Stoneridge Inc (SRI) 2005 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Third Quarter 2005 Stoneridge Earnings Conference Call. My name is Kellora (ph) and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Greg Fritz, Director of Corporate Finance and Investor Relations. Please proceed sir.

Thank you Kellora. Good morning everyone. By now you should have received our third quarter earnings release. The release has been filed with the SEC and has been posted on our website at www.stoneridge.com. Joining me on today's call are Gerry Pisaani, our President and Chief Executive Officer and Ed Mosel, our Chief Operating Officer.

Before we begin, I need to inform you that certain statements today may be forward-looking statements. Forward-looking statements include statements that are not historical in nature and include information concerning our future results or plans. Although we believe that such statements are based upon reasonable assumptions, you should understand that these statements are subject to risks and uncertainties and that actual results may differ materially. Additional information about such factors and uncertainties that could cause actual results to differ may be found in our 10-K filed with the SEC under the heading Forward-looking Statements. During today's call, we will also be referring to certain non-GAAP financial measures. Please see the Investor Relations section of our website for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures. Now, for the rest of the call, Gerry will provide an overview of the quarter and I will discuss the financial details of the quarter along with our guidance for the rest of the year. And with that, I'd like to turn the call over to Gerry.

Thank you Greg and thank you for joining us this morning. It is certainly an understatement to say that these are unprecedented times for the automotive industry when, in fact, we are in the final stages of consolidations and restructuring of a mature industry. Change represents risks, but it also offers opportunities to those who choose the right business model and focus on execution. We believe in our plan and we're focused. This year, the economics are daunting. Pricing deflation, material inflation, market share loss by our major automotive customers, and now medium duty truck production has slowed at our largest customer. A new risk is the financial instability of our Tier 1 customers amplified by the recent bankruptcy of Delphi. These factors contributed to our third quarter guidance shortfall and resulted in our revised full-year outlook.

So, what's keeping us up at night? Global pricing of mature products is forcing us to accelerate the transition of production to low-cost regions; Mexico, India, and China. This caused short-term operating inefficiencies as we phase down production and downsize the workforce, and hire and train new employees in our offshore facilities. Even after consolidating from three facilities to one with a 60 % reduction in court fees, our United Kingdom switch operation continue to operate below breakeven. This is caused by a combination of low volume, new product launch expense and training inefficiencies. In North America, the transition of harness production to Mexico is moving too slowly due to work force turnover in Mexico and the training required for new IT system for these facilities. These activities have added responsibilities to our associates and prevented them from pursuing process and products cost reductions as aggressively as they have in prior years. The combination of transitional inefficiencies, less cost reduction, and material inflation compounded by price concessions, have had a negative effect on our growth margins. While this situation is painful, our problems are short-term and we know how to solve them. What are we doing about it? We know how to manage in lean times. We are examining all discretionary expenses and making reductions. It is a healthy reading out of programs, products, and strategies that are not contributing to our long-term success or the bottom line. We will confer cash to self-fund our organic growth, which will require increased capital investment in the next few years. We have supported the higher SG&A expenses to accelerate our organic growth. Where these effects have been successful, we will continue to spend. But, in application areas where we have not been successful, we will bookshelf our technology and thrift our spending. In these times, we have to be more focused and disciplined. We will examine all business opportunities and the expectation of achieving our historic rate of return on invested capital, but while new products will improve our operating leverage, this will not help until the last quarter of 2006.

We will continue to utilize low-cost regions to harvest mature products and in the cases of India and China to participate in the growth of their markets. Stonebridge recently received approval to form a wholly owned business enterprise located in Suzhou, China, and we plan to launch manufacturing operations there before the third quarter of 2006. We see greater potential with our customers in China, Korea, Japan, and Australia, if we are strategically positioned in this region. Therefore, we have secured a production facility in Suzhou, about 50 miles northwest of Shanghai and we have assigned a management team under the direction of Mark Oaks (ph), Group Vice President, Sensor Products to lead this initiative. This is a logical progression from the establishment of our business development and purchasing office in Shanghai in 2004. We are pleased with the suppliers we have established in China and the encouragement we have been given by our customers to initiate sensor production locally.

