Federal-Mogul CEO Discusses Q3 2012 Results - Earnings Call Transcript

Federal-Mogul Corporation (NASDAQ:FDML)

Q32012 Earnings Call

October 19, 2012 10:30 am ET


David Pouliot - Director of Investor Relations

Rainer Jueckstock - Chief Executive Officer, Director and Member of Strategy Board

Michael Broderick - Chief Executive Officer of Global Aftermarket Division

Alan Haughie - Chief Financial Officer, Senior Vice President and Member of the Strategy Board


Patrick Archambault - Goldman Sachs

Brian Sponheimer - Gabelli & Company

Bret Jordan - BB&T Capital Markets


Good day, ladies and gentlemen, and welcome to the quarter three 2012 Federal-Mogul Corporation earnings conference call. My name is Ian. I will be your operator for today. At this all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. I would like to turn the call over to Mr. David Pouliot. He is the Director of Investor Relations. Please go ahead, sir.

David Pouliot

Thanks, operator. Good morning and welcome to Federal-Mogul's third quarter 2012 earnings conference call. Please turn to slide two. Please note that the statements made in our press release, presentation materials, subsequent discussion and the Q&A are covered under the Safe Harbor provisions.

Please turn to the agenda slide. Slide three. Our speakers today will provide an update on our Q3 quarterly results and the recent developments in the company. Rainer Jueckstock and Michael Broderick will briefly discuss the markets and current developments relating to their respective business segments and Alan Haughie will cover details of our third quarter financial results.

After their comments and review of the financial results, we will open up the call for your Q&A. Rainer?

Rainer Jueckstock

Yes, thank you, David and good morning to everybody on the phone. I want to cover in the beginning a few key operating results for the company and Alan will go deeper into details in a few moments.

Sales for the company in quarter three was $1.6 billion, down 2% in constant dollars. Gross margin was lower on volume impact, negative currency exchange and regional and product mix issues. We had to report the loss of $11 million net earnings during the quarter versus $34 million profit we reported in quarter three 2011. The quarter three loss in 2012 was greatly impacted by the European sales volume decline and the impact of unfavorable exchange in product mix. Alan will have a more detailed waterfall and additional analysis that will show some of these details in a moment.

Our EBITDA was down to $101 million in the quarter, $60 million lower than last year for the same reasons just described. The cash out for the quarter was impacted by capital investments as well as movement in net working capital and the final payment for spark plug business acquisition as well as $50 million pension contribution in the U.S.

While I don’t think we had a great quarter, I am afraid to see these market conditions going forward. Europe is moving towards recession and now also the German luxury carmakers and VW are choosing to lower their build rates. European heavy duty and industrial customers are down significantly and we see also a slowdown in the U.S. heavy duty demand. We saw several U.S. based heavy duty makers that reducing their orders quarter four by 10% and more and some of them even announced that these reductions in build rates will be the run rate for quarter one and quarter two next year.

We will see in the long run, that’s my belief, based on all the system slowdown and the currently still healthy demand of U.S. passenger car market. China, India and Brazil are slowing down and only in Russia we see still bullish market but that’s for the time being.

With this outlook, let me make a few comment about segmentation in Federal-Mogul and I turning to the next page. As previously announced we began operational segmentation in quarter three 2012. Two operating segments are led each by co-CEO reporting into Federal-Mogul's board of directors. The Powertrain and the vehicle component sectors have been established on the basis of end customer segments and these parts have become operational in the third quarter.

We believe there are several advantages regarding source alignment, decision making and utilization of unique skills and talents associated with these two business models. The big impact should be in management focus on the right priorities for their respective business and driving decision making in to fundamentals of each independent market and Federal Mogul business segment performance. We will present the third quarter and relevant comparisons of prior quarters on the two segment basis, all cost on corporate levels allocated.

Next page. The final two business segments is shown on this page. The first, Powertrain, we focus in Powertrain on engine components for OE/OES and we also produce NC segment products for the after market sold via our second segment. So key components are pistons, rings, liners, valve seats and guides, bearings, bushings, spark plugs, sealings and systems protection products. This is focused on combustion engines and gearboxes.

The vehicle component solution is focused on the end market for after market as well, OE and OES components for engines, braking, wipers, steering and suspension. It's an integrated braking, wipers, chassis and sealing business. In this segment we serve these related OE and OES Markets as well.

