Stoneridge Inc (SRI) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2011 Stoneridge, Inc. earnings conference call. My name is Jeremy and I will be your operator for today. At this time, all participants are in a listen-only mode. We will later conduct a question-and-answer session. (Operator Instructions) At this time, I would now like to turn the conference over to your host for today, Mr. Kenneth Kure, Director of Finance and Corporate Treasurer. Sir, you may proceed.

Good morning, everyone, and thank you for joining us on today's call. By now, you should have received our third quarter earnings release. The release has been or will shortly be filed with the SEC and has been posted on our website at www.stoneridge.com.

Joining me on today's call are John Corey, our President and Chief Executive Officer, and George Strickler, our Chief Financial Officer.

Before we begin, I need to inform you that certain statements today may be forward-looking statements. Forward-looking statements include those statements that are not historical in nature and include information concerning our future results or plans. Although we believe such statements are based upon reasonable assumptions, you should understand that these statements are subject to risks and uncertainties, and 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 Securities and Exchange Commission under the heading Forward-Looking Statements.

During today's call, we may refer to certain non-GAAP financial measures. Please see the Investor Relations section of our website for a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.

John will begin the call with an update on the current market conditions, operating performance in the third quarter, our growth strategies, business development, and his thoughts on future initiatives. George will discuss the financial and operational details of the quarter and future outlook. After John and George have finished their formal remarks, we will then open the call up to questions.

With that, I'll turn the call over to John.

Good morning. Our revenue for the third quarter was $195.9 million, an increase of $35.4 million or 22% over the prior year's third quarter sales. These results continue the strength in revenue growth we have experienced in the first half and were primarily driven by the commercial vehicle and agricultural markets. Our third quarter sales pace should put us on track to meet the high end of our annual guidance of $750 million to $775 million, which would be higher than our record year revenue of $752 million in 2008.

We reported earnings per share of $0.18, which was $0.13 above the prior year's third quarter but short on the marginal contribution at the gross margin line compared to last year, although in line with our program to address the operational, currency and commodity issues we have reviewed in the first and second quarter calls. George will provide additional details in the financial review.

In the third quarter sales in our agricultural and equipment category increased versus the prior year by approximately 29% to $38 million. This is a continuation of the first half growth of these sales where this category increased by 51%. Sales to our commercial vehicle customers increased by 36.8% to $107.8 million as a result of the increase in medium and heavy duty truck production in North America and Europe compared to the prior year. Sales in our passenger car and light segment was $50.1 million, which was a decline of 3.7%, compared to the prior year. While North American automotive production improved versus the third quarter of last year, the market volume increase was reduced by our planned scheduled roll-offs.

As we previously discussed we are realigning our product portfolio around key product families in emissions and actuations, which have attractive market growth potential while reducing our presence in the commodity or non-competitive product line such as headlamp switches and fuel shut-off switches. While volume did not increase at the market rate our EBIT margin for control devices improved to 7.5% in the third quarter versus 7.2% in the third quarter of 2010 on a year-to-date comparison basis.

While our overall business is performing well, we are still not converting at the rate we should from the North American wiring business. As previously discussed, our plan was to improve customer service levels, reduce premium freight, improve efficiencies to lower headcount and overtime and address organizational capabilities. We had to improve service levels to reduce premium freight. Our service levels are basically caught up and we are building inventory for the ag market increases expected during the first quarter of 2012.

For the third quarter premium freight was reduced by $2.4 million compared to the first quarter and $300,000 compared to the second quarter of this year. So we've brought down premium freight to normal levels. Labor costs and inefficiencies in the third quarter were lower than the first quarter by approximately $100,000 and the second quarter by about $200,000. Our reduction of labor costs was adversely impacted by a customer delay in the start-up of our new Saltillo facility resulting in redundant headcount as shipments will start in November versus the original plan of August. This also delayed the balancing of our headcount in the US facilities, which resulted in higher costs in the third quarter but will be normalized in the fourth quarter.

In our Mexican wiring operations we continue with programs to reduce absenteeism, turnover and improve employee training, although the benefits are slower than expected. As we reduce the turnover and improve employees' training, we will continue to see efficiency gains. With the numerous launches we've had in the last year and the past growth in the wiring business, we have had industrial engineering reviewing production to improve manufacturing, which will lead to further reductions in overhead and headcount.

The operational focus of the Vice President of Operations is on the wiring business and we expect there will be continued improvement in the fourth quarter demonstrated by increased manufacturing efficiency reducing headcount and overtime. To improve the wiring management team, he has replaced the Site Manager and the Material Director at the Mexican site where we are having the most troubles with seasoned manufacturing and material executives.

Our gross margin this quarter was 19.1%, which was below our 23% to 25% target range and below the 22.8% we recorded in the third quarter of 2010. This result was driven primarily by the impacts of our (technical difficulty).

Hey, John?

