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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
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.
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(Exact name of registrant as specified in its charter)
NEW YORK 11-1362020
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
37-18 NORTHERN BLVD., LONG ISLAND CITY, N.Y. 11101
- -------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(718) 392-0200
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
As of the close of business on October 29, 2004, there were 19,781,728
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.
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Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets
September 30, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Operations and Retained Earnings
(Unaudited) for the Three Months and Nine Months Ended
September 30, 2004 and 2003 4
Consolidated Statements of Cash Flows (Unaudited) for the
Nine Months Ended September 30, 2004 and 2003 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
Item 4. Controls and Procedures 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 6. Exhibits 29
Signature 30
2
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except for shares and per share data)
September 30, December 31,
2004 2003
------------ ------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 16,905 $ 19,647
Accounts receivable, net (Note 7) 176,790 174,223
Inventories (Notes 5 and 7) 270,094 253,754
Deferred income taxes 13,070 13,148
Prepaid expenses and other current assets 11,513 7,399
------------ ------------
Total current assets 488,372 468,171
------------ ------------
Property, plant and equipment, net of
accumulated depreciation (Notes 6 and 7) 104,305 112,549
Goodwill and other intangibles (Note 3) 72,578 71,843
Other assets 41,989 41,962
------------ ------------
Total assets $ 707,244 $ 694,525
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable (Note 7) $ 111,214 $ 99,699
Current portion of long-term debt (Note 7) 534 3,354
Accounts payable 49,567 58,029
Sundry payables and accrued expenses 47,140 42,431
Restructuring accrual (Note 4) 8,000 16,000
Accrued rebates 24,054 18,989
Accrued customer returns 29,453 24,115
Payroll and commissions 15,040 14,221
------------ ------------
Total current liabilities 285,002 276,838
------------ ------------
Long-term debt (Note 7) 114,381 114,757
Postretirement medical benefits
and other accrued liabilities 41,409 36,848
Restructuring accrual (Note 4) 15,028 15,615
Accrued asbestos liabilities (Note 14) 26,278 24,426
------------ ------------
Total liabilities 482,098 468,484
------------ ------------
Commitments and contingencies (Notes 7,8,10,12 and 14)
Stockholders' equity (Notes 7,8,9,10 and 12):
Common stock - par value $2.00 per share:
Authorized - 30,000,000 shares;
issued 20,486,036 shares 40,972 40,972
Capital in excess of par value 57,867 58,086
Retained earnings 141,387 141,553
Accumulated other comprehensive income 1,872 4,814
Treasury stock - at cost (1,123,308 and 1,284,428
shares in 2004 and 2003, respectively) (16,952) (19,384)
------------ ------------
Total stockholders' equity 225,146 226,041
------------ ------------
Total liabilities and stockholders' equity $ 707,244 $ 694,525
============ ============
See accompanying notes to consolidated financial statements.
3
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(In thousands, except for shares and per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Unaudited) (Unaudited)
Net sales $ 203,487 $ 214,479 $ 643,317 $ 516,329
Cost of sales 150,945 156,191 477,547 379,682
------------ ------------ ------------ ------------
Gross profit 52,542 58,288 165,770 136,647
Selling, general and administrative expenses 43,436 48,956 137,438 113,671
Integration expenses 4,669 1,926 8,592 2,702
------------ ------------ ------------ ------------
Operating income 4,437 7,406 19,740 20,274
Other income (expense) - net 823 125 1,766 (278)
Interest expense 3,474 4,070 10,389 10,276
------------ ------------ ------------ ------------
Earnings from continuing operations before taxes 1,786 3,461 11,117 9,720
Income tax expense 446 1,419 2,779 3,985
------------ ------------ ------------ ------------
Earnings from continuing operations 1,340 2,042 8,338 5,735
Loss from discontinued operation, net of tax (2,016) (591) (3,292) (1,372)
------------ ------------ ------------ ------------
Net earnings (loss) (676) 1,451 5,046 4,363
Retained earnings at beginning of period 143,805 149,439 141,553 148,686
------------ ------------ ------------ ------------
143,129 150,890 146,599 153,049
Less: cash dividends for period 1,742 1,728 5,212 3,887
------------ ------------ ------------ ------------
Retained earnings at end of period $ 141,387 $ 149,162 $ 141,387 $ 149,162
============ ============ ============ ============
PER SHARE DATA:
Net earnings per common share - basic:
Earnings per share from continuing operations $ 0.07 $ 0.11 $ 0.43 $ 0.39
Discontinued operation (0.10) (0.03) (0.17) (0.09)
------------ ------------ ------------ ------------
Net earnings (loss) per common share - basic $ (0.03) $ 0.08 $ 0.26 $ 0.30
============ ============ ============ ============
Net earnings per common share - diluted:
Earnings per share from continuing operations $ 0.07 $ 0.11 $ 0.43 $ 0.39
Discontinued operation (0.10) (0.03) (0.17) (0.09)
------------ ------------ ------------ ------------
Net earnings (loss) per common share - diluted $ (0.03) $ 0.08 $ 0.26 $ 0.30
============ ============ ============ ============
Average number of common shares 19,356,423 19,194,121 19,312,334 14,580,042
============ ============ ============ ============
Average number of common and dilutive shares 19,460,252 19,218,855 19,415,562 14,634,466
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
September 30,
-----------------------------
2004 2003
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net earnings $ 5,046 $ 4,363
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization 13,719 12,575
Loss on sale of property, plant and equipment 49 338
Equity income from joint ventures (872) (214)
Employee stock ownership plan allocation 1,233 708
Loss on discontinued operations, net of tax 3,292 1,372
Change in assets and liabilities, net of effects from acquisitions:
Increase in accounts receivable, net (3,201) (51,780)
(Increase) decrease in inventories (15,316) 10,028
(Increase) decrease in prepaid expenses and other current assets (5,193) 6,127
Decrease in other assets 810 689
Decrease in accounts payable (10,306) (3,431)
Increase in sundry payables and accrued expenses 9,774 8,761
Decrease in restructuring accrual (8,587) (500)
Increase in other liabilities 10,113 13,441
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Net cash provided by operating activities 561 2,477
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Cash flows from investing activities:
Proceeds from the sale of property, plant and equipment 887 85
Capital expenditures (6,112) (6,207)
Payments for acquisitions (2,906) (99,336)
------------ ------------
Net cash used in investing activities (8,131) (105,458)
------------ ------------
Cash flows from financing activities:
Net borrowings under line-of-credit agreements 11,515 43,686
Borrowings under new long term debt -- 10,000
Principal payments of long-term debt (3,196) (3,670)
Proceeds from the issuance of common stock, net of issuance costs -- 56,054
Increase in overdraft balances 1,844 4,670
Proceeds from exercise of employee stock options 569 27
Dividends paid (5,212) (3,887)
------------ ------------
Net cash provided by financing activities 5,520 106,880
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Effect of exchange rate changes on cash (692) 3,378
Net (decrease) increase in cash and cash equivalents (2,742) 7,277
Cash and cash equivalents at beginning of the period 19,647 9,690
------------ ------------
Cash and cash equivalents at end of the period $ 16,905 $ 16,967
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 12,026 $ 6,378
============ ============
Income taxes $ 1,627 $ 1,990
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See accompanying notes to consolidated financial statements.
5
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
Standard Motor Products, Inc. (referred to hereinafter in these notes to
consolidated financial statements as the "Company," "we," "us," or "our") is
engaged in the manufacture and distribution of replacement parts for motor
vehicles in the automotive aftermarket industry.
The accompanying unaudited financial information should be read in conjunction
with the audited consolidated financial statements and the notes thereto
included in our Annual Report on Form 10-K for the year ended December 31, 2003.
The unaudited consolidated financial statements include our accounts and all
domestic and international companies in which we have more than a 50% equity
ownership. Our investments in unconsolidated affiliates are accounted for on the
equity method. All significant inter-company items have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations for the interim periods are not
necessarily indicative of the results of operations for the entire year.
Where appropriate, certain amounts in 2003 have been reclassified to conform
with the 2004 presentation.
NOTE 2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In December 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46 (revised December 2003), Consolidation of Variable
Interest Entities ("FIN 46R"), which addresses how a business enterprise should
evaluate whether it has a controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, which was issued in January 2003. Effective January 1, 2004, we
adopted FIN 46R, which did not have a material effect on our consolidated
financial statements.