So detailed demographic information of the two segments is available in today's earnings press release. I will now cover in more detail, the Powertrain segment for quarter three 2012. As I said, we have to deal with difficult market headwinds, especially in Europe which is representing more than half of Powertrain sales. Several customers have announced plans to cut production in line with slower end customer demands throughout Europe, and the global commercial vehicle market.

I'm sure you have seen announcements. We are even seeing incentives amongst the luxury players in the traditionally strong markets in Europe. Yesterday that was an article in the press that Daimler is selling their luxury cars with more than 3,000 Euros means close to $4,000 incentive. VW announced to cut for the quarter four around 150,000 to 300,000 car production in Europe. Audi added additional down days, over shutting down four weeks, and the situation around Renault, Fiat, MAN, Scania and others are well known. So this is quite a difficult situation for Powertrain segment and we see, as I said, it is going forward in to the first half of 2013.

We see, for our segment no loss of market share. So opposite is the case, but overall, we are heavily impacted by the decline of these profitable region for our business. North America, we saw a relatively strong in the quarter and we expect year-over-year comparison on OE revenue to remain positive but also here our clouds on the horizon, as I said, especially heavy duty engine makers like Cummins, Navistar, Caterpillar have also announced to cut orders for the rest of the year and some of them announced that this is the run rate for quarter one and quarter two next year.

So that was deeply impacted by these volume reductions and as some of these market, especially the vehicle segments are quite profitable for us. We see it is affecting our own mix on to the profit margin. On top of this, compared to last year, we see significant currency exchange impact.

The biggest driver is our sales of 8% in the quarter three 2012 versus quarter three 2011 on a constant dollar basis, as described on these OE like vehicle and commercial customers slowing down. Sales in China engine markets are slowing to a pace that slower than our original forecast in 2012 due to economic and political considerations. The EBITDA in the segment was down by $109 million due to previously discussed revenue, currency and product mix issues.

We are starting to take significant actions to reduce total headcount in line with soft orders especially in Europe. We have been somewhat slow in this reaction, partly because customers cut orders which have been already in production. We have been, in several cases, faced this order reduction on short notice and the orders came down significantly faster than we could expect it and we could react to.

In the meantime we have eliminated around 300 positions especially in Europe, overall around 400 positions and this number will more than double by the end of the year. At the same time, we are cautious not to significantly impact our structural capacity to compete as we expect what we see here is, to a certain extent, a recession and we will see in the long run better numbers than today. But still, on the administrative side, we will have cost to cut on the SG&A side. We will try to retain, especially our engineering capabilities. Capacity investments are on hold or slowed down significantly while feature and technology investments are still on track.

On next page, you see a few highlights for the quarter. On the positive side, as mentioned earlier, we finished the acquisition of BorgWarner's spark plug business. We will not use the BERU brand name going forward. We will call these spark plugs fully into, going forward, as Champion, Federal-Mogul's spark plug brand names. You see also that we continue to invest heavily in technology. We believe in the long run technology is main driver for healthy margins and you see n this page also that we are still in the race with three new innovations for the PACE award in 2013.

With this, I would like to hand over to my colleague, Mike Broderick to speak about VCS.

Michael Broderick

Thank you, Rainer. In North America, we are pleased to see the volumes are stabilizing. I would like to also say that sales will still remain under significant pressure in North America. The gains are fragile and hope we are building the business one day at a time. In Europe, we face similar challenges as Powertrain with both OE and Aftermarket business contributing to lower exchange adjustment sales when compared to the prior quarter.

For VCS, we are continuing to aggressively pursue growth in China, India and other global markets where we continue to solid sales improvements this year, albeit from a somewhat lower starting base. We see the car part expansion in China and India as fantastic opportunities for profitable growth in the future as we get our distribution network established, and build recognition for our global brands, we will continue to build our resource base in the markets while expanding car part coverage, launching great promotional programs and building our sales base.

EBITDA was short of last year. It was $49 million in the quarter, down $3 million, primarily impacted by European softness previously mentioned. We continue to work on marginal footprint initiatives, most notably the friction of wipers restructuring announced earlier this year. The realignment is progressing according to plan. My last point, in line with our customer strategy, we are continuing to invest in premium brand support with promotions and product line expansion.

