Standard Motor Products Inc (SMP) 2008 Q3 法說會逐字稿

Good day everyone and welcome to the Standard Motor Products' Third Quarter Earnings Release. At this time, all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the conference over to Mr. Jim Burke. Go ahead, sir.

Okay, thank you. Good morning and welcome to Standard Motor Products' third 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 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 review the financial highlights and then turn it over to Larry, followed by Q&A.

First, I hope many of you like the new format with segment financial information prior to the call. This will allow me to hit the key highlights without running through all the numbers, which are now available in advance. Let's begin.

The key drivers for the quarter and the year-to-date results are the topline sales and the gross margin percentages, which I will review by segment. Engine Management net sales held up well through September. Third quarter was up 3.8%, and the nine-month numbers were up 2.8%. Leading the way has been our OE/OES channel. This leads us into a discussion [of this], because OE/OES has lower gross margins, but also significantly lower SG&A cost. The Engine Management gross margins were down about 3 points for the quarter and year-to-date. The lower margin was primarily a function of our transition out of Puerto Rico and Long Island City manufacturing and start-up costs in Mexico. To a lesser extent, the margin percent is also impacted by higher OE/OES channel mix.

The key is that we are seeing a positive trend, which we believe will return Engine Management margins to the mid-20s, with a longer-term focus at 28%. We expect to see good progress towards this goal in 2009. To recap the 2008 trend, in the first quarter '08, the margin for Engine Management was 25.4%. This was reflective of some, but reduced production, while we were still in Puerto Rico and Long Island City.

In the second quarter '08, our margins dipped to 21.7% and the reason we were burdened with duplicate overhead in those two facilities and Mexico start-up costs. Now our third quarter returned to 23.9% reflective of zero overhang from Puerto Rico and Long Island City and beginning to see efficiency improvements from Mexico. Our Mexico costs are decreasing nicely and the learning curve and efficiencies improved. In addition, we will see better overhead absorption, as we bleed off bridge inventories and increase production.

Turning to Temp Control. Net sales were down $6.4 million or 10.7% in the quarter, and down $9.5 million or 5.5% year-to-date. The reductions in Temp are threefold; approximately $6 million to $7 million reduction in annual pricing for 2008, a week summer season, and results of a weak economy for a discretionary repair.

On a more positive note for Temp, we believe inflationary pressures in China and transportation costs bodes well for price increase in 2009; the first increase in at least three years. Gross margins were obviously impacted by the $6 million to $7 million price decreases at the beginning of the year and lower sales volumes impacted production levels and overhead absorption. Our action plan for recovery of Temp gross margins are, continued cost reductions in the US, expanded production transfer to Mexico, and price increases for the 2009 season.

Europe, our net sales held up nicely. Third quarter sales were up 3.4% and year-to-date 7.6%, which was a function of a small wire and cable acquisition that we did in December '07. Gross margins in Europe were off almost 3 points, [but] down only a half a point year-to-date. The weakness on the British pound against the euro and other currencies negatively impacted our margins for purchased and manufactured products. Consolidated SG&A expenses for the quarter were favorable $1.6 million or half a point and year-to-date were favorable $800,000 or three-tenths of a point.

Our restructuring and integration expenses were down for the quarter, but up against the nine months last year, as we culminate the transition into Mexico. Two new cost reduction efforts have also been announced. The closure of our Reno distribution center with consolidation into our Virginia DC and the shutdown of our Kansas wire manufacturing and consolidation into our Mexico wire manufacturing operation. Both will have positive net results in 2009.

Our interest expense was favorable $1.5 million for the quarter and $3.5 million year-to-date. The interest expense savings is reflective of our debt reduction, the benefit of cash generated on the sale of our LIC building, inventory reductions and AR factoring programs, which some of our larger customers with associated draft fees of $400,000 for the quarter and $700,000 year-to-date recorded in SG&A expenses.

Consolidated income tax expense was distorted for the third quarter 2008, due to an increase in our projected effective annual tax rate from 42.6% as of Q2 '08 to 49.5% as of Q3 '08. The increase was primarily related to our retirement plan distribution and anticipated gains from the sale of two buildings in the UK that is now not forecasted to recur until 2009. Existing UK NOLs are available to offset these anticipated building gains, which will reduce the overall effective tax rate upon the sale. As we pointed out in the release, adjusting for restructuring expenses, utilizing a 40% statutory tax rate and excluding the gains from the sale of our LIC building and gains on the repurchase of our debentures, we achieved a $0.13 earnings per share in the third quarter.

