QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2020
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
Commission file number: 001-04743
Standard Motor Products, Inc.
(Exact name of registrant as specified in its charter)
New York
11-1362020
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
37-18 NORTHERN BLVD., LONG ISLAND CITY, New York
11101
(Address of principal executive offices)
(Zip Code)
(718) 392-0200
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $2.00 per share
SMP
New York Stock Exchange LLC
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer☑
Accelerated Filer ☐
Non-Accelerated Filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☑
As of the close of business on October 27, 2020, there were 22,446,114 outstanding shares of the registrant’s Common Stock, par value $2.00 per share.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Basis of Presentation
Standard Motor Products, Inc. and subsidiaries (referred to hereinafter in these notes to the consolidated financial statements as “we,” “us,” “our” or the “Company”) is engaged in the manufacture and distribution of replacement parts for motor vehicles in the automotive aftermarket industry with a complementary focus on the heavy duty, industrial equipment and original equipment service markets.
The accompanying unaudited financial information should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2019. The unaudited consolidated financial statements include our accounts and all domestic and international companies in which we have more than a 50% equity ownership, except in instances where the minority shareholder maintains substantive participating rights, in which case we follow the equity method of accounting. Investments in unconsolidated affiliates are accounted for on the equity method, as we do not have a controlling financial interest but have the ability to exercise significant influence. All significant inter-company items have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the interim periods are not necessarily indicative of the results of operations for the entire year.
Note 2. Summary of Significant Accounting Policies
The preparation of consolidated annual and quarterly financial statements in conformity with generally accepted accounting principles requires management 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 have made a number of estimates and assumptions in the preparation of these consolidated financial statements. 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 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. Some of the more significant estimates include allowances for doubtful accounts, cash discounts, valuation of inventory, valuation of long-lived assets, goodwill and other intangible assets, depreciation and amortization of long-lived assets, product liability exposures, asbestos, environmental and litigation matters, valuation of deferred tax assets, share based compensation and sales returns and other allowances.
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 31,2019.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Recently Issued Accounting Pronouncements
Standards that were adopted
Standard
Description
Date of
adoption
Effects on the financial
statements or other significant
matters
ASU 2017-04,Simplifying the Test for Goodwill Impairment
This standard simplifies the accounting for goodwill impairment. ASU 2017-04 removes Step 2 of the test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.
January 1,2020
The new standard will be applied prospectively when performing our annual impairment test of goodwill, or in an interim period if an event occurs, or circumstances change, that may indicate that the fair value of a reporting unit is below its carrying amount. We anticipate that the prospective adoption of the standard will not materially impact the amount of goodwill impairment, if any.
ASU 2016-13,Financial Instruments – Credit Losses
This standard creates a single model to measure impairment on financial assets, which includes trade accounts receivable. An estimate of expected credit losses on trade accounts receivable over their contractual life will be required to be recorded at inception, based on historical information, current conditions, and reasonable and supportable forecasts.
January 1,2020
The adoption of the standard did not have a material impact on the manner in which we estimate our allowance for doubtful accounts on trade accounts receivable, or on our consolidated financial statements.
Standards that are not yet adopted as of September 30,2020
The following table provides a brief description of recently issued accounting pronouncements that have not yet been adopted as of September 30,2020, and that could have an impact on our financial statements:
Standard
Description
Date of
adoption /
Effective
date
Effects on the financial
statements or other
significant matters
ASU 2019-12,Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes
This standard is intended to simplify the accounting for income taxes by removing certain ASC Topic 740 exceptions in performing intra-period tax allocations among income statement components, in calculating certain deferred tax liabilities related to outside basis differences, and in calculating income taxes in interim periods with year-to-date losses. In addition, this standard is also intended to improve consistency and add simplification by clarifying and amending the reporting of franchise taxes and other taxes partially based on income, the recognition of deferred income taxes related to the step-up in tax basis goodwill, and the reporting in interim periods of the recognition of the enactment of tax laws or rate changes.
January 1,2021, with early adoption permitted
The new standard clarifies the accounting for income taxes in certain technical areas that will not impact all companies. Although we currently believe that the technical clarifications in the new standard will not materially impact our accounting for income taxes, our consolidated financial statements and related disclosures upon adoption, we are currently evaluating its potential impact. The new standard can be applied on a prospective basis in certain instances and in other instances on a retrospective or modified retrospective basis.
ASU 2020-04,Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
This standard is intended to provide optional guidance for a limited time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The new standard is applicable to contracts that reference LIBOR, or another reference rate, expected to be discontinued due to reference rate reform.
Effective March 12,2020 through December 31,2022
The new standard may be applied as of the beginning of an interim period that includes March 12,2020 through December 31,2022. As certain of our contracts reference LIBOR, including our revolving credit facility and supply chain financing arrangements, we are currently reviewing the optional guidance in the standard to determine its impact upon the discontinuance of LIBOR. At this time, we do not believe that the new guidance, nor the discontinuance of LIBOR, will have a material impact on our consolidated financial statements and related disclosures.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 3. Business Acquisitions and Investments
2019 Business Acquisition and Investment
Jiangsu Che Yijia New Energy Technology Co., Ltd. Equity Investment
In August 2019, we acquired an approximate 29% minority interest in Jiangsu Che Yijia New Energy Technology Co., Ltd. (“CYJ”) for approximately $5.1 million. Our investment in CYJ was funded through borrowings under our revolving credit facility with JPMorgan Chase Bank, N.A. CYJ is a manufacturer of air conditioning compressors for electric vehicles and is located in China. Our minority interest in CYJ is accounted for using the equity method of accounting.
Pollak Business of Stoneridge, Inc. Acquisition
In April 2019, we acquired certain assets and liabilities of the Pollak business of Stoneridge, Inc. for approximately $40 million, subject to post-closing adjustments. In May 2019, the post-closing adjustments were finalized at $1.6 million, reducing the purchase price to $38.4 million. The acquisition was funded through borrowings under our revolving credit facility with JPMorgan Chase Bank, N.A. Stoneridge’s Pollak business had manufacturing and distribution facilities in Canton, Massachusetts, El Paso, Texas, and Juarez, Mexico, and distributed a range of engine management products including sensors, switches, and connectors. The acquisition, reported as part of our Engine Management Segment, enhanced our growth opportunities in the OE/OES, heavy duty and commercial vehicle markets and added to our existing expertise in aftermarket distribution, product management and service. We have not acquired any of the Pollak facilities or employees, and have relocated all production to our existing facilities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
The following table presents the allocation of the purchase price to the assets acquired and liabilities assumed, based on their fair values (in thousands):
Purchase Price
$
38,427
Assets acquired and liabilities assumed:
Inventory
$
3,331
Property, plant and equipment, net
45
Intangible assets
24,650
Goodwill
10,401
Net assets acquired
$
38,427
Intangible assets acquired of $24.7 million consist of customer relationships related to the acquired OE/OES business of $17.2 million that will be amortized on a straight-line basis over the estimated useful life of 10 years; customer relationships related to the acquired aftermarket business of $7.2 million that will be amortized on a straight-line basis over the estimated useful life of 15 years; a trademark of $0.2 million that will be amortized on a straight-line basis over the estimated useful life of 10 years; and a non-compete agreement of $0.1 million that will be amortized on a straight-line basis over the estimated useful life of 5 years. Goodwill of $10.4 million was allocated to the Engine Management Segment and is deductible for income tax purposes. The goodwill reflects relationships, business specific knowledge and the replacement cost of an assembled workforce associated with personal reputations, as well as the value of expected synergies.
