Standard Motor Products Inc (SMP) 2006 Q3 法說會逐字稿

Welcome to today's teleconference. [OPERATOR INSTRUCTIONS]

I'll now turn the program over to your moderator, Mr. Jim Burke. Go ahead, sir.

Thank you. Good morning and welcome to Standard Motor Products third quarter 2006 conference call. Independents from the Company are Larry Sills, Chief Executive Officer 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 will begin with a review of the financial highlights and then turn it over to Larry. On the consolidated net sales basis for the third quarter '06, our sales were $203.8 million, down $20.7 million or 9.2%. For the nine-month period, sales were $643 million, down $15.3 million or 2.3%. We'll review each of the sales variances by segment. Engine Management sales were $127.8 million, down $8.1 million or 5.9%. On a nine-month period, sales were $416.5 million, down $3.4 million or 0.8%. Engine Management sales in the third quarter were negatively impacted by customer efforts to reduce their purchases from us, while maintaining essentially flat distributor sales, and heavier-than-normal customer overstock returns, which reduces our net sales and also impacts our gross margins. We continue to monitor our sales volume on a year-over-year basis for a true indication of trends, and believe the less than 1% variance over nine months reflects a stable replacement market.

Temperature Control sales for the quarter were $59.9 million, down $14.6 million or 19.6%. For the nine-month period, sales were $181.3 million, down $14.3 million or 7.3%. Temperature Control sales were down significantly in the third quarter '06 against the very hot summer season in 2006. Somewhat distorting the current quarter Temp sales comparison was the ordering pattern from 2004 -- '05 by our customers. Due to weak preseason orders in 2005 and a very hot summer, customer Temp sales were up $19.7 million or a 36% in the third quarter '05. In other words, our Temp sales for the quarter and year-to-date were comparable back to 2004 levels. If we look back over this three-year period, for the third quarter, '04 Temp sales were roughly $55 million. In '05, they jumped to almost $75 million and in the third quarter '06, they were back to $60 million compared to $55 in '04.

Europe net sales for the quarter were $12.8 million, up $1.1 million or favorable 9.9%. For the nine-month period, sales were $32.6 million, up $1.5 million and up 4.4%. To recap the picture on sales, Engine Management was essentially flat year-over-year. Temp sales were down against 2005 but flat year-over-year against 2004 levels. And Europe, sales were up both for the quarter and on a year-to-date basis.

The gross margin improvement is the single most important driver in our continued improvement plan. Engine Management gross margin was 22.9% for the quarter, up 4.7 points for the quarter. For the nine-month period, gross margin was 24.2 and again up 3.7 points. Our Engine Management gross margin, while up 4.7 points over the third quarter '05, slipped backwards after achieving 24.7 in the first quarter and 24.9 in the second quarter '06. Two causes for the reduced margin. First, higher-than-normal returns in the quarter. And second, our wire, which is more seasonal, had a greater sales mix in the first half and this wire business was has a higher gross margin. However, the basic underlying trends are still positive. On another positive note, we continue to record favorable purchase price variances and make first-buy savings which will be reflected in our P&L as our inventory turns going forward.

Our Temperature Control gross margin was 23.4% for the quarter, off 1.7 points. For the nine-month period, the margin was 23.0%, up 0.6 points. The shortfall for the quarter was primarily due to reduced sales. Europe margin was 24.1% and up 1.6 points for the quarter. Nine months, 23.1%, up 1.5 points. Overall, the gross margin results reflect improvements across all three segments on a year-over-year basis.

Consolidated SG&A expenses were $40 million for the quarter, up $900,000, and as a percent of sales, 19.7%. For the nine-month period, SG&A expenses were $126.8 million, up $1.9 million and again, 19.7%. The third quarter 2005 reflected a benefit from revisions to our retiree medical program that saved us on an annualized basis $5 to $6 million. Excluding this benefit of $2.5 million, compared to the third quarter of '06, SG&A expenses were down $1.6 million in the current quarter. The nine months year-to-date increased spending is a combination of higher catalog spending cost and our J. D. Edwards implementation of ERP programs throughout the Engine Management segment. Consolidated integration expenses were up slightly in the quarter, but down significantly for the nine-month period. The 2006 spending primarily reflects the exit of product line manufacturing and Temperature Control and the relocation of Europe's UK manufacturing to a low cost Poland manufacturing site. As noted previously, we've completed the [inaudible] integration.

