Good day, and welcome to the Standard Motor Products Third Quarter Earnings Call. [Operator Instructions] Please note today's call is being recorded. It is now my pleasure to turn the conference over to Larry Sills. Please go ahead. .

Good morning, everyone, and welcome to Standard Motor Products Third Quarter Call. I am Larry Sills, Chairman of the Board. With me are Eric Sills, President and CEO; Jim Burke, Chief Operating Officer; and Nathan Iles, Chief Financial Officer. .

What we're trying to do this morning is Eric will review the highlights of the quarter and year-to-date. Jim will go over some of our operations, and Nathan will go deeper into the financial results. Then we'll open for question and answer. .

So let's go. And just to get us started, I'll turn it to Nathan for the forward-looking statement. .

Okay. Thank you, Larry. 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 these 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. .

Thank you, Nathan, and good morning, everyone, and welcome to our third quarter call. Overall, we're very pleased with our performance in the quarter. We set a record for sales even when compared to a surge in third quarter last year. We were able to consummate an acquisition in Europe with terrific strategic value.

And we were able to accomplish this while continuing to navigate the complexities of the ongoing pandemic, including the related supply chain challenges. .

We achieved sales of over $370 million in the quarter, up nearly 8% from the prior year with both divisions having all-time highs. This marks 5 consecutive record sales quarters, with year-to-date sales up now 17% over 2020. .

As noted in our press release, our gross margin saw some compression in the quarter, most notably in Engine Management, and there were 2 drivers for this. First, as with many companies, we have been experiencing inflationary headwinds across a host of our costs, including raw materials, labor and transportation.

We will be passing these along through price increases starting in the fourth quarter, and we'll, therefore, see recovery going forward. Jim and Nathan will provide some more color on this later on the call. .

The other element is an ongoing strategic channel shift. As I will discuss in greater detail in a few minutes, we have been dramatically growing our specialized OE business. This business represents 25% of our Engine Management sales in the quarter as compared to 14% of it last year. .

This OE channel has a different cost structure from our aftermarket business. While it has lower gross margin, this is entirely offset by lower SG&A as there are substantially lesser costs associated with distribution, sales and marketing. And therefore, it has comparable operating margins. .

All in, we were able to post strong profits in the quarter. Comparisons to the third quarter of 2020 are difficult as last year we experienced multiple onetime benefits due to the pandemic. But this year's quarterly earnings of $1.32 surpassed a more normalized 2019 by 30%. And on a 9-month basis, we are up over both 2019 and 2020 by 40%. .

Overall, we believe that our strong performance reflects ongoing successful execution of our strategic initiatives, both in our core aftermarket as well as in our diversified business channels.

And I can't say often enough that we could not have done this without the tireless efforts of our skilled and dedicated employees, who have risen to every challenge they have faced. .

Now let me now go into a review of our 2 product segments, beginning with Temperature Control.

As this division is mostly air conditioning products, not only is it highly seasonal, meaning that the majority of the sales happen in the summer months, it is also weather dependent, meaning that there can be fluctuations year-to-year depending on how hot the summer is. .

This year, we experienced both a very long and very hot season. The demand began early in the second quarter and continued unabated for the next many months. We finished the quarter up nearly 8% over a very robust third quarter last year, but more importantly, we are up 23% on the year. .

Let me now speak about Engine Management. Our top line sales in the quarter remained quite strong, up nearly 8% versus a strong 2020 and up 14% over 2019. As noted in the release, there were several contributors. .

Our aftermarket business has been very healthy. We continue to enjoy the ongoing elevated demand that the whole industry is experiencing. But it is our understanding based on certain industry data that we are outperforming in some key categories, and we believe that there are 2 contributing reasons. .

First, as we have discussed, we have implemented programs with all of our customers to pursue market share gains at The Street level, and indications are that these have been successful.

And second, we believe that while our service levels are not where we like them to be as we, too, have been hit with supply chain disruption, we believe that our in-stocks are better than many other suppliers, which, of course, can lead to increased sell-through. .

Furthermore, as we've been reporting, we've been quite successful earning new business with existing aftermarket customers. We have demonstrated our ability to be a strong supplier partner who has performed well in this challenging environment, and we have been rewarded for it.

Sales of this new business have been phasing in throughout the year with more this past quarter. .

