Standard Motor Products - Q2 2023

Transcript

Operator (participant)

Good day, everyone, and welcome to the Standard Motor Products Second Quarter 2023 Earnings Call and Webcast. To enter full screen mode, hover over the slide and click the full screen icon in the center of the viewer. To exit full screen mode, press Escape. After the presentation, we will open the floor for questions. You may register to ask a question over the phone by dialing star and one on your touch-tone keypad. If you require technical assistance during today's event, you can reference the Help link at the top of your screen. Please note, today's call will be recorded and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Tony Cristello, Vice President of Investor Relations. Please go ahead.

Tony Cristello (VP of Investor Relations)

Thank you, and good morning, everyone, and thank you for joining us on Standard Motor Products second quarter 2023 earnings conference call. I'm Tony Cristello, Vice President of Investor Relations, and with me today are Larry Sills, Eric Sills, President and CEO, Jim Burke, Chief Operating Officer, and Nathan Iles, Chief Financial Officer. On our call today, Eric will give an overview of our performance in the quarter. Jim will comment on our new distribution and supply chain efforts, and Nathan will then discuss our financial results with an update on our annual guidance. Eric will provide some concluding remarks and open up the call for Q&A. Before we begin this morning, I'd like to remind you that some of the material that we'll be discussing today may include forward-looking statements regarding our business and expected financial results.

When we use words like anticipate, believe, estimate, or expect, these are generally forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they are based on information currently available to us and certain assumptions made by us, and we cannot assure you that they will prove correct. You should also read our filings with the Securities and Exchange Commission for a discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements. I'll now turn the call over to Eric Sills, our CEO.

Eric Sills (President and CEO)

Well, thank you, Tony, good morning, everyone, welcome to our second quarter earnings call. Overall, our revenues were down slightly in the quarter, while we remain essentially flat year to date. Importantly, there were certain short-term factors influencing sales softness in the quarter, which we believe will be overcome in time. First, the quarter was unseasonably cool and wet, especially as compared to 2022, this had an adverse effect on our air conditioning business. Second, one of our largest aftermarket customers declared bankruptcy in January, we essentially sold them nothing throughout the entire first half. This business has now been sold at auction to other existing accounts, we expect a rebound as they replenish their depleted shelves. I'll address these issues further in discussing the impacted segments. Let me review each division separately, as each has slightly different dynamics.

To remind you, we entered the year realigning our reporting segments, carving out our non-aftermarket business into its own segment, called Engineered Solutions, leaving the other two solely reflective of the aftermarket. I'll first speak to the aftermarket, starting with Vehicle Control, which, as a reminder, was previously called Engine Management. We renamed it Vehicle Control entering this year to better reflect the breadth of categories within the offering, especially as it relates to powertrain-neutral products. Vehicle Control was down 1.1% in the quarter, though remains up 1.5% year-to-date. As noted in our release, the sales drop related to the customer bankruptcy was 2.2%, and so excluding that, we would have been up and thankfully, this is now in our rearview mirror.

Furthermore, we are seeing an overall favorability in our large customer sell-through. We believe this reflects ongoing health in the marketplace. Turning to Temperature Control, sales were down 8.1% in the quarter, bringing first half results 5.2% lower than 2022. As you're well aware, this is a highly weather-dependent seasonal business. 2022 was an exceptionally strong early season. The second quarter was up 6.4% over 2021, making for difficult comparisons. By contrast, 2023 saw an unseasonably cool and wet start to the season. That said, weather trends changed dramatically entering July, which has now been declared the hottest single month on record, with customer POS up double digits over last year. The heat continues.

Next, I'll speak to our Engineered Solutions segment, our non-aftermarket business focused on selling to manufacturers of vehicles and equipment across various end markets globally. Sales in Engineered Solutions were up 6.2% in the quarter, reflecting a combination of generally strong demands from key accounts, the impact of a small acquisition late last year, and the benefit of new business wins. We're very pleased with how this business is going. After several years working towards achieving critical mass, we believe we are now well positioned to take advantage of the combined strengths of the different pieces that we have assembled and are now achieving the cross-selling opportunities we have anticipated. Turning to profitability, there are a lot of moving pieces, and Nathan will get into the details in a few minutes.

