Standard Motor Products, Inc. (SMP) Q2 2015 Earnings Report, Transcript and Summary

Good day, everyone and welcome to today's program. At this time, all participants are in a listen-only mode. [Operator instructions] Please note this call may be recorded. I'll be standing by should you need any assistance. It is now my pleasure to turn the program over to Mr. Jim Burke.

Okay, thank you. Good morning and welcome to Standard Motor Products' Second Quarter 2015 Conference Call. In attendance from the company are Larry Sills, Chief Executive Officer; Eric Sills, President; 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 review the financial highlights, and then turn it over to Larry, and also Eric. Looking at the P&L, consolidated net sales in Q2 '15 were 269.4 million, down 3.2 million or 1.2%. And year to date, were 497 million, down 8.3 million or 1.6%. The strength of the U.S. dollar accounted for 2.2 million or roughly two-thirds of the second quarter shortfall. And, 4.2 million or roughly half of the year to date shortfall. Larry will discuss further our customer purchases and their POS sales. By segment, Engine Management net sales in Q2 '15 were 177 million, down 7.2 million or 3.9%. And year to date, were 354.1 million, down 9.4 million or 2.6%. Temperature Control net sales in Q2 '15 were 89.1 million, up 3.4 million or 4%. And year to date, were 137.8 million, up 700,000 or 0.5%. Incremental sales from our Annex Manufacturing acquisition at the end of April 2014 added 1.7 million to Temp Control's Q2 sales and 4.7 million to the first half sales results. We are pleased following two cool summers in 2013 and '14 that Temp Control sales started to accelerate in late June and has carried forward into July at higher levels. Consolidated gross margin dollars in Q2 were down 4.6 million at 27% down 1.4 points, and year to date, were down 8.7 million at 27.5% down 1.3 points. The Engine Management gross margin was 29.5% in Q2, down 0.9 points and 29.4% year to date, down 0.7 points. Impacting our Engine Management margins in Q2 and year to date were costs incurred to relaunch our diesel injector offering. A combination of returns from the field, product cost enhancements and outside purchases negatively impacted margins 5.5 million year to date. The majority of these costs are behind us at the end of the second quarter. Eric will review our diesel efforts in more detail. Temp Control gross margin was 19.4% in Q2, down 2 points and 19.7% year to date, down 2.3 points. 2014 was the second cool summer in a row and we were coming production levels in the second half of 2014. This reduced production level caused us to carry forward into 2015, 1.8 million higher unfavorable manufacturing variances than the prior year. These variances are expensed to the P&L as we turn our inventory and have been fully expensed as of the end of Q2 2015. The good news is we have increased production levels to keep up with 2015 demand that will bode well for second half Temp Control margins. Consolidated SG&A expenses in Q2 were 51.7 million, up 2.9 million at 19.2% of net sales versus 17.9% in Q2 '14. And year to date were 100.9 million, up 4.5 million at 20.3% of net sales versus 19.1% last year. The Q2 '15 spend level was within the 51 million to 52 million range we projected for 2015 quarterly levels. The increase includes 1.2 million unfavorable non-cash charge for prior service cost from winding down our post-retirement medical program. This program will cease in December 2016. The remaining small increase in SG&A expenses are predominantly from other employee benefit cost. Consolidated operating income before restructuring and integration expenses or litigation charge incurred in 2014 and other income net in Q2 '15 was 21 million, 7.8% of net sales versus 28.6 million at 10.5% of net sales in Q2 '14. And for the six months 2015 was 35.7 million, 7.2% of net sales versus 48.9 million at 9.7% of net sales last year. As pointed out in our press release, three items discussed above Engine Management, diesel enhancements 5.5 million, Temp Control unfavorable manufacturing variances 1.8 million and post-retirement amortization expense 1.2 million, totaling 8.5 million accounted for the bulk of the shortfall. Other non-operating income expense net improved 200,000 in Q2 '15 and 800,000 year to date, primarily from our investments in joint ventures over the prior year. The net effect of our operating results as reported in our non-GAAP reconciliation was diluted earnings per share in Q2 '15 of $0.59 versus $0.76 in Q2 '14 and year to date of $0.98 versus $1.30 in the first half 2014. While our sales were down slightly in the first half 2015, we are optimistic for the second half of '15, considering the uptick we have seen in Temperature Control demand. Our operating earnings were also down in the first half to the lower sales volumes and expenses incurred that are predominantly behind us. We anticipate stronger earnings in the second half 2015 over the second half of 2014. Looking at the balance sheet, accounts receivable increased roughly 34 million from December '14 due to the seasonal nature of our business and increased roughly 16 million over June '14 levels which is short-term timing in nature. Inventories were essentially flat with December '14 levels and down 15 million versus June '14 levels. Total debt was 53.1 million, down 3.7 million from December '14 and also down 18.7 million from March '15. Our cash flow was very strong in Q2 '15 generating 40 million from operations and 26 million year to date. In the second quarter 2015, our uses of cash were to fund pay down of debt 19 million, repurchase of stock 7 million and an increase in cash of roughly 5 million. In June, we amended our bank revolver to increase our annual allowance for cash dividends and share repurchases up to $20 million per year each. We also announced today that our Board of Directors have increased our share repurchase program from 10 million to 20 million this year. We repurchased 7 million to-date, leaving 13 million for further repurchases. Regarding dividends, we review this annually and anticipates slow and steady increases as we move towards our target of a one-third payout ratio. In summary, we feel more optimistic for the second half 2015 as this summer season is heating up and many of the costs impacting our first half are essentially behind us. Thank you and I’ll turn the call over to Larry.