Now, I would like to turn it over to Alan and rejoin for Q&A in a few moments.

Alan Haughie

Thanks, Mike. This morning, I will be discussing Federal-Mogul's third quarter and the year-to-date 2012 earnings.

Please turn to slide 11 for more details of our third quarter earnings performance. Sales fell by $130 million to $1.6 billion. This decrease of $130 million or 8% comprises $100 million or six points of adverse currency movements and $30 million or two points of constant dollar sales decline. I will provide a breakdown of these movements by segments and region in a moment. Gross margin decreased by $51 million and to two points of sales to $212 million, including unfavorable currency impacts of $18 million.

Both sales and gross margins were impacted by significantly lower OEM light and commercial vehicle production in Europe. I will cover those impacts more fully in the discussion of segment EBITDA since the drop in EBITDA of $60 million is, as one might expect, due to the lower gross margins. SG&A remained close to prior year levels with growth as a percentage of sales, due to the lower third-quarter volumes. Also, we recorded an OPEB curtailment gain of $51 million in the quarter.

As a reminder, in 2010, the company eliminated retiree health care for the non-union and salaried US workforce. Only a small portion of the liability that was eliminated could be recognized as income at that time. Now, as a result of further minor changes in retiree healthcare benefits in the U.S., we recognize as income, a further portion of that former liability.

We also recorded impairment charges of $53 million in the quarter. As a result of the segmentation process, we reallocated goodwill to the newly created segments. This process also resulted in a re-measurement of goodwill and definite-lived intangible assets. As a result, we recognize the impairment charges of $36 million. Additionally, we recorded some fixed asset impairments of $17 million. We recorded a tax benefit in the quarter of $8 million, including $14 million of benefit due to the impairments. As a result, the company recorded a net loss of $11 million.

On slide 12, we have a reconciliation of our profit measure, operational EBITA, to our net income for the period. During the quarter, we redefined operation EBITDA to include the service cost component of the U.S. based funded pension plan of about $5 million per quarter. Prior period EBITDA has also been restated to reflect this change. As a result, we now show EBITDA that is about $5 million lower per quarter than previously-published reports.

We feel this definition of operational EBITDA more closely reflects the cost of providing benefits to our U.S. employees exclusive of the mechanism used to fund those benefits. As with prior periods, we also exclude the non-cash OPEB curtailment gain and impairment charges from EBITDA.

Turning briefly to slide 13, Rainer explained the product segments in detail earlier and on this basis, I will cover the operational results of the two segments. First Powertrain, then VCS.

Slide 14 introduces the third quarter results divided between the two segments. Before discussing the financial performance of the segments, I will briefly describe the structure. We formerly reported the business in four segments, plus the corporate cost center. We now have two segments, each bearing its own embedded support functions. The column labeled corporate now merely contains the elimination of intersegment sales and the two types of non-EBITDA cost, $5 million of depreciation in the quarter and the $9 million of U.S. funded pension expense other than the service cost.

Referring now to the segments. About 90% of Powertrain's revenue is through OE customers and the other 10% is sold through the VCS segment. Hence the elimination of intersegment revenue. The VCS segment contains the aftermarket and the entire friction, wiper and chassis businesses and the VCS products that are not purchased from Powertrain are either externally sourced or manufactured within its own dedicated facilities.

Now focusing on the financial performances of the two segments. The foot of the page shows the EBITDA for the quarter of $101 million divided between Powertrain, with $52 million and VCS with $49 million. Together with the comparison to the previous year. Here we can see the decline in year-over-year EBITDA occurred in the Powertrain segment, with VCS being virtually flat.

So let's take a look at slide 15 which describes the third quarter performance of the Powertrain segment and is probably the key slide in understanding our third quarter EBITDA performance. Revenue here fell by $107 million and EBITDA fell by $57 million. If we strip out the adverse currency impact of $66 million from revenue and the $19 million from EBITDA, then we are left with $41 million constant dollar drop in segment revenue resulting in $38 million drop in EBITDA. This is the fundamental issue in the quarter.