From a high level, we are pleased to have been able to retain our margins, though the sales shortfall in Temperature Control drops to the bottom line in terms of earnings. Inflation persists, with costs remaining elevated across materials, labor, rent, and so on, and we are now dealing with a relatively new issue of the weakening U.S. dollar in countries where we have manufacturing, most notably Mexico. The single biggest cost increase continues to come from interest rates, impacting both our customer factoring programs and our borrowings. Through a combination of initiatives, we have largely been able to cover these cost increases, and I'm very proud of all of our people's efforts in this regard. With that, let me turn it over to James Burke, who will bring you up to speed on what's going on in our operations.

James Burke (COO)

Okay. Good morning, and thank you, Eric. As we disclosed in our earnings release, we are excited to share our aftermarket distribution network strategy expansion plans. We signed a new lease in Shawnee, Kansas, commencing on July 1, 2023. Why the expansion efforts now, and why Shawnee, Kansas? We service our U.S. aftermarket customers, excluding Forecast Trading Distribution, which is in Fort Lauderdale, Florida, with Vehicle Control and Temperature Control products from three primary distribution centers located in Disputanta, Virginia, Lewisville, Texas, and Edwardsville, Kansas. The existing footprint of these three facilities is roughly 1.2 million sq ft. The new Shawnee DC is roughly 575,000 sq ft, which adds an additional 211,000 sq ft, bringing our new footprint to 1.4 million sq ft once we exit the Edwardsville facility.

Currently, we are approaching capacity in our existing footprint. This addition will expand our throughput turnaround times. Our customers require the right part in the right place at the right time. We will be able to turn around customer orders in three days or less and ship thousands of emergency orders daily. This is an investment in our SMP value proposition to be the best full-line, full-service supplier of premium products. Other benefits include risk avoidance from our current single-point distribution model to a modified multi-point distribution strategy for high-volume, fast-moving SKUs. Why Shawnee, Kansas? We were very fortunate to find the new Shawnee DC located less than 5 mi from our existing Edwardsville DC. We will be able to retain our existing well-trained associates and management team, which minimizes any risk from a new greenfield startup.

Our planned timeline launch for the new DC will be to install some racking and equipment by the end of the first quarter, 2024, which will provide relief to our other DCs. This will be on a small-scale basis, while the larger scale automation picking lines are being installed during 2024. Beginning at the start of 2025, we will phase in various product categories and brands and anticipate being fully operational by the end of 2025. Obviously, this will add some redundant costs during the transition and some incremental costs once complete for the additional capacity. We estimate $2.5 million added costs in 2023, a partial year, and $7 million-$8 million added costs in 2024 on an annualized basis. We also anticipate some offsetting savings due to current inefficiencies, exiting Edwardsville redundant costs, and transportation cost savings.

Over time, with added sales growth, we anticipate we can delever some of these net added costs. We will have incremental CapEx spending in 2024 and 2025 to outfit the new DC. Fortunately, we own the existing Edwardsville location and anticipate putting this facility up for sale in late 2025, which should help offset a large portion of the Shawnee investment. Overall, we are very excited about bringing this new Shawnee DC on board, adding capacity, minimizing risk, maintaining well-trained existing workforce, and most importantly, better servicing our customers. I will also hit on a couple of supply chain topics. Overall, supply chain bottlenecks and delays have subsided with more reliable deliveries and lower transportation costs. While some commodities like copper and aluminum have decreased over the first half 2022, we have seen increases in copper and steel-based products from 2022 year-end levels.

Overall, we are seeing inflationary costs persist, primarily for electronics and labor costs, but at a slower pace than in 2022. The more reliable supply chain has allowed us to accelerate our inventory reduction efforts in the first half of 2023. This has been a tremendous benefit to our cash flow generated this year, but also adds a slight drag on gross margins from under-absorbed overhead, which Nathan will highlight shortly. Over the second half of the year, I see a slight build in inventory levels as we level load our manufacturing facilities and begin our seasonal build for Temperature Control products. I want to thank all of our SMP employees dedicated to servicing our customers. Thank you for your attention, and I will turn the call over to Nathan.

