Lawrence Sills - Executive Chairman James Burke - CFO & Executive VP of Finance Eric Sills - CEO, President & Director.

Daniel Drawbaugh - FBR Capital Markets & Co. Scott Stember - CL King & Associates Bret Jordan - Jefferies Kyle Cavanaugh - Palisade Capital Anna Jolly - G. Research.

Good day everyone and welcome the Standard Motor Products First Quarter Earnings Release Conference Call. [Operator Instructions]. It's now my pleasure to throw the conference over to the Executive Chairman of Standard Motor Products, Mr. Larry Sills. Please go ahead..

Good morning everyone and welcome to Standard Motor Products First Quarter Conference Call. We appreciate your taking the time to attend. Here for the company is Eric Sills, President and CEO; Jim Burke, Executive Vice President and CFO; and myself, Larry Sills, Executive Chairman.

Our agenda today, Jim burke will review the financial results of the first quarter, Eric will then go into a bit more depths on some of the key subjects and then we will open for questions, so let's begin..

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 discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements. Looking at the P&L, consolidated net sales in Q1 '18 were $261.8 million, down $20.6 million or 7.3%.

By segment, Engine Management net sales in the first quarter were a $199.5 million, down $11.8 million or 5.6%. By major product group wire and cable net sales were $38.8 million, down $7.4 million or 16%. We forecast a more normalized decline in wire and cable to be in the 6% to 8% range on an annual basis.

Engine Management net sales as a whole excluding wire and cable were $160.7 million down $4.4 million or 2.7%. We anticipate this product group will grow in the low to mid- single digits on an annualized basis. Eric will provide additional color around our customer order patterns and customer POS sales.

Temperature Control net sales in the first quarter were $60.2 million, down $10.1 million or 14.3%. This decline was anticipated and communicated during our last earnings call based on a mild 2017 summer season and higher customer ending inventorial levels. Also sales in the first quarter '17 were up 24% following the very hot 2016 season.

But looking back at history our first quarter '18 sales of $60.2 million or $3.4 million over the first quarter '16 sales at $56.8 million. Consolidated gross margin was 27.7% versus 29.8%, down 2.1 points. By segment Engine Management gross margin was 28.3% versus 30.3%, down two points.

We anticipate margins will improve over the balance of 2018 as plant moves are completed, eliminating costs and inefficiencies incurred during the transition. Temperature Control gross margin was 22.7% versus 25.2%, down to 2.5 points.

This drop in gross margin was expected as we curtailed production over the second half of 2017 due to the mild 2017 season. We anticipate margins will improve going forward and also realize benefits from our production transfer from our Grapevine, Texas facility to our low-cost Reynosa, Mexico facility.

Consolidated SG&A expenses were $57.7 million, up slightly by $300,000. As stated in our fourth quarter 2017 conference call we anticipate spending in the $59 million to $62 million level per quarter in 2018. Our second and third periods due to our seasonal temperature control sales will be at the high end of that range.

Consolidated operating income before restructuring and integration expenses and other income net in the first quarter '18 was $14.9 million, 5.7% of net sales versus $26.7 million at 9.5% of net sales last year. Gross margin improvements in both segments over the balance of 2018 will improve our operating margins going forward.

Excluding nonoperational gains and losses our diluted earnings per share in the first quarter were $0.46 versus $0.74 in the first quarter '17. Our 2018 results also include the benefit of a 26% effective tax rate as opposed to 36.7% in the first quarter 2017 from the tax law changes.

Looking at the balance sheet, accounts receivable increased $20.5 million from December '17 levels but decreased $19.6 million from March '17, mirroring our sales reduction in the quarter. Inventories reflected minor changes from December and March '17 levels.

After reviewing the revenue recognition pronouncement we modified our financial disclosure to report customer returns and core liability returns at gross as opposed to previously disclosing those liabilities net of our recoveries. With this change we also recognized unreturned customer inventory, a new item on our balance sheet at $18.7 million.

This change is primarily balance sheet disclosure only and no change to the P&L from past practices. Investments and unconsolidated affiliates reflects a $4.5 million increase which is primarily from our share ownership increase in Gwo Yng, a Chinese AC joint venture from 50% to 65%.

