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Executives

Teresa Hess – Director, IR

Ed Buker – President & CEO

Jim Nicholson – VP & CFO

Analysts

Charlie Rentschler – Wall Street Access

Brian Grad [ph] – DLS Capital Management

Rand Gessing [ph] – Neuberger Berman

Jason Nelson – Roumell Asset

Tecumseh Products Company (TECUA) Q3 2008 Earnings Call Transcript November 6, 2008 11:00 AM ET

Operator

Good morning and welcome to the Tecumseh Products Company's third quarter 2008 earnings conference call. All participants will be in a listen-only mode until the question-and-answer session of the conference. This conference call is being recorded at the request of Tecumseh Products. If anyone has any objections, you may disconnect at this time. I would now like to introduce Ms. Teresa Hess, Director of Financial Reporting and Investor Relations at Tecumseh Products. Ms. Hess, you may proceed.

Teresa Hess

Thank you, Katie. Good morning and welcome to Tecumseh Products third quarter 2008 conference call. On the call today are Ed Buker, President and CEO, and Jim Nicholson, Vice President, Treasurer, and Chief Financial Officer.

Yesterday afternoon, we announced the company’s third quarter 2008 results for the period ended September 30, 2008. If you did not yet receive a copy of the press release, please contact Amanda Passage at 616-233-0500 to have one sent to you. Please note that the release is also available on many news sites and it can be viewed on our corporate website at www.tecumseh.com.

Before I turn the call over to Ed and Jim to comment on our results, I would like to remind you that this conference call contains certain statements regarding the company’s plans and expectations, which are forward-looking statements and are made pursuant to the Safe Harbor provision of the Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company’s views at the time such statements are made with respect to the company’s future plans, objectives, events, and financial results such as revenues, expenses, income, earnings per share, operating margins, financial position, expected results of operation, and other financial items, as well as industry trends and observations.

In addition, words such as estimate, expect, intend, should, could, will, and variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. There are a number of factors, many of which are beyond the company’s control, which could cause actual results and outcomes to differ materially from those described in the forward-looking statements.

Risk factors exist and new risk factors emerge from time to time that may cause actual results to differ materially from those contained in the forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Furthermore, the company expressly disclaims any obligation to update, amend, or clarify forward-looking statements.

In addition to the foregoing, several risk factors are discussed in the company’s most recently filed Annual Report on Form 10-K and other SEC filings under the titles Risk Factors or Cautionary Statements with Regard to Forward-Looking Statements. And those discussions regarding risk factors as well as the discussion of forward-looking statements in such sections are incorporated by reference in this call.

With that said, I would now like to turn the call over to Ed Buker, President and CEO of Tecumseh Products.

Ed Buker

Thank you, Teresa. Good morning and welcome to our third quarter conference call. The call is being simultaneously broadcast on the Internet and will also be archived for replay starting this afternoon. The replay can be accessed at our website, www.tecumseh.com.

Today I will provide you with an update on our business from several perspectives. First, I will provide some context for our third quarter results as well as broader markets and their impact on those results. Then I’ll turn the call over to our CFO, Jim Nicholson, to go over our financial results for the quarter and nine months in greater detail. Then I’ll update you on our initiative to transform our company to world-class compressor and condensing unit manufacturer. Finally, we will open up the call to your questions.

It’s a very busy year so far. We made a lot of progress. Unfortunately, the condition of the global economy is served to mask some results of our efforts. The recent global slowdown had a detrimental effect on our sales volumes. The current decline has been marked by lack of credit availability for our customers, increased borrowing rates for those who are able to secure lines of credit, slowdowns in the housing market and double-digit inflation rates in some countries where we have key business operations. Any one of these factors taken independently would have had an inverse, adverse impact on our sales volume. Combined, the impact has been significant.

We are a global business. And under normal circumstances, declines in economic activities that affect one regional market would be balanced against great growth in other parts of the global. Unfortunately, the current slowdown is affecting all of our global markets with nearly equal severity with the declines in the third quarter and expected declines in the fourth quarter, greatly exceeding our previous expectations.

In response, many of our customers quickly reduced production volumes and canceled their delayed orders in an effort to reduce inventory levels. Although we responded quickly to this slowdown, including reducing our global headcount by 1,200 people over the course of the third quarter, instituting temporary shutdowns at many facilities and aggressively consolidating our manufacturing footprint, the impact on our financial results was significant.

Beyond the broad economic slowdown, many of our customers and suppliers were adversely impacted by the freezing of the credit markets. As a result, we saw increased pressure to pay some of our suppliers earlier. It became prudent to use the cash to eliminate receivables, sales which had become less attractive due to the spike in rates that accompanied the global financial crisis. In a nutshell, we used significant cash in the quarter to minimize financing costs.

The global financial crisis that became acute in the third quarter also resulted in dramatic changes and increased volatility of commodity and foreign currency exchange markets. With respect to currency’s increasing volatility and the unprecedented [ph] speed of increase in the value of US dollar relative to the euro, real and rupee had significant adverse effect on our bottom line results in the third quarter. While the weakening of these currencies is a positive for our results in the long run, the extremely rapid devaluation of the real and rupee in the quarter caused balance sheet re-measurement losses and mark-to-market losses to adversely affect our operating profit.

