Stoneridge Inc (SRI) 2004 Q3 法說會逐字稿

Good day, and welcome to the Stoneridge third-quarter 2004 conference call. Before we begin, the Company would like to remind you that statements made during this conference which are not historical facts may be considered forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. In addition, this conference call contains time-sensitive information that reflects management's bets analysis only as of the date of this live call. Stoneridge does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information, or circumstances that arise after the date of this call. For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to Stoneridge's quarterly earnings releases and periodic filings with the Securities and Exchange Commission.

We'd also like to remind you that during this call, all participants’ lines are in a listen-only mode. After the presentation, there will be a question-and-answer session. (Operator Instructions). Also, this call is being webcast and recorded for replay. Now, I'd like to hand the call over to Gerry Pisani.

Thank you. Good morning, everyone, and welcome to our third-quarter earnings call. With me today for the first time is Joe Mallak, the Company's Chief Financial Officer.

To begin today's call, I will make a few brief comments about the state of our business and the Company's served markets. And Joe will provide his perspective on the Company's third-quarter results and the outlook for the fourth quarter. Following the formal presentation, we will address any questions that you may have.

I'd like to start off by saying that we are pleased with our third-quarter performance. Diluted earnings per share for the quarter were 17 cents, which was in line with our guidance of 14 to 18 cents per share. Our sales increased 17 percent from this time last year, primarily because of our continued strength in the commercial vehicle market. Net income increased 26 percent from the third quarter of '03. As you can see, despite the challenging economic climate in which we operate, we continue to post solid financial results. We expect the commercial vehicle market to remain strong for the remainder of the year. However, we continue to anticipate softer conditions in the North American light vehicle market during the fourth quarter.

As I explained during our last conference call, we are pursuing all means to increase our top-line growth to offset the lack of pricing power in our industry. Our spending year-to-date on product development was $25 million, an increase of 5 million year-over-year. While it will take at least 24 months for these products to reach the market, we are already seeing an increase in new business awards.

We have been awarded a $9 million contract for our new high-temperature diesel exhaust gas sensor, which we will be launching in 2007. And we feel that there are more opportunities for us in the next generation emission control systems for diesel engines.

We continue to gain market share with our cost-effective fuel vapor canister valve actuator, with awards from Nissan, Hyundai and Subaru. We also received our first Seat Belt Sensor award from a leading Japanese tier one supplier, and our first Drivetrain Actuator award from VCS (ph).

These are just a few examples of our new technology going to market, and our customer diversification effort. I am optimistic that we can achieve an organic growth rate of more than 4 percent by 2007, because of our focus on passenger safety, fuel vapor management, emission controls, and the transition to control by (ph) wire.

We also believe that expanding our global presence will help our organic growth in several ways. First, by leveraging existing capability into adjacent markets; by adding customer diversity, a natural hedge to shifting market shares; by following our global customers and helping them reduce their supply base; and finally, by utilizing the low-cost aspect of some of these regions to remain competitive with our more mature products.

We took another step in this journey this last quarter by signing a joint venture agreement in India with them Minda Group. Minda is an $80 million privately-owned automotive supplier like Stoneridge. It is focused on electrical systems of the vehicle, but does not have all of our sensing and electronic capability. Our initial focus will be electronic instrumentation for India's automotive OEM's, as well as medium and heavy-duty truck OEM's. We are open to adding other capabilities to this joint venture as the Indian market matures. We see an opportunity to sort some of our low-volume mature products from the Minda Group as well. For example, low-cost single-function ignition switches. Our Indian joint venture and our previously-announced business development office in Shanghai, China represent the beginning of our Asian footprint.

Now, as we enter the fourth quarter, we are heavily engaged in the business planning and budgeting process. We expect commodity inflation to continue through 2005. And we seek constructive dialogue with our customers and suppliers to mitigate the effects on our bottom-line. We will continue the lean Six Sigma journey, and our best-cost producer strategies to remain competitive.

At this time, however, we are not prepared to give earnings guidance for 2005, until our analysis is complete. I will now turn the call over to Joe so that he can provide his perspective on the Company's third-quarter results, as well as guidance for the fourth quarter.

Thank you, Gerry. To start, I would like to advise that during the course of the call, I will be referring to income before interest, other income, taxes, depreciation, amortization, and also operating cash flow, net of fixed asset additions. These items are non-GAAP financial measures. Please see the Investor Relations section of the Company's website at www.Stoneridge.com for a presentation of the most direct comparable GAAP measures and reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures.

