Standard Motor Products, Inc. — Q3 2015 Form 10-Q
Business context and period: The company manufactures and distributes replacement motor-vehicle parts, primarily through its Engine Management and Temperature Control segments, with a growing focus on original-equipment service and related markets. This unaudited filing covers the quarter and nine months ended September 30, 2015; amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $270.0 | $257.0 | $767.0 | $762.3 |
| Gross profit / margin | $81.6 / 30.2% | $77.2 / 30.0% | $218.2 / 28.4% | $222.5 / 29.2% |
| Operating income | $30.0 | $28.3 | $66.2 | $66.4 |
| Continuing-operations earnings | $19.2 | $17.8 | $42.3 | $41.4 |
| Net earnings, including discontinued operations | $18.5 | $9.6 | $40.8 | $31.9 |
| Diluted EPS | $0.80 | $0.41 | $1.76 | $1.38 |
| Operating cash flow | Not separately presented | Not separately presented | $72.8 | $32.7 |
Margins and expenses: Q3 gross margin increased slightly as stronger Temperature Control margins more than offset lower Engine Management margins. For the first nine months, consolidated gross margin declined 0.8 percentage points. SG&A was $51.9 million in Q3, or 19.2% of sales, versus $48.8 million, or 19.0%; year to date it was $152.8 million, or 19.9%, versus $145.3 million, or 19.1%. Management cited higher distribution expense, compensation and benefits, and reduced postretirement prior-service-cost amortization.
Segment trends: Q3 Engine Management sales rose to $176.4 million from $169.9 million, while operating income fell to $24.7 million from $25.9 million; its margin pressure reflected higher alleged warranty provisions and costs related to improved diesel processes and quality controls. Temperature Control sales increased to $90.6 million from $82.2 million and operating income to $9.0 million from $4.3 million, helped by warmer summer weather and higher production volumes. Year to date, Engine Management sales declined to $530.4 million from $533.4 million; Temperature Control sales rose to $228.4 million from $219.3 million, including $4.7 million of incremental Annex acquisition sales.
Balance sheet, debt and liquidity
- At September 30, cash was $13.4 million; current assets were $479.3 million and current liabilities $246.7 million.
- Total debt was $24.6 million, down from $56.8 million at December 31, 2014. The revolving facility had $24.5 million outstanding and $168 million of additional borrowing availability. Its weighted-average rate was 2.4%; substantially all debt was variable rate.
- Nine-month cash flow from operations of $72.8 million funded $14.6 million of capital expenditures, $10.3 million of dividends, $15.5 million of share repurchases, and a $32.1 million reduction in revolving borrowings. Cash at period end was $13.4 million.
- The company sold $547 million of receivables during the first nine months, incurring $11.2 million in factoring charges recorded in SG&A. Management warned that disruption or termination of these arrangements could materially adversely affect collections, financial condition, results and cash flows.
- Inventory was $270.1 million, down from $278.1 million at year-end. Accrued customer returns were $44.2 million; the product warranty component was $25.9 million, compared with $21.8 million a year earlier.
Material changes, outlook and risks
- Prior-period comparison: Nine-month 2014 operating income included a $10.6 million litigation charge. Excluding that charge, 2014 operating income was $77.0 million, above 2015’s $66.2 million; management attributed the decline to lower gross margin and higher SG&A. The year-over-year increase in net earnings also reflects lower discontinued-operation losses, including a $12.8 million pre-tax asbestos provision recorded in 2014.
- Discontinued operations and asbestos: The company reported a $1.5 million nine-month discontinued-operations loss in 2015, versus $9.5 million in 2014. Approximately 2,190 asbestos cases were outstanding. The latest actuarial study estimated undiscounted settlement payments of $33.3–$51.1 million through 2058, excluding legal costs; estimated legal costs were an additional $40–$75.5 million. The recorded asbestos liability was $32.8 million. Management did not record a favorable adjustment because the difference from the study’s low end was not material, and cautioned that further provisions may be needed.
- Subsequent financing: In October 2015, the company replaced its GE-led facility with a JPMorgan-led secured revolving facility of up to $250 million, with a $50 million accordion and an October 2020 maturity. It wrote off $0.8 million of old financing costs and capitalized approximately $0.8 million of new costs. Management stated that operating cash flow, cash and available borrowing capacity should cover liquidity needs for at least twelve months, subject to no material adverse developments.
- Other subsequent event and capital returns: In October, the sole remaining unfunded SERP participant reached the payment date; the company recorded a $1.5 million settlement loss and distributed $7.6 million. The quarterly dividend increased to $0.15 per share in 2015. After September 30, the company repurchased another 70,242 shares for $2.5 million, leaving approximately $2 million available under its repurchase authorizations.
- Operating risks and outlook: The filing gives no specific earnings or revenue guidance. Management noted seasonal sales peaks in Q2 and Q3, with Temperature Control demand sensitive to summer weather and customer inventories. Risks include customer ordering and program changes, competition and pricing, unrecovered production or material costs, diesel quality and warranty exposure, foreign exchange, factoring availability, integration and cost-savings execution, and asbestos, product-liability, environmental and other litigation matters.
- Controls and accounting: Management concluded disclosure controls were effective at quarter-end and reported no material quarterly change in internal control over financial reporting. The company was evaluating the impact and adoption method for the new revenue-recognition standard, then expected to apply beginning January 1, 2018.
Investor verification priorities
- Track Engine Management warranty provisions, diesel quality costs and segment margins, alongside Temperature Control’s dependence on summer weather.
- Reconcile cash generation and working-capital movements, including factoring volume, its $11.2 million year-to-date cost, and exposure to the continuation of those programs.
- Review asbestos claim counts, actuarial assumptions, the $32.8 million recorded reserve against the settlement range, and legal-cost estimates.
- Confirm borrowing availability, covenant triggers and terms under the October 2020-maturity credit facility, and the effect of variable rates.
- Monitor customer returns and warranty accruals, and the company’s use of cash for dividends and share repurchases.