Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Kenneth A. Kure – Co-Treasurer & Finance Director

John C. Corey – President, Chief Executive Officer and Director

George E. Strickler – Chief Financial Officer, Co-Treasurer, CAO & EVP

Analysts

Jimmy Baker – B. Riley & Co. LLC

Robert Kosowsky – Sidoti & Co. LLC

Irina Hodakovsky – KeyBanc Capital Markets, Inc.

A. Rhem Wood – BB&T Capital Markets

Robert Kosowsky – Sidoti & Co. LLC

Stoneridge, Inc. (SRI) Q3 2013 Earnings Conference Call October 31, 2013 10:00 AM ET

Operator

Right, good morning to you. Ladies and gentlemen and welcome to the Third Quarter 2013 Stoneridge Earnings Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of today’s conference call instructions will be given for the question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded today, Thursday 31 of October 2013.

I would now like to turn the call over to Kenneth Kure, Corporate Treasurer and Director of Finance.

Kenneth A. Kure

Good morning, everyone, and thank you for joining us on today’s call. By now you should have received our third quarter earnings release. The release and accompanying presentation has been or will shortly be filed with the SEC and has been posted on our website at www.stoneridge.com.

Joining me on today’s call are John Corey, our President and Chief Executive Officer; and George Strickler, our Chief Financial Officer. Before we begin, I need to inform you that certain statements today may be forward-looking statements. Forward looking statements include statements that are not historical in nature and include information concerning our future results or plans.

Although we believe that such statements are based upon reasonable assumptions, you should understand that these statements are subject to risks and uncertainties, and actual results may differ materially.

Additional information about such factors and uncertainties that could cause actual results to differ may be found in our 10-K filed with the Securities and Exchange Commission under the heading Forward Looking Statements.

During today’s call, we’ll also be referring to certain non-GAAP financial measures. Please see the Investor Relations section of our website for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures.

John will begin the call with an update on the current market conditions, operating performance highlights, our growth strategies and business development, and his thoughts on future initiatives. George will discuss the financial and operational aspects of the third quarter and our outlook. We prepared and published an earnings presentation to provide more detailed schedules to help your understanding of our third quarter results and trends for a continued improvement.

A copy of these items can be found on our website at www.stoneridge.com in the Investor Relations section. After John and George have finished their formal remarks, we will then open up the call for questions.

With that I would like to turn the call over to John.

John C. Corey

Thanks Ken, good morning everyone and thank you for joining us on the call today. We’ve seen continued improvement across most of our business segments over the last three quarters and this quarter kept our momentum progressing. As we continue to improve operations, reduce cost, generate better cash flows and reduce debt levels we’ve been able to leverage this quarter-on-quarter up tick in activity with improved financial performance. Our third quarter results remain consistent with the lower end of our expectations and the annual guidance that we previously discussed.

We will go in a more detail on this later in the call. Consolidated revenue of $234 million as seen on Slide 4 increased by 6.5% from the third quarter of 2012 to the third quarter of 2013. This improvement was the result of new business sales for control devices in North America and commercial vehicle exports and product launches in the Europe despite the overall European industry volume weakness.

PST sales improved 12.5% local currency although the weaker riyal versus the dollar offset the increase in our U.S. dollar basis. The riyal depreciated from 2.03 to 2.28 or 12.5% versus the dollar during the third quarter of 2013.

Our market mix of automative and ag in North America and aftermarket in Brazil helped us improve our sales performance despite flat commercial vehicle markets in Europe, continued delayed recovery in the commercial vehicle market and customer share shifts in North America impacting volume expectations.

Control devices and electronics continued to exceed our corporate growth targets as they did in the second quarter as did PST. Wiring’s performance was impacted by continued weak market conditions and customer demand adjustments.

Our year-to-date operating margin nearly doubled to 4.6% this year compared to last year on slightly lower sales. Stoneridge excluding PST posted operating margins of 4.3% compared to 2.5% in the third quarter of 2012. This margin improvement also dropped to the bottom line as earnings per share increased from $0.15 per share in Q1 to $0.21 per share in Q2 and $0.19 per share in the third quarter of 2013 which was $0.17 a share higher than the third quarter of 2012.

Offsetting some of the progress we have made is the underperformance in the wiring business as we’ve had to adjust production schedules for reduced North America market expectation and responses to customer share changes resulting in lower volume which has resulted in an operating inefficiencies and a lower recovery of overhead cost in our Mexican facilities.

In terms of new business growth, new and replacement business awards for Stoneridge excluding PST business in the third quarter were $25.4 million representing $15.1 million in new business awards and $10.3 million in replacement awards. The cumulative nine month total for Stoneridge excluding PST totals $115 million of which $98.7 million are new business awards and $16.6 million are replacement awards.

Some of the highlight of those awards in the third quarter show our technology progress, geographic breadth and our ability to cross sell our products on a global basis. For example, we received a new business award for [indiscernible] from a commercial – before a commercial vehicle application in Turkey from a large North American OEM. This is an example of our ability to cross sell among our business unit, in this case our electronics business units secured to win from a control device business customer.

We also received the new award in our emission systems component further extension of our emissions growth strategy. We will update our current five year growth of $174 million in net new business excluding PST in early 2014, which will address years 2014 through 2018.

Sales from new business awards so far this year indicate that we are maintaining the cadence that we have indicated when we first published our five year look back in February.

Another key objective was the need to build more sustainable cost position on the culture of continuous improvement. Control devices, electronics and PST have improved significantly and are performing well. However the wiring business unit is underperforming due to decline in production schedules in response to customer requirements. Originally we thought we would see a slight improvement in the third quarter continuing into the fourth quarter.

