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.
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.
As related to the deemed repatriation of earnings of foreign subsidiaries, the Act includes a mandatory one-time tax on accumulated earnings of foreign subsidiaries. As a result, all previously unremitted earnings for which no U.S. deferred tax liability had been accrued are now subject to U.S. tax. In accordance with the guidelines provided in the Act, as of December 31, 2017 we have aggregated the estimated foreign earnings and profits, utilized participating deductions and available foreign tax credits. The gross repatriation tax was $2.3 million, which was offset by $0.9 million of foreign tax credits for a net repatriation tax charge of $1.4 million. The net repatriation tax of $1.4 million was recorded in the fourth quarter of 2017. During the second quarter of 2018, we updated our estimate of the gross repatriation tax to $2.5 million, which was paid in full to the U.S. Treasury and which has been reflected in the second quarter 2018 tax provision. Notwithstanding the U.S. taxation of these amounts, we intend to continue to invest most or all of these earnings indefinitely outside of the U.S., and do not expect to incur any significant additional taxes related to such amounts.
Interim Results of Operations:
Comparison of the Three Months Ended June 30, 20182019 to the Three Months Ended June 30, 20172018
Sales. Consolidated net sales for the three months ended June 30, 20182019 were $286.6$305.2 million, a decreasean increase of $26.1$18.6 million, or 8.3%6.5%, compared to $312.7$286.6 million in the same period of 2017.2018, with the majority of our net sales to customers located in the United States. Consolidated net sales decreasedincreased in both our Engine Management and Temperature Control Segments.
The following table summarizes consolidated net sales by segment and by major product group within each segment for the three months ended June 30, 20182019 and 20172018 (in thousands):
| | Three Months Ended June 30, | | | Three Months Ended June 30, | |
| | 2018 | | | 2017 | | | 2019 | | | 2018 | |
Engine Management: | | | | | | | | | | | | |
Ignition, Emission and Fuel System Parts | | $ | 162,462 | | | $ | 178,105 | | |
Ignition, Emission Control, Fuel and Safety Related System Products | | | $ | 181,831 | | | $ | 162,462 | |
Wire and Cable | | | 40,967 | | | | 45,244 | | | | 36,211 | | | | 40,967 | |
Total Engine Management | | | 203,429 | | | | 223,349 | | | | 218,042 | | | | 203,429 | |
| | | | | | | | | | | | | | | | |
Temperature Control: | | | | | | | | | | | | | | | | |
Compressors | | | 46,940 | | | | 49,644 | | | | 52,493 | | | | 46,940 | |
Other Climate Control Parts | | | 33,430 | | | | 37,747 | | | | 31,913 | | | | 33,430 | |
Total Temperature Control | | | 80,370 | | | | 87,391 | | | | 84,406 | | | | 80,370 | |
| | | | | | | | | | | | | | | | |
All Other | | | 2,837 | | | | 1,989 | | | | 2,724 | | | | 2,837 | |
| | | | | | | | | | | | | | | | |
Total | | $ | 286,636 | | | $ | 312,729 | | | $ | 305,172 | | | $ | 286,636 | |
Engine Management’s net sales decreased $19.9increased $14.6 million, or 8.9%7.2%, to $203.4$218 million for the three months ended June 30, 2018.2019. Net sales in the ignition, emissionsemission control, fuel and fuel systems parts product groupsafety related system products for the three months ended June 30, 20182019 were $162.5$181.8 million, a decreasean increase of $15.6$19.3 million, or 8.8%11.9%, compared to $178.1$162.5 million in the same period of 2017.2018. Net sales in the wire and cable product group for the three months ended June 30, 20182019 were $41$36.2 million, a decrease of $4.3$4.8 million, or 9.5%11.7%, compared to $45.2$41 million in the three months ended June 30, 2017.2018. Engine Management’s decreaseincrease in net sales for the second quarter of 20182019 compared to the same period in 20172018 primarily reflects the impact of a strong second quarter in 2017 driven by pipeline ordersincremental sales from our April 2019 acquisition of certain customers, who were inassets and liabilities of the processPollak business of increasing the breadthStoneridge, Inc., as well as general price increases and depth of their inventories. In addition,tariff costs passed on to customers. Engine Management’s year-over-year decreaseincrease in net sales reflectswas offset, in part, by the impact of the gradualgeneral decline in our wire and cable business which is an older technology used on fewer cars, and due to its product lifecycle. Incremental sales from our acquisition of the product lifecycle will continuePollak business of $10.7 million were included in the net sales of the ignition, emission control, fuel and safety related system products market from the date of acquisition through June 30, 2019. Compared to reduce overallthe second quarter of 2018, excluding the incremental net sales from the acquisition, net sales in the ignition, emission control, fuel and safety related products market increased $8.6 million, or 5.3%, and Engine Management net sales. Excluding the impact of the prior year pipeline orders and the decline in the wire and cable business, our Engine Management business experienced increases in the low single digits, in line with our long term forecast for the division. Furthermore, our customers are reporting increases in Engine Management sell-through, showing sequential improvement over the last few quarters.sales increased $3.9 million, or 1.9%.
Temperature Control’s net sales decreased $7increased $4 million, or 8%5%, to $80.4$84.4 million for the three months ended June 30, 2018.2019. Net sales in the compressors product group for the three months ended June 30, 20182019 were $46.9$52.5 million, a decreasean increase of $2.7$5.6 million, or 5.4%11.8%, compared to $49.6$46.9 million in the same period of 2017.2018. Net sales in the other climate control parts product group for the three months ended June 30, 20182019 were $33.4$31.9 million, a decrease of $4.3$1.5 million, or 11.4%4.5%, compared to $37.7$33.4 million in the three months ended June 30, 2017.2018. Temperature Control’s decreaseincrease in net sales for the second quarter of 20182019 compared to the same period in 2017 reflects2018 is primarily due to strong pre-season orders as customers rebuild their inventory levels after a very strong 2018 selling season, and to a lesser extent due to incremental pricing for tariff costs passed on to customers. The decline in net sales in the other climate control parts product group results from the impact of the introduction of air conditioner repair kits, which are sold as a mild 2017 summer leavingcomplete repair kit inclusive of the compressor and other climate control parts. These air conditioner repair kits have been well received and are classified as sales under the compressor product group, resulting in a shift in reported sales from the other climate control parts product group into the compressor product group. Demand for our customers with higher than normal inventory levels going into 2018, and a cool early spring. As such, 2018 pre-season orders were significantly lower than 2017. However, in mid-May, the weather finally turned warm, and we began to see a large influx of orders in June. A portion of these were shipped in June, with the balance carrying over into July. Due to the continuing warm weather, our customers are experiencing substantial POS increases over 2017. As such, incoming business remains robust, and we anticipate healthy Temperature Control sales in the third quarter.products may vary significantly with summer weather conditions and customer inventory levels.