Finally, because our organic growth efforts have exceeded expectations and we do not want to take on additional debt during turbulent times, we will delay any acquisition activity for at least six to nine months. What gives us confidence that our business plan is working? Most of our restructuring is progress to plan and will start to generate savings in 2006. The shutdown of one of our Boston, Massachusetts facilities and the resulting shift of more than $40 million in sales to Mexico is nearly completed without cost overruns or customer issues. The alignment of our electronic businesses continue to prove a competitive advantage. Our commercial vehicle OEM customers now see us as more capable of supporting their global platforms. Best practices, where the products are process-based are being shared across all business regions and business segments, including aftermarket sales and services tachographs.

Stonebridge continues to gain in market share with the next-generation tachograph scheduled to launch in 2006. We are also competing more effectively for the next generation vehicle electronics at major truck OEMs. Just last week, Stoneridge received an award worth $20 million annually from a major European commercial vehicle OEM. Some of this content will launch in 2006 and the majority will launch later in the decade. There was also a potential to leverage this award globally through derivative products. Our emphasis on safety, environmental, and write control applications, as well as commercial vehicle driver information systems have accelerated our gross annualized bookings to 137 million year-to-date with 50 million (ph) representing new business, that is new applications or new customers. This does not include the award mentioned earlier, which is a fourth quarter event. In the past three years, we had only averaged 115 million in gross bookings. Through the third quarter, we are 63 million ahead of last year's bookings. Our new business awards have been balanced across automotive and commercial vehicles and include 38 million with new customers. We extended our comprehensive supply agreement with international trucks through 2010 and have become the exclusive supplier of electronic instrumentation for Scania trucks and buses. I want to emphasize that these are annualized gross bookings and future year sales will be netted for product obsolescence, decontenting and market demand fluctuation.

In addition, both of our joint ventures continue to outperform our expectations. Minda Stoneridge, New Delhi, India has the potential to reach 6 million in sales and will be profitable to 2005, our first year of operation. We are burgeoning a 50 % growth rate in our second year. Minda has also become a low-cost supplier of component and mature electromechanical products to the Stoneridge Corporation.

PST Brazil continues to dominate the Brazilian and Argentine markets for motorcycle and four wheel vehicle alarms and immobilizers. It has expanded into OEM branded alarms, as well as aftermarket door latch and window actuators. It also supports our global commercial vehicle electronics programs in Brazil. PST has no short-term debt for the first time since we formed the joint venture and is in a position to begin paying dividends.

In summary, we feel the factors that are depressing our earnings are transitory. And that our management team is focused on resolving these short-term issues. We see 2006 as a year when we will begin to benefit from restructuring and in the last quarter from the launch of the new business that we are booking. Thank you.

Thank you Gerry. Before we go through the third quarter results in more detail, I would like to make a few broad comments. As our reported results indicate our earnings fell short of our previously issued guidance. The main variance from our guidance resulted from the Delphi bankruptcy filing, which cost us approximately $0.07 per share in the quarter. Compounding this impact was a reduction in our effective tax rate from our prior expectation due to a greater-than-expected loss in the quarter. This resulted in an unfavorable impact of 0.02 to $0.03 per share. When you review our performance relative to our previously issued guidance, it may be helpful to keep these factors in mind.

Now, I will review our results by line items, beginning with the income statement. Revenue for the third quarter of 2005 totaled 158.7 million compared to revenue of 164.3 million for the corresponding period in 2004 in the light vehicle market, revenue of 69.5 million compared with 71.6 million in the prior year. The decline was attributable to 1% decrease in North American traditional domestic production, as well as price reductions. Medium and heavy-duty truck sales totaled 71.8 million in the quarter and they were 2.4 million below the prior year total of 74.1 million. The decline was predominantly attributable to a 10% decline in production at our largest customer during the quarter and lower revenue for product phase-out in Europe. These events were offset by new business and increased volume with other customers. Sales to the agricultural and other markets totaled 17.4 million compared to 18.6 million in the prior year. The decline was due to lower demand in the agricultural market. By region, North American revenue accounted 79.3% of the third quarter revenue compared with 82.6% in the same period in 2004.

