Standard Motor Products, Inc.

Everyone, and welcome to the Standard Motor Products fourth quarter 2022 earnings call webcast. To enter full screen mode, hover over the slide and click the full screen icon in the center of the viewer. To exit full screen mode, press the escape. Later, we will open the phone lines for questions and answer sessions. You may register to ask a question by pressing the star and one key on your telephone keypad at any time. You may remove yourself from the question queue by pressing star and two. If you require technical assistance during today's event, you can reference the help link at the top of your screen. Please note today's call will be recorded and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Tony Crispello, Vice President of Investor Relations. Please go ahead.

Thank you, Corliss. Good morning, everyone, and thank you for joining us on Standard Motor Products' fourth quarter 2022 earnings conference call. I'm Tony Cristello, Vice President of Investor Relations, and with me today are Larry Sills, Chairman of the Board, Eric Sills, President and CEO, Jim Burke, Chief Operating Officer, and Nathan Isles, Chief Financial Officer. In conjunction with our reported financial results, we published a separate press release earlier this morning announcing the creation of a new segment, Engineered Solutions, and the renaming of our existing segments. In addition to the press release, we posted a supplementary slide presentation to the IR website providing more information on these changes. On our call today, Eric will provide an overview of our performance in the quarter, and Nathan will then discuss our financial results. Eric will then give an overview in greater detail on our newly cast segments and the underlying strategy before some concluding remarks and opening 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.

Thank you, Tony, and good morning, and welcome to our fourth quarter earnings call. I'd like to begin, as I always do, by recognizing all of the S&P employees globally. These last few years have been a wild ride, and our people have helped us navigate it all, outperforming many of our peers and emerging a stronger company for it. So thank you, everybody. As Tony mentioned, first we'll review the business with some insights into the future, but I'm also very excited to discuss the resegmentation of our business, which I'll cover later on the call. Overall, we are pleased with our top-line performance. For the full year, we were up 5.6% over 2021, with both divisions showing gains. Our sales in the fourth quarter did fall back slightly, down a half a point, which is best explained by segments, so let's get right into that, starting with engine management. For the full year, engine management sales were up 4%, but were down a bit over 1% in the quarter. This was largely due to going up against a difficult comparison as 2021 was very strong. It was also due in part to some customer ordering patterns, which can flex slightly quarter to quarter. However, as you look at customers' POS, their sell-through throughout the quarter continued to be strong, which excluding our wire business, showed nice gains over the prior year. Not only does this demonstrate the ongoing health of the marketplace and the continued success of our programs with our customers, but also tends to be a leading indicator of future orders to us. Temperature control continued to be strong, surpassing last year's sales by 5.2% in the quarter. It's important to note that Q4 is a light quarter for this seasonal category, yet it did reflect the ongoing robust pace as we ended up nearly 10% for the full year. Included in these overall numbers is our performance in our non-aftermarket business, what we are now calling engineered solutions, which I will explain in greater detail after Nathan reviews the numbers. Our sales for the year showed strong gains over the previous year. We saw the benefit from acquisitions, though partially offsetting this, was the temporary reduction of business with a specific account as they adjusted their build schedules. We remain very excited about this new channel. It's highly complementary to our aftermarket business, and you'll be hearing a lot more about it. Moving to profit, margins have continued to present a challenge. I'll touch on it, and Nathan will delve deeper. Along with the rest of the world, all year long we experienced elevated costs across many inputs. The industry has been largely receptive to passing it through, though there is always a lag in timing. Meanwhile, as we've been discussing, the rapid increase in interest rates, which affects our customer factoring programs, is creating a significant headwind. And while we are working diligently to adjust for it, both through cost reduction and pricing initiatives, it is impacting our bottom line, as Nathan will speak to. Here again, it's important to note that 2021 was the anomaly. As we have been explaining throughout 2021, we are enjoying many non-recurring benefits of emerging from the COVID lockdowns. So as you look at our non-GAAP operating profit, at 8.2%, they were in line with pre-pandemic levels, and that is in the face of surging inflation and interest rates. So let me talk for a bit about what we've been seeing in the market and how we are thinking about the future. I'll start with our aftermarket business, which makes up about 80% of our total revenues. The basic overall backdrop continues to show favorable trends. The vehicle fleet is aging. New vehicle availability, while improving, continues to be tight and is causing motorists to repair and maintain the vehicles they have. Gas prices have normalized, and miles driven remains high. There is obviously a lot of concern about the potential of an economic downturn, but the aftermarket tends to outperform in those times as people continue to need their vehicles to go about their lives. And our categories tend to do even better as they are non-discretionary in nature. The customer's vehicle is not operating properly and the repair is required. Additionally, our go-to-market strategy continues to resonate with our customers. 2022 set a high watermark for customer awards, reflecting their recognition of the value we provide and the positive POS results suggest ongoing demand strength. So while there will always be challenges, the marketplace and our position within it are very strong. Meanwhile, our engineered solutions business has remained robust, and we are very excited about where we're headed with this strategy. After several years in the making, we have built this into a sizable global business selling into diverse end markets. We believe that we have now reached a critical mass to be a meaningful supplier to a broad array of blue-chip customers and believe that the various pieces we have put together are really opening doors. So, again, you'll hear more about this after Nathan reviews the numbers. Nathan?

