options. Like in the past, you've sort of have -- sort of talked about looking at assets you own that makes sense, maybe 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 versus sort of 6 months ago, the M&A market has loosened up a little bit. So I know you're not going to sort of tell us if anything's on the horizon. But I mean maybe you can sort of categorize sort of the pace of [certain comps] you're having around divestitures?

Yes. I think as we look -- we've got numerous scenarios that we review constantly to drive shareholder value, 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 other calls.

So we're not eliminating any options, but we're also going to make sure we stay focused on what we see as a pretty solid continued performance in a volatile market. So we'll be opportunistic when it makes sense, but it will always go through that lens of long-term shareholder value creation.

This concludes our question-and-answer session. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.