Incremental net salesfrom the acquired Pollak business were $9.5 million for the three months ended March 31,2020, and were included in our consolidated statements of operations for the nine months ended September 30, 2020.
Note 4. Restructuring and Integration Expenses
The aggregated liabilities included in “sundry payables and accrued expenses” and “other accrued liabilities” in the consolidated balance sheet relating to the restructuring and integration activities as of December 31, 2019 and September 30, 2020 and activity for the nine months ended September 30, 2020 consisted of the following (in thousands):
Workforce
Reduction
Other Exit
Costs
Total
Exit activity liability at December 31, 2019
$
336
$
—
$
336
Restructuring and integration costs:
Amounts provided for during 2020
—
464
464
Cash payments
(94
)
(214
)
(308
)
Reclassification of environmental liability (1)
—
(250
)
(250
)
Exit activity liability at September 30, 2020
$
242
$
—
$
242
(1)
Included in restructuring and integration costs in the nine months ended September 30, 2020 is a $0.3 million increase in environmental cleanup costs related to ongoing monitoring and remediation in connection with the prior closure of our manufacturing operations at our Long Island City, New York location. The environmental liability has been reclassed to accrued liabilities as of September 30, 2020.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Restructuring Costs
Plant Rationalization Program
In February 2016, in connection with our ongoing efforts to improve operating efficiencies and reduce costs, we implemented a plant rationalization initiative. As part of the plant rationalization, all of our Grapevine, Texas production activities have been relocated to facilities in Greenville, South Carolina and Reynosa, Mexico; certain production activities at our Greenville, South Carolina facility were moved to our facility in Bialystok, Poland; certain service functions were relocated from Grapevine, Texas to our administrative offices in Lewisville, Texas; and our vacated Grapevine, Texas facility was sold.
The Plant Rationalization Program has been completed. Cash payments made of $59,000 during the nine months ended September 30,2020, and the remaining aggregate liability related to the program as of September 30,2020 of $117,000consists of severance payments to former Temperature Control employees.
Orlando Plant Rationalization Program
In January 2017, to further our ongoing efforts to improve operating efficiencies and reduce costs, we implemented a plant rationalization initiative at our Orlando, Florida facility. As part of the initiative, all of our Orlando, Florida production activities were moved to our facility in Independence, Kansas; certain production activities at our Independence, Kansas facility were moved to our facility in Reynosa, Mexico; and our Orlando, Florida facility was closed.
The Orlando Plant Rationalization Program has been completed. Cash payments made of $35,000 during the nine months ended September 30,2020, and the remaining aggregate liability related to the program as of September 30,2020 of $125,000 consists of severance payments to former Engine Management employees.
Integration Costs
Pollak Relocation
In connection with our April 2019 acquisition of certain assets and liabilities of the Pollak business of Stoneridge, Inc., we incurred certain integration expenses in connection with the relocation of certain inventory, machinery, and equipment from Pollak’s distribution and manufacturing facilities in El Paso, Texas, Canton, Massachusetts, and Juarez, Mexico, to our existing facilities in Disputanta, Virginia, Reynosa, Mexico and Independence, Kansas.
The Pollak Relocation has been completed. Integration expense recognized and cash payments made of $214,000 during the nine months ended September 30,2020 related to residual relocation activities in our Engine Management segment. There is no remaining aggregate liability related to the Pollak Relocation as of September 30,2020.
Note 5. Sale of Receivables
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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Pursuant to these agreements, we sold $213.3 million and $511.1 million of receivables during the three months and nine months ended September 30, 2020, respectively, and $199.6 million and $560.6 million for the comparable periods in 2019, all of which were reflected as a reduction of accounts receivable in the consolidated balance sheet at the time of sale. A charge in the amount of $3.5 million and $9.4 million related to the sale of receivables was included in selling, general and administrative expense in our consolidated statements of operations for the three months and nine months ended September 30, 2020, respectively, and $5.6 million and $17.7 million for the comparable periods in 2019.
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.
Note 6. Inventories
Inventories, which are stated at the lower of cost (determined by means of the first-in, first-out method) and net realizable value, consist of the following:
September 30,
2020
December 31,
2019
(In thousands)
Finished goods
$
192,182
$
241,472
Work in process
10,818
11,138
Raw materials
108,390
115,611
Subtotal
311,390
368,221
Unreturned customer inventories
19,964
19,722
Total inventories
$
331,354
$
387,943
Note 7. Acquired Intangible Assets
Acquired identifiable intangible assets consist of the following:
September 30,
2020
December 31,
2019
(In thousands)
Customer relationships
$
111,520
$
111,692
Trademarks and trade names
6,980
6,980
Non-compete agreements
3,266
3,276
Patents
723
723
Supply agreements
800
800
Leaseholds
160
160
Total acquired intangible assets
123,449
123,631
Less accumulated amortization (1)
(65,523
)
(59,431
)
Net acquired intangible assets
$
57,926
$
64,200
(1)
Applies to all intangible assets, except for trademarks and trade names totaling $5.2 million, which have indefinite useful lives and, as such, are not being amortized.
Total amortization expense for acquired intangible assets was $2 million and $6.1 million for the three months and nine months ended September 30, 2020, respectively, and $2 million and $6 million for the comparable periods in 2019. Based on the current estimated useful lives assigned to our intangible assets, amortization expense is estimated to be $2 million for the remainder of 2020, $6.8 million in 2021, $5.2 million in 2022, $4.9 million in 2023 and $33.8 million in the aggregate for the years 2024 through 2034.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 8. Leases
We have operating and finance leases for our manufacturing facilities, warehouses, office space, automobiles, and certain equipment. Our leases have remaining lease terms of up to ten years, some of which may include one or more five-year renewal options. We have included the five-year renewal option for one of our leases in our operating lease payments as we concluded that it is reasonably certain that we will exercise the option. Leases with an initial term of twelve months or less are not recorded on the balance sheet. Operating lease expense is recognized on a straight-line basis over the lease term. Finance leases are not material.
