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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NUMBER: 1-4743
STANDARD MOTOR PRODUCTS, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
NEW YORK 11-1362020
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
37-18 NORTHERN BLVD., LONG ISLAND CITY, N.Y. 11101
-------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(718) 392-0200
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer |_| Accelerated Filer |X| Non-Accelerated Filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
As of the close of business on October 31, 2006, there were 18,570,873
outstanding shares of the registrant's Common Stock, par value $2.00 per share.
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STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION
Page No.
--------
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets
as of September 30, 2006 (Unaudited) and December 31, 2005........ 3
Consolidated Statements of Operations and Retained Earnings
(Unaudited) for the Three Months and Nine Months Ended
September 30, 2006 and 2005....................................... 4
Consolidated Statements of Cash Flows (Unaudited)
for the Nine Months Ended September 30, 2006 and 2005............. 5
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited) for the Three Months and Nine Months Ended
September 30, 2006................................................ 6
Notes to Consolidated Financial Statements (Unaudited)............ 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 22
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 33
Item 4. Controls and Procedures........................................... 34
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................. 34
Item 6. Exhibits.......................................................... 35
Signatures................................................................... 36
2
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
September 30, December 31,
2006 2005
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................. $ 15,019 $ 14,046
Accounts receivable, less allowance for discounts and doubtful
accounts of $10,074 and $9,574 for 2006 and 2005, respectively .... 231,672 176,294
Inventories ........................................................... 228,098 243,297
Deferred income taxes ................................................. 14,287 14,081
Prepaid expenses and other current assets ............................. 9,511 7,972
------------ ------------
Total current assets .............................................. 498,587 455,690
Property, plant and equipment, net ........................................... 81,326 85,805
Goodwill and other intangibles, net .......................................... 56,787 67,402
Other assets ................................................................. 35,096 44,147
------------ ------------
Total assets ...................................................... $ 671,796 $ 653,044
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable ......................................................... $ 157,497 $ 149,236
Current portion of long-term debt ..................................... 542 542
Accounts payable ...................................................... 55,414 52,535
Sundry payables and accrued expenses .................................. 24,656 24,466
Accrued customer returns .............................................. 30,869 22,346
Restructuring accrual ................................................. 861 1,286
Accrued rebates ....................................................... 21,059 24,017
Payroll and commissions ............................................... 18,115 11,494
------------ ------------
Total current liabilities ...................................... 309,013 285,922
------------ ------------
Long-term debt ............................................................... 98,127 98,549
Post-retirement medical benefits and other accrued liabilities ............... 47,442 45,962
Restructuring accrual ........................................................ 418 11,348
Accrued asbestos liabilities ................................................. 20,903 25,556
------------ ------------
Total liabilities .............................................. 475,903 467,337
------------ ------------
Commitments and contingencies
Stockholders' equity:
Common stock - par value $2.00 per share:
Authorized - 30,000,000 shares; issued 20,486,036 shares ....... 40,972 40,972
Capital in excess of par value ........................................ 57,325 56,966
Retained earnings ..................................................... 115,959 109,649
Accumulated other comprehensive income ................................ 6,148 4,158
Treasury stock - at cost 2,179,854 and 2,315,645 shares in
2006 and 2005, respectively .................................... (24,511) (26,038)
------------ ------------
Total stockholders' equity ................................. 195,893 185,707
------------ ------------
Total liabilities and stockholders' equity ................. $ 671,796 $ 653,044
============ ============
See accompanying notes to consolidated financial statements.
3
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(In thousands, except share and per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------
2006 2005 2006 2005
(Unaudited) (Unaudited)
Net sales ...................................... $ 203,755 $ 224,438 $ 643,005 $ 658,276
Cost of sales .................................. 154,423 175,301 483,736 511,794
------------ ------------ ------------ ------------
Gross profit ............................ 49,332 49,137 159,269 146,482
Selling, general and administrative expenses ... 40,039 39,134 126,822 124,915
Restructuring expenses ......................... 598 218 828 4,620
------------ ------------ ------------ ------------
Operating income ........................ 8,695 9,785 31,619 16,947
Other income, net .............................. 820 67 1,980 1,046
Interest expense ............................... 5,118 4,552 14,826 12,617
------------ ------------ ------------ ------------
Earnings from continuing operations
before taxes ....................... 4,397 5,300 18,773 5,376
Provision for income tax ...................... 1,814 1,137 8,137 1,441
------------ ------------ ------------ ------------
Earnings from continuing operations ..... 2,583 4,163 10,636 3,935
Income (loss) from discontinued operation ...... 1,656 (449) 603 (1,240)
------------ ------------ ------------ ------------
Net earnings ............................ 4,239 3,714 11,239 2,695
Retained earnings at beginning of period ....... 113,368 115,694 109,649 120,218
------------ ------------ ------------ ------------
117,607 119,408 120,888 122,913
Less: cash dividends for period ................ 1,648 1,760 4,929 5,265
------------ ------------ ------------ ------------
Retained earnings at end of period ............. $ 115,959 $ 117,648 $ 115,959 $ 117,648
============ ============ ============ ============
PER SHARE DATA:
Net earnings per common share - Basic:
Earnings from continuing operations ....... $ 0.14 $ 0.21 $ 0.58 $ 0.20
Discontinued operation .................... 0.09 (0.02) 0.03 (0.06)
------------ ------------ ------------ ------------
Net earnings per common share - Basic .......... $ 0.23 $ 0.19 $ 0.61 $ 0.14
============ ============ ============ ============
Net earnings per common share - Diluted:
Earnings from continuing operations ....... $ 0.14 $ 0.21 $ 0.58 $ 0.20
Discontinued operation .................... 0.09 (0.02) 0.03 (0.06)
------------ ------------ ------------ ------------
Net earnings per common share - Diluted ........ $ 0.23 $ 0.19 $ 0.61 $ 0.14
------------ ------------ ------------ ------------
Average number of common shares ................ 18,306,178 19,547,319 18,265,784 19,509,040
============ ============ ============ ============
Average number of common shares and dilutive
common shares ............................. 18,371,435 19,577,972 18,297,979 19,546,261
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
September 30,
-------------
2006 2005
---- ----
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 11,239 $ 2,695
Adjustments to reconcile net earnings to net cash provided by (used in)
operating activities:
Depreciation and amortization 12,016 12,968
Increase in allowance for doubtful accounts 176 736
Increase in inventory reserves 3,617 2,595
Loss on disposal of property, plant and equipment 2 2,461
Equity income from joint ventures (865) (675)
Employee stock ownership plan allocation 893 1,009
Stock-based compensation 695 115
Increase in tax valuation allowance -- 685
Decrease (increase) in deferred income taxes 6,931 (1,030)
(Income) loss from discontinued operation (603) 1,240
Change in assets and liabilities:
Increase in accounts receivable (55,554) (110,261)
Decrease in inventories 11,582 15,780
Increase in prepaid expenses and other current assets (589) (1,411)
Decrease in other assets 2,781 2,195
Increase in accounts payable 8,193 7,848
Decrease in sundry payables and accrued expenses (2,768) (7,190)
Decrease in restructuring accrual (902) (5,179)
Increase in other liabilities 12,153 12,225
------------ ------------
Net cash provided by (used in) operating activities 8,997 (63,194)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of property, plant and equipment 14 1,937
Capital expenditures (7,664) (7,169)
------------ ------------
Net cash used in investing activities (7,650) (5,232)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under line-of-credit agreements 8,261 71,049
Principal payments and retirement of long-term debt (422) (407)
(Decrease) increase in overdraft balances (5,314) 2,046
Dividends paid (4,929) (5,265)
------------ ------------
Net cash (used in) provided by financing activities (2,404) 67,423
------------ ------------
Effect of exchange rate changes on cash 2,030 (335)
------------ ------------
Net increase (decrease) in cash and cash equivalents 973 (1,338)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 14,046 14,934
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 15,019 $ 13,596
============ ============
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest $ 16,169 $ 13,709
============ ============
Income taxes $ 2,855 $ 2,882
============ ============
Non-cash financing activity:
Reduction of restructuring accrual applied against goodwill $ 10,453 $ --
============ ============
See accompanying notes to consolidated financial statements.
5
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
THREE MONTHS ENDED SEPTEMBER 30, 2006
(Unaudited)
Accumulated
Capital in Other
Common Excess of Retained Comprehensive Treasury
Stock Par Value Earnings Income Stock Total
----- --------- -------- ------ ----- -----
Balance at June 30, 2006 .................. $ 40,972 $ 57,176 $113,368 $ 5,609 $(24,514) $ 192,611
Comprehensive income:
Net income ............................ 4,239 4,239
Foreign currency translation
adjustment .......................... 724 724
Unrealized loss on interest rate
swap agreements, net of tax ......... (110) (110)
Minimum pension liability
adjustment .......................... (75) (75)
---------
Total comprehensive income ............ 4,778
Cash dividends paid ....................... (1,648) (1,648)
Employee stock compensation ............... 149 3 152
Employee Stock Ownership Plan ............. -- -- --
-------- -------- -------- --------- -------- ---------
Balance at September 30, 2006 ............. $ 40,972 $ 57,325 $115,959 $ 6,148 $(24,511) $ 195,893
======== ======== ======== ========= ======== =========
NINE MONTHS ENDED SEPTEMBER 30, 2006
(Unaudited)
Accumulated
Capital in Other
Common Excess of Retained Comprehensive Treasury
Stock Par Value Earnings Income Stock Total
----- --------- -------- ------ ----- -----
Balance at December 31, 2005 ............... $ 40,972 $ 56,966 $109,649 $ 4,158 $ (26,038) $185,707
Comprehensive income:
Net income ............................. 11,239 11,239
Foreign currency translation
adjustment ........................... 2,412 2,412
Unrealized loss on interest rate
swap agreements, net of tax .......... (262) (262)
Minimum pension liability
adjustment ........................... (160) (160)
--------
Total comprehensive income ............. 13,229
Cash dividends paid ........................ (4,929) (4,929)
Employee stock compensation ................ 501 195 696
Employee Stock Ownership Plan .............. (142) 1,332 1,190
-------- -------- -------- -------- --------- --------
Balance at September 30, 2006 .............. $ 40,972 $ 57,325 $115,959 $ 6,148 $ (24,511) $195,893
======== ======== ======== ======== ========= ========
6
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
Standard Motor Products, Inc. (referred to hereinafter in these notes to
consolidated financial statements as the "Company," "we," "us," or "our") is
engaged in the manufacture and distribution of replacement parts for motor
vehicles in the automotive aftermarket industry.
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, 2005.
The unaudited consolidated financial statements include our accounts and all
domestic and international companies in which we have more than a 50% equity
ownership. Our investments in unconsolidated affiliates are accounted for on the
equity method. 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.
Where appropriate, certain amounts in 2005 have been reclassified to conform
with the 2006 presentation.
NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SHARE-BASED PAYMENT
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123R"). SFAS 123R requires that stock-based
employee compensation be recorded as a charge to earnings. SFAS 123R is
effective for interim and annual financial statements for years beginning after
December 15, 2005 and applies to all outstanding and unvested share-based
payments at the time of adoption. Accordingly, we have adopted SFAS 123R
commencing January 1, 2006 using a modified prospective application, as
permitted by SFAS 123R. Accordingly, prior period amounts have not been
restated. Under this application, we are required to record compensation expense
for all awards granted after the date of adoption and for the unvested portion
of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS 123R, we applied Accounting Principles Board
Opinions ("APB") No. 25 and related interpretations to account for our stock
plans resulting in the use of the intrinsic value to value the stock. Under APB
25, we were not required to recognize compensation expense for the cost of stock
options. In accordance with the adoption of SFAS 123R, we recorded stock-based
compensation expense for the cost of incentive stock options, restricted stock
and performance-based stock granted under our stock plans. Stock-based
compensation expense for the third quarter of 2006 was $149,100 ($91,600 net of
tax) or $0.01 per basic and diluted share and $559,500 ($343,800 net of tax) or
$0.02 per basic and diluted share for the nine months ended September 30, 2006.
