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Accuride Corporation (NYSE:ACW)

Q2 2008 Earnings Call

August 5, 2008 11:00 am ET

Executives

David K. Armstrong - Chief Financial Officer and Senior Vice President

John R. Murphy - President and Chief Executive Officer

Analysts

Analyst for Itay Michaeli - Citigroup

David Leiker - Robert W. Baird & Co.

Henry Kearns - UBS

Analyst for Sarah Thompson - Lehman Brothers Holdings Inc.

Adam Plissner - Credit Suisse

Rod Lache - Deutsche Bank

Analyst for Rod Lache - Deutsche Bank

Derrick Wenger - Jefferies & Company

Operator

Welcome to the second quarter 2008 Accuride Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, David Armstrong, Senior Vice President and Chief Financial Officer.

David K. Armstrong

With me today is Accuride’s President and CEO, John Murphy. We have attached a webcast with some slides that will help us with our presentation today. So, if we could turn to the Agenda slide.

On today’s call, John will provide an operational review, comment on some topside financial highlights and end with comments on our 2008 guidance. And I will then present a more detailed overview of the company’s second quarter 2008 financial results. We will then open up the line for questions.

As normal, we’d like to cover two administrative items before we start. First, financial information released this morning includes our GAAP results for the second quarter for both this year and last year, as well as, non-GAAP information that we believe is useful in evaluating the company’s operating performance, mainly adjusted EBITDA.

As required by Req. G, we have in our earnings release provided a reconciliation of the non-GAAP information we will be discussing today to the closest GAAP equivalent results. And the information on these reconciliations can be found in today’s press release and in our Company’s presentation and also on our website.

Second, I’d like to remind listeners that comments made during the course of this call and statements in our presentation will contain forward-looking statements and management may make additional forward-looking statements in response to your questions. Statements made in the course of this conference call that state the Company’s or management’s intentions, expectations or predictions of the future are forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time to time in the Company’s SEC filings.

With that, it’s my pleasure to turn the call over to John Murphy.

John R. Murphy

Just before getting into the second quarter operational highlights, I want to make one overview comment. I hate to start on a negative but in stating the obvious, the horrible demand environment continues for our business. As a quick refresher, you’ll recall that 2007 versus 2006 suffered about 35-40% unit volume loss. Year-to-date this year, we’ve experienced on average probably about another 20% relative to 2007. So, a weak demand of fundamentals continue. We can’t sidestep that.

On the other hand, there are a number of positive things going on internally and I want to just give you a few themes for the call quickly. First of all, we continue to gain momentum on organic growth revenue initiatives as well as operating improvements, particularly in the Components business and specifically the Foundry businesses.

SG&A reductions continue as well as cost reductions in the plants. From the cash and liquidity standpoint, the second half we’re expecting to be substantially free cash flow positive over $50 million with inventories reduced but with further reductions to come and also additional reductions in capital expenditures. Our liquidity continues to be strong at $158 million. Due to the persistent weak demand fundamentals, I have initiated a strategic review of all our capital and human resource assets in the Company and that’s something that we would expect to be a bold initiative to be articulated in the third quarter of 2008.

With that as a backdrop, I’d now like to turn to the second quarter operational highlights. First, as I’ve previously indicated, we are gaining significant ground in the Component segment in particular in the quarter, very substantial improvements in our brilliant operating unit and also at the Gunite operating unit. You can see here that, that was a gross profit improvement of $13.6 million over Q1 2008. Q1 did include $8 million of costs, however, associated with the related Gunite lockout, which has been successfully resolved. And productivity is at all time highs at the Gunite business. So, we’re expecting continued momentum in those business units for the balance of the year.

Organic growth initiatives, as you can see, currently offset the large volume losses associated with the general market. Our military wheel growth is up a solid $5 million and expected to continue. And we’ve had strong aftermarket sales in the Aluminum and Components area, and as you know, that’s an area we have targeted with new management, new strategies in the aftermarket areas, and expect that to the be a substantial contributor going forward.

Everyone has been concerned about the raw material impact on our as well as many other businesses. That’s a keen issue for Accuride in that we have about 70% of our costs of goods sold is raw materials sensitive, steel being the most important raw material for us although aluminum is important as well. I think we’ve done a very good job thus far in minimizing the impact of raw material price escalation, which has been extremely significant. And despite the fact that we have some modest losses due to the lag effect, where steel producers crammed out very substantial increases on short notice. We’re still targeting for a full recovery for 2008. To give you a sense, the overall impact of this cost increase is about $45-50 million for the Company for 2008.

As I alluded to earlier, we have initiated a strategic review of all our operating assets. At this point, it’s premature to conclude any of the details but we’re looking at everything. We’re looking at cost structures; we’re looking at the ability to move equipment with shutdown of any facility’s the appropriate, with further people reduction to be appropriate. All of these are being carefully examined but premature to quantify that impact. Although, we will be taking an aggressive look at this. In addition, we continue with SG&A cost reduction, a positive working capital management with CapEx containment and continued inventory reductions.

Now, let’s turn to the second quarter of financial highlights.

