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Stoneridge Inc. (NYSE:SRI)

Q3 2007 Earnings Call

November 2, 2007 11:00 am ET

Executives

George Strickler - EVP and Chief Financial Officer

John Corey - President and CEO

Analysts

Brandon Ferrell - KeyBanc Capital Markets

Brett Hoselton - KeyBanc Capital Markets

Operator

Good day ladies and gentleman. Welcome to the Stoneridge Third Quarter 2007 Conference Call. (Operator Instructions)

I would now like to turn the call over to Mr. George Strickler, the company's Executive Vice President and Chief Financial Officer. Please proceed, sir.

George Strickler

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 on our website at www.stoneridge.com. Joining me on today's call is John Corey, our President and Chief Executive Officer.

Before we begin, I need to inform you that certain statements today may be forward-looking statements. Forward-looking statements include statements that are not historical in nature and include information concerning our future results or plans.

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

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

During today's call, we will 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.

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

John Corey

Good morning and thank you for joining us on today's call. I would like to provide you with an update on our third quarter results and discuss our expectations for the remainder of the year.

Our sales for the third quarter approximated the prior year results at $172 million. Our organic growth and global market exposure continued to mitigate the substantial reductions in the North American commercial vehicle production.

Our new product launches in the areas of high temperature sensors, speed sensors and the launch of our second modular instrumentation award substantially mitigated the 43% decline in North American commercial vehicle production.

In addition, our European revenues continued to grow as we launched new products and the commercial vehicle production in Europe rises. Diluted earnings per share totaled $0.11 in the third quarter compared with $0.19 in the prior year.

In the third quarter, our joint ventures continued to perform well as our equity earnings increased 90% from the prior year. The main driver behind this increase is our PST Electronic Joint Venture. PST's revenues grew at over 47.5% in the third quarter.

We announced PST's filing with the Brazilian Security and Exchange Commission, the CVM. Given that we are in a quiet period, we will not comment further on PST.

We continue to focus our operational improvements in a difficult volume environment and we were able to improve operational performance as evidence by lower premium freight and scrap costs. We did not make as much progress in reducing inventory as volume declines were not offset with reductions in inventories.

We have programs underway which are starting to show some improvements in bringing inventories down without impacting service levels. However, as we have examined the issues around inventories, the needs will require additional action and resources to support a sustainable reduction. We are working to bring our inventories in line with volume expectations in the fourth quarter.

I would now like to review our restructuring program and the outlook for the remainder of the year. Our challenge has been how to best manage a balance of growth and customer requirements while developing an effective global footprint of manufacturing facilities, engineering resources and support operations.

In the last 18 months, we began by leveraging core support functions to support our business. Specifically, we have developed global purchasing, established a significant material buy in Asia, specifically China, and realigned information technology to provide for the development of a common ERP system.

As a second step, we started to focus on our SG&A structures. We combined our six business units under two key operating units, controlled devices and electronics. Within controlled devices, we are working on integrating the cost structures of the high stat operations into one business team where we previously had two separate and distinct business units.

In the electronics division, we are working on establishing one business unit in North America where we had two.

We developed common benefit programs for our employees in North America and continue to evaluate all of the corporate support costs to gain efficiency in those areas and eliminating cost centers such as our recent announcement that we sold our corporate aircraft.

At the same time, we have been evaluating the overhead structures of our manufacturing facilities. Today, we announced we are ceasing production operations at our Sarasota, Florida and Mitcheldean, England locations. While these are always difficult decisions, we feel they are necessary steps to reduce our manufacturing overhead and SG&A costs.

As we reviewed with you previously, these are two areas where Stoneridge metrics were on the high side. The future volume commitment to these two locations was insufficient to support the cost space.

Our decision to relocate manufacturing into other operations will improve cost profile and performance once completed. We will begin our restructuring program in the fourth quarter and expect to complete the program by the end of 2008.

We expect to recognize approximately $1 million of expenses related to this program in the fourth quarter and between $9 and $13 million of expenses over the life of this program after the expected gain on a facility sale.

Our restructuring program is expected to generate between $8 and $12 million of cost savings by 2009. We have detailed plans in place to be executed under the direction of senior leadership with the receiving locations supported by others as needed.

Our entire team is focused on executing these plans and meeting the targets. Given the current economic outlook, we feel these actions will allow Stoneridge to be more aligned with the market environment by establishing a global manufacturing footprint.