Our consolidated operating income -- and I'm going to exclude integration expenses -- for the quarter were $9.3 million, down $700,000. However, adjusting for the post-retiree medical discussed earlier of $2.5 million, we're actually favorable $1.8 million for the quarter. For a nine-month period, operating income was $32.4 million, up $10.9 million, year-over-year. Look at operating income by segment, and excluding integration expenses for all numbers, Engine management was $7 million, operating income up $4.5 million. Nine-month period, operating income, $30.5 million, up $10.2 million.

The Engine Management incremental operating income is a direct benefit of selling price increases and cost reduction efforts. Temperature Control, operating income $4.3 million down $2.8 million for the quarter. For the nine-month period, operating income was $11.9 million, down $200,000. The Temperature Control cost reduction efforts helped to maintain operating income within $200,000, despite a $14.3 million reduction in sales over nine months. Europe, operating income was $400,000 for the quarter, favorable $100,000. And for the year-to-date basis, operating income was $1 million and it was favorable $1 million against the break-even period last year. Europe continues with year-over-year improvements.

Earnings per share from continuing operations were $0.14 in the quarter compared to $0.13 in the third quarter '05, after adjusting for the benefit from post-retiree medical. And on a year-to-date basis, earnings per share from continuing ops were $0.58 compared to $0.20. The discontinued ops line reflects a $177 million favorable benefit in the current quarter related to a $3.4 million pretax adjustment to our asbestos accrual liability. Each year in the third quarter, we have a national actuarial firm evaluate our asbestos liability. The finding from this recent study was a slight decrease to our accrual.

Looking at the balance sheet, inventory reflects further improvements. In the third quarter, inventory was reduced $7 million and year-to-date, we're down $15.2 million. Total debt, as of September, was $256.2 million, down $38.7 million against September 2005 levels, And after adjusting for $11.9 million, when we repurchased [Dana] stock in December of '05, total debt is down $50.6 million against September 2005 levels. Our current revolver reflects borrowings of approximately $132 million, with excess availability of $80 million. From cash flow, our statistics for CapEx spending was $2.9 million for the quarter, and the nine-month period, $7.7 million. Depreciation and amortization was $4 million for the quarter and $12 million year-to-date. In summary, the key takeaways from the quarter were continued cost reductions and improving operating margins, despite reduced sales, and strong cash flow improvements from operations and inventory reductions.

With that, I'll turn it over to Larry.

Good morning. Obviously the market has reacted quite strongly to these numbers. We want you to know that we remain very optimistic about our progress for the balance of this year and for the future. With that in mind, let me review some of the key points and why we feel so positive. First, let's talk about Engine Management sales. What we saw in the third quarter was basically an inventory correction on the part of our customers. Year-to-date, our Engine Management sales are basically flat, and year-to-date, from what we see, our customer's Engine Management sales are basically flat. So, what happened this year was that our customers built inventory in the first six months and reduced it in the third quarter through less purchases and higher returns. We believe we are close to equilibrium now, going forward.

In Temp -- Temperature Control, as Jim said, we're down for the year about 7%. The main reason, as he pointed out, we're up against a very strong 2005. But there also has been some erosion due to influx of low-priced compressors coming in from China. We plan to deal with this in 2007 in two ways. First, we'll be importing them ourselves to add to the line so that we can be competitive here in 2007. And second, we are in the process of relocating our line of rebuilt compressors, which is still the heart of our business, to a plant in Reynoso, Mexico, where with the lower labor costs, we believe we'll be able to sell a rebuilt for 20% to 30% less than a new unit coming in from China, and therefore, maintain this very, very important segment of our business. On the positive side, in Temp, despite the decline in sales, Temperature Control gross margin was ahead of 2005, the net profit was about the same, excluding plant moves, and that's thanks to our efforts in cost reduction. Okay, that's the sales story.

