Standard Motor Products Inc

NYSE:SMP

Earnings Call Analysis

Steady Sales Growth with Robust Margins

This quarter showed a financial performance with higher sales and a gross margin rate improvement across all segments, leading to an earnings per share increase of $1.11. Despite a $14.2 million surge in factoring costs due to rising interest rates, operational efficiency has helped offset this impact. Inventory levels dropped significantly, aiding a robust cash flow from operations, and a considerable reduction in borrowings improved the leverage ratio to 0.8x. Looking ahead, expectations for full-year sales are a flat to low single-digit percentage growth compared to last year, with adjusted EBITDA projected at around 9.5%.

Record Sales and Debt Reduction

The company reported slight sales growth, hitting a new record for a quarterly result, accompanied by a notable increase in earnings. This positive performance came despite challenges such as rising interest rates. Moreover, the firm displayed robust cash flow, enabling the reduction of approximately one-third of its outstanding debt.

Segment-Wise Performance: Mixed Results

Vehicle Control sales were stagnant year-to-date and experienced a 3.4% dip in the recent quarter, attributed to tough comparisons and some customer-related headwinds. Despite these issues, the segment showed resilience with overall customer point-of-sale numbers improving compared to the previous year. Temperature Control, on the other hand, saw a quarterly increase of 5.3% in sales, aligning closely with last year's nine-month results. Engineered Solutions outperformed with an 8.4% sales boost, indicating strong demand and new business acquisition potential.

Earnings and Profitability Resilience

Inflationary pressures persisted, but the company managed to navigate these challenges successfully, leading to a 5.7% increase in earnings per share compared to the previous year. This was achieved by leveraging sales growth in key segments and other strategic measures, which also contributed to improved operating profit. The quarter's net sales did face a 3.4% decline mainly due to a customer bankruptcy, yet the company managed to maintain its profitability with Vehicle Control's adjusted EBITDA at 11.4% of net sales. Temperature Control's adjusted EBITDA for the quarter was at a healthy 11.9%.

Stable Sales Outlook and Strong Cash Flow

Overall, the company's net sales rose by 1.3% in the quarter, steadying the cumulative nine-month sales figures. The firm has shown progress in paying down its credit facilities by over $92 million thanks to improved operating cash flows. The full year 2023 sales are projected to show flat to low single-digit percentage growth, with an expected adjusted EBITDA of 9.5%.

Confidence in Future Growth

Looking ahead, the company has a confident outlook, having posted record sales and strong earnings growth. The North American aftermarket segment appears stable, backed by favorable demographic trends, and the company is poised to adapt to technological shifts, ensuring a robust foundation for future growth.

Guidance on Margins and Earnings

Consolidated operating income was reported at 9.1%, with an adjusted EBITDA of 11.4% in the quarter, reflecting higher than previous year's levels. Additionally, diluted earnings per share increased to $1.11. The firm expects depreciation and amortization as well as income tax rates to be consistent with 2022. Average quarterly interest expense on outstanding debt is anticipated to be around $4 million given the current interest rate environment.

Outlook for Full Year and Beyond

For the full year, the company's sales are expected to be relatively stable compared to the previous year, and the adjusted EBITDA margin forecast remains at 9.5%. The organization underscores its commitment to growth in both the Temp Control and Engineered Solutions segments and acknowledges its team's efforts in driving successful financial results and operational improvements.

Earnings Call Transcript 2023-Q3

[Operator]

To all sites on hold. We appreciate your patience and ask that you please continue to stand by. Thank you.

Good day, everyone, and welcome to the Standard Motor Products Third Quarter 2023 Earnings call webcast. [Operator Instructions] Please note, today's call will be recorded, and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Mr. Tony Cristello. Please go ahead, sir.

[Anthony Cristello, executive]

Thank you, Cory. Good morning, everyone, and thank you for joining us on Standard Motor Products Third Quarter 2023 Earnings Conference Call. I'm Tony Cristello Vice President of Investor Relations. And with me today are Larry Sills, Chairman Emeritus; Eric Sills, CEO and Chairman; Jim Burke, Chief Operating Officer; and Nathan Niles, Chief Financial Officer. On our call today, Eric will give an overview of our performance in the quarter, and Nathan will then discuss our financial results with an update on our annual guidance. Eric will provide some concluding remarks and open the call up for Q&A.

Before we begin this morning, I'd like to remind you that some of the material that we'll 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'll now turn the call over to Eric Sills, our CEO.