Nathan Iles (CFO)

All right, thank you, Jim. As Eric noted earlier, our sales were down in the second quarter, with lower Temperature Control sales impacting our bottom line. We did see improvement in our gross margin rates, which, at the consolidated level, offset factoring costs that continued to increase. We also made great progress reducing inventory levels, as Jim noted. As we go through the numbers, I'll give some more color on these items and other key drivers for the quarter and year so far, as well as provide an update on our financial outlook for the full year in 2023.

First, looking at our Vehicle Control segment, you can see on the slide that net sales of $183.8 million in Q2 were down 1.1% versus the same quarter last year, with the decrease driven by a 2.2% decline from the impact of a bankrupt customer, partly offset by increases with other customers as we continue to see favorable sell-through trends. For the first six months of Vehicle Control, sales were up 1.5%, despite the impact of a bankrupt customer, which was also a 2.2% drag on sales year to date, with the growth for the year so far a result of continued demand for our products and favorable sell-through. Vehicle Control's Adjusted EBITDA was 12.6% of net sales and up two points from Q2 last year.

It's important to note that we were up against an easy comparison as this segment saw a large impact from cost inflation and factory expenses in Q2 last year, and this year's quarter showed profits at a more normal level. Vehicle Control Adjusted EBITDA in the quarter was driven by gross margin rate expansion as a result of pricing and savings initiative, which overcame cost inflation, unfavorable overhead absorption from reducing inventories, and a $3 million or 1.7 percentage point increase in the cost of customer factoring programs. Vehicle Control Adjusted EBITDA for the first six months was 12.1%, basically flat, with 12.2% last year, mainly as a result of the margin expansion this segment saw in the second quarter, which offset higher factoring expenses.

Turning to Temperature Control, net sales in the quarter for that segment of $97.1 million were down 8.1%, sales for the first six months were down 5.2% as we saw a slow start to the selling season, as Eric pointed out. Temperature Control's Adjusted EBITDA was 7.2% of net sales in the quarter and 6.1% of net sales for the first six months, with both periods down from last year, mainly due to lower sales and higher factoring expenses. Looking at it more closely, Temp Control's gross margin rate was down 0.5 points in the quarter and 0.4 points for the first six months, as lower sales and lower production related to inventory reductions more than offset pricing and savings actions for this segment.

With margin rates down slightly, the combination of significantly higher costs from customer factoring programs and lower SG&A leverage led to a reduction in Adjusted EBITDA. Sales for our Engineered Solutions segment in the quarter of $72.2 million were up 6.2%, and sales for the first six months of $143.3 million were up 2%. While we said sales could be lumpy for this new segment as it begins to grow, we were pleased to see our sales increase as a result of strong demand and new business wins. Adjusted EBITDA for Engineered Solutions in the quarter came in at 13%, an increase of 2.1 points from last year, as strong sales growth and good channel and customer mix improved both the gross margin rate and SG&A leverage.

For the first six months, Adjusted EBITDA for Engineered Solutions was 12.3% and up 0.5 points from last year, mainly as a result of higher sales and improved SG&A leverage. Turning to our consolidated results, net sales in the quarter declined 1.8%, and for the first six months were basically flat, with both periods being impacted by a decline of 1.6% related to a customer bankruptcy, which, when excluded, shows growth in sales that essentially offset a slow start to the season in Temperature Control. While net sales were lower overall, our consolidated gross margin rate improved for both the quarter and first six months due to our initiatives that overcame other headwinds and resulted in gross margin dollar increases of 5.1% and 3.4% for the quarter and first six months, respectively.