Total debt at March 31 was $95.9 million which reflects an increase of $34 million from December 2017 to fund their seasonal working capital needs. Our cash flow statement reflects a $6 million use of cash in the first quarter from operations as compared to a $27 million use last year.

In general our cash flow from operations in the first quarter in any given year is used to fund seasonal working capital needs. Investing activities reflected a $13.3 million use of cash, $6.9 million being for capital expenditures and $6.4 million funding our China JVs. Eric will discuss further our joint venture investments in his comments.

Financing activities included our share repurchases of $3.2 million. In 2017 our board authorized up to $30 million share repurchase program. Through the end of first quarter '18 we repurchased 601,516 shares at a cost $20.7 million, an average price of roughly $46.

In summary, we are not satisfied with our first quarter results reflecting lower sales and margins. As stated earlier, we expect margin improvements in both segments to improve our results going forward. Thank you for your attention and I'll turn the call over to Eric..

Hi. Well, thank you, Jim, and good morning everybody. Overall while we are disappointed in the quarter the results were largely expected and discussed with you on our last earnings call and were due in large part to items that were timing related or short term in nature.

These are our operating divisions and different elements affecting them so I'll go through them separately. Starting with Engine Management. Engine Management sales declined 5.6% overall. However included in this number is our wire and cable product line.

Due to where it is in its life cycle wire and cable is in slow secular decline and thus pose down the overall division performance. Excluding wire and cable our engine management business was down 2.7%.

As we told you last year, in the first quarter few of our customers determined that they were under-inventoried and therefore placed large pipeline orders. This larger-than-normal pipeline program was now repeated this year and accounts for the entire sales shortfall.

I should note that the 2017 pipeline orders continued into the second quarter so we expect continued headwinds. As we always remind you, our customers' purchases from us tend to vary quarter-to-quarter as they flex their inventories and its better to look at it over a longer time horizon.

Furthermore, due to this lumpiness it better gauges our customers' sell-through and in the first quarter of this year our customers showed positive POS gains with sequential improvement month-over-month and we believe that this bodes well for the future.

Engine Management gross margins have remained behind our historical performance and is largely tied to the temporary cost of our plant moves. We have 2 such moves still underway.

To remind you, as part of the general cable ignition wire integration we are moving production from Nogales, Mexico to Reynosa, Mexico and we are also relocating our Orlando electronics plant into Independence Kansas.

The good news is that at the end of the first quarter we fully exited both Nogales and Orlando facilities and all of the fixed costs associated with them. Both Reynosa and Independence are making strong strides in coming up to full efficiencies as they staff up and train new personnel and we are pleased with the progress.

The worst is definitely behind us and we expect incremental improvements for the next few quarters and to be in normal run rates by the end of the year. The other item that's having an adverse impact on our gross margins is related to product mix.

While older technologies like wire and cable are in decline, we are seeing an increase in sales in new technologies. In the long run this is a positive. It shows that these later-application products are starting to hit the replacement cycle in the field.

Typically our profitability on new products is lower than legacy products as we have yet to tool them or resource them but we have a solid track record in these cost reduction activities so I'm confident that in the future we will achieve our typical margins.

Okay, turning to temperature control, our sales were down 14% in the quarter but this is compared to 2017s record setting 24% increase over the previous year.

The first quarter of any year in temperature control is almost entirely comprised of customers placing preseason orders, getting their stocking levels where they want them in preparation for the season. Therefore it's more about how they ended the previous year than how they did in the quarter itself.

To remind you, 2016 was a very hot summer and as a result customers ended that year light on inventory. They therefore bought very heavily in the first quarter of 2017 to get back to where they wanted to be. This cycle did not repeat this year.

After a cool summer they ended 2017 with higher inventories and therefore placed lighter preseason orders this year. We anticipated this and addressed it on our last earnings call. The first part of the second quarter tends to also be largely preseason orders.

