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Operator
Good day, everyone, and welcome to today's Standard Motor Products second quarter earnings release.
(Operator Instructions) Please note, this call may be recorded, and I'll be standing by if you should need any assistance.
It is now my pleasure to turn the conference over to the Executive Chairman of Standard Motor Products, Mr. Larry Sills.
Lawrence I. Sills - Executive Chairman
Good morning, everyone, and welcome to our second quarter conference call, and we appreciate your taking the time to attend.
Here from the company is Eric Sills, President and CEO; Jim Burke, Executive Vice President and Chief Financial Officer; and myself, Larry Sills.
Our agenda will be: first, Jim will review the quarter and 6-month results; then Eric will go into some more detail on some of our key initiatives; and then finally, we'll open up for questions.
So with that, let me turn it over to Jim, and let's go.
James J. Burke - CFO and EVP of Finance
Okay.
Thank you, Larry.
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.
In the second quarter, we experienced solid sales growth, very good Temperature Control margin expansion, but also the decline in Engine Management gross margin, primarily related to our various plant moves.
Reviewing the P&L, consolidated net sales in Q2 '17 were $312.7 million, up $23.8 million or 8.2%, and for the first half '17 were $595.1 million, up $67.2 million or 12.7%.
Excluding the General Cable incremental sales from our acquisition at the at end of May 2016, our Q2 '17 sales increase was $8.8 million or 3%, and for the first half, sales increased $28.8 million or 5.5%.
Engine Management net sales in Q3 '17 were up $24.5 million or 12.3%, and the first half of '17, up $55.1 million or 14.5%.
Again, excluding the incremental GC wire sales, Q2 '17 net sales were up $9.5 million or 4.8%, and first half net sales up $16.7 million or 4.4%.
These increases are slightly above our long-range forecast of low-single digits and higher than our customer's POS sales.
Eric will discuss this further.
Temperature Control net sales in Q1 and Q2, as we previously stated, reflect timing of preseason orders.
That is why we believe the 6-month sales increase of $13.4 million or 9.3% is more meaningful than quarterly results.
However, we remain cautious going into Q3, as we're up against a very hot 2016 summer season.
And similar to Engine Management, our Temp Control sales to our customers outpaced their POS sales.
Eric will elaborate further on this shortly.
Consolidated gross margin dollars in Q2 '17 were up $3.6 million at 29%, down 1.1, and year-to-date, we're up $14.7 million at 29.4%, down 0.9 points.
By segment, Engine Management gross margin in Q2 '17 was 29.4%, down 2.7 points, and year-to-date, 29.8%, down 2.1 points.
The Engine Management reduction in gross margin is primarily related to our plant moves, incurring additional costs for ramp up inefficiencies, duplication of overhead and cost associated with hiring and training new employees.
We believe these incremental costs are temporary, and expect to have Engine Management gross margins running at historical levels in the 31% to 32% range once the moves are complete in 9 to 12 months.
In addition, we are targeting $7 million to $10 million more company-wide savings, including SG&A expenses, as we complete these various moves.
Temp Control gross margin in Q2 '17 was 26.4%, up 2.9 points versus Q2 '16, and year-to-date, 25.9%, up 1.9 points against last year.
Temp Control margins reflect our higher production levels and benefits achieved from our shift to low-cost production in Reynosa, Mexico.
Consolidated SG&A expenses were up $5.3 million in Q2 '17 at 19.2% of net sales versus 18.9% last year, and year-to-date were up $9.7 million at 19.7% of net sales versus 20.4% in first half '16.
The increased spend in the quarter and the first half was primarily related to the incremental GC sales volume that did not start until June 2016.
We are pleased with the 0.7 point leverage improvement year-to-date and anticipate further savings when our plant moves are complete.
Consolidated operating income before restructuring and integration expenses and other income net in Q2 '17 was $30.6 million, 9.8% of net sales, versus $32.3 million at 11.2% of net sales last year, and for the first half, $57.3 million, 9.6% of net sales, versus $52.3 million, 9.9% of sales last year.
The reduction in consolidated operating income leverage is directly attributable to the Engine Management incremental cost impacting the gross margin.
Once the moves are complete, we should match or exceed historical operating income levels.
I would like to point out that our Temp Control operating income margin improved 2.4 points.
The net effect of our operational performance as recorded -- reported on our non-GAAP reconciliation was Q2 '17 diluted earnings per share of $0.81 versus $0.88 last year, and year-to-date diluted EPS of $1.54 versus $1.43 in the first half '16.