We are creating larger facilities that will lower our overhead structures while at the same time, we make sure that each facility is efficient and provides the lowest landed cost for our products.

We have made these decisions to accelerate the rate of change but yet to ensure that the organization can handle these actions with limited disruptions. Our goal is to complete the restructurings during 2008 so that by 2009, the organization can focus on growing the business profitably without the distractions of restructuring. These actions are a continuation of our plans to improve the performance of Stoneridge and drive value.

Regarding our expectations for the balance of the year, the outlook for improvements in the North America commercial vehicle production continues to move further out. The current outlook is for depressed production levels to continue in the fourth quarter.

However, based on our cost reduction activities and our third quarter performance we are maintaining our full year guidance despite the uncertainty and the microeconomic conditions of the fourth quarter, especially the weak Class 8 truck market in North America.

Overall, our full year outlook remains unchanged. Our expectation for the full year's earnings between $0.45 and $0.55 per diluted share. With that, I would like to turn the call over to George.

George Strickler

Thank you, John. Before we review the third quarter in detail, I would like to share a few financial highlights. We announced our restructuring program this morning. We expect his program to generate $8 to $12 million of pre-tax savings by 2009.

This program will allow us to reduce our cost space and move the company toward our long term operating margin goal of 8% to 10%. We have recently completed our new $100 million ABL revolving credit facility. This facility will replace our existing facility and provide significantly lower borrowing costs and flexibility.

This facility was also structured to allow us more flexible refinancing options should market conditions improve. I would now like to cover the third quarter results in more detail and then we will open up the call for questions.

Revenue increased approximately 30 basis points to $172.8 million in the third quarter. Favorable foreign currency translation contributed $3.2 million to our top line compared to the previous year.

Our revenues continue to be unfavorably impacted by the substantial decline in North America commercial vehicle production. During the quarter North America commercial vehicle production fell 43%.

Offsetting these declines were the impact of new program launches and strong European commercial vehicle production. Light vehicle revenue increased 14% to $70.5 million. The increase was attributable to new program launches in the areas of high temperature sensors and speed sensors.

Medium and heavy-duty truck sales totaled $82.8 million in the quarter down 12% from the prior year. Strong European commercial vehicle production and favorable foreign currency exchange rates were more than offset by 43% decline in North America commercial vehicle production due to the change in emissions regulations.

Sales to agricultural and other markets totaled $19.5 million and were $2.9 million above the prior year. The increase in sales was predominantly due to strong build rates of John Deere.

North America revenue accounted for 73.8% share of third quarter revenue compared with 75.6% for the same period last year. The percentage reflects the strong growth of our European operations and the production declines in the North America commercial vehicle market.

In the third quarter electronics revenues declined approximately 8% to $103 million. The decline was more than attributable to the reduction in North America commercial vehicle production. This decline was partially offset by strong revenue from our European commercial vehicle operations and favorable foreign currency exchange rates.

Revenues for the controlled devices increased 15% in the third quarter. New business revenue was the main driver behind the increase as our new high temperature sensor and speed sensor products contributed to our top line results in the quarter.

Third quarter gross profit totaled $37.9 million yielding a gross margin of 21.9%. Our gross margin was slightly below the prior year's level of 22.2%. Increased depreciation expense resulted in a 40 basis point year-to-year decline gross profit. These variances were offset by favorable product mix and our cost savings initiatives.

Our commodity and foreign currency hedging programs resulted in a slightly favorable offset to the unfavorable variances. As a reminder we have locked in approximately 1/3 of our total purchase for 2007 at favorable rates compared to the current price of copper.

We expect that the restructuring initiatives we announced today will result in further improvement to our gross margin levels upon completion. Our long-term gross margin target remains in the range of 23 to 24%.

Sales from low cost manufacturing locations accounted for 38% of total sales in the third quarter compared to 37% in the prior year. With our China operation ramping up and our restructuring initiatives we expect our sales from low cost locations to grow as we relocate labor intensive manufacturing over time as we expand our presence in -- low cost manufacturing locations in Mexico, Estonia and China and build on our growth potential in Brazil and India through our joint ventures.

Selling, general and administrative expenses totaled $32.4 million in the third quarter compared to $29.1 million in the previous year. The prior year SG&A figure benefited from the non-recurrence of a $1.2 million one-time gain related to the settlement of the life insurance benefits portion of a post-retirement benefit plan realized in the third quarter of 2006. The increase in SG&A during the quarter was related to additional design and development marketing expenses primarily in Europe.

