Standard Motor Products, Inc. (SMP) Q2 2019 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today's call. [Operator Instructions]. Please note, today's conference is being recorded, and I will be standing by if you should need any assistance. It is now my pleasure to turn today's program over to Larry Sills, Executive Chairman. Please go ahead, sir.

Thank you. Good morning, everyone, and welcome to Standard Motor Products' second quarter conference call, and we thank you for attending. Here for the company, Eric Sills, CEO and President; Jim Burke, Chief Operating Officer and CFO; and myself, Larry Sills, Executive Chairman. Agenda will be Jim Burke will review the second quarter financial results, then Eric will highlight a few key areas. And finally, we will open for questions. So again, thank you, and let's begin.

Okay. Thank you, Larry. 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 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. Looking at the P&L, our consolidated net sales in the second quarter were $305.2 million, up $18.5 million or 6.5%. As previously discussed, we acquired the Pollak business from Stoneridge back on April 1, 2019. Incremental sales from the acquisition in the second quarter were $10.7 million. Eric will provide additional color around the Pollak acquisition and also the integration. Excluding the Pollak sales, our consolidated net sales in Q2 were up $7.8 million or 2.7%. Our first half consolidated net sales were $588.9 million, up $40.5 million or 7.4%, and excluding the acquisition, were up $29.8 million or 5.4%. By segment, Engine Management net sales, excluding wire, in Q2 were $181.8 million, up $19.4 million or 11.9%. Excluding the Pollak acquisition sales, Engine Management sales without wire were up $8.7 million or 5.3%. For the 6 months, Engine Management sales without wire and without Pollak were up $23.6 million or 7.3%. Our wire and cable net sales in Q2 were $36.2 million, down $4.8 million or 11.6% and first half sales were $73.3 million, down $6 million or 7.6%. Our long-term forecast remains unchanged for Engine Management sales, excluding wire and acquisitions in the low- to mid-single digits, and the wire and cable net sales, which are in secular decline, to be down 6% to 8% per year. Temperature Control net sales in Q2 were $84.4 million, up $4 million or 5%, and for the first half, sales were $153.3 million, up $12.7 million or 9.1%. Our first half 2019 Temp Control sales primarily represent pre-season stocking orders, and the 2019 growth of 9.1% was against soft first half 2018 comparisons. This will change as we get to Q3, and we will be up against an 18.4% sales increase in the third quarter of 2018. Consolidated gross margin in Q2 '19 was 29.1% versus 28.4%, up 0.7 points and for the first half was 28.3% versus 28.1%, up 0.2 points. By segment, Engine Management gross margin in Q2 was 29.3% versus 28.4%, up 0.9 points and for the first half was 28.6% versus 28.4%, up 0.2 points. Engine Management margin improvement reflects favorable manufacturing costs in our wire business, as we return to historical productivity levels compared to incremental costs incurred during the integration. Also, continuous cost reduction efforts from in-house manufacturing and low-cost sourcing and finally, pricing efforts, including pass-through tariff costs incurred with a slight dampening effect on margin percentages. Temp Control gross margin in Q2 '19 was 26.7% versus 25.9%, up 0.8 points and for the first half was 25.3% versus 24.5%, up 0.8 points. Our second quarter and year-to-date gross margins benefited from favorable production levels, yielding favorable absorption variances. We are planning lower production levels in the second half 2019, which we believe will bring our full year margins back within our forecast of the 25% to 26% range. Consolidated SG&A expenses in Q2 were $60.5 million, up $2.8 million over Q2 '18 at 19.8% of sales versus 20.1% last year. For the first half, SG&A spend was $120.5 million, up $5.1 million at 20.5% of net sales versus 21.1% last year. The SG&A expense leverage was achieved with our incremental sales volumes and also savings achieved in our temperature-controlled distribution center compared to 2018 incremental costs incurred during the automation installation. Consolidated operating income before restructuring and integration expenses and other income net in Q2 '19 was 9.3% of net sales, up 1.1 points over 2018 and year-to-date was 7.9% of net sales, up 0.9 points over the first half '18. The net effect of our operational performance as reflected on our non-GAAP reconciliation was Q2 '19 diluted EPS of $0.92 versus $0.74 last year and for the six months, diluted EPS of $1.49 versus $1.20 in the first half of 2018. Looking at the balance sheet, AR increased $21.9 million since December '18 due to seasonality and was up $5.5 million versus June 2018 levels. Both increases reflect our higher sales level. Inventories increased $25.4 million over December '18 and increased $43.8 million over June '18. We have planned inventory reduction efforts over the second half of 2019, which will reduce our inventory and debt levels. Funding for these seasonal working capital increases was through our bank revolver. Total debt at June 30 was $135.2 million, reflecting an increase of $86 million against December '18. Almost $40 million of this increase was to fund our Pollak acquisition on April 1, 2019. Our cash flow statement reflects a $19.5 million use of cash in the first half 2019 versus $4.2 million cash generated from operations in '18. Changes in working capital accounted for the differences, and these increases are expected to lessen over the second half 2019. Investing activities reflects spending for our Pollak acquisition of $38.4 million in 2019 compared to our China joint venture funding of $8.6 million in 2018. Also included into 2019 was cash receipts of $4.8 million from the sale of our Grapevine, Texas facility in December '18, with cash proceeds received in early 2019. Financing activities included dividend payments of $10.3 million and share repurchases of $10.7 million. In the second quarter, we completed our $20 million authorized share repurchase program. In summary, we are very pleased with our Q2 and first half results, reflecting higher sales volumes, higher gross and operating margins and more specifically, significant improvements from our wire manufacturing operations and our Temp Control distribution automation efforts. I want to thank all our employees for the significant operational improvements in 2019. Thank you for your attention, and I will turn the call over to Eric.

