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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 MARCH 31, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NUMBER: 1-4743
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STANDARD MOTOR PRODUCTS, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
NEW YORK 11-1362020
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
37-18 NORTHERN BLVD., LONG ISLAND CITY, N.Y. 11101
- -------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(718) 392-0200
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filler. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |X| No |_|
As of the close of business on April 28, 2006, there were 18,470,891 outstanding
shares of the registrant's Common Stock, par value $2.00 per share.
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STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION
Page No.
--------
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets
as of March 31, 2006 (Unaudited) and December 31, 2005.......... 3
Consolidated Statements of Operations and Retained Earnings
(Unaudited) for the Three Months Ended March 31, 2006 and 2005.. 4
Consolidated Statements of Cash Flows (Unaudited)
for the Three Months Ended March 31, 2006 and 2005.............. 5
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited) for the Three Months Ended March 31, 2006........... 6
Notes to Consolidated Financial Statements (Unaudited).......... 7
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 1A. Risk Factors ................................................... 28
Item 6. Exhibits........................................................ 29
Signature................................................................ 30
2
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
March 31, December 31,
2006 2005
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................................. $ 8,093 $ 14,046
Accounts receivable, less allowance for discounts and doubtful
accounts of $10,609 and $9,574 for 2006 and 2005, respectively .......... 232,431 176,294
Inventories ................................................................ 249,626 243,297
Deferred income taxes ...................................................... 14,129 14,081
Prepaid expenses and other current assets .................................. 9,011 7,972
------------ ------------
Total current assets .................................................... 513,290 455,690
Property, plant and equipment, net ............................................... 84,340 85,805
Goodwill and other intangibles, net .............................................. 56,729 67,402
Other assets ..................................................................... 41,233 44,147
------------ ------------
Total assets ............................................................ $ 695,592 $ 653,044
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable .............................................................. $ 192,556 $ 149,236
Current portion of long-term debt .......................................... 542 542
Accounts payable............................................................ 64,572 52,535
Sundry payables and accrued expenses........................................ 21,776 24,466
Accrued customer returns ................................................... 22,443 22,346
Restructuring accrual ...................................................... 1,153 1,286
Accrued rebates ............................................................ 22,531 24,017
Payroll and commissions .................................................... 12,409 11,494
------------ ------------
Total current liabilities ............................................... 337,982 285,922
------------ ------------
Long-term debt ................................................................... 98,406 98,549
Post-retirement medical benefits and other accrued liabilities ................... 46,788 45,962
Restructuring accrual ............................................................ 418 11,348
Accrued asbestos liabilities ..................................................... 24,521 25,556
------------ ------------
Total liabilities ....................................................... 508,115 467,337
------------ ------------
Commitments and contingencies
Stockholders' equity:
Common stock - par value $2.00 per share:
Authorized - 30,000,000 shares; issued 20,486,036 shares ................ 40,972 40,972
Capital in excess of par value ............................................. 57,107 56,966
Retained earnings .......................................................... 109,848 109,649
Accumulated other comprehensive income ..................................... 4,256 4,158
Treasury stock - at cost (2,197,145 and 2,315,645 shares in
2006 and 2005, respectively) ............................................ (24,706) (26,038)
------------ ------------
Total stockholders' equity ........................................ 187,477 185,707
------------ ------------
Total liabilities and stockholders' equity ........................ $ 695,592 $ 653,044
============ ============
See accompanying notes to consolidated financial statements.
3
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(In thousands, except share and per share data)
Three Months Ended
March 31,
----------------------------
(Unaudited)
2006 2005
---- ----
Net sales ..................................................... $ 210,076 $ 207,326
Cost of sales ................................................. 156,845 158,891
------------ ------------
Gross profit ............................................ 53,231 48,435
Selling, general and administrative expenses .................. 43,788 42,076
Restructuring expenses ........................................ 87 524
------------ ------------
Operating income ........................................ 9,356 5,835
Other income (expense), net ................................... 350 (215)
Interest expense .............................................. 4,453 3,775
------------ ------------
Earnings from continuing operations before taxes ........ 5,253 1,845
Provision for income tax ..................................... 2,655 792
Earnings from continuing operations ..................... 2,598 1,053
Loss from discontinued operation .............................. (764) (407)
Net earnings ............................................ 1,834 646
Retained earnings at beginning of period ...................... 109,649 120,218
------------ ------------
111,483 120,864
Less: cash dividends for period ............................... 1,635 1,747
------------ ------------
Retained earnings at end of period ............................ $ 109,848 $ 119,117
============ ============
PER SHARE DATA:
Net earnings per common share - Basic:
Earnings from continuing operations ....................... $ 0.14 $ 0.05
Discontinued operation .................................... (0.04) (0.02)
------------ ------------
Net earnings per common share - Basic ......................... $ 0.10 $ 0.03
============ ============
Net earnings per common share - Diluted:
Earnings from continuing operations ....................... $ 0.14 $ 0.05
Discontinued operation .................................... (0.04) (0.02)
------------ ------------
Net earnings per common share - Diluted ....................... $ 0.10 $ 0.03
============ ============
Average number of common shares ............................... 18,192,774 19,440,356
============ ============
Average number of common shares and dilutive common shares .... 18,195,888 19,478,064
============ ============
See accompanying notes to consolidated financial statements.
4
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Three Months Ended
March 31,
--------------------------
2006 2005
---------- ----------
(Unaudited)
CASH FLOW FROM OPERATING ACTIVITIES
Net earnings ....................................................................... $ 1,834 $ 646
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization .................................................... 3,921 4,384
Increase to allowance for doubtful accounts ...................................... 461 330
Increase to inventory reserves ................................................... 1,161 87
Loss on disposal of property, plant and equipment ................................ 7 --
Equity income from joint ventures ................................................ (77) (8)
Employee stock ownership plan allocation ......................................... 297 335
Stock-based compensation ......................................................... 283 --
Decrease (increase) in deferred income taxes ..................................... 1,944 (50)
Loss from discontinued operation ................................................. 764 407
Change in assets and liabilities:
Increase in accounts receivable .................................................. (56,598) (47,821)
Increase in inventories .......................................................... (7,490) (6,017)
Increase in prepaid expenses and other current assets ............................ (146) (1,346)
Decrease in other assets ......................................................... 999 284
Increase in accounts payable ..................................................... 10,310 19,991
Decrease in sundry payables and accrued expenses ................................. (4,176) (11,455)
Decrease in restructuring accrual ................................................ (842) (2,325)
Increase (decrease) in other liabilities ......................................... (26) 70
---------- ----------
Net cash used in operating activities ........................................ (47,374) (42,488)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from the sale of property, plant and equipment .......................... 8 --
Capital expenditures ............................................................. (1,935) (1,873)
---------- ----------
Net cash used in investing activities ........................................ (1,927) (1,873)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under line-of-credit agreements ................................... 43,319 37,023
Principal payments and retirement of long term debt .............................. (142) (135)
Increase in overdraft balances ................................................... 1,727 3,331
Dividends paid ................................................................... (1,635) (1,747)
---------- ----------
Net cash provided by financing activities .................................... 43,269 38,472
---------- ----------
Effect of exchange rate changes on cash ............................................ 79 (250)
---------- ----------
Net decrease in cash and cash equivalents .......................................... (5,953) (6,139)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD ............................... 14,046 14,934
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD ..................................... $ 8,093 $ 8,795
========== ==========
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest ..................................................................... $ 5,722 $ 5,472
========== ==========
Income taxes ................................................................. $ 1,398 $ 1,563
========== ==========
Non-cash financing activity:
Reduction of restructuring accrual applied against goodwill .................. $ 10,221 --
========== ==========
See accompanying notes to consolidated financial statements.
5
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, 2006
(Unaudited)
Accumulated
Capital in Other
Common Excess of Retained Comprehensive Treasury
(In thousands) Stock Par Value Earnings Income (Loss) Stock Total
---------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 2005 ................... $ 40,972 $ 56,966 $ 109,649 $ 4,158 $ (26,038) $ 185,707
Comprehensive income:
Net income ................................. 1,834 1,834
Foreign currency translation adjustment .... 163 163
Unrealized loss on interest rate swap
agreements, net of tax ...... (72) (72)
Minimum pension liability adjustment ....... 7 7
----------
Total comprehensive income ................. 1,932
Cash dividends paid ............................ (1,635) (1,635)
Employee stock compensation .................... 283 283
Employee Stock Ownership Plan .................. (142) 1,332 1,190
---------- ---------- ---------- ---------- ---------- ----------
Balance at March 31, 2006 ...................... $ 40,972 $ 57,107 $ 109,848 $ 4,256 $ (24,706) $ 187,477
========== ========== ========== ========== ========== ==========
6
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
Standard Motor Products, Inc. (referred to hereinafter in these notes to
consolidated financial statements as the "Company," "we," "us," or "our") is
engaged in the manufacture and distribution of replacement parts for motor
vehicles in the automotive aftermarket industry.
The accompanying unaudited financial information should be read in conjunction
with the audited consolidated financial statements and the notes thereto
included in our Annual Report on Form 10-K for the year ended December 31, 2005.
The unaudited consolidated financial statements include our accounts and all
domestic and international companies in which we have more than a 50% equity
ownership. Our investments in unconsolidated affiliates are accounted for on the
equity method. All significant inter-company items have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations for the interim periods are not
necessarily indicative of the results of operations for the entire year.
Where appropriate, certain amounts in 2005 have been reclassified to conform
with the 2006 presentation.
NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SHARE-BASED PAYMENT
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R requires that stock-based
employee compensation be recorded as a charge to earnings. SFAS 123R is
effective for interim and annual financial statements for years beginning after
December 15, 2005 and will apply to all outstanding and unvested share-based
payments at the time of adoption. Accordingly, we have adopted SFAS 123R
commencing January 1, 2006 using a modified prospective application, as
permitted by SFAS No. 123R. Accordingly, prior period amounts have not been
restated. Under this application, we are required to record compensation expense
for all awards granted after the date of adoption and for the unvested portion
of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS No. 123R, we applied Accounting Principles Board
Opinions ("APB") No. 25 and related interpretations to account for our stock
plans resulting in the use of the intrinsic value to value the stock. Under APB
25, we were not required to recognize compensation expense for the cost of stock
options. In accordance with the adoption of SFAS 123R, we recorded stock-based
compensation expense for the cost of incentive stock options granted under our
stock plans. Stock-based compensation expense for the first quarter of 2006 was
$283,000 ($173,000 after tax) or $0.01 per basic and diluted share. The adoption
of SFAS123R did not have a material impact on our financial position, results of
operation or cash flows.
7
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
ACCOUNTING FOR UNCERTAIN TAX POSITIONS
In July 2005, the FASB issued an Exposure Draft of the proposed Interpretation,
"Accounting for Uncertain Tax Positions, an interpretation of FASB Statement No.
109". The proposed Interpretation would clarify criterion to be used in the
recognition of uncertain tax positions in an enterprise's financial statements.
The Company is evaluating the proposed Interpretation but does not believe it
would materially change the way our company evaluates tax positions for
recognition. The FASB expects to issue the final Interpretation in the first
half of 2006.
NOTE 3. RESTRUCTURING AND INTEGRATION COSTS
RESTRUCTURING COSTS
In connection with our acquisition of substantially all of the assets and the
assumption of substantially all of the operating liabilities of Dana
Corporation's Engine Management Group ("DEM") on June 30, 2003, we have reviewed
our operations and implemented integration plans to restructure the operations
of DEM. At the time, we announced that we would close seven DEM facilities,
which has subsequently occurred. As part of the integration and restructuring
plans, we accrued an initial restructuring liability of approximately $34.7
million at June 30, 2003. Such amounts were recognized as liabilities assumed in
the acquisition and included in the allocation of the cost to acquire DEM.
Accordingly, such amounts resulted in additional goodwill being recorded in
connection with the acquisition. Subsequent to the acquisition, our estimate of
the restructuring liability was updated and revised downward, with corresponding
reductions to goodwill, by $1 million, $1.2 million and $10.2 million as at
December 31, 2003, December 31, 2005 and March 31, 2006, respectively. As of
March 31, 2006, the restructuring accrual was at $1.6 million. We expect to pay
most of this remaining amount in 2006 and 2007.
Of the initial restructuring accrual, approximately $15.7 million related to
work force reductions and represented employee termination benefits. The accrual
amount primarily provides for severance costs relating to the involuntary
termination of employees, individually employed throughout DEM's facilities
across a broad range of functions, including managerial, professional, clerical,
manufacturing and factory positions. During the year ended December 31, 2005 and
the three months ended March 31, 2006, termination benefits of $2.3 million and
$0.1 million, respectively, have been charged to the restructuring accrual. As
of March 31, 2006, the reserve balance for workforce reductions was at $0.7
million.
The initial restructuring accrual also included approximately $18 million
consisting of the net present value of costs associated with exiting certain
activities, primarily related to lease and contract termination costs, which
will not have future benefits. Specifically, our plans were to consolidate
certain of DEM operations into our existing plants. At December 31, 2005, we had
a sublease commitment for one facility with Dana through 2021. However, on March
3, 2006, Dana filed a voluntary petition for relief under Chapter 11 of the US
Bankruptcy Code. Pursuant to a court ruling in connection with Dana's Chapter 11
bankruptcy proceedings, effective March 31, 2006, we were released from, and no
longer have any obligations with respect to, such lease commitment for the
facility. We have accounted for the termination of such lease commitment as a
reduction of $10.2 million in our restructuring accrual, with a corresponding
reduction to goodwill established on the acquisition of DEM. In addition to the
above reduction, exit costs of $0.7 million were paid as of March 31, 2006,
leaving the exit reserve balance for exit costs at $0.9 million as of March 31,
2006.
8
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Selected information relating to the restructuring costs included in the
allocation of the cost to acquire DEM is as follows (in thousands):
Workforce Other Exit
Reduction Costs Total
--------- ----- -----
Restructuring liability at December 31, 2005 ....... $ 809 $ 11,825 $ 12,634
Cash payments during first three months of 2006 .... (115) (727) (842)
Adjustments during first three months of 2006 ...... -- (10,221) (10,221)
-------- -------- --------
Restructuring liability as of March 31, 2006 ....... $ 694 $ 877 $ 1,571
======== ======== ========
INTEGRATION EXPENSES
During the first quarter of 2006 and 2005, we incurred integration expenses of
approximately $86,700 and $524,000, respectively. The 2006 amount relates to the
cost of moving our European production operations, while the 2005 costs related
primarily to the DEM integration which included costs primarily related to
equipment and inventory move costs, employee stay bonuses and other facility
consolidation costs.
NOTE 4. INVENTORIES
March 31, December 31,
2006 2005
---------------------------
(in thousands)
Finished goods, net ........... $ 185,525 $ 182,567
Work in process, net .......... 4,900 4,235
Raw materials, net ............ 59,201 56,495
------------ ------------
Total inventories, net .... $ 249,626 $ 243,297
============ ============
NOTE 5. CREDIT FACILITIES AND LONG-TERM DEBT
Total debt consists of (in thousands):
March 31, December 31,
2006 2005
---------------------------
CURRENT
Revolving credit facilities (1) .............. $ 192,556 $ 149,236
Current portion of mortgage loan ............. 542 542
------------ ------------
193,098 149,778
------------ ------------
LONG-TERM DEBT
6.75% convertible subordinated debentures .... 90,000 90,000
Mortgage loan ................................ 8,789 8,912
Other ........................................ 159 179
Less current portion of long-term debt ....... 542 542
------------ ------------
98,406 98,549
------------ ------------
Total debt ................................ $ 291,504 $ 248,327
============ ============
(1) Consists of the revolving credit facility, the Canadian term loan and the
European revolving credit facility.
Maturities of long-term debt during the five years ending December 31, 2006
through 2010 are $0.5 million, $0.5 million, $0.5 million, $90.5 million and
$0.6 million, respectively.
9
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
The Company had deferred financing cost of $4.5 million and $4.1 million as of
December 31, 2005 and March 31, 2006, respectively. These costs related to the
Company's revolving credit facility, the convertible subordinated debentures and
a mortgage loan agreement, and these costs are being amortized over three to
thirteen years.
REVOLVING CREDIT FACILITY
We are parties to an agreement with General Electric Capital Corporation, as
agent, and a syndicate of lenders for a secured revolving credit facility. The
term of the credit agreement is through 2008 and provides for a line of credit
up to $305 million. Availability under our revolving credit facility is based on
a formula of eligible accounts receivable, eligible inventory and eligible fixed
assets. After taking into effect outstanding borrowings under the revolving
credit facility, there was an additional $54.2 million available for us to
borrow pursuant to the formula at March 31, 2006. Our credit agreement also
permits dividends and distributions by us provided specific conditions are met.
At December 31, 2005 and March 31, 2006, the interest rate on the Company's
revolving credit facility was 6.7% and 6.7%, respectively. Direct borrowings
under our revolving credit facility bear interest at the prime rate plus the
applicable margin (as defined) or the LIBOR rate plus the applicable margin (as
defined), at our option. Outstanding borrowings under the revolving credit
facility (inclusive of the Canadian term loan described below), classified as
current liabilities, were $142.3 million and $185.4 million at December 31, 2005
and March 31, 2006, respectively. The Company maintains cash management systems
in compliance with its credit agreements. Such systems require the establishment
of lock boxes linked to blocked accounts whereby cash receipts are channeled to
various banks to insure pay-down of debt. Agreements also classify such accounts
and the cash therein as additional security for loans and other obligations to
the credit providers. Borrowings are collateralized by substantially all of our
assets, including accounts receivable, inventory and fixed assets, and those of
certain of our subsidiaries. The terms of our revolving credit facility provide
for, among other provisions, financial covenants requiring us, on a consolidated
basis, (1) to maintain specified levels of fixed charge coverage at the end of
each fiscal quarter (rolling twelve months) through 2008, and (2) to limit
capital expenditure levels for each fiscal year through 2008. The terms of our
revolving credit facility also provide, among other things, for the prohibition
of accepting drafts under our customer draft programs after November 18, 2005.
CANADIAN TERM LOAN
In December 2005, our Canadian subsidiary entered into a credit agreement with
GE Canada Finance Holding Company, for itself and as agent for the lenders, and
GECC Capital Markets, Inc., as lead arranger and book runner. The credit
agreement provides for, among other things, a $7 million term loan, which term
loan is guaranteed and secured by us and certain of our wholly-owned
subsidiaries and which term loan is coterminous with the term of our revolving
credit facility. The $7 million term loan is part of the $305 million available
for borrowing under our revolving credit facility.
