Standard Motor Products Inc (SMP) 2010 Q2 法說會逐字稿

Good day, everyone and welcome to today's program.

(Operators Instructions).

It is now my pleasure to turn the program over to Jim Burke. Please go ahead, sir.

Okay, thank you. Good morning, and welcome to Standard Motor Products second quarter 2010 conference call. In attendance from the Company are Larry Seals, 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.

Overall, I am pleased to report another favorable consecutive quarter, with very strong top line revenues, and also strong earnings momentum. Our net sales in the second quarter were $231 million, up $33.6 million or 17%. Excluding $7.3 million sales from the divestiture of our European segment last year, net sales were up $40.9 million, or 21.5%. By segment, Engine Management net sales were up $29.8 million or 24.3%. Temperature control also experienced solid sales performance with revenues up $8.3 million, or 12.6%. Consolidated gross margin dollars improved $12 million to 25.3%, up 1.8 points.

By segment, Engine Management gross margin was up $6.4 million to 24.5% for the quarter. The 24.5% in Q2 is up sequentially from Q1 2010, at 24.2%, but off 0.80 of a point from Q2 2009. Similar to the first quarter, Engine Management experienced a higher mix of OE OES sales, and also a higher mix of lower margin purchase products, primarily for newer model applications that we plan to lower the cost by in-house manufacturing, or resourcing the product from low-cost countries.

Looking forward, we will achieve the full benefit of our 2010 price increases in Q3, and expect our Engine Management gross margins to improve in the second half of 2010. Temp control gross margin improved $6.2 million to 24%, up 6.5 points. The 2009 temp control gross margins were reduced, due to lower production levels to slash inventories, in order to generate cash and pay off last year's convertible bond at maturity in July 2009. In 2010, we are benefiting from higher sales and higher production levels, which leads to favorable overhead absorption and improved gross margins.

Consolidated SG&A expenses increased by $5 million dollars, on the significant sales increase. The prior year quarter also included $1.7 million for Europe SG&A expenses, so the increase was actually $6.7 million excluding Europe. Included in this increase were AR draft fees for the accelerated collection of receivables. These fees increased $1.1 million due to improved sales levels. Overall, the net effect was a benefit of 50 basis points with SG&A expenses dropping to 18.1%, versus 18.6% of net sales last year. Consolidated operating profit, before restructuring and integration expenses, improved $7 million to $16.6 million. This reflects a 73% improvement over last year Q2, from a 17% growth in revenues.

Restructuring and integration expenses were essentially flat to last year in the quarter. As previously disclosed last quarter, we will incur higher spending in Q3 and Q4 this year, for our Hong Kong and Hayden consolidations. Again, one-time costs were estimated at $4 million, with annual benefits of $4 million. Excluding non-operational gains and losses in the quarter, we delivered diluted earnings per share of $0.38 versus $0.27 last year. And for the six months, diluted EPS of $0.52 versus $0.35 last year.

Looking at the balance sheet, accounts receivable increased $48.7 million versus the December 2009 level due to the strong sales performance and the seasonal nature of our temp control business. Inventory also increased, up $18.4 million against December 2009 levels, again related to the sales increase. Helping to offset a big portion of this working capital increase, was accounts payable increasing $31 million from December 2009 levels. Our total debt at June 2010 was $87.5 million, up $11.1 million from December 2009. By year-end, we should be able to achieve overall debt reductions from the December 2009 levels at $76 million.

In July, we prepaid our 15% $5 million notes outstanding with funds under our revolver, and we will retire the $12 million 15% convertible debt at maturity in April 2011. This will offer us further reductions in our interest expense. We currently have approximately a $115 million borrowing availability under our revolver. From our cash flow statement, CapEx spending in the quarter was $2.8 million, and for the six months $5.8 million. Depreciation and amortization for the quarter was $3.4 million, and for the first half, it was $6.7 million. With that, I'll turn it over to Larry Sills.