Volatility in commodity prices also had an impact during the quarter. Copper and steel remained the most significant commodity exposure we have in our manufacturing process, and both had been extremely volatile. Copper rose more than 30% through July, then subsequently fell 22% in the last two months of the third quarter. We’ve already hedged over 80% of our copper needs for the fourth quarter this year and lesser amounts into 2009. So the benefit of these price decreases is felt gradually by our business, as many of our hedges are at substantially higher prices than the current spot rate.

Prices for the specific type of electrical steel used in our manufacturing process rose nearly 80% in the first nine months of 2008. We do expect them to stabilize at current high levels, but there is increasing evidence that steel will decline in a manner consistent with other commodities. Since there is currently no well established market for hedging steel prices, we could benefit more quickly from any such decline.

Although we continue to make strides in accomplishing our strategic goals, in the third quarter we faced unprecedented upheaval in our markets around the globe. Despite these challenges, we believe we navigated the issues as well as could be expected, due in large part to the many actions we have taken to streamline operations and generate cash over the last year.

As a result of our efforts, all the fundamentals of managing in a crisis like this are in place. And as soon as volumes begin to recover, we are confident that our operating results would begin to more fully reflect the improvements we’ve enacted. Unfortunately, we do not anticipate any meaningful improvements in these external market conditions before mid 2009. So we must continue to be vigilant in managing our costs while conserving our financial resources.

Jim, will you elaborate on our financial results?

Jim Nicholson

Yes. Thank you, Ed. On the bottom line, we reported a net loss of $13.2 million or $0.71 per share for the third quarter of 2008 versus a net loss of $77.2 million or $3.89 per share in the year ago quarter. Income from continuing operations for the third quarter 2008 amounted to a net loss of $36.5 million, or $1.98 per fully diluted share, compared to a profit from continuing operations of $2.2 million, or $0.11 per fully diluted share a year ago.

Operating loss was $32.4 million for the current quarter compared with an operating profit of $5.3 million last year. Operating results included impairments, restructuring, and other charges of $16.2 million, which were mostly non-cash versus $100,000 in 2007. Excluding impairments, restructuring and other charges, the decline amounted to $21.6 million, which was caused by much lower unit volumes and the associated unfavorable overhead absorption, the effect of foreign current exchange rates, and higher SG&A costs.

During the third quarter, we had a number of shifts on the sales front. Consolidated net sales for the quarter fell $22.2 million to $256.2 million from $278.4 million in the third quarter of 2007. Excluding the impact of currency translation, consolidated net sales would have declined by $42.3 million in the quarter. Breaking down the total, $22.2 million decline in net sales, sales for refrigeration and freezer applications fell by $9.6 million, which equates to a decline of 14% in unit volumes. There was distinct pullback in volumes from our R&F customers around the entire globe as they took actions to adjust inventories in response to the dramatic slowdown in consumer demand in the regions where our customers operate.

Sales of compressors for air conditioning and other applications declined by $13.6 million, representing a 49% decline in unit volumes due to softer economic conditions, higher customer inventory levels, and cooler than normal weather in many markets. While this is a substantial decline, air conditioning applications represent only about 15% of our overall business. The decline in these sales was partially offset by sales of compressors used in commercial and after-market applications, which increased by $1 million. Unit sales for these applications fell by 27% during the quarter. However, the impact of price increases and currency effects helped to offset the unit volumes.

Cost of sales was $238.7 million in the third quarter of 2008 compared with $244.4 million in the prior year’s third quarter. As a percentage of net sales, cost of sales increased to 93.2% in the quarter from 87.8% last year. In dollar terms, gross margins declined $16.5 million to $17.5 million from $34.0 million in the third quarter of 2007.

By far, the biggest negative impact on gross profit was the level of unabsorbed overhead resulting from the decline in unit volumes during the quarter, which amounted to $11.1 million, followed by unfavorable foreign currency movements, which had an unfavorable impact of $8.6 million. This included $3.7 million of losses recognized in our income statement for the mark-to-market of currency forward contracts in India and balance sheet re-measurement losses in Brazil.

On the positive side, selling price increases exceeded increases in commodity costs by $3.3 million. Selling, general, and administrative expenses increased by $4.9 million to $33.7 million in the third quarter. The company spent $5.1 million in the quarter for one-time professional fees, mostly for unplanned professional fees including legal fees for corporate governance matters.

We’ve recorded expenses of $16.2 million in impairment, restructuring charges and other items in the third quarter of 2008. The majority of these expenses were a result of the consolidation and relocation of global manufacturing operations and included expenses recognized at our Brazilian, North American, and Indian locations, which accounted for $11.8 million, $3.6 million, and $600,000 respectively during the quarter.

With regard to cash flow, during the third quarter, cash used by operations amounted to $55.6 million. The most significant uses of cash during the quarter involved working capital requirements, particularly accounts receivable and accounts payable. With regard to accounts receivable, we reduced the amount of discounted receivables by $31 million during the period, which increased the net receivables recorded on our balance sheet, but allowed us to avoid unnecessary interest expense. In the cash of payables, we accelerated payments to cash and credit constraint suppliers during the period. The remaining cash used was primarily attributable to cash net losses, which were a result of the economic downturn adversely affecting our sales volumes.