First of all, on the Class 8 side for the quarter relative to the prior year, that was a bright spot in an otherwise weak picture. As you can see, that improved but Class 5 to 7 and Trailers continued to be a very weak. And on a year-to-date basis, as I previously indicated, all classes are down and that’s on top of deep declines versus the prior year.

From the standpoint of the consolidated results, you’d see we’re relatively flat on sales and Dave will give you some details on that. EBITDA are at just under $20 million, down about 30% versus the prior year. However, in the prior year, there’s a couple items that I think need to be called out. One, we had a one-time pricing item related to settlements with a customer. That affected us $6 million in Q2 and $14 million year-to-date. And also, our margins are impacted by inventory reductions. This is sound management and it’s really a volume-related impact due to the significant market contraction that I mentioned. That affected us $6 million in the quarter and $8 million on a year-to-date basis.

I think at this point, it’s appropriate to give you a couple data points on a year-to-date basis. And unfortunately, noncontrollables and one-time items completely obscure the net performance improvement that is going on inside the Company. The noncontrollables year-to-date, volume and foreign exchange, affected us over 500 basis points in margin. Inventory reduction, $8 million year-to-date, is a little over 150 basis points of a negative impact. The one-time pricing of $14 million is almost the 300 basis points impact. So, as you can see, there’s about a 9.5-10 percentage point margin impact on a EBITDA basis associated with those one-time, or volume and foreign exchange-related, issues. As previously explained, raw material is really almost too close to call at this point and expected to be neutral for the year. So, all of those factors, much of which out of our control or happened in the prior year, greatly overshadow about a 200 basis point improvement in that performance.

Moving on to our guidance. As you can see, our current range estimate, $85-100 million, with free cash flow at a break even level. This is basically premised on the production estimates indicated there. ADJ generally the high end of the range. We’ve shown a range here that we think is a more conservative, more in line with at least the current information we’re getting from our customers. We have yet to see any clear indications of solid improvement in the market fundamentals. In fact, just before the meeting, I got preliminary July orders. They continued to be weak, with about 10,000 units for Class 5 to 7 and only about 15,000 for Class 8. So, there’s nothing clear yet on the horizon that indicates us that we should be bullish about a substantial recovery in the second half.

Therefore, we have modified the guidance to reflect that. I won’t go through some of the details. Dave may touch on those or you may have questions that go into the guidance estimate. So, that’s where we’re at, at this point in time. Again, I would stress that we are making internal improvements. We intend to continue that. That’s one thing we have some reasonable degree of control over. The market is still not our friend but we tend to seize every opportunity to gain revenue or otherwise improve our operations as we wait for a more robust recovery in the economy and our industry sector.

With that, I’ll turn it over to Dave Armstrong for the financial review.

David K. Armstrong

Let’s move onto the next slide, which is Q2 2008 vs. Q2 2007. As John mentioned, sales were flat year over year. We did see a slight increase, or an increase in Class 8 sales in the second quarter but safe to about a 14% reduction in Class 5 through 7 builds, and a significant 36% drop in Trailer builds, and also about a 6% drop in the industry aftermarket. So, overall, a negative compared to last year.

Sales in our Wheels segment dropped $8.2 million or about 7%, principally due to the year over year $13.2 million decrease in light vehicle deal wheels. As we’ve discussed in the past, we seize supplying Ford in mid 2007 and so the year over year comparison is somewhat skewed. And then in addition to that, our light vehicle wheels were further affected in 2008 by the overall weakness in the pickup truck market and also the American Axle strike and its effect on GM truck builds. The steel wheel decrease was partially offset by stronger aluminum wheel sales and in addition we had about $5 million of new military wheel business in the second quarter.

Sales in Components increased $6.7 million or 6% year over year due to an increase in aftermarket revenue and also surcharge recovery of raw material costs. We anticipate increased sales levels as we past through significant increases in our raw material costs and this in turn will have a compressing effect on our margins in the future because those pass through do not create any margins.

Sales in other segments, which is principally Fabco and Brillion Farm is up about $1.3 million and stronger seasonal sales from our Brillion Farm division.

Gross profit margin in the second quarter decreased $7.1 million from $28.4 to $21.3. As John indicated, during the second quarter of 2007 we were aggressively building inventory in anticipation of our collective bargaining negotiations. In 2008, we were not building any inventory. So year over year, we had a $30 million reduction in inventory which affects our margins by approximately $8 million in Q2. And in addition, we had the resolution of a commercial dispute that John talked about and other prototype pricing in 2007, one-time prototype pricing, that impacted our margin comparison again by another $6 million.

The gross profit in Components in Q2 2008 includes about $1.2 million in severance and about $1.4 million in lag surcharge recovery, as John discussed.

Due to the prolonged downturn, we’ve initiated a number of cost-cutting measures, as John mentioned. As a result, operating expenses in the second quarter decreased $1.5 million to $12.7 million, compared to $14.2 million last year in the same period.

