Executives
Mark Oswald - Director of Investor Relations
John C. Plant - President, Chief Executive Officer, Director
Joseph S. Cantie - Chief Financial Officer, Executive Vice President
Analysts
Himanshu Patel - J.P. Morgan
Rod Lache - Deutsche Bank Securities
Chris Ceraso - Credit Suisse
Brett Hoselton - KeyBanc Capital Markets
John Murphy - Merrill Lynch
TRW Automotive Holdings Corp. (TRW) Q3 2008 Earnings Call October 30, 2008 8:00 AM ET
Operator
Welcome to the TRW conference call. All lines have been placed on listen-only mode. As a reminder, this conference call is being recorded. Presentation material for today’s call was posted to the company’s website this morning at www.trw.com/results. Please download the material now if you have not already done so. After the speakers’ remarks there will be a question and answer period. Due to today’s limitation on time, the company requests that participants limit follow up questions to one per caller. (Operator Instructions)
I would now like to introduce your host for today’s conference call, Mark Oswald, Director of Investor Relations.
Mark Oswald
I’d like to welcome everyone to our third quarter financial results conference call. Let me start by introducing myself. My name is Mark Oswald and I recently joined TRW as the Director of Investor Relations. Prior to joining TRW I spent 14 years at Ford Motor Company in various finance positions so I’m very familiar with the automotive industry. I’m excited about joining TRW and look forward to working with you as members of the investment community.
Joining me today are John Plant, our President and Chief Executive Officer, and Joe Cantie, our Chief Financial Officer. On today’s call John will provide an overview of the financial results and discuss other business related matters including an updated full-year outlook. After John’s comments Joe will provide an expanded review of the financial information. Then we’ll open the call to your questions.
There are a few items I’d like to cover before getting started. First, today’s conference call will include forward-looking statements. These statements are based on the environment as we see it today and therefore involve risks and uncertainties. I would caution you that our actual results could differ materially from the forward-looking statements made on this call. Please refer to slide 3 of the presentation for our complete Safe Harbor statement. The Risk Factors section of our 2007 Form 10K and our second quarter 2008 10Q contain additional information about risks and uncertainties that could impact our business. You can access a copy of our 2007 10K and 2008 quarterly SEC filings by visiting the Investor Information section on our website at www.trw.com or through the SEC’s website at www.sec.gov.
On a related matter, we expect to file our third quarter 10Q within the next day or so. Once filed the 10Q can also be accessed through either website.
In addition to the financial results presented on a GAAP basis we will be discussing non-GAAP information that we believe is useful in evaluating the company’s operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found on the conference call materials which are posted on the Investor Information section of our website at www.trw.com.
Finally, a replay of this call can be accessed via dial-in or through a webcast on our website. Replay instructions were included in the release this morning. We have not given permission for any other recordings of this call and do not approve or sanction any transcribing of the call.
This concludes my comments. I’ll now turn the call over to John Plant.
John C. Plant
We indicated in our October 7 pre-earnings announcement that this is a very stressed period for the automotive industry. In addition to sharply lower vehicle production levels in North America and Western Europe, the fallout surrounding the uncertain financial markets continues to loom over the industry as consumers’ ability to purchase new cars is limited.
As you can see from the results posted this morning, these volume and other charges contributed to TRW’s third quarter performance that was below our expectations discussed during the last call with you only three months ago. As a result we have and will continue to take the appropriate actions that you would expect in this environment in an attempt to mitigate the challenges.
Since our last conference call on the 31st of July the environment has deteriorated. Firstly, both actual and forecasted levels of vehicle production in Europe and North America have declined. The mix shift away from pickup trucks and sport utility vehicles to smaller and more fuel-efficient cars in North America and to smaller cars in Europe continues.
Also included in our financials is the increased level of restructuring charges that we take as additional actions to ensure the business is aligned with the changing market conditions.
Also commodity inflation as mentioned on our last call is having a greater impact on our bottom line compared with the first half results. I’ll discuss this and other challenges in more detail in a moment.
Despite the difficult environment we remain focused on advancing our strategic priorities. The four priorities remain: Achieving world-class quality, leveraging our global reach, investing in technology and continuing our relentless efforts to reduce costs. We continue to make solid progress on advancing these priorities.
Before discussing the specific actions, let me provide you with a brief financial overview of where we finished the quarter and the first nine months of the year. Joe will provide greater details during his financial review.
Third quarter sales of $3.6 billion were up 2.8% compared to the prior year period. Similar to second quarter results foreign currency translation and increased module sales drove the year-over-year increase in sales. Excluding these two items our sales declined by 9% which was the primary reason for the lower profit levels compared to prior year.
On the bottom line the company reported a third quarter loss of $54 million or $0.53 per diluted share reflecting the decline in core sales and a higher level of restructuring charges and taxes. These results are clearly disappointing; however they need to be viewed in the light of the industry back cloth and TRW’s determination to continue with business strategies that will improve the long-term competitiveness of the company.
