Stoneridge Inc (SRI) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2012 Stoneridge earnings conference call. My name is Lisa and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Ken Kure, Corporate Treasurer and Director of Finance. Please proceed, sir.

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 and the accompanying presentation has been, will shortly be, filed with the SEC, and has been posted to 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 statements that are not historical in nature, and include information concerning our future results or plans. Although we believe that such statements are based upon reasonable assumptions, you should understand that these statements are subject to risks and uncertainties, and actual results may differ materially.

Additional information about such factors and uncertainties that 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 will also be referring to certain non-GAAP financial measures. Please see the investor relations section of our website for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures.

John will begin to 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, including our current 2012 guidance.

George will discuss the financial and operational aspects of the quarter; thoughts on why our fourth quarter will be better than the first three quarters; and details of our 2012 guidance, and initial market outlook for 2013.

As we shared with you in our revised guidance on October 5, we have prepared and published an earnings presentation to provide more detailed schedules to help you understand our third-quarter results and the trends of the fourth quarter improvement, a copy of which 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'll turn the call over to John.

Good morning. Third-quarter results announced today are consistent with our current annual guidance issued on October 5. To recap the year, we begin 2012 with financial performance in the range of expectations for the first quarter. Beginning in the second quarter, the global economic slowdown significantly impacted our Brazilian operations, and muted the expected market improvements in the North American commercial vehicle segment, as we have discussed on prior calls.

Our third-quarter results, and fourth-quarter outlook in our current guidance, reflect the continued weakness in the global commercial vehicle markets; the impact of a customer share loss; and a slower recovery in the Brazilian market. We believe the second quarter was the bottom for Brazil, as third-quarter sales improved by $5.3 million, or 13.8%, over the second quarter. We also expect the fourth-quarter sales to be 10% to 15% above third-quarter sales, and slightly less than the first quarter of 2012 sales.

With the global market softness reducing revenue, we have taken, and are taking, actions to improve profitability and cash flow. Each business unit has implemented cost reduction actions to align cost structures as much as practical with the market softness. In addition, where possible, we are implementing pricing adjustments to partially offset higher commodity costs, and continuing work to reduce material costs and improve manufacturing productivity.

Slide 9 of our deck shows the impact of these actions on Stoneridge's core gross margins for the year. These actions are helping to keep gross margins nearly unchanged on lower volumes. Revenues in the third quarter were $219.3 million, an increase of $23.4 million, or 11.9% over the third quarter of 2011. This increase includes $43.8 million for PST's consolidated sales. Excluding the effect of PST's sales, Stoneridge core business sales of $175.5 million decreased by $20.4 million during the third quarter of 2012, or 10.4% compared to the third quarter of 2011.

Slide 5 of our deck has a complete P&L breakout on the third quarter of 2011 versus the third quarter of 2012. Slide 10 of our deck identifies Stoneridge's core sales decrease versus the prior-year third quarter, which is primarily from the commercial vehicle business for the reasons previously reviewed. Slide 11 provides the details behind the revenue change from the second quarter of 2012 to the third quarter of 2012.

We reported net income of $0.02 a share for the third quarter, which is $0.15 a share above the second quarter's loss per share, and within the range of our current guidance. Slide 7 of our deck identifies the major variances between the second and third quarters -- notably volume declines in our core business; cost reduction; benefits; and mix. Sales mix in the third quarter benefited from increased in higher-margin car alarms in the PST business, while Control Devices and our Electronics business experienced lower direct material charges, as can be seen on slide 13 of our deck.

PST sales volumes, while improved versus the second quarter, was at a slower rate of improvement than we were projecting, and reflects continuing uncertainty in the Brazilian economy. We are projecting further improvement in PST's revenues in the fourth quarter, as sales are historically stronger in the second half, due to the holidays of Christmas in the summer months in the fourth quarter.

Agriculture and equipment sales decreased in the third quarter versus the second quarter by approximately 10%, to $38.7 million. Ag sales in the quarter were also affected by an unexpected production adjustment from a customer for inventory balancing. However, in the fourth quarter, ag sales are forecasted to improve, and are reflected in our current guidance. Compared to the third quarter of the prior year, ag and the other equipment category sales were about flat. Slides 10 and 11 have the detail.

Sales in our passenger car and light truck category, which are predominantly Control Device sales, were at $48.5 million in the third quarter, compared to $51.4 million in the second quarter, due primarily to lower production schedules of our North American pass car producers and normal seasonality.

New business awards for Stoneridge's core business in the third quarter were $11.9 million, of which $8.6 million were new awards, and $3.3 million where replacement awards.

Minda Stoneridge, our unconsolidated JV in India, posted third-quarter sales of $10.4 million, a decrease of 14.1% versus the third quarter of last year. The sales decrease was driven primarily by a 20% reduction in the valuation of the Indian rupee compared to the US dollar. Excluding the effects of foreign exchange, Minda's sales were up 4% compared to the prior year, though our local joint venture is being affected by the weaker economic environment. Our share of Minda's net income for the second quarter was $207,000, a decrease of $183,000 from the prior year. The decrease was due primarily to increased material costs and SG&A costs in the third quarter of 2012.

PST, our Brazilian joint venture, recorded third-quarter 2012 sales of BRL88.8 million compared to BRL75.4 million in the second quarter of 2012, or an increase of 18% on volume, due primarily to the increase in car alarm sales in the aftermarket and dealer channels. PST's third-quarter US dollar sales were $43.8 million, based on an average exchange rate of BRL2.03 to the dollar, compared to $62.4 million in the third quarter of 2012 -- 2011; based on an average exchange rate of BRL1.72 to the dollar, or a devaluation of about 18%.

PST's gross margins, excluding $1.7 million for purchase accounting, was 41.3% in the third quarter of 2012, compared to 40% in the second quarter of 2012. The gross margin increase is primarily due to increased volume and favorable car alarm sales, and the second-quarter cost initiatives of approximately BRL3.3 million, or $1.3 million. PST's third-quarter operating income, excluding purchase accounting, was $14.2 million, which included approximately $2.2 million in benefits from cost reductions completed in the first half, as shown on slide 12 of our deck. We expect fourth-quarter results to have similar benefit.

Looking at the balance of the year, North American automotive production forecasts from industry projections are between 14.8 and 15 million units for 2012. The North American commercial vehicle market is weakening, and we believe annualized truck build level of 240,000 to 250,000 for Class 8 vehicles will result in a lower production rate in the fourth quarter. And there are still questions around this industry forecast. The most recent 2012 European production estimates show a reduction of 11% versus 2011 for heavy-duty trucks.

Our fourth-quarter projections reflect these market expectations for the commercial vehicle markets, improvements in Brazil, and continuing stability in the North American auto and ag markets. As indicated in our press release of October 5, we have revised our annual sales guidance to the range of $940 million to $962 million. Our current estimated gross margins remain in the range of 24.5% to 26.5%, which are near the levels that we originally guided to in February. Our current estimated operating income margins, in the range of 3.5% to 4.5%, and full-year earnings per share in the $0.35 to $0.45 per share range, are a result of the reduced sales levels, foreign exchange impacts, and adjustments to our cost structure.

Summing up the third quarter -- while we improved, we continued to be impacted by uncertainty in global markets and customers' responses to changing market conditions. Forecasting operational requirements in this in these markets is difficult, as we cannot adjust as quickly as customers adjust their demands from us. However, the cost reduction actions taken in the first half, and continuing actions in the third quarter, have helped offset the volume reductions, and will continue to improve our performance in the balance of the year.

With improvements in market volumes, we are positioned to benefit through improvement leverage, and a leaner, better-managed organization.

With that, I'd like to turn the call over to George.

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 third quarter, I will focus my comments on near-term market conditions and how we improve our profitability in the fourth quarter of this year, which will position Stoneridge well for next year.

The key aspect of our return to profitability is the recovery of PST sales and the benefits from the cost initiatives that were implemented in April and May of this year. PST sales levels have been highly volatile from month to month, as they sell products through multiple channels -- through retail consumers, dealers, mass merchandisers and OEMs.

The purchasing patterns of each distribution channel has been different, as consumers have reacted to uncertainty in the economy and dealers have adjusted inventories to reduce their debt load. As Brazil's economy showed signs of significant weakness in the second quarter, the consumer demand declined, which created excess inventory in the system. And as a result of the economic uncertainties and a lack of confidence in consumer demand, distributors began to reduce their inventory levers from 5 to 6 months on hand to 2 to 3 months, in anticipation of further slowdown.

The dealers took these actions in response to 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 our expectations, and resulted in a $15.2 million reduction in sales between the first and second quarters. PST sales did recover in the third quarter of this year by $5.3 million, or 13.8%, but not as robustly as we were expecting.

We are forecasting continuing improvement in the fourth quarter, as the seasonal effect of Christmas -- which is the largest retail demand holiday for electronics in the summer season occur -- which is historically a higher-demand period. We expect fourth-quarter sales to be about 10% to 15% above the third quarter, but still slightly less than the first quarter of 2012 sales.

We estimate that the favorable operating income impact of higher volume in the third quarter, compared to the second quarter, was approximately $2.2 million, based on increased PST sales. PST experienced a more favorable mix in the third quarter, due to a higher percentage of higher-margin aftermarket alarm systems and tracking systems, and a lower percentage of relatively lower-margin OES dealer sales, which affected our mix favorably by approximately $1.5 million in the third quarter of 2012, compared to our second quarter.

PST also recorded lower purchase accounting expense in the third quarter by approximately $1.1 million, as the balance of finished goods inventory write-up from the December 2011 ownership percentage increased transactions was fully expensed in the first and second quarters. And finally, the impact of PST's cost reduction initiatives implemented in the first and second quarter favorably affected operating income by approximately $2.2 million in the third quarter, and will be about the same in the fourth quarter.

Stoneridge's core businesses continued to perform well despite experiencing near-term weakness in the third quarter. Much of the production and sales reduction from our previous guidance was due to reductions in sales to a large North American commercial vehicle customer, and sales to our European customers below our expectations. We expect moderate improvement in the fourth quarter.

Volume reductions in our core business reduced our operating income by $7.5 million in the third quarter compared to the second quarter, but was partially offset by benefits from our cost initiatives, as our operating income increased in the third quarter compared to the second quarter.

Core SG&A expenses were lower in the third quarter compared to the fourth quarter because of seasonal vacation affects in Europe and net cost initiative benefits. These and other SG&A reductions improved operating income by approximately $4 million in the third quarter compared to the second quarter.

Foreign exchange impacts should stabilize as well, so long as the euro and the real stay in the EUR1.27 to US dollar and BRL2.05 ranges, respectively. And finally, our wiring group continues to make progress in improving their operating performance. Continued improvements in direct and indirect labor continue, but not at the pace to meet the significant drop in the third-quarter production volume.

Though the North America wiring business is now experiencing lower-than-planned sales level in the fourth quarter of this year, we still expect to improve our sales per employee by 11% compared to last year, as our productivity continues to improve.

As our current guidance indicates, we expect to see stronger sales and earnings performance in the fourth quarter compared to the third quarter, as the full effects of cost reductions, pricing to offset commodity increases, and other initiatives are recognized. Even with difficult market conditions, we maintained cash flow generation as one of our primary objectives for the year. Though we did not provide formal guidance on cash flow, we have guided on EBITDA on slide 9.

Further, as indicated on slide 20, we are on track to improve the total debt to EBITDA ratio significantly, from 3.5 times at December 31 of last year to 2.75 times at December of this year. Much of this improvement has already occurred, and we are on track to generate additional free cash flow to pay down additional debt in the fourth quarter. We will pay off our core business' ABL debt balance that balance of $11 million in the fourth quarter. PST has paid down their high-interest real-denominated working capital loans at the end of the third quarter, and will begin to pay down their US-dollar-denominated debt in the fourth quarter.

During the first three quarters of 2012, Stoneridge has paid down $47 million in total debt, with our core business paying down $27 million in the ABL borrowing for from free cash flow generated and existing cash balances; while PST has paid down approximately $20 million in working capital loans. We are projecting to pay off the remaining $11 million balance in our ABL facility at September 30; and approximately $3 million more of PST's debt by the end of this year.

John and I shared with you today our management team's actions to address the overall lower production volumes from the slowing markets. Our sales volume has been reduced for the year due to PST, as a result of Brazil's GNP running at less than 1.5% this year; softness and European commercial vehicle markets; and lower levels of commercial business in North America.

Even with the revenues drop, we have been able to maintain our gross margins in both our Stoneridge-based business and PST to ensure we continue to deliver our profitability and cash flow. We have implemented specific cost reduction initiatives at PST, European electronics and our wiring business. We have continued to improve our productivity and lean initiatives to improve our direct labor and overhead cost structures for the North America wiring business and the European commercial business.

We have worked diligently since the fourth quarter of last year to redesign our products, raise prices to cover commodity cost increases, and work with suppliers to drive down raw material cost as a percentage to net sales. And based on improved profitability, tighter management of our inventory, and capital expenditures, we will generate sufficient cash flow to pay down about $14 million of debt in the fourth quarter for both Stoneridge's ABL lines and PST debt.

This will reduce our debt leverage to 2.7 times by the end of this year, compared to 3.5 times at December of last year. And we believe we have taken the actions necessary to position the Company well for next year. We still believe the market dynamics are good for growth in pass car and light vehicle and the ag markets for 2013.

The fundamentals of the North American commercial vehicle market are such that the North America commercial fleet is running at 6.7 years of age, with increasing maintenance costs and more fuel-efficient engines being offered that may lead next year's Class 8 market to run at this year's level, or at a slight improvement, in the range of 240,000 to 250,000 units.

We have taken cost actions necessary in PST while the Brazilian market has improved in the third quarter, and expect it to improve even more in the fourth quarter, which should lead to improved financial performance.

We will now open up the call for questions.

(Operator Instructions). Rhem Wood, BB&T Capital Markets.

Good morning. My question is -- your guidance implies for Q4 an acceleration in both revenues and margins from third-quarter levels. I guess I'd kind of understand the margins a little bit better if you're able to take out some cost. But you've talked about the commercial vehicle being weak. And then it seems like that in Brazil it's pretty volatile from month to month. How confident are you that you'll be able to achieve those goals in the fourth quarter?

Well, I would go back by market. The North American automotive market, we think, is stable. It has shown stability this year. We continue to see that for the fourth quarter. What we do see in that market, specifically, is maybe specific models -- ins and outs -- just depending on what they're doing in their production cycles or their launch cycles. But there is no overall fundamental weakness in that channel right now.

North American ag market will improve in the fourth quarter, as this is normally their buildup for their peak selling season in the first quarter, so that market will be stable. The European market has been in the range -- we've always said all along that it would be 5% to 10% down. It looks like it's down, now, 11%. What we're seeing in the European market is some positive order input for export vehicles going down to the Latin American countries, primarily as Brazil, offset by some weakness in the -- I'll call it the domestic European countries, where the demand might be off a little bit, so they're taking production days out of their cycle. So that is, on balance, about where we expect it to be.

And then, the one that really is, for us, is the North American commercial vehicle market, and that has been trending down all year long. We think we factored in the right amount of that. And so we feel pretty comfortable in this. And then, again, in Brazil, we think the economy is improving, as we've seen in the second to the third quarter. It's not improving at the rate that we originally anticipated. But, as George said, with the holiday period down there, this would be a good time to see that demand increases somewhat. Although we don't expect a very robust Christmas season like in prior years, we do expect to see some demand from that.

And, Rhem, if you look at the different segments of the business, our pass car was down slightly in the third quarter. And that was more mix; but it will be up some in the fourth quarter over the third quarter. Brazil clearly is improving -- it was up almost 14% in the third quarter, and we just alluded today it would be up another 10% to 15%.

But what is important in that is the increase; is the margin shift we're getting. We're getting a better mix of alarm system sales, so the consumer demand -- even though it hasn't returned to the level we were expecting -- it is at a sufficient level that the key mix of products with our higher margin business is a bigger part of the mix there.

And the cost initiatives we took in Brazil are really starting to come into play. In the pass car business, where we did a lot of the work on commodity costs, raising prices, and actually redesigning products -- which started way back at the fourth quarter last year -- their cost of materials as a percent of sales have been improving, and we're looking for a continued improvement there.

The wiring business is really tracking well. Even though wiring sales will be flat in the fourth quarter, our electronics business will be up slightly, but our direct labor and overhead cost is actually trending down, even with the small increase in sales. I think it's a combination of the different markets and the mixes we're seeing in electronics.

Wiring will be flat; electronics will be up; the pass car will be up; ag will be slightly up, because of the start of the builds for John Deere. And then we're seeing improvement in direct labor and overhead, as that cost trend is going down in absolute dollar terms. And we've got a lot of actions in place, in terms of recovery commodity prices and redesign of products that's driving our raw material costs down.

Okay. As we look at Brazil, what is the best gauge to watch? Because some of those signals are mixed. Auto sales are okay, but GDP is running weak. And if you strip out the industrial component of that, it's really weak. And then, you guys have an aftermarket product. So just because it's auto sales doesn't mean -- I guess you're going to be selling them. So how do we think about that? And then also, have you launched your new home security and cargo tracking in Brazil yet?

Yes, we'll start with the home security and cargo tracking. They're actually having meetings this week with the various organizations around cargo tracking. And so they will start rolling that product out. The home alarm system, they put beta samples out on sites. They've gotten some feedback on those. We're changing some software on those. But, overall, the feedback has been very positive for the Positron brand, with the price points and the features that we're offering in the market. And so we're expecting that -- there will be very little rollout of that right now in the fourth quarter.

We're signing up distributors. And the way we'll do that is we will sell those alarm systems through our existing distribution network and maybe some new channels. And then we'll have professional installers go in and install that alarm for the homeowner, and then sign them up onto our service network. And that's really the advantage of the home alarm system that follows the car alarm and others, in that it's not only the hardware sale but it's also the service sale, which is a high-margin opportunity for us.

Regarding a good barometer for the Brazilian market, we really -- I can't say there's one thing that we had that we would say, that's indicative of it. What we try to watch now is distrubutors' inventories on hand versus the final demand. What I would say is that, as of this month, we see that the distributors' inventories are pretty much equal. They're not building inventories, and they're not reducing inventories.

I guess that kind of gives us a little bit of confidence that we're not seeing an inventory build that will spike, and then later on we'll have to take it down. So I guess the next, I would say, 30 days will tell how the quarter is going to go. Because most of the people will have to -- distributors will have to order their product for the Christmas selling season, if they haven't already started to put in those things.

But I don't have a real good flavor as to -- I look for things -- if I hear the export markets are improving with the commercial vehicle trucks going down there, that should be an indication of some economic activity. But in the automotive segment, when the government offers certain incentive programs, it skews that market demand. And I haven't found -- we haven't found that very useful for us in measuring what happens in those markets.

In fact, Rhem, in those incentives in the government in the month of August, they were actually skewed to low-end vehicles -- so 1000 cc and less. And so what you really saw was a mix into low-end vehicles versus what I would call the medium-level and the luxury vehicles; and that was up 28% in August, but then when they pulled it back, it was down 30% in September. So there's no real direct correlation between what's going on at that OEM level and then what's happening in the aftermarket channels.

Okay. Thanks, that's helpful. And then one more and I'll turn it over. Navistar has announced their agreement with Cummins on new engines and they have -- looks like that they're going to get some of these out at the end of the year. What are you guys seeing there? And how should we think about that with regards to how it flows through on margins and earnings and everything else?

Yes, I think Navistar said they'll get their 15-liter engine out in November. That will be the Cummins engine that they will put in their ProStar fleets. And then they will have a pre-launch 13-liter engine in March of next year, with full production, I guess, in April of next year. They have said they have signed that agreement, as you indicated.

As we look at this, in my estimation it's going to take Navistar a couple of quarters maybe to regain market credibility to some extent. I think their products will be -- they're good products out there. But I think they've got to regain some credibility in the market space. So as we look at them, it's always been, for us, a difficult call as to where their volumes are going to come out.

We constantly think we see the bottom of this, and then we see some additional adjustments. Not only because the market overall is declining, but because maybe there's some share shift. Again, we continue to look at this and think that they have hit the bottom. And we would expect to see that, as we develop our plans for next year, that they would gradually improve in the second half of the year, depending on what goes on in the market.

But I don't have -- at this stage, it's all in the demand cycle. We haven't heard anything from the fleets that would indicate significant changes in their patterns or buying behaviors.

Okay, so volumes to you guys would show up more in the second half of next year rather than anything near-term, right?

Well, I think they've maintained their volumes for this year. We're looking at truck builds -- Class 8 truck builds, I think, in the fourth quarter of a little over 1000 units a day. And then I think it's projected to improve in the second and third quarter. That's for the overall market. Now, Navistar's projections -- those are, I think, factored in around -- which we would say an 18% share of market, I think.

It's actually a little less than that.

Yes, it's down around 15%, 16% right now, Rhem. I think the answer is, is how fast does this take? And where do the fleets respond? But I would envision, if it really picks up for us, it will be more into 2013, somewhere out in the first, second quarter.

Okay, great. Thanks for the time.

Jimmy Baker, B. Riley & Company.

Good morning. Thanks for taking my questions. So I'm looking at slide 18 of your presentation here that shows the 284,000 North American Class 8 builds. Clearly, that looks aggressive. But if your commentary is correct, then at the low end builds are only, call it 240,000, that would imply only 20,000 builds here in the fourth quarter. So how could you hit your guidance if the market is down almost 70% sequentially?

Well, Jimmy, that slide really alludes to the external forecast of JD Power's. I think John has shared with you what we think it is. It's running more down around 240,000, 250,000, with being lower here in the third quarter and the fourth quarter. So we don't see a big uptick in the fourth quarter; I think it's going to run fairly consistent with what it is in the third quarter. And that's why we don't see any lift in our wiring business, which is driven from both sides; both the North American commercial side and from our primary customer. So I think we are going to continue to run in about the same level that we've seen here in the third quarter into the fourth quarter on the truck side.

Didn't you see about 63,000 or 64,000 builds in the third quarter?

Yes, if you look at the third -- well, there was about -- yes, in that range. We think it's actually -- in our forecast, it's down a little bit from that. And I think that's -- I think the industry is going to adjust their forecast. I think we're starting to see that in talking with other people. We're starting to see it come back down.

I think that there -- there's still a question out there whether there will be some pre-buys this year. I don't think that's a question anymore, so I think we'll see some softness. There's just a lot of uncertainty in the market space. It makes forecasting very, very difficult as to what we should plan on.

We're trying to stay in line with our customers. But as I said in my comments, it's very difficult when a customer reacts quickly to the market response that they're getting. And everybody's doing that. And we're seeing softness in the commercial vehicle markets; we're trying to adjust our cost structure to match that.

But I don't think anybody has a firm handle on where the end number is going to be. I think there is a lot of uncertainty out there. In Europe, for instance, we saw some manufacturers take days out of their production schedule just recently. Because they decided, okay, I'm a little over-inventoried and I'm going to take -- in the holiday period -- I'm going to keep the plant shut for an additional three or four days. And I think that's what we might see here. We just don't know what will happen in the December holiday period.

Right, that makes sense. Looking over to 2013, can you speak to your preliminary expectations for Western European commercial vehicle production there? And if your customers your customers are expecting, or have given any indication to you of their expectations, for a pre-buy ahead of Euro VI?

Well, no, I don't have that information. Our expectations right now, the positive side would be the market stays as it is today, with maybe some modest improvement. But I do not have a firm answer on what people are forecasting for Euro IV pre-buys.

Okay. And then lastly, can you talk about what level of production increase you'll be able to support -- whether in 2013 or beyond -- before some of these cost reductions that you are going to remove from the model will need to flow back in?

Well, Jimmy, we've taken -- almost all the cost initiatives we take for the most part are what I would call permanent, except for Brazil. We did take some actions there that ramped them down significantly. Because you know we actually produced and sold $55 million. Now some of that was currency in the first quarter. It fell to about $38 million.

So we took out about 300 direct and indirect labor in Brazil in the first quarter. That may have to adjust if we actually get the volume back substantially more than the level we're running right now. But I think it's running at a level that I think we're comfortable with, and the mix has improved.

In terms of our North American side, we really have the ability to ramp up substantially. And I think what I would also tell you is that our ability to flex with schedules today are much better than where they existed before. And so we have been tending to run our schedules light of what our EDI forecasts are from our customers. And we've had the ability -- because in Mexico, it's a little more difficult; once you hire employees, to let them go when the volume has dropped. So we're tending to run a little lighter, and then flexing up with the schedules.

But if you remember, back in this year, our previous guidance was up around $850 million. And that was a Class 8 level of running about 275,000 to 280,000. So we could clearly flex back up in that level to 275,000, 300,000 without really adding a lot of cost back. Because we are really starting to see significant productivity improvement in the wiring business, which is the one we struggled with the most. And our overhead cost structures are coming down, and that would not be replaced.

Some of the actions in the raw material costs was really about redesign that we did in the pass car and the control device business. That will not change. And we've seen a gradual improvement in our raw material costs as a percent to sales over the last two quarters. So that will be in place; the productivity in the wiring will not change. I think the only real aspect could be Brazil, if that volume would really start to ramp. Because if you remember, a year ago, Brazil did almost $240 million in sales in 2011; we're down running in the range of somewhere slightly less than $190 million.

So we may have to adjust some of the direct labor and some of the indirect labor in our Manaus facility to handle a demand surge there if it really increased.

Okay, that's helpful. Thanks for the color.

Robert Kosowsky, Sidoti & Company.

Just had a question looking into next year. Say it is kind of this like -- Volvo came out today and said it was a flattish outlook for next year for the global truck market. So say that is the case, even on the passenger side. How do you look at your gross margins trying to get to 2013, with some of the cost cuts that you're doing right now in addition to some of the benefits you are probably going to see from lower commodity costs, and just kind of other currency issues that also might come into play? So, a backbone for how we could see margins potentially trending towards next year.

Well, Rob, I think we've given -- and at our current guidance gives the range of where we think that is. Right now we're at the bottom end of the range. I think it would slightly improve with our cost initiatives. But I think what we're looking at right now, sales are going to be probably marginally better than they are this year in terms of topline growth. I would think our margins would stay pretty close to where we're at, or slight improvement, based on the initial volume that we're looking at for next year.

So, still remaining in this 19% to 20% range for the core --?

For the core business? No, it would be better than that. We've given guidance in our core business sitting at about 20.5% to 22%. I think we'll be in that range for next year.

Okay. And then say, next year comes and it's -- you pay down a lot of the debt that you're doing right now, would you turn your eyes towards buying back a significant amount of the Company? Because if you have another good year of free cash flow, you could potentially buy back 10%, 15% of the Company.

Well, we're somewhat limited by our indentures. And we've taken a look at that. And there is some limit for us to do that. It clearly would always be an alternative we've put on the board. But, quite frankly, we believe we have other investments that would give greater returns than buying back the stock.

We'll continue to evaluate it. But I think as we go -- and depending where the market is at, we do have some smaller bolt-on acquisitions. We need some investments in Brazil and India and China, which are three key emerging markets. But we've looked at that as an alternative. We have not made a decision. But we are somewhat limited by the indentures in how much we could really do.

Okay, thank you very much.

Joel Tiss, BMO.

So, just two questions. One, it seems to me the flavor that I'm getting from the truck makers is more that the customers are kind of playing chicken. The age of their fleet is up; their maintenance costs are up, as you said. And the tone seems to be more that it's just a matter of time before the orders come back in North America. And you guys seem to be saying that things are looking a little more flat for a longer period of time. So I just wondered if -- are you hearing specific things from your customers? Or what could be some of the reasons for the difference?

Well, one, is the natural optimism that I think people see as going forward. And we thought we had that at the beginning of this year. And if you recall, this year, everybody thought it was going to be very -- last year, in the fourth quarter, everybody thought 2012 was going to be a great year. Strong first half, strong second-half; as we got into the year, they saw it weakening, and started reducing expectations for the second half.

We are naturally more conservative because, as George has indicated, when we have to staff up for demands in our plants, we can't necessarily bail out of that cost right away when the demand doesn't materialize. So we're a little more cautious about this. And we try to correlate with what other suppliers are seeing in their forecasts and their demands to come up with what we think is realistic.

Yes, we pay attention to what our customers say, but we also try to validate that. There is the statement that the fleets have aging fleets and the maintenance costs are going up is true, and they could turn around and start to buy more. I think once somebody -- I think once the elections are over with, we get some sense of direction, of confidence of where things are going, people will then start to figure out how to operate. But right now, we can't forecast that in.

Okay, and just one other -- maybe a little bit of a weird question. Do you know if the Navistar customers are going to have to -- are going to want to, or have to test that Navistar truck with the Cummins 15-liter engine? Or because they're both relatively known quantities, people will just order them right away.

Well, I think they know the performance of the Cummins engine. And I think that they will -- so I don't think they will have any real issues with that. And that is that Cummins Engine; it's not a Navistar engine, so that's a proven performer. It's just like taking an engine and putting it in a body, I don't think there will be a lot of issues with that from the customer's perspective.

I think the other side will be more when they put the 13-liter with the new aftertreatment system in next year. And I think they will probably have some vehicles out on the road prior to that period of time, to have those tested out by the fleets. They will roll that out, I think, appropriately.

Right. That's usually a 9-month testing period.

Yes, well, I think they'll have some -- because they have the aftermarket treatment system from Cummins that -- their treatment systems from Cummins that's already proven; and they've just got to bolt it on to their engine. I think if there had some issues that customers will see those things right away. It could have some impact, but I'm not certain that it will.

Okay. Thank you very much.

Richard Hilgert, Stoneridge.

With Stoneridge? That's Morningstar.

Yes, that's Morningstar. How are you doing, Richard? We thought you changed teams.

Doing fine.

Glad you joined us. (laughter)

Looking at Europe and the markets over there, your main customer is Scania, at about 5% of your revenue. Total European revenue, it's about 21% of your total. Curious who the other large customers are over in the European market. And I'm also a little bit curious about what are the dynamics over in the European market that are different versus over here?

Over here, the fleets really drive the market; the fleets drive special specifications on the truck. They don't do that over in Europe. In the European market, we've had five years of economic decline; where we've actually had some recovery over here in the US since 2008, 2009.

So I'm curious, what are some of the major contrasts that you're seeing between the two; and, again, the larger customers that you have over there beside Scania?

Yes, well, we sell to all the major truck OEMs over there, except for Iveco, so we have product on every one of them. If you look at Scania's performance, they have probably more export weighted sales exposure. And so when the export markets upturn, for them it's a benefit. The other have it, too.

The rest of them -- as we look at it, in the European markets, I don't know if there's a good answer to the question of why is that market different than the North American market in terms of truck sales; because ultimately that's what you want to look at its truck sales. If you look at what they do, they're probably more regulated than we are. So they have a lot of things that get regulated on there from driver -- for the tachograph systems and other things.

But in terms of the actual vehicle, it's just features and products that the OEs are introducing that they find are attractive. If you look at, for instance, Volvo's new truck that they are launching out, they've talked about more interior cab room in the truck. Then people talk about the infotainment systems or other things.

But for the fleet owners, or the individual owner, it's really a cost of, one, the cost of running that truck, which is in a higher mileage, is a higher maintenance costs; fuel efficiency and fuel economy; and then, can they get financing for it. The fleets don't have a problem with that, but the smaller drivers do. And I think that's the same thing is true over in Europe.

Are there more owner-operators over in Europe or fewer, compared to our market here in the US?

That I don't know. I can't answer that. That's a good question, though. We'll try to get some information on that.

Well, Richard, if you look at the content within the four, Scania tends to do a lot more exports. So they were down this year almost 28%, because a lot of the Brazil exports fell. We're seeing some strengthening with Scania now, where they are starting to increase orders for export. Whereas as Volvo tends to be more a global platform, so they're doing better in the US, and they're up slightly -- a couple percent.

And then, MAN and Daimler are down roughly about what the European market is down, in the range of probably 5% to 10%. And they tend to concentrate more on the Eastern Bloc and also the Western sales. So every one of those four seemed to have a different dynamic of how they deal with their markets and where they penetrate different sales.

So, overall, we are down probably, on average, 5% to 10% this year. So it's consistent across the four. But each one of the four key customers are slightly different in terms of how they address their markets.

Okay. So then really it just boils down to the basics. There is nothing unique about the market, or different compared to the US market. We just need to look to the economic activity going on over there, as to when we might see the beginnings of a recovery; just like we do here in the US. (Multiple speakers) Aside from other things, like the Euro VI emission standards coming up, end these kinds of things.

That would be correct, yes. I think that's the way to look at it. I don't see any different motivation from the fleets or the individual owners, other than the same ones are here in North America.

Okay, great. Thanks, guys.

(Operator Instructions). Justin Long, Stevens.

One of the impressive aspects that I thought in the quarter was free cash flow generation. And it looks like one of the big drivers to that was the decline you guys saw in inventory. Just curious what the opportunity for further inventory reductions was -- or is, going forward? And just in general, how you think about working capital trending as we look into 4Q and into next year as well.

Well, you know, the two areas that we've really focused on, as you know, with inventories is really Brazil, and they are still running high. They've done a great job through September. They actually made another improvement here in October. But I think that's an area that we'll still continue to focus on. And there's probably another $5 million to $8 million we can do there.

And the other one is the wiring business. We're still running with high days, at around 40 to 41 days. Their goal is to get it to 30, so there's probably about $5 million improvement there. But we've really started to get better focused on inventory in the positions we have.

Moving forward, as you could imagine, with sales coming off into third and fourth quarter, we will have to make some investment in working capital next year and 2013, as the top line starts to grow. And I think the best measure of that is about $0.12 per dollar of sale per working capital. So if we're up $10 million or $20 million, you know we're going to need somewhere around $1 million to $2 million to $4 million, let's say, for working capital. But it won't be all that significant.

Okay, thanks. That's helpful color. When you think about the leverage ratio going forward, is there a long-term target you guys have? Obviously that's coming down, and will be down pretty significantly by the end of this year. Just trying to figure out how you balance paying down debt into 2013. Because it looks like, based on the free cash flow you're generating, you could potentially wipe out all debt, with the exception of the senior notes that become redeemable in late 2014. But just curious how you're thinking about that.

Well, clearly, we have some more work to do in Brazil. They still -- with the efforts they are doing, by the end of this year we'll have roughly about $20 million in dollar debt. And it's not so much that it's expensive, but it's highly volatile because the currency moves. It can be -- costs a lot more in interest expense. We hope to have most of that handled, by sometime late second half of next year, that we can pay probably about another $15 million to $20 million.

From there, we'll have the ABL paid off by the end of this year. And then it's really from that aspect, as we'll start looking at small investments in the emerging markets where we have alternatives to do; and some bolt-on acquisitions to really look at penetrating the market where we have some voids either end products or technologies or supporting customers.

But I think, for the most part, in the goals that you indicated, for us to get less than somewhere between 2 and 2.5 times, clearly we're not using the leverage to our advantage. And I also look at the parameter -- our debt to debt equity. We're going to approach that range of around 40%. That's a good level for us for the balance sheet, because I think one of the things in our business, with half of it being commercial, you always have cycles.

And if you remember our cycle back in 2008 and 2009, we had sufficient cash. And we could manage the peaks and the valleys. And we were running with cash between $90 million and $95 million during that period. So we do want to replenish some of the cash balance that we can manage through those cycles. But, clearly, we'll continue to generate cash over the next couple of years.

One of the alternatives we are looking at is maybe start to take out some of the bonds. We have the ability to buy up to 10% a year. That transaction looks interesting, based on the improvement in interest expense versus the cost. We can't take out all the bonds, because there's a prepayment penalty. But, clearly, I think we could ratchet some of those down. If we didn't have other alternative investments, we'd start taking out partials; maybe 10% of our long-term debt annually, which still is an attractive financial deal for us.

That make sense. Shifting gears a little bit, I wanted to ask a couple questions on Brazil. It seems like in the fourth quarter we should see a seasonal pickup. And we should also see an improvement in product mix as well. Could you remind me what product launches you have in the current quarter, and maybe talk about some of the product launches that you are planning on for next year, and how that might impact the product mix as well?

Yes, there really aren't any -- when we sell alarms, alarms are our higher-margin items versus the audio line. And that's part of the improvement in the third quarter mix. We've sold more alarms. That was a factor of the market recovering somewhat. We expect that to continue in the fourth quarter, so we should see a higher mix of the alarm systems.

As I've said, we are launching, in the fourth quarter -- these will be the cargo tracking system and the home alarm system. They won't have any significant impact on our market share in the fourth quarter, or on our revenue. But they will start to roll out all throughout next year, and should then have an opportunity for us to have increased revenues, even in a flat market, because of these new products.

And so those would be the two most significant launches that we have going on next year. There will be some other things that surround our security systems and our tracking systems that will be -- but they're not significant.

Okay, great. That's helpful. You mentioned there's been some volatility in Brazil month to month, which is certainly understandable given the macro uncertainty there. But any commentary on what you're seeing so far this quarter through the month of October?

Well, what we are -- the biggest thing, as I said, we follow what distributors are doing with their inventories. And we're seeing distributors be very prudent with their inventories. They're not taking them up to the normal -- we would say, we would have thought they would have taken them up maybe an additional month in inventories to prepare for the holiday season.

It's more like, maybe, an additional week or two weeks. So we're not seeing as much of a build, but we still are seeing the build. They are doing a better job of managing their inventory level to the final demand. So that gives us the best indication of where the market is. And, again, with these guys, we'll go through October, and then probably through the middle of November we'll determine a lot on how the market -- how the year is going to turn out. As they gain either more confidence or less confidence, they will start to increase those inventories, or start to -- or hold where they are. Because they are pretty much where they would normally hold their inventories right now.

So I would say in the next 15 to 20 days is going to be the -- or, I'd say 15 to 30 days would be the time for us to really assess that market. But we're not seeing any weakness in the market. We actually are still seeing gradually improving trends that we saw from the second quarter into the third quarter. And we expect to see that going on in the fourth quarter. And there's nothing today that would indicate that that's not going to continue.

And our mix is positive, as we saw in the third quarter. So our margins are hanging in there very well. We're pleased about that.

Great. That's good to hear. I appreciate the time.

There are no additional questions at this time. I would now like to turn the presentation back over to Mr. John Corey.

Well, I'd like to thank you for joining us on today's call. As we've try to highlight on today's call, there's a great amount of uncertainty, globally, in the markets -- the direction of the markets, and the growth of the markets, or the decline of the markets.

And we have taken positions that we believe will position us to be beneficial as the market recovers. We've taken cost of our businesses. We will continue to look at that and take that out. We're hoping -- we're seeing that we -- at the bottom end of the cycle, hopefully. And I think if 2013 -- as we've said -- if 2013 comes out with some volume improvement, we should be well-positioned to take advantage of that.

Certainly, if the Brazilian market improves significantly next year, we'll see a lot of advantage from that. Because the demand on those products, historically, has been quite good, and the margins have been quite high. So I think, in this period of time, it's prudent for us to do the things we've said -- manage our cost structure effectively; manage our working capital effectively; focus on generating cash flow; and then looking at selected product or market opportunities. And that is, indeed, what we're managing for as we go forward right now in the fourth quarter, and then looking early on in 2013.

So with that, I'd like to thank you all.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.