Standard Motor Products, Inc. (SMP) Q4 2011 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Standard Motor Products’ Fourth Quarter Earnings Call. [Operator Instructions] Please note this call may be recorded. I’ll be standing by if you should need any assistance. It is now my pleasure to turn the call over to Mr. Jim Burke, Chief Financial Officer. Please go ahead, sir.

Okay, thank you. Good morning, welcome to Standard Motor Products’ fourth quarter 2011 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 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. We are very pleased to report our 2011 financial results having achieved record sales and profits for our stakeholders. Consolidated net sales in Q4 were $174.2 million, up $1.2 million or 0.7% and full-year were $874.6 million up $63.7 million or 7.9%. Larry will go into more detail about sales. By segment Engine Management net sales in Q4 were $139.4 million, up $5.5 million or 4.1%, full-year Engine Management sales were $628.7 million, up $51.3 million or 8.9%. Inclusive in the Engine Management sales for the full-year were $11.8 million sales from acquisitions. Excluding the acquisition sales of $11.8 million, the 2011 full-year Engine Management sales increased $39.5 million or 6.8%. Temperature Control net sales in Q4 were $31.8 million, down $4.6 million or 12.6%. Throughout 2011, we stress the fact that our Temp Control business was seasonal, and quarter-to-quarter comparisons may not paint the overall picture of the business. This was especially true when we cautioned back in Q1, with a new spring promotion program, when sales were up 35%. For the full-year 2011 Temp sales were $233.7 million, up $11.6 million, the 2011 Temp Control season was very good up 5.2%, considering this increase followed one of the hottest seasons on record in 2010, when sales increased almost 13%. Consolidated gross margin dollars in Q4 improved $2.9 million to 27.8%, up 1.6 points for the full year and improved $21.5 million to 26.2%, up 0.6 points. By segment, Engine Management gross margin in Q4 improved $3.4 million to 26.6%, up 1.4 points and the full-year improved $16.8 million to 25.6%, up 0.6 points. We believe the 2 acquisitions completed during 2011 along with savings from make first-buy projects and low-cost sourcing will further benefit the gross margin percentage improvements in 2012. Our stated target is to achieve 27% to 28% gross margins in Engine Management. We are within a 140 basis points of the 27% low end of the range. Temp Control gross margin in Q4 was down $600,000 due to a sales decrease. However, the margin percent improved 1.3 points. Full year Temp Control gross margin improved $3.6 million to 23.5%, up 0.4 points. Our stated target in Temperature Control is to achieve 23% to 24% gross margins. In 2010 and 2011 we were within that range, at 23.1% in 2010 and 23.5% in 2011. Looking to improve further on our 23.5% in '11, our plan is to transfer a new compressor assembly to Mexico and look for additional low-cost sourcing opportunities. Consolidated SG&A expenses in Q4 were $41.5 million or 23.8% of net sales, unfavorable 1.3 points. The fourth quarter SG&A expenses increased $2.5 million versus Q4 '10, primarily from our Engine Management acquisitions inclusive of $0.5 million intangibles amortization. For the full-year SG&A expenses were $163.8 million or 18.7% of net sales favorable 100 basis points. 2011 SG&A expenses benefited from our post-retirement amendment mid-year generating a $3.6 million curtailment gain. Excluding the 2011 curtailment gain, SG&A expenses would have been 19.2% of net sales or 0.5 points favorable. As we look to 2012 SG&A expenses, I want to highlight a few non-cash incremental items that will increase 2012 expenses, the one I just mentioned, the post-retirement curtailment gain of $3.6 million, other post-retirement amortization of $2 million and additional intangibles amortization from our acquisitions in 2011, another $2 million. So there will be $7.6 million over the '11 expenses for non-cash incremental expenses. Consolidated operating profits before restructuring and integration expenses and before other income net were $65.3 million for the full-year. However, adjusting for the post-retirement curtailment gain of $3.6 million, consolidated operating profits were $61.7 million or 7% of net sales, compared to 2010, $48.2 million or 5.9% of net sales. This reflects a 110 basis point improvement. The net effect of our operational results is disclosed on our non-GAAP reconciliation was diluted earnings per share of $0.17 in the quarter versus a $0.11 in Q4 of last year, and a $1.57 year-to-date versus a $1.07 for the full year 2010. This reflects converting a roughly 8% sales increase into a 46.7% diluted earnings per share increase. Our GAAP to non-GAAP reconciliation included some significant items in Q4 and full year. They included reductions in restructuring and integration expenses, post-retirement curtailment gain, gain from the sale of a joint-venture interest, gains from sale of buildings, and lastly a significant tax provision benefit of $24.3 million in Q4 and $24.7 million for the full year. This tax provision benefit is a non-recurring, non-cash benefit primarily related to the reversal of a significant portion of our U.S. deferred tax valuation allowance and other tax adjustments. Looking at the balance sheet accounts receivable and inventory were in line with 2010 considering the acquisitions in '11. The 2 acquisitions BLD Products completed in April and Forecast Trading Corp completed in October accounted for the increase in goodwill and other intangibles of $45 million and also the increase in debt. Total debt was $73.3 million at December ‘11 versus $65.6 million at December ‘10. Excluding the $70.5 million spent on acquisitions, we would have reduced debt roughly $63 million during 2011 to below $3 million. Our year-end debt of $73.3 million reflects the debt to EBITDA ratio of a very comfortable 1:1. On August 29, we announced a share buyback program for $5 million, to-date, we have acquired roughly 320 shares at an average cost of $12.84 and have roughly $900,000 remaining available against our $5 million authorization limit. As we previously stated, we amended our bank facility in Q3 ’11, reducing our borrowing cost of 100 basis points and extend a maturity to March 15. At December ‘11, we had $73 million outstanding against this $200 million facility with $83 million additional borrowing capacity available. Lastly, our CapEx for the quarter was $4.3 million, and $11 million for the full year. Depreciation and amortization was $3.7 million for Q4 and $14.1 million for the full year. Thank you. And I will turn it over to Larry.

