Standard Motor Products Inc (SMP) 2008 Q1 法說會逐字稿

Welcome to today's teleconference. (OPERATOR INSTRUCTIONS). Please note this call may be recorded. I would now like to turn the call over to Mr. Jim Burke. Mr. Burke, please go ahead.

Good morning and welcome to Standard Motor Products' first quarter 2008 conference call. In attendance 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're based on information currently available to us at certain assumptions made by us, but 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.

Now I will discuss the highlights from the recent quarter, and then turn it over to Larry, followed by a Q&A period. Our consolidated results for the first quarter included the following highlights. The net sales increased $8.3 million or 4.1%. We also recorded a sale and leaseback on our Long Island City headquarters. From a cash flow standpoint the selling price was $40.6 million. We had fees and expenses of $3.3 million and other costs of mortgage defeasance and closing apportionments of $1.8 million. The net available cash for debt paydown was $35.5 million.

Looking at it from the P&L side, again the selling price was $40.6 million. We had a net book value of $5.8 million on the building and closing expenses of $3.2 million, for a total gain of $31.6 million.

For sale and leaseback accounting recognition we recorded $21.1 million gain in the first quarter '08, and have a deferred gain of $10.5 million which will be recognized over the initial lease term of 10 years.

In addition, we also had mortgage defeasance costs of $1 million for the mortgage, and we had a write-off of prior deferred finance fees of $400,000, so total expense pretax of $1.4 million.

The third item I wish to highlight was our progress with our restructuring plan to move our manufacturing operations from Puerto Rico and Long Island City to our low-cost facility in Reynosa, Mexico. This was reflected in the restructuring expenses of $2.8 million recorded in the first quarter.

Isolating the onetime events net of tax in the quarters for '08 and '07 that related to restructuring costs, loss on debt extinguishment, and the gain from the sale of the building, our non-GAAP earnings from continuing operations in '08 was $3.1 million compared to $3.4 million in Q1 '07, and on a diluted earnings per share basis $0.17 versus $0.18 last year.

I will now review our results by segment. Engine Management net sales were $143.4 million, favorable $5.9 million and up 4.3%. Sales growth was primarily from the OES channel, and Larry will go into this further. Also as disclosed in the fourth quarter '07, we are accruing for overstock returns in 2008 and recorded a net $1.1 million charge in the quarter.

Our gross margin in Engine Management. I want to provide three key numbers. In Q1 '07 our margin percent was 26.3%. For the full year '07 the margin percent was 25.6%. In our first quarter Engine Management margin was 25.4%. As you can see, we are essentially equal to the full year 2007 level, and we are accruing for overstock returns. But more importantly, we have the drag on margins in the first half '08 as we wind down Puerto Rico and Long Island City manufacturing, and also have the startup expenses with Mexico operations.

Our operating profit for Engine Management, excluding restructuring expenses, were $12 million. That is up $200,000 against Q1 '07. Our operating profit percentage, excluding restructuring expenses, was 8.3% in the first quarter compared to 7.1% for the calendar year 2007.

Temperature Control net sales were $49.6 million, down $1 million or 1.9%. The sales reduction in Temp Control was primarily from our 2008 price reduction strategy to be competitive against Chinese imports. The annual impact is estimated at $6 million.

Our gross margin percent in Temperature Control was 15.6%, down 5.6 points. The Temp margin was significantly impacted by the price reductions introduced in the first quarter. We plan for margins to recover during 2008 as we benefit from our transfer of compressor rebuilding to Mexico and cost reduction efforts to reduce overheads and SG&A expenses in the U.S.

In the quarter we had an operating loss, excluding restructuring expenses, of $700,000. This is down $2.7 million from Q1 '07, and again primarily from the price reductions.

Looking at Europe. Net sales were $11.2 million, favorable $800,000 and up 7.2%. The sales increase was primarily the incremental volume from a small wiring cable acquisition that we completed at the end of December '07. The gross margin percent was 28.4%, up 1.8 points. The margin percent improvement again relates to the wire acquisition, as we folded the production and support staff into our existing wire assembly plant in the UK.