Looking at the balance sheet, accounts receivable increased $5.2 million against September '07 level. However, accounts receivable decreased $40 million from the June '08 level with the introduction of AR draft programs late in the third quarter. Inventory decreased $13 million since December '07 level and it's back to levels at September '07. We expect further reductions in inventory, as we continue to work off bridge inventories built in '07. Total debt of (inaudible) against both September and December '07 levels.

Finally, I want to address our plan to pay off our convertibles, which mature in July '09. As we stated in the earnings announcement, we repurchased approximately 20 million debentures in the third quarter and cumulative to date approximately 30 million, leaving a balance outstanding of approximately 60 million. As you are all aware, the credit markets are very difficult. However, there are indications they are beginning to settle down.

Our action plan is twofold. First, from an internal perspective, our total debt keeps coming down; sale of our LIC building, AR factoring program with large key accounts, and inventory reduction efforts. And we have plans in place for further cost reductions. In addition, we have listed two new properties for sale in the US, our Reno distribution center and our Grapevine, Texas manufacturing building. These two new listings are on top of two buildings for sale in the UK.

Second, from an external perspective, we are working with our bank group to obtain a small tranche of mezzanine financing, reflecting the benefits of our cash flow improvements in 2009. As we develop both our internal and external plans to raise additional capital, we are committed to either individually or a combination of the two plans have a means to redeem the bonds at maturity or sooner.

Lastly on our cash flow statement, CapEx spending in the quarter was $2.7 million and the nine months number was $8 million. And depreciation and amortization in the quarter was $3.7 million and $10.7 million for the nine months.

With that I'll turn it over to Larry.

Okay, good morning. Jim has covered the numbers and the status of the convertibles, not much more to add, but I do want to cover a few things and then we'll open for questions.

The main point. One, the moves to Mexico are progressing very nicely. To refresh your memory, we now have three facilities in Reynosa, all are doing well and all three are growing. Engine Management is the largest one, it's our newest one as well. We brought product in there from Long Island City and Puerto Rico. As Jim said, we are still in the ramping up stage. We will be at full production, we anticipate, in the first quarter of 2009. Efficiency is improving, the costs are improving, we're hitting all our targets and this will have a positive effect on gross margin in 2009.

Wire and cable, we moved to a larger facility to expand our capacity. As Jim mentioned, we will be moving the remainder of our wire and cable assembly operation from Edwardsville to Reynosa over the next 12 months and that's going to account for roughly 75 jobs, which will be another good [phase].

Temperature Control, we keep bringing product down there and in 2009, roughly 75% of our rebuilt production will be done in Reynosa. We've added about 100,000 units from 2008, from roughly 230,000 to 330,000 and there's a saving, as we have said, of roughly $10 to $15 a unit. So, all are doing well and all are going to help our margins in 2009.

Number two. As Jim said, we have announced the closing of our Reno distribution center, that would be closed at year-end. The savings from an operational cost are not huge, about $0.5 million, but we will save about 1 to 2 million in inventory, because we won't have to have inventory in two places and now that permits us to sell the building, we anticipate 2 to 4 million even in this environment.

Number three. OES business continues to grow. Two previously announced moves are really hitting in the fourth quarter. Continental, which we have estimated at $10 million to $12 million a year; Lear, which will be about $3 million a year, all will begin in the fourth quarter of 2008, plus we are talking to many, many prospects and we continue to be very bullish on this business.

One negative is, we have started to see a slowdown in sales, which began in September and it continued in October. In talking to our accounts, it's not the end user that is down because sales through the car owner are holding up reasonably well, what we are seeing is that our accounts are reducing inventories, as I guess everyone in this economy is doing right now. This means it's a temporary situation and we hope it won't last much too long, but it's not a long-term thing, it is definitely a one-time inventory adjustment that we are seeing on the part of our customers.