REVOLVING CREDIT FACILITY--EUROPE
Our European subsidiary has a revolving credit facility, which provides for a
line of credit of up to $7.7 million. The amount of short-term bank borrowings
outstanding under this facility was $7 million and $7.2 million at December 31,
2005 and March 31, 2006, respectively. The weighted average interest rates on
these borrowings at December 31, 2005 and March 31, 2006 were 6.5% and 5.9%,
respectively. At March 31, 2006, there was an additional $587,000 available for
our European subsidiary to borrow.
10
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
SUBORDINATED DEBENTURES
In July 1999, we completed a public offering of convertible subordinated
debentures amounting to $90 million. The convertible debentures carry an
interest rate of 6.75%, payable semi-annually, and will mature in July 2009. The
convertible debentures are convertible into 2,796,120 shares of our common stock
at the option of the holder. We may, at our option, redeem some or all of the
convertible debentures at any time on or after July 15, 2004, for a redemption
price equal to the issuance price plus accrued interest. In addition, if a
change in control, as defined in the agreement, occurs at the Company, we will
be required to make an offer to purchase the convertible debentures at a
purchase price equal to 101% of their aggregate principal amount, plus accrued
interest. The convertible debentures are subordinated in right of payment to all
of the Company's existing and future senior indebtedness.
MORTGAGE LOAN AGREEMENT
In June 2003, we borrowed $10 million under a mortgage loan agreement. The loan
is payable in monthly installments. The loan bears interest at a fixed rate of
5.50% maturing in July 2018. The mortgage loan is secured by a building and
related property.
NOTE 6. COMPREHENSIVE INCOME
Comprehensive income, net of income tax expense is as follows (in thousands):
Three Months Ended
March 31,
--------------------
2006 2005
---- ----
Net income as reported ................................... $ 1,834 $ 646
Foreign currency translation adjustment. ................. 163 (393)
Minimum pension liability adjustment ..................... 7 71
Unrealized (loss) gain on interest rate
swap agreements, net of tax ............................ (72) 150
-------- --------
Total comprehensive income ............................... $ 1,932 $ 474
======== ========
NOTE 7. STOCK-BASED COMPENSATION PLANS
We have principally four fixed stock-based compensation plans. Under the 1994
Omnibus Stock Option Plan, as amended, which terminated as of May 25, 2004, we
were authorized to issue options to purchase 1,500,000 shares. The options
become exercisable over a three to five year period and expire at the end of
five years following the date they become exercisable. Under the 2004 Omnibus
Stock Plan, which terminates as of May 20, 2014, we are authorized to issue
options to purchase 500,000 shares. The options become exercisable over a three
to five year period and expire at the end of ten years following the date of
grant. Under the 1996 Independent Directors' Stock Option Plan and the 2004
Independent Directors' Stock Option Plan, we are authorized to issue options to
purchase 50,000 shares under each plan. The options become exercisable one year
after the date of grant and expire at the end of ten years following the date of
grant. Options forfeited under the stock option plans are eligible to be granted
again with respect to the options so forfeited. At March 31, 2006, under our
stock option plans, there were an aggregate of (a) 1,231,024 shares of common
stock authorized for grants, (b) 1,189,599 shares of common stock granted, and
(c) 41,425 shares of common stock available for future grants.
Effective January 1, 2006, we adopted SFAS No. 123R, "Share-Based Payment,"
which prescribes the accounting for equity instruments exchanged for employee
and director services. Under SFAS No. 123R, stock-based compensation cost is
measured at the grant date, based on the calculated fair value of the grant, and
is recognized as an expense over the service period applicable to the grantee.
The service period is the period of time that the grantee must provide services
to us before the stock-based compensation is fully vested. In March 2005, the
SEC issued Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment,"
relating to SFAS No. 123R. We have followed the SEC's guidance in SAB No. 107 in
our adoption of SFAS No. 123R.
11
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Prior to January 1, 2006, we accounted for stock-based compensation to employees
and directors in accordance with the intrinsic value method under APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Under the intrinsic value method, no compensation expense was recognized in our
financial statements for the stock-based compensation, because the stock-based
compensation that we granted was incentive stock options and all of the stock
options granted had exercise prices equivalent to the fair market value of our
common stock on the grant date. We also followed the disclosure requirements of
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended, "Accounting
for Stock-Based Compensation--Transition and Disclosure".
We adopted SFAS No. 123R using the modified prospective transition method. Under
this transition method, the financial statement amounts for the periods before
2006 have not been restated to reflect the fair value method of expensing the
stock-based compensation. The compensation expense recognized on or after
January 1, 2006 includes the compensation cost based on the grant-date fair
value estimated in accordance with: (a) SFAS No. 123 for all stock-based
compensation that was granted prior to, but vested on or after, January 1, 2006;
and (b) SFAS No. 123R for all stock-based compensation that was granted on or
after January 1, 2006.
There were no stock options granted in the three months ended March 31, 2006 and
2005. Accordingly, we have recognized compensation expense for prior years'
grants which vest after January 1, 2006 based on the grant-date fair value,
estimated in accordance with SFAS No. 123 which was used in our prior pro forma
disclosure. Further, the current quarter's expense reflects our estimate of
expected forfeitures which we determine to be immaterial, based on history and
remaining time until vesting of the remaining options. Stock-based compensation
expense for the first quarter of 2006 was $283,000 ($173,000 net of tax), or
$.01 per basic and diluted share.
The stock options granted prior to 2006 have been vesting gradually at annual
intervals. In our prior period SFAS No. 123 pro forma disclosures, our policy
was to calculate the compensation expense related to the stock-based
compensation granted to employees and directors on a straight-line basis over
the full vesting period of the grants.
Prior to this year, we provided pro forma net income and net income per common
share disclosures for stock option grants based on the fair value of the options
at the grant date. For purposes of presenting pro forma information, the fair
value of options granted is computed using the Black Scholes option pricing
model with the following assumptions applicable to each remaining unvested
annual grant:
Year of Grant: 2005 2004 2003
- ------------- ---- ---- ----
Expected option life............. 3.85 3.85 3.86
Expected stock volatility........ 39.05% 38.57% 39.16%
Expected dividend yield.......... 3.3% 2.7% 2.6%
Risk-free rate................... 4.00% 3.64% 2.76%
The expected term of the options is based on evaluations of historical and
expected future employee exercise behavior. The risk-free interest rate is based
on the US Treasury rates at the date of grant with maturity dates approximately
equal to the expected life at the grant date. Volatility is based on historical
volatility of the Company's stock.
12
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
Had we determined compensation cost based on the fair value at the grant date
for our pre-2006 stock option grants, our pro forma net income and net income
per common share would have been as follows:
Three Months Ended
March 31, 2005
--------------
Net earnings as reported ......................... $ 646
Less: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects .... (129)
--------
Pro forma net earnings ........................... $ 517
Earnings per share:
Basic - as reported ........................... $ 0.03
Basic - pro forma ............................. $ 0.03
Diluted - as reported ......................... $ 0.03
Diluted - pro forma ........................... $ 0.03
The following is a summary of the changes in outstanding options for the three
months ended March 31, 2006.
Three Months Ended
March 31, 2006
-------------------------
Weighted
average Weighted average Aggregate
exercise contract intrinsic
Shares price life (year) value
-------------------------------------------------------------
Outstanding at beginning
of year.................. 1,249,226 $ 14.42 5.2 $ 0
Expired.................... 55,827 $ 22.50 0 $ 0
Forfeited.................. 3,800 $ 12.99 7.5 $ 0
- --------------------------------------------------------------------------------------------
Outstanding at end of
quarter.................. 1,189,599 $ 14.04 5.2 $ 0
- --------------------------------------------------------------------------------------------
Options exercisable at end
of quarter............... 800,599 $ 14.95 3.4 $ 0
- --------------------------------------------------------------------------------------------
The following is a summary of the changes in non-vested options for the three
months ended March 31, 2006:
Weighted Average Grant
Shares Date Fair Value
------ ---------------
Non-vested shares at January 1, 2006 ...... 494,426 $ 3.04
Forfeitures ............................... 2,250 $ 3.44
Vested .................................... 103,176 $ 3.44
Non-vested shares at March 31, 2006 ....... 389,000 $ 2.93
As of March 31, 2006, we have $360,400 of total unrecognized compensation cost
related to non-vested awards granted under our various share-based plans, which
we expect to recognize over a weighted-average period of 1.0 year. No stock
options were exercised in the three months ended March 31, 2006.
13
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
NOTE 8. EARNINGS PER SHARE
The following are reconciliations of the earnings available to common
stockholders and the shares used in calculating basic and dilutive net earnings
per common share (in thousands, except share amounts):
Three Months Ended
March 31,
----------------------------
2006 2005
---- ----
Earnings from continuing operations .... $ 2,598 $ 1,053
Loss from discontinued operations ...... (764) (407)
------------ ------------
Net earnings available to
common stockholders ................. $ 1,834 $ 646
============ ============
Weighted average common shares
outstanding - basic ................. 18,192,774 19,440,356
Dilutive effect of stock options ....... 3,114 37,708
------------ ------------
Weighted average common shares
outstanding - diluted ............... 18,195,888 19, 478,064
============ ============
The shares listed below were not included in the computation of diluted earnings
per share because to do so would have been anti-dilutive for the periods
presented.
Three Months Ended
March 31,
----------------------------
2006 2005
---- ----
Stock options........................... 1,148,261 897,043
Convertible debentures.................. 2,796,120 2,796,120
NOTE 9. EMPLOYEE BENEFITS
In 2000, we created an employee benefits trust to which we contributed 750,000
shares of treasury stock 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. During the first quarter of 2006, we committed
118,500 shares to be released leaving 182,000 shares remaining in the trust.
