Item 7. Management’s Discussion and Analysis
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussion summarizes the significant factors affecting our results of operations and the financial condition of our business during each of the fiscal years in the three-year period ended December 31, 2020.
Overview
We are a leading independent manufacturer and distributor of premium replacement parts for the engine management and temperature control systems of motor vehicles in the automotive aftermarket industry with a complementary focus on the heavy duty, industrial equipment and original equipment markets.
We are organized into two operating segments. Each segment focuses on providing our customers with full-line coverage of its products, and a full suite of complementary services that are tailored to our customers’ business needs and driving end-user demand for our products. We sell our products primarily to automotive aftermarket retailers, program distribution groups, warehouse distributors, original equipment manufacturers and original equipment service part operations in the United States, Canada, Europe, Asia, Mexico and other Latin American countries.
Our Business Strategy
Our mission is to be the best full-line, full-service supplier of premium engine management and temperature control products .
The key elements of our strategy are as follows:
•
Maintain Our Strong Competitive Position in our Engine Management and Temperature Control Businesses . We are a leading independent manufacturer and distributor serving North America and other geographic areas in our core businesses of Engine Management and Temperature Control. We believe that our success is attributable to our emphasis on product quality, the breadth and depth of our product lines for both domestic and import vehicles, and our reputation for outstanding value-added services.
To maintain our strong competitive position, we remain committed to the following:
•
providing our customers with full-line coverage of high quality engine management and temperature control products and new technologies for all years, makes and models of vehicles on the road;
•
supporting our products with the highest level of value-added services;
•
supply chain excellence through supplier and customer focused initiatives, and continuing to maximize our production, supply chain and distribution efficiencies;
•
continuing to improve our cost position through increased global sourcing, increased manufacturing at our low-cost plants, and strategic transactions with manufacturers in low-cost regions; and
•
focusing on our engineering development efforts including a focus on bringing more product manufacturing in-house.
•
Provide Superior Value-Added Services and Product Availability . Our goal is to increase sales to existing and new customers by leveraging our skills in rapidly filling orders, maintaining high levels of product availability and offering a product portfolio that provides comprehensive coverage for all vehicle applications. Our marketing support provides insightful customer category management, technical support and award-winning programs, and our technically skilled sales personnel provide our customers with product selection, assortment and application support related to our products. In addition, we have a team dedicated to providing technical training on diagnosing and repairing vehicles equipped with complex systems.
28
Index
•
Expand Our Product Lines . Vehicle manufacturers continue to introduce new technologies and systems creating opportunities for us to expand our product lines. In addition, we intend to increase our sales by continuing to develop internally, or through potential acquisitions, the range of engine management and temperature control products that we offer to our customers. We are committed to investing the resources necessary to maintain and expand our technical capability to manufacture product lines that incorporate the latest technologies, including product lines relating to safety, advanced driver assistance and collision avoidance systems.
•
Broaden Our Customer Base and Diversify our Business . We seek to increase our customer base and diversify our business primarily by (a) leveraging our manufacturing and distribution capabilities to secure additional business globally with original equipment vehicle and equipment manufacturers and their service part operations, as well as our existing customer base of large retailers, program distribution groups, warehouse distributors, other manufacturers and export customers, (b) supporting the service part operations of vehicle and equipment manufacturers with value-added services and product support for the life of the part, (c) developing new product lines that compliment our existing product offering and have the potential for high growth within the automotive aftermarket and (d) expand our product offering in the heavy duty and commercial vehicle markets.
•
Improve Operating Efficiency and Cost Position . Our management places significant emphasis on improving our financial performance by achieving operating efficiencies and improving asset utilization, while maintaining product quality and high customer order fill rates.
•
Cash Utilization . We intend to apply any excess cash flow from operations and the management of working capital primarily to reduce our outstanding indebtedness, pay dividends to our shareholders, expand our product lines by investing in new tooling and equipment, grow revenues through potential acquisitions, and repurchase shares of our common stock. Commencing in the second quarter of 2020, we implemented many programs to conserve cash and reduce costs in response to the impact of the COVID-19 pandemic on our business, including by borrowing an additional $75 million under our amended credit agreement, and temporarily suspending our quarterly cash dividend payments and stock repurchases. In June 2020, we repaid the additional $75 million of borrowed funds. In September 2020, our Board of Directors approved to reinstate our stock repurchase program, and in October 2020, our Board of Directors approved the reinstatement of our quarterly cash dividend payments.
The Automotive Aftermarket
The automotive aftermarket replacement parts business differs substantially from the original equipment manufacturers (“OEM”) parts business. Unlike the OEM parts business that primarily follows trends in new car production, the automotive aftermarket replacement parts business primarily tends to follow different trends, such as:
•
the number of vehicles on the road;
•
the average age of vehicles on the road; and
•
the total number of miles driven per year.
29
Index
The automotive aftermarket industry is comprised of a large number of diverse manufacturers varying in product specialization and size. In addition to manufacturing, aftermarket companies must allocate resources towards an efficient distribution process in order to maintain the flexibility and responsiveness on which their customers depend. Aftermarket manufacturers must be efficient producers of small lot sizes, and must distribute, with rapid turnaround times, products for nearly all domestic and import vehicles on the road today.
Seasonality. Historically, our operating results have fluctuated by quarter, with the greatest sales occurring in the second and third quarters of the year and revenues generally being recognized at the time of shipment. It is in these quarters that demand for our products is typically the highest, specifically in the Temperature Control Segment of our business. In addition to this seasonality, the demand for our Temperature Control products during the second and third quarters of the year may vary significantly with the summer weather and customer inventories. Ordinarily, a warm summer, as we experienced in 2020, would increase the demand for our temperature control products, while a somewhat mild summer, as we experienced in 2019, may lessen such demand. In 2020, however, due to the impact of the COVID-19 pandemic, we initially experienced a significant reduction in customer demand for our products in the second quarter, with customer demand strengthening in the last half of the quarter and continuing throughout the second half of the year. As a result of this seasonality and variability in demand of our Temperature Control products, our working capital requirements typically 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.
