Q1 2023 Standard Motor Products Inc Earnings Call
Participants
Anthony Francis Cristello; VP of IR; Standard Motor Products, Inc.
Eric Philip Sills; CEO, President & Director; Standard Motor Products, Inc.
James J. Burke; COO, Member of the Office of Chief Executive & Director; Standard Motor Products, Inc.
Nathan R. Iles; CFO & Member of the Office of Chief Executive; Standard Motor Products, Inc.
Bret David Jordan; MD & Equity Analyst; Jefferies LLC, Research Division
Daniel Robert Imbro; MD & Research Analyst; Stephens Inc., Research Division
Robert Smith
Presentation
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.
Anthony Francis 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 Philip 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 resegmentation press release issued this past February.
Previously, we had 2 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 2 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 nonengine-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 3. 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 R. 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 Philip 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.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Daniel Imbro from Stephens Inc.
Daniel Robert Imbro
Congrats on the quarter.
Eric Philip Sills
Thank you.
Daniel Robert Imbro
Eric, in the end of your prepared remarks, you talked about the customer relationship strengthening. You mentioned customers are wanting less reliance in the Far East. And I'm just curious, when we look at the 4% kind of organic growth in Vehicle Control, are there share gains in there? Is that actually manifesting into business yet? Or is this just conversations you're having that could lead to further share gains in the future? Just thinking about, obviously, a few years ago, there were some headlines, but just thinking, are you winning any of that share back yet? Or how does that shape out?
Eric Philip Sills
Sure, Daniel. It's a very good question. And I think we look at share gains really in two ways. One is by getting additional business from our trading partners, and the other is what we see down channel in terms of how our brands and products are performing at the end user level. So let me speak to each of those separately.
In terms of new awards, there's always some wins and losses, there always are. But there's no doubt that over these last few years, we have gained a lot more than we've lost. And I do believe that, that has a lot to do with the value proposition that we go to market with, which has proven to be very sticky, especially in these more difficult times.
I highlighted just a couple of them in the prepared remarks in terms of supply chain stability, in terms of investing in technologies.
But there are a lot of other pieces to it as well. And arguably the single biggest moat is the fact that we're a full line provider with tens of thousands of SKUs, and they're really looking for partners, who can provide that breadth of coverage and the capability to really take care of the entire vehicle part.
As it relates to downstream market share, always a little bit more difficult to measure. However, the industry association over the last couple of years have really provided some nice insights into that, where they're able to show by product category, how our brands are performing compared to the overall market for the same product category. And they're measuring us, I think, on about a dozen or so different major categories that we're involved in. And on the vast majority of them, we're outperforming the competition.
So we believe that not only are we doing well directly with our partners, but by joining forces with them, I think, combined, we're doing very well downstream as well.
Daniel Robert Imbro
That's really helpful. I appreciate it, Eric. And then maybe Nathan, shifting over to SG&A. You mentioned continue to be well controlled. I guess the question, if you exclude the factoring cost increase year-over-year, are you guys actually levering SG&A as a percentage of sales due to that control right now? And if so, if factoring costs normalize, would we expect to see even better SG&A leverage in the back half of the year, given the underlying momentum?
Nathan R. Iles
Yes, Daniel. So as I noted, if you look at our SG&A without the factoring costs in it in the quarter, I think, as a percentage of net sales, we were in line with last year. And so that really kind of just reflects, I think, more of the general inflation you see in those costs each year.
To your point, we would expect to see leverage in the core SG&A excluding factoring, as sales grow slowly over time. So whether the second half or in the future, that's what we always expect.
Daniel Robert Imbro
Got it. And then last one for me. On Temperature Control, obviously, the first quarter is always dependent on kind of inventory levels and stocking. It feels like it's been a decent start to spring here in April as things normalize. I guess where are inventories today on the customer side? Are you seeing too much inventory out there that could weigh on Temperature Control as we get into 2Q? Or would you expect to snap back given some of the commentary from your customers that April has improved?
Eric Philip Sills
As we look at inventory in the channel, and we don't have visibility of all our customers. But for those that we do have visibility, I think, it's pretty representative. What we see is that their inventory at the end of the first quarter is roughly the same, maybe slightly elevated, but roughly the same as where they were same time last year. As you can imagine, we work very closely with them on planning preseason orders, and the preseason orders are roughly the same. They don't always land in the same months.
And so that's where you can see some swings quarter-to-quarter in preparation for the summer. But I think that they're in good position, and we're in a good position to be able to handle a hot summer. So now let's keep our fingers crossed that it gets hot.
Operator
(Operator Instructions) Our next question comes from Bret Jordan from Jefferies.
Bret David Jordan
You talked about POS color that you had early in the year. Could you talk about that POS sort of the composition of price versus units that you're seeing in the underlying market?
