Standard Motor Products Inc (SMP) 2008 Q2 法說會逐字稿

Welcome to today's teleconference. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the Q&A session. At this time, I'd like to turn the call over to Mr. Jim Burke. Please go ahead, sir.

Okay, thank you. Good morning, and welcome to Standard Motor Products second 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 contain forward-looking statements regarding our business and expected financial results. While we use words like anticipate, believe, estimate or expect, these are generally forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they are based on information currently available to us and certain assumptions made by us, and we cannot assure you that they will prove correct. You should also read our filings with the Securities and Exchange Commission for a discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements.

I'll begin with the financial highlights, and then at that point, turn it over to Larry for a Q&A period.

Our consolidated results for the second quarter reflects essentially breakeven financial results after adjusting for restructuring expenses and a deferred gain on our LIC building sale. However, we have achieved some critical milestones in the quarter. The LIC manufacturing and Puerto Rican manufacturing facility moves are complete and behind us. We continue to make forward progress with our OE/OES growth initiatives; and we also achieved significant additional cost reduction initiatives. And Larry will discuss each of these further in detail.

Now the results. The critical driver in the quarter was primarily the reduction in Engine Management gross profit percentage. I will begin with the Engine Management segment review.

Net sales for the second quarter in Engine Management were $138.5 million, favorable $400,000 or 0.3%. For the first half sales were $281.8 million, again favorable $6.3 million and up 2.3%. The net sales were basically flat in the second quarter, and reflects the slight increase for the half. The growth was primarily from the OE/OES channel.

Dropping down to gross margins, in Engine Management for the quarter, $30 million even. The percentage was 21.7% and off 5.2 points. For the half, the gross margin dollars were $66.4 million; 23.6%; and down 3 points. As we pointed out during our first quarter conference call, we would have a drag on gross margins in the first half of '08 related to the transition moves and the startup of our new Mexico facility. The impact was more than we fully expected, due to a delay moving out of our Puerto Rico facility in order to meet increased demand on those products and replenish our bridge inventory during the move.

We also incurred costs during the transition in LIC as we exited that manufacturing space. In Mexico, we incurred additional costs for set up and training during the launch, and we are very pleased with the progress and efficiencies being achieved.

And finally, due to the physical moves, we had less production hours, so our overall costs increased. We feel that the two moves are behind us, and we will continue to see additional production hours in Mexico in the third and fourth quarters. However, we will still be reducing inventory in the second half, and expect gradual margin improvement till 2005, when we expect to see the full benefit of our planned $9 million savings.

As forecasted, bridge inventories have been reduced by $8 million in the first half, and we achieved another $3 million reduction in the month of July in Engine Management. Operating profit, without restructuring expenses for Engine Management, was $4.9 million in the quarter, down $8.5 million. And for the half, $16.9 million and down $8.3 million. The variances at the operating profit line were the result of the lower gross margins.

Now turning to Temperature Control segment. Net sales were $61.5 million in the quarter, down $2.1 million, or 3.3%. For the half, sales were $111.1 million, down $3.1 million, and off 2.7%.

The temp summer season started slow with customer pre-season orders lower than expected. However, temperatures heated up, and we saw improved results in June, and July was stronger than July '07. The $2 million to $3 million lower sales volume is primarily related to the $6 million price reductions introduced in 2008 to compete with new Chinese imports.

Gross profit in the quarter was $12.2 million, 19.8% and down 1.1 points. For the half, gross profit was $19.9 million; 17.9%; and down 3.1 points. The price reductions in 2008 was the key driver for lower margins in the first half, and Larry will also discuss this further. Operating profit in Temperature Control was $3.6 million for the quarter, and that was favorable $100,000. For the half, operating profit without restructuring was $2.9 million, that was down $2.6 million. The cost reduction efforts in SG&A allowed us to slightly exceed the operating profit versus Q2 '07 despite the price reductions.

Europe, net sales were $12.6 million, favorable $1.4 million, and up 12.2%. For the half, $23.8 million; favorable $2.1 million; and again, up 9.8%. The incrementals sales volume primarily reflects a small wire and cable acquisition we completed in December '07, and additional OE/OEMs business.