Inventory Management. We face inventory management issues as a result of overstock returns. We permit our customers to return new, undamaged products to us within customer-specific limits (which are generally limited to a specified percentage of their annual purchases from us) in the event that they have overstocked their inventories. In addition, the seasonality of our Temperature Control Segment requires that we increase our inventory during the winter season in preparation of the summer selling season and customers purchasing such inventory have the right to make returns. We accrue for overstock returns as a percentage of sales after giving consideration to recent returns history.
Discounts, Allowances, and Incentives. We offer a variety of usual customer discounts, allowances and incentives. First, we offer cash discounts for paying invoices in accordance with the specified discount terms of the invoice. Second, we offer pricing discounts based on volume purchased from us and participation in our cost reduction initiatives. These discounts are principally in the form of “off-invoice” discounts and are immediately deducted from sales at the time of sale. For those customers that choose to receive a payment on a quarterly basis instead of “off-invoice,” we accrue for such payments as the related sales are made and reduce sales accordingly. Finally, rebates and discounts are provided to customers as advertising and sales force allowances, and allowances for warranty and overstock returns are also provided. Management analyzes historical returns, current economic trends, and changes in customer demand when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. We account for these discounts and allowances as a reduction to revenues, and record them when sales are recorded.
Impact of the Novel Coronavirus (“COVID-19”)
The global outbreak of the novel coronavirus (COVID-19) pandemic has created significant volatility, uncertainty and economic disruption in many countries in which we operate, including the United States, Mexico, Canada, Poland, and China. In certain countries in which we operate, national, state and local governments implemented a variety of measures in response to the COVID-19 pandemic that had the effect of restricting or limiting, among other activities, the operations of certain businesses. While many of these measures have eased, allowing for increased economic activity, there can be no assurances that restrictive measures will not be implemented again if the outbreak were to increase.
As we were declared an essential business under national and regional shelter-in-place orders, our business operations have continued throughout 2020. Although we initially experienced a significant reduction in customer demand for our products in the second quarter of 2020, our business began to rebound in the last half of the quarter as we experienced an increase in incoming orders and increased demand for our products. This trend continued into the second half of 2020 as our business improved to pre-COVID-19 levels with our customers’ POS sales exceeding their comparable figures for 2019, resulting in strong second half of 2020 results.
30
Index
In response to the COVID-19 pandemic, we established a committee, comprised of our executive officers, to oversee the Company’s risk identification, management and mitigation strategies regarding the impact of the pandemic on our business and operations. Among the issues that are actively being managed by the committee are those relating to the management of inventories and production volumes, cost reduction and cash preservation initiatives, and the enactment of policies and practices to ensure the health and safety of our employees, contractors and customers, as well as the impact of the continued duration and scope of the pandemic, of governmental measures in response to the pandemic, of potentially declining customer demand for our products, and of the potential future deterioration of general economic conditions and disruptions in our supply chain. The committee continues to meet on a regular basis, closely monitoring events related to the pandemic and any appropriate actions that may be taken.
Commencing in the second quarter of 2020, we implemented many cost reduction measures in response to the impact of the COVID-19 pandemic on our business, including the reduction of discretionary spending, salary reductions of our executive officers and Board of Directors, and suspension of our quarterly cash dividend payments and stock repurchases. In September 2020, our Board of Directors approved to reinstate our stock repurchase program; and in October 2020 our Board of Directors approved the reinstatement of our quarterly cash dividend of $0.25 per share. In November 2020, we reinstated the salaries of our executive officers and Board of Directors and retroactively restored their compensation.
Regarding the health and welfare of our employees, contractors and customers, we have implemented a number of policies and practices at all of our facilities. We have provided personal protection equipment, including face masks and gloves, to all our employees and require their usage while at work, have installed Plexiglas partitions where appropriate, and require temperature checks for all employees and visitors upon entering our facilities. We have established protocols for individuals who have tested positive, and for employees who have symptoms or have been exposed to the virus. All of our facilities are thoroughly cleaned and sanitized daily, and all state mandated protocols are followed as employees return to work after the lifting of shelter-in-place orders. The health and safety of our employees, vendors and visitors has always been and will continue to be our first priority.
The effects of the COVID-19 pandemic on our business, financial condition and results of operations in future periods may continue to be significant based upon the significant volatility, uncertainty and potential economic disruption caused by the pandemic.
See “Comparison of Results of Operations for Fiscal Years 2020 and 2019” of this Report for a further discussion of the impact of the COVID-19 pandemic on our business, results of operations and financial condition.
Impact of CARES Act and International Wage Subsidies
In March 2020, the U.S. enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act was passed to protect Americans from the public health and economic impacts of COVID-19. The CARES Act provides for fast and direct assistance for American workers, families and small businesses, and preserves jobs for American industries. As related to the preservation of jobs for American industries, the CARES Act includes the enactment of an employee retention feature, a payroll tax deferral opportunity and, in certain instances, payroll support and business loans.
The payroll tax deferral opportunity in the CARES Act enables businesses to enhance their cash flow by permitting the cash deferral of the payment of the employer’s share of the Social Security tax they otherwise would be responsible for paying to the federal government with respect to their employees. The amount of the cash deferral will be paid over the next two years, with 50% of the amount to be paid by December 31, 2021 and the remaining 50% by December 31, 2022. In April 2020, we elected to defer our share of the employers’ Social Security tax relating to wages paid to our employees. The total cash deferral as of December 31, 2020 is $5.5 million, which we plan to pay equally by December 31, 2021 and 2022.