Turning to our segments, power distribution revenues decreased 7% to 82.5 million. Decreased commercial vehicle production and price reductions were the primary factors behind the decline. Revenues for the control devices segment rose $500,000 to 76.3 million, primarily due to more stable production rates in the North American light vehicle market.

Moving along to gross margin, gross profit totaled 31.6 million for the third quarter compared to 39.7 million in 2004. The corresponding margin rate was 20%, down 4 percentage points from the prior year. The decrease in our gross margin is mainly due to price reductions, operating inefficiencies related to our restructuring efforts and reduced commercial vehicle volumes. These are partially offset by ongoing cost reduction initiatives. Sales from low-cost manufacturing locations accounted for approximately 37% of total sales in the third quarter. Selling, general, and administrative expenses were 30 million (ph) for the third quarter compared to 28.8 million in 2004. The increase in SG&A expenses primarily reflects the $2.4 million expense related to the Delphi Corporation bankruptcy filing and increased investment in product development activities, reduced spending on Sarbanes-Oxley compliance costs partially offset these increases. In connection with our previously announced restructuring plan, the company recorded charges of $823,000 for the third quarter of 2005. Our expectation for the total cost of the restructuring in 2005 remains unchanged at $5 million to $6 million. The company has recorded $4.6 million in restructuring charges through the first nine months of 2005. We expect to begin to see the benefits of these actions in 2006 with an estimated annual savings of approximately $5 million. Additionally, we will recognize a year-over-year benefit in 2006 from the correction of inefficiencies that were the result of the consolidation in the United Kingdom.

The company recognized a tax benefit of $1.4 million in the quarter or 30% of pretax income compared to an expensive $1 million or 20% of pre-tax income for the third quarter of 2004. For the full year, we expect our effective tax rate to approximate 50%, compared to our previous expectation of 43%. This change is primarily due to lower overall pre-tax earnings combined with greater than expected losses in the UK operation. Net income, the company recognized a third-quarter net loss of $3.3 million or $0.14 per diluted share compared with net income of 3.9 million or $0.17 per diluted share for the same period in 2004. Turning to cash flow for a moment, depreciation expense for the third quarter of 2005 was $6.2 million. Earnings before interest, other income, taxes, depreciation, and amortization was $6 million for the third quarter of 2005 compared with 17 million in 2004. Working capital excluding cash in the current portion of long-term debt was approximately 73.1 million at the end of the quarter, which was $2.1 million above the third quarter 2004 balance of 71 million. The higher levels of working capital are predominantly due to reduced accounts table and accrued expense balances. We did make progress on reducing our inventory levels during the quarter as inventory declined $4.3 million sequentially. Operating cash flow net of fixed asset additions was a source of cash of $2 million for the third quarter of 2005 compared to 1.8 million for the corresponding period in 2004. The improvement in our working capital, particularly accounts payable and inventory more than offset the increase in capital spending and lower net income in the quarter. Capital investments totaled $8.6 million in the third quarter of 2005 reflecting investments for new programs in the areas of switch and sensor products.

Applications in the area of safety, high temperature sensors, and speed sensors represented significant components of our capital investment during the quarter. From a debt and liquidity standpoint, Stoneridge continues to maintain a Conservative capital structure. Total debt as of the end of the third quarter of 2005 was $200.1 million. Total debt, less cash as of October 1st, was 154.1 million, down 8% from the prior year's level. Our revolving credit facility of $100 million remains undrawn at this time, and our cash balance as of October 1st increased to 45.9 million from 44.6 million at the end of the second quarter. We are revising a full-year forecast of $0.10 to $0.20 per diluted share. This compares to our previous guidance of $0.40 to $0.50 per share. Lower-than-expected third quarter results account for approximately half of this decline. The remaining reduction in our full-year outlook reflects lower expected volumes in the North American light and commercial vehicle market as well as a delay in expected restructuring benefits. As Jerry mentioned earlier, the operations remain focused on executing our restructuring plans and are examining all discretionary expenses, and reducing our cost base accordingly. With that, I would like to open up the call for questions. Operator?