In the third quarter as compared to last year vehicle production was down in North America and Europe, our two primary markets. In North America vehicle production was down by 16% with the Detroit three down a staggering 23%. One other important production statistic was that light truck production declined by some 32% while cars were up 4%. As you can imagine, the magnitude of the vehicle production decline and the mix shift has had a significant impact.
Through the first half of 2008 Europe held strong, provided TRW with a base to mitigate the troubles we were experiencing in North America. However Europe sales and production have now dropped faster and deeper than our original expectations. In Western Europe production was down 9% for the quarter compared to the same period a year ago. Europe is also experiencing a shift in sales from large and mid-size passenger cars to smaller cars which again is an unfavorable mix of value.
During the quarter we have also seen signs of softening in the emerging and high-growth markets of the world such as China, India, Russia and now South America.
Clearly this is a difficult production picture for the third quarter and we see this continuing for some time.
With respect to the year-to-date results, our sales were $12.2 billion, an increase of 12.6% driven by currency and modules. We posted year-to-date net earnings of $1.63 per share compared to $1.84 per share in the prior year excluding the debt retirement costs in 2007.
Turning now to third quarter business developments. During the quarter we had a high level of product launches which continued to strengthen our leading product and customer diversification. As an example, recent product launches in Europe allow us to participate in the mix shift to smaller cars and the demand for added safety features. Examples include the electric park brake on the [Renomigan] and driving curtains and side airbags for the Ford car.
With regard to innovative technology, we continue to offer leading edge systems and products that add value for our customers. During the quarter we highlighted the electrically powered hydraulic steering or EPHS system for light commercial vehicles at the truck showcase in Hanover. The steering system can offer fuel savings and reduce CO3 emissions and was recently launched on the Citroen Berlinger and the Persia Partner Bands.
Another example is a second generation slip control boost brake technology which was recently unveiled. This technology provides a 25% smaller and lighter electronically controlled hydraulic unit which is ideal for regenerative and low vacuum power train vehicles. This innovative brake technology improves fuel economy and reduced CO3 emissions.
The first generation product is in production on GM’s Chevrolet Tahoe and the GMC Yukon Hybrids.
Finally, we introduced active buckle lifter. This product is designed to make fastening seatbelts easier. In particular the feature is intended to assist the elderly and people with mobility challenges as they get into the vehicle.
Turning to the cost structure of the company. As you know we routinely review the cost base and restructure the business as appropriate to ensure TRW’s competitiveness. Our efforts on this front intensified during the third quarter as a result of significant production declines in North America and now Europe. We have and will continue to take timely and aggressive actions to ensure the business is aligned with the new realities of the markets.
Since the beginning of the third quarter we have initiated a number of actions focused on restructuring the business.
We finalized and in fact closed a seatbelt plant in Austria which had already been announced allowing us to move business to our plants in Eastern Europe. This plant is expected to close by the end of 2008. We also closed a module plant in St. Louis that supported a Chrysler assembly facility.
We have initiated a number of headcount actions across several locations in both North America and Europe. Most of these actions which were conceived commenced in the third quarter and most of the programs will be finalized by the end of the financial year. With these programs we have reduced our North American salary positions since the beginning of the year by approximately 18% or 1,200 heads through separation of employees, contractors and general attrition. In North America direct and indirect hourly labor positions have also been reduced by some 2,700 during the same period.
As a result of the actions we have taken, our restructuring and asset impairment expenses were some $32 million in the third quarter which is an increase of $19 million compared to last year. Our full-year estimate for restructuring expenses related to known projects is now approximately $95 million which is an increase of $20 million compared to the previous guidance. This is due to the headcount initiatives that have already commenced and plan to be completed by the end of the year.
We’ve continued to look at other possible programs that may be necessary as we advance our work to address the cost space and to better understand customers’ future vehicle plans. Separate from restructuring we continue to focus on sig sigma and business excellence programs to ensure efficiencies are incorporated in our day-to-day operations. We have made significant progress improving the efficiency over the last few years and are focused on continuing this progress.
As I indicated earlier, the challenges from commodity inflation have also intensified during the quarter. During our second quarter call we anticipated the gross full-year impact of commodity inflation to be about $150 million with the majority of costs incurred during the third and fourth quarters. During the third quarter commodity inflation was about $60 million and higher than the previous year by some $30 million. We continue to aggressively work to mitigate inflation through actions such as product changes, efficiency initiatives to supply chain management, and ultimate customer recoveries.
The recent decline of certain quoted commodity spot rates and the strengthening dollar are providing hope that commodity prices will level off and now decrease. It is too early to say whether the price moderations are sustainable and in any event the benefits of the declining commodity costs that we are now seeing will not accrue to the company until 2009 given the time lag that occurs during this process.
For the remainder of 2008 we will continue to have a negative commodity pricing effect. For the full year we now expect to see the gross commodity impact of inflation to be approximately $170 million.
Regarding our expectations for the balance of the year. For production; earlier in my comments I discussed the decline in vehicle production that occurred in the third quarter. Unfortunately we are experiencing a further worsening of volumes for the fourth quarter.
