Standard Motor Products, Inc. (SMP) Q3 2015 Earnings Report, Transcript and Summary

Good day, everyone and welcome to today's Standard Motor Products Third Quarter Earnings Release. At this time, all participants are in a listen-only mode. [Operator Instructions] Please note this call may be recorded. It is now my pleasure to turn today's program over to Jim Burke, Vice President of Finance and CFO. Please go ahead.

Okay, thank you, Christopher. Good morning and welcome to Standard Motor Products' Third 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 now the call over to Larry Sills with for some opening comments.

Thank you all for listening will have a slightly different format today. We've sent out two releases this morning, one on the quarterly earnings and one on announcement of managements succession. I feel like I would start by reviewing the management succession announcement then Jim will review the quarterly results and the Eric Sills will talk a bit about strategic planning going forward. And then finally will open for questions. So I'll start with the a quick review of that announcement and off course the details are in the release. But the highlights are that effective March 31 2016, Eric Sills will become CEO, I will become Executive Chairman of the Board, Jim Burke will become Executive Vice President and Chief Financial Officer and Dale Burks, Executive Vice President and Chief Commercial Officer. A word about the folks here, Eric, Jim and Dale all have extensive experience both in our company and in the industry. Eric while his primary focus has been in operations has also been involved in all other aspects of the company as well, but he has been responsible for our operations in United States, Mexico, Poland and Canada plus our joint ventures in China and Taiwan. He is also a supervising the integration of our eight recent acquisitions. Our improvement in all of these areas has been a major source of our profit growth over the last several years. Jim you will know he is extremely well respected both in the financial community and within our company. And Dale is responsible for what most people would say is the best sales and marketing organization in the aftermarket and together a former tremendous team. One further point, Eric will be only the fourth CEO in our 96 year history. I doubt there are many companies that you follow that have records anything like that. The benefit of this we believe is that it provides a strong sense of stability in company culture and this is something we believe is important and something that our customers appreciate and our employees appreciate. Secondly it enables us focus on long term strategy and we think these are very important, so all in all we are pleased with this, we are confident that we now have a team that will take us well into the future. So with that I thank you and now will turn it over to Jim for the numbers.