Given that 50% of Powertrain's revenue is in Europe, the drop of $41 million or 4% reflects an 8% decline in Powertrain's revenue and flat revenue elsewhere. In Europe, we have seen much sharper decline in both light vehicle, diesel and commercial vehicle production than we have in gasoline vehicle production. In North America, a modest increase in the Detroit Three light vehicle production was offset by significant declines in heavy duty demand.

These volume and mix impacts explain much but not all of the EBITDA declines for the quarter. Focusing first on the revenue volume drop of $94 million shown in the light blue bar at the foot of the EBITDA waterfall.

This reflects the impact from changes in the vehicle production alone. Even though if all that and labor had been removed to the same rate of sales decline, we would expect to lose EBITDA at about 30% from the revenue decline because this is our approximate available margin including the cost of direct labor.

Therefore the expected loss in EBITDA from the $94 million of sale volume decline is about $30 million. However, as discussed earlier the mix of demand in Europe has generally shifted towards gasoline products essentially to less technically complex and lower margin products and this has resulted in about $7 million of adverse mix. Hence the impact on EBITDA of the production volume decline is a combination of these two items $37 million hit to EBITDA, a conversion of about 39% on the loss volume.

Now this volume impact was partially offset by new program launches of $55 million, majority of which occurred in Europe, but given the startup cost of this new business, we generated $13 million of incremental EBITDA, a conversion of 24% on the additional sales.

Lastly, we have $30 million of productivity and inefficiency which still includes about $10 million of labor cost inflation and therefore roughly $20 million of inefficiency. This represents costs, primarily direct labor, that were not removed at the same rate as the volume decline, largely because the drops in European light vehicle, European commercial vehicle and U.S. heavy duty production were more pronounced than anticipated at the start of the quarter. These factors resulted in a decrease in EBITDA as a percent of sales of 4.7 points.

Tuning to slide 16 which describes the third quarter performance of the VCS segment. VCS revenue fell by $30 million and EBITDA by $3 million, almost entirely due to currency movements. Overall, global VCS revenue is stable year-over-year with a modest increase in North America sufficient to offset softness in Europe and the rest of the world. Even though the mix of products continues to pose a challenge, we continue gain savings on purchased components and materials sufficient to virtually offset this and labor inflation. Of course, our efforts to improve the manufacturing footprint in VCS continue. The change in EBITDA from pricing, I should mention, largely reflects a non-recurrence of prior year commercial incentives.

One slide 17, we provided a summary of the third quarter consolidated cash flow. Cash flow from operations and investing activities was an outflow of $192 million, compared to an outflow of $71 million in the prior year. The amount of cash consumed by working capital was roughly the same approximately $90 million per quarter. So the changing cash flow year-over-year of $121 million is mainly related to lower EBITDA of $60 million, pension payments of $50 million which were about $20 million higher than last year and the acquisition of the BERU's spark plug business for $52 million dollars.

Also, given the reduction in European OE production, the company began selectively reducing capital spending, resulting in $73 million of spend in the quarter compared to $105 million in the same quarter last year and $93 million in the second quarter of this year. We will continue to review our investment plans going forward. This leaves with liquidity of $500 million of cash and $0.5 billion in undrawn revolver.

Now, please turn to slide 18 for more details of our year-to-date earnings performance. The year-over-year sales declined about $196 million comprised of $258 million of adverse currency, partly offset by $72 million or 1% of constant sales growth and this reflects 2% growth in Powertrain and flat revenue in VCS. The gross margin decline of $98 million includes $42 million in negative exchange and as with the third quarter, the principal cause of the remaining margin decline is regional, market and product mix. Given the restructuring and impairment charges taken in this and prior, we were putting a net loss for the year-to-date of $37 million. EBITDA declined by $112 million to $418 million, $41 million of which relates to unfavorable exchange.

On slide 19, we have a reconciliation of our profit measure operational EBITDA to our net income for the first nine months. Again, we have reflected the EBITDA redefinition in these numbers with respect to the U.S. funded pension expense with EBITDA being about $15 million lower in both 2012 and 2011 than it would otherwise have been.

Slide 20 shows for the September year-to-date results, the performance of the two segments. At the foot of the page you can see how the $112 million decline in EBITDA is divided between the two segments. Essentially the Powertrain performance reflects a fairly stable first half and, as we know, a challenging third-quarter, whereas VCS shows the converse a stable third quarter but a challenging first half.