Good morning. Jim has gone over the numbers. I will cover a few of the highlights and then we will open for your questions. We are obviously quite pleased with 2011. We had record sales. We had record profits. We had improvement in both divisions; Engine Management and Temp. We had improvements in nearly every category; sales, gross margin, operating profit, cash flow all showed nice improvement. We made 2 fine acquisitions. In April we acquired BLD, a basic manufacturer of some significant emission control products. This business has now been relocated to 2 of our facilities; one in Reynosa, Mexico, one in Independence and we are now a basic manufacturer in this important group of products. That’s going very smoothly. In October, we acquired Forecast Trading Company, they are the leading supplier to the aftermarket of an economy line, engine management products because of the aging car population economy lines are increasingly important and we were - they are the number one line in the business and we are happy to have them as part of our company. Both of these acquisitions will make us stronger. Both are now fully integrated and up and running both will be accretive to earnings in 2012. Cash flow from operations was very strong. It was roughly $75 million. This enables us to make these 2 acquisitions with a minimal increase in debt and we were able to close out the year with a very healthy one-to-one debt to EBITDA ratio. The cash flow enables us to increase our dividend from $0.07 to $0.09 a quarter and enabled us as Jim mentioned to initiate a stock buyback program for up to $5 million. So adding all together and 2011 was very strong. Now looking ahead to 2012, we are optimistic going into the year, but we did mentioned 2 points of questions so why don't I start with them. First, the first quarter is going to have quite difficult comparisons with last year's first quarter. Last year if you recall, we were ahead as a company 23% at the end of the first quarter, at the time we announced this was not normal, it was the result of some higher than usual pipeline orders in both Engine Management and in Temp. Our customers worked these inventories down during the balance of the year. And we round up with an 8% increase. So that was the last 2 quarters work down from the 23 down to an 8. This year the pipeline orders are more in line with historical levels and this will obviously affect the first quarter comparisons but that’s really a one-time event. The second thing we pointed out was that one of our major retailers has begun purchasing certain air-conditioning products direct from China. We estimate this is going to have a negative impact in sales for the year of something between $15 million to $20 million, however this is balanced by some new Engine Management business that we’ve gotten that’s going to begin in the second quarter roughly $8 million to $10 million annualized first will have the benefits of our 2 acquisitions for the full year. So overall we are optimistic going into 2012, the industry demographics remain very strong, our customers continue to do very well in our product lines. We continue to make improvements in cost reduction and we will have the full year benefit of our 2 acquisitions. With that we’re happy to take your questions.

[Operator Instructions] We’ll go first to Aditya Oberoi with Goldman Sachs.

Great. My first question is more of housekeeping one, what was the normalized tax rate in the fourth quarter excluding all those one-time items?

I was looking it up. That was probably in the 39.5%.

Okay, which was, I would say a little bit lower than your guidance of like 40 to 42. And how should we think about it going forward?

I would say that we'd be targeting about a 40% tax rate consolidated.

