Stoneridge CEO Discusses Q3 2010 Results - Earnings Call Transcript

Oct.23.10 | About: Stoneridge, Inc. (SRI)

Stoneridge, Inc (NYSE:SRI)

Q3 2010 Earnings Call

October 22, 2010 10:00 am EST

Executives

John C. Corey – President, CEO, Director

George E. Strickler – Executive Vice President, CFO, Treasurer

Kenneth A. Kure - Corporate Treasurer, Director of Finance

Analysts

Bob Nicholson - Pine Cobble Capital

Matthew Mishan - KeyBanc Capital Markets

Robert Kosowsky - Sidoti & Co.

Tony Venturino – Federated Investors, Inc.

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Stoneridge Conference Call. My name is Stephanie and I'll be your operator for today. At this time all participants are in listen-only mode, later we will conduct a question-and-answer session. (Operator Instructions) I will now like to turn the conference over to your host for today Mr. Ken Kure, Corporate Treasurer and Director of Finance. You may proceed.

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 has been filed with the SEC and has been posted to our website at www.stoneridge.com. Joining me today on today's call are John Corey, our President and Chief Executive Officer and George Strickler our Chief Financial Officer.

Before I begin, I need to inform you that certain statements today may be made 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 fact or reasonable assumptions, you should understand that these statements are subject to risk 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 our growth strategy and business development and his thoughts on the market conditions. George will discuss the financial and operational details of the quarter and future outlook.

After John and George have finished their formal remarks, we will then open up the call to questions. With that, I would like to turn the call over to John.

John C. Corey

Good morning, although our net sales or net income increased in the third quarter versus the prior year period, our results were negatively impacted by the additional costs associated with the launch of a major customer program and supply shortages of electronic chips and electrical connectors. I will cover these in more detail later. However, these issues are being resolved in the actions we are taking to support our customer commitments will benefit our future.

Our other methods of performing in the ranges as expected. Sales for the quarter were $160.4 million, up $42.4 million or 36% higher than the prior year quarter. Increases in North American automotive production and higher North American and European commercial vehicle production provided the revenue improvement over the prior year period.

Based on the continuing strength in the market, we are raising our 2010 sales guidance range to be between $630 to $640 million from our previous guidance of $605 to $625 million. We expect future increases in sales as our primary serve markets continue to improve in 2011. Our third quarter gross margin of 22.5% is slightly below our range of 23% to 25%. But it is the fifth quarter in a row where we are above the 22% gross margin. Third quarter gross profit includes $1.3 million of premium freight costs and $1.7 million from a core product launch in one facility.

Operating income for the quarter was $5 million. Finally, we recorded net income of $648,000 or an EPS of $0.03 a share which included a $1.3 million book provision for – of deferred tax of $0.05 per share due to improved financial results of PST in Brazil.

This book provision does not impact our cash taxes. Our quarter end cash position was $84.9 million and in early October we used $9 million of our cash position to retire a portion of the principal balance of our debt as part of the refinancing initiative which we completed on October 4. Cash on hand after the refinancing will support our future growth plans.

Now let me go into the details behind the operational shortfall in the third quarter which was primarily from our North American Electronics Group. As we reported in prior quarters, the industry has experienced shortages of electronic components and various electrical connectors. Vendor allocations and erratic deliveries; a condition we have dealt with for most of the year resulted in inefficiencies in our production.

To manage material supply and customer deliveries, we utilized expedited freight to obtain parts and to ship product to avoid line shut down situations at our customer's facilities. This cost us about $1.3 million for the quarter compared to last year. Our team has done a good job of managing a part shortage and matching the most immediate needs of the customers to the product availability.

However, managing customer demand and material availability we did not fill all customer orders on time and built a back order on some products. Where we did not do a good job was in the managing and execution of a major program launch. There are several reasons this launch did not go well including the part shortage discussed above. However, the majority of the poor launch issues are our responsibility.

The end result was we fell behind this customer's requirements and created a back order build up. As we progressed through the quarter we saw progress in our launch but it was clear that we would not significantly reduce the back up – the build up and back orders from both the launch and the part shortages unless we scheduled the plants to work additional overtime and added people to support our production rates.

It was an expensive way to meet customer requirements but I felt it was the right action to take to significantly reduce our back orders by the end of September. We are now running with significantly less overtime. We still need to continue with our plan improvements and to manage the shortage of materials and the situation is improving and we do not believe given the current suppliers commitments that there will be a significant problem in the fourth quarter.

The additional labor and overtime cost costs us approximately $1.7 million in the third quarter which represents nearly $0.07 a share for the quarter. The third quarter was also impacted by material cost increases for copper as the average price in the third quarter increased by 22% compared to the third quarter of 2009. Though we hedged a portion of our remaining 2010 purchases, our third quarter results were negatively affected by approximately $600,000 excluding the $118,000 in hedge benefits.

We expect based on current comparable pricing to have a similar impact on the fourth quarter. Going forward much of the copper increases will be recovered in 2011 as over 50% of our sales to customers that have significant copper content have copper recovery provisions in our agreements or contracts.

Finally, our net income was unfavorably impacted by the volatile movements of foreign currency rates in September. Though many of the foreign denominated assets and liabilities are hedged with either derivative instruments or naturally, some exposures still exist.

During the quarter our net income was unfavorably impacted by $558,000 most of which occurred in the month of September. During the fourth quarter our financial team has taken steps to mitigate a significant portion of these exposures so they did not have the same impact on our earnings going forward. For the year, our foreign exchange exposures have generated a benefit of $1.1 million but a negative impact occurred in third quarter.