However that has not been the case and we have had to adjust our production schedules lower for continuing decline in customer advance. A breakdown of our segment results level can be seen on Slide 6 of our earnings presentation while Slide 7 and 8 also provides significant details around our year-over-year and sequential business progress by segment.

Control device revenue is mostly comprised of North American automotive and light truck business; however they are future growth for emissions applications for the commercial market in Europe and Asia and actuation in North America and Asia. Control devices 2013 year-over-year third quarter has the sales increase of 12.7% while compared to the second quarter of 2013, control devices sales decreased by 1.8% which is typical as a result of the summer shutdown period.

Sales in our passion to car and light truck category with 19.8% year-over-year increase due primarily to volume increases, and new product sales; for control devices global opportunities there will be mandated with higher emission standards and fuel economy guidelines coupled with technological capabilities like switch sensing and chip by wire new business wins referenced in the second quarter call will benefit future performance.

The Electronics segment contains most of our medium and heavy truck business and also has a strong global reach. The Electronics group is also performing well in spite of Europe and North America’s commercial markets and in line with our long term organic growth goals.

Year-over-year for the third quarter the Electronics Group reported a top line sales increase of 18.6% which was achieved in a flat production environment due to product launches which began in the second quarter and significant export increases to Brazil with our largest customer in Europe.

Compared to the second quarter, Electronics sales decreased 7.8% due to the normal shutdown, summer holiday shutdowns in July and August. The Electronics Group has a great partnership approach with their global clients, which resulted in a deep knowledge of our customers, this team has developed some very strong engineering and software capabilities as well which has expanded our content and develop larger platforms and content which should help us maintain solid growth for years to come.

This group oversees electronic applications in North America, Asia and Europe and we are seeing the benefits of leveraging our capability in Europe to support program awards into the North American and Asian markets. The wiring business is about 60% medium and heavy truck and 40% Ag and predominantly serves the North American markets.

Wiring has for several quarters been impacted by lower overall market demand and share losses by one of our customers which continued into the third quarter and is now forecasted to show lower volumes in the fourth quarter.

In this quarter the Group phase continuing ongoing revenue challenges it was down roughly 1.3% year-over-year with commercial vehicle sales volume being down 9.2% in the third quarter of 2013 compared to the third quarter of 2012.

The year-on-year reduction was a result of lower sales of large North American commercial vehicle customer. Agricultural equipment recovered some of their lower volume experience in the first half of 2013 as sales increased by 5% in the third quarter compared to the third quarter of the prior year.

During the third quarter, we had expected and planned for some moderate recovery in our sales in the North American commercial vehicle market based on customer forecast. These forecasts were reduced in the middle of the quarter because wiring is a labor intensive business, ramping it up or down creates operating inefficiencies and labor imbalances due to production schedule variability.

As a result, the wiring business had a negative impact from labor mix and overhead costs in the third quarter of 2013, which negatively impacted our third quarter by $0.13 a share as compared to the third quarter of 2012, as shown on Slide 9.

In addition, wiring sales were $1 million lower in the third quarter of 2013 compared with the third quarter of 2012, because of wiring significant exposure to the North American CD market, we are to some degree impacted due to the lower volume like other commercial vehicle suppliers.

As previously discussed, we have begun to move production among our wiring plans to better stabilize the demand pattern for each plant to minimize the disruption of changes in customer forecast. With the actions taken and underway from completing the plant move from our BCS facility in Michigan to Portland, Indiana in August and the rebalancing of the capacity between our four wiring plants in North America. We expect to see improvement in 2014 and an ability to leverage volume increases as they materialize.

PST sales in the third quarter of 2013 were 12.5% higher than the third quarter of 2012 on a local currency basis. On a US dollar basis, PST sales were flat compared to the third quarter of 2012 because of the devaluation of the Brazilian Real compared to last year.

PST’s local currency sales also posted their third sequential sales increase. PST’s revenue increases product mix, cost initiatives and debt reduction taken in last year continue to be key factors in their profitability improvement. The estimated EPS impact we’ve seen on Slide 9 of our deck. PST continues to see very solid gross margins, which excluding $300,000 for purchase accounting were largely maintained at 40% in the third quarter of 2013, when compared to 41.2% in the third quarter of 2012.

Margin were lower as the service business was impacted by general economic concerns by Brazilian a partial reduction in service programs from a large insurance company and increased audio volumes sold through mass merchandisers and OEM dealers, which carry a lower margin than the after market products.

Our Minda joint venture in India continues to deal with economic slowdown and significant devaluation of the currency. Minda sales decreased 16.5% versus the third quarter of last year. This sales decrease was driven primarily by a 12.7% reduction and the valuation of the Indian Rupee compared to the US dollar and general weakening of the Indian economy.

Excluding the effects of foreign currency exchange, Minda’s sales decreased by about 5.8% of the prior year and are being adversely affected by weaker economic environment in the region. Our share of Minda’s net income from operations in the third quarter with a profit of $97,000 compared to a profit of $207,000 in the third quarter of 2012.

In summary, our financial performance continue to improve in the third quarter compared to the third quarter of last year and consistent with the second quarter even though our sales declined in the third quarter compared to the second quarter.

Our objectives of top line organic growth and more sustainable cost position and improving technology in our development of new products and lastly on improved balanced sheet have kept the business largely on track. The fourth quarter remains challenging for the wiring business for the regions previously discussed and PST due to economic and customer uncertainty. We expect to see continued benefits from the North American automotive in the control device business and improvements in the European OEM production environment benefiting electronics.

