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Standard Motor Products, Inc. (NYSE:SMP)

The Wall Street Analyst Forum

November 27, 2007 9:50 am ET

Executives

Gerry Scott - President of Wall Street Analyst Forum

Larry Sills - Chairman and CEO

James Burke - VP of Finance and CFO

Gerry Scott - President of Wall Street Analyst Forum

Good morning, ladies and gentlemen. In our ongoing attempt to adhere to the public schedule, I would like to introduce the second company in this morning's program, Standard Motor Products. The company is a leading independent manufacturer and distributor of replacement parts for motor vehicles and the automotive aftermarket industry. The company is organized into two major operating segments, each of which focuses on a specific line of replacement parts.

The Engine Management Segment manufactures ignition and emission parts, on-board computers, ignition wires, battery cables and fuel system parts. The Temperature Control Segment manufactures and remanufactures air conditioning compressors and other air conditioning and heating parts. The company sells its products primarily to warehouse distributors and large retail chains in the United States, Canada and Latin America. The company also sells its products in Europe through its European Segment.

The company's customers consist of many of the leading warehouse distributors, such as CARQUEST and NAPA Auto Parts, as well as many of the leading auto parts retail chains, such as Advance Auto Parts, AutoZone, CSK Auto, O'Reilly Automotive, and Pep Boys. The company distributes parts under its own brand names, such as Standard, Blue Streak, BWD Automotive, Niehoff, Hayden and Four Seasons, and through private labels, such as CARQUEST and NAPA Auto Parts.

So, without any further introduction, I would like to introduce James Burke, Vice President of Finance and Chief Financial Officer; Larry Sills, Chairman and CEO, and we just ask the management to repeat the questions during the Q&A session for the webcast audience to hear both the answer as well as the question in context.

Thank you.

Larry Sills

Okay. Good morning. I see there are some people here who know us very well, and some people who, I guess, don't know us at all. I don't know how much detail to go into. I will probably split the difference and satisfy no one. But I'll do what I can. All right. This is a forward-looking statement. I think I can skip over that. Okay. Myself, Jim Burke, will keep moving forward. Here we go.

All right. I want to give a short synopsis of the background. As I say, I'm probably going to split the difference and satisfy nobody. But the key point to remember, is that within this industry the automotive aftermarket is a big and stable industry. We are a major player. That's a key fact to keep in mind.

We go to market with two product lines: Engine Management and Temperature Control. We are number one in each. We have a greater than 50% market share in each. And we enhanced our position in Engine Management about four years ago, when we made our major leap forward. We acquired our biggest competitor, Dana Engine Management, which, before that was actually our biggest single, individual competitor. It added about 60% to our Engine Management business.

There are large benefits to being number one. Obviously, you have economies of scale, but even more important, it gives you the ability to stand up with your customers, who themselves are growing larger and more powerful. We go to market with a broad array of products. If you're going to be in this business, you got to have a gigantic product line. You have to provide within your field every part for every car, domestic and import, all the way back 30 years ago to 2 years ago.

Well, you see here some of our products. The one on the upper right is the point and condenser, that hasn't been on a car since 1976, and we still sell over a million of them--a slow-moving industry. And on the bottom, you see some of the newer products, electronic. It's a wide variety of products. Now, this broad line gives you an edge. It gives you an edge over a short line distributor who tries to compete on price. You can command a price premium, because they need the coverage. It's also a difficult entry business.

So, someone who had a standing start and come up with 30,000 parts numbers is essentially inconceivable. So, there have been no new entries as a full line vendor for many, many years. And we do have, if you just look at the different kinds of products, a wide variety of manufacturing skills, which bodes well for the future as we go into different products in the future.

Our [technical difficulty] air conditioning, it's not quite as broad. We're talking only about 8000 SKUs, compared to the 30,000 for Engine Management. The key product is on the right-hand corner there…the compressor, which is the heart of the air conditioning part of your car. We rebuild them. We take the old one, we get them back, we take them apart, we clean them, we put in new parts where needed, and send them out again. We are the leading re-builder in the world, really, by a lot. We rebuild roughly 600,000 of these a year.

Now lately, this business, and specifically the compressor business, has been affected with imports coming in from China. This is the one part of our business where China has had a significant effect. Selling new ones at roughly the same price we sell a rebuild and give a consumer a choice of rather having new versus the rebuild is cheaper. Pardon?

Unidentified Audience Member

[Question Inaudible]

Larry Sills

So far, we haven't seen a problem. Most of the defects in this line, by the way, are not from the products. They are from poor installation. So it gets hard to tell what the true quality of the product really is. But, unfortunately, they're not covered with lead paint. If they were covered with lead paint, that would be helpful, but they're not.

