Standard Motor Products Inc (SMP) 2014 Q3 法說會逐字稿

Good day, everyone and welcome to today's 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 a Q&A session. (Operator Instructions) Please note this call is being recorded and I will be standing by should you need any assistance.

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

Okay. Thank you, [Elissa]. Good morning and welcome to Standard Motor Products third quarter 2014 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.

The key driver this quarter were disappointing sales. Temperature control was impacted by a cool summer season and Engine Management impacted by customer ordering patterns. Again, I'll review the quarter and the nine months results and Larry will address sales and operations in more detail.

Looking at the P&L, consolidated net sales in Q3 '14 were $257 million, down $7.1 million or 2.7% and year-to-date were $762.3 million, down $2.7 million or 0.3%.

By segment, Engine Management net sales in Q3 '14 were $169.9 million, down $8 million or 4.5% and year-to-date were $533.4 million, down $2.1 million or 0.4%. Again, Larry will provide further analysis on sales. Temperature control net sales in Q3 '14 were $82.2 million, down $2.7 million or 3.1% and year-to-date were $219.3 million, down $4.9 million or 2.2%.

Our acquisition of Annex Manufacturing at the end of April 2014 had a $3.4 million sales in the quarter and $6 million sales year-to-date.

Consolidated gross margins in Q3 '14 were 30%, down 0.3 points from 30.3% in Q3 last year and on a year-to-date basis, gross margins were 29.2%, matching the margins in 2013 despite lower sales this year.

By segment, Engine Management gross margin percentages were positive for the quarter and year-to-date. In Q3 '14 gross margin was 32.3%, up 0.5 point from Q3 '13 and year-to-date '14 gross margin was 30.8%, up 0.4 points from 30.4% last year. Temperature Control gross margin percentages were unfavorable for the quarter and year-to-date against last year. We reduced production levels in the last six months to lower inventories in line with lower sales. In Q3 '14 gross margin was 22.2%, down 2 points from 24.2% in Q3 last year and year-to-date gross margin was 22.1%, down 1 point from 23.1% for the nine months '13.

However, Q3 margins in '14 improved sequentially from 21.4% in Q2 '14 to 22.2% in Q3 '14. Contributing to this improvement in Q3 '14 are benefits from our Annex manufacturing acquisition and Gwo Yng joint venture formed earlier this year. We continue to look for Temperature Control gross margins to improve towards that 23% to 24% range.

Consolidated SG&A expenses in Q3 decreased $1.8 million to 19% of net sales versus 19.2% last year and year-to-date; SG&A expenses decreased $5.6 million to 19.1% of net sales versus 19.7% last year. We are pleased with the 0.6 points SG&A leverage achieved year-to-date on essentially lower volumes.

Consolidated operating income before the one-time litigation charge restructuring and integration expenses and other income net in Q3 was $28.4 million, down $1.1 million at 11.1% of net sales, down 0.1 points. But on a more positive note, year-to-date consolidated operating income was $77.3 million, up $4.4 million at 10.1% of net sales, and up 0.6 points.

In summary, the three takeaways for 2014 results to date are; sales were disappointing, second, gross margins year-to-date matches last year at 29.2% and third, SG&A leverage gain from 19.7% to 19.1% (inaudible) $4.4 million increase in consolidated operating income at 10.1% of net sales, reflecting a 0.6 points operating income improvement.

On an earnings per share basis from continuing operations excluding non-operational gains and losses, diluted EPS were $0.74 in the quarter versus $0.79 last year, but again more positively on a year-to-date basis, diluted earnings per share were $2.04 in '14 versus $1.91 in 2013.

Lastly, on the P&L review, we recorded a $12.8 million provision, $7.7 million net of taxes to increase our asbestos-related indemnity liability to $36.1 million. Each year in the third quarter we engage an independent actuary to assess our exposure for future asbestos claims. The 2014 valuation estimated our indemnity exposure on a gross undiscounted basis from September 2014 to 2058 over a 40-plus year period within a range of $36.1 million to [$55.4 million]. Legal expenses over the same 40-plus year period through 2058 were estimated to range between $43 million to $76.4 million. Legal expenses are expensed as incurred.

