Participants

Anthony Cristello; VP, IR; Standard Motor Products Inc

Eric Sills; Chairman of the Board, President, Chief Executive Officer; Standard Motor Products Inc

Nathan Iles; Chief Financial Officer; Standard Motor Products Inc

Scott Stember; Analyst; ROTH MKM

Bret Jordan; Analyst; Jefferies Financial Group Inc.

Carolina Jolly; Analyst; GAMCO Investors, Inc.

Presentation

Operator

Good morning, everyone. Welcome to today’s Standard Motor Products First Quarter 2024 earnings conference call. At this time, all participants are in a listen only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions) Also, today’s call is being recorded, and I will be standing by if anyone should need any assistance.
Now I’d like to turn the call over to Mr. Tony Cristello, Vice President of Investor Relations. Please go ahead, sir.

Anthony Cristello

Thank you, Bo, and good morning, everyone. Thank you for joining us on Standard Motor Products First Quarter 2024 earnings conference call. With me today are Larry Sills, Chairman Emeritus, Eric Sills, Chairman and Chief Executive Officer; 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 up the call 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 see.

Story continues

Eric Sills

Thank you, Tony, and good morning, everyone, and welcome to our first quarter earnings call. Let me open by thanking all of our employees around the world for their tireless efforts as we enter our 150 year. So it’s fair to say that our first quarter results were mixed. We’re pleased with our top line performance where we set a record for first quarter sales. However, as expected, our profitability continued to lag, demonstrating some of the challenges in keeping up with inflationary pressures.
Let me get into the details best explained at the segment level, starting with vehicle control after a soft fourth quarter, we are pleased to see a nice rebound in sales. We were up about 0.5 point over 2023, which was a challenging comp as Q1 of 2023 was very strong, up more than 4% over the previous year. After a soft end to last year, we were pleased to see a return to more normal demand. Customer POS was soft in the quarter, though, again, it’s being compared to a very strong sell-through last year.
Turning to temperature control. As you well know, the first quarter is not indicative of how the year will turn out. This is the time of year that we ship customers their preseason orders and then those can ship in late Q1 or early Q2 and whiplash numbers around. Ultimately, this division will depend on the total season and its dynamics when it gets hot, how hard it is and where and how long it stays that way. So let’s see how the year behaves on to Engineered Solutions.
The year is off to a strong start for sales, up 4.5% hitting a single quarter record. As discussed, the segment is highly fragmented, multiple end markets, multiple geographies and a highly diverse customer base with no account greater than 10% of sales. As such, you can see some volatility quarter to quarter in terms of customer end market channel mix. So overall we’re very pleased with how we’re doing. As we’ve been saying over the last few years, we’ve been gaining real traction as we get known as a capable supplier of a broad array of products and technologies.
As such, we’ve been being awarded new business and are continuously managing a very healthy pipeline of opportunities. It’s important to note that we need to keep the funnel of these opportunities fall as items go through their life cycle much faster than the aftermarket. But I leave — but I believe we are demonstrating our ability to do that and grow this new segment.
I’d like to spend a minute talking about our progress on a new state-of-the-art distribution center in Shawnee, Kansas. We’ve been discussing this for the last few quarters, but I’ll remind you of what we are building and why about a year ago, we came to the decision to expand our distribution capacity as we’ve been operating out of our existing footprint for many years. While our volume and SKU count has grown, we leased a brand new 575,000 square foot facility, about five miles from our existing Edwards go Kansas location, giving us about 200,000 additional square feet in a time. This will replace our Edwards location as we move that operation in.
But additionally, we plan to distribute the A and B movers currently single pointed out of our Virginia and Texas DCs, which will allow us to provide better service to our customers in the west and north. It will also provide risk mitigation for us as we will move from single point to multipoint distribution. We’re pleased to announce that we have started shipping vehicle control products to certain customers in April, and it’s going very well. We’ve begun with manual operations while we build out our automation, which will take place over the balance of the year we then plan to move in phases over the course of 2025. And when complete, we will be able to sell our Edwards facility likely in 2026 in the near term, we are incurring additional expense, and Nathan will provide details. But once complete, we will exit many of the duplicate costs and will be well positioned for the future.
Lastly, let me discuss some of the issues we’ve been experiencing on the cost side that are causing continues, continued pressure on profitability. I’ll keep it at a high level and Nathan will provide more details. Overall, as expected, our profitability is down from last year, so for different reasons in the aftermarket for engineered solutions in the aftermarket, we are pleased that we’ve been able to maintain our gross margins. The pressures have been on SG&A, where we continue to experience elevated expenses tied to our receivables, factoring programs as well as certain other areas.
In Engineered Solutions, while operating expenses have remained stable, the downward pressure has been on our gross margins, which then drop through to the bottom line. We have been experiencing product cost inflation, partly for material costs, but more so related to significant wage increases in Mexico in Europe, where a great deal of our Engineered Solutions volume is produced. We have also seen a modest mix shift over the last two quarters, which can fluctuate based on normal ebbs and flows of demand. And this too is impacting our margins.
Also To reiterate, we are experiencing a planned and temporary increase in spending on our new distribution center, both here and in the aftermarket. We continue to work aggressively at cost reduction and pricing with teams in place looking at all the levers and believe we will see incremental relief in the quarters to come.
So with that, I’ll turn it over to Nathan, who will dive in deeper.

