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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 JUNE 30, 2004
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.
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(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
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(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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of the close of business on July 30, 2004, there were 19,769,289 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
June 30, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Operations and Retained Earnings
(Unaudited) for the Three Months and Six Months Ended June 30, 2004 and 2003 4
Consolidated Statements of Cash Flows (Unaudited) for the Six Months
Ended June 30, 2004 and 2003 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits and Reports on Form 8-K 30
Signature 31
2
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except for shares and per share data)
June 30, December 31,
2004 2003
---------- -----------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 11,152 $ 19,647
Accounts receivable, net of
allowance for doubtful accounts and
discounts of $6,556 (2003 - $5,009) (Note 7) 222,288 174,223
Inventories (Notes 5 and 7) 265,102 253,754
Deferred income taxes 13,004 13,148
Prepaid expenses and other current assets 10,178 7,399
--------- ---------
Total current assets 521,724 468,171
--------- ---------
Property, plant and equipment, net of
accumulated depreciation (Notes 6 and 7) 106,810 112,549
Goodwill and other intangibles (Note 3) 72,630 71,843
Other assets 41,879 41,962
--------- ---------
Total assets $ 743,043 $ 694,525
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable (Note 7) $ 124,418 $ 99,699
Current portion of long-term debt (Note 7) 534 3,354
Accounts payable 76,103 58,029
Sundry payables and accrued expenses 44,899 42,431
Restructuring accrual (Note 4) 11,000 16,000
Accrued rebates 22,169 18,989
Accrued customer returns 26,516 24,115
Payroll and commissions 14,161 14,221
--------- ---------
Total current liabilities 319,800 276,838
--------- ---------
Long-term debt (Note 7) 114,507 114,757
Postretirement medical benefits
and other accrued liabilities 39,893 36,848
Restructuring accrual (Note 4) 15,588 15,615
Accrued asbestos liabilities (Note 14) 23,469 24,426
--------- ---------
Total liabilities 513,257 468,484
--------- ---------
Commitments and contingencies (Notes 7,8,10,12 and 14)
Stockholders' equity (Notes 7,8,9,10 and 12):
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 57,894 58,086
Retained earnings 143,805 141,553
Accumulated other comprehensive income 4,195 4,814
Treasury stock - at cost (1,131,747 and 1,284,428
shares in 2004 and 2003, respectively) (17,080) (19,384)
--------- ---------
Total stockholders' equity 229,786 226,041
--------- ---------
Total liabilities and stockholders' equity $ 743,043 $ 694,525
========= =========
See accompanying notes to consolidated financial statements.
3
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(In thousands, except for shares and per share data)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Unaudited) (Unaudited)
Net sales $ 235,049 $ 166,125 $ 439,830 $ 301,850
Cost of sales 172,781 122,306 326,602 223,491
------------ ------------ ------------ ------------
Gross profit 62,268 43,819 113,228 78,359
Selling, general and administrative expenses 46,150 32,725 93,478 64,715
Integration expenses 2,556 554 3,923 776
------------ ------------ ------------ ------------
Operating income 13,562 10,540 15,827 12,868
Other income (expense) - net 700 (129) 943 (403)
Interest expense 4,205 3,188 7,439 6,206
------------ ------------ ------------ ------------
Earnings from continuing operations before taxes 10,057 7,223 9,331 6,259
Income tax expense 2,514 2,923 2,333 2,566
------------ ------------ ------------ ------------
Earnings from continuing operations 7,543 4,300 6,998 3,693
Loss from discontinued operation, net of tax (851) (433) (1,276) (781)
------------ ------------ ------------ ------------
Net earnings 6,692 3,867 5,722 2,912
Retained earnings at beginning of period 138,854 146,655 141,553 148,686
------------ ------------ ------------ ------------
145,546 150,522 147,275 151,598
Less: cash dividends for period 1,741 1,083 3,470 2,159
------------ ------------ ------------ ------------
Retained earnings at end of period $ 143,805 $ 149,439 $ 143,805 $ 149,439
============ ============ ============ ============
Per share data:
Net earnings per common share - basic:
Earnings per share from continuing operations $ 0.39 $ 0.34 $ 0.36 $ 0.30
Discontinued operation (0.04) (0.03) (0.06) (0.06)
------------ ------------ ------------ ------------
Net earnings per common share - basic $ 0.35 $ 0.31 $ 0.30 $ 0.24
============ ============ ============ ============
Net earnings per common share - diluted:
Earnings per share from continuing operations $ 0.38 $ 0.34 $ 0.36 $ 0.30
Discontinued operation (0.04) (0.03) (0.06) (0.06)
------------ ------------ ------------ ------------
Net earnings per common share - diluted $ 0.34 $ 0.31 $ 0.30 $ 0.24
============ ============ ============ ============
Average number of common shares 19,346,553 12,493,796 19,290,048 12,234,764
============ ============ ============ ============
Average number of common and dilutive shares 22,247,798 15,334,225 19,394,511 12,305,907
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended
June 30,
--------------------------
2004 2003
---------- ---------
(Unaudited)
Cash flows from operating activities:
Net earnings $ 5,722 $ 2,912
Adjustments to reconcile net earnings to net cash
used in operating activities:
Depreciation and amortization 9,094 8,028
(Gain) loss on sale of property, plant and equipment (69) 134
Equity (income) loss from joint ventures (575) 115
Employee stock ownership plan allocation 822 504
Loss on discontinued operations, net of tax 1,276 781
Change in assets and liabilities, net of effects from acquisitions:
Increase in accounts receivable, net (48,699) (75,786)
Increase in inventories (10,324) (2,218)
(Increase) decrease in prepaid expenses and other current assets (1,814) 971
Decrease in other assets 912 2,632
Increase in accounts payable 5,984 13,743
Increase in sundry payables and accrued expenses 5,648 1,044
Decrease in restructuring accrual (5,027) --
Increase in other liabilities 5,030 2,252
--------- ---------
Net cash used in operating activities (32,020) (44,888)
--------- ---------
Cash flows from investing activities:
Proceeds from the sale of property, plant and equipment 482 77
Capital expenditures (3,727) (3,617)
Payments for acquisitions (2,906) (99,336)
--------- ---------
Net cash used in investing activities (6,151) (102,876)
--------- ---------
Cash flows from financing activities:
Net borrowings under line-of-credit agreements 24,719 81,972
Borrowings under new long term debt -- 10,000
Principal payments of long-term debt (3,070) (3,482)
Proceeds from the issuance of common stock, net of issuance costs -- 55,730
Increase in overdraft balances 12,090 175
Proceeds from exercise of employee stock options 469 27
Dividends paid (3,470) (2,159)
--------- ---------
Net cash provided by financing activities 30,738 142,263
--------- ---------
Effect of exchange rate changes on cash (1,062) 3,215
Net decrease in cash and cash equivalents (8,495) (2,286)
Cash and cash equivalents at beginning of the period 19,647 9,690
--------- ---------
Cash and cash equivalents at end of the period $ 11,152 $ 7,404
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 7,569 $ 6,378
========= =========
Income taxes $ 1,199 $ 1,990
========= =========
See accompanying notes to consolidated financial statements.
5
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, 2003.
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 2003 have been reclassified to conform
with the 2004 presentation.
NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities ("FIN 46R"), which addresses
how a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
Effective January 1, 2004, we adopted FIN 46R, which did not have a material
effect on our consolidated financial statements.
MEDICARE PRESCRIPTION DRUG, IMPROVEMENT AND MODERNIZATION ACT OF 2003
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the "Act") was signed into law. The Act expanded Medicare to
include, for the first time, coverage for prescription drugs. At present,
detailed regulations necessary to implement the Act have not been issued,
including those that would specify the manner in which actuarial equivalency
must be determined, the evidence required to demonstrate actuarial equivalency,
and the documentation requirements necessary to be entitled to the subsidy. Our
net periodic postretirement benefit cost does not reflect any amount associated
with the subsidy because we are unable to conclude whether the benefits provided
by our retiree medical plans are actuarially equivalent to Medicare Part D under
the Act until further governmental regulations are issued.
6
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits, was issued. Statement 132 (revised)
revises employers' disclosures about pension plans and other postretirement
benefit plans; it does not change the measurement or recognition of those plans.
Statement 132 (revised) retains and revises the disclosure requirements
contained in the original Statement 132. It also requires additional disclosures
about the assets, obligations, cash flows, and net periodic benefit cost of
defined benefit pension plans and other postretirement benefit plans. Our
disclosures in note 12 of notes to our consolidated financial statements
incorporate the requirements of Statement 132 (revised).
NOTE 3. GOODWILL AND OTHER INTANGIBLE ASSETS
GOODWILL
The changes in the carrying value of goodwill for our segments during the six
months ended June 30, 2004 are as follows (in thousands):
Engine Temperature
Management Control Europe Total
----------------- ---------------- -------------- -------------
Balance at December 31, 2003 $ 65,650 $ 4,822 $ 1,371 $ 71,843
Purchase accounting adjustments (13,313) - - (13,313)
----------------- ---------------- -------------- -------------
Balance at June 30, 2004 $ 52,337 $ 4,822 $ 1,371 $ 58,530
================= ================ ============== =============
In connection with the acquisition of Dana Corporation's Engine Management Group
("DEM"), and the completion of purchase price allocations in June 2004 (see note
4 of notes to our consolidated financial statements), goodwill has been adjusted
by $14.1 million for intangible assets (see Acquired Intangible Assets) based on
the fair market valuation performed during the second quarter of 2004.
Additionally, a purchase accounting adjustment relating to the acquired
inventory of $0.8 million was recorded during the second quarter of 2004.
ACQUIRED INTANGIBLE ASSETS
Acquired identifiable intangible assets associated with the acquisition of DEM,
as of June 30, 2004, consist of (in thousands):
Accumulated
Gross Amortization Net
------------------ ------------------ ----------------
Customer relationships $ 8,000 - $ 8,000
Trademarks and tradenames 6,100 - 6,100
------------------ ------------------ ----------------
$ 14,100 - $ 14,100
================== ================== ================
Of the total purchase price, $14.1 million was allocated to intangible assets
consisting of customer relationships and trademarks and tradenames; $8 million
was assigned to customer relationships and will be amortized on a straight-line
basis over the estimated useful life of 10 years; and the remaining $6.1 million
of acquired intangible assets was assigned to trademarks and tradenames which is
not subject to amortization as they were determined to have indefinite remaining
useful lives.
Estimated amortization expense for the next five years is: $0.4 million in 2004
(remaining six months) and $0.8 million in each year during 2005 through 2009.
7
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4. ACQUISITIONS, RESTRUCTURING AND INTEGRATION COSTS
ACQUISITION OF DANA'S EMG BUSINESS
On June 30, 2003, we completed the acquisition of substantially all of the
assets and assumed substantially all of the operating liabilities of DEM. Prior
to the sale, DEM was a leading manufacturer of aftermarket parts in the
automotive industry focused exclusively on engine management.
Under the terms of the acquisition, we paid Dana Corporation $93.2 million in
cash (includes $1.9 million paid in 2004 for final payment), issued an unsecured
subordinated promissory note of $15.1 million, and issued 1,378,760 shares of
our common stock valued at $15.1 million using an average market price of $10.97
per share. The average market price was based on the average closing price for a
range of trading days proceeding the closing date of the acquisition. Our final
purchase price was approximately $130.5 million, which included $7.1 million of
transaction costs.
We also issued to Dana Corporation on June 30, 2003 an unsecured subordinated
promissory note in the aggregate principal amount of approximately $15.1 million
as discussed more fully in note 7 of notes to our consolidated financial
statements.
In connection with the acquisition of DEM, we completed a public equity offering
of 5,750,000 shares of our common stock for net proceeds of approximately $55.7
million. The net proceeds from this equity offering were used to repay a portion
of our outstanding indebtedness under our revolving credit facility with General
Electric Capital Corporation.
On June 30, 2003, we also completed an amendment to our revolving credit
facility, which increased the amount available under the credit facility by $80
million, to $305 million, as discussed more fully in note 7 of notes to our
consolidated financial statements. We then financed the cash portion of the
acquisition purchase price and the costs associated with the acquisition by
borrowing from our amended credit facility.
The purchase price of the acquisition is summarized as follows (in thousands):
Value of common stock issued $ 15,125
Unsecured subordinated promissory note 15,125
Cash consideration 93,172
-------------
Total consideration 123,422
Transaction costs 7,077
-------------
Total purchase price $130,499
-------------
The acquisition purchase price was based upon the final book value of the
acquired assets of DEM less the book value of the assumed liabilities of DEM as
of the close of business on the closing date, subject to a maximum purchase
price of $125 million (not including transaction costs).
The following table summarizes the components of the net assets acquired based
upon the final purchase accounting (in thousands):
8
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Accounts receivable $ 65,162
Inventories 81,693
Property, plant and equipment 17,165
Goodwill 41,847
Intangible assets:
Customer relationships (estimated useful life of 10 years) 8,000
Trademarks and tradenames (indefinite life) 6,100
Other assets 128
-------------
Total assets acquired $220,095
-------------
Accounts payable $ 30,247
Sundry payables and accrued expenses 32,152
Accrued customer returns 7,013
Payroll and commissions 3,984
Other liabilities 16,200
-------------
Total liabilities assumed 89,596
-------------
Net assets acquired $130,499
-------------
The acquisition was accounted for as a purchase transaction in accordance with
SFAS No. 141, and accordingly, the assets and liabilities acquired were recorded
at their fair value at the date of the acquisition.
The excess of the purchase price over the estimated fair values of the net
assets acquired was recorded as goodwill. Certain adjustments were made to
goodwill subsequent to the acquisition date and are described in note 3 of notes
to our consolidated financial statements.
Goodwill of $41.8 million resulting from this acquisition has been assigned to
our Engine Management reporting unit. Goodwill associated with this acquisition
will be deductible for tax purposes.
The following table represents our unaudited pro forma consolidated statement of
operations for the three and six months ended June 30, 2003, as if the
acquisition of DEM had been completed at January 1, 2003. The pro forma
information is presented for comparative purposes only and does not purport to
be indicative of what would have occurred had the acquisition actually been made
at such date, nor is it necessarily indicative of future operating results.