In each of these instances, our favorable cash position allowed us to address unfavorable market conditions without incurring the costs of escalating interest rates or drawing upon lines of credit. These uses of cash were somewhat offset by our aggressive efforts to reduce inventory balances, which provided cash of $16.5 million during the quarter. At the end of the third quarter, our cash balance was $126.1 million, providing additional security for our operations amid these uncertain economic conditions.

The extreme volatility in certain commodity prices and in foreign currency exchange rates had substantial impacts on our business in the third quarter. We are actively engaged in forward purchase contracts and futures contracts to lock in prices and reduce the risk of commodity volatility on the majority of our forecasted copper use over the next several months. While these hedge positions protect us from increases in price, they also delay the benefit received from price decreases such as the one we’ve recently experienced. We’ve seen significant volatility in copper as prices surged throughout the first seven months of the year and subsequently have declined precipitously since July.

Aside from copper, our most significant remaining commodity exposure is steel, simply because there are no well established effective hedging vehicles available for steel. Unlike most commodities, steel prices for the specific type of electrical steel employed in our production has remained high throughout this year, although we are beginning to see opportunities to participate in falling prices.

Considering our hedge positions, we project that our full year commodity cost will exceed the prior year by approximately $50 million. To address this, we’ve previously implemented price increases ranging from 4% to 8%, the last of which went to effect at the start of the fourth quarter. With the recent size of the downward movement in commodity costs and growing excess capacity, we believe there will be a significant pressure on prices until normal economic activity resumes.

Turning to foreign exchange exposure, the recent unprecedented volatility in currency markets driven by the credit crisis has had a significant adverse impact on our results. From January 1 to July 31, 2008, the Brazilian real strengthened by 11.6% against the dollar, and in the following two months, the real weakened by 19.6%. Similarly, for the first nine months of the year, the euro weakened against the dollar by 3.7%, while the rupee weakened 18.8%. While the weakening in these key currencies has a favorable impact on our business over the long-term, the rapid and significant weakening in the third quarter caused balance sheet re-measurement losses to outweigh the benefit of transaction gains during the period.

In addition, due to the fact that we had entered into foreign currency forward exchange contracts in India when the rupee was stronger against the dollar, these foreign currency effects were $3.7 million unfavorable to the third quarter results when compared to the same period in 2007.

Let me spend a moment on interest expense as well. In the third quarter, our interest expense increased by approximately $400,000 from $6.6 million in the third quarter of 2007 to $7.0 million this year, due mainly to higher interest rates on our short-term borrowings in Brazil. We expect our borrowings in Brazil to decline significantly in the fourth quarter, as we apply the cash we received from refunds and non-income taxes in Brazil against that debt. On the positive side, given our sizable cash balance, our interest income for the third quarter more than doubled when compared to last year to $2.7 million.

I’ll now turn the call back over to Ed for some additional remarks.

Ed Buker

Thanks, Jim. In the third quarter, despite severe economic headwinds, we continue to make progress in achieving our operational objectives on moving forward with our long-term strategic plan. I’d like to share some of those strategic objectives with you in greater detail. More than a year our management team is focused on improving our company to the development and implementation of a sound, long-term, strategic plan.

Throughout this process, we’ve taken a number of tactical steps to modernize every aspect of our business, including our products and processes, our operations and manufacturing footprint, and our corporate governance and capital structure, all with the view of establishing Tecumseh as a world-class competitor in our core compressor, condensing unit business.

One of the first steps the company undertook to move in this direction was the divestiture of non-core businesses. We have also successfully completed the reversion of one of our vastly over-funded pension plans. These important initiatives strengthened our balance sheet and have not only given us the solid financial position needed to withstand the current economic contraction, it also provides us with the flexibility to shift our operational footprint.

During the year, we have been engaged in exhaustive process to determine the optimal strategic direction for Tecumseh as we move forward to world-class status. As we see it, being a world-class competitor means a variety of things, but most importantly, means striving to be the best manufacturer of compressors and condensing units designed and developed to the exact products that our customers demand, producing the most high quality and delivering them when our customers want them at a price that reflects the value we provide. In this global economy, also means establishing an operational footprint that utilizes best cost sources of production.

As part of this process, we have engaged the assistance of independent financial and strategic professionals from Rothschild and Charles River Associates, CRA, to review our business in detail to make strategic recommendations to our Board and management team. During this time, our Board has been fully engaged in the process and we’ve spent weeks and months to carefully evaluate every reasonable strategic option from selling the company in whole or in parts to engaging with the strategic partner to keeping our business exactly as it is as it once was, no options were left off the table.

This intensive, integral process has supported our vision of how best to serve our customers across the globe. In the past, Tecumseh’s prior management believed that the best approach to each market was to establish complete stand-alone entities in these markets. While this approach might have made sense at that time, we realize now that it created a series of redundant cost structures in parallel product development efforts that prevented us from operating efficiently on a global basis.