Al right, to begin let's look at the P&L. Consolidated net sales in Q3 '15 were 270 million, up 13 million or 5.1%. And year to date, were 767 million, up 4.7 million or 0.6%. Foreign exchange rates have had a negative impact on our sales this year. So the third quarter the impact was a minus 2.8 million and for the nine months the impact was 7.1 million. However we did benefit in the first half of this year from our Annex acquisition incremental sales 4.7 million incremental sales are included in our EBITDA results. By segment sales in both engine management and temperature control were positive in the quarter. Engine management net sales in Q3 '15 were 176.4 million, up 6.5 million or 3.8% and year-to-date were 530.4 million down 2.9 million or 0.6%. Engine Management net sales were impacted by unfavorable change in foreign exchange rates and our diesel return for inspection which was primarily impacted on our Q1 and Q2 sales results. We have made a cautionary note that Q4 ’14 Engine Management sales included pipeline orders that maybe difficult to match in Q4 ’15. As we stated in the release, our customers are reporting on average sales increases in the low to mid-single-digits for Engine Management which matches our expectations. Temperature Control net sales in Q3 were 90.6 million, up 8.4 million or 10.3% and year-to-date were 228.4 million, up 9.1 million or 4.2%. The first warm summer in three years produced the 10% sales increase in Q3 that should also bode well going into 2016, as customers sold down inventory towards the end of the season. As noted earlier, the year-to-date Temperature Control sales included 4.7 million incremental sales from the Annex acquisition at the end of April 2014. Consolidated gross margin dollars in Q3 were up 4.3 million at 30.2%, up 0.2 points and year-to-date gross margin dollars were down 4.3 million at 28.4% down 0.8 points. By segment, Engine Management gross margin was 31.3% in Q3, down one point and 30% year-to-date down 0.8 points. Impacting our Engine Management gross margin numbers are cost incurred to enhance our diesel offering. Year-to-date we incurred 5.9 million additional diesel cost from a combination of returns from the field for inspection, outside purchases at a premium and product cost quality enhancements. The bulk of this expense was incurred in the first-half with only a small amount in Q3, we do not expect any further significant expenses going forward. The good news is we can see the sequential margin improvement during 2015 going from 29.2% in Q1 to 29.5% in Q2 and 31.3% in Q3 for a year-to-date rate at 30% even. Temperature Control gross margin was 25.7% in Q3, up 3.5 points and 22.1% year-to-date the same as last year. As we pointed out during our Q2 call we expected margins to improve in the second half 2015, as production levels were increasing as opposed to last year second half 2014 when production levels were being dramatically reduced due to the cool 2014 season. Q4 is normally our lowest sales quarter and margins can be volatile based on the level of customer returns. However, we feel we are radically accrued for returns and with higher production levels this year, we expect to exceed last year’s Q4 margin at 18.6%. In addition, we will be in a better position entering 2016 without the carry forward of 1.8 million unfavorable variances that we experienced in 2015. Consolidated SG&A expenses in Q3 were 51.9 million, up 3.1 million at 19.2% of net sales versus 19% in Q3 last year. And year-to-date were 152.8 million, up 7.6 million at 19.9% of net sales versus 19.1% for the nine months 2014. The Q3 ’15 spend level was within the 51 million to 52 million range we projected for 2015 quarterly levels. Our post-retirement medical program accounted for 1.8 million year-to-date for the non-cash change in prior service cost amortization. This program terminates at the end of 2016. The remaining spend increase is primarily related to other employee benefit cost and distribution expenses. Consolidated operating income before restructuring and integration expenses, a litigation charge incurred in 2014 another income net otherwise non-GAAP operating income in Q3 was 29.6 million, 11% of net sales versus 28.4 million at 11.1% of net sales in Q3 last year. And for the nine months ’15 was 65.4 million, 8.5% of net sales versus 77.3 million at 10.1% of net sales last year. As pointed out in our release the majority of the year-to-date shortfall discussed earlier were Engine Management diesel enhancements for 5.9 million, Temperature Control unfavorable manufacturing variances carried over from 2014 of 1.8 million and post retirement amortization expense of 1.8 million totaling 9.5 million. These costs are behind us except for the post-retirement medical plan that terminates in December 2016. Other non-operating income expense net improved 400,000 in the quarter and 1.2 million year-to-date. The benefit in the quarter and year-to-date was primarily from foreign exchange impacts and improvements that are joint ventures. The net effect of our operating results is reported on our non-GAAP reconciliation with diluted earnings per share in Q3 15' of $0.80 versus $0.74 in Q3 14' and year-to-date of a $1.78 versus $2.04 during the nine months 2014. Overall we are very pleased with the performance in Q3 with consolidated 5% sales increase sequential [under] management gross margin improvements, 25.7% temperature control gross margin in the quarter, SG&A within targeted levels and non-GAAP EPS beat in Q3 of $0.80 versus $0.74 last year. Looking at the balance sheet, accounts receivable increased roughly 24 million from December '14 due to the seasonal nature of our business and increased 4.5 million from September'14 levels inventories are down roughly 8 million from December 14' and down roughly 6 million from September 14' levels. We expect inventory levels to increase by yearend to maintain service levels going into 2016. Total debt was 24.6 million, down 32.2 million from December '14 and down roughly 35 million from September '14 levels. In our press release we also announced entering into a new revolving credit facility with JPMorgan Chase as agent and a syndicate of lenders. The new 250 million facility while was our borrowing cost and expense on maturity five years to October 2020. We are very pleased to have completed this new facility. Our cash flow from operations was very strong in Q3 generating 46.7 million in the quarter and 72.8 million year-to-date. Our year-to-date use of cash was for debt pay down of 32 million, repurchase of stock 16 million, dividends of 10 million and capital expenditures of 15 million, totaling roughly 73 million. Our stock repurchase authorization was for 20 million and in the month of October we repurchased an additional 2 million bringing total repurchases to date to 18 million with 2 million still remaining open. Dividends were approved for the fourth quarter payable on December 1st at $0.15 per share and lastly as you can see capital expenditures increased year-to-date to roughly 15 million versus 9 million last year. We anticipate CapEx spending to be in the 20 million range annually as we fund our strategic initiative for higher in house manufacturing and hence gross margin improvements. In summary we noted a caution against matching last year's engine management Q4 sales levels but are optimistic entering 2016 with a tailwind to roughly 9 million to 10 million cost incurred in 2015 are behind us. Thank you for your attention. I'll now turn it over to Erick Sills.