All right. Thank you, Eric. As we go through the numbers, I'll first give some color on sales and margins for each division, then look at the consolidated results, cover some key balance sheet and cash flow metrics, and finally provide our expectations for the full year of 2023. First, looking at engine management, you can see on this slide that Q4 net sales of $242.4 million were down slightly versus the same quarter last year, with this year up against a difficult comparison in Q4 2021, where sales were up almost 6%. For the full year, sales on engine of $975.2 million were up 4%, with the increase driven primarily by sales from acquisitions made last year, higher pricing, and continued strong demand. Looking at the margin for engine, the fourth quarter gross margin rate was 28.5%, up 0.9 points from last year. As a combination of our cost savings efforts and pricing actions taken in the second half of the year overcame some of the inflationary pressures we've been experiencing. However, engines gross margin for the full year was down, mainly due to the higher costs we experienced across all inputs during the year as a result of persistent inflation. Temperature control net sales in Q4 2022 were up $3.1 million, or 5.2%. For the full year, we're up $33.9 million, or 9.7%, with the increases mainly reflecting a very strong summer season and higher pricing, both of which helped the division to outpace a record year last year. The gross margin rate for temperature control in the quarter was 26.2%, a decrease of 1.4 points from last year, while the gross margin rate for the full year of 26.8% was down 0.5 points from last year. The decrease in margin for the quarter was mainly due to the unfavorable mix of sales as the selling season came to an end, but also partly due to some unfavorable fixed cost absorption from lowering inventory levels. The slight decrease in margin for the full year was mainly due to cost inflation, like I noted for the engine segment. Before I move to the consolidated numbers, I want to make two points on our margins. First, we noted over the course of 2022 the impacts of inflation across all input costs. While we have seen some moderation in inflation on a number of inputs, inflation in general is still higher than normal. To offset this inflation, our engineering and operations teams continue to do an excellent job executing our sourcing and in-house manufacturing programs to lower our costs. And these cost savings efforts, combined with pricing, helped us improve our margins throughout the second half of the year in 2022. Second, I noted Temp Control's Q4 margin was impacted by unfavorable fixed cost absorption related to lowering inventory levels. As you know, we strategically increased our inventories in both 2021 and 2022 to manage supply chain volatility. Now that we are seeing things stabilize, we expect to lower inventories in 2023, which will cause some headwinds on our margin as we begin the year. Turning now to consolidated results, our consolidated net sales for the fourth quarter were essentially flat with last year, while full-year sales were up 5.6%, reflecting the impact of sales from acquisition, higher pricing, and continued strong demand. Our consolidated gross margin rate was up for the quarter, driven by the higher margins and management. And for the full year, our gross margin rate was down 1.1 points at 27.9%, largely as a result of the cost inflation I mentioned before. But we were pleased to report higher gross margin dollars on the back of strong sales growth. Moving to SG&A expenses, our consolidated SG&A expenses increased for both the quarter and full year, as rapidly rising interest rates continued to drive expenses from customer factoring programs higher. Our consolidated SG&A increased slightly in the quarter, up by $0.9 million versus last year, and this was the result of higher expenses for customer factoring programs being partly offset by lower incentive compensation expense given where the year ended. SG&A expenses for the full year increased by $23.5 million and included $20.6 million of higher factoring costs and $7.2 million of additional costs from acquisitions. Excluding the incremental factoring costs for the full year, our SG&A as a percentage of sales would have been better than last year. With respect to profitability, consolidated operating income, as shown here on the slide, was 7.9% of net sales for the quarter and 8.2% for the full year, and earnings per share and EBITDA were lower for both the quarter