In North America we now expect full-year production to be 12.9 million vehicles for the year which is a decline of 15% compared to 2007. This will be a reduction in the fourth quarter of some 19%. Within this estimate the Detroit 3 production is projected to be 7.7 million units, a decrease of 20% compared to last year. In terms of truck to car shift we are expecting that within the 12.9 million units of production there will be 24% fewer light trucks and 2% fewer cars compared to last year.
In Europe which held up relatively well during the first half of the year, this is now showing significant weakness primarily in Western Europe. For the full year we now expect vehicle production of 21.5 million units for total Europe. Within this estimate Western European production is 14.8 million units, a decline of about 6% but with a decline in the fourth quarter of some 15%.
Beyond North America and Western Europe sales and production levels with the high growth countries of the world such as Russia, China, India and South America also showing signs of slowing.
Reflecting on the full production outlook I just described, the impact on TRW for the remainder of 2008 is only partially mitigated by cost reduction actions and restructuring activities in the short term.
The decreases in vehicle production in all regions, commodity inflation, currency movements and uncertainty surrounding the global financial markets are reflected in our guidance today. Based on our assessment of the industry at this time we expect sales to be approximately $15.3 billion for 2008 reflecting low production levels and currency movements. This is $1.1 billion to $1.5 billion below our prior sales guidance. We expect our earnings per share to be in the range of $0.90 to $1.10.
Our estimate for pre-tax restructuring expenses has been raised to approximately $95 million. These restructuring costs are reflected in our numbers as a normal business expense. Capital spending will decrease in absolute dollars and remain at approximately 3.5% of the reduced sales. Finally we now expect full-year effective tax rate to exceed 50%.
As you can tell from this guidance, the second half of 2008 will be the worst six-month period we have faced since becoming an independent company. In addition to the impact of falling sales, charges related to the required restructuring to put ourselves in better shape for 2009 will result in TRW having net losses in the third and fourth quarters.
With regard to 2009 we have not yet finalized our operating income assumptions. However we do know that production for both North America and Europe will almost certainly be down in 2009 compared to 2008. The strengthening dollar will also have a negative impact on the business. We plan to discuss our 2009 assumptions with you when we report on our 2008 full-year results early next year.
In summary, of course I wish I had a better near-term outlook to discuss with you today. But as I said at the beginning of my comments, it’s an extraordinary time in the automotive industry and we want to have a clear sense of reality. It’s important for our current and prospective investors to recognize that TRW’s a strong growable franchise that is well diversified with strong technology and leading market positions. We will prevail through these short-term challenges and remain a leading supplier to the world car manufacturers.
With that I’ll now hand the call to Joe to discuss our financial results in further detail.
Joseph S. Cantie
As you can see from the results we issued this morning, several factors including lower global production, commodity inflation, increased restructuring expenses and tax expense despite a loss contributed to the weak quarter. We anticipate many of the headwinds that intensified during the third quarter will continue and even worsen through the fourth quarter and well into 2009.
I’ll expand on our guidance for the remainder of 2008 in a few minutes. First, let me review in more detail with you our third quarter and year-to-date results.
For the third quarter we reported sales of $3.6 billion, an increase of $97 million or 2.8% when compared to the prior year amounts. However excluding the effects of currency and the increase in module sales between quarters, both of which contributed an immaterial amount to profits, our third quarter sales declined about $300 million.
The loss contribution margin on this $300 million sales decline was the main reason behind our decline in operating profit for the quarter compared to last year. The lower level of sales resulted directly from the reduced production volumes discussed earlier by John. For completeness, currency translation benefited sales by $232 million and our modules sales increased $164 million compared to last year.
Unlike every quarter for the last few years, at current exchange rates currency translation will have a negative effect on sales beginning in the fourth quarter of 2008. As a reminder, the Euro to dollar exchange rate averaged $1.45 in last year’s fourth quarter.
Last comment on sales. Excluding the effects of currency and modules, our sales for the quarter were down 22% in North America, 5% in Europe and 2% in the rest of the world regions.
Moving down the income statement, operating income in the quarter was $12 million which is $83 million below the previous year. There were a number of factors that contributed to this decline, the largest of which was the lost contribution on the lower level of core sales I just mentioned.
In addition, restructuring and asset impairment expenses increased by $19 million between the two quarters. The positive effects of higher module sales as well as the benefits of cost reduction and restructuring programs were essentially offset by unmitigated commodity inflation, price reductions, negative currency impacts and other items.
Each of our three reporting segments reflect the lower level of core sales and profitability resulting in lower margins in the quarter compared to last year.
Below operating income, net interest and securitization expense was $43 million which is significantly below last year’s level of $56 million due to lower interest rates. For the fourth quarter we expect interest expense of approximately $50 million which is higher than our Q3 expense as a result of recent spikes in the LIBOR rates and five additional calendar days in the fourth quarter compared to our third quarter.