Our revenue for the quarter totaled $164.3 million compared to revenue of 140.8 million in the previous year. During the third quarter, North American medium and heavy-duty truck production increased 35 percent and was the main factor behind our sales increase. Our sales were also impacted by favorable foreign exchange rate, which added approximately $2.7 million to our top line. These factors were mitigated by a 3 percent decline in traditional domestic North American light vehicle production. North American revenue of $135.7 million increased 16.2 percent from 2003, while non-North American revenue increased 18.7 percent to $28.6 million.

In North America, the increase was primarily due to commercial vehicle markets. The increase in the European sales was also primarily attributed to increased commercial vehicle volume as well as favorable currency exchange rates. North American revenue accounted for 82.6 percent of our third-quarter revenue compared to 82.9 percent for the same period in 2003. Power Distribution revenue increased 23.9 percent to $88.6 million. Increased commercial vehicle production, and, to a much lesser extent, favorable currency exchange rates, were the primary drivers behind the sales grow. Revenue for the control device segments were essentially equal to the prior year at $75.7 million. Total passenger car and light truck revenues were $71.6 million, while the medium and heavy-duty truck sector revenues were $74.1 million. Sales to agricultural customers totaled 14.4 million, and other revenues were $4.2 million.

Gross profits totaled $39.5 million compared to 34.4 million in '03. The corresponding margin rate was 24 percent, down 0.4 percent from '03. The decrease in our gross margin is mainly attributed to the change in product mix; price reductions; high raw material costs, partially offset by a combination of higher production volumes; and the Company's continued focus on lean manufacturing utilizing Six Sigma principles. Sales from low-cost manufacturing locations accounted for approximately 37 percent of our total sales, compared to 30 percent in the prior year.

Selling, general, and administrative expenses were $28.9 million this quarter compared to 23.3 million in the third quarter of 2003. The increase in SG&A expenses primarily reflects increased investment in the Company's product development activity and increased sales and marketing efforts. Design and development programs currently underway focus on occupant safety, driveline, chassis, technograft (ph), instrument cluster products. Sarbanes-Oxley requirements as well as severance-related costs also negatively impacted SG&A this quarter.

Operating margin for the third quarter of 2004 was 6.4 percent compared to 7.9 percent for the same period last year. Interest expense for the quarter of $6 million was $800,000 below 2003 levels. The reduction in interest expense reflects our lower debt balance. Our full-year interest expense expectations remains unchanged at approximately $25 million. The Company recognized tax expense of $1 million in the third quarter, yielding an effective rate of 20 percent compared to $1.4 million or 30.8 percent in '03. The decrease in effective tax rate was primarily due to higher proportion of non-U.S. pretax income, which is taxed at a lower rate than the U.S. pretax income, and also to ongoing tax initiatives, partially offset by the expiration of certain U.S. tax credits, which are expected to be reinstated during the fourth quarter of 2004.

Net income in the third quarter was $3.9 million, or 17 cents per diluted share compared to net income of 3.1 million or 14 cents per diluted share in 2003. Depreciation expense for the quarter was $6.2 million, up from 5.6 million in the prior year. The increase in depreciation expense is attributed to the Company's increased capital investment. Income before interest, other income, taxes, depreciation, and amortization, was $17.1 million for the third quarter of 2004 compared with $17.4 million for the comparable period in 2003.

Working capital, excluding cash and the current portion of long-term debt, was $71.1 million on September 30th. Working capital was $16.6 million above the third quarter 2003 balance of $54.5 million. The higher level of working capital are predominately attributed to higher sales levels, resulted in increased accounts receivables and a planned increase in inventories to cover customer requirements as the Company combined three plants in the United Kingdom and started up an operation in Mexico. The increase in inventory was also attributed to delays in certain product launches.

Operating cash flow, net of fixed asset additions, was a source of cash of $1.5 million for the third quarter of 2004 compared to $16.4 million for the third quarter of 2003. The decrease in our operating cash flow this quarter was primarily due to the increase in accounts receivables, planned increase in inventory, as mentioned earlier, and an increase in capital investment.

Capital investment totaled $6.7 million in the third quarter, reflecting investments for new programs in areas of information displays, technograft, occupant safety, driveline, and chassis.