and full year for the reasons already discussed. However, as Eric noted, our operating profit and adjusted EBITDA as a percentage of sales was in line with historical trends, despite the pressures coming at us from inflation and interest rates. Turning now to the balance sheet, accounts receivable of $167.6 million at the end of the quarter were down $13 million in December 2021, with the decline a result of the timing of sales at year-end, as well as the write-off of a receivable related to a bankrupt customer, as noted in our release this morning. Inventory levels finished Q4 at $528.7 million, up $60 million from December 2021, with the increase a result of higher sales levels this year, inflation in inventory costs, and a strategic investment to buffer against supply chain volatility. As we worked through our peak seasonal inventory needs, our inventory was reduced $22.7 million from the June 30th levels. Looking at cash flows, our cash flow statement reflects cash used in operations for the full year of 2022 of $27.5 million as compared to cash generated of $85.6 million last year, with the biggest driver of cash usage being working capital. The use of cash from working capital mainly stemmed from making strategic investments in inventory during the first half of the year, but also the impact of lower accounts payable now that inventories have begun to decline. While our cash usage for the year was driven by first-half performance, it's important to note we did generate $68 million of operating cash flows in the second half of the year, which was in line with our historical trends. Regarding capital allocation in 2022, you can see on the slide that we continue to invest in our business through capital expenditures and generate returns to shareholders via dividends and share buybacks at a steady pace versus last year. Our borrowings for the year of $111 million were lower than last year after making payments on our credit facility of $29 million during the fourth quarter, bringing our total leverage down to 1.5 times adjusted EBITDA. Finally, I want to give an update on our sales and profit expectations for the full year of 2023. Regarding our top-line sales, we expect full-year 2023 sales growth in percentage terms to be in the low single digits, which again is in line with our historical growth rate. As we look at profit expectations for 2023, we'll be focusing on adjusted EBITDA in connection with our resegmentation announcement this morning and the differing margin profiles of our aftermarket and engineered solutions businesses. As such, we expect adjusted EBITDA to be approximately 10% for the full year in 2023 as we continue to face an uncertain operating environment and costs from customer factoring programs that will hit $45 to $50 million at current rates, but can still go higher depending on economic conditions and further rate hikes by the Federal Reserve. 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 to $5 million each quarter, given higher rates in average borrowings versus last year. Regarding the cadence of earnings across the four quarters in 2020, we expect Q1 will be impacted by headwinds from several things. including the usual carryover of unfavorable manufacturing variances from lower q4 production as well as from the impact of lowering our inventories further in 2023 higher year-over-year costs from customer factoring programs and some sales some temporary sales softness related to the bankruptcy of one of our customers and while we'll see headwinds to start the year we expect to improve from there as the business continues to move on Looking at operating cash flows in 2023, we expect inventories to be reduced, as I mentioned before, and for working capital balances in general to stabilize. As such, we expect operating cash flows to return to levels consistent with past years. As we see cash flows returning to normal, we were pleased to recently announce our board has approved an increase in our quarterly dividend, $0.27 to $0.29 per share, an increase of 7.4% and consistent with our long track record of dividend increases. To wrap up, we were pleased to report strong sales growth in 2022, all up against a record year in 2021, and continued improvement in gross margin from cost savings and pricing actions throughout the year. We thank all of our employees for helping us achieve these results in what remains a challenging economic environment. Thank you, and I'll now turn the call back to Eric to talk about our new operating segment.