Well. Thank you Jim, and good morning everybody. I'd like to just start with some brief comments regarding the announcement of the organizational change. Let me just say that I'm extremely excited about this opportunity. I believe we have the terrific team, Jim Burke, Dale Burks and myself we totaled 85 years with SMP and three of us have worked quite closely together for many of those years. I believe we have very complementary skills and great chemistry and look forward to working with them going forward. As important I believe we have tremendous strength behind us all the people throughout SMP are really the ones who are rolling the boat making everything happen. So the industry is doing well and I believe that we are well positioned for the future. So let's review the business, Jim's gone over the numbers and I thought I'd spent a little bit of time looking forward giving some headlines of our strategic direction. So as you all know the industry growth in general is predicted to be in the single digits due to all the favorable demographics that you are well aware of, increasing vehicle age, size and fleet and so on. But I believe that the key for SMP is that's projected at the majority of this growth is going to be with do it for me segment, the BIFM segment and I believe this plays very well with who we are and have always been which is a full line, full service supplier who really targets that professional installer base with professionally accepted brands and so we plan to continue to emphasize this approach and invest in all these services and programs as we believe that they are real differentiators, we believe that they are key to really helping our customers grow their commercial business. So this is the first address of our strategic plan is to continue to emphasize these services and so just to give you a flavor of some of the services I'm referring to, strong sales organization out there working with our customers and their sales organization at the installer level helping to pull back product through, award winning technical training on vehicle diagnostics and repairs we train 60,000 technicians every year and we believe that this is as never more important as it is now and going forward as the vehicles get more complex and the repairs become more difficult and the technicians really need this sort of help. And lastly we really have what we believe to be best in class supply chain programs which allow us to have very quick turnaround of orders out of our distribution centers, with high order fill, but also to work closely with our customers collaborating with them on forecast, helping them to determine what the appropriate product mix is so that they have the right products on their shelves. This is kind of a quick summary of some of the services that we plan to really double down on going forward. Secondary concentration for us is on our continuous improvement initiatives and cost reduction, those things that make us a stronger company. Some of the highlights here first is to increase how much we manufacture ourselves making more of what we sell. We have been investing heavily here, Jim spoke of the increase in CapEx as we invest more in tooling new products. We believe this helps us with our costs, it helps us control our quality and our order fill and frankly believe it's really what our customers expect with their suppliers is to be a basic manufacturer. Secondary is our drive to be a low cost manufacturer. When we first began this initiative back in 2005 only about 20% of our production was in our low cost plans and now that number is around 75%, so we are very pleased with what we’ve been able to do in this area and believe that our cost structure going forward is quite good. And the last focus on cost improvements, I am going to talk about is our emphasis on low cost sourcing, here we’ve been building up our organization out of Hong Kong with both procurement people, but as importantly, if not more importantly with engineers who are out there working side-by-side with our suppliers and this group has really contributed to organize material cost savings that we’ve been seeing year-over-year. That’s kind of quick round of some of the cost reduction initiatives. And the third area of concentration for us is growth and we pursue growth in two ways. The first is with organic product development launching new product lines, I think it's important to note that we need to continue de-launching these new lines and newer technologies as some of it's there really to replace the volume of decline in categories that are [later] in their lifecycle. So this isn't pure growth, some of it is against its replacement volume as we managed products due to lifecycle. But we are doing many things in this area some of which we’ve been telling you about such as our diesel program, our tire pressure sensing program, [tech smart] and we recently just this week announced the launch of a new Mass Air Flow program that we’re excited about as well. The other areas for growth is our trust towards acquisitions and to remind you of our focus on acquisitions, we’ve been seeking targets that really complement our core business and they fall in two main categories; first is bolt-ons aiming that we are requiring companies and the second is vertical integration where we’ll acquire our suppliers allowing us to quickly become a more basic manufacturer lowering our cost and gaining increased control our supply chain. Why is that that we focus on these two main areas, it's quite low risk with immediate synergies but in addition to just strengthening our core business they do typically get us into something adjacent to that business which gets us growth getting into a new market, a new technology and potentially even in new geography. So we have been quite active here, where we have done eight deals over the last few years all of which are now fully integrated into our business and we’ll continue to see targets that fit this mold. So in closing, I am excited about our business going forward, I believe we have solid plans and terrific team in place at all levels of our organization to make it happen. So with that, we will turn it over to the moderator and open it up for questions.

Thank you. [Operator Instructions] Our first question from Scott Stember with C.L. King. Your line is open.

