STANDARD MOTOR PRODUCTS, INC. - Quarter Report: 2021 June (Form 10-Q)

(Mark One)

For the quarterly period ended June 30, 2021

or

Commission file number:  001-04743

Note 1.  Basis of Presentation

Standard Motor Products, Inc. and subsidiaries (referred to hereinafter in these notes to the consolidated financial statements as “we,” “us,” “our,” “SMP,” or the “Company”) is a leading automotive parts manufacturer and distributor for engine management and temperature control systems of motor vehicles in the automotive aftermarket industry with a complementary focus on the heavy duty, industrial equipment and original equipment service markets.

The accompanying unaudited financial information should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2020.  The unaudited consolidated financial statements include our accounts and all domestic and international companies in which we have more than a 50% equity ownership, except in instances where the minority shareholder maintains substantive participating rights, in which case we follow the equity method of accounting.  In instances where we have more than a 50% equity ownership and the minority shareholder does not maintain substantive participating rights, our consolidated financial statements include the accounts of the company on a consolidated basis with its net income and equity reported at amounts attributable to both our equity position and that of the noncontrolling interest.  Investments in unconsolidated affiliates are accounted for on the equity method, as we do not have a controlling financial interest but have the ability to exercise significant influence.  All significant inter-company items have been eliminated.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  The results of operations for the interim periods are not necessarily indicative of the results of operations for the entire year.

Reclassification

Certain prior period amounts in the accompanying consolidated financial statements and related notes have been reclassified to conform to the 2021 presentation.

Note 2.  Summary of Significant Accounting Policies

The preparation of consolidated annual and quarterly financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods.  We have made a number of estimates and assumptions in the preparation of these consolidated financial statements.  We can give no assurance that actual results will not differ from those estimates.  Although we do not believe that there is a reasonable likelihood that there will be a material change in the future estimates, or in the assumptions that we use in calculating the estimates, the uncertain future effects, if any, of the COVID-19 pandemic, and other unforeseen changes in the industry, or business, could materially impact the estimates, and may have a material adverse effect on our business, financial condition and results of operations.  Some of the more significant estimates include allowances for doubtful accounts, cash discounts, valuation of inventory, valuation of long-lived assets, goodwill and other intangible assets, depreciation and amortization of long-lived assets, product liability exposures, asbestos, environmental and litigation matters, valuation of deferred tax assets, share based compensation and sales returns and other allowances.

There have been no material changes to our critical accounting policies and estimates from the information provided in Note 1 of the notes to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020.

Recently Issued Accounting Pronouncements

Standards that were adopted

Standards that are not yet adopted as of June 30, 2021

The following table provides a brief description of recently issued accounting pronouncements that have not yet been adopted as of June 30, 2021, and that could have an impact on our financial statements:

Note 3.  Business Acquisitions and Investments

2021 Business Acquisitions

In May 2021, we acquired 100% of the capital stock of Trumpet Holdings, Inc., a Delaware corporation, (more commonly known as “Trombetta”), for $111.7 million, subject to certain post-closing adjustments.  Trombetta is a leading provider of power switching and power management products to Original Equipment (‘‘OE’’) customers in various markets. The acquired Trombetta business was paid for in cash funded by borrowings under our revolving credit facility with JPMorgan Chase Bank, N.A., as agent, and has manufacturing facilities in Milwaukee, Wisconsin; Sheboygan Falls, Wisconsin; Tijuana, Mexico, as well as a 70% ownership in a joint venture in Hong Kong, with operations in Shanghai and Wuxi, China (“Trombetta Asia, Ltd.”). The acquisition will be reported as part of our Engine Management Segment, is an excellent fit for our strategy of expansion into the OE heavy duty market.