The adoption of SFAS 123R did not have a material impact on our financial
position, results of operation or cash flows.
7
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
ACCOUNTING FOR UNCERTAIN TAX POSITIONS
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 prescribes a threshold for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
Only tax positions meeting the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized upon adoption of
this Interpretation. FIN 48 also provides guidance on accounting for
derecognition, interest and penalties, and classification and disclosure of
matters related to uncertainty in income taxes. FIN 48 is effective for fiscal
years beginning after December 15, 2006 and, as a result, is effective for our
Company beginning January 1, 2007. FIN 48 will require adjustment to the opening
balance of retained earnings (or other components of shareholders' equity in the
statement of financial position) for the cumulative effect of the difference in
the net amount of assets and liabilities for all open tax positions at the
effective date. Management is currently assessing the impact, if any, which the
adoption of FIN 48 will have on our consolidated financial position, results of
operations and cash flows.
FAIR VALUE MEASUREMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS
157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurement. This statement applies under other accounting pronouncements
that require or permit fair value measurements and does not require any new fair
value measurements. SFAS 157 is effective for the fiscal year beginning after
November 15, 2007, which for the Company is the year ending December 31, 2007.
Management is currently assessing the impact, if any, which the adoption of SFAS
157 will have on our consolidated financial position, results of operations and
cash flows.
ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." SFAS 158 requires an employer to
recognize the overfunded or underfunded status of a defined benefit pension or
postretirement plan as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year in which the
changes occur through accumulated other comprehensive income in shareholders'
equity. This statement also requires an employer to measure the funded status of
a plan as of the date of its year-end statement of financial position, with
limited exceptions. The Company will be required to initially recognize the
funded status of a defined benefit postretirement plan and to provide the
required disclosures as of the end of the fiscal year ending after December 15,
2006, which for the Company will be the year ending December 31, 2006. The
requirement to measure plan assets and benefit obligations as of the date of the
employer's fiscal year-end statement of financial position is effective for
fiscal years ending after December 15, 2008 or for the Company's year ending
December 31, 2008. Management estimates the impact of adopting SFAS 158 will not
result in a material change to its total liabilities or shareholders' equity.
QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108
provides interpretive guidance on how the effects of prior-year uncorrected
misstatements should be considered when quantifying misstatements in the current
year financial statements. SAB 108 requires registrants to quantify
misstatements using both an income statement ("rollover") and balance sheet
("iron curtain") approach and evaluate whether either approach results in a
misstatement that, when all relevant quantitative and qualitative factors are
8
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
considered, is material. If prior year errors that had been previously
considered immaterial now are considered material based on either approach, no
restatement is required so long as management properly applied its previous
approach and all relevant facts and circumstances were considered. If prior
years are not restated, the cumulative effect adjustment is recorded in opening
accumulated earnings (deficit) as of the beginning of the fiscal year of
adoption. SAB 108 is effective for fiscal years ending on or after November 15,
2006, which for the Company is the year ending December 31, 2006. Management is
currently assessing the impact, if any, which the adoption of SAB 108 will have
on our consolidated financial position, results of operations and cash flows.
NOTE 3. RESTRUCTURING AND INTEGRATION COSTS
RESTRUCTURING COSTS
In connection with our acquisition of substantially all of the assets and the
assumption of substantially all of the operating liabilities of Dana
Corporation's Engine Management Group ("DEM") on June 30, 2003, we have reviewed
our operations and implemented integration plans to restructure the operations
of DEM. At the time, we announced that we would close seven DEM facilities,
which has subsequently occurred. As part of the integration and restructuring
plans, we accrued an initial restructuring liability of approximately $34.7
million at June 30, 2003. Such amounts were recognized as liabilities assumed in
the acquisition and included in the allocation of the cost to acquire DEM.
Accordingly, such amounts resulted in additional goodwill being recorded in
connection with the acquisition. Subsequent to the acquisition, our estimate of
the restructuring liability was updated and revised downward at various points
in time, with a cumulative reduction to goodwill of $12.6 million as of
September 30, 2006. The remaining restructuring accrual was $1.3 million as of
September 30, 2006. We expect to pay most of this remaining amount in 2006 and
2007.
Of the initial restructuring accrual, approximately $15.7 million related to
work force reductions and represented employee termination benefits. The accrual
amount primarily provides for severance costs relating to the involuntary
termination of employees, individually employed throughout DEM's facilities
across a broad range of functions, including managerial, professional, clerical,
manufacturing and factory positions. During the year ended December 31, 2005 and
the nine months ended September 30, 2006, termination benefits of $2.3 million
and $0.1 million, respectively, have been charged to the restructuring accrual.
As of September 30, 2006, the reserve balance for workforce reductions was at
$0.7 million.
The initial restructuring accrual also included approximately $18 million
consisting of the net present value of costs associated with exiting certain
activities, primarily related to lease and contract termination costs, which
will not have future benefits. Specifically, our plans were to consolidate
certain of DEM operations into our existing plants. At December 31, 2005, we had
a sublease commitment for one facility with Dana through 2021. However, on March
3, 2006, Dana filed a voluntary petition for relief under Chapter 11 of the US
Bankruptcy Code. Pursuant to a court ruling in connection with Dana's Chapter 11
bankruptcy proceedings, effective March 31, 2006, we were released from, and no
longer have any obligations with respect to, such lease commitment for the
facility. We have accounted for the termination of such lease commitment as a
reduction of $10.5 million in our restructuring accrual, with a corresponding
reduction to goodwill established on the acquisition of DEM. In addition to the
above reduction, exit costs of $0.8 million were paid as of September 30, 2006,
leaving the exit reserve balance for exit costs at $0.6 million as of September
30, 2006.
9
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Selected information relating to the restructuring costs included in the
allocation of the cost to acquire DEM is as follows (in thousands):
Workforce Other Exit
Reduction Costs Total
--------------------------------
Restructuring liability at December 31, 2005 .......... $ 809 $ 11,825 $ 12,634
Cash payments during first nine months of 2006 ........ (144) (758) (902)
Adjustments during first nine months of 2006 .......... -- (10,453) (10,453)
-------- -------- --------
Restructuring liability as of September 30, 2006 ...... $ 665 $ 614 $ 1,279
======== ======== ========
INTEGRATION EXPENSES
During the third quarter of 2006 and 2005, we incurred integration expenses of
approximately $0.6 million and $0.2 million, respectively. For the nine months
ended September 30, 2006 and 2005, we incurred integration expenses of $0.8
million and $4.6 million, respectively. The 2006 amount primarily relates to the
cost of moving our European production operations and the divestiture of a
production unit of our Temperature Control Segment. In the second quarter of
2005, the Company effected an asset write-down for the outsourcing of some of
its Temperature Control product lines resulting in a $3.5 million integration
expense. The remainder of the 2005 costs are primarily due to the DEM
integration.
NOTE 4. INVENTORIES
September 30, December 31,
2006 2005
(in thousands)
---------------------------
Finished goods, net .................. $ 163,051 $ 182,567
Work in process, net ................. 4,703 4,235
Raw materials, net ................... 60,344 56,495
------------ ------------
Total inventories, net ........... $ 228,098 $ 243,297
============ ============
NOTE 5. CREDIT FACILITIES AND LONG-TERM DEBT
Total debt consists of (in thousands):
September 30, December 31,
2006 2005
----------------------------
Current
Revolving credit facilities (1) .............. $ 157,497 $ 149,236
Current portion of mortgage loan ............. 542 542
------------ ------------
158,039 149,778
------------ ------------
Long-term Debt
6.75% convertible subordinated debentures .... 90,000 90,000
Mortgage loan ................................ 8,543 8,912
Other ........................................ 126 179
Less: current portion of long-term debt ...... 542 542
------------ ------------
98,127 98,549
------------ ------------
Total debt ............................... $ 256,166 $ 248,327
============ ============
(1) Consists of the revolving credit facility, the Canadian term loan and the
European revolving credit facility.
10
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Maturities of long-term debt during the five years ending December 31, 2006
through 2010 are $0.5 million, $0.5 million, $0.5 million, $90.5 million and
$0.6 million, respectively.
The Company had deferred financing costs of $4.5 million and $3.3 million as of
December 31, 2005 and September 30, 2006, respectively. These costs related to
the Company's revolving credit facility, the convertible subordinated debentures
and a mortgage loan agreement, and these costs are being amortized over three to
thirteen years.
REVOLVING CREDIT FACILITY
We are parties to an agreement with General Electric Capital Corporation, as
agent, and a syndicate of lenders for a secured revolving credit facility. The
term of the credit agreement is through 2008 and provides for a line of credit
up to $305 million. Availability under our revolving credit facility is based on
a formula of eligible accounts receivable, eligible inventory and eligible fixed
assets. After taking into account outstanding borrowings under the revolving
credit facility, there was an additional $68.8 million available for us to
borrow pursuant to the formula at September 30, 2006. Our credit agreement also
permits dividends and distributions by us provided specific conditions are met.
At December 31, 2005 and September 30, 2006, the interest rate on the Company's
revolving credit facility was 6.7% and 7.6%, respectively. Direct borrowings
under our revolving credit facility bear interest at the prime rate plus the
applicable margin (as defined) or, at our option, the LIBOR rate plus the
applicable margin (as defined). Outstanding borrowings under the revolving
credit facility (inclusive of the Canadian term loan described below), which are
classified as current liabilities, were $142.3 million and $149.2 million at
December 31, 2005 and September 30, 2006, respectively. The Company maintains
cash management systems in compliance with its credit agreements. Such systems
require the establishment of lock boxes linked to blocked accounts whereby cash
receipts are channeled to various banks to insure pay-down of debt. Agreements
also classify such accounts and the cash therein as additional security for
loans and other obligations to the credit providers. Borrowings are
collateralized by substantially all of our assets, including accounts
receivable, inventory and fixed assets, and those of certain of our
subsidiaries. The terms of our revolving credit facility provide for, among
other provisions, financial covenants requiring us, on a consolidated basis, (1)
to maintain specified levels of fixed charge coverage at the end of each fiscal
quarter (rolling twelve months) through 2008, and (2) to limit capital
expenditure levels for each fiscal year through 2008. The terms of our revolving
credit facility also provide, among other things, for the prohibition of
accepting drafts under our customer draft programs after November 18, 2005.
CANADIAN TERM LOAN
In December 2005, our Canadian subsidiary entered into a credit agreement with
GE Canada Finance Holding Company, for itself and as agent for the lenders, and
GECC Capital Markets, Inc., as lead arranger and book runner. The credit
agreement provides for, among other things, a $7 million term loan, which term
loan is guaranteed and secured by us and certain of our wholly-owned
subsidiaries and which term loan is coterminous with the term of our revolving
credit facility. The $7 million term loan is part of the $305 million available
for borrowing under our revolving credit facility.
REVOLVING CREDIT FACILITY--EUROPE
Our European subsidiary has a revolving credit facility, which provides for a
line of credit of up to $8.5 million. The amount of short-term bank borrowings
outstanding under this facility was $7 million and $8.3 million at December 31,
2005 and September 30, 2006, respectively. The weighted average interest rates
on these borrowings at December 31, 2005 and September 30, 2006 were 6.5% and
5.9%, respectively. At September 30, 2006, there was an additional $0.2 million
available for our European subsidiary to borrow.
