Lawrence Sills - Executive Chairman James Burke - EVP of Finance and CFO Eric Sills - President and CEO.

Scott Stember - CL King & Associates Daniel Drawbaugh - B. Riley FBR, Inc. Bret Jordan - Jefferies LLC Robert Smith - Center for Performance Investing Matthew Sherwood - Cooper Creek Partners.

Good day, everyone, and welcome to today's Standard Motor Products' Third Quarter Earnings Release. 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 that this call maybe recorded.

It is now my pleasure to turn the call over to Larry Sills, Executive Chair. Please go ahead..

Good morning, everyone, and welcome to Standard Motor Products third quarter conference call, and we thank you for attending. Here from the company, we have Eric Sills, President and CEO; Jim Burke, Executive Vice President and Chief Financial Officer; and myself, Larry Sills, Executive Chairman.

Our agenda for the morning, Jim will begin by reviewing the numbers; then Eric will go into a few subjects in some more detail. And then, finally, we'll have question-and-answer period. So again, we thank you for attending and let's begin. We'll start with Jim..

Okay. Thank you, Larry. As a preliminary note, I would like to point out that some of the material we will be discussing today may include forward-looking statements regarding our business and expected financial results. When we use words like anticipate, believe, estimate or expect, these are generally forward-looking statements.

Although we believe that the expectations reflected in these forward-looking statements are reasonable, they are based on information currently available to us and certain assumptions made by us, and we cannot assure you that they will prove correct.

You should also read our filings with the Securities and Exchange Commission for a discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements. Okay. Looking at the P&L, consolidated net sales in Q3 2018 were $296.6 million, up $15.6 million or 5.5%.

And for the nine months were $845.1 million, down $31.1 million or 3.5%. By segment, Engine Management net sales in Q3 were a $197.6 million, up $0.8 million or 0.4%. Our Wire and Cable sales in the quarter were down $2.8 million or 6.7%. Other Engine Management sales excluding Wire and Cable in the quarter were up $3.6 million or 2.3%.

Our year-to-date Engine Management sales as we stated previously and highlighted in our release, was up against large pipeline orders placed by a few customers in the first half of 2017. For the nine months 2018, our Engine Management sales were down $31 million or 4.9%. Engine Management sales without wire, were down $16.2 million or 3.2%.

Eric will provide additional commentary on the sales shortly. Temperature Control net sales in Q3 were very strong. In the quarter, Temp Control sales were up - were $96.1 million, up $14.9 million or 18.4% and year-to-date were $236.7 million, down $2.2 million or 0.9%. Consolidated gross margin in Q3 was 29.4%, matching last year's level.

And for the nine months year-to-date was 28.5% versus 29.4%, down 0.9 points. By segment, Engine Management gross margin in Q3 was 28.9%, down 0.5 points against last year, but up 50 basis points versus Q2 2018. And year-to-date, the gross margin of 28.6% was down 1.1 point versus the nine months 2017.

We are pleased with the 50 basis point improvement over the prior quarter as we continue to make strides in our wire consolidation. Temperature Control gross margin was very strong at 27.6%, reflecting continuous improvements throughout 2018. Year-to-date, Temp Control gross margin was 25.8%.

The warm 2018 summer season improved production levels and bodes well for a good start entering the 2019 season. Consolidated SG&A expenses in Q3 were $60.1 million, an increase of $5.2 million and year-to-date were a $175.6 million, an increase of $2.9 million.

The bulk of the SG&A dollar increase in Q3 and year-to-date were incurred in our Temp Control business. Eric will expand on this further. Consolidated operating income before restructuring and integration expenses and other income net in Q3 was $27.2 million, 9.2% of net sales against $27.6 million, 9.8% of net sales in Q3 2017.

For the nine months, the same operating income was $65.6 million, 7.8% of net sales against the prior year $84.6 million, 9.7% of net sales. More positively, during 2018, our operating income leverage has increased sequentially from 5.7% in Q1 to 8.2% in Q2 and now 9.2% in Q3.

The net effect of our operational performance as reported on our non-GAAP reconciliation was Q3 2018 diluted earnings per share of $0.83 versus $0.74 last year and for the nine months diluted EPS of $2.03 versus $2.28 for the nine months 2017.

Looking at the balance sheet, accounts receivable was a $163.3 million, up $23 million against December 2017 due to seasonality and essentially flat against September 2017 levels. Inventories at $318.4 million were down $8 million against December and down $14 million against September 2017 levels.