Regarding SG&A expenses, excluding the cost of customer factoring programs, which are shown separately on the page, expenses were well controlled in the quarter at 17.4% of net sales and in line with last year. Looking at the bottom line, consolidated operating income of 7.8% and Adjusted EBITDA of 10% in the quarter were flat with last year as an improved gross margin rate was offset by $4.8 million of higher factoring costs. For the first six months, consolidated operating income and Adjusted EBITDA were down as higher factoring costs were only partly offset by improvements in gross margin. As for diluted earnings per share, you can see our performance resulted in earnings of $0.84 for the quarter and $1.44 for the first six months.

Lower EPS was mainly due to lower Temperature Control sales, which dropped through to the bottom line, but also interest expense that was higher by $1.5 million in the quarter and $4.5 million in the first six months, mainly due to higher interest rates. One last point on our results. As you know, we report the results of the discontinued operation each quarter, which relates to a business bought in 1986 and subsequently sold in 1998. As noted in our press release this morning, since March of 2019, the company was involved in a legal proceeding in connection with a breach of contract claim for this discontinued operation.

In July, the court ruled in favor of the other party, and we were found liable for approximately $11 million in damages, and as such, we incurred a charge for this amount during the quarter. Turning now to the balance sheet. The key item here is our inventory level, which finished Q2 at $499.1 million, down $29.6 million from December last year and down $52.3 million from June last year. As we continue to focus on reductions in this area, note that we typically build inventories during the first half of the year in anticipation of the Temperature Control selling season. When viewed against average increases of $15 million in the first half of the year, this reduction in inventory represents a significant improvement in cash flow of almost $45 million in the first six months of this year.

Looking at cash flows, our cash flow statement reflects cash generated from operations in the first six months of $39.4 million, as compared to cash use of $95.3 million last year, with the improvement driven by a $118.6 million improvement in cash flows from inventory in the first six months. Our financing activity shows significant progress made in paying down our revolving credit facilities by $16.5 million as a result of improved operating cash flows and $50 million of repayments made in the quarter. We also paid $12.5 million of dividends during the first six months.

Our borrowings of $223 million at the end of Q2 were much lower than last year, and we finished the quarter with a leverage ratio of 1.4, lower than both June and December of last year. Before I finish, I want to give an update on our sales and profit expectations for the full year of 2023. Regarding our top line sales, we expect full year 2023 sales growth and percentage terms will be in the low single digits... Which includes the first half that was flat to last year and the second half that will see low single-digit growth rates typical for the business. Adjusted EBITDA is expected to be approximately 9.5% and lower than our prior estimate of 10%, as we noted in our release this morning. The lower estimate is a result of four things.

First, as I just said, our second quarter sales were softer than expected, leaving us flat to last year through six months. This will hurt our full-year sales performance. Second, additional interest rate increases announced by the Federal Reserve in June, when output factoring expenses at the top end of our prior range. These costs are expected to be $48 million-$50 million, using the current outlook for rates. Also, we anticipate the expansion of distribution capabilities in a new warehouse in Shawnee, Kansas, will result in duplicate overhead and startup costs beginning in the second half of the year. Finally, we've recently seen the U.S. dollar significantly weaken, where the majority of our international operations are located, weakening against both the Mexican peso and Polish zloty, and in turn, increasing our costs of production and inventory in those locations.

In connection with Adjusted EBITDA, we expect depreciation and amortization expenses and our income tax rate to be in line with 2022. We expect our interest expense on outstanding debt to be on average, about $4 million each quarter, given higher interest rates. Looking at operating cash flows in 2023, you can see we're well on track for operating cash flows to return to healthy full year levels consistent with years past. To wrap up, while sales were slower than we like, we were very pleased to report improved gross margin rates for the quarter and the year, as well as a significant improvement in cash flow, and very much appreciate the efforts of all of our team members in improving our business. Thank you for your attention. I'll now turn the call back to Eric for some final comments.

