Standard Motor Products, Inc. (NYSE:SMP) Q1 2023 Earnings Call Transcript May 7, 2023

Operator: Good day, everyone, and welcome to the Standard Motor Products First Quarter 2023 Earnings Call. [Operator Instructions] Please note today’s call will be recorded, and I will be standing by should you need any assistance. And it is now my pleasure to turn the conference over to Tony Cristello, Vice President of Investor Relations. Please go ahead.

Tony Cristello: Thank you, Chris. Good morning, everyone, and thank you for joining us on Standard Motor Products first quarter 2023 earnings conference call. I’m Tony Cristello, and with me today are Eric Sills, President and CEO; Jim Burke, Chief Operating Officer; and Nathan Iles, Chief Financial Officer. On our call today, Eric will give an overview of our performance in the quarter, and Nathan will then discuss our financial results. Eric will then provide some concluding remarks and open the call up for Q&A. Before we begin this morning, I’d like to remind you that some of the material that we’ll be discussing today may include forward-looking statements regarding our business and expected financial results. When we use words like anticipate, believe, estimate or expect, these are generally forward-looking statements.

Although we believe that the expectations reflected in these forward-looking statements are reasonable, they are based on information currently available to us and certain assumptions made by us, and we cannot assure you that they will prove correct. You should also read our filings with the Securities and Exchange Commission for a discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements. I’ll now turn the call over to Eric Sills, our CEO.

Eric Sills: Thank you, Tony, and good morning, everyone, and welcome to our first quarter earnings call. Overall, we are pleased with our top line performance, especially considering the comparison. We were up 1.6%, and this is on top of last year’s 17% growth. This will be the first quarter reporting by our new segments, so let me take a minute to remind you of the changes and then we’ll review each one. And if you would like a more thorough explanation, please see our re-segmentation press release issued this past February. Previously, we had two segments: Engine Management and Temperature Control, and both were a blend of aftermarket volume and sales into other markets. We have now separated these non-aftermarket sales into their own segment called Engineered Solutions.

This has left the other two segments solely reflective of aftermarket business. The other change was the renaming of Engine Management to Vehicle Control. As we reflected on the product categories covered within it, we came to the determination that the name Engine Management was no longer suitable as we had significant sales in non-engine-related categories, notably in powertrain neutral, safety and electrical products. We’ve recast our historical numbers along these new lines to make for apples-to-apples comparisons. So how are we doing, and I’ll start with Vehicle Control, the largest of the three. We saw strong performance here, up over 4%. There are various puts and takes here, including some benefits from pricing and some new business wins, offset by lower purchasing from a large bankrupt customer.

But the overriding theme is ongoing demand strength in the marketplace. We are also pleased to see that customer POS remains positive for our large customers throughout the period, even against strong POS numbers last year. And this tends to be a good indication of their future purchases from us. Temperature Control sales were slightly behind last year, which was a very tough comparison as last year was up nearly 30% over 2021. But more importantly, this is mostly a warm weather seasonal business, and we always caution not to read too much into first quarter sales as they mostly reflect preseason orders and the real test is in the summer months. Lastly, let me speak to where we are with Engineered Solutions. Here, we are off a couple of points from last year, but it is important to note that as compared to the aftermarket, we expect this business to vary slightly quarter-to-quarter.

We are selling to vehicle and equipment manufacturers across a wide array of end markets. And as they vary their production schedules, they can move their purchases around a bit. It’s also worth pointing out that last year’s first quarter was a high watermark for this business, so it was a tough comparison. And if you compare this quarter to the quarterly average from last year were up 5%. Overall, we continue to be very excited about Engineered Solutions. Now that we have launched our newly defined global strategy and are going to market with our combined portfolio, we are experiencing the cross-selling opportunities we had hoped for. Though as mentioned, new business awards can take some time before they show in revenue. Moving to profitability.

Earnings have continued to present a challenge. I’ll touch on it, and Nathan will delve deeper. For the past several quarters, we experienced elevated costs across many impacts. Overall, these costs have largely stabilized, though at an elevated level. It’s important to note that due to the diversity of our product offering, we are impacted by a host of different commodities with no single one dominating. Therefore, while we have seen some commodities peak and begin to subside, such as metals, others such as electronics have remained elevated and needless to say labor costs continue to rise. And interest rates, which have risen sharply since the middle of last year, have been affecting the cost of our customer factoring programs. The industry has been largely receptive to passing these costs through, though there is always a lag in timing.

That represents the highlights of the quarter. I’ll now turn it over to Nathan to review the numbers, after which I will speak to our views of the future. Nathan?