Tax expense for the third quarter was $23 million despite a loss before income taxes. The expense for the quarter results from earnings in certain profitable jurisdictions while the company has not recognized a tax benefit from losses in certain other jurisdictions. In addition there is a true up element in the quarter for the updated estimate of our full-year tax position. For the full year the effective tax rate is now expected to exceed 50% and is highly dependent upon our overall level of pre-tax earnings and the location of those earnings.
At the bottom line we posted a GAAP net loss of $0.53 per share compared with earnings of $0.22 per share in the 2007 period.
Finally, in terms of EBITDA we had $157 million for the quarter compared with $237 million for the prior year. Both of those numbers are after the restructuring expenses that we took in both quarters.
If we look at the year-to-date results for the nine-month period, we reported sales of $12.2 billion which is an increase of $1.4 billion or 12.6% compared with the same period last year. Currency translation accounted for about $1 billion of the variance and the increase in modules sales totaled $741 million. Excluding these two items, sales declined by 3.5% reflecting the steep decline in our third quarter sales.
Our operating income in the first nine months was $424 million which compares to $475 million in 2007. Again, a number of factors led to this decline including a $32 million increase in restructuring and asset impairment charges and one-off income items in the prior year that did not reoccur in 2008.
Below operating income, interest related expense was about $136 million in 2008 compared to $177 million last year. The decrease is due to the debt restructuring that took place in 2007 and lower interest rates between the two periods.
Tax expense for the nine-month period was $126 million or an effective tax rate of 43% which compares to $116 million in 2007. At the bottom line we reported GAAP net earnings of $1.63 per share which compares to net earnings of $1.84 per share in the previous year after excluding debt retirement expenses from last year. Finally, in terms of EBITDA we had $874 million this year compared to $890 million in the prior year.
Moving now to our capital structure. Overall we continue to be in very good shape. At quarter end our net debt outstanding was $2.7 billion which is a decrease of $297 million compared to the end of the prior year third quarter. We have no significant maturities of debt until 2012 and have liquidity available to us of approximately $1.5 billion. Our main source of liquidity is our revolver under our credit facilities which has a broad underwriting bank group. We had only minor exposure to Lehman Brothers which resulted in a loss of less than $30 million of our liquidity.
For the quarter operating cash flow was $79 million which compares to a use of $31 million in 2007 excluding a pay-down of an outstanding receivables facility draw in the prior year. As you can see our cash flow in the quarter was very good compared to last year despite our lower level of earnings. For the nine-month period net cash flow from operating activities was $4 million which compares favorably to a use of $89 million in the previous year. So in terms of cash flow, at the end of the third quarter we are ahead of where we were at this point last year.
Cap ex in the third quarter totaled $121 million which compares to $111 million in t he prior year. For the nine-month period cap ex was $338 million which is approximately the same as last year.
Switching subjects now to our expectations for the fourth quarter, John provided the full-year guidance and discussed the difficult industry conditions we are currently facing. To be frank, our sales volumes have reduced sharply for the fourth quarter. It’s not only the decline in absolute units but the cars that are being built are the smaller vehicles that carry less content with lower profitability for TRW.
Based on current forecasts our fourth quarter sales should be approximately $3.1 billion which is $800 million lower compared with last year’s fourth quarter. The contribution margin lost on these sales will be significant. The sales level is based on industry production of about 5 million units in Europe including Eastern Europe and 3 million units in North America which incorporates a 32% decline in light truck volumes compared to last year.
As John mentioned, the known restructuring actions we are currently implemented results in our guidance of approximately $95 million of expenses for the full year or about $30 million for the fourth quarter. We are continuing to look at other actions that will be necessary in reaction to the current environment which will most likely lead to additional restructuring charges and asset impairments that are not incorporated in our guidance today.
The last guidance item I’d like to discuss is taxes. As was the case in the third quarter despite having an expected loss before taxes, we will have tax expense in the fourth quarter given our geographic mix of earnings and our inability to recognize tax benefits associated with certain loss jurisdictions. As indicated earlier, the full-year effective tax rate is now expected to exceed 50%.
Our bottom line earnings per share guidance for the full year of $0.90 to $1.10 implies that we expect a net loss for the fourth quarter.
As you can tell from our comments today, the challenges that intensified over the past three months are expected to continue in the fourth quarter of 2008 and into 2009. We continue to work hard to mitigate those challenges as we navigate through this unprecedented time period in the automotive industry.
That completes my prepared comments. We’ll now move to the question and answer portion of the call.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from Himanshu Patel - J.P. Morgan.
Himanshu Patel - J.P. Morgan
Do you guys have any initial thoughts on the scope of restructuring expense for 2009 that may be involved?
John C. Plant
It’s a bit premature to say at this point. If you look at generally what we do, we tend to be very fast in addressing market conditions. So if you look at what we’ve already done since the view in the first half of this year, we have significantly increased our restructuring. As an example, in the October timeframe we looked at taking out an additional almost 1,000 salaried heads and in fact 70% of that will be completed by the end of this week. I think that generally speaking we have called it early, get on with it and execute and not make broad announcements. We didn’t make an announcement. We just executed.