MEDICARE PRESCRIPTION DRUG, IMPROVEMENT AND MODERNIZATION ACT OF 2003
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the "Medicare Modernization Act") was signed into law. The Medicare
Modernization Act expanded Medicare to include, for the first time, coverage for
prescription drugs. At present, proposed regulations necessary to implement the
Medicare Modernization Act have been issued, including those that would specify
the manner in which actuarial equivalency must be determined, the evidence
required to demonstrate actuarial equivalency, and the documentation
requirements necessary to be entitled to the subsidy. Based on such proposed
regulations, we believe that our prescription drug benefit for our employee
retirees (other than certain union retirees) are expected to meet the actuarial
equivalence test in 2006 and, therefore, we would be eligible to receive a
subsidy from Medicare. However, our net periodic postretirement benefit cost
does not reflect any amount associated with the subsidy because such subsidy is
immaterial in amount.
6
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits ("Statement 132 (revised)"), was
issued. Statement 132 (revised) revises employers' disclosures about pension
plans and other postretirement benefit plans; it does not change the measurement
or recognition of those plans. Statement 132 (revised) retains and revises the
disclosure requirements contained in the original FASB Statement 132. It also
requires additional disclosures about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. Our disclosures in note 12 of notes to our
consolidated financial statements incorporate the requirements of Statement 132
(revised).
NOTE 3. GOODWILL AND OTHER INTANGIBLE ASSETS
GOODWILL
The changes in the carrying value of goodwill for our segments during the nine
months ended September 30, 2004 are as follows (in thousands):
Engine Temperature
Management Control Europe Total
-------------------------------------------------------------
Balance at December 31, 2003 $ 65,650 $ 4,822 $ 1,371 $ 71,843
Purchase accounting adjustments (15,313) -- -- (15,313)
Foreign currency adjustment -- -- 148 148
------------ ------------ ------------ ------------
Balance at September 30, 2004 $ 50,337 $ 4,822 $ 1,519 $ 56,678
============ ============ ============ ============
In connection with the acquisition of Dana Corporation's Engine Management Group
("DEM"), and the completion of purchase price allocations in June 2004 (see note
4 of notes to our consolidated financial statements), goodwill has been adjusted
by $14.1 million for intangible assets (see Acquired Intangible Assets below)
based on the fair market valuation performed during the second quarter of 2004.
Additionally, a purchase accounting adjustment relating to the acquired
inventory of $0.8 million was recorded during the second quarter of 2004. During
the third quarter of 2004, an additional $2 million was reclassified to
intangible assets from goodwill.
ACQUIRED INTANGIBLE ASSETS
Acquired identifiable intangible assets associated with the acquisition of DEM,
as of September 30, 2004, consist of (in thousands):
Accumulated
Gross Amortization Net
--------------------------------------------
Customer relationships $ 10,000 $ 200 $ 9,800
Trademarks and tradenames 6,100 -- 6,100
------------ ------------ ------------
$ 16,100 $ 200 $ 15,900
============ ============ ============
Of the total purchase price, $16.1 million was allocated to intangible assets
consisting of customer relationships and trademarks and tradenames; $10 million
was assigned to customer relationships and will be amortized on a straight-line
basis over the estimated useful life of 10 years; and the remaining $6.1 million
of acquired intangible assets was assigned to trademarks and tradenames which is
not subject to amortization as they were determined to have indefinite useful
lives.
Estimated amortization expense for the next five years is $0.4 million in 2004
(remaining three months) and $1.1 million in each year during 2005 through 2009.
7
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4. ACQUISITIONS, RESTRUCTURING AND INTEGRATION COSTS
ACQUISITION OF DANA'S EMG BUSINESS
On June 30, 2003, we completed the acquisition of substantially all of the
assets and assumed substantially all of the operating liabilities of DEM. Prior
to the sale, DEM was a leading manufacturer of aftermarket parts in the
automotive industry focused exclusively on engine management.
Under the terms of the acquisition, we paid Dana Corporation $93.2 million in
cash (includes $1.9 million paid in 2004 for final payment), issued an unsecured
subordinated promissory note of $15.1 million (as discussed more fully in note 7
of notes to our consolidated financial statements), and issued 1,378,760 shares
of our common stock valued at $15.1 million using an average market price of
$10.97 per share. The average market price was based on the average closing
price for a range of trading days proceeding the closing date of the
acquisition. Our final purchase price was approximately $130.5 million, which
included $7.1 million of transaction costs.
In connection with the acquisition of DEM, we completed a public equity offering
of 5,750,000 shares of our common stock for net proceeds of approximately $55.7
million. The net proceeds from this equity offering were used to repay a portion
of our outstanding indebtedness under our revolving credit facility with General
Electric Capital Corporation.
On June 30, 2003, we also completed an amendment to our revolving credit
facility, which increased the amount available under the credit facility by $80
million, to $305 million, as discussed more fully in note 7 of notes to our
consolidated financial statements. We then financed the cash portion of the
acquisition purchase price and the costs associated with the acquisition by
borrowing from our amended credit facility.
The purchase price of the acquisition is summarized as follows (in thousands):
Value of common stock issued $ 15,125
Unsecured subordinated promissory note 15,125
Cash consideration 93,172
-----------
Total consideration 123,422
Transaction costs 7,077
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Total purchase price $ 130,499
-----------
The acquisition purchase price was based upon the final book value of the
acquired assets of DEM less the book value of the assumed liabilities of DEM as
of the close of business on the closing date, subject to a maximum purchase
price of $125 million (not including transaction costs).
The following table summarizes the components of the net assets acquired based
upon the final purchase accounting (in thousands):
8
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Accounts receivable $ 65,162
Inventories 81,693
Property, plant and equipment 17,165
Goodwill 39,847
Intangible assets:
Customer relationships (estimated useful life of 10 years) 10,000
Trademarks and tradenames (indefinite life) 6,100
Other assets 128
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Total assets acquired $220,095
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Accounts payable $ 30,247
Sundry payables and accrued expenses 32,152
Accrued customer returns 7,013
Payroll and commissions 3,984
Other liabilities 16,200
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Total liabilities assumed 89,596
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Net assets acquired $130,499
--------
The acquisition was accounted for as a purchase transaction in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations, and accordingly, the assets and liabilities acquired were recorded
at their fair value at the date of the acquisition.
The excess of the purchase price over the estimated fair values of the net
assets acquired was recorded as goodwill. Certain adjustments were made to
goodwill subsequent to the acquisition date and are described in note 3 of notes
to our consolidated financial statements.
Goodwill of $39.8 million resulting from this acquisition has been assigned to
our Engine Management reporting unit. Goodwill associated with this acquisition
will be deductible for tax purposes.
The following table represents our unaudited pro forma consolidated statement of
operations for the nine months ended September 30, 2003, as if the acquisition
of DEM had been completed at January 1, 2003. The pro forma information is
presented for comparative purposes only and does not purport to be indicative of
what would have occurred had the acquisition actually been made at such date,
nor is it necessarily indicative of future operating results.
Nine Months Ended
September 30, 2003
------------------
(In thousands)
Net sales $660,061
Earnings from continuing operations $ 3,265
Earnings before cumulative effect of accounting change $ 1,893
Net earnings $ 1,893
Net earnings per common share:
Net earnings - Basic $ 0.10
Net earnings - Diluted $ 0.10
On February 3, 2004, we acquired inventory from the Canadian distribution
operation of DEM for approximately $1.0 million. We have relocated such
inventory into our distribution facility in Mississauga, Canada.
9
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
RESTRUCTURING COSTS (DEM ONLY)
In connection with the acquisition, we have reviewed our operations and
implemented integration plans to restructure the operations of DEM. We announced
in a press release on July 8, 2003 that we will close seven DEM facilities. As
part of the integration and restructuring plans, we accrued an initial
restructuring liability of approximately $34.7 million at June 30, 2003
(subsequently reduced to $33.7 million during 2003). Such amounts were
recognized as liabilities assumed in the acquisition and included in the
allocation of the costs to acquire DEM. Accordingly, such amounts resulted in
additional goodwill being recorded in connection with the acquisition.
Of the total restructuring accrual, approximately $15.7 million related to work
force reductions and represented employee termination benefits. The accrual
amount primarily provides for severance costs relating to the involuntary
termination of employees, individually employed throughout DEM's facilities
across a broad range of functions, including managerial, professional, clerical,
manufacturing and factory positions. During the year ended December 31, 2003 and
the nine months ended September 30, 2004, termination benefits of $2.1 million
and $6.9 million, respectively, have been charged to the restructuring accrual.
We expect to pay the remaining termination benefits by December 31, 2004. In
addition, during 2004 there was a non-cash adjustment of $1.6 million, as
workforce reduction costs are expected to be less than amounts originally
estimated.
The restructuring accrual also includes approximately $18.0 million associated
with exiting certain activities, primarily related to lease and contract
termination costs, which will not have future benefits. Specifically, our plans
are to consolidate certain of DEM operations into our existing plants. At
September 30, 2004, seven facilities have ceased operating activities. During
the nine months ended September 30, 2004, $1.7 million of costs have been
charged to the restructuring accrual. We expect to pay such costs through 2021.