Eric Sills (President and CEO)

Thank you, Nathan. To conclude, let me spend a minute talking about current trends and how we're thinking about the future. Our aftermarket business, which makes up 80% of our total sales, continues to march forward, stable and strong. The addressable market continues to show far more favorable trends than unfavorable. The car population continues to grow and to age, with more vehicles entering the sweet spot in coming years. A combination of difficult economic times, elevated new vehicle pricing, and high interest rates, have car owners retaining their existing vehicles, thus requiring necessary repairs in non-discretionary categories like ours. Our relationship with distributors have never been stronger as they seek capable, committed suppliers like us, who execute at a high level for them. While external factors like the weather can have short-term impacts, the long view is favorable.

Our Engineered Solutions business is now in the fast lane. We're getting ourselves known by the blue-chip accounts in these various end markets. The doors that are opening to us are very encouraging. We are receiving more quoting opportunities than we could have hoped for and expect to get our fair share. We're now back to generating solid cash flow. After a period of intentionally increasing our inventory to accommodate supply chain instability, we are now successfully working it down, allowing us to pay down debt, return value to shareholders through dividends, reinvest in the company's manufacturing and distribution capabilities to prepare us for the future. We're tackling it with the strongest team we've ever had. I thank all of our employees worldwide. That concludes our prepared remarks.

With that, I'll turn it over to the moderator, and we'll open it up for questions.

Operator (participant)

Thank you. At this time, we'll open the floor for questions. If you would like to ask a question, please press star one on your touchtone phone. You may remove yourself at any time by pressing star two. Again, to ask a question, please press star one. We'll take our first question from Bret Jordan with Jefferies.

Bret Jordan (Managing Director and Senior Equity Research Analyst)

Hey, good morning, guys.

Eric Sills (President and CEO)

Good morning.

Bret Jordan (Managing Director and Senior Equity Research Analyst)

When you look at the 1.6% impact from that Auto Plus bankruptcy, does that abate in the second half with those assets having been acquired by somebody else? Are they, are they back to being a customer?

Eric Sills (President and CEO)

That's a great question, Bret. Yes, those, all the pieces of the business have now been acquired, and as I said in the prepared remarks, have been acquired by existing SMP accounts. We believe that in the long run, all that volume should return, but this bankruptcy was really very disruptive, as you can imagine, to the whole marketplace, and I think it could take a little while for all the dust to settle. As the new acquirers assess what they have and look at the inventory that they have acquired and look at it, within their own existing inventories, I think there could still be some period of absorption of that inventory and reconciling what they have. We think it could take a little while.

First, we're definitely very encouraged that the business is now back in business and by existing accounts that we have good relationships with, and so we are expecting to see it bounce back. I also think that there was a certain amount of that business that just over that period, was absorbed by other accounts that kind of get lost in the in the mix in terms of being able to track it. In the long run, the end market, the, the true demand is what it is, we'll get it back as the inventory works itself through the system.

Bret Jordan (Managing Director and Senior Equity Research Analyst)

Okay. Then on the redundant costs from the Shawnee, Kansas, DC, I think you called out $7 million-$8 million in 2024. There would be some offset. Could you give us a feeling for what the net impact might be?

James Burke (COO)

Yeah, Bret, this is James Burke. The $7 million-$8 million is on an annualized basis because, you know, we'll be staffing up and bringing on different costs that are in there. I think that'll be on an annualized basis versus a full year impact. The savings that we have are inefficiencies that are there in our existing facility. We'll exit Kansas fully. It'll be in stages, but we'll exit it in 2025, so there'll be savings coming from that in transportation. When all said and done, on a run rate basis, we believe that we could be incremental costs from a new DC that's there in the $3 million range, net $3 million-$4 million range.

Again, that's we're talking by the end of 2025, and we'll be updating our estimates as we proceed through to that period.

Bret Jordan (Managing Director and Senior Equity Research Analyst)

Okay. One last question on inventory levels for AC product. You commented on the soft start to the season. Could you talk about what retail inventories look like now on a maybe year-over-year basis?

Eric Sills (President and CEO)

Yeah, as, as we look at it, for those, we have visibility, and, and important to note that we only have that through June, so not sure what happened to their inventories in July, and their, their demand was very strong. Their sell-through in July was very strong. At the end of June, what we saw was that it was essentially flat throughout the course of the entire year, a little bit of, of noise month to month, but the big players kept their inventory roughly flat throughout. Now it's just a matter of that sell-through turning itself into replenishment orders to them. Yeah, they didn't enter this quarter fat.