Thank you, Nathan. As you saw, in conjunction with our financial results, we published a press release earlier this morning announcing the creation of a new segment, Engineered Solutions. This new segment will focus on products for both on-highway and off-highway vehicle and equipment manufacturers. We've discussed this growth area with you for the past many quarters, so it is not so much that it is a new business, but rather a recognition that we have achieved a level of success that warrants creating a new operating segment. This new segment will be carved from the existing two segments, leaving them focused on aftermarket sales. Concurrently, we decided to rename our engine management segment to vehicle control, which better reflects the current and evolving portfolio of products. More on that in a minute. To better understand the moving pieces, we posted a supplementary slide presentation to the investor relations website that walks through some of the rationales. We also have a totally revamped investor presentation posted on our website that lays out the two markets with much greater clarity than before, and we encourage you to review it. Going forward, we will now have three operating segments, engineered solutions, vehicle control, and temperature control. There are several reasons for doing this. The first is clarity. Recent growth has made engineered solutions a substantial business with critical mass, and we believe all stakeholders will benefit from the added visibility a carved-out segment provides. Secondly, while complementary, the aftermarket and engineered solutions have distinctly different operating models with different value propositions. And importantly, due to their different value propositions, they have different margin profiles. Both have strong and comparable EBITDA, but how you get there is quite different. The aftermarket has stronger gross margins, but due to the value-added services, there are higher operating expenses, especially in the areas of sales, marketing, distribution, and customer factoring programs. In contrast, engineered solutions have lower gross margins, but does not require the same level of value-added services. Therefore, EBITDA for this segment is simpler. Engineered Solutions also has different cash flow dynamics. Inventory requirements are lower due to minimal finished goods stock, and there are different customer payment terms, both of which translate into lower overall capital needs. Let me spend a minute taking a deeper dive on the three segments. First, let's look at Engineered Solutions as it is the new segment that requires further explanation. This new segment focuses on custom-engineered solutions to vehicle and equipment manufacturers or to their Tier 1 suppliers across diverse global end markets, including both on-highway and off-highway applications. Our offerings include product categories from both of our legacy operating segments and offer a broad array of conventional and future-oriented technologies, including those that are specific to vehicle electrification and those that are powertrain neutral. Through strategic acquisitions and organic growth, we achieved 2022 revenues of $270 million and broadened our market access with expanded product capabilities, combined customer lists, and global reach. Combining all the pieces is providing significant product cross-selling opportunities, which are beginning to bear fruit. We believe that we are at an inflection point for this business, and we are excited about the growth potential. We are pursuing multiple global end markets, and we are getting the attention of blue-chip customers who now recognize this is not a secondary business for us, but one we are committed to. So while growth might not be linear and new business wins can take time to show in the numbers, we feel that the long-term growth rate here can exceed that of our aftermarket channel. Our other two segments will remain focused on our aftermarket business. The aftermarket has always been and will remain the heart of what we do. For all the reasons we continually discuss, it's a fantastic market. It's large, stable, and able to withstand economic shocks. Furthermore, with over 100 years of experience, we are known as a leader in the space and one in which we hold an enviable position. We'll continue to invest in it, staying current on emerging technologies. As we look to the future, we recognize the need to rename engine management to vehicle control. This more accurately reflects the ongoing evolution of the products and categories S&P offers, which extend far broader than products for the engine, including products that are powertrain neutral as well as those that are electrification specific. There will be three subcategories within the segment, again, to provide better clarity. The first is ignition, emissions, and fuel, which will include categories related to the internal combustion engines. Included are the more traditional products, as well as new technologies to make the combustion engine more efficient, and based on the demographics of the car park, we believe this subsegment will continue to perform well into the future. The second subcategory is electrical and safety, which focuses on products not related to the powertrain, and as such will be unaffected by the eventual shift to electric vehicles. There are many well-established categories here, from ABS sensors and TPMS to various electrical switches and actuators, as well as many emerging technologies such as advanced driver assist products. The third subcategory is wire sets and other. This is the smallest, less than 10% of the segment, and is in secular decline. Our other aftermarket segment will continue to be called temperature controls. This aftermarket business segment is primarily related to passenger comfort, but is also focused on other thermal management systems in the vehicle. Not only is this segment largely immune from the transition to electrification, it is poised to benefit from it. The AC systems on electric vehicles tend to be more complex. The compressors contain motors and electronics rather than being belt-driven and are often deployed all year. There are also new systems on EVs related to battery temperature management, leading to more opportunities. Going forward, we're redefining the two subcategories within the segment to provide better clarity in the systems they address. The first, AC system components, will contain those products focused on air conditioning. And the second, other thermal components, will include parts that provide thermal management to other vehicle systems. So I realize this is a lot to absorb, and we encourage you to look at the materials we posted on our investor relations website, which help explain it. I also suggest you visit our new engineered solutions website, which will provide a good perspective on the products offered and markets served. You can find a link in the press release. We're very excited about our direction. We believe we have a winning strategy and feel that this resegmentation helps provide better clarity to all stakeholders about where we're headed. So to reiterate, we continue to be extremely bullish on the aftermarket and will remain steadfastly focused on it while also embracing this relatively new area, providing it with the horsepower it needs to really grow. With that, I'd like to turn the call over to the operator and open it up for questions.