Yes?

You're cutting out. You might want to start again from our gross margin.

Okay. Our gross margin this quarter was 19.1%, which was below our 23% to 25% target range and below the 22.8% we recorded in the third quarter of 2010, driven primarily by the impacts of the wiring operations, foreign exchange, cost of commodities and the start-up of a new facility in Mexico. The cost associated with the initial start up of the Saltillo facility in Q2 was approximately $600,000 and $2.3 million in the third quarter of 2011. Our current forecast projects fourth quarter negative impacts to be approximately $900,000 for this start up. For the year we expect the total cost to be $3.8 million, which is $900,000 less than what we had projected in our first quarter call.

As operational improvements take hold we expect gross margins to be about 21% in the fourth quarter and will continue to improve in 2012 as we benefit from lower commodity costs, a weaker Mexican peso and the improvement in the operations.

New business awards in the quarter were $87.9 million, which exceeded the record awards of $85.3 million, which was set during the second quarter of this year. Third quarter 2011 new business awards were $46.9 million above the prior year's third quarter excluding the Navistar contract renewal that occurred during the third quarter of 2010. The mix of awards in the third quarter was $64.2 million in replacement business and $23.7 million in new business. The most significant new business award in this quarter was a $20 million annual sales award for electronic control unit from a European construction equipment manufacturer. This award spans 10 years and the cumulative amount of the award is the largest single order ever won by the Company.

Minda Stoneridge, our JV in India, posted third quarter sales of $12.1 million, an increase of 50% versus the third quarter of last year. This sales increase was driven primarily by new business wins and to a less extent by market growth. Our share of net income was $389,000, which was $217,000 higher than last year. Our sales levels will reach nearly $50 million this year from last year's level of $33.4 million. Minda's annual sales projection should increase to $60 million to $65 million next year and exceed $75 million in the next two years. The Indian economy remains robust and demand for vehicles is increasing, which is a positive sign for the future.

PST, our Brazilian joint venture, recorded third quarter sales of BRL 107.2 million, an increase of 24.7% from BRL 86 million in the third quarter of 2010, which reflects a significant volume increase from the launch of our audio business with the mass merchandisers this year. Audio sales now represent nearly 27% of our volume in the third quarter versus approximately 7% in the third quarter last year. The audio business growth accounts for a significant increase in total PST sales, which is estimated to be 30% to 35% over last year's sales of BRL 321 million.

The audio line launch has reduced our gross margins to 42.3% in the third quarter from 50.2% in the third quarter of last year due to the mix of the business. We continue to invest in marketing promotions and SG&A expenses in the third quarter, which totaled BRL 5.3 million associated with the launch of the audio line. This lowered our operating income to 7.5% in the third quarter of this year but positions the company to sell a broad range of products with our Positron brand. We have also recently raised prices by 5% effective October 1 for nearly 70% of our product sales.

The initial launch of the audio line and associated costs are largely completed in the third quarter and we expect sales and net income for the fourth quarter of 2011 to be in the range of BRL 130 million to BRL 140 million and net income to be in the range of BRL 10 million to BRL 13 million. With this level of performance for the fourth quarter PST would return to gross margins in the 44% to 47% range and operating income in the 13% to 15% range. George will provide more details on PST in the financial section.

In summary, the operating and financial performance from our European, North American Electronics and Control Device businesses and our joint venture in India continue to do well, though our Brazilian joint venture slipped as it launched its audio line to the mass merchandiser channel in the second and third quarters. However we expect improved performance in the fourth quarter. We are making progress improving the wiring business and continue to see the improvement in the pace of change.

Our third quarter operating performance was better than our first and second quarter performance and should continue to improve as we benefit from the improvement in copper prices and the weakening of the Mexican peso. Our major served markets continue to grow. North American automotive production forecasts are projected to be between 12.8 million and 13 million units for 2011 and is forecasted to be in the range of 13.7 million units for 2012. The North American commercial vehicle market continues to improve as the age of the fleet, improving freight conditions and lower interest rates have released the pent-up demand for new commercial vehicles especially in Class A, which should continue to increase production volumes in this served market.

Current industry forecasts indicate North American commercial vehicle recovery will continue over multiple years. We expect continued growth in the construction and agricultural markets as this segment represents approximately 18% of our sales in 2010. Continuing market improvements and growth with our customers from new programs this year and next will drive top line sales. As we restore our operating performance and recover commodity costs and the currency impacts through contractual terms we will restore our financial performance into the targeted ranges.

With that, I'd like to turn the call over to George, to provide additional details on our performance and outlook.

Thank you, John. Our third quarter sales increased by $35.4 million or 22.1% over last year. Our third quarter sales were positively affected by increased volume in our medium-duty and heavy-duty and agricultural segments. Our earnings performance has improved compared to last year but we did not convert it to marginal contribution rate of $0.25 to $0.30 per dollar of sale at the gross margin levels we did last year. Our shortfall to our targeted marginal contribution was due to operating inefficiencies from excess headcount, overtime and premium freight in the wiring business, which accounted for $1.8 million.