Now turning to look at the positive events accomplished the third quarter. We booked $253 million in business wins which includes the previously announced five year contract renewal in July with Navistar, our largest customer.

Our year-to-date total bookings are approximately $316 million with approximately $96 million in new awards and the balance in renewals of existing business. Our cross selling and global execution efforts are showing results as evidence by a third quarter award from Telematics and tracking system with a leading European global truck manufacturer. We're particularly proud of this award as it represents the collaboration of our European instrumentation group and our Brazilian joint venture on a global competitive quote.

We will be producing and selling the truck and trades units both in Europe and South America. This award is valued at approximately $21 million of which approximately $11 million will be reported by our European business and the balance sold and produced by PST, our joint venture Brazilian operation.

We continue to expand and grow in emerging markets. In China in the fourth quarter of last year we had business development resources to begin to develop the electronic and control device businesses. We opened our new tech center in March of this year to develop electronics and wiring business by adding additional engineering tests capabilities. As a result of those efforts during the third quarter of 2010, we have won new business awards totaling $13 million.

These wins in a relatively short period of time reflect the positive growth momentum we are generating China. Some of the larger awards include one to a Chinese engine manufacturer for an instrument cluster and electronic body controller; another to a power equipment manufacturer for a wiring harness for a constructional agricultural application. We believe that we can develop our China operation to reach $50 to $75 million in sales over the next three to five years.

Our joint venture operations and financial results continues to return to the more normal levels of

2008 and – of 2007 and 2008 for both sales and profitability as the market fundamentals have improved both in India and Brazil. In India our JV sales are now forecasted to be approximately $32.6 million in 2010, an increase of approximately $12.2 million or 59% over 2009.

The market has continued its robust growth and the Indian economy is improving as GMP growth was at 8.3% in the most recent quarter. We believe our sales in India can reach $50 to $75 million in the next three to five years also. Our PST joint venture performance improved in the third quarter of 2010, recovering from the weaker first and second quarters of 2010.

Sales improved to $86.4 million (inaudible) in the third quarter and $64.1 million (inaudible) in the first quarter and $74.1 million (inaudible) in the second quarter. Operating margins increased to 19.3% in sales from 8.5% in the second quarter and 4.4% in the first quarter. PST is returning to their pervious performance levels, PST continued to land new customers. During the third quarter PST assigned an agreement with Wal-Mart. They will sell car audio and video systems under their market leading Positron Brand similar to what they do for GM and Fiat in the OES channel.

PST currently sells to car (inaudible) the largest mass merchandisers in Brazil and now will sell through Wal-Mart who's the third largest mass merchandiser in Brazil. Sales through this channel are forecasted to reach $48 million (inaudible) in 2011. In summary our third quarter, while an improvement over last year could have been better and is not reflective of the future performance of the company. We did not manage one launch out of several launches in the quarter as well as we should have.

We believe the actions taken, while costly to the quarter, supported our customer commitments and our future revenue streams we expect to get from the new business awards. We continue to see our major markets for automotive, commercial vehicle and agricultural improving in 2011. Primary, preliminary industry forecasts show increases for North American automotive production next year.

Likewise the commercial vehicle markets in North America and Europe are projected to continue their recovery. We still believe the commercial vehicle market is positioned for a significant rebound in 2011 as the age of the fleet and general economic envisions bode well for future production levels.

In addition the agricultural market continues to have a positive outlook and now represents about 16% of our sales. We have a good blend of business in each of these sectors and we will benefit with the market’s continuing recovery. We have growth with our customers from new programs this year and next. We have taken costs out and can leverage the volume increases. We are addressing our inefficiencies which lowered our performance in the third quarter. We believe that our fourth quarter results will show improvement over our third quarter results.

The plans we have developed and executed over the past three years are not negated by this quarter’s performance. The strategy we have been executing namely top line organic growth, expanding our customer base, geographic diversification, operating with a lower cost structure, resulting from our restructuring and lean implementation to derive continuous improvement, positions Stoneridge to improve financial performance.

With that I'd like to turn the call over to George to provide additional details on our performance and outlook.

George E. Strickler

Thank you, John. We established as our number one priority this year to refinance our 11.5% high yield bonds that would have matured May 1, 2012 as the high yield market opened favorable rates. On October 4 of this year we successfully completed the refinancing of our $183 million 11.5% bonds. With $175 million, 9.5% bonds which extended our maturity to October 15, 2017. This will save the company approximately $4.4 million in interest expense annually.

Even though our entire $183 million has been refinanced only $190.7 million will be redeemed early and remaining bonds will be called at par on November 4. This will cost us an additional $700,000 of interest expense in the fourth quarter until all the bonds are redeemed on November the fourth.

In conjunction with the refinancing we have entered into a fixed rate or variable rate swap of $45 million of our $175 million total bond debt representing 20%, 25% of our total debt position. If interest rates remain at currently levels, we expect to save an additional $700 to $800 thousand in interest expense per year.

We believe interest rates will stay low until at least the third quarter of 2012. Another area of importance that we are actively managing is our current cash tax position. Over the last five years we have not paid U.S. cash taxes due to our NOL position. The net operating loss has primarily been created by tax deductible good will related to our high debt acquisition in 1998 which has and will continue to generate a tax deduction of approximately $20 million per year through 2013.