Turning now to slide 21, which describe the year-to-date performance of the Powertrain segment, with segment revenue of $3.1 billion and EBITDA of $255 million. Compared to last year, Powertrain revenue fell by $141 million and EBITDA fell by $66 million, a majority of which occurred in the third quarter. In fact, the first half performance of Powertrain was a revenue drop of $34 million and an EBITDA of just $9 million. As a result, EBITDA, as a percent of revenue for the first nine months of the year, fell by 1.7 points to 8.1%.

Tuning now to slide 22, which describes the year-to-date performance of the VCS segment. Segment revenues of $2.2 billion and EBITDA as $163 million. Compared to last year, VCS revenue fell by $84 million and EBITDA fell by $46 million. If we strip out the adverse currency impacts of $88 million from revenue and $40 million from EBITDA, then we are left with $4 million constant dollar revenue increase and $32 million drop in EBITDA.

So although VCS sale was stable year-over-year, the mix of products has eroded margins compared to last year. One in excess of savings on purchased components and materials. Although not obvious here, the third quarter performance presented earlier, those reflects margin stabilization. This trend notwithstanding, the EBITDA margin fell by 1.7 points to 7.2% over the first nine months.

Finally on slide 23, we provide a summary of the first half consolidated cash flow. Cash flow from operations and investing activities is a net outflow of $403 million compared to an outflow of $158 million in the prior year. In essence, EBITDA is $112 million lower than last year. We have invested about $120 million more in accounts receivable than the prior year, primarily in support of the aftermarket and of course made a $52 million acquisition.

In summary, we have begun implementing actions to reduce the impact of current European softness. Under our new two segment structure, we are taking appropriate actions to offset the operating headlands of each segments and in this way focus our respective management teams on maximizing return on investment. That concludes our presentation.

Now, operator, I believe we are ready to open the line for Q&A. Could you please give the instructions?

Question-and-Answer Session


(Operator Instructions) Your first question is from the line of Patrick Archambault. Please go ahead, Patrick, you are in the call

Patrick Archambault - Goldman Sachs

That’s terrific. Thank you very much. Good morning, gentlemen. My main first question was on the walk that you had for the Powertrain side. I guess that’s the slide 15. Just help me understand labor productivity aspect. I understand that some of these changes that were put upon your introduction schedules came last-minute and you weren’t able to bring the fixed down in time but here it actually, unless I am not reading this right, it seems like fixed costs or productivity cost actually went up. So I can understand why they might have remained unchanged and not been able to offset the variable margin hit, or I should say the variable profit hit but how come they are rising would be my first question?

Alan Haughie

This is Alan here, Patrick. I will take that. The cost didn't actually rise. It's the way I choose to show the impact of volume. If you look at $94 million of lost revenue, if we assume, as I said, a 30% available margin, that assumes a significant portion of direct labor is totally 100% variable, totally variable. So if I expect to lose $30 million of EBITDA on $90 million reduction in revenue, then I am assuming all of that labor comes out on day one straightaway.

As Rainer pointed out, it is not possible to do that. So another way of looking at it would be to take the $30 million of labor inflation and add it to $37 million of volume and mix. So it means, $94 million loss in sales leaves you with a $67 million drop in EBITDA. That’s a very high conversion because what it means is all you can save in the short term is the material cost.

Difficult to save the labor cost over the short time and so in essence that would mean you lose the sales, you keep the labor. You save the material cost. Though you have got a very high loss of EBITDA on the additional volume. That’s essentially, I basically looked at two different angles.

Patrick Archambault - Goldman Sachs

That’s helpful. Yes, it does seem like a very high just we tend to think of variable margins as 30% in terms of overtime and variable labor. So it does seem like a very high incremental. They are incremental but obviously those things are different for every business and maybe Powertrain is higher. That’s helpful. Maybe give us a little bit of what you're thinking for the fourth quarter. It sounds like according to the color we got at the beginning of call obviously things are going be quite a bit worse. I think IHS is now taken their numbers down to 11%. So that gives you some lead way potentially if a lot of those units are getting taken out sort of at the December shutdown. So how good is your ability to really react to that with the schedules you now see for the fourth quarter?