Finally, our operating income totaled $5.2 million in the quarter compared with $9.1 million in the prior year. Third quarter income tax expense totaled $381,000 resulting in effective tax rate of 12.7%. The lower effective tax rate was primarily attributable to the benefit of the federal research and development tax credits a benefit for change and state tax law and a more favorable mix of lower tax foreign earnings.

We expect our 2007 effective tax rate to be between 18 and 22%. Stoneridge recognized third quarter net income of $2.6 million or $0.11 per share compared with net income of $0.19 per share in the prior year.

Depreciation expense for the third quarter was $7.3 million and amortization expense totaled $400,000. For the full year, we expect depreciation and amortization to approximate $29 million. Earnings before interest, other income, taxes, depreciation and amortization were $12.5 million in the third quarter compared to $15.7 million in the previous year.

Our primary working capital totaled $115.8 million at quarter end, which increased $11.2 million from the previous quarter. As a percentage of sales our working capital was 16.2% above both the second quarter level of 14.6% and the prior year level of 16.1%.

While we made good progress toward improving our working capital levels or working capital balances remain above our targeted range of 12% to 13% of sales. We see significant opportunity to reduce our inventory balances in 2007 and have made this a focus area for operations.

Operating cash flow net of fixed asset additions was a source of $4 million in the third quarter compared to a source of $10.4 million in the previous year. The higher working capital primarily related to higher accounts receivable balances. We continue to target primary working capital balance in the range of $0.12 to $0.13 per dollar of sales.

Capital investment totaled $3.4 million in the third quarter mainly reflecting investment in new products and testing equipment. Some significant components of our investment were in the areas of emissions and sensor products. For the full year we expect our capital spending to approximate $20 to $25 million.

Turing to liquidity, we completed our new revolving credit facility. This facility will provide us with significant flexibility going forward and eliminated our financial maintenance covenants. We have also structured this facility to allow us the flexibility to refinance our debt should the capital markets improve.

Our cash balance totaled $67.6 million compared with $46.7 million at the end of third quarter last year. Going forward we expect we will continue to fund our operational growth initiatives through our free cash flow generation and available cash balances. As part of this we will also continue to evaluate non-strategic assets for sale. In October, we sold our corporate aircraft as part of this program resulting in proceeds of $7.1 million.

Now, I would like to take a moment to discuss our outlook for the remainder of 2007. As mentioned by John for the full year based upon the current industry outlook our expectations for the full year remain unchanged at $0.45 to $0.55 per share. This projection assumes we incur $1 million of restructuring expenses during the quarter.

Operator, I would like to open up the call for questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Brett Hoselton with KeyBanc Capital Markets.

Brandon Ferrell - KeyBanc Capital Markets

Hey guys, this is Brandon.

John Corey

Good morning, Brandon. How are you?

Brandon Ferrell - KeyBanc Capital Markets

Good, how are you guys doing?

John Corey

Good.

Brandon Ferrell - KeyBanc Capital Markets

I wanted to touch on the Brazilian JV. I know, you guys said you couldn't comment on that, but it looks like you guys potentially maybe interested in creating some value there by reducing your ownership stake.

Just wondering, if that makes any strategic rationale sense to you and what your intentions might be, if you were to raise some cash?

John Corey

Brandon we cannot comment beyond what we have already issued in our press release related to PST.

Brandon Ferrell - KeyBanc Capital Markets

Well, just kind a touching on the idea of raising cash again, you guys do have a decent amount of cash on the balance sheet for a company of your size, any priorities in using that cash, we talking about funding growth or?

John Corey

We are evaluating a couple of things. I mean, as we have talked about in the past at some point in time we would like to go on and look at some acquisitions and we want to make sure that we have stabilized our operating position and our structure and with the move that we are making today and as those moves are completed we think we will have an opportunity to look at some acquisitions that might enhance our growth profile not only from a product perspective but also from expanding our market presence outside of North American markets.

George Strickler

And we have always said that our initial priority would be to continue to reduce our debt.

Brandon Ferrell - KeyBanc Capital Markets

Okay. Were there any operationally, any efficiencies like we saw in the second quarter that carried over into the third quarter in the UK and if so could you guys quantify that?

George Strickler

Well, we won't quantify it but the UK operation has continued to under perform and it did not improve that performance in the third quarter. We have started, we've changed the management team over there and we started to see some improvements.