Now George will discuss further details on the quarter as well as our outlook.

George E. Strickler

Thank you, John. As the markets have been generally improving over the last five quarters, we have been able to benefit from the actions that we implemented during 2012 to improve our operations, reduce our costs, generate positive cash flows, reduce our debt levels. Our third quarter 2013 performance was significantly better than the third quarter of 2012 was consistent with our expectations of improved profitability for the quarter.

Our sales for the third quarter increased by 6.5% compared to last year which was mostly driven by control devices and electronics. Our sales were down by 3.8% compared to the second quarter due to commercial volume in North America driven largely by key commercial accounts and share market loss and PST due to the currency devaluation of the riyal. Our third quarter improvement continues to trend showing quarter-on-quarter sales, gross margin and operating margin improvement over the past four quarters.

Revenues in the third quarter were $233.5 million, an increase of $14.2 million or 6.5% over the third quarter of last year driven primarily by higher market activity in North America and new business sales in North America and Europe and stronger export sales Europe to Brazil with our largest European customer.

Revenue in the third quarter of this year decreased by $9.3 million or 3.8% over the second quarter due mostly to seasonable summer shutdowns in North America and Europe and the decline in production increases forecast from a key customer account in North America.

The trend of the market has been improving over the last five quarters and from the improvements in our margins we’ve been able to leverage these revenue gains over the last three quarters. From our experience, our sales decline in the third quarter and the current production forecast of North American market will indicate continued weakness in the fourth quarter and PST’s uncertainty in the consumer markets.

We also believe that with further operational improvement especially in the wiring business as John discussed and continued improvement of our control device and electronics businesses, we can leverage our earnings further, we believe we’re positioned well to improve gross and operating margins as the markets continue to recover.

Our earnings per share in the third quarter of 2013 was $0.19 compared to our third quarter of last year earnings per share of $0.02 and down slightly from our $0.21 per share recorded in the second quarter of this year.

We posted operating margins on our Stoneridge business excluding PST of 4.3% compared to 2.5% with sales being higher by $15.1 million. For consolidated Stoneridge including PST, our operating margin has continue to progressively improve from 3.9% in the fourth quarter of last year to 4.4% in the first quarter of this year to 4.9% in the second quarter of this year. Our operating margin dropped slightly in the third quarter 2013 to 4.6% compared to previous quarters in 2013 due in part to lower sales volume and mix.

We’re adjusting our production schedules in our Mexico plants for lower volume, our EPS improved from $0.10 per share in the fourth quarter of last year to $0.15 per share in the first quarter of this year, a $0.21 in the second quarter and now reporting $0.19 in the third quarter of this year with slightly lower sales volume from the second quarter.

Operating margins excluding PST decreased slightly to 4.3% in the third quarter of this year from 4.9% in the second quarter due mostly less sales of higher profit control device and electronics products and higher direct material expenses in wiring.

PST’s operating margins exclude purchase accounting was 8.6% in the third quarter which is about equal to the second quarter of 8.8% which is mostly due to higher sales of audio which has slightly lower margins. Contributing to our performance were improved material costs as a percentage of sales benefiting the year-on-year earnings performance increase.

Slide 12 shows the direct material impacts of these actions on Stoneridge excluding PST gross margins. The PST impact is due mainly to lower service sales and higher audio sales in the quarter. In the third quarter of 2013, operating cash flow was an inflow of $19.2 million; third quarter 2013 cash flow was negatively impacted by increased inventory to support increasing sales levels mostly at PST.

We planned to reduce inventory levels both of wiring business and PST in the fourth quarter. Slide 4 of our deck has a complete P&L breakdown on third quarter of this year versus third quarter of last year. Slide 7 identifies Stoneridge excluding PST sales which were 8.2% above the prior year’s third quarter, primarily due to pass car and light trucks business.

Slide 9 of our deck identifies the major bridge item differences between the third quarter of this year and the third quarter of last year earnings per share. The third quarter 2013 compared to the third quarter of last year difference is primarily due to higher volume, lower SG&A cost and cost reduction benefits partially offset by wiring inefficiencies.

We continue to have positive cash flows one of our primary objectives for 2013. Cash generation has allowed us to reduce our enterprise risk and make great progress in our debt reduction goals as well. As indicated on Slide 14, we improved the total debt to EBITDA ratio from 3.5 times at December 31, 2011 the 2.9 times at December 31 of last year to 2.6 times at September 30 this year.

With our 2013 guidance we expect our debt to EBITDA to be in the range of 2 to 2.5 times by the end of this year. During 2012, we reduced debt by $65.7 million our ABL remains undrawn since November of 2012. We continue to forecast or reduce our net debt by approximately $25 million by December 31 of this year.

In addition to our net debt reduction, we’ve been able to better balance our currency exposures. Even though we continue to experience volatility in the Mexico Peso, Euro and Swedish krona and the Brazilian real compared to the U.S. dollar, we reported a $270,000 currency gain in the third quarter of this year compared to an expense of $961,000 in third quarter of last year.

The major contributor of last year’s currency expense was the significant U.S. dollar debt that existed at PST and the U.S. dollar debt has been reduced to $3.1 million as of September 30 of this year. Today John and I share with you the financial and operating performance of Stoneridge in each one of our four business segments over the last five quarters.

Overall we are comfortable that we have been able to create diversity with our core business segments that permit us to minimize the volatility in our markets, geographic regions and market swings between our business segments while providing us the opportunity to continue to reach our financial objectives of top line sales 6% to 8%, operating income in the range of 8% to 9% and generating annual cash flow in the range of $30 million to $35 million.