Higher copper prices and a stronger Mexico peso for our peso-denominated labor conversion and overhead costs at our Mexican facilities accounted for $2.9 million and the cost impact of starting up the new Saltillo manufacturing facility accounted for $2.3 million. These amounts were in line with the plan laid out in our first quarter and updated during our second quarter except for the start-up of our new facility in Saltillo. Compared to our estimates updated in the second quarter labor costs were higher than what we were expecting due to a customer delay in the start-up of the new Saltillo facility, resulting in redundant headcount as shipments will start in November versus the original plan of August. The cost of furloughed employees in the third quarter for the US facility whose product will be transferred to Saltillo was $1.1 million. These costs for the furloughed workers will be eliminated in the fourth quarter and will be in line with our plan for the fourth quarter.

John already covered the progress and the plans for operations, efficiencies and pricing but one of the most significant changes to our plan is what has happened in the currency and commodity markets during the last few months. During the last three quarters the cost of copper averaged $4.46 a pound in the first quarter, $4.30 per pound in the second quarter and $4.07 in the third quarter. As copper was dropping we executed hedging contracts to protect our future buys. We hedged the fourth quarter at $4.05 per pound and 6.5 million pounds or 70% of next year's consumption at $4.00 per pound. The current spot rate for copper is $3.64 per pound so we will not benefit from the lower spot rate in the fourth quarter but we will benefit in 2012 as 60% of our projected consumption is hedged at $4.00 per pound and 30% is open for market rates.

We have experienced the same potential benefit for the Mexican peso. During this year we will spend about $72 million of peso-equivalent expenses for direct labor and local expenses. The rate we will pay for the peso this year will approximate 11.90 Mexican pesos to one US dollar. We executed hedge contracts for the fourth quarter at MXN12.06 so we will not benefit significantly as the Mexico peso spot rate is currently at MXN 13.24.

For 2012, we have hedged $40 million at a forward rate of MXN 12.74 to one US dollar or 55% of our estimated spend for next year and 45% is still open to be purchased at the current spot rates. Mexico peso is trading at MXN 13.24 today, which should benefit us if it stays at the level compared to 2011 full-year expected rate of MXN 11.91. And as John previously said PST continues to be a significant part of our earnings performance but in the third quarter equity earnings were negatively impacted due to the interest expense and currency exchange of approximately BRL 4.3 million or greater than the third quarter of last year by BRL 3.5 million.

This would represent a reduction in our share of equity earnings of nearly $1 million for the third quarter of this year compared to the third quarter of last year. This amount represents the currency exchange on US dollar liabilities as the real devalued by 10.6% against the US dollar in the third quarter compared to the second quarter of this year and the interest expense on the current debt levels in Brazil. The estimated interest and FX costs in the fourth quarter compared to last year is projected to be about BRL 1.6 million and is included in the estimated range of net income for the fourth quarter that John just highlighted.

We've also been working to extend the term of our existing ABL maturity by five years. With the uncertainty of the global financial markets we are pursuing an extension of our $100 million ABL line to secure availability under a revolving credit agreement to the year 2016.

Revenue of $195.8 million in the third quarter of 2011 represents an increase of $35.4 million or 22.1% over the third quarter of 2010. Our sales increase is the result of increasing production volumes in our served markets, new business sales programs and continued economic improvement in all segments of our markets. For the third quarter light vehicle revenue decreased from $52 million to $50.1 million, a decrease of $1.9 million or 3.7%. And as John previously said the decrease was primarily attributable to scheduled program roll-offs for speed sensors, headlamp switches and fuel shut-off switches in North America as we realign our product portfolio around our key product families in emissions and actuation.

Sales in the medium and heavy-duty truck market totaled $107.8 million in the quarter, an increase of $29 million or 37% over the prior year third quarter. The revenue increase was primarily driven by an increase of 55.9% of North America commercial market production. Our sales with our top 10 customers were up by $29.4 million or 27.4% compared to the third quarter of last year. Western Europe commercial vehicle production is showing an increase of 15.3%. Sales to ag and other markets totaled $38 million, an increase of $8.4 million or 29%. North America revenue accounted for 75% share of the third quarter revenue and 78% for the same period last year.

In the third quarter Electronics revenues were $132.8 million compared to $99.1 million from the same period last year, an increase of $33.7 million or 34%. Favorable factors affecting the third quarter performance was a 55.9% increase in North America commercial vehicle production and a 15.3% increase at Western European commercial vehicle production.

Revenues for Control Devices at $63 million increased from $60.5 million compared to the third quarter of last year, which is an increase of $2.5 million or 4.1%. The increases in production of North America commercial vehicles and increased volume in ag customers were the primary reasons for our sales increase.

