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Stoneridge, Inc. (NYSE:SRI)

Q2 2014 Earnings Conference Call

August 11, 2014 10:00 a.m. ET

Executives

Ken Kure – Corporate Treasurer and Director, Finance

John Corey – President and CEO

George Strickler – Chief Financial Officer

Analysts

Justin Long – Stephens Inc.

Jimmy Baker – B. Riley & Co.

Robert Kosowsky – Sidoti

Operator

Good day, ladies and gentlemen. And welcome to the Second Quarter 2014 Stoneridge Earnings Conference Call. My name is Denise, and I will be the 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 would now turn the conference over to Mr. Ken Kure, Corporate Treasurer and Director of Finance. Please proceed.

Ken Kure

Good morning, everyone, and thank you for joining us on today’s call. By now you should have received our second quarter earnings release. The release and accompanying presentation has or 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 maybe 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 uncertainty, and actual results may differ materially.

Additional information about such factors and uncertainties that could cause actual results to differ maybe 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.

Now that the Wiring business has been sold, our financial reporting starting in the second quarter for control devices like (inaudible) and PST were reported continuing operations and Wiring has also reported as a single line called discontinued operations.

Our forward projections from this point would be for our remaining segment only as our historical results including the Wiring business are not relevant to our future performance.

John will begin the call with an update on significant events for the quarter, current market conditions, operating performance in the second quarter and growth strategies and business development. George will discuss the financial and operational aspects of the second quarter in more detail and in the repositioning of the company from closing the Wiring transactions and our thoughts on market value.

We have also prepared and published an earnings presentation to provide more detailed schedules to help your understanding of our second quarter result, trends for our continued improvement and update you on key initiatives to improve financial performance.

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

With that, I will turn the call over to John.

John Corey

Good morning. The sale of the wiring business begins our repositioning of the company for more consistent and sustainable financial and operational performance. Our second quarter has and our third and fourth quarter may include unusual impact from the sale of the Wiring business, recognition of the non-cash goodwill impairment and PST and refinancing to establish a new capital structure to deleverage the company and to lower our overall debt at a much lower interest rate.

We announced the sale of the Wiring business on May 26, 2014 and we completed the sale on August 1. As we shared with you on our last investor presentation of May 28, we made the decision to divest the Wiring business based on a strategic review of our future competitiveness.

We have recognized competitors were becoming larger through acquisitions and will become a more vertically integrated reducing raw material cost and leveraging labor and overhead. In our view to effectively continually compete would have required significant incremental investment. Wiring is a more of a commodity product so technological or engineering innovation offered limited differentiation possibilities.

The combination of Stoneridge Wiring business with Motherson Wiring business creates the size, scale and vertical integration which will be competitive in the markets. Included in the transaction are six manufacturing facilities located in Portland Indiana, Chihuahua, Saltillo and Monclova all locations in Mexico as well as our engineering and administrative center located in Warren, Ohio. The transaction involve about 4700 employees.

Net cash proceeds for the transaction were 71.4 million. With the sale completed, we have three business segments which are technology driven with global applications and offer greater opportunities to provide higher value to our shareholders.

Proceeds from the sale will be used to deleverage the company at a significantly lower interest expense and George will cover this in more detail in his comments.

Reviewing the business performance in the second quarter, control devices and electronics continue to perform well as the market trends improved as expected. PST’s performance was negatively impacted by the Brazilian economy as GMP growth was less than 2% in the second quarter. Brazilian inflation rate has increased to 6.4% while interest rates have arisen to a 11%.

In response to this weaker economic environment, PST has taken significant actions to address this. Stoneridge's consolidated revenues in the second quarter were 162.1 million which is a decrease of 7.7 million or 4.6% over the second quarter of 2013. Sales increased their control devices by 2 million or 2.7% in electronics by 4 million or 8.4%.

Revenues in our passenger car and light truck category which are predominantly control devices sales were 60.2 million in the second quarter, a 4.7% increase from the second quarter of 2013, sales of 57.5 million a higher volumes of existing products. Sales in our commercial vehicle category which are predominantly electronic sales were 61.1 million in the second quarter compared to 57.4 million, a 6.4% increase over the second quarter, primarily due to higher volume sales of instrumentation products in Europe. Slide four provides the detail.

