Standard Motor Products' (SMP) CEO Lawrence Sills on Q2 2014 Results - Earnings Call Transcript

Aug. 3.14 | About: Standard Motor (SMP)

Standard Motor Products, Inc. (NYSE:SMP)

Q2 2014 Results Earnings Conference Call

July 30, 2014, 11:00 AM ET

Executives

James Burke - VP, Finance and CFO

Lawrence Sills - Chairman and CEO

Analysts

John Lovallo - Bank of America Merrill Lynch

Brian Sponheimer - Gabelli & Company

Bret Jordan - BB&T Capital Markets

Robert Smith - Center For Performance Investing

Seth Basham - Wedbush Securities

David Tamberrino - Goldman Sachs

Operator

Welcome to the Second Quarter Earnings Release Conference Call, presented by Standard Motor Products' on Wednesday July 30, 2014. (Operator Instructions)

James Burke

Good morning and welcome to Standard Motor Products Second Quarter 2014 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.

We are pleased to report continued operating income improvements in the quarter and year-to-date excluding a one time litigation charge and other non-operational gains and losses. Non-GAAP operating income compared to prior year increased 4.9% in Q2 and 12.5% for the first half 2014.

Looking at the P&L, consolidated net sales in Q2 2014 were $272.5 million up $2.4 million or 0.9%. And year-to-date were $505.3 million up $4.5 million also 0.9%. By segment, Engine Management net sales in Q2, 2014 were $184.2 million, up $2.1 million or 1.2% for six months were $363.5 million up $5.9 million or 1.7%.

The Engine Management sales increase was at the low end of our expected range of low to mid single digit growth. Larry will further discuss sales performance shortly.

Temperature control net sales in Q2, 2014 were $85.7 million down $1 million or 1.2%. Excluding incremental sales of $2.6 million from our Annex Manufacturing acquisition at the end of April Q2, 2014 sales were down $3.6 million or 4.2%.

For the six months net sales were $137.1 million down $2.2 million or 1.6% and adjusting again for the 2.6 million Annex sales year-to-date net sales were down $4.8 million or 3.5%.

Temperature control sales are highly dependent on the weather during our Q1, 2014 earnings call on May 1st we noted at our cautiousness due to the cold temperature around the country through April. Unfortunately that cool trend has continued through the second quarter including very mild temperatures in July.

Consolidated gross margin dollars in Q2 were down 400,000 at 28.4% down 0.4 points however dollars for six months were up $1.7 million at 28.8%, up 0.1 points. By segment, Engine Management gross margin in Q2 improved $1.7 million at 30.4%, up 0.5 points and for six months improved $3.2 million at 30.1%, up 0.4 points. Overall, we are very pleased with the continued efforts to improve gross margins by the Engine Management team.

We've made significant strides achieving 30% plus margins and continue to work on initiatives to improve, though at a more moderate pace as the low hanging fruit has been harvested.

Temperature Control gross margin in Q2 declined $2 million at 21.4%, down 2.1 points and for six months declined $1.1 million at 22%, down 0.5 points. As we pointed out during our Q1 earnings call, we were scaling back production and gross margins would be pressured in the coming quarters due to unabsorbed overhead.

The temperature control team has reduced expenditures based on lower production levels and we look for margins to improve from the 21.4% level in Q2 for the second half of the year.

Consolidated SG&A expenses in Q2 decreased $1.7 million to 17.9% of net sales versus 18.7% last year. Year-to-date, SG&A decreased $3.8 million to 19.1% of net sales versus 20% last year. We are pleased with the expense controls in place.

Overall consolidated operating income before the one-time litigation charge restructuring and integration expenses and other income net in Q2 was $28.6 million, up $1.3 million at 10.1% of net sales, up 0.4 points and for six months was $48.9 million, up $5.4 million at 9.7% of net sales up a full point.

The 10.6 million litigation charge $6.4 million net of taxes as disclosed in our press release is a one-time non-recurring charge resulting from a tentative settlement of a legal proceeding with a third party. The legal proceeding arose from a former supplier's default of their commercial loan and our subsequent purchases of products from a third party that was alleged to be a controlled company of the original supplier.