Good morning. We're obviously pleased with the results to date. I'd just like to take a minute to put it in perspective, and then we'll open for questions. Over the last few years, our people have worked extremely hard on reducing costs and reducing debt. To recapitulate, we've moved over 50% of our production to low-cost countries. As Jim announced, we had two further planned consolidations which will take place later this year. We've reduced our salaried head count by roughly 10%. And in 2009, we reduced our debt by over a $100 million dollars. If you now lay on top of this lower cost base, a healthy sales increase, as Jim said 17% for the second quarter, roughly 11% for the six months, the results are obviously going to be favorable, and they were.

I'd like to talk about sales for a minute. The aftermarket, the entire aftermarket, as you've seen from reports that are coming out now from the distributors and the manufacturers, is doing quite well. The reasons have been documented, new car sales are down. The result is that the car population is the oldest it's been in probably 40 years, in excess of ten years on average. This is leading to increased replacement, increased repairs. Car dealers are closing down, it's estimated about 15% of the dealers are to be closed. This means more business for the independent aftermarket. And I personally believe there was some pent-up demand from 2009, because many of the situation existed in 2009. We didn't see the repair increase, and my personal belief is that people just weren't spending money on anything. And now that's catching up.

So all these factors are true for the entire aftermarket. Now for our particular lines, we've been helped further, by the following. First intent, it's been a good hot summer especially in the northeast part of the country. And in addition to that, we gained two new accounts during the year 2009, AutoZone and Pep Boys. We had them for part of the year last year, we have them for all the year this year. So those things helped the temp business, on top of the overall demographics.

Engine Management has been further helped. We have the business -- wire business that we acquired from Federal Mogul, primarily to Napa, We had a sales increase in 2009 in OE -- over 2009 -- in OE OES, although we are somewhat below the 2008 levels. And as we put in the release, we believe there is some inventory growth on the part of some of our distributors, bringing their inventories back to normalized levels. So these things all worked in our favor, in addition to the overall increase in the industry. So again to summarize, you have a sales increase, on top of a lower cost base, the results are going to be good. And they were. Further, from all indications, industry is continuing healthy into the third quarter, and so we are reasonably comfortable looking ahead. That's my quick summary, let us now open for questions.

(Operator Instructions).

We will take our first question from Tony Cristello with BB&T Capital Markets. Please go ahead.

Good morning.

Good morning, Tony.

First question, what is the timing, and I think, Jim, you had this in your prepared remarks, for in-house manufacturing or moving some of that production to low-cost sourcing, for some of the newer products you're introducing, which has sort of been a little bit of a headwind on some of the gross margin opportunity, at least here in the near term.

All right. What we're doing, and we're accelerating our efforts in this area, and we're measuring it, for the hours in manufacturing, and also for the purchasing. We are opening up a procurement office in Hong Kong, staffing it with engineers to accelerate the ability to be able to resource many of these newer applications overseas, and generate significant savings.

With that also, we are beefing enough our engineering talent, because we have significant opportunity to be able to grow the manufactured part, as we look at the hours. Now, trying to quantify that, we're in the 24.5%. We stay by our long term goal, that we think this efforts will be able to bring us closer to 27% to 28% gross margin for Engine Management. The timing of it, I cannot put specific marks on it. But we are very aggressive in 2010, trying to address this, and we also think we have significant opportunity with our Polish operation also.

This is mostly in the Engine Management category?

I am speaking strictly for Engine Management in this area. But we also have the same efforts going on in Temperature Control, but this Poland, and looking at Hong Kong, I'm addressing Engine Management, Tony.

Okay. Let's not look at this 27% to 28%, but is there a way you could quantify, what you think the impact is, at a 24.5%? Or maybe saying, how much of that product coming in, is representing on what percentage of that Engine Management product? I'm guess I'm just trying to understand.