Unreturned customer inventory of $21.3 million reflects our review with the revenue recognition pronouncement, recording anticipate customer returns at gross and recognizing the inventory held at customers.

Total debt at September was $51 million and the decrease of $10.8 million from December and the decrease of $22.1 million from September 2017 level. Our cash flow statement reflects $67.6 million cash from operations for the nine months 2018 versus $36.8 million cash from operations for nine months 2017.

The primary driver of the roughly $31 million improvement was favorable change in inventories as our 2017 reflected bridge inventory builds during our facility moves. Investing activities reflected $25.4 million use of cash or capital expenditures and China joint venture funding.

Financing activities included dividend payments of $14 million, share repurchases of $9 million and debt pay down of $10.5 million. In summary, we are pleased with our third quarter results. Sales were very strong led by Temp Control of 18% and an increase of 2.3% for Engine Management excluding Wire and Cable.

Gross margin was very strong in Temp Control and Engine Management reflected a 50 basis point improvement over the prior quarter, primarily from savings from our wire consolidation. And finally, our cash flow is very strong and the balance sheet is very healthy state. Thank you for your attention, and I'll turn it over to Eric..

Thank you, Jim, and good morning, everybody. As Jim has expressed, we are pleased with the quarter. The first half of the year saw some challenges as we were down in both sales and profits.

But on our last call we explained that these first half results were attributable to events that were either temporary or timing related, and that we expected to see improvements going forward. As anticipated, the third quarter rebounded nicely. I'll review the business by operating divisions starting with Engine Management.

As you have seen, we have begun breaking out Wire and Cable separate from the rest of the product categories in the division as they have different trajectories. Our Wire and Cable product line was down 6.7% for the quarter. As we have previously discussed, this category is an older technology and we can expect this type of gradual decline.

Meanwhile, the balance of our Engine Management business increased 2.3% over last year, which meets our stated expectations of low-single digit growth. Year-to-date, our sales in the non-wire portion of the Engine Management is down 3.2%.

But to remind you, a few of our customers placed large pipeline orders in the first half of 2017 as they sought to broaden their inventory assortment and this did not repeat this year and this made up the entirety of the year-to-date shortfall. Now that we have lapsed this, we expect more normalized year-over-year comparisons.

It's worth pointing out that our customers' sell-through of non-wire business has shown nice gains over the course of the year with the third quarter coming in at mid-single digits over last year. This was a good sign for us as our customer PLF tends to be a leading indicator of their future purchases from us.

Our Engine Management gross margin showed some improvement in the quarter, up 0.5 point from the last quarter. As we have been reporting, our margins have been adversely impacted by the integration of the General Cable operation into our plant in Reynosa, Mexico.

This has been a major task requiring the adding of over 400 employees and all of the cost associated with the inefficiencies of training new people. We are now starting to see improvements in the operation as our new employees come up to speed and this is reflected in our numbers.

As discussed on previous calls, the other trends impacting our margins is related to a shift in product mix. While older technologies like Wire and Cable are in decline, we are seeing an increase in sales in newer product categories. 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. In the near-term however, this is a drag on our margins as our profitability on new products tends to be lower than legacy products as we have yet to tool them or find lower cost sources.

We have a solid track record in these cost reduction activities, so we are confident that in the future we will achieve our typical margins. So overall, while we remained behind the last year, the margin trend is positive and we believe we will continue to see incremental improvement going forward.

Turning to Temperature Control, as expected, sales were very strong in the quarter. However, the first half of the year was well below 2017, and therefore, year-to-date we are down slightly. There are a few dynamics that work here.

Needless to say, air conditioning is a highly seasonal business with the majority of the sales happening in the summer, but it is also a weather-dependent business, meaning that not all summers are created equal and what happens in the season creates a great deal of volatility in other quarters as customers adjust their inventories in response.

Therefore to tell the story, I need to go back to 2016, which was a very warm summer. As a result, our customers entered 2017 light on inventory and bought very heavily in the first half of the year as they prepared for the season. But the summer never got hot and they ended 2017 with excess inventory.

So, the first half of this year their orders were very light, especially as compared to their enormous first half of 2017. Now the cycle will start again. This hot summer has brought down their inventories, so we expect next year's pre-season orders to be robust.

While these dynamics caused a great deal of volatility quarter-to-quarter as our customers rationalize their inventory, it is perhaps more telling to consider their sell-through. For the year, their POS is up in the high single digits, which compared to flat purchases from us provides some indication of what could happens next year.