SMP denied any wrong doing in this matter, but felt it was prudent to reach a settlement and put this matter behind us. Excluding this litigation charge, our non-GAAP diluted earnings per share in Q2 2014 were $0.76 versus $0.70 last year, an increase of 8.6%. And for the six months, diluted earnings per share were up 16.1% to $1.30 versus $1.12 last year.

Looking at the balance sheet, accounts receivable was up $19.1 million against December 2013 levels, but down $7.5 million against June 2013 levels. Inventory increased 23 million against December 2013, but again down $4.4 million against the June 2013 levels. Both AR and inventory increased mid-year based on our seasonal demand for Temperature Control business.

Partially offsetting these increases was accounts payable which increased $18.6 million since December and was flat with June 2013 levels.

Total debt was $59.1 million at June 2014, compared to $68.5 million at June 2013, reflecting a $9.4 million debt reduction. This reduction was accomplished inclusive of $37.7 million spending for three acquisitions in the first half of 2014.

Our cash flow statement reflects $17.6 million positive cash flow from operations for the six months, compared to $12.4 million cash used in operations during the first half 2013. The rate of increase in account receivable and inventory were substantially less in the first half of 2014 versus 2013.

Our uses for cash in 2014 to-date were to fund $37.7 million in acquisitions previously discussed, $6.4 million in capital expenditures, $6 million in dividends and $5.9 million in share repurchase program. We have $4.1 million available for future share repurchases against an earlier board authorized $10 million program.

In summary, we are pleased with our operational performance and operating income improvements despite the soft sales for the six months.

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

Lawrence Sills

Good morning. Jim has reviewed the basic numbers, I would like to discuss a few of the highlights and then we will open for questions. As Jim said from an operational point of view, we're quite pleased with the second quarter and to the first six months.

We continued to show improvement in all areas of operations on manufacturing products we used to buy, reducing purchase costs, achieving efficiencies and cost savings in SG&A and integrating our most recent acquisitions.

The results have been a solid increase in earnings per share up 8.6 for the quarter and about 16% for six month. The one disappointing area has been sales, essentially flat for the period.

However, as we advised, we received reports from our customers on their sales of our products. And these are showing increases in both lines in Temp Control and Engine Management in the low to mid single-digit range. Now typically this would translate into our sales growth fairly quickly.

But this year, for reasons I'll explain in a second, we are forecasting a relatively flat sales for the balance of the year.

Let me go to each of the divisions. In Engine Management if you recall, we had a very strong fourth quarter in 2013 we were up 14% which is a very, very high number for us. This was aided by certain pipeline orders that our customers put in.

It also included some heavy orders on some winter related items as - it was a very harsh winter. This has led to two effects; one, we're going to have the tough comparison in the fourth quarter, we go this year against last year. And we believe there is still some inventory overhang out there from that very strong fourth quarter. So that's Engine Management.

And Temp as Jim said this is our second cool summer in a row, those of you in the New York area it's in the low 70s here today and here we are at the very end of July. Overall it has been a slightly a better season than 2013 but still well below the 2012 which was a very hot summer.

So our customers as we have said are showing some moderate increases in Temp but we believe they are still working down inventories that they had left over from the poor 2013 season and that reflects the slight drop in sales this year.

Okay to conclude on sales, we're forecasting relatively flat sales for the balance of the year. But a return to our historical pattern of low to mid-single digits increases beginning in 2015.

Let's move to another important area which is acquisitions. We've made three since the beginning of this year. All of them are going well. I'll spend a minute on each.

The first was Pensacola Fuel Injection which is a rebuilder of diesel fuel injectors from Pensacola a rapidly growing business. This is a step in vertical integration as we used to buy everything from them. We now completed -- just completed the relocation of this operation to our factory in Grapevine, Texas, we anticipate significant improvements in cost, in delivery and in quality and from all we hear this business has an excellent potential.

The second acquisition is Annex Manufacturing, an importer and distributor of various temperature control products as with Pensacola, we purchased product from them. So we will be achieving some costs savings here.

