Stoneridge Inc (SRI) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Stoneridge second quarter 2012 earnings conference call. My name is Keith and I will be your operator for today. At this time all participants are in a listen only mode. Later on we will conduct a question and answer session. (Operator Instructions). As a reminder, today's conference is being recorded for replay purposes. And with that I would now like to turn the conference over to your host for today, Mr. Ken Kure, Corporate Treasurer and Director of Finance. Please go ahead, sir.

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

Joining me on today's call or 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 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'll 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 their most directly comparable GAAP measures.

John will begin the call with an update on the current market conditions, operating performance in the second quarter, growth strategies and business development and his thoughts on future initiatives including our updated 2012 guidance. George will discuss the financial and operational aspects of the quarter, thoughts on why our second half will be better than our first half and details of our 2012 guidance.

As we shared with you our revised guidance on August 2, we have prepared and published an earnings presentation to provide more detailed schedules to help you understand the second-quarter results and trends for the second-half improvement, a copy of which, again, can be found on our website. After John and George have finished their formal remarks we will then open up the call to questions. With that I will turn the call over to John.

Good morning. Last Thursday, August 2 we provided a revised annual guidance for both sales and earnings, second-quarter results announced today are consistent with that guidance. Our change in full-year guidance resulted from a significant change in selected markets and customer performance versus our first quarter and for the balance of the year.

After beginning the year with financial performance in the range of expectations in the first quarter, we experienced a particularly difficult second quarter, principally a slowing Brazilian economy impacted PST results and unfavorable movements in foreign exchange rates affected our earnings performance.

Weakness in the European commercial vehicle markets as well as lower sales to a large North American truck OEM below our projections further affected our second-quarter performance. Even with these market impacts our full-year sales for the Stoneridge base business is expected to be greater than last year.

Due to the continuing market and revenue softness we have and are taking actions to improve profitability and cash flow by restructuring our PST business, implementing pricing adjustments as a partial offset to higher commodity costs and continuing work to reduce material costs and improve manufacturing productivity.

As you can see on slide 9 of our deck, we expect our core gross margins for the year to be nearly unchanged on lower revenues due to these actions.

Revenues in the second quarter were $234.3 million, an increase of $43.8 million or 23% over the second quarter of 2011. This increase includes $35.8 million for PST's consolidated sales. Excluding the effects of PST sales of $38.5 million, Stoneridge's core business sales increased by $5.4 million during the second quarter of 2012, or 2.8% compared to the second quarter of 2011.

Slide 5 of our deck has a complete P&L breakout on the second quarter of 2011 versus the second quarter of 2012.

As seen on slide 10, Stoneridge's core sales increase was primary from the ag markets. Our overall growth was moderated somewhat by a decline in the European commercial vehicle sector. We reported a loss of $0.13 per share for the second quarter, $0.35 per share below the first quarter's earnings per share.

Slide 6 of our deck identifies the major variances between the first and second quarters, notably volume declines, foreign exchange and mix. The sales volumes by segment and products are shown on slide 10 of our deck.

The major driver of mix in the second quarter was a lower percentage of profitable car alarm sales and PST's business while Control Devices in the electronics devices business experienced higher direct material charges. PST sales volume was impacted by a slowing Brazilian economy as distributors reduced inventories responding to weaker consumer spending.

We are projecting in the second half a recovery in PST sales as distributors rebuild the channel and PST introduces new car alarms and adds new products in the cargo and home security categories, both scheduled to launch in the second half of this year.

In addition, PST sales are historically stronger in the second half due to the Brazilian holiday impact from Father's Day in August and Christmas and the summer holidays in the fourth quarter.

Agricultural equipment sales decreased in the second quarter versus the first quarter by approximately 12% to $43.1 million. This reduction is due to the normal seasonality as the ag markets are skewed to the winter months to prepare for the spring season. Compared to the second quarter of the prior year, the ag and equipment category increased $7.9 million or 22.4%, as shown on slide 10 and 11.

Sales in our passenger car and light truck category, which are predominantly control device sales, were $52.6 million in the second quarter compared to $55.1 million in the first quarter as we saw some push out of June sales into the third quarter. And the results of reducing our presence in commodity and noncompetitive product lines such as customer actuated switches.

Aside from volume weakness, second-quarter earnings were reduced by the devaluation of the Brazilian real and the euro against the US dollar and a restructuring charge at PST. We will incur a small restructuring charge in the third quarter as we complete the restructuring in our North American wiring and European commercial vehicle businesses.

New business awards for Stoneridge's core business in the second quarter were $88.9 million, of which $21.7 million was new awards and $67.2 million were replacement awards.