Eric Philip Sills
Yes. It's -- with the breadth of our offering, it's really a little bit hard to see what the different moving pieces are. There's no doubt, though, Bret, that price is a driver. And what we have seen -- again, I'm not really looking at Temperature Control because the first quarter POS is not particularly relevant. But on the Vehicle Control side, we have seen them being up in the mid-singles for the big guys. And I think that, that is -- it's a combination of units and price, but definitely price is a driver.
Bret David Jordan
Okay. And then you talked about the customers being largely receptive to passing costs through. Could you give us maybe a feeling as to where we might see some relief from what has been higher factoring costs as those prices are passed through by you?
Eric Philip Sills
I think what we've seen over the last 18 or so months, and it began really with commodity cost increases. And then as those stabilized, it was replaced more with the factoring or the interest rate increases. It's an iterative process with these guys. It is always a lag because it's hard to get ahead of it. It needs to be more reactive because we need to be able to go to them with the facts and not anticipation.
And so there is always that offset in timing. We feel as though we've been able to cover the majority of it either through pricing as well as we have a lot of cost reduction initiatives that we're always working on that helps to cover some of the balance of it. So again, it's continuing to be a dialogue with these guys. There continues to be receptivity when it's based in undeniable facts. And I think you're seeing that the marketplace continues to be rational in price as well. So we're cautiously optimistic that we'll be able to stay on top of it all.
Bret David Jordan
Okay. And then just a quick question. You talked about reducing inventory levels now the supply chains are normalizing a bit. Could you talk about maybe where you see as a healthy inventory balance or maybe how much working capital can come out from current levels?
James J. Burke
Bret, this is Jim Burke. Yes, we're not prepared to state a number where we are there. But we -- over the last 2 years, we had increased inventory levels significantly. That was on purpose trying to protect our customers from fill REITs in that. And with the confidence level now that we're seeing with supplier purchases that are there, we're able to tighten up the lead time there to safety stocks, bring our inventories down.
So without putting a hard number out there, we'll say we look for continued reductions in inventory as we go forward.
Operator
And our next question comes from Robert Smith from the Center for Performance Investing.
Robert Smith
So I was wondering in China was on the ground with your partners. What do you hear from them as far as U.S.-China relations and how it might impact you?
Eric Philip Sills
Well, it's certainly a hot topic. What we have seen on the ground at this point has really been business as usual. In relatively small players, our partners over there are Chinese. And so it really has been business as usual. But as you can imagine, we're paying very close attention to it and making sure that we have contingency plans and in anticipation of situation worsening.
But at this point, we have not really felt it or seen it. I think they're perhaps targeting larger companies, companies perhaps in different technologies and different verticals. So at this point, we have really not felt it, but we're paying close attention to it, for sure.
Robert Smith
And with respect to electric vehicles, I mean, there's so much on the burner here as far as the push to electric. What are you doing to study the aftermarket potential as it develops over the years? I mean what kind of studies have you undertaken? Or what do you see in that respect?
Eric Philip Sills
Well, it's certainly getting a tremendous amount of attention. And as you look at all the different forecasts of electrification first in terms of new vehicle sales and then the impact in the car park, most projections are still several years out before there's a significant impact. There's absolutely things that can accelerate that. You saw that announcement from the White House a few weeks ago, where through accelerating a rise in few economy standards, they're trying to get that adoption of new vehicles dramatically accelerated of electric vehicles.
So we do need to be prepared. We continue to see a very long tail for our combustion engine products and that part of our business continues to grow as the market and the car park and so on continues to grow. But we're certainly preparing our portfolio for a post-ICE world. That's one of the reasons why we went through the resegmentation and to provide better clarity into what categories have had the ability to be powertrain neutral.
And on the Temperature Control side, what we've seen and we've been communicating is it's actually poised to benefit from electrification as there's a lot more systems that need cooling, the air conditioning, the passenger comfort part gets more expensive and more complicated. So we see a lot of upside there, and we continue to add product categories in the safety side of things and the electrical side of things that will absolutely be there for the long run.
So we're really operating a two-pronged approach here, paying real close attention to the current while preparing for the future. And we're pretty -- we feel good about our position to handle it.
Robert Smith
With respect to the possibility -- probability now the softening economy, do you think that the Engineered Solutions, the possibilities are going to be more visible to you and you could strike some better deals, so to speak?
Eric Philip Sills
The way we're looking at Engineered Solutions is really about getting the attention of these customers by being able to go in with a much more robust portfolio and coherent strategy to be able to say Standard Motor Products, we're not just an aftermarket company, look at our ability to support you in your needs for your products. And so this is absolutely already opening doors for us. We're seeing cross-selling opportunities where one of the businesses that we acquired maybe had a customer, and we're now able to be talking to that customer about our products from a totally different part of our business and getting in the door that way.
So we see our growth potential here really through gaining market share, gaining visibility, gaining new business awards across such a broad array of different accounts, across different geographies, across different end markets. And so we're, I think, in the early days of this journey, but we're really excited about where it's going.
Operator
And with that, it appears that we have no further questions over the line at this time.
Anthony Francis 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.
