Lawrence Sills - Executive Chairman James Burke - Executive Vice President of Finance and Chief Financial Officer Eric Sills - President and Chief Executive Officer.

Matthew Paige - Gabelli & Co. Inc. Matthew Sherwood - Cooper Creek Partners Christopher Van Horn - B. Riley FBR, Inc..

Good day, everyone, and welcome to the Standard Motor Products Quarter Two Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note, this call maybe recorded. It is now my pleasure to turn the call over to Mr.

Larry Sills, Executive Chairman. Please go ahead..

Well, good morning, everyone, and welcome to our second quarter conference call. And we thank you for taking the time to attend. Here from the Company is Eric Sills, President and CEO; Jim Burke, Executive Vice President and CFO; and myself, Larry Sills, Executive Chairman.

Our plan for this call is we'll begin with Jim, who'll review the second quarter financial results; then Eric will go into certain of these subjects in more detail. And then, we'll open for questions. So with that, let's get started. So we'll start with Jim..

Okay. Thank you, Larry, and good morning. 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. All right, to begin, looking at the P&L. The consolidated net sales in Q2 2018 were $286.6 million, down $26.1 million or 8.3%.

And for the first half 2018, sales were $548.5 million, down $46.6 million or 7.8%. I'll provide the segment sales breakdown, and Eric will provide additional color based on the customer prior year pipeline orders and POS data. Engine Management net sales in Q2 2018 were $203.4 million, down $19.9 million or 8.9%.

Within Engine Management, our wire and cable net sales, reflecting 20% of the mix in Q2, were down $4.3 million or 9.5%. The balance of Engine Management sales, excluding wire, in Q2 were – down $15.6 million or 8.8%. Engine Management net sales in the first half 2018 were $402.9 million, down $31.7 million or 7.3%.

Wire and cable sales were down $12 million or 13.2%, and the balance of Engine Management sales were down $19.7 million or 5.7%. As stated earlier, Eric will expand further on our sales results. Temperature Control net sales in Q2 2018 were $80.4 million, down $7 million or 8%. In the first half, were $140.6 million, down $17.1 million or 10.8%.

Eric will elaborate further on the temp control sales. Consolidated gross margin in Q2 2018 was 28.4% versus 29%, down 0.6 points, and for the first half, was 28.1% versus 29.4%, down 1.3 points. By segment, Engine Management gross margin in Q2 2018 was 28.4% versus 29.4%, down one point, and for the half, 28.4% against 29.8%, down 1.4 points.

The Engine Management gross margin improved 10 basis points from 28.3% in Q1 to 28.4% in Q2. We expect accelerated margin improvement as we progress into the second half of 2018. Temp control gross margin in Q2 2018 was 25.9% versus 26.4%, down 0.5 points, and for the half, was 24.5% versus 25.9%, down 1.4 points.

As we discussed in our last Investor Call, the Q1 margin at 22.7% was burdened from lower production levels at the end of 2017. As production levels normalized going into 2018, our Q2 margins rebounded to 25.9% within our targeted annual range.

Consolidated SG&A expenses in Q2 2018 were $57.8 million, a savings of $2.6 million and 20.1% of net sales, and for the half, were $115.5 million, again, a savings of $2.3 million at 21.1% of net sales. SG&A variable expenses were reduced based on lower sales volumes in the quarter and year-to-date.

In addition, spending was curtailed for all controllable expenses. Consolidated operating income before restructuring and integration expenses and other income net in Q2 2018 was 8.2% of net sales, down 1.5 points, and for the half was 7% of net sales, down 2.6 points.

We anticipate operating margins to improve into the second half from higher gross margin percentages and SG&A leverage on higher sales.

The net effect of our operational performance as reported on our non-GAAP reconciliation was Q2 2018 diluted earnings per share of $0.74 versus $0.81 last year and for the six months, diluted EPS of $1.20 versus $1.54 in the first half of 2017.

Looking at the balance sheet, accounts receivable increased $33.8 million since December due to the seasonality of our business but decreased $13.9 million versus June last year on lower sales volumes. Inventories increased slightly from December levels but reduced $9.4 million versus June of last year.

Unreturned customer inventory of $18.2 million reflects our review of the revenue recognition pronouncement, recording anticipated customer returns at gross and recognizing inventory held at customers. Our total debt at June 18 was $93.7 million, an increase of $32 million against December 2017 to fund our seasonal working capital needs.

Our cash flow statement reflects $4.2 million cash from operations as opposed to a $6.8 million use of cash for the six months 2017. Cash from operations will significantly increase in the second half as our seasonable receivables are collected by year-end.

Investing activities reflected $19.9 million use of cash for capital expenditures and China joint-venture funding. Financing activities included dividend payments of $9.4 million and share repurchases of $7.6 million. We still have available authorization to repurchase an additional $17 million.

In summary, while disappointed with the first half results, we feel the tide has changed and anticipate improved sales and margins going forward. Thank you for your attention, and I'll turn it over to Eric..