Second quarter adjusted EBITDA was $19.7 million compared to $28 million in Q2 2007. Margin was 8% compared 11.6% in the prior year and EBITDA was negatively affected by $3.8 million of special items, including $1.2 million of negative foreign exchange, $1.2 million of severance cost, and $1.4 million of the surcharge lag situation all of which of those we intend to recover in Q3 and Q4.

Net interest expense declined to $8.5 million from $11.3 million in the second quarter of last year, due to $3.4 million in non-cash unrealized gains related to market-to-market of [inaudible].

In the second quarter of 2008, we realized a $2.3 million income tax benefit due to a favorable settlement of an IRS audit and the favorable change in our valuation allowance. Cash taxes in the second quarter were about $700,000 and we are estimating cash taxes in 2008 to be less than $5 million based on current EBITDA forecasts.

Second quarter net income decreased to $3.4 million, or $0.10 per diluted share, down from $4.9 million or $0.14 per diluted share in Q2 2007.

We can move to the year-to-date comparison slide. For the six months ended June 30, 2008, sales were $483 million compared with $570.6 million in the prior year period. 2007 revenue included almost $30 million in light wheel sales to Ford Gm and an additional $10 million in revenue related to the resolution of the commercial dispute. Factoring out the light vehicle business, the decline in sales was in line with the reduced demand that we’re seeing in commercial vehicle industry year over year. You will recall that the first quarter of 2007 was very strong due to the carry over of the 2006 pre-buy.

Year over year volume-wise on a six month basis, we saw a 10% drop in Class 8 builds and 18% drop in 5 through 7, and 38% drop in Trailer builds. And I also mentioned 6% drop in the aftermarket.

Gross profit for the six months declined to $33.6 million or 7% of sales from $52.6 million or 9.2% of sales in the prior year. That’s primarily due to the net reduction in sales due to the industry weakness and also the lower light vehicle business.

Gross profit in Components for the first six months of 2008 was impacted by about $8 million of one-time charges related to a labor disruption at Rockford, Illinois facility and a $1.8 million in severance-related charges, which we talked about in some detail in our last call.

Income from operations declined to $7.2 million from $23.9 million, despite a reduction in operating expenses totaling about $2.9 million in the first half of 2008 related to ongoing expenses in salary reduction initiatives. The reduced income was heightened due to the one-time charges that I previously mentioned.

Adjusted EBITDA was $38.2 million or 7.9% of sales from the first six months of 2008 compared to adjusted EBITDA of $77.5 million or 13.6% of sales for the same period in 2007. And John walked through the additional color but just to highlight that one more time, if you break down the change into four categories, you basically have volume and one-time pricing with $20 million of volume and $14 million of one-time pricing that occurred in 2007. Foreign exchange was $4.3 million. Raw material, we incurred approximately $13 million of additional economic costs in the second quarter. We recovered approximately $12 million of such costs and anticipate break even on a raw material recovery basis by the end of the year.

Operational performance actually did see some good improvements of about $8 million. That was principally due to the restructuring of the steel wheel business that we began towards the end of last year. We also anticipate further improvements in operating performance as the actions we’ve taken in Components segment continue to gain traction and as we aggressively pursue cost-cutting measures that John discussed. We also had an inventory reduction that impacted margins by about $8 million, as John mentioned.

Moving on in the year-to-date, net interest expense increased to $24.2 million from $23.2 million, primarily due to higher debt cost and $1.2 million in non-cash unrealized losses related to a market-to-market of interest rates swaps. We had a net loss overall of $8.4 million or -$0.24 per diluted share for the first six months of 2008. That compares with $3 million or $0.09 per diluted share in the prior year. And again, obviously contributing to that net loss in 2008 was the $8 million of charges related to the Rockford work stop at the beginning of this year.

Let’s move on to the second quarter versus first quarter slide. Overall, we had an increase in sales of about $6.7 million, principally due to an increased aftermarket and sales and also surcharges in the Components segment. Sales in the Wheels segment were negatively affected by reduced light vehicle builds, which affected our steel business by about $2.5 million. And offsetting that was an increase in aluminum sales.

Gross profit increased $9.1 million, primarily due to the improved performance in the Components segment. As we mentioned, there was a pretty hefty headwind of about $8 million in the first quarter related to the Rockford facility. But even aside from that, the Components segment is showing some solid improvements and we’ve gained some good momentum and anticipate additional improvements throughout the third and fourth quarter.

Operating expenses improved about $900,000 versus Q1, which again, emphasizes our emphasis on cost-cutting as we work through this prolonged downturn. And as John mentioned, we’ve implemented a task force to put additional focus on cost reduction opportunities across the Company.

Moving on to the cash flow slide, in the second quarter of 2008 cash from operating activities was a negative $4.1 million. CapEx totaled $9.4 million, resulting in negative free cash flow of $13.5 million compared to positive free cash flow of $6.8 million in the second quarter of 2007.

The increased cash usage was primarily due to an increase in inventory from some pre-buy of raw materials in anticipation of pricing actions by our suppliers and by some working capital issues, including higher accounts receivables due to some surcharge pass-through, some slowness in implementation of a new ERP system that one of our subsidiaries which increased our receivables by about $2.5 million for the quarter, and we also had a decrease in payables as we took advantage of some early pay discounts and also due to some special timing of some CapEx projects throughout the quarter.