Okay great, very helpful. Now, I had a question, Jim you outlined a couple of factors that should help your margins further in 2012 on the Temperature Control side like shifting the compressor assembly business to Mexico and looking for other outsourcing opportunities. Can you highlight some of the factors that would drive margin growth on the Engine Management side?

On Engine Management, we're going to get the benefits of the 2 acquisitions and the BLD one was even completed. Larry mentioned we transferred the bulk of that one to Mexico and also to Independence. So those 2 acquisitions will help. The forecast trading, which is more of the economy line, that’s fully sourced. We'll be coordinating with the vendors from Forecast and from Standard Motors, taking the best of either one and also looking to bring in-house manufacturing. That will benefit us also. But on an ongoing basis, you can always think about, we have a pipeline of projects that we're always working on from engineering to bring in-house manufacturing, and that's an ongoing basis. So we'll get savings from make first-buy and the other one is from procurement savings in the Far East. We have a number of initiatives in Engine Management.

Great, very helpful. And on the Engine Management side, again do you guys see some SG&A benefit as well as you kind of fully integrate these 2 acquisitions?

Yes. As the sales grow over the last couple of years, we gained significant leverage on the business. So we will be looking for additional savings in there. The non-cash items, I pointed out were significant enough for '12 to think about those as a percent we'll incur additional expenses for the acquisitions on incremental sales of about $30 million to $35 million, but then we'll be looking for other savings throughout the organization.

Great, and maybe this last one is for Larry. Larry, you mentioned that you guys lost one of the big customers to the customer deciding to source their products from China. How much do you think this has a spillover effect on other customers also starting to think on those lines? Basically what I am trying to get at is like, traditionally you moved out of some of the businesses, which we were like really low key in technology, and I am trying to understand if the whole technology landscape in respect of products coming from China has moved up.

Okay, that’s a very good question. And we are expecting that question. First of all, as we have said many times, China is a competitor. They are a competitor more in Temp than in Engine Management because the Engine Management line is more spread out, there is a lot more part numbers and it is a lot more high-tech. Air Conditioning is more concentrated, and relatively fewer part numbers and these are easier parts to manufacture. So we see more competition in Temp than in Engine. Now this is not a new phenomena. Temperature Control products have been coming out of China for many years. In the past, several of our customers have attempted to do that, and frankly in a year or 2 they decide to come back, because they have come to the conclusion that the issues of long lead times and returns and all the stuff tends to eat up all the potential savings. So our strategy, and we are not going to ignore China, it’s obviously a major competitor for us now as for most American companies is twofold really, to just be the best possible supplier we could be in terms of quality, in terms of customer service, in terms of fast turnaround on orders, and to keep working on cost so that if we feel that we can get to within 10% to 15% of the China cost, and we can do that, we feel between a combination of automation and manufacturing in our low-cost facilities in Poland and in Mexico, and if we can get to within 10% to 15% of the China cost to balance against all the benefits we offer, we are confident going forward. So that’s basically our strategy with China.

And we will go next to Greg Garner with Singular Research.

Question about the Forecast Trading, did you mention that the manufacturing's sourced already? I just want to understand what exactly you mean by that? That’s not something that in other words that you can source to Mexico and improve the margins on that?

Yes. Forecast Trading is a total purchase product and resell. So our choices will be to consider vendors that we have, vendors that they have and also the product families that we have where we are manufacturing. So, yes, we will be looking for product to go into our low-cost manufacturing locations which we identify as both Mexico and Poland. So we will get benefits from that and also the combination of volume with our vendors.

And the $8 million to $10 million in Engine Management Business expected to start in the second quarter, is that associated with Forecast Trading or is this something else?

No, it’s different.

That’s just overall product category that we gained new business in 2012.

Okay. And the way the gross margins were strong in the fourth quarter, it's safe to assume there is no price discounting from volumes. And as I remember, in the first quarter of 2011, there was the higher volumes in the first quarter, there was some volume discounts given, and since we are going back to a more normal order pattern it looks like for 2012, it seems to me that margins would be stronger than they were last year as a result.

Really what we did last year and it's focused on the Temperature Control line, we implemented a spring promotion program. So it was really, as they ordered early and they had the product available, so this way the repair can be done as needed, there was a discount offered on the Temperature Control line. That was really the only discounts that were offered in there. That program will continue in place this year, so there should be no disparity quarter-over-quarter on pricing or adjustments on that.