So, our strategy is, therefore, to relocate our rebuilding operation currently just outside of Dallas, we're in the process of relocating it to Reynosa, Mexico. This is a labor-intensive part, so, obviously, labor-saving. We believe we can save roughly $7-$10 a unit in Mexico, versus Texas. Our goal will be, therefore, to sell a rebuild unit at roughly 25%-30% below the new one coming in from China. And we think we can do that, and do that profitably. And we're about half way moved to Mexico by the year 2008.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

We hope to be able to maintain our margins today, once we are fully there in Mexico, okay, and sell it at a 25% lower than the new one. That's the main issue with that. Looking at the industry, the demographics give you a mixed data. So, it's a huge industry. It's, essentially, a stable industry. It doesn't change much, year-to-year.

Some positive factors--the average age of the car is rising, the cars are lasting longer. This is a good thing for us, because we sell parts for old cars. So the more old cars, this is good. They refer to the sweet spot as 6-10 years old. That's a prime replace. If you guys own cars that are 6-10 years old, that's when we sell you parts. And that so-called sweet spot is also rising Okay.

Now, some facts. There are, and I don't have choice for, miles driven typically went up about a point or two a year. It's been growing up a point or two a year for us. We haven't seen the '07 numbers--they're not out yet, but we believe from what we see, that the price of oil, which I'm sure will be one of your questions, has not caused a decrease, but the increase has slowed down, so that maybe instead of 1% or 2%, it maybe up a half a point. But people are still driving; they'll have to get to work. So miles driven has not suffered--just a little bit, not much.

And with the newer products, the unit prices are higher. So those are all the favorable trends, balanced by the parts are, frankly, made better, the cycle of the parts are longer Some of the new technology you're going from wearing parts--the points and condensers were wearing--they rubbed against each other, they had to be replaced. Now you have electronics, doesn't move. It still needs to be replaced, but much less frequently.

The line of moving products here. We calculate, and it's improving, so that they tend to balance out. And our forecast, and that has been so for the last few years, is that in dollars -- not in units, we thought them as a unit -- and dollars is going to be, roughly, flat. And that is our plan, and our estimate going forward. Therefore, to grow, you got to either get in new businesses or get new customers--because your current customers are roughly flat. And if you see that, if you follow the industry, you see the big guys are all 1% or 2%, one way or the other, up or down. So it's basically a flat industry in dollars.

Okay. There are three [technical difficulty] parts in the market. One in the left is still the major part of the business. We refer to it as the traditional channel. It is the one that winds up at the independent repair shop. It takes three steps to get there because of all of the inventory. There are huge players here, the biggest one is NAPA, Genuine Parts. They have huge national chain. The second largest is a private company, we refer to as CARQUEST, and then there are a host of independents. We are very, very strong in that channel, still the biggest channel. We sell, essentially, everybody, I just said.

The central column, the retailers, there are five big retailers. They are all public. They cater to the do-it-yourself. They are AutoZone, Pep Boys, O'Reilly, Advance, CSK, all public companies. Okay. They tend to be for older cars, less affluent customer. We do well with this chain as well. We are the major supplier to four of them and a minor supplier to AutoZone.

The channel on the right, this is through the car dealer. This is where you bring your car to the car dealer to get it fixed. We do very little in this channel. It should be about 20% of the business. We do very little and this we see as our growth opportunity.

Here's the chart. It shows that our traditional, the retail, others -- sales other. OE/OES is only 7% of our business. If we were to get to 20%, which is the national average, we would gain about $150 million in sales, it will get us to 20%.

Now, the timing for this is good. Delphi, the General Motors supplier, as you all know, closing down 20 of their 29 factories suddenly. They need a home for these products. They have to supply these replacement parts through the car dealer. Visteon is likely to follow. Some of the large OE houses, OE suppliers are looking to exit the service business. They hate the service business. They're not paying in that today. They want to be able to concentrate on new car production and the service business because, they have to carry their parts for another 10 years, they hate it.

Well, that's our business. We're going after it aggressively. We have picked up about $25 million of new business. We haven't hit on numbers yet. It will mostly hit in '08. But these are signed agreements, and we are looking for more. And we think this is a potential area for excellent growth, naturally the growth rate.

All right. Just quickly, and I will go through the numbers, there are some recent things. I mentioned the -- I'm sorry, yeah..

Unidentified Audience Member

The manufacturers hate the service business.