Bret Jordan (Managing Director and Senior Equity Research Analyst)

Okay, great. Thank you.

Operator (participant)

Thank you. We'll take our next question from Daniel Imbro with Stephens.

Daniel Imbro (Managing Director and Senior Equity Research Analyst)

Yep. Hey, good morning, guys. Thanks. I have questions.

Eric Sills (President and CEO)

Morning.

Daniel Imbro (Managing Director and Senior Equity Research Analyst)

I wanna follow maybe on, on Bret's last question, just around maybe some more near-term trends. We've heard some varying commentary on kind of how 2Q progressed. Can you talk about any notable trend shifts you saw on your sales results from April through June? Could we dig into July a little bit more? We've had some pretty big heat waves coming through. Has that been a tailwind? Have trends accelerated here in the third quarter? Just any color on the monthly cadence would be great.

Eric Sills (President and CEO)

The monthly cadence within the second quarter was nothing exceptional. So, you know, anything can happen in a given month. I think when you look at the cadence for our distributors, that's gonna be more about true end market demand cadence. For us, is you're gonna have the influence of their reorder patterns, so we didn't see anything notable in that quarter. Entering July, you know, the books are not closed yet on it, but what we have seen is a nice uptick, certainly on the Temperature Control side, on their orders to us, as would be expected, and you mentioned the heat. I think it's too early to make any real strong observations of how that plays out for the balance of the summer.

Daniel Imbro (Managing Director and Senior Equity Research Analyst)

Got it. That's helpful. Then maybe shifting to the guidance, Nathan, as you look at the back half, obviously, guide implies pretty notable ramp in op margin, maybe as costs alleviate, and, and to Eric's point, top line gets a little bit better. How do you think about the sustainability of this high singles operating margin or low doubles as we look at 2024, 2025? Obviously, Jim just mentioned there's a few savings coming, but, you know, what do you think the right intermediate-term margin should be for this? Can we get back to 10% next year?

Nathan Iles (CFO)

Yeah, Daniel, so as, as I mentioned in my remarks, we, we do have some headwinds coming at us in the second half of the year, and at least one of those was related to currency. As you know, those markets can, can swing around, and you don't know exactly when those will turn. We, we can't be sure when headwinds will, will abate. That said, we're always working on, on savings programs, continuous improvement projects. As we go into 2024, and, and from there, we'll still look to have those projects in place and, and improve our margins like we've always said we would, by 10 to 20 basis points, as those programs come through, successfully.

Daniel Imbro (Managing Director and Senior Equity Research Analyst)

Got it. The last one from me. Eric, I think you mentioned in your prepared remarks, you're starting to realize the cross-selling within Engineered Solutions. Any more color or quantification you can provide on just how, how you're feeling about or capturing that opportunity?

Eric Sills (President and CEO)

Yeah, well, I can't get into, you know, specific business wins or specific accounts, but what we have really started to see over these last few quarters is that, you know, as, as we've talked about in the past, we've assembled a bunch of smaller companies into one, and each of those had their own customer list, their own product categories, in some cases, even their own geography. So they were fairly they were good, but they were limited in what they were able to do. Now, one entity's customer list gets opened up to the broader portfolio, it gives our people something to sell. So for example, I'll just give you one example. It was a large ConAg account that came with an acquisition two years ago that we had never done any business with.

We're selling them air conditioning because that was something that we had. That customer needed it. Their previous supplier, before we had acquired them, obviously couldn't service that type of product. So we see those types of opportunities, and we're new in this space, so we're really just getting our name out there. As we have these meetings with these accounts, and they're able to see all of our capabilities, and they're assessing their supply base, they are asking us to quote on quite a lot of product. It's a pretty long cycle from being asked to quote, to getting the award, to actually seeing it start to show up in production and revenue.