The big event for us over the last two years has been working on Engine Management gross margin. It has been the primary focus for us, and I'm happy to report that we are making excellent progress. We're up nearly four points here today versus 2005, and we look forward to continued improvement. We have a new round of pricing, which is beginning in the fourth quarter, which will carry over into 2007. We have ongoing purchase cost reduction and ongoing new manufacturing cost savings, both important initiatives and both are ahead of plan. The benefits of these will be accruing in the months ahead and into 2007.

Next, we announced the closing of our plant in Puerto Rico, which had about 250 jobs. Unfortunately, the demise of the 936 tax incentive made Puerto Rico an expensive place to do business. We are relocating the products to two existing plants. One in Reynoso, Mexico, where we're already doing wire sets and Four Seasons rebuilt compressors. And the other part to an existing factory in Independence, Kansas. So, we're essentially eliminating one factory operation. This is a two-year project. We want to make sure we do it carefully. We estimate a one-time cost, mostly severance, in the neighborhood of $6 million and annual savings, when fully moved, of $7 million. This is a good project.

Next, we got our first new OES business. It is small, and we will begin shipping in 2007. However, we are in discussions on many other product groups and we are optimistic about future developments here. Finally, we have a nice improvement in Europe. As Jim said, we have now relocated all UK Engine Management production from the UK. We have outsourced some to low-cost areas and we have transferred the balance to our new location in Poland. Incidentally, we're very optimistic about this new factory in Poland, with competitive costs and availability of material and labor. Our European business has made large strides over the last few years. We've gone from a $5 million operating loss and we will have a net profit in 2007. So, for all of these reasons, as I said, we are very optimistic about the future. That's our story.

We now open for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Derrick Wenger with Jefferies & Co. Go ahead, please.

Yes, thank you. I've got depreciation and amortization of $4 million. What were capital expenditures in the quarter, I missed that? And the outlook for the year? And can you now pay-down converts with the excess bank line?

Okay The CapEx spending for the quarter was $2.9 million and $7.7 million for the nine-month period. Again, on an annualized basis, the CapEx spending would appear to be coming in towards the $10 to $12 million range for the coming year. The second question on the converts, we have a basket available for acqui -- acquiring stock or converts and that, but at the present time, it is not our intention to be acquiring any of the converts at this time.

Can you used the line to pay down the debt at maturity?

Our revolver matures before the convert, if I understood your question correct, Derrick. Our convert matures in 2009. The revolver matures in December of '08.

Right. Are you going to be renewing that?

Well, obviously, we feel that there'll be ample opportunity and we're addressing this in the near future, with a plan to have in place for 2007 to review what our financing strategy will be.

Thank you.

Thank you. We'll take our next question from Dennis with Rutabegger Capital. Please proceed.

Or Rutabaga. Good morning, guys. To drill down into Engine Management a bit, Larry, I think you've said before that we were getting pricing in the segment. I think it was working out to about $1 million per month, roughly 2%. So, I mean -- so, year-over-year for the nine months, you know, your volume would have been down that -- down 2% to have flat sales. Is that right?

Yes, that's correct. That is actually our forecast that we have said all along. We see the business, because of the change and mix of products, that will be a decline of perhaps 2% to 3% in units to be compensated for by a price increase. And that's exactly what's happening, and your observation is correct. We have a slight decline in units and a slight increase in price and it comes out basically flat.

And looking at --

-- average selling price on the other units.

Right.

Okay, okay. And then -- but looking at the market then, you'd say you didn't lose any larger accounts or anything where you had an abnormally high returns that led to, you know, again, either a customer shift or something of that nature? It was just their pruning back.