11
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
SUBORDINATED DEBENTURES
In July 1999, we completed a public offering of convertible subordinated
debentures amounting to $90 million. The convertible debentures carry an
interest rate of 6.75%, payable semi-annually, and will mature in July 2009. The
convertible debentures are convertible into 2,796,120 shares of our common stock
at the option of the holder. We may, at our option, redeem some or all of the
convertible debentures at any time on or after July 15, 2004, for a redemption
price equal to the issuance price plus accrued interest. In addition, if a
change in control, as defined in the agreement, occurs at the Company, we will
be required to make an offer to purchase the convertible debentures at a
purchase price equal to 101% of their aggregate principal amount, plus accrued
interest. The convertible debentures are subordinated in right of payment to all
of the Company's existing and future senior indebtedness.
MORTGAGE LOAN AGREEMENT
In June 2003, we borrowed $10 million under a mortgage loan agreement. The loan
is payable in monthly installments. The loan bears interest at a fixed rate of
5.50% maturing in July 2018. The mortgage loan is secured by a building and
related property.
NOTE 6. COMPREHENSIVE INCOME
Comprehensive income, net of income tax expense is as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Net income as reported $ 4,239 $ 3,714 $ 11,239 $ 2,695
Foreign currency translation adjustment 724 1,056 2,412 (725)
Minimum pension liability adjustment (75) 56 (160) 290
Unrealized (loss) gain on interest rate swap
agreements, net of tax (110) 44 (262) 108
-------- -------- -------- --------
Total comprehensive income $ 4,778 $ 4,870 $ 13,229 $ 2,368
======== ======== ======== ========
NOTE 7. STOCK-BASED COMPENSATION PLANS
We have five stock-based compensation plans. Under the 1994 Omnibus Stock Option
Plan, as amended, which terminated as of May 25, 2004, we were authorized to
issue options to purchase 1,500,000 shares. The options become exercisable over
a three to five year period and expire at the end of five years following the
date they become exercisable. Under the 2004 Omnibus Stock Plan, which
terminates as of May 20, 2014, we were authorized to issue options to purchase
500,000 shares. The options become exercisable over a three to five year period
and expire at the end of ten years following the date of grant. Under the 1996
Independent Directors' Stock Option Plan and the 2004 Independent Directors'
Stock Option Plan, we were authorized to issue options to purchase 50,000 shares
under each plan. The options become exercisable one year after the date of grant
and expire at the end of ten years following the date of grant. Under the 2006
Omnibus Incentive Plan, which was approved by our shareholders in May 2006, we
are authorized to issue equity awards of up to 700,000 shares. Equity awards
forfeited under the previous stock option plans and incentive plan are eligible
to be granted again under the 2006 Omnibus Incentive Plan with respect to the
equity awards so forfeited. At September 30, 2006, under our stock option plans,
there were an aggregate of (a) 1,103,986 shares of common stock authorized for
grants, (b) 1,059,311 shares of common stock granted, and (c) no shares of
common stock available for future grants. At September 30, 2006, under our 2006
Omnibus Incentive Plan, there were an aggregate of (a) 700,000 shares of common
stock authorized for grants, (b) 95,225 shares of common stock granted, and (c)
604,775 shares of common stock available for future grants.
12
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Effective January 1, 2006, we adopted SFAS 123R, "Share-Based Payment," which
prescribes the accounting for equity instruments exchanged for employee and
director services. Under SFAS 123R, stock-based compensation cost is measured at
the grant date, based on the calculated fair value of the grant, and is
recognized as an expense over the service period applicable to the grantee. The
service period is the period of time that the grantee must provide services to
us before the stock-based compensation is fully vested. In March 2005, the SEC
issued Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment,"
relating to SFAS 123R. We have followed the SEC's guidance in SAB 107 in our
adoption of SFAS 123R.
Prior to January 1, 2006, we accounted for stock-based compensation to employees
and directors in accordance with the intrinsic value method under APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Under the intrinsic value method, no compensation expense was recognized in our
financial statements for the stock-based compensation, because the stock-based
compensation that we granted was incentive stock options and all of the stock
options granted had exercise prices equivalent to the fair market value of our
common stock on the grant date. We also followed the disclosure requirements of
SFAS 123, "Accounting for Stock-Based Compensation," as amended, "Accounting for
Stock-Based Compensation--Transition and Disclosure".
We adopted SFAS 123R using the modified prospective transition method. Under
this transition method, the financial statement amounts for the periods before
2006 have not been restated to reflect the fair value method of expensing the
stock-based compensation. The compensation expense recognized on or after
January 1, 2006 includes the compensation cost based on the grant-date fair
value estimated in accordance with: (a) SFAS 123 for all stock-based
compensation that was granted prior to, but vested on or after, January 1, 2006;
and (b) SFAS 123R for all stock-based compensation that was granted on or after
January 1, 2006. Stock-based compensation expense for the third quarter of 2006
was $149,100 ($91,600 net of tax) or $0.01 per basic and diluted share and
$559,500 ($343,800 net of tax) or $0.02 per basic and diluted share for the nine
months ended September 30, 2006.
Had we determined compensation cost based on the fair value at the grant date
for our pre-2006 stock option grants, our pro forma net income and net income
per common share would have been as follows (in thousands, except per share
data):
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
------------------ ------------------
Net earnings as reported ............................. $ 3,714 $ 2,695
Less: Stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects ........................... 183 495
-------- --------
Pro forma net earnings ............................... $ 3,531 $ 2,200
======== ========
Earnings per share:
Basic - as reported .............................. $ 0.19 $ 0.14
-------- --------
Basic - pro forma ................................ $ 0.18 $ 0.11
-------- --------
Diluted - as reported ............................ $ 0.19 $ 0.14
-------- --------
Diluted - pro forma .............................. $ 0.18 $ 0.11
-------- --------
13
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Stock Option Grants
There were no stock options granted in the nine months ended September 30, 2006
and options to purchase 280,500 shares of common stock were granted in the nine
months ended September 30, 2005. Accordingly, we have recognized compensation
expense for prior years' grants which vest after January 1, 2006 based on the
grant-date fair value, estimated in accordance with SFAS 123 which was used in
our prior pro forma disclosure. Further, the current quarter's expense reflects
our estimate of expected forfeitures which we determine to be immaterial, based
on history and remaining time until vesting of the remaining options.
The stock options granted prior to 2006 have been vesting gradually at annual
intervals. In our prior period SFAS 123 pro forma disclosures, our policy was to
calculate the compensation expense related to the stock-based compensation
granted to employees and directors on a straight-line basis over the full
vesting period of the grants.
Prior to this year, we provided pro forma net income and net income per common
share disclosures for stock option grants based on the fair value of the options
at the grant date. For purposes of presenting pro forma information, the fair
value of options granted is computed using the Black Scholes option pricing
model with the following assumptions applicable to each remaining unvested
annual grant:
Year of Grant: 2005 2004 2003
------------- ---- ---- ----
Expected option life.................... 3.85 3.85 3.86
Expected stock volatility............... 39.05% 38.57% 39.16%
Expected dividend yield................. 3.3% 2.7% 2.6%
Risk-free rate.......................... 4.00% 3.64% 2.76%
The expected term of the options is based on evaluations of historical and
expected future employee exercise behavior. The risk-free interest rate is based
on the US Treasury rates at the date of grant with maturity dates approximately
equal to the expected life at the grant date. Volatility is based on historical
volatility of the Company's common stock.
The following is a summary of the changes in outstanding stock options for the
nine months ended September 30, 2006:
Weighted Weighted Average
Average Remaining
Exercise Contractual
Shares Price Term (years)
------------------------------------------
Outstanding at beginning
of year........................... 1,249,226 $ 14.42 5.2
Expired............................. 180,665 $ 20.43 0
Forfeited........................... 9,250 $ 12.70 6.4
Outstanding at end of
Quarter........................... 1,059,311 $ 13.40 5.3
Options exercisable at end
of quarter........................ 928,186 $ 13.66 4.8
The aggregate intrinsic value of outstanding stock options was $0.5 million, of
which $0.4 million relates to options that are exercisable.
14
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
The following is a summary of the changes in non-vested stock options for the
nine months ended September 30, 2006:
Weighted
Average Grant
Shares Date Fair Value
------ ---------------
Non-vested shares at January 1, 2006 ............. 494,426 $ 3.04
Forfeitures....................................... 3,625 $ 2.87
Vested............................................ 359,676 $ 3.16
-------
Non-vested shares at September 30, 2006........... 131,125 $ 2.72
=======
Stock option-based compensation expense was $89,200 ($54,800 net of tax) for the
third quarter of 2006 and $461,400 ($283,300 net of tax) for the nine months
ended September 30, 2006. As of September 30, 2006, we have $178,300 of total
unrecognized compensation cost related to non-vested stock options granted under
our various option-based plans, which we expect to recognize over a
weighted-average period of 0.5 years. No stock options were exercised during the
nine months ended September 30, 2006.
Restricted and Performance Stock Grants
Under our 2006 Omnibus Incentive Plan, the Company is authorized to issue, among
other things, shares of restricted and performance-based stock to eligible
employees and directors. Prior to the time a restricted share becomes fully
vested or a performance share is issued, the awardee cannot transfer, pledge,
hypothecate or encumber such shares. Prior to the time a restricted share is
fully vested, the awardee has all other rights of a stockholder, including the
right to vote (but not receive dividends during the vesting period). Prior to
the time a performance share is issued, the awardee shall have no rights as a
stockholder. Restricted shares become fully vested upon the third and first
anniversary of the date of grant for employees and directors, respectively.
Performance-based shares are subject to a three year measuring period and the
achievement of Company performance targets and, depending upon the achievement
of such performance targets, then may become vested on the third anniversary of
the date of grant. Management believes it is probable that the performance
targets will be achieved.
All shares and rights are subject to forfeiture if certain employment conditions
are not met. Under the plan, 700,000 shares are authorized to be issued. For the
third quarter ended September 30, 2006, 7,900 restricted and performance-based
shares were granted (4,150 restricted shares and 3,750 performance-based
shares). For the nine months ended September 30, 2006, 95,225 restricted and
performance-based shares were granted (67,725 restricted shares and 27,500
performance-based shares). In determining the grant date fair value for U.S.
GAAP purposes, the stock price on the date of grant, as quoted on the New York
Stock Exchange, was reduced by the present value of dividends expected to be
paid on the shares issued and outstanding during the requisite service period,
discounted at a risk-free interest rate. The risk-free interest rate is based on
the U.S. Treasury rates at the date of grant with maturity dates approximately
equal to the restriction or vesting period at the grant date. The fair value of
the shares at the date of grant is amortized to expense ratably over the
restriction period. For the quarter ended September 30, 2006, forfeitures are
estimated at 2% for employees and 0% for executives and directors, respectively,
based on evaluations of historical and expected future turnover.
The Company recorded compensation expense related to restricted shares and
performance-based shares of $59,900 ($36,800 net of tax) and $0 for the quarter
ended September 30, 2006 and 2005, respectively, and $98,100 ($60,200 net of
tax) and $0 for the nine months ended September 30, 2006 and 2005, respectively.
The unamortized compensation expense related to the Company's restricted and
performance-based shares was $575,900 at September 30, 2006 and is expected to
be recognized over a weighted average period of 2.6 and 0.6 years for employees
and directors, respectively.
15
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
The Company's restricted and performance-based share activity was as follows for
the nine months ended September 30, 2006:
Weighted
Average Grant
Date Fair Value
Shares Per Share
------ ---------------
Balance at January 1, 2006 ............. -- --
Granted ............................. 95,225 $ 7.21
Vested .............................. 200 $ 7.84
Forfeited ........................... -- --
------
Balance at September 30, 2006 .......... 95,025 $ 7.21
======
The weighted-average grant date fair value of restricted and performance-based
shares granted during the nine months ended September 30, 2006 was $686,500, or
$7.21 per share. No restricted or performance-based shares were authorized,
granted, outstanding or vested during the nine months ended September 30, 2005.