We believe we can more effectively serve our customers and meet their needs by leveraging the power of our global organization across selected local markets. We can be more competitive, achieve greater operating leverage by shifting high cost manufacturing to locations with the most advantageous overall cost structure. These products can then be shipped globally where local teams can complete the process of customization to best meet the demands of our local markets and customers.

Similarly, we’ve realized the limitations of vertical integration in our business and pursued steps to optimize our level of vertical integration. In our view, in-house production capability only makes sense for products and processes that are essential to meeting the customer demand and where there is no viable and economic alternative from local supply.

We need to focus our operations on what we do best and leave the rest to our supply partners. A good example of this old school approach to vertical integration is our manufacturing operation in Brail. That operation was set up by prior management in a way reminiscent of Henry Ford's Rouge River plant with iron ore coming in coming in one door and Model Ts going out the other. In 2008 with the Brazilian economy more modernized that it was when our plants were originally built, this is a process that no longer makes sense for our business. We are currently evaluating the best alternative to ensure supply of critical components.

We have already implemented substantial improvements to our manufacturing process on a global basis. For example, we’ve completed 37 Kaizen training events. These events combined with other operational initiatives yield significant improvements in productivity and efficiency, including a 13% reduction in the size of our manufacturing footprint. We also expect to reduce our headcount by 25% in 2008, which reflects greater operational efficiency as well as right-sizing efforts reflecting current economic conditions.

Over the longer term, we see the potential to better optimize our product offerings, identifying and successfully penetrating those markets that offer the greatest opportunities for our products, our engineering team over a short timeframe is identified and is developing a globally consistent new product development process that establish clear product platforms with the objective of eliminating overlap in product offerings.

All these efforts have been undertaken in light of our ultimate goal of reaching pretax margins of 3% to 5% or better over the next three years. We have developed a stage plan over this time period to achieve these results and believe that the plan can mostly be funded by cash generated by ongoing operations. There is no big bank cash depleting approach to our plan.

Looking beyond our operations, manufacturing footprint, and quality initiatives, our Board and management team are looking to make improvements across our entire business, including Tecumseh’s corporate governance and capital structure. As part of this process, we are actively reviewing potential options for bringing our governance and capital structures up to date and in line with industry best practices.

Over the past year we’ve made significant strides in improving our corporate governance, including strengthening the independence of our Board as well as updating our Board committee charters and governance guideline. With regard to our capital structure based on own benchmark data and conversions with a large number of shareholders, we remain convinced that our current dual cost structure must be changed. We believe that our Class A and Class B shares should be consolidated into a single class of voting stock, and we are committed to doing just that in the near term.

As many of you are no doubt aware, we are currently involved in preparing for a special meeting of the shareholders to be held on November 21. I encourage all of you to read through the proxy statement we filed with the SEC on October 24 as well as the supplement to materials filed subsequent to our proxy become more familiar with the governance issues we face and the important steps our Board and management team are taking to modernize our corporate governance and to increase the value of the business for all shareholders.

While we made progress in improving our operation, the dramatic slowdown in virtually all of our markets has more than offset that progress in the short-term. Although we continue to closely control costs, our biggest challenge now is the top line. As softening demand, particularly in emerging markets, depresses our revenues, we must make every effort to work closely with our suppliers and customers to weather the storm. Fortunately, significant challenges like those we currently face often present opportunities. And the Board and management team will continue to evaluate potential actions that might be taken in this environment to further adjust our operational footprint.

While we don’t expect the current economic conditions to change the actions we will take to execute our strategic plan, they could affect their timing. Continued adverse trends and sales volumes could accelerate the timing, and amounts of severance costs will incur to appropriately size the business to current level’s demand. We will continue to exercise prudence with regard to use of our cash, including investments and capital expenditures and working capital, keeping in mind that our sizable cash balance will be a critical asset for us as we work through this slowdown.

This concludes our prepared comments for this morning. Operator, Katie, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll take our first question from Charlie Rentschler of Wall Street Access. Please go ahead.

Charlie Rentschler – Wall Street Access

Yes. Good morning, everybody.

Ed Buker

Good morning, Charlie.

Charlie Rentschler – Wall Street Access

The cash loss from operations in the third quarter, I surmise, was right around $20 million. Is that fair?

Jim Nicholson

Let’s just work some of the math together. That seems a little high.

Charlie Rentschler – Wall Street Access

Well, if I take out the impairment cost from the $36.5 million, take out the $16.2 million, we get to $20.3 million.

Jim Nicholson

And add back depreciation of $12 million for the –

Charlie Rentschler – Wall Street Access

Okay. So I’m down to around $8 million. Is that right?

Jim Nicholson

Right.

Charlie Rentschler – Wall Street Access

Okay. And with that –

Jim Nicholson

I’m sorry, Charlie. And of that $8 million, $5 million are professional fee costs that were unplanned.

Charlie Rentschler – Wall Street Access

Okay. So I’m then down to about $3 million for cash loss?

Jim Nicholson

Yes.