Larry Sills

Right.

Unidentified Audience Member

Do the car dealers hate the service business?

Larry Sills

No. The car dealers like the service business.

Unidentified Audience Member

They like the service business.

Larry Sills

They make a lot of money in the service business.

Unidentified Audience Member

So how does that play out?

Larry Sills

Well, it plays out that the only guy would like to just sell the new production, but he is selling 100,000 at a time. (inaudible), sets up his machines and run through months on him. Now, he has to supply the next 10 years. He hates to supply the next 10 years, but he has to. He has an agreement to supply the next 10 years, because they need the parts. They love if we can get this out of their hand. One of them said, the replacement business; the service business, is 1% of my volume and 50% of my whole. Okay. But they have to supply the car dealers. The car dealer needs that business and loves that business. Does that answer your question?

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Right.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

They can't get out. What they would like to do, is going back to manufacturer. But ideally, the manufacturer would like to have someone like us take over that job through them.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

I don't know if that answers your question, but it seems okay. So that is, in fact, what's transpired.

Okay. I mentioned we acquired Echlin roughly four years ago. Biggest thing we ever did at the company--that had nine facilities, we closed seven of them. We moved them into our locations. A lot of work, quite costly, there were a lot of inventory write-downs, there were a lot of learning curve issues, lots of issues. Our numbers suffered. Our gross margin went from, historically, in the 28% range, it hit a low--I think about three years ago, of 20%. The numbers suffered dramatically.

We've been digging ourselves out of the hole. Jim will go over the numbers. We now broke 26%, and we're looking to get back to that 28%-29% number. The best news is, we kept every single customer, and they had some really good ones. We kept NAPA, O'Reilly, CSK, Pep Boys. This was their customer list; kept them all. But that was very good performance; we were very pleased about that.

Second event, we're in the process of relocating two of our oldest facilities: one here in Long IslandCity, some of you may have visited it, and another one in Puerto Rico. Long Island City just got too expensive; Puerto Rico get lots of 936 tax benefits. Post jobs, roughly 400 in total, being transferred mostly to Mexico.

One-time costs, some of which we took this year, some of which we will take next year, of roughly $9 million, once fully located, and they will be fully located by next year--mid third or fourth quarter next year-with the annualized savings of $9 million, which we'll mostly get in the year '09; some of it '08, all of it in '09.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Well, they are reactive with the Four Seasons. This is not (inaudible) when I said the reactive had to do with the Four Seasons, which, coincidently, is also going to Mexico. This is Engine Management, but we do not have a Chinese pressure. We do not that kind of pricing pressure. So most of the savings will hit the bottom line. I may have jumped at your question…was that your question?

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Yeah, it's a good question. We do not see this, I can't say zero, but it will be much less of a factor in Engine Management than it is in Temperature. And the difference is Temperature Control is a more consolidated line. Those compressors are half the business and there may be 10 models of compressors. So it's a more consolidated product. The volumes per SKU are much higher and it's a relatively simple product to make. That perfectly lends itself to China. This is a broad array of products. There is not a huge amount of volume in any one, and there are highly technical specifications.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Yes. There are some others in the temp side as well. They are, frankly, we're getting it from China as well, and they go along for the ride. The board game is the compressors. And there are products in this line, as well, and we buy some products in Engine Management from China, as well. But you don't have that huge visible impact that you had in the compressors--the air conditioning compressors. Okay.

That's Engine Management. Here we've talked about this. We reduced prices in '07. We hit our numbers in '07. We hit our gross margin in '07, which you will see. Frankly, we're going to have some reductions in '08. Hopefully, that will be the end of it. And we'll start to come out of the hole as we relocate the compressors to Mexico. And our goal is to maintain the current margins and perhaps even improve them in the future, because we'll not only be relocating into Mexico, but we're looking to hit some overhead costs as well. This is a more price competitive business than the Engine.

Okay. The third one is Europe, which is a big success story. We went from a loss to a profit and we've done it really by doing all the right things. So it's gratifying. You do something right and it works. We exited the business. We exited the air conditioning business in Europe. We just weren't big enough to be effective. We closed down the factory in UK, which was high cost. And we opened up what I think will be a very excellent operation in Eastern Poland, which is a low cost; the wages in the Eastern Poland roughly the same as Mexico.

And with the part of the EUC, you can sell throughout Europe without the trade barriers, and as opposed to Mexico. There's tremendous amount of skill workers available, engineers down to unskilled labors, all readily available. We see this as a place to grow in. So we are pleased with that.

