Stoneridge, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Stoneridge designs and manufactures electrical and electronic components and systems for commercial, automotive, agricultural, and off-highway vehicles. Amounts below are in millions of dollars, except per-share data and percentages.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $195.9 | $160.4 | $579.3 | $474.8 |
| Operating income | $7.0 | $5.6 | $21.1 | $17.8 |
| Net income attributable to Stoneridge | $4.5 | $1.3 | $10.8 | $7.0 |
| Diluted earnings per share | $0.18 | $0.05 | $0.44 | $0.29 |
- Sales grew 22.1% in Q3 and 22.0% for the nine-month period. Q3 growth was led by Electronics, with segment sales up 33.0%; Control Devices sales rose 4.1%.
- Gross margin fell to 19.1% from 22.8% in Q3; nine-month gross margin was 19.8% versus 23.1%. Cost of goods sold rose faster than sales, reflecting foreign exchange, commodities, and manufacturing inefficiencies.
- Q3 operating income increased 25.2%; nine-month operating income rose 18.8%. Nine-month net income attributable to Stoneridge increased 54.0%. Lower interest expense supported earnings, while equity earnings from PST declined.
- For the nine months, operating cash flow was negative $17.4 million, versus positive $3.2 million in 2010. Investing cash use was $20.3 million, principally including $20.7 million of capital expenditures; financing provided $10.2 million. Cash declined $28.7 million to $43.2 million.
- At September 30, cash was $43.2 million and total debt carrying value was approximately $183.0 million, including $12.9 million current and $170.1 million long-term. The $175 million senior secured notes bear 9.5% interest and mature in 2017. The company had $10 million drawn on its asset-based facility and reported $69.6 million of borrowing capacity. Management said cash and facility availability should meet operating and growth needs.
- Total current assets were $268.2 million and current liabilities $142.6 million. The filing reports cash of $8.8 million domestically and $34.4 million abroad.
Changes and management commentary
- Management attributed higher sales to recovering North American and European commercial-vehicle markets, agricultural vehicle demand, new business, and favorable currency translation. North American commercial-vehicle production increased 55.9% and European commercial-vehicle production 28.1% in Q3 year over year.
- Q3 results were negatively affected by approximately $1.9 million from unfavorable currency movements, $1.2 million from commodity costs, and $1.3 million from labor inefficiencies at North American wiring facilities. For the nine months, management cited approximately $5.5 million of currency-related cost, $4.0 million of commodity impact, $3.7 million of labor inefficiencies, and $2.6 million of additional premium freight.
- Management said it was reducing direct labor and improving manufacturing processes, and expected these actions to reduce inefficiencies. It also cited the start-up of a new Mexico facility as a contributor to inventory and cash needs.
- Outlook was conditional rather than earnings guidance: management expected commercial-vehicle production to continue increasing and agricultural markets to improve through the rest of 2011. It cited a 2011 North American automotive production forecast of 12.7–12.9 million units, versus 11.9 million in 2010. Higher copper prices and foreign exchange, particularly Mexican peso exposure, were identified as risks. No specific revenue or earnings guidance was provided.
- Capital expenditures were expected to rise in the rest of 2011, including an estimated $5–6 million for the Saltillo facility start-up.
Risks, contingencies, and unusual items
- The company changed inventory accounting from LIFO to FIFO effective January 1, 2011 and retrospectively adjusted prior periods. The change increased inventory and reduced accumulated deficit by $2.4 million as of January 1, 2010; it increased nine-month 2011 net income by $1.6 million versus the LIFO presentation.
- 2010 comparisons include a one-time gain associated with placing UK subsidiary SPL into administration, including approximately $2.3 million in other income and a $1.2 million tax benefit. The 2010 nine-month segment results also included offsetting SPL-related entries; comparisons should be read with the filing’s adjustments and explanations.
- Cash-flow hedges for currency and copper had $14.2 million of reported unrealized losses in accumulated other comprehensive income at September 30, 2011. A $45 million interest-rate swap changes exposure on part of the fixed-rate notes to six-month LIBOR plus 7.19%; it reduced nine-month interest expense by $0.6 million.
- The company was in compliance with its principal asset-based facility covenants. BCS had previously violated fixed-charge and tangible-net-worth covenants, received waivers, and those covenants were eliminated through the facility’s expiration. The facility matures in November 2012; BCS’s revolving facility and the China term loan mature in 2012.
- Potential BCS acquisition payments include up to $3.2 million annually in 2012 and 2013, plus approximately $0.5 million in 2012, subject to performance targets; $0.4 million was accrued. An environmental remediation accrual of $1.3 million remained for the Sarasota site, pending further groundwater sampling and regulatory approval. Warranty and recall liabilities were $3.1 million.
- Management identified possible Section 382 limits on use of tax loss and credit carryforwards following a 2010 secondary offering; evaluation was ongoing. The company maintained a valuation allowance against federal, state, and certain foreign deferred tax assets. Ordinary-course litigation was not expected by management to have a material adverse effect, but product liability and recall exposure remains.
Important facts for investors to verify
- Whether working-capital use, particularly receivables and inventory, moderates and operating cash flow recovers.
- Whether management’s labor and process improvements restore gross margins, and whether the Mexico facility start-up creates further costs or inventory needs.
- Whether vehicle production assumptions, commodity prices, and Mexican peso and other currency exposures develop as management expects; assess hedge effectiveness and potential cash impacts.
- Debt service, facility availability and 2012 refinancing needs, including the impact of the floating-rate swap and covenant terms.
- The eventual effect of the inventory accounting change, tax valuation allowance and Section 382 review, as well as BCS contingent payments and environmental remediation.