Looking at the balance sheet, accounts receivable was up $20.4 million against December '13 year-end and up slightly $3.7 million against September '13 levels. Inventory was up roughly $7 million against both December '13 and September '13 levels. The increase in both AR and inventory are primarily related to acquisitions completed earlier in the year.

Total debt was $59.3 million at September '14 compared to $21.5 million at December '13, reflecting an increase of $37.8 million during the nine months 2014. As reflected on our cash flow statement, the $37.8 million debt increase funding our acquisitions of $37.7 million earlier in the year. Our cash flow from operations of $33 million was essentially flat with the same period last year. However, excluding the one-time litigation settlement of $10.7 million paid in September '14, cash flow from operations would have been $10.7 million higher to $43.4 million.

Other uses of cash in 2014 were $9.3 million for capital expenditures, $8.9 million for dividends, and $9.5 million for share repurchases. In early October, we completed our $10 million authorized share repurchase program, acquiring roughly 284,000 shares at an average price of $35.18.

In summary, despite disappointing sales in the quarter and year-to-date, we are pleased with our operational performance as reflected in our year-to-date consolidated operating income, improvement of $4.4 million to $77.3 million or 10.1% of net sales.

Thank you. I will now turn the call over to Larry before we open for Q&A.

Good morning, everybody. Jim has reviewed the numbers and I assume you've all seen the release. I would like to expand on just three topics. The first is sales. First we'll start with Temperature Control. Now the third quarter of the year represents the main quarter for the year for the Temperature Control business, and July and August are typically the two biggest months. 2013 was a cool summer, 2014 was even cooler.

Now the business -- the temp business can vary plus or minus 20%, based on the temperature and so obviously this cool summer affected us in lower sales. That's two years in a row now. Statistics would say that next year will be better because three years in a row is unlikely, but of course one cannot promise that.

Engine Management. The sales tend to be more stable and more predictable. And with a business that has estimated annual growth of roughly low to mid-single digits, based on demographics with an aging vehicle population. Now our customers have been achieving that. They've had sales increases in our line in the 3% to 5% range, both in 2013 and in 2014 but their purchases are vary from that, some up, some down. Now in 2013, we had a volume increase of 7% for the year and actually 14% in the fourth quarter alone. In 2014, we've been essentially flat and the difference is really a result of one-time events.

Now in for 2013, as we've reported to everybody, several of our customers invested in inventory to broaden their coverage to better compete for the commercial business. Now this was not repeated in 2014. So obviously that affected the comparative results, plus we have seen a bit of inventory reduction going on in this year. And frankly, that's a healthy thing in the long run. So what we've seen is basically one-time events, which affected the comparisons, but we believe that in the long run they will balance out and that the Engine Management business will continue to grow in the low to mid-single digit range. Now, of course, our goal is to do better than that with new products, additional business and acquisitions and so on, but that's the rate in which we anticipate industry sales to grow.

All right. Let's move on to internal operations and our people have done a really excellent job here, which is why we've had an increase in profit despite disappointing sales. I'll just list a few things. We're manufacturing products we used to buy, which provides us with lower cost, better control over quality, better control over delivery, we are even now looking to bring back manufacturing of products that we had previously outsourced to China, which will be a very good thing.

We continue to improve our operations in Mexico and in Poland, and now we've added a joint venture in China for Temperature Control business. We've reduced purchase costs helped by an engineering office in Hong Kong, which continues to grow. We've controlled SG&A costs. We continue to streamline and automate our distribution centers, which we already believe are the best in the industry. So, as a result of all these and other things that's why we've been able to improve the profit despite the disappointing sales.

All right. Third and finally, let me talk a minute about acquisitions, as you know, we've made eight in the past three years. All are on target of hitting their numbers and being fully integrated. Three this year. To remind everyone, one was Pensacola Fuel Injectors, it's a rebuilder of diesel fuel injectors, that's a growing business; Annex Manufacturing, an importer and distributor of temperature control parts; and then our 50% joint venture with Gwo Yng, a leading manufacturer of temp control parts in China.