In addition, during 2004 there was a non-cash adjustment of $1.6 million as exit
costs are expected to be more than originally estimated.
Selected information relating to the remaining restructuring costs is as follows
(in thousands):
Workforce Other
Reduction Exit Costs Totals
-----------------------------------------
Restructuring liability at December 31, 2003 $ 13,615 $ 18,000 $ 31,615
Cash payments during first nine months of 2004 (6,896) (1,691) (8,587)
Adjustments (1,600) 1,600 --
----------- ---------- ----------
Restructuring liability as of September 30, 2004 $ 5,119 $ 17,909 $ 23,028
----------- ---------- ----------
INTEGRATION EXPENSES (DEM ONLY)
During the third quarter of 2004 and 2003, we incurred $4.4 million and $0.9
million, respectively, of costs related to the DEM integration. For the nine
months ended September 30, 2004 and 2003, we incurred $8.3 million and $0.9
million, respectively, of costs related to the DEM integration. These costs
primarily related to equipment and inventory move costs, employee stay bonuses
and other facility consolidation costs.
10
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 5. INVENTORIES
September 30,
2004 December 31,
(unaudited) 2003
----------------------------
(in thousands)
Finished Goods $ 198,431 $ 191,340
Work in Process 5,879 7,913
Raw Materials 65,784 54,501
------------ ------------
Total inventories $ 270,094 $ 253,754
============ ============
NOTE 6. PROPERTY, PLANT AND EQUIPMENT
September 30,
2004 December 31,
(unaudited) 2003
----------------------------
(in thousands)
Land, buildings and improvements $ 72,120 $ 71,900
Machinery and equipment 139,314 137,770
Tools, dies and auxiliary equipment 20,756 20,068
Furniture and fixtures 29,352 27,743
Computer software 12,505 12,514
Leasehold improvements 7,280 7,285
Construction in progress 5,576 4,280
------------ ------------
286,903 281,560
Less: accumulated depreciation and amortization 182,598 169,011
------------ ------------
Total property, plant and equipment - net $ 104,305 $ 112,549
============ ============
NOTE 7. CREDIT FACILITIES AND LONG-TERM DEBT
CREDIT FACILITIES
Effective April 27, 2001, we entered into an agreement with General Electric
Capital Corporation, as agent, and a syndicate of lenders for a secured
revolving credit facility. The term of the credit agreement was for a period of
five years and provided for a line of credit up to $225 million.
On June 30, 2003, in connection with our acquisition of DEM we amended and
restated our revolving credit facility to provide for an additional $80 million
commitment. This additional commitment increases the total amount available for
borrowing under our revolving credit facility to $305 million from $225 million
and extends the term of the credit agreement to 2008. Availability under our
revolving credit facility is based on a formula of eligible accounts receivable,
eligible inventory and eligible fixed assets which includes the purchased assets
of DEM. Available borrowings pursuant to the formula at September 30, 2004 are
$86.6 million.
Direct borrowings under our revolving credit facility bear interest at the prime
rate plus the applicable margin (as defined in the credit agreement) or the
LIBOR rate plus the applicable margin (as defined in the credit agreement), at
our option. Outstanding borrowings under this revolving credit facility,
classified as current liabilities, was $106.7 million and $95.9 million at
September 30, 2004 and December 31, 2003, respectively. Borrowings are
collateralized by substantially all of our assets, including accounts
receivable, inventory and fixed assets, and those of our domestic and Canadian
subsidiaries. The terms of our revolving credit facility provide for, among
other provisions, financial covenants requiring us, on a consolidated basis, (1)
to maintain specified levels of earnings before interest, taxes, depreciation
and amortization (EBITDA) as defined in the amendments to the credit agreement,
at the end of each fiscal quarter through December 31, 2004, (2) commencing
September 30, 2004, to maintain specified levels of
11
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
fixed charge coverage at the end of each fiscal quarter (rolling twelve months)
through 2007, and (3) to limit capital expenditure levels for each fiscal year
through 2007. At September 30, 2004, we were not in compliance with the EBITDA
financial covenant, however we received a waiver of such covenant for fiscal
quarters ending September 30, 2004 and December 31, 2004.
In addition, our foreign subsidiary has a revolving credit facility. The amount
of short-term borrowings outstanding under this facility was $4.5 million and
$3.8 million at September 30, 2004 and December 31, 2003, respectively.
LONG-TERM DEBT
On July 26, 1999, we completed a public offering of convertible subordinated
debentures amounting to $90 million. The convertible debentures carry an
interest rate of 6.75%, payable semi-annually, and will mature on July 15, 2009.
The convertible debentures are convertible into 2,796,120 shares of our common
stock. We may, at our option, redeem some or all of the debentures at any time
on or after July 15, 2004, at the redemption prices set forth in the agreement
plus accrued interest. In addition, if a change in control, as defined in the
agreement, occurs we will be required to make an offer to purchase the
convertible debentures at a purchase price equal to 101% of their aggregate
principal amount, plus accrued interest.
In connection with our acquisition of DEM, we issued to Dana Corporation on June
30, 2003 an unsecured subordinated promissory note in the aggregate principal
amount of approximately $15.1 million. The promissory note bears an interest
rate of 9% per annum for the first year, with such interest rate increasing by
one-half of a percentage point (0.5%) on each anniversary of the date of
issuance. Accrued and unpaid interest is due quarterly under the promissory
note. The maturity date of the promissory note is December 31, 2008. The
promissory note may be prepaid in whole or in part at any time without penalty.
On June 27, 2003, we borrowed $10 million under a mortgage loan agreement. The
loan is payable in equal monthly installments. The loan bears interest at a
fixed rate of 5.50% maturing in July 2018. The mortgage loan is secured by the
related building and property.
September 30,
2004 December 31,
(unaudited) 2003
----------------------------
Long term debt consists of: (in thousands)
6.75% convertible subordinated debentures $ 90,000 $ 90,000
Unsecured promissory note 15,125 15,125
Mortgage loan 9,495 9,824
Other 295 3,162
------------ ------------
114,915 118,111
Less: current portion 534 3,354
------------ ------------
Total non-current portion of
long-term debt $ 114,381 $ 114,757
============ ============
NOTE 8. INTEREST RATE SWAP AGREEMENTS
We do not enter into financial instruments for trading or speculative purposes.
The principal financial instruments used for cash flow hedging purposes are
interest rate swaps. We enter into interest rate swap agreements to manage our
exposure to interest rate changes. The swaps effectively convert a portion of
our
12
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
variable rate debt under the revolving credit facility to a fixed rate, without
exchanging the notional principal amounts.
In October 2003, we entered into a new interest rate swap agreement with a
notional amount of $25 million that is to mature in October 2006. Under this
agreement, we receive a floating rate based on the LIBOR interest rate, and pay
a fixed rate of 2.45% on the notional amount of $25 million.
In July 2001, we entered into two interest rate swap agreements with an
aggregate notional principal amount of $75 million, one of which matured in
January 2003 and the other matured in January 2004. Under these agreements, we
received a floating rate based on the LIBOR interest rate, and paid a fixed rate
of 4.92% on a notional amount of $45 million (matured in January 2004) and 4.37%
on a notional amount of $30 million (matured in January 2003).
If, at any time, the swaps are determined to be ineffective, in whole or in
part, due to changes in the interest rate swap or underlying debt agreements,
the fair value of the portion of the interest rate swap determined to be
ineffective will be recognized as gain or loss in the statement of operations in
the "interest expense" caption for the applicable period. It is not expected
that any gain or loss will be reported in the statement of operations during the
year ending December 31, 2004 nor was any recorded in 2003.
NOTE 9. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss), net of income tax expense is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands) (in thousands)
Net earnings (loss) as reported $ (676) $ 1,451 $ 5,046 $ 4,363
Foreign currency translation adjustments 430 122 (593) 3,855
Minimum pension liability adjustment (2,610) -- (2,610) --
Change in fair value of interest rate
swap agreements (141) 336 261 949
-------- -------- -------- --------
Total comprehensive income, net of taxes $ (2,997) $ 1,909 $ 2,104 $ 9,167
======== ======== ======== ========
Accumulated other comprehensive income is comprised of the following:
September 30, December 31,
2004 2003
-----------------------------
(in thousands)
Foreign currency translation adjustments $ 5,187 $ 5,780
Unrealized income (loss) on interest rate
swap agreement, net of tax 150 (111)
Minimum pension liability (3,465) (855)
------------ ------------
Total accumulated other comprehensive income $ 1,872 $ 4,814
============ ============
NOTE 10. STOCK BASED COMPENSATION PLAN
Under Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("Statement No. 123"), we account for stock-based
compensation using the intrinsic value method in accordance with APB Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations. Stock
options granted during the three months and nine months ended September 30, 2004
13
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
and 2003 were exercisable at prices equal to the fair market value or greater of
our common stock on the dates the options were granted; therefore, no
compensation cost has been recognized for the stock options granted.