Gross Margins. Gross margins, as a percentage of consolidated net sales, decreasedincreased to 29.1% in the second quarter of 2019, compared to 28.4% in the second quarter of 2018, compared to 29% in the second quarter of 2017.2018. The following table summarizes gross margins by segment for the three months ended June 30, 20182019 and 2017,2018, respectively (in thousands):
Three Months Ended June 30, | | Engine Management | | | Temperature Control | | | Other | | | Total | | | Engine Management | | | Temperature Control | | | Other | | | Total | |
2019 | | | | | | | | | | | | | |
Net sales | | | $ | 218,042 | | | $ | 84,406 | | | $ | 2,724 | | | $ | 305,172 | |
Gross margins | | | | 63,780 | | | | 22,551 | | | | 2,574 | | | | 88,905 | |
Gross margin percentage | | | | 29.3 | % | | | 26.7 | % | | | — | | | | 29.1 | % |
| | | | | | | | | | | | | | | | | |
2018 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net sales | | $ | 203,429 | | | $ | 80,370 | | | $ | 2,837 | | | $ | 286,636 | | | $ | 203,429 | | | $ | 80,370 | | | $ | 2,837 | | | $ | 286,636 | |
Gross margins | | | 57,782 | | | | 20,800 | | | | 2,707 | | | | 81,289 | | | | 57,782 | | | | 20,800 | | | | 2,707 | | | | 81,289 | |
Gross margin percentage | | | 28.4 | % | | | 25.9 | % | | | — | | | | 28.4 | % | | | 28.4 | % | | | 25.9 | % | | | — | | | | 28.4 | % |
| | | | | | | | | | | | | | | | | |
2017 | | | | | | | | | | | | | | | | | |
Net sales | | $ | 223,349 | | | $ | 87,391 | | | $ | 1,989 | | | $ | 312,729 | | |
Gross margins | | | 65,599 | | | | 23,111 | | | | 1,956 | | | | 90,666 | | |
Gross margin percentage | | | 29.4 | % | | | 26.4 | % | | | — | | | | 29 | % | |
Compared to the second quarter of 2017,2018, gross margins at Engine Management decreased 1increased 0.9 percentage points from 29.4%28.4% to 28.4%29.3%, while gross margins at Temperature Control decreased 0.5increased 0.8 percentage points from 26.4%25.9% to 25.9%26.7%. The gross margin percentage decreaseincrease in Engine Management compared to the prior year reflects a year-over-year increaseour return to historical productivity in inefficiencies and redundant costs incurred during our various planned production moves,Reynosa, Mexico wire plant after the lengthy integration of General Cable, as well as a decline in production volumes.certain pricing actions, which more than offset the negative impact of tariff costs passed on to customers without any markup. The gross margin percentage decreaseincrease in Temperature Control compared to the prior year resulted primarily from lowerthe favorable impact of higher production volumes following a mild 2017 summer season.offset, in part, by tariffs passed on to customers without any markup.
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) were $60.5 million, or 19.8% of consolidated net sales, in the second quarter of 2019, as compared to $57.8 million, or 20.1% of consolidated net sales, in the second quarter of 2018, as compared to $60.32018. The $2.7 million or 19.3% of consolidated net sales, in the second quarter of 2017. The $2.5 million decreaseincrease in SG&A expenses as compared to the second quarter of 20172018 is principally due to lower(1) incremental expenses of $1.5 million from our acquisition of certain assets and liabilities of the Pollak business of Stoneridge. Inc., including amortization of intangible assets acquired; and (2) higher selling and marketing expenses, and higher costs incurred in our accounts receivable factoring program, all of which are associated with our decline inhigher sales volumes.volumes, along with slightly higher other general and administrative costs.
Restructuring and Integration Expenses. Restructuring and integration expenses for the second quarter of 20182019 were $0.2$0.6 million compared to restructuring and integration expenses of $1.2$0.2 million for the second quarter of 2017. The $12018. Restructuring and integration expenses incurred in the second quarter of 2019 of $0.6 million year-over-year decreaserelated to the relocation of certain inventory, machinery, and equipment acquired in our April 2019 acquisition of the Pollak business of Stoneridge, Inc. to our existing facilities in Disputanta, Virginia, Reynosa, Mexico and Independence, Kansas; while the restructuring and integration expenses reflects the impact of lower expenses incurred in connection withthe second quarter of 2018 of $0.2 million related to the plant rationalization program that commenced in February 2016, the Orlando plant rationalization program that commenced in January 2017, and the wire and cable relocation program announced in October 2016, all of which were winding down during 2018 and substantially completed as of December 31, 2018.
Other Income (Expense), Net. Other income, net was $3,000 in the second quarter of 2019, compared to $42,000 in the second quarter of 2018. Other Income, net in the second quarter of 2019 and 2018 included gains and losses on disposal of property, plant and equipment, and sublease rental income in 2018 of a portion of our facility in Canada.
Operating Income. Operating income increased to $27.7 million in the second quarter of 2019, compared to $23.4 million in the second quarter of 2018. The year-over-year increase in operating income of $4.3 million is the result of impact of higher consolidated net sales and higher gross margins as a percentage of consolidated net sales offset, in part, by higher restructuring and integration expenses and higher SG&A expenses.
Other Non-Operating Income, Net. Other non-operating income, net was $1.4 million in the second quarter of 2019, compared to $0.5 million in the second quarter of 2018. The year-over-year increase in other non-operating income, net results primarily from the increase in year-over-year equity income from our joint ventures offset, in part, by the unfavorable impact of changes in foreign currency exchange rates.
Interest Expense. Interest expense increased to $1.7 million in the second quarter of 2019, compared to $1.3 million in the second quarter of 2018. The year-over-year increase in interest expense reflects the impact of both higher average outstanding borrowings in 2019 when compared to 2018, and higher year-over-year average interest rates on our revolving credit facility.
Income Tax Provision. The income tax provision in the second quarter of 2019 was $6.9 million at an effective tax rate of 25% compared to $5.8 million at an effective tax rate of 25.5% for the same period in 2018. The lower effective tax rate in the second quarter of 2019 compared to the second quarter of 2018 results primarily from the reduced state and local effective tax rate, and a change in the U.S. and foreign mix of pre-tax income.
Loss from Discontinued Operations. During the second quarter of 2019 and 2018, the loss from discontinued operations, net of tax was $1.1 million and $0.9 million, respectively. The loss from discontinued operations, net of tax reflects legal related expenses associated with our asbestos liability, and interest accrued in the second quarter of 2019 related to the November 2018 verdict in an asbestos case in California which we are currently appealing. As discussed more fully in Note 16, “Commitments and Contingencies” in the notes to our consolidated financial statements (unaudited), we are responsible for certain future liabilities relating to alleged exposure to asbestos containing products.
Comparison of the Six Months Ended June 30, 2019 to the Six Months Ended June 30, 2018
Sales. Consolidated net sales for the six months ended June 30, 2019 were $588.9 million, an increase of $40.4 million, or 7.4%, compared to $548.5 million in the same period of 2018, with the majority of our net sales to customers in the United States. Consolidated net sales increased in both our Engine Management and Temperature Control Segments.
