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TEN > SEC Filings for TEN > Form 10-Q on 6-Nov-2012All Recent SEC Filings

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Form 10-Q for TENNECO INC


6-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As you read the following review of our financial condition and results of operations, you should also read our condensed consolidated financial statements and related notes beginning on page 6.

Executive Summary

We are one of the world's leading manufacturers of emission control and ride control products and systems for light, commercial and specialty vehicle applications. We serve both original equipment (OE) vehicle designers and manufacturers and the repair and replacement markets, or aftermarket, globally through leading brands, including Monroe ®, Rancho®, Clevite® Elastomers, Marzocchi®, Axios™, Kinetic™ and Fric-Rot™ ride control products and Walker ®, Fonos™, DynoMax®, Thrush™ and Lukey™ emission control products. We serve more than 64 different original equipment manufacturers and commercial vehicle engine manufacturers, and our products are included on nine of the top 10 car models produced for sale in Europe and nine of the top 10 light truck models produced for sale in North America for 2011. Our aftermarket customers are comprised of full-line and specialty warehouse distributors, retailers, jobbers, installer chains and car dealers. As of December 31, 2011, we operated 87 manufacturing facilities worldwide and employed approximately 24,000 people to service our customers' demands.

Factors that continue to be critical to our success include winning new business awards, managing our overall global manufacturing footprint to ensure proper placement and workforce levels in line with business needs, maintaining competitive wages and benefits, maximizing efficiencies in manufacturing processes and reducing overall costs. In addition, our ability to adapt to key industry trends, such as a shift in consumer preferences in response to higher fuel costs and other economic and social factors, increasing technologically sophisticated content, changing aftermarket distribution channels, increasing environmental standards and extended product life of automotive parts, also play a critical role in our success. Other factors that are critical to our success include adjusting to economic challenges such as increases in the cost of raw materials and our ability to successfully reduce the impact of any such cost increases through material substitutions, cost reduction initiatives and other methods.

For the third quarter of 2012, light vehicle production was up 14 percent in North America, seven percent in Australia, six percent in China, and two percent in South America. Light vehicle production was down in the third quarter of 2012 when compared to the third quarter of 2011 by six percent in Europe and three percent in India.

We have a substantial amount of indebtedness. As such, our ability to generate cash - both to fund operations and service our debt - is also a significant area of focus for our Company. See "Liquidity and Capital Resources" below for further discussion of cash flows and Item 1A, "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Total revenues for the third quarter of 2012 were $1,778 million slightly up from $1,773 million in the third quarter of 2011. Excluding the impact of currency and substrate sales, revenue was up $89 million, or 6 percent, from $1,373 million to $1,462 million, driven primarily by strong OE light vehicle production volumes in North America and China and incremental commercial vehicle business revenues globally.

Cost of sales: Cost of sales for the third quarter of 2012 was $1,494 million, or 84.0 percent of sales, compared to $1,492 million, or 84.2 percent of sales in the third quarter of 2011. The following table lists the primary drivers behind the change in cost of sales ($ millions).

                   Quarter ended September 30, 2011   $ 1,492
                   Volume and mix                          71
                   Material                               (12 )
                   Currency exchange rates                (73 )
                   Other Costs                             16

                   Quarter ended September 30, 2012   $ 1,494


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The increase in cost of sales was due primarily to the year-over-year increase in production volumes, other costs, mainly manufacturing, partially offset by lower material costs and the impact of foreign currency exchange rates.

Gross margin: Revenue less cost of sales for the third quarter of 2012 was $284 million, or 16.0 percent, versus $281 million, or 15.8 percent in the third quarter of 2011. The effects on gross margin resulting from higher volumes and material cost management were partially offset by a higher mix of OE revenues, negative currency and higher manufacturing costs.

Engineering, research and development: Engineering, research and development expense was $28 million and $32 million in the third quarters of 2012 and 2011, respectively. Increased engineering cost recoveries and a stronger U.S. dollar drove the decrease in expense year-over-year.

Selling, general and administrative: Selling, general and administrative expense was down $7 million in the third quarter of 2012, at $94 million, compared to $101 million in the third quarter of 2011. A $5 million benefit from property recoveries related to transactions originated by The Pullman Company before being acquired by Tenneco in 1996 and the stronger U.S. dollar primarily drove the decrease in expense year-over-year.

Depreciation and amortization: Depreciation and amortization expense in the third quarter of 2012 was $49 million, compared to $51 million in the third quarter of 2011 primarily due to a stronger U.S. dollar.