If we accounted for stock-based compensation using the fair value method of
Statement No. 123, as amended by Statement No. 148, the effect on net earnings
and basic and diluted earnings per share would have been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands, except (in thousands, except
per share amounts) per share amounts)
Net earnings (loss) as reported $ (676) $ 1,451 $ 5,046 $ 4,363
Less: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (129) (35) (323) (103)
---------- ---------- ---------- ----------
Pro forma net earnings $ (805) $ 1,416 $ 4,723 $ 4,260
========== ========== ========== ==========
Earnings per share:
Basic - as reported $ (0.03) $ 0.08 $ 0.26 $ 0.30
========== ========== ========== ==========
Basic - pro forma $ (0.04) $ 0.07 $ 0.24 $ 0.29
========== ========== ========== ==========
Diluted - as reported $ (0.03) $ 0.08 $ 0.26 $ 0.30
========== ========== ========== ==========
Diluted - pro forma $ (0.04) $ 0.07 $ 0.24 $ 0.29
========== ========== ========== ==========
At September 30, 2004, an aggregate 1,561,245 shares of authorized but unissued
common stock were reserved for issuance under our stock option plans.
NOTE 11. EARNINGS PER SHARE
Following are reconciliations of the earnings available to common stockholders
and the shares used in calculating basic and dilutive net earnings per common
share:
Three Months Ended Nine Months Ended
September 30, September 30,
(Unaudited) (Unaudited)
----------------------------- -----------------------------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands, except per share amounts)
Earnings from continuing operations $ 1,340 $ 2,042 $ 8,338 $ 5,735
Loss from discontinued operations (2,016) (591) (3,292) (1,372)
------------ ------------ ------------ ------------
Net earnings (loss) available to
common stockholders $ (676) $ 1,451 $ 5,046 $ 4,363
============ ============ ============ ============
Weighted average common shares
outstanding - basic 19,356,423 19,194,121 19,312,334 14,580,042
Dilutive effect of stock options 103,829 24,734 103,228 54,424
------------ ------------ ------------ ------------
Weighted average common shares
outstanding - diluted 19,460,252 19,218,855 19,415,562 14,634,466
============ ============ ============ ============
14
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The shares listed below were not included in the computation of diluted earnings
(loss) per share because to do so would have been anti-dilutive for the periods
presented.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
---- ---- ---- ----
Stock options 726,099 963,648 726,099 843,658
Convertible debentures 2,796,120 2,796,120 2,796,120 2,796,120
========== ========== ========== ==========
NOTE 12. EMPLOYEE BENEFITS (U.S. PLANS ONLY)
In 2000, we created an employee benefits trust to which we contributed 750,000
shares of treasury stock to the trust. We are authorized to instruct the
trustees to distribute such shares toward the satisfaction of our future
obligations under Employee Benefit Plans. The shares held in trust are not
considered outstanding for purposes of calculating earnings per share until they
are committed to be released. The trustees will vote the shares in accordance
with their fiduciary duties. We have committed 225,000 shares in the prior
years. During March 2004, we committed 110,000 shares to be released leaving
415,000 shares remaining in the trust.
In October 2001, we adopted an unfunded Supplemental Executive Retirement Plan
(SERP). The SERP is a defined benefit plan pursuant to which we will pay
supplemental pension benefits to certain key employees upon retirement based
upon the employees' years of service and compensation.
We provide certain medical and dental care benefits to eligible retired
employees. Our current policy is to fund the cost of the health care plans on a
pay-as-you-go basis.
The components of net period benefit cost for the three months ended September
30 are as follows:
Pension Benefits Postretirement Benefits
----------------------------------------------------
2004 2003 2004 2003
----------------------------------------------------
(in thousands)
Service cost $ 113 $ 88 $ 871 $ 637
Interest cost 80 55 455 411
Amortization of prior service cost 28 28 31 31
Actuarial net loss 37 36 20 10
---------- ---------- ---------- ----------
Net periodic benefit cost $ 258 $ 207 $ 1,377 $ 1,089
========== ========== ========== ==========
The components of net period benefit cost for the nine months ended September 30
are as follows:
Pension Benefits Postretirement Benefits
----------------------------------------------------
2004 2003 2004 2003
----------------------------------------------------
(in thousands)
Service cost $ 339 $ 264 $ 2,613 $ 1,911
Interest cost 240 165 1,365 1,233
Amortization of prior service cost 84 84 93 93
Actuarial net loss 111 108 60 30
---------- ---------- ---------- ----------
Net periodic benefit cost $ 774 $ 621 $ 4,131 $ 3,267
========== ========== ========== ==========
During the third quarter of 2004, we recorded a minimum pension liability
adjustment of $2.6 million related to the benefit plan in our European segment.
The adjustment was recorded in "accumulated other comprehensive income."
15
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 13. INDUSTRY SEGMENTS
Our three reportable operating segments are Engine Management, Temperature
Control and Europe.
Three Months Ended September 30,
---------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------
Operating Operating
--------- ---------
Net Sales Income (Loss) Net Sales Income (Loss)
--------- ------------- --------- -------------
(in thousands)
Engine Management $ 136,269 $ 8,586 $ 133,364 $ 6,493
Temperature Control 54,821 1,368 69,261 6,478
Europe 10,352 (508) 10,001 (1,253)
All Other 2,045 (5,009) 1,853 (4,312)
-------------- -------------- -------------- --------------
Consolidated $ 203,487 $ 4,437 $ 214,479 $ 7,406
============== ============== ============== ==============
Nine Months Ended September 30,
---------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------
Operating Operating
--------- ---------
Net Sales Income (Loss) Net Sales Income (Loss)
--------- ------------- --------- -------------
(in thousands)
Engine Management $ 422,802 $ 30,650 $ 288,436 $ 25,745
Temperature Control 182,266 6,645 191,239 8,502
Europe 31,375 (878) 31,954 (2,061)
All Other 6,874 (16,677) 4,700 (11,912)
-------------- -------------- -------------- --------------
Consolidated $ 643,317 $ 19,740 $ 516,329 $ 20,274
============== ============== ============== ==============
NOTE 14. COMMITMENTS AND CONTINGENCIES
In 1986, we acquired a brake business, which we subsequently sold in March 1998
and which is accounted for as a discontinued operation in the accompanying
consolidated financial statements. When we originally acquired this brake
business, we assumed future liabilities relating to any alleged exposure to
asbestos-containing products manufactured by the seller of the acquired brake
business. In accordance with the related purchase agreement, we agreed to assume
the liabilities for all new claims filed on or after September 1, 2001. Our
ultimate exposure will depend upon the number of claims filed against us on or
after September 1, 2001 and the amounts paid for indemnity and defense thereof.
At December 31, 2001, approximately 100 cases were outstanding for which we were
responsible for any related liabilities. At December 31, 2002, the number of
cases outstanding for which we were responsible for related liabilities
increased to approximately 2,500, which include approximately 1,600 cases filed
in December 2002 in Mississippi. We believe that these Mississippi cases filed
against us in December 2002 were due in large part to potential plaintiffs
accelerating the filing of their claims prior to the effective date of
Mississippi's tort reform statue in January 2003, which statute eliminated the
ability of plaintiffs to file consolidated cases. At December 31, 2003 and
September 30, 2004, approximately 3,300 and 3,500 cases, respectively, were
outstanding for which we were responsible for any related liabilities. Since
September 1, 2001, the amounts paid for settled claims are $2.1 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
16
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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, which study is updated in the third quarter
of each year, 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. We concluded that no amount within the range of settlement
payments was more likely than any other and, therefore, recorded the low end of
the range as the liability associated with future settlement payments through
2052 in our consolidated financial statements, in accordance with generally
accepted accounting principles.
Accordingly, based on the information contained in the actuarial study and all
other available information considered by us, we recorded an after tax charge of
$16.9 million as a loss from discontinued operation during the third quarter of
2002 to reflect such liability, excluding legal costs.
In accordance with our accounting policy, the actuarial study was updated as of
August 31, 2004 using methodologies consistent with the September 2002 study.