Total debt as of September 30th, 2004 was $200.2 million. Total debt less cash declined by 0.5 percent in the quarter and by 8.6 since September 30th, 2003. The revolver of $100 million remains undrawn at this time, and our cash balance as of September 30th increased to $32.1 million from $31.3 million last quarter.

The three quarters of 2004 have been strong for Stoneridge. Our fourth-quarter outlook remains somewhat more tempered, as we anticipate a more challenging light vehicle product environment in the fourth quarter. While we do not anticipate a substantial change from our current outlook, the light vehicle market bears the most risk to our fourth-quarter outlook. As such, our full-year guidance is unchanged at $1.10 to $1.20 per diluted share. However, within this guidance, we are incurring fourth-quarter costs of approximately 3 cents per share relating to the combination of the three facilities in the UK. We expect the process to be completed within the next nine months, and we expect to begin realizing cost savings in the second half of 2005. The majority of these costs will be incurred in the fourth quarter of this year. With that, I would like to open up the call for questions. Operator?

(Operator Instructions). From Morgan Stanley, our first question comes from Monica Keany.

Good morning. I was wondering if you could just delineate for us just the basics on sort of your raw material buys -- like what types of raw materials are you buying? And what was the overall impact in the quarter?

The major commodity buy is molded plastics and plastic resins. And following that category would be electronic components. We do -- we are starting to see the inflation in the petroleum-based products in the resins we buy and in the molded plastics. But interestingly enough, in the electronic component area, we still see a deflationary trend, at least for the time being.

So, in terms of your raw material purchases annually, what is that dollar amount?

Total raw material purchases?

Yes.

Total material would be about $260 million. And that's -- those are round numbers. I don't have any detailed sheets in front of me. I should mention another category. Of course, copper, because of our wire harness business, copper would be a commodity that we'd be buying quite a bit of.

Okay. And what kind of increases -- well I guess backing up, how do you purchase resin? Do you have contracts? Do you buy spot? How are you --?

Usually, we enter into annual buys, and, therefore, we can contain our material costs over a period of a calendar year.

Okay. And do you have a dollar amount that you were hit by in the quarter? On a gross basis?

It was roughly about $300,000.

Okay. And in terms of -- we were trying to think about trends going forward --

Joe is giving you a net number. That would be net for, you know, favorable variances, material purchases, as well as increases. As I say, some of the elements -- some of the components -- like electronics, is still seeing some deflationary effects, and maybe some better buying practices on our part. We've, in the last year, gone to a commodity-based management system with our decentralized companies, that allow us to leverage the buy across Stoneridge. So we are buying more intelligently today; it's having a favorable effect on some of these components.

Okay. And can you talk a little bit -- you talked about the organic growth strategy for the next couple of years. And you also talked about increasing your geographic presence. Can you talk about -- update us again on the acquisition strategy?

As we discussed last time, the purpose here is, of course, to diversify the customer base. And if we can do that and introduce new technologies into our portfolio, that would be a two for. So primarily, diversify the customer base. And we see that the logical market to do that in would be Europe. So our emphasis right now is looking at Europe for synergistic acquisitions. We're not opposed to entering the Asian market on a more aggressive basis. But we think that from our business development office in China, we'll get a better perspective on how we should do that -- whether it should be through wholly-owned acquisitions or joint ventures, and that will be a little behind the European strategy in developing.

So in terms of how we should think about acquisition strategy, versus debt pay down, how should be think about that?

Well currently, you know, the debt pay down, we have the $200 million of high yield sitting out there that we cannot call until May of 2007 at 5.75 percent. And so right now, we don't see it as an appropriate thing for us to be going out and using our cash for that. So I think the acquisitions would be on top of our list before we go out and spend the incremental money to buy back that debt at the level it's trading at.

Okay. Great. Thank you.

And the next question will come from David Bitterman from Deutsche Bank.

Two questions. One is on the acquisition strategy, can you give us a sense as to -- sort of what your hot buttons might be in terms of leverage multiples or appropriate multiples? Obviously, I think the market would like to -- I think the market would recognize acquisitions here to be a good thing. But can you give us a sense as to your feelings on appropriateness of acquisitions in terms of leveraging effects and things like that?

Well, I think as far as -- we've discussed this before -- as far as leverage on the Company, we don't want to return to where we were in '99 in 2000 with the extremely high leverage we experienced, because it did hurt our internal organic growth -- our ability to fund our product development initiative. I think we have a long way to go before we get to that level of leverage.