The hard part is trying quantify this even internally, when we look at this. We're dealing with an excess of 30,000 SKUs, and you're always adding new part numbers in there. I think the key that we saw in the first half with the improving margins, is that we'll get the benefit of the full price increase, now coming into the second half. So with that, we think our margins will improve nicely for the second half over the first half. And again, we continue to work on all these cost initiatives to lower our cost base.

Okay, then another question on the margin. When you think about the initiatives you've put in place on the cost side of the equation, how should we think about it as we move into 2011, and beyond? And let's just say, assuming a more normalized operating environment, trends are very good right now, but more normalized. How should we think about the incremental margin in the shift, in the changes you've done to your business, is each dollar going to become more more profitable? And when sort of is the inflection point, to start to see that flow through?

Very good question. Again, I'll remind, as we attempt to grow our OE OES business, that will also impact gross margins, but have a benefit on our operating margins. So we have a number of variables working. What we have seen, and what we believe will continue, is that our pricing will be favorable to our inflation costs, that we have significant opportunity to shift to low-cost sourcing, and at the same thing with our manufacturing efforts to go to to low-cost countries. And again we're really looking at -- it's not that dramatic, we're looking at anywhere from, call it, 24.5 -- or if I can round it to 25, going to 27 or 28. So we're talking two or three points, we're talking $15 million on a $500 million base or more. And it's a combination of price increases and cost reduction efforts.

Okay, and one last question maybe, Larry, when you look at sort of this industry backdrop, and just the acceleration we've seen in trans businesses is very strong right now. Outside of sort of the tailwinds in the industry today, can you maybe discuss a little bit sort of acquisition, or the opportunities, or just the environment today of your competitors, and the competitive opportunities that you see? And then second, the OE OES side of the business, which a few years ago, we started seeing more aggressive approach. And that sort of softened, and at least given what was going on in the industry. Can you talk about how you look at that business today, and what that might look like a year or two from now?

Okay, you've asked many questions. I'll divide them into two pieces, acquisitions and OE OES, okay? We are looking at acquisitions. As we told people, that was one of the reasons that we sold equity last year. We now have the wherewithal to do acquisitions. We are looking at some, but we are going to be very prudent about it. We obviously don't have unlimited resources. So we are going to pick those that we think will have the best long-term benefit for our Company, combined with the least risk. So those are our obvious criteria, and we are looking, and we are looking aggressively. But nothing to report. OE OES, yes, we're a little disappointed in the sales at this moment. However, we have a very -- we built up our sales organization. And we are seeing many, many prospects out there. We are pursuing them aggressively, and we still believe this is a good growth potential area for our Company. So I trust that answers your questions, Tony.

You did. Thank you very much. I appreciate it.

Okay.

And we'll take our next question from Aditya Oberoi with Goldman Sachs. Please go ahead.

Hi, guys, great quarter.

Okay. Thank you.

I just have a couple of housekeeping questions first. On the interest expense, you mentioned debt reduction actions that you are undertaking should be favorable. Can you quantify the run rate of interest expense savings that you want to see? I'm sorry, you will have to repeat it, you faded out on the second half of the question. I'm sorry, I was just asking, on the run rate of interest expense savings that you want to see, because of the debt restructuring action that you took?

Well, we'll get the favorable cash flow benefits so, as we reduce working capital of the business, because of the seasonal nature of the business, which you would build into your model, I anticipate. But one of the benefits that you will see now, over the second half of the year, is that we were able to take a piece of the debt structure at $5 million. And essentially, it will be at our revolver rate. So just round the numbers, less than 5% as opposed to 15%. So that'll be a 10% cost benefit there. And then we have a $12 million outstanding on the convertible, which matures in April of next year. And we have more than sufficient capacity under our revolver.

Okay. Great, and then on SG&A, you guys had a pretty decent quarter, and looking at SG&A as a percentage of sales, is this kind of run rate that we should be thinking about going forward, or do you see some cost creeping back?