The following tables provide quantitative disclosures related to our operating leases (in thousands):
Balance Sheet Information
September 30,
2020
December 31,
2019
Assets
Operating lease right-of-use assets
$
30,910
$
36,020
Liabilities
Sundry payables and accrued expenses
$
8,648
$
8,739
Noncurrent operating lease liabilities
23,452
28,376
Total operating lease liabilities
$
32,100
$
37,115
Weighted Average Remaining Lease Term
Operating leases
5.1 Years
5.6 Years
Weighted Average Discount Rate
Operating leases
3.7
%
3.7
%
Three Months Ended
September 30,
Expense and Cash Flow Information
2020
2019
Lease Expense
Operating lease expense (a)
$
2,290
$
2,199
Nine Months Ended
September 30,
2020
2019
Lease Expense
Operating lease expense (a)
$
6,906
$
6,633
Supplemental Cash Flow Information
Cash paid for the amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
6,810
$
6,490
Right-of-use assets obtained in exchange for new lease obligations:
Operating leases
$
611
$
856
(a)
Excludes expenses of approximately $0.7 million and $1.6 million for the three and nine months ended September 30, 2020, respectively, and approximately $0.8 million and $1.9 million for the comparable periods in 2019, respectively, related to non-lease components such as maintenance, property taxes, etc., and operating lease expense for leases with an initial term of 12 months or less, which is not material.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Minimum Lease Payments
At September 30, 2020, we are obligated to make minimum lease payments through 2028, under operating leases, which are as follows (in thousands):
2020
$
2,235
2021
8,631
2022
7,071
2023
5,715
2024
3,881
Thereafter
7,844
Total lease payments
$
35,377
Less: Interest
(3,277
)
Present value of lease liabilities
$
32,100
Note 9. Credit Facilities and Long-Term Debt
Total debt outstanding is summarized as follows:
September 30,
2020
December 31,
2019
(In thousands)
Revolving credit facilities
$
8,416
$
52,460
Other (1)
3,683
4,585
Total debt
$
12,099
$
57,045
Current maturities of debt
$
11,996
$
56,916
Long-term debt
103
129
Total debt
$
12,099
$
57,045
(1)
Other includes borrowings under our Polish overdraft facility of Zloty 13.7 million (approximately US $3.5 million) and Zloty 16.7 million (approximately US $4.4 million) as of September 30, 2020 and December 31, 2019, respectively.
Revolving Credit Facility
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 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 supply chain financing agreements and eligible inventory. After taking into account outstanding borrowings under the amended credit agreement, there was an additional $238.4 million available for us to borrow pursuant to the formula at September 30, 2020. Outstanding borrowings under the amended credit agreement, which are classified as current liabilities, were $8.4 million and $52.5 million at September 30, 2020 and December 31, 2019, respectively; while letters of credit outstanding under the credit agreement were $3.1 million at September 30, 2020 and December 31, 2019. Borrowings under the credit agreement have been classified as current liabilities based upon accounting rules and certain provisions in the agreement.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
At September 30, 2020, the weighted average interest rate on our amended credit agreement was 3.5%, which consisted of an alternative base rate loan of $8.4 million. At September 30,2020, there were no direct borrowings outstanding. The interest rate for direct borrowings under our amended credit agreement at September 30,2020 was 1.4%. 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%. During the nine months ended September 30, 2020, our average daily alternative base rate loan balance was $1.3 million, compared to a balance of $1.6 million for the nine months ended September 30, 2019 and a balance of $1.7 million for the year ended December 31, 2019.
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 September 30, 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.
Polish Overdraft Facility
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 US $7.5 million). The facility, as amended, expires in December 2020. 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 September 30, 2020 and December 31, 2019, borrowings under the overdraft facility were Zloty 13.7 million (approximately US $3.5 million) and Zloty 16.7 million (approximately US $4.4 million), respectively. We anticipate that the overdraft facility will be renewed in the fourth quarter of 2020.
Deferred Financing Costs
We had deferred financing costs of $0.7 million and $0.9 million as of September 30, 2020 and December 31, 2019, respectively. Deferred financing costs are related to our revolving credit facility. Deferred financing costs as of September 30, 2020 are being amortized in the amounts of $0.1 million for the remainder of 2020, $0.2 million in 2021, $0.2 million in 2022, and $0.2 million in 2023.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 10.Stock-Based Compensation Plans
We account for our stock-based compensation plans in accordance with the provisions of FASB ASC 718, Stock Compensation, which requires that a company measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost is recognized in the consolidated statement of operations over the period during which an employee is required to provide service in exchange for the award.
Restricted and Performance Stock Grants
As part of the 2016 Omnibus Incentive Plan, we currently grant shares of restricted stock to eligible employees and our independent directors and performance-based shares to eligible employees. We grant eligible employees two types of restricted stock (standard restricted shares and long-term retention restricted shares). Standard restricted shares granted to employees become fully vested no earlier than three years after the date of grant. Long-term retention restricted shares granted to selected executives vest at a 25% rate on or within approximately two months of an executive reaching the ages 60 and 63, and become fully vested on or within approximately two months of an executive reaching the age 65. Restricted shares granted to directors become fully vested upon the first anniversary of the date of grant.
Performance-based shares issued to eligible employees are subject to a three-year measuring period and the achievement of performance targets and, depending upon the achievement of such performance targets, they may become vested no earlier than three years after the date of grant. Each period we evaluate the probability of achieving the applicable targets, and we adjust our accrual accordingly. Restricted shares (other than long-term retention restricted shares) and performance shares issued to certain key executives and directors are subject to a one or two year holding period upon the lapse of the vesting period. Forfeitures on stock grants are estimated at 5% for employees and 0%% for executives and directors based on our evaluation of historical and expected future turnover.
Our restricted and performance-based share activity was as follows for the nine months ended September 30, 2020:
Shares
Weighted Average
Grant Date Fair
Value Per Share
Balance at December 31, 2019
852,540
$
35.26
Granted
208,525
38.22
Vested
(67,404
)
33.53
Forfeited
(6,750
)
43.74
Balance at September 30, 2020
986,911
$
35.98
We recorded compensation expense related to restricted shares and performance-based shares of $5.7 million ($4.3 million, net of tax) and $5.3 million ($3.9 million, net of tax) for the nine months ended September 30, 2020 and 2019, respectively. The unamortized compensation expense related to our restricted and performance-based shares was $17.5 million at September 30, 2020, and is expected to be recognized as they vest over a weighted average period of 4.1 years and 0.8 years for employees and directors, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 11.Employee Benefits
We provide certain medical and dental care benefits to 16 former U.S. union employees. The postretirement medical and dental benefit obligation to the former union employees as of September 30,2020, and the related net periodic benefit cost for the plan for the three and nine months ended September 30,2020 and 2019 were not material.
We maintain a defined contribution Supplemental Executive Retirement Plan for key employees. Under the plan, these employees may elect to defer a portion of their compensation and, in addition, we may at our discretion make contributions to the plan on behalf of the employees. In March 2020, we made company contributions to the plan of $0.3 million related to calendar year 2019.
We also have an Employee Stock Ownership Plan and Trust for employees who are not covered by a collective bargaining agreement. In connection therewith, we maintain an employee benefits trust to which we contribute shares of treasury stock. We are authorized to instruct the trustees to distribute such shares toward the satisfaction of our future obligations under the plan. The shares held in trust are not considered outstanding for purposes of calculating earnings per share until they are committed to be released. The trustees will vote the shares in accordance with their fiduciary duties. During the nine months ended September 30,2020, we contributed to the trust an additional 44,700 shares from our treasury and released 44,700 shares from the trust leaving 200 shares remaining in the trust as of September 30,2020.