The integration of all three are proceeding on schedule, Annex and the Fuel Injection lines will be fully relocated to SMP operations by year-end, and we look forward to increase benefits from all three of these in 2015.

So to summarize, yes, we're disappointed in the sales, but we're pleased with the improvements we've made in many areas and are quite optimistic looking forward.

So, thank you. And with that, we shall open for questions.

(Operator Instructions) John Lovallo, Bank of America Merrill Lynch.

Hey guys, thanks for taking the call.

Good morning, John.

First question is, I mean, obviously, the weather is a big impact on temperature. I guess the question is, is there anything that -- any actions you guys can take whether it's through acquisitions or expanded product lines that could somehow reduce some of the seasonality there?

Well, we said that our goal is -- that's a good question. We've said that our goal, we can't control the weather. But what we want to make ourselves is, so that if it's a lousy year, sales here, we do pretty good. And if it's a good product in a hot summer, we do extremely well, and we just suffered two mediocre ones in a row. But I think we are working well towards positioning ourselves in that area.

We now have all of our -- most of our compression manufacturing in Mexico with the acquisition -- with the joint venture in China with Gwo Yng that covers most of the rest of the product line, so our cost in that end of the business is quite low and we feel we can compete with really anybody. And the Annex acquisition actually gives us an opening for a new business, which is heat of course. So that's obviously anti-air conditioning season. It's a business we are just beginning in. We're very, very early stages, but that is an area, which will give you some winter business to match the summer. So, we think we're taking the steps to improve this.

Okay, that's very helpful. Thank you. And then one follow-up, this year there is a growing concern in the market that that some of the customers are absorbing more pressure, whether it's on pricing or on payment terms and I really would say this is always a part of the business. But have you guys seen anything more recently there's been increasing pressure on those fronts?

Not really. We deal with it, we're in a highly competitive position business and we've been doing this for years and years and we continue to do it. We continue to try to be a very wonderful supplier and keep our costs down to do well within this difficult environment. But frankly, we haven't seen really significant changes.

That's very helpful. Thank you.

Okay.

Scott Stember, Sidoti & Company.

Yes. Hi, good morning, how are you guys? Last couple of quarters you talked about how you are streamlining and cutting costs in your Temperature Control business. Assuming that we go back to normalized demand, let's say, second and the third quarter of 2015, can you maybe talk about some of the incremental margin opportunities you can get in that segment?

Yeah. Okay, this is Jim Burke. I'll response to that. Again, for the last two years we've been cutting production to match the sales levels that we've seen in there. So if we go back far enough to almost to what we did the CompressorWorks acquisition, we have that incremental volume, which will help in our margins. So, what I pointed out in my comments, we're looking for Temperature Control to get back to the 23% to 24% range, you could see that we were in the 22% range this past quarter and very pleased that we were able to get benefits already from the acquisition that we're seeing from Annex Manufacturing and the joint venture in China. Once production levels improve, I expect to hit the 23%, 24%, and hopefully we can even move past that.

Got you. Can you just give an update on the (inaudible) how many SKUs you have in the program right now, and any gains there recently?

Stember, I don't have in the top my head, I'm guessing, we have maybe 600, 700 SKUs. If I got that wrong, Jim will get back to you. I think it's in that range. We're still quite at the early stages of that business. The main thing is to get our name out there, so that installers think of us, when they have a funny looking product that they're trying to get. It takes time but we see, we're getting our name out and we have -- we are optimistic about the future.

Okay. Just a last question. What is the percentage of product that was either sourced or produced outside of North America or outside of the U.S. this quarter?

We don't disclose that on -- either on a quarterly or annual basis, our manufacturing is upwards to 70% of our sales that are in there.

Okay. Thank you so much.

Bret Jordan, BB&T Capital Markets.

Hi, good morning.

Hi, Bret.

I guess as you look at the Temperature Control specifically and channel inventory levels we've had a couple of soft years in the categories. So, I guess, could you give us some perspective on -- I guess, historically how we're looking right now, what it would take to sort of rebuild to a normalized inventory level in the channel?

You're talking about our inventory or customers' inventory?