In August 1994, we established an unfunded Supplemental Executive Retirement
Plan (SERP) for key employees. Under the plan, these employees may elect to
defer a portion of their compensation and, in addition, we may at our discretion
make contributions to the plan on behalf of the employees. During March 2006,
contributions were $69,000 for calendar year 2005.
In October 2001, we adopted a second unfunded SERP. The SERP is a defined
benefit plan pursuant to which we will pay supplemental pension benefits to
certain key employees upon retirement based upon the employees' years of service
and compensation. We use a January 1 measurement date for this plan.
We provide certain medical and dental care benefits to eligible retired
employees. Our current policy is to fund the cost of the health care plans on a
pay-as-you-go basis. Effective September 1, 2005, we restricted the eligibility
requirements of employees who can participate in this program, whereby all
active participants hired after 1995 are no longer eligible. In the three months
ended September 30, 2005, in accordance with SFAS No. 106, Employers' Accounting
For Post-Retirement Benefits Other Than Pensions, we recognized a curtailment
gain of $3.8 million for our post-retirement plan mainly related to the above
changes made to our plan. The curtailment accounting requires us to recognize
immediately a pro-rata portion of the unrecognized prior service cost as a
result of the changes.
14
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the "Medicare Reform Act") was signed into law. The Medicare Reform
Act expanded Medicare to include, for the first time, coverage for prescription
drugs. In connection with the Medicare Reform Act, the FASB issued FASB Staff
Position ("FSP") No. FAS 106-2, which provides guidance on accounting for the
effects of the new Medicare prescription drug legislation for employers whose
prescription drug benefits are actuarially equivalent to the drug benefit under
Medicare Part D and are therefore entitled to receive subsidies from the federal
government beginning in 2006. On January 21, 2005, the Centers for Medicare and
Medicaid Services released final regulations implementing major provisions of
the Medicare Reform Act. The regulations address key concepts, such as defining
a plan, as well as the actuarial equivalence test for purposes of obtaining a
government subsidy. Pursuant to the guidance in FSP No. FAS 106-2, we have
assessed the financial impact of the regulations and concluded that our
post-retirement benefit plan will be qualified for the direct subsidies and,
consequently, our accumulated post-retirement benefit obligation decreased by
$9.3 million. As a result, our 2005 post-retirement benefit cost decreased by
approximately $1.1 million. The impact of the Medicare Reform Act on our
post-retirement plan was compounded by changes made during the year in the
modalities of the plan, namely regarding increased participant contributions and
reduced eligibility.
As a result of the reduced eligibility and Medicare subsidy explained above, we
are benefiting in 2006 from a reduction to our post-retirement benefit costs
through negative amortization of prior service costs.
The components of net period benefit cost for the three months ended March 31 of
our North America and UK deferred benefit plans are as follows (in thousands):
Pension Benefits Postretirement Benefits
-----------------------------------------
2006 2005 2006 2005
-----------------------------------------
Service cost ......................... $ 99 $ 130 $ 202 $ 910
Interest cost ........................ 100 131 478 549
Amortization of prior service cost ... 28 40 (713) 31
Actuarial net loss ................... (16) 5 309 1
Amortization of unrecognized loss .... -- -- 1 1
------ ------ ------ ------
Net periodic benefit cost ............ $ 211 $ 306 $ 277 $1,492
====== ====== ====== ======
NOTE 10. INDUSTRY SEGMENTS
Our three reportable operating segments are Engine Management, Temperature
Control and Europe.
Three Months Ended March 31,
-----------------------------------------------------
2006 2005
-----------------------------------------------------
Operating Operating
Net Sales Income (Loss) Net Sales Income (Loss)
--------- ------------- --------- -------------
(in thousands)
Engine Management ...... $148,885 $ 12,197 $140,441 $ 10,080
Temperature Control .... 49,068 1,433 53,562 1,557
Europe ................. 9,777 40 10,945 (479)
All Other .............. 2,346 (4,314) 2,378 (5,323)
-------- -------- -------- --------
Consolidated ........... $210,076 $ 9,356 $207,326 $ 5,835
======== ======== ======== ========
15
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
NOTE 11. COMMITMENTS AND CONTINGENCIES
ASBESTOS. In 1986, we acquired a brake business, which we subsequently sold in
March 1998 and which is accounted for as a discontinued operation. When we
originally acquired this brake business, we assumed future liabilities relating
to any alleged exposure to asbestos-containing products manufactured by the
seller of the acquired brake business. In accordance with the related purchase
agreement, we agreed to assume the liabilities for all new claims filed on or
after September 1, 2001. Our ultimate exposure will depend upon the number of
claims filed against us on or after September 1, 2001 and the amounts paid for
indemnity and defense thereof. At December 31, 2005 and March 31, 2006,
approximately 4,500 cases and 3,600 cases, respectively, were outstanding for
which we were responsible for any related liabilities. In the first quarter of
2006, we settled a significant number of cases. We expect the outstanding cases
to increase gradually due to recent legislation in certain states mandating
minimum medical criteria before a case can be heard. Since inception in
September 2001 through March 31, 2006, the amounts paid for settled claims are
approximately $3.9 million. We do not have insurance coverage for the defense
and indemnity costs associated with these claims.
In evaluating our potential asbestos-related liability, we have considered
various factors including, among other things, an actuarial study performed by a
leading actuarial firm with expertise in assessing asbestos-related liabilities,
our settlement amounts and whether there are any co-defendants, the jurisdiction
in which lawsuits are filed, and the status and results of settlement
discussions. 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 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. 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, thereby increasing our liability to $27.3
million as of September 30, 2002. 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, we update the actuarial study during the third
quarter of each year. The most recent update to the actuarial study was
performed as of August 31, 2005 using methodologies consistent with the
September 2002 study. The updated study has estimated an undiscounted liability
for settlement payments, excluding legal costs, ranging from $25 to $51 million
for the period through 2049. Although there was a decline in the range of
liability as compared to the prior year study, given the relative volatility of
the actuarial evaluations over the prior three years, we decided to maintain a
reserve of $27.6 million until more experience is gained. Legal costs, which are
expensed as incurred, are estimated to range from $16 to $20 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. Given the uncertainties
associated with projecting such matters into the future and other factors
outside our control, we can give no assurance that additional provisions will
not be required. Management will continue to monitor the circumstances
surrounding these potential liabilities in determining whether additional
provisions may be necessary. At the present time, however, we do not believe
that any additional provisions would be reasonably likely to have a material
adverse effect on our liquidity or consolidated financial position.
16
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-(CONTINUED)
ANTITRUST LITIGATION. On November 30, 2004, we were served with a summons and
complaint in the U.S. District Court for the Southern District of New York by
The Coalition For A Level Playing Field, which is an organization comprised of a
large number of auto parts retailers. The complaint alleges antitrust violations
by the Company and a number of other auto parts manufacturers and retailers and
seeks injunctive relief and unspecified monetary damages. In August 2005, we
filed a motion to dismiss the complaint, following which the plaintiff filed an
amended complaint dropping, among other things, all claims under the Sherman
Act. The remaining claims allege violations of the Robinson-Patman Act. Motions
to dismiss those claims were filed by us in February 2006. Plaintiff has filed
opposition to the motions, and we expect to file replies thereto in June 2006,
after which we expect a decision from the court regarding these motions.
Although we cannot predict the ultimate outcome of this case or estimate the
range of any potential loss that may be incurred in the litigation, we believe
that the lawsuit is without merit, deny all of the plaintiff's allegations of
wrongdoing and believe we have meritorious defenses to the plaintiff's claims.
We intend to defend vigorously this lawsuit.
OTHER LITIGATION. We are involved in various other litigation and product
liability matters arising in the ordinary course of business. Although the final
outcome of any asbestos-related matters or any other litigation or product
liability matter cannot be determined, based on our understanding and evaluation
of the relevant facts and circumstances, it is our opinion that the final
outcome of these matters will not have a material adverse effect on our
business, financial condition or results of operations.
WARRANTIES. We generally warrant our products against certain manufacturing and
other defects. These product warranties are provided for specific periods of
time of the product depending on the nature of the product. As of March 31, 2005
and 2006, we have accrued $13 million and $13 million, respectively, for
estimated product warranty claims included in accrued customer returns. The
accrued product warranty costs are based primarily on historical experience of
actual warranty claims. Warranty expense for the three months ended March 31,
2006 and 2005 were $13.1 million and $11.1 million, respectively.