Well, what I think what we said previously, I think in 2010 versus 2009. In 2009, we dramatically cut back, because we had to address the convertible bond that we had maturing, so we did have some cost in 2010 related to inflation, as we put -- re-implemented our salary increases for employees, and some of our spending and marketing programs. But the run rate, where we are in 2010, is basically constant. We don't see creep. We are very prudent on watching our SG&A expenses. The one area that is in there, that -- and I did point out was the AR draft fees, which is a variable item, that will move up and down with our sales volume.

Got you. And one last question, maybe probably for, Lawrence, is that on the individual builds, you had mentioned that was -- that the inventory builds at the distributor level was a helpful factor for this year -- or this quarter revenues numbers. And I would just like to know the status of that. Are we going to see some more benefits in the next few quarters, or do you guys feel that the distributors are at the right level of inventory now?

Well, that's rather hard to speculate. But my -- our belief is that they are currently at the right levels. So that we are not anticipating further inventory buildup in the months ahead. We think they are back where they should be.

Okay, great. Thanks a lot guys.

Okay. Thank you.

And we'll take our next question from Walter Schenker with NAB Partners. Please go ahead. Hi, Larry. Hi, Jim. A series of questions, in no particular order. In looking at temp control, there are obviously some pricing, there is some new accounts. If you were to look at a significant customer, sort of on a apples to apples basis, what sort of unit increases did you see, without picking a name like that Napa, or somebody like that?

Okay, that's a good question. Say, excluding new accounts and such?

Right.

Correct?

Yes, that's the question.

I'd say, it's a few points, single digits.

Okay.

And I will anticipate your next question. Okay.

Maybe it ought be better.

But I think we're dealing with some quality improvements in this product line. So that, compared to the product of six or seven years ago, it's a better product today. So we are seeing improvement. We're seen solid improvement, balanced by definitely improved margins, as we move more product to Mexico so it's a very, very healthy business even though the product is a little better than it was before.

And as you are the, by far the largest player in the industry as people have gone by the wayside, if the weather in the South anyway remains warm, should that benefit you in the second half, as some of the people who cherry pick items might not have inventory to supply?

Well, as you go into the second half of the year, maybe in the deep South, but certainly in this part of the world, people are hesitant to replace a sale. So if they sold a compressor in September say, which will happen, they will not necessarily replace that in inventory buying from us, with the logic that they'll probably have to sit on it for six months. So that's why even though the sales continue at the field level into say, September or October in the South, our sales to them, start to drop off substantially.

Is it somewhat related, is it too early to have any feel, given how strong end markets are, and temperature in the Northeast was, on what your returns are likely to be in the fourth quarter?

(Multiple speakers). We reserve all year for fourth-quarter returns, we believe we are adequately reserved.

I always believe you're adequately reserved. However, you've come through a couple -- the way you reserved has been averaging over historic periods, you've come through some pretty depressing periods for the industry, and for the market, in which people were very concerned, not you, but everybody -- with their balance sheets. And therefore it would seem likely to me, although we'll find out in six months, that you may have less than normal return levels, given how hot it's been on temp.

That's not an unreasonable hypothesis.

Okay. Different question. Dividend policy. I know you're paying one.

Yes, and we have stated our dividend policy of roughly one-third of earnings per share, which is coming -- currently $0.05 a quarter. And we will just continue to look at that, and our Board will look at it in the months and quarters ahead.

So if your earnings were to be meaningfully higher than, let's say $0.60, of which $0.20 is one-third, then one might expect or should expect, not might -- should expect, the dividend to increase. I realize that members of your Board would like to see it, once the year is over?

Again, it's up to our Board, and we look at many issues, not just what the earnings per share is, but what our capital means are at the time, et cetera. So the Board will look at many things when it comes time to make the decision.

So it may or may not be a one-third policy.

It may not be a rigid mathematical one-third policy.

Okay, and last question. You've referred to couple a time to the full impact of pricing in the third quarter versus the second quarter,given the caveats of different accounts and many SKUs and everything else. Could you give us -- is that 1%, 3%, 2% as you guesstimated?