Three Months Ended Six Months Ended
June 30, 2003 June 30, 2003
------------------ ------------------
(In thousands)
Net sales $ 235,528 $ 445,582
Earnings from continuing operations $ 1,419 $ 1,223
Earnings before cumulative effect
of accounting change $ 986 $ 442
Net earnings $ 986 $ 442
Net earnings per common share:
Net earnings - Basic $ 0.05 $ 0.02
Net earnings - Diluted $ 0.05 $ 0.02
On February 3, 2004, we acquired inventory from the Canadian distribution of DEM
for approximately $1.0 million. We have relocated such inventory into our
distribution facility in Mississauga, Canada.
9
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
RESTRUCTURING COSTS
In connection with the acquisition, we have reviewed our operations and
implemented integration plans to restructure the operations of DEM. We announced
in a press release on July 8, 2003 that we will close seven DEM facilities. As
part of the integration and restructuring plans, we accrued an initial
restructuring liability of approximately $34.7 million at June 30, 2003
(subsequently reduced to $33.7 million during 2003). Such amounts were
recognized as liabilities assumed in the acquisition and included in the
allocation of the costs to acquire DEM. Accordingly, such amounts resulted in
additional goodwill being recorded in connection with the acquisition.
Of the total 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, 2003 and
the six months ended June 30, 2004, termination benefits of $2.1 million and
$4.5 million, respectively, have been charged to the restructuring accrual. We
expect to pay the remaining termination benefits by December 31, 2004. In
addition, during 2004 there was a non-cash adjustment of $1.6 million, as
workforce reduction costs are expected to be less than amounts originally
estimated.
The restructuring accrual also includes approximately $18.0 million associated
with exiting certain activities, primarily related to lease and contract
termination costs which will not have future benefits. Specifically, our plans
are to consolidate certain of DEM operations into our existing plants. At June
30, 2004, five of the seven facilities have ceased operating activities. We
expect that all facilities will be vacated during 2004. During the six months
ended June 30, 2004, $0.5 million of costs have been charged to the
restructuring accrual. We expect to pay such costs through 2021. In addition,
during 2004 there was a non-cash adjustment of $1.6 million as exit costs are
expected to be more than originally estimated.
Selected information relating to the remaining restructuring costs is as follows
(in thousands):
Workforce Other
Reduction Exit Costs Totals
----------------- ---------------- --------------
Restructuring liability at December 31, 2003 $ 13,615 $ 18,000 $31,615
Cash payments during first six months of 2004 (4,478) (549) (5,027)
Adjustments (1,600) 1,600 -
----------------- ---------------- --------------
Restructuring liability as of June 30, 2004 $ 7,537 $ 19,051 $26,588
----------------- ---------------- --------------
INTEGRATION EXPENSES
During the second quarter of 2004 and for the six months ended June 30, 2004, we
incurred $2.6 million and $3.9 million, respectively, of costs related to the
DEM integration. These costs primarily related to equipment and inventory move
costs, employee stay bonuses and other facility consolidation costs. During the
second quarter of 2003 and for the six months ended June 30, 2003, we incurred
$0.6 million and $0.8 million, respectively, related to the consolidation of
facilities within our Temperature Control segment and European operations.
10
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 5. INVENTORIES
June 30, December 31,
2004 2003
(unaudited)
----------- -----------
(in thousands)
Finished Goods $193,378 $191,340
Work in Process 5,733 7,913
Raw Materials 65,991 54,501
-------- --------
Total inventories $265,102 $253,754
======== ========
NOTE 6. PROPERTY, PLANT AND EQUIPMENT
June 30, December 31,
2004 2003
(unaudited)
---------------- ---------------
(in thousands)
Land, buildings and improvements $ 71,711 $ 71,900
Machinery and equipment 138,342 137,770
Tools, dies and auxiliary equipment 20,561 20,068
Furniture and fixtures 28,008 27,743
Computer software 12,496 12,514
Leasehold improvements 7,274 7,285
Construction in progress 6,524 4,280
---------------- ----------------
284,916 281,560
Less: accumulated depreciation and amortization 178,106 169,011
---------------- ----------------
Total property, plant and equipment - net $ 106,810 $ 112,549
================ ================
NOTE 7. CREDIT FACILITIES AND LONG-TERM DEBT
CREDIT FACILITIES
Effective April 27, 2001, we entered into 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 was for a period of
five years and provided for a line of credit up to $225 million.
On June 30, 2003, in connection with our acquisition of DEM we completed an
amendment to our revolving credit facility to provide for an additional $80
million commitment. This additional commitment increases the total amount
available for borrowing under our revolving credit facility to $305 million from
$225 million, which now expires in 2008. Availability under our revolving credit
facility is based on a formula of eligible accounts receivable, eligible
inventory and eligible fixed assets which includes the purchased assets of DEM.
Available borrowings pursuant to the formula at June 30, 2004 are $87.1 million.
Direct borrowings under our revolving credit facility bear interest at the prime
rate plus the applicable margin (as defined in the credit agreement) or the
LIBOR rate plus the applicable margin (as defined in the credit agreement), at
our option. Outstanding borrowings under this revolving credit facility,
classified as current liabilities, was $120.3 million and $95.9 million at June
30, 2004 and December 31, 2003, respectively. Borrowings are collateralized by
substantially all of our assets, including accounts receivable, inventory and
fixed assets, and those of our domestic and Canadian 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 earnings before interest, taxes, depreciation and amortization
(EBITDA) as defined in the amendments to the credit agreement, at the end of
each fiscal quarter through December 31, 2004, (2) commencing September 30,
2004, to maintain specified levels of fixed charge coverage at the end of each
fiscal quarter (rolling twelve months) through 2007, and (3) to limit capital
expenditure levels for each fiscal year through 2007.
11
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In addition, a foreign subsidiary of ours has a revolving credit facility. The
amount of short-term borrowings outstanding under this facility was $4.1 million
and $3.8 million at June 30, 2004 and December 31, 2003, respectively.
LONG-TERM DEBT
On July 26, 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 on July 15, 2009.
The convertible debentures are convertible into 2,796,120 shares of our common
stock. We may, at our option, redeem some or all of the debentures at any time
on or after July 15, 2004, at the redemption prices set forth in the agreement
plus accrued interest. In addition, if a change in control, as defined in the
agreement, occurs 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.
In connection with our acquisition of DEM, we issued to Dana Corporation on June
30, 2003 an unsecured subordinated promissory note in the aggregate principal
amount of approximately $15.1 million. The promissory note bears 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 is due quarterly under the promissory
note. The maturity date of the promissory note is December 31, 2008. The
promissory note may be prepaid in whole or in part at any time without penalty.
On June 27, 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.
June 30, December 31,
2004 2003
(unaudited)
------------ -----------
Long term debt consists of: (in thousands)
6.75% convertible subordinated debentures $ 90,000 $ 90,000
Unsecured promissory note 15,125 15,125
Mortgage loan 9,605 9,824
Other 311 3,162
-------- --------
115,041 118,111
Less: current portion 534 3,354
-------- --------
Total non-current portion of
long-term debt $114,507 $114,757
======== ========
NOTE 8. INTEREST RATE SWAP AGREEMENTS
We do not enter into financial instruments for trading or speculative purposes.
