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Standard Motor Products, Inc. (NYSE:SMP)

Q2 2010 Earnings Call Transcript

August 2, 2010 11:00 am ET

Executives

Jim Burke – VP, Finance and CFO

Larry Sills – Chairman and CEO

Analysts

Tony Cristello – BB&T Capital Markets

Aditya Oberoi – Goldman Sachs

Walter Schenker [ph] – NAB Partners

Brian Sponheimer – Gabelli & Company

Annie Northrose [ph] – Taylor Advisors [ph]

Operator

Good day everyone and welcome to today’s program. At this time, all participants are in a listen-only mode. Later you will have the opportunity to ask questions during our Q&A session. (Operator Instructions) Please note today’s call is being recorded.

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

Jim Burke

Okay. Thank. Good morning and welcome to Standard Motor Products second quarter 2010 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 will review the financial highlights and then turn it over to Larry followed by Q&A.

Overall I am pleased to report another favorable consecutive quarter with very strong top-line revenues and also strong earnings. Our net sales in the second quarter were $231 million, up 33.6 million or 17%. Excluding $7.3 million sales from the divestiture of our European segment last year, net sales were up $40.9 million or 21.2%.

By segment, engine management net sales were up $29.8 million or 24.3%, temperature control also experienced solid sales performance would revenues up 8.3 million or 12.6%.

Consolidated gross margin dollars improved $12 million to 25.3%, up 1.8 points. By segment, engine management gross margin was up $6.4 million to 24.5% for the quarter. The 24.5% in Q2 is up sequentially from Q1 '10 at 24.2%, but off a 10th of a point from Q2 ‘09.

Similar to the first quarter, engine management experience a higher mix of OES sales and also a higher mix of lower margin purchase products, primarily for newer model applications that we plan to lower the cost by in-house manufacturing or re-sourcing the product from low cost countries. Looking forward, we will achieve the full benefit of our 2010 price increases in Q3 and expect our engine management gross margins to improve in the second half of 2010.

Temp control gross margin improved $6.2 million to 24%, up 6.5 points. The 2009 temp control gross margins were reduced due to lower production levels this last inventories in order to generate cash and pay off last year’s convertible bond, debt maturity in July ‘09.

In 2010, we are benefiting from higher sales and higher production levels, which leads to favorable overhead absorption and improved gross margin. Consolidated SG&A expenses increased $5 million on significant sales increase. The prior year quarter also included $1.7 million for Europe SG&A expenses, so the increase was actually $6.7 million, excluding Europe.

Included in this increase were, AR draft these for the accelerated collection of receivables. These fees increased $1.1 million due to improved sales levels. Overall, the net effect was a benefit of 50 basis points with SG&A expenses dropping to 18.1% versus 18.6% of net sales last year.

Consolidated operating profit before restructuring and integration expenses improved $7 million to 16.6 million. This reflects a 73% improvement over last year Q2 from a 17% growth in revenues.

Restructuring and integration expenses were essentially flat to last year in the quarter. As previously disclosed, last quarter we will incur higher spending in Q3 and Q4 this year for our Hong Kong and Hayden consolidations. Again, one-time costs were estimated at $4 million with annual benefits of $4 million.

Excluding non-operational gains and losses in the quarter we delivered diluted earnings per share of $0.38 versus $0.27 last year and for the six-months diluted EPS of $0.52 versus $0.35 last year.

Looking at the balance sheet accounts receivable increased $48.7 million versus December ‘09 level due to the strong sales performance and the seasonal nature of our temp control business. Inventory also increased up $18.4 million against December ‘09 level. Again, related to the sales increase. Helping to offset a big portion of this working capital increase was accounts payable increasing $31 million from December ‘09 levels.

Our total debt at June 2010 was $87.5 million up $11.1 million from December ‘09. By year end we should be able to achieve overall debt reductions from the December ‘09 levels at $76 million.

In July, we prepaid or 15% $5 million note outstanding with funds under our revolver and we will retire the $12 million 15% convertible debt at maturity in April 2011. This will offer us further reductions in our interest expense. We currently have approximately a $115 million borrowing availability under our revolver.

From a cash flow statement CapEx spending in the quarter was $2.8 million and for the six months by $5.8 million. Depreciation and amortization for the quarter was $3.4 million and for the first half it was $6.7 million.

With that, I’ll turn it over to Larry Sills.