The updated study has estimated an undiscounted liability for settlement
payments, excluding legal costs, ranging from $28 million to $63 million for the
period through 2049. The change from the prior year study was a $1.5 million
increase for the low end of the range and a $7.9 million decrease for the high
end of the range. As a result, in September 2004, an incremental $3 million
provision was added to the asbestos accrual increasing the reserve to
approximately $28.2 million. Legal costs, which are expensed as incurred, and
are reported in loss from discontinued operation in the accompanying statement
of operations and retained earnings, are estimated to range from $22 million to
$27 million during the same period.
We plan on performing a similar actuarial analysis during the third quarter of
each year for the foreseeable future. Given the uncertainties associated with
projecting such matters into the future, the short period of time that we have
been responsible for defending these claims, and other factors outside our
control, we can give no assurance that additional provisions will not be
required. Management will continue to monitor the circumstances surrounding
these potential liabilities in determining whether additional provisions may be
necessary. At the present time, however, we do not believe that any additional
provisions would be reasonably likely to have a material adverse effect on our
liquidity or consolidated financial position.
We are involved in various other litigation and product liability matters
arising in the ordinary course of business. Although the final outcome of any
asbestos-related matters or any other litigation or product liability matter
cannot be determined, based on our understanding and evaluation of the relevant
facts and circumstances, it is our opinion that the final outcome of these
matters will not have a material adverse effect on our business, financial
condition or results of operations.
We generally warrant our products against certain manufacturing and other
defects. These product warranties are provided for specific periods of time of
the product depending on the nature of the product. As of September 30, 2004 and
2003, we have accrued $16.8 million and $23.1 million, respectively, for
estimated product warranty claims. The accrued product warranty costs are based
primarily on historical experience of actual warranty claims. Warranty claims
expense for the three months ended September 30, 2004 and 2003, were $14.7
million and $16.7 million, respectively, and $40.0 million and $40.3 million for
the nine months ended September 30, 2004 and 2003, respectively.
17
STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table provides the changes in our product warranties:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Balance, beginning of period $ 17,465 $ 15,545 $ 13,987 $ 10,360
Preliminary assumed liabilities of
Dana's EMG business -- 6,479 -- 6,479
Liabilities accrued for current year sales 14,665 16,657 40,039 40,296
Settlements of warranty claims (15,300) (15,589) (37,196) (34,043)
---------- ---------- ---------- ----------
Balance, end of period $ 16,830 $ 23,092 $ 16,830 $ 23,092
========== ========== ========== ==========
Note 15. Sale of Accounts Receivable
During 2004, we entered into agreements with certain financial institutions (on
behalf of itself or for any third party purchaser) to sell from time to time at
the option of either party an undivided interest in certain of our receivables
to such financial institutions. Pursuant to these agreements, we irrevocably
sold an aggregate of $136.3 million of receivables for the nine months ended
September 30, 2004. We transferred and conveyed all right, title and interest in
the receivables and have no further obligation with respect to the sold
receivables.
The sold receivables were removed from our balance sheet at the time of sale.
The discount associated with the sold receivables was $1.1 million and $1.6
million in the third quarter of 2004 and for the nine months ended September 30,
2004, respectively, and is included in "selling, general and administrative
expenses."
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS IN
THIS REPORT ARE INDICATED BY WORDS SUCH AS "ANTICIPATES," "EXPECTS," "BELIEVES,"
"INTENDS," "PLANS," "ESTIMATES," "PROJECTS" AND SIMILAR EXPRESSIONS. THESE
STATEMENTS REPRESENT OUR EXPECTATIONS BASED ON CURRENT INFORMATION AND
ASSUMPTIONS. FORWARD-LOOKING STATEMENTS ARE INHERENTLY SUBJECT TO RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE WHICH ARE
ANTICIPATED OR PROJECTED AS A RESULT OF CERTAIN RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO A NUMBER OF FACTORS, SUCH AS ECONOMIC AND MARKET
CONDITIONS; THE PERFORMANCE OF THE AFTERMARKET SECTOR; CHANGES IN BUSINESS
RELATIONSHIPS WITH OUR MAJOR CUSTOMERS AND IN THE TIMING, SIZE AND CONTINUATION
OF OUR CUSTOMERS' PROGRAMS; THE ABILITY OF OUR CUSTOMERS TO ACHIEVE THEIR
PROJECTED SALES; COMPETITIVE PRODUCT AND PRICING PRESSURES; INCREASES IN
PRODUCTION OR MATERIAL COSTS THAT CANNOT BE RECOUPED IN PRODUCT PRICING;
SUCCESSFUL INTEGRATION OF ACQUIRED BUSINESSES; PRODUCT LIABILITY MATTERS
(INCLUDING, WITHOUT LIMITATION, THOSE RELATED TO ESTIMATES TO ASBESTOS-RELATED
CONTINGENT LIABILITIES); AS WELL AS OTHER RISKS AND UNCERTAINTIES, SUCH AS THOSE
DESCRIBED UNDER QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND
THOSE DETAILED HEREIN AND FROM TIME TO TIME IN THE FILINGS OF THE COMPANY WITH
THE SECURITIES AND EXCHANGE COMMISSION. THOSE FORWARD-LOOKING STATEMENTS ARE
MADE ONLY AS OF THE DATE HEREOF, AND THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE OR REVISE THE FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW
INFORMATION, FUTURE EVENTS OR OTHERWISE. THE FOLLOWING DISCUSSION SHOULD BE READ
IN CONJUNCTION WITH THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE IN THIS 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").
Prior to the acquisition, DEM was a leading manufacturer of aftermarket parts in
the automotive industry focused exclusively on engine management. Our plan is to
restructure and to integrate the DEM business into our existing Engine
Management business.
Under the terms of the acquisition, we paid Dana Corporation $93.2 million in
cash, issued an unsecured promissory note of $15.1 million, and issued 1,378,760
shares of our common stock valued at $15.1 million. Our final purchase price was
approximately $130.5 million, which included $7.1 million of transaction costs.
In connection with the acquisition, we have reviewed our operations and
implemented integration plans to restructure the operations of DEM. As part of
the integration and restructuring plans, we closed seven of the DEM facilities,
and we estimate total restructuring costs of $33.7 million. Such amounts were
recognized as liabilities assumed in the acquisition and included in the
allocation of the cost to acquire DEM.
Based on our most recent estimates of the total restructuring costs,
approximately $15.7 million relates to work force reductions and employee
termination benefits. This amount primarily represents severance costs relating
to the involuntary termination of DEM employees individually employed throughout
DEM facilities across a broad range of functions, including managerial,
professional, clerical, manufacturing and factory positions. The restructuring
costs also include approximately $18.0 million associated with exiting certain
activities, primarily related to lease and contract termination costs.
19
The DEM acquisition in 2003 was strategic and continues to be our primary focus
in 2004. The critical goals we established for a successful integration were to
maintain the DEM customer base; reduce excess capacity by closing seven of the
acquired facilities in a 12 to 18 month timeframe; and complete the transition
for $30-35 million of cash outlays in restructuring and integration costs during
this same period. The integration has proceeded on schedule, and all DEM
operations including manufacturing, distribution, MIS, finance, sales and
marketing have been transferred to SMP locations. As planned, we have exited
seven of the acquired nine facilities, and this has been accomplished within our
original time frame of twelve to eighteen months. The integration moves have
been completed within budget, and thus far we have maintained all the DEM
customers. Based on our current expectations, we continue to believe that as we
achieve the planned material product cost savings, and our new employees achieve
normal efficiency, we will accomplish our target of $55 million annual savings
from the DEM acquisition. It is our goal to begin approaching this number by the
second half of 2005.
On February 3, 2004, we acquired inventory from the Canadian distribution
operation of DEM for approximately $1.0 million. We have relocated such
inventory into our distribution facility in Mississauga, Canada.
SEASONALITY. Historically, our operating results have fluctuated by quarter,
with the greatest sales occurring in the second and third quarters of the year
and revenues generally being recognized at the time of shipment. It is in these
quarters that demand for our products is typically the highest, specifically in
the Temperature Control segment of our business. In addition to this
seasonality, the demand for our Temperature Control products during the second
and third quarters of the year may vary significantly with the summer weather.
For example, a cool summer may lessen the demand for our Temperature Control
products, while a hot summer may increase such demand. As a result of this
seasonality and variability in demand of our Temperature Control products, our
working capital requirements peak near the end of the second quarter, as the
inventory build-up of air conditioning products is converted to sales and
payments on the receivables associated with such sales have yet to be received.
During this period, our working capital requirements are typically funded by
borrowing from our revolving credit facility.
The seasonality of our business offers significant operational challenges in our
manufacturing and distribution functions. To limit these challenges and to
provide a rapid turnaround time of customer orders, we traditionally offer a
pre-season selling program, known as our "Spring Promotion", in which customers
are offered a choice of a price discount or longer payment terms.