The following table provides the changes in our product warranties (in
thousands):
Three Months Ended
March 31,
--------------------------
2006 2005
---- ----
Balance, beginning of period.................... $ 12,701 $ 13,194
Liabilities accrued for current year sales...... 13,143 11,127
Settlements of warranty claims.................. (12,794) (11,339)
-------- --------
Balance, end of period.......................... $ 13,050 $ 12,982
======== ========
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS MADE PURSUANT TO THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
FORWARD-LOOKING STATEMENTS IN THIS REPORT ARE INDICATED BY WORDS SUCH AS
"ANTICIPATES," "EXPECTS," "BELIEVES," "INTENDS," "PLANS," "ESTIMATES,"
"PROJECTS" AND SIMILAR EXPRESSIONS. THESE STATEMENTS REPRESENT OUR EXPECTATIONS
BASED ON CURRENT INFORMATION AND ASSUMPTIONS AND ARE INHERENTLY SUBJECT TO RISKS
AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE WHICH
ARE ANTICIPATED OR PROJECTED AS A RESULT OF CERTAIN RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, ECONOMIC AND MARKET CONDITIONS; THE PERFORMANCE
OF THE AFTERMARKET SECTOR; CHANGES IN BUSINESS RELATIONSHIPS WITH OUR MAJOR
CUSTOMERS AND IN THE TIMING, SIZE AND CONTINUATION OF OUR CUSTOMERS' PROGRAMS;
CHANGES IN THE PRODUCT MIX AND DISTRIBUTION CHANNEL MIX; THE ABILITY OF OUR
CUSTOMERS TO ACHIEVE THEIR PROJECTED SALES; COMPETITIVE PRODUCT AND PRICING
PRESSURES; INCREASES IN PRODUCTION OR MATERIAL COSTS THAT CANNOT BE RECOUPED IN
PRODUCT PRICING; SUCCESSFUL INTEGRATION OF ACQUIRED BUSINESSES; PRODUCT AND
ENVIRONMENTAL LIABILITY MATTERS (INCLUDING, WITHOUT LIMITATION, THOSE RELATED TO
ASBESTOS-RELATED CONTINGENT LIABILITIES OR ENVIRONMENTAL REMEDIATION
LIABILITIES); AS WELL AS OTHER RISKS AND UNCERTAINTIES, SUCH AS THOSE DESCRIBED
UNDER RISK FACTORS, QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
AND THOSE DETAILED HEREIN AND FROM TIME TO TIME IN THE FILINGS OF THE COMPANY
WITH THE SEC. FORWARD-LOOKING STATEMENTS ARE MADE ONLY AS OF THE DATE HEREOF,
AND THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE OR REVISE THE FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
IN ADDITION, HISTORICAL INFORMATION SHOULD NOT BE CONSIDERED AS AN INDICATOR OF
FUTURE PERFORMANCE. THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH
THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, INCLUDING THE NOTES
THERETO, INCLUDED ELSEWHERE IN THIS REPORT.
BUSINESS OVERVIEW
We are a leading independent manufacturer and distributor of replacement parts
for motor vehicles in the automotive aftermarket industry. We are organized into
two major operating segments, each of which focuses on a specific segment of
replacement parts. Our Engine Management Segment manufactures ignition and
emission parts, on-board computers, ignition wires, battery cables and fuel
system parts. Our Temperature Control Segment manufactures and remanufactures
air conditioning compressors, and other air conditioning and heating parts. We
sell our products primarily in the United States, Canada and Latin America. We
also sell our products in Europe through our European Segment.
As part of our efforts to grow our business, as well as to achieve increased
production and distribution efficiencies, on June 30, 2003 we completed the
acquisition of substantially all of the assets and assumed substantially all of
the operating liabilities of Dana Corporation's Engine Management Group ("DEM").
Our plan was to restructure and to integrate the DEM business into our existing
Engine Management business, which we have completed. At the time, we announced
that we would close seven DEM facilities, which has subsequently occurred. We
continue to review our operations and implement plans to continue to achieve
cost savings and operating efficiencies.
Under the terms of the acquisition, we paid Dana Corporation $93.2 million in
cash, issued an unsecured promissory note of $15.1 million, and issued 1,378,760
shares of our common stock valued at $15.1 million. Including transaction costs,
our total purchase price was approximately $130.5 million. On December 29, 2005,
we entered into a Repurchase and Prepayment Agreement with Dana, in which we
repurchased the 1,378,760 shares of our common stock at a repurchase price of
$8.63 per share (or an aggregate approximate repurchase price of $11.9 million)
and prepaid at a discount the $15.1 million unsecured promissory note plus
accrued and unpaid interest for an aggregate approximate amount of $14.5
million. We recognized the discount of $1.0 million as a gain on the repayment
of the note as well as the unrecognized deferred interest expense thereon of
$0.2 million as income in 2005.
In connection with our acquisition of DEM, we reviewed our operations and
implemented integration plans to restructure the operations of DEM. As part of
the integration and restructuring plans, we accrued an initial restructuring
liability of approximately $34.7 million at June 30, 2003. Such amounts were
recognized as liabilities assumed in the acquisition and included in the
allocation of the cost to acquire DEM. Accordingly, such amounts resulted in
additional goodwill being recorded in connection with the acquisition.
Subsequent to the acquisition, our estimate of the restructuring liability was
updated and revised downward, with corresponding reductions to goodwill, by $1
million, $1.2 million and $10.2 million as at December 31, 2003, December 31,
2005 and March 31, 2006, respectively. As of March 31, 2006, the restructuring
accrual was at $1.6 million. We expect to pay most of this remaining amount in
2006 and 2007.
18
Of the initial restructuring accrual, approximately $15.7 million related to
work force reductions and represented employee termination benefits. The accrual
amount primarily provides for severance costs relating to the involuntary
termination of employees, individually employed throughout DEM's facilities
across a broad range of functions, including managerial, professional, clerical,
manufacturing and factory positions. During the year ended December 31, 2005 and
the three months ended March 31, 2006, termination benefits of $2.3 million and
$0.1 million, respectively, have been charged to the restructuring accrual. As
of March 31, 2006, the reserve balance for workforce reductions was at $0.7
million.
The initial restructuring accrual also included approximately $18 million
consisting of the net present value of costs associated with exiting certain
activities, primarily related to lease and contract termination costs, which
will not have future benefits. Specifically, our plans were to consolidate
certain of DEM operations into our existing plants. At December 31, 2005, we had
a sublease commitment for one facility with Dana through 2021. However, on March
3, 2006, Dana filed a voluntary petition for relief under Chapter 11 of the US
Bankruptcy Code. Pursuant to a court ruling in connection with Dana's Chapter 11
bankruptcy proceedings, effective March 31, 2006, we were released from, and no
longer have any obligations with respect to, such lease commitment for the
facility. We have accounted for the termination of such lease commitment as a
reduction of $10.2 million in our restructuring accrual, with a corresponding
reduction to goodwill established on the acquisition of DEM. In addition to the
above reduction, exit costs of $0.7 million were paid as of March 31, 2006,
leaving the exit reserve balance for exit costs of $0.9 million as of March 31,
2006.
SEASONALITY. Historically, our operating results have fluctuated by quarter,
with the greatest sales occurring in the second and third quarters of the year
and revenues generally being recognized at the time of shipment. It is in these
quarters that demand for our products is typically the highest, specifically in
the Temperature Control Segment of our business. In addition to this
seasonality, the demand for our Temperature Control products during the second
and third quarters of the year may vary significantly with the summer weather
and customer inventories. For example, a cool summer may lessen the demand for
our Temperature Control products, while a hot summer may increase such demand.
As a result of this seasonality and variability in demand of our Temperature
Control products, our working capital requirements peak near the end of the
second quarter, as the inventory build-up of air conditioning products is
converted to sales and payments on the receivables associated with such sales
have yet to be received. During this period, our working capital requirements
are typically funded by borrowing from our revolving credit facility.
The seasonality of our business offers significant operational challenges in our
manufacturing and distribution functions. To limit these challenges and to
provide a rapid turnaround time of customer orders, we have traditionally
offered a pre-season selling program, known as our "Spring Promotion," in which
customers are offered a choice of a price discount or longer payment terms.
INVENTORY MANAGEMENT. We face inventory management issues as a result of
warranty and overstock returns. Many of our products carry a warranty ranging
from a 90-day limited warranty to a lifetime limited warranty, which generally
covers defects in materials or workmanship and failure to meet industry
published specifications. In addition to warranty returns, we also permit our
customers to return products to us within customer-specific limits (which are
generally limited to a specified percentage of their annual purchases from us)
in the event that they have overstocked their inventories. The Company accrues
for overstock returns as a percentage of sales, after giving consideration to
recent returns history. In addition, the seasonality of our Temperature Control
Segment requires that we increase our inventory during the winter season in
preparation of the summer selling season and customers purchasing such inventory
have the right to make returns.
19
In order to better control warranty and overstock return levels, we tightened
the rules for authorized warranty returns, placed further restrictions on the
amounts customers can return and instituted a program so that our management can
better estimate potential future product returns. In addition, we established
procedures whereby a warranty will be voided if a customer does not follow a
twelve-step warranty return process with respect to certain products.
DISCOUNTS, ALLOWANCES AND INCENTIVES. In connection with our sales activities,
we offer a variety of usual customer discounts, allowances and incentives.
First, we offer cash discounts for paying invoices in accordance with the
specified discounted terms of the invoice. Second, we offer pricing discounts
based on volume and different product lines purchased from us. These discounts
are principally in the form of "off-invoice" discounts and are immediately
deducted from sales at the time of sale. For those customers that choose to
receive a payment on a quarterly basis instead of "off-invoice," we accrue for
such payments as the related sales are made and reduce sales accordingly.
Finally, rebates and discounts are provided to customers as advertising and
sales force allowances, and allowances for warranty and overstock returns are
also provided. Management analyzes historical returns, current economic trends,
and changes in customer demand when evaluating the adequacy of the sales returns
and other allowances. Significant management judgments and estimates must be
made and used in connection with establishing the sales returns and other
allowances in any accounting period. We account for these discounts and
allowances as a reduction to revenues, and record them when sales are recorded.
