Ken Kure – Corporate Treasurer and Director of Finance
John Corey – President and CEO
George Strickler – EVP, CFO and Treasurer
Stoneridge, Inc. (SRI) Q2 2008 Earnings Call Transcript July 31, 2008 11:00 AM ET
Good day, ladies and gentlemen, and welcome to the Q2 2008 Stoneridge earnings conference call. My name is Lequisha and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator instructions) I would now like to turn the presentation over to your host for today's call, Ken Kure, Corporate Treasurer. Please proceed.
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 has been filed with the SEC and has been posted on our Web site 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 may be forward-looking statements. Forward-looking statements include statements that are not historical in nature and include information concerned about our future results or plans.
Although we believe that such statements are based upon a reasonable assumption, you should understand that these statements are subject to risks and uncertainties and actual results may differ materially. Additional information about such factors and uncertainty that could cause actual results to differ may be found in our 10-K filed with the Securities and Exchange Commission under the heading "Forward-looking Statements.”
During today's call, we'll also be referring to certain non-GAAP financial measures. Please see the Investor Relations section of our Web site for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures.
John will begin today's call with an update on our results and his thoughts on the remainder of the 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'll then open up the call to questions.
With that, I'll turn the call over to John.
Good morning and thank you for joining us on today's call. We will provide you with an update on our progress in the second quarter and discuss our expectations for the remainder of the year.
For the quarter, our sales of $213.2 million increased by $29.4 million, or 16%. Our first quarter set a record for Stoneridge in terms of quarterly revenue exceeding $200 million. We have now done it again, as we have achieved our second consecutive quarterly sales level over $200 million.
Our sales in the first half were $416.3 million, an increase of $47.5 million, or 12.9% compared to last year. This increase was achieved in spite of the decline in the North American light truck production and flat commercial vehicle production.
Our operating income totaled $10.8 million, compared with $6.9 million in the prior year, an increase of $3.9 million, or 56.5%. Our 2008 second quarter operating income includes $3.7 million in restructuring charges, which were the result of our Mitcheldean, UK, and Sarasota, Florida, restructuring efforts, previously announced in October of 2007.
Finally, our diluted earnings per share, which includes approximately $0.12 per share for the restructuring expenses, totaled $0.20 in the second quarter, compared with $0.11 per share in the prior year. The prior year earnings per share included approximately a $0.05 per share gain from the sale of two buildings. Including our restructuring charges, the current earnings per share increased by $0.09 per share, or 81.8% over the prior year.
Our first half operating income was $24.9 million, an increase of $8.3 million, or 50%, compared to the prior year. On this management team's first call in 2006, we reviewed our plans for the company by focusing on improving operations, improving financial performance, and increasing market penetration. As we review the quarter, you'll see we continue to follow this plan and we are adjusting to the new market realities.
The management team continues to improve the performance in the face of a difficult environment in North America and for the commercial truck and light vehicle markets. North American light vehicle production was down 21% at the traditional domestic manufacturers, our primary automotive customers, driven by the dramatic shift away from light truck and SUVs due to high fuel prices. Adding to this decline was the strike at American Axle. Both of these events have impacted our results.
Production in North American commercial market increased modestly by 6%. Our European commercial vehicle markets remain strong and this should continue for the balance of the year. Our after-market business in Europe is showing some signs of softening sales, indicating potential weakness for the European markets in 2009, as our order book is full for the remainder of 2008 for new commercial vehicle business.
Stoneridge higher sales and earnings during the second quarter are due to improved end-market exposures, new business wins, and geographic diversification. During the quarter, we posted good results in our North American and European commercial businesses.
Sales from new products enhanced our mix and margins in North America, as well as the continued strength in the agricultural sector. Agricultural sales improved by 16.7% in the second quarter. In addition, we improved our position in the agriculture segment by signing a new agreement maintaining $55 million in current business and adding $5 million in new business annually starting in 2009.
Offsetting the increase in the North American sales was the decline in domestic passenger car and light truck production, and reduced sales and operating profits from the American Axle strike.
While still a small part of our organization, sales and profits by our China operations continue to expand. We're exploring ways and opportunities to accelerate our growth in the local Asian market. The integration of a small after market company we acquired during the first quarter in Sweden is progressing as planned. We expect the acquired company will expand our Tachograph business in the Scandinavian market, which represents further progress for this product line.