[Eric Sills, executive]

Well, thank you, Tony, and good morning, everyone, and welcome to our third quarter earnings call. Overall, we're pleased with our results. Our sales were up slightly, setting a record for a single quarter, and we saw a nice increase in earnings even in the face of interest rate headwinds. Additionally, we continue to show strong cash flow improvement, allowing us to pay down about 1/3 of our outstanding debt.

Let me address each segment settle. I'll first speak to the aftermarket starting with vehicle control. Vehicle control was essentially flat year-to-date and down 3.4% in the quarter. This was against a record quarter a year ago, which posted nearly 6% growth, so it was a difficult comparison. There were also two other notable drivers. First, as mentioned in the release, we continue to see the impact of the customer bankruptcy announced earlier in the year. After a half year of potentially no revenue, the business was acquired a few months ago by a handful of existing SMP customers. We believe that in the long run, the business will bounce back to historic levels, but we recognize that this could take a while as they absorb the acquired locations and inventories, and therefore, we expect an ongoing drag on the business, which should diminish over time.

Secondly, the third quarter of 2022 saw a greater amount of pipeline over than this year. These tend to flex quarter-to-quarter and year-to-year as customers adjust their planograms and can therefore create a bit of noise. Importantly, we always look at customer POS as an indicator of true end-user demand. And in aggregate, our large customers remained ahead of last year. Now let me turn to temperature control. Due to a cool spring, we experienced a very slow start to the season, especially when compared to 2022 and entered the third quarter down 5.2%. But as you know, it got quite hot across most of the country and remains so throughout the summer. Sales were up 5.3%, allowing us to post an all-time record for a quarter and bringing us back to within a point of last year's 9-month sales.

Next, I'll speak to our Engineered Solutions segment, which is our non-aftermarket business focused on selling to manufacturers of vehicles and equipment across various end markets globally. Sales and Engineered Solutions were up 8.4% in the quarter, reflecting a combination of generally strong demand from key accounts and the benefit of new business wins. We're very pleased with how this business is going. We have built a program with a great combination of diverse products, end markets and geographies and are gaining traction as a capable supplier to blue-chip accounts, and we believe the sky is the limit. Turning to profitability. We are pleased to see strong gains, posting an EPS increase of 5.7% versus last year. Inflation persists with costs remaining elevated across materials, labor, rent and so on as well as the significant impact from rising interest rates affecting both our customer factoring programs and now borrowing. But through a combination of initiatives, we have largely been able to cover these cost increases, and I'm very proud of all of our people's efforts in this regard. So with that, let me turn it over to Nathan Iles, who will dive a bit deeper into the numbers and what's behind it.

[Nathan Iles, executive]

All right. Thank you, Eric. As noted before, our sales were up in the third quarter with increases in both the Temp Control and Engineered Solutions segment, which along with other actions, helped drive improvement in operating profit over last year. We also continue to make great progress reducing our inventory levels. As we go through the numbers, I'll give some more color on these items and other key drivers for the quarter and first nine months as well as provide an update on our financial outlook for the full year 2023.

First, looking at our Vehicle Control segment. You can see on the slide that net sales was $190.9 million in Q3 or down 3.4% versus a difficult comparison last year, with the decrease driven by the impact of the bankrupt customer as well as some customer pipeline orders, which did not recur this year. For the first nine months in vehicle control, sales were down slightly by 0.3%, with the decline showing both the impact of the customer bankruptcy as well as lower Q3 pipeline orders. But excluding these impacts, we've seen growth for the year so far as a result of continued demand for our products and favorable sell-through.

Vehicle controlled adjusted EBITDA was 11.4% of net sales for the quarter and 11.9% for the first 9 months, with both periods down from last year. Looking at the drivers, we saw a nice expansion in the gross margin rate for vehicle control of 1.4 points in the quarter and 1.9 points for the first nine months. This expansion was a result of pricing and savings initiatives, which overcame cost inflation and the impact of lower production and lowering inventory. However, the improvement in gross margin was more than offset by a combination of higher factoring costs and lower operating expense leverage as a result of lower sales.

While vehicle controls adjusted EBITDA is down year-over-year, I would point out that we've made a lot of progress offsetting the headwinds we faced recently as our gross margin improvements outpaced the rising cost of factoring programs for both the quarter and the year so far.

Turning to Temperature Control, net sales in the quarter for that segment of $123.6 million were up 5.3%, while sales for the first nine months were down by 1% as we saw strong sales in the quarter mostly offset we've been a slow start to the selling season. Temperature Control adjusted EBITDA, was 11.9% of net sales in Q3 and slightly ahead of last year and was driven by two things primarily. First, strong sales combined with other initiatives to improve the gross margin rate and second, the performance of our equity investments in our joint ventures in China, which falls below the operating profit line but improved in the quarter. The combination of these two things overcame the higher cost of customer factoring programs in the third quarter.