That said, in this division the sales all occurred in the late spring and summer and are based on the temperature, so time will tell how 2018 will turn out. Our gross margins in Temperature Control went backwards in the quarter for a related reason. When we saw demand softening last year we throttled back our production in our plants.

This caused an under-absorption of fixed costs. This too was discussed in our last earnings call. This is now behind us and now that all of our production is in low-cost countries, either in our plant in Mexico or in our 2 joint ventures in China we expect to return to profitability and expect this to be a solid year overall.

Speaking of these joint ventures let me spend a minute talking about FGD. To remind you, FGD is not a new company rather it is a well-established manufacturer of air conditioning compressors and a long-standing major supplier of ours in which we acquired a 50% stake last November.

It's obviously still quite new to us and we are still learning but thus far we're delighted with what we've seen. It's an excellent plant, very high quality, quite automated with a terrific management team.

It has excellent synergies with our plant in Reynosa where we tend to make complimentary products with the ability to seek the best location on a part-by-part basis. And what we are perhaps most excited about is the potential for sales into the fast-growing Chinese market.

They have made nice inroads with a few vehicle manufacturers there with solid opportunities for expansion. There are also strong synergies with our other joint venture Gwo Yng. They're located in the same city, Foshan, and have complementary air conditioning products. So again it's early but we are excited and welcome FGD into the SMP family.

So in closing, we continue to have a strong place in a strong and healthy market and while there are some short-term issues we're dealing with the fundamentals have not changed. And once these short-term issues are behind us we'll be stronger than ever and as such we remain very excited about our future.

With that I will turn it back over to the moderator and we'll open it up for questions..

[Operator Instructions]. We'll take our first question from Christopher Van Horn with B. Riley..

This is Dan Drawbaugh on the line for Chris and I appreciate you taking our questions.

So just to start, you mentioned that your customers were seeing sort of low single-digit -- in engine management low single-digit sell out trends, can you give us a sense of how that trended through the quarter and maybe what you've seen so far in the second quarter?.

Sure, actually we saw month-over-month improvement throughout the quarter. January frankly was pretty soft, February and March came back and we've seen that trend continue and into April. So we're pleased with what we've seen so far this year in Engine Management POS sales..

And then following on that.

What is your sense from customers about their satisfaction with their stocking levels? I think in the -- in the recent quarters destocking sort of from a high level has been something of a headwind to aftermarket suppliers and I'm curious to know what you're seeing from your customers specifically on Engine Management there?.

Sure. What we have seen, we didn't have, as you've been hearing about, destocking, we did not have that situation, but it was similar in that the change in our sales had to do with our customers selecting their inventories.

But ours more had to do with a few of our customers last year placing larger-than-typical orders, so it's more of an increased stocking last year that has not repeated. So now that that has happened, what we have seen is that the inventories for the most part have really stabilized.

It's important to note that we work closely with all of our major accounts on category management, helping them to tailor their inventories very specific to locations so to make sure that they have the right mix in the right spot, and so there's an ongoing work that we do with them.

But what we've seen really is that the increase in stocking that happened last year stabilized them where they want to be and we believe that that has led to some of the improvements in new POS..

And then last one for me, you're guiding wire and cable to be I guess down in that 6% to 8% range, that follows an organic decline in 2017 as well as in 2016, I'm just curious what your thought process is around when that business can stabilize and what level that might be stable at?.

Speakers is there a response?.

Keith, are you able to hear us?.

I can hear you now, we could not hear you before..

All right--.

Repeat that question --.

Yes, I will repeat the answer. We are hearing from Dan what the long-term forecast is on the wire and cable business.

So if you already heard this, hear it again, if it was -- if we were cut off the answer to that Dan was that it is a -- it's not going to, we don't expect it to stabilize, it is just a product category that has largely been engineered off of vehicles, there are still some new vehicles being sold with ignition wires in it but for the most part it's in decline and we expect that trend to continue..

We can go next to Scott Stember with C.L. King..

Eric, you made a comment that it sounds like those headwinds in Engine Management have continued into the second quarter.

Were you alluding to the fact that last year in the second quarter that you still had some customers that were buying heavily or is there something else going on?.