NOTE 8. EARNINGS PER SHARE
The following are reconciliations of the earnings available to common
stockholders and the shares used in calculating basic and dilutive net earnings
per common share (in thousands, except share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2006 2005 2006 2005
---- ---- ---- ----
Earnings from continuing
operations ........................ $ 2,583 $ 4,163 $ 10,636 $ 3,935
Income (loss) from discontinued
operations ........................ 1,656 (449) 603 (1,240)
---------- ---------- ---------- ----------
Net earnings available to
common stockholders ............... $ 4,239 $ 3,714 $ 11,239 $ 2,695
========== ========== ========== ==========
Weighted average common shares
outstanding - basic ............... 18,306,178 19,547,319 18,265,784 19,509,040
Dilutive effect of restricted stock ... 64,998 -- 32,195 --
Dilutive effect of options ............ 259 30,653 -- 37,221
---------- ---------- ---------- ----------
Weighted average common shares
outstanding - diluted ............. 18,371,435 19,577,972 18,297,979 19,546,261
========== ========== ========== ==========
16
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
The shares listed below were not included in the computation of diluted earnings
per share because to do so would have been anti-dilutive for the periods
presented.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2006 2005 2006 2005
---- ---- ---- ----
Stock options.......................... 1,059,311 1,233,348 1,059,311 1,226,780
Convertible debentures................. 2,796,120 2,796,120 2,796,120 2,796,120
NOTE 9. EMPLOYEE BENEFITS
In 2000, we created an employee benefits trust to which we contributed 750,000
shares of treasury stock. We are authorized to instruct the trustees to
distribute such shares toward the satisfaction of our future obligations under
employee benefit plans. 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 first quarter of 2006, we committed 118,500 shares to be
released leaving 182,000 shares remaining in the trust.
In August 1994, we established an unfunded Supplemental Executive Retirement
Plan (SERP) 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 2006,
contributions of $69,000 were made related to calendar year 2005.
In October 2001, we adopted a second unfunded SERP. The SERP is a defined
benefit plan pursuant to which we will pay supplemental pension benefits to
certain key employees upon retirement based upon the employees' years of service
and compensation. We use a January 1 measurement date for this plan.
We provide certain medical and dental care benefits to eligible retired
employees. Our current policy is to fund the cost of the health care plans on a
pay-as-you-go basis. Effective September 1, 2005, we restricted the eligibility
requirements of employees who can participate in this program, whereby all
active employees hired after 1995 are no longer eligible to participate. In the
three months ended September 30, 2005, in accordance with SFAS No. 106,
Employers' Accounting For Post-Retirement Benefits Other Than Pensions, we
recognized a curtailment gain of $3.8 million for our post-retirement plan
mainly related to the above changes made to our plan. The curtailment accounting
required us to recognize at that time a pro-rata portion of the unrecognized
prior service cost as a result of the changes.
In December 2003, the Medicare Prescription Drug, Improvement, and Modernization
Act of 2003 (the "Medicare Reform Act") was signed into law. The Medicare Reform
Act expanded Medicare to include, for the first time, coverage for prescription
drugs. In connection with the Medicare Reform Act, the FASB issued FASB Staff
Position ("FSP") No. FAS 106-2, which provides guidance on accounting for the
effects of the new Medicare prescription drug legislation for employers whose
prescription drug benefits are actuarially equivalent to the drug benefit under
Medicare Part D and are therefore entitled to receive subsidies from the federal
government beginning in 2006. On January 21, 2005, the Centers for Medicare and
Medicaid Services released final regulations implementing major provisions of
the Medicare Reform Act. The regulations address key concepts, such as defining
a plan, as well as the actuarial equivalence test for purposes of obtaining a
government subsidy. Pursuant to the guidance in FSP No. FAS 106-2, we have
assessed the financial impact of the regulations and concluded that our
post-retirement benefit plan will be qualified for the direct subsidies and,
consequently, our accumulated post-retirement benefit obligation decreased by
$6.7 million.
17
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
As a result of the reduced eligibility and Medicare subsidy explained above, we
are benefiting in 2006 from a reduction to our post-retirement benefit costs
through negative amortization of prior service costs.
The components of net period benefit cost for the three months ended September
30 of our North America and UK defined benefit plans are as follows (in
thousands):
----------------------------------------------
Pension Benefits Postretirement Benefits
----------------------------------------------
2006 2005 2006 2005
----------------------------------------------
Service cost .................................. $ 99 $ 130 $ 200 $1,078
Interest cost ................................. 100 131 581 776
Amortization of transition obligation ......... -- -- 1 --
Amortization of prior service cost (credit) ... 28 40 (713) 123
Actuarial net (gain) loss ..................... (16) 4 480 1
SFAS 106 curtailment gain ..................... -- -- -- (3,842)
------ ------ ------ ------
Net periodic benefit (benefit) cost ........... $ 211 $ 305 $ 549 $(1,864)
====== ====== ====== ======
The components of net period benefit cost for the nine months ended September 30
of our North America and UK defined benefit plans are as follows (in thousands):
----------------------------------------------
Pension Benefits Postretirement Benefits
----------------------------------------------
2006 2005 2006 2005
----------------------------------------------
Service cost .................................. $ 296 $ 390 $ 604 $2,714
Interest cost ................................. 301 393 1,536 1,854
Amortization of transition obligation ......... -- -- 3 --
Amortization of prior service cost (credit) ... 83 120 (2,140) 185
Actuarial net (gain) loss ..................... (48) 14 1,099 3
SFAS 106 curtailment gain ..................... -- -- -- (3,842)
------ ------ ------ ------
Net periodic benefit cost ..................... $ 632 $ 917 $1,102 $ 914
====== ====== ====== ======
NOTE 10. INDUSTRY SEGMENTS
The following tables show our net sales and operating income by our operating
segments (in thousands):
Three Months Ended September 30,
------------------------------------------------------
2006 2005
------------------------------------------------------
Operating Operating
Net Sales Income (Loss) Net Sales Income (Loss)
--------- ------------- --------- -------------
Engine Management ...... $127,752 $ 6,958 $135,819 $ 2,349
Temperature Control .... 59,917 3,986 74,537 7,078
Europe ................. 12,813 98 11,600 250
All Other .............. 3,273 (2,347) 2,482 108
-------- -------- -------- --------
Consolidated ........... $203,755 $ 8,695 $224,438 $ 9,785
======== ======== ======== ========
18
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Nine Months Ended September 30,
------------------------------------------------------
2006 2005
------------------------------------------------------
Operating Operating
Net Sales Income (Loss) Net Sales Income (Loss)
--------- ------------- --------- -------------
Engine Management ...... $416,462 $ 30,450 $419,855 $ 19,478
Temperature Control .... 181,289 11,585 195,539 8,577
Europe ................. 36,191 490 34,679 (212)
All Other .............. 9,063 (10,906) 8,203 (10,896)
-------- -------- -------- --------
Consolidated ........... $643,005 $ 31,619 $658,276 $ 16,947
======== ======== ======== ========
NOTE 11. COMMITMENTS AND CONTINGENCIES
ASBESTOS. In 1986, we acquired a brake business, which we subsequently sold in
March 1998 and which is accounted for as a discontinued operation. When we
originally acquired this brake business, we assumed future liabilities relating
to any alleged exposure to asbestos-containing products manufactured by the
seller of the acquired brake business. In accordance with the related purchase
agreement, we agreed to assume the liabilities for all new claims filed on or
after September 1, 2001. Our ultimate exposure will depend upon the number of
claims filed against us on or after September 1, 2001 and the amounts paid for
indemnity and defense thereof. At December 31, 2005 and September 30, 2006,
approximately 4,500 cases and 3,300 cases, respectively, were outstanding for
which we were responsible for any related liabilities. We believe that the level
of new cases will decrease gradually due to recent legislation in certain states
mandating minimum medical criteria before a case can be heard. Since inception
in September 2001 through September 30, 2006, the amounts paid for settled
claims are approximately $4.9 million. We do not have insurance coverage for the
defense and indemnity costs associated with these claims.
In evaluating our potential asbestos-related liability, we have considered
various factors including, among other things, an actuarial study performed by a
leading actuarial firm with expertise in assessing asbestos-related liabilities,
our settlement amounts and whether there are any co-defendants, the jurisdiction
in which lawsuits are filed, and the status and results of settlement
discussions. As is our accounting policy, we engage actuarial consultants with
experience in assessing asbestos-related liabilities to estimate our potential
claim liability. The methodology used to project asbestos-related liabilities
and costs in the study considered: (1) historical data available from publicly
available studies; (2) an analysis of our recent claims history to estimate
likely filing rates into the future; (3) an analysis of our currently pending
claims; and (4) an analysis of our settlements to date in order to develop
average settlement values. The most recent actuarial study was performed as of
August 31, 2006. Based upon all the information considered by the actuarial
firm, the actuarial study estimated an undiscounted liability for settlement
payments, excluding legal costs, ranging from $22.1 million to $53.9 million for
the period through 2050. The change from the prior year study was a $3.2 million
decrease for the low end of the range and a $2.6 million increase for the high
end of the range. Based on the information contained in the actuarial study and
all other available information considered by us, we concluded that no amount
within the range of settlement payments was more likely than any other and,
therefore, recorded the low end of the range as the liability associated with
future settlement payments through 2050 in our consolidated financial
statements, in accordance with generally accepted accounting principles.
Accordingly, a $3.4 million benefit was recorded to our discontinued operation,
and we adjusted our accrued asbestos liability to approximately $22.1 million.
Legal costs, which are expensed as incurred and reported in loss from
discontinued operation, are estimated to range from $11.6 million to $21.6
million during the same period.
19
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
We plan to perform an annual actuarial evaluation during the third quarter of
each year for the foreseeable future. Given the uncertainties associated with
projecting such matters into the future and other factors outside our control,
we can give no assurance that additional provisions will not be required.
Management will continue to monitor the circumstances surrounding these
potential liabilities in determining whether additional provisions may be
necessary. At the present time, however, we do not believe that any additional
provisions would be reasonably likely to have a material adverse effect on our
liquidity or consolidated financial position.
ANTITRUST LITIGATION. On November 30, 2004, we were served with a summons and
complaint in the U.S. District Court for the Southern District of New York by
The Coalition For A Level Playing Field, which is an organization comprised of a
large number of auto parts retailers. The complaint alleges antitrust violations
by the Company and a number of other auto parts manufacturers and retailers and
seeks injunctive relief and unspecified monetary damages. In August 2005, we
filed a motion to dismiss the complaint, following which the plaintiff filed an
amended complaint dropping, among other things, all claims under the Sherman
Act. The remaining claims allege violations of the Robinson-Patman Act. Motions
to dismiss those claims were filed by us in February 2006. Plaintiff has filed
opposition to our motions, and we subsequently filed replies in June 2006. Oral
arguments were originally scheduled for September 2006, however the court has
adjourned these proceedings until a later date to be determined. Although we
cannot predict the ultimate outcome of this case or estimate the range of any
potential loss that may be incurred in the litigation, we believe that the
lawsuit is without merit, deny all of the plaintiff's allegations of wrongdoing
and believe we have meritorious defenses to the plaintiff's claims. We intend to
defend vigorously this lawsuit.
OTHER LITIGATION. We are involved in various other litigation and product
liability matters arising in the ordinary course of business. Although the final
outcome of any asbestos-related matters or any other litigation or product
liability matter cannot be determined, based on our understanding and evaluation
of the relevant facts and circumstances, it is our opinion that the final
outcome of these matters will not have a material adverse effect on our
business, financial condition or results of operations.