Our third quarter gross margin was 19.1%, which was short of our targeted range of 23% to 25%. The controllable costs for premium freight, excessive headcount, overtime and operating inefficiencies, which totaled $1.8 million, and the start-up of the Saltillo facility, which totaled $2.3 million, represents nearly $4.1 million of costs, which reduced our gross margin by 2.1% of sales in the third quarter but is forecast to improve by $2.3 million in the fourth quarter. A commodity and peso exchange rate cost approximately $2.9 million, which also reduced our gross margin by 1.5% of sales, which we are implementing price recoveries to offset the cost increases and could benefit the improvement in commodity costs and the peso currency. The improvement from these activities could improve gross margin to 21% in the fourth quarter and continued improvement next year.

Selling, general and administrative expenses totaled $30.5 million, which is lower than the $31 million in the third quarter of last year. SG&A as a percentage of sales was 15.5%, the lowest it has been since third quarter 2006. We continue to control our SG&A expenses without adversely affecting our business development efforts.

Income tax expense for the third quarter was $1.5 million on a pre-tax income of $5.8 million. As reported for December 31 of last year, the Company is in a cumulative loss position and continues to provide evaluation allowance offsetting its federal, state and certain foreign deferred tax assets. As a result no tax expense has been provided on US income for the year. However the Company is required to provide deferred tax expense related to the earnings of our PST joint venture, which is unaffected by our valuation allowance position.

The decrease in tax expense for the three months ended September 30 compared to the same period of last year was attributable to lower earnings generated by our PST joint venture, which was partially offset by an increase in tax due to the improved financial performance of our European operations as well as an increase in Mexican tax due to increased production volumes at certain of our Mexican facilities. The quarterly effective tax rates may fluctuate significantly due to the interaction of the valuation allowance and country-specific levels of profitability as well as the deferred tax expense related to our investment in PST. We anticipate an annual effective tax rate of approximately 28% to 32% and we anticipate cash taxes to be approximately $3.4 million to $3.8 million.

As previously reported the Company has provided a full valuation allowance against its US deferred tax assets at December 31, 2008 and continues to maintain this full valuation allowance. As required the Company evaluates its valuation allowance quarterly, however, whether and when a valuation allowance may be reversed is generally determined and recorded during the fourth quarter of the fiscal year. The Company will review its valuation allowance again for the year ending December 31 of this year. The Company experienced a significant negative impact on our 2008 earnings when the valuation allowance was recorded. Therefore if a portion of the valuation allowance is reversed, it would have a favorable impact on the results for the fourth quarter and year-to-date of this year.

Stoneridge reported a second (sic) quarter net income of $4.5 million or $0.18 per share. This compared with prior year net income of $1.3 million or $0.05 per share. Depreciation expense for the third quarter was $4.8 million. Our primary working capital totaled $125 million at quarter-end, which increased by $27.9 million from the third quarter of last year with inventory accounting for $17.9 million of the increase. As a percentage of trailing 12 months of sales our primary working capital increase was 16% of sales in the prior year third quarter to 16.9% of sales in the third quarter of this year. Our primary working capital days increased by 8.7% compared to the third quarter of last year. Current working capital levels for receivables and payables are a function of increasing sales and operational activities.

Inventories are high at $72.2 million and currently exist at 41 days of inventory. Historically we have managed our inventories in the range of 35 to 38 days. Our higher than normal inventories are primarily due to continued operating difficulties in the wiring business. One of our improvement areas is working to reduce our inventories over the next two quarters by $15 million to $17 million or about eight days of inventory.

Operating cash flow was a source of cash of $5.7 million in the third quarter compared to a source of cash of $10.7 million in the third quarter of last year. Our cash flow results in the third quarter were primarily driven by the decrease in inventory and accounts payable while accounts receivable increased from the previous quarter due to higher sales. Capital investment for the quarter totaled $6.6 million mainly reflecting investment in new products in the wiring operation and Control Device segment. We are forecasting to finish the year with total capital spending in the range of $25 million to $30 million range, which includes $4 million to $5 million for the new Saltillo facility in Mexico.

As of September 30 we have $69.6 million of availability under the $100 million asset-based lending facility, a significant improvement from the $61.3 million level at December of last year. Our borrowing base has increased by $10.8 million since the first quarter of 2010 as increased accounts receivable balances are the direct result of higher sales. As part of the bond refinancing in October of last year we extended the maturity of our ABL to November 1 of 2012. We are currently working to extend our ABL by five years at attractive rates and similar terms as the current ABL market has maintained its strength.

Our third quarter ending cash balance totaled $43.2 million compared with $84.9 million at the end of the third quarter of last year. Our cash burn was mostly driven by increased accounts receivable caused by increased sales, inventory driven by increased sales, operating inefficiencies and component pre-buys in the wiring business and lower profitability in the wiring business. We will continue to manage our capital expenditures and working capital to sustain and/or improve our cash flow. And going forward we expect we will continue to fund our operational growth initiatives mostly through our free cash flow generation and available cash balances.