However, we did add incremental SG&A expenses to support this new business. SG&A expenses also increased in the first quarter while we were transitioning to a new facility consolidating distribution and office functions. This allowed us to exit two owned facilities in the UK, which we have classified as assets held for sale, and hope to sell both facilities in 2008. Anticipated selling price is about $4 million, with a net book value of $2 million, and an anticipated future gain of $2 million.

Our operating profit, excluding any restructuring expenses, was $500,000 in the quarter, and that was down $300,000 versus Q1 '07. We expect reductions in SG&A expenses going forward reflected in year-over-year operating margin percent improvements.

Other income, as discussed earlier, included the gain on the sale of the building and the debt extinguishment costs. Excluding those onetime items, other income was favorable $500,000.

Looking at our balance sheet, Accounts Receivable increased $29.3 million against March '07. The increase is reflective of the $8.3 million sales improvement in the quarter. And the balance of the $20 million increase is a carryforward from the last year, reflecting extended terms in the industry. We plan to evaluate factoring programs with some of our large customers to accelerate cash collections and pay down debt. We will be recording any factoring discount fees in SG&A expenses, and we will also benefit from lower interest expense.

Net inventory increased $8 million against March '07; however, it decreased $1.8 million against December '07. This is important since we are essentially beginning to reduce our bridge inventories and anticipate further reductions per quarter going forward. For the year our target is a reduction of $15 million to $20 million, offset by inventory increases related to new OES business, such as our recent Continental productline acquisition.

Total debt at March of '08 was $270.9 million. Our North American revolver is currently at approximately $180 million, with excess availability before our reserve of $90 million. The reserve is a $15 million per quarter to accommodate the $90 million bond maturity in July of '09. Currently we have two quarters and a reserve for that of $30 million. So excluding the reserve, we have current excess availability of $60 million.

We expect to generate favorable cash flows in 2008, also accelerate AR collections with customer accounts receivable factoring programs. We're currently evaluating alternatives for our $90 million bond maturity in July '09, and we will seek alternatives financing or absorb the redemption with excess availability under our revolver.

Just to point out, our other long-term liabilities increased approximately $10 million, which reflects the deferred gain on the Long Island City sale and leaseback. From a cash flow standpoint in the quarter our CapEx spending was $2.9 million and our depreciation and amortization was $3.4 million.

At this point I will turn it over to Larry Sills.

Good morning. Jim has gone over the numbers. You have seen the release, and I would just like to highlight a few key areas, and then we will open for questions. The three areas are I would like to talk about OE/OES sales, plant moves and the Temperature Control business.

First, OE/OES. We think we are on a very nice track here. Sales are running about $25 million ahead of last year on an annual basis. And mostly this is new business that we gained during the latter part of 2007, and which we are now shipping.

In addition, as we announced last quarter, we have acquired the equipment and inventory from Continental for their line of pressure sensors. Annual volume is $10 million to $15 million a year. We will shortly begin transferring this equipment to our factory in Independence and began shipments. We will see some volume this year and the full amount and in 2009.

Beyond that there are many, many prospects we're pursuing, and overall there is a lot going on in this business. Our total OE/OES business is now running at the rate of close to $100 million a year, and there is plenty of room for growth. That is first.

Second, plant moves. They are pursuing smoothly. Puerto Rico and Long Island City were closed as of the end of April, which is slightly ahead of schedule. Reynosa, Mexico is up and running. The good news here is that the managerial roles there are by being taken by our key people who transferred from Long Island City and Puerto Rico, so they know the business. It is the same product. It is the same equipment. It is the same IT structure. And with the same managerial group, we're confident that it is going to run smoothly.

Savings estimate, to remind you, we are staying with it, it is $9 million a year. We will see a little of it this year and the full amount in 2009.

The other major plant move which we have been talking about is shifting rebuilt compressors from Grapevine, Texas to another facility in Reynosa. We have begun to accelerate this transfer. This year, 2008, we will produce over 50% of our units there, and next year we plan to produce 80 to 90% of our units there. Since this is a labor intensive business rebuilding, we anticipate savings of $10 to $15 per unit. That is the plant moves.