Looking at the balance sheet, AR increased $53 million since December, which is reflective of higher sales concentration in Q2 and Q3.
Inventories increased $28.4 million in -- since December.
This increase is to support our Q2 and Q3 higher sales volume and bridge inventories for the plant moves.
Partially offsetting these working capital increases, accounts payable increased $20 million since December.
Total debt increased $24 million since December to fund these working capital needs.
However, total debt of $79 million reflects a $21 million reduction from June of 2016.
Our cash flow statement reflects a $6.8 million use of cash from operations in the first half '17 versus $23.7 million proceeds in the first half '16 due to the higher working capital needs this year.
We expect strong cash generation from operations in the second half of 2017, which will be used to fund our capital expenditures, dividends, share repurchase program and further debt reduction.
Through June 30, we repurchased roughly 109,000 shares for $5.3 million, leaving $14.7 million open against our $20 million authorization.
In summary, while we did experience a slight reduction in margins and earnings in Q2, our earnings remain favorable year-to-date.
More importantly, we believe these transition costs will be eliminated once moves are complete, and we will deliver improved operating margins going forward.
Thank you for your attention.
I'll now turn the call over to Eric.
Eric Philip Sills - CEO, President and Director
Well, thanks, Jim, and good morning, everyone.
Jim's covered the numbers, but I thought I'd provide some additional color.
Sales continued at favorable pace, which I'll get to in a minute, but the headline, that is, that the earnings are down for the quarter, although we remain ahead for the year.
Step back in the quarter was all in the Engine Management division and was caused almost entirely by costs associated with integrating the General Cable wire acquisition as well as our other plant moves.
This is currently underway.
And we referred to these onetime costs in previous earning calls and they're all intentional and geared towards making us a stronger and more profitable company in the future, but in the near term, they are having a financial impact.
Now let me go through them one by one.
The biggest is in the integration of the General Cable ignition wire business.
To remind you, we acquired this business in May of 2016, and we're very pleased with it so far.
Sales have been solid.
We've retained all of the accounts, and we've greatly improved the fill rates across the board, in which, frankly, we were not in particularly good shape when we acquired the business.
This business was roughly the same size as our legacy wire business, and essentially a mirror image of it, with similar products, plants and other functions.
And by combining the 2, we are able to generate terrific synergies by eliminating all the duplicate functions and by gaining economies of scale.
Last year, we consolidated distribution and certain back-office functions, all of which are working quite well, but the heavy lifting of the consolidation really didn't begin until this year, as we set out to combine the 2 manufacturing operations by relocating all of their production from Nogales, Mexico to our plant in Reynosa, Mexico.
This relocation has caused various temporary costs.
As we transition production, we're experiencing ramp up inefficiencies as the receiving location comes up to speed, expenses resulting from hiring and training of hundreds of new employees and various other costs associated with production moves.
We've transferred several manufacturing lines already, all completely successfully, but we won't be finished until the end of the first quarter in next year, and until then, we expect these costs to continue, although at reduced rates.
But once we exit the Nogales location, not only will we have the costs behind us, but we'll be able to eliminate all the duplicate overhead of having 2 factories.
Similarly, but to a lesser extent, we're in the midst of other plant moves as well.
Over the last year, we've relocated all of our ignition coil production to Poland and all of our diesel products to South Carolina.
We're still coming up to full productivity at the receiving locations, but are absolutely heading in the right direction.
We are now also proceeding with the previously announced plan to merge our Orlando electronics plant into Independence, Kansas, which will be complete by the middle of next year.
So this one is in the earlier stages than the other moves.
So as mentioned, all of these actions are leading to nice savings, but in the interim, are causing some additional costs.
That said, we believe the worst is behind us, and we should see incremental improvements over the next few quarters.
Continuing in Engine Management.
Sales have continued at a solid pace, up both for the quarter and for the year.
Now part of this was due to the additional General Cable volume that we only had for 1 month in Q2 of last year, but excluding the impact of the acquisition, organic sales are up as well.
Now some of this increase is due to customer pipelines, as customers expand their inventory breadth, especially in later model applications and newer product categories, which we feel is all very positive news going forward.
But as we look at their POS, our major customers' sell-through for the quarter was basically flat to last year, although this did show some sequential improvement from Q1, which had been down.
And as we have said many times, our customers' purchases from us and their sales out can differ in any individual quarter due to their order patterns, but they tend to even out over time, and we continue to anticipate low single-digit growth in Engine Management in the long run.