Charlie Rentschler – Wall Street Access

And as you look ahead, and I know you probably haven’t completed your budget for 2009, but how much further, Ed, could sales per quarter fall? In other words, we just had $256 million of sales in the third quarter and it was obviously pretty darn rough. But I mean, could this get as low as $225 million, $200 million? Can you – is it fair to ask you to predict what could be kind of the trough?

Ed Buker

Charlie, I would say it’s probably not fair, but that doesn’t mean you won’t ask me. The issue we currently see is that there doesn’t appear to be any particular location on the globe that has settled down enough to have the credit become available enough to start it back up. So we look at this and we look at this quarter, and I have got new good news in the quarter that would give me any indication that it’s going to even flat. And in fact, I look at December as a very challenging month for us. I’m not sure how many of our operations will even be able to produce in December because of the lack of need. So we are looking at that kind of big concern from our perspective. I don’t know what that translates into dollars yet, Charlie, because December is usually a weaker month anyway.

Charlie Rentschler – Wall Street Access

Right. And I know, you and your new management team, you’ve been very active for 12 months or so on cost reduction. But can you share with us what some of the major opportunities are out there that are fairly easy to grab? Is there some stuff out there just you can give us a little color on over the next 12, 15 months?

Ed Buker

We have about five or six projects. And if you took a look at our Investor Relations description letter dated on October 31, we list them out about 21 projects over those three years – and give you some indication that document that it's in the range of $2 million, $3 million, $4 million worth of – up to $6 million worth of CapEx to get about twice that each time as we roll forward. There is some severance cost that is included in parts of that that aren’t included in the CapEx. But those are the kind of straightforward taking three different lines in three different countries that are operating at a third full and moving it to one spot where we have best-in-class costs and filling the line up to meet the volume. It’s those kind of simple step-by-step processes. And our management capability is currently the limiting factor. We can’t move faster than our ability to consolidate those. Or it doesn’t matter how much money we’ve got, we will have goofed up the transition, then we will lose more than we recover. So it’s management capability that limits the speed of our improvements.

Operator

And we’ll take our next question from Brian Grad [ph] of DLS Capital. Please go ahead.

Brian Grad – DLS Capital Management

How you doing, guys?

Ed Buker

Good, Brian. How are you?

Teresa Hess

Hi, Brian.

Brian Grad – DLS Capital Management

I was a lot uglier than I was hoping for, but times are tough. Could you go into a little bit more detail with me? You talked about how you accelerated some payables to some of your accounts that were running tight on credit. Are you getting back on the other side on the receivable side from your accounts, or are you just – are days payable –?

Jim Nicholson

Let’s talk about the receivable side for a second. So we had – we had fairly major sales programs going on in both Europe and Brazil, and they are costly. And we have cash that earns at a certain rate and we incur finance charges at a much higher rate. Matter of fact our total interest costs for the year would run about north of $20 million. So we are essentially rationalizing, what I’ll call, the financing structure of the business to save interest costs. In Brazil and in some locations, we actually earn interests on receivable balances. And what has happened is that the – essentially what we can earn outweighs the benefit of what we could get from selling them in the future. So this is – I review these as not actually investments in working capital, but really a restructuring of how we finance the business to lower our overall interest cost. With respect to the payables, again in Brazil – Brazil is a country that’s used to be in a highly inflationary environment. And therefore it is normal ordinary course for customers to be charged interest and for vendors to charge interest to us. So the fact that we accelerated payments in Brazil to these vendors, we in fact will save interest costs. So it’s – at the end of the day from a financing perspective is not irrational behavior.

Brian Grad – DLS Capital Management

Okay. I guess my concern is that the way it was worded was, because some of the guys did – our vendors were tight on cash. We accelerated payments. But how risky are the receivable side of the business if you don’t get that paid back as quickly? Are any of your customers in danger of not paying you? And are you taking any –? I’m sorry?

Ed Buker

We’d be happy to address that. Historically, if you look at our costs of bad debts that we’ve incurred, it is extremely low versus other businesses like us. Our top customers tend to be very large and stable companies, certainly our largest top five, ten, whatever you want to call it. We keep very close tabs. We watch our delinquency rates, which also are extremely low. We only have globally receivables out of terms – just out of normal terms not exceeding 2%. And when those rates start to increase, we are very quick to respond. So this is an area of the business that we watch very closely. Currently we don’t see any sign – again, we’re watching very closely any signs that we are about to incur losses.

Brian Grad – DLS Capital Management

Okay.

Jim Nicholson

Brian, we have a weekly – some people have a daily, but I have a weekly view of all of our receivables globally. Daily on inventory, daily on – weekly on receivables so that when there is any movement, I know immediately where it was, why it is, what they have done. And I also know about credit holds related to these issues. It is one of the stronger things that the company has in place and does very, very well.

Brian Grad – DLS Capital Management

Okay, okay. One more quick question for you and then I’ll go back in the queue. Your headcount, what are you going to be down to by the end of the year?

Ed Buker

We are under 8,000. And it depends on how difficult sales become by the end of the year and how much lower than that we will be.

Brian Grad – DLS Capital Management

Okay.

Ed Buker

It’s not a fixed number. That’s not an appropriate way for us to view the business. Our number has to be scaled exactly to the volume that we can handle and then structure ourselves accordingly.