Gross margins in Europe, actual dollars were $3 million; 24.3% of sales; down 0.3 of a point. For the half, they were $6.2 million; 26.2%, and favorable 0.6 of a point.

The margin percent slipped in the second quarter, and that was primarily related to the exchange rate with weakness on the British pound against the euro. Operating profit in Europe was $400,000 in the quarter and $900,000 year-to-date.

Looking at the balance sheet. Accounts receivable increased $75.4 million versus December '07. This is primarily due to seasonality. However, many of our large customers offer AR factoring programs, and we plan to access these programs to improve cash flow going forward.

Inventory decreased $8 million in the first half, and we expect this trend to improve as we continue to reduce bridge inventories built in '07. As I mentioned earlier, Engine Management already achieved the $3 million reduction in July.

Our total debt at June of '08 was $273.9 million. Currently, our North American revolver is at $190 million, and we have excess availability of approximately $80 million. That excludes any reserve for the convert that's maturing.

In the past month, we purchased 8 million of the 90 million bonds outstanding at a discount, and there is about 82 million remain open. We will also continue to evaluate future bond repurchases going forward. We expect to generate favorable cash flows in the second half of '08, and also accelerate AR collections with the customer factoring programs. In addition, we also continue to evaluate other financing alternatives to address the current 82 million bond maturity in July '09 to provide sufficient liquidity in the business.

Lastly, cash flow numbers, CapEx spending in the quarter was $2.4 million; $5.3 million for the half; and depreciation and amortization was $3.6 million in the quarter, and $7 million for the half.

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

Okay. Good morning. Jim has covered the numbers. And I'm just going to highlight a few key areas, and then we'll open for questions.

Okay. The single key area in this quarter, as Jim pointed out, was the gross margin in Engine Management. And that is essentially the entire shortfall. What I want to assure everybody is that this is a temporary situation. It all had to do with the close of Puerto Rican and Long Island City, and the move to Reynosa, Mexico.

As we wound down Long Island City and Puerto Rico, we had some closing costs at the end. As we started Reynosa, we had startup costs, but very little production hours out of all the locations, as we were working off our bridge inventory, which was planned. And this is what caused the shortfall in gross margin. Again, I want to confirm this is a temporary situation.

PR -- Puerto Rico and Long Island City are now totally closed down. Reynosa is increasing production month by month. As of today, they are approximately at 50% of planned capacity. Equipment continues to arrive. People are being hired and trained. And our goal is to have everything planned, up and running by the end of 2008.

Incidentally, we are very pleased with what we see so far. It's a good operation. I was just there a little bit ago, and we think this operation has a very fine future for the Company.

Financially, what this means is, as Jim mentioned, we anticipate gradual improvement in the gross margin. through the balance of 2008. And we fully anticipate achieving our original target of $9 million of savings, starting in 2009.

Finally, regarding Engine Management gross margin, we have initiated a second round of price increases, roughly 3% to 3.5%, which is being implemented over the next several months. We will see some of this benefit in 2008, but obviously, because of the timing, mostly will be in 2009.

So that's gross margin Engine Management. And again, I think that's the key to the whole story.

We'll talk gross margin in Temperature Control. Here you have a different issue, and it's all about pricing. Over the last three years, we've reduced prices in this line roughly $15 million in order to compete with imports from China. We think we're now at the bottom and we look forward to a turnaround in 2009. As I'm sure you all see, costs from China are escalating. And we are confident that we will be able to get a price increase in this line in 2009, which is the first time we'll have seen that for quite awhile.

Also, as we have said, we are continuing to shift rebuild compressor production, which is still the bulk of our compressor business. And by the end of this year, beginning of next year, 80% of our rebuilds will have been transferred to Reynosa. And this is a major cost-saving, which we'll see in 2009.

Okay, the third area to discuss is the OE/OES business -- continues to grow. In our release, we announced two transactions. The first is Continental, which we had talked about before. We have now moved the first production line from Continental's plant near Buffalo to our own facility in Independence. It's in the process of being set up, as we speak, and the balance of the lines will be transferred during this year. As we have said, the volume is in the $10 million to $12 million annually, and we'll start to see some of that volume this year, but mostly will be next year.