Nathan Iles

Thank you, Eric. As was noted earlier, the first quarter of the year largely turned out as expected as sales, operating profit and earnings per share were in line with the expectations we laid out in our last call as we go through the numbers, I’ll first give some color on the results by segment and at the consolidated level, then cover some key balance sheet and cash flow metrics, and finally, provide a brief update on our financial outlook for the full year 2020 for First, looking at our vehicle controls segment.
You can see on this slide that net sales of $185.5 million in Q1 were up 0.5% with the increase driven by solid demand for our products across all categories. Vehicle controls Adjusted EBITDA was 10.4% of net sales for the quarter and down from last year. Looking at the drivers of EBITDA for the quarter, the gross margin rate vehicle control in Q1 was flat with last year as cost savings and pricing offset inflation in cost of goods sold. However, SG&A expenses increased in the quarter, mainly due to inflationary increases I’ll touch more on later. And factory expenses increased $0.9 million as a result of higher interest rates and those increases resulted in lower adjusted EBITDA in the quarter.
Turning to temperature control, net sales in the quarter for that segment of $71.6 million were down 1.1% as we saw a slight variation in preseason ordering patterns versus last year. But keep in mind that the first quarter is not indicative of the full year and the seasonal business. Temperature controls adjusted EBITDA in Q1 of 4.7% was 0.1 points better than last year. The improvement was driven by a higher gross margin rate that was helped by savings initiatives, partly offset by inflation in SG&A costs.
Sales for Engineered Solutions segment in the quarter were up 4.5% as we were pleased to see our sales continue to increase as a result of strong demand and new business wins with both existing and new customers.
Adjusted EBITDA for engineered solutions in the quarter was down from last year, primarily due to cost inflation, the drivers of which Eric noted before, an unfavorable customer sales mix in the quarter, which resulted in lower gross margin for the segment. We also saw some inflation in SG&A costs in this segment just as we saw in the aftermarket segments.
Turning to our consolidated numbers, the change in our net sales and margin versus Q1 last year was the result of the changes in our segments as highlighted. Regarding consolidated SG&A expenses were up versus last year and were 19.5% of net sales in the quarter. I know that our costs were up in our segment results. So let me give a little more color on the drivers of the consolidated level.
You can see on this slide that costs were up $4.2 million, and this included $1.1 million of startup costs related to our new distribution center. Excluding these costs expenses increased $3.1 million or about 5%. The increase included elevated distribution expenses across a number of costs, including higher lease expense and certain locations. As we look to offset some of the inflation headwinds on operating expenses. We’ll be reviewing levers to reduce our costs going forward.
One final note on our consolidated results, you can see the cost of customer factoring programs increased by $0.9 million in Q1. But I would point out that we can see the cost of those programs leveling out now that interest rates have been more steady, albeit at a much higher level than several years ago.
Turning now to the balance sheet. Accounts receivable were $203.9 million at the end of the quarter and inventory levels finished Q1 at $520.7 million, with both balances in line with March last year. Increases in receivable and inventory from December 2023 relate to the seasonal increases in sales and preparation for temp control selling season.
Our cash flow statement reflects cash used in operations for the first quarter of $45.7 million as compared to cash used of $20.4 million last year. Cash used in operations last year was aided by a reduction in inventory balances that did not recur this year after we brought inventory back down to normal levels through the course of 2023, our investing activities show an increase in capital expenditures this year $5.7 billion, which includes $2.6 million of investment related to our new distribution center.
Financing activity show borrowings on our revolving credit agreement of $58.7 million in the first quarter, which were used to fund operations, capital expenditures and pay $6.4 million of dividends. We also began repurchasing shares under an existing $30 million authorization from our Board and repurchased 2.6 million of shares during the quarter. We continue to purchase shares in the second quarter, and as we noted in our release this morning purchased an additional 3.5 million through April 29th for a total of 6.1 million repurchased so far this year. Our net debt of $187.7 million in Q1 was much lower than last year, and we finished the quarter with a leverage ratio of 1.6 times and lower than last year’s ratio.
Before I finish, I want to give an update on our sales and profit expectations for the full year 2024. Regarding our top line sales, we are maintaining the expectations we laid out before and expect full year 2024 sales will show flat to low single digit percentage growth. We’re also maintaining our expectations for adjusted EBITDA which we expect to be in a range of 9% to 9.5% and essentially flat 2023. This estimate continues to include factoring expenses of $45 million to $48 million, largely flat with 2023 as we remain in a high and uncertain interest rate environment.
US dollar remains at a multiyear low against key currencies in Mexico and Poland. And some additional costs related to the expansion of distribution capabilities in our new warehouse in Kansas, which we estimate is $5 million to $6 million incremental costs in 2024.
In connection with our adjusted EBIT outlook, we expect our interest expense on outstanding debt to be on average about $3 million to $4 million each quarter, and we expect our income tax rate to be 25%. Borrowings are expected to remain roughly flat from December 2023 to December 2024, as cash flows normalize, and we look to invest approximately $25 million in our new DC and return cash to shareholders via dividends and share repurchases.
Regarding operating expenses for the full year, keep in mind, our operating expenses are incurred ratably across the year and do not necessarily vary with top line sales as the majority of these costs are fixed in nature. As such, we anticipate total operating expenses inclusive of factoring will range from $76 million to $82 million for each of the last three quarters of 2024.
To quickly wrap up, we were pleased to see our sales increase in Q1 despite slightly slower preseason orders in Temp Control and a turn in results in line with the forecast while also increasing shareholder returns through share repurchases in the quarter. Thank you for your attention, and I’ll turn the call back to Eric for some final comments.