We are encouraged that most of our business segments and markets are running well, the control device electronics business units are performing well. Each one of the business units have been able to perform well above the market growth rates. Control devices was up 12.7% in the third quarter of this year, over the same period of last year which was on top of the sales increase in the second quarter of this year of 8.5% over the second quarter of last year.

But growth is reflecting the business units capability, the focus of technology and product offerings in the market requirements, geographic reach and ability to meet customer requirements cross sell their technologies to multiple customers. Electronics has been able to grow significantly in the phase of commercial market being down in both European and North American markets.

The electronics business unit sales were up 18.6% in the third quarter of this year compared to the third quarter of last year, this was driven by significant sales by our largest customer in Europe was the major exporter to Brazil and product launches have started in the second quarter of this year. The electronics team has been able to enhance their software engineering capabilities for a more integrated solutions for their global customers such as the low end instrumentation for the Asian market.

They are working to build their successful product and technology platforms using their European capabilities which permit them to transfer the capabilities to the North American and Asia markets. PST still has risk due to the uncertainty of the overall Brazilian economy and the significant devaluation of the Brazilian Real over the last two years.

In the first quarter 2012 the Real was at about $1.75 to the U.S. dollar, today it’s about 2.2 to the U.S. dollar which represents a devaluation of nearly 20% during the two year period. The market Brazil to come more complex during the last five years during this period PST’s market channels have changed from predominantly an aftermarket business 85% of PST sales were through that channel.

Today PST sales are 42.5% aftermarket, 17.8% with the OEM dealers, 16% mass retailers, 10% we think our products tracking devices, we have a significant branch in RGT and are representing 10% of our sales.

This has led to more complexity but also offers PST many more opportunities to expand product offerings, new technologies and ability to enter adjacent markets. A few examples PST is now entering the cargo tracking market and home security. We have discovered that cargo tracking is a very technical sales driven by more driver management applications requires more benefits and features but once these capabilities are developed they represent long term sales opportunities, overall PST’s performance in the local market is improved in the last five quarters, PST’s mix of products has improved with alarm systems and tracking devices returning to their historical share of PST sales.

With the disruption in the market in the [indiscernible] some of the Chinese peers with imported products; we are experiencing a return in some of the volume to the audio business while margins are returning to total PST to more historical levels in the 40% to 43% range.

We’re forecasting that PST’s growth will continue in the tracking device area which will keep our gross and operating margins in the range of historical levels. The wiring business is the one business segment that we continue to provide resources that enhance their processes and people to make sure our cost structure is in balance with the variability we are experiencing with our customer schedules. This is our one business that is labor intensive and must have a robust supply chain cost as to make sure we can keep these imbalance as our customer demands can change our production schedules significantly which brings the cost inefficiency in excess inventories.

This has been a challenging in this year as we continue to experience significant variability from our customers demand schedules and in few cases the customer schedules have been down this year to date and their fourth quarter forecast continue to show declines in share market.

We will continue to work to make this business successful as it has been over many years. And in summary 2013 has not been as robust as was forecasted early in the year however we’ve been able to manage and perform well within the markets we participate, our diversification provide us the opportunity to minimize the volatility that has been different in each one of our business segments, the passenger car market North America, our electronics business in Europe and PST and local currency have performed well in spite of the lower market in Europe, the commercial market in Europe has been down but we have performed well and it appears we’re starting to see some strengthening in the forecast late in the year.

PST is starting to show more stability in the market but still face uphill challenges and the overall GDP is growing around 2% and the consumer sentiment is somewhat pessimistic. We believe that the wiring business can improve but it will take some stability in our customer schedules especially from our key account continue to lose market share in the third quarter and continues to show lower share market for the fourth quarter. We do believe that commercial market fundamentals are still favorable for volume increases in 2014. Regardless of the market changes, we have continued to manage those activities that we can control.

We have continued to improve our operations and our operations team is put in place standard metrics across all 19 facilities worldwide. The specific objectives are cost management, quality and delivery of service targets. Each one of our business segments have worked to improve our raw material costs of sales over the last eight quarters and we have recognized the improvement.

We have managed our control book cost by SG&A and D&D to hold the line of costs in relations to our top line sales. We continue to work on our direct labor costs and overhead costs in relations of the sales as we try to react to the volatility we are experiencing in our customer demand schedules, especially in our wiring business.

We believe we have positioned our four businesses as well to finish this year and be at the low end of our annual guidance, but just as important to continue and deliver improving operating and financial performance for 2014. We will provide our guidance in 2014 and that new business estimates sometime in February of next year.

We will now open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question today is from the line of Jimmy Baker of Riley & Company. Over to you Jimmy.

Jimmy Baker – B. Riley & Co. LLC

Hi, good morning and thanks for taking my questions.

John C. Corey

Hi, Jimmy.

George E. Strickler

Hi, Jimmy.

Jimmy Baker – B. Riley & Co. LLC

So I was just hoping we get start with a couple question on the cost side. Can you maybe just speak to the sequential gross margin trends at the core business? Is the compression there all wiring related and then just talk about the sequential compression in gross margin at PST as well?

John C. Corey

Yeah, in the core business, it is wiring business. The margins are where we want them to be for both electronic and control devices and they have improved, and so they’re maintaining what our targets are to those businesses, so it really as an issue with wiring.