Note 12.Fair Value Measurements
The carrying value of our financial instruments consisting of cash and cash equivalents, deferred compensation, and short term borrowings approximate their fair value. In each instance, fair value is determined after considering Level 1 inputs under the three-level fair value hierarchy. For fair value purposes, the carrying value of cash and cash equivalents approximates fair value due to the short maturity of those investments. The fair value of the assets held by the deferred compensation plan are based on the quoted market prices of the underlying funds which are held in registered investment companies. The carrying value of our revolving credit facilities, classified as short term borrowings, equals fair market value because the interest rate reflects current market rates.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Note 13.Earnings Per Share
The following are reconciliations of the earnings available to common stockholders and the shares used in calculating basic and dilutive net earnings per common share (in thousands, except per share data):
Three Months Ended
September 30,
Nine Months Ended
September 30,
2020
2019
2020
2019
Basic Net Earnings Per Common Share:
Earnings from continuing operations
$
36,212
$
22,654
$
57,675
$
56,313
Loss from discontinued operations
(7,587
)
(7,903
)
(9,456
)
(9,914
)
Net earnings available to common stockholders
$
28,625
$
14,751
$
48,219
$
46,399
Weighted average common shares outstanding
22,349
22,330
22,372
22,360
Earnings from continuing operations per common share
$
1.62
$
1.01
$
2.58
$
2.52
Loss from discontinued operations per common share
(0.34
)
(0.35
)
(0.42
)
(0.44
)
Basic net earnings per common share
$
1.28
$
0.66
$
2.16
$
2.08
Diluted Net Earnings Per Common Share:
Earnings from continuing operations
$
36,212
$
22,654
$
57,675
$
56,313
Loss from discontinued operations
(7,587
)
(7,903
)
(9,456
)
(9,914
)
Net earnings available to common stockholders
$
28,625
$
14,751
$
48,219
$
46,399
Weighted average common shares outstanding
22,349
22,330
22,372
22,360
Plus incremental shares from assumed conversions:
Dilutive effect of restricted stock and performance-based stock
409
424
423
454
Weighted average common shares outstanding – Diluted
22,758
22,754
22,795
22,814
Earnings from continuing operations per common share
$
1.59
$
1.00
$
2.53
$
2.47
Loss from discontinued operations per common share
(0.33
)
(0.35
)
(0.41
)
(0.44
)
Diluted net earnings per common share
$
1.26
$
0.65
$
2.12
$
2.03
The shares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented or because they were excluded under the treasury method (in thousands):
Three Months Ended
September 30,
Nine Months Ended
September 30,
2020
2019
2020
2019
Restricted and performance-based shares
268
269
271
260
Note 14.Industry Segments
We have two major reportable operating segments, each of which focuses on a specific line of replacement parts. Our Engine Management Segment manufactures and remanufactures ignition and emission parts, ignition wires, battery cables, fuel system parts and sensors for vehicle systems. Our Temperature Control Segment manufactures and remanufactures air conditioning compressors, air conditioning and heating parts, engine cooling system parts, power window accessories and windshield washer system parts.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
The following tables show our net sales, intersegment revenue and operating income for each reportable segment (in thousands):
Three Months Ended
September 30,
Nine Months Ended
September 30,
2020
2019
2020
2019
Net Sales (a)
Engine Management
$
229,554
$
215,973
$
603,825
$
647,204
Temperature Control
110,393
88,301
234,227
241,631
All Other
3,662
3,449
7,798
7,826
Consolidated
$
343,609
$
307,723
$
845,850
$
896,661
Intersegment Revenue (a)
Engine Management
$
4,725
$
4,758
$
11,405
$
15,028
Temperature Control
1,784
1,504
4,562
5,223
All Other
(6,509
)
(6,262
)
(15,967
)
(20,251
)
Consolidated
$
—
$
—
$
—
$
—
Operating Income
Engine Management
$
36,409
$
29,477
$
74,564
$
77,530
Temperature Control
16,641
7,478
20,260
16,682
All Other
(5,086
)
(5,651
)
(16,516
)
(17,223
)
Consolidated
$
47,964
$
31,304
$
78,308
$
76,989
(a)
Segment net sales include intersegment sales in our Engine Management and Temperature Control segments.
For the disaggregation of our net sales from contracts with customers by geographic area, major product group and major sales channels for each of our segments, see Note 15, “Net Sales.”
Note 15. Net Sales
Disaggregation of Net Sales
We disaggregate our net sales from contracts with customers by geographic area, major product group, and major sales channels for each of our segments, as we believe it best depicts how the nature, amount, timing and uncertainty of our net sales are affected by economic factors.
The following tables provide disaggregation of net sales information for the three months and nine months ended September 30, 2020 and 2019 (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Nine months ended September 30, 2019 (a)
Engine
Management
Temperature
Control
Other (b)
Total
Geographic Area:
United States
$
577,974
$
230,581
$
—
$
808,555
Canada
20,655
9,390
7,826
37,871
Mexico
14,601
508
—
15,109
Europe
9,957
424
—
10,381
Other foreign
24,017
728
—
24,745
Total
$
647,204
$
241,631
$
7,826
$
896,661
Major Product Group:
Ignition, emission control, fuel and safety related system products
$
538,718
$
—
$
4,625
$
543,343
Wire and cable
108,486
—
360
108,846
Compressors
—
145,080
1,288
146,368
Other climate control parts
—
96,551
1,553
98,104
Total
$
647,204
$
241,631
$
7,826
$
896,661
Major Sales Channel:
Aftermarket
$
536,228
$
217,453
$
7,826
$
761,507
OE/OES
95,241
22,638
—
117,879
Export
15,735
1,540
—
17,275
Total
$
647,204
$
241,631
$
7,826
$
896,661
(a)
Segment net sales include intersegment sales in our Engine Management and Temperature Control segments.
(b)
Other consists of the elimination of intersegment sales from our Engine Management and Temperature Control segments as well as sales from our Canadian business unit that does not meet the criteria of a reportable operating segment.
Geographic Area
We sell our line of products primarily in the United States, with additional sales in Canada, Mexico, Europe, Asia and Latin America. Sales are attributed to countries based upon the location of the customer. Our sales are substantially denominated in U.S. dollars.
Major Product Group
The Engine Management segment of the Company principally generates revenue from the sale of automotive engine replacement parts including ignition, emission control, fuel and safety related system products, and wire and cable parts. The Temperature Control segment of the Company principally generates revenue from the sale of automotive temperature control systems replacement parts including air conditioning compressors and other climate control parts.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
Major Sales Channel
In the aftermarket channel, we sell our products to warehouse distributors and retailers. Our customers buy directly from us and sell directly to jobber stores, professional technicians and to “do-it-yourselfers” who perform automotive repairs on their personal vehicles. In the Original Equipment (“OE”) and Original Equipment Service (“OES”) channel, we sell our products to original equipment manufacturers who redistribute our products within their distribution network, independent dealerships and service dealer technicians. Lastly, in the Export channel, our domestic entities sell to customers outside the United States.
Note 16.Commitments and Contingencies
Asbestos
In 1986, we acquired a brake business, which we subsequently sold in March 1998 and which is accounted for as a discontinued operation in the accompanying statement of operations. When we originally acquired this brake business, we assumed future liabilities relating to any alleged exposure to asbestos-containing products manufactured by the seller of the acquired brake business. In accordance with the related purchase agreement, we agreed to assume the liabilities for all new claims filed on or after September 2001. Our ultimate exposure will depend upon the number of claims filed against us on or after September 2001, and the amounts paid for settlements, awards of asbestos-related damages, and defense of such claims. At September 30, 2020, approximately 1,540 cases were outstanding for which we may be responsible for any related liabilities. Since inception in September 2001 through September 30, 2020, the amounts paid for settled claims are approximately $33.9 million. We do not have insurance coverage for the indemnity and defense costs associated with the claims we face.