The principal financial instruments used for cash flow hedging purposes are
interest rate swaps. We enter into interest rate swap agreements to manage our
exposure to interest rate changes. The swaps effectively convert a portion of
our variable rate debt under the revolving credit facility to a fixed rate,
without exchanging the notional principal amounts.
In October 2003, we entered into a new interest rate swap agreement with a
notional amount of $25 million that is to mature in October 2006. Under this
agreement, we receive a floating rate based on the LIBOR interest rate, and pay
a fixed rate of 2.45% on the notional amount of $25 million.
12
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In July 2001, we entered into two interest rate swap agreements with an
aggregate notional principal amount of $75 million, one of which matured in
January 2003 and the other matured in January 2004. Under these agreements, we
received a floating rate based on the LIBOR interest rate, and paid a fixed rate
of 4.92% on a notional amount of $45 million (matured in January 2004) and 4.37%
on a notional amount of $30 million (matured in January 2003).
If, at any time, the swaps are determined to be ineffective, in whole or in
part, due to changes in the interest rate swap or underlying debt agreements,
the fair value of the portion of the interest rate swap determined to be
ineffective will be recognized as gain or loss in the statement of operations in
the "interest expense" caption for the applicable period. It is not expected
that any gain or loss will be reported in the statement of operations during the
year ending December 31, 2004 nor was any recorded in 2003.
NOTE 9. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss), net of income tax expense is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2004 2003 2004 2003
------- ------- ------- -------
(in thousands) (in thousands)
Net earnings as reported $ 6,692 $ 3,867 $ 5,722 $ 2,912
Foreign currency translation adjustments (854) 3,276 (1,021) 3,733
Change in fair value of interest rate
swap agreements 473 289 402 613
------- ------- ------- -------
Total comprehensive income, net of taxes $ 6,311 $ 7,432 $ 5,103 $ 7,258
======= ======= ======= =======
Accumulated other comprehensive income is comprised of the following:
June 30, December 31,
2004 2003
---------- ----------
(in thousands)
Foreign currency translation adjustments $ 4,759 $ 5,780
Unrealized income (loss) on interest rate
swap agreement, net of tax 291 (111)
Minimum pension liability (855) (855)
---------- ----------
Total accumulated other comprehensive income $ 4,195 $ 4,814
========== ==========
NOTE 10. STOCK BASED COMPENSATION PLAN
Under Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("Statement No. 123"), we account for stock-based
compensation using the intrinsic value method in accordance with APB Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations. Stock
options granted during the three months and six months ended June 30, 2004 and
2003 were exercisable at prices equal to the fair market value or greater of our
common stock on the dates the options were granted; therefore, no compensation
cost has been recognized for the stock options granted.
If we accounted for stock-based compensation using the fair value method of
Statement No. 123, as amended by Statement No. 148, the effect on net earnings
and basic and diluted earnings per share would have been as follows:
13
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ----------------------------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands, except (in thousands, except
per share amounts) per share amounts)
Net earnings as reported $6,692 $3,867 $5,722 $2,912
Less: Total stock-based employee compensation
expense determined under fair value method for all
awards, net of related tax effects (129) (34) (194) (68)
------------ ----------- ----------- ------------
Pro forma net earnings $6,563 $3,833 $5,528 $2,844
============ =========== =========== ============
Earnings per share:
Basic - as reported $ 0.35 $ 0.31 $ 0.30 $ 0.24
============ =========== =========== ============
Basic - pro forma $ 0.34 $ 0.31 $ 0.29 $ 0.23
============ =========== =========== ============
Diluted - as reported $ 0.34 $ 0.31 $ 0.30 $ 0.24
============ =========== =========== ============
Diluted - pro forma $ 0.34 $ 0.31 $ 0.29 $ 0.23
============ =========== =========== ============
At June 30, 2004, an aggregate 1,619,645 shares of authorized but unissued
common stock were reserved for issuance under our stock option plans.
NOTE 11. EARNINGS PER SHARE
Following are reconciliations of the earnings available to common stockholders
and the shares used in calculating basic and dilutive net earnings per common
share:
Three Months Ended Six Months Ended
June 30, June 30,
(Unaudited) (Unaudited)
----------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(in thousands, except per share amounts)
Earnings from continuing
operations $ 7,543 $ 4,300 $ 6,998 $ 3,693
Loss from discontinued operations (851) (433) (1,276) (781)
------------ ------------ ------------ ------------
Earnings available to common
stockholders 6,692 3,867 5,722 2,912
Interest related to convertible
debentures 911 911 -- --
------------ ------------ ------------ ------------
Net earnings available to
common stockholders $ 7,603 $ 4,778 $ 5,722 $ 2,912
============ ============ ============ ============
Weighted average common shares
outstanding - basic 19,346,553 12,493,796 19,290,048 12,234,764
Effect of convertible debentures 2,796,120 2,796,120 -- --
Dilutive effect of stock options 105,125 44,309 104,463 71,143
------------ ------------ ------------ ------------
Weighted average common shares
outstanding - diluted 22,247,798 15,334,225 19,394,511 12,305,907
============ ============ ============ ============
The average shares listed below were not included in the computation of diluted
earnings (loss) per share because to do so would have been anti-dilutive for the
periods presented.
14
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Stock options 782,878 885,408 773,599 878,408
Convertible debentures -- -- 2,796,120 2,796,120
========= ========= ========= =========
NOTE 12. EMPLOYEE BENEFITS
In 2000, we created an employee benefits trust to which we contributed 750,000
shares of treasury stock to the trust. 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. We have committed 225,000 shares in the prior
years. During March 2004, we committed 110,000 shares to be released leaving
415,000 shares remaining in the trust.
In October 2001, we adopted an unfunded Supplemental Executive Retirement Plan
(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 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.
The components of net period benefit cost for the three months ended June 30,
are as follows:
Pension Benefits Postretirement Benefits
-------------------------------- ------------------------------
2004 2003 2004 2003
-------------- ------------ ------------- -------------
(in thousands)
Service cost $ 113 $ 88 $ 871 $ 637
Interest cost 80 55 455 411
Amortization of prior service cost 28 28 31 31
Actuarial net loss 37 36 20 10
-------------- ------------ ------------- -------------
Net periodic benefit cost $ 258 $ 207 $ 1,377 $ 1,089
============== ============ ============= =============
The components of net period benefit cost for the six months ended June 30, are
as follows:
Pension Benefits Postretirement Benefits
-------------------------------- ------------------------------
2004 2003 2004 2003
-------------- ------------ ------------- -------------
(in thousands)
Service cost $ 226 $ 176 $1,741 $1,274
Interest cost 160 110 911 821
Amortization of prior service cost 56 56 62 62
Actuarial net loss 74 72 40 21
-------------- ------------ ------------- -------------
Net periodic benefit cost $ 516 $ 414 $2,754 $2,178
============== ============ ============= =============
15
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 13. INDUSTRY SEGMENTS
Our three reportable operating segments are Engine Management, Temperature
Control and Europe.