I just want to finish with a list of some positive macro trends to remind people where we are in this business. These are not short-terms things, but these will be positive over the months to come. Number one. The parts business is a relatively good place to be if people keep their cars longer and they have to fix them. Number two, gas prices are down and we believe this will lead to a reversal of the trend where people had slowed down on their driving. Number three, commodity prices are down, an example will be platinum. Platinum is the largest single ingredient in our oxygen centers. That has dropped 48% and we already see it reflected in our cost in that product. We're seeing this in other products as well.

Car leasing is down and historically leased cars buy less from the aftermarket. And number five, which I think you've been reading lately, is car dealers are closing down. 450 in 2007, the estimate is 700 in this year, that's about a 5% drop. The anticipation is more going to close in the future. The closing of the car dealer also tends to send more business to the aftermarket. So these are all positive trends. Meanwhile, we continue to do what we can control, which is to reduce cost and to gain OES business.

With that we open for questions.

Thank you. (OPERATOR INSTRUCTIONS). And it looks like we'll take our first question from [Brian Sponheimer] with Gabelli Company. Go ahead, please.

Good morning Larry. Good morning, Jim.

Good morning.

Looking forward to seeing you in Las Vegas next week. Just want to talk about the tax rate going forward, just as far as -- with a 90% rate, because of this you can kick back -- is that -- when can we expect that to reverse?

Yes. For the full year, we had forecasted now a 49.5% rate and for next year, I see that that rate to be very close near the statutory rate of 40%.

Okay. Obviously lighter in the first half of the year than in the second?

No. I think it will be at an effective annual rate without any anomalies, again we had a swing in the rates for this quarter and because we had the sale of the building and a sizable gain, it kind of distorted the third quarter when we put an adjustment in. But I think the effective rate that we developed for 2009 would be hopefully very close and maintain that rate throughout the year.

Okay. And just anecdotally you spoke about a mild summer affecting business, would an equally harsh winter be a boost in that sense. I think you know --

No. In the old days, with the old traditional ignitions, yes, when it got really cold the cars didn't start and we sold a lot of parts. Electronic ignition has changed that. So, really cold winters don't have that much of an effect on our Engine Management business any longer.

Okay. I'll hop back in line, again, look forward to seeing you next week at our conference.

Okay.

All right.

Very good. Thank you.

Thank you. Our next question comes from Walter Schenker from Titan Capital Management. Go ahead, please.

Good morning, Walter.

Good morning. And Jim, can you give me some more understanding of exactly what's happening on accounts receivable, the draft programs factoring, and the economics of that?

Okay. And it's again with our large customers where they have an agreement with the financial institution and what we do is we have the ability, once we accept the draft and enter into one of these agreements, to either hold the draft or place the draft for collection. And our accounting treatment and again because we are collecting the draft early, there is a draft fees related to it, primarily those are based on our customers' financial condition, which the rates are very reasonable to ours, and we have the ability then to accelerate the cash collections, which we've been doing and then to pay down debt. So, we see it as a good opportunity for managing the working capital and the receivables in the business.

And when I look at the September 30th, '08, September 30th, '07 balance sheets and I see accounts receivables growth of 250 versus 245 roughly, how are those draft -- how does that affect the receivable number?

Well, it's sold and it's off of our balance sheet with no recourse.

And therefore, this year versus last year in round terms, how much of this have you used?

Well, we entered into them at the end of the third quarter and the bulk of the receivables that we are seeing reductions was coming in really entering into the fourth quarter. So while at September '07 there was expansion in the DSOs that were there, we began with the draft program, but now we've accelerated it, as we rolled into the fourth quarter.

And therefore the third quarter, I want to kill this, but the third quarter inventory -- I mean receivable number for '08 is -- had de minimis draft receivables factored in it?

Well, it was a -- in a year-to-date, there was balances that we had accelerated collections on, but there was growth in the receivables prior to that, if you go back. So you look from June, I had pointed out, we have collected $40 million in receivables. The key is, Walter, why it -- it's difficult when you accelerate the collection of the receivables, some of it you would have been collecting already, as they would have been coming due, because what you do is, you amass all of the receivables that are in the customers payable to you.

Okay. And again, just to circle again. Interest was down 1.5 million quarter-over-quarter, however the fees for these drafts theoretically should be netted against that, because if you would hold the inventory, you'd be -- have less of inventory.

That's correct, yes.

And those fees were -- I'm sorry, was that 600 or --?

