Standard Motor Products, Inc. (SMP) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the Third Quarter Earnings Release Conference Call presented by Standard Motor Products on Thursday, October 27, 2016. [Operator Instructions] It’s pleasure to turn the conference over to Mr. Larry Sills. Please go ahead, sir.

Good morning everybody, and we welcome you all to our third quarter conference call. We thank you for taking the time to join us. Attending from the company is Eric Sills, President and CEO; Jim Burke, Chief Financial Officer; and myself Larry Sills, Executive Chairman. Our agenda for today, Jim Burke will review the numbers, then Eric Sills will review some of our more recent events, and then we’ll open it for questions. So with no further ado, Mr. Burke?

Yes, Thank you. 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. All right. To begin, we are pleased to report our results for the third quarter 2016, which reflects continued strong sales performance, earnings momentum, and increasing cash flows from operations. Looking at the P&L, consolidated net sales in Q3 2016 were $300.8 million, up $30.8 million, or a 11.4%. Excluding $22.8 million in the quarter from our wire acquisition completed in May 2016, our consolidated net sales were up $8 million, or 2.9%. Consolidated net sales year-to-date were $828.7 million, up $61.7 million, or 8%. Excluding $31.3 million year-to-date for the wire acquisition, consolidated net sales were up $30.4 million, or 4%. Both the quarterly and the year-to-date sales performance results were within our expectations of low to mid single-digit growth. By segment, Engine Management net sales in Q3 2016 were $200.8 million, up $24.4 million, or 13.8%. And without wire acquisition sales of $22.8 million, or up $1.6 million, or 0.9%. Engine Management net sales year-to-date were $580.3 million, up $49.9 million, or 9.4%. And without the wire acquisition sales of $31.3 million were up $18.6 million, or 3.5%. Temperature Control net sales in Q3 2016 were $96.8 million, up $6.2 million, or 6.8%, and year-to-date were $241.1 million, up $12.6 million, or 5.5%. As we pointed out in our release, our major customers reported POS sales increases in Temperature Control through September of approximately 9%. This would indicate our customers were able to reduce inventory levels in 2016, which should be beneficial going into 2017. Consolidated gross margin dollars in Q3 2016 were up $14.1 million at 31.8%, up 1.6 points, and year-to-date were up $37.5 million at 30.9%, up 2.5 points. By segment, Engine Management gross margin in Q3 2016 was 33.3%, up 2 points, and year-to-date was 32.4%, up 2.4 points. Increased production levels, continuous improvement and efforts, in-house manufacturing, and low-cost sourcing led to our Engine Management margin expansion. Temp Control gross margin in Q3 2016 was 26.6%, up 0.9 points and year-to-date was 25.1%, up 3 points. Similar to Engine Management, increases in production levels, cost reduction efforts, including low-cost sourcing have improved Temp gross margins above our targeted 23% to 24% levels. Going forward, we will target Temp margins of 25% in an average summer season with further improvements once our Grapevine facility integration is complete. Savings will materialize in late 2017 and fully in 2018 from that closure. Eric will provide further color on this initiative. Consolidated SG&A expenses in Q3 2016 were $61.3 million, up $9.4 million at 20.4% of net sales versus 19.2% in Q3 2016, and year-to-date were $169 million, up $16.2 million, again at 20.4% of net sales versus 19.9% last year. Last quarter during our earnings call, we estimated SG&A spend level would increase from the $52 million to $54 million, up to the $56 million to $58 million range with our wire acquisition. We were above that level and there were four primary drivers that SG&A increases in the quarter and for the nine months. First, was our wire acquisition incremental expenses. Second, variable distribution expenses for labor and freight costs related to the higher volume. Also, increased AR draft expenses due to the higher volumes and higher interest rates. And lastly, were provisions for incentive compensation based on our earnings improvement in 2016. We anticipate SG&A expenses to scale back to $57 million to $59 million range for Q4 2016, due to the lower sequence seasonal sales in Q4 versus Q3 levels. Consolidated operating income before restructuring and integration expenses and other income net in Q3 2016 was $34.4 million at a 11.4% of net sales versus $29.6 million at a 11% of net sales last year, and year-to-date was $86.7 million at 10.5% of net sales versus $65.4 million at 8.5% of net sales last year. 2015 results included roughly $10 million one-time costs, identified in our earnings release. Adjusting for these costs of $1 million in Q3 2015 and $9.5 million for the nine months 2015, our non-GAAP operating income in Q3 2016 increased $3.7 million, or roughly 12%, and year-to-date increased $11.8 million, or roughly 16%. The net effect of our operational results is reported on our non-GAAP reconciliation was Q3 2016 diluted earnings per share of $0.92 versus $0.80 in Q3 last year. And year-to-date diluted EPS of $2.35 versus $1.78 last year. Looking at the balance sheet, accounts receivable increased $37.9 million from December 2015 level, reflecting seasonal nature of our business and accounts receivable increase for our wire acquisition. The increase is only $11.5 million against September level, which is all associated with the wire acquisition. Inventories increased $16.8 million from December 2015, which reflects an increase from the wire acquisition and some bridge inventory build leading to our facility restructuring initiatives. Goodwill and other intangibles increased $49.2 million from December 2015. The wire acquisition added $55 million in 2016, offset by intangibles amortization. Total debt at September 30, was $70 million, roughly the amount we paid for our $67 million wire acquisition in May 2016, funded from our bank revolver. In addition, we had an increase of $11.7 million in cash that was used to further reduce debt in October when individual LIBOR loans were maturing. Our cash flow statement reflects cash generated from operations was $59 million in Q3 2016 and $83 million for the nine months 2016. This reflects a $10 million increase over the nine-month period 2015. We also expect additional cash generated from operations in Q4 2016 when seasonal working capital is reduced. To recap, we are very pleased with the quarter and year-to-date results, reflecting sales growth, increased operating margins, and increased cash from operations. In addition, we are optimistic with future savings to be generated from our wire acquisition integration and our Grapevine facility closure. Thank you for your attention. I will turn the call over to Eric Sills.