Minda Stoneridge, our unconsolidated JV in India, posted second-quarter sales of $12.1 million, a decrease of 22% versus the second quarter of last year. The sales decrease was driven primarily by a 25% reduction in the valuation of the Indian rupee compared to the US dollar. Excluding the effects of foreign exchange, Minda's sales are down 7% compared to the prior year on a weaker economic environment.

Our share of Minda's net income for the second quarter was $91,000, a decrease of $122,000 from the prior year, this decrease was primarily due to a US GAAP accounting adjustment for deferred taxes of $207,000 in the second quarter of 2012.

Excluding the deferred tax adjustment Minda would have reported a net income of $298,000 or a 40% increase over the second quarter of last year. Minda's gross margins also improved from 9.8% in the second-quarter of last year to 12.2% this year, due mostly to lower material costs.

PST, our Brazilian joint venture, recorded second-quarter sales of BRL75.5 million compared to BRL95.4 million in the first quarter of 2012, or a decrease of 26.3% on volume primarily due to decreases from the audio business with mass merchandisers and retailers in the sale of car alarms.

PST's second-quarter US dollar sales were $38.5 million based on an average exchange rate of BRL2.05 to the US dollar compared to $53 million in the first quarter of 2012 based on an average exchange rate of BRL1.79 to the US dollar, a devaluation of the Brazilian real to the US dollar of 13.7%. George will discuss in more detail the projected results from PST due to the weakening of the Brazilian real which stands at BRL2.02 to the dollar at August 8.

PST's gross margins, excluding the $1.4 million charge for purchase accounting, were 40% in the second-quarter of 2012 compared to 42.6% in the first quarter of 2012. The gross margin reduction is primarily due to a reduction in sales volume and mix as alarm systems were much lower in the second quarter.

Gross margin in the second quarter was also affected by restructuring costs of approximately BRL3.3 million, or $1.6 million. Excluding the effects of purchase accounting and restructuring, PST's second-quarter operating margin was a negative 1% compared to a positive 6.4% in the first quarter of 2012 and was impacted mostly by reduced volume and a devaluation of the Brazilian real.

The restructuring charge in Q2 resulted from a headcount reduction discussed in the first-quarter and the outsourcing of wire harness productions. PST is forecasting future benefits from these actions of [BRL]4.4 million and the second half of the year. These actions are in response to the changing market conditions which are below our original expectations for the year.

Looking at the balance of the year, North American automotive production forecasts from industry projections are between 14.7 and 14.9 million units for 2012. For the North American commercial vehicle market we believe annualized truck builds in the range of 270,000 to 280,000 for Class 8 vehicles for the rest of the year with some adjustment for specific customer performance for the last half of 2012.

The most recent European 2012 production estimates remain in the range of 5% to 10% reduction versus 2011. For the second half our projections have lower growth expectations for the North American commercial vehicle market but still positive growth over last year, a continuation of the lower European commercial vehicle market and an improvement in Brazil over a depressed second-quarter and continuing growth in the North American auto and ag markets.

As indicated in our press release of August 2, we have revised our sales guidance to the range of $970 million to $1.009 billion. Our revised gross margins in the range of 24.5% to 26.5% which is near the levels that we originally guided to in February and reaffirmed in May. Our revised operating income margins in the range of 4.5% to 6% and earnings per share in the $0.75 to $1 per share range are a result of reduced sales levels, lower foreign exchange impacts and the restructuring.

Summing up the second-quarter, we were negatively impacted by significant declines in the Brazilian market, the rapid foreign-exchange movement and volume weaknesses. We could not adjust costs quickly enough to improve from the impact of volume declines. However, the actions started in the second quarter and continuing actions in the third quarter will improve performance in the balance of the year as we are projecting.

With that I would like to turn the call over to George to provide additional details on our performance and outlook, including further details on our guidance for 2012.

Thank you, John. As John has shared with you his thoughts on the changes in the markets and the macroeconomic factors that have affected our performance in the second quarter, I will focus my comments on near-term market conditions and how we will improve our profitability in the third and the fourth quarters of this year.

The key aspect of a return to profitability is recovery of PST sales and the restructuring efforts that were implemented in April and May of this year. PST sales are highly volatile as they sell products in multiple channels such as retail, consumers, dealers, mass merchandisers and OEMs, the purchasing patterns in each distribution channel has been different.

As Brazil's economy showed signs of significant weakness in the second quarter, consumer demand declined which created excess inventory in the system. As a result of the economic uncertainties and the lack of confidence and consumer demand, distributors begin to reduce their inventory levels from five to six months on hand to two to three months in anticipation of a further slowdown.

The dealers took these actions in response to the demand levels that were not sustainable for future demand and to reduce their debt levels. The result of these factors led to a sales drop that went beyond their expectations and resulted in a BRL20 million reduction in sales between the first and second quarters.