The following table summarizes consolidated net sales by segment and by major product group within each segment for the six months ended June 30, 2019 and 2018 (in thousands):
| | Six Months Ended June 30, | |
| | 2019 | | | 2018 | |
Engine Management: | | | | | | |
Ignition, Emission Control, Fuel and Safety Related System Products | | $ | 357,892 | | | $ | 323,539 | |
Wire and Cable | | | 73,339 | | | | 79,378 | |
Total Engine Management | | | 431,231 | | | | 402,917 | |
Temperature Control: | | | | | | | | |
Compressors | | | 92,304 | | | | 76,838 | |
Other Climate Control Parts | | | 61,026 | | | | 63,763 | |
Total Temperature Control | | | 153,330 | | | | 140,601 | |
| | | | | | | | |
All Other | | | 4,377 | | | | 4,944 | |
| | | | | | | | |
Total | | $ | 588,938 | | | $ | 548,462 | |
Engine Management’s net sales increased $28.3 million, or 7%, to $431.2 million for the first six months of 2019. Net sales in ignition, emission control, fuel and safety related system products for the six months ended June 30, 2019 were $357.9 million, an increase of $34.4 million, or 10.6%, compared to $323.5 million in the same period of 2018. Net sales in the wire and cable product group for the six months ended June 30, 2019 were $73.3 million, a decrease of $6.1 million, or 7.6%, compared to $79.4 million in the six months ended June 30, 2018. Engine Management’s increase in net sales for the first six months of 2019 compared to the same period in 2018 primarily reflects the impact of incremental sales from our April 2019 acquisition of certain assets and liabilities of the Pollak business of Stoneridge, Inc., as well as pipeline orders from certain customers in the first quarter of 2019, general price increases and tariff costs passed on to customers. Engine Management’s year-over-year increase in net sales was offset, in part, by the general decline in our wire and cable business due to its product lifecycle. Incremental sales from our acquisition of the Pollak business of $10.7 million were included in the net sales of the ignition, emission control, fuel and safety related system products market from the date of acquisition through June 30, 2019. Compared to the first six months of 2018, excluding the incremental net sales from the acquisition, net sales in the ignition, emission control, fuel and safety related system products market increased $23.7 million, or 7.3%, and Engine Management net sales increased $17.6 million, or 4.4%. The 4.4% increase in Engine Management net sales reflects the impact of pipeline orders from certain customers in the first quarter of 2019, general price increases, tariff costs passed on to customers, and low single digit organic growth.
Temperature Control’s net sales increased $12.7 million, or 9%, to $153.3 million for the first six months of 2019. Net sales in the compressors product group for the six months ended June 30, 2019 were $92.3 million, an increase of $15.5 million, or 20.1%, compared to $76.8 million in the same period of 2018. Net sales in the other climate control parts product group for the six months ended June 30, 2019 were $61 million, a decrease of $2.8 million, or 4.3%, compared to $63.8 million in the six months ended June 30, 2018. Temperature Control’s increase in net sales for the first six months of 2019 compared to the same period in 2018 is primarily due to strong pre-season orders as customers rebuild their inventory levels after a very strong 2018 selling season, and to a lesser extent due to incremental pricing for tariff costs passed on to customers. The decline in net sales in the other climate control parts product group results from the impact of the introduction of air conditioner repair kits, which are sold as a complete repair kit inclusive of the compressor and other climate control parts. These air conditioner repair kits have been well received and are classified as sales under the compressor product group, resulting in a shift in reported sales from the other climate control parts product group into the compressor product group. Demand for our Temperature Control products may vary significantly with summer weather conditions and customer inventory levels.
Gross Margins. Gross margins, as a percentage of consolidated net sales, increased to 28.3% in the first six months of 2019, compared to 28.1% during the same period in 2018. The following table summarizes gross margins by segment for the six months ended June 30, 2019 and 2018, respectively (in thousands):
Six Months Ended June 30, | | Engine Management | | | Temperature Control | | | Other | | | Total | |
2019 | | | | | | | | | | | | |
Net sales | | $ | 431,231 | | | $ | 153,330 | | | $ | 4,377 | | | $ | 588,938 | |
Gross margins | | | 123,473 | | | | 38,742 | | | | 4,653 | | | | 166,868 | |
Gross margin percentage | | | 28.6 | % | | | 25.3 | % | | | — | | | | 28.3 | % |
| | | | | | | | | | | | | | | | |
2018 | | | | | | | | | | | | | | | | |
Net sales | | $ | 402,917 | | | $ | 140,601 | | | $ | 4,944 | | | $ | 548,462 | |
Gross margins | | | 114,252 | | | | 34,467 | | | | 5,159 | | | | 153,878 | |
Gross margin percentage | | | 28.4 | % | | | 24.5 | % | | | — | | | | 28.1 | % |
Compared to the first six months of 2018, gross margins at Engine Management increased 0.2 percentage points from 28.4% to 28.6%, while gross margins at Temperature Control increased 0.8 percentage points from 24.5% to 25.3%. The gross margin percentage increase in Engine Management compared to the prior year reflects our return to historical productivity in our Reynosa, Mexico wire plant after the lengthy integration of General Cable, as well as certain pricing actions, which more than offset the negative impact of tariff costs passed on to customers without any markup. The gross margin percentage increase in Temperature Control compared to the prior year was attributable primarily to favorable production variances carried forward from 2018 as compared to the prior year’s unfavorable deferred production variances carried forward from 2017 offset, in part, by tariffs passed on to customers without any markup.
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) increased to $120.5 million, or 20.5% of consolidated net sales, in the first six months of 2019, as compared to $115.5 million, or 21.1% of consolidated net sales in the first six months of 2018. The $5 million increase in SG&A expenses as compared to the first six months of 2018 is principally due to (1) incremental expenses of $1.5 million from our acquisition of certain assets and liabilities of the Pollak business of Stoneridge. Inc., including amortization of intangible assets acquired; and (2) higher selling, marketing and distribution expenses, and higher costs incurred in our accounts receivable factoring program, all of which are associated with higher sales volumes, along with slightly higher other general and administrative costs.
Restructuring and Integration Expenses. Restructuring and integration expenses for the six months ended June 30, 2019 were $0.6 million compared to restructuring and integration expenses of $3.1 million in the same period of 2018. Restructuring and integration expenses incurred in the first six months of 2019 of $0.6 million related to the relocation of certain inventory, machinery, and equipment acquired in our April 2019 acquisition of the Pollak business of Stoneridge, Inc. to our existing facilities in Disputanta, Virginia, Reynosa, Mexico and Independence, Kansas; while the restructuring and integration expenses incurred in the first six months of 2018 of $3.1 million related to the plant rationalization program that commenced in February 2016, the Orlando plant rationalization program that commenced in January 2017, and the wire and cable relocation program announced in October 2016, all of which were substantially completed as of June 30,December 31, 2018.
Other Income (Expense), Net. Other expense, net was $3,000 in the first six months of 2019, compared to other income, net was $42,000 in the second quarter of 2018, compared to $0.3 million in the second quarterfirst six months of 2017.2018. During the second quarterfirst six months of 2017,2018, we recognized a deferred gain of $0.3$0.2 million related to the sale-leaseback of our Long Island City, New York facility. The recognition of the deferred gain related to the sale-leaseback of our Long Island City, New York facility ended in the first quarter of 2018 upon the termination of the initial 10-year lease term for the facility.