The preliminary allocation of purchase price to assets acquired and liabilities assumed is based upon estimates of fair values utilizing customary valuation procedures and techniques, as well as other information compiled by management. While we believe these preliminary estimates provide a reasonable basis for estimating the fair value of the assets acquired and liabilities assumed, and do not anticipate that any adjustments to these values will be significant, we will continue to evaluate available information prior to finalization of the amounts, particularly the amounts related to intangible assets, deferred income taxes, noncontrolling interests and the final agreement of post-closing adjustments. The following table presents the preliminary allocation of the purchase price to the assets acquired and liabilities assumed (in thousands):

Intangible assets acquired of $54.7 million consist of customer relationships of $39.4 million that will be amortized on a straight-line basis over the estimated useful life of 20 years; developed technology of $13.4 million that will be amortized on a straight-line basis over the estimated useful life of 15 years; and a trade name of $1.9 million that will be amortized on a straight-line basis over the estimated useful life of 10 years.  Goodwill of $49 million was allocated to the Engine Management Segment.  The goodwill reflects relationships, business specific knowledge and the replacement cost of an assembled workforce associated with personal reputations.  The intangible assets and goodwill are not deductible for tax purposes.

Revenues from the acquired business included in our consolidated statement of operations from the acquisition date through June 30, 2021 were $5.7 million.

In March 2021, we agreed to acquire the soot sensor product lines from Stoneridge, Inc. The product lines to be acquired manufacture sensors used in the exhaust and emission systems of diesel engines. The product lines are located in Stoneridge’s facilities in Lexington, Ohio and Tallinn, Estonia.  We are not acquiring these facilities, nor any of Stoneridge’s employees, and will be relocating the production lines to our engine management plants in Independence, Kansas and Bialystok, Poland, respectively.  The acquisition, to be reported as part of our Engine Management Segment, is an excellent fit for our strategy of expansion into the OE heavy duty market.  Customer relationships to be acquired include Volvo, CNHi and Hino.

The product lines located in Stoneridge’s facility in Lexington, Ohio were acquired in March 2021 for $2.1 million, and were paid for in cash funded by borrowings under our revolving credit facility with JPMorgan Chase Bank, N.A. The assets acquired include inventory, machinery & equipment and certain intangible assets.  The product lines at Stoneridge’s Tallinn, Estonia facility will be acquired at a future date for approximately $800,000.  Tallinn, Estonia assets to be acquired consist solely of machinery & equipment.

The following table presents the allocation of the purchase price to the assets acquired and liabilities assumed through June 30, 2021, based on their fair values (in thousands):

Intangible assets acquired of approximately $0.8 million consist of customer relationships that will be amortized on a straight-line basis over the estimated useful life of 10 years.

Revenues from the acquired business included in our consolidated statement of operations from the acquisition date through June 30, 2021 were $3.8 million.

Note 4.  Restructuring and Integration Expenses

Restructuring Costs

Plant Rationalization Programs

The 2016 Plant Rationalization Program, which included the shutdown and sale of our Grapevine, Texas facility, and the 2017 Orlando Plant Rationalization Program, which included the shutdown our Orlando Florida facility, have been substantially completed.  Cash payments made of $72,000 during the six months ended June 30, 2021, and the remaining aggregate liability of $107,000 consists of severance payments to former employees terminated in connection with these programs.

Note 5.  Sale of Receivables

We are party to several supply chain financing arrangements, in which we may sell certain of our customers’ trade accounts receivable to such customers’ financial institutions.  We sell our undivided interests in certain of these receivables at our discretion when we determine that the cost of these arrangements is less than the cost of servicing our receivables with existing debt.  Under the terms of the agreements, we retain no rights or interest, have no obligations with respect to the sold receivables, and do not service the receivables after the sale.  As such, these transactions are being accounted for as a sale.

Pursuant to these agreements, we sold $203.1 million and $394.4 million of receivables during the three months and six months ended June 30, 2021, respectively, and $147.7 million and $297.9 million for the comparable periods in 2020.  Receivables presented at financial institutions and not yet sold as of June 30, 2021 and December 31, 2020 were approximately $5 million and $50 million, respectively, and remained in our accounts receivable balance for those periods.  All receivables sold were reflected as a reduction of accounts receivable in the consolidated balance sheet at the time of sale.  A charge in the amount of $3 million and $5.7 million related to the sale of receivables was included in selling, general and administrative expense in our consolidated statements of operations for the three months and six months ended June 30, 2021, respectively, and $3.1 million and $5.9 million for the comparable periods in 2020.