We believe that sales for PST will recover through the balance of 2012 primarily because of the seasonal effect of Father's Day in August which is normally the second-highest electronics demand period, Christmas which is the largest retail demand holiday for electronics and the summer season which falls in the fourth quarter which has been historically a higher demand period.

The fourth quarter is also positively affected as the December pay period includes an extra pay called the 13th month salary resulting in consumers with more disposable income. Dealers have been rebuilding and maintaining their inventories to more sustainable levels. And though only one month of sales activity has occurred, we are pleased to see that July sales tracked according to the guidance estimate.

PST sales of alarm systems improved in July which was helped by the launch of our new alarm system which included a 7% price increase for the introduction of their new alarm. PST management is taking cost and pricing actions that we believe will help generate improvements in the third and fourth quarter of this year compared to the second quarter.

We estimate that the favorable operating income impact of higher volume in the third quarter will be approximately $4.4 million based on increased PST sales. We also estimate that PST will sell into more favorable mix in the second half due to a higher percentage of higher-margin aftermarket and tracking systems and a lower percentage of relatively lower margin [OES] sales.

PST will record lower purchase accounting expenses for the final two quarters and we expect a $1.2 million improvement in the third quarter as the balance of finished goods inventory write-up, which is a non-cash charge from the December 2001 ownership percentage increase transaction which was fully expensed in the first and the second quarters.

And finally, PST's direct material and pricing action should affect our mix favorably by approximately $1.5 million in the third quarter this year compared to our second quarter.

In regards to Stoneridge's core business, they continue to perform well. Our guidance indicates a somewhat reduced sales forecast for the second half of this year. And much of this reduction from our previous expectation is due to reductions in sales to a large North America commercial vehicle customer.

Sales to our European customers in the second half will also be lower because of weaker market conditions. We expect volume of our core business to reduce our operating income by $900,000 in third quarter compared to the second quarter.

Our guidance also indicates a significant increase in profitability for the second half. Pricing actions and direct material savings are expected to improve operating income in the third quarter by $2.8 million compared to the second quarter of 2012 for our Control Devices and wiring business groups.

Net restructuring benefits combined with SG&A savings should improve operating income by $1.7 million in the third quarter compared to the second quarter. Foreign exchange impacts should stabilize as long as the Euro and the real stay in the EUR1.27 to US dollar and BRL2 to the dollar respectively. As we saw in the second-quarter, further deterioration of these two currencies can have a dramatic impact on our financial results.

Finally, our wiring group continues to make progress in improving their performance, we continue to see improvement in their direct labor and overhead. Reductions in these expense categories from the second quarter are expected to be $1.9 million. Continued improvements in direct labor and indirect labor continue as planned as well as improving savings on premium freight.

Though the North America wiring business is now experiencing a lower than planned sales level in the second half of this year, we still expect to improve our sales per employee by 23% compared to last year as we will reduce our headcount by an additional 611 people between July and December.

I would like to give some clarity of the cadence for second half. Though our expected sales levels in the third and the fourth quarter are relatively close by amounts, we expect to see stronger earnings performance in the fourth quarter compared to the third quarter as the full effects of the restructuring, cost reductions, pricing and other initiatives are recognized.

Finally, I would like to discuss cash flow generation for the second half. Though we did not give formal guidance on cash flow, we have guided on EBITDA on slide 9.

And further, as indicated on slide 20, we intend to improve the total debt to EBITDA ratio significantly from 3.5 times at December 31 of last year to 2.23 times at December 31 of this year. Much of this improvement will occur because we intend to use our free cash flow to pay down our core business' ABL debt facility and PST will pay down their real denominated working capital loans which carries higher interest costs.

During the first half of 2012 Stoneridge core businesses paid down approximately $13 million in ABL borrowing from existing cash balance and PST paid down approximately BRL4.2 million in working capital loans. And we are projecting to pay off the remaining balance on our ABL facility at June 30 which stood at $25 million and approximately [$]8 million additional on PST's debt by the end of the year.

As John and I shared with you today and last Thursday, with our revised guidance our sales volume has been reduced for the year due to PST and the weakening of the Brazilian economy, softness in European commercial vehicle markets and lower levels of commercial business in North America. Even with the lower forecast our Stoneridge base business sales in 2012 will exceed our 2011 sales level.

In addition, even with the revenue drop we have been able to maintain our gross margin at both our Stoneridge base business and PST to ensure we continue to deliver our profitability and cash flow. We have shared our specific programs to restructure our cost of PST, European electronics and our wiring business.

