Stoneridge Q3 2007 Earnings Call Transcript

| About: Stoneridge, Inc. (SRI)

Stoneridge Inc. (NYSE:SRI)

Q3 2007 Earnings Call

November 2, 2007 11:00 am ET


George Strickler - EVP and Chief Financial Officer

John Corey - President and CEO


Brandon Ferrell - KeyBanc Capital Markets

Brett Hoselton - KeyBanc Capital Markets


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

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

George Strickler

Good morning everyone. And thank you for joining us ontoday's call. By now you should have received our third quarter earningsrelease. The release has been filed with the SEC and has been posted on ourwebsite at Joining me on today's call is John Corey, ourPresident and Chief Executive Officer.

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

Although we believe that such statements are based uponreasonable assumptions, you should understand that these statements are subjectto risks and uncertainties and actual results may differ materially.

Additional information about such factors and uncertaintiesthat would cause actual results to differ may be found in our 10K filed withthe Securities and Exchange Commission under the heading Forward-LookingStatements.

During today's call, we will also be referring to certainnon-GAAP financial measures. Please see the Investor Relations section of ourwebsite for a reconciliation of these non-GAAP financial measures to the mostdirectly 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. Iwould like to provide you with an update on our third quarter results anddiscuss our expectations for the remainder of the year.

Our sales for the third quarter approximated the prior yearresults at $172 million. Our organic growth and global market exposure continuedto mitigate the substantial reductions in the North American commercial vehicleproduction.

Our new product launches in the areas of high temperaturesensors, speed sensors and the launch of our second modular instrumentationaward substantially mitigated the 43% decline in North American commercialvehicle production.

In addition, our European revenues continued to grow as welaunched 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 toperform well as our equity earnings increased 90% from the prior year. The maindriver behind this increase is our PST Electronic Joint Venture. PST's revenuesgrew at over 47.5% in the third quarter.

We announced PST's filing with the Brazilian Security andExchange Commission, the CVM. Given that we are in a quiet period, we will notcomment further on PST.

We continue to focus our operational improvements in adifficult volume environment and we were able to improve operationalperformance as evidence by lower premium freight and scrap costs. We did notmake as much progress in reducing inventory as volume declines were not offsetwith reductions in inventories.

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

I would now like to review our restructuring program and theoutlook for the remainder of the year. Our challenge has been how to bestmanage a balance of growth and customer requirements while developing aneffective global footprint of manufacturing facilities, engineering resourcesand support operations.

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

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

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

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

At the same time, we have been evaluating the overheadstructures of our manufacturing facilities. Today, we announced we are ceasingproduction operations at our Sarasota, Florida and Mitcheldean, Englandlocations. While these are always difficult decisions, we feel they arenecessary steps to reduce our manufacturing overhead and SG&A costs.

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

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

We expect to recognize approximately $1 million of expensesrelated to this program in the fourth quarter and between $9 and $13 million ofexpenses over the life of this program after the expected gain on a facilitysale.

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

Our entire team is focused on executing these plans andmeeting the targets. Given the current economic outlook, we feel these actionswill allow Stoneridge to be more aligned with the market environment byestablishing a global manufacturing footprint.

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

We have made these decisions to accelerate the rate ofchange but yet to ensure that the organization can handle these actions withlimited disruptions. Our goal is to complete the restructurings during 2008 sothat by 2009, the organization can focus on growing the business profitablywithout the distractions of restructuring. These actions are a continuation ofour plans to improve the performance of Stoneridge and drive value.

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

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

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

George Strickler

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

This program will allow us to reduce our cost space and movethe company toward our long term operating margin goal of 8% to 10%. We haverecently completed our new $100 million ABL revolving credit facility. Thisfacility will replace our existing facility and provide significantly lowerborrowing costs and flexibility.

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

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

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

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

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

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

North America revenue accounted for 73.8% share of thirdquarter revenue compared with 75.6% for the same period last year. Thepercentage reflects the strong growth of our European operations and theproduction declines in the North America commercial vehicle market.

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

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

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

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

We expect that the restructuring initiatives we announcedtoday will result in further improvement to our gross margin levels uponcompletion. Our long-term gross margin target remains in the range of 23 to24%.