In evaluating our potential asbestos-related liability, we have considered various factors including, among other things, an actuarial study of the asbestos related liabilities performed by an independent actuarial firm, our settlement amounts and whether there are any co-defendants, the jurisdiction in which lawsuits are filed, and the status and results of such claims. As is our accounting policy, we consider the advice of actuarial consultants with experience in assessing asbestos-related liabilities to estimate our potential claim liability;and perform an actuarial evaluation in the third quarter of each year and whenever events or changes in circumstances indicate that additional provisions may be necessary. The methodology used to project asbestos-related liabilities and costs in our actuarial study considered: (1) historical data available from publicly available studies; (2) an analysis of our recent claims history to estimate likely filing rates into the future; (3) an analysis of our currently pending claims; and (4) an analysis of our settlements to date in order to develop average settlement values. Based 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 and awards of asbestos-related damages 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.
In accordance with our policy to perform an annual actuarial evaluation in the third quarter of each year, an updated actuarial study was performed as of August 31, 2020. The results of the August 31, 2020 study included an estimate of our undiscounted liability for settlement payments and awards of asbestos-related damages, excluding legal costs and any potential recovery from insurance carriers, ranging from $58.1 million to $99.3 million for the period through 2065. The change from the prior year study was a $6.1 million increase for the low end of the range and a $8.7 million increase for the high end of the range. The increase in the estimated undiscounted liability from the prior year study at both the low end and high end of the range reflects certain assumptions based upon our actual experience, our historical data and events that may occur in the future. Based upon the results of the August 31, 2020 actuarial study, in September 2020, we increased our asbestos liability to $58.1 million, the low end of the range, and recorded an incremental pre-tax provision of $8.7 million in earnings (loss) from discontinued operations in the accompanying statement of operations. Future legal costs, which are expensed as incurred and reported in earnings (loss) from discontinued operations in the accompanying statement of operations, are estimated, according to the updated study, to range from $51.9 million to $89.5 million for the period through 2065. As related to our potential asbestos-related liability, we were found liable for $7.6 million in compensatory damages as a defendant in a 2018 asbestos liability case in California. We are pursuing all rights of appeal of this case. Total operating cash outflows related to discontinued operations, which include settlements and legal costs net of taxes, were $4.7 million and $6.2 million for the nine months ended September 30, 2020 and 2019, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)
We plan to perform an annual actuarial evaluation 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. Given the uncertainties associated with projecting such matters into the future and other factors outside our control, we can give no assurance that additional provisions will not be required. We will continue to monitor events and changes in circumstances surrounding these potential liabilities in determining whether to perform additional actuarial evaluations and whether additional provisions may be necessary. At the present time, however, we do not believe that any additional provisions would be reasonably likely to have a material adverse effect on our liquidity or consolidated financial position.
Other Litigation
We are currently involved in various other legal claims and legal proceedings (some of which may involve substantial amounts), including claims related to commercial disputes, product liability, employment, and environmental. Although these legal claims and legal proceedings are subject to inherent uncertainties, based on our understanding and evaluation of the relevant facts and circumstances, we believe that the ultimate outcome of these matters will not, either individually or in the aggregate, have a material adverse effect on our business, financial condition or results of operations. We may at any time determine that settling any of these matters is in our best interests, which settlement may include substantial payments. Although we cannot currently predict the specific amount of any liability that may ultimately arise with respect to any of these matters, we will 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.
Warranties
We generally warrant our products against certain manufacturing and other defects. These product warranties are provided for specific periods of time of the product depending on the nature of the product. As of September 30, 2020 and 2019, we have accrued $28.6 million and $20.6 million, respectively, for estimated product warranty claims included in accrued customer returns. The accrued product warranty costs are based primarily on historical experience of actual warranty claims.
The following table provides the changes in our product warranties (in thousands):
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements in this Report are indicated by words such as “anticipates,” “expects,” “believes,” “intends,” “plans,” “estimates,” “projects,” “strategies” and similar expressions. These statements represent our expectations based on current information and assumptions and are inherently subject to risks and uncertainties. Our actual results could differ materially from those which are anticipated or projected as a result of certain risks and uncertainties, including, but not limited to, changes in business relationships with our major customers and in the timing, size and continuation of our customers’ programs; changes in our supply chain financing arrangements, such as changes in terms, termination of contracts and/or the impact of rising interest rates; the ability of our customers to achieve their projected sales; competitive product and pricing pressures; increases in production or material costs, including procurement costs resulting from higher tariffs, that cannot be recouped in product pricing; the performance of the aftermarket, heavy duty, industrial equipment and original equipment markets; changes in the product mix and distribution channel mix; economic and market conditions; successful integration of acquired businesses; our ability to achieve benefits from our cost savings initiatives; product liability and environmental matters (including, without limitation, those related to asbestos-related contingent liabilities and remediation costs at certain properties); the effects of widespread public health crises, including the novel coronavirus (COVID-19) pandemic; as well as other risks and uncertainties, such as those described under Risk Factors, Quantitative and Qualitative Disclosures About Market Risk and those detailed herein and from time to time in the filings of the Company with the SEC. Forward-looking statements are made only as of the date hereof, and the Company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. In addition, historical information should not be considered as an indicator of future performance. The following discussion should be read in conjunction with the unaudited consolidated financial statements, including the notes thereto, included elsewhere in this Report.
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 Culture
Our Company was founded in 1919 on the values of ethics, integrity, common decency and respect for others. These values continue to this day and are embodied in our Code of Ethics, which has been adopted by the Board of Directors of the Company to serve as a statement of principles to guide our decision-making and reinforce our commitment to these values in all aspects of our business. We believe that our commitment to our Company, our employees and the communities within which we operate has led to high employee satisfaction and low employee turnover, and our commitment to our customers, suppliers and business partners has resulted in high customer satisfaction, as evidenced by the customer awards that we routinely win, and decades-long customer relationships.
We also take environmental and social issues seriously. We believe that our commitment to identifying and implementing positive environmental and social related business practices strengthens our Company, improves our relationship with our shareholders and better serves our customers, our communities and the broader environment within which we conduct our business.
Seasonality
Historically, our operating results have fluctuated by quarter, with the greatest sales occurring in the second and third quarters of the year and revenues generally being recognized at the time of shipment. It is in these quarters that demand for our products is typically the highest, specifically in the Temperature Control Segment of our business. In addition to this seasonality, the demand for our temperature control products during the second and third quarters of the year may vary significantly with the summer weather and customer inventories. For example, a warm summer, as we experienced in 2020, may increase the demand for our temperature control products, while a somewhat mild summer, as we experienced in 2019, may lessen such demand. 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.
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 the first nine months of 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 third quarter 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 third quarter 2020 results.
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, which will be paid on December 1, 2020 to shareholders of record on November 16, 2020. We continue to analyze our cost structure, and may modify or terminate any cost reduction measures taken as general business conditions warrant, or implement additional cost reduction measures in response to future challenges which may arise from the COVID-19 pandemic.