Three Months Ended June 30,
---------------------------------------------------------------------------
2004 2003
------------------------------------- ---------------------------------
OPERATING INCOME OPERATING INCOME
NET SALES (LOSS) NET SALES (LOSS)
----------------- ---------------- -------------- ---------------
(in thousands)
Engine Management $144,869 $13,302 $ 76,265 $ 9,601
Temperature Control 76,251 6,637 76,216 4,217
Europe 10,753 (149) 11,413 (322)
All Other 3,176 (6,228) 2,231 (2,956)
----------------- ---------------- -------------- ---------------
Consolidated $235,049 $ 13,562 $ 166,125 $ 10,540
================= ================ ============== ===============
Six Months Ended June 30,
----------------------------------------------------------------------------
2004 2003
------------------------------------- ----------------------------------
OPERATING INCOME OPERATING INCOME
NET SALES (LOSS) NET SALES (LOSS)
----------------- ---------------- -------------- -----------------
(in thousands)
Engine Management $286,533 $ 22,395 $ 155,071 $ 19,253
Temperature Control 127,445 5,470 121,978 2,024
Europe 21,023 (370) 21,953 (808)
All Other 4,829 (11,668) 2,848 (7,601)
----------------- ---------------- -------------- ----------------
Consolidated $439,830 $ 15,827 $ 301,850 $ 12,868
================= ================ ============== ================
NOTE 14. COMMITMENTS AND CONTINGENCIES
In 1986, we acquired a brake business, which we subsequently sold in March 1998
and which is accounted for as a discontinued operation in the accompanying
consolidated financial statements. 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, 2001, approximately 100 cases were outstanding for which we were
responsible for any related liabilities. At December 31, 2002, the number of
cases outstanding for which we were responsible for related liabilities
increased to approximately 2,500, which include approximately 1,600 cases filed
in December 2002 in Mississippi. We believe that these Mississippi cases filed
against us in December 2002 were due in large part to potential plaintiffs
accelerating the filing of their claims prior to the effective date of
Mississippi's tort reform statue in January 2003, which statute eliminated the
ability of plaintiffs to file consolidated cases. At December 31, 2003 and June
30, 2004, approximately 3,300 and 3,500 cases, respectively, were outstanding
for which we were responsible for any related liabilities. Since September 1,
2001, the amounts paid for settled claims are $2 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. Actuarial consultants with experience in assessing asbestos-related
liabilities completed a study in September 2002 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
16
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
claims history to estimate likely filing rates for the remainder of 2002 through
2052; (3) an analysis of our currently pending claims; and (4) an analysis of
our settlements to date in order to develop average settlement values. 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 $27.3 million to $58 million for the period through 2052. 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 2052 in our
consolidated financial statements, in accordance with generally accepted
accounting principles.
Accordingly, based on the information contained in the actuarial study and all
other available information considered by us, we recorded an after tax charge of
$16.9 million as a loss from discontinued operation during the third quarter of
2002 to reflect such liability, excluding legal costs. As is our accounting
policy, the actuarial study was updated as of August 31, 2003 using
methodologies consistent with the September 2002 study. The updated study has
estimated an undiscounted liability for settlement payments, excluding legal
costs, ranging from $27 million to $71 million for the period through 2052. We
continue to believe that no amount within the range is a better estimate after
the updated study, therefore, no adjustment was recorded as our consolidated
balance sheet at September 30, 2003 reflected a total liability of approximately
$27 million. Legal costs, which are expensed as incurred, and are reported in
loss from discontinued operation in the accompanying statement of operations and
retained earnings, are estimated to range from $21 million to $28 million during
the same period. We plan on performing a similar actuarial analysis during the
third quarter of each year for the foreseeable future. Given the uncertainties
associated with projecting such matters into the future, the short period of
time that we have been responsible for defending these claims, 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.
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.
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 June 30, 2004 and
2003, we have accrued $17.5 million and $15.5 million, respectively, for
estimated product warranty claims. The accrued product warranty costs are based
primarily on historical experience of actual warranty claims. Warranty claims
expense for the three months ended June 30, 2004 and 2003, were $13.3 million
and $13.5 million, respectively, and $25.4 million and $23.6 million for the six
months ended June 30, 2004 and 2003, respectively.
The following table provides the changes in our product warranties:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Balance, beginning of period $ 14,738 $ 11,305 $ 13,987 $ 10,360
Liabilities accrued for current year sales 13,310 13,474 25,374 23,639
Settlements of warranty claims (10,583) (9,234) (21,896) (18,454)
-------- -------- -------- --------
Balance, end of period $ 17,465 $ 15,545 $ 17,465 $ 15,545
======== ======== ======== ========
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS. 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. FORWARD-LOOKING STATEMENTS 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 A NUMBER OF FACTORS, SUCH AS
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; 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 LIABILITY
(INCLUDING, WITHOUT LIMITATION, THOSE RELATED TO ESTIMATES TO ASBESTOS-RELATED
CONTINGENT LIABILITIES) MATTERS; AS WELL AS OTHER RISKS AND UNCERTAINTIES, SUCH
AS THOSE DESCRIBED UNDER QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK AND THOSE DETAILED HEREIN AND FROM TIME TO TIME IN THE FILINGS OF THE
COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION. THOSE 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. THE FOLLOWING DISCUSSION
SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE IN THIS
FORM 10-Q.
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
(subsequently referred to as "DEM"). Prior to the acquisition, DEM was a leading
manufacturer of aftermarket parts in the automotive industry focused exclusively
on engine management. Our plan is to restructure and to integrate the DEM
business into our existing Engine Management business.
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. Our final purchase price was
approximately $130.5 million, which included $7.1 million of transaction costs.
In connection with the acquisition, we have reviewed our operations and
implemented integration plans to restructure the operations of DEM. We announced
in a press release on July 8, 2003, that we would close seven of the DEM
facilities. As part of the integration and restructuring plans, we estimate
total restructuring costs of $33.7 million. Such amounts were recognized as
liabilities assumed in the acquisition and included in the allocation of the
cost to acquire DEM.
Based on our most recent estimates of the total restructuring costs,
approximately $15.7 million relates to work force reductions and employee
termination benefits. The amount primarily provides for severance costs relating
to the involuntary termination of DEM employees, individually employed
throughout DEM facilities across a broad range of functions, including
managerial, professional, clerical, manufacturing and factory positions.
18
The restructuring also includes approximately $18.0 million associated with
exiting certain activities, primarily related to lease and contract termination
costs. Specifically, our plans are to consolidate seven DEM operations into our
existing plants. The restructuring accrual associated with other exiting
activities specifically includes incremental costs and contractual termination
obligations for items such as leasehold termination payments incurred as a
direct result of these plans. At June 30, 2004, five of the seven facilities
have ceased operating activities. We expect that all facilities will be vacated
during 2004.
The DEM acquisition in 2003 was strategic and continues to be our primary focus
in 2004. The critical goals we established for a successful integration were to
maintain the DEM customer base; reduce excess capacity by closing seven of the
acquired facilities in a 12 to 18 month timeframe; and complete the transition
for $30-35 million of cash outlays in restructuring and integration costs during
this same period. We believe that we are on target for meeting all of these
goals. Based on our current expectations, we continue to believe that the DEM
integration will enable us to generate incremental profits throughout 2004 and
an ongoing $40-45 million of operating income from the acquisition beginning in
2005.
On February 3, 2004, we acquired inventory from the Canadian distribution of DEM
for approximately $1.0 million. We have relocated such inventory into our
distribution facility in Mississauga, Canada.