Good morning. On the Engine Management side, you guys had a very nice rebound in business in this quarter, I know that in the past few quarters there has been commentary about the customer or two that has been optimizing inventory and is it fair to assume that that process has run its course or were you able to grow your business in this manner despite the fact that it was continuing?

Good morning, Scott. It's really a combination of the two, but yes what we referred to in the past there are some customers working down their inventory, we do believe that that is behind us as we’ve seen the orders from those guys come back to more normal levels. But then we are just seeing kind of that incremental growth that we would expect.

But maybe talk about the competitive side of the business on some of your core products or some of your older legacy products, how that is stacking up and what you're seeing from a pricing standpoint? And maybe also just touch base on [tax mart] seems like you have some nice advancements there, maybe just talk about as that becomes a bigger piece of the pie what that can do in 2016 and beyond?

Sure, on the first part of your question; first about the competitive environment out there and its effect on pricing, thinking [indiscernible] it is competitive out there, we’re in a competitive business it's nothing new to that. And pricing is tough which is really one of the reasons why we focus heavily on our cost reduction initiatives to drive the bottom line but we think we are doing okay out there and as it relates to [tax mark], has been very nice we launched the line in 2011 so it's only four years in and we've seen some nice steep growth on it as we add a lot more products, draw in the different categories that we are in, we think that it took a little bit of time as you would expect to get some brand recognition out there and we think that it's now starting to get that traction and so we are investing in it, we have some good dedicated resources internally to drive it and look forward to seeing what it can do for us going forward.

And just lastly how many skews you have in [tax mark] right now?

I believe the number's about 900 and adding the few hundred each year.

Thank you. [Operator Instructions] Will go next to Bret Jordan with Jefferies. Your line is open.

On that last question around completion obviously a competitor yesterday was talking about potentially expecting the cadence for competition to change, is that something that you are seeing, I mean it’s a competitive world but are you expecting that the competitive landscape has got any changes coming in the next couple of months or status quo.

I don’t think that there is anything imminent that's going to change things it's been tough, it's been tough for years of the concentrations and consolidation to customer base and with different types of competitors coming in but I think it's just more or the same quite frankly.

Okay and I guess with Wells in the NGK portfolio now the behavior there is status quo. Is Wells behaving as well it did previously?

Yes we really haven’t seen any changes, they are a good company and we've been good competitors with them for forever really and so now that they are part of NGK, no we really haven’t seen any of the changes of their behavior.

And then last question on their positions are you looking at businesses that would essentially [as you serve] similar category management positions that you have now or would you look at the sort of one off product lines that you can fit within your manufacturing asset base.

Well I think Eric said it quite well in his talk. I think both of those things which you said because they both fit into our mold, which is what we call Bolton and that would be related lines, related companies or vertical integration. And I think if I understood your point, I think you were referring to both of those and that remains our strategy, we think it's a best to way go.

Okay and I guess when you think about size of potential acquisitions, given the fact that you've got more capital access and less debt now, is there a sort of the range that you think is the maximum or I guess how we think about which you could look at out there?

This is Jim Burke, Bret. Probably the other way to answer that is what leverage are we comfortable putting on the business so very comfortable that if we moved up to three times debt to EBITDA we're in excess of the 100 million on EBITDA, so we have plenty ahead room in that area there, so we've been doing mainly say in the $30 million to $50 million range. We are very comfortable, those are nice right size to put on but not we are not against to finding any larger or more significant opportunities. Again we stay focused within primarily within our inter management temperature control area.

[Operator Instructions] Will take a follow up question from Scott Stember with C.L. King. Your line is open.

So on the diesel side it seems like you've had compare the investment this last year and with those costs seemingly in the rear view mirror, can you may just talk about what we could expect on the growth side on the sale side in 2016 and beyond and just the general overall opportunities there?

Sure Scott. This is Eric. Certainly 2014 and 2015 were heavily focused on getting the program right in terms of what we had in the box as well as what the overall program looks like and if we are now quite confident and comfortable where we put together and we recently did a more substantial re-launch into the market place with new cataloging, new packaging and lot of additional sales support materials and it is being quite well received by the customer base and so we've been enjoying a double digit growth before we started putting the [indiscernible] behind it and we think that's going to continue. We don’t typically give specific guidance on size of individual product lines but it is a nice good sized business for us and we think it's going to grow well now that we have the program that we’re ready to emphasize.

And we have no further questions at this time. I’ll turn the call back to our presenters for any closing remarks today.

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