31
Index
The employee retention feature of the CARES Act enables employers to obtain a tax credit for wages paid to employees unable to provide services to the company as a result of COVID-19. The tax credit is limited to 50% of up to $10,000 of wages per employee paid, or incurred, from March 13, 2020 through December 31, 2020. Although our manufacturing facilities were deemed to be an essential business and continued to operate, our headquarters in Long Island City, New York were forced to close under the New York State shelter-in-place mandate by the governor, which resulted in a $0.9 million tax credit as of December 31, 2020.
Additionally, we filed for wage subsidies in Canada and Poland under laws in those countries. After qualifying, in August 2020, we received a wage subsidy of CND $1.7 million (approximately US $1.3 million) from the Canadian government, and a wage subsidy of Zloty 2.8 million (approximately US $0.7 million) from the Polish government.
Impact of Changes in U.S. Trade Policy
Changes in U.S. trade policy, particularly as it relates to China, as with much of our industry, have resulted in the assessment of increased tariffs on goods that we import into the United States. Although our operating results in 2020 have been only slightly impacted by the tariff costs associated with Chinese sourced products, we have taken, and continue to take, several actions to mitigate the impact of the increased tariffs, including but not limited to, price increases to our customers. We do not anticipate that the increased tariffs will have a significant impact on our future operating results. Although we are confident that we will be able to pass along the impact of the increased tariffs to our customers, there can be no assurances that we will be able to pass on the entire increased costs imposed by the tariffs.
32
Index
Comparison of Results of Operations For Fiscal Years 2020 and 2019
Sales . Consolidated net sales for 2020 were $1,128.6 million, a decrease of $9.3 million, or 0.8%, compared to $1,137.9 million in the same period of 2019, with the majority of our net sales to customers located in the United States. Consolidated net sales decreased in our Engine Management Segment and increased in our Temperature Control Segment.
The following table summarizes consolidated net sales by segment and by major product group within each segment for the years ended December 31, 2020 and 2019 (in thousands):
Year Ended December 31,
2020
2019
Engine Management:
Ignition, Emission Control, Fuel & Safety Related System Products
$
691,722
$
705,994
Wire and Cable
143,963
143,167
Total Engine Management
835,685
849,161
Temperature Control:
Compressors
163,071
160,485
Other Climate Control Parts
118,883
117,870
Total Temperature Control
281,954
278,355
All Other
10,949
10,397
Total
$
1,128,588
$
1,137,913
Engine Management’s net sales decreased $13.5 million, or 1.6%, to $835.7 million for the year ended December 31, 2020. Net sales in ignition, emission control, fuel and safety related system products for the year ended December 31, 2020 were $691.7 million, a decrease of $14.3 million, or 2%, compared to $706 million in the same period of 2019. Net sales in the wire and cable product group for the year ended December 31, 2020 were $144 million, an increase of $0.8 million, or 0.6%, compared to $143.2 million in the same period of 2019. Engine Management’s decrease in net sales for the year ended December 31, 2020 compared to the same period in 2019 results primarily from lower year-over-year net sales in the second quarter of 2020 reflective of the impact of the COVID-19 pandemic and the resulting national and regional shelter-in-place orders related thereto. After a downturn in net sales initially in the second quarter of 2020 due to impact of the COVID-19 pandemic, customer orders strengthened in the last half of the second quarter and continued throughout the second half of 2020, resulting in strong Engine Management net sales in the second half of 2020, which have largely offset the steep declines experienced earlier in the year.
Temperature Control’s net sales increased $3.6 million, or 1.3%, to $282 million for the year ended December 31, 2020. Net sales in the compressors product group for the year ended December 31, 2020 were $163.1 million, an increase of $2.6 million, or 1.6%, compared to $160.5 million in the same period of 2019. Net sales in the other climate control parts group for the year ended December 31, 2020 were $118.9 million, an increase of $1 million, or 0.9%, compared to $117.9 million for the year ended December 31, 2019. Temperature Control’s increase in net sales for the year ended December 31, 2020, when compared to the same period in 2019, reflects the impact of a strong second half of the year after a significant year-over-year decrease in net sales in the first and second quarters of 2020. The lower year-over-year net sales in the first half of 2020 reflects the impact of strong pre-season orders in the first quarter of 2019 that did not recur in the first quarter of 2020; and the impact in the second quarter of 2020 of the COVID-19 pandemic and resulting national and regional shelter-in-place orders related thereto. After a downturn in net sales in the first quarter of 2020, and initially in the second quarter of 2020 due to impact of the COVID-19 pandemic, Temperature Control’s net sales strengthened in the last half of the second quarter and continued throughout the second half of 2020, aided by the impact of very warm summer weather conditions, which more than offset the declines earlier in the year. Demand for our Temperature Control products may vary significantly with summer weather conditions and customer inventory levels.
33
Index
Margins. Gross margins, as a percentage of consolidated net sales, increased to 29.8% for 2020, compared to 29.2% for 2019. The following table summarizes gross margins by segment for the years ended December 31, 2020 and 2019, respectively (in thousands):
Year Ended
December 31,
Engine
Management
Temperature
Control
Other
Total
2020
Net sales (a)
$
835,685
$
281,954
$
10,949
$
1,128,588
Gross margins
251,747
75,161
9,747
336,655
Gross margin percentage
30.1
%
26.7
%
—
%
29.8
%
2019
Net sales (a)
$
849,161
$
278,355
$
10,397
$
1,137,913
Gross margins
251,560
70,064
10,176
331,800
Gross margin percentage
29.6
%
25.2
%
—
%
29.2
%
(a)
Segment net sales include intersegment sales in our Engine Management and Temperature Control segments.
Compared to 2019, gross margins at Engine Management increased 0.5 percentage points from 29.6% to 30.1%, while gross margins at Temperature Control increased 1.5 percentage points from 25.2% to 26.7%. The gross margin percentage increases at both Engine Management and Temperature Control reflect the impact of improved year-over-year absorption in the third and fourth quarters of 2020, as production volumes increased due to higher year-over-year customer demand, which more than offset the decline in gross margins in the second quarter of 2020 caused by lower absorption and production volumes. The lower production volume at both Engine Management and Temperature Control in the second quarter of 2020 was reflective of the general slowdown in the worldwide economy caused by the COVID-19 pandemic, as we temporarily reduced production levels in several of our facilities in line with lower customer demand. As customer demand began to increase, the production levels at all of our facilities were adjusted to meet the increase in customer demand, resulting in higher year-over-year production volumes in the second half of 2020.