As a result, we do not expect to pay any cash taxes in the U.S. until approximately 2012 or 2013. Over the last five years PST has been remitting dividends to us normally in December of each year. The dividends from PST have not caused us to pay cash taxes in the U.S. due to our tax loss carry forth position.

However as a result of certain tax accounting principles we are required to provide deferred tax expense at the U.S. statutory rate of 35% on the equity earnings from our PST joint venture. With the significant improvement in equity earnings from PST in the third quarter we provided deferred tax in reported earnings period.

For the third quarter this represented tax expense of $1.3 million or $0.05 per share and for the total year to date represents $1.9 million or $0.08 per share. In the last two quarters we launched 13 programs which will add to our sales growth in 2011. Both of these launches ran successfully and only one launch is having difficulty. As the market continues to transition from this significant downturn toward a recovery and our sales have increased from a low of $475 million in 2009 to annualized rate of $630 million to $640 million for 2010.

We will continue to manage the challenges of a significant growth for the production ramps in such a short time frame. Though we continue to be diligent in managing our costs, certain events in the third quarter have occurred which prohibit us from recognizing our full potential to generate operating profits in the third quarter.

As John discussed earlier, honoring customer commitment through a difficult launch even when it means increased costs have combined to adversely affect their profitability this quarter by $1. 7 million for operating inefficiency, head count increases in overtime. In addition, component shortages have caused decreased premium freights this quarter, $1.3 million. The premium freight that has been running at elevated levels all through the quarters this year compared to last year.

Our team has addressed these issues during the quarter and they should not have as much of an impact in the fourth quarter. Now I'd like to cover you some of the details regarding the financial performance from the quarter. Revenue of $160.4 million in the third quarter of 2010 represents an increase of $42.4 million or 36% over the third quarter of 2009.

Our sales increases is the result of increase in production volumes that are serve markets, new business programs, sales and improving the economic conditions. For the third quarter light vehicle revenue increased from $41.3 million to $52 million, an increase of $10.7 million or 25.9%. The increase was primarily through (inaudible) the 26. 1% increase in traditional domestic production in our control device segment.

Sales in the medium and heavy duty truck market totaled $78.8 million in the quarter, an increase of $17 million or 27.5% over the prior year third quarter. The revenue increase was primarily driven by the increase of 25.1% in the North American commercial vehicle production.

European commercial vehicle production is showing an increase of 76%. Sales to agriculture and other markets totaled $29.6 million, an increase of $14.4 million or 95%. North American revenue accounted for 78% share of the third quarter revenue and 78% for the same period last year.

In the third quarter electronics revenues were $99.9 compared to $70.2 million from the same period last year, an increase of $29.7 million or 42.4%.

Factors, favorable factors, affecting the third quarter performance was a 25.1% increase in North American commercial vehicle production and a 76% increase in European commercial vehicle production. Revenues for control devices $60.5 million, an increase from $47.8 compared to the third quarter of 2009 which is an increase of $12.7 million or 26.5%. The 26.3% increase in production in North American of light vehicles the (inaudible) domestic manufacturers was the primary reason for the increase.

Our third quarter gross margin was 22.5%. This marks the fifth quarter in a row that our gross margin was greater than 22%. The continued increase is primarily due to our cost structure initiatives and positively benefited by higher sales volume. Sales from low cost manufacturing locations accounted for 47.1% of total sales for the third quarter, compared to 45.8% in the prior year.

The increase is due to volume increases at our Mexican facilities. Production line moves from our Mitcheldean, U.K. operations to China and Estonia have contributed the increase in our low cost manufacturing locations as well. So, general and administrative expenses total $31 million which is consistent with the $31.4 million in the second quarter and $29.6 million in the first quarter this year.

Our design and development expense is $9.2 which is consistent with our second quarter expense at $10.2 million and $9.2 million in the first quarter. Our SGA expenses in the third quarter this year excluding restructuring is down compared to 2007 and 2008 by $1.6 and $2 million respectively.

Income tax expense for the third quarter was $2 million on a pre-tax income of $2.6 million. As reported for December 31 of last year, the company is in a cumulative loss position and continues to provide a valuation allowance offsetting its federal, state and certain foreign deferred tax assets. As a result, no tax expense was provided on US income in the third quarter.

The company is required to provide deferred tax expense related to the earnings of our PST joint venture which is unaffected by our valuation allowance position.

The increase in tax expense for the three months ended September 30 of this year compared to three months ended September 30 the last year, which is primarily attributable to the improving performance of the US and foreign operations as well as the tax we are required to provide related to our PST joint venture. Due to the valuation allowance deferred tax related to our investment in PST and the pattern of projected earnings that quarterly affects the tax rates may fluctuate significantly. We expect the 2010 annual effective tax rate to be between 28% and 32% and cash taxes of only approximately $1.5 million to $1.8 million.

Stoneridge report a third quarter net income of $648,000 or $0.03 per share, this compared with prior net loss of $844,000 or $0.04 per share. Depreciation expense for the quarter was $4.7 million and amortization expense was negligible as most of the intangibles had been written off in December of 2008.

Our primary working capital totaled $94.1 million at quarter end, which increased by $14.4 million from the third quarter of last year. As a percentage of sales our working capital decreased from 16% to sales in the prior year to 15.5% to sales in the third quarter of this year. Our working capital measures were significantly influenced by the drop in sale revenue we experienced in 2009. Earned working capital levels are a function of increasing sales and operational activities we are now experiencing. As markets return our long term goal still remains and the primary working capital is 12% of sales and we are projecting we can reach 13.4% by the end of this year.