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 “Interim Results of Operations” 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 September 30, 2020 is $3.5 million, which we plan to pay equally by December 31, 2021 and 2022.
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. We are currently reviewing the employee retention feature of the CARES Act to determine our eligibility for the 50% tax credit throughout the company.
Additionally, we filed for wage subsidies in Canada and Poland under local law. 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, which will be paid in three equal installments beginning in August 2020 through October 2020, with the total amount paid through September 30, 2020 of Zloty 1.9 million (approximately US $0.5 million).
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 for the first nine months of 2020 have been slightly impacted by the timing of 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.
Comparison of the Three Months Ended September 30, 2020 to the Three Months Ended September 30, 2019
Sales. Consolidated net sales for the three months ended September 30, 2020 were $343.6 million, an increase of $35.9 million, or 11.7%, compared to $307.7 million in the same period of 2019, with the majority of our net sales to customers located 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 three months ended September 30, 2020 and 2019 (in thousands):
Three Months Ended September 30,
2020
2019
Engine Management:
Ignition, Emission Control, Fuel and Safety Related System Products
$
190,891
$
180,826
Wire and Cable
38,663
35,147
Total Engine Management
229,554
215,973
Temperature Control:
Compressors
70,785
52,776
Other Climate Control Parts
39,608
35,525
Total Temperature Control
110,393
88,301
All Other
3,662
3,449
Total
$
343,609
$
307,723
Engine Management’s net sales increased $13.6 million, or 6.3%, to $229.6 million for the three months ended September 30, 2020. Net sales in ignition, emission control, fuel and safety related system products for the three months ended September 30, 2020 were $190.9 million, an increase of $10.1 million, or 5.6%, compared to $180.8 million in the same period of 2019. Net sales in the wire and cable product group for the three months ended September 30, 2020 were $38.7 million, an increase of $3.5 million, or 10%, compared to $35.1 million in the three months ended September 30, 2019. Engine Management’s increase in net sales for the third quarter of 2020 compared to the same period in 2019 reflects the impact of pent up demand at the consumer level, as evidenced by the substantial increase in customer POS sales, which resulted in large customer orders in the third quarter of 2020, as customers replenished their inventories which had been reduced during the early days of the pandemic. We anticipate demand normalizing towards our longer range forecast of low single digit growth.
Temperature Control’s net sales increased $22.1 million, or 25%, to $110.4 million for the three months ended September 30, 2020. Net sales in the compressors product group for the three months ended September 30, 2020 were $70.8 million, an increase of $18 million, or 34.1%, compared to $52.8 million in the same period of 2019. Net sales in the other climate control parts product group for the three months ended September 30, 2020 were $39.6 million, an increase of $4.1 million, or 11.5%, compared to $35.5 million in the three months ended September 30, 2019. Temperature Control’s increase in net sales for the third quarter of 2020 compared to the same period in 2019 results primarily from an increase in customer demand stemming from the impact of very warm summer weather conditions and low preseason ordering earlier in the year. 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 31.4% in the third quarter of 2020, compared to 29.9% in the third quarter of 2019. The following table summarizes gross margins by segment for the three months ended September 30, 2020 and 2019, respectively (in thousands):
Three Months Ended
September 30,
Engine Management
Temperature Control
Other
Total
2020
Net sales
$
229,554
$
110,393
$
3,662
$
343,609
Gross margins
72,361
32,212
3,175
107,748
Gross margin percentage
31.5
%
29.2
%
—
31.4
%
2019
Net sales
$
215,973
$
88,301
$
3,449
$
307,723
Gross margins
66,264
22,973
2,851
92,088
Gross margin percentage
30.7
%
26
%
—
29.9
%
Compared to the third quarter of 2019, gross margins at Engine Management increased 0.8 percentage points from 30.7% to 31.5%, while gross margins at Temperature Control increased 3.2 percentage points from 26% to 29.2%. The gross margin percentage increase in Engine Management compared to the prior year primarily reflects the positive impact of higher year-over-year absorption due to higher sales levels and production volumes, and the positive impact of favorable product and customer mix. The gross margin percentage increase in Temperature Control compared to the prior year reflects primarily the positive impact of higher year-over-year absorption due to higher production volumes. The higher production volumes at both Engine Management and Temperature Control is reflective of the significant increase in customer orders during the third quarter of 2020.
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) were $59.5 million, or 17.3% of consolidated net sales, in the third quarter of 2020, as compared to $59.9 million, or 19.5% of consolidated net sales, in the third quarter of 2019. The slight decrease in SG&A expenses of $0.4 million as compared to the third quarter of 2019 is principally due to lower selling and marketing costs, and lower costs incurred related to our accounts receivable supply chain financing arrangements resulting from lower discount rates which were offset, in part, by higher distribution costs. The higher year-over-year distribution expenses are in line with the significantly higher net sales in the third quarter of 2020 when compared to the third quarter of 2019.
Restructuring and Integration Expenses. Restructuring and integration expenses for the third quarter of 2020 were $0.3 million compared to restructuring and integration expenses of $0.8 million for the third quarter of 2019. Restructuring and integration expenses incurred in the third quarter of 2020 relate to the increase 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; while the restructuring and integration expenses incurred in the third quarter of 2019 consist of costs related to residual relocation activities in our Engine Management segment in connection with our integration of the Pollak business of Stoneridge, Inc., acquired in April 2019.
Operating Income. Operating income increased to $48 million in the third quarter of 2020, compared to $31.3 million in the third quarter of 2019. The year-over-year increase in operating income of $16.7 million is the result of the impact of higher consolidated net sales, higher gross margins as a percentage of consolidated net sales, slightly lower SG&A expenses, and lower restructuring and integration expenses.
Other Non-Operating Income, Net. Other non-operating income, net was $0.5 million in the third quarter of 2020, compared to $0.2 million in the third quarter of 2019. The year-over-year increase in other non-operating income, net results primarily from the favorable impact of changes in foreign currency exchange rates offset, in part, by a decrease in year-over-year equity income from our joint ventures.
Interest Expense. Interest expense decreased to $0.5 million in the third quarter of 2020, compared to $1.5 million in the third quarter of 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 in the third quarter of 2020 was $11.8 million at an effective tax rate of 24.6% compared to $7.4 million at an effective tax rate of 24.5% for the same period in 2019. The effective tax rate in the third quarter of 2020 is essentially flat when compared to the effective tax rate in the third quarter of 2019.