We also continue to improve our productivity, our direct labor and overhead cost structure, especially in North America wiring business and European commercial business. We have worked diligently since the fourth quarter of last year to redesign our products, raising prices to cover commodity cost increases and work with suppliers to drive down costs. We expect to recognize a benefit of nearly 1% of raw material costs and net sales in both the third and the fourth quarter.

And based on improved profitability, tighter management of inventory and capital expenditures we will generate sufficient cash flow to pay down $33 million of debt in the second half. This will reduce our debt leverage to 2.3 times by December of this year compared to 3.5 times in December of last year. With that I would now like to open the call for questions.

(Operator Instructions). Robert Kosowsky, Sidoti.

I was wondering if you could give a little more color, I kind of missed it I think on the cadence of the operating margin in the legacy business. Do you expect that to be up 4Q versus 3Q?

We do, it's going to be up in the third quarter, then slightly better in the fourth quarter and it is really the result of the pricing actions that I alluded to, Rob, plus we will get the full benefit of any of the restructuring costs we have handled in the second and the third quarter.

But absent any of those restructuring -- extraordinary restructuring items you still expect pretty comparable margins but just a little bit higher in the fourth-quarter even though revenue should be pretty flat?

Yes, in our deck we actually show a projection of our key cost components and there is two things really driving that, it's the productivity that we are experiencing in our wiring business. But just as importantly, it's the pricing initiatives in our raw material cost of sales.

And I think in that slide deck it shows pretty clearly there is a further improvement in the raw material cost in the fourth quarter over the third quarter and that is what is driving some of the cadence of the margins improving in the fourth-quarter even higher than the third quarter.

Okay, presumably the raw materials in question are kind of precious metals that are going up I would assume. And I know you tried to raise prices earlier this year. And were those price increases just not enough and is there any way you can kind of index or kind of any thoughts on that?

Well, we are trying on certain things, we are moving aggressively to try to index copper better than we have. We do have a copper escalation clause, but we think the clause is too long. So we are -- this year we are hedged out on copper; that is what you see in our assumptions we have got copper at 4.05, although the market rate is lower. So we will start to work on contracts that will shorten that window and index that.

We have tried to index some of the other costs. We are having, I would say, limited opportunities for that and mixed results. But we are getting some pricing increase for things like rare earth magnets and other things that really impacted us as China has restricted those. And we are redesigning some of that product out too, so that will roll out over the second half of this year.

And if you look at the trend, Rob, it really started and a lot of those was the Control Devices in the fourth quarter of last year. And what John mentioned with both the pricing and the redesign, that took two or three quarters to get fully in place and so they are being more recognized here in the third and the fourth quarter.

Okay, and then any commentary on just how the business was in July from just the core business, but then also PST. And if you did see -- I think you mentioned a sales rebound at PST. Do you think that was more sell-through at your customers or is it more kind of restocking because inventory has gotten low?

I think the distributors down there like to maintain a two to three month supply of inventories on their shelves and I think that they had reached that level at the end of June. And so there is some restocking; we have not yet gone in-depth to understand how much restocking, but we still believe they are staying in that.

The other thing was we introduced our new alarm, so that drove some additional business into the markets at that point in time. And I think that in general they were feeling -- our alarm sales in the month were up versus the prior month, so we were feeling pretty comfortable about that.

Now there is still some -- we've got to still sort out some things down in that market space and monitor it very closely. But with the introduction of the new alarm, car alarm, that should be a positive for us. That also has -- and when we reduce the old inventory we will have a cost reduction from the new chip that we have in that alarm.

And then with the introduction of the cargo alarm and the home security systems, while they won't be big hitters this year they will start to launch those programs in the second quarter to drive that forward for the balance of this year and then primarily in 2013.

Okay, but I guess just looking at both PST and the legacy business, did July look like it was a good month and that kind of gave you the confidence to issue the guidance that you did? Is that kind of where that ultimately came from?

Yes. I mean, we saw that come out and we saw, as George said earlier, we looked at our top-line revenues in the PST business and their early projections show that they were hitting those targets.

July was right on our plan, Rob. I think that the question we have, has the market really stabilized or was this sort of a rebalancing they had in the inventory. John and I will be down there in the next two weeks and I think we will have a better feel of is this sort of a readjustment from what they did in the second quarter in inventories or can this be sustainable. Right now our guys feel strong enough that it is sustainable at these levels we are looking at.

You've got to remember, in the first quarter we billed about $54 million and that was at a rate of about 1.79. In the second quarter we did $38.5 million, that was really pushing from two things -- one, a drop in the volume, there was about $10 million of that, the other drop, $5 million, was the currency.

So we are looking for an uplift and as we looked at it it's probably in the range of around $48 million in the third quarter, so it is an uplift from where we are at, but the exchange is still sitting around 2.02 to 2.03, we don't know which way that direction is going, but I think the government has indicated they are going to try to manage the real in the range of about 1.85 to 1.90.