Exactly correct. We've studied of some our biggest accounts, and the bigger ones are really doing a job of their own inventory management. And we see that their purchases have been running behind their sales. And that's okay, because in the long run, that balances out just fine.

Ok. And in terms of the make or buy question that I know is ongoing within the segment, have earlier indications indicated that you may have placed a wrong bet there at all, in terms of product line that you might have expected to be moving fast enough that it made sense for you to make it and yet those volumes aren't, you know, materializing?

No, no, that's not the case. When we look at it -- first we look at it product by product, not line by line. So, this particular product, the goal -- we look at its sales, regardless of other line sales. And we try to manufacture it early in its life cycle. So, it is still on the upswing. So, no, no, we're doing very well on that. So, the fact that distributor caps are in decline has no impact on this new, let's say, sensor that we will now make, because that one is going to grow. And we need that to make up for the ones that the distributor caps are in decline.

Yes. As you look out and are able to make that shift in the way you would like, particularly on the -- I remember you talking in previous calls about the -- particularly your need to do more internal manufacturing on the electronics side with Engine Management. But as you look out a few years, what kind of gross margins do you think you'd be able to do? Is 24% kind of where the best you think you can do, or is there more opportunity?

Well, Dennis, we don't put out forecasts but we're at 24% today and we feel with the savings that we're achieving -- we pointed out we're achieving purchase price savings and make first-buy, which you were just speaking about. And on an annualized basis, these are significant numbers. They have not yet even hit our P&L, as we are achieving these savings now and they're in the lower-cost inventory. So, we believe that we have further opportunities and have had Engine Management margins in the past of 28%. We said that was where ultimately our goal would be targeting for at least that number.

That's great. That's all I was looking for. Thanks a lot.

You're welcome.

Thank you. We'll take our any next question from bill Dezellem from Titon Capital Mar -- Management .

Thank you, we had a couple of questions. First of all, what is the magnitude of the price increase that you are just now beginning to implement?

I would say it is somewhat comparable to the ones in the past. We're still working it out, so I can't really give you a firm number. But it might be a little bit less than the last round. We're still working on it. And it will roll in gradually over the next three to four months.

And is our recollection correct that that's roughly 5% that you had done in the past?

No, no, no. It is a lot closer to 2%, 2.5%.

Ok, great. And then the second question is would you detail the OES order and -- it may sound like a silly question, but why did this OE choose to work with you, and really, what were the issues surrounding it that led to awarding this win to Standard?

Frankly, I would rather not announce the name of the company. We will do it when we have something more to report. And it is relatively small. What makes them look at us right now, the reason we're optimistic is that you were reading that both Delphi and Visteon are closing factories, and they need someone to fill in that gap. And we are a very viable Company to fill in that gap. So, we are having ongoing discussions with these companies, and I wish I had something more concrete to report right now, but we are having serious discussions in this area.

Thank you.

Thank you. We'll take our next question from [Walter Shanker] with Titan Capital. Go ahead.

Hello, Walter.

Hello, gentlemen. I guess I'll see you guys tomorrow. To what extent do you think the returns you already received might impact your normal return seasonal pattern in the fourth quarter?

I could try that one. The Engine Management doesn't really have a seasonal pattern, because it's not a seasonal business.

I'm sorry. Larry, let me stop you. I didn't mean from the seasons of the business, but it has been somewhat traditional, I thought, in this business that in the fourth quarter, people clean up balance sheets and look at their year. And I thought you actually usually got more returns in the fourth quarter, having nothing to do with demand patterns, but had to do with the distributors cleaning up their inventory for year end?

That's more in the Temp line. In the Engine it's -- they tend to do it annually, because they deal with lots of lines and they can't do them all at once, so they tend to scatter them throughout the year. I can't really give you a forecast for the fourth quarter on Engine. And that was with the big returns for this quarter.

On the returns, it was traditional WD-type customers or retail?

That's getting into an area I would really not rather discuss, but it was a heavy quarter, obviously.