Sales from low cost manufacturing locations accounted for38% of total sales in the third quarter compared to 37% in the prior year. Withour China operation ramping up and our restructuring initiatives we expect oursales from low cost locations to grow as we relocate labor intensivemanufacturing over time as we expand our presence in -- low cost manufacturinglocations in Mexico, Estonia and China and build on our growth potential inBrazil and India through our joint ventures.

Selling, general and administrative expenses totaled $32.4million 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 $1.2million one-time gain related to the settlement of the life insurance benefitsportion of a post-retirement benefit plan realized in the third quarter of2006. The increase in SG&A during the quarter was related to additionaldesign and development marketing expenses primarily in Europe.

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

We expect our 2007 effective tax rate to be between 18 and22%. Stoneridge recognized third quarter net income of $2.6 million or $0.11per share compared with net income of $0.19 per share in the prior year.

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

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

While we made good progress toward improving our workingcapital levels or working capital balances remain above our targeted range of12% to 13% of sales. We see significant opportunity to reduce our inventorybalances in 2007 and have made this a focus area for operations.

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

Capital investment totaled $3.4 million in the third quartermainly reflecting investment in new products and testing equipment. Somesignificant components of our investment were in the areas of emissions andsensor products. For the full year we expect our capital spending toapproximate $20 to $25 million.

Turing to liquidity, we completed our new revolving creditfacility. This facility will provide us with significant flexibility goingforward and eliminated our financial maintenance covenants. We have alsostructured this facility to allow us the flexibility to refinance our debtshould the capital markets improve.

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

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

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

Question-and-Answer Session


(Operator Instructions) And your first question comes fromthe 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


Brandon Ferrell - KeyBanc Capital Markets

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

Just wondering, if that makes any strategic rationale senseto 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 issuedin our press release related to PST.

Brandon Ferrell - KeyBanc Capital Markets

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

John Corey

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

George Strickler

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

Brandon Ferrell - KeyBanc Capital Markets

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

George Strickler

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

But then really its a lot of work they needs to be completedto get that facility aligned and I think that was helped in the decision Isaid, this just doesn't have the cost profile or the volume commitment fromcustomers 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 thesecond quarter, so fair to say probably commensurate with that level here inthe third?

George Strickler

Yes. I would say that that is probably but as you rememberthat 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 fourthquarter, is there any potential risk that that carries into '08?

John Corey

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

As far as, the other things, we had a lot of productlaunches this year in the first quarter and second quarter that caused us somedifficulties and we expect that we will not have that same level of difficultygoing forward.

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

Brandon Ferrell - KeyBanc Capital Markets

Okay. If you guys think about SG&A now, and justrestructuring in general, I think this is obviously the first cohesive planthat we have seen announced in terms of restructuring. I know you guys havetalked 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 saythis is potentially the first of many announcements that we will see over thecourse of the next year in terms of restructuring?

George Strickler

No. I wouldn't say that. I think when we talked aboutSG&A we said it was a combination of some restructuring initiatives that wewould have to undertake. It was also, as we grow our business keeping a cap onthose expenses so we allow growth to drive that forward without addingadditional 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


John Corey

Good morning, Brett.

Brett Hoselton - KeyBanc Capital Markets

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

John Corey

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

We still have some added investments to make in thatoperation in terms of engineering and development efforts and then to selectwhich products that we will put over there. We have five lines that arecurrently in the manufacturing across a broad range of our products. So wewould expect to see that accelerate over the next several years as we winbusiness 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 bethe outlook for your [Ag] business in general and then also the commercialvehicle business in general and specifically I am thinking about the market asopposed to your own personal organic growth?

John Corey

I think that what we have seen in the Ag business iscontinued good market growth and as George mentioned our growth with John Deerehas 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 theforecast because not only is the impact from the emissions which we expect tobe ended by now. But we are also seeing a weakness in truck traffic.

So as the truck traffic downturns people aren't purchasingtrucks at the same rate that they probably were previously and I'm not quitesure 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 doappreciate it.

John Corey

Thank you.


(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 yousee with today's announcement of the closure of some facilities that we areprogression on the plan that we have previously discussed and that involvesaround.

One, operational improvements, two financial improvementsand then, three ultimately going after the marketing improvements and I thinkwe 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 executeand we are quite pleased with our performance so far although we recognize westill have a lot to do.

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


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

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