Stoneridge, Inc. Q1 2008 Earnings Call Transcript

| About: Stoneridge, Inc. (SRI)

Stoneridge, Inc. (NYSE:SRI)

Q1 2008 Earnings Call

May 2, 2008 11:00 am ET


Ken Kure - Corporate Treasurer, Director of Finance

John Corey – President, Chief Executive Officer and Director

George Strickler – Executive Vice President, Chief Financial Officer and Treasurer


Katherine O’Connor - Deutsche Bank

Brett Hoselton - KeyBanc Capital Mkts.


Welcome to the First Quarter 2008 Stonebridge earnings conference call. (Operator Instructions) I would now like to turn the call over to your host for today’s call, Ken Kure.

Ken Kure

By now, you should have received our first quarter earnings release. The release has been filed with the SEC and has been posted on our website at Joining me on today’s call is John Corey, our President and Chief Executive Officer, and George Strickler, our Chief Financial Officer.

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

Although we believe that such statements are based upon reasonable assumptions, you should understand that these statements are subjects to risks and uncertainties and actual results may differ materially. Additional information about such factors and uncertainties that can cause actual results to differ may be found in our 10-K with the SEC under the heading forward-looking statements.

During today’s call, we will be referring to certain non-GAAP financial measures. Please see the investor relations section of for a reconciliation of those non-GAAP financial measures to our most directly compatible GAAP measures.

John will begin the call with an update of our results and his thoughts on our 2008 outlook and market conditions. George will discuss the financial details of the quarter along with our guidance for the rest of the year. After John and George have finished their formal remarks, we will then open up the call for questions.

With that, I’ll turn the call over to John.

John Corey

I would like to provide you with an update on our progress in the first quarter 2008 and to discuss our expectations for the reminder of the year. For the quarter, our sales our sales $203.1 million, increased by $18.1 million or 9.8%. This is the first time the company has reached sales of greater than $200 million in any quarter. This increase was a notable achievement in the face of a significant decline in the North American light truck and commercial vehicle production.

Our operating income totaled $14.1 million compared with $9.7 million in the prior year, an increase of $4.4 million or 45.4%. Our 2008 first quarter operating income included $2.5 million in restructuring changes which were the results of our Mitcheldean, UK, and Sarasota, Florida, restructuring efforts previously announced in October 2007.

Finally, our diluted earnings per share totaled $0.28 in the first quarter which included approximately $0.09 a share for the restructuring expenses compared with $0.21 cents a share in the prior year, an increase of $0.07 per share or 33%. We are pleased to continue our progress to improve our quarter-over-quarter performance.

In regards to our market environment, the conditions in our end-markets performed as expected. Productions in North American commercial market declined 26% while the North American light vehicle production was down 13% at traditional domestic manufactures. On a positive note, our largest North American commercial vehicle customer’s production declined approximately 15% in the first quarter which created a slightly more favorable impact for Stoneridge relative to the overall market.

Despite these challenges in North America, Stoneridge reported higher sales and earnings during the first quarter. This was attributable to our balanced end-market exposures and new business wins. During the quarter, we posted strong results in our European commercial vehicle business, our Brazilin joint venture continues to perform well, sales from new products improved our mix and margins in the North American market, and the strength of the agricultural market continues to benefit our sales and income in the US.

As a partial offset to our increase in our North American sales, we were negatively impacted by the loss of some pressure and fluid level sensor products produced in our Sarasota facility and reduced sales and operating profits resulted from the American Axle strike. Our sales will continue to be negatively impacted by approximately $2 million per month as long as the American Axle strike continues.

Finally, our North American sales have benefited by the continued strength in the agricultural market. Agriculture sales improved by 12.1% in the first quarter reflecting strength with a few of our key customers. Our joint venture in Brazil reported another strong quarter.

Local currency revenues increased 36.5% in the quarter, and our portion of equity earnings increased from $2 million in 2007 to $3.6 million in the first quarter of this year, an increase of $1.6 million or approximately 80%. Part of the US earnings improvement is attributable to the strength of the Brazilian real compared to the US dollar. The Brazilian real has appreciated approximately 18% against the US dollar compared to the first quarter of 2007.

In addition, PST continues to report strong results in its aftermarket business particularly in the security products area and new business with the OEMs in Brazil. Given PST’s strong pipeline of new products, we continue to expect strong growth rates of results from this venture.