I’m not saying to you that we are done at this point. I think that we’ll continue to examine the overall cost space and we will either take additional actions in the fourth quarter if we think we need to or in the early part of next year. I’m hoping that if we take the actions which we’ve taken already, we already completed them, and the ones which we could contemplate to readdress the lower levels of production, I’m hoping that the significant portion of that will be behind us within the next six months.
At this point I would imagine that the 2009 restructuring as we see it today should be lower than 2008. But it’s a bit premature to be able to really define that at this point in time.
Himanshu Patel - J.P. Morgan
It sounds like the trajectory you’re talking about is elevated restructuring expense for second half ’08 and maybe into early ’09 and then maybe tapering down into sort of a level more consistent with first half ’08 by the end of ’09. Is that a fair characterization?
John C. Plant
I think that’d be fair. Absolutely because we’re going to right size the operation. You’ve already seen we’ve actually taken quite a dramatic step already and as I said 70% is completed by tomorrow of the almost 1,000 salaried managers and directors. Everything we’re going to do to right size the organization I think the majority will be completed within six months.
Himanshu Patel - J.P. Morgan
Two last questions. Joe, on the cash flow can you just help us again during periods of volume declines, should we think of working capital as being a source for you guys next year or is that too early to call right now?
Joseph S. Cantie
Too early to call because it depends on which geography, which customer but generally speaking you’re right on the theory. As volumes come down, your working capital should come in. The comment I’ll make sure I highlight to you is if we go through a period here where sales decline clearly in the first half of ’09, your working capital comes in but if sales all of a sudden pick up in the fourth quarter next year, you’re going to end the year with working capital usage. Quite frankly I’m hoping that’s going to be the case where the sales and production rebound by this time next year. Obviously if it doesn’t, then we’ve got working capital inflow.
Himanshu Patel - J.P. Morgan
Any initial thoughts on European industry production for ’09?
John C. Plant
We read your reports of 19 million. Clearly it’s going to be reduced form this year but I’m not sure yet we’re ready to say it’s 19. We’re going through that evaluation at the moment and trying to pick the right levels as a blend for the world so we have been fairly pessimistic on the US.
We’ve got to be very cautious on Europe for sure because we tend to be at the [inaudible] area. We thought we were this year but quite honestly I will say the fourth quarter declines in Europe were something which we did not [inaudible] a few months ago. But next year we’ll have a very cautious build assumption and probably in other parts of the world as well.
So we’re going to right size the operation and our goal is to generate income, operating income for sure to lower levels.
Joseph S. Cantie
I’ll just add that clearly we’re going to be talking with all of our customers as well in trying to get the best information we can to set that, and the reason we’re not being more expansive today is this stuff is moving so rapidly every week that I’m lucky that we were able to provide you a fourth quarter view on what production is going to be. It’s just too early for us to try to take a reasonable stab at 2009 right now.
Himanshu Patel - J.P. Morgan
And Joe that was actually part of my question. Are things still moving around weekly in Europe? I know September was some fairly fast production cuts but have we entered into some stabilization in Europe right now?
John C. Plant
I think maybe I’ll comment on that one. Post the September announcements we saw further cuts announced by [Persio] and [Renault] in the last 10 days. That was like cutting build by outside of 25% and 30% or maybe it’s the other way around respectively for those companies. We’ve had Dahmler announce that they’re taking additional weeks out around the Christmas timeframe.
Joseph S. Cantie
14 plants, four weeks.
John C. Plant
So it’s quite dynamic at the moment. I don’t know what it means necessarily for production but we saw announced this morning that [inaudible] and Ford are taking an engine plant down which implies to display engines to Land Rover and [inaudible]. So there’s a lot of stuff still moving around but we’re trying to take a very cautious assumption.
I think December is going to be a particularly quiet month and quite honestly we’re not really sure that things come back in the first half of January. I think we’re going to be quite pessimistic over our December, second half and January assumptions. It’s still moving but I don’t anticipate let’s say PSA announcing another 30% cut. When they’re done they have to load the plants and get on with it because the labor, the parts, etc. I think it’s stabilizing now because it’s only 36 or 37 production weeks till the end of the year now.
Operator
Our next question comes from Rod Lache - Deutsche Bank Securities.
Rod Lache - Deutsche Bank Securities
Joe, in your comments you mentioned significant earning sensitivity to the production cuts. Could you just give us your thoughts on decremental margins at this point given your current mix with the modules being higher and as you enter into 2009 that factor and the magnitude of restructuring savings you’d expect to get against that?
Joseph S. Cantie
Generally speaking we run at about a 25% contribution margin across the entire business so depending on what areas and what products, it goes up or down from there. But it is somewhere around that 25%. Now that typically holds true for movements of call it a half million or a million units going up or down.
When you have periods where you’re going down more than millions in units, you’re decremental margins tend to get slightly worse as that happens. As you’re trying to pull out costs as quickly as possible there are always those lingering ones that creep into that contribution margin. That’ll give you a sense of how to gauge that.