Larry Sills

Well, good morning. We’re obviously pleased with results to-date. I’d like to take a minute to put it in perspective and then we’ll open for questions. Over the last few years our people have worked extremely hard on reducing costs and reducing debt. To recapitulate we’ve moved over 50% of our production to low-cost countries. As Jim announced, we have two further plant consolidations which will take place later this year.

We’ve reduced our salaried head count by roughly 10% and in 2009 we reduced our debt by over $100 million. If you now lay on top of this lower cost base, a healthy sales increase as Jim said 17% for the second quarter roughly 11% for the six months, the results are obviously going to be favorable and they were.

I’d like to talk about sales for a minute. The aftermarket, the entire aftermarket as you’re seeing from reports that are coming out now from the distributors in the manufactures is doing quite well. The reasons have been documented, new car sales are down, the result is that the car population is the oldest; it’s been in probably 40 years in excess of ten years on average this is leading to increased replacement, to increase repairs.

Car dealers are closing down, estimated as about 15% of the dealers are going to be closed; this means more business for the independent aftermarket. And I personally believe there was some pent-up demand from 2009 because many of these situations existed in 2009, we didn’t see the repair increase and in my personal belief is that people just weren’t spending money on anything. And now that’s catching up, so all these factors are true for the entire aftermarket.

Now for our particular lines, we’ve been held further by the following. First in temp, it’s been a good hot summer, especially in the northeast part of the country. And in addition to that we gained two new accounts during the year 2009, AutoZone and Pep Boys, we had them for part of the year last year we have them for all the year this year.

So those things helped the temp business on top of the overall demographics. Engine management has been further helped. We have the wire business that we acquired from federal mobile, primarily to NAPA, we have a sales increase in 2009 in OE overall ‘09 in OE and OES, although, we are somewhat below the 2008 levels. And we as we put in the release, we believe there is some inventory growth on the part of some of our distributors bringing their inventories back to normalized levels. So, these things all worked in our favor, in addition to the overall increase in the industry.

So again to summarize, we have a sales increase on top of a lower cost base, the results are going to be good and they were. Further from all indications industry is continuing healthy into the third quarter and so we are reasonably comfortable looking ahead.

That’s my quick summary, let us know open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Tony Cristello with BB&T Capital Markets. Please go ahead.

Tony Cristello – BB&T Capital Markets

Good morning.

Larry Sills

Good morning, Tony.

Tony Cristello – BB&T Capital Markets

First question, what is the timing and I think Jim you have this in your prepared remarks for in-house manufacturing or moving some of that production to low-cost sourcing for some of the newer products you’re introducing what sort of has been a little bit of headwind on some of the gross margin opportunity at least here in the near term.

Larry Sills

Right. What we’re doing and we’re accelerating our efforts in this area and we’re measuring it for the hours in manufacturing and also from the purchasing. We are opening up a procurement office in Hong Kong staffing it with engineers to accelerate the ability to be able to resource many of these newer applications overseas and generate significant savings. With that also we are big beefing up our engineering talent because we have significant opportunity to be able to grow the manufactured part as we look at the hours. Now, trying to quantify that we’re in the 24.5%, we stay by our long-term goal that we think this effort will be able to bring us closer to 27% to 28% gross margin for engine management. The timing of it, I cannot put specific marks on it but we are very aggressive in 2010 trying to address this and we also think we have significant opportunity with our Polish operation also.

Tony Cristello – BB&T Capital Markets

This is mostly in the Engine Management category?

Larry Sills

It’s being strictly for Engine Management in this area. While we also have the same efforts going on in temperature control but this Poland and looking at Hong Kong in these efforts here, I’m addressing Engine Management, Tony.

Tony Cristello – BB&T Capital Markets

Okay. Well, let’s not look at when you get this 27% or 28% but is there where you could quantify what you think the impact is added 24.5% or maybe saying, how much of that product coming in is representing on what percentage of that Engine Management product and I’m just trying to understand how much of it…

Larry Sills

Yeah. The hard part is trying to quantify this even internally when we look at, as we were dealing with an excess of 30,000 SKUs and you’re always adding new part numbers in there. I think the key that we saw in the first half and with the improving margins is that we’ll get the benefit of the full price increase now coming into the second half. So with that we think our margins will improve nicely for the second half over the first half. And again, we continue to work on all these cost initiatives to lower our cost base.

Tony Cristello – BB&T Capital Markets

Okay. And then another question on the margin, when you think about the initiatives you’ve put in place on the cost aside of the equation. How should we think about is as we move into 2011 and beyond and let’s just say assuming a more normalized operating environment trends are very good right now but more normalized. How should we think about the incremental margin in the shift in the changes you’ve done to your business is that is each dollar going to become more-and-more profitable and when sort of the inflection point start to see that flow through?