Loss from Discontinued Operations. Loss from discontinued operations, net of income tax, during the third quarter of 2020 and 2019, reflects information contained in the actuarial studies performed as of August 31, 2020 and 2019, other information available and considered by us, and legal expenses associated with our asbestos related liability. During the third quarter of 2020 and 2019, we recorded a loss of $7.6 million and $7.9 million from discontinued operations, respectively. The loss from discontinued operations for the third quarter of 2020 and 2019 includes a $8.7 million and $9.7 million pre-tax provision, respectively, to increase our indemnity liability in line with the August 31, 2020 and 2019 actuarial studies. 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 Nine Months Ended September 30, 2020 to the Nine Months Ended September 30, 2019
Sales. Consolidated net sales for the nine months ended September 30, 2020 were $845.9 million, a decrease of $50.8 million, or 5.7%, compared to $896.7 million in the same period of 2019, with the majority of our net sales to customers in the United States. 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 nine months ended September 30, 2020 and 2019 (in thousands):
Nine Months Ended September 30,
2020
2019
Engine Management:
Ignition, Emission Control, Fuel and Safety Related System Products
$
498,204
$
538,718
Wire and Cable
105,621
108,486
Total Engine Management
603,825
647,204
Temperature Control:
Compressors
141,011
145,080
Other Climate Control Parts
93,216
96,551
Total Temperature Control
234,227
241,631
All Other
7,798
7,826
Total
$
845,850
$
896,661
Engine Management’s net sales decreased $43.4 million, or 6.7%, to $603.8 million for the first nine months of 2020. Net sales in ignition, emission control, fuel and safety related system products for the nine months ended September 30, 2020 were $498.2 million, a decrease of $40.5 million, or 7.5%, compared to $538.7 million in the same period of 2019. Net sales in the wire and cable product group for the nine months ended September 30, 2020 were $105.6 million, a decrease of $2.9 million, or 2.7%, compared to $108.5 million in the nine months ended September 30, 2019. In April 2019, we acquired certain assets and liabilities of the Pollak business of Stoneridge, Inc. Incremental sales from our acquisition of the Pollak business of $9.5 million were included in the net sales of the ignition, emission control, fuel and safety related system products market for the nine months ended September 30, 2020. Excluding the incremental sales from the acquisition, net sales in the ignition, emission control, fuel and safety related system products market decreased $50 million, or 9.3%, and Engine Management net sales decreased $52.9 million, or 8.2%. Engine Management’s decrease in net sales for the first nine months of 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; and to a lesser extent the impact of several pipeline orders from certain customers in the first quarter of 2019 that did not recur in the same period of 2020. 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 quarter and continued throughout the third quarter of 2020, resulting in strong Engine Management net sales in the third quarter of 2020, which have partially offset the declines from earlier in the year.
Temperature Control’s net sales decreased $7.4 million, or 3.1%, to $234.2 million for the first nine months of 2020. Net sales in the compressors product group for the nine months ended September 30, 2020 were $141 million, a decrease of $4.1 million, or 2.8%, compared to $145.1 million in the same period of 2019. Net sales in the other climate control parts product group for the nine months ended September 30, 2020 were $93.2 million, a decrease of $3.3 million, or 3.5%, compared to $96.5 million in the nine months ended September 30, 2019. Temperature Control’s decrease in net sales for the first nine months of 2020 compared to the same period in 2019 results from lower year-over-year net sales in the second quarter of 2020 reflective of the impact of the COVID-19 pandemic and resulting national and regional shelter-in-place orders related thereto; and to the impact of strong pre-season orders in the first quarter of 2019 that did not occur in the first quarter of 2020. After a downturn in net sales 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 quarter and continued throughout the third quarter of 2020, aided by the impact of very warm summer weather conditions, which partially offset the declines earlier in the year. 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, decreased slightly to 28.7% in the first nine months of 2020, compared to 28.9% during the same period in 2019. The following table summarizes gross margins by segment for the nine months ended September 30, 2020 and 2019, respectively (in thousands):
Nine Months Ended
September 30,
Engine
Management
Temperature
Control
Other
Total
2020
Net sales
$
603,825
$
234,227
$
7,798
$
845,850
Gross margins
175,296
60,828
6,377
242,501
Gross margin percentage
29
%
26
%
—
28.7
%
2019
Net sales
$
647,204
$
241,631
$
7,826
$
896,661
Gross margins
189,737
61,715
7,504
258,956
Gross margin percentage
29.3
%
25.5
%
—
28.9
%
Compared to the first nine months of 2019, gross margins at Engine Management decreased 0.3 percentage points from 29.3% to 29%, while gross margins at Temperature Control increased 0.5 percentage points from 25.5% to 26%. The gross margin percentages at both Engine Management and Temperature Control reflect the negative impact of lower year-over-year absorption in the second quarter of 2020 due to lower sales levels and production volumes, offset by improved year-over-year absorption in the third quarter of 2020, as production volumes increased due to higher customer demand. The lower production volume at both Engine Management and Temperature Control in the second quarter of 2020 is 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 have been adjusted to meet the increase in customer demand, resulting in higher year-over-year production volumes in the third quarter of 2020. We continue to closely monitor customer demand and inventory levels as we manage the production levels at all of our facilities.
Selling, General and Administrative Expenses. Selling, general and administrative expenses (“SG&A”) decreased to $163.7 million, or 19.4% of consolidated net sales, in the first nine months of 2020, as compared to $180.5 million, or 20.1% of consolidated net sales in the first nine months of 2019. The $16.8 million decrease in SG&A expenses as compared to the first nine months of 2019 is principally due to (1) lower selling and marketing expenses, (2) lower costs incurred related to our accounts receivable supply chain financing arrangements resulting from lower sales volumes, as well as lower discount rates, and (3) lower other general and administrative expenses resulting from the impact of our cost reduction measures implemented in the second quarter of 2020, including the reduction of discretionary spending, all of which more than offset the impact of incremental expenses of $1.1 million from our April 2019 acquisition of certain assets and liabilities of the Pollak business of Stoneridge Inc., including amortization of intangible assets acquired.
Restructuring and Integration Expenses. Restructuring and integration expenses for the nine months ended September 30, 2020 were $0.5 million compared to restructuring and integration expenses of $1.5 million in the same period of 2019. Restructuring and integration expenses incurred in the third quarter of 2020 relate to (1) the increase 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) 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; while restructuring and integration expenses incurred in the third quarter of 2019 consist solely of costs related to the residual relocation activities in connection with our integration of the Pollak business of Stoneridge, Inc.
Operating Income. Operating income was $78.3 million in the first nine months of 2020, compared to $77 million for the same period in 2019. The year-over-year increase in operating income of $1.3 million is the result of the impact of lower SG&A expenses and lower restructuring and integration expenses, which more than offset the impact of lower consolidated net sales, and lower gross margins as a percentage of consolidated net sales.
Other Non-Operating Income, Net. Other non-operating income, net was $0.6 million in the first nine months of 2020, compared to other non-operating income, net of $2.3 million in the first nine months of 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. 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 $2.1 million in the first nine months of 2020, compared to $4.3 million for the same period 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 the nine months ended September 30, 2020 was $19.1 million at an effective tax rate of 24.9%, compared to $18.6 million at an effective tax rate of 24.9% for the same period in 2019. The effective tax rate in the first nine months of 2020 is essentially flat when compared to the effective tax rate in the first nine months of 2019.
Loss from Discontinued Operations. Loss from discontinued operations, net of income tax, during the nine months ended September 30, 2020 and 2019, reflects information contained in the actuarial studies performed as of August 31, 2020 and 2019, other information available and considered by us, and legal expenses associated with our asbestos related liability. During the first nine months of 2020 and 2019, we recorded a loss of $9.5 million and $9.9 million from discontinued operations, respectively. The loss from discontinued operations for the nine months ended September 30, 2020 and 2019 includes a $8.7 million and $9.7 million pre-tax provision, respectively, to increase our indemnity liability in line with the August 31, 2020 and 2019 actuarial studies. 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.