Goodwill impairment: There were no goodwill impairment charges in the third quarter of 2012. In August 2011, we performed an impairment evaluation of our Australian reporting unit's goodwill balance as a result of continued deterioration of that reporting unit's financial performance driven primarily by significant declines in industry production volumes in that region. As a result of our impairment evaluation, we concluded that the remaining amount of goodwill related to our Australian reporting unit was impaired and accordingly, we recorded a goodwill impairment charge of $11 million during the third quarter of 2011.

Earnings before interest expense, taxes and noncontrolling interests ("EBIT") were $111 million for the third quarter of 2012, an improvement of $27 million when compared to $84 million in the third quarter of the prior year. Stronger light vehicle production volumes in North America and China, the related fixed manufacturing cost absorption, incremental commercial vehicle business, effective operational cost control, which included decreased material costs net of recoveries partially offset by increased manufacturing costs, a benefit of $5 million from property recoveries related to transactions originated by The Pullman Company before being acquired by Tenneco in 1996, higher engineering cost recoveries, and no goodwill impairment charges drove the year-over-year increase to EBIT. Partially offsetting the increase were higher restructuring and related expenses and $2 million of negative currency.

Total revenues for the first nine months of 2012 were up three percent to $5,610 million from $5,421 million for the first nine months of 2011. Excluding the impact of currency and substrate sales, revenue was up $385 million, from $4,163 million to $4,548 million, driven by higher year-over-year OE vehicle production levels, incremental commercial vehicle revenue and higher North American aftermarket sales.

Cost of sales: Cost of sales for the first nine months of 2012 was $4,696 million, or 83.7 percent of sales, compared to $4,523 million, or 83.4 percent of sales in the first nine months of 2011. The following table lists the primary drivers behind the change in cost of sales ($ millions).

                 Nine months ended September 30, 2011   $ 4,523
                 Volume and mix                             348
                 Material                                   (10 )
                 Currency exchange rates                   (210 )
                 Other Costs                                 45

                 Nine months ended September 30, 2012   $ 4,696


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The increase in cost of sales was due primarily to the year-over-year increase in production volumes, and other costs, mainly manufacturing, partially offset by lower material costs and the impact of foreign currency exchange rates.

Gross margin: Revenue less cost of sales for the first nine months of 2012 was $914 million, or 16.3 percent, versus $898 million, or 16.6 percent in the first nine months of 2011. The effect on gross margin resulting from higher volumes and material cost management were more than offset by a higher mix of OE revenues, negative currency and higher manufacturing costs.

Engineering, research and development: Engineering, research and development expense was $94 million and $102 million in the first nine months of 2012 and 2011, respectively. Increased spending to support customer programs, technology applications, and growth in emerging markets were more than offset by increased engineering cost recoveries and a strong U.S. dollar which drove the decrease in expense year-over-year.

Selling, general and administrative: Selling, general and administrative expense was $321 million and $328 million in the first nine months of 2012 and 2011, respectively. Increased costs due to investments in new facilities in China and Thailand were more than offset by reduced stock-indexed compensation, lower aftermarket changeover costs, and a $5 million benefit from property recoveries related to transactions originated by The Pullman Company before being acquired by Tenneco in 1996.

Depreciation and amortization: Depreciation and amortization expense in the first nine months of 2012 was $148 million, compared to $156 million in the first nine months of 2011 primarily due to a stronger U.S. dollar.

Goodwill impairment: There were no goodwill impairment charges in the first nine months of 2012. We recorded a goodwill impairment charge of $11 million during the first nine months of 2011.

EBIT was $344 million for the first nine months of 2012, an improvement of $53 million, when compared to $291 million in the first nine months of 2011. Higher light vehicle OE production volumes, the related fixed manufacturing cost absorption, incremental commercial vehicle business, higher North American aftermarket sales, a $5 million benefit from property recoveries related to transactions originated by The Pullman Company before being acquired by Tenneco in 1996, increased engineering cost recoveries and no goodwill impairment charges drove the year-over-year increase to EBIT. Partially offsetting the increase were higher costs due to investments in new facilities in China and Thailand, unfavorable pricing, primarily related to contractual price reductions, higher restructuring and related expenses, increased manufacturing and freight expenses and negative currency of $19 million.

Results from Operations

Net Sales and Operating Revenues for the Three Months Ended September 30, 2012 and 2011

The following tables reflect our revenues for 2012 and 2011. We present these reconciliations of revenues in order to reflect the trend in our sales in various product lines and geographic regions separately from the effects of doing business in currencies other than the U.S. dollar. We have not reflected any currency impact in the 2011 table since this is the base period for measuring the effects of currency during 2012 on our operations. We believe investors find this information useful in understanding period-to-period comparisons in our revenues.