That will help us and then I think the market looks like it is stabilizing, at least on the dealer side and the mass merchandisers. And then, as we indicated, the strong selling months are really coming up here in August and the fourth quarter especially with the summer season and the Christmas holidays.

That is helpful. And just one other quick question. On PST it looks like there is maybe like $0.20 or so of cost cuts that you are doing. And how do we kind of -- where do the cost cuts come from and is there any kind of -- the superficial concern is that you might be starting to cut into bone just because the market did decline as fast as it did. And just kind of any kind of thoughts on that how you are looking at the cost cuts down there.

The largest cost came out of the manufacturing operations as we adjusted the headcounts to reflect the lower volume expectations going through. Also as we have introduced this new alarm system, one of the benefits of that is that there is fewer parts to assemble on that so we have less direct labor on that.

But we have adjusted other overhead centers to reflect what we believe is the new reality of the Brazilian market. So that means we have looked at -- we have put a lot of investment into engineering and getting ready to launch these new programs, so we want to now cash in on that investment. So we throttled back a little bit on our engineering and done a little -- some of the few other overhead areas.

But we have not harmed the business though. And as the business improves we can add back to the direct labor. But I think our overhead structures have been adjusted to where we feel comfortable with them and so does the Brazilian management team.

Okay, so it's less like permanent cost cuts and more just kind of flexing to the market environment?

Well, yes, I would say that in engineering, as we look at that, engineering and some of the other overhead structures like that, they may be permanent just depending on what we have because we want to drive the launch of these new businesses and so we don't need to as much in new business development so to speak because we've got three new products coming out to the market right now of significance to the business.

All right, thank you very much and good luck with the back half, guys.

Richard Hilgert, Morningstar.

I was curious to get a little bit more color on the business model down there in Brazil and how the aftermarket works with these types of products. The types of products coming out of PST are a bit more discretionary in nature they are not more repair aftermarket parts, they are more parts that you would buy to add to your vehicle.

And I am wondering, in the Brazilian market do you buy a new car and then buy these aftermarket -- the stereo, the video, the alarm, all of these things -- do you by that on your own and have it installed or how does that dynamic work? In other words would new car sales help that business more or would it be detrimental to the business.

Well, you have actually summed it up pretty well. When you buy a new car in Brazil typically you will buy a car that is stripped, I mean without options. And then because there is a tax on what you pay for the vehicle.

So, then as soon as you buy that vehicle you can then either through the OES channel, meaning through the dealer channel which we sell to, have your alarm installed, have an upgraded radio installed or something else installed -- or more traditionally you will go to an independent distributor or retailer and have those products installed.

If you looked at the PST product portfolio, we had things like power window lifts and backup alarms and security alarms, those things are traditionally installed in the independent aftermarket.

One thing that disrupts that is if you sell a fully loaded vehicle in that market, and last year the government had modified various incentives to we saw a period of time where imports were coming in fully loaded and into the marketplace. And then they were restricting our business.

The governments rolled that back as local suppliers have got -- local manufacturers of cars have gotten upset about that, so they've rolled back that tax policy. So we believe that the aftermarket is -- we sell to the OES channel, so we are selling to the dealer network and we sell into the independent channel and where those alarms and products are installed.

Since the government has incentivized the industry and we have seen new car sales improve the last couple of months in Brazil versus the first four or five months of the year, in the back half if that kind of trend continues that should help PST?

Yes, we believe it will help PST. The one wildcard there as we are looking at it is consumer discretionary income, I mean PST, a lot of PST sales are influenced by that. So as we look at that that is going to be the key.

Now what happened down in Brazil is that last year credit was probably fairly available, this year there has been some restriction on credit and so that is what we've got to monitor is how much discretionary spending can the consumer afford when they are having to put more money into their vehicle to buy the original vehicle. In other words last or you could buy it with 10% down and finance the rest; this year you may have to pay 40% down and finance the rest.

So that's the one thing that we don't have a good handle on yet, what does that mean for consumer discretionary income. The second aspect will be as Brazil improves -- you know, Brazil does a lot of exports to China. As the China market improves and we just -- indications are that China is stimulating their economy now -- they will take a lot of those commodities from Brazil and that improves their economy and that puts more discretionary income out.

So then would it also be fair to say given the economic environment that you just described that consumers might wind up in the second half here buying a new vehicle, but they might not purchase all of the amenities? And you might have less penetration but higher volume new vehicle sales in Brazil?

It's a possibility, but I don't think -- I think that that's perhaps the wildcard. But I think from what we saw we don't see that happening. The distributors don't believe that's happening. However, with any consumer product that could change pretty quickly as it did in the second quarter. But what we are seeing now is from our conversation with the distributors they are positive on the outlook for the environment.