Brian Grad – DLS Capital Management

Understand. And so when that comes – that comes down with sales and then hopefully when things turn up, you won’t have to bring the number of people you employed back up to the same level it was before because you are getting operational efficiencies. Is that where I’m going with that?

Ed Buker

That’s correct. That’s exactly the idea we are following.

Brian Grad – DLS Capital Management

Okay, great I’m sorry, let me ask just one more quick one. What do you think your breakeven sales level is to absorb your fixed overhead, because you mentioned that part of the loss that you face there was absorption of overhead?

Jim Nicholson

Let me answer that question not in detail. Mix, global mix from quarter to quarter, value of currencies kind of affects this. But if I gave you one statistic, I think it might help you, in essence, do that math. Our variable component of cost of goods sold, we believe is in the 85% to 87% range. So if you take our financials and you assume that SG&A, just for argument, say it is fixed. You should be able to do some math around these figures.

Brian Grad – DLS Capital Management

And so you use $110 million for that – for SG&A?

Jim Nicholson

Yes.

Ed Buker

But Brian, let me help you. Don't ever assume that SG&A fixed. There is always ways to make it better.

Brian Grad – DLS Capital Management

I’m hoping that that’s what you’re going to say.

Teresa Hess

Well, we’ve got $11 million that we’ve already incurred year-to-date for a one-time professional fee. So certainly we’ve got lots of opportunities just from that perspective to reduce SG&A.

Brian Grad – DLS Capital Management

No, hopefully this is not going to be a hockey one-time, hockey professional fees. You know what I’m talking about, right? You know, you (inaudible) is the third one-timer of the night?

Ed Buker

Yes, right.

Teresa Hess

No hat tricks.

Brian Grad – DLS Capital Management

Okay. All right. Thanks, guys.

Ed Buker

Thank you.

Operator

And we’ll take our next question from the side of Rand Gessing [ph] of Neuberger Berman. Please go ahead.

Rand Gessing – Neuberger Berman

Hi, good morning.

Ed Buker

Good morning, Ryan.

Teresa Hess

Hi, Ryan.

Rand Gessing – Neuberger Berman

So it sounds like the things we have going on around payables and receivables are not necessarily timing issues that will flush back or flush out going forward. It sounds like it’s more structural things you do in both pieces. Is that fair?

Ed Buker

Yes. I would characterize structural in terms of financing of the business. The rate in which we collect receivables, the days sales outstanding and the DPO, those fundamentally aren’t really changing.

Rand Gessing – Neuberger Berman

Yes. Do you still have a fair amount of discounted receivables out or – with this $30 million, whatever you did in the quarter, have you?

Jim Nicholson

So you will see this when you see the Q it will be disclosed. So at the end of the second quarter, we had about $70 million of discounted receivables outstanding. At the end of the third quarter, that number was $39 million. And we would expect that number as we collect for future sources of cash and generate cash from operations that we will continue to bring down either receivable sales or outstanding debt, whichever one tends to represent the most expensive form of financing that we have.

Rand Gessing – Neuberger Berman

Okay. So that’s on its way to virtually being eliminated on the receivable side over time?

Jim Nicholson

You know, Brazil is a very tricky issue, and we pursue which one ultimately reduces our net financing cost to the lease level. And that formula changes from time to time. Our current view is that your statement is correct that you will see these – the discounted receivables to diminish.

Rand Gessing – Neuberger Berman

Yes. The payables comment about trouble suppliers, is that sort of de minimis in the scheme of the payables –?

Jim Nicholson

Yes. In the grand scheme of things, it is de minimis. But one of the things – Brazil, one of the things – the reasons that the currency weakened so much is the lack of availability for dollars. And that has affected some suppliers. It's potentially you're credit constrained with respect to export financing.

Rand Gessing – Neuberger Berman

Got you. All right. And I heard from a number of different sources that Brazil obviously has gotten a lot weaker as a region in-house, the economy there on the ground, but also it sounds like it’s still growing a bit. Is the Brazilian economy still somewhat resilient?

Ed Buker

Well, it depends on who you listen to. Clearly their economy has been affected by the crisis. Rising interest rates have an immediate effect on consumer spending. In the long run, we do think it’s a good economy that’s being currently affected by the financial crisis.

Rand Gessing – Neuberger Berman

Okay. In the past you’ve sort of gone through and given us a walk of what you think certain buckets of cash look like for timing and whatnot. Can you give us an update on that?

Ed Buker

Yes, I’d be happy to do that. Matter of fact, I want to do that because with changing currency that is – it’s probably worth updating. So let’s start with cash on hand given the fact that we brought our net financing. It’s currently at about $126 million. The next biggest chunk that we talked about and the number we had at 6/30 on our balance sheet for receivables, for non-income taxes in Brazil was $137 million. If you just update that number based upon exchange rates at 9/30 versus the exchange rate at 6/30, that outstanding receivable was $116 million without any collections. So $21 million essentially just lost in the translation of stating those in terms of dollars instead of reais as they are collected. Using that 9/30 rate, subsequent to 9/30, we collected $53.5 million of that balance. Okay? So you’d see – in the fourth quarter you will see further application of that cash to reduce either borrowings or receivable sales.

