Standard Motor Products, Inc. (NYSE:SMP) Q4 2022 Earnings Call Transcript February 22, 2023
Operator: Good day, everyone, and welcome to the Standard Motor Products Fourth Quarter 2022 Earnings Call Webcast. 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 Cristello, Vice President of Investor Relations. Please go ahead.
Tony Cristello: 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 Iles, 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 remaining 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 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, and welcome to our fourth quarter earnings call. I’d like to begin, as I always do, by recognizing all of the SMP 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 forward 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 0.5 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, but 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 as 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 affect 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 were enjoying many nonrecurring 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 revenue. 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’s 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 the 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?
Nathan Iles: 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, but this year up against a difficult comparison in Q4 ’21, where sales were up almost 6%. For the full year, sales of 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, Engine’s 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 were 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.
Photo by Chad Kirchoff on Unsplash
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 acquisitions, higher pricing and continued strong demand. Our consolidated gross margin rate was up for the quarter, driven by the higher margin engine management. And for the full year, our gross margin rate was down 1.1 points to 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 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 to result of higher sales levels this year, inflation and inventory costs and a strategic investment to buffer against supply chain volatility. As we work through our peak seasonal inventory needs, our inventory was reduced $22.7 million from the June 30th level. 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 re-segmentation 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 million 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 million 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 of 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 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 mobile 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 of $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 segments.
Eric Sills: 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 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 rationale. 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 of carved-out segment design. 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 had 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 working 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 of 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 would 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 SMP 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 fuels, which will include categories related to the internal combustion engine. 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 sub-segment 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 Control. 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 and 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 re-segmentation 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 we’ll 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.
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