Our gross margins have continued to improve. In the first quarter, our gross margin reached 25.5% compared to 26% in the fourth quarter of 2007 and 23.1% in the first quarter of last year. The gross margin improvement is the result of our new business and better mix of products in North America; continued efforts to recover commodity cost increases; and design and redesign of some of our products in North America; benefits realized from our hedging approximately 20% of our copper requirements; and some improvements in our operating efficiencies such as reduction in scrap in our agricultural product lines.

As an example, our agricultural production line has shown a significant improvement this year with a 45% reduction in material scrap compared to last year. While our results have improved, we are still not operating with the efficiency and effectiveness level we are striving for on a sustainable basis. While we have seen improvements in our operational efficiency, there are still opportunities to gain from our operational excellence efforts. We are focusing on leaning our operations and improving our product launches, which will reduce waste scrap premium fee.

While still small, our China operation continues to grow. We continue to increase penetration in the Asia market with increased sales and improved profitability and cash flow. During the quarter, we acquired a small aftermarket company in Sweden. The acquired company will aid in expanding our tachograph business in the Scandinavian market, which represents further progress for this product line in Europe.

Our restructuring plans are on track for both Mitcheldean and Sarasota. Our first quarter restructuring efforts were focused on building inventories to facilitate the move of our production lines scheduled for the second, third, and fourth quarters. Our inventories have increased by about $5.9 million by the end of March to facilitate production line transfers. These production line moves will be substantially completed by November for both operations. As a result, we will experience greater restructuring expenses in the second and third quarters and a lower amount in the fourth quarter.

We continue to pursue the sale of our Sarasota facility which will most likely be completed in the second half of this year. This sale is included in our previously announced restructuring cost of $9 to $13 million for the year.

One other area of focus continues to be our inventories. Our inventories have increased by $9.2 million in the first quarter. As mentioned before, we have increased our inventories by $5.9 million due to our restructuring efforts, while $3.3 million represented increases from our operations. We have stepped up our efforts to manage our inventories at lower levels especially in our North American operations. I’ve challenged our organization to refocus their efforts in this area in the area of inventory and working capital management. We have substantial room for improvement in the remaining 9 months.

Going forward, the macroeconomic picture continues to point towards a challenging environment in which we will operate, particularly in our North American commercial and light vehicle businesses. The North American commercial market appears to be tracking towards the lower end of our previous expectations of a decline in the range of 25% to 35%.

While many industry observers previously expected production bottoming out in the first half of 2008, we are cautious, as we have not experienced any increased orders in the North American commercial vehicle market for the second half. We will face the challenges with the same fundamental focus that has resulted in our operational progress today, focusing on the aspects of our business which are under our control. From my perspective, this represents the majority of what we face on a daily basis.

Specifically, we will focus on our cost structure and controlling discretionary spending, achieving world-class operating metrics, and driving our cash flow through focused working capital management and improved profitability. From a cross-structure standpoint, we will complete our restructuring initiatives by the end of the year that will reduce our manufacturing overhead structures.

Macroeconomic environment for 2008 will be challenging. Our expectation for full year earnings is in the $0.75 to $0.85 range per diluted share which includes restructuring expenses in the range of $9 to $13 million after the expected benefit of the Sarasota facility sale. While I’m pleased with the results of the quarter, we still have opportunities in our operations for improvement and turning sales gains to improve financial performance.

With that, I’d like to turn the call over to George.

George Strickler

Before we review the first quarter, I’d like to share a few financial highlights in the quarter. Our restructuring programs continue to track the plan. We are pleased with the committed effort made by Stoneridge employees at both the Sarasota, Florida, and Mitcheldean, UK, facilities. Our hedging programs are allowing us to partially reduce our exposure to commodity and currency price volatility. We have hedged approximately 20% of our projected copper buy for the year to reduce the volatility of one of our major commodities. The cost of our manufacturing inefficiency, though still too high, has continued to improve.

In the first quarter of 2008, this improved by approximately $700,000 compared to the first quarter of last year. We have commented that we want to improve our cost of capital. During the first quarter of 2008, we repurchased $11 million in long-term bonds that had a coupon rate of 11.5% and an additional $6 million in April. We have purchased $17 million of our long-term bonds through April of this year, and we will continue to pursue opportunities as the capital markets recover.

We will continue to control our costs as a way to offset the lower production levels in North America to improve our financial results, and we will continue to focus on cash flow and improving our return on invested capital. As part of our restructuring program, we are working to sell our Sarasota manufacturing facility which we are targeting to sell in the second half of the year.