No, that's exactly right, Scott. There was a couple of accounts that had been placing these pipeline orders. It took several months to fulfill them because they were fairly large. If you exclude that dynamic the other accounts actually are really up from last year.

So, yes, that strictly has to do with a year-over-year comparison of pipeline orders and the sell-through has been pretty consistently up for all of our accounts this year..

And you also said that it seems as if I guess that those inventory are in balance now, so would you say that shortly that we should start to see that I guess the order starting to pick back up particularly if you're sell-through rates are seemingly accelerating?.

The best I can say on that is that costumer POS does tend to be a bellwether of what we see in the future, but we'll wait and see. They're selling through at a better rate than they were a year ago so we hope that bodes well..

Okay, and on temperature control. Obviously last year record preseason orders, this year very, very difficult comparisons.

Assuming a moderate, just a normal summer how do you see the inventory situation at your customer levels for temperature control products now as we are working our way through the second quarter?.

That's a good question, Scott. They for the most part, and again when I speak of customer POS or customer inventory, it's not necessarily the entire universe out there, it's several of our major accounts we have access to and we use that to kind of extrapolate out.

What we have seen is at the end of the first quarter our major accounts were still a bit higher in inventory than they were at the end of the first quarter in 2017. So we believe that the preseason softness continues a little bit into the second quarter. And frankly April was pretty cool.

But April is typically still not an air condition month, a lot's going to depend on what happens over the next couple of months. And over the third quarter we're pleased to see that it's finally gotten to be warm here in the northeast.

And predictions are that it's going to be a warmer summer than last year but who knows what -- how to predict the weather..

Just a last question.

I think it'll be good for us just to have a reminder, particularly since the last year plus has been hampered by all these costs mainly related to what's going on in Mexico but can you just again remind us outside of the inefficiencies which are hard to quantify maybe just talk about the onetime costs that occurred notably in 2017 and in the first quarter of '18 that go away.

So just so we get an idea of the amount of leverage, sales leverages that you're going to gain back over the course of the next 18 months..

Yes, hi Scott, this is Jim Burke. Yes, the -- all these costs are repetitive costs from running out of both, multiple locations, the one we're moving from in the case in Nogales or what was Orlando and even Grapevine if we go back into the discussion over 2017.

And then you have the added overhead cost from both locations and you're winding down, that's what generates all these costs and also inefficiencies. Part of the costs of setting up in the new locations which was very difficult was the hiring process, training and turnover as you work through and stabilize the workforce.

Probably the key is the gross margins where we'll see getting back and what we're saying, stating is that Engine Management we're targeting a get back to the 31%, 32% level and Temperature Control what we had previously said were 25%, 26% and that we would be able to have further benefits as we exit Grapevine.

So we feel confident moving towards the end of a year that we can recover to those margins. And then we have our regular day-to-day block and tackling for improvements with bringing in product -- product in-house to manufacture and low-cost sourcing..

But so the first quarter definitely saw a significant amount of those duplicative costs that you talked about, and it sounds --.

Yes, yes. And what we're saying is the key that Eric pointed out is that we now have at this point other than basically cleaning up we have the facilities, any remaining costs will be part of our restructuring cost until we -- the lease expires that we would have that's in there. And so it's just minor clean up that anything that we have in there.

The bulk of all that overhead costs and repetitive costs will be out of our operations..

Got it. And just last on the labor situation.

I know that was, added an additional headwind for you guys but has that stabilized?.

It continues to a degree. We still have a certain amount of hiring to do in Reynosa. Mostly, to remind you, mostly was affecting us not in our ability to hire people but our ability to train the brand new hires and so it was this repetitive hiring, training, losing them and starting over again.

We still have roughly 100 jobs or so to add down there, so we expect that you're going to continue to have a little bit of that churn but it's definitely, the worst is behind us and it's stabilizing..

[Operator Instructions]. We can go next to Bret Jordan with Jefferies..

Could you sort of give us some picture last year as far as when the temperature control business really fell out of bed. I mean it's obviously a mild summer but were there months that where the POS were significantly out of line with the long-term average? Just so we could sort of look at the cadence of this summer against last..