But then really its a lot of work they needs to be completed to get that facility aligned and I think that was helped in the decision I said, this just doesn't have the cost profile or the volume commitment from customers in the future that would allow us to maintain that operation.

Brandon Ferrell - KeyBanc Capital Markets

Okay. I think it was about $3 million to $4 million in the second quarter, so fair to say probably commensurate with that level here in the third?

George Strickler

Yes. I would say that that is probably but as you remember that wasn't all attributed to the UK operation?

Brandon Ferrell - KeyBanc Capital Markets

The $3 to $4 million in the last quarter?

George Strickler

It was all operations in total.

Brandon Ferrell - KeyBanc Capital Markets

Okay. Any sense of how that might trend here in the fourth quarter, is there any potential risk that that carries into '08?

John Corey

Well I think the inherent plan as we start to unwind manufacturing operations there, that should be in our cost structure that the estimate that we have presented today. So we don't expect to see significant improvement in the underperforming operations but those are operations that we are targeting now to relocate.

As far as, the other things, we had a lot of product launches this year in the first quarter and second quarter that caused us some difficulties and we expect that we will not have that same level of difficulty going forward.

Other than, Brett it is part of our announcement as you know that we will incur some premium labor and build up cost of inventory as part of the restructuring which was included in the $1 million.

Brandon Ferrell - KeyBanc Capital Markets

Okay. If you guys think about SG&A now, and just restructuring in general, I think this is obviously the first cohesive plan that we have seen announced in terms of restructuring. I know you guys have talked about 8% to 10% SG&A over time, possibly by 2009.

That doesn't get you there I would say. So is it safe to say this is potentially the first of many announcements that we will see over the course of the next year in terms of restructuring?

George Strickler

No. I wouldn't say that. I think when we talked about SG&A we said it was a combination of some restructuring initiatives that we would have to undertake. It was also, as we grow our business keeping a cap on those expenses so we allow growth to drive that forward without adding additional cost.

Brandon Ferrell - KeyBanc Capital Markets

Okay. I'm going to pass it over to Brett.

Brett Hoselton - KeyBanc Capital Markets

Hey, gentlemen. How are you today?

George Strickler

Good.

John Corey

Good morning, Brett.

Brett Hoselton - KeyBanc Capital Markets

Can you talk a little bit about the outlook for your operations in Asia?

John Corey

Well our China operation as we have just started that operation really in 2006. We are starting to quote business out of that operation now for the local market and we are actually quite pleased with the performance of that business.

We still have some added investments to make in that operation in terms of engineering and development efforts and then to select which products that we will put over there. We have five lines that are currently in the manufacturing across a broad range of our products. So we would expect to see that accelerate over the next several years as we win business in the local market.

Brett Hoselton - KeyBanc Capital Markets

And then, also and this is not Asia related. I am just -- this is just generally speaking. Can you comment on what your perceive to be the outlook for your [Ag] business in general and then also the commercial vehicle business in general and specifically I am thinking about the market as opposed to your own personal organic growth?

John Corey

I think that what we have seen in the Ag business is continued good market growth and as George mentioned our growth with John Deere has been very good in this period. We don't see any slowdown in that right now.

On the commercial vehicle side we are concerned about the forecast because not only is the impact from the emissions which we expect to be ended by now. But we are also seeing a weakness in truck traffic.

So as the truck traffic downturns people aren't purchasing trucks at the same rate that they probably were previously and I'm not quite sure how we are playing, we are playing that in cautiously in regards to that. We don't expect to see an upturn until second quarter of '08.

Brett Hoselton - KeyBanc Capital Markets

Great. Well thank you very much gentlemen. Certainly do appreciate it.

John Corey

Thank you.

Operator

(Operator Instructions) And there are no further questions. I will now turn the call back over to management for closing remarks.

John Corey

Good. Well, I would like to thank you and I think what you see with today's announcement of the closure of some facilities that we are progression on the plan that we have previously discussed and that involves around.

One, operational improvements, two financial improvements and then, three ultimately going after the marketing improvements and I think we are well positioned now and underway on all three of those segments.

So it is a challenge for the team now to go out and execute and we are quite pleased with our performance so far although we recognize we still have a lot to do.

With that, I would like to thank you all for joining us on today's call.

Operator

We thank you for your participation in today's conference. This concludes the presentation.

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