Temperature Control gross margin in the quarter improved nicely. We are pleased with what we have accomplished here having completed all of our plant moves as we now have the vast majority of our Temp Control production in low cost regions.

As pointed out in our press release, the one down spot in divisional performance was in SG&A where we basically negated the majority of the gross margin gains with increased distribution costs. There were two things that play here.

First, due to the serge and requirements in a concentrated time frame, we needed to add significant labor costs to meet demand. This was compounded by a tight labor market especially for seasonal workers. Secondly, in early 2018, we installed new automation in the warehouse.

And with the early start of the season, if you recall the heat came very early this year, we were forced to run at rather inefficiently throughout the season. We fully expect to have this new system optimized by year-end and to be ready for next season.

And not only will it allow us to be more efficient, it will greatly reduce our need for seasonal labor increases. Lastly, I'd like to provide an update on the impact of the Chinese tariffs. As you know, they are now in effect three tranches of product categories covering $250 billion in U.S. imports.

We have products in all three tranches across both of our divisions. As we informed you on our last call, we will be passing this on to our customers and expect minimal direct impact on us.

It's worth noting that while we do import a substantial amount of product from China, our larger footprint is in North America, likely more so than many of our competitors. We therefore are less reliant on China than others, which we think will help us in the long run.

In closing, while the first half of the year had various challenges which continue to be a drag on our year-to-date performance, the third quarter saw some of those issues sunset with others showing real signs of improvement.

We obviously still have a lot of work ahead of us, but we believe that once we get these relatively short-term issues behind us with the ongoing favorable dynamics in the industry and our strong position in the market, we are optimistic about the balance of the year and the future as we enter our 100th year. So, thank you.

That concludes our prepared remarks. With that, I will turn it over to the moderator and we will open it up for questions..

Certainly [Operator Instructions] And our first question comes from Scott Stember with CL King. Please go ahead..

Good morning, guys..

Good morning, Scott..

Can you just take a step back and talk about the broader market, obviously we're seeing some very strong recovery in the automotive aftermarket, a lot of talk whether it's weather or car park. Can you maybe just from your perspective what you're hearing from your top customers, what's driving that.

And if it's just weather, should the car park be a nice additional tailwind for 2019?.

I think it's perhaps helpful to look at the two divisions separately because there are some slightly different dynamics. Obviously on the Temperature Control business is entirely about the weather. And so, I don't need a go over what I've discussed in my prepared remarks.

We do think that this will help us into next year due to the inventory levels out there. Engine Management, you know this is just kind of steady Eddie marching on where we do talk to our customers and we're seeing it in their earnings releases.

Yeah, there seems to be a little bit of a strengthening of the market out there whether it's the basic dynamics of the car park, those are continuing to be favorable as it relates to the age of the vehicles, miles driven and so on.

I just think that it's - we're seeing a slight improvement, but these things they could be cyclical, anything can happen quarter-to-quarter, year-to-year. On the long run we see it's just going to march along in the low-single digits, right now it's maybe perhaps a little bit on the higher side of that..

Got it. And maybe just a little more granularity on the tariffs, you might have given this on the last call, but I remember the percentage of stuff that you have coming from China.

And secondly, when you're passing these with these price increases through, it sounds as if the discussions with your top customers, I guess they understand and they had accepted it and there hasn't been any headwind on that front..

First of all in terms of the amount of our products that are coming from China, we don't disclose specifics there, but it is the smaller part of what we do, it's the minority of what we do as explained. We're much more here in Mexico, U.S., Canada, Poland. So, while we do have a lot coming from China, it's the minority.

As it relates to passing them through, yes, we have been in discussions with all of our customers. They are accepting them, you are hearing on their calls that they are planning on passing them through as well. So, we're really not seeing the pushback, we see it all going through..

All right. Just lastly on the factoring side, with interest rates going up you didn't mention it as a headwind, but just trying to figure out how that all plays in with pricing going forward and what you're seeing the impact on the numbers? And that's all I have. Thank you..

Okay. Hi Scott, this is Jim Burke. Yeah. So, on the interest rates we're impacted on the draft fees and on our borrowings. On the borrowings, our debt levels are very low; we have a healthy balance sheet. So, $50 million of that would be exposed any slight interest rate increases. The bigger picture is on the draft fees that you point out.