Well, thank you, Jim, and good morning, everybody. All right. So Jim’s covered the numbers. And as you heard, we’re quite pleased with the results, both in terms of our top line growth and our improvements in profitability. So there’s no need for me to rehash any of that. I thought I’d spend some time talking about recent events and then we’ll open it up for questions. So starting with an update on the General Cable’s wire acquisition, we’re really – we’re quite excited with how it is going. First of all, the acquisition was, it was a perfect fit in terms of meeting our criteria of our acquisition strategy, tucks in very nicely with our existing wire business, almost a perfect overlay with what we’re already doing. So we’re able to integrate it relatively easily and quickly and relatively low risk and start to enjoy the synergy. So how are we doing with it. We’ve only owned it for about four months now. But since that time, we’re very pleased with how it’s performing. Sales are actually slightly stronger than we had anticipated. All of the operating metrics are improving and we’re pleased to say that we have retained all the customers. So we have now begun the integration of the two businesses and are making nice strides. Distribution, we have completed the distribution integration. They were distributing product from a location in Altoona, Pennsylvania. As of a couple weeks ago, we have moved the last of the customers into our distribution center in Edwardsville, Kansas and so that is now complete and doing quite nicely. And as you saw in the press release, we’ve now announced our plants and what we would be doing to integrate the manufacturing operations. So the deal came with a plant in the Nogales, Mexico and meanwhile we had a very similar plant in Reynosa, Mexico about a 1,000 miles east of there doing really all the same products. After some careful evaluation of what our options were. We have determined that Reynosa will be the surviving location. And so we’ll take approximately the next 12 months to move all the production from the Nogales into Reynosa ultimately closing the Nogales plant. We just made this announcement to the plant personnel yesterday and into today and they’re taking it about as well as we could expect. In terms of overall integration expense of the business, we expect approximately $3 million in one-time cost, about 2.5 of this is expense related to severance, and plant moves in about a $0.5 million in CapEx. And while this business upon acquisition was already profitable, most of the synergies that we expect have yet to be achieved. So once the business is fully integrated, we expect it to be operating at roughly the same types of operating margins as the rest of Engine Management. All right. Turn to an update on our plant restructuring. As we announced earlier this year, we’ve decided to relocate certain of our manufacturing operations. Reminding you of what we’re doing, we are taking all the production out of our Grapevine, Texas plant and moving it to Reynosa, Mexico and some to Greenville, South Carolina, and concurrently we’ll be moving some product from Greenville to our low-cost plant in Poland. At the end of this transition that we’ll be closing the Grapevine facility and selling the property. This whole transition will take us through the end of next year to complete. But we are making very nice progress. Several of the lines have already moved and we’re on budget and on schedule. Once it’s done, we expect us to generate about $6 million to $7 million in pre-costs savings annualized and most of this really won’t occur until all the moves are complete. And we have previously announced that we would have one-time cost of approximately $9 million and we remain very comfortable with that number. Offsetting this one-time cost will be the proceeds from the sale of the building, which we are now marketing and we’re seeing some good interest in the property, and we expect it to sell it for about $5 million. All right. The last topic I’d like to discuss, we’ve been recently touting efforts to expand our offering, looking for complementary product lines, and one that we’re especially excited about is, what we’re doing with diesel. Our diesel program, we believe is far in a way the most comprehensive full-line program in the aftermarket and we’re doing very well with it enjoying about 35% year-over-year growth. Earlier this year – earlier this week, we announced that we’ve entered into an exclusive supply and distribution agreement with PurePower Technologies. PurePower is a former Navistar company that produces original equipment diesel injectors among some other products. And this relationship will allow us to bring to the independent aftermarket the only line of new as in not remanufactured new OE injectors, which we think will be very well received, both by our trading partners as well as their professional technician customers. This relationship with PurePower we think brings together our two companies very complementary strengths. We bring to the party skills in sales, marketing and distribution, as well as access to the market and they are far in a way the highest quality product out there. And so we’re very excited about the relationship. We’re excited about what we think we’re going to be able to do with diesel going forward. So that’s a roundup of recent events. In closing, we’re having a very good year. We certainly have a lot going on, but we have a terrific team here at SMP to get it done and we’re excited about the future. So with that, I will turn it back to the moderator and we’ll open it up for questions. Thank you.