Customers inventory.

Customers inventory. Well, we do track that, and the good news is that our customers are getting [quite a scoot] and are very careful. And I'd say that their inventory levels here are not terribly different than they were a couple of years ago. So if that's what you're thinking, I think that's what we see.

Okay. So you're not seeing an accelerated order cycle for them to get inventory back up if we get a warm season projected for next year?

Well, that wouldn't be happening at this time. If that happens, that would happen early next year.

Right. But my question is, are their inventories levels so low after two weak season that they would need to have excess orders to get back to a in-stock position?

No, I'd say that's unlikely. I'd say their inventories are reasonably adequate.

Okay. And then I guess a question on the outsourced product. Is there enough products you can bring back into your production that you could get your operating margins, your margin back up just filling your capacity with products you're otherwise outsourcing, and that if we don't get a recovery in temperatures at some point, can we get the gross margins up by just reallocating the production?

You're talking about the Temp business or everything?

Everything is good, but specifically the Temp business?

All right. The Temp business, now that with the acquisition of -- or the joint venture with Gwo Yng, we are very little outsourced. Again, the compressors are in Mexico, much of the rest of the line is in China. So I would say basically all the popular items, we just started with the Gwo Yng, all right? We're just starting to see the benefits of that. But there's not much outsourcing going on in Temp, if that was your question. The improvement there we'll see as hopefully the volume picks up and the production picks up, then you'll start to see the manufacturing volume go up and hence the gross margin. But we are very little outsourced right now in Temp and I think that's a very good thing. We're basic and we're low cost.

Can we think about margin expansion and the outsourced on Engine Management or is that not something we see moving the needle here near-term?

Yes, since we keep working on that. So we keep making more and more stuff. And this is very healthy. It's counterbalanced to some extent by the fact that we had several thousand new part numbers a year, because our requirement is that we keep our customers current on everything, and that leads to something like several thousand. Many of these are at certainly the beginning, we're not going to manufacture them, they are slow moving and the volume isn't really known yet. So those have minimal margin. So on one end of the pie, we're adding a lot of stuff with low margin, on the other end of the pie, we are improving margin. So I think we'll see some improvement, but I think Jim is giving you some forecast for what we're looking for in the gross margin.

I think Bret, that was on the 23% to 24% range for Temp and hopefully we get a good season with good production, we can do better. We're very pleased with the Engine Management margins being now north of 30%. And again, a lot of the low hanging fruit to our low cost facilities in Mexico and Poland have been achieved, we're always evaluating different product lines and to move the needle significantly in that area now would be either acquisitions and/or if we bring back a product category that we may have outsourced previously.

Okay. Great, thank you.

You're welcome.

(Operator Instructions) Walter Schenker, MAZ Partners.

Larry, Jim hello.

Hello, Walter how are you?

Two questions. First, I realize it's non-cash, but it's been hanging up for a long time. On the asbestos, did you change the people who -- I mean it's three years, it hadn't changed and suddenly this year it changed, I would have thought by now -- although they still advertise over time the trial lawyers that most of the people who might be found have been found. I'm just as a general commentary, why would it suddenly pop now, do you have any -- we just say curiosity, if I realize it's not that fundamental? Second question would be a better question.

Okay. All right. So I'll answer the first one. No, we didn't change [advisors] we continue to work and deal with this. We get very few small amount of cases that are in. I think it's just the cases that we're handling and again, it's over a 50-year almost 40-plus year period that they are looking at. So the amount of the increase over 40 some years is still small.

Okay. Because they hadn't changed the number of years (inaudible)?

It's always each year they're moving it, they're looking at a plus or minus, we've seen a little bit of noise $2 million or $3 million. As a matter of fact the previous year, we felt that it was started and maybe to be slightly lower. We didn't adjust the accrual this year slightly above. Again, there are so many variables that are in there, so -- and it's over a 40-plus year period that it's very difficult. So we continue to assess it each year and do not think it would be material -- any material change.