On the PST business, the margins that really is a mix shift that we look at the higher end products, higher margins products like the alarm systems and like tracking systems versus I’d call mid margins products of audio. So as we see more audio sales, you’re going to see a pressure on that.

And in this quarter, what we’ve seen because of the Brazilian economic uncertainty, we’ve seen some impacts to our service business, which is very high margin. And then you might recall that business is where we selling alarm system and a person wants to have the ability to track their car – on tracking system they want the ability to track their car. But we provide that service and collect a fee for that. As we’ve lost some business in that market primarily due to a insurance company reducing their exposure to that markets. Those margins have moved down a little bit.

Jimmy Baker – B. Riley & Co. LLC

Okay, that’s helpful. And you’ve made a lot of progress in your consolidated business; really it’s on a progress. But wiring obviously does remain a challenge and I understand you expect that to improve in 2014. Can you just speak to what gives you conviction that 2014 will be different there? It seems like this segment has been a focus of attempted improvement for a couple years now, but just by its nature or customer concentration it seems challenging to battle the volatile nature of that business?

John C. Corey

Right, yeah, the issue there really for us in the wiring business as we said is as we’ve seen share shifts in the – North American manufacturers and those share shifts have impacted us to a large degree. We think that those share shifts are over with now and that there should be no further downward decline and we expect that we will see that with modest market improvement next year but perhaps may be some reversal of that share loss of some customers that that will improve for us and then also our latest look from the Ag market says that, that should be within our range of forecast which is again 40% of our business and the third quarter was up 5%, so we’re starting to hopefully see the further improvement there.

Jimmy Baker – B. Riley & Co. LLC

Okay, thanks John. So last one from me I will pass it off and just hoping you can help us understand how you’re planning for Q4 on a sequential basis, I realized that PST is seasonally strongest quarter can you just speak to the magnitude of the expected seasonal uptake there and then what are you planning for in terms of volume at your commercial vehicle and Ag customers sequentially in Q4 versus Q3?

John C. Corey

Well on PST it’s a while that is their strongest fourth quarter as you indicated we’ve really look at have to monitor how the distributors are buying inventory and at this stage the distributors appear to be fairly well stocked. What we do know is we are having problems with one large distributor in the order pattern because they put in a new system and that system is not performing for them and it lost control of their inventories and order patterns.

So that could move the volume quite significantly as they either drop orders or add orders. We are cautious about Brazil because of the really the economic uncertainty of what’s going on in that marketplace, we had what I will call an acceptable Father’s Day buy in.

So we’ll see as we go forward, we do expect some good audio sales out of that and we expect to see increases in our audio sales and the question for us will really be how the alarm sales perform and I don’t have a real good answer on that because I really can’t predict the demand patterns of that other than knowing that our distributors have bought their normal requirements and so we’re not seeing any increase in those requirements or any decrease in those requirements right now. And the other part was the, the commercial vehicle market in this marketplace I think the commercial vehicle market in North America – well on Europe it’s going to be some pre-buy there in Europe.

We’re not going to there is going to be a modest pre-buy in Europe for commercial vehicles that will give us some benefits in North American markets the commercial vehicle market is really relatively I guess flat we don’t see any real growth into that market in the fourth quarter and it really depends on its customers pickup the shares that they’ve lost we’re not, we’re concerned about that because as we’ve said the third quarter, we have to provide the capability to ship product to the customer and you can’t take that out quickly. So the trends have not been favorable in that marketplace and so there is going to be a challenge for us in the fourth quarter there in the wiring business.

George E. Strickler

Our current forecast is showing that the North American commercial market is relatively flat in the fourth quarter compared to the third quarter. I think the forecast we are all starting to see now though is they are forecasting an uplift in 2014 especially in the first quarter.

So we need to be somewhat cautious about that because that’s when you get these imbalances of labor costs and inventory position. So we’re currently going through that really evaluating that position right now.

Jimmy Baker – B. Riley & Co. LLC

Okay. Thanks a lot George, thanks for the time John.

Operator

Thank you. Next question comes from the line of Robert Kosowsky of Sidoti.

Robert Kosowsky – Sidoti & Co. LLC

Good morning, guys. How are you doing?

John C. Corey

Hi, Rob.

George E. Strickler

How about yourself?

Robert Kosowsky – Sidoti & Co. LLC

Yeah, doing pretty good, just building on the wiring business is to make sure you got few things clear given North America truck how do you fly into 4Q. So we assume that wiring will be pretty flattish from a revenue standpoint and we shouldn’t see much more degradation on the operating loss?

George E. Strickler

Yeah again I hate to give you that indication because as I look at what happened into the third quarter where we expected to see some increases and then saw the schedules cut in the middle of the third quarter, it really depends on what manufactures are going do to their production schedules they could be adjusted relatively quickly as they were in the third quarter catching us to having to adjust.

So while the market looks flat and if everybody meets their expectations and we should probably follow those trends but again I would put a high degree of caution around the change in share, and the change in production schedules.

Robert Kosowsky – Sidoti & Co. LLC

Okay, as far as that I will go at…

George E. Strickler

And Rob, we do see that the wiring will be a little bit under that same issue that a big flat or maybe even slightly down in the fourth quarter with the demand schedules we are seeing right now but the other businesses look like they will continue as they did in the second or third quarter.

Robert Kosowsky – Sidoti & Co. LLC

Okay and then also within the wiring business, how do you feel about the actual operations of the business and I understand volume is like a major issue but as far as where do we stand on getting approval to make product on each of different plants and then in addition are you keeping extra labor right now just because if you do have that 2014 pick up you don’t want to be call like you were back in 2011 when you don’t have the right labor staffing?