Turning to Temperature Control.
As Jim mentioned, sales for the first half of the year are up 9.3%.
However, much of that was preseason orders.
Overall, these preseason orders were stronger than 2016.
If you recall, 2016 was an extremely hot summer and, therefore, customers ended last year somewhat light on inventory.
In the first half of 2017, therefore, customers' purchases were up.
However, their sell-through is slightly behind.
The key will be sales through the summer and as mentioned, 2016 was extremely hot and Q3 of last year was up 6.8% versus 2015.
So the comps will be challenging.
And so far, we have seen a softening of demand in July.
Profits in the Temp Control division are at an all-time high.
This is the result of a great deal of hard work on our cost structure as we move production to Mexico and are also seeing the benefits of our relatively new joint venture in China.
And we're not finished here.
We are still in the process of moving the remaining production lines from Texas to Mexico, all of which will be complete by the end of the year.
So in closing, the quarter was a bit of a mixed bag, but we are confident that in the long run, all of the efforts will pay off.
As we stated in the press release, we expect incremental improvements throughout the year.
And once all of these moves are behind us, we intend not only to return Engine Management gross margins to their historical highs in the 31% to 32% range, but expect to deliver an additional $7 million to $10 million on additional savings throughout the company.
In the meantime, we have over 4,000 people working very hard to make this happen, and I want to thank them for all their efforts.
So with that, I will return this to the moderator, and we will open it up for questions.
Operator
(Operator Instructions) We'll take our first question from Bret Jordan of Jefferies.
Bret David Jordan - Equity Analyst
I was looking at the Temperature Control in the prior year.
Obviously, a very strong gross margin and a tough comparison.
I guess, is there a way to -- how much of that margin could you still see in this quarter, just given the improving operating efficiency?
Or if we have a tough Q3 comparison, are we likely to see a really big turn down in gross margins year-over-year as well?
James J. Burke - CFO and EVP of Finance
Yes.
Bret, this is Jim Burke.
No, it wouldn't be a that fast a reaction.
We think we will lower the overall cost structure out there.
And again, with production volumes drives the margin, it would be more gradual.
That would be in there.
And again, the impact of how we have to react to inventory level.
So it would not be a dramatic impact in Q3.
Bret David Jordan - Equity Analyst
Okay.
And I guess, as we've mentioned that, and obviously, the current quarter, it sounds as if July year-over-year is down in the POS data?
Eric Philip Sills - CEO, President and Director
Well, we don't see the POS yet for July, so we're not -- we can only speculate how our customers are doing with their sell-through.
But we are seeing a softening of their demand to us.
Bret David Jordan - Equity Analyst
Okay.
And then one last question on Engine Management.
You mentioned that most of the margin impact was onetime costs related to its integration.
But you mentioned some other -- obviously, you've been shifting some assets in production and Engine Management.
How much was General Cable versus other on the margin impact?
James J. Burke - CFO and EVP of Finance
Bret, we don't break out the individual ones in there.
But from scaling it, General Cable is a sizable portion of it, that's at least 50% of the impact.
But we don't break out the individual pieces.
Bret David Jordan - Equity Analyst
And you kind of talked about in your prepared remarks, but I guess, what's the -- how many more quarters do you think we see the one-time charges for it?
At what point it'll have we fully-consolidated the General Cable incremental overhead?
James J. Burke - CFO and EVP of Finance
Yes.
What we stated there was 9 to 12 months.
Again, as some of it close through the balance sheet and the to the P&L that's in there.
So fully exhausted by June of next year -- Q2 of next year.
But again, we're hoping that we would see gradual improvement as we move forward.
Operator
(Operator Instructions) We'll move next to Scott Stember of CL King.
Scott Lewis Stember - Senior VP & Senior Research Analyst
Could you talk about the sequential improvement in Engine Management sell-through you that you saw?
And maybe just talk about broader -- broadly speaking, what you see going on there in the market?
And you talked about getting back to that low single-digit growth rate.
Just talk about what you're seeing in your business and the industry as well?
Eric Philip Sills - CEO, President and Director
Sure.
Absolutely.
The first quarter of 2017, our major customers reported their POS down a few points, and that, I think, tracks with not just our categories but overall what they're seeing due to the mild winter and perhaps some other variables as well.
We did see that sequential improvement month-over-month, quarter-over-quarter to where second quarter, essentially, was flat to the previous year.
So that's what we see.
The trends are positive, and so we hope that, that trend will continue.