Thank you, Jim, and good morning, everybody. Well, Jim went through the numbers, so I'll only add some color on a few pieces and then provide an update on our latest acquisition. Overall, as you've heard, we are very pleased with the quarter. Both divisions performed quite well, posting strong sales and profits, and this reflects recovery from some of our recent short-term challenges previously discussed and positive momentum from our various initiatives. I'll review each division separately, starting with Engine Management. Overall, our divisional sales remained strong for the quarter. Our wire and cable business continue to track downwards, reflecting the ongoing decline of the product category. However, excluding wire, the rest of the Engine Management business was up almost 12% in the quarter, a gain of almost $20 million. There are a few components here. First and the largest is the contribution from our recent acquisition of the Pollak business. This deal closed on April 1, so we had it for the entire quarter. It contributed a bit more than half of the entire gain. I'll speak more about the acquisition a bit later in my remarks, but we are quite pleased so far. Excluding Pollak, our non-wire Engine Management business was up a bit over 5% for the quarter. This strong performance is a combination of a few elements. First, we enjoyed strong demand within our OE business. That said, this segment can be somewhat volatile, and while the first half has been favorable, we expect a slight softening for the second half. Secondly, as previously stated, we have been passing through tariffs and have also achieved some nominal price increases. Beyond that, ongoing aftermarket demand is keeping pace with our expected low single-digit growth. Our customer sell-through in the quarter was also up in the low single digits, tracking with their purchases. Engine Management gross margins also continued to improve nicely, showing positive sequential performance. Much of this performance -- much of this improvement is due to finally achieving historic productivity in our wire plant in Mexico. To remind you, we spent the last several quarters integrating the acquired General Cable production, doubling the plant and incurring fairly substantial temporary costs. The plant is now fully stabilized and doing quite well, and we are delighted at what they have accomplished. We also saw the benefits of certain pricing actions, although, from a gross margin percent standpoint, this was largely offset by passing through the tariffs at our costs. Moving to Temperature Control. This is always a somewhat complicated sales story to tell due to ordering dynamics. Sales were up 5% from last year. However, it's important to split the quarter into two pieces. April and May are really still pre-season as customers prepare their shelves for summer. As discussed in the first quarter call, pre-season activities far surpassed last year, and that trend continued into the second quarter. June marks the beginning of the summer season. If you recall, last year, the summer heat began early and demand was very strong in June. However, due to the strong demand, coupled with our early struggles with new warehouse automation, we ended last June with an order backlog, which transferred some sales into July. Although this June was substantially cooler and incoming demand was lower, we ended the quarter fully current on shipping our orders. So while this makes for a good quarter, we are cautious in how we are viewing the third quarter, which really defines our Temp Control here, and we are going against very strong comps. Customer sell-through in the quarter was down mid-single digits. That said, it has now gotten hot around the country, and there are early indications of positive POS trends in July. Notably, within SG&A, we saw a nice improvement in distribution expense. As previously mentioned, last year, we are operating our distribution center very inefficiently as we implemented new systems, and that is now behind us. This should prove to be a continuing trend throughout the season as we incurred high distribution costs throughout the entirety of 2018. Lastly, I'd like to give an update on our recent acquisition of the Pollak business from Stoneridge. To remind you of what it is, this is a $40 million plus business selling various switches, sensors and connectors, largely for commercial vehicle applications. About 75% of it is for OE. The remaining 25% is aftermarket, sold into the heavy-duty aftermarket channel as opposed to through our typical distributors. The products are currently manufactured in two Stoneridge plants. The majority in Canton, Massachusetts and the balance in Juárez, Mexico. We acquired all of the production equipment but did not acquire the plants or any of the employees. Therefore, Stoneridge is manufacturing the products for us as we gear up to relocate the production to existing SMP plants. The majority will go to our Engine Management plant in Mexico. As you can imagine, once we relocate it from Massachusetts, we will be able to enjoy significant cost savings. The relocation will take the balance of the year, so we expect to realize full synergies some time in 2020. But we believe that the more important benefit will be in the ability to grow the business by taking advantage of the full resources of SMP as well as our breadth of products to expand the offering. So while the business is still quite new and we have a great deal to do, we are very excited about the potential. When you add it all together, we're quite pleased with the quarter. Sales are up for both divisions. And after a cool spring, things are starting to get hot across the country. We've recovered from all of our short-term cost challenges. Although, they were painful while they were occurring, they were all designed to make us a better company. We integrated acquisitions, shifted production to low-cost plants and invested in process improvements. And now that they are done, we can reap the rewards. We have an excellent new business with Pollak, allowing us to diversify our portfolio in adjacent spaces with clear synergies, and so we feel very good about our future as we continue to celebrate our 100th year. That concludes my prepared remarks. With that, I will turn it back over to the moderator, and we will open it up for questions.