INTERIM RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2006 TO THE THREE MONTHS ENDED MARCH
31, 2005
SALES. Consolidated net sales in the first quarter of 2006 were $210.1 million,
an increase of $2.8 million or 1.3%, compared to $207.3 million in the first
quarter of 2005, driven by an increase of $8.4 million in our Engine Management
Segment partially offset by declines of $4.5 million in Temperature Control and
$1.2 million in our European Segments. The increase in sales in our Engine
Management Segment benefited in part from price increases. The decline in our
Temperature Control Segment was due to a scale-back of its pre-season
promotional program in 2006.
GROSS MARGINS. Gross margins, as a percentage of net sales, were 25.3% in the
first quarter of 2006 compared to 23.4% in the first quarter of 2005 with
corresponding improvements in our Engine Management, Temperature Control and
European Segments. The margin increase in our Engine Management Segment was due
to price increases implemented near the end of 2005 and in the first quarter of
2006, as well as reduced product costs. The improvements in our Temperature
Control and Europe Segments were mainly due to product cost reductions.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses (SG&A) increased by $1.7 million to $43.8 million in the
first quarter of 2006, compared to $42.1 million in the first quarter of 2005.
The increase in SG&A expenses was driven by marketing expenses increasing by
$2.3 million, partially offset by a reduction of $0.7 million in draft expenses
as we terminated our accounts receivable draft program in the fourth quarter of
2005. As a percentage of net sales, first quarter 2006 SG&A expenses were
generally in line with the same period in 2005.
RESTRUCTURING EXPENSES. Restructuring expenses, which include restructuring and
integration expenses, decreased $437,000 compared to the first quarter 2005.
Integration expenses in the first quarter of 2006 were $87,000 for moving our
European production operations, compared to $524,000 incurred in the first
quarter of 2005 for the DEM restructuring which is now substantially completed.
20
OPERATING INCOME. Operating income was $9.4 million in the first quarter of
2006, compared to $5.8 million in the first quarter of 2005. The increase was
primarily due to higher operating profits from higher Engine Management sales
and product cost reductions in most segments, partially offset by higher SG&A
expenses.
OTHER INCOME (EXPENSE), NET. Other income, net increased to $350,000 in the
first quarter of 2006, compared to an expense of $215,000 in the first quarter
of 2005. The increase was primarily due to foreign exchange movements as well as
improved equity income from European joint ventures.
INTEREST EXPENSE. Interest expense increased by $678,000 in the first quarter
2006 compared to the same period in 2005, due to higher borrowings and higher
average borrowing costs. The increase in borrowing is due to higher accounts
receivable levels as a result of the termination of our accounts receivable
draft program in the fourth quarter of 2005, which generated a $739,000
reduction in draft expenses as mentioned in the SG&A discussion above.
INCOME TAX PROVISION. The income tax provision was $2.7 million in the first
quarter of 2006, compared to $792,000 for the same period in 2005. The increase
was primarily due to higher pre-tax earnings and a higher effective rate for the
first quarter of 2006 due to a one time reduction in our deferred tax asset of
$436,000, which was a discrete tax item added to our provision otherwise
determined using an estimated annual effective tax rate. The reduction in our
deferred tax asset was primarily due to recently enacted state tax changes.
Excluding the impact of the $436,000 one time adjustment, our effective tax rate
for continuing operations was approximately 42% in the first quarter of 2006
compared to 43% in first quarter of 2005.
Deferred tax assets, net of a valuation allowance of $26.1 million and deferred
tax liabilities of $17.3 million were $40.6 million as of December 31, 2005.
Approximately $110 million of taxable income must be generated in 2006 and
subsequent years in order to realize the deferred tax assets. We believe it is
more likely than not that we will be able to generate this level of taxable
income within 6 years of December 31, 2005, based on the assumptions that our
Puerto Rican affiliate's profits will create US taxable income following the
expiration of Section 936 of the Internal Revenue Code and that our US based
Engine Management Segment continues to improve as we realize savings from cost
reduction efforts. Also, our US net operating loss carry forwards of $37.3
million expire between 2021 and 2025, and our alternative minimum tax credit
carry forwards of approximately $6 million have no expiration date. The results
of the first quarter 2006 are generally in line with the aforementioned
assumptions. We continue to monitor our trends and weigh these against our
recent domestic loss carry forward history. At this time, we have concluded that
our current level of valuation allowance continues to be appropriate.
LOSS FROM DISCONTINUED OPERATION. Losses from discontinued operation include
legal expenses associated with our asbestos-related liability. We recorded
$764,000 and $407,000 as a loss from discontinued operation in the first quarter
of 2006 and 2005, respectively. The increase is due to one-time tax costs
associated with the liquidation of the residual assets of the pension plan of
the discontinued operation segment. As discussed more fully in note 11 of our
notes to our consolidated financial statements, we are responsible for certain
future liabilities relating to alleged exposure to asbestos-containing products.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. During the first quarter of 2006, cash used in operations
amounted to $47.4 million, compared to $42.5 million in the same period of 2005.
The increase is primarily attributable to an increase in accounts receivable due
to the termination of our accounts receivable draft program at the end of 2005.
INVESTING ACTIVITIES. Cash used in investing activities was $1.9 million in the
first quarter of 2006, compared to $1.9 million in the same period of 2005,
which consisted primarily for capital expenditures in both periods.
21
FINANCING ACTIVITIES. Cash provided by financing activities was $43.3 million in
the first quarter of 2006, compared to $38.5 million in the same period of 2005.
The increase is primarily due to an increase in borrowings under our line of
credit, primarily to finance the increase in accounts receivable following the
termination of our accounts receivable drafts programs.
We are parties to an agreement with General Electric Capital Corporation, as
agent, and a syndicate of lenders for a secured revolving credit facility. The
term of the credit agreement is through 2008 and provides for a line of credit
up to $305 million. Availability under our revolving credit facility is based on
a formula of eligible accounts receivable, eligible inventory and eligible fixed
assets. After taking into effect outstanding borrowings under the revolving
credit facility, there was an additional $54.2 million available for us to
borrow pursuant to the formula at March 31, 2006. Our credit agreement also
permits dividends and distributions by us provided specific conditions are met.
Direct borrowings under our revolving credit facility bear interest at the prime
rate plus the applicable margin (as defined in the credit agreement) or 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 certain
of our subsidiaries. The terms of our revolving credit facility provide for,
among other provisions, financial covenants requiring us, on a consolidated
basis: (1) to maintain specified levels of fixed charge coverage at the end of
each fiscal quarter (rolling twelve months) through 2008; and (2) to limit
capital expenditure levels for each fiscal year through 2008. The terms of our
revolving credit facility also provide, among other things, for the prohibition
of accepting drafts under our customer draft programs after November 18, 2005.
In December 2005, our Canadian subsidiary entered into a credit agreement with
GE Canada Finance Holding Company, for itself and as agent for the lenders, and
GECC Capital Markets, Inc., as lead arranger and book runner. The credit
agreement provides for, among other things, a $7 million term loan, which term
loan is guaranteed and secured by us and certain of our wholly-owned
subsidiaries and which term loan is coterminous with the term of our revolving
credit facility. The $7 million term loan is part of the $305 million available
for borrowing under our revolving credit facility.
In addition, in order to facilitate the aggregate financing of the DEM
acquisition in June 2003, we completed a public equity offering of 5,750,000
shares of our common stock for net proceeds of approximately $55.7 million. We
also issued to Dana Corporation 1,378,760 shares of our common stock valued at
approximately $15.1 million and an unsecured subordinated promissory note in the
aggregate principal amount of approximately $15.1 million due December 31, 2008.
The promissory note had an interest rate of 9% per annum for the first year,
with such interest rate increasing by one-half of a percentage point (0.5%) on
each anniversary of the date of issuance. Accrued and unpaid interest was due
quarterly under the promissory note. On December 29, 2005, we entered an
agreement with Dana, in which we repurchased the 1,378,760 shares of our common
stock at a repurchase price of $8.63 per share (or an aggregate approximate
repurchase price of $11.9 million) and prepaid at a discount the $15.1 million
unsecured promissory note plus accrued and unpaid interest for an aggregate
approximate amount of $14.5 million.
In June 2003, we borrowed $10 million under a mortgage loan agreement. The loan
is payable in equal monthly installments. The loan bears interest at a fixed
rate of 5.50% maturing in July 2018. The mortgage loan is secured by the related
building and property.
Our profitability and working capital requirements are seasonal due to the sales
mix of temperature control products. Our working capital requirements usually
peak near the end of the second quarter, as the inventory build-up of air
conditioning products is converted to sales and payments on the receivables
associated with such sales begin to be received. These increased working capital
requirements are funded by borrowings from our lines of credit. In 2004 and the
first quarter of 2005, we also received the benefit from accelerating accounts
receivable collections from customer draft programs. However, in the second
quarter of 2005 we reduced the early monetizing of these accounts receivable
under the draft program. An amendment to our revolving credit facility in
November 2005 prohibits us from accepting drafts under our customer draft
programs after November 18, 2005. We anticipate that our present sources of
funds will continue to be adequate to meet our near term needs.
22
In October 2003, we entered into an 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.
In July 1999, we issued convertible debentures, payable semi-annually, in the
aggregate principal amount of $90 million. The debentures carry an interest rate
of 6.75%, payable semi-annually. The debentures are convertible into 2,796,120
shares of our common stock, and mature on July 15, 2009. The proceeds from the
sale of the debentures were used to prepay an 8.6% senior note, reduce short
term bank borrowings and repurchase a portion of our common stock.
As of March 31, 2006, we have Board authorization to repurchase additional
shares at a maximum cost of $1.7 million. During 2005 and the first quarter of
2006, other than the repurchase of our common stock held by Dana as discussed
above, we did not repurchase any shares of our common stock either in the open
market or otherwise.