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.
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 traditionally offer 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 instituted an aggressive inventory reduction campaign
initiated in 2001. We targeted a minimum $30 million inventory reduction in
2001, but exceeded our goal by reducing inventory by $57 million that year. In
2002 and 2003, we further reduced inventory by $8 million and $4 million,
respectively, before giving consideration to the DEM acquisition. Importantly,
while reducing inventory levels, we maintained customer service fill rate levels
of approximately 93%. During the first six months of 2004, inventory levels have
increased in our Engine Management segment. We believe this increase is
temporary as we manage through the DEM integration process, while attempting to
maintain customer service fill rates. By the end of 2004, we plan on reducing
inventories further as DEM begins to become effectively integrated.
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 in the event that they have overstocked
their inventories. In particular, 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, beginning in
2000 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, with respect to our air conditioning compressors, our most significant
customer product warranty returns, we established procedures whereby a warranty
will be voided if a customer does not follow a twelve step warranty return
process.
19
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. During the first six months of 2004, cash used in
operations amounted to $32 million, compared to $44.9 million in the same period
of 2003. The decrease is primarily attributable to higher net earnings and a
lower increase in accounts receivable. The lower increase in accounts receivable
is primarily the result of certain of our significant customers implementing
negotiable draft programs, whereby cash collections of accounts receivable
balances can be made early at our option, but at a discount to us. The cost of
such discounts is recorded as interest expense. Partially offsetting these
benefits were lower increases in accounts payable, higher increases of
inventory, as discussed earlier, and cash paid against the restructuring
accrual. During the first six months of 2004, inventory levels have increased in
our Engine Management segment. We believe this increase is temporary as we
manage through the DEM integration process, while attempting to maintain
customer service fill rates. By the end of 2004, we plan on reducing inventories
further as DEM begins to become effectively integrated.
INVESTING ACTIVITIES. Cash used in investing activities was $6.2million in the
first six months of 2004, compared to $102.9 million in the same period of 2003.
The decrease is primarily due to the payment for the acquisition of DEM on June
30, 2003. During 2004, activity reflects the acquisition of DEM in Canada and
the final cash payment for the DEM acquisition.
FINANCING ACTIVITIES. Cash provided by financing activities was $30.7 million in
the first six months of 2004, compared to $142.3 million in the same period of
2003. The change is primarily due to the financing related to the acquisition of
DEM on June 30, 2003.
Effective April 27, 2001, we entered into 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 was for a period of
five years and provided for a line of credit up to $225 million.
On June 30, 2003, in connection with our acquisition of DEM, we completed an
amendment to our revolving credit facility to provide for an additional $80
million commitment. This additional commitment increases the total amount
available for borrowing under our revolving credit facility to $305 million from
$225 million, which now expires in 2008. Availability under our revolving credit
facility is based on a formula of eligible accounts receivable, eligible
inventory and eligible fixed assets, which includes the purchased assets of DEM.
We expect such availability under the revolving credit facility to be sufficient
to meet our ongoing operating and integration costs.
Direct borrowings under our revolving credit facility bear interest at the prime
rate plus the applicable margin (as defined in the credit agreement) or the
LIBOR rate plus the applicable margin (as defined in the credit agreement), at
our option. Borrowings are collateralized by substantially all of our assets,
including accounts receivable, inventory and fixed assets, and those of our
domestic and Canadian subsidiaries. The terms of our revolving credit facility
provide for, among other provisions, new financial covenants requiring us, on a
consolidated basis, (1) to maintain specified levels of earnings before
interest, taxes, depreciation and amortization (EBITDA) as defined in the
amendments to the credit agreement, at the end of each fiscal quarter through
December 31, 2004, (2) commencing September 30, 2004, to maintain specified
levels of fixed charge coverage at the end of each fiscal quarter (rolling
twelve months) through 2007, and (3) to limit capital expenditure levels for
each fiscal year through 2007.
In addition, in order to facilitate the aggregate financing of the acquisition,
we completed a public equity offering of 5,750,000 shares of our common stock
for net proceeds of approximately $55.7 million and issued to Dana Corporation
1,378,760 shares of our common stock valued at approximately $15.1 million.
20
LIQUIDITY AND CAPITAL RESOURCES
(CONTINUED)
In connection with our acquisition of DEM, on June 30, 2003 we issued to Dana
Corporation an unsecured subordinated promissory note in the aggregate principal
amount of approximately $15.1 million. The promissory note bears 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 is due quarterly under the promissory
note. The maturity date of the promissory note is December 31, 2008. The
promissory note may be prepaid in whole or in part at any time without penalty.
On June 27, 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. Our working capital is further
being impacted by restructuring and integration costs, as well as inventory
build-ups necessary to ensure order fulfillment during the DEM integration.
These increased working capital requirements are funded by borrowings from our
lines of credit. In 2004, we also received the benefit from accelerating
accounts receivable collections from customer draft programs. While this program
is new in 2004, we cannot ensure such programs will remain going forward. 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 a new interest rate swap agreement with a
notional amount of $25 million that is to mature in October 2006. Under this
agreement, we receive a floating rate based on the LIBOR interest rate, and pay
a fixed rate of 2.45% on the notional amount of $25 million.
On July 26, 1999, we issued our convertible debentures, payable semi-annually,
in the aggregate principal amount of $90 million. 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.
During 1998 through 2000, the Board of Directors authorized multiple repurchase
programs under which we could repurchase shares of our common stock. During such
years, $26.7 million (in the aggregate) of common stock has been repurchased to
meet present and future requirements of our stock option programs and to fund
our Employee Stock Option Plan (ESOP). As of December 31, 2003, we have Board
authorization to repurchase additional shares at a maximum cost of $1.7 million.
During 2003, 2002 and 2001, we did not repurchase any shares of our common
stock.
The following is a summary of our contractual commitments, inclusive of our
acquisition of DEM as of December 31, 2003. There have been no significant
changes to this information at June 30, 2004.
---------------------------------------------------------------
(IN THOUSANDS) 2004 2005 2006 2007 2008 THEREAFTER TOTAL
- -------------------------------------------------------------------------------------------------------------------------------
Principal payments of
long term debt $ 3,354 $ 555 $ 581 $ 610 $ 582 $ 112,429 $118,111
Operating leases 12,824 12,156 9,322 5,752 4,512 39,481 84,047
Interest rate swap agreements 207 -- (59) -- -- -- 148
Severance payments related
to integration 1,283 -- -- -- -- -- 1,283
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total commitments $17,668 $12,711 $9,844 $ 6,362 $5,094 $ 151,910 $203,589
========== ========== ========== ========== ========== ========== ==========
The table above excludes approximately $12 million (after adjustment in 2004) of
severance expected to be paid in 2004 after the DEM facilities are closed.
21
INTERIM RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED JUNE 30, 2004 TO THE THREE MONTHS
ENDED JUNE 30, 2003
SALES. Consolidated net sales in the second quarter of 2004 were $235 million,
an increase of $68.9 million, or 41%, compared to $166.1 million in the second
quarter of 2003. The net sales increase was primarily due to the increased sales
volumes resulting from the acquisition of DEM. Net sales generated in the second
quarter of 2004 from DEM were approximately $62 million. Excluding DEM net
sales, our core Engine Management net sales were up $6.6 million or 8% in the
second quarter of 2004. In our Temperature Control business, net sales were flat
in the second quarter of 2004.