WARRANTIES. We generally warrant our products against certain manufacturing and
other defects. These product warranties are provided for specific periods of
time of the product depending on the nature of the product. As of September 30,
2006 and 2005, we have accrued $15.1 million and $16.8 million, respectively,
for estimated product warranty claims included in accrued customer returns. The
accrued product warranty costs are based primarily on historical experience of
actual warranty claims. Warranty expense for the three months ended September
30, 2006 and 2005 were $13.7 million and $15 million, respectively, and $41.2
million and $42.1 million for the nine months ended September 30, 2006 and 2005,
respectively.
The following table provides the changes in our product warranties (in
thousands):
-----------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------
2006 2005 2006 2005
---- ---- ---- ----
Balance, beginning of period....................... $ 15,391 $ 15,898 $ 12,701 $ 13,194
Liabilities accrued for current year sales......... 13,674 14,952 41,211 42,121
Settlements of warranty claims..................... (13,917) (14,059) (38,764) (38,524)
-------- -------- -------- --------
Balance, end of period............................. $ 15,148 $ 16,791 $ 15,148 $ 16,791
======== ======== ======== ========
20
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
NOTE 12. SUBSEQUENT EVENT
On October 10, 2006, the Company announced plans to close its Puerto Rico
manufacturing facility related to our Engine Management Segment following the
expiration of the Internal Revenue Code Section 936 benefit and to further our
efforts in streamlining costs. We will move these operations to other
manufacturing sites of the Company. The facility move and closure is planned to
occur in a phased manner over the next 24 months. In connection with this
closing, the Company will incur one-time termination benefits to be paid to
certain employees at the end of a specified requisite service period. The
Company estimates these termination benefits will amount to approximately $2.8
million which will be recognized as expense ratably over the requisite service
period. The Company also expects to incur approximately $3 million in various
expenses to move the production assets, close the Puerto Rico facility and
relocate some employees. These expenses will be recognized as incurred. No
related expenses have been incurred or recognized during the nine months ended
September 30, 2006.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS MADE PURSUANT TO THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
FORWARD-LOOKING STATEMENTS IN THIS REPORT ARE INDICATED BY WORDS SUCH AS
"ANTICIPATES," "EXPECTS," "BELIEVES," "INTENDS," "PLANS," "ESTIMATES,"
"PROJECTS" AND SIMILAR EXPRESSIONS. THESE STATEMENTS REPRESENT OUR EXPECTATIONS
BASED ON CURRENT INFORMATION AND ASSUMPTIONS AND ARE INHERENTLY SUBJECT TO RISKS
AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE WHICH
ARE ANTICIPATED OR PROJECTED AS A RESULT OF CERTAIN RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, ECONOMIC AND MARKET CONDITIONS; THE PERFORMANCE
OF THE AFTERMARKET SECTOR; CHANGES IN BUSINESS RELATIONSHIPS WITH OUR MAJOR
CUSTOMERS AND IN THE TIMING, SIZE AND CONTINUATION OF OUR CUSTOMERS' PROGRAMS;
CHANGES IN THE PRODUCT MIX AND DISTRIBUTION CHANNEL MIX; THE ABILITY OF OUR
CUSTOMERS TO ACHIEVE THEIR PROJECTED SALES; COMPETITIVE PRODUCT AND PRICING
PRESSURES; INCREASES IN PRODUCTION OR MATERIAL COSTS THAT CANNOT BE RECOUPED IN
PRODUCT PRICING; SUCCESSFUL INTEGRATION OF ACQUIRED BUSINESSES; PRODUCT AND
ENVIRONMENTAL LIABILITY MATTERS (INCLUDING, WITHOUT LIMITATION, THOSE RELATED TO
ASBESTOS-RELATED CONTINGENT LIABILITIES OR ENVIRONMENTAL REMEDIATION
LIABILITIES); AS WELL AS OTHER RISKS AND UNCERTAINTIES, SUCH AS THOSE DESCRIBED
UNDER RISK FACTORS, QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
AND THOSE DETAILED HEREIN AND FROM TIME TO TIME IN THE FILINGS OF THE COMPANY
WITH THE SEC. FORWARD-LOOKING STATEMENTS ARE MADE ONLY AS OF THE DATE HEREOF,
AND THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE OR REVISE THE FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
IN ADDITION, HISTORICAL INFORMATION SHOULD NOT BE CONSIDERED AS AN INDICATOR OF
FUTURE PERFORMANCE. THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH
THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, INCLUDING THE NOTES
THERETO, INCLUDED ELSEWHERE IN THIS REPORT.
BUSINESS OVERVIEW
We are a leading independent manufacturer and distributor of replacement parts
for motor vehicles in the automotive aftermarket industry. We are organized into
two major operating segments, each of which focuses on a specific segment of
replacement parts. Our Engine Management Segment manufactures ignition and
emission parts, on-board computers, ignition wires, battery cables and fuel
system parts. Our Temperature Control Segment manufactures and remanufactures
air conditioning compressors, and other air conditioning and heating parts. We
sell our products primarily in the United States, Canada and Latin America. We
also sell our products in Europe through our European Segment.
As part of our efforts to grow our business, as well as to achieve increased
production and distribution efficiencies, on June 30, 2003 we completed the
acquisition of substantially all of the assets and assumed substantially all of
the operating liabilities of Dana Corporation's Engine Management Group ("DEM").
Under the terms of the acquisition, we paid Dana Corporation $93.2 million in
cash, issued an unsecured promissory note of $15.1 million, and issued 1,378,760
shares of our common stock valued at $15.1 million. Including transaction costs,
our total purchase price was approximately $130.5 million. On December 29, 2005,
we entered into a Repurchase and Prepayment Agreement with Dana, in which we
repurchased the 1,378,760 shares of our common stock at a repurchase price of
$8.63 per share (or an aggregate approximate repurchase price of $11.9 million)
and prepaid at a discount the $15.1 million unsecured promissory note plus
accrued and unpaid interest for an aggregate approximate amount of $14.5
million. We recognized the discount of $1 million as a gain on the repayment of
the note as well as the unrecognized deferred interest expense thereon of $0.2
million as income in 2005.
In connection with our acquisition of DEM, we reviewed our operations and
implemented integration plans to restructure the operations of DEM. As part of
the integration and restructuring plans, we accrued an initial restructuring
liability of approximately $34.7 million at June 30, 2003. Such amounts were
recognized as liabilities assumed in the acquisition and included in the
allocation of the cost to acquire DEM. Accordingly, such amounts resulted in
additional goodwill being recorded in connection with the acquisition.
Subsequent to the acquisition, our estimate of the restructuring liability was
updated and revised downward at various points in time, with a cumulative
reduction to goodwill of $12.6 million as of September 30, 2006. As of September
30, 2006, the remaining restructuring accrual was $1.3 million. We expect to pay
most of this remaining amount in 2006 and 2007.
22
Of the initial restructuring accrual, approximately $15.7 million related to
work force reductions and represented employee termination benefits. The accrual
primarily provides for severance costs relating to the involuntary termination
of employees, individually employed throughout DEM's facilities across a broad
range of functions, including managerial, professional, clerical, manufacturing
and factory positions. During the year ended December 31, 2005 and the nine
months ended September 30, 2006, termination benefits of $2.3 million and $0.1
million, respectively, have been charged to the restructuring accrual. As of
September 30, 2006, the reserve balance for workforce reductions was at $0.7
million.
The initial restructuring accrual also included approximately $18 million
consisting of the net present value of costs associated with exiting certain
activities, primarily related to lease and contract termination costs, which
will not have future benefits. Specifically, our plans were to consolidate
certain of DEM operations into our existing plants. At December 31, 2005, we had
a sublease commitment for one facility with Dana through 2021. However, on March
3, 2006, Dana filed a voluntary petition for relief under Chapter 11 of the US
Bankruptcy Code. Pursuant to a court ruling in connection with Dana's Chapter 11
bankruptcy proceedings, effective March 31, 2006, we were released from, and no
longer have any obligations with respect to, such lease commitment for the
facility. We have accounted for the termination of such lease commitment as a
reduction of $10.5 million in our restructuring accrual, with a corresponding
reduction to goodwill established on the acquisition of DEM. In addition to the
above reduction, exit costs of $0.8 million were paid as of September 30, 2006,
leaving an exit reserve balance of $0.6 million as of September 30, 2006.
SEASONALITY. Historically, our operating results have fluctuated by quarter,
with the greatest sales occurring in the second and third quarters of the year
and revenues generally being recognized at the time of shipment. It is in these
quarters that demand for our products is typically the highest, specifically in
the Temperature Control Segment of our business. In addition to this
seasonality, the demand for our Temperature Control products during the second
and third quarters of the year may vary significantly with the summer weather
and customer inventories. For example, a cool summer may lessen the demand for
our Temperature Control products, while a hot summer may increase such demand.
As a result of this seasonality and variability in demand of our Temperature
Control products, our working capital requirements peak near the end of the
second quarter, as the inventory build-up of air conditioning products is
converted to sales and payments on the receivables associated with such sales
have yet to be received. During this period, our working capital requirements
are typically funded by borrowing from our revolving credit facility.
The seasonality of our business offers significant operational challenges in our
manufacturing and distribution functions. To limit these challenges and to
provide a rapid turnaround time of customer orders, we have traditionally
offered a pre-season selling program, known as our "Spring Promotion," in which
customers are offered a choice of a price discount or longer payment terms.
INVENTORY MANAGEMENT. We face inventory management issues as a result of
warranty and overstock returns. Many of our products carry a warranty ranging
from a 90-day limited warranty to a lifetime limited warranty, which generally
covers defects in materials or workmanship and failure to meet industry
published specifications. In addition to warranty returns, we also permit our
customers to return products to us within customer-specific limits (which are
generally limited to a specified percentage of their annual purchases from us)
in the event that they have overstocked their inventories. The Company accrues
for overstock returns as a percentage of sales, after giving consideration to
recent returns history. In addition, the seasonality of our Temperature Control
Segment requires that we increase our inventory during the winter season in
preparation of the summer selling season and customers purchasing such inventory
have the right to make returns.
In order to better control warranty and overstock return levels, we tightened
the rules for authorized warranty returns, placed further restrictions on the
amounts customers can return and instituted a program so that our management can
better estimate potential future product returns. In addition, we established
procedures whereby a warranty will be voided if a customer does not follow a
twelve-step warranty return process with respect to certain products.
23
DISCOUNTS, ALLOWANCES AND INCENTIVES. In connection with our sales activities,
we offer a variety of usual customer discounts, allowances and incentives.
First, we offer cash discounts for paying invoices in accordance with the
specified discounted terms of the invoice. Second, we offer pricing discounts
based on volume and different product lines purchased from us. These discounts
are principally in the form of "off-invoice" discounts and are immediately
deducted from sales at the time of sale. For those customers that choose to
receive a payment on a quarterly basis instead of "off-invoice," we accrue for
such payments as the related sales are made and reduce sales accordingly.
Finally, rebates and discounts are provided to customers as advertising and
sales force allowances, and allowances for warranty and overstock returns are
also provided. Management analyzes historical returns, current economic trends,
and changes in customer demand when evaluating the adequacy of the sales returns
and other allowances. Significant management judgments and estimates must be
made and used in connection with establishing the sales returns and other
allowances in any accounting period. We account for these discounts and
allowances as a reduction to revenues, and record them when sales are recorded.
INTERIM RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2006 TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2005
SALES. Consolidated net sales for the three months ended September 30, 2006 were
$203.8 million, a decrease of $20.7 million, or 9.2%, compared to $224.4 million
in the same period of 2005, mainly due to Temperature Control net sales
decreasing $14.6 million or 19.6% and Engine Management net sales decreasing
$8.1 million or 5.9%. Our European Segment experienced higher sales of $1.1
million or 9.9%. The decrease in Temperature Control sales was primarily due to
reduced demand resulting from a cooler summer than the prior year and reduced
consumer discretionary spending due to higher energy costs, as well as
competition from low cost foreign imports. The decrease in Engine Management
sales was mainly due to reduced demand and higher than average customer returns
as customers reduced their inventories.