[OPERATOR INSTRUCTIONS]. Blaine Marder, Loeb Partners Corp.

Can you flush out a little bit on the gross margins? Year-over-year, in the quarter, you were down about $8 million and for year-to-date, down about 14 million? Can you tell us, raw materials, you said in the last call was about $4 million, do you still expect material inflation of 4 million or is it worse? And then can you talk about plant efficiencies, year-to-date in terms of that $14 million number, and perhaps pricing or any other color you could give us on that number will be great.

I'll respond on the raw material side. Yes, we are still forecasting material price increases in aggregate about $4 million and we have some initiatives at play in China to bring that down with the sourcing of printed circuit boards and we also have some efficiencies in the consolidation of our electronic component purchases, but I think the effect this year could be about $4 million. The other portion of that?

Blaine, I think you referred to the operational inefficiencies, some of the issues there. If I could take a moment or two and step back, I'd like to maybe provide a little more color on the term consolidation, if you will and what that's creating in terms of opportunities and issues for us. At the outset of 2005, we began a major corporate initiative to strengthen our operations through consolidation and the transfer of manufacturing to low-wage regions. In addition, we continued deploying our lean manufacturing across the enterprise and launched several new ERP systems, such that all of our operations are managing their businesses within a price-wise system. So, a major, major initiative. And in the 18 months period from January 2005 to June 2006, we will have accomplished the following. We will have approximately 30 % reduction in manufacturing floor space in the US. Approximately 50 % of our North American production will be from our Mexican facility and to our lean initiatives, we have not had to add any additional floor space in Mexico. And as Gerry mentioned earlier, we achieved nearly a 60 % reduction in floor space in England. And as Gerry also mentioned, at the end of the third quarter 2006, we will have our first manufacturing site operational in China. Globally, our consolidation activities have impacted 12 different operations, many in significant ways. But, because of the commitment and hard work of many of our employees, a significant percentage of this effort is going well and will begin to generate savings in the fourth quarter. As Gerry alluded to, we continue, however, to struggle with the English consolidation. We completed all of our line transfers and people moved in August, with the anticipated benefit that should have begun in the fourth quarter have been more than offset by start appearances. Basically, misjudgments on both the number of employees who would relocate 16 miles and the workforce demographics of the new locations have led to turnover and efficiency, excessive overtime, scrap, additional training and redundant labor. In addition, significant reductions in forecasted volume has forced us to operate at far less than our full capacity. And finally, we are struggling with the startup of a major new product launch. It's a bit like the perfect storm in England. But, we are adjusting each of these issues. The workforce is stabilizing. Launch improvements are being made across divisional teams to significantly improving the operational results. However, this will take several more months with improvements continuing to escalate. In a final comment, I would make to reiterate something, Gerry said earlier, is that while our global procurement initiative is generally offsetting our commodity inflation to the tune of around 4 million, our historical cost reduction programs have been compromised with so much of our focus on consolidation. This means that we have not kept pace with the customers' price sense. In 2006, however, we will be able to refocus on that vital (ph) activity. So, I hope that gives you some kind of a broad background in terms of the overall and what we're trying to accomplish.

It does, but you really need to put some numbers around it because I think what everyone on this call is trying to understand is what is the real earnings power here. I mean, if you really -- you just cut your guidance by 50 % and obviously, your stock is now down 50%. So, people are trying to figure out what is the real earnings power here? What I'm asking you is what is the dollar amount of inefficiencies because what we're going to do is, we're going to go forward and we're going to make some assumptions about the topline and then where are those inefficiencies, how much of that you get back, and you need to give us some sense of the dollar amount of the magnitude of what we're talking about here.

A couple of things that may help you, Blaine, is that our one-time spending as we indicated earlier in the call is going to be 5 to $6 million on restructuring this year. We don't expect a substantial amount next year. In fact, most of it is going to be relatively closer to zero. So, that would be one number to keep in mind. We have also indicated earlier in the call that we expect to achieve $5 million in ongoing cost savings from these efforts. So, those should be two numbers that help you put a little color to that.