Certainly. [Operator Instructions] And we’ll take our first question from Scott Stember with C.L. King. Please go ahead. Your line is open.

Hello, Scott, good morning.

Good morning and nice quarter. Could you maybe talk about on the Temperature Control side, you obviously benefited some of the record warmth throughout the country, and it seems though if you’re telegraphing at the inventories that your customers are in really good shape. Maybe just talk about any expectation on the carryover into the fourth quarter of any strength, and frame it out versus the fact that, last year in the fourth quarter, you had a 9% decline in Temperature Control. Maybe just talk about whether there’s again any incremental spillover that goes into the fourth quarter and expectation there?

Scott, this is Eric. The fourth quarter is historically a very soft season for Temperature Control. September, in certain parts of the country remained pretty warm. And so that allowed, as Jim alluded to, our customers to continue to sell and bring down their inventories. And so we do think that they’re very well positioned for the 2017 season. But really – Q4 is always a soft season. So I wouldn’t expect to see much other than we typically do.

Got it. And for General Cable, can you maybe just give us an idea of the seasonality of the wire business? So we can get a sense of what to expect in the fourth quarter, or even maybe the first quarter going into next year?

It is not a particularly seasonal line, Scott. So I think you can look at it relatively flat quarter-to-quarter.

Probably maybe just to add to that, the fourth quarter be in a little bit light and maybe a little more in the spring, but other than that?

Right. So it’s not the type of seasonality you would expect in a more temperature-related line.

Okay. And last question on the PurePower announcement, maybe just talk about the size of this contract, the potential contribution to sales, and maybe just give a little bit more color about the actual relationship itself?

All right. Well, in terms of forecasting what it’s going to look like in growth, we typically don’t give those types of projections. But we think it can be a very nice compliment to what we’re already doing. But what we’re selling to-date is our remanufactured product. And by bringing in some new product, we think that that is an exclusive thing coming into the aftermarket. We’ll get some nice traction. We think it will – we hope, it will largely take business away from the OE channel rather than cannibalize anything we already have. They’re an excellent company. They’re a young company. Navistar, only recently spun them off. But it’s very talented group of people, very sophisticated operation out of South Carolina. And so, we’re really just getting started with this relationship with them with an initial offering. But we’ve had very positive discussions with them about what’s next to add to the arrangement.

Got it. That’s all I have for now. Thank you.

Thanks, Scott.

Okay. Thank you.

[Operator Instructions] And we’ll take our next question from Brett Jordan with Jefferies. Your line is open. Please go ahead.

Good morning, gentlemen. It’s David Kelley in for Brett. Thanks for taking my question.

Good morning, Dave.