Absolutely. At this time, we will open the floor for questions. If you would like to ask a question, please press the star key. followed by the 1 key on your touch-tone phone. Questions will be taken in the order in which they are received. If at any time you would like to remove yourself from the questioning queue, please press star 2. Again, to ask a question, please press star 1. We will take our first question from Daniel Imbro. Your line is open.

Carolyn, on for Daniel. Thanks for taking our question. Good morning. Good morning. I wanted to ask about pricing initiative expectations for 2023. Do you expect incremental price increases will need to be taken this year to inflate margins? And then if so, could you describe what you're assuming on cadence and magnitude relative to last year?

Sure. So really, as we've been saying for the last many quarters, we continue to pursue price increases to keep up with cost increases, although really requiring a combination of pricing as well as our own internal cost reduction initiatives. This has been ongoing really through the last many quarters, and as we look into 2023, we will continue to be mindful of where the costs are headed, and we'll be working with our customers to adjust accordingly. I believe, as Nathan mentioned, we've seen somewhat of a flattening of a lot of our material cost inflation, albeit at a high level, But we're continuing to watch closely what happens with interest rates. So I realize that's not a specific answer other than we will continue to track. We need to be in reaction mode to it, difficult to get ahead of it. As such, that tends to mean that there is a lag between when we see the costs and when we're able to get the pricing. But we continue to believe the market is receptive to adjusting according to what's going on in the world.

That's helpful. Thank you. As a follow-up, could you maybe provide some thoughts on your joint venture operations and your outlook for growth this could provide for 2023 results?

Sure. I'll speak to how the JVs are doing, but as it relates to outlook for growth, and Nathan can speak more clearly to it, but with the exception of one, our JVs do not get consolidated to our overall revenue. They just show under other operating profit. But we continue to be pretty bullish on what we're seeing with the JVs. They are performing well for the two separate purposes that they are designed to provide, one being to provide high-quality, low-cost product to come back here to North America to support the aftermarket, but also to sell into third-party markets specifically for engineered solutions. globally. And really, for all of them, we're seeing very nice progress. The one that I do tend to call out, because I think it's seeing the best growth trajectory, is called CYJ This is the joint venture that manufactures electric compressors for electric vehicles, where much of that business stays into the electric vehicle market in Asia, but is now starting to gain nice traction in Europe and North America as well. I really think we have something there from a technology standpoint, and they're starting to get the attention of customers who are looking for suppliers of this technology. newer electrification technology. So we're still pretty bullish on really all of our JVs.

That's super helpful. Thanks, guys. That's all for me.

Thank you.

Our next question comes from Scott Timber. Your line is open.

Good morning, guys, and thanks for taking my questions.

Thanks, Scott.

I think you guys alluded to it a little bit, but maybe you could give a little more granular detail of the guidance of low singles for 23 by the three new reporting segments. Engineered solution sounds like that will probably lead the way. Maybe just give a little more detail on that.