Additionally, we show the component of our revenue represented by substrate sales in the following tables. While we generally have primary design, engineering and manufacturing responsibility for OE emission control systems, we do not manufacture substrates. Substrates are porous ceramic filters coated with a catalyst - precious metals such as platinum, palladium and rhodium. These are supplied to us by Tier 2 suppliers as directed by our OE customers. We generally earn a small margin, intended to cover handling costs, on these components of the system. As the need for more sophisticated emission control solutions increases to meet more stringent environmental regulations, and as we capture more diesel after treatment business, these substrate components have been increasing as a percentage of our revenue. While these substrates dilute our gross margin percentage, they are a necessary component of an emission control system. We view the growth of substrates as a key indicator that our value-add content in an emission control system is moving toward the higher technology hot-end gas and diesel business.


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Our value-add content in an emission control system includes designing the system to meet environmental regulations through integration of the substrates into the system, maximizing use of thermal energy to heat up the catalyst quickly, efficiently managing airflow to reduce back pressure as the exhaust stream moves past the catalyst, managing the expansion and contraction of the emission control system components due to temperature extremes experienced by an emission control system, using advanced acoustic engineering tools to design the desired exhaust sound, minimizing the opportunity for the fragile components of the substrate to be damaged when we integrate it into the emission control system and reducing unwanted noise, vibration and harshness transmitted through the emission control system.

We present these substrate sales separately in the following table because we believe investors utilize this information to understand the impact of this portion of our revenues on our overall business and because it removes the impact of potentially volatile precious metals pricing from our revenues. While our original equipment customers generally assume the risk of precious metals pricing volatility, it impacts our reported revenues. Excluding substrate catalytic converter and diesel particulate filter sales removes this impact.

                                                          Three Months Ended September 30, 2012
                                                                                                           Revenues
                                                                                        Substrate          Excluding
                                                                      Revenues            Sales          Currency and
                                                    Currency          Excluding         Excluding          Substrate
                                    Revenues         Impact           Currency          Currency             Sales
                                                                       (Millions)
North America Original
Equipment
Ride Control                       $      160       $       -        $       160       $         -       $         160
Emission Control                          537               -                537               227                 310

Total North America Original
Equipment                                 697               -                697               227                 470
North America Aftermarket
Ride Control                              139               1                138                 -                 138
Emission Control                           55               -                 55                 -                  55

Total North America
Aftermarket                               194               1                193                 -                 193
Total North America                       891               1                890               227                 663
Europe Original Equipment
Ride Control                              112             (13 )              125                 -                 125
Emission Control                          328             (38 )              366               131                 235

Total Europe Original
Equipment                                 440             (51 )              491               131                 360
Europe Aftermarket
Ride Control                               50              (6 )               56                 -                  56
Emission Control                           29              (3 )               32                 -                  32

Total Europe Aftermarket                   79              (9 )               88                 -                  88
South America & India                     140             (28 )              168                24                 144
Total Europe, South America &
India                                     659             (88 )              747               155                 592
Asia                                      186               2                184                17                 167
Australia                                  42              (1 )               43                 3                  40

Total Asia Pacific                        228               1                227                20                 207

Total Tenneco                      $    1,778       $     (86 )      $     1,864       $       402       $       1,462


Table of Contents
                                                            Three Months Ended September 30, 2011
                                                                                                              Revenues
                                                                                           Substrate          Excluding
                                                                         Revenues            Sales          Currency and
                                                       Currency          Excluding         Excluding          Substrate
                                     Revenues           Impact           Currency          Currency             Sales
                                                                         (Millions)
North America Original
Equipment
Ride Control                        $      149        $         -       $       149       $         -       $         149
Emission Control                           500                  -               500               225                 275

Total North America Original
Equipment                                  649                  -               649               225                 424
North America Aftermarket
Ride Control                               133                  -               133                 -                 133
Emission Control                            60                  -                60                 -                  60

Total North America Aftermarket            193                  -               193                 -                 193
Total North America                        842                  -               842               225                 617
Europe Original Equipment
Ride Control                               138                  -               138                 -                 138
Emission Control                           335                  -               335               117                 218

Total Europe Original Equipment            473                  -               473               117                 356
Europe Aftermarket
Ride Control                                57                  -                57                 -                  57
Emission Control                            35                  -                35                 -                  35