Beyond our strong aftermarket, our specialized original equipment channel has also contributed to our growth, both with rebounding legacy business as well as the addition of recent acquisitions.

By specialized OE, I mean that while we do have a certain amount of passenger car business, our efforts have been much more in niche areas such as medium- and heavy-duty vehicles, construction and agricultural equipment, lawn and garden, power sports and others. .

We find these markets to be very attractive. Product life cycles tend to be longer, technology more stable, competition less fierce, and price pressures tend to be less as well. While we have grown this business through organic product development, the bigger push has been through M&A. .

This year, we have made 3 acquisitions in this arena, including one during the third quarter. In September, we acquired Stabil, a European manufacturer of OE electronics, sensors and clamping devices doing approximately $25 million in annual revenue. We welcome the 200-plus employees to the SMP family. .

The company is headquartered on the outskirts of Stuttgart, Germany, considered the epicenter of the German auto industry. And their manufacturing facility is in Hungary, taking advantage of the great combination of high skills and low costs that the area has to offer.

Their strong R&D capabilities, along with our long-standing relationship with blue-chip customers, make for a powerful combination with our existing location in Poland, where we employ over 700 people. .

The 3 acquisitions this year combined for annual sales of around $100 million. And when added to our legacy business in these niche channels, we are now at a run rate of nearly $300 million. And while each of the pieces is attractive individually, what's really exciting to us is the power of the combination. .

Each as a stand-alone represented a limited product offering, a narrow customer base and specific geography. As we put the pieces together, we are already seeing opportunities to cross-sell, taking advantage of expanded manufacturing footprints and engineering capabilities. .

Our geographic reach has expanded significantly. In recent years, we have added 4 joint ventures in China to sell into the region and now have a broad European presence. Importantly, a significant portion of the product is not reliant on combustion engine powertrains.

Many are not powertrain specifics, such as the power management products of the Trombetta acquisition or the air conditioning products from our Chinese JVs, while others are specifically geared towards alternative energy vehicles, such as battery cooling products for electric buses and trucks, HVAC compressors for electric vehicles and our compressed natural gas injectors for heavy-duty trucks.

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As I look at this new business channel, I truly believe that the sky is the limit. And I am very excited to see where we can take it. .

At this point, I'll hand it over to Jim to review our operations. .

Okay. Thank you, Eric. I will provide a brief update on our supply chain challenges and the associated inflationary pressures. .

First, on our supply chain. SMP, similar to other manufacturers and distributors, has been challenged procuring our basic raw material and commodity needs, such as semiconductor chips, plastic resins, silicone and metal-based commodities.

Many of these components have been placed on allocation with lead times, in some cases, extending 365 days or longer. .

This results in a substantial strain on our efforts to schedule and manage the production cycle. However, through the benefit of our North American footprint and Poland manufacturing operations, we believe we are better able to manage these challenges than our suppliers, who elect to source the vast majority of their products from China.

Being a low-cost basic manufacturer with operations in Mexico, the U.S., Canada and Poland, we are in a far better position to control our own destiny than sourcing finished goods from China for resale. .

Transportation logistics from Asia have caused significant delivery delays, the impact of container shortages, vessel availability, congested ports on each end, all of which causing havoc within the supply chain.

While SMP is not immune to these delays, through a combination of our higher North American and Poland manufacturing footprint and our willingness to invest in inventory, we are better served to meet our customer demand spikes. .

Our supply chain, manufacturing and distribution operating teams have been creative at finding alternate vendors, alternative materials and alternate ports of entry to improve our competitive position. Our customers have acknowledged these efforts stating SMP as one of their top tier suppliers.

In addition, we believe this has been a real differentiator, assisting SMP with new business wins in 2021. .

One last point on the supply chain has been a shortage of skilled and unskilled labor. Our HR and operating teams developed flexible and creative incentives to add additional heads and to minimize turnover. We also thank our team members who volunteered to travel to different locations to meet varying demand sites. .

Next on the inflationary front. Inflation is real, and it's anyone's guess if it's peaked or transitory. We have experienced increases across the board from semiconductor chips to commodities with the most volatile increases from international shipping costs.

International container costs have increased eightfold from $3,000 prepandemic rates to heights of $25,000 per container. .