The one area not doing as well as we would like from a numbers' point of view is Temp Control. As we said in the release, the preseason orders were light. We believe there are two reasons for this. Our customers finished up last year with some fairly substantial inventories. And just as important, I think, people have fear of the economy. We're not so willing to invest. They're going to wait to see what the season brings.

However, our customer base has held up nicely, and in fact, we even gained a few customers this year. So now we are ready for the season, and the business will depend on how this season goes.

As Jim mentioned, we implemented our second price reduction in two years. This one was also about $6 million on an annual basis. With this latest reduction we feel we're now fully competitive with the imports from China, but obviously the margins are not where they need to be. As Jim said, in addition to shifting more compressors to Mexico, we are working aggressively to reduce headcount and to cut general expenses. Our goal is to return gross margin to the low 20s as a first step.

All in all, we're not dissatisfied with our business as where we are standing at the end of this first quarter. And now we will open it for questions.

(OPERATOR INSTRUCTIONS). Walter Schenker, Titan Capital.

Let me start out by saying, while I realize the accounting is right, restructuring costs, the real costs moving plants from high cost markets to low cost markets is not treated by all companies -- I am not arguing about your accounting -- as necessarily restructuring costs. This has been a continuing process for many years now, and those costs are real costs. So hopefully management and the Board, when they look at the cost of this Company and the performance of the Company, take into account that these real cash costs are real costs, where they are taking into account costs spent in the past, and you can't keep taking them out and looking at your performance and saying, gee, from continuing operations our performance is okay, because we're taking out these restructuring costs, which are fundamental to running the business. So that is a statement and not a question.

All right. Can I respond?

Sure.

Obviously. Now when we decide what to do on something like this and plan such a move, we obviously look at the two elements -- what is the onetime cost and what is the annual saving. In this case the moving of these two locations, which were Puerto Rico and Long Island City, I believe the onetime costs -- Jim will correct me if I get it wrong -- were in the $12 million range.

Yes. It was $9 million plus the additional --.

It was $9 million plus the $3 million for the pension liability. And with an annual savings estimate of $9 million a year, obviously that is good program. It is slightly more than a one year payback. We don't treat it lightly. We look at it very, very carefully. It just happens that you ten to spend the money before you get the savings. That is why we tend to put it out. But we're very cognizant of that.

I'm not arguing it is a good or bad business decision. It is a fundamental business decision you probably have to make. However, you probably when you get the savings are not taking them as onetime savings and breaking them out from your operating earnings because they are the result of onetime expenses.

They are ongoing savings. Let's not --.

Let's not go there?

Let's go on.

Okay. What have you done relative to pricing versus a year ago?

Well, we just implemented around -- took effect -- you wouldn't have seen in in the first quarter. It kicked in the very end of the first quarter. We are anticipating on a conservative basis -- this is not counting the dropping in Four Seasons -- on the Engine Management side we are forecasting in our budgeting 2 to 3%. And that is where we are, where we predicted we would be at this point. The pricing environment is not bad. People are in fact implementing price increases.

One hears about in the generic term all sorts of raw material costs, either because they are petroleum-based or metals-based, going up fairly sharply in world markets. Can you give us some sense as to what is happening on your input raw material costs?

Jim Burke speaking. We experience the same commodity increases in the fuel prices. We're benefiting from offshore cost reductions. Overall our plan is, and we're holding to that yet from what we have seen, 1 to 2% increase in total inflation costs.

With certain products obviously going way higher than that. But that is our -- we believe that will be the total average.

Okay. We have spent on many calls, and hopefully we're still targeting substantial improvements in gross margin to get back to the high 20% range, mid to high 20% range -- we were going back a number of years before all the restructuring and consolidation costs. First question, is that still a target?

Yes. That is Engine Management target.