PST sales declined by 13.8 million or 29.5% with currency to valuation being 2.5 million of the reported 13.8 million revenue decline compared to the prior year second quarter. PST experienced lower demand across most of its prior client reflect in the economy’s impact on consumer behavior and to some degree a shift in purchases by the mass merchandiser from audio to television sets related to the World Cup.

The Brazilian management team has taken aggressive actions to reduce direct labor in SG&A. In April they took charge of $400,000 for restructuring. PST will benefit from this in 2014 by 4.6 million and in 2015 by 7 million.

In July PST reduced an additional 140 people in staff and management’s positions to continue reduce their cost structure. A charge of $900,000 will be taken in the third quarter but will benefit the P&L by 1.4 million in the 2014 with an annual benefit of 3.9 million in 2015. Slide 14 contains the details. If we would add the first and second quarter actions, we will see a 10.9 million benefit in 2015.

PST’s gross margin excluding 300,000 for purchase accounting was 37.1% in the second quarter of 2014 compared to 42.5% in the second quarter of 2013. This decrease was due to lower volume driven by lower car and motorcycle alarms which traditionally have higher margins and audio sales were also lower than the prior year.

Excluding purchase price accounting, PST had an operating loss of 1.2 million or negative 3.6% sales compared to a positive 8.8% in the second quarter of 2013. In a difficult economic environment, PST management continues to lower the cost structure and improve their product offer.

First, the newly designed audio line and we will begin reducing cost by 9 million to 10 million which will be improving margins in 2015. Second, actions today’s to reduce cost in April and July of 2014 and benefit 2015 by 10.9 million. Third, their track and trace line should benefit from the new technology that they have developed which has the best anti-jamming capabilities in the industry. Four: Michelin’s acquisition of Sascar compared to track and traces establishes value in the track and trace business in Brazil and supports our outlook that the new business opportunities continue to be develop, which can drive double digit annual growth.

Finally, as the economy recovers PST’s financial performance can return to more historical levels.

Consolidated Stoneridge operating income margin decreased to 3.8% in the second quarter of 2014 compared to 6.9% in the second quarter of 2013 due to PST’s performance and currency impacts. Stoneridge operating margins excluding PST remain flat compared to the first quarter of 2015, PST’s margins excluding purchase accounting with the negative 3.6% in the second quarter versus the first quarter’s operating margin of negative 3.2%. Slide five of our deck has a complete P&L breakout on 2014 versus the second quarter of 2013 for continuing operations which includes the PST goodwill charge of 29.3 million or $0.85 a share for the second quarter.

Slide four indentifies the Stoneridge segment shell increases and decreases versus the prior year second quarter. Slide eight of our deck identifies the bridge item differences between the second quarter of 2014 and the second quarter of 2013 earnings per share. The quarter’s difference is primarily due to our growth in revenues, a controlled device in electronics offset by unfavorable mix and lower volume. In addition, we incurred higher design and development expenses of control devices and electronics to support new business launches in 2015.

EPS from continuing oprations excluding the goodwill impairment charge was $0.06 per share compared to our second quarter 2013 EPS of $0.21 a share. Our operating margin and businesses excluding PST was 6.8% compared to 7.1% from the second quarter of last year.

Operating income was lower than second quarter of 2014 compared to last year’s level for controlled devices and electronics as I said higher spending for D&D was incurred to support product launches at control devices. Our net new business wins over the next five years remain intact as the majority of our future program run has been generated by control devices and electronics.

New and replacement business awards for Stoneridge's control device and electronic business in the second quarter were 32.7 million, representing29.1 million in new business awards and 3.6 million in replacement awards. Two of our larger new business wins in the second quarter include an electronics cluster and control module for our large Chinese heavy truck manufacture was totaled 8.2 million and another shift-by-wire award for a large North American passenger vehicle and light truck customer which totaled 4.5 million.

As we have previously stated, we expect shift-by-wire category to be a significant contributor to control devices global growth over the next three years with potential annual peak revenue of 150 million for this category of product by 2016. This is a significant growth considering the three years ago we did not have any business in this product line.