In terms of how that is -- how that reflects and what the approach is from us, our accounts tend to order from us much lumpier than they sell as they look to flex their inventory and refresh their cladograms and manage their own cash flow, et cetera.
So in any given month or any given quarter, you could see some peaks and valleys, but the overall trend, as we continue to say, we expect to be in that low-single digits.
We are seeing some nice -- more recent traction in our newer product categories and our later model applications, which is very good.
It's showing that these newer vehicles are starting to hit some of that replacement cycle.
So we're seeing a little bit of a mix shift to the newer stuff.
Scott Lewis Stember - Senior VP & Senior Research Analyst
And just following up on that.
I don't know if you could get this granular, but during the quarter, if look at the POS, did you notice an acceleration, as the quarter finished out?
And then maybe just talk about some of those new products that you just referred to, that on the late-model cars, that are starting to add some business for you guys?
Eric Philip Sills - CEO, President and Director
Different customers had different experience month-to-month throughout the quarter, but I would say that the overall trend was slightly up.
It was really coming out of the very beginning of the year, which -- was when the year hit its low.
Newer categories.
We've been talking about some of these on the recent calls.
Diesel continues to be a very strong growth category for us into the 30-or-so percent year-over-year growth trajectory, and its combination of broadening the category with more parts, getting more customer adoption.
And I think, just generally, what's happening within the diesel space is that the repairs are moving into the general repair base as opposed to in the diesel specialist base, and so the overall general aftermarket industry is benefiting from that and as are we.
The other categories that we have been investing in lately and are seeing nice adoption, and it's variable valve timing products, evaporative emissions products, anti-lock brake system sensors.
We're just seeing a lot of these categories really starting to move in the right direction, which, to be frank, we need them to, because we see other older categories dropping off.
For example, ignition wire business, as we've stated, is going to decline just due to life cycle in that 5-or-so percent per year range.
So we need these newer technologies to replace that volume.
So it's not all incremental growth.
Some of it is replacing lines in decline.
Scott Lewis Stember - Senior VP & Senior Research Analyst
Okay, great.
And just a couple of -- last question, just real quick.
You said that, at least referring to General Cable, that it sounds as if the worst is behind, and that it sounds as if things get better from here.
Maybe just talk about the degree of recovery?
I know that you said that by the first quarter, we should be in a much better place.
But maybe just talk about how much you've seen already in these costs?
And how quick you would expect them to come back?
And then, Jim, just on the SG&A, maybe just give some comments about where that could be on a quarterly basis going forward?
Eric Philip Sills - CEO, President and Director
Scott, I'm going to try to answer the question little bit more qualitatively.
One of the real gating issues for General Cable was that we did not have enough space in our Reynosa plant.
We needed to expand the building by about 75,000 feet, which was by -- it was 100,000 the building.
So we're growing it by 75%.
And until we are able to do that, we were operating, especially, inefficiently with some additional temporary swing space that we are renting down there and just a little bit of the additional hoops you have to jump through when you don't have the space.
We are able to -- that building expansion is now essentially complete, and coming into August, we'll be able to start utilizing the expanded space.
So now it's really, I think, in many ways an inflection point of this move, and allows us to accelerate and take advantage of some of that.
And I think you had a question about SG&A, which -- maybe you could for repeat it for Jim.
Scott Lewis Stember - Senior VP & Senior Research Analyst
Yes.
The question was just on whether there was anything that comes out of the number going forward?
And maybe just some high-level commentary about where the number could be over the next few quarters?
James J. Burke - CFO and EVP of Finance
Well, again, not in absolute dollars, this ties in between the $7 million to $10 million that we said, as a combination of margin improvement and SG&A.
And part of it relates back to the General Cable integration that we still have costs related to SG&A.
While we're working always on cost reduction efforts in distribution in all areas, we will have costs that will be eliminated once we complete the full integration of GC.
Operator
(Operator Instructions) We'll take our next question from Robert Smith of Center for Performance Investing.
Robert Smith
So after these plant moves and consolidation, from point of view of company-wide, what do the facilities' utilization look like now?
Eric Philip Sills - CEO, President and Director
Okay.
That's a good question.
We are -- really within all of our plants, we don't have any substantiate capacity constraints.
There's always individual production lines that are -- you start to get close to capacity, but they're all very scalable.
So there's nowhere we're say, we're running 24/7, and if something doesn't give, we're going to have trouble.
So we have plenty of unutilized capacity.
We're in good shape.
Robert Smith
Okay.