Operating Income. Operating income decreased to $23.4was $45.7 million in the second quarterfirst six months of 2018,2019, compared to $29.4$35.7 million for the same period in the second quarter of 2017.2018. The year-over-year decreaseincrease in operating income of $6$10 million is the result of the impact of lowerhigher consolidated net sales, and lowerhigher gross margins as a percentage of consolidated net sales, which more than offset the impact of lower SG&A expenses and lower restructuring and integration expenses offset, in part, by higher SG&A expenses.
Other Non-Operating Income, Net. Other non-operating income, net was $0.5$2.1 million in the second quarterfirst six months of 2018,2019, compared to $1other non-operating income, net of $0.4 million in the second quarterfirst six months of 2017.2018. The year-over-year declineincrease in other non-operating income, net resultedresults primarily from lowerthe increase in year-over-year equity income from our joint ventures offset, in part, by the unfavorable impact of changes in foreign currency exchange rates, and the year-over-year decline in the actuarial net gain related to our postretirement medical benefit plans. Our postretirement medical benefit plans to substantially all eligible U.S. and Canadian employees terminated on December 31, 2016.rates.
Interest Expense. Interest expense increased to $1.3$2.8 million in the second quarterfirst six months of 2018,2019, compared to $0.7$1.9 million for the same period in the second quarter of 2017.2018. The year-over-year increase in interest expense reflects the impact of both higher average outstanding borrowings in 2018during the first six months of 2019 when compared to 2017,the same period in 2018, and the higher year-over-year average interest rates on our revolving credit facility.
Income Tax Provision. The income tax provision infor the second quarter of 2018six months ended June 30, 2019 was $5.8$11.3 million at an effective tax rate of 25.5%25.1%, compared to $11.4$8.8 million at an effective tax rate of 38.5%25.7% for the same period in 2017.2018. The lower effective tax rate in the second quarterfirst six months of 20182019 compared to the second quarterfirst six months of 2017 reflects2018 results primarily from the impact of the Tax Cutsreduced state and Jobs Act enactedlocal effective tax rate, and a change in the U.S. in December 2017, which included a broad rangeand foreign mix of tax reform affecting businesses, including the reduction of the federal corporate tax rate from 35% to 21%, changes in the deductibility of certain business expenses, and the manner in which international operations are taxed in the U.S.pre-tax income.
Loss from Discontinued Operations. Loss During the first six months of 2019 and 2018, the loss from discontinued operations, net of tax was $2 million and $1.5 million, respectively. The loss from discontinued operations, net of tax reflects legal related expenses associated with our asbestos-related liability. We recorded $0.9 millionasbestos liability, and $0.5 million as a loss from discontinued operations forinterest accrued in the second quarterfirst six months of 2019 related to the November 2018 and 2017, respectively.verdict in an asbestos case in California which we are currently appealing. As discussed more fully in Note 16, “Commitments and Contingencies” in the notes to our consolidated financial statements (unaudited), we are responsible for certain future liabilities relating to alleged exposure to asbestos containing products.
Comparison of the Six Months Ended June 30, 2018 to the Six Months Ended June 30, 2017
Sales. Consolidated net sales for the six months ended June 30, 2018 were $548.5 million, a decrease of $46.6 million, or 7.8%, compared to $595.1 million in the same period of 2017. Consolidated net sales decreased in both our Engine Management and Temperature Control Segments.
The following table summarizes consolidated net sales by segment and by major product group within each segment for the six months ended June 30, 2018 and 2017 (in thousands):
| | Six Months Ended June 30, | |
| | 2018 | | | 2017 | |
Engine Management: | | | | | | |
Ignition, Emission and Fuel System Parts | | $ | 323,539 | | | $ | 343,258 | |
Wire and Cable | | | 79,378 | | | | 91,405 | |
Total Engine Management | | | 402,917 | | | | 434,663 | |
| | | | | | | | |
Temperature Control: | | | | | | | | |
Compressors | | | 76,838 | | | | 87,545 | |
Other Climate Control Parts | | | 63,763 | | | | 70,136 | |
Total Temperature Control | | | 140,601 | | | | 157,681 | |
| | | | | | | | |
All Other | | | 4,944 | | | | 2,763 | |
| | | | | | | | |
Total | | $ | 548,462 | | | $ | 595,107 | |
Engine Management’s net sales decreased $31.7 million, or 7.3%, to $402.9 million for the first six months of 2018. Net sales in the ignition, emissions and fuel systems parts product group for the six months ended June 30, 2018 were $323.5 million, a decrease of $19.8 million, or 5.8%, compared to $343.3 million in the same period of 2017. Net sales in the wire and cable product group for the six months ended June 30, 2018 were $79.4 million, a decrease of $12 million, or 13.2%, compared to $91.4 million in the first six months of 2017. Engine Management’s decrease in net sales for the first six months of 2018 compared to the same period in 2017 reflects the impact of the strong first six months of 2017 driven by pipeline orders from certain customers, who were in the process of increasing the breadth and depth of their inventories. In addition, Engine Management’s year-over-year decrease in net sales reflects the impact of the gradual decline in our wire and cable business, which is an older technology used on fewer cars, and due to the product lifecycle will continue to reduce overall Engine Management net sales. Excluding the impact of the prior year pipeline orders and the decline in the wire and cable business, our Engine Management business experienced increases in the low single digits, in line with our long term forecast for the division. Furthermore, our customers are reporting increases in Engine Management sell-through, showing sequential improvement over the last few quarters.
Temperature Control’s net sales decreased $17.1 million, or 10.8%, to $140.6 million for the first six months of 2018. Net sales in the compressors product group for the six months ended June 30, 2018 were $76.8 million, a decrease of $10.7 million, or 12.2%, compared to $87.5 million in the same period of 2017. Net sales in the other climate control parts product group for the six months ended June 30, 2018 were $63.8 million, a decrease of $6.3 million, or 9%, compared to $70.1 million in the first six months of 2017. Temperature Control’s decrease in net sales for the first six months of 2018 compared to the same period in 2017 reflects the impact of a mild 2017 summer leaving our customers with higher than normal inventory levels going into 2018, and a cool early spring. As such, 2018 pre-season orders were significantly lower than 2017. However, in mid-May, the weather finally turned warm, and we began to see a large influx of orders in June. A portion of these were shipped in June, with the balance carrying over into July. Due to the continuing warm weather, our customers are experiencing substantial POS increases over 2017. As such, incoming business remains robust, and we anticipate healthy Temperature Control sales in the third quarter.