Eric Sills

Well, thank you, Nate. And in closing, I’d like to spend a minute on how we are thinking about the future. The aftermarket continues to be a strong and stable market. All signs suggest that after a few years of unusual demand behavior coming out of the pandemic, it has returned to its historical long-term trend of low single digit growth, which makes sense when you consider the basic dynamics of the addressable market, where things change very slowly. But in the right direction, car park slowly gets larger and older miles driven has returned to stable levels.
People are keeping their cars longer, especially in light of the high cost of new vehicles. And when you put these together, they add up to slow growth. We recognize that the record inflation over these last few years have caused challenges to consumers and while this could dampen discretionary purchases, much of what we sell is nondiscretionary in nature, Engineered Solutions is more difficult to summarize, as it is so diverse and end market customer product and geography. But as we have been saying, we believe our sales trajectory will be less determined by ebbs and flows in these markets as it will be by gaining and launching new business wins and building on these wins, it’s obviously not lost on us that we have work to do to return to our historic margins, and we are focusing diligently on this. So overall, when you put it all together, the long view remains quite positive.
So that concludes our prepared remarks. At this point, I will turn it back over to the moderator, and we’ll open it up for questions.

Question and Answer Session

Operator

Thank you, Mr. Sills. (Operator Instructions) Scott Stember, ROTH MKM.

Scott Stember

Good morning, guys. Thanks for taking my questions this morning, Scott. Eric, you talked about how, I guess, the weakness that we saw in Q4 sort of sort of reverse and that things are back to normal yet. On the other hand, you talked about POS being a little soft. Is that more just a function of tough year-over-year comparisons or is there something else going on?

Eric Sills

I think that’s a fair statement, Scott, that it is more about the fact that the first quarter of 2023 was really quite strong. If you think about the POS trends come in through the fourth quarter of last year and into this year and last year, we saw a sequential erosion of that POS month over month, and that continued a bit into January of this year. And now we start to see a bit of a rebound. So if you look at the whole quarter this year, POS was a bit soft, but I think that it also does reflect that more of that return to where we’d expect it to be.

Scott Stember

So you say soft, are we talking flat or down slightly for the whole quarter?

Eric Sills

It moderated throughout the quarter. And overall it was roughly in that flat. There were some periods and some customers that were a little bit up or down from that. But overall, it’s that that’s what we saw.