April and May are still preseason, where customers are positioning their inventories, and then June sees the beginning of the selling season. As we stated on our first quarter call, we expected continued headwinds due to a combination of record-setting preseason orders in 2017, and customers ending the year with above-average inventories.

This was then compounded by a cool wet spring. However, in the second half of May, the country began to see heat, which continued through June, and our customers saw extremely strong POS gains, which in turn, triggered heavy replenishment orders to us. We are able to ship some of this surge in the quarter, with the balance rolling into July.

The heat has continued, orders have remained strong, and we're optimistic about a solid third quarter. Lastly, I'd like to spend a minute talking about the recent tariffs and the anticipated impact. As of July 6, the first tranche of the so-called Section 301 tariffs have taken effect.

And several of our product categories in both divisions were affected, although the larger impact was in Temperature Control. We've been in contact with our customers, and it is fully expected that we will pass this cost through.

It's worth noting that while we do import a substantial amount of product from China, we also have a significant North American footprint, which we think will help us in the long run. So in closing, we are obviously disappointed in the year thus far, but do believe that the issues are clear, and they are either timing-related or temporary.

And with the ongoing favorable dynamics of the industry and our strong position in the market, once we get these relatively short-term issues behind us, we are optimistic about the balance of the year and the future as we enter our 100th year. So with that, I will turn it back to the moderator, and we will open it up to your questions..

[Operator Instructions] And we will take our first question from Matthew Paige from Gabelli. Please go ahead. Your line is open..

Good morning. I just wanted to touch a little more on Temperature Control.

Do you think your customer's will look to carry less inventory into the New Year than they did in 2017? Or do you think there is room for more restocking activity from them?.

Our expectation is that they should end 2018 lighter on inventory than they ended 2017. They ended 2017 heavy not by choice, but by the soft selling season. And so that was really what created the headwinds coming into 2018.

Due to the strong summer that we've been experiencing and the expectation, hopefully, that it will continue, we would assume that they would end this year lighter on inventory than they ended last year, which will then impact 2019 preseason orders.

So as you can see, you have this year-over-year compounding effect of preseason orders followed by what happens within the season and so we can only anticipate, but we would expect that they should enter 2019 lighter than they entered this year..

Okay. And then, my second question. I wanted to touch on margin. You noted some of the older business is rolling off as the installed base shrinks and new business, obviously, having a lower margin. You've done, historically, a good job in continuing to invest in new products.

Why is this more of a pressure now on margin than it has in the past as the old products roll off and the new products ramp up?.

I'm not sure if it's necessarily that substantially different in the past. Perhaps there is a slight acceleration in the shift, there's a life-cycle shift in our product portfolio. But there's really nothing new about it. This is just how it's worked, really, forever.

As we add new items, they typically come in at a high cost, and then as the demand starts to pick up, they work their way into our engineering queue and we tool them and bring them in-house for substantial savings. It may be happening slightly accelerated from the past. We have stepped up our investments in engineering talent and CapEx to address it.

And so we think that we will be able to get caught up. So we're not concerned with it..

Okay. I appreciate the time. Thanks for answering the questions..

All right. Thank you, Matt..

Our next question comes from Bret Jordan from Jefferies. Please go ahead. Your line is open..

Hey, good morning. This is Ethan on for Bret. Thanks for taking our questions. Just back to the tariffs.

What products are impacted most? And does your lower exposure in China position you to potentially gain share from competitors?.

Well, as mentioned, Temperature Control division is hit harder, and specifically, within it, the largest part of it that could get caught in the net of this first round of 301 tariffs, is the compressor, which is really the heart of the air-conditioning system.

If you look at our portfolio, first of all, a full third of the compressors that we sell, are remanufacturing, which is kind of unique for us. Most of our competitors only have new compressors. So a big chunk of what we do is reman and that was not affected.

And then if you look at the new compressors, the majority of what we sell, we manufacture ourselves in Mexico, and again, it is safe. So now you're down to the smaller part of our compressor business that is affected. And we believe that the fact that we do have less exposure to China than perhaps the rest of the field can be helpful in the future..

Okay, great. Thank you.

And then just with regard to the Engine Management, the sell-through, do we expect that to continue moving into next quarter, the strong sell-through?.

We would hope so. We're seeing and you are hearing this from our trading partners as well that they are pretty optimistic that this year is continuing to be pretty strong overall with year-over-year sell-through gains. We've seen a nice trend quarter-to-quarter so far this year. So we're optimistic it'll continue..

Awesome. Great, thank you. And then finally, just with regard to Temperature Control. If we see the heat continue over into July and the warmer temperatures, how should we think about selling just with regard to third quarter? Not year-end, I know you mentioned that you expect inventory to come down year-on-year..

Right. This is Jim Burke. And again, we don't comment on future periods and warn looking at quarter-over-quarter or even monthly. But the key is, the season is hot. It's continued from June into July, so as Eric pointed out earlier, we believe we'll have a good, strong third quarter for Temperature Control..