[Operator Instructions]. We'll take our first question from Bret Jordan with Jefferies.

This is Mark Jordan on for Bret. So thinking about the Engine Management sales increase ex the Pollak acquisition and the wire and cable is up above 5%, low single digit organic. So I'm thinking about how much of that was from pricing and how much of it was from OE.

We don't get into the specifics of the different segments within it, but if you look at the general growth, as mentioned, we did have a little bit from pricing and tariffs, and so it's a balance between organic unit volume growth and some of the benefits of pricing and tariffs.

Okay. Great. And it looks like the Reynosa facility is now up and running pretty efficiently. Should we expect to see gross margin benefits going forward in the segment? And then how should we think about the Pollak volumes transitioning down there? Should it maintain the same productivity?

Okay. Yes. This is Jim Burke. And just to be clear on Reynosa, we basically have three facilities, and they are separated between the different plants. So this is separate than the wire plant, which now we feel is humming along at historic productivity levels. This is going into our other Engine Management facility that's there. And from a margin standpoint, we are anticipating healthy margin improvements from the Pollak acquisition as we transfer the bulk of this from Canton, Mass down to our Reynosa facility, a smaller portion of it to our Independence, Kansas location and part of it is moving from one of Stoneridge's locations in Mexico -- Juárez over to Reynosa. But we're anticipating a very nice margin improvements from this business. When we put Pollak all together, we believe the operating margins will be very strong, matching or exceeding our Engine Management margins.

And then just one quick question for the Engine Management gross margin, what is it that we're expecting this year? I think I missed it when you mentioned it earlier.

Well, we have targeted for the full year to be in the 29% to 30% range as we're looking for our longer-term guidance and state that -- then for next year, we'll be looking to get back into the 30% and hopefully, look for continued in-house manufacturing and low-cost sourcing to stay above 30% and grow it.

[Operator Instructions]. And we'll take our next question from Robert Smith [ph].

Yes. So looking ahead, longer term, you see OEM contributing a greater share of your total mix. Is it the amount it accounts for?

