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Standard Motor Products, Inc. (NYSE:SMP)

Q3 2013 Earnings Conference Call

October 31, 2013 11:00 AM ET

Executives

James J. Burke – Vice President-Finance and Chief Financial Officer

Lawrence I. Sills – Chairman and Chief Executive Officer

Analysts

John Lovallo – BofA Merrill Lynch

David L. Kelley – BB&T Capital Markets

Walter Schenker – MAZ Partners

Patrick K. Archambault – Goldman Sachs & Co.

Efraim P. Levy – Standard & Poor's Investment Advisory Services LLC

Operator

Good day, everyone, and welcome to the Standard Motor Products Third Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Please note this call may be recorded. I will be standing by should you need any assistance.

It is now my pleasure to turn the conference over to Mr. Jim Burke. Please go ahead, sir.

James J. Burke

Okay. Thank you. Good morning and welcome to Standard Motor Products third quarter 2013 conference call. In attendance from the company are Larry Sills, Chief Executive Officer, and myself Jim Burke, Chief Financial Officer.

As a preliminary note, I would like to point out that some of the material we will be discussing today may include forward-looking statements regarding our business and expected financial results. When we use words like anticipate, believe, estimate or expect, these are generally forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they are based on information currently available to us, and certain assumptions made by us, and we cannot assure you that they will prove correct.

You should also read our filings with the Securities and Exchange Commission for a discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements.

I’ll begin with a review of the financial highlights, and then turn it over to Larry followed by Q&A.

The key highlights in the quarter were overall sales reduction, strong gross margins and very positive cash flows. Looking at our top line, consolidated net sales in Q3 2013 were $264.2 million, down $11.8 million or 4.3%. For nine months they were $765 million, up $8.4 million or 1.1%. By segment, Engine Management net sales in Q3 2013 were $177.9 million, up $2.1 million or 1.2%. For the nine months they were $535.5 million, up $24.1 million or 4.7%.

Sequentially Engine Management net sales in Q1 2013 were up 7.7%, as we noted customers were broadening their inventory levels. Q2 net sales were up 5.4% reflecting strong growth and this most recent Q3 quarter net sales were up 1.2% as we were up against Q3 2012, which included pipeline orders. And year-to-date overall we’re up almost 5%. As we have stated in each of the past quarters this year, we believe industry demographics remain positive for the foreseeable future and expect and Engine Management sales to mirror industry trends in the low to mid single digits.

Temperature Control net sales in 2013 were impacted by a cool, wet spring followed by a moderate to cool summer season, compared to 2012, which was one of the hottest summers on record.

Q2 2013 net sales were $84.8 million, down $10.4 million or 10.9%, nine months year-to-date net sales were $224.2 million, down $9.3 million or 4%. However, adjusting for CWI acquisition, completed at the end of April 2012 for nine month sales were off $26 million or 11.1%.

Larry, will further touch on our Temperature Control Segment. The key takeaway is, despite the reduction in our weather dependent sales we are able to deliver consolidated earnings improvement. Consolidated gross margin dollars in Q3 improved $2.3 million at 30.3%, up 2.1 points, dollars year-to-date improved $22 million at 29.2% up 2.5 points.

The consolidated margin percentage point improvement also benefited from a higher mix of Engine Management sales due to the 2013 cool summer season. Engine Management gross margin in Q3 improved $5.4 million at 31.8%, up 2.6 points and year-to-date improved $22.2 million at 30.4%, up 2.9 points. Engine Management margin trend in the current year and over the last several of years, is reflective of our key strategic initiatives that Larry will review further.

Temperature Control gross margin in Q3, decreased $2.7 million at 24.2%, down 0.1 point, year-to-date increased $200,000 at 23.1%, up 1 point. The Q3 gross margin percentage was essentially flat and the decrease in dollars was volume related. The CWI acquisition added incremental volume that improved year-to-date margins within our 23% to 24% target gross margins, despite a weak summer season. Short-term the Temp gross margin may be under pressure in Q4 2013 and Q1 2014 due to reduced production levels as we scale down inventory.

Consolidated SG&A expenses in Q3 decreased $300,000, but increased as a percent of net sales to 19.2% versus 18.5% in Q3 2012. Year-to-date SG&A expenses increased $8.5 million to 19.7% of net sales versus 18.8% last year.