So with that you can tell that for example in our third quarter where we lost $300 million of our core sales, if you apply that contribution margin, we lost a lot there. Then we offset that by all the actions John was referring to in cutting people and cutting every cost we can around the place so that you actually didn’t see that much of a decline in our profitability in the third quarter.
Of course as sales come down, we will continue to try to offset that contribution margin with actions but as you know it’s diminishing returns. You just can’t keep cutting, cutting, cutting so that’s the pressure that we have to face and we’re working hard to see how we can as John said right size this business for the lower levels.
Rod Lache - Deutsche Bank Securities
What is the percentage module sales for you right now and decremental margins there?
Joseph S. Cantie
Our module business is about 7% to 8% of our sales overall. We will not have the increases next year that we had this year so this was the completion of the ramp up and in fact with production going down next year you’ll probably have a decline in modules. Module business for us normally is 2% to 3% margin.
Rod Lache - Deutsche Bank Securities
For a lot of quarters, I guess up until maybe this one, the fx really didn’t have much impact on EBIT. If you get the Euro falling into 2009, is it fair that that also wouldn’t have much impact? I know there’s a lot of cross currencies so it’s not quite as simple as that.
Joseph S. Cantie
Generally speaking what you saw over the last couple of years is as we benefited on the sales line, we had very little effect on the EBIT line because what we gained in translation we lost to transaction places like the Czech Republic where we sell in Euros and our cost space is in Czech so you get a situation where the Czech is appreciating versus the Euro. Generally speaking normally the currencies move in such a way that you would think as we come down again we’d have a similar effect where it wouldn’t affect our profit; however you can get periods of time where those currencies don’t move in the same timing.
For example, the Czech crown has strengthened about 9% versus the Euro this year despite the strengthening of the dollar that has just occurred in the month of October against the Euro. What I’m basically saying is I can’t guarantee you that it won’t have a P&L affect as the dollar strengthens as was the case the flip side the other way around.
Rod Lache - Deutsche Bank Securities
Two things we’ve been hearing about recently are consolidation of purchasing such as Mercedes/BMW or maybe who knows if this GM/Chrysler thing happens, but certainly there seems to be some consolidation and there’s also some manufacturers are suggesting delays in product development. Could you just broadly speak about how that’s affecting you or you’re expecting that to affect you in terms of pricing or cap ex? Is that something that’s a factor just in the intermediate term?
John C. Plant
Let me go in reverse order. I think the fact that vehicle manufacturers are stepping up early to address their product plans is a net good thing rather than having a sense of unrealism that everybody keeps working on everything and chewing up engineering time and therefore cap ex which in the end wouldn’t be [inaudible]. I’m actually pleased by that effect in more global platforms because it enables us to focus our engineering and also right size indeed our own engineering rather than have it working on things which may never see the light of day, which clearly has happened in the past where platforms just didn’t get through. I think that’s a good thing for us.
In terms of your consolidation question, it seems a bit premature. I’m not seeing it’s going to make that amount of difference. What will be interesting to look at is if you raise the question one more level in that if there’s further consolidation in the vehicle manufacturers, then normally you get follows in consolidation amongst the part suppliers. Everything seems to remain in balance.
I don’t really know how to answer it at this point apart from saying we’ll see if Mercedes and BMW do come together, certainly BMW has changed its sourcing processes in the last 12 months. It’s difficult to see them getting any more difficult than they already are. And they obviously have always wanted the best prices, etc.
So my expectation is at this point is not a lot to report on that front, certainly not for the next year or so because I just think the supply base is not going to be in a position to be offering much lower prices than they do today.
Operator
Our next question comes from Chris Ceraso - Credit Suisse.
Chris Ceraso - Credit Suisse
Slide 20 in your section Joe, you showed the leverage ratio and said that you were in compliance. Can you just give us on your math or the math that fits with your covenant what the number was, what the ratio was at the end of Q3?
Joseph S. Cantie
We’re very fortunate. As you know we refinanced our debt in the early part of last year during that period where they were in this thing called covenant light, so we did very well. You can see our maximum leverage and minimum interest cover. On the maximum leverage our requirement was 4. We were just over 2 so it’s about half of what the requirement was. On the minimum interest coverage, the requirement was 2.75. We’re in excess of 6. So Chris you can tell by that that the spread is very large and under any scenario of decreased earnings going forward, you can see that we’re in really good shape.
Chris Ceraso - Credit Suisse
Would that be true even if we annualized your EBITDA run rate from this quarter?
Joseph S. Cantie
Yes. If you did that, we would still comply.
Chris Ceraso - Credit Suisse
The outlook for Europe you said was pretty weak but the emerging markets are slowing down. Do you have a specific expectation for Eastern Europe in terms of production in Q4 versus a year ago?