The following is a summary of our contractual commitments as of December 31,
2005. Other than as discussed below, there have been no significant changes to
this information at March 31, 2006. At December 31, 2005, we were parties to a
sublease agreement with Dana Corporation, which agreement was originally
scheduled to expire in 2021. However, on March 3, 2006, Dana filed a voluntary
petition for relief under Chapter 11 of the US Bankruptcy Code. Pursuant to a
court ruling in connection with Dana's Chapter 11 bankruptcy proceedings,
effective March 31, 2006, we were released from, and no longer have any
obligations with respect to, such lease commitment for the facility. As such,
our operating lease commitment in each year for the five year period from 2006
to 2010 has been reduced by $1.2 million per year and for period from 2011-2015
has been reduced by $14.5 million in the aggregate. The table below in the
"Operating leases" line item has been revised to reflect these reductions.
-----------------------------------------------------
(IN THOUSANDS) 2006 2007 2008 2009 2010 2011-2015 TOTAL
- -----------------------------------------------------------------------------------------------------------
Principal payments of
long term debt ......... $ 542 $ 555 $ 512 $ 90,530 $ 560 $ 6,392 $ 99,091
Operating leases .......... 6,941 5,839 4,650 3,240 1,175 7,140 28,985
Interest rate swap
agreements ............. (496) -- -- -- -- -- (496)
Post-employee
retirement benefits .... 970 1,069 1,536 1,655 1,768 10,849 17,847
Severance payments related
to integration ......... 396 413 -- -- -- -- 809
-------- -------- -------- -------- -------- -------- ----------
Total commitments $ 8,353 $ 7,876 $ 6,698 $ 95,425 $ 3,503 $ 24,381 $ 146,236
======== ======== ======== ======== ======== ======== ==========
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to our business operations and
the understanding of our results of operations. The impact and any associated
risks related to these policies on our business operations is discussed
throughout "Management's Discussion and Analysis of Financial Condition and
Results of Operations," where such policies affect our reported and expected
financial results. For a detailed discussion on the application of these and
other accounting policies, see note 1 of the notes to our consolidated financial
statements in our Annual Report on Form 10-K for the year ended December 31,
2005. You should be aware that preparation of our consolidated quarterly
financial statements in this Report requires us to make estimates and
assumptions that affect the reported amount of assets and liabilities,
disclosure of contingent assets and liabilities at the date of our consolidated
financial statements, and the reported amounts of revenue and expenses during
the reporting periods. We can give no assurance that actual results will not
differ from those estimates.
23
REVENUE RECOGNITION. We derive our revenue primarily from sales of replacement
parts for motor vehicles from both our Engine Management and Temperature Control
Segments. We recognize revenues when products are shipped and title has been
transferred to a customer, the sales price is fixed and determinable, and
collection is reasonably assured. For some of our sales of remanufactured
products, we also charge our customers a deposit for the return of a used core
component which we can use in our future remanufacturing activities. Such
deposit is not recognized as revenue but rather carried as a core liability. The
liability is extinguished when a core is actually returned to us. We estimate
and record provisions for cash discounts, quantity rebates, sales returns and
warranties in the period the sale is recorded, based upon our prior experience
and current trends. As described below, significant management judgments and
estimates must be made and used in estimating sales returns and allowances
relating to revenue recognized in any accounting period.
INVENTORY VALUATION. Inventories are valued at the lower of cost or market. Cost
is generally determined on the first-in, first-out basis. Where appropriate,
standard cost systems are utilized for purposes of determining cost; the
standards are adjusted as necessary to ensure they approximate actual costs.
Estimates of lower of cost or market value of inventory are determined at the
reporting unit level and are based upon the inventory at that location taken as
a whole. These estimates are based upon current economic conditions, historical
sales quantities and patterns and, in some cases, the specific risk of loss on
specifically identified inventories.
We also evaluate inventories on a regular basis to identify inventory on hand
that may be obsolete or in excess of current and future projected market demand.
For inventory deemed to be obsolete, we provide a reserve on the full value of
the inventory. Inventory that is in excess of current and projected use is
reduced by an allowance to a level that approximates our estimate of future
demand.
We use cores (used parts) in our remanufacturing processes for air conditioning
compressors. The production of air conditioning compressors involves the
rebuilding of used cores, which we acquire either in outright purchases from
used parts brokers, or from returns pursuant to an exchange program with
customers. Under such exchange programs, we reduce our inventory, through a
charge to cost of sales, when we sell a finished good compressor, and put back
to inventory at standard cost through a credit to cost of sales the used core
exchanged at the time it is eventually received from the customer.
SALES RETURNS AND OTHER ALLOWANCES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS.
Management must make estimates of potential future product returns related to
current period product revenue. Management analyzes historical returns, current
economic trends, and changes in customer demand when evaluating the adequacy of
the sales returns and other allowances. Significant management judgments and
estimates must be made and used in connection with establishing the sales
returns and other allowances in any accounting period. At March 31, 2006, the
allowance for sales returns was $22.4 million. Similarly, 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 March 31, 2006, the allowance for doubtful
accounts and for discounts was $10.6 million.
ACCOUNTING FOR NEW CUSTOMER ACQUISITION COSTS. New customer acquisition costs
refer to arrangements pursuant to which we incur change-over-costs to induce a
new customer to switch from a competitor's brand. In addition, change-over-costs
include the costs related to removing the new customer's inventory and replacing
it with Standard Motor Products inventory commonly referred to as a stocklift.
New customer acquisition costs are recorded as a reduction to revenue when
incurred.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements, we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves
estimating our actual current tax 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 or decrease this allowance in a period, we must include an
expense or recovery, respectively, within the tax provision in the statement of
operations.
24
Significant management judgment is required in determining the adequacy of our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our net deferred tax assets. At March 31,
2006, we had a valuation allowance of $26.1 million, due to uncertainties
related to our ability to utilize some of our deferred tax assets. The
assessment of the adequacy of our valuation allowance is based on our estimates
of taxable income by jurisdiction in which we operate and the period over which
our deferred tax assets will be recoverable.
In the event that actual results differ from these estimates, or we adjust these
estimates in future periods for current trends or expected changes in our
estimating assumptions, we may need to modify the level of valuation allowance
which could materially impact our business, financial condition and results of
operations.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL. We assess the
impairment of identifiable intangibles and long-lived assets whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important, which could trigger an impairment
review, include the following: (a) significant underperformance relative to
expected historical or projected future operating results; (b) significant
changes in the manner of our use of the acquired assets or the strategy for our
overall business; and (c) significant negative industry or economic trends. With
respect to goodwill, if necessary, we test for potential impairment in the
fourth quarter of each year as part of our annual budgeting process. We review
the fair values of each of our reporting units using the discounted cash flows
method and market multiples.
In the event our planning assumptions were modified resulting in an impairment
to our assets, we would be required to include an expense in our statement of
operations, which could materially impact our business, financial condition and
results of operations.
RETIREMENT AND POST-RETIREMENT MEDICAL BENEFITS. Each year, we calculate the
costs of providing retiree benefits under the provisions of SFAS 87, Employers'
Accounting for Pensions, and SFAS 106, Employers' Accounting for Post-retirement
Benefits Other than Pensions. The key assumptions used in making these
calculations are disclosed in notes 13 and 14 of the notes to our consolidated
financial statements in our Annual Report on Form 10-K for the year ended
December 31, 2005. The most significant of these assumptions are the eligibility
criteria of participants, the discount rate used to value the future obligation,
expected return on plan assets and health care cost trend rates. We select
discount rates commensurate with current market interest rates on high-quality,
fixed-rate debt securities. The expected return on assets is based on our
current review of the long-term returns on assets held by the plans, which is
influenced by historical averages. The medical cost trend rate is based on our
actual medical claims and future projections of medical cost trends. Under FSP
No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," the Company has
concluded that its post-retirement plan is actuarially equivalent to the
Medicare Part D benefit and accordingly recognizes subsidies from the federal
government in the measurement of the accumulated post-retirement benefit
obligation under SFAS 106, "Employers' Accounting for Post-Retirement Benefits
Other Than Pensions". In addition, in accordance with SFAS No. 106, Employers'
Accounting For Post-Retirement Benefits Other Than Pensions, in September 2005
we recognized a curtailment gain of $3.8 million for our post-retirement plan
related to changes made to our plan, namely reducing the number of participants
eligible for our plan by making all active participants hired after 1995 no
longer eligible.
ASBESTOS RESERVE. We are responsible for certain future liabilities relating to
alleged exposure to asbestos-containing products. 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.