Okay. And what can you tell me to understand how Forecast Trading fits into the product line, I mean, this is a totally new segment but apparently it’s a higher growth area than the traditional high end products and is a scenario that you might be looking for additional acquisitions, is it there we see more opportunity here. I just want to better understand your thinking.

Well, let me try to explain it. We already have an economy line. But the belief was and there was a proper belief that these guys were really the experts at it. And they had developed some excellent sources. They had product differentiation. And we felt that this was a good vehicle to ride on, a good horse to ride we want to say, in this growing part of the market. We don’t envision any further acquisitions here because these guys are covering the landscape very well. So that was the benefit. So we had an economy line. They had an economy line. Frankly we like their economy line little better. And as we are looking at combining some of the purchasing for cost savings, that will be even a further improvement. So does that answer your question?

Yeah. Yeah, it does. And are there opportunities in this, with the acquisition for some product line extensions too?

No, they cover. It’s a pretty broad line as it is.

And we’ll go next to Walter Schenker with MAZ Partners.

Your thoughts on what sort of target you might have this year on raising prices, if any.

Okay. Well, let’s put last year and this year. I’ll give you both. How’s that? We’ve had to make some adjustments, again due to competition from China and the pricing in 2011 netted out to about a 1% increase. We feel that again we have to deal with the pressures. We are forecasting a similar increase in 2012 for both lines.

Okay. I won’t get into our discussion about allowing the tail to wag the dog. I’ll just leave it at that. In regard to the customer you lost for air, you lost the whole account or just the high-volume items in the account?

Yeah, it’s just the latter. We certainly didn’t use lose the account. They are still a very large account, but they don’t make all the products in China. So you lose the more popular ones, the easier ones for them to make and not all the product categories either. There always a part of life. That’s all. So a part of life.

So they cherry-picked a piece of line?

Correct.

And decide this was in China?

Correct.

And lastly, what’s going on? I mean, for years you talked about, I know, you’ve made some small acquisitions, but they really haven’t been the significant type of opportunity you would hope for in OES. Obviously the supplies are all doing a lot better now. The order companies are doing better now, although this is still tertiary to the main thrust of what they are doing. Is this something that's sort of is always out there on the horizon, but probably never will be fulfilled meaning a significant acquisition in OES?

That’s the question?

That’s the question. I’m sorry.

Well, Well that will never be fulfilled. I can’t answer that, but we still look upon this as a growth category for us. It’s a good extension of our regular business. We are looking. We are going to be prudent about it. And when we see something that’s good, we’ll do it. If we see something that’s not, we won’t. We continue to look, if that’s your question.

Okay. I won’t waste time on what people look at and what they actually do. And lastly, on air, given your ability to remanufacture and your cost in Mexico, why is China meaningfully cheaper than you can bring stuff in from Mexico, all in including the remanufactured piece?

All right. I oversimplified. Segment aligned into new compressors and rebuild compressors. We can rebuild a compressor in China and do that for about an average of 15% to 20% below a new compressor coming in from China. That we can do. And as long as we continue to do that, our rebuild business will be quite strong and we still sell roughly half the compressors we’ve sell or rebuild and that will always be a major edge for us. The other half of the business is new compressors. And that is the one where the China stuff is cheap. Now it’s not as cheap as the rebuild, but it’s cheaper than U.S. rebuilds and customers do like a new compressor to have the choice and the price is close. So the competition that we have been discussing here is about new compressors. And here we say that we are beginning to manufacture them, before all we have done is buy them. But we can manufacture them and assemble them in Mexico this is a process that is just starting. And with that we can get within close enough to the cost of bringing one in from China that we feel comfortable that we’re going to hold the vast majority of business. Does that answer your question?

It generally does, although I’m sort of surprised given the history of air and returns and I know some difficulties. One of your customers had a big problem with that. But that is not another major negative factor bringing in from China.

Yeah, right. These are all the things on our side and we are pretty comfortable with that. We are going to be able to do fine. There were a lot of issues in buying from China and returns is a big one. And the fact that it’s a highly seasonal business is another one. So we are okay with this.

And we’ll go next to Adam Brooks with Sidoti & Company, LLC.

Yes. Just a few housekeeping questions at this point. If you look at SG&A, can you take out, you mentioned about $0.5 million in intangibles and the other costs in SG&A that were associated with the acquisition, because SG&A does seem a bit high, usually there is a sequential decline from 3Q to 4Q?