A couple ones, and I guess, a quick follow-up on Temperature Control inventory levels at the customer level. I mean, how do we think about exiting the summer season obviously a very hot summer. How do we think about their inventory levels versus maybe longer-term historical averages? Obviously, we’re coming off a couple years, where inventory was high exiting the season. Are we kind of back in line with what you’d expect over a longer-term average, or are we looking at very light inventory, as we head into 2017, just wondering how do you think?

I think it’s more of a normal inventory. They haven’t led it to super low levels. But we think that they’re in a very healthy position to start the year. So I’ll consider it more normal than light.

Okay, great. Thanks. I appreciate that. And then quickly just why don’t you could provide some color on the Engine Management volume pipeline heading into Q4, or maybe what’s your stand that to close out the year end here, even some thoughts into 2017 would be great as well?

Well, as we’ve always said, our sales out quarter-to-quarter can be semi-lumpy, because our customers are large and they place their orders lumpier than they are selling. And in the end, it comes out to the low single-digit growth that we’ve historically said and it’s historically has come out at that in terms of ongoing run rate. I wouldn’t expect to see anything different going forward. But again, quarter-to-quarter, you could see some things move around a little bit.

Sure, great. I appreciate that. And then one more and I’ll pass along. Given these operating initiatives, the ignition wire acquisition, I guess, how should we think about Engine Management margin opportunity maybe as we look out towards the end of 2017, as some of these things start to roll off? What are your thoughts a longer-term there?

David, it is Jim Burke. Again, the – we had a continuous improvement in there and that’s really our stated goal for Engine Management. Day-to-day, our engineering teams are working on bringing product in-house manufacturing. You see some of the initiatives that we have move into low-cost areas. So we think, again, a competitive marketplace, but our stated goal in Engine Management is continuous improvement.

Okay, great. Thanks, guys. I appreciate the – you answered my question.

Thank you, David.

Thank you, David.

[Operator Instructions] And we’ll take our next question from Brian Sponheimer with Gabelli. Please go ahead. Your line is open.

Hi, everyone, how are you?

Good. Good morning, Brian.

Hey, good morning.

Look forward to seeing you next Tuesday. Eric, you mentioned diesel and your capacity for acquisitions is obviously sizable. But what’s the landscape as far as targets, as far as you’re concerned that can really add to your product base broadened your customer profile if that’s a goal and it seems like but just how relationship that it is?

Yes, we’re very pleased with how our acquisition strategy has played out. It has been relatively conservative, or narrow in the types of targets that we look for. And so that’s going to continue to be our strategy. We think that there is still somewhat of a pipeline out there, and so we’re going to stick with the plan that’s worked very well for us.

Okay. And just as far as OES initiatives, can you give an update on anything that’s developed over the course of the year?

Sure. I’ll speak to OE in more general terms. It continues to march along at roughly 8% or so percent of our business. But it’s a very different type of business, as you know. The life cycle is much quicker, so to retain that type of steady sales means, you’re constantly having to replenish business that’s falling off. And what’s happened over the last several years is, I think that we have done a nice job of trading up in terms of the quality of the business that we have in OE in terms of the profitability. as we focus on things where we have more strength, where it’s taking more advantage of our competencies. And so we’ve kind of narrowed our focus on what we look for, we have done well really capitalizing on the Annex acquisition of a couple of years ago into Temperature Control heavy duty in the OE product, which largely comes out of our joint venture in China looking at – working with our Poland operation, which has a great combination of high scale and low cost. And also the General Cable deal came with a good chunk of OE business as well. So I think that what’s happened over time is, we continue to focus on it as a nice compliment to our core business. We’ve become tighter on the types of business we will chase to make sure it is profitable for us. And so it’s something that that we continue to work on. We have an organization that’s dedicated to it and we see that there’s still some good opportunities and we pursue it.

Okay. I think the last one I’ll ask is, with your customer base, any change in their own stance as far as, I guess, their payables or your receivables in factoring?

Brian, it’s a competitive marketplace that’s there. And I think the – customers have the ability to avail themselves through the draft program. They’re using it there, and I think it’s fairly constant in that arena.

Okay. All right I’ll see you on next Tuesday.

Okay, very good.

Thank you, Brian.

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

Okay folks. Thank you very much. I’ll just wrap it up and repeat what you guys have said here. We are pleased with the results for the third quarter and for the year-to-date. And with all the initiatives that we have in place that you’ve heard about now, we look forward to the future. So thank you very much for attending.

Okay. Thank you and good bye.

This does conclude today’s program. Thank you for your participation. You may disconnect at any time.