Minda Stoneridge are unconsolidated JV in India post to second quarter sales of 11.1 million an increase of 16% versus the second quarter of last year and despite of 9.5% evaluation of the Indian Rupee.

Excluding the effects of foreign currency exchange, Minda sales increased by 27.1% compared to the prior year. Our share of Minda's net income from operations in the second quarter was a profit of $147,000 compared to a profit of $73,000 in the second quarter of 2013.

In summary, from our market perspective, the North American passenger car and commercial vehicle and the European commercial vehicle sales met our market expectations and the outlook is positive.

PST underperformed to Brazil’s continued economic weakness. As we review our outlook for the businesses, control devices and electronic should continued perform to well. PST will have a difficult second half given the economy but the cost and product actions they are taking should benefit the second half.

While the Brazilian market is down as we saw in the second quarter of 2012, to the second quarter of 2013 the turnaround can be significant. With the sale of the Wiring business, we have three businesses which have the capability to deliver double digit operating income before corporate expenses. The sensors and actuation market growth will benefit control devices, and the growth in electronics will benefit our electronics business.

As the Brazilian market recovers and we launch the new products we will see PST performance return to former levels. We will have a new flexible debt structure and significantly lower interest expense.

Overall, the company has attractive products and technology portfolio which can deliver improved results. With that I would like to turn the call over to George.

George Strickler

Thank you, John. As Ken mentioned earlier, our overview and discussion in the second quarter results will not include our wiring segments performance for the current and prior year. With the sale of the wiring business, we believe we have repositioned the company for enhanced shareholder value for the future.

Over the last three years, we have had negative impacts from volatility in our financial results from our wiring business that has negatively impacted our evaluation metrics. The inconsistent financial performance of our wiring business has resulted in Stoneridge trading lower than the peers in our sector. This has resulted in a lower market capitalization and was one of the major reasons for the decision to sale the wiring business. In addition to John’s comments the investments required more vertically integrate to lot of raw material cost.

With the completion of the wiring transaction on August 1st, we took a major step in addressing this issue. As an additional benefit of the wiring business sale, we’ve improved our risk profile and our geographic diversification would be more balanced. We now have a balance for sales between North America at 48%, Latin America at 20.3%, Europe/Asia 30.5% with growth coming in all four regions. This can be seen on chart seven.

Our customer has improved with a balance between automotive and commercial customers this can be seen on Chart six. PST is having negative impact in the last four quarters but our PST management team has been very aggressive in their cost alignment actions to correspond with the market opportunities by channel.

Chart 14 lists the key cost actions that we are generating net savings for PST of $5.4 million in 2014 with an annualized benefit in 2015 of over $20 million. The question that may arise was some of the 2015 cost savings needed to be utilized to address competitive pricing pressures in the market.

With a completion of the wiring transaction, we call 10% of our existing bond $17.5 million at 103 of par using some of the proceeds from the transactions. Now with the close of the wiring transaction, we will begin aggressively deleverage the company as our first priority by paying down debt and lowering our interest expense.

One of our main goals in the refinancing is to provide stability of long-term borrowing capacity or providing the ability to pay down debt which will offer flexibility at substantially lower interest rates. We are preparing the company take advantage of the lower interest rates by ensuring we are ready to refinance the long-term bonds by October 15 of this year.

One other issue that we needed to address in the second quarter was the assessment goodwill impairment for PST in Brazil. Due to the uncertainties of the Brazilian economy, we have reassessed the economic value of PST based on discounting cash flows. From these factors, the goodwill impairment assessment resolved and recording a non-cash goodwill impairment of 29.3 million or $0.85 per share. But even with this valuation reduction, PST has carrying value in excess of $130 million which is supported by the recent acquisition of Sascar by Michelin.

Our ability to drive top-line sales and profitability remains our number one objective for continuing operations, with the completion of the sales of wiring business the proceeds from the transaction and the cash flow generation capabilities of our continuing operations remains our seconds area of emphasis.

In the second quarter, operating cash flow was an inflow of 9.1 million in comparison of 4 million during the second quarter of last year. This was driven by lower receivables as a result of the lower than expected sales of PST.