Note 6.  Inventories

Inventories, which are stated at the lower of cost (determined by means of the first-in, first-out method) and net realizable value, consist of the following:

Note 7.  Acquired Intangible Assets

Acquired identifiable intangible assets consist of the following:

In May 2021, we acquired 100% of the capital stock of Trumpet Holdings, Inc. (more commonly known as “Trombetta”).  Intangible assets acquired of $54.7 million consist of customer relationships of $39.4 million that will be amortized on a straight-line basis over the estimated useful life of 20 years; developed technology of $13.4 million that will be amortized on a straight-line basis over the estimated useful life of 15 years; and a trade name of $1.9 million that will be amortized on a straight-line basis over the estimated useful life of 10 years.

In March 2021, we acquired certain assets and liabilities of the particulate matter sensor product lines from Stoneridge, Inc.  Intangible assets acquired of approximately $0.8 million consist of customer relationships that will be amortized on a straight-line basis over the estimated useful life of 10 years.

Total amortization expense for acquired intangible assets was $2.1 million and $4.1 million for the three months and six months ended June 30, 2021, respectively, and $2 million and $4.1 million for the comparable periods in 2020. Based on the current estimated useful lives assigned to our intangible assets, amortization expense is estimated to be $4.6 million for the remainder of 2021, $8.4 million in 2022, $8.1 million in 2023, $8 million in 2024 and $73.1 million in the aggregate for the years 2025 through 2041.

Note 8.  Leases

We have operating and finance leases for our manufacturing facilities, warehouses, office space, automobiles, and certain equipment.  Our leases have remaining lease terms of up to ten years, some of which may include one or more five-year renewal options.  We have included the five-year renewal option for one of our leases in our operating lease payments as we concluded that it is reasonably certain that we will exercise the option.  Leases with an initial term of twelve months or less are not recorded on the balance sheet.  Operating lease expense is recognized on a straight-line basis over the lease term.  Finance leases are not material.

The following tables provides quantitative disclosures related to our operating leases and includes all operating leases acquired in the Trombetta acquisition from the date of acquisition (in thousands):

Minimum Lease Payments

At June 30, 2021, we are obligated to make minimum lease payments through 2028, under operating leases, which are as follows (in thousands):

Note 9.  Credit Facilities and Long-Term Debt

Total debt outstanding is summarized as follows:

Revolving Credit Facility

In December 2018, we amended our Credit Agreement with JPMorgan Chase Bank, N.A., as agent, and a syndicate of lenders.  The amended credit agreement provides for a senior secured revolving credit facility with a line of credit of up to $250 million (with an additional $50 million accordion feature) and extends the maturity date to December 2023.  The line of credit under the amended credit agreement also allows for a $10 million line of credit to Canada as part of the $250 million available for borrowing.  Direct borrowings under the amended credit agreement bear interest at LIBOR plus a margin ranging from 1.25% to 1.75% based on our borrowing availability, or floating at the alternate base rate plus a margin ranging from 0.25% to 0.75% based on our borrowing availability, at our option.  The amended credit agreement is guaranteed by certain of our subsidiaries and secured by certain of our assets.

Borrowings under the amended credit agreement are secured by substantially all of our assets, including accounts receivable, inventory and certain fixed assets, and those of certain of our subsidiaries. Availability under the amended credit agreement is based on a formula of eligible accounts receivable, eligible drafts presented to the banks under our supply chain financing arrangements and eligible inventory. After taking into account outstanding borrowings under the amended credit agreement, there was an additional $112.3 million available for us to borrow pursuant to the formula at June 30, 2021. The loss of business of one or more of our key customers or, a significant reduction in purchases of our products from any one of them, could adversely impact availability under our revolving credit facility.

Outstanding borrowings under the credit agreement, which are classified as current liabilities, were $135 million and $10 million at June 30, 2021 and December 31, 2020, respectively; while letters of credit outstanding under the credit agreement were $2.6 million and $2.8 million at June 30, 2021 and December 31, 2020, respectively.  Borrowings under the credit agreement have been classified as current liabilities based upon accounting rules and certain provisions in the agreement.