Temp controlled adjusted EBITDA for the first nine months of 8.5% of net sales was down from last year as a slightly higher gross margin rate was more than offset by higher factoring costs so far this year. Looking at it in more detail, the impact on pricing and cost savings actions benefited the gross margin rate, but was partly offset by lower production related to lowering inventory levels. So while gross margin improved by 0.2 points to this segment, this was more than offset by higher interest rates on factoring programs as well as some lower leverage in SG&A costs due to lower sales.

Looking at Engineered Solutions, sales for that segment in the quarter of $71.8 million were up 8.4% and sales for the first nine months of $215.1 million were up 4%, and we were pleased to see our sales continue to increase as a result of strong demand in new business wins. Adjusted EBITDA for Engineered Solutions in the quarter came in at 15.6% and an increase of 4.6 points from last year. And for the first 9 months, adjusted EBITDA for Engineered Solutions was 13.4% and up 1.9 points from last year. The improvement for both the quarter and the year so far was the result of strong sales growth good channel and customer mix, which improved the gross margin rate and better SG&A leverage given higher sales.

Turning to our consolidated results. Net sales in the quarter were up 1.3% due to higher sales of intent Control and Engineered Solutions. And for the first nine months, sales were basically flat as growth in Engineered Solutions was offset by small declines in the aftermarket segment. Our consolidated gross margin rate improved for both the quarter and first nine months due to our initiatives that overcame other headwinds results in a gross margin dollar increase of 7.5% to 4.9% for the quarter and first nine months, respectively.

Regarding SG&A, excluding the cost of customer factoring programs, which are shown separately on the stage, Expenses were well controlled in the quarter of 16.9% of net sales and in line with last year. Looking at the bottom line. Consolidated operating income was 9.1% and adjusted EBITDA of 11.4% in the quarter were higher than last year as higher sales and an improved gross margin rate across all segments offset $4 million of higher factoring costs. This also drove an increase in earnings per share of $1.11 in the quarter.

For the first nine months, consolidated operating income and adjusted EBITDA were down as higher factoring costs really partly offset by improvements in gross margin and has also resulted in lower diluted earnings per share for the year so far. However, I would also point out that while our operating profit is down $4.4 million in the first nine months, this is after absorbing a $14.2 million increase in factoring costs, which highlights the work we've done to offset the headwinds of rising interest rates.

Turning now to the balance sheet and cash flows. The key item here is our inventory level, which finished Q3 at $479.8 million, down $48.9 million from December last year and down $54.5 million from September last year as we continue to focus on reductions in this area. Our cash flow statement reflects cash generated from operations in the first nine months of $132.9 million as compared to cash used of $75.5 million last year, with the improvement driven by $129.6 million improvement in cash flow from inventory during the first nine months.

Our financing activities shows significant progress made in paying down our credit facilities by $92.1 million as a result of improved operating cash flows, including a $75.6 million worth of repayments made in the quarter. We also paid $18.8 million of dividends during the first 9 months. Our borrowings of $147.6 million at the end of Q3 were much lower than last year, and we finished the quarter with a leverage ratio of 0.8x lower than both September and December last year.

Before I finish, I want to give an update on our sales and profit expectations for the full year 2023. Regarding our top line sales, we expect full year '23 sales will show flat to low single-digit percentage growth versus last year. given performance to date and the fact that temp control season is now largely finished. Adjusted EBITDA is expected to be approximately 9.5% and unchanged from our estimate last quarter. This estimate includes the full year sales performance as noted factoring expenses of $48 million to $50 million using the current outlook for rates, some additional costs related to the expansion of distribution facilities in our new warehouse in Shane, Kansas, and a weaker U.S. dollar that while strengthening recently to still lower against the Mexican peso versus last year.

In action with adjusted EBITDA, we expect depreciation and amortization expenses and our income tax rate to be in line 2022. Further, we expect our interest expense on outstanding debt to be on average about $4 million each quarter, given higher interest rates. Ramp-up, we were pleased with our overall higher sales in the quarter and our Temp Control and Engineered Solutions segment. And our improved gross margin rate across all segments as well as the continued significant improvement in cash flow that we saw, and we very much appreciate the efforts of all of our key members and achieving these results. Thank you for your attention. I'll now turn the call back to Eric to wrap up.