While our revenue performance is good, we did not launch two new electronic products early in the year due to issues with meeting or exceeding customer expectations. Rather than rush these to markets, we decided to postpone the launch until next year to add further product enhancements. Improving our product launch capabilities represents another opportunity for us for future business gains.
Our joint venture in Brazil reported another strong quarter. Local currency revenue increased 31% in the quarter. And our portion of equity earnings increased from $2.1 million in 2007 to $2.8 million in the second quarter this year, an increase of $700,000, or approximately 47%. The Brazilian Real appreciated by approximately 19.8% against the U.S. dollar, compared to the second quarter of 2007.
In addition, PST continues to report strong results in its after-market businesses, 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 and results from this venture, especially if the Brazilian economy remains strong.
Our gross margins have continued to improve. In the second quarter, our gross margins grew 23.1%, compared to 21.1% in the second quarter of last year. The gross margin improvement is a result of our new business wins, increased volume in our commercial vehicle segments, a better mix of products in North America, continued efforts to recover commodity increases in the design and redesign of some of our products in North America, and benefits realized from hedging approximately 20% of our copper buy.
We continue to manage our raw material costs aggressively. Unlike most automotive suppliers, we do not have any significant purchase of steel. Our primary commodities materials are copper, zinc and nickel. Our major purchases for components are for plastic molded parts, connectors, electronics, and board assembly.
We continue to hedge our primary commodities in the short-term to mitigate volatility. In the longer term, we will pursue recovery through our customers or mitigate the impact through redesign of our products.
In the case of electronic components, we have established global sourcing, which has continued to benefit us with annual reductions based on volume benefits we can offer to a few key suppliers.
Operationally, we have shown improvements in the cost of poor quality of the second quarter 2008, compared to a similar sales level basis in 2007. The work over the last two years, especially in the North American electronics, has improved our financial performance.
While improving, we lack consistency in operations. Not all units are performing at an acceptable level at the same time. In the second quarter we added a director of lean operations, who has extensive manufacturing experience working in the global environment, to focus on manufacturing efficiencies and inventory management.
Our restructuring plans are on track for the Mitcheldean, UK, and Sarasota, Florida, facilities. Our second quarter restructuring effort was focused on building inventories to facilitate the move of our production lines. We started to move some production lines in the second quarter and will accelerate the move of production lines into the third and fourth quarters.
Our inventories have increased by $5.3 million by the end of June to facilitate the production line transfers. The production line move will be substantially completed by the end of 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. Our transfer is proceeding as planned. However, we have had some selective quality issues. Management is dedicating more time to ensure that the quality issues are addressed and resolved.
We continue to pursue the sale of the Sarasota facility. The expected gain on the sale, which is in the range of $3 million to $4 million, is included in our previously announced net restructuring costs of $9 million to $13 million for the year.
Our original and current earnings guidance includes a pre-tax gain on the sale of the Sarasota facility in the range of $3 million to $4 million in the fourth quarter that may be delayed until 2009, because of difficult commercial real estate market and more stringent financing requirements.
Inventories overall increased $12.7 million by the end of the second quarter, compared to the end of last year. As mentioned before, we increased inventories by $5.3 million due to restructuring efforts, while $7.4 million represents increases from operations. Excluding the impact of product line transfers, inventory days have improved by approximately 8%. We have substantial room for improvement and the director of lean manufacturing will be working in this area, where he has significant experience.
Going forward, we face a challenging environment, particularly in the North America commercial and light vehicle business. Given the almost weekly adjustments to the build plans from our early customers, forecasting material and production planning has become much more difficult.
For the second half of 2008, the traditional domestic light vehicle OEMs are forecasted to be down 12% to 15% compared to the last half of 2007. The North American commercial vehicle market appears to be tracking towards a modest recovery, though at the lower end of our previous expectations.
While we expect some improvement in the second half, we remain cautious, as we have not experienced the magnitude of increased orders in the North American commercial market that was being projected. We are facing these challenges with the same fundamental focus that has resulted in our progress to-date; working on the aspects of our business which are under our control in the short-term, and adjusting our market strategies longer term to reflect the new realities.