Our sequential SG&A spend in 2013 has been fairly consistent with Q1 at $49.6 million, Q2 at $50.6 million and again Q3 at $50.6 million. Consolidated operating profit before restructuring and integration expenses and other income net in Q3 was $29.5 million, up $2.6 million at a 11.2% of net sales, up 1.5 points. And year-to-date was $72.9 million, up $13.5 million at 9.5% of net sales, up 1.7 points.

We are very pleased with the operational earnings improvement for both the quarter and the year-to-date results. Our restructuring and integration expenses in Q3 increased $1.3 million and $1.8 million year-to-date. In the quarter, we implemented a voluntary separation program in our sales force incurring a $1.8 million charge that is expected to generate $1.5 million annual savings beginning in 2014.

The net effect of our operational results as reported on our non-GAAP reconciliation was diluted earnings per share in Q3 2013 of $0.79 or $0.73 last year and year-to-date of $1.91 versus a $1.55 last year. This reflects an improvement of 8% in the quarter and 23% for the nine months year-to-date.

Looking at the balance sheet, accounts receivable increased $43.4 million from December 12 reflecting the seasonal nature of our business compared to September 12 AR was $19.4 million lower due to lower sales in the quarter.

Inventory at September 30 was up $1.7 million from December 12 levels but reflects a $26 million reduction in the quarter that was build as a safeguard for our CWI integration. Benefiting from changes in working capital, total debt decreased $36 million in Q3 from June 30 levels and decreased $8 million from December 12 year end. Our remaining debt outstanding is $32 million.

In summary, we are pleased with our operational performance in the quarter and year-to-date highlighted by gross margin expansion and positive cash flows to reduce debt.

Thank you. I will now turn the call over to Larry before we open for Q&A.

Lawrence I. Sills

Good morning everybody. Jim has reviewed the numbers and we can go into a bit more detail later on if you like, but was I like to do is dig a little bit deeper and to two of the elements of our quarter. One is the gross margin improvement and the other is Temperature Control sales.

First gross margin, our folks have worked very hard in this area over the last several years with a goal of being the low cost, high quality manufacturer in the industry. We’ve done this in several areas. First, we’ve had a major initiative to manufacture parts that we use to buy and we’ve made the investments in R&D and in capital. Benefits of manufacturing obviously reduced cost which is what you see in the numbers, but also better control of quality and better control of supply and we are continuing aggressively in this area.

Secondly, we’ve relocated manufacturing operations to low cost areas. We’ve talked about that before. We now have over a 1000 jobs in Mexico and roughly 3000 in Poland. This represents somewhat about 60% our total manufacturing. We’ve also had an effort to reduce purchasing costs and helping along the way we have an office in Hong Kong, staffed primarily by engineers and this is helping us both to expedite the purchasing process and to ensure quality.

And fourth, we had integrated and streamlined of various acquisitions and I am going to come back to that in a bit. Okay, all these have contributed to gross margin, it’s what you’ve seen and efforts in all these areas are continuing.

All right, now just looking back to temp sales, the other big event, as we’ve said temperature is a very weather related business, sales can fluctuate plus or minus 20% depending on the temperature. 2012 was a very warm summer and 2013 was a very cool summer and that’s what you’ve seen in the results.

Now our goal in this division considering the variability based on weather is we want to be able to do well in the cool summer and very well in the hot summer. And we think we’re positioned to do this especially now that we have CompressorWorks fully integrated.

So I want to talk about acquisitions in general and then we can get to CompressorWorks in particular. All right, we’ve evolved an acquisition strategy. We’ve made 5 acquisitions in the last two years; quickly one was BLD which was a supplier authorizing Engine Management. One was Forecast Trading, which was the leading economy supplier in Engine Management. Third we made an investment in Orange Electric. It was our primary supplier for tire pressure monitoring sensors, TPMS, which we feel has a huge growth potential.

Fourth we acquired the OES business from our former European subsidiary. Again that’s an area we want to grow. And fifth is CompressorWorks. All are fully integrated, all are achieving the goals. And what they have in common, these are products we know and understand. We believe this acquisition strategy minimizes risks, maximizes savings and we plan to continue.

Specifically on CompressorWorks, I think our folks did an excellent job here. We relocated the CWI production to our plant in Reynosa which effectively doubled their production of new compressors. We combined distribution centers, we merged product lines all done on a very tight schedule because of the seasonality and to be ready to the season, and all went well.