Our business continues to show significant growth as the market has recovered for the North America and European market and ag continues its strength. John shared with you how we are addressing customer service levels, which is significantly better than our performance in the first two quarters of this year. As a result we've been able to reduce premium freight to more normal levels. We made progress on our labor inefficiencies but we need to continue to accelerate our progress. We were short of our projections for labor costs in the third quarter by $1 million due to the delay of the start-up of the new Saltillo facility, which impacted us by the higher costs in our US facility due to higher headcount and furloughed workers. Costs of our new facility in Saltillo, which had no recovery in volume as customer shipments have been delayed from August until November.

We will benefit from improved copper costs and Mexico peso rates as I covered with you earlier though not much in the fourth quarter, as we hedged all the requirements, but should experience greater benefits in 2012. We have initiated pricing actions to offset the escalation of costs that have been impacting us in the first half of this year. With these actions we have taken we expect our gross margin to be approximately in the 21% range in the fourth quarter and return to at least the gross margin we had in 2010, which was nearly 23%.

We are working to improve our cash flow position with the improvement in our profitability and the reduction of our inventory from 41 days to 31 days by the second quarter of next year. We believe we can extend our ABL by five years, which will secure our debt and availability of our loans for the next five years for the revolving credit agreement with attractive rates and terms. We continue to work on a PST transaction for this year. We remain cautiously optimistic that a transaction can be completed in the near term. Regardless of the timing of PST, PST is positioned for a good fourth quarter and is well positioned well for 2012.

Our financial and operational performance has been improving over the first three quarters and we need to continue to accelerate the improvement in our operating shortfalls for the wiring business by ensuring that the improvements are sustainable as we continue to grow.

Operator, I would now like to open up the call for questions.

Certainly sir. (Operator Instructions) And, ladies and gentlemen, your first question will be coming from the line of Robert Kosowsky with Sidoti. You may proceed.

Good morning, guys.

So the higher labor costs that are in the quarter, those weren't related to Chihuahua. They were more related to just the delay in starting Saltillo? Is that the right way of looking at it?

The way to look at this, Rob, is essentially we had geared up the new Saltillo plant that it was going to start in August. It's been delayed until November. So we've actually had duplicate headcount in both the Saltillo facility and our US facility. So we furloughed workers in the second quarter. Then we had to bring them back on to produce inventory in the third quarter. So essentially we had all the Saltillo costs with no recovery because of shipments and then we had the Portland costs so we had to produce product in the third quarter. So that cost us roughly $1.1 million in our US facility. And as you remember our cost was estimated to be lower in Saltillo in the third quarter by about $800,000 versus what we incurred. So that additional cost was probably about $1.9 million in the third quarter versus our plan.

I would also say that we have opportunities to improve the operational efficiency of our Mexican operations, particularly in Chihuahua, and that will reduce headcount further. So, I mean, the team is working on that at the same time.

So did you end up reducing headcount in Chihuahua as well?

Yes. We had some headcount reduction in Chihuahua and in part -- and so that the absolute numbers did come down and the production increased but we continue to think that we've got some more opportunities there. One of the programs started and we launched at a different Mexican facility was because of all the volume ramps we've had the business awards we've had we believe that we've gotten some operational inefficiency that came in with those volume ramps and so now we've got the industrial engineers going back and revamping the operations or looking at the operations to streamline the processes.

Okay. And then -- all right and then also could you go back over the early -- what's your level of confidence on the facility actually opening up in November? Is it like a November 1 date --

Yes. Well we just got PPAP approval so we can -- we got conditional PPAP approval and we were ready to go before but the customer wasn't. We got conditional PPAP approval and so we'll begin shipping out of there, product, in the month of November. So we still have a few more steps to go through but I mean we can ship today. They've got the line running and producing and the customer has been down and given up conditional approval to go ahead and ship.

So the customer has okayed it. So there shouldn't be any more delays there.

Yes. It's a conditional approval. They want to see some things that are done differently so we have to go through and do those. But that's more in the normal course of business. You typically get a PPAP approval or some type of conditional approval because they want to see certain things done differently or a different way and then we go through and do those things and then they come back and give you full approval.

Okay. And then could you go back over the PST guidance that you had for the year because I kind of lost some of those numbers.

Yes. We actually indicated, Rob, that sales would be in the range of BRL 130 million to BRL 140 million in the fourth quarter and net income would be in the range of BRL 10 million to BRL 13 million.

BRL 10 million to BRL 13 million. Okay.

I did talk about the exchange but we do have some that I indicated but it's included in that forecast.

Okay. So what exchange rate is most appropriate? Just using the current rate right now?