Really to looking at it right now, the -- all of last year tracks behind the previous year. Again the only meaningful months are really the hot months. But, yes, you're looking at once it came in to June or so, May, June it really fell off and continued that way throughout the balance of the summer..

So POS is entering in a easy comp about now..

Yes, within the next 60 days, 30 to 60 days, yes..

Could you talk about what you're seeing from an inflation standpoint just in your costs, materials.

Obviously you've had some labor issues and the expense side with things like the interests and vendor financing and maybe what you see as far as the pricing environment to your customers for the balance of the year whether you're going to pass them through?.

Okay, yes, hi, Brett, this is Jim Burke. Yes, we're experiencing what all the other companies are facing, see labor cost increases and fringe benefits that we have there. Commodity costs will experience many of the same increases there.

The one thing with our product offering, we don't have any single commodity that dominates anything either in Engine Management or Temperature Control and we have efforts underway with bringing, as I pointed out earlier, bringing in-house manufacturing and low-cost sourcing.

So we do experience and we are seeing costs and inflation within our business.

And with that is also the rising interest rates that you brought up and we see that twofold, that's one on our borrowings that we have, so we see it in interest expense but also in our SG&A expenses as part of the [indiscernible] fees, that's more tied to the LIBOR rates that are there.

And all of these input costs that are increasing you correctly bring up about our pricing and I think I'll ask Eric to speak to that..

So we continue to be in a competitive market, so price increases are always somewhat tough to come by.

But we think that really after several years of essentially no pricing at all we're finally entering a more favorable environment, a more inflationary period and so we are hopeful that we're going to be able to get some price increases during and cover some of these inflationary costs that Jim is speaking to..

And then one quick final, I think a couple of other suppliers have talked about customers managing down inventory levels, obviously not just as you are comparing against a tough sell-in.

Are you seeing any of the primary retailers doing anything dramatic as far as just inventory reduction strategy?.

No, not with our product categories..

Our next question comes from Kyle Cavanaugh with Palisade Capital..

So I understand a lot of the duplicative costs are being eliminated and that should help margins going forward.

Just looking at the quarter it seems like there was a fair amount of sales being leveraged that wasn't expected out there as well and I was wondering going forward do you expect continuation of some sales deleverage in the second quarter? It sounds like with the comments around Engine Management there might still be some there.

So just trying to gauge the cadence of the remaining three quarters of the year on the margin expansion..

Right. And there is two points in there Kyle, I think to your question.

So one on the sales piece, Eric pointed out that, yes, we will see a little bit of headwinds there with the inventory levels that we had within Temperature Control, but we're expecting that production levels will balance out, we're absorbing the remainder of the inefficiencies in the balance of 2018 and we fully expect that the margin improvements will go back and return to our historic levels that we were able to achieve which again are 31% to 32% within engine management and upwards to 25%, 26% or better within Temperature Control..

So do you see sales leveraged by the end of the year?.

We'll get leverage of sales especially in our second and third quarter on SG&A while I did point out that we'll have increased absolute dollar spend in SG&A with the sales increase and our volume there, yes, we will get a leverage on that SG&A as a percent of sales..

[Operator Instructions]. We'll go next to Carolina Jolly with Gabelli..

Just one to kind of follow up on the inflationary environment that you mentioned.

Can you kind of talk about your historic ability to push those prices through, anything you're seeing currently which I do know you touched on briefly and then what factors might affect your ability to do so?.

Historically, as I mentioned a few minutes ago, we have really been dealing with our costs internally through our own margin improvement cost reduction type programs. And historically it was more of a struggle to get any price increases through.

We're always in negotiations with all of our customers, so I can't really get into any of the specifics, but we do believe that there's probably more of a general appetite out there at this point to see some inflation, and so that's what we're hoping we're going to be able to take advantage of..

It appears we have no further questions at this time. I'll return the floor to you speakers for any additional comments..

Okay. That concludes our call. Thank you very much for attending..

Goodbye..

Thank you..

And this will conclude today's program. Thanks for your participation. You may now disconnect..