Well, the total amount that increased was $2.5 million. $0.5 million was intangibles and then there would have been incremental expenses for the acquisitions that were in there. So besides that, I mean, it’s just a little bit of noise with timing, nothing significant. No incremental cost or any change in the dynamics of the SG&A expenses.

And can you give us a sense of how much revenue you got from BLD and from Forecast in the quarter?

It was approximately $7 million.

Okay. And real quick going back to China, you’ve mentioned you’ll be happy if you can get within 10% to 15% of the China cost. Can you give us a sense of how far you are from that at this point?

Well, it varies by product, but we’re getting better and better.

[Operator Instructions] We’ll go next to the side of Robert Smith with the Center For Performance Investing.

Grateful for the dividend increase. Just wanted to reassure myself that your policy is to defer earnings to the dividend?

Yes, thank you, Bob. Yes, our policy is with a target of one-third of earnings per share, we’re obviously under that right now. And we will continue to evaluate it as the year goes on, but that is our stated target one-third.

So Larry, looking at the future I mean, where you are now, I mean, a few years you could be a $1 billion top-line company. The question is where would the margin target be on a longer term basis? I know we spoke of the gradual increase in margins and your kind of bumping up against the high-end?

Well, I think Jim has mentioned our margin targets, so we can…

I think, I think of it, the overall picture where still the industry is a very competitive industry and we’re a very large player. And that’s so, right now in Engine Management we were at, I think I’ve said 140 points with a low-end that are range there, and roughly 2.5 points on the high-end. We continue to strive to make that and hopefully be able to, at some point, maybe to move that range up. Temperature Control, we’ve had 2 very good seasons we are right in that mid range. We don’t stop. That was just guidance that we wanted to provide going back 2 or 3 years ago, because this is where we felt we could bring the businesses. So we’re very close, and we’ll continue to look for cost reductions.

On the acquisition front, I mean, what is most important to you looking at a perspective acquisition? What are the criteria that you use?

I’ve a pretty simple criteria. It has to make us better or we have to be able to make them better. And therefore, the key thing we look at is synergies. And in these last 2, they both made us better and they both had synergies. The BLD made us basic in a key product group, and then we were able to have additional savings as we relocated it to our factories, especially in Mexico. And the forecast OEM got us into this, made us stronger in this growing segment of the business and we anticipate synergies there as well, especially in the cost of goods sold area. So that’s what we look at. These were 2, in my mind, ideal acquisitions. And that remains our criteria.

And the opportunities out there?

Yes, there were opportunities out there.

And we’ll go next to Efraim Levy with S&P Capital IQ.

As far as the impact of the air conditioning parts shift, is that an immediate effect or is there a lag before the actual sales? And also that’s a little bit lower margin business that you are losing in you'll replace some of that $8 million to $10 million would be higher margin that when you loss?

That number we gave you was our estimate for the net effect in the year 2012. Okay?

Would you see that in the first quarter, I mean did they drop at bit already or…

Yes, we see, we'll see it within the first quarter, yeah.

Okay, so it’s already take enough time.

Time when a year ago there were heavy pipeline orders and this year they are not. So, yes, a hunk of that is will be seen in the first quarter. I forgot your second half…

In terms of margin, so is the net margin...

It had a slightly lower margin than the much of the line because it was, we were really buying them and selling them. So it had somewhat lower margin than some of the rest of the products, yes.

I think the other part there you can look at the loss business, it would mirror think of it as the margin on Temp in the 23% and the gains on engine that we're getting, which is a point or two high or so. if you look at it they would mirror the margins that we report for the Engine Management and Temperature Control. So, the new business i.e., has a better point and a half or so margin on it than what's going out?

Yeah, that's what I was suspecting I wanted to confirm it, so. And as far as, you’ve mentioned the gas price as a potential negative is that because of we’ve a fewer miles driven some less wear and tear in there for less replacement so what’s the role for it?

Well, our feeling on that and you're hearing that when you’re hearing any of the public companies or industries they’ve always mentioned effect of gas prices. So, here is just our personal belief. Our personal belief is that unless there is a dramatic spike higher than today, and let’s say in excess of $5 a gallon something like that people will not significantly change their driving habits. So if the amount of mileage drops 1% to 2% say, because of the higher prices, which is roughly what it dropped in the year 2011, for our particular product groups there was essentially no impact. So our feeling is, is that unless it really gets high, the impact on our business, on our product lines will be minimal.

[Operator Instructions] And it appears that we have no further questions.

Okay, with that I want to thank everybody for joining our call today. Thank you.

That concludes today’s teleconference. You may now disconnect, and have a wonderful day.