Scott Stember

Got it. And then on the engine solutions side, it looks like the other most of the growth came from the other segment. Is that UTV mostly? Or is there something else in there and what’s driving that?

Eric Sills

But we don’t we don’t go into the specifics of what’s behind that and what’s behind it that all other, there’s many different end markets in there from motorsports to lawn and garden hydraulic stationary engines. There’s a lot of different pieces in there. And as we always say, there’s going to be some movement quarter to quarter based on the build schedules of the customers within the. So I wouldn’t read too much in to the fact that any subsegment goes up or down in a quarter.

Scott Stember

Got it. And then my last question is just on the margin side, you talked about, I guess, labor wages and things like that. How are you addressing that? And what is a good margin, I guess, where should we look for the margin to eventually land in a more normalized environment for this segment?

Nathan Iles

(inaudible) on the Engineered Solutions segment you’re asking about.

Scott Stember

Yeah. Thanks.

Nathan Iles

So I think, Scott, the gross margin we’d be looking at and I guess to give a little bit of history before I started, if you go back several years, the gross margins have kind of ranged between 18% and 20% over time. And so as we look at offsetting cost headwinds and cost reductions in this area, we look to be getting back into that range. I think on the very bottom line, adjusted EBITDA and where we tend to talk about that number recently. We’d expect that segment to also continue to be in line with the aftermarket, but once the other headwinds are offset.

Operator

Bret Jordan, Jefferies.

Bret Jordan

Hey, morning, guys. You bet, could you talk about temperature control inventory at the customer level ending Q1 and how we are year over year?

Eric Sills

Sure. And I think you can’t just look at it after Q1, but as as they’re building up their entirety of their preseason orders, which did continue into the beginning of Q2. And what I would say is that basically they’re in good shape for the season, maybe slightly above where they were going into last selling season. But they’re healthy and where they would want them to be. So Now ultimately, it’s about what happens with the weather. And so really we’re hoping that that begins over the next few weeks and lasts for a long time.

Bret Jordan

And you talked about new customers, was that primarily the engineered solutions or did you pick up new customers in the aftermarket as well?

Eric Sills

That’s correct, Brett, we were referring specifically to two within Engineered Solutions and not so much new customers as new awards with existing customers, although there is a little bit of that as well, one thing just to kind of characterize what happens in that industry is it’s a lot of base hits. It’s not like you’re landing a new platform with a light vehicle manufacturer and all the segments of multi multimillion dollar award. It’s a lot of base hits on and we have been — that we have been getting those.

Bret Jordan

Okay. And then final question, I guess on pricing outlook, and we’ve seen most of the inflation pass through, or is there still some to come to offset the continued high rates?

Eric Sills

Yes. So it’s a competitive market, as you well know. And so pricing is not easy to come by. We continue to work with all of our customers where we can to be able to share with them what we’re experiencing with cost inflation on. So nothing specific to report. We continue to work on it, but it is getting tougher.

Operator

Thank you. (Operator Instructions) Carolina Jolly, Gabelli.

Carolina Jolly

So in terms of kind of industry commentary, it sounded like some areas that the industry there was have a weak start to the spring selling season. Would you, given your kind of inventory and category, mix have exposure to that underlying trend?

Eric Sills

No, I’m not sure I completely understand your question that are you asking whether we’re tracking with the overall numbers of the large public companies as they report?

Carolina Jolly

Just in terms — it did sound like there was more of a DIY.

Eric Sills

No, I see what you’re saying. Most of our products are not DIY. There’s certainly a bit of work there that certain shade tree mechanics are able to do, but the majority of our products are professionally installed and dumb. So I think it has less to do really with the DIY. customer versus the GIFM. customer. It has more to do with discretionary versus nondiscretionary type purchases and the majority of what we’re selling is nondiscretionary. And so while I think you have some economically challenged consumers who are perhaps deferring things that they don’t need our typically our types of products, our break fix and if the cars not work in it, they may have to buy.

Operator

(Operator Instructions) And gentlemen, it appears we have no further questions today. Mr. Cristello, I’d like to hand things back to you, sir, for any closing comments.

Anthony Cristello

Again, we want to thank everyone for participating in our conference 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 Investor Relations website. We hope you have a great day. Thank you.

Eric Sills

Thank you.

Operator

Ladies and gentlemen, that will conclude the Standard Motor Products First Quarter Earnings Conference Call. Again, thanks so much for joining us. We wish you all a great day. Good bye.