I think the current rate right now of BRL 1.75 is pretty good. I see the real strengthened again this morning. It's down around BRL 1.73 but I think the rate we're translating at now is about BRL 1.75.

Okay. And then can you talk a little bit about the margin profile looking forward as we get into next year and also the seasonality of equity income as well?

I don't have the quarter breakdown because we're working on that right now but we clearly see -- we indicated our sales would be up 30% to 35%. We have seen a shift in our product mix with PST because the audio launch is so large as we get into mass merchandisers. The alarm system business is still solid. It's at a constant level. It hasn't really been growing but those margins are very consistent with what they've been historically. And the audio margins we talked about in the past would be somewhere in the range of about 25%. But we actually think they'll be north of that at this point, somewhere between 25% and 30%. So that's what's really driving the overall gross margin down that we indicated. We're in the 44% to 47% range for the fourth quarter.

So I think that's a pretty good profile and then we indicated in the fourth quarter that our operating margins will be in that -- right around the 13% range. And so that should be a good level for 2012.

All right. Thank you very much.

You're welcome, Rob.

(Operator Instructions) Your next question will be from the line of Matthew Mishan with KeyBanc. Go ahead.

Good morning, guys.

Morning, Matt.

I believe you had some military orders flowing through in the back half, could you give the cadence of when those are coming in?

Well we had actually in the third quarter we did ship some military orders in September. I don't think there's much of a carryover into the fourth quarter on those. And that was -- I don't know the exact, if there is an exact carryover into October. So we'll have to look at that and get back to you but we did ship product into the military.

Yes. There was more in the third quarter, Matt, and there's still -- there's a little bit remnant in the fourth quarter. I know in the marketplace there's been indication there's been more military business coming but it's within that annual range that we've always talked about that we would sell somewhere between $20 million and $25 million for the year.

Okay. So the military business would be down in 4Q versus 3Q?

I would say at this point that would be a pretty good assumption. We don't have any firm orders at this point.

What's your sense about Navistar regaining its -- and I know you guys are more on the Class 5 through 7 site, what's your sense on Navistar regaining some Class 8 market share in the fourth quarter?

Well you know from the numbers that we're looking at we believe that the strategies that Navistar has in place that they will gain the market share back. And I think clearly their engine strategy - 13 liter, 15 liter, has been successful. I think what we all recognize looking at the numbers, it's probably at a slower pace than what's in the current forecast. So we still believe that they will gain it. I think our caution would be that we look at that as probably a 2012 as they start to sort of gain their market share back. I don't think you're going to see the significant -- the whole pick up that they were forecasting for the second half and specifically the fourth quarter.

And did they give you any particular reason why they delayed their launch? I believe that they pulled this -- for you guys at least, they pulled this facility up by about a year in plans and then kind of pushed it back on you.

Yes. Well part of the issue was we have to be able to communicate electronically and there have to be certain protocols that have to be done by engineering and I just think that with workloads and other things that they got behind and we got -- sending those protocols down so we could test to make sure. Because that's the facility that will produce on the attribute base so it'll produce the instrument panel, the dash panel, based on a specific configuration. So it has to be very -- we have to make sure we've got the right electronic communication going on and that has to be done through engineering. And so I think that they had just workload for them, they got a little bit behind.

So your sense is it's an operational issue more so than a demand issue?

More so than what?

A demand issue.

Yes. No. I don't think -- no I don't think. Because the benefits to them of this move, they achieve some significant cost savings to them. So even if it was a demand issue I think that they would still look at obtaining the cost on whatever demand they have.

Can you give us an update on two things. First, the headcount in Chihuahua. I believe you had taken out about 900 folks as of the end of July. And secondly an update on commodity recovery.

Well on the headcount we have trended and we're still in that range. We believe we have more to go in the fourth quarter, Matt, both Chihuahua and Monclova and we're actively and fully working on that. And I think Saltillo will be a nice improvement along with the US facility. So that I think continues on and we will hit all the targets that we laid out in our last -- when we updated the second quarter plan with our operations and we're very much on track for that.

Where we're at in commodities and currencies, this has been a pretty fluid situation and as the market started dropping I'll talk about copper first. And I gave you the ranges, what our average copper was last year starting at about $4.46, $4.30 and about $4.07 in the three quarters. As that market started to drop we felt -- and the demand seemed to be pretty strong, we went out and hedged our fourth quarter requirements at $4.05. So we will not get a real significant benefit from copper compared to spot rates here in the fourth quarter but we should enjoy some benefits of the commodity because our average price this year has been probably in the range of $4.20 to $4.30. So that will actually give us a benefit of year-over-year. And that's fully hedged at 70% at about $4.00 a pound at this point.