We anticipate that the inventory, A/R and A/P issues were fully resolved in a pretty much one-time item and then things will return back to normal in the third quarter. And although we are currently in a negative cash flow position, we anticipate we will be break even by year end as we continue to aggressively push our inventory reduction program and other working capital projects. I should remind you also that historically the fourth quarter is our strongest cash producing quarter of the year.

A couple of other items. Depreciation and amortization in the second quarter was approximately $11.5 million. Last year was about $14.5 million for the same period. And if you recall, last year included some accelerated depreciation of about $1.3 million related to some light wheel equipment. We currently anticipate spending about $33 million on CapEx in 2008, which is lower than we previously indicated.

Moving on to the Debt and Leverage slide, Company ended the second quarter with total debt of $572.7 million, $33.2 million of cash, given a net debt of $539.5 million. Revolver availability remains at $125 million which gives us total liquidity of $158.2 million. And as of the end of the second quarter, the leverage ratio as defined by our credit agreement was 7.12x. And all debt amortization has increased pay through 2011.

Now, let me point out that when analyzing our covenants, it’s important to recall that the definition of EBITDA in our bank agreement is slightly different than normal GAAP definition that we regularly report, and exclude certain items such as severance costs, 123-R share-based compensations, certain other non-recurring non-cash items. Year-to-date, that different of bank EBITDA versus GAAP EBITDA is about $4.2 million, that bank EBITDA is higher than the GAAP EBITDA by $4.2 million. And for the full year, we currently are estimating that difference to be about $8 million on a full-year basis.

I should add that we are closely monitoring our debt covenants and currently believe that we have adequate cushion throughout the remainder of 2008. At the same time, we realize there could be friction in covenants in Q1 of 2009, depending on the speed and the degree of the ramp up of new truck builds in the first part of next year. We are therefore carefully reviewing this area and evaluating various options and alternatives. The future direction will, of course, depend on market conditions, both in commercial vehicle industry and in the debt markets.

One additional item I would like to mention that we had in our press release. Under FAS 142, we are required to assess goodwill and any indefinite lived intangible assets or impairment. We do that on an annual basis and more frequently if circumstances indicate that impairment may have occurred. As most of you know, the analysis of potential impairment of goodwill requires a 2-step approach. The first step is an estimation of fair value of each operating segment and then a step one indicates that impairment potentially exists. The second step is performed to measure the amount of the impairment, if any. And a goodwill impairment would exist if the estimated fair value of goodwill is less than its carried value.

During the last two weeks of the quarter, we experienced a significant decline in our stock price resulting from the overall economic and industry conditions. We determine that this is an indicator of impairment and that an impairment analysis under FAS 142 will be required and so we are in the process of reviewing the fair value of each of our seven operating segments. This step one process is not yet completed and we’re unable to disclose which, if any, of our operating segments may have concerns in this step one process. In the event that one or more of our operating segments fails step one, we will perform a step two calculation to determine the amount of any impairment. If such an impairment is indicated, it will be reported in the third quarter and such a charge, if it happens, is non-cash or will be non-cash and would not affect our liquidity or tangible equity or debt covenant ratios. So, with that, I would like to turn the call back over to the moderator for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Itay Michaeli with Citi.

Analyst for Itay Michaeli - Citigroup

A couple of questions on your steel outlook. How difficult is it for one to get those surcharges in the system and how much of your guidance relies on those recoveries?

John R. Murphy

When you say get through to the system, I assume you mean work with the customers to recover the increases.

Analyst for Itay Michaeli - Citigroup

Exactly.

John R. Murphy

Okay, it continues to be difficult. This is a problem that we‘ve, unfortunately, become well experienced with through our past spiraling raw material increases. This one, I think, is perhaps different in that this has been a persistent problem of commodity prices over the past probably 4-5 years. So, it’s well understood with our customers. No one likes it, us or the customers. We’re not making money on it but we need to fully recover it. So, that’s our task. Our sales and marketing group has been immersed in working through that series of issues very carefully on a customer by customer basis and we’re confident that we will do extremely well in terms of overall recovery but as they’ve pointed out, that still will probably cost us a percentage point in margin due to the fact that we get the revenues with no margins associated with them. But we’re confident in our action plan.

Analyst for Itay Michaeli - Citigroup

And how much of your guidance then, what is based on in terms of steel recoveries?

John R. Murphy

What do you mean? We basically assume that we’ll recover fully.

Analyst for Itay Michaeli - Citigroup

Okay, understood. Thank you.

Operator

And our next question will come from David Leiker with Robert W. Baird.

David Leiker - Robert W. Baird & Co.

What’s your expectations for D&A and capital spending for the year? I don’t think I’ve heard you say that.

David K. Armstrong

CapEx is going to be $30-35, probably about $33 million. That’s what we have targeted right now. D&A is $42 million. $47 million, I’m sorry.

David Leiker - Robert W. Baird & Co.

Great. And then--

David K. Armstrong

And clarify, let me clarify. Depreciation is $42 million; amortization is another $5 million on top of that. So, it’s $47 million.