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) decreased to $224.7 million, or 19.9% of consolidated net sales in 2020, as compared to $234.7 million, or 20.6% of consolidated net sales in 2019. The $10 million decrease in SG&A expenses as compared to 2019 is principally due to lower selling and marketing expenses, lower costs incurred related to our accounts receivable supply chain financing arrangements resulting primarily from lower discount rates , annual savings initiatives, and to a lesser extent by certain non-recurring benefits from cost reduction initiatives . These decreases more than offset the impact of slightly higher distribution expenses, COVID-19 related costs, and $1.1 million of incremental expenses from our April 2019 acquisition of certain assets and liabilities of the Pollak business of Stoneridge Inc., including amortization of intangible assets acquired.
Intangible Asset Impairment. In December 2020, a large retail customer informed us of its decision to pursue a private brand strategy for its engine management product line. As a result of this development, we anticipate that products sold under the BWD trademark will be significantly reduced and uncertain beyond the first quarter of 2021. In connection with the decision, we recorded an impairment charge of $2.6 million in 2020.
Restructuring and Integration Expenses. Restructuring and integration expenses were $0.5 million in 2020 compared to restructuring and integration expenses of $2.6 million in 2019. Restructuring and integration expenses incurred in 2020 relate to (1) $0.3 million in environmental cleanup costs for ongoing monitoring and remediation in connection with the prior closure of our manufacturing operations at our Long Island City, New York location, and (2) $0.2 million in costs related to the residual relocation activities in our Engine Management segment in connection with our integration of the Pollak business of Stoneridge, Inc., acquired in April 2019. Restructuring and integration expenses incurred in 2019 of $2.6 million consisted of (1) $2.2 million of expenses related to relocation of certain inventory, machinery and equipment acquired in our April 2019 acquisition of the Pollak business of Stoneridge, Inc. to our existing facilities, and (2) $0.4 million in environmental cleanup costs for the ongoing monitoring and remediation at our Long Island City, New York former manufacturing facility.
34
Index
Operating Income. Operating income was $108.9 million in 2020, compared to $94.5 million in 2019. The year-over-year increase in operating income of $14.4 million is the result of the impact of higher gross margins as a percentage of consolidated net sales, lower SG&A expenses and lower restructuring and integration expenses, which more than offset the impact of lower consolidated net sales and the impairment charge related to the BWD trademark.
Other Non-Operating Income (Expense), Net. Other non-operating income, net was $0.8 million in 2020, compared to $2.6 million in 2019. The year-over-year decrease in other non-operating income, net results primarily from the decrease in year-over-year equity income from our joint ventures, which more than offset the year-over-year reduction in foreign exchange losses. The lower year-over-year equity income from our joint ventures is reflective of the general slowdown in the worldwide economy caused by the COVID-19 pandemic.
Interest Expense. Interest expense decreased to $2.3 million in 2020, compared to $5.3 million in 2019. The year-over-year decrease in interest expense reflects the impact of lower year-over-year average interest rates on our revolving credit facility, and lower average outstanding borrowings in 2020 when compared to 2019.
Income Tax Provision . The income tax provision for 2020 was $27 million at an effective tax rate of 25.1%, compared to $22.7 million at an effective tax rate of 24.8% in 2019. The higher effective tax rate in 2020 compared to 2019 results primarily from an increase in state and local taxes, and a change in the mix of U.S. and foreign income.
Loss From Discontinued Operations. Loss from discontinued operations, net of income tax, reflects information contained in the actuarial studies performed as of August 31, 2020 and updated in December 2020 to reflect events that occurred in the fourth quarter of 2020, and as of August 31, 2019, as well as other information available and considered by us, and legal expenses and other costs associated with our asbestos-related liability. During the years ended December 31, 2020 and 2019, we recorded a net loss of $23 million and $11.1 million from discontinued operations, respectively. The loss from discontinued operations for the year ended December 31, 2020 and 2019 includes a $25.7 million and $9.7 million pre-tax provision, respectively, to increase our indemnity liability in line with the 2020 and 2019 actuarial studies; and legal expenses and other miscellaneous expenses, before taxes, of $5.4 million during both 2020 and 2019. As discussed more fully in Note 21 “Commitments and Contingencies” in the notes to our consolidated financial statements, we are responsible for certain future liabilities relating to alleged exposure to asbestos containing products.
Comparison of Results of Operations For Fiscal Years 2019 and 2018
For a detailed discussion on the comparison of fiscal year 2019 to fiscal year 2018, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Restructuring and Integration Programs
All of our restructuring and integration programs have been substantially completed. For a detailed discussion on the restructuring and integration costs, see Note 3, “Restructuring and Integration Expense,” of the notes to our consolidated financial statements.
35
Index
Liquidity and Capital Resources
Operating Activities. During 2020, cash provided by operating activities was $97.9 million compared to $76.9 million in 2019. The year-over-year increase in operating cash flow is primarily the result of the decrease in inventories compared to the year-over-year increase in inventories in 2019, the smaller year-over-year increase in prepaid expenses and other current assets, the increase in accounts payable compared to the year-over-year decrease in accounts payable in 2019, and the increase in sundry payables and accrued expenses compared to the year-over-year decrease in sundry payables and accrued expenses in 2019, partially offset by the increase in accounts receivable compared to the year-over-year decrease in accounts receivable in 2019.