John C. Corey

Yeah it’s a very good question, we’ve largely complete, we are in the process of moving product to various plants that will continue through the first quarter of 2014 we are getting approval from the customers to do that we are rebalancing that so that’s going on so that process is moving well

In addition we are changing we modified some of our trucks manufacturing practices which have been implemented on how we place demand on the floor.

And so that in particularly in one plant so that’s going to help that and then as far as labor yes that’s the real challenge as we look at the forward forecast for 2014 as George indicated we are seeing some upturns in those forecasts if those forecast materialize and we have to be prepared to produce the product. So our challenge right now is to go back to our customer base and try to validate with them the reasoning behind their uptick in their forecast for 2014.

In addition, one of the things we’ll do in the fourth quarter is as we’ve said all along because the peak season in Ag is really the first quarter, we will be building some inventory over the fourth quarter for that market and so that should help to minimize that but yeah we don’t expect to see a similar result that we had did this year in the first quarter.

Robert Kosowsky – Sidoti & Co. LLC

Okay and then just building on to Ag how do that look into next year do you think that’s going to be kind of a growth market for you at least the pre-season sales?

John C. Corey

I wouldn’t say it’s a growth market I would say its consistent with the forecast I mean we don’t see any decline in the forecast some people were concerned about that I said that we are looking at we’ll have another meeting with our largest customer here in December and we’ll get a real good outlook as to what goes on in their first quater but right now we are not seeing any softness in their schedules.

Robert Kosowsky – Sidoti & Co. LLC

Okay, and then I guess two other questions one is on the direct material that it’s definitely been trending down over last year kind of picked up a little bit from the first half I was wondering if you can explain what that was and also more broadly with the improvements we’ve seen year-over-year, could you maybe tangle out pricing declines versus just your own material productivity improvements?

John C. Corey

Well I think if you go back a couple of years you looked at the control device business segment we talked about it that we were impacted by things like railroad magnets were there was significant price increases and we get a lot of work over the last two years to one fine new sources of material and two to redesign the product around that.

So that’s really one of the things is benefiting the material line on that that aspect. In addition, we’re doing a lot of redesign to use alternative materials. And then if you look at Electronics business, as electronic components age, they have a natural degradation of their costs.

So the longer of component has been in the market, the lower to costs but it comes and tell us then to like and when you have to do a last time buy, so that also benefits us. And then I think on the wiring business, I think we’ve seen stability on the copper basis. So that’s kind of where we see everything right now.

George E. Strickler

And the uptick in the third quarter was really mixed more than anything rather than the wiring business.

Robert Kosowsky – Sidoti & Co. LLC

Okay. And anyway of kind of frame how much was this, do you have the statistics for maybe just raw material productivity versus just kind of general kind of price declines for that or do you maybe just blockade, which is a bigger impact to the year-over-year declines?

George E. Strickler

Well, if you look at and we track and we have 11 commodities we work worldwide and we typically negotiate our contracts in the fourth quarter, which we are doing right now for the following year. Those plans are pretty well in place and they’re very consistent. So anything that you’re seeing and movement in the raw material costs of sales is being driven more by mix as opposed to specific actions or increases or decreases in raw material costs.

Robert Kosowsky – Sidoti & Co. LLC

Okay, that’s helpful. And then finally SG&A look like it came in pretty as much lower than at least what I was modeling and I was wondering if this like $42 million to $43 million to sustainable, is there any like kind of like may this kind of an anomaly or kind of how should we look at that line item going forward?

George E. Strickler

Well, I think the biggest reflection you’re seeing as you can imagine was sum of where our earnings performance, the biggest modification went in there would be sort of our annual set of compensation. So that will sort of vary based on how we’re performing. And so right now that change, what I would continue to model is exactly what you are looking at in the first half for an ongoing basis for 2014.

John C. Corey

And I would say just add on to George, when we set our incentive compensation, they are at high targets and so there is probably a correct proportion of that and so if we don’t achieve that than it rolls back in.

Robert Kosowsky – Sidoti & Co. LLC

Okay, this quarter is maybe a little bit abnormally low. But first half of the year run rates are kind of?

John C. Corey

I think we’ve been managing our SG&A fairly consistent so.

Robert Kosowsky – Sidoti & Co. LLC

Cool, thank you very much.

John C. Corey

Thanks, Rob.

Operator

Thank you. Our next question comes from the line of Brett Hoselton of Key Bank; over to you.

Irina Hodakovsky – KeyBanc Capital Markets, Inc.

Hello, everyone this is actually Irina Hodakovsky on for Brett. How are you guys doing?

John C. Corey

Hi, Irina.

George E. Strickler

Hi, Irina, how are you?

Irina Hodakovsky – KeyBanc Capital Markets, Inc.

I’m doing well, thank you. Guys a couple of questions for you, you mentioned that North American customer reduced their production forecast. Can you speak to the level of the changes they need to do to schedule?

John C. Corey

I do not have the specifics of the reduction, George I don’t think I don’t want to…?

George E. Strickler

No, Irina I guess to give you sort of because it’s happening both in the medium truck and the heavy-duty. And so if you look at our forecast for the year heavy truck class aid is down roughly about 10.5%. As you look at the share shift, our one key customer is down almost 19%. So there is an impact there and there was a forecast that we’d believe that we pickup the third and fourth quarter that is not materialized. So it’s not so much that the volume is down. It’s the anticipated forecast of increased demand. It’s coming in the third and fourth quarter.