Now the benefits have been masked – somewhat masked by a poor selling season but we feel we’re very well positioned for 2014. So that’s our story. We like the way the company is headed. Industry demographics we made favorable, and we are optimistic about the future.

So thank you and with that we open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll go first in the side of John Lovallo from Bank of America Merrill Lynch.

John Lovallo – BofA Merrill Lynch

Hi guys thanks for taking the call.

Lawrence I. Sills

Good morning, John.

John Lovallo – BofA Merrill Lynch

First question is on the voluntary separation program. Can you give us an idea of maybe how many employees that affected and if there is an opportunity for more actions along these lines?

Lawrence I. Sills

The plan in this area, here it’s evolving approximately 20 employees but what we’re doing in this area is we are upgrading the technical nature of our stats. So some of these are senior people who are retiring and then it is we’re replacing some of them with more technician type, tech type people.

James J. Burke

And we have no further plans in that area in the short-term, if you’re asking that.

John Lovallo – BofA Merrill Lynch

Sure, thank you. That’s helpful. And then thinking about the 60% of your production in low-cost facilities at this point, is there an opportunity to ship more to the low-cost facilities or do you think that you’re pretty much as far as you can go?

Lawrence I. Sills

I think we have achieved what they like to call here the low hanging fruit. We’ve moved the bulk of the labor intensive tasks and much of which remains are products that are highly automated i.e. fuel injection, and coil-on-plug and things like that, which frankly doesn’t makes sense to move. So I think most of it is behind us we will always be looking. But I think the bulk of it has been done.

John Lovallo – BofA Merrill Lynch

Yes, it’s helpful, if I can sneak one more in here. In May, I believe you amended your credit facility. I am just wondering if this has given you more flexibility in terms of acquisitions and repurchases. And if so, I mean would you consider expanding the repurchased program kind of above and behind what’s needed to fund the comp plans.

Lawrence I. Sills

The day we did amend the facility as we previously, I believe it was in May. We have the flexibility there for acquisitions, to be able to complete, and we’re active always looking and trying to be opportunistic there. We have currently about $5 million outstanding on our share repurchase program. And again, we address that with our Board on the continuing basis. And plus if we are not – we have $32 million outstanding in debt. We would look to again the other uses of cash would be dividends and/or share buybacks.

John Lovallo – BofA Merrill Lynch

Okay, thanks very much guys.

Lawrence I. Sills

You’re welcome.

Operator

And we'll go next to the side of Bret Jordan with BB&T Capital.

David L. Kelley – BB&T Capital Markets

Good morning. This is actually David Kelley in for Bret. Just a couple of quick questions, and first is, if you are looking at – the recent news in the industry obviously with Advance Auto Parts and the acquisition of GPI. I just want to get your thoughts on potential customer inventory consolidation. What your expectations are for the next six months or so. And the potential impacts on gross margin as well?

Lawrence I. Sills

You’re talking about for the industry or for us.

David L. Kelley – BB&T Capital Markets

Both would be great.

Lawrence I. Sills

I’ll talk about the industry. Obviously when you – when a major acquisition like this one of the ways they look to help pay for it is by reducing distribution centers. So that is going to create some excess inventory in the system. So I don’t have to quantify that at this point. But this has happened many times in the past and takes a little while and the industry deals with it. So I would imagine there will be some extra inventory floating around, which depresses production from manufacturers and they have surprise effect in the short-term, but that is a short-term effect. I forgot the rest of your question, sorry.

David L. Kelley – BB&T Capital Markets

Great, thank you. Yes, just kind of piggybacking off of that. So are your expectations, will there be some give-and-take on price here that could impact gross margins over the next six months given the consolidation of three of these larger customers?

Lawrence I. Sills

Again, you’re asking for the industry. Again, I can only speak in general terms, but again highly competitive industry these were both very large accounts.

David L. Kelley – BB&T Capital Markets

Well thank you.

Lawrence I. Sills

That’s clearly my personal speculation, okay.

David L. Kelley – BB&T Capital Markets

All right, great, thanks.

Lawrence I. Sills

Okay.

David L. Kelley – BB&T Capital Markets

A quick follow-up on SG&A, I think, Jim, you mentioned that sequentially it's been very consistent throughout, year-to-date in 2013. Any expectations for the fourth quarter, just for modeling purposes, given that seasonally it's your least strong sales quarter historically in the fourth quarter?