The other side of the question is, if one looks at SG&A costs, which we don't seem to spend as much time on, and we just look over the last three years, SG&A as a percentage of sales have gone from 20.1%, 20.7%, 21.4%, which is going the wrong way. And I realize OES is going to swing the SG&A and the gross margins a little bit. But why it has this Company, as we have gotten through the consolidation, not been able to do a better job controlling SG&A costs and reducing SG&A costs as another way to try and enhance profitability?

Again, we have continuous programs looking at our total expenses. I don't have the details. I would probably agree with your percentages that are in there correctly. Within the first quarter we did identify higher SG&A expenses related to our Europe operation and consolidation that is in place there.

But we have an aggressive program to look and evaluate expenses. I could say within Temperature Control we have identified a number of savings, which are going to help recover the cost reduction -- the price reductions that we've taken.

We also have, and it has been in place for the last two years, an MIS integration to bring our entire operations over to J.D. Edwards platform, and we have been incurring additional expenses. That plan is to be completed in 2009. All of our Temperature Control business is on that platform and roughly half of our Engine Management, or a little more than half, has been converted. We have been incurring incremental expenses maintaining duplicate platforms, and that will cease at the end of '09.

But we see this as an area that we have to aggressively attack. As there is continuous pressure on margins, we will be going after SG&A expenses.

We look at that more than anything else probably. And we continue to take action. We have taken action in Four Seasons and we have taken some action here in Engine Management this year too. We watch that very, very carefully.

Alan Weber, Robotti & Company.

When you talked about Engine Management, if I got this correct, you compared the first quarter gross margin, and said it was basically similar to the year '07, but that included higher levels of returns and I guess disruption from the moving of the two plants. Is that correct basically?

Yes.

And let me just clarify. The point I was trying to address was I think more appropriately for the Engine Management, because we were hit with full returns for '07, or the bulk of the returns in '07 in the fourth quarter, was the full year margin at 25.6%, and our first quarter '08 was at 25.4%.

No in addition, in the 25.4% we are accruing for overstock returns, which was approximately a little over $1 million, because we're trying to match our expenses to our sales better in there. In addition, during this transition, and this is what we have been saying all along why we will only see partial savings in '08, is as we wind down our two manufacturing facilities, Puerto Rico and Long Island City, we have underabsorbed costs in those facilities, as we have added overhead in the Mexico facilities and we're not fully absorbed or efficient in Mexico. Those costs, while they will impact the first half of '08, we expect to see better margins as we go into the second half of '08. I hope that answers it.

That is what kind of what you explained before. Then when you talk about the cost savings of $9 million, all things equal, if I looked at last -- let's take '07 revenues, I would just add $9 million to the operating profit. Is that have how you -- when you talked about the cost savings do you expect it to fall -- really fall right down to the operating profit of Engine Management?

That is a little too simple. Yes, if everything else was equal, obviously the $9 million will go to the bottom. But it is a dynamic industry, and some of the trends are working against us. So we have to work on that. The biggest trend working against us is the shift in customer base away from the traditional towards the retail and the OES, and this has a bit of a negative on the gross margin.

Not all of that $9 million is going to fall to the bottom line. That, plus other steps that we will take, will follow to the bottom line. But it is not quite that straightforward.

Can you talk, Larry, you didn't talk about -- because your results in revenues are actually -- seemed quite strong, especially when one considers the overall aftermarket, and you read declining number of miles driven. Did you pick up marketshare, or what kind of -- is it higher pricing? What accounted for the higher revenues?

The higher revenues is really the OES. The other revenues were flat. So you can see we didn't go down. But our basic revenue customer by customer, some are up, some are down, but are pretty much flat, and the increase was new OES business. So that is the new business that we picked up. We haven't lost any business. And we haven't seen really a drop in the industry based on all the problems in the economy.

It may come later this summer, I don't know -- as miles driven are going to continue to decline. Again, remember our Engine Management business is not really a discretionary sale. People repair their car because they got to go to work. Temp, however,, is somewhat more of a discretionary sale because you can drive with your windows open. But if it is hot enough, it is not a discretionary sale any more.