You're not answering my question. The 5 to 6 million is not a gross margin item. You break that out separately. And the cost savings we already knew about. I mean, we need to understand what the operation -- what you're spending there, and perhaps maybe talk about pricing then year-over-year and then that will help me back into the number.

We have not historically provided specific pricing guidance, Blaine, and we haven't broken out specifics on plants and the pay is passed either from a cost standpoint other than to say those are the two substantial impacts on the figures year-to-date.

And finally, my last question. You took the reserve for Delphi in the quarter, but prior quarter, you took a reserve and you mentioned a short list, how is that -- the short list is kind of shaping up, if you will, I mean would you expect more reserve charges next quarter?

That's a difficult question to answer. I mean, we certainly monitor everything, Blaine. Obviously, it's more dependent on when people file from an accounting standpoint. I still think there are issues in the industry, but from our standpoint, Delphi was probably the most significant company we were monitoring so far this year, given their announcement in July.

I guess, these are difficult things to predict and actually I think that there was a strong contingent itself that Delphi would not go bankrupt. We don't see anyone right now who is in that same situation and of course, you know, I think October 17th was a triggering event. So, we continue to monitor as you say and are very hard things to predict. Regarding your question on the inefficiencies, I understand where you're coming from and we will see a gradual reduction of those inefficiencies as we go through the rest of this year and into the first part of next year. So, we do expect substantial improvement. What's difficult to put a precise number on is, will we see some moderation in pricing because of the weakness in the supply base, we hope so. We see some conciliatory comments coming out of Ford and Chrysler, and in addition, will we be able to get back on track with our cost reductions, we haven't added people to handle these transitions. And so, it's impacting the work force and then we really are appreciative of the hard work our associates have been doing. We want to get them back now in process and product cost reduction. So, I think we will see a significant reduction in those inefficiencies.

Laura Thurow, Robert W. Baird.

I just wanted to follow-up on the guidance and the change there. I know that you spent half of that with the Q3 shortfall and the balance was from (indiscernible), commercial build, and restructuring. Can you give us a sense of how much each of those contributed to the balance of the guidance change? Were they all kind of similar in magnitude with one worse than the other?

I would say, Laura, that between the two, you are looking at roughly -- to give rough magnitude, probably 50-50 between those two items. I mean that's always a difficult thing to frame. There's a lot of things moving around, but if you look at the change in the fourth quarter from our perspective, those are two major items, as well as our new tax rate guidance has gone up as well. As you run your model I'm sure, you'll notice that also versus 43% would imply a relatively high tax rate in the fourth quarter as well.

The combination of pricing and of inefficiencies and of course we're addressing both those issues with the transition of product into Mexico because we reduced prices of reduction effect and once we gain the efficiency back in our Mexican facilities, the variance disappears. The reason why we are hesitant to put specific numbers on it is that we are in the process right now of budget finalization and a rigorous examination of all the cost factors; discretionary costs, estimations of how fast we get these inefficiencies under control. And I think it's pretty immature for us to give you that number. We're going to be in a better position in the next conference call to give you some guidance in that area.

Lastly, just to follow-up on your medium-duty commercial vehicle customer, they talked about taking some capacity out of their Springfield facility, could you give us a little color on what that means for you, near-term, longer-term?

Of course, we can only give you an answer based on what we have been able to learn. We are tied to the production rates and they don't know what's called as the sales rate. We started the year probably at about these volume levels and then as the year went on, the production peaked. And now, it would be the end of the fiscal year, at International, which is our major medium-duty customer, they brought the production rates down to where they were in the beginning of the year. However, they recently have said they expect next year's sales to be strong. So, it could be an inventory correction although there has been some reference to slower sales rates. But, right now (indiscernible) next year, they expect the sales rate to pick up again. But, we are really not any more knowledgeable than what I've been able to say.

And Laura just to add, I think as Greg mentioned, lower volume in the fourth quarter certainly, international, has a significant impact on that.

Okay, thanks. That's all I have.

Are there any more questions?

Blaine Marder, Loeb Partners Corp.

What did you say the product development expenses were in the quarter?

Let me just check that Blaine.

And then next year, would you expect product development to continue to go up, be flat or go down, or are you still in the budgeting process?