Joseph S. Cantie
For the fourth quarter we’re expecting no increase in Eastern Europe at all and we’re expecting Western Europe to be down 15%. So weighting those two together you get an overall down of somewhere around 11% or 12%. Eastern Europe continues to do well because Eastern Europe is where all the smaller cars are produced, B car levels, so the cars that are being produced are in that smaller level. So their production is holding up okay. I can’t believe I’m saying that flat is okay but Eastern Europe’s doing okay right now.
Chris Ceraso - Credit Suisse
You mentioned that you’re contemplating more restructuring actions. Should we assume that those are going to be more targeted toward Europe as the declines there are more recent than what you’ve been dealing with in North America?
John C. Plant
I think as we are looking to make sure we are right sized for 2009, you have to assume that they’d be both in Europe and the US. We’ve taken a lot in recent years in both continents. We focused in the US some time ago as production levels have come from like $17.5 million going back to I think the early 2000s. Progressively over the last seven years we’ve now come to this stub 13 level and going lower. So clearly I think we’ve done a really good job of right sizing ourselves on the way down and it’s not finished yet.
But clearly we’re going to be doing some things in Europe as well. It’ll be everywhere to make sure that we’re in the right shape. It’s not going to be necessarily whole plant closures like we did for example in Austria. We just wiped out the plant there to move all the production to Eastern Europe. We’re in the process of finishing that now. As you know from prior discussions I don’t like what I call knee-jerk restructuring because it tends to be rather fast.
So I’m looking at in the accelerating the sort of continuity of the restructuring plan that we already have but also taking a broad sweep through the functions which really should flex with not just specific industry volume but also, for example if there’s going to be fewer platforms, then there will be a requirement for a reduced level of engineering and program management and all these sort of things as well. That is not plant specific so it’s a broad sweep through the business.
Joseph S. Cantie
I’ll just add that of course we are prioritizing where the best return for the money we spend to restructure as well. We have a lot of experience at restructuring over the years and we’ll do this in a very thought through and analyzed method.
Chris Ceraso - Credit Suisse
On the cash flow, typically the fourth quarter’s your best cash flow quarter. It looks like you had a better than normal cash flow quarter here in Q3. Was there any timing involved in that that’s going to borrow from Q4 or do you still expect a real strong fourth quarter to the extent that volume allows?
Joseph S. Cantie
No borrowing. We still expect to have a healthy fourth as we always do. You’re right. We always have a healthy fourth quarter. We expect to have a healthy fourth quarter as well and again no timing.
John C. Plant
Because September closed a touch early, if we’d have had the same timing in September in ’08 that we had in ’07 about a couple days difference, we’d have been in an even stronger cash position.
Joseph S. Cantie
John’s right. We closed the quarter on September 26 this year and September 28 last year. Believe it or not, those two days do matter because we collect a lot of payments. The one benefit to lower volumes is that working capital comes in.
Operator
Our next question comes from Brett Hoselton - KeyBanc Capital Markets.
Brett Hoselton - KeyBanc Capital Markets
Commodity costs are up $170 million this year. It sounds like your expectation is that we’re going to see less of an impact into next year but I would assume that it’s still going to be up. Is that a fair assessment?
John C. Plant
I don’t know whether we can call that out yet for 2009 because it really depends upon the steepness of the other side of the curve we’ve been going up. My thought is that bulk commodities are declining on a monthly basis at the moment so we might see some lag effect into the first part of 2009 but for the year I don’t know I can say to you that we’re going to have a year-on-year reflect at this point in time just because of the rates of change, of commodity prices right now.
Joseph S. Cantie
We’ll give you in early February when we report but just take oil as an example. The volatility on it is incredible.
John C. Plant
Hydrocarbons of all sorts falling possibly 10% a month. I don’t know.
Brett Hoselton - KeyBanc Capital Markets
Restructuring savings. Obviously you’ve increased your restructuring pretty dramatically as you move to the back half of the year here. What are your expectations for savings in 2009 at this point in time?
John C. Plant
When we do the plant specific restructuring, the general payback assumption we would expect to be around about the two-year mark. When we do I’ll say more broad-based types of function restructuring, it’s a quicker time period because it’s essentially salaried labor and generally salaried labor has a payback in less than 12 months. The actions we’ve just taken for example, I mentioned almost 1,000 salaried managers and directors which at 70% will be completed by this Friday, the payback on that is obviously is clearly on the shorter side.
Brett Hoselton - KeyBanc Capital Markets
As far as contribution margins, is there a material difference between North America and European contribution margins?
Joseph S. Cantie
Typically in normal times they’re very close to each other, but what you’ve had over the last year is North America has come down a lot faster than Europe has. Europe now is coming down and will come down through ’09. So if you think of that effect, my decremental margins in North America are slightly higher than what they are in Europe today. But I expect Europe to be catching up unfortunately as the production comes down as we move through the next six months.
Brett Hoselton - KeyBanc Capital Markets
As we think about this mix shift between cars and trucks, can you give us some sense as to the order of magnitude on the content per vehicle of that shift from cars to trucks or from larger cars to smaller cars in Europe?