And as far as the multiple we would be willing to pay, it certainly depends on the due diligence and the prospects for growth in any acquisition target. We do a very thorough job of analyzing cash flows and the basis under which any acquisition could be grown. So the multiple is directly in relation to the growth rate of the Company we're looking at. And possibly Joe could add some other aspects to that.

Gerry had it right on the money. We just don't want to position the Company where we can't invest internally (indiscernible) any organic growth. And that's too important to us at this time.

Sure. And Joe, would you consider using your equity as a currency if you identified something that was perhaps larger? Or you're really looking more at tucked-in type things?

I think that all financing vehicles would be evaluated and the Board has made it real clear that we're going to do the best thing for the shareholders in the long run.

And going back on the internal focus and the higher R&D and marketing in the quarter, is there sort of a threshold for you guys? Obviously the SG&A was up quite a bit year-on-year. It looks like it's obviously driving, for you guys, a pretty good top line. But is there a point where we start to see that SG&A ease, or what's the right sort of run rate for SG&A as a percentage of sales for you guys?

Well, as you look at our peer group -- and when I say peer group, I mean those people who are into engineered products -- the range of D&D is typically in the range of 5 to 7 percent of sales. The electronics companies, because of the shorter product lifecycles, tend to be at the higher end of the range. Those that are into sensors and the products with longer lifecycles tend to be at the lower end of the range. Right now, because of our top line growth, I think we're still below 5 percent. So I don't think we're at the high end of the scale of the peer group. I think that, however, I'm comfortable with the range of let's say 4.5 to 6.

But we analyze these major development programs on a periodic basis. And our constantly looking at the probability of success, the acceptance of the market, do we have a sponsoring customer, who is willing to validate the technology. And again, looking at all the front-end investment, we do a time-based cash flow -- discounted cash flow analysis. So we have a filter on our technology pipeline. And there's a lot of hurdles and gates you have to go through to continue funding the program. And we're not opposed to bookshelfing some of this technology if we don't think it's going to go to market in the next year.

So we have a rigorous process. If you want a broad range, I'd say 5 to 6 percent would be a range that we could live with. But it's all based on the expected results.

Great. I appreciate the thoughts. Thank you.

And our next question will come from Kaminian Assomini (ph) from JPNC (ph).

Hello, it's Kurt Ludtke from J.P. Morgan. Hello, guys? Can you hear me? I wanted to make sure I understood this $260 million number that Joe mentioned earlier. That probably is both raw material and purchased components? I'm guessing? Is that right?

Actually, the number was 240.

240? Okay.

240.

And is that both raw material and purchased components?

Yes, it is.

How much is --?

That is year-to-date.

Oh, okay. So on an annual basis, we need to --

You need to annualize it, correct.

Annualize it? Okay. So what percentage of that is resin?

You know, I don't have that right now. We'll try to get back to you.

I can give you a rule of thumb, but it's not accurate. So I'd rather have Joe get back to you.

Okay. And I suspect that resin is -- you buy that on -- you said annual contracts, and -- but you don't have a pass-through on resin, I guess. That's my guess.

In the industry today, there are very few pass-throughs. This is a concept we're discussing with our customers. Of course, there's a lot more focus on that. But I'd say you find that fewer than 10 percent of the contracts have any pass-through provision on them.

Do you have pass-throughs on copper?

With some of our customers, not all.

Okay.

Because that has been historically a volatile commodity.

Yes.

Whereas steel hasn't been. And resin hasn't been.

Okay. What, with respect to resin, do all the contracts -- are they calendar? Are they basically resetting at year-round?

Well, we only mold half of the engineered plastic components that we utilize. We outsource quite a bit of the molding. So on outsourcing, those contracts would run probably multiple years, and they wouldn't all come due at the same time. And it's with the base resins where we mold internally that we generally run on a fiscal year as far as locking in the price of the resin.

Okay. How much of the -- how much do you think your resin buy is going to roll over at year-end?

Well, probably 50 percent of it.

But we're going to talk about a number later, I guess? What kind of year-over-year increase do you think there will be? Is there a range that you can give us on --?

On resin?

Yes.

Well, the published numbers we're seeing in the trade journals is that resin prices would be up as much as 20 percent.

Okay. Okay.

That doesn't mean we're going to accept that first 20 percent proposal though.

Right, right. And then you've always got the option going back to your customers and asking for a release, right?

Those were the alternatives. Other alternatives that are being discussed are buying with our customers in a combined buy, using their purchasing power and their discounts. There's a number of initiatives we have on the table.