Rainer Jueckstock

Patrick, Rainer speaking. Situation for the fourth quarter from an order forecast would, we have in hand is what we saw in September which was quite a low month. What we have to see is, if a customer taking of 10% of its order, of its build schedule, we very often have a significant higher number he's taking out of our order book because of the inventory reductions.

So we are in this situation we have in most of all European country units flexible schedules installed, flexible means this, a few weeks notice period. We are able to reduce shift models. We are able to reduce headcount. We are able to reduce hours paid and we see for quarter four that this flexibility is coming in to play. Nobody knows what will be the order book for quarter four. In July we saw relatively healthy September, but coming out of the summer vacation, most of our customers in Europe had significant reduction in orders. Within September was our replenishment time.

We see these last few weeks, a little bit more stability. I don't think that we will have significant order cuts but I don't know. That's what we see currently.

Patrick Archambault - Goldman Sachs

Okay, I am sorry if you hinted at this in your answer, but within the fourth quarter, do you think most of the cuts would be relegated to the December shutdown just being longer

Rainer Jueckstock

We follow to a certain extent what our customers are doing because we have, in most of our products, some form of just in time supply and when we see customers like VW or Daimler Auto announcing shutdown days, we will have subsequent shutdown days in a similar pattern and that's what we are doing and some of these customers are now in extended shutdown during Christmas and we will do the same.

Patrick Archambault - Goldman Sachs

Okay. If I can just squeeze in one more and I will let somebody else get on here. Can you just clarify again the mix headwinds? It sounds like it wasn't only a function of volume but it sounds like diesel was an issue which you quantified and I guess did you mention luxury as well? Is there a weakening mix within luxury versus volume brands? I wasn't quite sure and if there's any other factors that I am missing on the mix side I would love to just clarify that list

Rainer Jueckstock

I might start and Alan might help me in some numbers. Within all European operations and to a certain extent, that’s valid for the U.S. as well, heavy duty is a significant contributor to both top line as well as bottom line. So does the business in Powertrain as for heavy duty and industrial applications and it range from lots marine application for ocean vessels to heavy duty trucks and here we see, barely cyclical business.

Especially for marine application, we see a drop down to 50% while heavy duty in the different markets came down between 5% to 15%. That’s what we see in Europe and North America and we have a few percent points higher margins on heavy duty and industrial than we have on automotive. Within the automotive segment, Europe is roughly half, gasoline half, diesel. We saw, in the last few months, shift the by a few percent points towards more gasoline and more gasoline is very often focused on smaller engines. So you three cylinder and small four cylinder engine, gasoline and while you have in the luxury segment more diesel applications in Europe and this is hitting us also here. Diesel application have higher content of federal Federal-Mogul products and decline on to diesel, an over proportional decline on diesel means an over proportional decline of sales for us subsequently also margins.

Alan Haughie

I don’t think I can add anything to that, Rainer.

Rainer Jueckstock



Thank you for your question. We have another question in the queue. This one is from the line of Brian Sponheimer. Please go ahead, Brian. You are in the call.

Brian Sponheimer - Gabelli & Company

Good morning. Brian Sponheimer, I am from Gabelli & Company. I wanted to spend some time talking about your working capital. Now knowing that third quarter is usually a build time for you because of the aftermarket. Given where volumes are, it surprised me that you had $50 million uptick not only in AR but also in inventory. So can you talk about that?

Alan Haughie

The accounts receivable movement legacy is essentially the terms in the aftermarket. There was a drift in certain areas of aftermarket towards longer term as you probably know and I would say that is maturing or quite reaching its plateau about now. So you see this non volume related movement in receivables which reflects those terms.

One other point that I should mention is that we have made a decision, a commercial decision, not to factor any of these receivables. So it would have been possible for us. We could have spent money that it would have hit our earnings to cover that cash much more quickly but at this point in time we do not see the financial need for that cash and therefore we are not engaging the factoring. So we were bearing it all, as it were, in the manner in which we are showing our cash flow statement.

One of the other aspects of managing the aftermarket is delivery performance It's essential that, as you know, we maintain very, very high levels of delivery performance and one of the key factors to that his holding the right inventory in the right places. One of Mike's drives is to focus very much on this delivery performance and again even in a quarter where we had relatively weak up OE performance which there was some inventory reductions we, under the new segmentation, and where Mike felt the need for inventory, to move the right parts to right place at the right time then we did that in order to improve our delivery performance.