Okay, sorry to everyone's time. In looking at your sales and looking at your major customers, have you seen any material difference in the order patterns, because of increased efficiency from a large player in the industry who recently in the last few years had a major acquisition and therefore is operating more efficiently as opposed to your large traditional customer who really just continues to roll along.

So the question is, is that a function, are your sales consistent across your major customers or is it somewhat skewed that the very large customers who had big acquisitions are becoming more efficient in doing it and therefore buying a little bit less?

There is always a bunch of different things going on. In the short run, obviously as acquisitions are made there will always be some closing consolidation of stores and warehouses, because they are duplicate. But that's short-term. What I've seen, if you want to say that there are difference. I think we have all gotten much more sophisticated, that's the right word in forecasting. And we do a better job, our customers do a better job. We have initiatives with almost all of our major customers where -- almost on a weekly basis. Our supply chain people are on the phone with their supply chain people. And we go over it part number by part number by part number and this is a good thing.

Now in many cases, our people will say you don't, you have 12 in that [store], you don't need 12, you need eight. On this other one you need more. So we're working with them almost down to the individuals view. And in the short-term that can create some returns or just reduced ordering, but in the long run, I think we will all do a much better job of watching the inventories and I think that's a good -- if there's a change, that's the change I've seen.

Okay. And just on inventories in your comment, which I think I'm paraphrasing correctly, that there has been some reduction increased efficiency in inventories at your customer level through this year that has been reflected through the year or that something you expect might have some impact as we go late in the year and people tend to do some returns?

Well, returns do tend to come in towards the end of the year, but we've accrued for that. Jim can you go into that in more detail? But the actual analysis is ongoing, ongoing and we're all learning from it, we're still learning, we're going to get better, we're going to get better.

Okay. I'll see you next week. Thanks a lot.

(inaudible).

Robert Smith, Center for Performance Investing.

Hello, Bob. Hi.

Mr. Smith your line is open. Do you have us on mute?

Yes, sorry. Hi, good morning. I was on mute. So you mentioned, Larry, bringing back some manufacturing from China. Could you give us kind of a brief overview of how you see the Chinese economy and business with particular (inaudible) what you're doing?

Okay. I guess you're referring to the Gwo Yng joint venture.

Yeah.

Which is in its early stages, we've [had] it about six months now. We think this going to work out very nicely, but it's -- we have work to do.

You mean what?

The main thing is, we have to get them -- really bring them up to our standards, which are very high compared to Chinese standards. But we think it's got a good potential. And will it grow in China? I think that is the future, but at the current -- our emphasis is really more in getting, let's get it exactly right first and then we can look upon growing into China.

And the bringing back of some production back here or --?

No, no, no that's there, that's to be there.

No, but you mentioned that, you are thinking --

That's in Energy Management. We have some initiatives there, yes. We have one big product there is coils. And we have a fabulous coil operation in Poland. But we're very pleased to see that when we started the initial analysis. We can produce coils in Poland cheaper than we can buy them from China. And that's a very good thing. So that's in the future, that's a two-year, three-year project, but it's -- we feel good about it.

Okay. And how is Orange doing?

Orange is doing fine. To remind everybody, we have a 25% investment in the company. The Orange company themselves are growing quite nicely internationally and are looking to do business in Japan and Taiwan and China all through the (inaudible). Yes, the product category, we refer to it as TPMS, which stands for Tire Pressure Monitoring Systems. So that's the Orange company as a whole.

Our own sales of that product, we're in the early stages, because these have been mandated on cars only in the last six, seven years, and this is a product which tends to fail every five, six, seven years. So we're very early in the cycle. But we have a good product, we are starting to make some nice penetration and we think it has a good future. So on both ends we think our sales will grow and they will grow more internationally.

If you could, would you increase your own (inaudible)?

Again, we have a Board of Directors that are there, and that would always be under consideration, but we're working very nicely with the management team there.

Thanks so much. Good luck.

Okay. Thank you.

Thank you. (Operator Instructions) And gentlemen, it appears we have no further questions at this time. I'll turn it back to you for any final remarks.

Okay. Again, we want to thank everyone for joining our call today. Good-bye.

This does conclude today's program. We appreciate your participation. You may now disconnect. Have a great day.