GROSS MARGINS. Gross margins were up slightly at 26.5% in the second quarter of
2004 compared to 26.4% in the second quarter of 2003.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $13.5 million to $46.2 million in the
second quarter of 2004, compared to $32.7 million in the second quarter of 2003.
This increase was primarily due to increased expenses resulting from the DEM
integration. However, as a percentage of net sales, selling, general and
administrative expenses decreased slightly to 19.6% in the second quarter of
2004 from 19.7% in the second quarter of 2003.
INTEGRATION EXPENSES. Integration expenses in the second quarter of 2004 were
$2.6 million, all related to the DEM integration, compared to $0.6 million in
the second quarter of 2003 which primarily related to expenses associated with
the consolidation of facilities within our Temperature Control segment.
OPERATING INCOME. Operating income was $13.6 million in the second quarter of
2004, compared to $10.5 million in the second quarter of 2003. We continue to
make good progress with our DEM integration and remain on target for completion
by the end of the year. Distribution and administrative facility moves are in
varying stages and are expected to be completed by the end of the third quarter
of 2004.
OTHER INCOME (EXPENSE), NET. Other income, net, increased primarily due to
reduced foreign exchange losses and higher income from joint ventures.
INTEREST EXPENSE. Interest expense increased by $1.0 million in the second
quarter 2004 compared to the same period in 2003, due to higher borrowing levels
as a result of the DEM acquisition and interest costs incurred as a result of
customer negotiable draft programs, previously discussed.
INCOME TAX PROVISION. The effective tax rate for continuing operations decreased
from 41% in the second quarter of 2003 to 25% in the second quarter of 2004,
primarily due to anticipated reduced losses in our European segment, for which
no income tax benefit is being recorded. In addition, higher earnings are
anticipated in our Hong Kong and Puerto Rico operations, which are lower tax
rate jurisdictions. The 25% current effective tax rate reflects our anticipated
tax rate for the balance of the year.
LOSS FROM DISCONTINUED OPERATION. Losses from discontinued operation, net of tax
reflect legal expenses associated with our asbestos related liability. We
recorded $0.9 million and $0.4 million as a loss from discontinued operations
for the three months ended June 30, 2004 and 2003, respectively. As discussed
more fully in note 14 of our notes to our consolidated financial statements, we
are responsible for certain future liabilities relating to alleged exposure to
asbestos containing products.
22
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2004 TO THE SIX MONTHS ENDED JUNE 30,
2003
SALES. Consolidated net sales for the six months ended June 30, 2004 were $439.8
million, an increase of $137.9 million, or 46%, compared to $301.9 million in
the same period of 2003. The net sales increase was primarily due to the
increased sales volumes resulting from the DEM acquisition. Net sales generated
for the first six months ended June 30, 2004 from DEM were approximately $122
million. Our core Engine Management net sales increased approximately $10
million, or 6% and our Temperature Control net sales increased approximately $5
million or 4%.
GROSS MARGINS. Gross margins, as a percentage of consolidated net sales,
decreased slightly by 0.3 percentage points to 25.7% for the six months ended
June 30, 2004 from 26% in the same period of 2003. The decrease was related to
DEM acquisition which was not present in the prior period.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $93.5 million or 21.3% of consolidated net
sales for the six months ended June 30, 2004, compared to $64.7 million or 21.4%
of consolidated net sales in the same period of 2003. The increase is primarily
attributable to increased expenses resulting from the DEM integration.
INTEGRATION EXPENSES. Integration expenses for the six months ended June 30,
2004 were $3.9 million, all related to the DEM integration compared to $0.8
million for the same period in 2003, which was primarily related to the
consolidation of facilities in both our Temperature Control and European
Segments.
OPERATING INCOME. Operating income increased by $2.9 million to $15.8 million
for the six months ended June 30, 2004, compared to $12.9 million in the same
period in 2003. We continue to make good progress with our DEM integration and
remain on target for completion by the end of the year. Distribution and
administrative facility moves are in varying stages and are expected to be
completed by the end of the third quarter of 2004.
OTHER INCOME (EXPENSE), NET. Other income, net, increased primarily due to
reduced foreign exchange losses and higher income from joint ventures.
INTEREST EXPENSE. Interest expense increased by $1.2 million for the six months
ended June 30, 2004 compared to the same period in 2003, due to higher borrowing
levels as a result of the DEM acquisition and interest costs incurred as a
result of customer negotiable draft programs, previously discussed.
INCOME TAX PROVISION. The effective tax rate for continuing operations was 25%
for the first six months of 2004 and 41% for the first six months of 2003. The
decrease was primarily due to anticipated reduced losses in our European segment
for which no income tax benefit is being recorded. The 25% current effective tax
rate reflects our anticipated effective tax rate for the balance of the year.
However, significant changes in the mix of earnings in our domestic or foreign
operations and changes in operating results in our European segment could have a
significant impact on our effective tax rate.
LOSS FROM DISCONTINUED OPERATION. Loss from discontinued operation, net of tax
reflect legal expenses associated with our asbestos related liability. We
recorded $1.3 million and $0.8 million as a loss from discontinued operations
for the six months ended June 30, 2004 and 2003, respectively. As discussed in
note 14 of the notes to our consolidated financial statements, we are
responsible for certain future liabilities relating to alleged exposure to
asbestos containing products.
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 the consolidated financial
statements of our Annual Report on Form 10-K for the year ended December 31,
23
2003. Note that our preparation of this Quarterly Report on Form 10-Q 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 period. There can be 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 our Engine Management, Temperature Control and
European segments. We recognize revenue from product sales upon shipment to
customers. As described below, significant management judgments and estimates
must be made and used in connection with the 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.
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.
SALES RETURNS AND OTHER ALLOWANCES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS. The
preparation of financial statements requires our management to make estimates
and assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period.
Specifically, our 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
June 30, 2004, the allowance for sales returns was $26.5 million. Similarly, our
management must make estimates of the uncollectability of our accounts
receivables. Management specifically analyzes accounts receivable and analyzes
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 June 30,
2004, the allowance for doubtful accounts and for discounts was $6.6 million.
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 exposure 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 recovery is not likely, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense
within the tax provision in the statement of operations.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. At June 30, 2004, we had
a valuation allowance of approximately $23.2 million, due to uncertainties
related to our ability to utilize some of our deferred tax assets. The valuation
24
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, we may need to establish an additional valuation
allowance which could materially impact our business, financial condition and
results of operations.
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: significant underperformance relative to expected
historical or projected future operating results; significant changes in the
manner of our use of the acquired assets or the strategy for our overall
business; and significant negative industry or economic trends. With respect to
goodwill, if necessary, we will 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.
RETIREMENT AND POSTRETIREMENT MEDICAL BENEFITS. Each year we calculate the costs
of providing retiree benefits under the provisions of SFAS 87 and SFAS 106. The
key assumptions used in making these calculations are disclosed in notes 11 and
12 of the notes to the consolidated financial statements of our Annual Report on
Form 10-K for the year ended December 31, 2003. The most significant of these
assumptions are 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.