Nathan Iles: All right. Thank you, Eric, and good morning, everyone. As Eric noted earlier, we had a good first quarter of the year as sales were higher than last year and margins and operating profits were in line with the expectations we laid out at the beginning of the year. As we go through the numbers, I’ll first give some color on the results by segment and at the consolidated level. And as I do, you’ll see we’ve identified the cost of our customer factoring program separately, given the increasing size of the cost. I’ll also cover some key balance sheet and cash flow metrics and finally, provide an update on our financial outlook for the full year in 2023. First, looking at Vehicle Control, you can see on the slide that net sales there in Q1 were $184.6 million and up 4.1% versus the same quarter last year, with the increase driven primarily by continued strong demand for our products.

Vehicle Controls adjusted EBITDA of $21.5 million in Q1, was 11.6% of net sales, down 2.2 points from Q1 last year. Looking at the pieces of adjusted EBITDA for Vehicle Control, gross margin was up 0.4 points from last year at 31.7%, helped by higher sales and favorable mix, while SG&A expenses remained well under control at 18.4% of net sales. However, the decline in adjusted EBITDA was primarily the result of a $4.2 million increase in the cost of our customers’ factoring programs, which by itself accounted for the drop of 2.2 points in adjusted EBITDA. Looking at Temperature Control, net sales there in Q1 2023 of $72.4 million, were down 0.9%, but this is up against Q1 last year when sales grew by almost 30%. We were pleased to see sales remain at higher levels, but also note that the first quarter is not indicative of the full year in the seasonal business.

Temperature Controls adjusted EBITDA of $3.3 million in Q1, was down from last year and came in at 4.6% of net sales. Looking at the pieces for Temp Control, gross margin rate in the quarter declined slightly to 26.5% and was impacted by inflation and costs and headwinds from lower production. But the biggest driver of the decline was the incremental $1.3 million in expenses from customer factoring programs, which accounted for a 1.8% drop in adjusted EBITDA in the quarter. Turning to Engineered Solutions. Sales there in the quarter of $71 million, were down 2% versus last year, and as noted before, were mainly impacted by changes in customer ordering patterns. Adjusted EBITDA for Engineered Solutions in the quarter came in at 11.6%, a decrease of 1.1 points from last year.

The decline was mainly due to lower sales volume, but also the impact of cost inflation and the same lower production experienced by other segments, partly offset by lower SG&A expenses. Turning now to our consolidated results. Consolidated net sales mainly reflect the growth we saw in Vehicle Control with Q1 ’23 finishing up 1.6% versus Q1 last year. Given the growth in consolidated sales and a higher margin rate in Vehicle Control, we reported higher consolidated gross margin dollars in Q1 and a margin rate flat with last year of 27.8%. Regarding SG&A expenses, excluding the cost of customer factoring programs, which are shown separately on the page, SG&A expenses were well controlled and in line with last year at 18.5% of net sales. Looking at the bottom line.

Consolidated operating income was 6.6% of net sales, down 1.7 points from Q1 last year, and adjusted EBITDA of $29 million was down $6.4 million from last year. With the decline in both metrics, the result of the combined $5.5 million increase in factoring expenses we experienced in the aftermarket segments. As per diluted earnings per share, you can see our performance resulted in earnings of $0.61 per share versus $0.92 last year. And in addition to the drivers already discussed, was impacted by $3.1 million of higher interest expense resulting from a higher debt level, but mainly due to higher interest rates. Before I move to the balance sheet and cash flows, I want to make a few summarizing points on our results. First, our gross margin performance reflects the fact that we continue to experience elevated, albeit moderating levels of inflation as well as headwinds from lowering production volumes to right size inventory levels as supply chains become more stable.

While flat, the results showed the positive impact of pricing and cost savings initiatives are having in overcoming these pressures. Second, our SG&A expenses remain well under control across all segments. However, as I’ve said, we continue to face higher costs and customer factoring programs due to higher interest rates. And while the rates are out of our control, we’re continuing to work on pricing and savings initiatives to address these costs. Third, I noted we incurred higher interest expense mainly due to higher rates in the quarter. In order to address rising rates, we fixed the rate on $100 million or about 40% of our total debt on June 1 last year. We’re also focused on reducing our debt by generating cash from inventory reductions.

So as you can see, while we’re facing a lot of pressure from current interest rates and elevated inflation, our core business is performing well. Sales have continued to increase. We are executing programs to improve our results, and SG&A is under control, which has led to operating profit margins that, while down, are in line with historical levels despite unique challenges. Further, we continue to see an adjusted EBITDA margin in our Engineered Solutions business that is in line with our aftermarket businesses and in the first quarter actually finished better than the aftermarket. Turning now to the balance sheet. Accounts receivable of $210.8 million at the end of the quarter, were up $43.2 million from December 22, with the increase mainly a result of higher sales during the quarter.