In addition, they had sales to outside customers of in the $10 million to $12 million range. We maintained 100% of this business plus we see sort of potential for new business. By the end of the year, as this will be relocated to our Lewisville, Texas facility with anticipation - with anticipated savings in both people and in expenses. It's going well.

The third is a 50-50 joint venture with Gwo Yng. The leading manufacturer of various temperature control lines. The best way to think of it is basically everything in the Temp line with the exclusion of compressors. There are several benefits we anticipate one is this is another example of vertical integration as we were a large customer of theirs therefore we will – be seeing cost savings in product.

Strategically, with compressors now in Mexico and much of the rest of the line as a result of this acquisition or joint venture. In China, we believe we are now the low cost, high quality manufacturer in the Temperature Control business, which is a very strong competitive position.

Further, third, we hope to use Gwo Yng as a base to begin penetrating the rapidly growing Chinese Temp Control market. So, all good things. And let's summarize now and then we will open to questions. We are optimistic going forward.

Number one, our customer base is strong. Our customers continue to generate sales increases in both our product lines. We continue to focus on improvements and cost reductions in all areas of the operation. Our acquisitions are performing well and are contributing to our bottom line. And our cash flow is strong.

As a result, we look forward to the balance of the year and now we will open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) First we will go to the site of John Lovallo. Please go ahead. Your line is open.

John Lovallo - Bank of America Merrill Lynch

Hey, guys. Thanks for taking the call.

Lawrence Sills

Hi.

John Lovallo - Bank of America Merrill Lynch

Hi. First question is one of your competitors had cited some increased pricing pressure from competitors on certain product line. So I'm just curious if you guys are seeing any of that and if there has been any change in kind of the OE pricing dynamic as well?

Lawrence Sills

As we all know we're in a pretty competitive business, but thus far we have been able to achieve price increases roughly inline with inflation and we expect to continue doing that.

John Lovallo - Bank of America Merrill Lynch

Okay. That's helpful. And then in terms of the temperature control business, realizing it's been relatively mild weather throughout much of the country, it has also been pretty dry weather and I thought that there might have been some of an offset given that. I mean is this really just kind of more driven by heat as opposed to dryness?

Lawrence Sills

Yeah. Rain doesn't really affect it but humidity affects it by the way. But it's primarily heat and humidity, that's the business. And just look outside the window today - beautiful day, but not so good for our business.

John Lovallo - Bank of America Merrill Lynch

Got you. And then finally in terms of the acquisition landscape any high level comments on what you are seeing out there?

Lawrence Sills

Well, we continue to look. We think we have a pretty good model plus our balance sheet is strong. We look in two main areas I think vertical integration and I think you see the three we did this year are all basically vertical integration, which means not much sales to show for it, but nice savings.

And we also look for bolt-on acquisitions which should be related lines as we have done in the past. These are businesses we know and markets we know and we believe it minimizes risk. But I have nothing to report right now, but we are continuing to look.

John Lovallo - Bank of America Merrill Lynch

Great. Thanks very much guys.

Lawrence Sills

Okay.

Operator

Next we will go to site of Brian Sponheimer. Please go ahead.

Brian Sponheimer - Gabelli & Company

Hi. Good morning guys.

James Burke

Hi, Brian.

Brian Sponheimer - Gabelli & Company

Jim, as I am looking at this balance sheet and kind of adding on to what Larry just said, you've got 52 million in net debt or so you're going to have 105 million to 110 million EBITDA this year. What's the right amount of leverage that you would like to see on the balance sheet weighing acquisitions, returning cash to shareholders, dividend, et cetera?

James Burke

Well you bring out the good point. If we had the 100 million plus of EBITDA that we are generating, all of the key uses of cash, so we have opportunities where we've had a steady stream of increasing the dividends, well we hope that would continue. We also look for the share repurchase program.

Again on the question related to leverage, of course we have such an improved EBITDA level. I think even if we had to scale up at anything larger cumulative acquisitions to 2.5 times still gives us plenty of gunpowder.