INVENTORY MANAGEMENT. We instituted an aggressive inventory reduction campaign
initiated in 2001. We targeted a minimum $30 million inventory reduction in
2001, but exceeded our goal by reducing inventory by $57 million that year. In
2002 and 2003, we further reduced inventory by $8 million and $4 million,
respectively, before giving consideration to the DEM acquisition. During the
first nine months of 2004, inventory levels have increased in our Engine
Management segment. We believe this increase is temporary as we manage through
the DEM integration process, while attempting to maintain customer service fill
rates. We have targeted an inventory reduction goal in 2005 and 2006 of $30
million and $20 million, respectively, due to the DEM integration process.
We face inventory management issues as a result of warranty and overstock
returns. Many of our products carry a warranty ranging from a 90-day limited
warranty to a lifetime limited warranty, which generally covers defects in
materials or workmanship and failure to meet industry published specifications.
In addition to warranty returns, we also permit our customers to return products
to us within customer-specific limits in the event that they have overstocked
their inventories. In particular, the seasonality of our Temperature Control
segment requires that we increase our inventory during the winter season in
preparation of the summer selling season and customers purchasing such inventory
have the right to make returns.
In order to better control warranty and overstock return levels, beginning in
2000 we tightened the rules for authorized warranty returns, placed further
restrictions on the amounts customers can return and instituted a program so
that our management can better estimate potential future product returns. In
addition, with respect to our air conditioning compressors, our most significant
customer product
20
warranty returns, we established procedures whereby a warranty will be voided if
a customer does not follow a twelve step warranty return process.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. During the first nine months of 2004, cash provided by
operations amounted to $0.6 million, compared to $2.5 million in the same period
of 2003. The decrease is primarily attributable to increased levels of
inventory, increased payments of accounts payable and cash payments against the
restructuring accrual. Offsetting the decrease was a lower increase in accounts
receivable. The lower increase in accounts receivable is primarily the result of
certain of our significant customers implementing negotiable draft programs,
whereby cash collections of accounts receivable balances can be made early at
our option, but at a discount to us. The cost of such discounts is recorded as
selling, general and administrative expenses. During the first nine months of
2004, inventory levels have increased in our Engine Management segment. We
believe this increase is temporary as we manage through the DEM integration
process, while attempting to maintain customer service fill rates. We have
targeted an inventory reduction in 2005 and 2006 of $30 million and $20 million,
respectively, to improve Engine Management inventory turns to historical levels.
INVESTING ACTIVITIES. Cash used in investing activities was $8.1 million in the
first nine months of 2004, compared to $105.5 million in the same period of
2003. The decrease is primarily due to the payment for the acquisition of DEM on
June 30, 2003. During 2004, payments for acquisitions include DEM in Canada and
the final cash payment for the DEM acquisition.
FINANCING ACTIVITIES. Cash provided by financing activities was $5.5 million in
the first nine months of 2004, compared to $106.9 million in the same period of
2003. The decrease is primarily due to the financing related to the acquisition
of DEM on June 30, 2003.
Effective April 27, 2001, we entered into an agreement with General Electric
Capital Corporation, as agent, and a syndicate of lenders for a secured
revolving credit facility. The term of the credit agreement was for a period of
five years and provided for a line of credit up to $225 million.
On June 30, 2003, in connection with our acquisition of DEM, we completed an
amendment to our revolving credit facility to provide for an additional $80
million commitment. This additional commitment increases the total amount
available for borrowing under our revolving credit facility to $305 million from
$225 million, and extends the term of the credit agreement to 2008. Availability
under our revolving credit facility is based on a formula of eligible accounts
receivable, eligible inventory and eligible fixed assets, which includes the
purchased assets of DEM. We expect such availability under the revolving credit
facility to be sufficient to meet our ongoing operating and integration costs.
Direct borrowings under our revolving credit facility bear interest at the prime
rate plus the applicable margin (as defined in the credit agreement) or the
LIBOR rate plus the applicable margin (as defined in the credit agreement), at
our option. Borrowings are collateralized by substantially all of our assets,
including accounts receivable, inventory and fixed assets, and those of our
domestic and Canadian subsidiaries. The terms of our revolving credit facility
provide for, among other provisions, new financial covenants requiring us, on a
consolidated basis, (1) to maintain specified levels of earnings before
interest, taxes, depreciation and amortization (EBITDA) as defined in the
amendments to the credit agreement, at the end of each fiscal quarter through
December 31, 2004, (2) commencing September 30, 2004, to maintain specified
levels of fixed charge coverage at the end of each fiscal quarter (rolling
twelve months) through 2007, and (3) to limit capital expenditure levels for
each fiscal year through 2007. At September 30, 2004, we were not in compliance
with the EBITDA financial covenant, however we received a waiver of such
covenant for the fiscal quarters ending September 30, 2004 and December 31,
2004.
In addition, in order to facilitate the aggregate financing of the DEM
acquisition, we completed a public equity offering of 5,750,000 shares of our
common stock for net proceeds of approximately $55.7 million and issued to Dana
Corporation 1,378,760 shares of our common stock valued at approximately $15.1
million.
21
In connection with our acquisition of DEM, on June 30, 2003 we also issued to
Dana Corporation an unsecured subordinated promissory note in the aggregate
principal amount of approximately $15.1 million. The promissory note bears an
interest rate of 9% per annum for the first year, with such interest rate
increasing by one-half of a percentage point (0.5%) on each anniversary of the
date of issuance. Accrued and unpaid interest is due quarterly under the
promissory note. The maturity date of the promissory note is December 31, 2008.
The promissory note may be prepaid in whole or in part at any time without
penalty.
On June 27, 2003, we borrowed $10 million under a mortgage loan agreement. The
loan is payable in equal monthly installments. The loan bears interest at a
fixed rate of 5.50% maturing in July 2018. The mortgage loan is secured by the
related building and property.
Our profitability and working capital requirements are seasonal due to the sales
mix of temperature control products. Our working capital requirements usually
peak near the end of the second quarter, as the inventory build-up of air
conditioning products is converted to sales and payments on the receivables
associated with such sales begin to be received. Our working capital is further
being impacted by restructuring and integration costs, as well as inventory
build-ups necessary to ensure order fulfillment during the DEM integration.
These increased working capital requirements are funded by borrowings from our
lines of credit. In 2004, we also received the benefit from accelerating
accounts receivable collections from customer draft programs. While this program
is new in 2004, we cannot ensure such programs will remain going forward. We
anticipate that our present sources of funds will continue to be adequate to
meet our near term needs.
In October 2003, we entered into a new interest rate swap agreement with a
notional amount of $25 million that is to mature in October 2006. Under this
agreement, we receive a floating rate based on the LIBOR interest rate, and pay
a fixed rate of 2.45% on the notional amount of $25 million.
On July 26, 1999, we issued convertible debentures, payable semi-annually, in
the aggregate principal amount of $90 million. The debentures are convertible
into 2,796,120 shares of our common stock, and mature on July 15, 2009. The
proceeds from the sale of the debentures were used to prepay an 8.6% senior
note, reduce short term bank borrowings and repurchase a portion of our common
stock.
During 1998 through 2000, the Board of Directors authorized multiple repurchase
programs under which we could repurchase shares of our common stock. During such
years, $26.7 million (in the aggregate) of common stock was repurchased to meet
present and future requirements of our stock option programs and to fund our
Employee Stock Option Plan (ESOP). As of December 31, 2003, we have Board
authorization to repurchase additional shares at a maximum cost of $1.7 million.
During 2003, 2002 and 2001 and the first nine months of 2004, we did not
repurchase any shares of our common stock.
The following is a summary of our contractual commitments, inclusive of our
acquisition of DEM as of December 31, 2003. There have been no significant
changes to this information at September 30, 2004.
---------------------------------------------------------
(IN THOUSANDS) 2004 2005 2006 2007 2008 THEREAFTER TOTAL
- ------------------------------------------------------------------------------------------------------------------
Principal payments of long
term debt $ 3,354 $ 555 $ 581 $ 610 $ 582 $112,429 $118,111
Operating leases 12,824 12,156 9,322 5,752 4,512 39,481 84,047
Interest rate swap agreements 207 -- (59) -- -- -- 148
Severance payments related
to integration 1,283 -- -- -- -- -- 1,283
-------- -------- -------- -------- -------- -------- --------
Total commitments $ 17,668 $ 12,711 $ 9,844 $ 6,362 $ 5,094 $151,910 $203,589
======== ======== ======== ======== ======== ======== ========
The table above excludes approximately $12 million (after adjustment in 2004) of
severance expected to be paid in 2004 after the DEM facilities are closed.