Inventory levels finished Q1 at $522 million, down $6.7 million from December ’22 and down $12.4 million from March 2022 as we focus on reducing inventories. Note that we typically build inventories during the first half of the year in anticipation of the Temp Control selling season. And when viewed against average increases of $10 million in Q1, this reduction in inventory represents a significant improvement in cash flow of almost $17 million in the first quarter. Turning to cash flows. Our cash flow statement reflects cash used in operations in the first quarter of $20.4 million as compared to $104 million last year, an improvement of $83.6 million, driven by a $74 million improvement in cash flows from inventory during the quarter. Our financing activities included $33.5 million of borrowings on our revolving credit facilities, which were used mainly to fund our seasonal working capital requirements and $6.3 million of dividends paid during the quarter.

Our borrowings in Q1 2023 were significantly improved and were $87 million lower than last year, driven by improved cash flow from inventory. Finally, I want to give an update on our sales and profit expectations for the full year 2023. Regarding our top line sales, we are maintaining expectations we laid out before and anticipate full year 2023 sales growth in percentage terms will be in the low single digits, in line with our historical growth rate. We’re also maintaining our expectations for adjusted EBITDA, which we expect will be approximately 10% for the full year in 2023 and includes costs from customer factoring programs that will hit $45 million to $50 million at current rates. In connection with adjusted EBITDA, we expect depreciation and amortization expenses and our income tax rate to be in line with 2022, but expect our interest expense on outstanding debt to be about $4 million to $5 million each quarter, given higher rates than average borrowings versus last year.

Looking at operating cash flows in 2023. We expect to continue to reduce inventory levels and are on track to see operating cash flows return to healthy levels consistent with past years. As we maintain our expectation for the year, we were pleased to announce this morning that our Board has approved a quarterly dividend of $0.29 per share to be paid on June 1 of this year. To wrap up, we were pleased to report growing sales in the first quarter and bottom line results that were in line with our expectations. We thank all of our team members for helping us achieve these results in what continues to be a unique economic environment. Thank you all for your attention. I’ll now turn the call back to Eric for some final comments.

Eric Sills: Thank you, Nathan. And before opening for questions, let me just talk a bit about what we’ve been seeing in the market and how we’re thinking about the future. Start with our aftermarket business, which makes up about 80% of our total revenue. Market conditions continue to be favorable as most trends are positive. The vehicle age is increasing, and that’s expected to continue as both the cost and availability of new cars remain a challenge for consumers. Miles driven are nearing historic levels and gas prices have normalized. And while we appear to be heading into a difficult economic times, our industry tends to do well in that environment. Furthermore, as our categories are largely nondiscretionary, they tend to outperform other categories in such situations.

Cars are essential transportation for most Americans. When they are not operating properly, they get repaired. Additionally, our relationships with our customers are stronger than ever. And while we can never be complacent, we believe that we have emerged from the last few years in an even better position than before. Our customers are looking for partners that can care for their needs going forward. We believe they are seeking suppliers whose supply chains have less reliance on the Far East and suppliers who are investing in the technologies of the future, and we fare both on — fare well on both of those accounts. So while there will always be challenges, the marketplace and our position within it are very strong. We also remain excited about the momentum in our Engineered Solutions business.

We came out of the gates this year with the formal launch of our strategy to pursue new business across a wide range of products, geographies and end markets. The opportunities are vast. And as we get our name and capabilities known to the customers in these channels, we are confident we will get more than our share of awards. Our growth will be in gaining market share from our small base, and we have already started to see this here in the U.S. as well as in Europe and elsewhere. From a cash management standpoint, over time, we have adhered to a disciplined capital allocation strategy using cash flows to both invest in our business and provide returns to shareholders. We remain committed to this approach and now that we are seeing our supply chain stabilize, we have begun reducing our inventories and expect to show strong improvement in our cash flow.

And as our cash flows increase, we intend to reduce our outstanding debt level, return value to shareholders through the higher dividend we announced at the beginning of the year and invest in our future through purchases of tooling and equipment to support development of new technologies. And we were able to accomplish all of this due to the talented commitment of all of our employees globally, and we thank them for that. With that, I’d now turn the call back to the operator, and we’ll open it up for questions.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Daniel Imbro from Stephens Inc.

Operator: [Operator Instructions] Our next question comes from Bret Jordan from Jefferies. Your line is open.

Operator: And our next question comes from Robert Smith from the Center for Performance Investing. Your line is open.

Operator: And with that, it appears that we have no further questions over the line at this time.

Tony Cristello: Okay. We want to thank everyone for participating in our conference call today. We’d be happy to answer any follow-up questions you may have. Our contact information is available on our press release or Investor Relations website. Hope you have a great day. Thank you.

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