After highlighting these supply chain challenges and inflationary pressures, the obvious question is what are we doing to mitigate these issues? First, let me reiterate again how fortunate we are to have our North American and Poland manufacturing footprint, which helps alleviate some of these pressures. .

In addition, we are very proud of our SMP team members, who have successfully implemented new and alternative creative ideas. However, despite these heroic efforts, we have been burdened with higher costs, so we have implemented price increases taking effect in early Q4 to offset cost pressures and improve gross margins. .

In closing, these have been challenging times. 2021 has been a remarkable year with lost customer volume to start the year followed by supply chain challenges that ironically, we believe, gave us a competitive advantage, leading to new business wins, all the while completing 3 strategic acquisitions in 2021.

Our overall success is a direct reflection of our dedicated team members driven to meet our customer needs. .

Thank you for your attention. I'll now turn the call over to Nathan for his financial summary. .

Great. Thank you, Jim. The numbers, I'll walk through the operating results for the third quarter and first 9 months and also cover some key balance sheet and cash flow metrics. .

Looking first at the P&L. Consolidated net sales in Q3 2021 were $370.3 million, up 7.8% versus Q3 last year. And for the first 9 months were $988.9 million, up 16.9% versus last year. .

Looking at it by segment, Engine Management net sales in Q3 were $247.2 million, up $17.6 million versus the same quarter last year. For the first 9 months, we're up $88.6 million. While these are significant increases, the comparisons are made against a highly volatile year in 2020, and so it's better to compare our results to 2019. .

On this 2-year stack comparison, Engine net sales were up 14.4% for the quarter and up 7% for the first 9 months, with the increases being a result of successful customer initiatives, new business wins and generally robust market demand.

Further, acquisitions made this year contributed sales of $20.5 million in the quarter and $30 million for the first 9 months. .

Temperature Control net sales in Q3 2021 were $119.1 million, up 7.9% versus the third quarter last year and were up 23% for the first 9 months. And like we said for Engine, it's better to compare our 2021 results to 2019.

And on that basis, Temp Control sales were up 34.9% for the quarter and 19.2% for the first 9 months, with the increases mainly reflecting a very long and hot summer selling season as noted before. .

Turning to gross margins. Our consolidated gross margin in Q3 2021 was down 3 points to 28.4% versus last year, but for the first 9 months remained 0.4 points higher than last year at 29.1%. .

one, normal production volume and therefore, lower absorption versus Q3 last year when sales and production both surged; the impact of cost inflation across a variety of inputs; and a change in sales mix between the aftermarket and specialized OE channels. .

For the first 9 months, Engine Management gross margin was relatively flat, down 0.2 points to 28.8% as lower margins in the quarter offset the higher performance from the first half of the year, which benefited from a rebuild of our inventories. .

Gross margin for Temperature Control in the quarter was 28.4%, a decrease of 0.8 points from 29.2% last year, but for the first 9 months was up 1.2 points to 27.2%.

The decrease in margin during the quarter was driven mainly by inflation in our costs, partly offset by strong sales in production, while the improved performance for the year so far reflects the impact of strong summer season sales volumes. .

Looking ahead to gross margin expectations for the rest of the year, in Engine Management, we continue to see strong sales volume and expect to see a benefit from higher pricing as we pass higher costs on to our customers.

As such, we expect our fourth quarter margin for Engine to recover from the Q3 level and be in the range of 28% to 29%, which also means we expect our full year 2021 margin for Engine to be in the same 28% to 29% range. .

For our Temp Control segment, we expect gross margin to remain consistent with our year-to-date performance so far and finished at approximately 27% for the full year. .

Moving now to SG&A expenses. Our consolidated SG&A expenses in Q3 increased by $7 million, ending at 18% of sales versus 17.3% in Q3 last year, and included $3 million of expenses from acquired businesses.

For the first 9 months, SG&A spending was up $19.6 million, including $4.1 million of expenses from acquired businesses and as a percentage of sales ended lower at 18.5% of net sales versus 19.4% last year.

The increases in expenses for both the quarter and first 9 months resulted mainly from higher selling and distribution costs due to both higher sales levels and inflation in our costs. .

As a percentage of sales, SG&A increased in the quarter as certain discretionary spending cuts implemented during the pandemic were removed this year and inflation had distribution costs.