Even just over the course of this year, the number of new opportunities that we have, on our plate to work on, has grown dramatically. We're, we're pretty excited.

Daniel Imbro (Managing Director and Senior Equity Research Analyst)

Great. I appreciate it. Thanks.

Operator (participant)

Thank you. We'll take our next question from Scott Stember with Roth MKM. Scott, you may be muted. Scott, your line is open. Please unmute on your end. We'll go next to, Robert Smith with the Center for Performance Investing.

Robert Smith (Investment Adviser)

Hi. Good morning. Thanks for taking my questions. I'm quite interested in the Shawnee move.

... I just wanna, I, I heard that you said that going forward, say, beginning in 2026, that the efficiency would, would be a plus $3 million-$4 million. Was that correct?

James Burke (COO)

Yeah. Hi, Robert. This is James Burke. The net savings of the $7 million-$8 million that we said annualize, after we achieve savings that in there, we believe the ongoing run rate will be in that $3 million-$4 million range. Now, those savings will be achieved over the period of time, a small part of it in 2024, more of it in 2025, and then fully in 2026, as we're fully operational.

Robert Smith (Investment Adviser)

Yeah. It, it seems rather a conservative figure, $3 million-$4 million, from a totally new facility with automation and robotics. I mean, am I missing something?

James Burke (COO)

Well, one of, one of the pieces there, our Edwardsville DC that we have, is fully owned. I believe it's mostly fully depreciated that's on there. We'll have the advantage of when we sell it and, and taking that capital that's in there to offset, future, impact. The new lease on 575,000, you incur the cost there and the, property taxes on that. That's incremental, whereas most of on the existing owned facility wouldn't have had costs that are in there.

Robert Smith (Investment Adviser)

Oh, got it. Is there any prospect of actually buying the facility?

James Burke (COO)

No, that's not our intent to be in the real estate. We're fortunate from years past that we own the other one there. We'll put that up for sale, and that'll be a, a nice, favorable cash flow benefit.

Robert Smith (Investment Adviser)

Right. Are there any such possibilities with the other two facilities, DCs?

James Burke (COO)

Well, that's where we'll, we'll wind up feeling, achieving the efficiency savings that were in there, that we'll be able to, you know, scale down. Most of that'll be where we have ramped-up temporary workforce, so we really won't be even incurring any wind-down costs for personnel in those areas there, and we'll staff up. What the one big benefit is, in the new Shawnee facility, we bring over our full staff and management team, knowing our systems, knowing the product categories, knowing the part numbers and everything, and we'll staff up gradually during that period of time. The savings will be achieved. Yes, there'll be some automation there, but a lot of the savings will be in the other two distribution centers, which are, you know, really at capacity at the moment now.

Robert Smith (Investment Adviser)

And so-

Eric Sills (President and CEO)

A significant portion, just to add to that, Robert, to give some color. As Jim described it, we're gonna be moving some of the distribution out of the other DCs to go into this Shawnee distribution center. Right now, all, a majority of our Vehicle Control is coming out of Virginia, which has to ship all the way across the country to West Coast customers. This will now put that inventory in the middle of the country, which will allow us to service our customers better, certainly from a transportation time standpoint, but also from a freight cost, we're gonna be halfway there already. So that's where you're gonna see some, some nice benefits as well.

Robert Smith (Investment Adviser)

Yeah, I follow. Later on in the 20s, toward the end of the decade, do you foresee a possibility of doing something with the other one or two DCs? I mean, expanding those?

James Burke (COO)

Well.

Robert Smith (Investment Adviser)

New, or new structures.

James Burke (COO)

I, I anticipate with this additional 200,000+ sq ft that we added, we'll have sufficient capacity for the future, but I hope we grow significantly. At this point, we don't have initial plans for the other two locations, but that'll be a good problem to be faced in a couple of years out.

Robert Smith (Investment Adviser)

Yeah. As you, as you expand in Engineered Solutions, the possibility of folding some of the distribution into the new Shawnee facility or the other, your other two?