As indicated on Slide 13, we have improved our total debt to EBITDA ratio from 2.9 in December 31 2012 to 2.7x times in December 31 of last year. And with our 2014 guidance and the sale of the wiring business we expect our debt to EBITDA to be in the range of 1.5 times to 2.5 times by the end of the year and includes the effects or expected refinancing initiative.

Our North America ABL remains undrawn since November 2012. During the inventory buildup of PST, they temporarily borrowed $7 million in short term debt in the first quarter of this year to fund working capital growth needs in the first quarter but will pay down the debt before the end of the year as they lower inventories in last nine months of the year and see Slide 13 of our deck.

We have discussed over the last year, our continued focus to grow the top-line with profitable business with the completed sale of the wiring business we’ll be able to focus our resources on leveraging our technology capabilities by further investing in both our electronics and control device segments that have always had greater profitability and cash flow potential.

During our last earnings call we shared some of the key initiatives on which we continue to make progress.

Now that we have closed the wiring transaction, we will continue to pursue both on acquisitions for controlled device and electronics businesses. And all of these initiatives will continue to improve our financial performance and all will enhance shareholder value. Our favorable outlook is based on our confidence that we have repositioned the company for improved operations and financial performance.

Our continuing operations are improving for controlled devices and electronics even though Brazil suffers from lower GDP growth in consumer uncertainty. With continuous weakness in Brazil, PST has managed by continuous realigning their cost structure to match their channel and product opportunities.

The company has repositioned as a higher value of market participant with the completion of wiring transaction on August 01, 2014. 10% of our debt would be redeemed by September 02 of this year as the company begins its deleveraging process using the proceeds from the sale of the wiring business.

We intend to refinance our remaining outstanding of $157.5 million in senior notes by October 15 of this year which will significantly reduce our interest expense. These actions have been taken to produce more consistent and predictive financial performance which we believe will lead to an increased shareholder value.

Our EBITDA for 2014 excluding the noncash goodwill charge is running at the year at nearly $69 million and combined with improvement of our continuous operations and deleveraging our debt we are well positioned to improve our shareholder value.

We will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Justin Long with Stephens. Please proceed.

Justin Long – Stephens Inc.

Thanks and good morning guys.

Corey

Good morning, Justin.

George Strickler

Good morning.

Justin Long – Stephens Inc.

My first question is on PST, did a good job of breaking out the cost initiatives on the slide in the presentation but as we think about this business longer term, what’s a reasonable operating margin target we should be thinking about?

John Corey

We have always said that the PST – historically PST is operated at a double digit operating margin and we expect that to reoccur as we go forward. It’ll be a different mix of products that’ll drive that. The alarm business was a double digit – significantly high double-digit performer and that as a track and trace business grows that will offset of the margin that we might see coming down in the alarm businesses as the market stabilizes. And then the audio business, with the cost reduction will drive that up into a higher contribution range. Audio line was usually around the 20% gross margin range, 20%-22% we expect that to bring that up over 30% with these new lines. So we will have product lines that will drive on a gross margin basis over a 40% plus gross margin will be exceptionally audio line and we think that will return the business. Plus, one other things we are going to do PST is going to do is not going to – as the business comes back we are going to hold cost structure – try to hold the cost structure as to support higher leverage on our existing base.

Ken Kure

But Justin, I think it’s reasonable as we get into 2015 as there we should see operating margins – operating income margins in the range of about 10% to 11%.

Justin Long – Stephens Inc.

Okay. That's great. That's helpful. And taking a step back and just looking bigger picture, I know you guys have historically discussed some longer-term targets for the business, organic revenue growth of 6% to 8%, an operating margin target of 8% to 9%. Now that you have divested wiring, does it change how you think about these targets, is it that the top line target that stays relatively the same but the margin target is higher now, because you got rid of wiring, how are you thinking about that?

George Strickler

I think Justin, I think what you are going see is we’ve always targeted 6% to 8% on the top-line, I think excluding wiring now you will see a little faster rapid growth there, in fact with the net new business which has not really been impacted substantially. It’s out there to about 176 million but up that wiring was only 5 million. So I think you are going to see us more, little higher than that 6% to 8% target.