22
INTERIM RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2004 TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2003
SALES. Consolidated net sales in the third quarter of 2004 were $203.5 million,
a decrease of $11.0 million, or 5.1%, compared to $214.5 million in the third
quarter of 2003. The decrease in net sales was primarily in our Temperature
Control segment. Temperature Control net sales decreased by $14.4 million from
the comparable period in 2003 as a result of a very cold and wet summer. Engine
Management net sales increased $2.9 million or 2.2% in the third quarter of 2004
as compared to the comparable period in 2003.
GROSS MARGINS. Gross margins decreased to 25.8% in the third quarter of 2004
compared to 27.2% in the third quarter of 2003. The margin decrease was
primarily related to lower net sales in our Temperature Control segment.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $5.6 million to $43.4 million in the third
quarter of 2004, compared to $49.0 million in the third quarter of 2003. This
decrease was primarily due to savings achieved from the DEM integration offset
by an increase of $1.1 million in discount fees associated with the sale of
customer receivables (see note 15 of our notes to consolidated financial
statements). As a percentage of net sales, selling, general and administrative
expenses decreased to 21.3% in the third quarter of 2004 from 22.8% in the third
quarter of 2003.
INTEGRATION EXPENSES. Integration expenses in the third quarter of 2004 were
$4.7 million, primarily related to the DEM integration, compared to $1.9 million
in the third quarter of 2003, which primarily related to expenses associated
with the DEM integration and with the third quarter of 2003 divestiture of a
product line within our European segment.
OPERATING INCOME. Operating income was $4.4 million in the third quarter of
2004, compared to $7.4 million in the third quarter of 2003. The decrease was
primarily due to lower net sales in our Temperature Control segment and
increased expenses incurred related to the DEM integration and discount fees
related to the sale of customer receivables in 2004 as discussed above.
OTHER INCOME, NET. Other income, net, increased to $0.8 million in the third
quarter of 2004 compared to $0.1 million in the third quarter of 2003. The
increase was primarily due to reduced foreign exchange losses and higher income
from joint ventures.
INTEREST EXPENSE. Interest expense decreased by $0.6 million to $3.5 million in
the third quarter 2004 compared to $4.1 million the same period in 2003,
primarily due to the expiration of one of our interest rate swap agreements in
January 2004.
INCOME TAX PROVISION. The effective tax rate for continuing operations decreased
from 41% in the third quarter of 2003 to 25% in the third quarter of 2004,
primarily due to anticipated reduced losses in our European segment, for which
no income tax benefit is being recorded. In addition, higher earnings are
anticipated in our Hong Kong and Puerto Rico operations, which are lower tax
rate jurisdictions. The 25% current effective tax rate reflects our anticipated
tax rate for the balance of the year. However, significant changes in the mix of
earnings in our domestic or foreign operations and changes in operating results
in our European segment could have a significant impact on our effective tax
rate.
LOSS FROM DISCONTINUED OPERATION, NET OF TAX. Loss from discontinued operation,
net of tax reflect provisions for future indemnity payments and legal expenses
associated with our asbestos related liability. We recorded a charge, net of
taxes, of $2.0 million and $0.6 million as a loss from discontinued operations
for the three months ended September 30, 2004 and 2003, respectively. As
discussed more fully in note 14 of our notes to our consolidated financial
statements, we are responsible for certain future liabilities relating to
alleged exposure to asbestos containing products.
23
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2004 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2003
SALES. Consolidated net sales for the nine months ended September 30, 2004 were
$643.3 million, an increase of $127 million, or 24.6%, compared to $516.3
million in the same period of 2003. The net sales increase was primarily due to
the increased sales volumes resulting from the DEM acquisition. Our Engine
Management net sales increased approximately $134 million, or 47%, offset by our
Temperature Control net sales decrease of approximately $9 million or 5%.
GROSS MARGINS. Gross margins, as a percentage of consolidated net sales,
decreased by 0.7 percentage points to 25.8% for the nine months ended September
30, 2004 from 26.5% in the same period of 2003. The decrease was related to the
DEM acquisition, which was only included in one quarter in the prior period and
the reduction in Temperature Control segment net sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $137.4 million, for the nine months ended
September 30, 2004, compared to $113.7 million, in the same period of 2003. The
increase was primarily attributable to the increased sales volume from the DEM
acquisition and $1.6 million of discount fees associated with the sale of
customer receivables (see note 15 of notes to our consolidated financial
statements). As a percentage of net sales, selling, general and administrative
expenses decreased to 21.4% for the nine months ended September 30, 2004
compared to 22% for the comparable period in 2003.
INTEGRATION EXPENSES. Integration expenses for the nine months ended September
30, 2004 were $8.6 million, primarily related to the DEM integration compared to
$2.7 million for the same period in 2003, which was primarily related to
expenses associated with the DEM integration and with the divestiture of a
product line within our European segment.
OPERATING INCOME. Operating income decreased by $0.6 million to $19.7 million
for the nine months ended September 30, 2004, compared to $20.3 million in the
same period in 2003. The decrease was primarily the result of increased expenses
incurred related to the DEM integration and discount fees associated to the sale
of customer receivables in 2004.
OTHER INCOME (EXPENSE), NET. Other income, net, increased to $1.8 million for
the nine months ended September 30, 2004 compared to $(0.3) million in the same
period in 2003. The increase was primarily due to reduced foreign exchange
losses and higher income from joint ventures.
INTEREST EXPENSE. Interest expense increased by $0.1 million to $10.4 million
for the nine months ended September 30, 2004 compared to $10.3 million in the
same period in 2003, due to the issuance of the promissory note related to the
DEM acquisition offset by the reduction of interest due to the expiration of one
of our interest risk swap agreements in January 2004.
INCOME TAX PROVISION. The effective tax rate for continuing operations was 25%
for the first nine months of 2004 and 41% for the first nine months of 2003. The
decrease was primarily due to anticipated reduced losses in our European segment
for which no income tax benefit is being recorded. The 25% current effective tax
rate reflects our anticipated effective tax rate for the balance of the year.
However, significant changes in the mix of earnings in our domestic or foreign
operations and changes in operating results in our European segment could have a
significant impact on our effective tax rate.
LOSS FROM DISCONTINUED OPERATION, NET OF TAX. Loss from discontinued operation,
net of tax reflect provisions for future indemnity payments and legal expenses
associated with our asbestos related liability. We recorded $3.3 million and
$1.4 million as a loss from discontinued operations for the nine months ended
September 30, 2004 and 2003, respectively. As discussed in note 14 of the notes
to our consolidated financial statements, we are responsible for certain future
liabilities relating to alleged exposure to asbestos containing products.
24
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,
2003. Note that our preparation of this Quarterly Report on Form 10-Q requires
us to make estimates and assumptions that affect the reported amount of assets
and liabilities, disclosure of contingent assets and liabilities at the date of
our consolidated financial statements, and the reported amounts of revenue and
expenses during the reporting period. There can be no assurance that actual
results will not differ from those estimates.
REVENUE RECOGNITION. We derive our revenue primarily from sales of replacement
parts for motor vehicles, from our Engine Management, Temperature Control and
European segments. We recognize revenue from product sales upon shipment to
customers. As described below, significant management judgments and estimates
must be made and used in 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.
SALES RETURNS AND OTHER ALLOWANCES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS. The
preparation of financial statements requires our management to make estimates
and assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period.
Specifically, our management must make estimates of potential future product
returns related to current period product revenue. Management analyzes
historical returns, current economic trends, and changes in customer demand when
evaluating the adequacy of the sales returns and other allowances. Significant
management judgments and estimates must be made and used in connection with
establishing the sales returns and other allowances in any accounting period. At
September 30, 2004, the allowance for sales returns was $29.5 million.
Similarly, our management must make estimates of the uncollectability of our
accounts receivables. Management specifically analyzes accounts receivable and
analyzes historical bad debts, customer concentrations, customer
credit-worthiness, current economic trends and changes in our customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts. At
September 30, 2004, the allowance for doubtful accounts and for discounts was
$6.2 million.
ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements, we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income, and to the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we
25
establish a valuation allowance or increase this allowance in a period, we must
include an expense within the tax provision in the statement of operations.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. At September 30, 2004,
we had a valuation allowance of approximately $23.2 million, due to
uncertainties related to our ability to utilize some of our deferred tax assets.
The valuation allowance is based on our estimates of taxable income by
jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable.