At June 30, 2021, the weighted average interest rate on our amended credit agreement was 1.3%, which consisted of $135 million in direct borrowings. At December 31, 2020, the weighted average interest rate on our amended credit agreement was 1.4%, which consisted of $10 million in direct borrowings.  During the six months ended June 30, 2021, our average daily alternative base rate loan balance was $1 million, compared to a balance of $1.7 million for the six months ended June 30, 2020 and a balance of $1.5 million for the year ended December 31, 2020.

At any time that our borrowing availability is less than the greater of either (a) $25 million, or 10% of the commitments if fixed assets are not included in the borrowing base, or (b) $31.25 million, or 12.5% of the commitments if fixed assets are included in the borrowing base, the terms of the amended credit agreement provide for, among other provisions, a financial covenant requiring us, on a consolidated basis, to maintain a fixed charge coverage ratio of 1:1 at the end of each fiscal quarter (rolling four quarters).  As of June 30, 2021, we were not subject to these covenants.  The amended credit agreement permits us to pay cash dividends of $20 million and make stock repurchases of $20 million in any fiscal year subject to a minimum availability of $25 million.  Provided specific conditions are met, the amended credit agreement also permits acquisitions, permissible debt financing, capital expenditures, and cash dividend payments and stock repurchases of greater than $20 million.

Polish Overdraft Facility

Our Polish subsidiary, SMP Poland sp. z.o.o., has entered into an overdraft facility with HSBC France (Spolka Akcyjna) Oddzial w Polsce, formerly HSBC Bank Polska S.A., for Zloty 30 million (approximately $7.9 million).  The facility, as amended, expires in December 2021.  Borrowings under the overdraft facility will bear interest at a rate equal to WIBOR + 1.5% and are guaranteed by Standard Motor Products, Inc., the ultimate parent company.  At June 30, 2021 and December 31, 2020, borrowings under the overdraft facility were Zloty 9 million (approximately $2.4 million) and Zloty 0.4 million (approximately $0.1 million), respectively.

Deferred Financing Costs

We have deferred financing costs of approximately $0.5 million and $0.7 million as of  June 30, 2021 and December 31, 2020, respectively.  Deferred financing costs are related to our revolving credit facility.  Deferred financing costs as of June 30, 2021 are being amortized in the amounts of $0.1 million for the remainder of 2021, $0.2 million in 2022, and $0.2 million in 2023.

Note 10. Stock-Based Compensation Plans

We account for our stock-based compensation plans in accordance with the provisions of FASB ASC 718, Stock Compensation, which requires that a company measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award.  The cost is recognized in the consolidated statement of operations over the period during which an employee is required to provide service in exchange for the award.

Restricted and Performance Stock Grants

In May 2021, our Board of Directors and Shareholders approved an amendment and restatement to the 2016 Omnibus Incentive Plan (the “Plan”).  The Plan, as amended and restated (1) increased the number of shares available for issuance under the Plan by 950,000 shares (from 1,100,000 shares to 2,050,000 shares); (2) increased the number of shares available for issuance to nonemployee directors by 100,000 (from 250,000 shares to 350,000 shares); and (3) revised the Plan in response to certain changes made in applicable federal tax laws.  The restated and amended 2016 Omnibus Incentive Plan terminates in May 2026.

Under the revised and amended 2016 Omnibus Incentive Plan, we are authorized to issue, among other things, shares of restricted and performance-based stock to eligible employees and restricted stock to directors of up to 2,050,000 shares.  Shares issued under the Plan that are cancelled, forfeited or expire by their terms are eligible to be granted again under the Plan.

As part of the Plan, we currently grant shares of restricted stock to eligible employees and our independent directors and performance-based shares to eligible employees.  We grant eligible employees two types of restricted stock (standard restricted shares and long-term retention restricted shares).  Standard restricted shares granted to employees become fully vested no earlier than three years after the date of grant.  Long-term retention restricted shares granted to selected executives vest at a 25% rate on or within approximately two months of an executive reaching the ages 60 and 63, and become fully vested on or within approximately two months of an executive reaching the age 65. Restricted shares granted to directors become fully vested upon the first anniversary of the date of grant.