In terms of operating income which is the most important for us in ROIC, I think you are going to see our immediate targets go up a little quicker than what we anticipated but I think longer term, we still hold that view of 8% to 9% is a good level because there’s going to be a lot of competitive pressures, you are seeing consolidation of supply base and competitive pricing pressures. But even with that level, we will generate substantially north of 20% ROIC and that’s our most important target. It’s really the ROIC which comes from the business and cash generation.

You will see that between the continuing operations in the proceeds of wiring I think we can substantially ramp down our debt and that gives us the ability to invest and make the priority choices for the investment in control devices and electronics specially and would even entail some bold-on acquisition. So I think the modeling you might say, you can get above that level. But right now to achieve that 8% to 9% over this next year to 18 months is I think our immediate goal and then we will measure it from there but pricing becomes initial consolidation and supply basis is always important to where that level finally settle down.

Justin Long – Stephens Inc.

Okay. That make sense. I'm going to ask two quick ones on the guidance and then pass it along. But first, I wanted to get what you were using for the first two quarters of the year for EPS, what we should be comparing to, I guess, the full-year guidance?

Ken Kure

It’s a continuing operations Justin, piece of it. That's what we have used. In the first quarter, it comes out to $0.02 and in the second, negative 79.

George Strickler

It’s $0.06, so...

Ken Kure

... from continuing operations.

Justin Long – Stephens Inc.

So $0.02 in the first quarter and then $0.06 in the second?

Ken Kure

Right.

Justin Long – Stephens Inc.

Okay, great. That’s helpful. And then secondly on the $0.10 of benefit you said you expected from lower debt and interest cost, could you walk through what you are assuming as you calculate that a certain level where this, where this debt get refinanced?

George Strickler

I think with the rates we are seeing in the market we looked at a different alternatives, how we are going approach and I think we have mentioned that we are going to use some flexibility in terms of the ability to pay down debt. And our assumption is essentially that we think we can refinance step somewhere between 2.5% and 4% and under annual interest basis also gives us the ability to pay down debt as we generate cash, we’ve done a tax restructuring in Europe, so we can bring the cash back from Europe, we can utilize the cash from continuing operations but for the most part, the averages is right there between 2.5% and 4% and that will be over a 5 year tenure. So it does have a significant bearing on our interest expense.

Justin Long – Stephens Inc.

Great, that sounds good. I’ll leave it to then pass it along, I appreciate the time.

John Corey

You are welcome Justin.

Operator

Our next question comes from Jimmy Baker with B. Riley & Company. Please proceed.

Jimmy Baker – B. Riley & Co.

Hi, good morning guys. Thanks for taking my questions. So just a follow up there to the interest savings, can you maybe just paying us a little bit more than a elaborate picture of how you would like to see the CAP structure at your end beyond let’s say the EBITDA leverage ratio that you are targeting, just trying to understand exactly how you will be let’s say balancing lowering the gross debt outstanding against retaining some dry powder for M&A?

George Strickler

Well, we’ve looked at different alternatives Jimmy in the market, we looked at bank debt, we’ve looked at revolving credit agreements in long-term indentures and we are leaning more towards the bank debt and revolver, capability because one of the things the company will do is generate significant amount of cash flow.

Our primary focus right now is getting the company de-levered and reducing interest expense substantially and then what we would envision from this structure and we do have the ability to do a forward hedge because most of the floating rates, so we can take forward hedges on the interest expense and those are still very attractive over a five year term.

And then as we go out I think if we make an acquisition and will be permitted to do this that we could arrange some what I would longer term permanent fixed rate money for any potential acquisitions that bigger than what we would have from our line that the line sufficient and of the size that we will have availability and flow and have the ability to make what I call the bold-on acquisitions as John and I have always talked about.

And still gives us flexibility that we can pay down debt which is what we were limited by buyer indenture provisions because the investors rate, they are almost found existing today and are coupons are 9.5%, so we are trying to create that structure that permits us to pay short term, we can do an interest rate swap so that we can lock into fixed rate, those rates were attractive right now in the marketplace. So we get the combination of both things we have substantial availability from this, we can meet the acquisitions and at the same time we can pay down the debt and lower interest expense.

Jimmy Baker – B. Riley & Co.