GROSS MARGINS. Gross margins, as a percentage of consolidated net sales,
increased to 24.2% in the third quarter of 2006 compared to 21.9% in the third
quarter of 2005 mainly due to Engine Management margin improvements of 4.7
percentage points, partially offset by a 1.7 percentage point decrease in
Temperature Control margin. Our European Segment also experienced increased
margins of 24.1% in the third quarter of 2006 as compared to 22.5% in the same
period of 2005. In the third quarter of 2006, the margins in Engine Management
benefited mainly from price increases and improved procurement and manufacturing
costs, partially offset by higher customer returns, as compared against
inventory write-offs adversely affecting 2005 margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative (SG&A) expenses increased by $0.9 million to $40 million in the
third quarter of 2006, compared to $39.1 million in the third quarter of 2005.
SG&A expenses were slightly higher due to increased general administration and
marketing expenses, partially offset by a reduction in distribution costs
resulting from lower sales and by a reduction of $1 million in draft expenses as
we terminated our accounts receivable draft program in the fourth quarter of
2005. The increase in general administration expenses was driven by a $3.8
million SFAS 106 curtailment gain applied against third quarter of 2005
expenses. As a percentage of net sales, SG&A expenses for the third quarter of
2006 increased to 19.7% from 17.4% for the same period in 2005.
RESTRUCTURING EXPENSES. Restructuring expenses, which include restructuring and
integration expenses, increased to $0.6 million in the third quarter of 2006,
compared to $0.2 million in the third quarter of 2005. The 2006 expenses related
mostly to severance costs related to the move of our European production
operations and the divestiture of a production unit of our Temperature Control
Segment. The restructuring expense for the third quarter of 2005 related to the
DEM integration which has since been substantially completed.
24
OPERATING INCOME. Operating income was $8.7 million in the third quarter of
2006, compared to $9.8 million in the third quarter of 2005. Improved gross
margins more than offset lower sales. However, SG&A expense increased $0.9
million as the third quarter of 2005 benefited from a postretirement medical
benefit as discussed above. After adjusting for the postretirement medical
benefit, operating income increased $1.4 million period over period.
OTHER INCOME, NET. Other income, net increased $0.8 million in the third quarter
2006 compared to the same period in 2005, primarily due to higher equity income
and exchange gains from the strengthening Canadian dollar.
INTEREST EXPENSE. Interest expense increased by $0.6 million in the third
quarter 2006 compared to the same period in 2005 primarily due to higher
interest rates during the period and the elimination of our accounts receivable
draft program which increased our borrowing costs. However, while the
elimination of the accounts receivable draft program contributed to the interest
expense increase, it also contributed to the reduction in draft expenses in SG&A
expenses, as discussed above.
INCOME TAX PROVISION. The income tax provision was $1.8 million in the third
quarter of 2006 compared to $1.1 million for the same period in 2005. The
increase was primarily due to a higher effective rate for the third quarter of
2006 which was 41.3% compared to 21.5% in the third quarter of 2005. The
increase in the effective tax rate is primarily due to the December 31, 2005
expiration of Section 936 of the Internal Revenue Code with regard to our Puerto
Rico operations which are taxed at the U.S. statutory rate starting in 2006.
Deferred tax assets, net of a valuation allowance of $26.1 million and deferred
tax liabilities of $17.3 million, were $40.6 million as of December 31, 2005.
Approximately $110 million of taxable income must be generated in 2006 and
subsequent years in order to realize the net deferred tax assets. We believe it
is more likely than not that we will be able to generate this level of taxable
income within 6 years of December 31, 2005, based on the assumptions that our
Puerto Rico affiliate's profits will create US taxable income following the
expiration of Section 936 of the Internal Revenue Code and that our US based
Engine Management Segment continues to improve as we realize savings from cost
reduction efforts and the move of our Puerto Rico operations to the U.S. and
Mexico. Also, our US net operating loss carry forwards of $37.3 million expire
between 2021 and 2025, and our alternative minimum tax credit carry forwards of
approximately $6 million have no expiration date. The results of the third
quarter of 2006 are generally in line with the aforementioned assumptions. We
continue to monitor our trends and weigh these against our recent domestic loss
carry forward history. At this time, we have concluded that our current level of
valuation allowance of $26.1 million continues to be appropriate.
INCOME (LOSS) FROM DISCONTINUED OPERATION. Income (loss) from discontinued
operation, net of tax, reflects legal expenses associated with our asbestos
related liability and adjustments thereto based on the information contained in
the actuarial study and all other available information considered by us. We
recorded $1.7 million as income and $0.4 million as a loss from discontinued
operation for the third quarter of 2006 and 2005, respectively. The income for
the third quarter of 2006 reflects a $3.4 million pre-tax adjustment to reduce
our indemnity liability in line with our most recent actuarial valuation report,
partially offset by legal fees incurred in litigation, whereas the loss for the
same period of 2005 reflects only legal expenses. As discussed more fully in
note 11 in the notes to our consolidated financial statements, we are
responsible for certain future liabilities relating to alleged exposure to
asbestos containing products.
25
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2006 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2005
SALES. Consolidated net sales for the nine months ended September 30, 2006 were
$643 million, a decrease of $15.3 million, or 2.3%, compared to $658.3 million
in the same period of 2005. The net sales decrease was primarily due to our
Temperature Control net sales decreasing by $14.3 million or 7.3% due to reduced
demand resulting from a cooler summer than the prior year and reduced consumer
discretionary spending due to higher energy costs, as well as competition from
low cost foreign imports. Engine Management net sales also decreased by $3.4
million due to reduced demand and higher than average customer returns.
GROSS MARGINS. Gross margins, as a percentage of consolidated net sales,
increased by 2.5 percentage points to 24.8% for the nine months ended September
30, 2006 from 22.3% in the same period of 2005. The increase was mainly driven
by Engine Management gross margin increases to 24.2% from 20.5% of sales for the
nine months ended September 30, 2006 and 2005, respectively. The margin increase
in our Engine Management Segment was primarily due to price increases
implemented near the end of 2005 and in the first quarter of 2006, as well as
reduced procurement and manufacturing costs. Temperature Control and Europe
margin percentages increased slightly due to improved costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative (SG&A) expenses increased $1.9 million to $126.8 million or 19.7%
of consolidated net sales for the nine months ended September 30, 2006, compared
to $124.9 million or 19% of consolidated net sales in the same period of 2005.
The increase in SG&A expenses was driven mainly by increases in marketing and
general and administrative expenses, partially offset by a reduction of $2.4
million in draft expenses as we terminated our accounts receivable draft program
in the fourth quarter of 2005 and a reduction in distribution costs as a result
of lower sales. The increase in marketing expenses is due to new catalogue
spending, and the increase in general administrative expenses was mainly due to
our ongoing efforts to fully integrate our operations into a common enterprise
resource planning system.
RESTRUCTURING EXPENSES. Restructuring expenses, which include restructuring and
integration expenses, decreased to $0.8 million for the nine months ended
September 30, 2006, compared to $4.6 million for the same period in 2005. The
2006 expenses related mostly to severance costs related to the move of our
European production operations and the divestiture of a production unit of our
Temperature Control Segment. Expenses for the same period in 2005 were primarily
for a non-cash asset impairment charge of $3.4 million in our Temperature
Control business related to a strategic decision to outsource products
previously manufactured, while the remainder was mostly related to the DEM
integration which has since been substantially completed
OPERATING INCOME. Operating income increased by $14.7 million to $31.6 million
for the nine months ended September 30, 2006, compared to $16.9 million in the
same period in 2005. The increase was primarily due to higher gross profit from
Engine Management's 3.7 point improvement in gross profit percentage, lower
integration expenses and the elimination of the accounts receivable draft
program fees, partially offset by higher SG&A expenses.
OTHER INCOME, NET. Other income, net increased $0.9 million for the nine months
ended September 30, 2006 compared to the same period in 2005, primarily due to
higher exchange gains on the strengthening Canadian dollar as well as higher
equity income.
INTEREST EXPENSE. Interest expense increased by $2.2 million for the nine months
ended September 30, 2006 compared to the same period in 2005 due to higher
average borrowings and higher borrowing costs. The increase in average
borrowings is due to the termination of our accounts receivable draft program in
the fourth quarter of 2005, as well as the funding of the repurchase of our
common stock held by Dana for $11.9 million.
INCOME TAX PROVISION. The income tax provision was $8.1 million for the nine
months ended September 30, 2006 compared to $1.4 million for the same period in
2005. The increase was primarily due to higher pre-tax earnings and a higher
effective rate for the nine months ended September 30, 2006 which was 43.3%
compared to 26.8% for the same period in 2005. The increase in the effective tax
rate is primarily due to the December 31, 2005 expiration of Section 936 of the
Internal Revenue Code with regard to our Puerto Rico operations which are taxed
at the U.S. statutory rate starting in 2006. Deferred tax assets, net of a
valuation allowance of $26.1 million and deferred tax liabilities of $17.3
million, were $40.6 million as of December 31, 2005. As discussed above, we have
concluded that our current level of valuation allowance of $26.1 million
continues to be appropriate.
26
INCOME (LOSS) FROM DISCONTINUED OPERATION. Income (loss) from discontinued
operation, net of tax, reflects legal expenses associated with our asbestos
related liability and adjustments thereto based on the information contained in
the actuarial study and all other available information considered by us. We
recorded $0.6 million as income and $1.2 million as a loss from discontinued
operation for the nine months ended September 30, 2006 and 2005, respectively.
The income for the nine months ended September 30, 2006 reflects a $3.4 million
pre-tax adjustment to reduce our indemnity liability in line with our most
recent actuarial valuation report, partially offset by legal fees incurred in
litigation, whereas the loss for the same period of 2005 reflects only legal
expenses. As discussed more fully in note 11 of the notes to our consolidated
financial statements, we are responsible for certain future liabilities relating
to alleged exposure to asbestos containing products.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. During the first nine months of 2006, cash provided by
operations amounted to $9 million, compared to cash used in operations of $63.2
million in the same period of 2005. The period over period improvement of $72.2
million is primarily attributable to a lower increase in accounts receivable of
$54.7 million and an increase in net earnings. The lower increase in accounts
receivable was caused partly by a smaller balance in accounts receivable as of
September 30, 2006 as compared the balance as of September 30, 2005 due to
delays in monetizing the remaining drafts as of September 30, 2005 and by
December 2005 levels which were higher than in December 2004 following the
termination of our accounts receivable draft program at the end of 2005.
INVESTING ACTIVITIES. Cash used in investing activities was $7.7 million in the
first nine months of 2006, compared to $5.2 million in the same period of 2005.
The increase of $2.4 million was primarily due to lower proceeds from the sale
of property, plant and equipment.
FINANCING ACTIVITIES. Cash used in financing activities was $2.4 million in the
first nine months of 2006, compared to cash provided by financing activities of
$67.4 million in the same period of 2005. The decrease is primarily due to the
reduction in borrowings under our line of credit, which was $62.8 million lower
in the nine months ended September 30, 2006 compared to the same period in 2005.
We had lower borrowings due to an improvement in cash provided by operating
activities and a decrease in our bank overdraft balances.