The other thing we are doing, and this is important, we are not flooding the market with product. There are some products down there where they have an unregulated supply of product into the marketplace from the manufacturers and that just leads to price for us.

On our alarm system business we have consciously taken a decision not to just flood the market with alarms which will then lead the distributors, when they have a lot of inventory they just cut the price and move it on through. So we are trying to regulate that also to keep pricing support in place in the market.

And, George, I was wondering if you could talk a little bit about your expectations for debt reduction going forward. With cash flow not quite being what you had thought it might be, and economies being not quite as robust as we had thought maybe six to eight months ago, has that changed your cash flow usage? Are you looking to maybe put a bit more back into the cash balance as opposed to paying down the debt or where are you out on the debt reduction schedule.

Well, I think you know and I shared today that we are going to pay down on the normal -- our cash balance is sitting right around $39 million, it will actually go up probably in the range of about $10 million through year end with our current forecast. And even with that that will permit us to pay down all of the ABL debt that we have in our North America market, that is $25 million.

And the real active plan we have is part of this balance of the questions you have basked in Brazil we were doing an audio launch and there's a lot of components that came in for both that and the alarm systems. We believe there is an opportunity to reduce inventory in the range of about $9 million in Brazil. So between their improved profitability in the second half and that inventory reduction we will pay down about $8 million in Brazilian debt.

So we feel comfortable that we will reduce debt about $33 million in the second half, it will build our cash out slightly by probably $5 million to $10 million. And then I think the one issue we are looking at is we had accomplished a tax restructuring in Europe and we are working on that of really pulling back some cash out of our European operations and balance that with some local debt that can balance our exposures in Europe.

So I think everything that we see between profitability, our inventory program and we still have some room because of some of these. And we alluded that a reduction in some of the customer programs that we'll be able to pull some of our capital in. So I think we will generate sufficient cash flow that will pay down debt fairly significantly; right now our forecast is about $33 million.

And then our debt to EBITDA, as I mentioned, will drop to about 2.2 times by December 31 of this year with that kind of a reduction. So we feel pretty good about where our balance sheet strength is at.

That has been kind of the historic range for that metric and I am curious -- are you anticipating that you are going to kind of -- after this year you are going to more or less hang out at that kind of a range and let the EBITDA give you the room in that range bringing it down? Or do you think after this year, after the debt reduction that we have already talked about that there will be further cash use on the debt?

Well, the one key thing, Richard, even though we get the debt down, I think the one that we do want to focus on is still reducing debt in Brazil. And as you know, they have been a significant cash generator over the years and we see that returning in the second half of next year.

So even with a reduction they are going to be sitting on substantial debt in dollars roughly about $15 million to $18 million in dollars. And then we will have working capital loans in local currency and their local rates are about 14%. And then even though the dollar rates are 4.5% you are always exposed to exchange swing like we recognized in the second quarter.

So we have a ways to go yet of paying down Brazilian debt which we didn't really have a lot of Brazilian debt over the last couple of years. So that will be a focus next year is to really get the Brazilian debt and that's sitting in the range of probably $25 million and that will be a primary objective we have to reduce interest cost and reduce the exposure risk that we have in Brazil.

Beyond that I think we still have growth plans and there are voids that we have around our markets, especially in the emerging markets and Europe and Asia as we develop our synergy over some of our programs like [EGT] in Europe and what we are doing in the China development and India and Brazil. So we have what we call some bolt on acquisitions that fit in the longer term strategy where we have for our businesses.

So that will be our primary focus is really getting debt pay down in Brazil for next year in addition to the second half of this year and then look at investments we need to make to support our business growth in the emerging markets and in Europe especially in our Control Devices EGT business.

Okay, so the rest of this year the focus is getting the ABL down and then next year it will be more focused on the Brazilian debt reduction?

Yes, I think this year, the second half Brazil is going to generate positive cash flow, but it won't be enough to pay off all the debt we have there and it is high interest cost and it's got an exposure risk to it, so we will really focus on paying down Brazilian debt next year.

The final area that I wanted to get a little bit better feel for was what all is going on with the volume expectations coming out of Navistar? You mentioned in your prepared remarks that this is what we are looking at for Commercial Vehicle sales here in North America with the adjustment for your customer, I was assuming that was probably Navistar.

But I am curious to know with the recent announcement with Cummins and utilizing the Cummins technology, once they got that deal in place was there any kind of a pickup in their orders for the second half of the year or are they still kind of about the same, they are still guiding you about the same kind of production rates for the full year or how did all of that work out?