Okay. Good morning and thank you for attending the call. I believe the release plus Jim's financial review has really covered the key points. I'll review a few of them in a bit more detail and then Eric will report on our recent acquisitions and then we will open for your questions. Here is the key point. As we said and as Jim said, we are disappointed in the first six months about the sales and the profits, but we believe that most of the factors are short-term in nature and we are optimistic about the balance of the year. Regarding sales, we just got the latest demographic report and they remain positive. The average age of light vehicle has just grown a little more. It is now 11.5 years, highest ever. And the number of light vehicles on the road has also grown up 2.1% in 2014 versus 2013. This just continues the steady trend of slow and steady continued growth and that's what we forecast for the market as a whole. Our customers are reporting sales increases are in line if you average them out. They are up in the low single digits. However, the purchases as a group are slightly down. And as we said in the release, we believe there are a variety of reasons for this. Some of the main ones, our companies are integrating their recent acquisitions. We have some different timing year over year of pipeline orders and things of that nature, but we believe in the long run these balance out and we look forward to a return to low single digit sales increases. On Temp Control, we finally got a warm summer. Sales in July have been strong. It's a 100 degree today in Dallas. There are heat warnings in New York City and we are looking forward to a good third quarter in Temp. Keep in mind that the Temperature Control season is fairly short and historically sales begin tapering off at the end of August. In terms of costs and profit, Jim has reviewed this in detail and so I don’t see the need to repeat, but if you have questions, of course, we will bring them up. And again to reconfirm the main point, we believe the issues are short-term in nature. They are mostly behind us and we are looking for a profit improvement in the second half. Acquisitions have become an increasingly important part of our picture, so we have asked Eric to provide you with an update on some of our most recent ones. And then when he is finished, we will open for questions. Okay. Eric?

All right. Well, good morning, everybody. And before I get into the details of our recent acquisitions, I would like to just take a minute to explain what our acquisition strategy has been. Our focus has been to seek targets that complement our existing business. And so these fall into two main categories, the first we call bolt-on acquisitions meaning that we are acquiring competitors and the second type is a vertical integration type of an acquisition, where we are acquiring our supplier which allows us to become a more basic manufacturer, lowering our costs and gaining increased control over the supply chain. The rationale for this approach, these deals have very clear benefits and immediate synergies with minimal risk. And in addition to strengthening our core business, they do tend to also get us into something new leader in new market or a new technology et cetera. So that's been our model and we have been very active on that over the last many years, in fact over the last four years or so, we have done eight different deals and are continuing to look at various opportunities. And with that, I'd l just give you a brief update on our three most recent. The first two are related both in our Temp Control business. There is Gwo Yng Enterprises which is a Chinese manufacturer of Temp Control products and Annex Manufacturing, Annex is a Texas based distributor of Temp products and they were Gwo Yng's exclusive distributor in North America and that's why these deals were related and done simultaneously back in April of 2014. So just a minute on each. Annex, again they were the distributor here in the U.S. and while SMP was there largest account, they did bring a bunch of new business, largely in OES and heavy duty channels, which are both important growth areas for us. By the end of 2014, we’ve completely integrated the business closed all their locations for the [B] operations into hours and achieved all the anticipated cost savings, while retaining all the customers. Gwo Yng a large manufacture of various Temp Control products such as hose assemblies, accumulators filter drives and switches. And these categories are the one remaining whole in our Temp Control offering where we were not basic manufacturer, so they were perfect fit. So setup as a joint venture, 50-50 joint venture where we own 50% and the other half is owned by the founder, who continues to manage the day-to-day operations. As we were largest customer through Annex, we saw immediate cost reductions and have since added many additional products that we have been sourcing from other suppliers. We’re very excited about the potential here, it’s a large capable low-cost manufacturing operation and we expect to grow it significantly by adding more products not only for our Temp Control business, but for Engine Management business as well. The last deal I want to speak about was our Pensacola Fuel Injection acquisition. They were remanufacturer of diesel products and they were our primary supplier of these products. Diesel has been identified as a very strong growth category for us and one that we needed to be basic in, so we acquired their remanufacturing operations back in January of 2014 and by the end of last year, we had relocated it all to our Grapevine, Texas plant. Since moving it into our plant, we have made significant strides improving the product themselves, improving our manufacturing processes. And as Jim mentioned, we spent a significant amount of money in the first half for this year getting the program where we wanted to be. This is now largely behind us and we actually foresee some nice cost improvement opportunities going forward without compromising the quality enhancements that we built in. So we are very excited about our future in diesel. We have what we believe to be an excellent program from the acquisition, which we have since rounded out with many other diesel categories. We’re expanding our coverage rapidly and it’s being very well received by our customers. So that’s a round-up of our most recent investments and with that I’ll turn it back over.