Net earnings during 2020, were $57.4 million compared to $57.9 million in 2019. During 2020, (1) the increase in accounts receivable was $71.9 million compared to the year-over-year decrease in accounts receivable of $2.8 million in 2019; (2) the decrease in inventories was $18 million compared to the year-over-year increase in inventories of $17.9 million in 2019; (3) the increase in accounts payable was $7.4 million compared to the year-over-year decrease in accounts payable of $2 million in 2019; (4) the increase in prepaid expenses and other current assets was $0.4 million compared to the year-over-year increase in prepaid expenses and other current assets of $8.3 million in 2019; and (5) the increase in sundry payables and accrued expenses was $40.7 million compared to the year-over-year decrease in sundry payables and accrued expenses of $3 million in 2019. The increase in receivables and decrease in inventories during 2020 is reflective of the significant increase in net sales in the second half of 2020 and the timing of cash receipts from customers; while the cash impact of the increase in sundry payables and accrued expenses relates primarily to the timing of the payment of customer rebates. We continue to actively manage our working capital to maximize our operating cash flow.
Investing Activities . Cash used in investing activities was $17.8 million in 2020 compared to $54.8 million in 2019. Investing activities in 2020 consisted of capital expenditures of $17.8 million.
Investing activities in 2019 consisted of (1) net cash proceeds of $4.8 million received in January 2019 from the December 2018 sale of our property in Grapevine, Texas; (2) the payment of $38.4 million for our acquisition of certain assets and liabilities of the Pollak business of Stoneridge, Inc.; (3) the payment of $5.1 million for our acquisition of an approximate 29% minority interest in Foshan Che Yijia New Energy Technology Co., Ltd.; and (4) capital expenditures of $16.2 million.
Financing Activities . Cash used in financing activities was $71.5 million in 2020 compared to $23.4 million in 2019. During 2020, (1) we reduced our borrowings under our revolving credit facility by $42.5 million; (2) we reduced our borrowings under lease obligations and our Polish overdraft facility by $4.2 million; (3) we made cash payments for the repurchase of shares of our common stock of $13.5 million; and (4) we paid dividends of $11.2 million. Cash provided by operating activities was used to pay down our revolving credit facility, our lease obligations and Polish overdraft facility, and to fund our investing activities, purchase shares of our common stock and pay dividends.
Cash used in financing activities was $23.4 million in 2019. During 2019, (1) we increased borrowings under our revolving credit facility by $8.8 million; (2) we made cash payments for the repurchase of shares of our common stock of $10.7 million; and (3) we paid dividends of $20.6 million. Borrowings under our revolving credit facility, along with cash provided by operating activities, were used to fund our investing activities, purchase shares of our common stock and pay dividends.
Dividends of $11.2 million and $20.6 million were paid in 2020 and 2019, respectively. In January 2020, our Board of Directors voted to increase our quarterly dividend from $0.23 per share in 2019 to $0.25 per share in 2020. In April 2020, in response to the impact of the COVID-19 pandemic on our business, our Board of Directors approved to temporarily suspend our quarterly cash dividend payments and stock repurchases. In September 2020, our Board of Directors approved to reinstate our stock repurchase program; and in October 2020 our Board of Directors approved the reinstatement of our quarterly cash dividend of $0.25 per share, which was paid on December 1, 2020 to shareholders of record on November 16, 2020.
36
Index
Comparison of Liquidity and Capital Resources For Fiscal Years 2019 and 2018
For a detailed discussion of our Liquidity and Capital Resources comparison of fiscal year 2019 to fiscal year 2018, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Liquidity
Our primary cash requirements include working capital, capital expenditures, regular quarterly dividends, stock repurchases, principal and interest payments on indebtedness and acquisitions. Our primary sources of funds are ongoing net cash flows from operating activities and availability under our secured revolving credit facility (as detailed below).
In December 2018, we amended our Credit Agreement with JPMorgan Chase Bank, N.A., as agent, and a syndicate of lenders. The amended credit agreement provides for a senior secured revolving credit facility with a line of credit of up to $250 million (with an additional $50 million accordion feature) and extends the maturity date to December 2023. The line of credit under the amended agreement also allows for a $10 million line of credit to Canada as part of the $250 million available for borrowing. Direct borrowings under the amended credit agreement bear interest at LIBOR plus a margin ranging from 1.25% to 1.75% based on our borrowing availability, or floating at the alternate base rate plus a margin ranging from 0.25% to 0.75% based on our borrowing availability, at our option. The amended credit agreement is guaranteed by certain of our subsidiaries and secured by certain of our assets.
Borrowings under the amended credit agreement are secured by substantially all of our assets, including accounts receivable, inventory and certain fixed assets, and those of certain of our subsidiaries. Availability under the amended credit agreement is based on a formula of eligible accounts receivable, eligible drafts presented to the banks under our supply chain financing arrangements and eligible inventory. After taking into account outstanding borrowings under the amended credit agreement, there was an additional $237.1 million available for us to borrow pursuant to the formula at December 31, 2020. The loss of business of one or more of our key customers or, a significant reduction in purchases of our products from any one of them, could adversely impact availability under our revolving credit facility.
Outstanding borrowings under the credit agreement, which are classified as current liabilities, were $10 million and $52.5 million at December 31, 2020 and 2019, respectively; while letters of credit outstanding under the credit agreement were $2.8 million and $3.1 million at December 31, 2020 and 2019, respectively. Borrowings under the credit agreement have been classified as current liabilities based upon accounting rules and certain provisions in the agreement.
At December 31, 2020, the weighted average interest rate on our amended credit agreement was 1.4%, which consisted of $10 million in direct borrowings. At December 31, 2019, the weighted average interest rate on our amended credit agreement was 3.5%, which consisted of $40 million in direct borrowings at 2.3% and an alternative base rate loan of $12.5 million at 5%. Our average daily alternative base rate loan balance was $1.5 million and $1.7 million during 2020 and 2019, respectively.