For further information regarding the impact of the COVID-19 pandemic on our business, refer to the paragraphs entitled, “Impact of the Novel Coronavirus (COVID-19)” and “Impact of CARES Act and International Wage Subsidies,” in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10Q.
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 4, “Restructuring and Integration Expenses,” of the notes to our consolidated financial statements (unaudited).
Liquidity and Capital Resources
Operating Activities. During the first nine months of 2020, cash provided by operating activities was $78.6 million compared to $43.1 million in the same period of 2019. The increase in cash provided by operating activities during the first nine months of 2020 compared to the same period in 2019 resulted primarily from the increase in net earnings, the larger year-over-year decrease in inventories, the decrease in prepaid expenses and other current assets compared to an increase in prepaid expenses and other current assets in the prior year, the smaller year-over-year decrease in accounts payable, and the increase in sundry payables and accrued expenses compared to a decrease in sundry payables and accrued expenses in the prior year, partially offset by the larger year-over-year increase in accounts receivable.
Net earnings during the first nine months of 2020 were $48.2 million compared to $46.4 million in the first nine month of 2019. During the first nine months of 2020, (1) the increase in accounts receivable was $104 million compared to the year-over-year increase in accounts receivable of $16.6 million in 2019; (2) the decrease in inventories was $53.3 million compared to the year-over-year decrease in inventories of $11.8 million in 2019; (3) the decrease in accounts payable was $13.1 million compared to the year-over-year decrease in accounts payable of $24.1 million in 2019; (4) the decrease in prepaid expenses and other current assets was $5.6 million compared to the year-over-year increase in prepaid expenses and other current assets of $6.5 million in 2019; and (5) the increase in sundry payables and accrued expenses was $51.9 million compared to the year-over-year decrease in sundry payables of $2.6 million in 2019. The increase in receivables and decrease in inventories during the first nine months of 2020 is reflective of the significant increase in net sales in the third quarter of 2020; while the cash impact of the increase in sundry payables and accrued expenses relates primarily to the timing of customer returns and 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 $13.2 million in the first nine months of 2020, compared to $51 million in the same period of 2019. Investing activities during the first nine months of 2020 consisted of capital expenditures of $13.2 million; while investing activities during the first nine 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 April 2019 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 Jiangsu Che Yijia New Energy Technology Co., Ltd.; and (4) capital expenditures of $12.3 million.
Financing Activities. Cash used in financing activities was $59.1 million in the first nine months of 2020 as compared to cash provided by financing activities of $9.6 million in the same period of 2019. During the first nine months of 2020, (1) we reduced our borrowings under our revolving credit facility by $44 million as compared to the increase in borrowings under our revolving credit facility of $34.5 million in 2019; (2) we made cash payments in the first nine months of 2020 for the repurchase of shares of our common stock of $8.7 million as compared to $10.7 million in 2019; and (3) we paid dividends of $5.6 million in the first nine months of 2020 as compared to $15.4 million in the comparable period last year. 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 will be paid on December 1, 2020 to shareholders of record on November 16, 2020.
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 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 supply chain financing arrangements and eligible inventory. After taking into account outstanding borrowings under the amended credit agreement there was an additional $238.4 million available for us to borrow pursuant to the formula at September 30, 2020. Outstanding borrowings under the amended credit agreement, which are classified as current liabilities, were $8.4 million and $52.5 million at September 30, 2020 and December 31, 2019, respectively; while letters of credit outstanding under the amended credit agreement were $3.1 million at September 30, 2020 and December 31, 2019. Borrowings under the amended credit agreement have been classified as current liabilities based upon accounting rules and certain provisions in the agreement.
At September 30, 2020, the weighted average interest rate on our amended credit agreement was 3.5%, which consisted of an alternative base rate loan of $8.4 million. At September 30, 2020, there were no direct borrowings outstanding. The interest rate for direct borrowings under our amended credit agreement at September 30, 2020 was 1.4%. 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%. During the nine months ended September 30, 2020, our average daily alternative base rate loan balance was $1.3 million, compared to a balance of $1.6 million for the nine months ended September 30, 2019, and a balance of $1.7 million for the year ended December 31, 2019.
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 September 30, 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 US $7.5 million). The facility, as amended, expires in December 2020. 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 September 30, 2020 and December 31, 2019, borrowings under the overdraft facility were Zloty 13.7 million (approximately US $3.5 million) and Zloty 16.7 million (approximately US $4.4 million), respectively. We anticipate that the overdraft facility will be renewed in the fourth quarter of 2020.
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 $213.3 million and $511.1 million of receivables during the three months and nine months ended September 30, 2020, respectively, and $199.6 million and $560.6 million for the comparable periods in 2019, all of which were reflected as a reduction of accounts receivable in the consolidated balance sheet at the time of sale. A charge in the amount of $3.5 million and $9.4 million related to the sale of receivables was included in selling, general and administrative expense in our consolidated statements of operations for the three months and nine months ended September 30, 2020, respectively, and $5.6 million and $17.7 million for the comparable periods in 2019.
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 $20 million of our common stock under a 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, during the year ended December 31, 2018 and nine months ended September 30, 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, in the open market or through private transactions, as market conditions warrant, under a new stock repurchase program. Under this program, during the three months ended March 31, 2020, we repurchased 222,741 shares of our common stock at a total cost of $8.7 million. 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 stock repurchases. In September 2020, our Board of Directors approved to reinstate our stock repurchase program. There were no shares of common stock repurchased in the second quarter and third quarters of 2020 and, as such, as of September 30, 2020, there was approximately $11.3 million available for future stock purchases under the program. During the period from October 1, 2020 through October 27, 2020 there have been no additional shares of common stock repurchased.
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 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 of our business, refer to Item 1A “Risk Factors” in our quarterly reports on Form 10-Q for the periods ended March 31, 2020 and June 30, 2020, and Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ending December 31, 2019.
The following table summarizes our contractual commitments as of September 30, 2020 and expiration dates of commitments through 2028 (a):
(In thousands)
2020
2021
2022
2023
2024
2025-2028
Total
Operating lease obligations
$
2,235
$
8,631
$
7,071
$
5,715
$
3,881
$
7,844
$
35,377
Postretirement benefits
9
32
29
25
25
50
170
Severance payments related to restructuring and integration
58
155
28
1
—
—
242
Total commitments
$
2,302
$
8,818
$
7,128
$
5,741
$
3,906
$
7,894
$
35,789
(a)
Indebtedness under our revolving credit facility is not included in the table above as it is reported as a current liability in our consolidated balance sheets. As of September 30, 2020, amounts outstanding under our revolving credit facilities were $8.4 million.
Critical Accounting Policies
We have identified several accounting policies 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, 2019.
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 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.
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 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 September 30, 2020, 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 September 30, 2020 and December 31, 2019, 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 September 30, 2020 and December 31, 2019.
In addition, 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. During the three months and nine months ended September 30, 2020, we sold $213.3 million and $511.1 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 $2.1 million and $5.1 million negative impact on our earnings or cash flows during the three months and nine months ended September 30, 2020, 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, 2019.
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 September 30, 2020, 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.
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).
Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document).
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).
** 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.