But as the share market did materialize both in Class 8 and the medium truck is the same and as you know the medium truck is up to tier 7.5%, but our key customer is down almost 6%. So that has created a swing where we’re building and planning based on forecast in the third and fourth quarter. The volume is fairly consistent, but it’s what we had to do prepare for production and inventory positions to support that.

So as those schedules got adjusted in the third quarter, we are seeing the same trend in the fourth quarter. But I think as John and I shared a little earlier, we’re seeing fairly significant increases in early 2014. So that’s what we’re trying to measure and sensitize right now is how does that materialize this quarter-to-quarter because when you start running that through the four wiring plants it becomes rather complex in terms of how you made them both direct and indirect labor and also your inventory positions to support that demand.

Irina Hodakovsky – KeyBanc Capital Markets, Inc.

So the following question John is with the wiring operation, which it seems like some of the issues maybe forthcoming in the fourth quarter and it could be the volume of these could be weaker in the fourth quarter than it was in the third or at the very least the same? And then with PST and uncertainty is there and the margins that business puts out your full year guidance was maintained. Can you speak to what are the positives that keep your confidence going that those margin objectives will be met?

John C. Corey

Yeah, I think when you look at the North American automotive market that’s where our Control Devices participates. We had a very storng quarter in the third quarter there and we expect to see that trend continue. I mean the only thing that would impact that would be shutdown schedules for the holidays. But I mean I think that right now we’re forecasting to see continued strength in the North American automotive market and the Control Device business units performing very well.

In addition our European Electronics business for the OEM market is performing well as we said because of product launches and we are seeing some pre-buy for the emission standard. Now that the degree of what that is we’re still watching that, but we are going to have some experience of pre-buy in the fourth quarter for that. So that gives us some confidence there. The one challenge really is what happens in North American electronics because we’ve got a large customer there that’s again not performing as one. But so that gives us some confidence.

And then offset on the wiring business, I mean we continue to look at managing the cost structure of the wiring business and we are on a plan to continue to take out costs out of that wiring business. I guess the real challenge for us there is to how much costs we get out versus looking at the forward demand in the first quarter as George said and just by way of example, because it’s a material I mean labor intensive business, it’s usually takes us about I would say two months to get a person up to speed where they’re operating on efficiency.

So the challenge becomes then and if you’re going to have an increase in the first quarter, do you take labor out in the fourth quarter, only to reintroduce labor in the first quarter at less efficient rate? And so that’s the variability that we’re dealing with. But I think to looking at right now the forecast for Brazil, looking at forecast for Control Devices, looking at the forecast for electronics, those two electronics and Control Devices look very good.

Brazil as we said it’s a aftermarket business and so it could shift around. It could move aggressively around the Christmas holidays. But we have not seen anything from the distribution base yet that would indicate there is significant problem there. We’ll track that monitor that really happens during this month of October as they load up their products on October, November and then wiring is really the – how fast the customer share shift returns.

Irina Hodakovsky – KeyBanc Capital Markets, Inc.

Well, thank you very much, guys.

John C. Corey

Thanks, A. Rhem.

Operator

Thank you. (Operator Instructions) We have our next question from the line of Justin Long of Stephens, Inc, over to you Justin.

Unidentified Analyst

All right, guys. This is actually Brian Conley [ph] filling in for Justin today. Guys you have another strong quarter?

John C. Corey

Thank you.

George E. Strickler

Thank you.

Unidentified Analyst

So my first question is on Europe, it sounds like Europe is getting a little bit better and I was wondering if you could provide an update on the percent of operating income coming from Europe right now and kind of where you think that percentage trends over the course of the next several years?

George E. Strickler

Brian we are going to be disclosing our Q here. I think we’ll follow tomorrow and I think in there you will be able to see the different margins each one of the segments.

Unidentified Analyst

Okay.

George E. Strickler

But it is performing very well like it did in the first, the second quarter even in the down market and John alluded the fact that we are starting to see some of the schedules actually late in the year and even some potential pre-buy. So Europe we feel pretty comfortable with where they are at and the things that they are doing.

Unidentified Analyst

Okay, great, thanks. And secondly and if I think about the capital allocation going forward it seems like the priority is an acquisition could you just comment on the activity you are seeing in the M&A market and the likelihood that we see something in the next year?

John C. Corey

Well, we have a process underway where we are reviewing several different alternatives we don’t want to really get into a bid process that we don’t think win there I mean the last couple of times we’ve been through to those bid processes we couldn’t justify the valuation that’s maybe an investment firm could so we are reviewing a lot of companies right now we’ve got a process I would expect that we would probably be able to conduct a transaction sometime next year that would support our control device business as we look at that.

But all as I can say that there is an active process on but we are being disciplined about it but we don’t want to pay too much still we want to try to get an accretive business onto the book so.

Unidentified Analyst

Right. Well that’s all from me, thanks for the time.

John C. Corey

Yeah. Thanks, Brian.

Operator

Thank you. Next question comes from the line of Rhem Wood, over to you.

A. Rhem Wood – BB&T Capital Markets

Hey, good afternoon guys.

George E. Strickler

Hi, Rhem.

A. Rhem Wood – BB&T Capital Markets

Thanks for taking my question. A lot of mine have been answered, but real quickly do you talk about the Brazilian real it’s come down from its high point. But still kind of above your two or five number you plan do you have any thoughts on where that will grow and second part if you could 2014 guidance with that when would that be again?

George E. Strickler

Well, last year Rhem did it around the second week of February and I think it will be in that same range somewhere probably second week we typically don’t close till the end of February but I think most companies are out with some kind of guidance late January, early February so we’ll probably follow-up with the same kind of thing that we’ll do something around that second week of February.