John C. Plant
While Joe’s getting the specific numbers on that, the way I think about it is clearly against extraordinarily dramatic production cuts. If you would say for 4x and the modules our sales have fallen a lot less than the vehicle production cuts and essentially we’ve taken all of the mix shift and the volume where there’s been underlying content growth, which has been able to offset all of that and coming with numbers significantly less than production cuts. Whether that continues or not, who knows. It depends on the shape of the mix in the future. Joe, have you got the numbers?
Joseph S. Cantie
Yes. The way to think about it is our average content on vehicles is about $350 per vehicle. If you think of light trucks, sport utilities, we’re clearly into the $400s and in some cases over $500. When you think of pass cars, we’re below the $350 somewhere around $250 to $300 mark. You can just tell from that that we clearly lose more sales on a pickup truck versus a small car and in practical terms if you just think of a brake unit, it’s larger and bigger, has more content to it on a pickup truck than it does for a small car.
Operator
Our next question comes from John Murphy - Merrill Lynch.
John Murphy - Merrill Lynch
If we think about your restructuring and what you’ve been doing, you’ve been pretty consistent about restructuring over time but you’re ramping that up. I was just wondering as you ramp this up, how much of it is structural and how much of it is variable? Because when we look at other companies that are overexposed, the Detroit 3 in North America, that’s not really a problem that you’re having so the structural cuts seem like they should be a lot smaller than the variable cuts. I know it’s a hard concept to think about but sometime in 2010/2011 volume’s going to recover and I was just curious whether you’d be adding structural costs back into the system or ramping back up as volumes recover?
John C. Plant
I think we’ll be very slow in adding structural costs back to the business because generally when you cut it out you tend to find ways of doing without it. You cannot say never because clearly if certain things which required us to let’s say add to engineering as an example, we would certainly want to do that. But generally speaking the leverage on the positive side that you get as volumes do increase, because when you make more of the same, if volumes pick up in 2010 for example or late ’09 which I’m not sure we’re really expecting, but if it does, making more of the same is a really good period for us.
I’d be loathe to add structural costs back to the business at all unless I could see a really, really good reason for doing so. I would expect the first period of time, a significant period of time, would be one where sales increase, people buy more cars, buying more of the same. The engineering is already done so we’re not going to do it anymore. It’s hard to think about it right now but we’d like to be enjoying the upside part of that curve just as much as we don’t like the downside part of the curve at the moment.
John Murphy - Merrill Lynch
So if we think it potentially in 2010, and once again it’s a hard thing to think about, of a 10% pop back up in production in North America and Western Europe, which would be great, you think that with the cuts you’re taking you would not be cutting into the bone on any capacity and you’d be able to handle that with what you’re structured at at the time?
John C. Plant
Yes. This goes back to the question answered earlier about restructuring as we go into next year for plants. We’re not going to take out any more plants that were not already on our list because I think that’s very inefficient restructuring. So why [inaudible] capacity out and then you suddenly acquired what you think you need in 2010. I think that’s very inefficient.
I’d rather do a lateral type of cost cuts when you may face conditions if it’s a 12 to 18 months who knows, starting the middle of this year. So if it’s as long as 18 months and then volume begins to come back; I have no intention of being out there then and saying, “Oh. I need to build a new plant and put new equipment in.”
The answer is the restructuring that we’ll contemplate particularly in Europe with the relative cost risk, what I call lateral type of restructuring across the space rather than taking fundamental capacity out which would then be required to be rebuilt. It’d be very costly to take it down and then very costly to take it back up. So that’s not something that we’re going to do.
John Murphy - Merrill Lynch
On the business case for modules, you guys keep highlighting that they’re very low margin. I’m just wondering when you run the business case for those, how do you justify them? Are we looking at fairly high returns on those with low asset intensity? I’m just curious how you justify the business case there.
Joseph S. Cantie
They’re cash positive, great return on capital, very little capital associated with piecing together modules and then it also has some other inherent benefits for the business because it protects where we might have part of the components going into the module and allows us to perhaps work with the customer to increase our level of componentry into that module. So the business case is clearly built on return on capital and is very good for us in that sense.
John Murphy - Merrill Lynch
So we’re looking at return on capital rates well north of 15%? Is that a safe assumption?
Joseph S. Cantie
Yes.
John Murphy - Merrill Lynch
Joe, just on the covenants that you have in your credit agreements. As far as the add backs for restructuring, are there any limits there or just how are these restructuring charges dealt with in your covenants?
Joseph S. Cantie
Our covenants are out there public and basically when you read them you’ll find that noncash related charges are not a factor in the covenant analysis. Cash is. So basically as we spend cash, they have an impact on our covenants. As I mentioned when Chris asked the question, we have plenty of leeway with our covenants and I don’t see them restricting our ability to do anything that we need to do that John talked about to right size this business.
I think we’re past an hour so we’re going to cut it off at that point. I’d like to thank everybody for joining us this morning and we look forward to reporting our progress to you in early February.
Operator
This does conclude today’s conference call. We appreciate your participation. You may disconnect at this time.
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