Larry Sills

Very good question. Again I’ll remind as we attempt to grow our OE/OES business that will also impact gross margins but have a benefit on our operating margins. So, we have a number of area bulls working. What we have seen and what we believe will continue is that our pricing will be favorable to our inflation costs that we have significant opportunity to shift to low-cost sourcing and at the same thing with our manufacturing efforts to go to low-cost countries. And again we’re really looking at – it’s not that dramatic. When we look at it, we’re looking at anywhere from call it 24.5 or if I can round it to 25 going to 27 or 28. So we’re talking two or three points, we’re talking $15 million on 500 million based or more. And it’s the combination of price increases and cost reduction efforts.

Tony Cristello – BB&T Capital Markets

Okay. And one last question and maybe, Larry when you look at this industry backdrop and just acceleration we see in trend businesses very strong right now. Outside of the tailwinds in the industry today, can you maybe discuss a little bit acquisition or the opportunities or just the environments today of your competitors in the competitive opportunity you see.

And then, second, the OE/OES side of the business which few years ago we started to see more aggressive approach in the soft and at least given what was going on in the industry. Can you talk about how you look at that business today and what that might look like a year or two from now?

Larry Sills

Okay. You’ve asked many questions. I’ll divide them into two pieces acquisitions and OE/OES. Okay? We are looking at acquisitions. As we told people, that was one of the reasons that we sold equity last year. We now have the wherewithal to do acquisitions. We are looking at some but we are going to be very prudent about it. We obviously don’t have unlimited resources. So we are going to pick those that we think will have the best long-term benefit for our company, combined with the least risk. So those are our obvious criteria. And we are looking and we are looking aggressively but nothing to report.

OE/OES, yeah, we’re a little disappointed in the sales at this moment. However, we have very – we built up our sales organization. And we are seeing many, many prospects out there. We are pursuing them aggressively. And we still believe this is a good growth potential area for our company. So I trust that answers your questions, Tony.

Tony Cristello – BB&T Capital Markets

You did. Thank you very much. I appreciate it.

Larry Sills

Okay.

Operator

And we will take our next question from Aditya Oberoi with Goldman Sachs. Please go ahead.

Aditya Oberoi – Goldman Sachs

Thanks. Hi, guys. Great quarter.

Larry Sills

Okay. Thank you.

Aditya Oberoi – Goldman Sachs

I just have a couple of housekeeping questions first. On the interest expense, you mentioned debt reduction actions that you are undertaking should be favorable. Can you quantify the run rate of interest expense savings that you are going to see?

Jim Burke

I’m sorry. You’re going to have to repeat it. You faded out on the second half of the question.

Aditya Oberoi – Goldman Sachs

I’m sorry. I was just asking on the run rate of interest expense savings that you are going to see because of the debt restructuring action they you took.

Jim Burke

We will get the favorable cash flow benefits so as we reduce working capital because of the seasonal nature of the business which you would build into your model, I anticipate. But one of the benefits that you’ll see now over the second half of the year is that we were able to take a piece of the debt structure at $5 million and essentially it will be at our revolver rates just round the numbers less than 5% as opposed to 15%. So that will be 10% cost benefit there. And then we have a $12 million outstanding on the convertible which matures in April of next year. We have more than sufficient capacity under our revolver.

Aditya Oberoi – Goldman Sachs

Right. Okay. Great. And on SG&A, did you guys had a pretty decent quarter in looking at SG&A as a percentage of sales? Is this the kind of run rate that we should be thinking about going forward or do you see some cost creeping back?

Jim Burke

Well, I think what we had said previously – I think in ‘10 versus ‘09 and ‘09 we dramatically cut back, because we had to address the convertible bond that we had maturing. So we did have some cost in ‘10 related to inflation as we put re-implemented our salary increases for employees and some of our spending and marketing programs.

But the run rate where we are in 2010 is basically constant. We don’t see creep – we are very prudent on watching our SG&A expenses. The one area that is in there that – and I did point it out was in the AR draft fees, which is a variable item that will move up and down with our sales volume.

Aditya Oberoi – Goldman Sachs

Got you. And one last question, maybe probably for Lawrence is that, on the inventory builds, you have mentioned that it was – that inventory builds at the distributor level was a helpful factor for this year – our this quarter revenues numbers. And I would just like to know the status of that. Are we going to see some more benefits in the next few quarters or do you guys feel that distributors are at the right level of inventory now?