But the percentage declined in the first 9 months, which reflects improved leverage on higher sales volumes helped by our specialized OE business acquisitions, which come lower overall operating costs. .

Our consolidated operating income before restructuring, integration and acquisition expenses and other income net in Q3 2021 was down 3.4 points to 10.7% of net sales versus Q3 last year, but for the first 9 months was 10.8% of net sales, up 1.5 points from last year. .

As we note on our GAAP to non-GAAP reconciliation of operating income, our performance resulted in third quarter 2021 diluted earnings per share of $1.32 versus $1.59 last year. And for the first 9 months, diluted earnings per share of $3.54 versus $2.53 last year. .

The decrease in our operating profit and earnings per share for the quarter was mainly due to lower gross margin percent and lower SG&A expense leverage. But as we noted before, Q3 '20 -- 2020 margins were abnormally high as sales and production surged as lockdowns kept expenses low.

While profit as a percentage of sales and earnings per share declined in the quarter, they remained better than more normalized third quarter of 2019, which was not impacted by cost inflation. .

As for the first 9 months, the increase in our operating profit and earnings per share was mainly due to higher sales volumes, higher gross margin percent and improved SG&A expense leverage. .

Turning now to the balance sheet. Accounts receivable of $224.4 million at the end of the quarter were down $13.6 million from September 2020 and up $26.4 million from December 2020, with the decrease in the quarter mainly a result of timing of sales in the quarter versus last year and the increase over year-end as a result of higher sales. .

Inventory levels finished the quarter at $414.7 million, up $102.7 million from September last year and up $69.2 million from December last year, with the increase as a result of both higher sales levels this year and the rebuild of our inventory position after the sales surge we experienced in the last half of last year. .

Looking at cash flows. Our cash flow statement reflects cash generated from operations in the first 9 months of 2021 of $79.1 million as compared to $78.6 million last year. And while cash generated was flat, the working capital movements were different from last year. .

And regarding working capital accounts, cash used there was $44 million for the first 9 months, both this year and last year.

While we used more cash for inventory this year as we replenished our shelves, this was offset by higher accounts payable balances as well as less cash used in funding accounts receivable due to the timing of collections and management of our supply chain factoring programs. .

Looking at investments. We used $19.4 million of cash for capital expenditures during the first 9 months, up from $13.2 million last year as we continually find investment opportunities to expand our capabilities and become more efficient in our processes.

We also used $124.7 million to fund our acquisitions of the aforementioned Trombetta, Stabil and switch and sensor businesses. .

Our financing activities included $16.7 million of dividends paid and another $26.5 million paid for repurchases of our common stock.

Financing activities also included $121.9 million of borrowings on our revolving credit facilities, which were used mainly to fund our acquisitions, but also for investments in capital and returns to shareholders through dividends and share buybacks. .

While borrowings were higher this year, we finished the quarter with total debt of less than 1x EBITDA and had more than sufficient remaining available capacity under our revolving credit facility of $119 million even after making record levels of investments and shareholder returns. .

In summary, we are very pleased with our operating results so far this year. These results led to strong cash flow generation, which supported 3 great acquisitions, significant continued returns to shareholders and helped us finish the third quarter with low levels of debt and a substantial amount of liquidity. .

Additionally, and as announced this morning, our results for the year so far led our Board to approve a new $30 million stock repurchase program. And last, but most important, we thank all of our dedicated employees for their continued effort in helping the company achieve these results. .

Thank you all for your attention. I'll now turn the call back to Eric to wrap up. .

Well, thank you, Nathan. And before opening it up for questions, let me just close by again stating that we're delighted with our quarter and the year-to-date, and I'm very proud of how our people performed. Our financial performance has been strong, both in sales and profits.

We've been active in M&A with 3 complementary deals this year and have done so while navigating the complexities of the ongoing pandemic, keeping our people safe and managing through supply chain challenges. .

And I absolutely feel we are a stronger organization for it. We're pleased with the overall state of the industry and of our standing within it, and we are very excited about the future. .

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

[Operator Instructions] We'll take our first question from Daniel Imbro with Stephens Inc. .

This is Joe Enderlin on for Daniel. So you touched on today that you're going to start passing through costs in the fourth quarter.