I would now like to cover the first quarter results in more detail, and then we will open up the call for questions. Revenue of $203.1 million in the first quarter represents an increase of $18.1 million, or 9.8 percent. Our year-over-year improvement in revenue was primarily attributable to new program sales, favorable foreign currency exchange, and strong production in our European commercial vehicle businesses. These factors offset substantial declines in our North American light and commercial vehicle revenues due to production declines.

For the first quarter, light vehicle revenue declined from $74 million to $70.3 million, a decrease of 3.7 million or 5%. The decline was primarily attributable to the previously announced business losses of pressure sensors and fluid level sensors in our Sarasota, Florida, facility, but was also impacted by the 13% decline in traditional domestic production. Medium and heavy-duty truck sales totaled $104.6 million in the quarter, an increase of $19.6 million, or 23% over the prior year.

This significant revenue increase was driven by new government business, strong European commercial vehicle production, and favorable foreign currency exchange rates more than offsetting the 26% decline in North American commercial vehicle production which was due to the change in emissions regulations and weakening economic conditions. Sales to agriculture and other markets totaled $28.3 million, an increase of $2.3 million or 9.2% above last year. The increase in our agriculture sales was predominantly due to strong build rates of John Deere.

North American revenue accounted for 73.6% share of the first quarter revenue compared to 71.8% for the same period last year. The percentage increase of our North America revenue reflects the growth of new business in our North America commercial markets. In the first quarter, electronics revenues were $133.2 million, compared to $110.6 million last year, an increase of $22.6 million or 20.4%. Positive factors in the quarter were strong revenue from our North American commercial vehicle operations, due in part to new government business, strength in our European markets, and currency exchange range. Offsetting these favorable factors was the 26% decline in North American commercial vehicle production.

Revenues for control devices of $69.9 million declined from $74.5 million last year, a decrease of $4.6 million, or 6.2%. Loss of revenue of the pressure sensor and fluid level sensor of our Sarasota facility was the main driver main the decrease, in addition to the 13% decline in production of North American light vehicles.

Our first quarter gross profit was $51.8 million, resulting in a gross margin of 25.5%. The gross margin increased over 200 basis points from the prior year level and is consistent with our fourth quarter 2007 gross margin. This increase was due to new business sales and favorable sales mix relative to the prior year.

Our commodity-hedging program resulted in the slightly favorable offset to the first quarter copper price variances. Given the recent rise in copper prices, we are expecting more significant impact in the second quarter if current copper price levels remain in the current range of $3.75 to $4 per pound. Sales from low-cost manufacturing locations accounted for 35% of total sales for the first quarter compared to 36% in the prior year.

Reduction is due to higher Stoneridge North America sales in the current quarter. With our China operation ramping up and our announced production line moves from our Mitcheldean UK operation to China and Estonia and our corporate-wide initiatives, we expect our sales from low-cost locations to grow as we relocate labor-intense manufacturing over time. We will continue to expand our presence in the three low-cost manufacturing locations in Mexico, Estonia, and China, and our new facility in Estonia is scheduled to be completed early in the fourth quarter of this year.

Selling, general, and administrative expense totaled $36.3 million in the first quarter, compared to $33.1 million in the previous year. Approximately half the increase in SG&A is due to increased design and development activities related to new product launches and business development in our European commercial vehicle units.

First quarter income tax expense totaled $5.1 million, resulting in an effective tax rate of 43.9%. The higher effective tax rate is primarily attributable to restructuring costs associated with our UK operations, which provided no tax benefit and an unfavorable impact due to the expiration of the federal research and development tax credit. We expect our 2008 effective tax rate to be between 38% and 41%.

Stoneridge recognized first quarter net income of $6.5 million, or $0.28 per share, which included approximately $0.09 per share of restructuring charges, compared with net income $0.21 per share, in the prior year. Depreciation expense for the first quarter was $7.3 million and amortization expense totaled $100,000. For the full year, we expect depreciation and amortization to approximate $30 million.

Earnings before interest, other income, taxes, depreciation, and amortization were $21.5 million in the first quarter compared to $16.9 million in the previous year. Our primary working capital totaled $127 million at quarter end, which increased $16.7 million from the end of the year.

As a percentage of sales, our working capital increased slightly from 15.3% of sales in the prior year to 15.6% of sales in the first quarter of this year. The increase was partially due to bank builds of inventory to facilitate production transfers occurring at our Sarasota, Florida, and Mitcheldean, UK, facilities. While we have made progress towards improving our working capital levels, our working capital balances remain above our target range of 12% to 13% of sales. We see significant opportunity to reduce our inventory balances in 2008 and have made this a focus area for our operations.