Total Europe Aftermarket                    92                  -                92                 -                  92
South America & India                      162                  -               162                26                 136
Total Europe, South America &
India                                      727                  -               727               143                 584
Asia                                       159                  -               159                28                 131
Australia                                   45                  -                45                 4                  41

Total Asia Pacific                         204                  -               204                32                 172

Total Tenneco                       $    1,773        $         -       $     1,773       $       400       $       1,373


Table of Contents
                                                           Three Months Ended September 30, 2012
                                                        Versus Three Months Ended September 30, 2011
                                                           Dollar and Percent Increase (Decrease)
                                                                                     Revenues
                                                                                     Excluding
                                                                                   Currency and
                                                                                     Substrate
                                           Revenues            Percent                 Sales             Percent
                                                             (Millions Except Percent Amounts)
North America Original Equipment
Ride Control                               $      11                  7 %          $          11                7 %
Emission Control                                  37                  7 %                     35               13 %

Total North America Original Equipment            48                  7 %                     46               11 %
North America Aftermarket
Ride Control                                       6                  5 %                      5                4 %
Emission Control                                  (5 )               (8 )%                    (5 )             (8 )%

Total North America Aftermarket                    1                  1 %                     -                -
Total North America                               49                  6 %                     46                7 %
Europe Original Equipment
Ride Control                                     (26 )              (20 )%                   (13 )            (10 )%
Emission Control                                  (7 )               (2 )%                    17                8 %

Total Europe Original Equipment                  (33 )               (7 )%                     4                1 %
Europe Aftermarket
Ride Control                                      (7 )               (9 )%                    (1 )             (2 )%
Emission Control                                  (6 )              (19 )%                    (3 )            (12 )%

Total Europe Aftermarket                         (13 )              (13 )%                    (4 )             (3 )%
South America & India                            (22 )              (14 )%                     8                5 %
Total Europe, South America & India              (68 )               (9 )%                     8                1 %
Asia                                              27                 17 %                     36               27 %
Australia                                         (3 )               (5 )%                    (1 )             (2 )%

Total Asia Pacific                                24                 12 %                     35               20 %

Total Tenneco                              $       5                  0 %          $          89                6 %


Table of Contents

Light Vehicle Industry Production by Region for Three Months Ended September 30, 2012 and 2011 (According to IHS Automotive, October 2012)

                                                           Three Months Ended September 30,
                                                                             Increase           % Increase
                                              2012             2011         (Decrease)          (Decrease)
                                                           (Number of Vehicles in Thousands)
North America                                   3,631           3,182               449                  14 %
Europe                                          4,273           4,541              (268 )                (6 )%
South America                                   1,168           1,148                20                   2 %
India                                             858             881               (23 )                (3 )%

Total Europe, South America & India             6,299           6,570              (271 )                (4 )%
China                                           4,338           4,091               247                   6 %
Australia                                          67              63                 4                   7 %

Total revenues for the third quarter of 2012 were $1,778 million ($324 million in aftermarket revenues and $1,454 million in original equipment revenues), slightly up from $1,773 million ($339 million in aftermarket revenues and $1,434 million in original equipment revenues).

North American light vehicle production increased 14 percent, while industry Class 8 commercial vehicle production was up nine percent and industry Class 4-7 commercial vehicle production was up seven percent in the third quarter of 2012 when compared to the third quarter of last year. Revenues from our North American operations increased in 2012 compared to last year's third quarter due to higher OE sales of both business units. Aftermarket revenues were even with last year's third quarter. The increase in North American OE revenues was primarily driven by improved production volumes, which accounted for $44 million of the year-over-year change in revenues, on Tenneco-supplied vehicles. Also contributing to the increase was a five percent increase in commercial vehicle OE revenues year-over-year. The increase in ride control aftermarket revenue for North America was primarily due to higher volumes and price increases which were offset by lower emission controls volumes.

Our European, South American and Indian segment's revenues decreased in the third quarter of 2012 compared to the third quarter of last year, due to decreased sales in all European OE and aftermarket business units, as well as in South America. In the third quarter of 2012, total European light vehicle industry production was down six percent, and industry Class 8 commercial vehicle production was down nine percent while industry Class 4-7 commercial vehicle production was down two percent when compared to the third quarter of 2011. Currency negatively impacted Europe OE revenues by $51 million and also negatively impacted European aftermarket revenues by $9 million year-over-year. Excluding currency, Europe OE revenues improved due to higher volumes of $20 million as well as the ramp-up on commercial vehicle programs. Excluding currency, European ride control aftermarket revenues were down compared to last . . .

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