Gross Margins. Gross margins, as a percentage of consolidated net sales, decreased to 28.1% in the first six months of 2018, compared to 29.4% during the same period in 2017. The following table summarizes gross margins by segment for the six months ended June 30, 2018 and 2017, respectively (in thousands):
Six Months Ended June 30, | | Engine Management | | | Temperature Control | | | Other | | | Total | |
2018 | | | | | | | | | | | | |
Net sales | | $ | 402,917 | | | $ | 140,601 | | | $ | 4,944 | | | $ | 548,462 | |
Gross margins | | | 114,252 | | | | 34,467 | | | | 5,159 | | | | 153,878 | |
Gross margin percentage | | | 28.4 | % | | | 24.5 | % | | | — | | | | 28.1 | % |
| | | | | | | | | | | | | | | | |
2017 | | | | | | | | | | | | | | | | |
Net sales | | $ | 434,663 | | | $ | 157,681 | | | $ | 2,763 | | | $ | 595,107 | |
Gross margins | | | 129,723 | | | | 40,818 | | | | 4,235 | | | | 174,776 | |
Gross margin percentage | | | 29.8 | % | | | 25.9 | % | | | — | | | | 29.4 | % |
Compared to the first six months of 2017, gross margins at Engine Management decreased 1.4 percentage points from 29.8% to 28.4%, and gross margins at Temperature Control decreased 1.4 percentage points from 25.9% to 24.5%. The gross margin percentage decrease in Engine Management compared to the prior year reflects a year-over-year increase in inefficiencies and redundant costs incurred during our various planned production moves, as well as the lower production volumes. The gross margin percentage decrease in Temperature Control compared to the prior year resulted primarily from lower production volumes following a mild 2017 summer season.
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) decreased to $115.5 million, or 21.1% of consolidated net sales, in the six months ended June 30, 2018, as compared to $117.8 million, or 19.8% of consolidated net sales, in the same period of 2017. The $2.3 million decrease in SG&A expenses as compared to the first six months of 2017 is principally due to lower selling and marketing expenses which are associated with our decline in sales volumes.
Restructuring and Integration Expenses. Restructuring and integration expenses for the six months ended June 30, 2018 were $3.1 million compared to restructuring and integration expenses of $2.8 million in the same period of 2017. The year-over-year increase in restructuring and integration expenses in the first six months of 2018 compared to the first six months of 2017 reflects the impact of higher expenses incurred in wire and cable relocation program announced in October 2016 and the Orlando plant rationalization program that commenced in January 2017, which more than offset the lower expenses incurred in the plant rationalization program that commenced in February 2016. All of the restructuring and integration programs were substantially completed as of June 30, 2018.
Other Income, Net. Other income, net was $0.3 million and $0.6 million in the six months ended June 30, 2018 and 2017, respectively. During 2018 and 2017, we recognized $0.2 million and $0.5 million, respectively, of deferred gain related to the sale-leaseback of our Long Island City, New York facility. The recognition of the deferred gain related to the sale-leaseback of our Long Island City, New York facility ended in the first quarter of 2018 upon the termination of the initial 10-year lease term for the facility.
Operating Income. Operating income was $35.7 million in the first six months of 2018, compared to $54.9 million for the same period in 2017. The year-over-year decrease in operating income of $19.2 million is the result of lower consolidated net sales, lower gross margins as a percentage of consolidated net sales, slightly higher restructuring and integration expenses, which more than offset the impact of lower SG&A expenses.
Other Non-Operating Income, Net. Other non-operating income, net was $0.4 million in the first six months of 2018, compared to other non-operating income, net of $1.9 million in the first six months of 2017. The year-over-year decline in other non-operating income, net resulted primarily from lower year-over-year equity income from our joint ventures, the unfavorable impact of changes in foreign currency exchange rates, and the year-over-year decline in the actuarial net gain related to our postretirement medical benefit plans. Our postretirement medical benefit plans to substantially all eligible U.S. and Canadian employees terminated on December 31, 2016.
Interest Expense. Interest expense increased to $1.9 million in the first six months of 2018, compared to $1.2 million for the same period in 2017. The year-over-year increase reflects the impact of both higher average outstanding borrowings during the first six months of 2018 when compared to the same period in 2017, and the higher year-over-year average interest rates on our revolving credit facility.
Income Tax Provision. The income tax provision for the six months ended June 30, 2018 was $8.8 million at an effective tax rate of 25.7%, compared to $20.9 million at an effective tax rate of 37.7% for the same period in 2017. The lower effective tax rate in the first six months of 2018 compared to the first six months of 2017 reflects the impact of the Tax Cuts and Jobs Act enacted in the U.S. in December 2017, which included a broad range of tax reform affecting businesses, including the reduction of the federal corporate tax rate from 35% to 21%, changes in the deductibility of certain business expenses, and the manner in which international operations are taxed in the U.S.
Loss from Discontinued Operations. Loss from discontinued operations, net of tax, reflects legal expenses associated with our asbestos-related liability. We recorded $1.5 million and $1.1 million as a loss from discontinued operations for the six months ended June 30, 2018 and 2017, respectively. As discussed more fully in Note 16, “Commitments and Contingencies” in the notes to our consolidated financial statements (unaudited), we are responsible for certain future liabilities relating to alleged exposure to asbestos containing products.
Restructuring and Integration Programs
As of June 30, 2018, theThe plant rationalization program that commenced in February 2016, the wire and cable relocation program announced in October 2016, and the Orlando plant rationalization program that commenced in January 2017, arewere all substantially completed.completed as of December 31, 2018. As a result of our recent acquisition of the Pollak business of Stoneridge, Inc., we expect to incur approximately $1.6 million of integration expenses related to the relocation of certain inventory, machinery, and equipment from Pollak’s distribution and manufacturing facilities to our existing facilities in Disputanta, Virginia, Reynosa, Mexico and Independence, Kansas.
For a detailed discussion on the restructuring and integration costs, see Note 5, “Restructuring and Integration Expenses,” of the notes to our consolidated financial statements (unaudited).
Liquidity and Capital Resources
Operating Activities. During the first six months of 2018,2019, cash used in operating activities was $19.5 million compared to cash provided by operating activities wasof $4.2 million compared to cash used in operating activities of $6.8 million in the same period of 2017.2018. The year-over-year increasedecrease in operating cash flow is primarily the result of the smallerlarger year-over-year increase in inventories, the year-over-year decrease in accounts payable compared to the year-over-year increase in accounts receivable, andpayable in the smaller year-over-year increase in inventories, offset, in part, by the decrease in net earnings,same period of 2018, and the larger year-over-year increase in prepaid expenses and other current assets offset, in part, by the increase in net earnings, the smaller year-over-year increase in accounts receivable, and the smaller year-over-year decrease in sundry payables and accrued expenses compared the year-over-year increase in sundry payables and accrued expenses in the same period of 2017.expenses.