Yes, I think that we have to go back again -- they will revise their schedules every month so we really -- they just inked that new deal with Cummins, they have to see the reaction from the fleet to that deal and they will adjust their forecast. But right now we haven't seen any further decline in their forecast.

And I would say based on where they are we don't expect to see a further decline. I think this was a very positive move for them because there was a lot of uncertainty in the marketplace about would they ever have a certified engine. Now they have gone and said, okay, we will have certified engines.

In addition, the deal to sell the 15 liter Cummins engine kind of fills a gap that they had so they can focus first on getting the 13 liter certified, then going to the 11 liter and the 15 liter and getting those certified. So I think it was a positive move and I think -- we will watch it closely, but I think that will eliminate a lot of the concerns some of the fleets had.

I think as a follow up to your question though is that we've taken sort of a conservative approach in terms of demand with all our customers, specifically Navistar, because it leads to excess headcount and inventory planning.

So we have been very prudent in how we sort of schedule our operations now and we've added a VP of ops last year and I think he has been adjusting his production schedules to demand plan and we are really seeing the improvement in that area, printing and freight is gone, excess inventory is really coming down and productivity is jumping.

So we have been sort of on the fence measuring that Navistar progress. And I think they have taken the positive steps. But our approach has been conservative in terms of a planning basis for Stoneridge.

Okay, great. Thanks, guys.

[Marcelo Choi], B. Riley & Co.

There seems to be considerable uncertainty as to what 2013 holds for CD production both in North America and Europe. Can you share your expectations for 2013 relative to 2012? And can you speak to what level of variances you can handle from those expectations before you see significant margin compression?

That is a good question. We are just about ready to go in to our planning sessions for next year and so we haven't finalized our volume projections for the year. One of the things we are going to do is, as we look at industry projections, everybody has access to those, but we are going to try to adjust those.

As we saw this year, the industry projections for North America with specific customer movements impacted us a little bit differently than the overall growth rate in the market. So I do not have a good answer to give you today on what our projections will be for next year.

I will say, just what George just said is that as we have looked at our operations we have adjusted our cost structures in those operations to be more reflective of a lower volume. I think that just in general in the North American market I think there still is demand for new vehicle sales because we haven't fully recovered from the last four years, I would say from the 2006 surge, and fleets will it eventually replace those vehicles, the age of the fleet is going up.

In the European markets I think as the export markets start to improve again I think they will move those up. We are not forecasting for next year; I don't believe we are seeing any significant upturn, so we are trying to adjust our -- we are adjusting our cost structure for that. But we don't see any significant downturn either. But again, we are right at the time when we start looking earnestly at what we think the outlook will be for the balance of 2013.

And just shifting over to new business cadence, I believe that you said for Q2 you saw about $89 million in new business and I guess most of that was replacement.

Yes, about $67 million replacement, $20-some-million in new.

Okay. So how does that relate to the $195 million forecast that you put out there through 2015? And I guess what part of that have you recognized -- have come online first half of 2012.

Well, you know, for this year and in our last investor presentations we just posted we said that our new business at that $195 million would be in the range of about 10% to 14% for this year. The one impact has been is that we had a major platform for a large European commercial account that got pushed from the fourth quarter into the second quarter of next year.

So other than that one I think everybody is pretty well on track, but that one had a significant impact. It will lower sales in the fourth quarter, but there was a trade-off because the engineering expense and the things we were doing to develop that just about matched the profitability drop.

So it will show in that cadence in terms of our net new business, it will look like it will be down but it really just moves into the second quarter of next year. And it was really -- it was a specification issue on our customer in two specific suppliers related to that program launch. So other than that we are still in cadence with that launch this year in 2012 and that was the only major one that moved on us.

Yes, and China is -- and I forgot that one -- as we have stated, the EGT legislation got pushed and a lot has to do with their gas distribution in China as it matches up with the engines and they have -- that was originally supposed to go into effect in 1-1-2012 that now has been pushed back to 1-1-2013 and I think John and I were just in China and I get -- we get the inkling that that is probably going to be delayed even a little bit more.

But the key accounts that we signed with Tenneco, Cummins, Dongfeng, they are gearing up that they would start here late fourth-quarter, in fact we are moving a line into China right now that we are getting up here in August and September to really [further] developments. So we are probably six months behind EGT development in China and it was really pushed out because of the Chinese legislative -- on the emission standards.

Okay, great. Thank you, that's all for me.

Robert Kosowsky, Sidoti.

Yes, just one more question, George. What should we use for a tax rate for the year?

Well, that is a good question because, Rob, it was originally -- you know we started the year out around 26%, but as our income improves in North America and as we have discussed in the past with the valuation allowance that will tend to drive the effective rate down.