Great. Thank you for taking our questions..

You are welcome..

Our next question comes from Matthew Sherwood from Cooper Creek. Please go ahead. Your line is open..

Hey guys.

How are you doing?.

Good morning, Matt..

Good. So just had a quick one on the SG&A that was – you had sort of expected it to be in the $62 million range, and it was a lot lower than that.

How much of that is sort of sustainable cost savings versus reversal of bonus accrual, or just something like that that's more short-term in nature? And what are your expectations for the balance of the year?.

Right, yes. This is Jim Burke, Matt. Again, it is isolated, really, to the quarter. So sales were down. So our draft fees would be down also that we would have there. We curtailed wherever we had controllable expenses. We reduced incentive comp expenses. So again, for a range, this is probably two quarters of being in the $57 million range.

And I had said it was up to $62 million. If we get stronger sales, it'll scale up again. Maybe the $62 million is still on a high-end mark, but between the lower $57 million and $62 million..

Okay.

But if the sales just stood on weaker side, you think that this is a sustainable number?.

Yes. So again, significant expenses that are in there, I mean, there are at about annual numbers of about $200 million, one other $255 million $240 million that's in there. But yes, I can't speak quarter-to-quarter, a number of variables going on here.

But sales, usually, again, third quarter would be our higher sales, higher SG&A, and then scaling in back again in the fourth quarter, when sales are down, we're out of the Temperature Control season..

Great. Thanks a lot Jim..

All right..

Thank you, Matt..

Our next question comes from Christopher Van Horn with B. Riley FBR. Please go ahead. Your line is open..

Good morning. Thanks for taking the questions..

Good morning, Chris..

So let me just make sure I understand correctly, as the gradual decline of the wire and cable, some of the maybe the legacy business is rolling off, are we pretty much done there? Or is there still more to come that you see in the future?.

Wire and cable, we expect that trend, that 6% to 7% or so, that's a long-term trend. It's a product technology that's largely been engineered off vehicles. It is still on some new vehicles, and we are fortunate to be getting some of those contracts. But no, this is just due to where it is in the life cycle. It continues along those lines..

Okay, great. Thanks. And then, it also sounds like the benefits that you're going to see from some of the plant moves, you're pretty close to kind of starting to see the opposite trajectory of having to spend and build that up.

Is that the right way to think about it? Are we going to start – do you think maybe by the end of this year, we're at full benefit of those plant moves? Or is there any timing you can give us?.

Yes. This is Jim Burke, Chris. We're expecting to see, over the second half of 2018 now, incremental improvements and stepping up. So we add 2 quarters in there at roughly to 28.4%. So we feel we're moving up against that. Now our long-term target there is 31% to 32%.

And we feel that the bulk of the plant move integrations will be behind us as there a little carryover that goes into the beginning of 2019 because of FIFO inventory, maybe a little bit. But going into 2019, we're targeting to be improvements and I would have to scale it at that 30% to 31%. And then at longer-term, moving back upwards to 31%, 32%..

Got it. Great. Thanks for that color. And then on the ADAS product line here, you've essentially doubled your part count over the past couple of months.

And I'm just curious where you see that product line going, obviously, more and more cars will have this technology, but where you kind of see that going? And then what – have you seen sort of the sell-through begin on those part categories? And how that's kind of – how is that tracking?.

Yes, we have had a big push in adding coverage in some of these categories such as, for those – others on the call may be less familiar, such things as lane departure systems and adaptive cruise controls, some of the active safety components. It is still very new technology. So the failure rates are quite low.

We have been expanding our offering because we feel that there are benefits to being first to market and getting the shelf space for when it does take off. But as of now, it's still low sales. We hope that it will become a strong category, and we believe it is in our wheelhouse as the guys who expected to be the ones who have sensor coverage.

And so that's why we're positioning ourselves. But as of now, it's still small..

Okay, and that was my next question. You do believe you're kind of first to market here because I have not seen some other suppliers get into this area..

Well, we're not alone on the shelves, but we are out there with – I would say, best-in-class offering..

Yes, okay. And then final from me. Just a little bit of uptick in CapEx.

Could you give any more details there of what that was from? And then any sort of outlook of what you're thinking for CapEx going forward?.

Yes. This is Jim Burke again. Yes, we have said on our prior calls that we're scaling up the CapEx. These are opportunities as investing. And the newer technologies, they cost more than we're getting into. So we're probably on the range of $25 million for this year or plus.

Some of it was capacity related with our plant moves and integrations that we had this year. But this is one of our capital allocations that we're investing in the business. But probably, in the $25 million range should be more of a norm on an annual basis..

Okay, great. Thanks so much for the time..

Thank you, Chris. End of Q&A.

[Operator Instructions] And we do not appear to have any questions at this time..

Okay, then. Thank you very much for attending. This concludes our second quarter conference call. Thank you very much..

On behalf of our client, I’d like to thank you for joining us. This concludes our presentation..