At any time that our borrowing availability is less than the greater of either (a) $25 million, or 10% of the commitments if fixed assets are not included in the borrowing base, or (b) $31.25 million, or 12.5% of the commitments if fixed assets are included in the borrowing base, the terms of the amended credit agreement provide for, among other provisions, a financial covenant requiring us, on a consolidated basis, to maintain a fixed charge coverage ratio of 1:1 at the end of each fiscal quarter (rolling four quarters). As of December 31, 2020, we were not subject to these covenants. The amended credit agreement permits us to pay cash dividends of $20 million and make stock repurchases of $20 million in any fiscal year subject to a minimum availability of $25 million. Provided specific conditions are met, the amended credit agreement also permits acquisitions, permissible debt financing, capital expenditures, and cash dividend payments and stock repurchases of greater than $20 million.
Our Polish subsidiary, SMP Poland sp. z.o.o., has entered into an overdraft facility with HSBC France (Spolka Akcyjna) Oddzial w Polsce, formerly HSBC Bank Polska S.A., for Zloty 30 million (approximately $8 million). The facility, as amended, expires in December 2021. Borrowings under the overdraft facility will bear interest at a rate equal to WIBOR + 1.5% and are guaranteed by Standard Motor Products, Inc., the ultimate parent company. At December 31, 2020 and 2019, borrowings under the overdraft facility were Zloty 0.4 million (approximately US $0.1 million) and Zloty 16.7 million (approximately US $4.4 million), respectively.
37
Index
In order to reduce our accounts receivable balances and improve our cash flow, we are party to several supply chain financing arrangements, in which we may sell certain of our customers’ trade accounts receivable to such customers’ financial institutions. We sell our undivided interests in certain of these receivables at our discretion when we determine that the cost of these arrangements is less than the cost of servicing our receivables with existing debt. Under the terms of the agreements, we retain no rights or interest, have no obligations with respect to the sold receivables, and do not service the receivables after the sale. As such, these transactions are being accounted for as a sale.
Pursuant to these agreements, we sold $695.1 million and $719 million of receivables for the years ended December 31, 2020 and 2019, respectively, which was reflected as a reduction of accounts receivable in the consolidated balance sheet at the time of sale. A charge in the amount of $12.2 million, $22 million and $24.4 million related to the sale of receivables is included in selling, general and administrative expenses in our consolidated statements of operations for the years ended December 31, 2020, 2019 and 2018, respectively.
To the extent that these arrangements are terminated, our financial condition, results of operations, cash flows and liquidity could be adversely affected by extended payment terms, delays or failures in collecting trade accounts receivables. The utility of the supply chain financing arrangements also depends upon the LIBOR rate, as it is a component of the discount rate applicable to each arrangement. If the LIBOR rate increases significantly, we may be negatively impacted as we may not be able to pass these added costs on to our customers, which could have a material and adverse effect upon our financial condition, results of operations and cash flows.
In May 2018, our Board of Directors authorized the purchase of up to an additional $20 million of our common stock under a stock repurchase program. Under this program, during the year ended December 31, 2018 and 2019, we repurchased 201,484 and 221,748 shares of our common stock, respectively, at a total cost of $9.3 million and $10.7 million, respectively, thereby completing the 2018 Board of Directors authorization.
In March 2020, our Board of Directors authorized the purchase of up to $20 million of our common stock under a stock repurchase program. Under this program, during the year ended December 31, 2020, we repurchased 323,867 shares of our common stock, at a total cost of $13.5 million. As of December 31, 2020, there was approximately $6.5 million available for future stock purchases under the program. In February 2021, our Board of Directors authorized the purchase of up to an additional $20 million of our common stock under a new stock repurchase program, thereby increasing the amount available for future stock purchases to approximately $26.5 million. Stock will be purchased under the programs from time to time, in the open market or through private transactions, as market conditions warrant.
We anticipate that our cash flow from operations, available cash and available borrowings under our revolving credit facility will be adequate to meet our future liquidity needs for at least the next twelve months. Significant assumptions underlie this belief, including, among other things, that we will be able to mitigate the future impact, if any, of the COVID-19 pandemic and the decision of a large retail customer to pursue a private brand strategy for its engine management product line on our business and operating cash flow by managing our inventories and production levels to align with customer demand for our products, and effectively managing our costs and expenses, and that there will be no material adverse developments in our business, liquidity or capital requirements. If material adverse developments were to occur in any of these areas, there can be no assurance that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our revolving credit facility in amounts sufficient to enable us to pay the principal and interest on our indebtedness, or to fund our other liquidity needs. In addition, if we default on any of our indebtedness, or breach any financial covenant in our revolving credit facility, our business could be adversely affected.
For further information regarding the risks in our business, refer to Item 1A, “Risk Factors,” of this report.
38
Index
The following table summarizes our contractual commitments as of December 31, 2020 and expiration dates of commitments through 2028 (a) (b):
(In thousands)
2021
2022
2023
2024
2025
2026-2028
Total
Operating lease obligations
$
8,945
$
7,231
$
5,819
$
3,931
$
2,960
$
5,551
$
34,437
Postretirement benefits
32
29
25
25
25
25
161
Severance payments related to restructuring and integration
146
32
1
—
—
—
179
Total commitments
$
9,123
$
7,292
$
5,845
$
3,956
$
2,985
$
5,576
$
34,777
(a)
Indebtedness under our revolving credit facilities is not included in the table above as it is reported as a current liability in our consolidated balance sheets. As of December 31, 2020, amounts outstanding under our revolving credit facility was $10 million.
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.
You should be aware that preparation of our consolidated annual and quarterly financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. We can give no assurance that actual results will not differ from those estimates. Although we do not believe that there is a reasonable likelihood that there will be a material change in the future estimates, or in the assumptions that we use in calculating the estimates, the uncertain future effects, if any, of the COVID-19 pandemic, and other unforeseen changes in the industry, or business, could materially impact the estimates, and may have a material adverse effect on our business, financial condition and results of operations.