We are parties to an agreement with General Electric Capital Corporation, as
agent, and a syndicate of lenders for a secured revolving credit facility. The
term of the credit agreement is through 2008 and provides for a line of credit
up to $305 million. Availability under our revolving credit facility is based on
a formula of eligible accounts receivable, eligible inventory and eligible fixed
assets. After taking into account outstanding borrowings under the revolving
credit facility, there was an additional $68.8 million available for us to
borrow pursuant to the formula at September 30, 2006. Our credit agreement also
permits dividends and distributions by us provided specific conditions are met.
Direct borrowings under our revolving credit facility bear interest at the prime
rate plus the applicable margin (as defined in the credit agreement) or, at our
option, the LIBOR rate plus the applicable margin (as defined in the credit
agreement). Borrowings are collateralized by substantially all of our assets,
including accounts receivable, inventory and fixed assets, and those of certain
of our subsidiaries. The terms of our revolving credit facility provide for,
among other provisions, financial covenants requiring us, on a consolidated
basis: (1) to maintain specified levels of fixed charge coverage at the end of
each fiscal quarter (rolling twelve months) through 2008; and (2) to limit
capital expenditure levels for each fiscal year through 2008. The terms of our
revolving credit facility also provide, among other things, for the prohibition
of accepting drafts under our customer draft programs after November 18, 2005.
27
In December 2005, our Canadian subsidiary entered into a credit agreement with
GE Canada Finance Holding Company, for itself and as agent for the lenders, and
GECC Capital Markets, Inc., as lead arranger and book runner. The credit
agreement provides for, among other things, a $7 million term loan, which term
loan is guaranteed and secured by us and certain of our wholly-owned
subsidiaries and which term loan is coterminous with the term of our revolving
credit facility. The $7 million term loan is part of the $305 million available
for borrowing under our revolving credit facility.
In addition, in order to facilitate the aggregate financing of the DEM
acquisition in June 2003, we completed a public equity offering of 5,750,000
shares of our common stock for net proceeds of approximately $55.7 million. We
also issued to Dana Corporation 1,378,760 shares of our common stock valued at
approximately $15.1 million and an unsecured subordinated promissory note in the
aggregate principal amount of approximately $15.1 million due December 31, 2008.
The promissory note had an interest rate of 9% per annum for the first year,
with such interest rate increasing by one-half of a percentage point (0.5%) on
each anniversary of the date of issuance. Accrued and unpaid interest was due
quarterly under the promissory note. On December 29, 2005, we entered into an
agreement with Dana, in which we repurchased the 1,378,760 shares of our common
stock at a repurchase price of $8.63 per share (or an aggregate approximate
repurchase price of $11.9 million) and prepaid at a discount the $15.1 million
unsecured promissory note plus accrued and unpaid interest for an aggregate
approximate amount of $14.5 million.
In June 2003, we borrowed $10 million under a mortgage loan agreement. The loan
is payable in equal monthly installments. The loan bears interest at a fixed
rate of 5.50% maturing in July 2018. The mortgage loan is secured by the related
building and property.
Our profitability and working capital requirements are seasonal due to the sales
mix of temperature control products. Our working capital requirements usually
peak near the end of the second quarter, as the inventory build-up of air
conditioning products is converted to sales and payments on the receivables
associated with such sales begin to be received. These increased working capital
requirements are funded by borrowings from our lines of credit. In 2004 and the
first quarter of 2005, we also received the benefit from accelerating accounts
receivable collections from customer draft programs. However, in the second
quarter of 2005 we reduced the early monetizing of these accounts receivable
under the draft program. An amendment to our revolving credit facility in
November 2005 prohibits us from accepting drafts under our customer draft
programs since November 18, 2005. We anticipate that our present sources of
funds will continue to be adequate to meet our near term needs.
In October 2003, we entered into an interest rate swap agreement with a notional
amount of $25 million that matured in October 2006. Under this agreement, we
received a floating rate based on the LIBOR interest rate, and paid a fixed rate
of 2.45% on the notional amount of $25 million. We have not entered into a new
swap agreement to replace this agreement.
In July 1999, we issued convertible debentures, payable semi-annually, in the
aggregate principal amount of $90 million. The debentures carry an interest rate
of 6.75%, payable semi-annually. The debentures are convertible into 2,796,120
shares of our common stock, and mature on July 15, 2009. The proceeds from the
sale of the debentures were used to prepay an 8.6% senior note, reduce short
term bank borrowings and repurchase a portion of our common stock.
As of September 30, 2006, we have Board authorization to repurchase additional
shares at a maximum cost of $1.7 million. During 2005 and the first nine months
of 2006, other than the repurchase of our common stock held by Dana as discussed
above, we did not repurchase any shares of our common stock either in the open
market or otherwise.
28
The following is a summary of our contractual commitments as of December 31,
2005. Other than as discussed below, there have been no significant changes to
this information at September 30, 2006. At December 31, 2005, we were parties to
a sublease agreement with Dana Corporation, which agreement was originally
scheduled to expire in 2021. However, on March 3, 2006, Dana filed a voluntary
petition for relief under Chapter 11 of the US Bankruptcy Code. Pursuant to a
court ruling in connection with Dana's Chapter 11 bankruptcy proceedings,
effective March 31, 2006, we were released from, and no longer have any
obligations with respect to, such lease commitment for the facility. As such,
our operating lease commitment in each year for the five year period from 2006
to 2010 has been reduced by $1.2 million per year and for the period from
2011-2015 has been reduced by $14.5 million in the aggregate.
The table below in the "Operating leases" line item has been revised to reflect
these reductions.
-------------------------------------------------
(IN THOUSANDS) 2006 2007 2008 2009 2010 2011-2015 TOTAL
-----------------------------------------------------------------------------------------------------------------
Principal payments of long
term debt ....................... $ 542 $ 555 $ 512 $ 90,530 $ 560 $ 6,392 $ 99,091
Operating leases .................... 6,941 5,839 4,650 3,240 1,175 7,140 28,985
Interest rate swap agreements ....... (496) -- -- -- -- -- (496)
Post-employee retirement
benefits ........................ 970 1,069 1,536 1,655 1,768 10,849 17,847
Severance payments related
to integration .................. 396 413 -- -- -- -- 809
------ ------ ------ -------- ------ -------- --------
Total commitments ......... $8,353 $7,876 $6,698 $ 95,425 $3,503 $ 24,381 $146,236
====== ====== ====== ======== ====== ======== ========
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to our business operations and
the understanding of our results of operations. The impact and any associated
risks related to these policies on our business operations is discussed
throughout "Management's Discussion and Analysis of Financial Condition and
Results of Operations," where such policies affect our reported and expected
financial results. For a detailed discussion on the application of these and
other accounting policies, see note 1 of the notes to our consolidated financial
statements in our Annual Report on Form 10-K for the year ended December 31,
2005. You should be aware that preparation of our consolidated quarterly
financial statements in this Report requires us to make estimates and
assumptions that affect the reported amount of assets and liabilities,
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 can give no assurance that actual results will not
differ from those estimates.
REVENUE RECOGNITION. We derive our revenue primarily from sales of replacement
parts for motor vehicles from both our Engine Management and Temperature Control
Segments. We recognize revenues when products are shipped and title has been
transferred to a customer, the sales price is fixed and determinable, and
collection is reasonably assured. For some of our sales of remanufactured
products, we also charge our customers a deposit for the return of a used core
component which we can use in our future remanufacturing activities. Such
deposit is not recognized as revenue but rather carried as a core liability. The
liability is extinguished when a core is eventually returned to us. We estimate
and record provisions for cash discounts, quantity rebates, sales returns and
warranties in the period the sale is recorded, based upon our prior experience
and current trends. As described below, significant management judgments and
estimates must be made and used in estimating sales returns and allowances
relating to revenue recognized in any accounting period.
INVENTORY VALUATION. Inventories are valued at the lower of cost or market. Cost
is generally determined on the first-in, first-out basis. Where appropriate,
standard cost systems are utilized for purposes of determining cost; the
standards are adjusted as necessary to ensure they approximate actual costs.
Estimates of lower of cost or market value of inventory are determined at the
reporting unit level and are based upon the inventory at that location taken as
a whole. These estimates are based upon current economic conditions, historical
sales quantities and patterns and, in some cases, the specific risk of loss on
specifically identified inventories.
29
We also evaluate inventories on a regular basis to identify inventory on hand
that may be obsolete or in excess of current and future projected market demand.
For inventory deemed to be obsolete, we provide a reserve on the full value of
the inventory. Inventory that is in excess of current and projected use is
reduced by an allowance to a level that approximates our estimate of future
demand.
We utilize cores (used parts) in our remanufacturing processes for air
conditioning compressors. The production of air conditioning compressors
involves the rebuilding of used cores, which we acquire generally either in
outright purchases or from returns pursuant to an exchange program with
customers. Under such exchange programs, we reduce our inventory, through a
charge to cost of sales, when we sell a finished good compressor, and put back
to inventory at standard cost through a credit to cost of sales the used core
exchanged at the time it is eventually received from the customer.
SALES RETURNS AND OTHER ALLOWANCES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS.
Management must make estimates of potential future product returns related to
current period product revenue. Management analyzes historical returns, current
economic trends, and changes in customer demand when evaluating the adequacy of
the sales returns and other allowances. Significant management judgments and
estimates must be made and used in connection with establishing the sales
returns and other allowances in any accounting period. At September 30, 2006,
the allowance for sales returns was $30.9 million. Similarly, management must
make estimates of the uncollectability of our accounts receivable. Management
specifically analyzes accounts receivable and historical bad debts, customer
concentrations, customer credit-worthiness, current economic trends and changes
in our customer payment terms when evaluating the adequacy of the allowance for
doubtful accounts. At September 30, 2006, the allowance for doubtful accounts
and for discounts was $10.1 million.
ACCOUNTING FOR NEW CUSTOMER ACQUISITION COSTS. New customer acquisition costs
refer to arrangements pursuant to which we incur change-over costs to induce a
new customer to switch from a competitor's brand. In addition, change-over costs
include the costs related to removing the new customer's inventory and replacing
it with Standard Motor Products inventory commonly referred to as a stocklift.
New customer acquisition costs are recorded as a reduction to revenue when
incurred.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements, we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves
estimating our actual current tax expense together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income, and to the extent we believe that it is more likely than not that the
deferred tax assets will not be recovered, we must establish a valuation
allowance. To the extent we establish a valuation allowance or increase or
decrease this allowance in a period, we must include an expense or recovery,
respectively, within the tax provision in the statement of operations.
Significant management judgment is required in determining the adequacy of our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our net deferred tax assets. At September
30, 2006, we had a valuation allowance of $26.1 million, due to uncertainties
related to our ability to utilize some of our deferred tax assets. The
assessment of the adequacy of our valuation allowance is based on our estimates
of taxable income by jurisdiction in which we operate and the period over which
our deferred tax assets will be recoverable.
In the event that actual results differ from these estimates, or we adjust these
estimates in future periods for current trends or expected changes in our
estimating assumptions, we may need to modify the level of valuation allowance
which could materially impact our business, financial condition and results of
operations.
30
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL. We assess the
impairment of identifiable intangibles and long-lived assets whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important, which could trigger an impairment
review, include the following: (a) significant underperformance relative to
expected historical or projected future operating results; (b) significant
changes in the manner of our use of the acquired assets or the strategy for our
overall business; and (c) significant negative industry or economic trends. With
respect to goodwill, if necessary, we test for potential impairment in the
fourth quarter of each year as part of our annual budgeting process. We review
the fair values of each of our reporting units using the discounted cash flows
method and market multiples.
In the event our planning assumptions were modified resulting in impairment to
our assets, we would be required to include an expense in our statement of
operations, which could materially impact our business, financial condition and
results of operations.