Net earnings during the first six months of 20182019 were $23.9$31.6 million compared to $33.5$23.9 million in the first six months of 2017.2018. During the first six months of 2018,2019, (1) the increase in accounts receivable was $34.5$26.6 million compared to the year-over-year increase in accounts receivable of $53.1$34.5 million in 2017;2018; (2) the increase in inventories was $6.7$19.7 million compared to the year-over-year increase in inventories of $27$6.7 million in 2017;2018; (3) the increase in prepaid expenses and other current assets was $3$6.4 million compared to the year-over-year increase in prepaid expenses and other current assets of $0.9$3 million in 2017;2018; (4) the decrease in accounts payable was $7 million compared to the year-over-year increase in accounts payable of $15.7 million in 2018; and (4)(5) the decrease in sundry payables and accrued expenses was $9.1$7.5 million compared to the year-over-year increasedecrease in sundry payables and accrued expenses of $5.7$9.1 million in 2017.2018. The inventory increase during the first six months of 2019 reflects the impact of the inventory build-up of air conditioning products at our Temperature Control segment in anticipation of a strong 2019 summer season, as well as the inventory increases resulting from the Pollak acquisition; while the decrease in accounts payable during the first six months of 2019 results from the timing of the inventory purchases at our Temperature Control segment. We continue to actively manage our working capital to maximize our operating cash flow.
Investing Activities. Cash used in investing activities was $19.9$41.2 million in the first six months of 2018,2019, compared to $8.8$19.9 million in the same period of 2017.2018. Investing activities during the first six months of 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.; and (3) capital expenditures of $7.6 million. Investing activities during the first six months of 2018 consisted of (1) the payment of the third and final contribution of $5.8 million for our November 2017 acquisition of a 50% interest in a joint venture with Foshan Guangdong Automotive Air Conditioning Co., Ltd., a China-based manufacturer of air conditioning compressors for the automotive aftermarket and the Chinese OE market; (2) the payment of initial installments of $2.8 million for our 15% increase in equity ownership in an joint venture with Gwo Yng Enterprise Co., Ltd., a China-based manufacturer of air conditioner accumulators, filter driers, hose assemblies and switches for the automotive aftermarket and OEM/OES markets; and (3) capital expenditures of $11.3 million. Investing activities during the first six months of 2017 consisted of capital expenditures of $8.8 million.
Financing Activities. Cash provided by financing activities was $17.2$66.6 million in the first six months of 20182019 as compared to $11.8$17.2 million in the same period of 2017.2018. During the first six months of 2018,2019, (1) we increased borrowings under our revolving credit facility by $31.5$86.3 million as compared to the increase in borrowings under our revolving credit facility of $24.1$31.5 million in 2017;2018; (2) we made cash payments in the first six months of 20182019 for the repurchase of shares of our common stock of $7.6$10.7 million as compared to $5.2$7.6 million in 2017;2018; and (3) we paid dividends of $9.4$10.3 million in the first six months of 20182019 as compared to $8.7$9.4 million in the comparable period last year. In February 2018,2019, our Board of Directors voted to increase our quarterly dividend from $0.19 per share in 2017 to $0.21 per share in 2018.2018 to $0.23 per share in 2019.
In October 2015,December 2018, we entered into aamended our Credit Agreement with JPMorgan Chase Bank, N.A., as agent, and a syndicate of lenderslenders. 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 aextends the maturity date in October 2020.to December 2023. The line of credit under the amended credit 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 factoring agreements, eligible inventory, eligible equipment and eligible fixed assets. After taking into account outstanding borrowings under the amended credit agreement, there was an additional $158.3$116.8 million available for us to borrow pursuant to the formula at June 30, 2018.2019. Outstanding borrowings under the amended credit agreements,agreement, which are classified as current liabilities, were $88.5$130 million and $57$43.7 million at June 30, 20182019 and December 31, 2017,2018, respectively. Borrowings under the restatedamended credit agreement have been classified as current liabilities based upon the accounting rules and certain provisions in the agreement.
At June 30, 2019, the weighted average interest rate on our amended credit agreement was 3.7%, which consisted of $130 million in direct borrowings. At December 31, 2018, the weighted average interest rate on our amended credit agreement was 3.5%3.9%, which consisted of $80$40 million in direct borrowings at 3.3%3.4% and an alternative base rate loan of $8.5$3.7 million at 5.3%5.8%. At December 31, 2017, the weighted average interest rate on our credit agreement was 2.7%, which consisted of $57 million in direct borrowings. During the six months ended June 30, 2018,2019, our average daily alternative base rate loan balance was $1.9$1.6 million, compared to a balance of $5.2$1.9 million for the six months ended June 30, 20172018, and our average daily alternative base rate loana balance of $3.8$1.8 million for the year ended December 31, 2017.2018.
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 June 30, 2018, 2019, 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.
In December 2017, our
Our Polish subsidiary, SMP Poland sp.z.o.o., has entered into an overdraft facility with HSBC Bank Polska S.A. (“HSBC Poland”) for Zloty 30 million (approximately $8 million). The facility, as amended, expires onin December 2018.2019. Borrowings under the overdraft facility will bear interest at a rate equal to WIBOR + 0.75% and are guaranteed by Standard Motor Products, Inc., the ultimate parent company. At June 30, 2019 and December 31, 2018, borrowings under the overdraft facility were Zloty 19.118.8 million (approximately $5.1$5 million). and Zloty 19.9 million (approximately $5.3 million), respectively.
In order to reduce our accounts receivable balances and improve our cash flow, we sell undivided interests in certain of our receivables to financial institutions. We enter these agreements at our discretion when we determine that the cost of factoring 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 $184.1$190 million and $341.6$361 million of receivables during the three months and six months ended June 30,, 2018, 2019, respectively, and $224.3$184.1 million and $404.1$341.6 million for the comparable periods in 2017.2018. A charge in the amount of $6.3$6.4 million and $11.7$12.1 million related to the sale of receivables is included in selling, general and administrative expense in our consolidated statements of operations for the three months and six months ended June 30, 2018,2019, respectively, and $6.4$6.3 million and $11.6$11.7 million for the comparable periods in 2017.2018. If we do not enter into these arrangements or if any of the financial institutions with which we enter into these arrangements were to experience financial difficulties or otherwise terminate these arrangements, our financial condition, results of operations and cash flows could be materially and adversely affected by delays or failures to collect future trade accounts receivable.
During 2017, our Board of Directors authorized the purchase of up to $30 million of our common stock under stock repurchase programs. Under these programs, during the year ended December 31, 2017 and the threesix months ended March 31,June 30, 2018, we repurchased 539,760 and 61,756112,307 shares of our common stock, respectively, at a total cost of $24.8 million and $2.9 million, respectively. Additionally, in April 2018 and May 2018, we repurchased 20,900 and 29,651 shares of our common stock, respectively, at a total cost of $1 million and $1.3$5.2 million, respectively, thereby completing the 2017 Board of Directors’ authorizations.
In May 2018, our Board of Directors authorized the purchase of up to an additional $20 million of our common stock under a new stock repurchase program. Stock will be purchased from time to time, in the open market or through private transactions, as market conditions warrant. Under this program, in Mayduring the six months ended June 30, 2018 and Juneyear ended December 31, 2018, we repurchased 29,60445,964 and 16,360201,484 shares of our common stock, respectively, at a total cost of $1.3$2.1 million and $0.8$9.3 million, respectively. As ofAdditionally, during the three and six months ended June 30, 2018, there was approximately $17.9 million available for future stock repurchases under the program. During the period from July 1, 2018 through July 27, 2018,2019, we repurchased an additional 17,39092,209 and 221,748 shares of our common stock, respectively, under the program, at a total cost of $0.8$4.4 million, and $10.7 million, respectively, thereby reducing the amount available for future stock repurchases undercompleting the 2018 Board of Directors authorization to $17.1 million.authorization.