Rand Gessing – Neuberger Berman

So that would leave you with about $62 million left.

Ed Buker

Correct. Now we expect to get another $5 million to $6 million or so still before the end of the year subject to the vagaries of – it’s the government work. With the remainder spread out probably over both 2009 and 2010, but recognized, that was at 9/30 rates. The 9/30 rate was – the accounting rate was 191. And today it stands around 210. So there would be further – if you are trying to state this in dollar terms, essentially further shrinkage, just to put in perspective, that $116 million at 9/30 is about $104 million at today’s rates. Okay? Just so everyone can think about what that source of cash represents at today’s rate, in aggregate, it’s about $104 million compared to the $137 million we talked about last quarter. We’ve also talked about the IRS refund, how in the past the IRS was challenging the position. We’ve had some movement with respect to that. And therefore we think that there will be resolution instead of it taking two or more years to complete that resolution, it’s within a year. And we still believe that we will essentially prevail on this matter.

Rand Gessing – Neuberger Berman

What’s the size of that roughly?

Ed Buker

That’s $14 million.

Rand Gessing – Neuberger Berman

Okay.

Ed Buker

We still are on track for the hourly pension reversion. Our estimate of the value of that that has not changed. We had a fairly sizable range of $35 million to $45 million. And that is – certainly within the first half of 2009, given the fact that we haven’t heard from the IRS at this point in time. That could slip into the second quarter, but definitely in the first half. And then we made a commitment. We said, hey, even our inventory has been going up through the first half of the year. We are still expecting a $25 million to $30 million decline in inventory before the end of the year. It went $61.5 million in the third quarter. And currently, in light of what’s going on with volumes, we’ll be even more aggressive. We think that we will exceed that $30 million estimate by the time we get to the end of the year. So there is an addition – beyond the $16 million, there is probably much more.

Rand Gessing – Neuberger Berman

Can we sign you up for some in ’09 on the inventory side?

Ed Buker

You should be able to sign me up every year for some more on inventory side until we get to the point that we are operating at a world-class level.

Rand Gessing – Neuberger Berman

And then do we get some – do we still have some escrow from the FASCO transaction that would be freed up, or –?

Ed Buker

You’re good. You read your documents that we filed. There is escrow left. There is between $2 million and $3 million of remaining escrow for the general sale that escrow agreement ends, I think, in February. So if there are no additional claims prior to that date, there might be a little bit of money coming back. There are also some escrows set up for a warranty matter, which – but our projections wouldn’t be fully consumed, but probably not enough cash to really talk about.

Rand Gessing – Neuberger Berman

Okay. All right. I’ll stop, so someone else can get – and I’ll get back in queue. Thanks.

Ed Buker

No problem.

Operator

And we’ll take our next question from the side of Jason Nelson of Roumell Asset. Please go ahead.

Jason Nelson – Roumell Asset

Hi, good morning. The previous caller actually – the previous participant actually asked my primary question about walking through the incoming non-operating cash. But I guess just when I think about what you guys are still looking to receive from Brazil IRS pension reversion, and basically right now – you guys are basically being valued at a zero enterprise value with a world-class compression – federation business. Any more non-core asset sales potentially on the docket?

Jim Nicholson

We are – if you recall in our financial statements, we still have some operations that are classified as discontinued. These are residual motor operations and motor part operations that have supply internally as well as externally. We currently have a marketing effort going on for those assets. I don’t know if anything we get concluded before the end of this year, but we’ll certainly have more direction as to where that’s headed before the end of this year.

Jason Nelson – Roumell Asset

Any range on the potential for these?

Jim Nicholson

I think it would be unfair to try and articulate a range because there is – because they are also a supplier internally, how that gets unwound, what components get sold. There are multiple ways that this thing could ultimately get wrapped up, and therefore it’s too difficult to predict that range.

Jason Nelson – Roumell Asset

Okay, okay. Also I guess one – I know you’ve been receiving help from Rothschild and other professionals and outside consultants. I don’t know why the caller mentioned the hockey stick, whatever, reference. I mean, are these professional fees basically coming to an end pretty soon?

Ed Buker

None of the professional fees in this quarter are related to any ongoing strategy or operational consultants. They are all governance related issues. And I dearly hope they come to an end very soon.

Jason Nelson – Roumell Asset

Okay. So assuming this proxy battle gets wrapped up, then this is a one-time event?

Jim Nicholson

Yes.

Jason Nelson – Roumell Asset

Okay. All right. Thank you.

Operator

And we’ll take a follow-up question from the side of Charlie Rentschler of Wall Street Access.

Charlie Rentschler – Wall Street Access

Hi. No, my questions have been answered. Thank you.

Operator

Okay. It looks as though we do have another follow-up question from the side of Brian Grad of DLS Capital.

Brian Grad – DLS Capital Management

Hey, Jim. In terms of the money that’s coming back from Brazil, is there any repatriation that you would have to pay on that to bring it back to the States, or is it most likely going to be applied directly to the Brazilian operation?