David Leiker - Robert W. Baird & Co.

Okay, great. I’m a little confused on this raw material. You said $45-50 million of raw material cost this year. Correct?

John R. Murphy

Total 2008 escalation based on our current [inaudible {31:40}].

David Leiker - Robert W. Baird & Co.

Okay, how much of that have been recovered today in the first half of the year?

John R. Murphy

All but what they’ve indicated. Remember, this is quarter by quarter. I gave you a total year number. David, in the first half, we’ve recovered all but $1.4 million due to the lag effect because our suppliers gave us basically no notice. We’re working it through with our customers appropriately. We’re expecting to recover that lag effect in the balance of the year by customized plans with individual customers, which could include trading some timing for volume gains. But our expectation is that in the second half we will recover that shortfall in the first half.

David Leiker - Robert W. Baird & Co.

How much of that $45-50 million fell in the first half?

David K. Armstrong

$13 million.

David Leiker - Robert W. Baird & Co.

Okay, and you expect to be able to recoup all of that here in the second half of the year?

John R. Murphy

Correct.

David Leiker - Robert W. Baird & Co.

In terms of your organic growth, what do you think you’re running today in terms of organic revenue growth?

David K. Armstrong

I’m not sure we call it a run rate today. We’re gaining business. We’ve got substantial growth potential out there. I’ll give you an example. I’m not going to refer to individual customers. That is generally our practice not to identify individual customers but we have an example of new business opportunities, $30 million annualized. We don’t have it yet so I don’t build that in the run rate. We’re reasonably confident that we may get that. It’s not certain but we’ve got numerous items like that, that are out there. So, what our target is overall is to generate 3x of GDP growth and of course as you know, we’re GDP business so 1x is the market, 2x would be the organic growth. So, that’s basically our macro target today. As we get more evidence, of course, we may be able to indicate a specific run rate but we’re looking for substantial growth on the OEM side as well as the aftermarket side.

David Leiker - Robert W. Baird & Co.

The military business, what particular programs are driving them?

John R. Murphy

The LTAP and I think also we are actively pursuing other programs. That’s principally in the wheel area although we are currently beefing up our organization to focus on a broader military specialty segment, which would include other products, the body chassis parts; we’re looking at potentially a military trailer-type vehicle, etc. But those are some good initial business wins primarily in the wheel area.

David Leiker - Robert W. Baird & Co.

How large is the military business today?

John R. Murphy

It’s small, relative to what we think is possible. Probably in the $15 million area but we think over the next several years, we could grow that business to be a niche of perhaps $100-200 million. That would be our goal.

David Leiker - Robert W. Baird & Co.

Okay, as we look at your guidance with the lowered debt, how much of that was the result of a shortfall here in Q2, as opposed to the back half of the year?

David K. Armstrong

I think it’s more volume-driven as we’re seeing the volumes continue to be flat and drop in the second half of the year.

John R. Murphy

I would say it’s really all volume based. In fact, really not a shortfall versus our estimates in the second quarter and this, of course, would be before any restructuring or other business possibilities that are yet to be awarded.

David Leiker - Robert W. Baird & Co.

Just one last item. As you’re going through your product portfolio and some markets you sell into, what are the two and three positions where you think you have the strongest competitive spots?

John R. Murphy

In different products?

David Leiker - Robert W. Baird & Co.

No, just generally across the business. Where do you think you have the strongest market position?

John R. Murphy

Well, of course, we continue to be the clear leader in the steel wheels. That continues and I think that position has been further strengthened by actually some of the opposite effects of the raw materials and the dramatically escalating freight rates. So, I think that makes it much more difficult for offshore competition plus we’ve improved the competitiveness of our products with a lighter wheel. I think we’ve talked about before and you’re probably aware of, we also segmented the market where the price point product for the distribution of the aftermarket. So, we’ve improved. That business’ competitiveness. Fundamentally, we’ve restructured it and we’re looking at further cost reduction activities.

The foundry business, I think, is the big improvement where in the past that had a competitive disadvantage. Now, we believe we have a competitive advantage in the Gunite business on the hub and drum side and also have now turned brilliant from a marginal foundry into, we think, one of the best foundries in its area of focus. So, I would say the foundry businesses, which include hubs, drums and other industrial products including highly chord, casting, etc. or plus the steel wheels business. I think we also continue to be extremely competitive in the aluminum wheel business.

Areas where we need to improve our competitiveness would be in the seating area where we’ve been a strong player with a great brand. We’re upgrading our product line currently to improve that competitiveness. We’ve talked about that before. And I think the imperial business, which is a highly fragmented area in the body chassis market. We’re intending to improve our competitiveness there through solution centers that we target nearby our customers with greater value added content and other services. So, I think that covers the majority of our business units.

Operator

And our next question will come from Henry Kearns with UBS.

Henry Kearns - UBS

Quick question for you on the price increases. Have you felt any volume degradation or market share shifts to competitors across the business stemming from those price increases?