Are you asking if that's a growing trend? If you are, Robert, yes, it's -- with Pollak being largely OE, that does move the needle a bit. Prior to that, it was tracking at about 12%. So now maybe it brings it up to about 14% of our overall business. I think it is -- and as it does grow, I think it's worth, perhaps, defining it a little bit more clearly than perhaps we have in the past. Much of our OE business, it's not your typical selling to the car manufacturers, light vehicle markets. A lot of what we're doing is more in niche areas, commercial vehicle, heavy-duty industrial, farm, agricultural, et cetera, so it's a slightly different business than what most people think of when they think of OE. The life cycles tend to be a bit longer and technology changes don't occur quite as rapidly. So we are seeing this as a nice area for growth for us. The Pollak piece fits very nicely within that strategy, and we do hope to continue to grow it.

Are you looking for further opportunities to acquire?

Well, both through acquisition as well as organic growth. Our -- as I mentioned in my prepared remarks, when we acquired Pollak, the intent was not to milk it. The intent was to grow it. And so we're putting resources behind it. It brought some very blue chip accounts with it. Some of which we had already doing -- been doing business with, others were newer to us. We'll be adding technical resources and expect to be able to capitalize on it

And then a further thought, longer-term in nature. Do you have any thoughts about the on-demand car services that are -- seem to be gaining more visibility and popularity as far as the population of cars themselves go?

On demand, you're referring to ride share services, Uber and Lyft in the area?

Yes. Things like that. The car side.

Yes. It is growing. It still represents a very small percentage of total miles driven, partially because it's mostly an urban phenomenon at this point. There's a lot of speculation of what it will do to vehicle park versus total miles driven. You will need potentially fewer of them, but they're going to get worked much harder. So does that -- do those cancel each other out in terms of replacement parts demand? That's some of the speculation. We see this as just another one of the very long-term, slow moving, evolutionary trends that the whole industry is watching to see how it's going to play out. We don't anticipate it as a negative or a positive for us, certainly not in the near-term.

Yes. Can you comment on any other trends that you see in your particular industry that might not be that apparent to us?

Again, just to reiterate what I just said, nothing happens particularly quickly in the aftermarket, which is -- it means we're not going to have any dramatic ups, but it also means we're not going to have any dramatic downs. It's very stable and predictable and slow moving. So yes, there's always these ongoing evolutionary trends of automotive technology, some of which presents challenges. Others present opportunities, more parts to be sold, more different types of emissions controls and safety-related devices and systems cooling products. So while some of it is creating us to develop some new muscles, there's as much upside to it as there is downside. So it's just an ongoing trends that you see everybody talking about whether it's technology trends, customer purchasing behavior trends, and we roll with it as we have for the last 100 years.

And we'll move next to Kyle Kavanaugh with Palisade Capital.

I had a question on the Temperature Control side. Could you give a little bit more color as to some of your assumptions? Like, if the weather stays where it is, you remain cautious or you need the weather to get hotter for it to kind of -- comment differently? And I don't know if you can put any numbers on different scenarios like if trends are what they are right now, you would expect in the third quarter -- and maybe implications on margins as well? And I think you've -- in the past, you've talked about the long-term goals on margins and does that remain the same?

This is Jim Burke speaking. Maybe first on the sales. Really, at this point, many of the -- on the POS, which if it stays hot, it should stay strong, but they'll be eating out of the distributors' inventories. Hopefully, it lasts longer and we get the replacement orders that are in there, but I still -- we still stand behind that Q3 '18 was a very large quarter that we're going up against. So we remain cautious on that. Regarding margins, we have had the benefit of inventory growth that's there, so your productivity and your absorption, you get benefits on that. We -- dependent upon -- we're cautious now, so we'll curtail inventory a little bit. That can change dependent on the orders. But if it's as we predict, production levels will be lower. That means our unit costs will be slightly higher. The bulk of that will probably be felt in Q4 and a little bit as a similar patterns in the past into Q1 of next year because what's going to hit the cost of sales for Q3 of next quarter is what we've been building so far. So we think Temperature Control gets back to 25%, 26% versus the high 26.7%, I think, in Q2, and then into 2019, we're very pleased with our operations. On a balanced basis, we think that we exceed the 26% and grow the margins in Temperature Control. Hopefully -- does that answer all your questions?

Yes. That was very helpful.

[Operator Instructions]. And we have no further questions over the phone at this time. I'll return the floor back to our speakers.

Okay, folks. That concludes our second quarter conference call. Thank you all for attending.

Okay. Goodbye.

This will conclude today's program. Thank you, again, for your participation. You may now disconnect, and have a wonderful day.