Short term, we're managing our cost structures by addressing our direct labor and variable overhead costs to match reduced production levels, control of discretionary spending, and pursuing world-class operating metrics, and cash flow through focused working capital management and improved profitability.
From a cost structure standpoint, we will complete our restructuring initiative by year-end and that will reduce our manufacturing overheads and improve our operation effectiveness, benefiting our future performance.
For the longer term, we continue to look for growth opportunities to offset the decline in light truck and to diversify our customer base. As an example, we just secured an order from a major Asian customer for our trailer tow products starting in December of this year. While not large, it's a recognition of the quality of our product and provides us with the opportunity to grow with this customer in the future.
As discussed earlier, we have extended our business with one of our key customers in the North American agricultural market. We are competing to win a European emissions business that will be produced in North America and we just won an emissions award with an Asian customer which will start in 2009. Both of these emission awards are evidence of our gaining traction in this segment.
Lastly, we have several product launches in the last half, which will increase our content per vehicle in Europe in 2009. The environment for the remainder of 2008 will be challenging. We are reaffirming our expectations for full-year earnings to be in the range of $0.75 to $0.85 per diluted share, which includes net restructuring expenses in the range of $9 million to $13 million, after the expected benefit of the Sarasota facility sale.
Our current guidance includes a pre-tax gain on the sale of the Sarasota facility in the range of $3 million to $4 million, through a difficult commercial real estate market and more stringent finance–although it may be postponed due to difficult commercial market and stringent financing requirements.
While I am pleased with the results for the quarter, we still have opportunities to improve and increase the contribution from sales gains into improved financial performance. The restructuring, once completed this year, will benefit future performance of our company.
While we are facing a difficult environment and the vehicle mix has an impact on us, we continue to work our plan of improving operations, improving financials, and increasing market penetration, leading to improved shareholder value.
With that, I would like to turn the call over to George.
Thank you, John. Before we review the second quarter, I'd like to share a few financial and operational highlights in the quarter that applies to the original plan we shared with you previously we are executing.
Our restructuring programs continue to track to plan. 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 this year to reduce the volatility on our major commodities. Cost to manufacturing inefficiency, though still too high, continue to improve. Costs of poor quality in the second quarter 2008 have improved compared to the similar sales level of 2007.
We are committed to improve our cost to capital. During the first quarter of 2008, we purchased $11 million of long-term bonds and an additional $6 million in April of our long-term 11.5% coupon bonds for a total of $17 million, which will benefit us in 2009 with lower interest expense. We'll continue to monitor the capital markets and we'll pursue recapitalization opportunities as the capital markets recover.
On May 19, 2008, we announced that we were rescinding our IPO filing with the CEM, which is the SEC equivalent in Brazil. The equity markets have been under significant pressure and we did not believe it was a good time to come to market. However, we will restart the process when we believe the equity markets will be more receptive to an IPO for our Brazilian joint venture.
We will continue to focus on cash flow and improving our return on invested capital, driving our target to 15% by 2009. Compared to the second quarter of 2007, we have improved our debt to debt plus equity from 57% to 44.8%, the lowest level in the last 6 years. This strengthens our balance sheet to manage in the difficult market conditions.
As part of a restructuring program, we are working to sell our Sarasota manufacturing facility. We are targeting the sale in the second half of the year. A difficult commercial real-estate market and more stringent financing requirements for potential buyers may delay the sale until 2009.
Included in our guidance of $0.75 per share to $0.85 per share, we've included a pretax gain of $3 million to $4 million, represents a range of $0.08 to $0.11 per share, which is included in our guidance.
During the second quarter, we needed to enhance our plans based on the changes we are experiencing in the market. Even though we are performing well, we are evaluating the impact of the announced production decreases for the light truck and SUV market announced by our traditional North American customers.
We will continue to manage our cost structures as a way to offset the lower production levels in North America and improve our financial results. We have already started to take actions to offset the lower production schedules anticipated in the second half.
We are delaying or canceling discretionary spending in the second half that is not tied to specific production requirements, new business, or cost-savings opportunities. We're adjusting our direct labor staffing levels and variable costs to match the reduced production levels.
I would now like to cover the second quarter results in more detail and then we will open up the call for questions.