Brazil's tax rate is 19% on average, so what is happening right now, as the Brazil income dropped you will see that the effective tax rate starts to go down just because of the US income is a bigger percentage of that.

So we will see some variability to that but I would continue to assume that Brazil's tax will be right around 19%, the US income is starting to come through with no taxes so that will start to drive our effective tax rate down.

Okay, so lower than 19%, like (multiple speakers) or something like that?

Yes, it will as more income. And I would think it would be in the range of 14%, 18%, somewhere in that for the year.

Okay. And I guess that is about it.

And it really -- it's because of the mix in earnings, Rob. That's what you've got to remember because it can vary. If Brazil's profitability starts coming back it will start to drive it because they are at 19%. Europe has certainly been impacted, they have got a higher tax rate than that in the US. So you will get some variability to that based on what the income is doing.

Okay and just one other thing. You thought that third-quarter PST US dollar revenue would be somewhere in like the $48 million or so give or take?

Yes, I think that is the range we are currently looking at.

Okay. And do you see much gross margin difference between third-quarter and fourth-quarter?

Well, you know it really depends on the mix and I think John shared that with you. It gets back to normal mix and we experienced lower alarm sales in the second quarter. And it is not so much because we are maintaining margins by segment, by products segment. If alarm system goes back to its more normal level then, yes, we will see the ranges.

But our first -- as you know, our margins in PST were -- they were like 41.6 and 40 in the second quarter. So we are maintaining those margins, just the mix in how those products come out. But we did start to see alarm systems improve in July with the launch of our new alarm system.

All right, thank you very much and good luck, guys, thank you.

(Operator Instructions). Irina Hodakovsky, KeyBanc.

I just have a piggyback question on your North American assumption. I know you have made some adjustments for specific OEMs. Can you share your baseline assumptions for North American heavy-duty?

What we have done, Irina, is that we essentially, as you know, we come off the J.D. Power's (inaudible), we also get EDI releases from our customers. So what we have really done, and you probably saw it in our slide deck, that we made the comment that we have adjusted and reflected what the current EDI forecasts are.

And I alluded in my comments earlier that we have been somewhat I would call it cautionary because when we rely totally on those forecasts and it leads to headcount and raw materials and that. So we've probably taken a more balanced position, but a conservative position to make sure that we don't build and get ahead of ourselves in terms of materials.

But we feel much more comfortable with our manufacturing capabilities today that we can flex up and down with schedules, but we are going to be more prudent on the side of being conservative so that we are not building inventories or having excess people in the process.

Yes, if you look at J.D. Power's, they are still forecasting around 300,000 units in Class 8 and we are more down, as I said in the talk, -- we look at the 270,000 to 280,000 range for us. And as George said, the reason for doing that is becomes it becomes difficult -- when volumes don't materialize you have to flex your plant down and that is one of the things we experienced in the second quarter. We are trying to get headcount out and we have to be a little more aggressive on that.

The other side of that is there are some long lead items in inventory. And so if you are forecasted -- over forecasted on volume you end up building up inventory. And so we are trying to be a little more conservative on those fronts as we think that -- as this market continues it looks like it is getting a little -- still growing but a little bit softer than what everybody expects.

(Inaudible) your baseline as long as your OEM assumptions are both conservative going into the second half?

I would say yes, that is what we have now.

Thank you, guys, that's all I had.

And we have no other questions now at this time. So I would like to turn it back over to management for closing remarks.

Good. Well, I would like to say that the second quarter volatility in the global markets, especially as we saw in Brazil, and some of the currency movements really added up to a disappointing quarter.

However, there are some positives in this business that were probably masked by that quarter and that is that the agricultural markets and the car markets in North America remain in good shape and we are expecting a gradual improvement in the global commercial vehicle markets. And more importantly, an improvement in the Brazilian markets after their significant decline in the second quarter.

As we have looked at this, we have taken and are taking corrective actions to adjust the cost structure from recovery of material cost with pricing actions and redesigns to the operational realignment that we have undertaken.

And if you look at our operations, as George had indicated, we see some significant improvements in our operations and, more importantly, a demonstration that we can continue to move forward with those improvements and be prepared as volume comes back up to handle the volume increases.

Finally, I would like to just say with the realignment of the management team that we recently announced we have added focus to each business unit. And as we have seen under the head of the new operation -- under the head of the operations, when we add that focus we can expect additional benefits from that.

So we are looking forward to the balance of the year, we think we have tailored our plans to reflect what the market conditions are and then the rest is up to execute on our plans and continue the improvements in our business and take the cost out, as we have indicated on today's call. So I would like to thank you all for joining us on today's call.

Ladies and gentlemen, that will conclude today's conference. Thank you very much for joining us and you may now disconnect. Everyone have a great day.