ASBESTOS RESERVE. We are responsible for certain future liabilities relating to
alleged exposure to asbestos-containing products. A September 2002 actuarial
study estimated a liability for settlement payments ranging from $27.3 million
to $58 million. 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
2052 in our consolidated financial statements, in accordance with generally
accepted accounting principles.
As is our accounting policy, the actuarial study was updated as of August 31,
2003 using methodologies consistent with the September 2002 study. The updated
study has estimated an undiscounted liability for settlement payments, excluding
legal costs, ranging from $27 million to $71 million for the period through
2052. We continue to believe that no amount within the range is a better
estimate after the updated study, therefore, no adjustment was recorded as our
consolidated balance sheet at September 30, 2003 reflected a total liability of
approximately $27 million. Legal costs, which are expensed as incurred, are
estimated to range from $21 million to $28 million during the same period. We
plan on performing a similar 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 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 operations. Legal expenses associated with
asbestos-related matters are expensed as incurred and recorded as a loss from
discontinued operations in the statement of operations.
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.
25
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities ("FIN 46R"), which addresses
how a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
Effective January 1, 2004, we adopted FIN 46R, which did not have a material
effect on our consolidated financial statements.
MEDICARE PRESCRIPTION DRUG, IMPROVEMENT AND MODERNIZATION ACT OF 2003
In December 2003, the Medicate Prescription Drug, Improvement and Modernization
Act of 2003 (the "Act") was signed into law. The Act expanded Medicare to
include, for the first time, coverage for prescription drugs. At present,
detailed regulations necessary to implement the Act have not been issued,
including those that would specify the manner in which actuarial equivalency
must be determined, the evidence required to demonstrate actuarial equivalency,
and the documentation requirements necessary to be entitled to the subsidy. Our
net periodic postretirement benefit cost does not reflect any amount associated
with the subsidy because we are unable to conclude whether the benefits provided
by our retiree medical plans are actuarially equivalent to Medicare Part D under
the Act until further governmental regulations are issued.
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits, was issued. Statement 132 (revised)
revises employers' disclosures about pension plans and other postretirement
benefit plans; it does not change the measurement or recognition of those plans.
Statement 132 (revised) retains and revises the disclosure requirements
contained in the original Statement 132. It also requires additional disclosures
about the assets, obligations, cash flows, and net periodic benefit cost of
defined benefit pension plans and other postretirement benefit plans. Statement
132 (revised) generally is effective for fiscal years ending after December 15,
2003. Our disclosures in Note 12 of notes to our consolidated financial
statements incorporate the requirements of Statement 132 (revised).
26
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. We
have exchange rate exposure primarily with respect to the Canadian Dollar and
the British Pound. Our exposure to foreign exchange rate risk is due to certain
costs, revenues and borrowings being denominated in currencies other than a
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 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, as discussed in note 8 of notes to our consolidated financial
statements. We invest our excess cash in highly liquid short-term investments.
Our percentage of variable rate debt to total debt is 46% at December 31, 2003
and 52% at June 30, 2004.
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, 2003.
ITEM 4. CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial
officer, we conducted an evaluation of our disclosure controls and
procedures, as such term is defined under Rule 13a-14(c) promulgated
under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), as of the end of the period covered by this report. Based on
their evaluation, our principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective.
(b) There have been no significant changes (including corrective actions
with regard to significant deficiencies or material weaknesses) in our
internal controls or in other factors that could significantly affect
these controls subsequent to the date of the evaluation referenced in
paragraph (a) above.
27
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 in the accompanying
consolidated financial statements. 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, 2001, approximately 100 cases were outstanding for which we were
responsible for any related liabilities. At December 31, 2002, the number of
cases outstanding for which we were responsible for related liabilities
increased to approximately 2,500, which include approximately 1,600 cases filed
in December 2002 in Mississippi. We believe that these Mississippi cases filed
against us in December 2002 were due in large part to potential plaintiffs
accelerating the filing of their claims prior to the effective date of
Mississippi's tort reform statute in January 2003, which statute eliminated the
ability of plaintiffs to file consolidated cases. At December 31, 2003 and June
30, 2004, approximately 3,300 and 3,500 cases, respectively, were outstanding
for which we were responsible for any related liabilities. Since September 1,
2001, the amounts paid for settled claims are $2 million. We do not have
insurance coverage for the defense and indemnity costs associated with these
claims.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) Our 2004 Annual Meeting of Stockholders was held on May 20, 2004
(b) The following persons were elected as our directors:
Lawrence I. Sills
Arthur D. Davis
William H. Turner
John L. Kelsey
Frederick D. Sturdivant
Marilyn F. Cragin
Arthur S. Sills
Robert M. Gerrity
Kenneth A. Lehman
28
(c) The following matters were voted upon at the Annual Meeting:
(1) Election of Directors:
VOTES FOR VOTES WITHHELD
Lawrence I. Sills 13,843,691 4,554,669
Arthur D. Davis 14,149,365 4,248,995
William H. Turner 14,936,482 3,461,878
John L. Kelsey 14,936,427 3,461,933
Frederick D. Sturdivant 14,936,457 3,461,903
Marilyn F. Cragin 13,929,519 4,468,841
Arthur S. Sills 14,003,929 4,394,431
Robert M. Gerrity 14,844,418 3,553,942
Kenneth A. Lehman 14,936,482 3,461,878
(2) Adoption of our 2004 Omnibus Stock Option Plan:
VOTES FOR VOTES AGAINST VOTES WITHHELD
14,564,117 1,416,550 2,417,693
(3) Management's Proposal to adopt our 2004 Independent Outside Director's Stock Option Plan:
VOTES FOR VOTES AGAINST VOTES WITHHELD
14,525,945 1,421,184 2,451,231
(4) Stockholder Proposal Requesting the Board of Directors to Redeem the
Preferred Share Purchase Rights:
VOTES FOR VOTES AGAINST VOTES WITHHELD
8,014,403 7,839,587 2,544,370
The Board, consistent with its fiduciary duties, regularly reviews matters
related to the Company's corporate governance, including the Preferred Share
Purchase Rights issued pursuant to the Rights Agreement dated as of February 15,
1996 (the "Rights"). In this regard, since the 2004 Annual Meeting, the Board
reviewed the voting results regarding the stockholder proposal to redeem the
Rights. Notwithstanding the vote of the stockholders requesting the redemption
of the Rights, the Board is not required to redeem such Rights. Moreover, the
Board continues to believe that the Rights are important for the protection of
the Company's stockholders, and, therefore, the Board has decided that it should
not redeem the Rights.
29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT(S)
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.
(b) REPORTS ON FORM 8-K
On April 29, 2004, we filed a current report on Form 8-K reporting
under Item 12 - Results of Operations and Financial Condition that
Standard Motor Products, Inc. issued a press release announcing its
financial results for the quarter ended March 31, 2004 and a quarterly
dividend. A copy of the press release was filed as an exhibit to such
Form 8-K.
30
SIGNATURE
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): August 9, 2004 /S/ JAMES J. BURKE
-----------------------------------
James J. Burke
Vice President Finance,
Chief Financial Officer
(Principal Financial and Accounting
Officer)
31