David K. Armstrong

No, actually because I think we’re going to such great lengths to do this properly and work with our customers. As difficult as it is, our goal is to turn this into a net positive in the sense that we work with the customers to show some flexibility in the timing of this so they can make their respective adjustments. But at the same time, in order to counter date that, we’re trying to work with them to gain additional business and we are having some success. Now, I don’t want to indicate to you that this is an easy thing to just go out and gain business while everyone’s choking on material costs but I think it’s being managed extremely well by our sales and marketing group and I think our customers are respectful of our position and are also working with us. So, our goal is to come out of this hole financially, not with a profit on the raw material increases. They’re already substantial. But also, to position us positively, gain some new business in connection with the price increases and be positioned to gain further business with them going forward.

Henry Kearns - UBS

So, are your competitors matching the price increases?

John R. Murphy

I think, Henry, this isn’t an Accuride issue as much as it’s an industry issue.

Henry Kearns - UBS

Sure.

John R. Murphy

And so, the raw material increases are affecting all competitors across the board. Sometimes, depending on the business unit, but sometimes the competitors are leading with the price increases; sometimes we will, but we’re seeing price increases all over.

David K. Armstrong

But yes, others, depending on the business, are also increasing prices, the Chinese that are importing materials are increasing prices. Other of our competitors are in fact increasing their prices. This isn’t an everything done just like in accordance with some standard protocol. We are also positioning ourselves for a possible, like I said, to get an edge in the marketplace and gain business.

Henry Kearns - UBS

And I guess the question on CapEx, where are you cutting it across your businesses? And then, if you were to win some of the new business that you mentioned earlier, would that affect the overall CapEx outlook as we look out towards the end of ‘08 and beyond?

John R. Murphy

No, we’re cutting it very carefully and I’m not going to give you a lot of specifics because they’re not going to be individual big lumps. We don’t spend, as you know, a fortune on CapEx as it is. We’re about 3-4% of sales typically. What we’re doing is we’re trimming where it’s unessential to spend it now. So, anything that can be realistically deferred without sacrificing major strategic programs, etc., it’s an eye for that. We protect it and complete it. The Erie press project, which was very significant component of that. So, we’re being austere but not foolish. We don’t have an arbitrary capital freeze; we’re not suspending important cost reduction projects, but we are trimming the CapEx.

So, our goal is well and when we go through the strategic review of our assets, will be to maximize Accuride’s position with regard to its asset utilization. First, as a quick backdrop, I’ll get this out of the way too, we would’ve liked to have had a crystal ball but now that we’re looking at essentially a 4-year period of demand that’s not robust in 2007 through 2010 really, I mean with some improvements in ’09, we’re trying to restructure our asset base. Now, at the same time, we want to optimize or maximize that while not precluding opportunity to a significant degree in the future. So, we’re not going to idle, for example, a third of our capability. We’re going to try to protect the opportunity for the future while being a very cost effective for both now and the future. So, we’re looking at things, for example, consolidating the functions in the wheel business; we’re looking at do we need all the individual facilities? Could there be some consolidation there? Is there an opportunity to move assets effectively? Etc. So, a number of things going on there but, again, the purpose will be to try to optimize that capital spend and the ultimate capital configuration.

Operator

And your next question will come from Analyst for Sarah Thompson with Lehman Brothers.

Analyst for Sarah Thompson - Lehman Brothers Holdings Inc.

Just a quick question on Slide 5, the $6 million item in 2Q. Can you describe that a bit more and do you expect any similar items in 3Q and 4Q?

David K. Armstrong

There could be some. Well, there would be some impact embedded in our guidance already due to anticipated inventory reductions. I think the strong point here is despite the fact that there’s always some price to pay for inventory reductions, it’s the right thing to do. Our inventories, as we go out of the year, will be approved in terms of the terms. And then of course, remember, we’re looking at the glass as probably half-empty today, right? But if you look at it, it’s half-full. All these negative effects, what I call, “noncontrollables” of volume, including the price we’re paying for reducing inventories related to weak volumes will reverse as volume improves. But yes, there could be some additional impact which is already factored into the second half numbers and that will reverse as volumes does improve.

Analyst for Sarah Thompson - Lehman Brothers Holdings Inc.

Okay, and on your accounts payables, they were down fairly significantly and you mentioned that was due to taking advantage of customer price discounts and some CapEx timing. How do you see accounts payable for the rest of the year?

David K. Armstrong

I think where it is now, if you look at days outstanding, is without thirty or so and I think that it’ll be similar to that. So, I don’t see a lot of significant downside there. And hopefully, it’ll be back to normal levels.

John R. Murphy

Hopefully, some ability to stretch that out some. One of the reasons that’s so low relative to our receivables and so on is we’re getting squeezed. On the one hand, we’re not playing the game with our customers that our suppliers are with us. So, clearly they have more leverage and so we’re essentially getting dictated terms by steel/aluminum suppliers and so forth. There’s very little flexibility. That drives the majority of the payables but we’re possible we’ll extend those.

Analyst for Sarah Thompson - Lehman Brothers Holdings Inc.