[Eric Sills, executive]

Thank you, Nathan. So just to close, let me reiterate how pleased we were with our quarterly results. We posted record sales and showed strong growth in earnings. North American aftermarket continues to show its stability as the basic demographics of their market remain favorable. The car park is growing and aging, miles driven and rebounded. And while there can always be some noise quarter-to-quarter, the fundamentals remain as [indiscernible].

Technology shifts are surely coming, but there's nothing new about that, and we feel well positioned to evolve with it. So we really feel quite good about our future here. As for Engineered Solutions, we are obviously in a different stage of our journey. While we are well established in the aftermarket, here, we are just getting known. But the moves we have made in the past few years in creating a cohesive global business is clearly hitting its strat. We continue to receive opportunities across a host of products and end markets and are clearly seeing a strengthening in customer relationships that will surely open more doors.

And as I always say, we are tackling with the best team out there, and I'm immensely grateful to all of our talented [indiscernible]. And so that concludes our prepared remarks. At this point, we'll open it up for questions. So I'll turn it back to you.

[Operator]

And we'll take our first question from the line of Daniel Imbro with Stephens.

[Daniel Imbro, analyst]

Eric, maybe I'll start at a higher level. In this group, I think you mentioned that large customers in aggregate are still up that kind of implies a positive industry backdrop. Are you seeing -- or how are you thinking any change in that outlook? Some participants are noting more repair deferrals curious if from your purview where you see a lot of customers, are you seeing anything changing in terms of sales trends or volume trends in the industry?

[Eric Sills, executive]

So that's a fair question. And what I would say is that, in general, we are seeing that kind of ongoing low single-digit growth within -- speaking specifically, vehicle control temperature control, obviously, has a lot of movement to the weather. But we're -- I think we're basically back to that low single-digit long-term trends that the industry has always seen as it relates to any deferred maintenance and so on, a lot of our categories are not really maintenance related. They're hard failure. And so really, your car needs our products, you tend to not be able to do very well. So we don't necessarily see any impacts from that, which could theoretically because in other categories by economic trends, we're really looking at the addressable market being stable and strong.

[Daniel Imbro, analyst]

Understood. That's great. Maybe a couple on the Engineered Solutions segment. Results were really strong there, impressive profit growth First, maybe how are you thinking about the fourth quarter? I know you had some light vehicle and domestic exposure. Is there any potential disruption from the ongoing UAW strike embedded in the guide? And then, Nathan, when we look at the margin performance, was there anything anomalous in there? Or is it mid-teens segment EBITDA margin sustainable?

[Eric Sills, executive]

So as it relates to what we're seeing in Engineered Solutions right now, and I think you're specifically asking about any light vehicle impact. It's a relatively small portion of our overall sales, certainly, and even with engineered solutions, we service so many other end markets. We have really seen very nominal impact as a result of this strike and now it appears that at least with Ford, it's resolving itself. And so any impact really would have been minor and short term. So we don't really expect anything out of that.

[Nathan Iles, executive]

So on the market for Engineered Solutions, I'd just point out, like we said before, that the customer base in this segment is very diverse. And we do expect to have some changes in margin quarter-to-quarter just because of the diverse mix of customers in the business. And so as I remarked before, really, a lot of the improvement was driven by an improved customer mix versus last year. on a long-term basis, I would just point you to the nine months numbers for this segment, which there showed gross margin of 20.6% and probably closer to where the business settles out on a long-term basis. So I think that we would still believe that Engineered Solutions versus the aftermarket is comparable on an adjusted EBITDA basis [indiscernible].

[Daniel Imbro, analyst]

Great. That's helpful. And maybe last one for me, Nathan on the guide on the EBITDA margin outlook. I think you maintained it at 9.5%. Obviously, 3Q was stronger than that. So can you maybe help us understand the outlook, maybe what are the headwinds coming in the fourth quarter that we should be aware of as you thought about kind of keeping that guidance.

[Nathan Iles, executive]

Yes. So just the headwinds that I pointed out in the remarks around some of the incremental costs around the new warehouse as well as the FX that at least from the Mexican peso is still a little bit against us in the fourth quarter. I think to your point, obviously, adjusted EBIT is a bit stronger than the guide come out of Q3. But the other thing that will swing Q4 around a bit is the temp control business and the season as that comes to an end, the fourth quarter is always a lower profit quarter anyway. So that's what's inside the expectation.

[Operator]

I will take our next question from the line of Bret Jordan with Jefferies.