In the event that actual results differ from these estimates, or we adjust these
estimates in future periods, we may need to establish an additional valuation
allowance which could materially impact our business, financial condition and
results of operations.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL. We assess the
impairment of identifiable intangibles and long-lived assets whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important, which could trigger an impairment
review, include the following: significant underperformance relative to expected
historical or projected future operating results; significant changes in the
manner of our use of the acquired assets or the strategy for our overall
business; and significant negative industry or economic trends. With respect to
goodwill, if necessary, we will test for potential impairment in the fourth
quarter of each year as part of our annual budgeting process. We review the fair
values of each of our reporting units using the discounted cash flows method and
market multiples.
RETIREMENT AND POSTRETIREMENT MEDICAL BENEFITS. Each year we calculate the costs
of providing retiree benefits under the provisions of SFAS 87, Employers'
Accounting for Pensions, and SFAS 106, Employers' Accounting for Postretirement
Benefits Other than Pensions. The key assumptions used in making these
calculations are disclosed in notes 11 and 12 of the notes to our consolidated
financial statements in our Annual Report on Form 10-K for the year ended
December 31, 2003. The most significant of these assumptions are the discount
rate used to value the future obligation, expected return on plan assets and
health care cost trend rates. We select discount rates commensurate with current
market interest rates on high-quality, fixed rate debt securities. The expected
return on assets is based on our current review of the long-term returns on
assets held by the plans, which is influenced by historical averages. The
medical cost trend rate is based on our actual medical claims and future
projections of medical cost trends.
ASBESTOS RESERVE. We are responsible for certain future liabilities relating to
alleged exposure to asbestos-containing products. A September 2002 actuarial
study estimated a liability for settlement payments ranging from $27.3 million
to $58 million. We concluded that no amount within the range of settlement
payments was more likely than any other and, therefore, recorded the low end of
the range as the liability associated with future settlement payments through
2052 in our consolidated financial statements, in accordance with generally
accepted accounting principles.
In accordance with our accounting policy, the actuarial study was updated as of
August 31, 2004 using methodologies consistent with the September 2002 study.
The updated study has estimated an undiscounted liability for settlement
payments, excluding legal costs, ranging from $28 million to $63 million for the
period through 2049. The change from the prior year study was a $1.5 million
increase for the low end of the range and a $7.9 million decrease for the high
end of the range. As a result, in September 2004, an incremental $3 million
provision was added to the asbestos accrual increasing the reserve to
approximately $28.2 million. Legal costs are estimated to range from $22 million
to $27 million during the same period. We plan on performing a similar annual
actuarial analysis during the third quarter of each year for the foreseeable
future. Based on this analysis and all other available information, we will
reassess the recorded liability and, if deemed necessary, record an adjustment
to the reserve, which will be reflected as a loss or gain from discontinued
operations. Legal expenses associated with asbestos-related matters are expensed
as incurred and recorded as a loss from discontinued operations in the statement
of operations.
26
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
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities ("FIN 46R"), which addresses
how a business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
Effective January 1, 2004, we adopted FIN 46R, which did not have a material
effect on our consolidated financial statements.
MEDICARE PRESCRIPTION DRUG, IMPROVEMENT AND MODERNIZATION ACT OF 2003
In December 2003, the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 (the "Medicare Modernization Act") was signed into law. The Medicare
Modernization Act expanded Medicare to include, for the first time, coverage for
prescription drugs. At present, proposed regulations necessary to implement the
Medicare Modernization Act have been issued, including those that would specify
the manner in which actuarial equivalency must be determined, the evidence
required to demonstrate actuarial equivalency, and the documentation
requirements necessary to be entitled to the subsidy. Based on such proposed
regulations, we believe that our prescription drug benefit for our employee
retirees (other than certain union retirees) are expected to meet the actuarial
equivalence test in 2006 and, therefore, we would be eligible to receive a
subsidy from Medicare. However, our net periodic postretirement benefit cost
does not reflect any amount associated with the subsidy because such subsidy is
immaterial in amount.
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS
In December 2003, FASB Statement No. 132 (revised), Employers' Disclosures about
Pensions and Other Postretirement Benefits ("Statement 132 (revised)"), was
issued. Statement 132 (revised) revises employers' disclosures about pension
plans and other postretirement benefit plans; it does not change the measurement
or recognition of those plans. Statement 132 (revised) retains and revises the
disclosure requirements contained in the original FASB Statement 132. It also
requires additional disclosures about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. Statement 132 (revised) generally is effective for
fiscal years ending after December 15, 2003. Our disclosures in note 12 of notes
to our consolidated financial statements incorporate the requirements of
Statement 132 (revised).
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, primarily related to foreign currency exchange
and interest rates. These EXPOSURES are actively monitored by management. We
have exchange rate exposure primarily with respect to the Canadian Dollar and
the British Pound. Our exposure to foreign exchange rate risk is due to certain
costs, revenues and borrowings being denominated in currencies other than a
subsidiary's functional currency. Similarly, we are exposed to market risk as
the result of changes in interest rates which may affect the cost of our
financing. It is our policy and practice to use derivative financial instruments
only to the extent necessary to manage exposures. We do not hold or issue
derivative financial instruments for trading or speculative purposes.
We manage our exposure to interest rate risk through the proportion of fixed
rate debt and variable rate debt in our debt portfolio. To manage a portion of
our exposure to interest rate changes, we enter into interest rate swap
agreements, as discussed in note 8 of notes to our consolidated financial
statements. We invest our excess cash in highly liquid short-term investments.
Our percentage of variable rate debt to total debt was 46% at December 31, 2003
and 49% at September 30, 2004.
Other than the aforementioned, there have been no significant changes to the
information presented in Item 7A (Market Risk) of our Annual Report on Form 10-K
for the year ended December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer,
we conducted an evaluation of our disclosure controls and procedures, as
such term is defined under Rule 13a-15(e) promulgated under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of
the period covered by this report. Based on their evaluation, our
principal executive officer and principal financial officer concluded that
the Company's disclosure controls and procedures are effective in
providing reasonable assurance that material information relating to the
Company and its consolidated subsidiaries was made known to them during
the period covered by this report.
On November 1, 2004, our independent registered public accounting firm,
Grant Thornton LLP, orally notified our Audit Committee that they had
identified several deficiencies which, when considered in the aggregate,
constituted a significant deficiency regarding our internal controls.
However, we have no reason to believe that these deficiencies resulted in
(a) a material weakness in our internal controls or (b) any material
inaccuracy to our financial statements. The deficiencies noted related to
(a) network security issues, (b) back-up and recovery matters, (c)
disaster recovery and business continuity plans and procedures, and (d)
documentation regarding IT policies and procedures. We have assigned a
high priority to the short term and long term improvement of our internal
controls and are in the process of correcting all of these deficiencies.
We plan to remediate these deficiencies as promptly as practicable.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referenced in paragraph
(a) above.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In 1986, we acquired a brake business, which we subsequently sold in March 1998
and which is accounted for as a discontinued operation in the accompanying
consolidated financial statements. When we originally acquired this brake
business, we assumed future liabilities relating to any alleged exposure to
asbestos-containing products manufactured by the seller of the acquired brake
business. In accordance with the related purchase agreement, we agreed to assume
the liabilities for all new claims filed on or after September 1, 2001. Our
ultimate exposure will depend upon the number of claims filed against us on or
after September 1, 2001 and the amounts paid for indemnity and defense thereof.
At December 31, 2001, approximately 100 cases were outstanding for which we were
responsible for any related liabilities. At December 31, 2002, the number of
cases outstanding for which we were responsible for related liabilities
increased to approximately 2,500, which include approximately 1,600 cases filed
in December 2002 in Mississippi. We believe that these Mississippi cases filed
against us in December 2002 were due in large part to potential plaintiffs
accelerating the filing of their claims prior to the effective date of
Mississippi's tort reform statute in January 2003, which statute eliminated the
ability of plaintiffs to file consolidated cases. At December 31, 2003 and
September 30, 2004, approximately 3,300 and 3,500 cases, respectively, were
outstanding for which we were responsible for any related liabilities. Since
September 1, 2001, the amounts paid for settled claims are $2.1 million. We do
not have insurance coverage for the defense and indemnity costs associated with
these claims.
We are involved in various other litigation and product liability matters
arising in the ordinary course of business. Although the final outcome of any
asbestos-related matters or any other litigation or product liability matter
cannot be determined, based on our understanding and evaluation of the relevant
facts and circumstances, it is our opinion that the final outcome of these
matters will not have a material adverse effect on our business, financial
condition or results of operations.
ITEM 6. EXHIBITS
10.13 Third Amendment to Amended and Restated Credit Agreement dated
August 11, 2004, among Standard Motor Products, Inc. as Borrower
and General Electric Capital Corp. and Bank of America, as
Lenders, filed with this report.
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: November 15, 2004 /s/ James J. Burke
------------------
James J. Burke
Vice President Finance,
Chief Financial Officer
(Principal Financial and Accounting
Officer)
30