Operating cash flow is a source of cash $10. 7 million in the third quarter compared to the source of cash $26.6 million in the previous year. Our cash flow results in the third quarter were affected by the increase in accounts receivable and inventory offset partially by increased accounts payable, which are a function of sales and customer mix. Capital investment for the quarter totaled $3.4 million mainly reflecting investments in new products in sensors and wiring as well as IT spending for ERP implementation in North America Electronics.

We are forecasting to finish the year with a total capital spending in the range of $18 million to $20 million. We are forecasting that we will have a free positive cash flow for the year. As of September 30, 2010, we have $72.4 million of availability under our $100 million asset based lending facility; this is a significant improvement from the $54.1 million level at December 31 of last year. Our borrowing base has increased by $18.3 million since the fourth quarter of last year has increased account receivable balance as a direct result of higher sales. We have no borrowings drawn against our asset based lending facility.

As part of the bond refinancing we extended the maturity of our ABL to November 1, 2012. Our quarter end cash balance is totaled $84.9 million compared with $91.9 million at the end of last year. Our cash firm was mostly driven by increased accounts receivable driven by increased sales. We will continue to manage our capital expenditures and working capital, sustain and/or improve our cash flow.

Going forward we expect we will continue to fund our operational growth initiatives through our free cash flow generation and available cash balances. As the market recovers our working capital will begin to grow in dollar terms but we will continue to improve our base to achieve our primary working capital target of 12% of sales.

We initiated changes to our business nearly four years ago to position the company for better operating and financial performance. Our plans were curtailed in the second half of 2008 and most of 2009 with a significant market downturn that forced us to implement more aggressive changes to our business in order to contend with the market decline.

Our quarterly financial results for 2010 are reflecting improvements we have made in the business. Even though our net sales level is nearly $100 million lower than the average sale of 2007 and 2008 of close to $740 million our profitability is improving due to our cost restructuring. We are projecting that our sales for 2010 will be in the range of $630 million to $640 million, which is a significant improvement for a low $475 million in sales in 2009 as the market returns and the results of our organic growth.

Our current business split is represented by 51% commercial 33% fast car and light vehicle and 16% heavy. Of the commercial market about 2/3 is in the US and 1/3 is in Europe and for our North America commercial market we are approximately 67% medium and 33% heavy. In Europe we are about 52% medium and 48% heavy. We have experienced a significant improvement in US fast cars and vehicles as the market has improved from under 10 million annual production units to more robust level of 11.4 million to 11.6 million units that we have been running since the second quarter of this year.

Our future plans are based on leveraging our cost reduction and growing from a combination of market growth and from new business awards. We have reduced our fixed cost structure by taking four operating facilities and eliminating redundant overhead centers as we consolidate our malleable business units to two key businesses: control devices and electronics. We consolidated our management teams of North America by combining our wiring and electronics business units in 2008, combining our Canton, Massachusetts and Lexington, Ohio business units in August 2009.

Part of the benefit was cost but we also benefited for more focus on development of technology and new products, cornerstone customers, geographic growth like cross selling our technologies to movable customers and in more concentrated efforts on the developing markets: Brazil, India and China.

Our plan at the beginning of 2010 included net new business awards of $227 million over the next five-year period and we have landed of $96 million of gross new business awards for the first 9 months of this year. This new awards will contribute to our significant growth over the next five years. We have been benefiting from the return of our companies financial and operating performance in the emerging markets; Brazil, India and China. Brazil and India reported equity earnings in the third quarter of this year of $3.9 million, which is the highest level they have reported in nearly seven quarters.

We are not expecting a significant increase in commercial vehicle production in the fourth quarter, which is why we have only raised our sales forecast for this year to $630 million to $640 million. We do expect the commercial business to begin to improve by the first quarter 2011, accelerating the second quarter and especially in the second half of next year. The market is now projecting this significant increase in the commercial market for next year. North American commercial vehicles market is forecasting growth of 18.2% in medium duty vehicles and 56.8% in heavy duty vehicles. Europe is projecting an increase in medium truck of 40.3% and heavy duty truck at 27.8%. These vehicles projections plus our net new business awards will drive significant growth for us next year.

We have addressed the critical issues that we laid out in our original plans four years ago. We have reduced our fixed cost structures, we have refocused our DAD expenditures to move up the value chains (inaudible) and provide us the opportunity to cross sell our products and technologies to movable customers. We have made investments in China, India and Brazil to grow in the emerging markets. We have refinanced our $183 million 11.5% coupon bonds with new $175 9.5% coupons that extends our maturity factor with 15 to 2017. We have extended our ABL by one year to November 2012 to provide us with opportunity to refinance at the best possible rates.

We are well positioned for profitable growth that will permit us to achieve our (inaudible) target of reaching 15% by 2011, 2012 and generating positive free cash flow to continue to reinvest in the business.

Now John would like to make one more comment before we turn the call over for questions.

John C. Corey

Thanks George. As many of you are aware, on October 7, 2010 Stoneridge filed an S-3 registration statement with the SEC indicating the Draime’s family intention to sell their shares. SEC regulations forebode us from commenting on the subject and as such we will not be providing any addition information beyond what is included in the S-3 filing.

Operator, with that I would like to open up the call for questions.

Question-and-Answer session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Bob Nicholson with Pine Cobble Capital. You may proceed.