I think and I'm looking back, it was 700 year-to-date.

Okay. Ineffectively though the advantage to you is the interest fees you're paying is less than what you would pay the banks, grow the money for the money. That's what you're doing?

Well, we do it -- one, it could be neutral on a cost basis with LIBOR plus a spread that we do it. And then we take the advantage of having the cash and then paying down our debt. So again, it's a basis on the customers' arrangement with the financial institution. Where we are presently is many of them in there, our largest customers are favorable to us.

Great. That would fill that. And just one other question, because I want to monopolize the call, we have had through the last decade or last five years picking a time frame, a constant restructuring of our manufacturing cost basis. At this point, while we -- given what you've already announced, is there much less to do?

Yes. I would say we're reaching the end of that. We're down -- you are just talking about Engine Management there.

Yes.

Yes.

Are there some going on in --

Well, now that we've moved the wire and cable, so we will, there isn't much more in the horizon, yes. There'll be some. I think we can still build up Mexico. The more we can bring to Mexico, the better we are. And we still do a fair amount of assembly operations in various locations. So, I'm hoping we will have more, because the payback on it is terrific. I think it will be less. I think we've done the big ones, but there is still some room for growth and we should be happy about that, not unhappy about that.

Okay.

It's a tremendous payback for the move cost.

It will live long enough. Thank you.

Okay.

Okay, Walter.

Thank you. (OPERATOR INSTRUCTIONS). And our next question comes from Robert Smith with Center For Performance Investing. Go ahead, please.

Good morning. Along those lines, is the weakness in the Mexican peso a benefit to you, I mean the recent weakness?

Well, yes.

Yes, it would be. Again for what the costs are that we are, because we're manufacturing down there. So, we do get a slight benefit there and I think again, I wouldn't to be counting on such turmoil in the currency markets over the last 30 to 40 days. We can't predict. But the weakness there, yes, it's a benefit.

In working with banks and other financing possibilities, the question of restrictive covenants may come up. I mean how would this work in respect to continuing the dividend?

Well, that's a two-part question there. We have a covenant based on our revolver, which triggers only if our excess availability drops below a floor number, which is approximately $30 million. Then we would measure that covenant in there. So, we're above that number, we haven't had to measure it, and then there is no restriction on the dividends that we have in place.

But essentially, you are trying to kind of restructure some of the financing going forward, aren't you, I mean?

Absolutely. Yes, that's one of our two plans that we have in place. So, we are looking at putting in a small tranche of mezzanine financing that would be in place for the bonds. Again saying that we have approximately, at this point now we bought back almost 30, we have 60 outstanding.

Might that affect the question of the dividend as well?

The dividend we always address on each quarter and we will look at that and absolutely we review that each quarter based on our cash flows and what's happening with our attempts to do refinancing.

I'd love to see it retain, but in this kind of an environment you never know what's going to be (inaudible) .

Right. And that's why we quarter-by-quarter discussed with our Board and we agreed that at this point, which is why we approved it to the next quarter. We feel we can pay the dividend and repurchase the convertibles. That's what it looks at this point. But should that situation change, we'll have to act accordingly, but at this point that's what it looks like.

But your wishes aren't to continue to pay the dividend going forward.

Yes. As long as it doesn't interfere with our overall financial situation, which thus far it has not.

Can you say a few words about the competitive environment in this kind of an economic --?

Yes. We are in a very competitive industry as you know. But one of our biggest competitive problems has been cheap product coming in from China and that's certainly what caused the problem in Four Seasons and it had some effect on Engine Management. From what we read and from what you read, that's going to diminish if Chinese costs are going up. Everyone says now we made the right choice by picking Mexico instead of China. So, that big element of competitive price pressure should be diminishing, that's a very, very positive thing. The rest of it we always had competitors, we always do have competitors, we always will have competitors, I don't see a big change really.

And any weaker systems out there sort of thing?

Yes. Well, it's a tough world right now, everybody is -- we're doing our best. So, I don't see anything [imminent] on the horizon.

Do you have any viewpoint on the current turmoil, it's kind of [developing in] the industry itself?

You mean about the car manufacturer?

Yes.

I'd rather not comment, that's not our field, I'll let the other guys talk about that.

Okay. Thank you.

Okay.

Thank you. Our next question comes from Bill Desellum with Titan Capital Management.