Larry Sills

Well, that’s rather hard to speculate but my – our belief is that they are currently at the right levels. So that we are not anticipating further inventory buildup in the months ahead. We think they are back where they should be.

Aditya Oberoi – Goldman Sachs

Okay. Great. Thanks a lot guys.

Jim Burke

Okay. Thank you.

Operator

And we will take our next question from Walter Schenker [ph] with NAB Partners. Please go ahead.

Walter Schenker – NAB Partners

Hi Larry.

Larry Sills

Good morning.

Walter Schenker – NAB Partners

Hi, Jim.

Jim Burke

Good morning.

Walter Schenker – NAB Partners

A series of question in no particular order. In looking at temp control, there are obviously, there is some pricing, there are some new accounts. If you were to look at a significant customer, sort of on an apples-to-apples basis, what sort of unit increases did you see, without picking a name like NAPA or somebody like that?

Larry Sills

Okay. That’s a good question. See, excluding new accounts and stuff.

Walter Schenker – NAB Partners

Right.

Larry Sills

Correct?

Walter Schenker – NAB Partners

Yes, that’s the question.

Larry Sills

Yes. I’d say it’s a few points. Single digit and I will anticipate your next question.

Walter Schenker – NAB Partners

Okay.

Larry Sills

And as we move – maybe it ought be better. But I think we’re dealing with some quality improvements in this product line, so that compared to the product of six, seven years ago, it’s a better product today. So we are seeing improvement. We’re seeing solid improvement, balanced by definitely improved margins as we move more product to Mexico. So it’s a very, very healthy business, even though the product is a little better than it was before.

Walter Schenker – NAB Partners

And as you are the – by far largest players in the industry, as people gone by the wayside. If the weather in the South anyway, remains warm, should that benefit you in the second half as some of the people who cherry pick items might not have inventory to supply?

Larry Sills

Well, when you go into the second half of the year maybe in the Deep South, but certainly in this part of the world people are hesitant to replace a sale. So they sold a compressor in September say, which will happen, they will not necessarily replace that inventory buying from us with the logic that they probably have sit on for six months. So that’s why even though the sales continue at the field level into say September, October in the South, our sales to them start to drop off substantially.

Walter Schenker – NAB Partners

Is it somewhat related – is too early to have any feel given how strong end-markets are and temperature in the Northeast was on what your returns are likely to be in the fourth quarter?

Larry Sills

We reserve all year for fourth quarter returns. We believe we are adequately reserved.

Walter Schenker – NAB Partners

I always believe you’re adequately reserved, however, you’ve come through a couple – the way you reserve is an averaging over historic periods, you’ve come through some pretty depressing periods for the industry and for the market, in which people were very concerned at not you, but everybody their balance sheets. And therefore, it would seem likely to me although we’ll find out in six months that you may have less than normal return levels given how hot it’s been on temp?

Larry Sills

That’s not an unreasonable hypothesis.

Walter Schenker – NAB Partners

Okay. Different question, dividend policy. I know, you’re paying pain one.

Jim Burke

Yes. And we have stated our dividend policy of roughly one-third of earnings per share, which is coming – currently $0.05 a quarter. And we will just continue to look at that and our Board will look at it in the months and quarters ahead?

Walter Schenker – NAB Partners

So if your earnings were to be meaningfully higher than let say $0.60, of which $0.20 is one-third than one might expect or should expect – might should expect the dividend increase, as well as your members of your Board would like to see it once the year is over?

Jim Burke

Again it’s up to our Board and we’ll look at many issues not just what the earnings per share is, but what our capital means to allocated time et cetera. So the Board will look at many things when it comes time to make the decision.

Walter Schenker – NAB Partners

So it may or may not be a one-third policy?

Jim Burke

It must not be a rigid mathematical one-third policy.

Walter Schenker – NAB Partners

Okay. And last question, you referred a couple of time to the full impact of pricing in the third quarter versus the second quarter, given the caveats of different accounts and many SKUs and everything else. Could you give us – is that 1%, 3%, 2% as you guesstimated?

Jim Burke

Are you asking me to tell you what our price increases was for the year, is that the question?

Walter Schenker – NAB Partners

No. I’m asking you to tell us, what the incremental effect, since I don’t know what the effect in the second quarter is as you’re not telling me, might be in the third quarter over the second quarter since you brought it up as a positive factor going forward?

Jim Burke

Well, I can only say this, we are now – the price increases are not only fully implemented. As we go into the third quarter, our price increases are at least as good as inflation and that’s I would like to leave it at that if you don’t mind.