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 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 of our business, please refer to the Risk Factors section of our Annual Report on Form 10-K for the year ending December 31, 2017.2018.
The following table summarizes our contractual commitments as of June 30, 20182019 and expiration dates of commitments through 2028 (a) (b) (c):
(In thousands) | | 2019 | | | 2020 | | | 2021 | | | 2022 | | | 2023 | | | | 2024- 2028 | | | Total | |
Operating lease obligations | | $ | 4,342 | | | $ | 7,689 | | | $ | 7,027 | | | $ | 5,818 | | | $ | 5,281 | | | $ | 11,316 | | | $ | 41,473 | |
Postretirement benefits | | | 20 | | | | 36 | | | | 32 | | | | 29 | | | | 25 | | | | 76 | | | | 218 | |
Severance payments related to restructuring and integration | | | 333 | | | | 225 | | | | 69 | | | | 24 | | | | — | | | | — | | | | 651 | |
Total commitments | | $ | 4,695 | | | $ | 7,950 | | | $ | 7,128 | | | $ | 5,871 | | | $ | 5,306 | | | $ | 11,392 | | | $ | 42,342 | |
(In thousands) | | 2018 | | | 2019 | | | 2020 | | | 2021 | | | 2022 | | | | 2023-2028 | | | Total | |
Lease obligations | | $ | 4,743 | | | $ | 8,078 | | | $ | 6,990 | | | $ | 6,355 | | | $ | 5,364 | | | $ | 3,932 | | | $ | 35,462 | |
Postretirement benefits | | | 317 | | | | 39 | | | | 36 | | | | 32 | | | | 29 | | | | 101 | | | | 554 | |
Severance payments related to restructuring and integration | | | 512 | | | | 413 | | | | 183 | | | | 72 | | | | 2 | | | | — | | | | 1,182 | |
Total commitments | | $ | 5,572 | | | $ | 8,530 | | | $ | 7,209 | | | $ | 6,459 | | | $ | 5,395 | | | $ | 4,033 | | | $ | 37,198 | |
| (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 June 30, 2018,2019, amounts outstanding under our revolving credit facilities were $88.5$130 million. |
| (b) | We anticipate total aggregate future severance payments of approximately $1.2$0.7 million related to the plant rationalization program the wire and cable relocation program and the Orlando plant rationalization program. AllThese programs arewere substantially completed as of June 30,December 31, 2018. |
| (c) | As of January 1, 2019 we adopted ASU 2016-02, Leases, which resulted in the recording of the lease obligations on our consolidated balance sheet. For information related to our adoption of ASU 2016-02, see Note 2 “Summary of Significant Accounting Policies” and Note 3 “Leases” of the notes to our consolidated financial statements (unaudited). |
Critical Accounting Policies
We have identified theseveral accounting 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. There have been no material changes to our critical accounting policies and estimates from the information provided in Note 1 of the notes to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2017,2018, except for changes made as a result of the adoption of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, FASB ASU 2016-02, Leases,described under the heading, “Recently Issued Accounting Pronouncements” in Note 2 and in Note 3, “Net Sales,“Leases,” of the notes to our consolidated financial statements (unaudited).
You should be aware that preparation of our consolidated quarterly financial statements in this Report requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, 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 assurances 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 estimate or in the assumptions that we use in calculating the estimate, unforeseen changes in the industry, or business could materially impact the estimate 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. 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 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. 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 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 unrecorded 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.
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 June 30, 2018, the allowance for sales returns was $42.5 million.
Similarly, we must make estimates of the uncollectability of our accounts receivable. We specifically analyze accounts receivable and analyze historical bad debts, customer concentrations, customer credit‑worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. At June 30, 2018, the allowance for doubtful accounts and for discounts was $5.5 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 Standard Motor Products inventory commonly referred to as a stocklift. New customer acquisition costs are recorded as a reduction to revenue when incurred.
Accounting for Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that it is more likely than not that the deferred tax assets will not be recovered, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, we must include an expense or recovery, respectively, within the tax provision in the statement of operations.
We maintain valuation allowances when it is more likely than not that all or a portion of a deferred 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 $0.4 million as of June 30, 2018 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.
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. As of June 30, 2018, we do not believe there is a need to establish a liability for uncertain tax positions. Penalties and interest associated with income tax matters are included in the provision for income taxes in our consolidated statement of operations.
Valuation of Long‑Lived and Intangible Assets and Goodwill. At acquisition, we estimate and record the fair value of purchased intangible assets, which primarily consists 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.
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, than the two-step impairment test is not required. If we are unable to reach this conclusion, then we would perform the two-step impairment test. Initially, the fair value of the reporting unit is compared to its carrying amount. To the extent the carrying amount of a reporting unit exceeds the fair value of the reporting unit; we are required to perform a second step, as this is an indication that the reporting unit goodwill may be impaired. In this step, we compare the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill and recognize a charge for impairment to the extent the carrying value exceeds the implied fair value. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to all of the assets (recognized and unrecognized) and liabilities of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. In addition, identifiable intangible assets having indefinite lives are reviewed for impairment on an annual basis using a methodology consistent 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.
Postretirement Medical Benefits. Each year, we calculate the costs of providing retiree benefits under the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 712, Nonretirement Postemployment Benefits. The determination of postretirement plan obligations and their associated costs requires the use of actuarial computations to estimate participant plan benefits the employees will be entitled to. The key assumptions used in making these calculations are the eligibility criteria of participants and the discount rate used to value the future obligation. The discount rate reflects the yields available on high-quality, fixed-rate debt securities.
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 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.
Asbestos Litigation. We are responsible for certain future liabilities relating to alleged exposure to asbestos-containing products. In accordance with our accounting policy, our most recent actuarial study as of August 31, 2017 estimated an undiscounted liability for settlement payments, excluding legal costs and any potential recovery from insurance carriers, ranging from $35.2 million to $54 million for the period through 2060. 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 of settlement payments 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. Based upon the results of the August 31, 2017 actuarial study, in September 2017 we increased our asbestos liability to $35.2 million, the low end of the range, and recorded an incremental pre-tax provision of $6 million in loss from discontinued operations in the accompanying statement of operations. In addition, according to the updated study, future legal costs, which are expensed as incurred and reported in loss from discontinued operations in the accompanying statement of operations, are estimated to range from $44.3 million to $79.6 million for the period through 2060. We will continue to perform an annual actuarial analysis during the third quarter of each year for the foreseeable future. Based on this analysis and all other available information, we will continue to reassess the recorded liability and, if deemed necessary, record an adjustment to the reserve, which will be reflected as a loss or gain from discontinued operations.
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 2, “Summary of Significant Accounting Policies” of the notes to our consolidated financial statements (unaudited).