Unidentified Company Representative

All right, I think the key is that it’s consistent and I would advice if you look at the absolute dollars and looking our trend over the last year, fourth quarter will basically comes down a bit, because also a lot of our cost and SG&A are semi-effects, that’s in there. So the key would be area that you’ve exempted to use it as a percent of sales. So I look at the trend and look at the spend over the last over 2012 and over 2013.

David L. Kelley – BB&T Capital Markets

All right, great. Very helpful, thank you.

Operator

And we will go next from the side of Walter Schenker from MAZ Partners.

Lawrence I. Sills

Hello Walter.

Walter Schenker – MAZ Partners

Hi, Larry, Jim. A comment which is obviously tongue-in-cheek and then a couple of questions, which is the music while we wait for your call on the day the stock effectively hits 40 should be more upbeat, Maybe Happy Days are Here Again or something like that.

Lawrence I. Sills

I think it will.

Walter Schenker – MAZ Partners

Two things; first, in regard to inventories the fourth quarter on Temp, you've indicated that the next couple of quarters, obviously, given the sales pattern, you're a little heavy on inventory and will cut back on production. Do you have any feel since you can look through some of your customers? Was it already starting to happen as to what type of return patterns they may have in the fourth quarter and that they may be somewhat heavy in inventory as well?

Lawrence I. Sills

I think they have done a good job of watching their own inventories. So the inventory we are talking about is obviously our own. There maybe some – obviously, everybody's sales were less than they would have hoped, but again we have pretty good rules here. And but more as importantly, I think our customers have gotten very good at managing this. So there maybe some, but I don’t think it’s going to be gigantic.

Walter Schenker – MAZ Partners

Okay. And then a question/lecture, I guess which I've been known to do. The dividend is still $0.11. It's been years now of talking about a dividend payout target and not meeting that target and making very minimal progress toward meeting that target, I would just say that for the credibility of that actually being a publicly stated target, the dividend either should be moved significantly or maybe you should withdraw it.

Lawrence I. Sills

You remarks were to dividend, you mean for the target, right?

Walter Schenker – MAZ Partners

The payout ratio, I am sorry.

Lawrence I. Sills

Fair enough Walter. And we continually review this with our Board and we see opportunities on this, but again also as we look for the dividend to be steady increases over the long haul and movement towards that one-third payout ratio. And I am sure you won’t hold this before improving the earning significantly in 2013.

Walter Schenker – MAZ Partners

No, no, I'm not, but your payout isn't a third of last year's earnings, forgetting about the increase this year. So, we're running further and further behind, but that's my point. I'll see you guys next week. Thank you.

James J. Burke

Point delivered. We will see you next week, okay.

Operator

And we will go next to the side of Robert Smith. Please go ahead.

Lawrence I. Sills

Hey Rob, good morning.

Unidentified Analyst

Good morning. Congratulations, yes, also on the price of the stock. So, okay I kind of go with what Walt just said about the dividend. I mean, I'd like to see some movement in that and you might at these levels kind of combine it maybe with some kind of a stock splitter or a stock dividend, anyway, it's a thought. But the other side of the coin is, if you're buying back stock, so I don't know how you might feel about that. But nevertheless, I was wondering if you could give me a reading on the sensor business and how that's going?

Lawrence I. Sills

You are referring to the tire sensor, I assume.

Unidentified Analyst

Yes.

Lawrence I. Sills

Because we have lot of sensors, but I am guessing that’s not we are talking about. We remain very optimistic about that. Just to remind everyone, this is the, it's called Tire Pressure Monitoring Systems. They have been mandated on all U.S. cars for the last five or six years. It is reputed to be a major growth event, because they actually do fail, about 100% failure rate, because the battery wear out, and it’s four on every car. So it’s a good business and it’s a very competitive business now there are many people in it, but we made an investment in our vendor company called Orange Electric, comes from Taiwan and we are very pleased with how it’s going so far.

Unidentified Analyst

Can you share any numbers or growth rates, I mean, that they're experiencing?

Lawrence I. Sills

No, we don’t like to get into that level of detail, but it is growing and again the forecast for the industry is 300% growth in five years.

Unidentified Analyst

Yes, I also want to congratulate you on moving down the debt level. I guess during the next financial crisis you won't have to say sorry or anything like that. But, anyway, along those lines, what might be an optimum debt-equity ratio that you're looking for going forward?