And one more on your aftermarket business. In the past, you said you wanted to double your penetration there and I think you talked about $50 million in new business in ‘08. Just wondering if you could provide an update on that and how you’re doing against some of your previous comments?

John R. Murphy

Yes, as we indicated, we are gaining ground in the aftermarket. We talked, I think, specifically about aluminum and components. We expect further gains in the second half. One of the things that hasn’t come up, and this has been countered to most other market cycle, our estimates are the aftermarket at large, meaning the available aftermarket, not our share. The aftermarket is actually struck by about 6 percentage points this year. So, we’re countering that with the organic growth. We expect the organic growth to continue. We’ve got a very serious aftermarket effort and is starting to gain traction. So, we’ll continue to report on the progress of that.

David K. Armstrong

But yes, it’s $50 million is still sort of a broad goal that we’re looking at for annual improvement.

Operator

And our next question will come from Adam Plissner with Credit Suisse.

Adam Plissner - Credit Suisse

Just a follow up again, the $13 million year-to-date gross, in fact, in raw material and the $45 million target. Let’s say the difference between those, the $32 million and some odd, that’s yet to come, are those price increases that have been put through? Your anticipated price increases is sort of variability to when they actually flow through, is there an actual time period that the supply basis expected to put through incremental prices?

John R. Murphy

We’ve got it all scheduled out. We’ve got a very detailed model that shows it quarter by quarter. We’re not really going to disclose all those details but you’re right. The majority of it’s in place. Well, it’s in place, meaning negotiated with the customers through surcharge mechanisms or agreed upon price increases and so I think that is why our confidence level is very high. We were able to delay in some cases steel price increases although, in fact, we had to cope with the fact that we’ve had steel contracts were breached basically by our steel suppliers. Then we, in turn, had to go our customers and push this through. So, that’s why I think under the circumstances we’ve done an excellent job. It’s not an easy issue but it’s essential to our livelihood. So, that’s what we’ve done.

In the case of aluminum, we’ll actually get some further catch up because in those cases, some mechanisms actually by the time it rolls through it’s close to a 6-month impact. And so we do have some on a business by business basis. In the aluminum business we have some losses that aren’t fully recovered in 2008 but will be recovered in 2009. For the total company, this comment still remains the same, which is we’re expecting a full recovery for the overall company independent of the individual business characteristics.

Adam Plissner - Credit Suisse

John, I know you commented that when you go through the fair value assessment and the potential impairment you may put through in Q3 would be a non-cash charge but as you go through a more formalized strategic review and decide whether to do facility consolidation, move assets, what is the anticipated cash cost of those moves and would you expect it to be significant? And is there a possibility that you’d be looking to do cash generated moves like cash asset sells?

John R. Murphy

First of all, we’re not going to give any indication because we haven’t completed work. So, I’m not going to give you a guess-timate at this stage in time. What you can expect that it will be a bold initiative, meaning we’re not looking at finding $100,000 here and there. We’re looking for large impact potential. The only thing that we’ll be invested in will be something that will have a very high internal rate of return. So, we’re not going to do anything financial foolish just to say we’ve took some very tough actions. And we would like to package anything completely. So it’s easy to understand the cash effects, the return effects, and any non-cash impact. So, I think that’s a way of saying we’ll give you the answer at the end of Q3 but it’s premature to say. The impairment review has not been completed. The strategic review of assets has not been completed. So, we’re not going to give indications prior to that time. And of course, none of the potential benefits but it would be accruing to the business are reflected in our guidance, nor or any of the cash costs that might be reflected.

Adam Plissner - Credit Suisse

Okay, but is it fair to say you’re not willing? The upfront costs or the benefits, I imagine, as you just laid out, it will be all clear for us in terms of the payback, but is it fair to say that you’re comfortable with the liquidity today you would go down the process of actually spending a large chunk of change? It just seems like a little bit of an awkward time to spend big dollars up front today, right?

John R. Murphy

Well, we’re not looking at it with an eye to spend big dollars. So, again, I’ll go back and say we’re not going to draw out, I guess, a range estimate. So, we’ll see. It will be done prudently with all the factors taken into account that you’re thinking about.

Adam Plissner - Credit Suisse

Dave, you gave you a bridge scenario, I guess, in the [inaudible {52:13}] from Q1 to Q2 sequentially, and I guess the EBITDA improvement and the cash flow improvement, that’s baked into your forecast. Was wondering if you could help me just think about that sort of two-fold, A) if you’re running $18.5-19 million in the first two quarters and the back half, obviously, implies $25-30 million in the quarter. The bridge sequentially there and then just in general, when I look at the cash flow that’s necessary to be generated in the second half of the year break even target. The big ticket item there, I guess, surrounded by working capital. Just your comments around delivering on that.

David K. Armstrong

I think first of all as far as the second half of the year, a lot of the increases will come from some of the improvements that we’ve already put in place in the Components side, some new business that’s coming on that’s been in our forecast for some time, and some significant operational improvements that have gained traction in this second quarter that we’re seeing come forward. Year over year, I think it’ll be, as far a third quarter and fourth quarter, there’ll be some significant improvements on the Components side.

Sorry, what was the other question?

