Stoneridge, Inc. — Q2 2017 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2017; unaudited. Unless otherwise noted, amounts below are in millions of U.S. dollars.
Business context and reporting period
Stoneridge designs and manufactures electrical and electronic components and systems for automotive, commercial, motorcycle, off-highway and agricultural vehicle markets. Its segments are Control Devices, Electronics and PST.
The results include Orlaco from its January 31, 2017 acquisition. Orlaco makes camera-based vision systems and related products. On May 16, 2017, Stoneridge acquired the remaining 26% of PST, making it wholly owned.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $209.1 | $186.9 | $413.4 | $349.5 |
| Operating income | $15.7 | $13.6 | $30.8 | $22.1 |
| Net income attributable to Stoneridge | $9.0 | $11.6 | $18.2 | $18.8 |
| Diluted EPS | $0.32 | $0.41 | $0.64 | $0.67 |
| Gross margin | 30.3% | 28.2% | 30.1% | 28.0% |
| Operating margin | 7.4% | 7.3% | 7.5% | 6.3% |
- Second-quarter sales increased 11.9%; first-half sales increased 18.3%. The filing attributes growth to higher sales across segments, including Orlaco, new Control Devices products and increased PST monitoring-service volume.
- Operating cash flow was $27.0 versus $17.8 in the first half of 2016. Capital expenditures were $15.2 versus $12.0. Investing activities used $92.7, including $77.5 for the Orlaco acquisition. Financing activities provided $56.7, primarily reflecting increased revolver borrowings.
- Cash was $44.2 at June 30, 2017, down from $50.4 at year-end 2016. Current assets were $286.2 and current liabilities $126.9.
- Revolver borrowings were $132.0, up from $67.0 at year-end, and other debt totaled $12.4. The company reported compliance with its credit-facility covenants. The $300.0 facility matures in September 2021.
- Total assets were $521.0, up from $394.5 at year-end, largely reflecting the Orlaco acquisition. Goodwill was $36.2 and intangible assets were $76.7 at June 30.
Material changes versus comparable periods
- Q2 operating income rose $2.1, but net income attributable to Stoneridge fell $2.6 and diluted EPS declined from $0.41 to $0.32. The primary reason was $3.8 higher income tax expense; the effective tax rate rose to 36.8% from 10.9%.
- First-half operating income increased 39.3%, while attributable net income declined $0.6. The effective tax rate rose to 35.0% from 11.4%, chiefly following the prior-year release of U.S. federal, certain state and foreign valuation allowances, and due to nondeductible earn-out fair-value adjustments.
- Gross margin improved year over year, aided by lower material costs, favorable currency effects on certain purchases, operating improvements and product mix. Orlaco inventory fair-value step-up expense partly offset the improvement.
- Q2 segment sales increased 4.7% in Control Devices, 24.0% in Electronics and 16.0% in PST. Electronics operating income fell to $2.8 from $4.5, with the acquired Orlaco business and higher development costs affecting results; PST returned to operating income of $1.1 from a $1.1 loss.
- SG&A and design-and-development expenses increased, partly due to Orlaco, including $2.1 of Q2 expense from an earn-out fair-value adjustment. First-half results also included $1.3 of Orlaco transaction costs.
Outlook, commentary, risks and unusual items
- Management expected 2017 sales growth in North American automotive markets from recent Control Devices launches, despite forecasting North American automotive production to decline by 0.4 million units to 17.4 million. It also expected China automotive growth from sensor and shift-by-wire products, a roughly stable North American commercial-vehicle market, and slight growth in Europe.
- Management described PST’s Brazilian market and economy as weak and moderated its 2017 sales and earnings expectations. It continued reviewing PST’s cost structure; PST had used factoring and short-term bank borrowing to support liquidity amid slower receivable collections.
- Management said product launches, operating efficiencies and Orlaco supported growth and margins. It cautioned that customer pricing pressure, production levels, foreign exchange, commodity prices, suppliers, labor, customer concentration and debt covenants could affect results.
- Orlaco acquisition consideration was $83.9, including contingent consideration. Orlaco contributed $28.5 of post-acquisition first-half sales and $0.045 of net income; Q2 post-acquisition results included a $0.547 net loss. Purchase-price allocation remained preliminary.
- The fair value of earn-out liabilities was $15.6 at June 30, including Orlaco and PST obligations. PST’s earn-out is uncapped and based on future performance. Stoneridge also reported $6.2 of PST dividends payable to former noncontrolling-interest holders by January 1, 2020, subject to inflation adjustment.
- Contingencies include a Brazilian tax assessment of approximately $28.0, for which management considered loss not probable and recorded no accrual, and other PST civil, labor and tax matters totaling $13.8 that were considered reasonably possible but not probable. A product warranty and recall liability of $8.5 was recorded.
- In the Verde matter, class certification was denied and the case proceeded as a single-plaintiff matter; no liability was recorded. A separate vehicle-control-device class action remained pending, with a class-certification hearing scheduled for August 2017; no liability was recorded. Management said ordinary-course legal matters were not expected to have a material adverse effect, while noting that outcomes could not be predicted with certainty.
- Cash-flow hedges and foreign-currency exposures remain relevant; management reported that a weaker U.S. dollar had favorably affected certain material costs and reported results in the first half. The filing also notes product-liability, warranty and recall risks.
Most important facts for investors to verify
- Whether sales growth and margin improvement persist after separating Orlaco’s contribution from underlying segment performance.
- Whether Orlaco integration, profitability and the preliminary acquisition accounting meet management’s expectations, and how contingent consideration changes.
- Whether higher taxes continue to weigh on earnings, and how cash taxes compare with management’s expectation of historical levels as a percentage of income.
- Whether the company can generate sufficient operating cash to fund capital spending and reduce revolver borrowings while remaining within covenants.
- Developments in Brazil, including PST liquidity and earnings, the tax assessment, other contingencies and foreign-exchange exposure.
- Updates on the pending product litigation, warranty and recall claims, and the related recorded liabilities.