And then in the peso as we laid out it's about MXN 72 million that we buy so roughly on a quarterly basis that's a little under $20 million, about $18 million a quarter. We fully hedged that fourth quarter at MXN 12.06. And as the peso was weakening we felt that was a good rate to protect our fourth quarter position. Since then as you know the peso has dropped significantly more. We've hedged about $40 million at MXN 12.74. It's currently trading this morning at MXN 13.24 so it's open. And really what we've been waiting for is to ensure that the overall volume for 2012 looks pretty firm because it does give an opportunity on both copper and peso to lock into some better rates for next year and guarantee that position.

So we think the copper and the commodity costs that we've experienced all this year we can offset versus the current levels, and that's assuming it stays at the current levels, by probably about 60% of that cost. And then the rest has to come through pricing, which we've been actively working on to compensate for higher commodity costs.

And do you -- because you started experiencing the higher commodity costs in the first quarter on this -- you have about -- if I'm not mistaken, 55%, 60% of your contracts are indexed. Shouldn't you be expecting to receive commodity recovery from some of your first and second quarter costs in the fourth quarter here?

Yes. We would. Because it's as you know it's a six-month lag so we would start to experience our copper surcharges with our contracts so we should start seeing some of that in the fourth quarter.

And just a couple of other questions. Any thoughts on potential supply disruptions coming out of the flooding in Thailand?

No. We've done a -- the current report is that we're not seeing any disruptions. We're doing similar process that we had when we had the Japanese crisis. So we've got the purchasing groups monitoring that situation closely. The latest report is that we don't see any issues and they've gone through our supply base and our supply base is going through their supply base to work on that. But we haven't seen anything yet.

Okay. Great. And just your thoughts on European production and what you're hearing from some of your customers and then I'll jump off.

Yes. Well, we're actually the European both Volvo and Scandia have moved down their production. We're looking at it to be about equal, maybe up slightly for this year just depending really on some weakness in the export markets primarily to Brazil. And maybe some weakness in the European markets but now with the announcement today regarding potential program for the Greek debt crisis, it may give some more [pendency] to European markets. So I think it's just -- our guess right now is that it's going to be flat to this year to up maybe 10%.

Okay. Thank you very much.

Thanks, Matt.

And your next question will be from the line of Stefan Mykytiuk from Pike Place Capital. Go ahead.

Good morning.

Morning.

Just you guys threw out a lot of numbers. I'm just trying to make sure I got them all down here but in terms of Q4 versus Q3, you're saying I think you'll have about a $1.4 million decline in the cost related to Saltillo?

Yes. Saltillo will go -- we had $2.3 million this quarter. It'll drop to about $900,000 in the fourth quarter.

Okay. And then the $1.1 million of labor that you had kind of doubled up in the US covering for Saltillo. That goes away as well? That's incremental to that?

Right. It actually --

Well, not all of it, right?

We have a slight increase at $200,000 because we're rebuilding for the John Deere business in the fourth quarter. So the net change is about $900,000 between the third quarter and the fourth quarter.

Okay. And then how much do you expect to recover in terms of surcharges and the improvement in the dollar-peso and that other category that you outlined?

I don't know if we have a good number we can share this morning because it's got to do with the surcharges and our pricing and so we don't have a good number to share with you this morning on that side.

Okay. But that's -- is that still going to be positive going from Q3 to Q4?

Yes. It will. We've missed -- by us hedging and we thought they were good rates at the time so we locked ourselves into some positions much different than current spot rates.

Okay. But those are the three components that will get us from the 19% gross margin in Q3 up to 21% in Q4.

That's right.

Okay. And then in terms of PST I think you said BRL 10 million to BRL 13 million of net income in reais in Q4 and we divide by 1.75, which is like 5.5 million to 7.5 million in dollars?

That's right. And then 50% of that for our share.

Okay. That was in total. Okay.

Total.

Okay. All right. And then SG&A you expect that to be pretty much flat going into the fourth quarter then?

For?

Versus Q3?

For Stoneridge?

Yes. For the company as a whole.

I don't know of any -- yes. There shouldn't be any major change. I don't have it in front of me but we shouldn't see any major changes in SG&A.

Okay. And then in terms of the -- I know you gave kind of some shades of outlook for 2012. It sounds like revenue should be up because of the industry production going up. And then the goal is to try to get back to incremental margins of something north of 20%.

Yes. And it'll probably even be better than that because of the depressed state from this year of our inefficiencies that we had in the copper and the peso impact.

Right. That's I think the last time I had seen you -- at one of the analyst lunches it was $18 million or so of drag that you had on this year that will hopefully reverse next year.

Yes. I think there's drag of about $24 million in total and I think we can offset, looking at the whole basket, all but about $5 million to $6 million of that. And the rest has to come from pricing enhancements should offset that differential.

Okay. Great. Okay. Thanks very much.

You're welcome.

And your next will be from the line of Robert Kosowsky with Sidoti. Go ahead.

Yes. What was the other income in the quarter?