So again, we will have – I don't expect cash to build up. We'll look for debt reductions; capital expenditures as we see opportunities. We'll be funding more in the second half of the year. I think it will be higher than the first half for spending and we have opportunities again for dividends, acquisitions and share repurchase.

Brian Sponheimer - Gabelli & Company

Okay. And just looking at the landscape, any change – from some of your customers with Advance and CARQUEST coming together, any changes in terms that or pricing that you need to negotiate?

James Burke

No, that has not created any change. Again we were highly concentrated before and we're highly concentrated now. I don't – we have not seen any change really in the landscape.

Brian Sponheimer - Gabelli & Company

All right. Thank you, hope for some hot August for you.

James Burke

There you go.

Lawrence Sills

Thank you, Brian.

Operator

Next we'll go to the site of Bret Jordan. Please go ahead. Your line is open.

Bret Jordan - BB&T Capital Markets

Yeah, sort of follow-up to that last question, if you haven't seen any change in pricing terms yet, have you seen any change in order patterns? Is there any inventory consolidation that maybe slowing short-term orders? And I guess do you expect any change in pricing looking out to the second half?

James Burke

Well, I think the pricing we discussed we don't see any change there. Yes, I believe that is another factor. Every time there is a big acquisition like this – this is a big one and you know about it. There are some other little ones that are going on that they are sort of under the radar. Whenever this occurs there's going to be some consolidation, people will look for efficiencies, they'll say we don't need three distribution centers, we only need two, et cetera.

That's going on – and it's going on, let say the last six months, 12 months at a fairly rapid pace more rapid than before. And yes, this does lead to inventory reduction. And I think that is another area where our customers are showing sales increases and we are not. And I think that's another reason as this inventory needs to be absorbed.

Now this is a one time event, and again, I think it leaves the industry in a stronger and healthier position for the future. But I think it has had some effect, it's very difficult to quantify but some short-term effect on our own sales.

Bret Jordan - BB&T Capital Markets

Okay. And then a question on Engine Management you mentioned the strong fourth quarter last year maybe created some overhang. Specifically what areas of overhang are you seeing, I guess what product lines just so we can sort of monitor the channel to see when those may clear?

James Burke

It's – well, I can't pinpoint it to a product line, it's a general.

Bret Jordan - BB&T Capital Markets

Okay. And then one last one -

James Burke

Some product lines that are growing and some that are shrinking but there is nothing specific.

Bret Jordan - BB&T Capital Markets

Okay. And then I guess a last question on channel inventory, I mean you've had two tough years for AC and there was not much of a second half order cycle for the retailers last year. I guess what's your feeling -- how close we are to bottom in channel inventory at the retailers in AC.

You had mentioned that their sales are up but they are not ordering product. At what point do they not take inventory any lower?

Lawrence Sills

Well as far as this year goes in about two, or three weeks from now the ordering is going to really stop because nobody is going to start ordering air conditioning parts in September unless you're in Texas or Florida or something.

So for most of the country the buying season is effectively over. Will they finish up the year I believe well just based on what their sales are and what their purchases are they will finish up this 2014 in better inventory shape than 2013 and that's why we are predicting the return to sales increases next year.

Bret Jordan - BB&T Capital Markets

Okay. Great, thank you.

Lawrence Sills

Thank you, Bret.

Operator

Next we will go to the site of Robert Smith. Please go ahead.

Robert Smith - Center For Performance Investing

Thanks for taking my call.

Lawrence Sills

Hello Bob.

Robert Smith - Center For Performance Investing

Hi. Could you give us some more color on the Chinese joint venture and what the opportunity is in China?

Lawrence Sills

New about Sales in China?

Robert Smith - Center For Performance Investing

Yeah. Well I mean the 50-50 joint venture.

Lawrence Sills

Yeah, I understand what you mean. Well the 50-50 joint venture we worked together we are their largest customer and were before and so we work with them to make them hopefully an even better supplier. And as a result of that we achieve some nice cost reductions on our product. And that's – that's one area.

And the second what I referred to is it's very, very early and way too soon to really say anything. But they are a well regarded operation. There is a market out there in China and we are going to start to look and see what we can do to sell some stuff in China.