Jim Nicholson

That’s a good question. Ultimately we will have cash in various parts around the world, including the US, Europe and Brazil. Right now, you can see what other investors are doing, is they are in fact pulling out of Brazil, basically the flight to safety. All things being equal. If you believe that their economy will be strong and growing in the future and their currency strengthening, and they still offer the highest real interest rates in the world, until we have a good use for that cash and if we believe in that view of the world, they represent an attractive place to invest cash. The first use will be to reduce expensive debt, but also the most expensive place to borrow in the world. So the first use will be to eliminate those financings.

Brian Grad – DLS Capital Management

What’s your current financing balance down there?

Jim Nicholson

The current – let’s say at 9/30 – let’s talk about 9/30. It was $50 million. It’s in the –

Teresa Hess

The total balance sheet debt for all of our operations was about $53 million, $55 million.

Jim Nicholson

Yes. So it must be about $45 million, plus they have probably – of the $39 million in discounted receivables, they probably have $35 million of it.

Brian Grad – DLS Capital Management

So you’ve got $53 million that will make the debt disappear and reduce the receivables balance essentially?

Jim Nicholson

Right.

Brian Grad – DLS Capital Management

Okay, that’s fine. Thanks.

Ed Buker

Thank you.

Operator

And it looks like we have another follow-up question from the side of Rand Gessing of Neuberger Berman.

Rand Gessing – Neuberger Berman

Hello again. Can you give us any sense for what we should expect on the interest expense line based on some of the stuff you’re doing, I guess, with the receivables financing?

Jim Nicholson

Given the influx of the non-operating cash sources and depending on their timing and how they were applied, we ultimately believe that we’re going to drive that number to – net financing cost to zero or better.

Rand Gessing – Neuberger Berman

And is that reasonable for the back half of ’09?

Jim Nicholson

I got to do some – Rand, I’m going to have to get back. I’m going to have to do some math because I don’t know exactly when the tipping point is.

Rand Gessing – Neuberger Berman

Okay. All right. Do you have a sense of whether some of the competitors have been more naked to copper and might be more aggressively taking price down? I guess the question is, any sense for whether your competitors are differently positioned relative to pricing and raw material hedging.

Ed Buker

I can’t – Rand, I can’t tell you that. I think I have enough insight into where they currently stand. I can tell you that a couple of them are leveraged, and I would hate to be competing in a leveraged environment, in a high-cost country situation. So I can’t imagine how difficult some of their jobs are. Couple of others are part of larger companies, I just can’t get inside to see well enough. Those are – there is some pricing activity from some people. And I could tell you that with the dramatic commodity movements, all the customers figured out over the past several years that commodities affect their price and they concluded this is less, maybe it should be less. And we’re working – it will be a very, very tough professional negotiations with all of our customers, keeping ourselves covered and them covered with the security we put in place.

Rand Gessing – Neuberger Berman

And I know it’s a complicated question, but what are your thoughts as it relates to timing and sort of degree of help we can get from some of the things that have gone on with currency and raw materials?

Ed Buker

We have an ongoing – we worked hard over the past year and a half to take the instability out of the pricing of currency and commodities. And that instability has also limited our downside. We are hedged through next year at some levels in all commodities and currencies. And we keep a rolling average taking a look at that and taking advantage of stuff. And so we are in the – I don’t know I can give – what’s the number for next year?

Jim Nicholson

Let’s put it just away directionally, Rand, how about that?

Rand Gessing – Neuberger Berman

Yes.

Jim Nicholson

If you look at today’s opportunity in light of our coverage levels, you’re going to find that our opportunity to buy copper is less. The cost – overall cost will be less than what it was in ’08 and the rates that we will realize on the currencies will be better than what they were in ’08. Right? I think it’s premature this time of year for us to start to articulate the magnitude of those opportunities.

Rand Gessing – Neuberger Berman

Does that – do you think that will firm up as you get into ’09?

Jim Nicholson

Yes, because part of it is, you can’t just take costs in the vacuum knowing that you’re also negotiating prices. Right? So what’s going to be the net gain or less with respect to those commodity costs versus where pricing turns out to be. But in terms of absolute spend and absolute realization of currency, we would expect those to be better in ’09 than what they were in ’08.

Ed Buker

And a big commodity for us is steel, which we’re not hedged at all. So the more dramatically that looks, the more dramatically we will see impact.

Rand Gessing – Neuberger Berman

I mean, you talked about the negative impact of both raw materials and currency in the last couple of years, and you just updated that for ’08 in this third quarter release. I mean, is it possible that we have positive numbers in those spaces next year versus just last heard [ph]?

Ed Buker

If we do our jobs right, yes.

Rand Gessing – Neuberger Berman

Okay. All right, thanks.

Operator

And it appears as though we have no further questions at this time.

Ed Buker

Okay, Katie, thank you very much. I’d like to thank everybody for participating in the call. And we’ll talk with you again at the end of the fourth quarter and end of the year as soon as we are back at it. We will try to keep you up to speed with the other things going on in our life. Thank you.

Operator

This concludes today’s teleconference. You may disconnect at any time. Thank you, and have a great day.

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