Performance-based shares issued to eligible employees are subject to a three-year measuring period and the achievement of performance targets and, depending upon the achievement of such performance targets, they may become vested no earlier than three years after the date of grant.  Each period we evaluate the probability of achieving the applicable targets, and we adjust our accrual accordingly.    Restricted shares (other than long-term retention restricted shares) and performance shares issued to certain key executives and directors are subject to a one or two year holding period upon the lapse of the vesting period.  Forfeitures on stock grants are estimated at 5% for employees and 0% for executives and directors based on our evaluation of historical and expected future turnover.

Our restricted and performance-based share activity was as follows for the six months ended June 30, 2021:

We recorded compensation expense related to restricted shares and performance-based shares of $4 million ($3 million, net of tax) and $3 million ($2.2 million, net of tax) for the six months ended June 30, 2021 and 2020, respectively. The unamortized compensation expense related to our restricted and performance-based shares was $13.1 million at June 30, 2021, and is expected to be recognized as they vest over a weighted average period of 4 years and 0.8 years for employees and directors, respectively.

Note 11. Employee Benefits

We provide certain medical and dental care benefits to 16 former U.S. union employees.  The postretirement medical and dental benefit obligation to the former union employees as of June 30, 2021, and the related net periodic benefit cost for the plan for the three and six months ended June 30, 2021 and 2020 were not material.

We maintain a defined contribution Supplemental Executive Retirement Plan for key employees.  Under the plan, these employees may elect to defer a portion of their compensation and, in addition, we may at our discretion make contributions to the plan on behalf of the employees.  In March 2021, we made company contributions to the plan of $0.5 million related to calendar year 2020.

We also have an Employee Stock Ownership Plan and Trust for employees who are not covered by a collective bargaining agreement.  In connection therewith, we maintain an employee benefits trust to which we contribute shares of treasury stock.  We are authorized to instruct the trustees to distribute such shares toward the satisfaction of our future obligations under the plan. The shares held in trust are not considered outstanding for purposes of calculating earnings per share until they are committed to be released.  The trustees will vote the shares in accordance with their fiduciary duties.  During the six months ended June 30, 2021, we contributed to the trust an additional 61,800 shares from our treasury and released 61,800 shares from the trust leaving 200 shares remaining in the trust as of June 30, 2021.

Note 12. Earnings Per Share

The following are reconciliations of the net earnings attributable to SMP and the shares used in calculating basic and dilutive net earnings per common share attributable to SMP (in thousands, except per share data):

The shares listed below were not included in the computation of diluted net earnings per common share attributable to SMP because to do so would have been anti-dilutive for the periods presented or because they were excluded under the treasury method (in thousands):

Note 13. Fair Value Measurements

The carrying value of our financial instruments consisting of cash and cash equivalents, deferred compensation, and short term borrowings approximate their fair value.  In each instance, fair value is determined after considering Level 1 inputs under the three-level fair value hierarchy.  For fair value purposes, the carrying value of cash and cash equivalents approximates fair value due to the short maturity of those investments.  The fair value of the assets held by the deferred compensation plan are based on the quoted market prices of the underlying funds which are held in registered investment companies. The carrying value of our revolving credit facilities, classified as short term borrowings, equals fair market value because the interest rate reflects current market rates.

Note 14. Industry Segments

We have two major reportable operating segments, each of which focuses on a specific line of automotive parts in the automotive aftermarket with a complementary focus on the heavy duty, industrial equipment and original equipment service markets.  Our Engine Management Segment manufactures and remanufactures ignition and emission parts, ignition wires, battery cables, fuel system parts and sensors for vehicle systems.  Our Temperature Control Segment manufactures and remanufactures air conditioning compressors, air conditioning and heating parts, engine cooling system parts, power window accessories and windshield washer system parts.

The following tables show our net sales, intersegment revenue and operating income for each reportable segment (in thousands):

For the disaggregation of our net sales from contracts with customers by geographic area, major product group and major sales channels for each of our segments, see Note 15, “Net Sales.”

Note 15.  Net Sales

Disaggregation of Net Sales

We disaggregate our net sales from contracts with customers by geographic area, major product group, and major sales channels for each of our segments, as we believe it best depicts how the nature, amount, timing and uncertainty of our net sales are affected by economic factors.

The following tables provide disaggregation of net sales information for the three months and six months ended June 30, 2021 and 2020 (in thousands):