RETIREMENT AND POST-RETIREMENT MEDICAL BENEFITS. Each year, we calculate the
costs of providing retiree benefits under the provisions of SFAS 87, Employers'
Accounting for Pensions, and SFAS 106, Employers' Accounting for Post-retirement
Benefits Other than Pensions. The key assumptions used in making these
calculations are disclosed in notes 13 and 14 of the notes to our consolidated
financial statements in our Annual Report on Form 10-K for the year ended
December 31, 2005. The most significant of these assumptions are the eligibility
criteria of participants, the discount rate used to value the future obligation,
expected return on plan assets and health care cost trend rates. We select
discount rates commensurate with current market interest rates on high-quality,
fixed-rate debt securities. The expected return on assets is based on our
current review of the long-term returns on assets held by the plans, which is
influenced by historical averages. The medical cost trend rate is based on our
actual medical claims and future projections of medical cost trends. Under FSP
No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," the Company has
concluded that its post-retirement plan is actuarially equivalent to the
Medicare Part D benefit and accordingly recognizes subsidies from the federal
government in the measurement of the accumulated post-retirement benefit
obligation under SFAS 106, "Employers' Accounting for Post-Retirement Benefits
Other Than Pensions". In addition, in accordance with SFAS No. 106, Employers'
Accounting For Post-Retirement Benefits Other Than Pensions, in September 2005
we recognized a curtailment gain of $3.8 million for our post-retirement plan
related to changes made to our plan, namely reducing the number of participants
eligible for our plan by making all active participants hired after 1995 no
longer eligible.
ASBESTOS RESERVE. We are responsible for certain future liabilities relating to
alleged exposure to asbestos-containing products. In accordance with our
accounting policy, our most recent actuarial study estimated a liability for
settlement payments, excluding legal costs, ranging from $22.1 million to $53.9
million. Based on the information contained in the actuarial study and all other
available information considered by us, we concluded that no amount within the
range of settlement payments was more likely than any other and, therefore,
recorded the low end of the range as the liability associated with future
settlement payments through 2050 in our consolidated financial statements, in
accordance with generally accepted accounting principles. Legal costs, which are
expensed as incurred and reported in loss from discontinued operation, are
estimated to range from $11.6 million to $21.6 million during the same period.
We plan to perform an annual actuarial analysis during the third quarter of each
year for the foreseeable future. Based on this analysis and all other available
information, we will continue to reassess the recorded liability and, if deemed
necessary, record an adjustment to the reserve, which will be reflected as a
loss or gain from discontinued operation.
OTHER LOSS RESERVES. We have numerous other loss exposures, such as
environmental claims, product liability and litigation. Establishing loss
reserves for these matters requires the use of estimates and judgment of risk
exposure and ultimate liability. We estimate losses using consistent and
appropriate methods; however, changes to our assumptions could materially affect
our recorded liabilities for loss.
31
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS.
SHARE-BASED PAYMENT
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123R"). SFAS 123R requires that stock-based
employee compensation be recorded as a charge to earnings. SFAS 123R is
effective for interim and annual financial statements for years beginning after
December 15, 2005 and applies to all outstanding and unvested share-based
payments at the time of adoption. Accordingly, we have adopted SFAS 123R
commencing January 1, 2006 using a modified prospective application, as
permitted by SFAS 123R. Accordingly, prior period amounts have not been
restated. Under this application, we are required to record compensation expense
for all awards granted after the date of adoption and for the unvested portion
of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS 123R, we applied Accounting Principles Board
Opinions ("APB") No. 25 and related interpretations to account for our stock
plans resulting in the use of the intrinsic value to value the stock. Under APB
25, we were not required to recognize compensation expense for the cost of stock
options. In accordance with the adoption of SFAS 123R, we recorded stock-based
compensation expense for the cost of incentive stock options, restricted stock
and performance-based stock granted under our stock plans. Stock-based
compensation expense for the third quarter of 2006 was $149,100 ($91,600 net of
tax) or $0.01 per basic and diluted share and $559,500 ($343,800 net of tax) or
$0.02 per basic and diluted share for the nine months ended September 30, 2006.
The adoption of SFAS 123R did not have a material impact on our financial
position, results of operation or cash flows.
ACCOUNTING FOR UNCERTAIN TAX POSITIONS
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 prescribes a threshold for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
Only tax positions meeting the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized upon adoption of
this Interpretation. FIN 48 also provides guidance on accounting for
derecognition, interest and penalties, and classification and disclosure of
matters related to uncertainty in income taxes. FIN 48 is effective for fiscal
years beginning after December 15, 2006 and, as a result, is effective for our
Company beginning January 1, 2007. FIN 48 will require adjustment to the opening
balance of retained earnings (or other components of shareholders' equity in the
statement of financial position) for the cumulative effect of the difference in
the net amount of assets and liabilities for all open tax positions at the
effective date. Management is currently assessing the impact, if any, which the
adoption of FIN 48 will have on our consolidated financial position, results of
operations and cash flows.
FAIR VALUE MEASUREMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS
157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurement. This statement applies under other accounting pronouncements
that require or permit fair value measurements and does not require any new fair
value measurements. SFAS 157 is effective for the fiscal year beginning after
November 15, 2007, which for the Company is the year ending December 31, 2007.
Management is currently assessing the impact, if any, which the adoption of SFAS
157 will have on our consolidated financial position, results of operations and
cash flows.
32
ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." SFAS 158 requires an employer to
recognize the overfunded or underfunded status of a defined benefit pension or
postretirement plan as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year in which the
changes occur through accumulated other comprehensive income in shareholders'
equity. This statement also requires an employer to measure the funded status of
a plan as of the date of its year-end statement of financial position, with
limited exceptions. The Company will be required to initially recognize the
funded status of a defined benefit postretirement plan and to provide the
required disclosures as of the end of the fiscal year ending after December 15,
2006, which for the Company will be the year ending December 31, 2006. The
requirement to measure plan assets and benefit obligations as of the date of the
employer's fiscal year-end statement of financial position is effective for
fiscal years ending after December 15, 2008, or for the Company's year ending
December 31, 2008. Management estimates the impact of adopting SFAS 158 will not
result in a material change to its total liabilities or shareholders' equity.
QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108
provides interpretive guidance on how the effects of prior-year uncorrected
misstatements should be considered when quantifying misstatements in the current
year financial statements. SAB 108 requires registrants to quantify
misstatements using both an income statement ("rollover") and balance sheet
("iron curtain") approach and evaluate whether either approach results in a
misstatement that, when all relevant quantitative and qualitative factors are
considered, is material. If prior year errors that had been previously
considered immaterial now are considered material based on either approach, no
restatement is required so long as management properly applied its previous
approach and all relevant facts and circumstances were considered. If prior
years are not restated, the cumulative effect adjustment is recorded in opening
accumulated earnings (deficit) as of the beginning of the fiscal year of
adoption. SAB 108 is effective for fiscal years ending on or after November 15,
2006, which for the Company is the year ending December 31, 2006. Management is
currently assessing the impact, if any, which the adoption of SAB 108 will have
on our consolidated financial position, results of operations and cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, primarily related to foreign currency exchange
and interest rates. These exposures are actively monitored by management. Our
exposure to foreign exchange rate risk is due to certain costs, revenues and
borrowings being denominated in currencies other than one of our subsidiary's
functional currency. Similarly, we are exposed to market risk as the result of
changes in interest rates, which may affect the cost of our financing. It is our
policy and practice to use derivative financial instruments only to the extent
necessary to manage exposures. We do not hold or issue derivative financial
instruments for trading or speculative purposes.
We have exchange rate exposure, primarily, with respect to the Canadian dollar,
the British pound, the Euro, the Japanese Yen and the Hong Kong dollar. As of
December 31, 2005 and September 30, 2006, our monetary assets and liabilities
which are subject to this exposure are immaterial, therefore the potential
immediate loss to us that would result from a hypothetical 10% change in foreign
currency exchange rates would not be expected to have a material impact on our
earnings or cash flows. This sensitivity analysis assumes an unfavorable 10%
fluctuation in both of the exchange rates affecting both of the foreign
currencies in which the indebtedness and the financial instruments described
above are denominated and does not take into account the offsetting effect of
such a change on our foreign-currency denominated revenues.
33
We manage our exposure to interest rate risk through the proportion of fixed
rate debt and variable rate debt in our debt portfolio. To manage a portion of
our exposure to interest rate changes, we enter into interest rate swap
agreements. We invest our excess cash in highly liquid short-term investments.
Our percentage of variable rate debt to total debt was 60% at December 31, 2005
and 61.5% at September 30, 2006.
Other than the aforementioned, there have been no significant changes to the
information presented in Item 7A (Market Risk) of our Annual Report on Form 10-K
for the year ended December 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Exchange Act, as
of the end of the period covered by this Report. Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of the end of the period
covered by this Report.
(b) Changes in Internal Control Over Financial Reporting.
During the quarter ended September 30, 2006, we have not made any changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
We continue to review, document and test our internal control over financial
reporting, and may from time to time make changes aimed at enhancing their
effectiveness and to ensure that our systems evolve with our business. These
efforts will lead to various changes in our internal control over financial
reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In 1986, we acquired a brake business, which we subsequently sold in March 1998
and which is accounted for as a discontinued operation. When we originally
acquired this brake business, we assumed future liabilities relating to any
alleged exposure to asbestos-containing products manufactured by the seller of
the acquired brake business. In accordance with the related purchase agreement,
we agreed to assume the liabilities for all new claims filed on or after
September 1, 2001. Our ultimate exposure will depend upon the number of claims
filed against us on or after September 1, 2001 and the amounts paid for
indemnity and defense thereof. At December 31, 2005 and September 30, 2006
approximately 4,500 cases and 3,300 cases, respectively, were outstanding for
which we were responsible for any related liabilities. We believe that the level
of new cases will decrease gradually due to recent legislation in certain states
mandating minimum medical criteria before a case can be heard. Since inception
in September 2001 through September 30, 2006, the amounts paid for settled
claims are approximately $4.9 million. We do not have insurance coverage for the
defense and indemnity costs associated with these claims.
34
On November 30, 2004, we were served with a summons and complaint in the U.S.
District Court for the Southern District of New York by The Coalition For A
Level Playing Field, which is an organization comprised of a large number of
auto parts retailers. The complaint alleges antitrust violations by the Company
and a number of other auto parts manufacturers and retailers and seeks
injunctive relief and unspecified monetary damages. In August 2005, we filed a
motion to dismiss the complaint, following which the plaintiff filed an amended
compliant dropping, among other things, all claims under the Sherman Act. The
remaining claims allege violations of the Robinson-Patman Act. Motions to
dismiss those claims were filed by us in February 2006. Plaintiff has filed
opposition to our motions, and we subsequently filed replies in June 2006. Oral
arguments were originally scheduled for September 2006, however the court has
adjourned these proceedings until a later date to be determined. Although we
cannot predict the ultimate outcome of this case or estimate the range of any
potential loss that may be incurred in the litigation, we believe that the
lawsuit is without merit, deny all of the plaintiff's allegations of wrongdoing
and believe we have meritorious defenses to the plaintiff's claims. We intend to
defend vigorously this lawsuit.
We are involved in various other litigation and product liability matters
arising in the ordinary course of business. Although the final outcome of any
asbestos-related matters or any other litigation or product liability matter
cannot be determined, based on our understanding and evaluation of the relevant
facts and circumstances, it is our opinion that the final outcome of these
matters will not have a material adverse effect on our business, financial
condition or results of operations.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
STANDARD MOTOR PRODUCTS, INC.
(Registrant)
Date: November 9, 2006 /s/ James J. Burke
------------------
James J. Burke
Vice President Finance,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ Luc Gregoire
----------------
Luc Gregoire
Corporate Controller and
Chief Accounting Officer
36
STANDARD MOTOR PRODUCTS, INC.
EXHIBIT INDEX
EXHIBIT
NUMBER
------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
37