We were just wondering how your customers responded to your plan to raise prices? And then are you seeing any evidence of the end customer traffic slowing because of these prices going up?.

Well, thank you for the questions. And so let me answer the 2 pieces. First, in terms of customer acceptance and responsiveness, I think what we're seeing, and I'm sure you're hearing this from all other suppliers and the distributors is right now, everybody is experiencing the same inflationary pressures.

And the sentiment is that as long as all boats rise, it makes sense to be able to accommodate the cost increases. So it's always competitive, but we believe that it's been well received. .

As it relates to potential impact on demand, I guess, is what you're asking, the vast majority of our products are nondiscretionary items. Your vehicle is down, and you need the part. So in that regard, it's not entirely price sensitive. If you need that ignition oil, you're going to buy that ignition oil.

So we don't expect any suppression of demand as a result. .

That's super helpful. As a follow-up, I was going to ask, the balance sheet is in good shape today.

How much leverage would you be willing to take on to fund acquisitions if the right deal became available?.

Yes. Hey, Joe, it's Nathan. So our balance sheet is very strong, as you say. I would say, overall, our capital allocation strategy remains the same. We're disciplined in our M&A outlook. And so we'll focus on the things that make sense for us, but we won't take on any more leverage than what makes sense for the company as a whole. So. .

[Operator Instructions] We'll go next to Scott Stember with CL King. .

Congrats on the strong results. Just a question on, I guess, your inventory situation on the Engine Management business. You talked about how you've been able to, I guess, outperform other guys because of your manufacturing footprint and where you're sourcing your products from.

But could you just talk about how thin your inventories are and potential -- or how much sales are being left on the table just because of what's going on?.

Yes. Scott, Jim Burke. Eric pointed out earlier, our fill rates, we're not satisfied where they are. We're doing -- we believe we're doing better. We hear from the customers that are there, and that's a direct reflection of the investment that we've had in inventory and dealing with vendors and the difficulties in supply and product. .

I would not quantify a significant amount of lost sales because of it. Yes, there's some, but I wouldn't call it significant that's in there because our fill rates, as I said, are not to where we want it to be, but still very strong. .

I would say we've -- inventory is part of working capital has been a significant increase this year. We ended last year at a low point. The investment that we've made so far has benefited us. But I'd say we're managing through that investment level now, and I would not anticipate replicating any further increases there. Thank you. .

Got it. And then on the Engine Management, some structural changes for the gross margin. But assuming price increases go through as you want them, what is the longer term -- basically, the longer-term gross margin expectations? I think in the past, it's been 29% to 30% if I'm not mistaken.

Has that changed? That -- it sounds like it just structurally will. .

Yes. Scott, this is Nathan. And just to maybe reiterate what I said in my remarks, we think our margins for Engine will recover to the 28% to 29% range in the fourth quarter after some of the pricing comes through.

We would expect to sort of stick at that level going into 2022, but certainly have our eyes on the many moving pieces, as I said, inflation and pricing being 2 of those. So we'll just continue to monitor that as we go forward. .

Okay. And just lastly on the SG&A side, $66 million in the quarter. You just talked about some reasons why it was up. And I know last year, we were in austerity measures.

But how should we look at SG&A or your operating expenses in the fourth quarter and if that run rate will continue into next year?.

Yes, Scott. So we expect to continue to have pretty good leverage. I think for the full year, as a percentage of net sales, we'd expect our SG&A to be around the 19% level. And then again, depending on where sales volumes go next year, that would be the baseline for any further improvement. .

[Operator Instructions] And we do have another follow-up from Scott Stember with CL King. .

Yes, I knew I forgot to ask a question. On Temperature Control, obviously, another very, very strong year.

How are we on inventory heading into the slower season and heading into the prebuying season early next year?.

Scott, I assume you're referring to customer inventory levels, correct?.

Yes. Yes, exactly. .

Okay. Well, what we've seen is that they were able to stay pretty healthy really throughout the season to sell in, roughly match the sell through. And so they're coming out into the off-season in pretty healthy stead. .

It appears we have no further questions in queue. I'll return the floor to you for any additional or closing remarks. .

Okay. This concludes our third quarter call, and we thank you all for attending. .

Thank you. .

This does conclude today's program. Thanks for your participation. You may now disconnect..