Walter Schenker – NAB Partners

Okay. Thank you.

Larry Sills

Thank you, Walter.

Operator

And we’ll take our next question from Brian Sponheimer with Gabelli and Company. Please go ahead.

Brian Sponheimer – Gabelli & Company

Hi, good morning.

Jim Burke

Good morning, Brian.

Brian Sponheimer – Gabelli & Company

All right. One going back to two temp control, we have a bit geographic bias given where we are and how hot the summer has been in the Northeast. Can you comment on whether this summer in Texas, which is a lottery here for you and just the remainder of the deep shaft has been, any different than you’ve seen in the past quick.

Larry Sills

You’re asking about the temperature.

Brian Sponheimer – Gabelli & Company

Yeah.

Larry Sills

The temperature – actually it was in the Saturday Times. So they showed the whole country. Texas, which is our biggest single market, was actually below average temperatures. Now below average temperatures in Texas in July is still pretty hot, but it is below average. The big surge is the one we see was in the Northeast, which is our smallest market.

Brian Sponheimer – Gabelli & Company

So it’s reasonable to assume that the year-over-year increase that we saw in temp control can be replicated just not in a normal summer basis.

Larry Sills

Yeah, again, our biggest market wasn’t particularly hot.

Brian Sponheimer – Gabelli & Company

Right. All right. And going, just talking on OE/OES lines and opportunities that you see either now or over the first and the next 12 to 24 months, what have you seen as far as change in motivation by the OEMs regarding actually selling these lines at a price that you would find reasonable.

Larry Sills

Well, again, we are talking to them and that’s really all I can say at this point, they move rather slowly. So we’re talking to them.

Brian Sponheimer – Gabelli & Company

There are no license shift over there, of course, in the last three months.

Larry Sills

They have factories, they have many, many issues they’re dealing with, but we are talking to them.

Brian Sponheimer – Gabelli & Company

Okay. All right. Great. Thank you.

Jim Burke

Okay.

Operator

And our next question comes any Annie Northrose [ph] of Taylor Advisors [ph]. Please go ahead.

Annie Northrose – Taylor Advisors

Hi guys. Great quarter. Two questions, typically, see our quarter three is higher from an earnings perspective and that should be, I mean, do you feel that should still be the case because there was no pull in because of the weather?

Larry Sills

Are you talking about temp or everything?

Annie Northrose – Taylor Advisors

Everything business.

Larry Sills

I don’t think you could be…

Jim Burke

We’re not that specific to say one quarter third versus second quarter, it's really impacted, but obviously by large driver of the revenues. And some of our larger customers, I mean purchase orders could be the cutoff of a week between how the calendar falls in there and the temperature control sales. So I don’t think usually the second and third quarters are fairly close.

Annie Northrose – Taylor Advisors

Okay. Very good and can you talk when you might bring the polling facility on or something to that effect.

Larry Sills

Well, it’s on and growing and we have ambitious plans for future growth.

Annie Northrose – Taylor Advisors

What do you think the future growth might start up? Is it something in the near term or we’re still working through it?

Larry Sills

Well, it's a steady, steady increase. It’s not one big platform jump. So the biggest avenue for their growth – they basically have three customers. They sell our former European company Intermotor, that’s still their biggest business and that is growing slightly as the Intermotor business happens to be doing okay.

The second is selling direct to some OEs, but the big growth area is producing products there that we will sell in the U.S. that some of the stuff, Jim, was talking about products that we’re currently not making money on and we will be making nice profit on once we start buying it from Poland. That is a slow and steady plan for growth, which is going on through the balance of this year and with more ambitious plans into next year.

Annie Northrose – Taylor Advisors

Great. And can you highlight anything in engine management for us? Just talk a little bit about it to tell us some of the trends or what you’re seeing in it?

Larry Sills

Well, I think we’ve covered that. Our customers tell us the business is good. Our customers tell us business is still healthy. So, as far as that goes, we are anticipating continuing that basic element of growth. Again, whatever there was in inventory appreciation in the second quarter, we do not think will be continued into the third quarter.

Annie Northrose – Taylor Advisors

Okay. Great job, guys. Thanks so much.

Larry Sills

Great. Thank you, Annie.

Operator

And it appears we have no further questions at this time.

Larry Sills

Okay. I want to thank everyone for joining our conference call today. Goodbye.

Operator

This concludes today’s teleconference. You may disconnect at any time. Thank you and have a great day.

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