Okay. Are there any other -- other than copper and resin -- are there any other raw materials that we need to be focused on?

Well, I think -- yes, those are the two that we're focused on, and the most important for Stoneridge. But of course, the higher cost of energy base because of the oil inflation, is going to roll through a lot of other commodities. So I don't think we're seeing the end of this. And I think that every industry is going to be faced with this dilemma, and I think ultimately, it will be passed through. It's a question of how soon.

I mean we're not talking about a North American issue here. We're talking about a global issue, because of the higher consumption rates in Asia, and particularly in China. So it's a matter of reaching a win-win solution with our customers and our suppliers. But no supply base can absorb these types of inflationary factors for any lengths of time and continue to be responsive to the needs of our customers to replenish our assets and continue our product development efforts. And our customers realize that.

Yes. With respect to the 300,000 net impact, what was the gross impact in the quarter?

You know, I don't have that number offhand. Just a second. I'll try to. No, we'll have to get back to you on that.

Okay. And then on the RC, I heard you say it was undrawn. But what is the availability to you?

$100 million.

All 100 is available? And I'm sorry, but I can't remember. Do you accelerate receivables?

No, we do not.

You don't do that? Okay. I appreciate it. Thanks a lot, guys.

And our next question will come from Michael Kender from Citigroup.

Yes, on the consolidation program over in the UK, it said 3 cents a share impact in fourth quarter. Was there any meaningful impact in third quarter from that?

There was 1 cent impact in the third quarter.

Okay. And what about the next year, how much --?

It will be minimum. Majority of it's being hit in this quarter.

Okay. And also, you'd mentioned inventories were up temporarily. How much -- what was the order of magnitude there? I mean was it meaningful or --?

Let us get back to you on that one.

Okay. Thank you.

(Operator Instructions). The next question comes from Brett Hoselton from KeyBanc Capital Markets.

Joe, with regard to the tax rate, in the beginning of the year, you're running in that low-30s range. This quarter, you dropped down in the mid-20 percent range. Going forward, what do you expect there? What do you think is a reasonable rate to use?

You know, it's a difficult thing to see. And we know that we've got -- that Congress just approved another tax credit that's coming back that's going to retro-adjust in third and fourth quarter. And until we evaluate how that's going to flow through our operation and everything, it will definitely be off the 30. But at this point, the full year, we'll probably end up in the high-20 level.

Okay. And then, Gerry, you talked quite a bit about organic growth and so forth. I'm wondering if you are prepared at this point in time to maybe quantify some of that growth? Do have any idea what kind of a sales backlog you might have, incremental sales in '05 or some of the out-years or maybe in organic growth rate that's a reasonable expectation of some kind?

Well, the expectation I've put out there is that we see this being about 4 percent year-over-year. But we have to fill that pipeline. And we generally see 24 to 30 months from when we succeed in demonstrating engineering capability to when that product goes to market. So that's why I'm saying the full impact won't be seen until 2007. But we'll start to see some impact in 2006.

And as far as giving you, right now, a finite dollar amount for those years, that's difficult to do, because we're still booking business in those time periods. Some of our products have shorter development times than others.

Fair enough. The 4 percent number that you threw out, what was that again? What would that be representative of?

I think that could represent a sustainable year-over-year compounded annual growth rate coming strictly from organic growth as opposed to acquisitive growth.

And so would that be something that you'd build up as you -- I mean would we -- as you look out in '06 and '07, you would hope to achieve a 4 percent growth rate? Or would you say that you're currently achieving a 4 percent growth rate and then it would accelerate from there?

No, I think that's what we hope to achieve. As I mentioned in our recent history, we've had periods of high leverage, where we went through austerity. We did the job we had to do to reduce the leverage on the balance sheet.

Okay. Excellent. Thank you very much, gentlemen.

And that was our last question and concludes our Q&A period. I would like to hand the call back over to management to close the call.

Alright. To sum up, I'd like to state that we are very pleased with this performance. Like everyone in our industry, we've been operating in a difficult environment with commodity costs rising, customer pricing pressures, and increased costs relating to Sarbanes-Oxley requirements. Our management's continued focus on best practices, including lean manufacturing, Six Sigma-driven process improvements, and supply chain integration, is gaining traction, and has enabled us to reach our third-quarter earnings estimate and hold our guidance for the full-year. We thank you for participating this morning, and we anticipate our next conference call will be at the end of January. Thank you.