Adam Plissner - Credit Suisse

Sequential EBITDA and then cash flow.

David K. Armstrong

Cash flow has always been, historically, we’ve always had fourth quarter as our strongest quarter. And I think based on some of the actions that we’re taking with regard to working capital and reduction of inventory, payables, receivables, etc., that this year will be very similar to what we’ve had in the past.

If you recall last year, we were in similar position of being overall negative, I believe, year-to-date and had very significant cash generation in the second half of the year.

Adam Plissner - Credit Suisse

Okay, and I missed what you said on the sequential EBITDA. Is it mainly volume driven, the improvement in the back half there?

David K. Armstrong

I think there’s some volume and there’s some operational improvements. Combination.

Operator

And our next question will come from Analyst for Rod Lache with Deutsche Bank.

Analyst for Rod Lache - Deutsche Bank

I wanted to ask about the other segment. Could you talk a little bit about what’s driving the strong growth and margin expansion in that business?

John R. Murphy

The other meaning Fabco and Brillion Farm?

Analyst for Rod Lache - Deutsche Bank

Right.

John R. Murphy

Okay, briefly Fabco continues to be a solid niche with a good margin. There’s not significant revenue growth. In fact, typically they’re affected a little less than some of our other businesses but they’re probably down marginally. Brillion Farm, I think there we have an issue of they’re doing a good job running the business but also the agricultural industry has actually been one of the healthier industries. So, unfortunately we’ve only got a small diversity slice of that but it’s positive. So, I think those, Dave, are those units that are included there?

David K. Armstrong

Right.

John R. Murphy

I think those are compressible things going on there.

Analyst for Rod Lache - Deutsche Bank

And then on the aluminum side, I think you had said in previous calls that you were hedged through with the first half of ‘08. Just wanted to ask about what the P&L effect would be when those hedges come off and what the pricing progression is to your customers. Are you already taking price?

John R. Murphy

Let me recap a couple of details I mentioned before. Remember, on the line item of aluminum as one of our business units in this global raw material recovery scheme, as I indicated, we’re expecting a negative recovery in aluminum in the second half, and that’s largely due to the timing of our raw material pass through mechanisms with our customers, which basically on an average, probably comes close to a 6-month cycle. So, we go out of the year with a deficit. We will recoup that in the first half of 2009 but that individual item now is exposed in that we don’t have those hedges in the second half. And David is correcting me and saying we are putting in some. So we have some degree of shield in the second half but much more exposure than we had in the first half. And based on where prices are today, that’s how we see it. If that would change, that would change the situation but overall we’ll have a full recovery there but not in 2008. And that’s in the mix of the overall full recovery for Accuride in 2008 for its business units.

Analyst for Rod Lache - Deutsche Bank

On the light truck side, do you have a number for revenue impact excluding the loss of the Ford business for this quarter, or some kind of a magnitude of how much revenue was lost there?

John R. Murphy

You’re saying due to just weak conditions with the SUV, pickup and the actual--

David K. Armstrong

About $2.5 million.

Analyst for Rod Lache - Deutsche Bank

And what vehicles are your key exposures there? Is it mostly the 900?

David K. Armstrong

Yes.

Operator

And our next question will come from Derrick Wenger with Jefferies & Company.

Derrick Wenger - Jefferies & Company

If you could review the covenants and those most likely to violate in the first quarter of ‘09 and where you stand specifically with the guards to those covenant calculations now. And secondly, capital expenditures for ‘09 if you can. If you can make out that yet. I know you said 3-4% of sales but just wondered if you have any guidance.

David K. Armstrong

Let me give you what the covenants are. Three covenants: leverage, interest covenants and fixed charge. The covenant for this quarter is 9.75. For leverage, the interest coverage is 1.1. Fixed charge is 0.55. And again, we do well within that range. The covenant for Q3 is 8.5 leverage, 1.3 interest coverage, fixed charge is 0.6. In Q4, 5.75 leverage, 1.8 interest coverage, 0.95 fixed charge. And for Q1, 4.5 leverage, 2.5 interest coverage, and 1.35 fixed charge.

The covenants are pretty much locked steps. So, if you breach one, you breach all. As far as what we anticipate breaching, we’re not in a position to even say that we’re going to at this point. It’s kind of too early to call. We’re looking at it very closely and we’ll be able to give more comment on that as we gain more visibility as we get closer.

John R. Murphy

One thing I would stress though. We believe there’s probably tremendous negative overhang to our stock associated with this issue. We’ve obtained timely amendments to our debt agreements anytime that was ever required. We’re very skillful at that. We work closely with our banks at that and we’re confident that when and if we need to address that, we will address it in a timely manner and successfully.

Derrick Wenger - Jefferies & Company

Okay, and the CapEx ‘09?

David K. Armstrong

Probably a similar kind of level at this stage but it’s premature to really provide guidance on that.

Operator

Due to time constraints, this concludes our question-and-answer session.

David K. Armstrong

I’d like to thank everybody for joining us in our call and we look forward to talking with you again next quarter.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Accuride Corporation Q2 2008 Earnings Conference Call
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