Okay, thanks. And then maybe could you just talk about the impact if any to your electronic segment from the wiring sale going forward and let’s say maybe you could share a little bit of your customer’s response to the wiring announcement?

John Corey

Yes, I think as we went into talk to all of our major customers on the transaction and they were supportive of that transaction and so I think they have viewed as a positive thing. We handled it very well because one of things that customers are concerned about would – would this go to a firm that would just start slashing and burning costs in the wiring business and would bring value to our customers are wiring. I think with the Motherson’s acquisition, they see the opportunities for the synergies that we have talked about. So that's positive and in addition we are continuing to solve those customers electronics products, where we had agreements, a common agreement those agreements have been split now. So we have an agreement for Stoneridge and Motherson will have their own agreement on the wiring business. But overall we don’t see a significant – we don’t see any negative impact from the transaction on the electronic business and we see a significant positive for the customers as they go through this process with Motherson.

Ken Kure

And some of the transactions, Jimmy that we have or direct with our customers themselves. So those contracts are on place and so electronics has done a very good job over the years and they remain as a supplier to few of those key customers.

Jimmy Baker – B. Riley & Co.

Understood. That's helpful. And lastly, just a clarification on the guidance. I think the prior guide assumed about 1.5 million a quarter, or I will it call it $6 million for the year, in purchase price accounting charges at PST. Is that still correct or does the updated guide assume some benefit there or lowering of those charges after the $23 million write-down?

Ken Kure

No, they both included 3.3 million in non-cash expense. So that hasn’t changed Jimmy, right. We will come out and give you some more guidance in terms of what that is amortization in the future.

Jimmy Baker – B. Riley & Co.

Okay. Got it. Thanks very much for the time.

Ken Kure

You we are welcome.

Operator

(Operator Instructions) Our next question comes from Robert Kosowsky with Sidoti. Please proceed.

Robert Kosowsky - Sidoti

Good morning, guys how are you doing?

John Corey

Good.

George Strickler

Fine. Rob, yourself?

Robert Kosowsky – Sidoti

In slide 14, just a couple clarification questions regarding the PST cost cuts. First off, the 4.7 million, are those cost cuts all slated to hit in the second half of this year?

George Strickler

Say that one again Rob?

Robert Kosowsky - Sidoti

The $4.7 million of benefits from cost cuts?

George Strickler

That's all coming in the second half.

Robert Kosowsky - Sidoti

Okay. And then next year, the total benefit from that round is going to be 10.9 million minus 4.7 million. So an additional 6 million relative to that?

George Strickler

Yes, exactly.

Robert Kosowsky - Sidoti

Okay. Cool. And then as you look at the 2015 actions and the change to go to the design houses, what are some risk points about changing your cost structure to go to this? Do you see more upside potential or downside risk to that $9 million to $10 million of cost cuts? I want to get a better sense of the risk profile of actually realizing that $9 million to $10 million. And also, are we on schedule, as well?

John Corey

As we have talked about in the audio business, we needed to get the certain scale before we can leverage the supply base and so PST has been able to grow that business rather aggressively. At one point in time, we feel we are about the number two audio supplier in the market, so on doing that, we have now gone direct to these design houses and leveraged that spend. So we have locked in, there is the new rate, sort of new price.

I guess the two factors that might impact that would be one: currency movements and then two is, as George said, if those happen how you have to, do you use some of that in the competitive marketplace, what our competitors are going to go on the market space but outside of that I think that those savings are pretty much locked in.

Now again, it’s a fluid market, so we are looking at right now and saying as we execute our plan, as we drain down the old audio line so to speak, then will start introducing new components in the audio line and that is new designs on the audio line which should generate drive those savings. And originally we thought that would happen at the second half of this year but due to the slowdown in the market it has been pushed out a little bit as we managed the inventories.

George Strickler

And Rob, we have had our engineering teams in China twice now. Once early in the second quarter and once right at the end of the second quarter, so we have gone through the designs, what their capabilities are.

So we know the cost structures of those components and original and final designs. The only thing that limited us from implementing quicker and the numbers that you are looking at was build up the inventory in the lower sales in Brazil.