James J. Burke

Again it will trigger upon what our acquisition opportunities are so. So again, debt to equity at the point now where our equity is 1:1 be really looking at what a sealing would be in there, looking at a multiple of EBITDA, I would say as a cap that we’d targeted to would be 2.5. Obviously that gives us significant amount of headroom. So the key is being opportunistic on acquisitions.

Unidentified Analyst

Yeah. Sounds intelligent, sure. And are there any particular changes in the competitive environment that you might want to share with us?

Lawrence I. Sills

No, I can’t think of any offhand. Again they’ve referred to this major customer movement, advance in clockwise, but now I think at this point the manufacturing base is quite stable.

Unidentified Analyst

Thanks so much. Good luck.

Lawrence I. Sills

Thank you.

Operator

And we will go next to the side of Patrick Archambault from Goldman Sachs. Please go ahead.

Patrick K. Archambault – Goldman Sachs & Co.

Thank you. Good morning. A couple here from me, just in terms of the M&A environment, you guys have obviously accomplished a lot, successfully integrating, I think five acquisitions recently. How do you see the M&A landscape going forward? Is there still a large number of attractive targets that seem like they come in reasonable price ranges to sort of sustain the level of activity that you've done or how would you describe that landscape?

Lawrence I. Sills

Patrick, the five that we have done was really a – and couple of them were a little sizable and the others were small and that was a significant amount for us over that two year period.

James J. Burke

We are opportunistic, but I would say overall that there is not a complete pipeline of available acquisitions that you can anticipate, how many we would be able to close, but we are always looking, we are always talking and our key focus is really looking at opportunities within our vendor base and we want to look to bring in how it is manufacturing, so that’s our strategy and we look to hopefully pull some.

Patrick K. Archambault – Goldman Sachs & Co.

Thanks, that's helpful. And my other one is just on the Temperature Control, the inventory reductions affecting 4Q and 1Q. You said that would probably pressure gross margin somewhat. Can you just help us try and get an order of magnitude of what the impacts might be of that?

James J. Burke

It’s a good question, we don’t put out the guidance that’s on there but if you look back over the years because, the impact of how much is going to be is really the – in the couple of points. We’re in the 23% to 24% and probably you look back where we were a couple of years back. We may have hit into the 19%, 20% range but I don’t envision that impact. So a couple of points is the area.

Lawrence I. Sills

Again it’s a little bit lower volume. Also just on the absolute dollar impact is not that significant either during that period.

Patrick K. Archambault – Goldman Sachs & Co.

Understood. Okay, great. Thank you very much, guys.

Operator

(Operator instructions) We’ll go next to the side of Efraim Levy from S&P IQ please go ahead.

Efraim P. Levy – Standard & Poor's Investment Advisory Services LLC

Hi. Patrick took a bunch of my questions all at once, but as far as the Temperature operating margins for the quarter, so if you look at them, they have been flat from year-to-year, what do you think they would have [indiscernible], put it differently what did you look at the normal contribution margins for Temperature?

James J. Burke

Again, it’s a good question Efraim, but we don’t put the guidance out. I think the key that we talked when they were up, if you look at gross margin, I like to look at there well within our range of 23% to 24%. And we think we have opportunities hopefully once we get into a full season what we were looking forward to in 2014 with the integration of CWI. As we point out the SG&A spend, it’s fairly consistent there will be an increase you can look we disclose by segment the dollar numbers and that incremental change will move up and down. So you can take those two numbers from to get the operating profit. Currently in the quarterly we were at operating profit in Temperature Control for 8.8%.

Efraim P. Levy – Standard & Poor's Investment Advisory Services LLC

But as far as the underlying, you think that the operating margins would be improving in that segment, if they were normalized on sales?

James J. Burke

Yes, of course we’re gaining more leverage on the SG&A. I’m still holding to the 23% to 24% gross margin but obviously the absolute dollars that we would generate would be significantly more on a hopefully normalized of season. So we still be in the 23% to 24% earnings on a full year basis for gross margin, leverage gained on the SG&A and incremental dollars.

Efraim P. Levy – Standard & Poor's Investment Advisory Services LLC

Okay, thanks a lot.

Lawrence I. Sills

You are welcome.

Operator

(Operator Instructions) We’ll pause briefly for any follow up questions in the queue. Thank you. Mr. Burke, we no further questions at this time.

James J. Burke

Okay, with that then I want to thank everybody for joining our call today. Thank you.

Operator

Thank you for your participation in today’s conference. This does conclude your conference. Please feel free to disconnect anytime.

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