Revenue Recognition. We derive our revenue primarily from sales of replacement parts for motor vehicles from both our Engine Management and Temperature Control Segments. We recognize revenues when our performance obligation has been satisfied and the control of products has been transferred to a customer which typically occurs upon shipment. Revenue is measured as the amount of consideration we expect to receive in exchange for the transfer of goods or providing services. The amount of consideration we receive and revenue we recognize depends on the marketing incentives, product warranty and overstock returns we offer to our customers. For certain of our sales of remanufactured products, we also charge our customers a deposit for the return of a used core component which we can use in our future remanufacturing activities. Such deposit is not recognized as revenue at the time of the sale but rather carried as a core liability. At the same time, we estimate the core expected to be returned from the customer and record the estimated return as unreturned customer inventory. The liability is extinguished when a core is actually returned to us, or at period end when we estimate and recognize revenue for the core deposits not expected to be returned. We estimate and record provisions for cash discounts, quantity rebates, sales returns and warranties in the period the sale is recorded, based upon our prior experience and current trends. Significant management judgments and estimates must be made and used in estimating sales returns and allowances relating to revenue recognized in any accounting period.
Sales Returns and Other Allowances and Allowance for Doubtful Accounts. 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 and/or the result of installation error. In addition to warranty returns, we also permit our customers to return new, undamaged products to us within customer-specific limits (which are generally limited to a specified percentage of their annual purchases from us) in the event that they have overstocked their inventories. At the time products are sold, we accrue a liability for product warranties and overstock returns as a percentage of sales based upon estimates established using historical information on the nature, frequency and average cost of the claim and the probability of the customer return. At the same time, we record an estimate of anticipated customer returns as unreturned customer inventory. Significant judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. Revision to these estimates is made when necessary, based upon changes in these factors. We regularly study trends of such claims. At December 31, 2020 and 2019, the allowance for sales returns was $41 million and $35.2 million, respectively.
39
Index
Similarly, we must make estimates of the collectability of our accounts receivable. We specifically analyze accounts receivable and analyze historical and current economic trends, as well as reasonable and supportable forecasts, customer concentrations, customer credit‑worthiness, and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. At December 31, 2020 , the allowance for doubtful accounts and for discounts was $5.8 million.
New Customer Acquisition Costs . New customer acquisition costs refer to arrangements pursuant to which we incur change-over costs to induce a new customer to switch from a competitor’s brand. In addition, change-over costs include the costs related to removing the new customer’s inventory and replacing it with our inventory commonly referred to as a stock lift. New customer acquisition costs are recorded as a reduction to revenue when incurred.
Inventory Valuation. Inventories are valued at the lower of cost and net realizable value. Cost is 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 and net realizable value of inventory are determined by comparing the actual cost of the product to the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation of the inventory.
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. Future projected demand requires management judgment and is based upon (a) our review of historical trends and (b) our estimate of projected customer specific buying patterns and trends in the industry and markets in which we do business. Using rolling twelve month historical information, we estimate future demand on a continuous basis. As such, the historical volatility of such estimates has been minimal.
We utilize cores (used parts) in our remanufacturing processes for air conditioning compressors, diesel injectors, and diesel pumps. The production of air conditioning compressors, diesel injectors, and diesel pumps involves the rebuilding of used cores, which we acquire either in outright purchases from used parts brokers or from returns pursuant to an exchange program with customers. Under such exchange programs, at the time of sale of air conditioning compressors, diesel injectors, and diesel pumps, we estimate the core expected to be returned from the customer and record the estimated return as unreturned customer inventory.
In addition, many of our customers can return inventory to us based upon customer warranty and overstock arrangements within customer specific limits. At the time products are sold, we accrue a liability for product warranties and overstock returns and record as unreturned customer inventory our estimate of anticipated customer returns. Estimates are based upon historical information on the nature, frequency and probability of the customer return. Unreturned core, warranty and overstock customer inventory is recorded at standard cost. Revision to these estimates is made when necessary, based upon changes in these factors. We regularly study trends of such claims.
Accounting for Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that it is more likely than not that the deferred tax assets will not be recovered, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, we must include an expense or recovery, respectively, within the tax provision in the statement of operations.
40
Index
We maintain valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In determining whether a valuation allowance is warranted, we evaluate factors such as prior earnings history, expected future earnings, carryback and carryforward periods and tax strategies. We consider all positive and negative evidence to estimate if sufficient future taxable income will be generated to realize the deferred tax asset. We consider cumulative losses in recent years as well as the impact of one-time events in assessing our pre-tax earnings. Assumptions regarding future taxable income require significant judgment. Our assumptions are consistent with estimates and plans used to manage our business, which includes restructuring and integration initiatives that are expected to generate significant savings in future periods.
The valuation allowance of $1.6 million as of December 31, 2020 is intended to provide for the uncertainty regarding the ultimate realization of our U.S. foreign tax credit carryovers and foreign net operating loss carryovers. The assessment of the adequacy of our valuation allowance is based on our estimates of taxable income in these jurisdictions and the period over which our deferred tax assets will be recoverable. Based on these considerations, we believe it is more likely than not that we will realize the benefit of the net deferred tax asset of $44.8 million as of December 31, 2020, which is net of the remaining valuation allowance.
In the event that actual results differ from these estimates, or we adjust these estimates in future periods for current trends or expected changes in our estimating assumptions, we may need to modify the level of the valuation allowance which could materially impact our business, financial condition and results of operations.
In accordance with generally accepted accounting practices, we recognize in our financial statements only those tax positions that meet the more-likely-than-not recognition threshold. We establish tax reserves for uncertain tax positions that do not meet this threshold. During the years ended December 31, 2020, 2019 and 2018, we did not establish a liability for uncertain tax positions. Penalties associated with income tax matters are included in the provision for income taxes in our consolidated statement of operations.