Yes, we would incur the increases there. But similar to any other commodity cost, inflation pressures that we're having, these costs would be pushed on to our customer base..

Got it. Thank you..

Okay..

Thank you..

And our next question comes from Christopher Van Horn with B. Riley FBR. Please go ahead..

Hi. This is Dan Drawbaugh on the line for Chris. Thank you for taking our questions. So, just to start, can you talk a little bit more about one of those last remarks you made on China that some of your competitors source a bit more product from China.

Is that a specific product category, is that a specific segment, just what is the scope of the share gain opportunity that you might have because of that dynamic?.

It's very difficult to - it's very early in this to know if it's going to have impact on share gain. But with this - the tranche at this point really is the majority of our product categories are included in the tariff.

And so, if you want to consider couple of big categories on the Temperature Control side, the heart of the Temp Control business is compressors. Our compressors while we do have some coming from China from our own joint venture as well as other suppliers, the majority of what we're doing is coming out of our plants in Reynosa, Mexico.

Meanwhile, our competitors are much more China-based. On the Engine Management side, the biggest category affected is ignition coils, the largest category within Engine Management. Much of what's out in the marketplace is from China, whereas for us, the vast majority of our coil offering is from Poland.

So, these just give you a bit of an indication of the potential or benefit that SMP would had, but it's way too early to talk about any share changes..

Okay, understood. I appreciate the color. Sticking with Temperature Control, can you kind of breakdown those factors that you mentioned as increasing SG&A in that segment in the quarter.

How much of that increase was related to the start-up cost that presumably should roll-off the P&L after this automation program is fully launched and how much was the labor market if you can help with that?.

So, the - this is Jim Burke speaking again. On the Temperature Control SG&A impact, you could see that we were up approximately two points that was impacted in the quarter. So, if we - our expectation would be at a minimum to be able to recover and get back to where we were with other saving.

So, you could take that two point increase on the sales for the quarter. And again, the big increase was primarily all within the third quarter, there was a little bit in the second quarter. So, it's pretty much winds up being split there between half the volume is in the sales surge and the other half is in the inefficiencies..

Okay, great. That helps a lot. Thank you. And then last one from me. I know that you've talked pretty extensively about the ongoing roll-off of Wire and Cable and I think we all kind of understand that.

Can you remind us what the margin dynamic is going to be as that continues to roll-off? Is Wire and Cable - will that generally result in there being a more margin accretive mix in that segment or is it fairly neutral?.

Just to refresh everybody's memory there, when we acquired the wire business there, roughly a third of the General Cable wire business that we picked up was in this OE/OES arena.

So, what you see in that for the aftermarket you wanted to have slightly lower margin on OE mix there and lower SG&A and our operating profit leverage looks to be reasonably close there. Overall, we expect our Wire and Cable business to be neutral to match our overall Engine Management margins..

Okay, thanks. I appreciate the time..

You're welcome..

All right. Thank you..

And our next question comes from Bret Jordan with Jefferies. Please go ahead..

Hi. Good morning, guys..

Hello..

Hello Bret..

Hey, a question on the Engine Management new products, you're talking about the negative margin impact as you haven't tooled them up and in many cases you're buying them outside to distribute them.

Is there anything structural about those new products that once they were internal and you had improved the resourcing cost, they wouldn't hit the old Engine Management margins?.

A bit they should. Once we bring them in-house either in [indiscernible] or to low cost suppliers, they should match our margins on other things that we make or buy in lower cost regions. So, it's really just a matter of getting them into the queue and getting them tooled or resourced and then it normalizes.

Coming right behind them though of course is more new items and the pipeline goes on forever..

Right. And then in our Temperature Control, sorry, I mean obviously that was one of the primary categories tariffs back on the July rate. So, maybe you would see some share gains there.

Do you have an idea what your market share is in that space, how much is there to pick-up?.

It's pretty hard to measure. There is plenty of people out there, some who are full line, some who are doing pieces of it. It's difficult to quantify. But there - it's a competitive market out there; we're in there at customers of our competitors and doing what we can. Meanwhile, they are talking to our customers..

Right.

But it would seem that they are talking to your customers with a higher cost product, right? So, I mean I guess at some point you're the category manager for how many of the big four retailers?.

Most of them..

Okay, all right. Thank you..

Thank you, Bret..

And our next question comes from Robert Smith with the Center for Performance Investment. Please go ahead..

Hello, Robert..