And the returns were still -- it was my understanding -- again, I obviously don't understand -- that your returns typically are controlled within a parameter, meaning I can't return 50% of sales? You know, some sort of number.

That's right. We have rules, we have procedures and we work with our customers at all times to try to make sure their inventory is in balance. And I think that, overall, we do a pretty good job. It was just at this quarter, an awful lot came in. But overall, we keep it well under 5%, and that's our target.

Okay. And this is an editorial. Could you once again explain why it takes a series of months to implement a price increase? You know I'm smiling.

We've got lots of customers and lots of part numbers and lots of competitors and it just takes awhile to do it. We just completed a round about three -- in the first quarter. But we're working on it, Walter. Believe me, it is a very high priority.

Ok, Larry, thank you.

Thank you. We'll take our next question from [Irene Tarcov] with Banc of America. Go ahead.

I was wondering if there's any covenants that you have in your resolving credit facility and whether availability depends on borrowing base or how it's determined?

We have a fixed charge coming in there that we measure quarterly on a trailing four quarters, and we're well within the limits of our covenant, so we don't foresee any problems with that.

Thank you.

Thank you. We'll take our next question from John Abbey with JDA Capital. Go ahead, please.

Hi, I wanted to see if you -- the gross margins in the Temperature Control business were down. You mentioned the sales reduction. Is there also raw material price pressure in that business?

Yes. Part of the -- part of a -- across all of our segments, we're hit with the higher energy cost, commodity prices in there. However, overall, we said as we've continued with outsourcing more product to the Far East, we've been able to offset some of that price inflation with net savings. So, while we do have net savings, it is impacted by the economic conditions of higher prices.

Do you see that continuing in the first few months here of this quarter?

Again, it is movement in commodities. The prices are up significantly. We monitor it very closely. It impacts our competitors, also. So -- and we're wherever possible pricing for it. So, we still believe net-net, after all of our outsourcing and purcha -- purchase price reductions, that we're able to achieve net savings.

Ok. Thanks.

You're welcome.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our next question from Robert Smith with Center for Performance Investing. Go ahead, please.

Hi, good morning.

Good morning, Bob.

The accrued asbestos liability, you characterized it as being a slight reduction. It was nearly $5 million. Is that slight? It seemed a little more.

It was a -- roughly a $3.5 million pretax adjustment. And again, it is something that's manageable. We're getting decreasing number of cases. The firm reflected it as coming down. We recorded it. But you know, once it is all gone and complete, then I'll be more optimistic. You know, it's favorable, but I don't play it up that much. It's a $3.4 million favorable adjustment we have.

All right, thanks. The accounts receivable moved ahead rather substantially, yet the reserve just kind of inched up. You feel comfortable with that?

Yes. A large part of that relates also to a reserve for cash discount with the higher level of growth receivables versus December, and we believe that our receivables are in very good shape.

And the $7 million of savings from Puerto Rico would be reflected fully in which year, would you say?

Well, it's --

'08?

No, we'll finish it. I mean it's not going to be a [step], but it's going to be gradual. We're going to begin moving the jobs in the next few months and it will take, we're estimating, 18 months to do beyond that. So, close to 24 months from now, and there will be some improvement during that period of time. At the end of that time is when we'll see the $7 million.

That's '09 really?

Yes, fully in '09. But some of it in '07 and some of it in '08 and fully in '09.

Thanks.

Thank you. We'll take a follow-up question from Bill Dezellem with Titan Capital. Go ahead, please.

Thank you. It is Tieton Capital Management. Let's see, I wanted to circle back to the inventory reduction that took place sequentially and the fact that sales were down sequentially, and really try to see what you can do to help us in terms of understanding the impact on the gross margin that the decline in inventories had, especially in light of the decline in sales sequentially?

You're talking about our inventory reduction?

Yes, that is correct.