Leases. We determine if an arrangement is a lease at inception. For operating leases, we include and report operating lease right-of-use (“ROU”) assets, sundry payables and accrued expenses, and noncurrent operating lease liabilities on our consolidated balance sheet for leases with a term longer than twelve months. Finance leases are reported on our consolidated balance sheets in property, plant and equipment, current portion of other debt, and long-term debt.
Operating lease ROU assets and operating lease liabilities are recognized at the lease commencement date based on the present value of the total lease payments over the lease term. Our ROU assets represent the right to use an underlying leased asset over the existing lease term, and the corresponding lease liabilities represent our obligation to make lease payments arising from the lease agreement. As most of our leases do not provide for an implicit rate, we use our secured incremental borrowing rate based on the information available when determining the present value of our lease payments. Our lease terms may include options to terminate, or extend, our lease when it is reasonably certain that we will execute the option. Lease agreements may contain lease and non-lease components, which are generally accounted for separately. Operating lease expense is recognized on a straight-line basis over the lease term.
Valuation of Long‑Lived and Intangible Assets and Goodwill. At acquisition, we estimate and record the fair value of purchased intangible assets, which primarily consist of customer relationships, trademarks and trade names, patents and non-compete agreements. The fair values of these intangible assets are estimated based on our assessment. Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations. Goodwill and certain other intangible assets having indefinite lives are not amortized to earnings, but instead are subject to periodic testing for impairment. Intangible assets determined to have definite lives are amortized over their remaining useful lives.
41
Index
We assess the impairment of long‑lived assets, identifiable intangibles assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. With respect to goodwill and identifiable intangible assets having indefinite lives, we test for impairment on an annual basis or in interim periods if an event occurs or circumstances change that may indicate the fair value is below its carrying amount. Factors we consider important, which could trigger an impairment review, include the following: (a) significant underperformance relative to expected historical or projected future operating results; (b) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (c) significant negative industry or economic trends. We review the fair values using the discounted cash flows method and market multiples.
When performing our evaluation of goodwill for impairment, if we conclude qualitatively that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then a quantitative impairment test would not required. If we are unable to reach this conclusion, then we would perform a goodwill quantitative impairment test. In performing the quantitative test, the fair value of the reporting unit is compared to its carrying amount. A charge for impairment is recognized by the amount by which the reporting unit’s carrying amount exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit.
Identifiable intangible assets having indefinite lives are reviewed for impairment on an annual basis using a methodology similar with that used to evaluate goodwill. Intangible assets having definite lives and other long-lived assets are reviewed for impairment whenever events such as product discontinuance, plant closures, product dispositions or other changes in circumstances indicate that the carrying amount may not be recoverable. In reviewing for impairment, we compare the carrying value of such assets to the estimated undiscounted future cash flows expected from the use of the assets and their eventual disposition. When the estimated undiscounted future cash flows are less than their carrying amount, an impairment loss is recognized equal to the difference between the assets fair value and their carrying value.
There are inherent assumptions and estimates used in developing future cash flows requiring our judgment in applying these assumptions and estimates to the analysis of identifiable intangibles and long‑lived asset impairment including projecting revenues, interest rates, tax rates and the cost of capital. Many of the factors used in assessing fair value are outside our control and it is reasonably likely that assumptions and estimates will change in future periods. These changes can result in future impairments. In the event our planning assumptions were modified resulting in impairment to our assets, we would be required to include an expense in our statement of operations, which could materially impact our business, financial condition and results of operations.
Share-Based Compensation. The provisions of FASB ASC 718, Stock Compensation , require the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values on the grant date. The value of the portion of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in our condensed consolidated statement of operations. Forfeitures are estimated at the time of grant based on historical trends in order to estimate the amount of share-based awards that will ultimately vest. We monitor actual forfeitures for any subsequent adjustment to forfeiture rates.
Environmental Reserves. We are subject to various U.S. Federal, state and local environmental laws and regulations and are involved in certain environmental remediation efforts. We estimate and accrue our liabilities resulting from such matters based upon a variety of factors including the assessments of environmental engineers and consultants who provide estimates of potential liabilities and remediation costs. Such estimates are not discounted to reflect the time value of money due to the uncertainty in estimating the timing of the expenditures, which may extend over several years. Potential recoveries from insurers or other third parties of environmental remediation liabilities are recognized independently from the recorded liability, and any asset related to the recovery will be recognized only when the realization of the claim for recovery is deemed probable.
42
Index
Asbestos Litigation. In evaluating our potential asbestos-related liability, we use an actuarial study that is prepared by a leading actuarial firm with expertise in assessing asbestos-related liabilities. We evaluate the estimate of the range of undiscounted liability to determine which amount to accrue. Based on the information contained in the actuarial study and all other available information considered by us, we have concluded that no amount within the range was more likely than any other and, therefore, in assessing our asbestos liability we compare the low end of the range to our recorded liability to determine if an adjustment is required. Legal costs are expensed as incurred. We will continue to perform an annual actuarial analysis during the third quarter of each year for the foreseeable future, and whenever events or changes in circumstances indicate that additional provisions may be necessary. Based on the actuarial studies and all other available information, we will continue to reassess the recorded liability and, if deemed necessary, record an adjustment to the reserve, which will be reflected as a loss or gain from discontinued operations. See Note 21, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements in Item 8 of this Report for additional information.
Other Loss Reserves. We have other loss exposures, for such matters as legal claims and legal proceedings. Establishing loss reserves for these matters requires estimates, judgment of risk exposure, and ultimate liability. We record provisions when the liability is considered probable and reasonably estimable. Significant judgment is required in both the determination of probability and the determination as to whether an exposure can be reasonably estimated. As additional information becomes available, we reassess our potential liability related to these matters. Such revisions of the potential liabilities could have a material adverse effect on our business, financial condition or results of operations.
Recently Issued Accounting Pronouncements
For a detailed discussion on recently issued accounting pronouncements and their impact on our consolidated financial statements, see Note 1, “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Item 8 of this Report.
43
Index