Bob Nicholson - Pine Cobble Capital

Hi guys. Just a couple of things I wanted to clarify. If I just walk through – it sounds like there is a lot of moving parts in this quarter. If I just walk through a couple of the big items and I start with the pre-tax number of $5 million and then add to that the one-time expenses associated with the expedited freight of $1.3 million for the quarter. So operating income plus $1.3 million for expedited freight; plus it sounds like there's $1.7 million of what are going to be unusual costs related to the program launch that gets me to $8 million pre-tax. Then it sounds like there are some costs associated with the fluctuation in copper that ultimately gets recovered. Which gets me to sort of $8.5 of operating income which would have been – I think a much more consistent number for operating income margin to what were you've talked about before in terms of the incremental margin. If I run all of that through and back out interest expense, the Brazilian equity income and then apply a normalized tax rate, not the catch-up provision for Brazil of say 30%, that gets me to a much different number in terms of the net income from the quarter. So my question is how should we think about the recurring nature of the one-time issues? How comfortable are you in your ability to keep fixed costs from creeping back as production begins to really ramp up next year?

John C. Corey

What we are looking at right now is we look at electrical – part of it is supply disruption, so we look at this on electrical connectors, we are seeing that is not as severe as it used to be so we see some improvement on electrical components, chipsets and stuff. We are generally looking at an industry forecast that call for recovery in the second quarter of 2011, so we believe we will be managing component issues through the fourth and first and second quarter of the year but I think we have done a pretty good job in managing that because that has been a condition that has been in place for the first half of this year as well. When we see it – it’s improving. The situation is getting better. We are having less instances of premium freight shipment so I think that benefit will start to – I mean that will come into play and as I said in the fourth quarter we don’t see a severe shortage of these parts that we saw before, so I think that will comeback.

In addition on our operations, the one factory that was causing us the problems with the product launches – George said we launched about 12 programs in the last 2 quarters, we had one that has been a (poor match). We worked aggressively at that factory, we will continue to have some work to do at the fourth quarter there but that is already reducing its overtime, we will reduce its headcount and we will see improved performance out of that business in the fourth quarter and going forward.

And then to sort of relate those dollars that you rightfully highlighted, the $5 million is operating income and the pre-tax income is $2.6 million. The launch cost of $1.7 million, those are pretty well behind us at this point. I mean we caught up with most of the back order we have with our customers. Premium freight is something we have been experiencing all year. Our normal run rate is somewhere around 300,000 to 400,000 so that incremental 1.3. We do see an improvement onto that in the fourth quarter of roughly, probably half of that. Copper, I think as we mentioned, it’s accelerated, copper is now up to about $3.80 a pound. We will incur roughly about the same amount in the fourth quarter depending on some volume. But with our surcharge mechanism that we mentioned in here that it’s – we have 50% of our contracts covered, actually higher than that with the new Navistar contract but that takes us about 15 months to get into full implementation. So is Copper, if it levels off at this period our surcharge mechanisms have a six-month lag period to it so if it stabilizes at this level we will not incur any additional cost beyond what we have.

And then I think the other item – we talked about the launch cost, the premium freight, the copper and then the exchange was really a unique thing because we have inter-company obligations (inaudible) in Europe and in Mexico. We have been hedging those positions and year-to-date we have positive position benefit of about $1.1 million. It was negatively impacted because of the swing in the currencies in September in fact the (inaudible) where we have our manufacturing location in Europe is actually revalued against the Euro.

And then our Mexico obligations were impacted the month of September so I think we are in pretty good shape with the currency impact that we mentioned. And then I did want to highlight because it is important is that on a cash tax basis, we are only projecting that we will pay cash taxes of about $1.5 million, $1.8 million this year and we under accounting tax guidelines, we are accruing a corporate tax rate of 35% on PSTs earnings even though when we remit the dividend this December, there are no cash taxes paid on that. It will -- all of them would watch itself through when we absorb the full amount of tax laws carried forward.

Bob Nicholson - Pine Cobble Capital

So if I again – just going – trying to go through some of the one-time item, it sounds like after you get through these unusual items, the core earnings prior the business this quarter, if I just run through the simple math, it gets me to $0.18 or $0.20. So the core engine and the core cost structure you guys have put in place, it sounds like that is intact, you feel good about that and you're setting yourself up. It's going to take a couple of quarters until we get to the peak of the truck cycle ramping for that to shine through. Is that still a fair assessment of how you guys think about the margin potential?

George E. Strickler

Yeah, that is exactly right. We think what we just have to do now is execute. We got all the heavy works behind us in terms of the restructuring in the form of the cost take out. Those things will stay out and so we – if the market improves then with our new awards then we are going to benefit from that.

Bob Nicholson - Pine Cobble Capital

Okay, terrific. Thanks, guys.

John C. Corey

I think the one thing that we tried to highlight, too is that we have not seen the commercial ramp that there has been a lot of reports about it, but it is out there and it appears and it is coming more in the first quarter and gets stronger in the second quarter and then the second half of next year so we are positioned for that and that is what our forward plan is really based on.

Operator

Your next question comes from the line of Matthew Mishan with KeyBanc. You may proceed

Matthew Mishan - KeyBanc Capital Markets

Good morning George, John, Ken.

John C. Corey

Hello, Matthew.

Matthew Mishan - KeyBanc Capital Markets

I just wanted to go back to the program launch costs. I believe, in the second quarter, you also had some one-time impacts of some slight disruptions, the Euro and the program launch cost. Is this the same program that you were having some issues with in the second quarter as well?