[Unknown Analyst]

This is Patrick Buckley on for Brett. How are you guys thinking about inventory levels as we head into '24. Are we pretty close back to optimal or maybe some more work to be done there?

[Eric Sills, executive]

Are you referring to inventory on our shelves or our inventory sitting on customer shows?

[Unknown Analyst]

Yes, I suppose both would be helpful.

[Eric Sills, executive]

So I'll speak to the customer inventories and Jim can speak to ours. What we're really seeing is very rational stable inventory on our customers' shelves. You're always going to have a little bit of flexing quarter-to-quarter, period to period. But basically, it shows that there their inventory is really where they want it to be, and we work closely with them. So we have pretty good visibility into what their intentions are. So nothing really to note on customer shows.

[James J. Burke, executive]

This is Jim Burke. We're very pleased with the inventory performance that we had in the recent quarter and really year-to-date. So we took significant working capital down out of the business. At this point, going forward, we start to build inventories in the Temperature Control in. So vehicle control will probably be about neutral. Maybe we'll get a little bit of a benefit there. But from this point forward, we start to build and get ready for the next season there. But I'd say you should look at relatively reasonable levels, no significant changes.

[Unknown Analyst]

Got it. That's helpful. And then as you look at cadence throughout the quarter, it sounds like momentum picked up towards the end after the colder spring. How have things progressed into Q4? And how much more tailwind are you guys expecting from the summer heat.

[Eric Sills, executive]

Well, really the summer season at this point is largely over. It -- so I wouldn't read too much into what happens in the few weeks of October. But yes, it was a strong summer really throughout the third quarter, which, as we said, allowed us to recover from the slow start.

[Operator]

[Operator Instructions] Our next question comes from the line of Scott Stember with Roth MKM.

[Scott Stember, analyst]

Congrats on the quarter. .

[Unknown Executive]

Thank you.

[Scott Stember, analyst]

Some industry players have been talking about potential price disinflation. Are you starting to see any of that? I mean, obviously, you guys have put through a lot of price increases to cover raws, but -- and factoring costs. But what's your view on the pricing environment right now?

[Eric Sills, executive]

Yes. We're really not seeing it in our categories, partly because they are not commodity driven. And so we've seen that the overall costs have not come down. Our costs have not come down. So we're not really seeing much. You obviously talked to the distributors as to what their pricing strategies are. And we're hearing, as you said, some different things. But we are really not seeing anything and we believe in our categories is nondiscretionary hard failure parts, they're not that price sensitive industry. .

[Scott Stember, analyst]

Got it. And back to the UAW strike. You talked about Engineered Solutions, but in vehicle control, is there any potential if you haven't seen it already for benefit in the aftermarket side?

[Eric Sills, executive]

That's also a great question. And the short answer is no. We really have not seen any impact. One of the things that we have been reading about is really that they had anticipated this, and it stocked up their parts distribution are ahead of it, and they are not at zero, they are as we're reading, and I'm not saying anything that's not public information. But they have continued a kind of partial staff to operate those parts of the carbon. So no, it really has not had any impact on our whole channel really.

[Scott Stember, analyst]

Got it. And then the guide for top line is a little bit lower. Is that really pertaining to vehicle control and the customer loss? Or is there anything else?

[Eric Sills, executive]

No. I think that's really it. And the fourth quarter can be somewhat volatile. As you know, as the end control season is largely over, and there could be adjustments. And so we're just taking a slightly conservative view on it and also looking at where we are -- where we are after nine months. So yes, that's really [indiscernible]

[Scott Stember, analyst]

And then lastly, the bankruptcy, I think last quarter, you might have given what the impact to vehicle control sales or do you have that for this quarter?

[Eric Sills, executive]

Yes. It's -- we were able to provide some rough numbers prior to the piece is getting acquired because we're able to show a specific zero-revenue-type situation. Now that it's been acquired by other accounts, and it really just kind of gets lost in the mix as to what that impact is because it's been distributed across several different other customers and all of the different dynamics within their businesses. So yes, we're at this point and really going forward as well, unable to really specify what that impact is, but we just know that there is some overall softness as they rationalize with that.

[Operator]

And there appears to be no further questions at this time. I'll hand the call back over to the speakers for any closing remarks. .

[Anthony Cristello, executive]

Thank you, and we want to thank everyone for participating in our conference call today. We understand there's a lot of information presented, and we'll be happy to answer any follow-up questions you may have. contact information is available on our press release or our corporate website. And we hope you have a great day. Thank you.

[Operator]

This concludes today's conference. Thank you for your participation, and you may now disconnect.