The other income was all the FX, Rob, with the volatility going on is that we have a lot of sort of dollar liabilities around the world and so we had a Mexico peso liability that we have from our operations in Mexico. We had a significant benefit there. We had an offset to part of that with a dollar obligations in Europe because the Europe rate moved by about 7%. So it's the net result of what happened to the peso and the dollar was it strengthened tremendously over the last probably 45 days and created a negative impact as I shared with you in Brazil because of their dollar liabilities they have for imports they're bringing in from China. So that shouldn't be recurring. I think it looks like the rates are starting to stabilize. The euro is back up to EUR 1.40 today. It dipped to EUR 1.33 at the end of August, which created that negative impact. And we've done some things to move our cash and reduce that liability and then the Mexico operation, we've actually taken some of our cash and deposited it in Mexico pesos to offset some of that to try to mitigate the exposures we have in different currencies with the volatility we're seeing in exchange rates.

Okay. That's helpful. And then just going back to the PST guidance if I convert it using today it looks like revenue is going to be up maybe $18 million, $19 million in US dollars versus last year. But it only looks like operating income is up about $600,000. So I'm just wondering how robust spending is like right now and kind of what margins we can be expecting on this incremental revenue going into next year.

Yes. Well I think the biggest change you're seeing, Rob, is the expenses are pretty well in line. They're going to be up slightly because some of the commission costs on the audio business is directly related to volume so they'll fluctuate based on that volume. And then I did allude to the fact that I think the range of our margins are more -- they probably have dropped, not dropped but they've come down probably four to five basis points because of the audio volume. And it's got bigger content. I think our margins we're looking at in audio is right around 25% to 30% now. Our alarm businesses are up around 55% to 60%. So I think as the volume drives -- and Brazil was growing at a rate of about 10% to 15%, not it's growing this year at 30% to 35%.

We're starting to see the channel shift and mix going into these mass merchandisers, which is reducing those so-called gross margin levels but I think our operating income as we indicated will be in the 13% to 15% range. So we should get an uplift on dollar contributions at both the gross margin and operating income because of the higher volume.

Okay. Thanks for that.

You're welcome.

And your next question will be from the line of Matthew Mishan with KeyBanc. Go ahead.

Yes. Just a couple of follow-ups. Has anything changed in your desire to actually consolidate PST?

No. I don't think so.

No. In fact the operation still is doing well and I think the basic reasons of why we'd want to do it are still in place. And as we stated before is really in the hands of our partner and it does appear that -- worked his way through some of those issues so we're actively back engaged with him in terms of the agreements and working with him. So we continue to move that process forward.

Is there any particular timeframe you're looking at? I know you said you had wanted to try and do that by the end of the year. Is that still the case or is it potentially pushed off a little bit?

No. There's an expressed interest to still do it before the end of the year but when you get into legal documentation, all those kind of things it may delay beyond that. But it would be our interest to do it as soon as we could and that would be this year if we could.

And on the base alarm business there, you would typically see a seasonal uptick in the second half versus the first half I believe. Did you see that this year? Or is there any change to that business?

Well -- and we gave you the forward guidance you're going to see the normal uplift in the fourth quarter especially. But we would typically have seen more an uplift in the third quarter, which we did and I think part of it was the transition we had going on with the audio business. In the alarm system there seems to be -- it flattened out a little bit in the third quarter. We don't think it's structurally anything in the marketplace because our share of market has stayed the same. But alarm system sales seem to have flattened a little bit over the last quarter or so.

And then I believe you -- if I'm not mistaken did you -- was there an outstanding balance on the revolver at the end of the year, at the end of the quarter?

Yes. There was. We borrowed $10 million, Matt. Because one of the issues we have is our cash is predominantly a lot of the cash is in Europe so as we've had the inventory build, which is really more North America then we drew against the revolver to cover that.

All right. Thank you.

You're welcome.

(Operator Instructions) And with no further questions at this time, I'd like to hand the call back to management for any closing remarks.

Okay. Well. Thank you for joining us on today's call. As you can see we're still not where we want to be on the wiring business but we're encouraged by the improvements that are going on there. As we look at the metrics we get out of that business we see that we continue to see those improvements. Things such as the inventory build for the upcoming ag season, we're on plan for that. We're on plan for our production output. We're on plan at our customer service levels. And we're working to reduce our overall cost of that business. The markets themselves look very favorable going forward, both the North American commercial vehicle and the automotive markets and those should benefit the European also looks reasonably attractive right now. And I think with the settlement of the debt crisis -- or the potential settlement of the debt crisis we'll look to see if that has any rebound to that market.

But overall the outlook for the fourth quarter, our volume looks good and as it continues on into 2012 and we leverage our business we expect to deliver improved financial performance. So I'd like to thank, everybody, for joining us today.

Ladies and gentlemen, we thank you for joining today. And that does conclude today's conference. You may now disconnect and have a wonderful day.