Revenue of $213.2 million in the second quarter represents an increase of $29.4 million, or 16%. Our year-over-year improvement in revenue was primarily attributable to new programs sales, strong production in our European commercial vehicle businesses and favorable foreign currency exchange. These factors more than offset declines in our North America light vehicle revenues and production decline.
In the second quarter, light vehicle revenue declined from $76.5 million to $63 million, a decrease of $13.5 million, or 17.6%. The decline was primarily attributable to the 21% decline in traditional domestic production and the previously announced business losses of pressure sensors and fluid level sensors at our Sarasota, Florida, facility.
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. Significant revenue increase was driven by new government business, strong European commercial vehicle production, and favorable foreign currency exchange rates more than offset the decline in North America light vehicle production.
Sales to agricultural and other markets totaled $23.1 million, an increase of $3.3 million, or 16.7% above last year. Increase in agricultural sales was predominantly due to strong build rates at John Deere.
North America revenue accounted for 72.7% share of second quarter revenue, compared to 72.1% for the same period last year. The percentage increase of our North America revenue reflects the growth in new business in our North America commercial markets.
In the second quarter, Electronics revenues were $149.4 million, compared to $107.9 million last year, an increase of $41.5 million or 38.5%. 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 rates. Another favorable factor affecting the second quarter performance was the 6.4% increase in North America commercial vehicle production.
Revenues for Control Devices of $63.8 million declined from $75.9 million last year, for a decrease of $12.1 million, or 2.9%. 21% decline in production in North America light vehicles for the traditional domestic manufacturing, loss of revenue of pressure sensors and fluid level sensors at Sarasota facility were the main drivers behind this decrease.
Our second quarter gross profit was $49.4 million, resulting in a gross margin of 23.2%. Our gross margin increased over 200 basis points from the prior year level. This increase was due to new business sales and favorable sales mix relative to the prior year.
Commodity hedging programs resulted in a slightly favorable offset to second quarter copper price variances. Expect a similar impact in the third and fourth quarters, if current copper price levels remain in the current range of $3.50 to $3.75 per pound.
Sales from low-cost manufacturing locations accounted for 36% of total sales in the second quarter, compared to 40% in the prior year. Reduction is due to higher percentage of North American sales in the current quarter.
Our China operation ramping up and our announced production line moves from our Mitcheldean, UK, operations to China and Estonia, and our corporate wide initiatives, expect our sales from low-cost locations to grow as we relocate labor-intensive manufacturing over time.
We will continue to expand our presence in the three low-cost manufacturing locations in Mexico, Estonia, and China. Our new facility in Estonia is scheduled to be completed by November of this year.
Selling, general and administrative expenses totaled $36.7 million in the second quarter, compared to $33.6 million the previous year. The increase in SG&A is primarily due to increased design and development activities related to new product launches, and our European and North America commercial vehicle units restructuring activities.
Second quarter income tax expense totaled $4.1 million, resulting in an effective tax rate of 46.4%. The higher effective tax rate is primarily attributable to restructuring costs associated with our UK operations, which provided no tax benefits 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 40% and 42%.
Stoneridge recognized second quarter net income of $4.7 million, or $0.20 per share, which included approximately $0.12 per share of restructuring charges, compared with net income of $0.11 per share, or an increase of $0.09, or 81.8% over last year.
In addition, the prior year earnings per share included $0.05 per share from the gain of the sale of two buildings. Depreciation expense in the second quarter was $7 million, and amortization expense totaled $100,000. For the full year, we expect depreciation and amortization of approximately $29 million.
Earnings before interest, other income, taxes, depreciation, and amortization was $17.8 million in the second quarter, compared to $14.3 million the previous year, an increase of $3.5 million, or 24.5%. The primary working capital totaled $136 million at quarter-end, which increased $31.3 million from the end of the year.
For percentage of sales, our working capital increased from 14.2% to sales in the prior year to 16.3% to sales in the second quarter of this year. Primary reason for the increase was accounts receivable at $28.7 million, due to our sales increase this year of $47.5 million compared to last year.
Our day sales and receivables have been at 60.1 days, and slightly higher than prior year to customer terms and sales mix. The increase in inventory was partially due to bank builds of inventory to facilitate production transfers occurring both at Sarasota, Florida, and Mitcheldean, UK, facilities.