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
Quantitative and Qualitative Disclosure about Market Risk
We are exposed to market risk, primarily related to foreign currency exchange and interest rates. These exposures are actively monitored by management. Our exposure to foreign exchange rate risk is due to certain costs, revenues and borrowings being denominated in currencies other than one of our subsidiary’s functional currency. Similarly, we are exposed to market risk as the result of changes in interest rates, which may affect the cost of our financing. It is our policy and practice to use derivative financial instruments only to the extent necessary to manage exposures. We do not hold or issue derivative financial instruments for trading or speculative purposes. As of June 30, 2018,2019, we do not have any derivative financial instruments.
Exchange Rate Risk
We have exchange rate exposure, primarily, with respect to the Canadian Dollar, the Euro, the British Pound, the Polish Zloty, the Mexican Peso, the Taiwan Dollar, the Chinese Yuan Renminbi and the Hong Kong Dollar. As of June 30, 20182019 and December 31, 2017,2018, our monetary assets and liabilities which are subject to this exposure are immaterial, therefore, the potential immediate loss to us that would result from a hypothetical 10% change in foreign currency exchange rates would not be expected to have a material impact on our earnings or cash flows. This sensitivity analysis assumes an unfavorable 10% fluctuation in the exchange rates affecting the foreign currencies in which monetary assets and liabilities are denominated and does not take into account the incremental effect of such a change on our foreign currency denominated revenues.
Interest Rate Risk
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 have in the past entered into interest rate swap agreements. We invest our excess cash in highly liquid short-term investments. Substantially all of our debt is variable rate debt as of June 30, 20182019 and December 31, 2017.2018.
In addition, from time to time, we sell undivided interests in certain of our receivables to financial institutions. We enter these agreements at our discretion when we determine that the cost of factoring is less than the cost of servicing our receivables with existing debt. During the three months and six months ended June 30, 2018,2019, we sold $184.1$190 million and $341.6$361 million of receivables, respectively. Depending upon the level of sales of receivables pursuant these agreements, the effect of a hypothetical, instantaneous and unfavorable change of 100 basis points in the margin rate may have an approximate $1.8$1.9 million and $3.4$3.6 million negative impact on our earnings or cash flows during the three months and six months ended June 30, 2018,2019, respectively. The charge related to the sale of receivables is included in selling, general and administrative expenses in our consolidated statements of operations.
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, 2017.
2018.
(a) | Evaluation of Disclosure Controls and Procedures. |
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this Report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Report.
(b) | Changes in Internal Control Over Financial Reporting. |
During the quarter ended June 30, 2018,2019, we have not made any changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
We review, document and test our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in the 2013 Internal Control – Integrated Framework. We may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business. These efforts may lead to various changes in our internal control over financial reporting.
PART II – OTHER INFORMATION
The information required by this Item is incorporated herein by reference to the information set forth in Item 1, “Consolidated Financial Statements” of this Report under the captions “Asbestos” and “Other Litigation” appearing in Note 16, “Commitments and Contingencies,” of the notes to our consolidated financial statements (unaudited).
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
The following table provides information relating to the Company’s purchases of its common stock for the second quarter of 2018:2019:
Period | | Total Number of Shares Purchased (1) | | | Average Price Paid Per Share | | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | | | Maximum Number (or Approximate Dollar Value) of Shares that may yet be Purchased Under the Plans or Programs (2) | |
| | | | | | | | | | | | |
April 1 – 30, 2018 | | | 20,900 | | | $ | 47.96 | | | | 20,900 | | | $ | 1,307,351 | |
May 1 – 31, 2018 | | | 59,255 | | | | 44.34 | | | | 59,255 | | | | 18,679,954 | |
June 1 – 30, 2018 | | | 16,360 | | | | 47.87 | | | | 16,360 | | | | 17,896,821 | |
Total | | | 96,515 | | | $ | 45.72 | | | | 96,515 | | | $ | 17,896,821 | |
Period | Total Number of Shares Purchased (1) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | Maximum Number (or Approximate Dollar Value) of Shares that may yet be Purchased Under the Plans or Programs (2) |
| | | | |
April 1 – 30, 2019 | 14,400 | $ 49.65 | 14,400 | $ 3,696,761 |
May 1 – 31, 2019 | 77,809 | 47.51 | 77,809 | — |
June 1 – 30, 2019 | — | — | — | — |
Total | 92,209 | $ 47.84 | 92,209 | $ — |
| (1) | All shares were purchased through the publicly announced stock repurchase programs in open-market transactions. |
| (2) | During 2017,In May 2018, our Board of Directors authorized the purchase of up to $30an additional $20 million of our common stock under a new stock repurchase programs.program. Under these programs,this program, during the six months ended June 30, 2018 and year ended December 31, 2017 and three months ended March 31, 2018, we repurchased 539,76045,964 and 61,756201,484 shares of our common stock, respectively, at a total cost of $24.8$2.1 million and $2.9$9.3 million, respectively. Additionally, in April 2018during the three and May 2018,six months ended June 30, 2019, we repurchased 20,90092,209 and 29,651221,748 shares of our common stock, respectively, under the program, at a total cost of $1$4.4 million and $1.3$10.7 million, respectively, thereby completing the 20172018 Board of Directors’ authorizations.Directors authorization. |
In May 2018, our Board of Directors authorized the purchase of up to an additional $20 million of our common stock under a new stock repurchase program. Stock will be purchased from time to time, in the open market or through private transactions, as market conditions warrant. Under this program, in May 2018 and June 2018, we repurchased 29,604 and 16,360 shares of our common stock, respectively, at a total cost of $1.3 million and $0.8 million, respectively. As of June 30, 2018, there was approximately $17.9 million available for future stock purchases under the program. During the period from July 1, 2018 through July 27, 2018, we repurchased an additional 17,390 shares of our common stock under the program at a total cost of $0.8 million, thereby reducing the amount available for future stock repurchases under the Board of Directors authorization to $17.1 million.
Exhibit Number | |
| |
31.1 | |
| |
31.2 | |
| |
32.1 | |
| |
32.2 | |
101.INS** | XBRL Instance Document |
101.SCH** | XBRL Taxonomy Extension Schema Document |
101.CAL** | XBRL Taxonomy Extension Calculation Linkbase Document |
101.LAB** | XBRL Taxonomy Extension Label Linkbase Document |
101.PRE** | XBRL Taxonomy Extension Presentation Linkbase Document |
101.DEF** | XBRL Taxonomy Extension Definition Linkbase Document |
101.SCH** XBRL Taxonomy Extension Schema Document
101.CAL** XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB** XBRL Taxonomy Extension Label Linkbase Document
101.PRE** XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF** XBRL Taxonomy Extension Definition Linkbase Document
** | In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to the Original Filing shall be deemed to be “furnished” and not “filed.” |
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: July 30, 2019 | | |
Date: July 31, 2018
| /s/ James J. Burke |
| James J. Burke |
| Executive Vice President Finance, Chief Operating Officer and |
| Chief Financial Officer |
| (Principal Financial and |
| Accounting Officer) |