Hi. Thanks for taking my question. My query is more long-term in nature. I was wondering if you could address the promise of the development of the Chinese automotive aftermarket and what kind of strategies you have to approach this. Thanks..

That's a great question, Bob. We right now are doing very little in sales in China. One of the main strategic reasons why we acquired or entered these two joint ventures in the region was not just to lower our cost with the North American market, but really as a beach head to sell into the region.

We right now are exploring how best to approach it whether it is the China aftermarket versus China OE. We're developing our plans. And we fully expect it to be able to participate in that fast growing market. I would say that the China aftermarket is still very, very young especially for our types of products.

So, while you have all these vehicles on the road, the average age of the cars in China is only 4.5 years.

So, right now the aftermarket that does exist in China is really maintenance related parts, filters, brakes, it's not getting into the our types of categories yet, but the car park is frankly just too young which may mean that our better avenue in is with OE where they are now selling north to 25 million cars a year.

One of our joint ventures what really attracted us to it FGD, the compressor plant; a good chunk of their business is selling compressors to Chinese vehicle manufacturers. So, we see really nice opportunities in the region. We have been putting resources there to pursue it.

And we'll report more as we have more to say, but we're excited about the potential there..

Yeah. I must admit you being a generational business yourselves, but it's good to look longer term and I'm encouraged to hear that you want to be an important player and are looking to expose more assets and company resources to that, it's a wise decision..

Thank you..

And our next question comes from Matt Sherwood with Cooper Creek Partners. Please go ahead..

Hey guys.

How are you doing?.

All right. Hello Matt..

Hello..

Nice quarter. Just had a quick question, just sort of looking at the gross margins of the different segments. I guess on TC, you've had a really good margin this year.

Do you see sort of further strength as we look forward? Do you guys still like update your ranges there?.

This is Jim Burke, Matt. We always - we're always going to be evaluating them. And again, this is - we're having a good season, I think the first quarter was down at 22% only because of the carry forward from the prior year, but we feel very good about the full year for 2018 and we'll address - and as we go into 2019.

The bulk of our manufacturing is in low cost for Temperature Control. We expect - our guidance there was 25 to 26 and we should easily hold that and we'll be reviewing it at the end of the year..

Okay. Then on EM, I guess like how quickly can we get back to that 30% sort of margin, you had a nice improvement sequentially.

Can we be there in the relatively near-term or does it take a little heavy lifting to get back there in light of the mix?.

Right. And all the points that we addressed so far, we're making improvements on the wire consolidation, our engineering efforts are focused on bringing product in-house to manufacture. We're basically coming close to the 29% margin levels. And it's going to be a step basis.

Going into 2019, my next hurdle will be let's get over to 30%, let's get up there and then I have to look at that 31% to 32% margin that I have there.

But I want to be able to get, I think if we're looking more short-term, the target is really for the 30% level to achieve, 30% to 31%, but we still have longer term focus that we think with our engineering efforts that we can still recover, but that's longer term out there.

But does that answer your question?.

Yeah, it's good. And then just on the SG&A side, I guess you said you run heavy this year, but on the other hand like in Q2 you were talking about [ph] bonusing and stuff like that that had been cut back a little bit.

I guess like does SG&A grow over the next year or do you think you can offset some of the growth with some of the productions in seasonal lever et cetera?.

Yeah. Kind of summarizing the SG&A that's there, yeah, we curtailed a lot of our spending in the first half and throughout the year because of the impact that we had on sales against last year and compensate - incentive compensation we tailored back. However, we did have the inefficiencies we talked about in Temperature Control.

So, to some degree they're going to be offsetting. We expect fully to be able to reduce Temperature Control inefficiencies, but then I'll be faced with some inflationary costs that will be going up into next year.

Where we really can gain on this is if we can get leverage on sales for our organic sales if we can pick-up and if there is any gains there and/or as we're always evaluating looking at acquisitions where we have benefits there.

The General Cable Wire and Cable acquisition is a good example of where we are able to achieve and consolidate that with our existing wire business and have SG&A savings..

Thanks a lot. Thanks, guys..

Very good, Matt..

Thank you, Matt..

[Operator Instructions] And it appears there are no further questions over the phone. At this time, I would like to go ahead and turn the program back over to the speakers for any closing remarks..

Thank you all for attending. This concludes our third quarter report. Thank you very much..

Thank you..

Thank you..

This does conclude today's program. Thank you for your participation. You may disconnect at any time..