While we made some progress toward improving our working capital levels, our working capital balances remain above our targeted range of 12% to 13% of sales. We see significant opportunity to reduce our inventory balances in 2008 and a major focus area for operations. The new director of lean operations will be focusing on manufacturing efficiencies and supply chain management, which supports our global operation.
Operating cash flow net of fixed asset additions was a use of $2.2 million in the second quarter compared to source of $5.1 million the previous year. Our cash flow results in the second quarter were affected by increased inventory to support bank builds for our restructuring initiatives, while our increased accounts receivable due to higher sales.
Cash flow, particularly in the area of working capital management, will remain a focus for the remainder of the year as we continue to target our primary working capital balance in the range of $0.12 to $0.13 per dollar sale.
Capital investment totaled $6.1 million in the second quarter, mainly reflecting investment in new products. Some significant areas of our investment were in emission, sensor products, and instrumentation business. For the full year, we expect our capital expense to be approximately $26 million.
Turning to liquidity, we currently have $90.1 million of availability under our $100 million asset-based lending facility. We have no borrowings drawn against our revolving credit facilities. Our quarter-end cash balance totaled $81 million, compared to $66 million at the end of the second quarter 2007, even after purchasing $17 million in long-term bonds from the end of the second quarter. Going forward, we expect we will continue to fund operational growth initiatives for free cash flow generation and available cash balances.
Now I'd like to take a moment to discuss our outlook for the remainder of 2008. John mentioned previously, for the full year, based upon the current industry outlook, we are reconfirming our previous annual guidance in the $0.75 to $0.85 range, which includes net restructuring expenses of $9 million to $13 million and assumes we can complete the sale of our Sarasota facility before year-end. The effective gain on the sale of the building is estimated between $0.08 and $0.11 per share. Due to the difficult commercial real estate market and stringent financing requirements to our potential buyers, the sale of the facility may be delayed until 2009.
This year has not played out as we had originally expected. We did not forecast the significant drop we are now experiencing in the light vehicle market in North America. We were expecting the medium and heavy-duty truck market to come back stronger by the end of the third and fourth quarters.
However, our original plans to which we are executing, anticipated that we needed to grow the top line with new business wins, needed to lower our costs and improve our margins, needed to restructure our manufacturing overhead centers, and streamline our organization to reduce our SG&A expense.
We wanted to refinance our long-term debt and we wanted to pursue an IPO for our Brazilian joint venture. Some of these efforts are contributing to our improved performance in 2008. Just as importantly, these initiatives will benefit us significantly in 2009.
Our earnings per share in 2008 is forecast to be higher than last year. At the same time, we are absorbing approximately $9 million in net restructuring expense. We continue to monitor the capital markets so we are positioned to refinance our long-term bonds when the capital markets are more receptive.
We plan to continue the IPO process with our Brazilian joint venture once we determine the global equity markets have stabilized. Our annual guidance does not include any potential impact from IPO transaction for our Brazilian joint venture. As our markets have become more difficult, we continue to readjust our plans to address the changes by growing our top-line, managing our cost structures, and driving our cash flow to address the market challenges that we are facing.
Operator, I would now like to open up the call for questions.
(Operator instructions) At this time, there are no questions.
Okay. Well, if there are no questions, I'll just close the session with the following comments. I think that as we look at the market environment, particularly in North America, everybody is being challenged by this environment. I think our company is better positioned
from the fact that we've taken action early to restructure our businesses. As you know, we've started our restructuring program last year and will wrap up – largely wrap it up this year although we may have a few other things that we might do later in the year to further enhance our capabilities for next year.
So I think that Stoneridge is well-positioned. I think that you're seeing that the balance of our mix of products in both the commercial vehicle market and the automotive market, that we're able to pick up in other areas. We're winning new awards. We're happy with our rate of winning new awards, so I think that as we go through this, there will be some difficult times, but we're largely optimistic about the future of this company and where we're going and what we're doing, and I think as you see, when we get out of this major restructuring effort, we'll have a much leaner organization, a much more focused company, fewer operating plants and less overhead structure, which should position us well to compete in the future.
And again, I'd finally like to say, again, I'd like to thank the team, because our associates here are the ones who produce the results. And if you look at these results, again, they're very good results in a very difficult environment.
So with that, I'd like to thank you all for joining us on the call.
Thanks for your participation in today's conference. This concludes the presentation. You may now disconnect.
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