Anyway, that is long answer. We're not unhappy with our sales and they are proceeding okay.

My final question, Jim, I think I missed international operating profit in the quarter, what was that?

Hold on one second.

I had revenue but I do not have the earnings.

It was $500,000 for the quarter.

Versus?

It was down $300,000 from the prior year. And the point I wanted to make there, while gross margins were up, it was the incremental SG&A expenses while we -- twofold, one, we took on the new acquisition. And the other part was we're moving into a new location, which is going to give us -- provide us a benefit to free up facilities and sell two buildings there and generate some cash.

I guess as you talk about the selling of two buildings. Jim, can you just run through as you see it for the balance of the year kind of the balance sheet? Because given on the surface the sale of the building, it was kind of surprising to see payables up $36 million.

You mean receivables?

No, I mean note payable from December '07 to March of '08 was up $36 million in long-term debt (multiple speakers).

Notes payable.

Again from December we're going through the seasonal nature of our business. So really the fourth quarter sales versus the first quarter sales are significant. So that is normal.

To some degree you hit on, or we thought you were mentioning -- you know, we increase our accounts payable that is in there as we are -- you know, Temperature Control is building inventory.

I think you've asked about the balance sheet. If I hit the highlights on the balance sheet again, accounts receivable I think that increase that we have seen last year will be steady at this point. I'm not targeting any further erosion in BSOs. And I'm also looking at opportunities to consider factoring with our major customers, so that would provide a benefit to the cash generation.

Inventories I think will be a strong benefit to working capital management throughout the balance of '08, and probably carry forward into '09, again excluding any new OES business that we pick up. Those are the key items I think that are in there for the balance sheet.

Tony Cristello, BB&T Capital Markets.

This is actually Alan for Tony. The first question, did you see any carryover of the negative impact from the customer rebranding effort that you launched on the Engine Management side in the fourth quarter that may have rolled into the first quarter results?

The cost of the rebranding. Yes, the majority of those costs are behind us now that we have completed for those two major customers, that the large DCs are completed. There will be small cost, but that will be immaterial as we move forward. So that is completed, and the positive as we build strong customer goodwill.

In the first quarter if those costs had been to the magnitude of several hundred thousand, or just under $1 million, what will be the impact in the first quarter relative to what we saw in the fourth quarter?

Again, I don't have the full amount broken out.

It wouldn't be more than that.

If I had to estimate it is in the $1 million to $2 million, $1 million range.

Could you all comment on and maybe trends that you have seen with sales to your traditional and retail customers so far in the second quarter relative to what you saw towards the end of the first quarter?

That is such a short period of time. You're talking about April --?

You are asking second quarter, which again --.

It seemed to slow down relative to February and January for the aftermarket, and I was wondering if you have seen any pick up moving now into April and into May?

The sales are decent starting the second quarter. That is all I can tell you. But it is just beginning.

Maybe to say it more clearly, we don't see any significant drop-off or uptick. It is normalized results.

Then switching gears a little bit, with respect to the incremental OES volume that you intend to have realized in 2008, how much do you see going to the Temperature Control segment in particular?

They're getting their piece of it. Maybe 20%, 30% of the total? They got some.

We spent a good amount of time speaking about the price reduction that you all how have implemented on the Temperature Control side to remain competitive. What do you see in terms of organic growth in your unit shipments in Temperature Control for 2008? Do you expect that to be kind of flat, down? Just any color would be very helpful.

It is really, of all our businesses that is the one that is the least predictable. It is very much a function of the weather. If we have a very hot summer, we will sell a lot. If we have a very cool summer, we won't. And it is at this point way too early to predict.

Phil Dumas, Geode Capital.

A question for Jim. On the headquarters sales proceeds, $35ish million, did you collect that in this quarter?

Yes.

So that would to pay down notes payable?

And the mortgage that we had on the LIC building, which was in there a little less than $8 million.

Can you tell me the rate on the revolver, what you pay for money there?

LIBOR plus 1.25. There is a grid for that.

Right now is like 5, 6, 7% or so?

No, it is down in the 4% range.