25
In accordance with our accounting policy, we update the actuarial study during
the third quarter of each year. The most recent update to the actuarial study
was performed as of August 31, 2005 using methodologies consistent with the
September 2002 study. The updated study has estimated an undiscounted liability
for settlement payments, excluding legal costs, ranging from $25 to $51 million
for the period through 2049. Although there was a decline in the range of
liability as compared to the prior year study, given the relative volatility of
the actuarial evaluations over the prior three years, we decided to maintain the
reserve of $27.6 million until more experience is gained. Legal costs are
estimated to range from $16 to $20 million during the same period. We plan on
performing a similar 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 operation. Legal expenses associated with asbestos-related
matters are expensed as incurred and recorded as a loss from discontinued
operation 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
SHARE-BASED PAYMENT
In December 2004, the FASB issued SFAS No. 123R. SFAS No. 123R requires that
stock-based employee compensation be recorded as a charge to earnings. SFAS 123R
is effective for interim and annual financial statements for years beginning
after December 15, 2005 and will apply to all outstanding and unvested
share-based payments at the time of adoption. Accordingly, we have adopted SFAS
123R commencing January 1, 2006 using a modified prospective application, as
permitted by SFAS No. 123R. Accordingly, prior period amounts have not been
restated. Under this application, we are required to record compensation expense
for all awards granted after the date of adoption and for the unvested portion
of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of SFAS No. 123R, we applied Accounting Principles Board
Opinions (APB) No. 25 and related interpretations to account for our stock plans
resulting in the use of the intrinsic value to value the stock. Under APB 25, we
were not required to recognize compensation expense for the cost of stock
options. In accordance with the adoption of SFAS 123R, we recorded stock-based
compensation expense for the cost of incentive stock options granted under our
stock plans. Stock-based compensation expense for the first quarter of 2006 was
$283,000 ($173,000 after tax) or $0.01 per basic and diluted share. The adoption
of SFAS123R did not have a material impact on our financial position, results of
operation or cash flows.
ACCOUNTING FOR UNCERTAIN TAX POSITIONS
In July 2005, the FASB issued an Exposure Draft of the proposed Interpretation,
"Accounting for Uncertain Tax Positions, an interpretation of FASB Statement No.
109". The proposed Interpretation would clarify criterion to be used in the
recognition of uncertain tax positions in an enterprise's financial statements.
The Company is evaluating the proposed Interpretation but does not believe it
would materially change the way our Company evaluates tax positions for
recognition. The FASB expects to issue the final Interpretation in the first
half of 2006.
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. Our
exposure to foreign exchange rate risk is due to certain costs, revenues and
borrowings being denominated in currencies other than one of our subsidiary's
functional currency. Similarly, we are exposed to market risk as the result of
changes in interest rates, which may affect the cost of our financing. It is our
policy and practice to use derivative financial instruments only to the extent
necessary to manage exposures. We do not hold or issue derivative financial
instruments for trading or speculative purposes.
We have exchange rate exposure, primarily, with respect to the Canadian dollar,
the British pound, the Euro, the Japanese Yen and the Hong Kong dollar. As of
December 31, 2005 and March 31, 2006, our monetary assets and liabilities which
are subject to this exposure are immaterial, therefore the potential immediate
loss to us that would result from a hypothetical 10% change in foreign currency
exchange rates would not be expected to have a material impact on our earnings
or cash flows. This sensitivity analysis assumes an unfavorable 10% fluctuation
in both of the exchange rates affecting both of the foreign currencies in which
the indebtedness and the financial instruments described above are denominated
and does not take into account the offsetting effect of such a change on our
foreign-currency denominated revenues.
We manage our exposure to interest rate risk through the proportion of fixed
rate debt and variable rate debt in our debt portfolio. To manage a portion of
our exposure to interest rate changes, we enter into interest rate swap
agreements. We invest our excess cash in highly liquid short-term investments.
Our percentage of variable rate debt to total debt was 60% at December 31, 2005
and 66% at March 31, 2006.
Other than the aforementioned, there have been no significant changes to the
information presented in Item 7A (Market Risk) of our Annual Report on Form 10-K
for the year ended December 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in reports we file or submit under the
Exchange Act is recorded, processed, summarized, and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Exchange Act, as
of the end of the period covered by this Report. Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of the end of the period
covered by this Report.
(b) Changes in Internal Control Over Financial Reporting.
During the quarter ended March 31, 2006, we have not made any changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
We continue to review, document and test our internal control over financial
reporting, and may from time to time make changes aimed at enhancing their
effectiveness and to ensure that our systems evolve with our business. These
efforts will lead to various changes in our internal control over financial
reporting.
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. When we originally
acquired this brake business, we assumed future liabilities relating to any
alleged exposure to asbestos-containing products manufactured by the seller of
the acquired brake business. In accordance with the related purchase agreement,
we agreed to assume the liabilities for all new claims filed on or after
September 1, 2001. Our ultimate exposure will depend upon the number of claims
filed against us on or after September 1, 2001 and the amounts paid for
indemnity and defense thereof. At December 31, 2005 and March 31, 2006
approximately 4,500 cases and 3,600 cases, respectively, were outstanding for
which we were responsible for any related liabilities. In the first quarter
2006, we settled a significant number of cases. We expect the outstanding cases
to increase gradually due to recent legislation in certain states mandating
minimum medical criteria before a case can be heard. Since inception in
September 2001 through March 31, 2006, the amounts paid for settled claims are
approximately $3.9 million. We do not have insurance coverage for the defense
and indemnity costs associated with these claims.
On November 30, 2004, we were served with a summons and complaint in the U.S.
District Court for the Southern District of New York by The Coalition For A
Level Playing Field, which is an organization comprised of a large number of
auto parts retailers. The complaint alleges antitrust violations by the Company
and a number of other auto parts manufacturers and retailers and seeks
injunctive relief and unspecified monetary damages. In August 2005, we filed a
motion to dismiss the complaint, following which the plaintiff filed an amended
compliant dropping, among other things, all claims under the Sherman Act. The
remaining claims allege violations of the Robinson-Patman Act. Motions to
dismiss those claims were filed by us in February 2006. Plaintiff has filed
opposition to the motions, and we expect to file replies thereto in June 2006,
after which we expect a decision from the court regarding these motions.
Although we cannot predict the ultimate outcome of this case or estimate the
range of any potential loss that may be incurred in the litigation, we believe
that the lawsuit is without merit, deny all of the plaintiff's allegations of
wrongdoing and believe we have meritorious defenses to the plaintiff's claims.
We intend to defend vigorously this lawsuit.
We are involved in various other litigation and product liability matters
arising in the ordinary course of business. Although the final outcome of any
asbestos-related matters or any other litigation or product liability matter
cannot be determined, based on our understanding and evaluation of the relevant
facts and circumstances, it is our opinion that the final outcome of these
matters will not have a material adverse effect on our business, financial
condition or results of operations.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this Report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or results of operations.
The risk factors included in our Annual Report on Form 10-K have not materially
changed, other than as set forth below.
WE MAY INCUR LIABILITIES UNDER GOVERNMENT REGULATIONS AND POLICIES AND
ENVIRONMENTAL LAWS, WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Domestic and foreign political developments and government regulations and
policies directly affect automotive consumer products in the United States and
abroad. Regulations and policies relating to over-the-highway vehicles include
standards established by the United States Department of Transportation for
motor vehicle safety and emissions. The modification of existing laws,
regulations or policies, or the adoption of new laws, regulations or policies,
could have a material adverse effect on our business, financial condition and
results of operations. Our failure to comply with these laws and regulations
could subject us to civil and criminal penalties.
28
Our operations and properties are also subject to a wide variety of increasingly
complex and stringent federal, state, local and international laws and
regulations, including those governing the use, storage, handling, generation,
treatment, emission, release, discharge and disposal of materials, substances
and wastes, the remediation of contaminated soil and groundwater and the health
and safety of employees. Such environmental laws, including but not limited to
those under the Comprehensive Environmental Response Compensation & Liability
Act, may impose joint and several liability and may apply to conditions at
properties presently or formerly owned or operated by an entity or its
predecessors, as well as to conditions at properties at which wastes or other
contamination attributable to an entity or its predecessors have been sent or
otherwise come to be located.
The nature of our operations exposes us to the risk of claims with respect to
such matters, and we can give no assurance that violations of such laws have not
occurred or will not occur or that material costs or liabilities will not be
incurred in connection with such claims. Specifically, in connection with our
acquisition of Dana Corporation's engine management business, Dana retained
responsibility to remediate known environmental claims and contaminations with
respect to certain acquired or leased properties. However, we may be subject to
future environmental liabilities to the extent that there are unknown
contaminations on such properties. In addition, on March 3, 2006, Dana filed a
voluntary petition for relief under Chapter 11 of the US Bankruptcy Code. To the
extent that Dana is released from any of its environmental remediation liability
or indemnification obligations to us as a result of its Chapter 11 bankruptcy
proceedings, third parties (including governmental agencies) may seek to have us
pay the environmental remediation costs for such properties asserting claims
against us as a prior owner or occupier of such properties. Although we believe
that we have valid defenses to any asserted environmental claims, we can give no
assurance that we would be successful in our defenses or that we will not be
subject to future environmental liability with respect to such properties.
One of our facilities is currently undergoing minor environmental remediation.
The environmental remediation costs at such facility are covered by an insurance
policy of $3 million, which is subject to a $1.5 million deductible; we have
purchased additional environmental insurance coverage in the amount of $2
million with a $0.1 million deductible relating to such facility. We also
maintain two $10 million environmental policies to cover our existing U.S.
facilities. Based upon our experience to date, we believe that the future cost
of compliance with existing environmental laws, and liability for known
environmental claims pursuant to such environmental laws, will not give rise to
additional significant expenditures or liabilities that would be material to us.
However, future events, such as new information, changes in existing
environmental laws or their interpretation, and more vigorous enforcement
policies of regulatory agencies, may have a material adverse effect on our
business, financial condition and results of operations.
ITEM 6. EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
29
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: May 10, 2006 /s/ James J. Burke
------------------
James J. Burke
Vice President Finance,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ Luc Gregoire
Luc Gregoire
Corporate Controller and
Chief Accounting Officer
30
STANDARD MOTOR PRODUCTS, INC.
EXHIBIT INDEX
EXHIBIT
NUMBER
- ------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer furnished pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.