All right. That's again a very quick summary of the company. I'll let Jim now go over some numbers, then I'll wrap it up and then we'll open up for questions.

James Burke

Hi, good morning. I'm going to hit the highlights from the recent third quarter filing and cover the three months, nine months and the key drivers in our business. Looking at the recent quarter against the three months '06, you can see net sales were up $2.4 million, a little more than 1%.

However, as Larry pointed out, we divested a business in December of '06 in Europe: our Temperature Control business. So, the third quarter of '06 included $3.3 million of sales from that business. So excluding that, we were actually up $5.7 million, or roughly 2.9%. Sales were up in all segments.

Looking at the gross profit percent, you can see that we were up 2.3 points, generating an incremental $5.3 million. This was primarily from the Engine Management business, which was up a full 4 points within the three-month period, and I have a slide on that coming up, also.

I've broken out operating profit excluding restructuring expenses. As Larry pointed out, we're going to be incurring $9 million over the '07-'08 period, and we want to isolate that. So looking at operating profit before restructuring expenses, we were up $2.5 million, or 1.1 points. The restructuring expenses, again, in this period here was inclusive of Puerto Rico, and we sold the building in Fort Worth, part of our Temperature Control business, generated $3.5 million from the sale of that building, and incurred some expenses, as we relocated into one of our other facilities.

As you drop down, look at the diluted earnings per share, again, we excluded the restructuring expenses, but we also excluded the gain on the Fort Worth building. We had a gain of 800,000 something there. So the results were $0.30 against $0.16 for the prior quarter.

Now, Standard Motors has a discontinued operation. Again, we were just trying to hit highlights here, pick a point out for you. That was a break business that we sold back in '98. We have recurring [specific] expenses on the liability on our books in the current quarter.

Once a year, we have an independent actuarial valuation on that. In the current quarter--we do it the third quarter of every year--we incurred a $2.8 million adjustment to that increase in the reserve, the pre-tax adjustment. That basically offset the favorable adjustment that the actuaries calculated last year.

This time last year, we took a favorable $3.2 million. If you look at the two combined, that basically was a net adjustment in there. The total reserve is approximately $25 million on our books, which is for a period out over the next 50 years.

Looking at the nine-month numbers, you can see our sales were down roughly $20 million, but $11 million of that was related to the nine months of Temperature Control in Europe at $11.7 million, or so. So, excluding that, sales were up $8.7 million or 1.4%.

However, the gross profit, even on the reduced sales, was up 1.4 points, or up $3.9 million. Again, operating profit excluding the restructuring expenses that was up almost $2 million over 0.5 points. Inclusive in there were nice teams from both Engine Management in our European business.

Temperature Control, as Larry has pointed out, had contracted sales on lower margins, related to the Chinese imports. However, we feel and we've reviewed the plans of relocating that business that we know to reduce costs and improve the profitability. Again, on a nine-month basis, the diluted earnings per share excluding the special items $0.80 against $0.61 for the nine months.

We put up a slide really to explain the Engine Management, what's happened over the gross margin. This is really the key driver in our recovery. And if you look at the 12 months so far, that's when we hit the low point at 20%. In 2006, we recovered 4.5 points to 24.6, and we're pleased with the results for 2007.

As you can see, we recovered again another 2.5 points from 24.2 to 26.7 for the nine months. Each point were $550 million in Engine Management--sales roughly adds $5.5 million--so at 26.7, with a stated goal, of looking for 28%-29% in the future. How we are going to get there? We talked about the moves from Puerto Rico and Long Island City that are going to be generating savings in that area.

Now, we talk about OES opportunities. The OES business, those come with lower gross margins, but with significantly lower SG&A expenses. So, we're sticking with the stated goal of 28% to 29%, unless we gain a significant business, but they will deliver the same operating profit margin percents.

Our balance sheet and the comparison we have up there is for September '06, and basically in line. I'll point out one area from working capital, which is the inventory. We had an $11 million increase. This again relates planned build, inventory build for the transition for the move, so that we're able to supply the customers when we shut down the plants and machining centers for a couple of months during that move.

So, we expect once the moves are complete, that we'd able to take out $15 million. One point is also within the third quarter '07, we completed our share buyback, and we bought back, roughly, 542,000 shares, or roughly $5 million.

With that, I'll turn it back over to Larry to review future initiatives. Thank you.

Larry Sills

Well, this is just the quick summary in conclusion, then we will open it up. We're very optimistic about the future. We think we have a good story on both the topline and the bottomline. In the topline we see a large potential in this OES business, can be really a dramatic change in the company if some pf the thing will happen. So we see a good topline potential and we see a cost saving on the bottom side through the plant moves.