So that actually gets to my question. My next question is why, given you had $35 million, did you pay down the revolver when you could have bought the converts for potentially 12, 15 plus percent yield to put? I'm just trying to figure out the use of proceeds here and where your best return is on your dollar.

That is a good question. We are evaluating and looking at what our decision is to address the redemption of the bonds. We're not looking -- initially we have a reserve against that revolver, and we continue to look at it, and we will address the bond redemption either before or at maturity.

But I guess I'm wondering why you wouldn't have considered that in the quarter, given you had $35ish million, or the $30 million -- I guess it would have been $25 million, $30 million in cash in hand? Did the banks require you to pay down that line?

Any cash receipts that we take in are used automatically to pay down our line, but we also have authorization from our banks to be able to have redemptions against our bond. And again, as I said, we'll consider it as we move forward.

Right now we are evaluating all of our options and alternatives. (multiple speakers) We did not want to have -- to answer your question specifically, we did not want to pull a trigger immediately to say we're just going to take that cash and buy back the bonds. We are evaluating it prudently as we look at the total of $90 million and what we're doing as we generate the cash in the business.

So you're looking at it in aggregate essentially?

Yes.

The alternatives in aggregate, okay. I appreciate that. The only last question, the only other question I have is have you guys given cash flow guidance for 2008?

No, in essence the Company's policy and for our Board is that we limit the amount of guidance that we provide on there. Again, a large piece, one-third, of our business is volatile with the seasonal nature of the business. So we will identify specific items. We believe we're going to be generating cash, margins are improving. And we believe one of the strong benefits will be inventory reductions. The other new item that I pointed out is that we're looking at AR factoring programs with some of our larger customers, so that would again be a very strong cash generation.

Do you think that factoring may kick-in in this quarter or potentially next quarter?

Yes, we are addressing it. And it would be in the second quarter and into the second half of the year.

So D&A and CapEx I think you said offset for the year, is that true?

Probably the D&A is slightly ahead of the CapEx spending. Again, CapEx for our normal business, we're probably in the $15 million plus any acquisition that we spent for any equipment. And probably the D&A is in the $15 million range also.

So a good indication of cash flow essentially is essentially operating earnings minus any interest expense -- minus cash interest expense. That is fair, right?

Yes. (multiple speakers). And working capital improvements.

Right. Thanks, Jim. I appreciate it.

Robert Smith, Center for Performance Investing.

Guys, here's a rhetorical question. Is there such a thing as Groundhog Day in the business community where we can take the sale of this plant in subsequent quarters? But not even a chuckle?

Oh, I got it. Okay, thank you.

First question. Tell me something about wage rates in China and Mexico. Evidently -- how our Chinese manufacturers continuing to -- continually able to take price reductions if their wage rates are rising, from what I read?

But they are rising though from a very low base.

I understand. Raw material costs are increasing, so what are these guys doing?

Well, actually what you're starting to see now is inflation in China. Both because their costs are increasing, and you're seeing the Chinese currency, the yuan, rise as well. So there is pressure -- upward pressure on products coming in from China.

For me that is good news, because we will be producing stuff in Mexico, competing with stuff from China, certainly in the Four Seasons line. And I consider that good news. That is why we feel that we have reduced prices in Four Seasons at this point, as low as they will need to go.

This is playing catch-up on your part?

We did it. Yes. And hopefully the inflation from Mexico will in the future be lower than the inflation from China, which is what we think is going to happen. That is good news for us.

I understand. Thanks for some color on that. So in your long-term planning function internally, what do you think OES can look like say in three to five years? I assume you have a three to five-year plan?

We do. If we were only to achieve the industry average, which would be 20% -- as I say, we're now running at around $100 million, that would take us to $160 million. So $60 million increase just gets us to industry average, and I would like to say we could do little better than the industry average. So there is a very large potential out there, very large.

There are currently no more questions in the queue.

Very good. I want to thank all shareholders and analysts for joining the conference call today. Thank you.

Thank you.

This concludes today's conference. Thank you and have a great day.