Robert Kosowsky - Sidoti

Okay. That's helpful. And then on the shift-by-wire opportunity in control devices, I was wondering if you could talk about what some of the initial design expenses are; but then, maybe more importantly, talk about -- as soon as this thing is ramped up, and it seems like we are getting closer to having this meaningful revenue lift, is this margin profile going to be accretive to the 28% that you posted this quarter?

John Corey

In the shift-by-wire because of the magnitude of the project itself and there is two key customers involved in this is that one: you saw some higher D&D cost in the second quarter that we referred to and really had to reflect on the additional expenses we are incurring right now because they are trying to accelerate some of the ramp up for 2015. In addition to that I think what you are going find and I think we share with this before is, we don’t see a substantial uplift in the gross margin because of the volume and these parts are now selling at $120 to $150 a part that what you are really going to get is a good leverage of the SG&A and D&D investments we have made. So we get a bigger lift at the Op income and we will go to gross margin level for the shift-by-wire.

And when we look at these parts, there is multiple models that will have this. So each model might have a slightly different design characteristic to it. So that requires some additional engineering capabilities to it. While the common components or standardize the exterior might be different.

In addition, there is different software modification that have to go into these things. Overall, it’s – so those are where the predominant expenses are now as we start to move these products through into the production cycle.

Robert Kosowsky - Sidoti

Okay. But is it fair to look at, say, as we get to fourth quarter next year, this particular slice of business could be coming in at, like, a 10%-plus operating margin profile?

George Strickler

It’s got the opportunity to get to that low level, that double digit.

Robert Kosowsky - Sidoti

Okay. And I think you mentioned that you are currently on a run rate of about $68 million of EBITDA. Is that right what you have said George?

George Strickler

Right.

Robert Kosowsky - Sidoti

So if I did some pretty simple math on that, you can easily get to, like, $1 of free cash flow based on that. And I'm just wondering: as soon as you get past this debt refi, and you get to a more, maybe, flexible bank debt environment, do you think you would be looking to start buying back stock? Because it seems like the stock is pretty attractive at just 10, 11 times this free cash flow estimate.

Ken Kure

Yes, we always have discussions with our Board regarding that. I mean, as George said at the beginning, we think our stock is undervalued in the marketplace. We think part of that was our erratic performance and as we start to stabilize and improve the performance, we think the stock value will start to drive back up. And so we will continue to evaluate that but there is nothing currently expected on that front.

Robert Kosowsky - Sidoti

But that's a point of discussion as you get past this debt refi that maybe you could turn to that if the stock is still where it is?

Ken Kure

I am hoping when get passed this, that refinancing and we will start to see, one of things that we are seeing is that we gradually, we are optimistic that we are seeing some of the improvement in the Brazilian market. So as we start to see these things come back and if you look at our performance of our control device business and our electronic business, both we think are performing relatively well. Right now, we should continue to do that and as we bring on the PST business back up to standard, I think the stock price is going to go up, people are going to see it.

Robert Kosowsky - Sidoti

All right. Thank you very much, and good luck.

George Strickler

Thanks Rob.

Operator

We have no further questions. I will now return the call back over to management for closing remarks. Please proceed.

John Corey

Thank you for joining us on the call. It was a quarter with a lot of activities going on, I think as we said the notable though is repositioning the company with the sale of the wiring business and then we’ll restructure the debt level. As I just eluded too before we are -- the markets are in control devices and electronics are positive and we expect those to remain that way as we go forward here for the next balance of the year. And we are seeing at least preliminary signs that are encouraging coming out of the Brazilian market in terms of sales improvement coming through that market. So we expect to see further improvements coming out of Brazil and with the cost reductions taken out of Brazil with the modest revenue enhancements, we will be able to, hopefully, get that business back to where it should be and relatively short term. However, we also look at that say presidential elections happening in October and so we are managing the PST business as if it’s going to the market revenues are going to be about where they are today in our projections. So we are optimistic about where we can go with the company now and we look forward to talking to you about our third quarter. Thanks very much.

Operator

This concludes today’s conference. You may now disconnect. Have a great day.

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Source: Stoneridge's (SRI) CEO John Corey on Q2 2014 Results - Earnings Call Transcript

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