There is no after-market as we see it's here, it's too soon for that. But there is some what we call OES business selling through other – selling through dealerships, et cetera, et cetera, but way too soon to speculate on what that would be.

Robert Smith - Center For Performance Investing

Okay. And with respect to the balance sheet and the dividend, there is sort of club in the investment community of companies that have raised dividends for 10 straight years. I mean considering the payout ratio is well under your target, perhaps you might consider beginning a program or something like that to join this club, where you could kick up the dividend in a cent quarter for any number of years.

I am sure you could handle it and put it under your belt that might be an interesting way to bring more attention to the company in the investment community. Thanks and good luck.

Lawrence Sills

Thank you for that comment. Thank you.

James Burke

Okay, that was...

Operator

Next we'll go to the site of Seth Basham. Please go ahead. Your line is open.

Seth Basham - Wedbush Securities

Hi, Good morning. Thank you for taking my question. So my first question is around Engine Management, you guys talked about some potentially carryover inventory there. But if you think about the harsh winter we had last year, have you seen any evidence that we are still seeing knock on sales as a result of that harsh winter and people still doing repairs as result of their cars being beat up through that period?

Lawrence Sills

That might be true for some other product lines not ours. And that's probably coming to an end -- those other companies can better tell you about that.

For example, with all the salt on the roads. It chews up a lot of engine parts. So that has had a beneficial effect for other product lines but not ours. So I can't really comment on that.

Seth Basham - Wedbush Securities

Okay. And then secondly going back to the questions around Advance and CARQUEST getting together -- do you expect to pick up or lose any volume as a result of that merger?

Lawrence Sills

They are both good customers of ours we do business with both of them and we have nothing to report.

Seth Basham - Wedbush Securities

Okay. Thank you.

Lawrence Sills

Thank you.

Operator

Next we'll go to the site of David Tamberrino. Please go ahead.

David Tamberrino - Goldman Sachs

Yes, good morning and thanks for taking my questions. I jumped on a little late so I'm not sure if you covered this already but I just wanted to get a little sense of kind of the timing of the one time costs that you'll see for the year for the integrations of the acquisition that you are working on.

I understand you expect them to be accreting – accretive to earnings exclusive of them but just kind of get an understanding of the timing of maybe some of the one time costs as they roll-off of 2014 as we go into 2015?

James Burke

Our cost in that area, as, we're continuously moving facilities and operations towards – to our low cost areas there but these are ones Annex is located in Texas currently. We're moving it consolidated into Texas. The other one that were completing now Pensacola is going from Florida it's a small operation.

So overall our restructuring costs have been in at approximately $2 million or a little less $1.5 million, $2 million range and it will be -- wont be significant for any particular quarter but that we kind of have a run rate at that with movement of product lines around to our offshore facilities.

David Tamberrino - Goldman Sachs

Okay. And when do you expect to have those two fully integrated?

James Burke

In 24 -- by the end of 2014.

David Tamberrino - Goldman Sachs

Okay. And then as I look at your SG&A expense you guys have done a pretty good job of reducing that and gaining some leverage year-over-year. Is this the current level you expect to be at kind of the $49 million for the rest of the year and then on top of that kind of going into 2015 how much more leverage do you think you can get from there?

James Burke

Okay. Again, we're very pleased I guess last year we run that were running at the 50 million range and now we have achieved down to $40 million, $48 million, $49 million.

I think it will be consistent. Again some of it is sales driven. So we've had some savings there a little bit. But we are holding the cost.

I think the leverage that we gain is when we get the sales back So you could imagine we are holding very tight controls on all of the spending that's in that area. We have experienced favorable medical costs year-over-year which is assisting us there.

But I don't see any significant increases going forward the leverage will be as topline sales grows and we reduce as a percent of sales.

David Tamberrino - Goldman Sachs

Great. Thank you for your time.

James Burke

Okay. Thank you, David.

Operator

(Operator Instructions) It appears we have no further questions.

James Burke

Okay. I want to thank everyone for joining our conference call today and good bye.

Operator

That's concludes the teleconference. Thank you for your participation. You may now disconnect.

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