Okay, thank you, Eric. And that concludes our formal presentation. Thank you for attending and we will now open for questions.

[Operator Instructions] We’ll take our first question from Scott Stember of C.L. King.

Last quarter you guys talked about currency, the Canadian dollar and its impact I believe on the Engine Management business. Can you talk about -- you also talked about putting some pricing increases through to offset that. Can you maybe talk about how that was received and maybe what we could expect in the back half of the year, how that would impact sales?

Yes, we put in a price increase a few months ago to sort of compensate for the drop in the Canadian dollar. It went through with absolutely no issues and because they appreciated it and we see no problems in the months ahead.

And Jim in the past you talked about what you expect the Temperature Control margins to return to once we see a more normalize sales environment. Can you talk about where you would expect the back half of the year? And maybe even on a full year basis for Temperature Control gross margins to look.

Yes, okay. We said -- publicly have said that we felted a normal year on an annual basis, the margins would return to 23% to 24% and that we normally have some unfavorable variances that carryover into the beginning of the year. My expectation is that we’ll have healthier margins in the back half of 2015 and it will -- so, because we’re generating favorable manufacturing variance where -- and that will bode well for going into next year also, but again our stated target would be 23%, 24% and then we don't stop there. That's what we think would be the normal range we can get to and then we have constant efforts working on cost reductions to improve from that point.

And just maybe just taking a higher level look back at Engine Management you talked about some of the optimization going on at some large customers I guess that are integrating their acquisitions, could you maybe just talk anecdotally have you had any conversations with them to figure out the timeline and when they expect to be more aggressive in taking an inventory to match what their purchases or what their retail are showing?

I really don't want to get into any specifics with any customers because we don't do that, but on balance, the sense is that the integration process is pretty much complete and they are looking forward to more normalize in the future.

[Operator Instructions]. We’ll move next to Chris Van Horn of FBR & Company. Your line is open.

Can you give us an update on the TPMS market and kind of your strategic vision there, is there any change to what you see as an opportunity set?

Well thank you for the question, Eric, can you handle that one? Did you hear it?

Sure, yes. For TPMS, we think it's a large growth category, in general, it's a large market growth category as the sensors which really only came online in around 2008 are now starting to hit their sweet spot of replacement. So we think it's going to be a very large market. We think we have put together good program that is being well received by our customers, so at this point, we’re growing nicely with it and we think it's going to be great.

Have you seen penetration for that product across all your customers or are you still building out the inventories there?

We have business with several of our customers, but there are other manufactures, other suppliers out there with strong programs as well, so we’re seeing both some market share gains for ourselves plus just general market growth.

And then on the heavy duty channel, can you give me a sense of what the mix is today and kind of your long term goal for that channel because we know that the fleet size for every truck has been growing and it seems like a good opportunity?

I’ll take a crack at that. We are slowly and I emphasize slowly making in-roads there and I think we have increasingly products available that will help us penetrate that market. You heard about diesel. We have an alternate fuel program based on natural gas that we are producing injectors for that in our Greenville factory, so we think the heavy duty market is quite strong and we are a very tiny player in it, but we’re looking to add products that will help us penetrate that market and we think it has a nice future.

[Operator Instructions]. We’ll move next to John Sullivan of Olstein Capital.

I was just wondering, if you guys could give me a little color on to the increasing accounts receivable both year over year and sequentially given the revenues?

Yes. Many of the receivable -- well, to sort a large portion of the receivables we factor, so with our larger customer, so we collect them. What you are seeing in that growth and we had it at the end of our first quarter also is more related to timing of the end of a quarter that you would see in there, so virtually no change in programs to our customers, it's just timing and nature and we would expect that to be a favorable cash benefit as we would approach towards the end of the year, so depended upon what fourth quarter sales are.

[Operator instructions] And it appears that we have no further questions at this time.

Okay. I want to thank everybody for joining our call today then. Enjoy the balance of the summer. Thank you.