Hi.

Hello, Bill.

Thank you. Good morning. Relative to the issues that you're seeing with the Chinese and lower pricing -- higher pricing. Is that something that you are anticipating or is that something that you have, actually seeing some definitive signs that it's going to happen.

Well, we've seen it, we've seen it. It varies somewhat by product group, but we are seeing increases 10% or more on stuff we buy, some other product lines you're seeing 20% and 30%. It's a combination of various factors, they have wage inflation. They have -- the freight costs are killing them and the currency, well, it hasn't floated as much as it ought have, it's probably up, I'm trying to the remember, 6%, 7% against the dollar. So, if you add all those things that you got price increases coming out of China.

And how are your customers responding when the Chinese that they have been buying from are raising their prices, is that leading to a change in your customers buying the business?

We've had in Four Seasons, where this was most prevalent, we've had people come to us and say, `Hey, we'd rather buy from you now.`

And then relative to your outsourcing to some Chinese manufacturers, has that changed the economics of that decision, bring that back (inaudible) .

Absolutely, absolutely. So -- but I think the biggest benefit really is going to give us the opportunity to raise prices in Four Seasons, that's a biggest benefit.

That's bigger than the customers buying more from -- [more of them].

Yes, well, (inaudible) actually in the short run the biggest one is, we get a price increase.

Okay. Great. Thank you.

Thank you, Bill.

Thank you. (OPERATOR INSTRUCTIONS). And we have a follow-up from Brian Sponheimer with Gabelli Company. Go ahead please.

(inaudible) a question, you spoke about retail stores cutting their inventory down to (inaudible) , at what point does it become necessary for those customers to restock?

Well, they are the ones who have to answer that, I'm -- it's not for me to say, but they will obviously reach a position where they hit the level that they anticipated and they're going to have to start ordering again. I can't answer that question, they do. But it should come fairly soon, but I can't answer that question.

Okay. I suppose I should have framed it better in historical terms, say, from what you witnessed in 2001 and 2002 to now, has there been an acceleration in retail stores cutting inventories --

This is the biggest we've ever seen.

Okay.

And I'm sure it's a reflection of the economy where everyone is nervous. So that even though they are selling it and their sales aren't down, it's a -- much at all, if anything, and you'll see those when they give their reports, all the big guys report. This is the biggest inventory reduction exercise I can recall.

Thank you. (OPERATOR INSTRUCTIONS). And our next question comes from [Tom Marks]. Go ahead, please.

Yes. Good morning.

Good morning.

Is Temperature Control division just very bothersome? It seems like we depend on the weather all the time and it doesn't seem that you're very competitive in that area. I've asked this question once before and have you ever entertained selling that division and do an Engine Management stuff in that you do well. I mean this is very frustrating. I hope that the weather is hot. And even if it's hottest, no guarantee that we're going to pick up the business, so have you ever considered selling this Temperature Control? It seems to be a pet project of yours that seems like you're in love with it. And I wouldn't, I'd prefer to see you sell it, reduce some debt or put into Engine Management?

Well, it's something we grapple with all the time. And of course I'll never say no to anything at this point. Let me give you the reasons that thus far we have decided to stay in the business. It's the business where I think our competitive position is the strongest, now that especially the Chinese stuff is coming up. So we have a very, very strong competitive position, that's number one. Number two, it's a project with no technological obsolescence to it. That's a very positive thing. Number three, it absorbs a lot of cost from our Engine Management division, because they share a lot of services. Two big ones would be the sales organization and IT. When we looked at it, if we got rid of Four Seasons, we would be -- we couldn't say it's proportional amount of those two big costs.

And finally, I think we are at the bottom of the pricing cycle, that's killed us the last three years. And so you do that plus you move to Mexico, plus the synergies that we have with Engine Management and the numbers look good. And it's really not that much dependent on the weather. We're trying to forecast it with low sales and then if it gets extraordinarily high, that's a plus. So, we're not hopefully that dependent on the weather. But this is something we constantly look at, we have to, it's our fiduciary responsibility.

Thank you.

Thank you. It appears we have no further questions at this time.

Okay. With that I'd like to thank everyone for joining our call. Good-bye.

This concludes today's teleconference. We thank you for your participation and you may disconnect at any time.