The second announcement was Lear. This is smaller, about $3 million a year. This equipment is also being transferred to Independence. And that's two new businesses for OES. Now, there is a good secondary benefit to these small acquisitions because our customer base is now rapidly expanding. These two companies, Lear and Continental, were supplying a wide host of customers, including some in China. And now we will be getting those customers. And we see that as a big step forward for us in this business, which we really have very high hopes for in the future.

Okay, the final subject -- and then we'll open for questions -- the final subject is cost control. And to repeat what we said in the release, two main initiatives -- one, we have eliminated about 60 salaried positions, about 5% of our total. And they will be eliminated between now -- some have been already -- and the end of the year.

And second, we have amended the retiree medical program, created a significant reduction in our liability here, actuarially came out to 24.5 reduction, which we are taking over roughly four years. beginning this last June 1.

So, those are the highlights of our report. We are now happy to open for questions.

(OPERATOR INSTRUCTIONS). Walter Schenker, Titan Capital.

The expenses relating to Long Island City and Puerto Rico that affected the quarter were basically as anticipated, and so you knew this quarter was going to be, when you included those, fairly severely depressed? Or they were somewhat unanticipated and exceeded your expectations?

A little of both. One, we anticipated margins to be lower from lower production hours and the overhang of costs in both Puerto Rico, Long Island City and starting up Mexico. But a new event, as we had multiple product lines to move out of Puerto Rico, a very large group of parts were being exhausted to bridge inventory faster than we anticipated. And that delayed the close of that operation because we had to build up the bridge inventory for the move. So we incurred additional expenses in that area also.

Does that answer your question?

Okay, it half answers it. The second half is -- and I'm not trying to get an exact number -- it was twice, a lot more, a little bit more than you would have expected in some way to get some sense as to the variance?

Well, without quantifying it, probably the largest impact within the period relates to the reduced production hours. And it's all your fixed costs and your cost increase that are in there. And then you have the overhang we have starting up Mexico with very few production hours. So it's a function of all three facilities. We anticipated it internally, we forecasted it to be down. We don't provide specific guidance, but we had stated that the margins would be softer in the first half of '08.

Okay. Second question, a fair number of people -- and I've asked this to you guys off-line but -- continue to talk about escalating raw material costs. I know you're putting in another price increase. Can you just sort of go over what you're seeing on a cost structure basis, from a raw material and a transportation cost standpoint?

We're experiencing similar increases that other companies are getting. The one benefit that we've been able to achieve up until now has been, again, because of the 30,000 SKUs primarily within Engine Management, as we're able to outsource these products and reduce the impact of other commodity costs. The combination of it all together as we're measuring it now is still less than 2%.

And therefore your price increases are fully covering your raw material cost increases, anyway?

Yes.

Okay, and last question -- we've talked about OES a bunch, because obviously maybe that's the answer. A lot of disruption going on at the OE side. The potential market is supposed to be very large. We continue to get a small part of it. After years of negotiating with people, what opens the floodgates so we actually ramp this up more quickly?

I'm not sure I understand -- what will create more growth here, is that what you're asking?

Very large players, be it Delphi or Visteon -- we can go through all the big supplier players -- don't want to service the OES market.

Correct.

They account for most of the volume in the OES market, not Continental. I know you've spoken to some of these auto companies and companies about possibly, at some point in the future, getting some of the OE business. We've been talking about it for a number of years -- I'm not putting it on your shoulders, but is there a point where we finally start to get bigger chunks of it?

Well, we did pick up, over the last year, going from memory, I'd say five different product groups from Delphi. It included wire, included modules, included caps and rotors. So we picked up a decent amount of business from Delphi. We haven't been as successful with Visteon, but we continue to explore certain areas.

So I think there's still business to be gotten there. But the more we dig into it, we see that there are other companies, not just Delphi and Visteon, that had pieces of this business, i.e., Continental and Lear. And we're getting some from them too. And the more we get into it, the more potential customers we get and the more potential openings there are. So, again, we see this as a very nice growth area for us in the future.

(OPERATOR INSTRUCTIONS). Alan Weber, Robotti & Co.

First question was, Jim, I think you said that you brought back some of the notes? Was that the --?