Operating cash flow net of fixed asset additions was a source of $3.1 million in the first quarter compared to a use of $11.9 million in the previous year. Our cash flow results in the first quarter represented significant improvement over the prior year. Cash flow, particularly in the areas of working capital management, will remain in focus for the remainder of the year. We continue to target primary working capital balance in the range of $0.12 to $0.13 per dollar of sales.

Capital investments totaled $5.5 million in the first quarter, mainly reflecting investment in new products. Some significant areas of our investment were in the emissions, sensory products, and instrumentation businesses. For the full year, we expect our capital spending to approximate $29 million.

Turning to liquidity, we currently have $83.1 million of availability under asset-based lending facility. At this time we have no borrowing drawn against our revolving credit facilities. Our quarter end cash balance totaled $88 million, compared with $54 million at the end of the first quarter of 2007.

As highlighted before, we purchased $11 million of long-terms bonds in the first quarter. We purchased an additional $6 million in the month of April for a total of $17 million through April 7, 2008. Going forward, we expect we will continue to fund our operational growth initiatives through our free cash generation and available cash balances.

Now, I’d like to take a moment to discuss our outlook for 2008. As mentioned by John, for the full year, based upon the current industry outlook, our expectations for the full year are $0.75 to $0.85 per share including restructuring charges. Our restructuring charges will be in the range of $9 to $13 million after the expected benefit of the Sarasota facility sale.

As stated in our press release, our annual guidance does not include any potential impact from an IPO transaction in our Brazilian joint venture. We had previously announced in October 2007 that our joint venture company in Brazil had filed for an IPO transaction. Although we remain hopeful that PST can continue the IPO process this year, it is dependent on the stabilization of the global equity markets.

Today the North American macroeconomic challenges are tracking toward our expectations. Overall, the outlook for our North American operations continue to trend slightly lower, while our European commercial vehicle operations are tracking above expectations. Our first quarter performance reflects our ability to manage through difficult market conditions in North American, especially in the commercial truck market. We continue our work to improve our top line growth and at the same time improve our cost position with our restructuring efforts which will be substantially completed by the end of this year. These efforts are starting to be realized in our financial and operational results.

Operator, I would now like to open the call for questions.

Question-And-Answer Session


(Operator Instructions) Your first question comes from Katherine O’Connor - Deutsche Bank.

Katherine O’Connor - Deutsche Bank

Could you talk a little bit about what your expectations are for you end-market goods through the second half of the year? And then how do you think you match up versus end-market performance whether or not you have new business coming online that would help you outperform or have business that would be rolling off that way you might sort of underperform what the end-market will do.

George Strickler

I don’t think there’s any business that we have that would roll off. Of course if there is some de-contenting, that might be, but I don’t think we see anything in our plans or anything from our customer that would have things rolling off that we haven’t already factored in. We’re looking at the markets and we’re looking North American production of cars and light trucks to be down around 14.3, which is below what we had our original plans together for.

Our operations are looking to make sure there is structure to a level of around that $14.3 million. I think the bigger issue is the mix, and the issue for us will be the examination of left impact of the switch from trucks. You saw GM’s announcement of the GMC-900 and the production cuts, and we’re going to assess that impact on our operation because we knew that product could go on into those platforms.

On the commercial vehicle, I think as we’ve indicated, we see that performing in the range that we talked, 25% to 35% decline. One of our bigger customers internationally happens to be doing slightly better than that right now. We expect that to continue and we expect to get some benefit from that. On the European side, that market still remains very robust and we’re anticipating well, but we don’t see any significant downside in that market either.

Katherine O’Connor - Deutsche Bank

I know that the first half the military sales should be stronger than the second half. Could you just give us an update on that, and then speak to whether or not the content you have for military sales, do you have content with all the OEMs or only certain OEMs where there are end-market contracts?

George Strickler

We have had an initiative here to expand our presence into the government sales but they include military sales through the opportunities that we’ve afforded ourselves that first came on the military platform. We don’t have a significant exposure, although across the broad front we have many customers on that as we discussed before. We do think you will see continuing emphasis on our part to expand our presence in government sales, and so we would expect that maybe this year, we might see some decline in the second half based on the builds in the first half. Overall, we think that’s going to be a growing channel for us.

Katherine O’Connor - Deutsche Bank

For the vehicle I think you have the content on, I think there are three major OEMs that provide that vehicle to the US government. Are you on one, two, or three of those different OE platforms? Could you just give us some color on that?

George Strickler

We’re with one now, but we are always honing others.