Well, we are providing it as one single corporate growth number and not looking to break it out into the different segments, partly because it's early in the year and there's a lot of moving pieces. As mentioned in my prepared remarks and as you're alluding to, we believe that engineered solutions and long-term growth potential that can exceed that of the aftermarket simply because we're dealing with a business that is much more diverse globally, so a lot more end markets to find growth in, and we're starting with a relatively small base, so it's really more about new business wins than just growing with the market. But that could take time, Scott, and it can be lumpy as wins come on, some things fall off. And so we're not giving specific guidance by segment, but we're comfortable that all combined we're going to be in that low single-digit range that we're speaking to.

Got it. And then on temperature control, you guys called out some gains in winter-related products. First time, I guess, I'm really hearing that. some talk about that. Maybe just go into a little more detail there and how big of this segment is winter-related products.

So it's still a relatively small part of what temperature control is. Temp control is still largely about air conditioning and therefore summer seasons. There are winter categories related to heater cores being one of the larger blower motors. And so we are – I can't get into details of the specific customer wins, but we've been having some nice growth in that area. Again, not enough to dramatically move the needle. It's still largely a summer business.

Got it. And then the last question before I jump back in the queue, talking about some of the price increases that have gone through to cover notably the factoring costs. I think you said an additional 45%. $50 million this year coming up. Maybe talk about your expectations to fully cover these costs and what can't be covered. How much of that $45 to $50 million will be offset by cost cuts or efficiency improvements?

Well, Nathan can get into the details in a minute, but a lot of that is really run rate differences versus previous year, and so some of it has already been accommodated, and discussions with customers are always ongoing. So now a lot really depends on further movement from the Fed and the fact that that happens. But a lot of these increases have already taken place.

Right. And, Scott, I would just point out the range of $45 to $50 million wasn't additional. That's what we think the cost will be in 2023, given where the Fed is right now on interest rates.

Okay.

And what was the number for 2022, so we could just get an incremental? Yeah, the number for 2022 was about $32 million. Okay.

That makes sense. That helps. All right. Thank you, guys.

Scott. Our next question comes from Brett Jordan. Your line is open.

Hey, good morning, guys.

Morning, Brett.

Ask again on the growth outlook. Could you tell us how you see same skew price inflation contributing to that growth guide for 23?

There's a lot of moving pieces in there. Pricing, unit volume, some flexing of customer order patterns, a lot of different pieces. But as you can imagine, pricing has had probably more of an outsized influence in the past year than in previous years. But you have a lot of pieces in that number.

Okay. But I guess since we are comparing against a high pricing environment in the last year or two, do you see price being positive in 23, or are we more on units now rather than tickets?

It's a blend of the two, but pricing will continue to be an influence.

Okay. And then on temperature control, I guess, could you give us some color as how retail inventories look, you know, at this point of the year going into spring?

Sure. So as we look at the inventories of our major customers where we have that visibility, year-end 2022, they were a bit higher than the previous year. 2021, they really ended pretty low. So they're a bit healthier coming into this year. That said, as we look at the preseason orders that we have in-house and are continuing to discuss with our accounts, the preseason orders remain healthy, comparable to the previous few years. But as you know very well, Brett, you've been following us a long time. All this is just in preparation for what really happens, which is in the summer. And so we'll see how the summer turns out. We're going up against two very hot years in a row. But that's really where we're going to see how the year pans out.

Okay. And then one last question. On that AutoPlus bankruptcy and the charge, could you remind us sort of how that shakes out? I mean, years ago when Metro went bankrupt, did you wind up recovering a portion of that write-off? And sort of what's the sort of timing and expectation there?

Yeah, Brett, so I guess with regard to the charge that we took and noted this morning in the release, you know, that was our best estimate of what may be recoverable. As you know, bankruptcy is still very early days. Credit committee just formed last week, and so we're still watching closely, but don't have any real updates from where we are now.

Okay, great. Thank you. Thank you.

It appears we have no further questions at this time.

Okay, thank you. We want to thank everyone for participating in our call today. We understand there was a lot of information presented, and we'll be happy to answer any follow-up questions you may have. Our contact information is available on our press release or our investor relations website. And we hope you have a great day. Thank you.

Thank you, ladies and gentlemen. This concludes today's program. You may now disconnect.