The Real it’s clear that is being influenced along with the Indian Rupee and buy would be U.S. policy an economic policy it’s being filed and so both of those have revalued over the last month or so. I think where how we view and I think there is a long-term consensus John and I were just in Brazil couple of weeks ago the feeling is that the Real will continue to devalue over the next couple of years in fact they have at going to around 235 over the next two years, I think the most important thing for us is two things one is that we import a lot of dollar components and when we talk about a 20% devaluation ultimately that translates into higher costs in the local markets. So we have to orderly raise prices and when it happens in a short-term it’s very hard to recover prices in a 30 day, 60 day period. But when it happened in 2012 it took us about 5 months to really get prices work through because of the inventory positions.

The competitors were sitting on so, that will be our primarily goal as then when we do have disruption in the currencies can we get recovery in a fairly short period of time. to recover that and then the second thing that we’ve done is and this is not only Brazil but its worldwide, if you see our results and why we highlighted it where we use to have currency disruptions back in the second quarter 2012, which cost us pretty significantly I think we have worked hard to balance our currency positions in Europe and Mexico.

We still hedge because that is sort of like a single cost transaction for us in Brazil we balance that, we pay down all the dollar there and then $3 million so, we actually had a slight gain in the third quarter even though the currency moved fairly significantly. So the thing that it will influence is how you convert your income statement so if the currency devalues by 8% that we’ll have 8% lower sales, lower operating earnings and everything else and if it revalues by 8% or above by 8%.

So I think that’s how we view it now and I think we’ve mitigated our risk that we see in the currencies Mexico we have to stay very close to that because as you know we spend about $16 million a year equivalent in Mexico pesos because we produce products and sold primarily for the U.S. market. So when that like we always have to constantly keep an eye on the peso where it’s at because it has a direct impact on our operating costs and how we covert for local currency overheads and direct labor.

A. Rhem Wood – BB&T Capital Markets

Okay thanks that was helpful and then lastly can you just talk about your kind of lean initiatives or kind of where that stands how many facilities you have left to do, and may be quantify what kind of impact is left in running continues improvement to lean to the facilities

John C. Corey

Well yeah its not like its always a on going process, it’s a continuous journey that we got to improve it, we have that process underway in all our facilities and so but our emphasis really has been on the wiring business because that would benefit the most from because of it’s high labor content as we have improve in the lean out those efficiencies since so we have some target set for them I think as we looked at our operating George what was that 3% that?

George E. Strickler

3.5% we’ve set a goal worldwide what we call controllable costs so that would exclude like depreciation and property taxes which are somewhat fixed but everything else we have that metric out there and it’s a little more difficult, as you can imagine the wiring business because it varies so much by the schedules that we have, the other businesses are very well on track for that in every other plant has got that those metrics in place though.

John C. Corey

Yeah and as part of that one of our – while we don’t qualified as lean part of our costs management structures we have to move some product as we talked about we were moving some transferring some product out of our U.S. facilities down to our Mexican facilities in the Control Device segment and that program is underway and should be completed most of it completed by the fourth quarter of this year and then one probably one line going into the first quarter of next year, so we have that’s been another avenue that we are going down it’s not traditional lean, but it is reducing that cost structure.

A. Rhem Wood – BB&T Capital Markets

Great, thanks. Keep up the good work.

John C. Corey

Thanks, Rhem.

Operator

Thank you. And the question comes from the line of Robert Kosowsky, over to you Robert.

Robert Kosowsky – Sidoti & Co. LLC

Yeah, just one last question, would you expect fourth quarter to be a cash flow from operations quarter?

George E. Strickler

From operations?

John C. Corey

Yeah, it will be a good quarter Rob, because typically our sales go down in November and December that generally releases a lot in receivables. And we are working on reducing our inventories in the range of about $5 million to $8 million. So we would expect to see good operating cash flow in the fourth quarter.

Robert Kosowsky – Sidoti & Co. LLC

Okay, so $5 million to $8 million potentially sequential of inventory drawdown?

John C. Corey

Right.

Robert Kosowsky – Sidoti & Co. LLC

Thank you, very much.

John C. Corey

You’re welcome.

Operator

Thank you. And now I would like to turn the call back over to the management for any final comments. Thank you.

John C. Corey

Yeah, well thanks for joining us on today’s call. I realized that we’re all in little uncertain about the fourth quarter, but I’d point out these facts of looking at going beyond the fourth quarter and looking into 2014, even if the commercial vehicle market in Europe doesn’t improve, we’ve proven this year in our Electronics segment in the OEM side of the business that we can operate in this reduced environment and operated good margin. So that’s a very positive factor for us, as we look at 2014. If the commercial vehicle market improves in Europe, we’ll get some benefit of that.

As we look at the North American automotive market, the projections for 2014 are continued growth in that market and of course our Control Device business unit has performed very well this year so far and should continue to do so and it should look for both favorably for 2014 also.

As we look at the wiring business, I would say that we seen as customer losing significant share. That looks like it’s at the bottom and it’s turning around, so if nothing else happens on the growth side of that business in terms of the market, we should see some benefit from that. So I think there are a lot of favorable trends going on for us in our business as we look forward and we’re trying to navigate through these quarters. But overall the direction I think consistently is a very positive one for 2014.

So I like to again thank you for joining us on today’s call.

Operator

Thanks very much. Ladies and gentlemen that now concludes your conference call for today. You may now disconnect. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Stoneridge's CEO Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts