Stoneridge, Inc. (SRI) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2012 Stoneridge Earnings Conference Call. My name is Lisa, and I will be your operator for today. [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 company presentation has been or 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’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 the most directly comparable GAAP measures. John will begin the call with an update on the current market conditions, operating performance in the third quarter, our growth strategies, business development, and his thoughts on future initiatives, 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 3 quarters and details of our 2012 guidance and initial market outlook for 2013. As we shared with you on 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 which can be found on our website. After John and George have finished their formal remarks, we’ll then open up the call to questions. With that, I will 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 began 2012 with [ph] 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 and 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 [ph] 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’re implementing pricing adjustments to partially offset higher commodity cost and continuing work to reduce material cost 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 the PST’s consolidated sales. Excluding the effect of PST 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 ’11 versus the third quarter of ’12. Slide 10 of our deck identifies Stoneridge’s core sales decrease versus the prior year third quarter, which was 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 ’12 to the third quarter of ’12. We reported net income of $0.02 of 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 and higher margin car alarms in the PST business, while controlled devices in our electronic business experienced lower direct material charges as can be seen in Slide 13 of our deck. PST sales volume 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 and the summer months in the fourth quarter. Agricultural 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 controlled 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 were stronger in [ph] core business in the third quarter were $11.9 million, of which $8.6 million were new awards and $3.3 million were 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 20% reduction in the valuation of the Indian rupee compared to the U.S dollar. Excluding the effects of foreign exchange, Minda 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 increase material costs and SG&A cost in the third quarter of 2012. PST, our Brazilian joint venture, recorded third quarter 2012 sales of BRL 88.8 million, compared to BRL 75.4 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 U.S dollars sales were $43.8 million based on an average exchange rate of 2.03 reais to the dollar, compared to $62.4 million in the third quarter of 2011 based on an average exchange rate of BRL 1.72 to the dollar, for a devaluation of about 18%. PST’s gross margins excluding $1.7 million per 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 in favorable car alarm sales and the second quarter cost initiatives were approximately BRL 3.3 million or USD 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 forecast from industry projections are between 14.8 million to 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 estimate 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 margin is 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 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 we’ll continue to improve our performance in the balance of the year. With improvements in market volumes, we’re positioned to benefit through improved 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 this year, which will position Stoneridge well for next year. The key aspect of our return to profitability is recovery of PST sales and the benefits from the cost initiatives that were implemented in April and May of this year. PST sales levels had been highly volatile from month-to-month as they sell products to multiple channels through retail consumers, dealers, mass merchandisers and OEMs. The purchasing patterns of each distribution channel have been different as consumers had 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 the lack of confidence in consumer demand, distributors began to reduce their inventory levels 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 suspecting [ph]. We’re forecasting continued improvement in the fourth quarter as the seasonal effect of Christmas, which is the largest retail demand holiday for electronics, and the summer season occur, which is historically 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 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 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 increase transaction 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 America commercial vehicle customer and sales to our European customers below our expectations. We expect moderate improvement in the fourth quarter. Volume reduction in our core business reduced our operating income by 7.5 million in the third quarter compared to 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 impact should stabilize as well so long as the euro and the reais stay in the 127 to U.S. dollar and 205 ranges, respectively. And finally, our wiring group continues to make progress 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 volumes. Though the North American wiring businesses is now experiencing lower than planned sales level in the fourth quarter 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 have 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 3.5x at December 31 of last year to 2.75x at December of this year. Much of this improvement has already occurred and we’re on track to generate additional free cash flow to pay down additional debt in the fourth quarter. We will pay off of our core businesses ABL debt balance of $11 million in the fourth quarter. PST has paid down their high interest reais-denominated working capital loans at the end of third quarter and will begin to pay down their U.S. dollar denominated debt in the fourth quarter. During the first 3 quarters of 2012, Stoneridge has paid down $47 million in total debt with our core business paying down $27 million, and [ph] ABL borrowing 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 slowing markets. Our sales volume has been reduced for the year due to PST as a result of Brazil GNP running at less than 1.5% this year, softness in European commercial vehicle markets and lower levels of commercial business of North America. Even with the revenues drop, we’ve been able to maintain our gross margins of both our Stoneridge base business and PST to ensure we continue to deliver our profitability and cash flow. We’ve implemented specific cost reduction in this -- initiatives of PST, European Electronics and our wiring business. We’ve 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 costs 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 ABL lines and PST debt. This will reduce our debt leverage to 2.7x by the end of this year, compared to 3.5x at December of last year. And we believe we’ve 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 markets to run at this year’s level or at a slight improvement in the range of 240,000 units to 250,000 units. We’ve taken cost actions necessary in PST while the Brazilian market is improving in the third quarter and expected 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] Your first question comes from the line of Rhem Wood with BB&T Capital Markets.

Okay. So my question is, your guidance kind of implies for Q4 an acceleration in both revenues and margins from third-quarter levels, and I guess I kind of understand the margins a little bit better if you’re able to take out some cost, but you talked about kind of commercial vehicle being weak and then things like in Brazil it’s pretty volatile from month-to-month. So 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 in 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 next -- 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 will be 5% to 10% down, 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 primary in 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 cycles. So, that is on balance about where we expected to be. And 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’ve 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 will be a good time to see that our market -- that the 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.

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 will be up in other 10% to 15%. But what’s important in that is the increases, the margin were ship [ph] 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 the sufficient level that the key mix of products with our higher margin businesses -- a bigger part of the mix there. So -- and their 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 cost raising prices and actually redesigning products, which started way back in the fourth quarter of last year. Their cost of materials as a percent of sale have been improving and we’re looking for 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 the sales. So, 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 cost down.

Okay. As we look at Brazil, I mean what is the best gauge to watch, because some of those signals were mixed and auto sales are okay. But GDP is running weak and if you trip up the industrial kind of component of that it’s really weak. And then you guys have kind of an aftermarket product, so just because it’s auto sales and then I guess you’re going to be selling them. 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 in cargo tracking; they’re actually having meetings this week with various organizations around cargo tracking. And, so they’ll 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 deposit on 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 roll out of that right now in the fourth quarter. We’re signing up distributors and the way we would 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 going in and install that alarm for the home owner and then sign them up onto our service network, and that’s really the advantage of the home alarm system, it 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 margined 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 distributors’ inventories on hand versus the final demand, and 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 then they’re not reducing inventories. So, 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 their Christmas selling season if they haven’t already started putting in those things. So 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, 1,000 cc and less and so what you really saw was a mix into low-end vehicles versus what I’d call sort of a medium level in 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 is no real direct correlation between what’s going on at that OEM level and what’s happening in the aftermarket channels.

Okay. That’s helpful, and then one more and I’ll turn it over. Navistar has announced their agreement with Cummins on the new engines and they have -- looks like they are going a get some these out at the end of the year. I mean 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 will 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’ll have kind of a prelaunch 13-liter engine in March of next year, with full production, I guess, in April of next year. They’ve said they signed that agreement as you indicated. As we look at this, it’s going to -- 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 would be -- there are good products out there but I think they have 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 of the market overall is declining but because maybe there are 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 stay, they would gradually improve in the second half of the year dependent on what goes on in the market. But I don’t have -- I mean 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 we -- they’ve maintained their volumes for this year, we’re going to look at truck builds or Class 8 truck build I think in the fourth quarter of a little over 1,000 units a day and then I think it’s projected to improve in the second, 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 really less and it’s down around 15%, 16% right now, Rhem. I think the answer is as how fast does this take and where do the fleets respond, but I will envision if it really picks up for us it will be more into 2013, somewhere out in the first and second quarter.

Your next question comes from the line of Jimmy Baker with B. Riley & Company.

So, I’m looking at Slide 18 of your presentation here that shows 284,000 North American Class 8 builds, so clearly that looks aggressive but if your commentary it’s correct 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 Powers. I think John shared with you what we think it is, it’s running more down around 240,000, 250,000 with sort of being lower if you’re 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. I mean, that’s why we don’t see any lift in our wiring business, which is driven both -- from both sides, both the North America commercial side and from our primary customer. So I think we’re going to continue to run in about the same level that we’ve seen in the third quarter, into the fourth quarter on the truck side.

Well, and do you see about 63,000 or 64,000 builds in the third quarter?

Yes. If you look at the third quarter -- well, there was about in that range or I think -- 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. So, I think that there is 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 and 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 aligned with our customers. 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 is 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 of handle on where the end number’s 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 3 or 4 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, kind of your preliminary expectations for Western European commercial vehicle production there? And if your customers are expecting or have given any indication to you of their expectations for a pre-buy ahead of Euro 6?

Well, no, I don’t have that information. I mean, 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 6 pre-buys.

Okay. And then lastly, can you maybe just talk about what level of production increase you will be able to support whether in ’13 or beyond before some of these cost reductions that you kind of removed 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 permit [ph] except for Brazil. We did take some actions there, that sort of ramped them down significantly because we actually produced and sold $55 million, and 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 are running right now. But it’s -- I think it’s running at a level that I think we’re comfortable with and the mix is improved. In terms of our North America 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’ve 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 sort of let them go when the volume is 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 running about $275 million to $280 million. So we could clearly flex back up in that level to $275 million, $300 million without really adding a lot of cost back because we’re 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. And some of the actions in the raw material cost was really about redesign that we did in the pass car and the controlled device business. That will not change, and we’ve seen a gradual improvement in our raw material costs as a percent of sales over the last 2 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 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 Minous [ph] facility to handle a demand surge there if it really increased.

Your next question comes from the line of Robert Kosowsky with Sidoti.

I just had a question like looking into next year, say it is kind of this like Bob looking at it today and said it was flattish outlook for next year for the global truck market. So say, that is kind of the case even on the passenger side. Kind of how do you look at your gross margins trending into 2013 with some of the kind of cost cuts that you’re doing right now in addition to some of the benefits you’re probably going to see from kind of lower commodity cost and just kind of other, kind of maybe currency issues that also might come into play. So just kind of a background for how we could see margins potentially trending towards next year?

Well, Rob. I think we have given in our current guidance sort of gives the range of where we think that is. Right now, we’re sort of 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 top line growth. So, 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, it’s still remaining in this 19% to 20% range for the core counters [ph] business?

It would be better than that. I mean -- so, when we have given guidance in our core business sitting at about 20.5 to 22, I think we will be in that range for next year.

Okay, and then say next year comes and it’s -- you paid 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, I mean you 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 alternate 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, so we’ll continue to evaluate it. But, I think as we go and depending where the markets have, we do have some smaller bolt-on acquisitions, we need some investments in Brazil and India and China, which are 3 key emerging markets, but we’ve looked that as an alternate, we’ve not made a decision, but we are somewhat limited by the indentures and how much we could really do.

You are next question comes from line of Joel Tiss with BMO.

So just 2 questions. One, it seems to me sort of the flavor that I’m getting from the truck makers is more that the customers are kind of playing of chicken, their -- 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 seems 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 in going forward and we thought we had that at the beginning of this year and if you recall, this year everyone thought it was going to be [ph] 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’re 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 bit more cautious about this. And we kind of try to correlate with what other suppliers are seeing in their forecasts and their demands to come up what we think is realistic, yes, we pay attention to what our customers say, but we will also try to validate that. There is -- the statement that the fleets have aging fleets and the maintenance cost is going up is true and they could turn around and start to buy more. I think once somebody gets -- once the elections are over with, we get some sense of direction and 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 weird question, do you know if the Navistar customers are going have to, are going to want to or have to test that Navistar truck with the Cummins 15-liter engine or because they are both relatively known quantities, people will just order them right away.

Well, I think they know the performance of the Cummins engine, I think that they will -- so I don’t think they will have any real issues with that, that is the Cummins engine, it’s not a Navistar engine, so that’s a proven performer, so it’s just like taking an engine and putting it in an body. I don’t think there will be a lot of issues with that from the customers’ perspective, I think the other side will be more when they put the 13-liter with a new after treatment system in next year and I think they’ll probably have some vehicles out on the road prior to that period of time to have those tested out by the fleet. So they’ll roll that out I think appropriately.

Right. That’s usually kind of a 9-month testing period?

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

Your next question comes from the line of Richard Hilgert with Stoneridge (sic) [Morningstar].

Not Stoneridge, that’s Morningstar.

Yes. It’s Morningstar, I know Richard, we thought you changed teams. We’re glad you joined us.

Looking at Europe and the markets over there, your main customer is Scania at about 5% of your revenue and 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 over 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 5 years of economic decline where we’ve actually had some recovery over here in the U.S. since 2008, 2009. So I’m curious, what are some of the major contrasts that you’re seeing between the 2 and again the larger customers that you have over there besides Scania?

Yes. What 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 than -- and so, when the export market’s up turned, for them it’s a benefit, I mean the others have it too. The rest of them, as we look at it, in the European markets, I mean, I don’t know if there is 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 truck sales. I know that 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, from the tachograph systems and other things. But in terms of the actual vehicle, I mean it’s just features and products that the OEs are introducing that they find 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 that truck. And then people will 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 miles, is a higher maintenance costs, fuel efficiency or 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 U.S.?

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

But Richard, if you look at the content within the 4, 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 starting to increase orders for export. Whereas Volvo tends to be more global platform, so they’re doing better in the U.S. and they’re up slightly couple of percent and then MAN [ph] and Daimler are down roughly about what the European markets 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 4 seem to have a different dynamic as to how they deal with their markets and where they penetrate different sales. So overall we’re down probably on average 5% to 10% this year, so it’s consistent across the 4, but each one of the 4 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 U.S. 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 U.S.? Aside from other things like the Euro 6 emission standards coming up in these kinds of things?

That would be correct. Yes, I think that’s the way to look at it. I mean, I don’t see any different motivation from the fleet to the individual owners other than the same ones are here and in North America.

[Operator Instructions] Your next question comes from the line of Justin Long with Stephens.

One of the impressive aspects that I thought in the quarter with 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, the 2 areas that we’ve really focused on as you know with inventories is really Brazil, and they’re 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, there is 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 is 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 in the third and the fourth quarter, we will have to make some investment in working capital next year in ‘13 as the top line starts to grow. And I think the best measure of that is about $0.12 per dollar of sale to working capital, so if we’re up $10 million, or $20 million, 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. 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’re 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 is expensive but it’s highly volatile because the currency moves it can be – cost us a lot more in interest expense. So, 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 sort of penetrating the market where we have some voids either in products or technologies or supporting customers. But, I think for the most part in the goals that you’ve indicated for us to get less than somewhere between 2x and 2.5x, clearly, we’re not using the leverage to our advantage, and I’ll also look at the parameter, our debt-to-debt equity we’re going to approach that range around 40%, that’s as 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 ‘08 and ’09, we had sufficient cash, 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 sort of manage through those cycles, but clearly we’ll continue to generate cash over the next couple of years and so we’ll start looking -- 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 is prepayment penalty, but clearly I think we could ratchet some of those down if we did have other alternatives investment so we start taking out partials and maybe 10% of our long-term debt annually which is still an attractive financial deal for us.

That makes sense. Shifting gears a little bit, I wanted to ask a couple of 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 sold more alarms that was the 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 said, we’re 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 our revenue, but they will start to roll out all throughout next year and should have then and have opportunity for us to have increase revenues even in a flat market because of these new products. And so those will be the 2 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 are not significant.

Okay, great. That’s helpful. And you mentioned, there has 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’re -- as a -- 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. So they are not taking them up to the normal as we would say, we would thought they would have taken up maybe an additional month in inventories to prepare for the holiday season. It’s more like maybe an additional week or 2 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 middle of November, we’ll determine a lot on how the market, how the year is going to turn out as they -- as they gain either more confidence or less confidence, they will start to increase those inventories or start -- or start to maintain -- or hold where they are because they are pretty much where they normally would hold their inventories right now. So I would say, in the next 15 to 20 days is going to be the time, I would 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’re actually are still seeing the gradual 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 is 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, so we are pleased about that.

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

Well, I like to thank you for joining us on today’s call as we’ve tried to highlight on today’s call; there is 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. We’ve taken positions that we believe will position us to be beneficial as the market recovers, we’ve taken cost out of our businesses, we will continue to look at that and take that out, we’re hoping we are seeing that at the bottom end of the cycle hopefully. And I think in 2013, as we said, 2013 comes out with some margin improvement -- 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 is historically has been quite good and the margin’s been quite high. So I think in this period of time, it’s prudent for us to do the things we said: manage our cost structure effectively, manage our working capital effectively, focus on generating cash flow and then looking at selective product to market opportunities and that is indeed what we are managing for as we go forward right now in the fourth quarter and then looking early on 2013. So with that, I would like to thank you all.

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