And then one thing, which I didn't really spend anytime talking about, but we are now, and have been for a year, engaged in sourcing material and component parts and some finished goods, mostly from the Far East. We now have a buying office in Shanghai. We have engineers on site. And we've been able to get some very nice savings, some of which have hit the P&L, some of which will hit next year.

So to me, if you combine all these things, we got the topline potential with OES, we got the bottomline savings to plant moves to low cost countries and through sourcing more to low cost countries and we have a good story. So, that's it. We're optimistic about the future and I thank you for listening. It was a very quick summary, but anything you want go ahead.

Question-And-Answer-Session

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Well, we already got most of the pricing hits. There will be a little more next year, but we got most of the pricing hit already.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Right. But you'll see a little more pricing hit next year.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Well, that's what I think. I'll repeat what you have to say. The gross margins are more instead of, let's say, 25%, 27% in the traditional aftermarket, they are at least 10 points lower than that in the OES. However, the SG&A is much lower. You have no sales expense to speak of. We have a lot of SG&A, we have sales force, cataloguing, returns, all these things don't exist.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

It gets pretty close. The operating margins, yes, operating profit would be roughly similar to (inaudible), less gross margin, less SG&A, the operating margin roughly the same.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Right.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Yes, that's a good script. 25-30 is what people tell you is the right script. At 25-30, people will buy a rebuild, especially in -- not everybody, probably not the people in this room, but…

Unidentified Audience Member

[Question Inaudible]

Larry Sills

But especially [uniting] the costs $200. So, by the time we get to the car owners, you're talking of $50 or $60 savings. That should be the right number, 25-30. 40 would be better, but 25-30 should be okay. Yeah.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

We don't give those.

Unidentified Audience Member

[Question Inaudible]

James Burke

We don't give out forecasts.

Larry Sills

We don't give those out. Sorry.

Unidentified Audience Member

[Question Inaudible]

Larry Sills

10 operating, that's a high number.

James Burke

We think the key driver is within our Engine Management business and the gross margins. That's where we have the significant pull over the years (inaudible). But we feel we can bring that back to the 28%-29%. Then, you can look at the historical model. The company and our position has been that we did our…

Unidentified Audience Member

[Question Inaudible]

Larry Sills

10 is a high number. I don't think we ever had. Did we have a 10 operating, going back?

Unidentified Audience Member

[Question Inaudible]

James Burke

The numbers are readily available.

Larry Sills

Yeah. I'm lost to give out a number like that. Yes, sir?

Unidentified Audience Member

[Question Inaudible]

Larry Sills

It is true?

Unidentified Audience Member

[Question Inaudible]

James Burke

Yes. Now the question was what is Standard Motor's doing with the debt picture, the leverage that we have on the business, and a comment about our repurchase of stock. For the repurchase of the stock, we felt that it was a good opportunity. We felt we've exceeded any stock option programs within the company. We have an unrestricted stock program. We also have an ESOP program for the employees as a part of their retirement plan. So this was a funding mechanism that was a requirement that we would have in the business. So, that's speaking for a nominal amount of $5 million.

Regarding the debt, earlier this year, in March, we redid our five-year plans. So we have a five-year facility in place for $275 million, with a $50 million increase that is available in there, if we needed to size it up to $325 million. No liquidity issues, it's an asset-based facility. We have roughly $90 million-$100 million of excess borrowing capacity against that facility as we speak today.

Our bank group has been with us the better part of the 10 years. GE Capital is our lead. They reduced our LIBOR spread from 2 1/4 down to 1 1/4. So it was a very favorable deal that we had in place for March of '07. And we've also built-in the availability to absorb, if we wish, and have the capacity for it, the $90 million convert that we have outstanding which matures in July of '09. That may not be the direction we go. We're looking today at all different opportunities of how we would refinance that $90 million. But our fall back position is that we would be able to absorb it under our current revolver.

Unidentified Audience Member

[Question Inaudible]

James Burke

Yes, yes. 32 in change. Less than a…

Unidentified Audience Member

[Question Inaudible]

Larry Sills

We're going to have, I think, a scheduled breakout session as someone else may need the room. So I thank…

Unidentified Audience Member

[Question Inaudible]

Larry Sills

Any more questions? All right. Thank you for participating.

Gerry Scott - President of Wall Street Analyst Forum

Standard Motor will be available in the breakout session. The breakout session is the Dickenson room if you go to the hallway and take a right.

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