John C. Corey

Yeah, the supply disruptions have been something that we have been confronted all this year. I think that each quarter we talked about disruptions in electrical components and connectors primarily on chipsets and some other things and that affects both of our business on both the control device business to the extent that we have some electrical content on our products there and also our electronics business. On the launch, a relatively complex launch that we started in the second quarter but we really did not see the full impact of that until the third quarter when we were really ramping up.

Matthew Mishan - KeyBanc Capital Markets

Okay. You're confident at this point, that the back orders have been filled. Is it – was there a bottleneck on your sales a little bit in the third quarter and are you going to catch up a little bit on that in the fourth quarter?

John C. Corey

I think we got it all out in the third – well, we got about $2.5 million that we would say that carried over from the third quarter, but by in large because we pushed all this business out we got the – we made the commitment to our customers and that is really kind of a normal, I would say more normal carry over when you look at the month end so. You know with our customers you cannot keep them – you cannot keep a line shut down situations so we make sure we met those commitments.

Matthew Mishan - KeyBanc Capital Markets

Okay. And then, I also noticed the pace of the equity income definitely increased in 3Q. Is that a sustainable event going forward, or do you expect – or was that just seasonally high?

John C. Corey

No, I think we see – they are bringing on new products. We talked about the car and audio and the PST and General Motors what they are selling. It was probably a little higher than we expected in the third quarter but it should run in that range. Historically, we have always said that around $3 million as you know is better this quarter at $3.9 but we see them now having a sustainable level of both – their margins have improved and we saw that in June and it ran of the whole third quarter so we feel good about where they are at.

George E. Strickler

Yeah, and our Indian joint venture is that continues to ramp, at the rate that it’s doing it should be able to improve and it has demonstrated it can improve its profitability as it gets more in line there, so we think both of those things are in positive trajectories.

Matthew Mishan - KeyBanc Capital Markets

Moving on to contribution margin, as you think about contribution margins going forward, given – I believe in the past, you've said between 25% and 30% would be your expected contribution margin on the increase in sales. Given some of the one-time issues you've seen in 2010, are you more confident that in 2011 you can hit that 25% to 30%, or can you actually exceed it, given some of the one-time issues you've seen in 2010?

John C. Corey

Well, I think we have always said that we will run in that 25% to 30% range, Matt, and I think we will continue in that range if we have the opportunity to because of some of the new products that are coming on, but I would continue to use the 30% as a marginal contribution on sales growth.

Matthew Mishan - KeyBanc Capital Markets

And just lastly on interest expense, I think you mentioned that interest expense was going to pick up a little bit because we were we are beginning to be at par. Do you have a number you're thinking for the 4Q on interest expense at this point?

George Stickler

Well, all the chance on that one, Matt. I think if you just do some quick arithmetic we have a $175 million of the new issue we had $183 million. There is going to be a portion of the time which is going to be about $700,000 worth of interest, because we are not finished fully extinguishing the bonds until November 4 and the incremental interest is coming from about 70 – we did $109 million in principal balance on October 4, so there will be a month’s worth of interest on the $70 odd million dollars extra on the 11.5 before they retired on the November 1.

Matthew Mishan - KeyBanc Capital Markets

So it is coming down then in 4Q?

George Stickler

Yes, it will but there is a small – it is not going to be – it is not like on October 1. We also have $175 in interest only. There was a small period of double carry.

Matthew Mishan - KeyBanc Capital Markets

Then if I do the math correctly, I'm assuming, if you were to annualize it around – at around $22 million maybe $22.5 million in interest expense, you come down next year by about $4.5 million?

John C. Corey

Yeah, $4.5 million plus as we mentioned we have done an interest rate swap and so depending on what (inaudible) is doing that can move it but we estimated the benefit of $600,000 to $700,000.

Matthew Mishan - KeyBanc Capital Markets

All right. Great. Thank you very much guys.

John C. Corey

You are welcome, Matt.

Operator

Your next question comes from the line of Robert Kosowsky with Sidoti & Co. You may proceed.

Robert Kosowsky - Sidoti & Co.

Hi, good morning guys. How are you doing?

John C. Corey

Good. Yourself?

Robert Kosowsky - Sidoti & Co.

I am doing pretty good. I was just wondering if you could give us a little bit more color as to what went wrong with the product launch. Looks like a new product you guys were coming up with or it had a hard time scaling up? Was it issues with quality or supply-chain or – more color on that would be great.

John C. Corey

Sometimes when you get engineering specifications or drawing and that they are not accurate and that starts the problem off so when you – we had some issues with some incorrect engineering parameters on the product and that started the problem. This was really in our wiring business so it is complex wiring harnesses that have a lot of sub assemblies that go along with them and so we had to start, we had to learn from that, we had to build new board from that and when we started the -- We had a lot of training and development time that went into that and so I think it started from some poor engineering drawings and instructions to some poor development work on our side, to some issues we had with the efficiencies on our factory floor and getting parts to the floor on time. A variety of operational issues that we are now largely – we now largely addressed and continue to work to finalize so we can run very efficiently.

Robert Kosowsky - Sidoti & Co.

Okay, that's helpful. How do we have more confidence that more issues like this will not sprout up, once like cyclical demand comes up? Kind of you changed some of the engineering processes that you have? How do you address that given the market might have a good year next year?