We are still working through the budgeting process, but it's not going to go up. I would say flat or slightly lower, if we feel that somebody's programs aren't gaining traction. But, we are still in that evaluation process.

And to answer your original question, Blaine, approximately $9.5 million in the third quarter.

And then the capital expenditures, where would you see those and the depreciation coming in for the year?

About 26 million for both is what we are looking at right now.

And you are scrutinizing capital expenditures as well?

Where we have discretion on capital, we are certainly scrutinizing it, but the majority of our capital investment is tied to new product development and launch. And that's why I made reference to the fact that we are being very frugal with our cash because as our bookings have grown and we are very encouraged by that trend, it will of course require more capital investments in manufacturing equipment utility.

And then on the last call, you mentioned that the working capital levels, inventory you said it would come down for the rest of the year, is that still the case?

Yes it is. We continue to track down as we consolidate and work through our built-up inventories.

We had about $4.3 million sequential decline in the second quarter to the third quarter, Blaine.

And there is still more inventory to come out because of the fact that we had to build inventory to protect our customers during the transition.

And Gerry it sounds like from your comments, what you're saying is, we want to self fund our operations, and so you're kind of going to judge the top line and make some forecast and then pick out expenses accordingly to allow you to self fund the operations without borrowing incrementally, is that fair?

That's right. We are trying to fund our organic growth. I mean the borrowing capability is there, when we are ready to go back out look at acquisitions, but we definitely want to not only fund our organic growth but also get back into a positive cash flow so we can continue to accumulate cash.

Very good. Thank you gentlemen.

Brook (ph), Friedman, Billings, Ramsey Group Inc.

What was your depreciation and amortization expense for the quarter?

Depreciation was $6.2 million, amortization was about 400,000.

With Delphi, is there any way that you can talk to us about how significant a customer it is in terms of sales and receivables at risks?

Well, the receivables at risk would represent what we booked in the quarter. The estimates for that would be $2.4 million.

As far as sales at risk, we don't see that right now. Even if they move a lot of the operations offshore, we see a lot of their operations going into China, we are moving to cover that risk by establishing sensor manufacturing in China. They are one of the companies that encouraged us to do that. In fact and this is speculative on my part, there maybe an upside for us here, because they are still a self sufficient on certain sensor products, and we feel that maybe in a more realistic evaluation of their cost structure, some of that products would be outsourced.

On your gross margin, talk about some of these inefficiencies coming off in the near future? Whatever you saved or maybe not saved but, is it fair to think of the gross margin of third quarter as a low point, you would expect that to expand, fourth-quarter and then into 2006?

I think, two parts of that question, the first is seasonally and generally it's a low point for us. Production levels globally tend to bottom in the third quarter. So from the third to fourth quarter, you would generally see a pickup there. I do think perhaps, Ed or Gerry to put some color on the operational --.

I think definitely during 2006 as we have already discussed that the inefficiencies become minimized and we're definitely going to be improving our gross margins as we go through the year. The consolidations will be completed as I mentioned largely by June of 2006. And so we anticipate continuing trends in the positive directions. So I think, the second, like Greg said, we look at it as bottomed out here in 2005.

And you probably already said this I must have missed, are you going to see a reduction in inefficiencies in the fourth quarter, I think it should start right now or is it more heavily weighted to the first half of 2006?

Just before we address that, it is important versus our expectations, I mean look at our guidance for offset, part of it is that, we are not seeing the benefits we thought we were, but Ed can probably speak to you as far as from a baseline performance level.

Brooks, as I mentioned earlier, we have got 12 operations that are involved in this consolidation and the majority of them have done very well. And we're seeing some progress in the fourth quarter already. Unfortunately, it's been kind of weighted by some of the performance, a lack thereof, if you will, in England. And so it's matched the improvement that we thought we would have by the fourth quarter of 2005. That we fully expect will continue to be minimized during the early part of 2006.

Okay thank you.

[OPERATOR INSTRUCTIONS]. Gentlemen, it appears we have no further questions.

Alright, I want to thank everybody again and we look forward to speaking with you shortly after the close of the fourth quarter.

Ladies and Gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.