Yes, the convertible bonds.

Right, the convertible bonds. And when did you say that took place?

In the month of July.

Okay, so it's not on the balance sheet, okay. And at what price and can you buy back any more, or the thought process?

Yes, I don't have any firm prices I'm giving out, but I'm just monitoring it. We do set up a reserve in our revolver, so we're looking at, if the discounts are reasonable there, we'll pick off a few more of the bonds. But we evaluate it as we move forward. So currently outstanding there's a little more -- $82 million, roughly.

Okay. And then the next question was -- when you talk about with the Long Island City and Puerto Rico closing of $9 million savings, can you talk about -- I know you don't give guidance, but off of what point should we be looking? I mean, because you look at the six months in '08 --?

Yes, right. I understand your question. Let me try to answer it. It's not $9 million from now, which was down. Okay? The $9 million was based on our costs prior to the move. We have a lot of one-time hits now. So it's not $9 million from today, which would basically get you back to where we were. It's $9 million from then. And we remain very comfortable with that. Do you follow my point?

Yes, okay, so it's not right, because as you just said --

It's not $9 million from today. No, $9 million from today gets you back to where we were. It's $9 million from then.

Okay. And then kind of related to the prior question -- Larry, just your thoughts -- with the decline in new auto sales, I mean, I know short term, it doesn't mean that really much for the Company, putting aside this OES business, but what -- longer-term, any thoughts or any views on today's situation?

Well, all right, again, it's a complicated answer. In the short-term, less new car sales equals more older cars on the road, which is a good thing. Of course, this is then balanced by less miles driven, as you all see. So, there's a lot of moving parts here and sort of hard to add them up and come with a single answer. So you've got some things that are positive; you have some things that are negative.

The other thing that's happening, which as you've all seen, is that car leasing has gone down. And car leasing was always assumed to be a negative for the aftermarket, because after that car was returned after the three-year rental period, it typically went back to the car dealer for repairs. So, the industry lost its first repair. You follow that? That, again, as car leasing goes down, that's a benefit because we wouldn't be seeing that for several years now.

There's a lot of moving parts here. We stick by our original forecast that in the aftermarket piece of the business, our aftermarket piece of the business, we will see, partly because of quality improvements, a slight decrease in units to be matched as with a slight increase in pricing. So you got flat dollars in the aftermarket and growth will be from our new business, primarily OES business. And that remains a reasonable forecast, in my opinion.

(OPERATOR INSTRUCTIONS). Tony Cristello, BB&T Capital Markets.

This is actually [Allen] in for Tony. Just had two questions, both on the Engine Management side. First off, if we try to back out some of the duplicate overhead from both Puerto Rico and Long Island City, and some of the work off of the bridge inventory, can you give us some sense as to what adjusted or normalized engine management gross margin would have been in the second quarter?

Well, again, that would be putting out specific numbers there. And again, because of many moving parts, we're going to -- we have the margin percent that's out there below 22% for the quarter. We feel that's going to only improve, getting back to where we were at the 25% or 26% levels before we went into this move. And we feel we're going to be able to get savings on it. It's only a short-term period; we're talking about the second half of '08. And then we feel we'll be back at production levels in '09. Now, we're still going to be taking some inventory out that went into the '09 period also, but we think that will still be getting back more to a normalized level.

Okay. And then I guess as a follow-up question, if we look at total sales at $138.5 million and pretty much flat year-over-year, with the addition of the incremental OES business, and if we backed out looking at just the core, I mean, that would imply maybe the core is down. So could you give a little more color around maybe some particular product lines or areas of weakness during the quarter?

Well, the Engine Management has about 40 or 50 different product lines in it, some of which are declining because they haven't been on cars for 10 years, i.e., distributor caps, carburetor kits; you have lines that are growing. It's not one answer there; it's a lot of answers. But again, I think if you back out the new OES business, our existing aftermarket is pretty close to flat.

Okay. All right. That's all I had. Thank you guys very much.

(OPERATOR INSTRUCTIONS) And we have no further questions.

Okay, I want to thank everyone for joining our call this morning. Bye.

This concludes today's teleconference. You may disconnect your lines. Thank you and have a great day.