John C. Corey

Yeah, that is really the question. As we said, we did 12 launches in the electronics. We have added these in this business over the last – in the last two quarters, although this one launch did not run well. If we go back and we do a lesson to learn on this things and unfortunately sometimes we don’t learn our lessons and we didn’t – we need to relearn them and so we engage with people, but we are putting in different metrics into the system. The head of that business is personally engaged putting in those metrics to make sure we got accountability and measurement criteria that come up and down the line. I would never say “never”, there are always possibilities that you have problems with the large programs because of timing of events. You know in the industry you get a program and what you would say would be – maybe you would have 12 months to develop and design that program and put it on the floor, by the time the customer finalizes their specifications that might drop down to 8 to 9, 6 months so you really got to scramble. So there is always that possibility. You just have to try to manage it more effectively.

Robert Kosowsky - Sidoti & Co.

Okay. To what extent did your customer feel the impact on this bad product launch? Then also more broadly on the component supply issue, what extent did you guys bear the brunt for your customers so that kind of not passed on the chain?

John C. Corey

The customer felt the problem because they were not – they had trucks in the yards so to speak that they couldn’t ship out until we got the parts to them. Now, we were not the only supplier that was causing them problems so I am not going to say that it was all of ours. As we have said, towards the end of the quarter, we worked with them very closely to develop a plan of how we were going to get out of this situation and in part of that plan was also discussing with them the component availability, making sure that we were setting the right priorities or what products to produce to ship to them to get their most urgent needs out. I think we did a good job, also a fair to good job of doing that. I mean anytime you disrupt a customer you can’t really say you did a great job, so I think we did a fair job of getting out that, executing on that. We still have some work to do there.

Regarding the component shortages, that is also I think where our team actually has done a very good job in managing that possibility over the course of this year, so everybody from our purchasing to our operations people to our customer sales organization works with the customer in trying to identify what the issues are, trying to identify what their needs and requirements are and trying to satisfy them. I think for the most part, we did good job. We have done a good job in and managing that component shortage.

Robert Kosowsky - Sidoti & Co.

Okay. How did you guys troubleshoot this? Did you guys get alternate suppliers, were components more expensive from the same supplies that you used or what?

John C. Corey

Well, we buy components direct and then we went out to the distribution channel and bought components in the distribution channel where distributor has had components on hand and so we purchased some. We are looking at all sources of components. It becomes difficult to change a component, you can’t really change one in a product unless you get a deviation from the customer and so we have gone out and scavenged so to speak for – in the marketplace from distributors and others.

Robert Kosowsky - Sidoti & Co.

Then also can you talk about some of the new business wins and where they kind of fall in the mix between heavy-duty, medium-duty and I guess US versus international on the Electronic side?

John C. Corey

Yeah, well if you look at the, if you look at the $96 million, it is –I think we said about $23 million was on the control device side if I remember correctly the rest would be on the electronic side and electronics is almost all -- as George gave you the spread out of heavy duty and medium duty and (inaudible). We will get the specific number for you on that and in that I think the biggest news is that we were able to renew with our largest customer, a 5-year long term agreement with them which as George said gives us – puts in place a copper escalation cost, so we have been able to in the future protect us some of the vagaries of the copper commodity market.

Robert Kosowsky - Sidoti & Co.

Okay. Then finally, how much cash do you want to keep on the balance sheet to remain comfortable?

John C. Corey

Well, we have always said that we probably looked at about $25 to $30 million and the rest will be used for growth opportunities and that has always been one of the things that we done for the business. We have looked at – since 2008 have looked at some acquisitions that we -- but we never felt that they were valued correctly or that they were the right fit for us, so we will continue that as we go forward how to sell on both our geographic footprint our products footprint. We might have some smaller sized acquisitions in the future.

Robert Kosowsky - Sidoti & Co.

Okay, thank you very much. Good luck with this next quarter.

John C. Corey

Thanks, Rob.

Operator

(Operator Instructions) Your next question comes from the line of Tony Venturino with Federated Investors. You may proceed.

Tony Venturino – Federated Investors, Inc.

Good morning gentlemen. Thanks for taking my call. Actually, most of my questions have been answered, but I just want to get some give some more color around the launch and some of these component shortages. I think you said that the customer was okay at the end with the product launch. Is that a fair assessment, or how would you –?

John C. Corey

Oh, I wouldn’t say they were okay with it. They were never okay with it when you have problems with it. I think what we did is we got to a working agreement where we started to meet commitments and we started to demonstrate to them and that we were meeting our commitments and got on a sound footing. We are not – I am not saying we are out of the woods yet, but we are on a sound footing now. We are not having the same kind of problems we had before and as a result we were able to – the factories are running back down on more normal operations. Although we still have some problems on component shortages and we still have some other issues that we have to sort out but not at the magnitude that we faced in the third quarter.

Tony Venturino – Federated Investors, Inc.

So was there any sort of long-term damage to this relationship or just kind of near-term?

John C. Corey

Well, we are going to have to go and sit down and discuss with the customer the issues that we had and what we have done to put it in place I think overall our relationship with the customers have been good. We serviced them fairly well across the board but in this particular case, we did not do that so we want to get the problems fixed and demonstrate to them how we are doing that. We have done that for the last several – last month and going into this month and once we do that, then we will sit down and them and talk about what the opportunities are for the future. As we have this launch from we won two major awards with that customer in this past quarter and so they were (inaudible) and Global awards.

Tony Venturino – Federated Investors, Inc.

Okay.