Are you asking me to tell you what our price increases for the year? Is that the question?

No, I'm asking you to tell us what the incremental effect, since I don't know what the effect in the second quarter is, you are not telling me, might be in the third quarter over the second quarter, since you brought it up as a positive factor going forward?

I can only say this. We are now -- the price increases are now fully implemented. As we go into the third quarter, our price increases are at least as good as inflation. And that's -- I would like to leave it at that, if you don't mind.

Okay, thank you. Thank you, Walter.

And we'll take our next question from Brian Sponheimer with Gabelli & Company. Please go ahead.

Good morning.

Morning, Brian.

One, going back to temp control. We have a bit geographic bias, given where we are, and how hot the summer has been in the Northeast. Can you comment on whether this summer in Texas, which is a large region for you, and just the remainder of the deep south, has been any different than you've seen in the past?

You're asking about the temperature?

Yes.

The temperature, actually this was in the Saturday Times, so they showed the whole country, Texas which is our biggest single market, was actually low average temperatures. Now below average temperatures in Texas in July is still pretty hot, but it is below average. The big surge, is the one we see, was in the Northeast, which is our smallest market.

So it's reasonable to assume that the year-over-year increase that we saw in temp control can be replicated, just on a normal summer basis?

Our biggest market wasn't particularly hot.

And going on -- just talking on a OE and OES lines and opportunities that you see either now or over the course of the next 12 to 24 months, what have you seen as far as change in motivation by the OEMs, regarding actually selling these lines at a price that you would find reasonable?

Well again, we are talking to them. And that's really all I can say at this point. They move rather slowly. So we're talking to them.

(Multiple speakers).

-- the factories have many, many issues that they are dealing with, but we are -- we are talking to them.

Okay. Alright, great. Thank you.

Our next question comes from Amy Norflus of Pilot Advisors. Please go ahead.

Hi, guys. Great quarter.

Thank you.

Two questions. Typically quarter three is higher from an earnings perspective, and that should be -- do you still feel should still be the case, there was no pull in because of the weather?

Are you talking about temp or everything?

Everything, business.

Well, I don't think you can be -- we're not that specific to say one quarter, third versus second quarter, it -- it's really impacted by a large driver of the revenues. And some of our larger customers, I mean, purchase orders could be the cut off of the week, between how the calendar follows in there, and the temperature control sales. So I don't think -- usually the second and third quarters are fairly close.

Okay. Very good. And and can you talk when you might bring the Poland facility on or something to that effect?

Well, it's on. And growing. And we have ambitious plans for future growth.

When do you think the future growth might start up. Is it something in the near term, or are we still working to it?

It's a steady, steady increase, it's not one big platform jump. So the biggest avenue for their growth -- they -- they have got just three customers. They sell our former European company, Intermotor. That's still their biggest business, and that is growing slightly, as the Intermotor business happens to be doing okay. The second, is selling direct to some OE. But the big growth area is producing products there, that we will sell in the US. That's some of the stuff Jim was talking about, products that we're currently not making money on, and we will be making nice profit on, once we start buying it from Poland That is a slow and steady plan for growth, which is going on through the balance of this year, and with more ambitious plans into next year.

Great. And can you highlight anything in Engine Management for us, that -- that -- just talk about little it? Tell us some of the trends or strengths, or what you're seeing it?

Well, I think we've covered that. Our customers tell us business is good. Our customers tell us business is still healthy. So as far as that goes, we are anticipating continuing that -- the basic element of growth. Again, what ever there was in inventory appreciation in the second quarter, we do not think would be continued into the third quarter.

Perfect, great job, guys. Thanks so much.

Thank you, Amy.

It appears we have no further questions at this time.

Okay, I want to thank everyone for joining our conference call today. Good bye.

This concludes today's teleconference. You may disconnect at any time. Thank you, and have a great day.