Brian Sponheimer - Gabelli & Company

Okay, all right, that makes sense. Let's talk also about your pricing promotions as far as the aftermarket is concerned. Obviously for investors, biggest concern going forward is whether relative to two or three years ago your aftermarket business is structurally less profitable than it once was and if you are becoming more promotional on price would certainly lend credence to that argument. Could you take a couple of minutes to discuss of discredit that please?

Michael Broderick

Brian, this is Mike. I think that’s a good point for explanation. I think we are going to start acting more like a premium house where it is going to be less price and more product differentiation to be able to support the brand. So what you all would be able to see is actually margin should play out accordingly.

Brian Sponheimer - Gabelli & Company

Okay, so does this somewhat creation of the move towards value based products that's taking place over the course of the last two years?

Michael Broderick


Brian Sponheimer - Gabelli & Company

So this is reversal, okay. And just finally going back to the OE business, for the most part you guys stake your claim on diesel and we are seeing some softness and not only the Chinese demand for the luxury market but the Germans, the European side as well. If you are thinking two or three years out, about mix, relative to where it's been, say in the last year, a year before that, do think you are going to be able to see a recovery or is this something what we could potentially be seeing a real headwind for Federal-Mogul over the course of the next 18 to 24 months?

Rainer Jueckstock

Rainer speaking. Good question and we try to understand where the market is moving. Again, for us, in Europe, around 70% of everything we do in Powertrain is around diesel. Passenger car and heavy duty and industrial. So it's a significant portion of our business. We have no doubt industrial and heavy duty, there is no alternative to diesel. So that is normal cyclical movements up and down. This business will come back and we have great products. We are, and most of our customers already this Euro 6 applications approved. We have for the U.S., US'10 emission regulations and (inaudible) already fulfilled with our products.

So that’s cyclical nature of the business. On the passenger car in Europe, we believe in the long run, there will be a stable 50-50 between gasoline and diesel. We see in all of our customers, let's say, developed modern and modern gasoline because the European customer base have tendency to buy both. So we see countries like Austria where you might have up to 70% diesel cars, in Germany, U.K, it is around 50% and you have going into more Scandinavian countries, around 35% to 40%. Relatively stable and the mix shift we see is to a certain extent currently more difference at countries with higher diesel demands like France, Spain and Italy or down in countries with less diesel demand like on Northern European countries, they are still stable therefore we have the mixture towards gasoline. So we do not see significant shift going forward between diesel and gasoline but yes that will be from time to time swings back and forwards by a few percent points.


Thank you, Brian. We have another question for you. This one is from the line of Bret Jordan. Please go ahead. You are in the call.

Bret Jordan - BB&T Capital Markets

A couple of questions following up there on the vendor term side. You commented that the terms are reaching a plateau. Is that a seasonal plateau or is that an absolute plateau looking forward in the next year level?

Alan Haughie

Well, it's not a seasonal plateau. The maturation of the terms as they have moved into place.

Bret Jordan - BB&T Capital Markets

Okay, so you don’t see that necessarily being a major change in working capital, one way or the other from here?

Alan Haughie


Bret Jordan - BB&T Capital Markets

Okay, as you made the decision not to factor what is the margin benefit to you to not get involved in factoring programs?

Alan Haughie

Essentially, the cost of the factoring but that varies by program.

Bret Jordan - BB&T Capital Markets

Right, are you getting any pricing benefits which is purely the spread of your cost of capital versus the cost to factoring?

Alan Haughie

I don’t want to be really drawn, I need the broader commercial benefits of the program. Sorry.

Bret Jordan - BB&T Capital Markets

Okay, all right. I guess as you just talk about getting less price driven and more of a differentiated product strategy on the aftermarket, what category do you see lending themselves most of product differentiation looking at the portfolio?

Michael Broderick

Friction and chassis.


Thank you very much. We have no further questions. So at this stage, I would like to turn the call over to you, David Pouliot for some closing remarks.

David Pouliot

Thanks, Ian. I would like to thank you all for joining our Q3 conference call. We look forward to having you at our fourth quarter conference call.


Thank you, sir. Thank you for your participation in today's conversation, gentlemen. That concludes the presentation and you may now disconnect. Do enjoy the rest of your day.

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