Katherine O’Connor - Deutsche Bank

Then, in terms of the shift you were talking about, the mixed shift, cars versus trucks, can you remind us on the light vehicle side, where your mix was, cars versus trucks?

George Strickler

We’re about 30% passenger car and light truck, and we’re about 50% in medium and heavy-duty truck.

Katherine O’Connor - Deutsche Bank

I guess when you were speaking about the light vehicles in North America, when you were taking about the effect of a negative mix shift and GM taking down truck production, I was speaking more to that. Within the light vehicle segment, do you have what your mix is, truck versus car?

George Strickler

I don’t have that with me here where we split it down to that level, but we are evaluating the recent releases from General Motors to understand what that potential impact could be.

Katherine O’Connor - Deutsche Bank

Moving on to the bonds you repurchased, in total you repurchased $17 million.

George Strickler

That’s right.

Katherine O’Connor - Deutsche Bank

Do you have plans to continue to do that in the open market?

George Strickler

Well, I think its all part of our overall capital plan that we said before. I think our intention is we wanted to refinance our debt, but we felt that the rates were attractive and we have a limit, and I think we’re pretty at that level with what we’ve repurchased so far, and we’ll reevaluate our position.

Katherine O’Connor - Deutsche Bank

In terms of the Brazilian IPO filing, I know that you can’t really speak to the actual filing, but I just wondered did you actually ever say what the use of proceeds were, or what is the use of proceeds stated in that filing because it’s in Portuguese obviously, so is there anyway you can tell us?

George Strickler

For the Brazilian company, what they were going to use the proceeds for

John Corey

The initial filing which was made does not have that requirement. We were to the point of the next filing, generally that is one of the requirements in that final filings which we never got it through, so none of that was ever disclosed, and as you can understand, we can’t really address that.


Your next question comes from Brett Hoselton - KeyBanc Capital.

Brett Hoselton - KeyBanc Capital Mkts.

George, the sales increase in the first quarter was very substantial, much better than I expected. I know you’ve identified some of the factors there. I was hoping you might be able to bucket some of those factors that drove the improvement in sales.

George Strickler

Katherine asked the question about the government business. That certainly had an influence in the first quarter. The European medium and heavy-duty truck had a significant influence on that, so I would say it’s really in those two key area, and the ag market, so those three contributed for most of the increase, and then I think we did talk about the foreign currency which amounted to about $4 million, so it was really wrapped in those three key areas for the top line.

Brett Hoselton - KeyBanc Capital Mkts.

You’ve got a year-over-year increase of about $18 million. $4 million was due to FX, so you’ve got $14 million left. Would you bucket it evenly across the other three items, military, Europe, and agriculture?

George Strickler

Well, I think we talked about it. Ag was up roughly about $3 million, so that would be $3, and $7, that’d be 11, and then I think you can just about split those between the two.

Brett Hoselton - KeyBanc Capital Mkts.

As you look at your guidance for 2008 and thinking about higher commodities cost, can you speak to what are some of the commodities that you see yourself having more exposure to in terms of risk to your guidance and what kind of thoughts have you factored into it.

George Strickler

The primary one is really copper, and we just did a reassessment of that, and it’s hard to tell you but part of what’s driving it is the dollar. The consumption that we have in copper is our primary one. Zinc, we’ve got that fully hedged for the year, so copper could influence. We purchase about five million pounds a year in copper, so you can sort of swing the factor based on the price.

Brett Hoselton - KeyBanc Capital Mkts.

Are you kind of assuming that copper remains at the current pricing levels? I guess what I’m wondering is you are not anticipating copper pricing and being able to get any more coverage from your customers that might be a risk or anything along those lines.

George Strickler

I think John mentioned that we don’t get it from a direct, but what we do is I think our organization focuses on product design and redesign, and we tend to recover that way. We have had some success in some of our markets doing that in the past.


This concludes our question-and-answer portion of the call.

John Corey

As we said when we started here and now this is our second year anniversary of the call, we put a process together and we’re following that process. First and foremost in that process is the people and the team, and I think the results that you’ve seen us being able to produce over this period of time are results of that team, that getting focused and paying attention to the details, and it’s really just very basic.

We focus on the operational execution. Final execution of the market and execution of the team does it all, so I’d like to thank the team for that. We are working in difficult markets right now. We don’t see any relief from those markets, but I think appropriately we’ve been able to mitigate the impact of those markets because of some of our initiatives. We continue to see opportunities for this business both operationally and in the growth areas and we will continue to focus our efforts on those things. We are very pleased with our performance so far. We’ll continue to work on that. Again, we’d like to thank everybody for their hard work in our organization.

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