Do you guys have a raw materials price index internally, I mean, that you can contrast and see what is happening to raw material prices like steel and copper?
James J. Burke - CFO and EVP of Finance
Right.
Robert, this is Jim Burke.
Yes, we -- well, again, to point out, while no single commodity is a dominant factor our cost of goods sold.
We experience, obviously, all the same commodity changes.
We see copper going up, but from an index standpoint, one of the other benefits, we add like 3,000 new SKUs per year that we have to buy from Tier 1 suppliers, make available to our customers.
And our engineering teams are always working on bringing those in-house to manufacturer or overseas to Asia, along with component sourcing.
So we struggle to -- along to absorb the commodity increases, but more offset it by resourcing product to low-cost Asian sources where we can with components and even finished good parts.
Robert Smith
All right.
And how about the ability to offset those increases through your own price increase?
James J. Burke - CFO and EVP of Finance
Right.
And there is a number of variables that go in there, and we evaluate the commodity cost changes, exchange rate changes that's in there, labor and medical inflation cost.
All of those variables go in, and it's a competitive environment.
So we price where we can.
In certain categories, we have more opportunity, and we're competitive in other areas.
Robert Smith
All right.
And next question.
What does the acquisition landscape look like?
And what might be an optimum size that you would be willing to reach for?
Eric Philip Sills - CEO, President and Director
All right.
Well, we are always looking at additional opportunities, but we have a particular and specific profile that we're looking for, for what makes a good candidate for us.
And so we're going to stick within that profile.
And to remind you of what that is, we'll buy one of two types of businesses, either it'll be a bolt-on acquisition, essentially a direct competitor similar to the General Cable deal, where you're able to merge the 2 operations and get all the synergies that we've been talking about.
And the other is acquiring a supplier of ours to help us be a more basic manufacturer and get that additional -- eliminate a step and maybe able to take that margin, plus typically those get us into something slightly new.
So for example, that would've been the diesel acquisition or the tire pressure sensor purchase that we did in Taiwan a couple of years ago.
So we're going to continue to look at those 2 types of deals as they both very much complement our core business, strengthen our core business, but perhaps get us into something a little bit different.
In terms of the pipeline that's out there, we do believe there are still opportunities.
We have a team that's constantly focused on identifying them.
As you're aware looking at our balance sheet, we have the wherewithal to do them.
You had asked about size.
We don't necessarily have a particular size, because it's more about fit and opportunity, but they do -- if you look at the history, over the last 10 deals, they're all in that $20 million to $60 million range, and that's kind of our sweet spot.
Robert Smith
And -- you know, I think that's -- do you have anything to say about the news that's been popping about electric cars and automobile production, where we're all headed in the time frames?
I know it's kind of longer term so to speak, but got maybe a view of the -- where this is going?
Eric Philip Sills - CEO, President and Director
Well, certainly, there has been a great deal of chatter out there about technology shifts and especially with electrification, electric vehicles.
But all of the projections suggest is that it's going to be a very slow evolution.
Within the U.S., in particular -- perhaps it'll go a little more rapidly in Europe or China, but in America, they're still predicting -- most predictions are 2025.
It's still only 5% new vehicle sales.
And since we are really looking at the 260 million cars out there and not the new car production, the impact that it'll have on the aftermarket will be even longer than that.
Now that being said, we do -- we're not pooh-poohing this.
We recognize, the technology change is real, and we're staying up on it and identifying where our opportunities exist in the newer technologies.
Robert Smith
With Ascend the kind of changing its viewpoint here with interest rates, do you have any thoughts about taking on some longer term debt?
James J. Burke - CFO and EVP of Finance
Yes, Robert.
Again, Jim Burke.
At this point, no.
You know, where -- the luxury now versus many years ago, we're generating well over $100 million in EBITDA to be able to a service our capital expenditures and that.
Even within the range of a profile of acquisitions in the $40 million to $60 million range, we can quickly absorb those also.
We don't -- I don't see anything on the horizon that would be significant that we would go after, but we would always evaluate that, if there was a sizable acquisition that we did.
Operator
(Operator Instructions) And it appears that we have no further questions at this time.
Lawrence I. Sills - Executive Chairman
Okay.
We would like to thank everyone for joining our conference call this morning.
And we'll be speaking to you again for Q3.
Thank you.
Eric Philip Sills - CEO, President and Director
Thank you.
Operator
This does conclude today's Standard Motor Products second quarter earnings release conference call.
You may now disconnect your lines, and everyone, have a great day.