John C. Corey

We had one hiccup and we continue to hit and very favorably we received some other contracts we were very significant with this customer.

Tony Venturino – Federated Investors, Inc.

Okay. That's fair. Then yesterday, Freescale had commented on their issues, their supply issues and that they had kind of worked through all lot of the constraints that they had had. But when they had shipped out to their customers like you, you were seeing issues, not you specifically but customers like you were seeing issues with other components in the chain. Do you think we're getting close to the end here? It sounds like you're saying this is going to be another couple of quarters of issues. Where are specifically are kind of the main constraints?

John C. Corey

Well, at some chipset we feel we will see another couple of quarters of those things and there are some problems and some of it actually when we start to dig in to it, some of it goes to path it has taken on line and they are not bringing back on capacity as rapidly as they would have in the past. The other thing is that we are at a record demand for chips worldwide, so even though the industry went down with all the advent of electronics and content of electronics chips and chips demand is going up so there needs to be more capacity brought on. And in some cases as simple as somebody as a supplier changing their ERC system and having problems with matching up orders and demand properly so you know this strengthens – we are managing that, too. But I think what we are hearing from all our customers on our group is telling us our electronic group and purchasing people are telling us it will continue to get better but it is going to probably be on a more normal state by the second quarter – before the end of the second quarter.

Tony Venturino – Federated Investors, Inc.

Okay. And then just a couple of last quick questions, clarifications. D&A, you had said depreciation I think was $4.7 million. I didn't hear the amortization part. Could you give me a total number for them?

George Strickler

Our amortization is all right so $4.7 is the depreciation.

Tony Venturino – Federated Investors, Inc.

Okay. $4.7 million and so and then, on the balance sheet, the debt level is $183 million and changed. Is that pre or post-refile?

George Strickler

That is pre. That is pre-refile.

Tony Venturino – Federated Investors, Inc.

That is pre. Okay. Could you give me what the debt levels are now? You kind of talked around that, but –

George Strickler

That will be $175 million and then we have about $1 million of our subsidiary in North America and its been running around that level so I think you will see at about $176 million.

Tony Venturino – Federated Investors, Inc.

$176 million. Then you had I believe it was $183 million minus $109 million that's left, that goes out in November though?

George Strickler

Right.

John C. Corey

That will be – we will end up paying about a month of interest additonal 11.5% on those bonds that we have not redeemed.

Tony Venturino – Federated Investors, Inc.

Okay. All right. That's it for me. Thanks.

John C. Corey

You are welcome.

Operator

Your next question comes from the line of Robert Kosowsky with Sidoti. You may proceed.

Robert Kosowsky - Sidoti & Co.

Just another couple of questions. Could you talk a little more in detail about the new PST products that are coming out, especially the one where you cross-sell I think with the Electronics division? Also, could you maybe talk about the margin profile of the new products relative to the 19% margin I guess we saw in the third quarter?

John C. Corey

Well, we don’t really disclose margins but in a lot of the track and trace systems can use common components basically what it is with the telematic systems that a large customer wanted. They can track and trace trucks – the truckers and so we combine the ability. PST as we reported in the past has been a leader – has been one of the leaders in the Brazilian market of developing that tracking systems down there for vehicles because the insurance industry wanted that so they have that capability in there. In addition to our European capabilities we are able to design a system using the experience we have in Brazil and also using our experience we have with our taco graph system in Europe to come up and meet the customers’ expectations and beyond that not only the expectations for the design and the development but then the expectations for manufacturing, because we can manufacture our products in Brazil and we manufacture the products in Europe.

Robert Kosowsky - Sidoti & Co.

You guys said that was like a $23 million project on an annualized basis?

John C. Corey

Yeah, $22 million when it is fully ramped up and about half of that goes into Europe and half of that will go into Brazil and in addition, this system, wow. There are no laws mandating it for North American market. Overtime fleet to North America will probably migrate towards more of this type of system even if it is not legislated and we have a good opportunity because we designed this system for both Europe and Latin America, South America to bring that system with that customer into North America should it be needed.

Robert Kosowsky - Sidoti & Co.

Okay. Thank you very much. I guess when does the (inaudible) distribution system start to land up? Is that a fourth-quarter event?

John C. Corey

Well, they just signed it so it will start out slow here in the fourth quarter that will really start to come in 2011.

Robert Kosowsky - Sidoti & Co.

Okay, thank you very much and good luck.

John C. Corey

Thank you.

Operator

And with no further question in queue, I would now like to turn the call back over to Mr. John Corey for any closing remarks. You may proceed.

John C. Corey

Well, thank you. We have said all along we have put a plan together. We have been executing on that plan our execution. Our execution in this quarter was not flawless as we have demonstrated in the past, but the overall fundamentals of the business still remain strong and still remain well-poised for the recovery that is happening and every indication of the trend of the recovery will show that both the automotive and commercial vehicle markets will recover in 2011 – continue to recover so we are going to get positive up-lifts from that. In addition, we are very encouraged as the relatively quick wins we have had in China, because if you think about it we have put resources on the ground really a lot of resources last year and in six to eight months we have won that $13 million worth of business and so we continue to see good growth opportunities there. So while the quarter did not come in as we expected because some of the reasons we had, most of those reasons that are completely issues that will be resolved and mitigated as we go forward and we see no reason to -- I said to modify the direction of the company or where we are going or what we are doing and we are very optimistic about the future.

Well, thank you very much for joining us on the call.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.

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