Well, Bill, you're correct. When we do reduce inventories, it reduces our absorption, so it does have an impact on our gross margins. But we have felt all along with Engine Management, after the amalgamation of the Dana business that there was opportunity from working capital management and cash flow benefit, and we had identified that last year. We are seeing the favorable results of that, and we feel that we still have further opportunity going forward in this area. But yes, if I understand the question, we did have inventory reduction, even on reduced sales. And two, it did have a slight negative impact on margins.

And, Jim, that's what I was looking for is trying to understand what was the actual impact that you estimate on margins from the inventory reduction?

Right. Because of all of the different plants, we -- it's very difficult to quantify that number, Bill. And I can't say -- you know, you're not looking at something that is greater than -- greater than some point. It is tenths of a point, or something. It is not the magnitude of a full percent or something like that. We have 30,000 SKUs and many of them purchased, many of them manufactured in multiple plants, so it does have a slight negative impact. I don't have a number to quantify to specify what that is as a one-time cost. But we continue to expect to reduce inventories going forward and on a year-over-year base, it should be about flat.

That's helpful. Thank you.

You're welcome.

Thank you. We'll take our next question from Bruce Winter, a private investor. Go ahead, sir.

Yes, thank you. Do you have any estimates you can give us about your market coverage like how many SKUs you have versus the total number of SKUs in your universe, or what are the odds that an average car on the road -- a random car on the road would have a need for one of your parts? And secondly, how do you decide to add or remove SKUs from your list?

Okay, that's a good question. The business we're in, our customers demand that we get as close to 100% coverage as we can, because that's the business they're in. So, we work very hard in that area and we measure ourselves. And what we do is we measure the cars on the road, that information is readily available. And we are shooting for 100 and 100 is not really attainable. But our goal is roughly 95% of the cars on the road that have some substantial volume to them, and our definition of that is cars that have a population of 10,000 or more. And we go back to 1984 up to 2005 and that's our benchmark. Now we measure ourselves against that. Our customers measure ourselves against that. So -- and we are as good or better than anyone. So, does that answer your question?

Yes. And just to follow -- a very good answer. And a follow-up, you talked about a sensor. What does the impact of new technologies play into what you just said?

Well, technology has changed the cards dramatically in the last ten, 15 years and we've gone from basically a mechanical ignition, with points and condensers and distributor caps and carburetors, to highly electronic fuel injectors, sensors, computers, et cetera. We are very pleased that we have been able to make that transition. But keep in mind that the population moves very, very, very slowly, because our market is not new cars. Our market is the 200-plus million vehicles on the road and that changes a few percent a year. So, it's a very gradual changing market place.

So, you feel Standard is up-to-date on technology as anybody else?

Absolutely.

How do you get your computer chips? Do you have to design them yourself or --?

We do reengineering. We've got some pretty smart people. But what's helping us right now is that, as we have been developing closer relationships with some of the car manufacturers who are talking to them about OES sales, we now have a better insight into some of their engineering than we had before, and that's very, very helpful.

So technology is a long-term competitive advantage rather than a detriment to your Company, do you think?

Yes, we think that.

Good. Thank you.

Thank you. We'll take a follow-up question from Robert Smith with the Center for Performance Investing. Go ahead, sir.

Larry, looking at OES possibilities, I mean this small order that you had, can you give us some time frame as to how long that was under negotiation?

A very long time, Bob. These guys -- they're very careful. They're a huge organization. They have lots of committees. They have engineering committees. They've got marketing committees. They've got legal committees. They've got everything.

So this small order was from a -- such a large organization?

Pardon?

This small order was from --

Yes, it was from a large organization.

Okay. So, in looking at a time line again, are we to look at Delphi [inaudible] to see what their plant closing schedules are like? What's --

It would be a pretty good clue, and it's probably giving them some impetus to move a bit quicker.

Yes --

Yes, they are -- they are facing schedules for closing plants.

So, how soon would they have to put something in place before a plant actually slows down?

That's a detail I really can't get into, Bob. I don't know their business that well.

Okay, thanks.

it appears we have no further questions at this time, sir.

Okay, very good. All right. With that, I'd like to thank everyone for joining our conference call today. Good bye.