Eric Sills (President and CEO)

The, the majority of our Engineered Solutions business, Robert, is built to order, so we do not typically warehouse much of it at all. Most of that ships directly from our factories. There's some that we do hold a, a bit of safety stock for the accounts, but it's not like the aftermarket, where you're stocking a significant amount of inventory for stock orders. It's all built to order for these accounts.

Robert Smith (Investment Adviser)

Good. Yeah, got it. Thanks. Yeah, give me an idea as to, you're very optimistic about Engineered Solutions, and what's on, what's on the landscape as far as possible, additional acquisitions in the near term?

James Burke (COO)

Robert, this is James Burke again. As I've said many times, we, you know, we have a team that covers really the geographical space as we look worldwide and also functional product category lines. We're evaluating always opportunities that are there. You know, the last couple of acquisitions we did were in the Engineered Solutions space. We're optimistic about that category. We've seen growth, so we're focused on both our Vehicle Control, Temperature Control categories and Engineered Solutions. You know, nothing at this point to announce.

Robert Smith (Investment Adviser)

Mm. Any particular comments about, Mexico or China?

Eric Sills (President and CEO)

Could you be more specific on what your concerns are?

Daniel Imbro (Managing Director and Senior Equity Research Analyst)

Well, well, listen, there's a, there's a lot of, you know, ambiguity going on as far as the politics and what's happening in sort of both countries. I was wondering what you, what you guys are looking at from your viewpoint?

Eric Sills (President and CEO)

Well, you know, we're, we're pretty committed to our footprint in, in both of those countries. As I think you're aware, we have a lot more in Mexico than we do in China. We've been building out our manufacturing capabilities in Mexico for going on 30 years, I think. While really the only thing we see adverse going on in Mexico is, is some of the cost increases, most notably related to labor costs. Right now, we're, we're seeing it in, in currency, but that's, you know, hard to predict how long of a trend that would be. No, we're, we're very pleased with, with our footprint in Mexico. We have excellent management teams there. We have pushing 2,000 people there.

One of the nice things we see is some of our big customers are growing their business in, in the Mexico market, allows us to follow them in. That's the Mexico story. China, we're there as well. We have four joint ventures, as you're aware, I believe. Three of them are on the Temperature Control side, and one came with the acquisition of Trombetta, doing power management, power distribution products. They're really there for two purposes. One is to continue to bring high quality, low-cost product back here to North America, but also to sell Engineered Solutions business, globally. They're all doing well, and we're very pleased with how we're doing. We're obviously very aware of geopolitical complexity, and we pay close attention to that.

We look to mitigate some of that risk through, you know, vendor diversification, redundancy, and so on. We're pretty committed to what we're doing there, and we've seen very nice results.

Robert Smith (Investment Adviser)

Okay. How about your Eastern European operations?

Eric Sills (President and CEO)

Eastern European, we have two, two manufacturing operations there. Where our, our largest and one that's been part of us the longest is in Poland, in eastern Poland, it's really just a fantastic plant, 700 people strong. An area where we're seeing potentially the, the, the biggest opportunities for Engineered Solutions quoting, due to the combination of high quality, high technology, and low cost. Now more recently, we have a plant outside of Budapest in Hungary that came with the Stabil acquisition. It's been terrific for us as well. Not only are we seeing a lot of opportunities to sell to third parties, what it brought to us was electronics manufacturing in Europe, and now they've become a supplier to our Poland plant. We're really pleased with how we're building out.

We've kind of moved from having a manufacturing plant in Poland to have a European-wide business, and we're continuing to invest heavily there, and we're just very pleased with what we're seeing.

Robert Smith (Investment Adviser)

Any reverberations from the Ukraine situation?

Eric Sills (President and CEO)

No, it's, it's really business as usual. You know, when the war first broke out a year and a half ago or so, we quickly mobilized to understand what the potential impact could be on the supply chain. It was fortunate to have found that there was, we had no suppliers in the region. We had no customers, except one very small one in the region. Fear was that it was gonna potentially impact our utilities infrastructure there. It did not. This is now a year and a half ongoing, and so it's really proven to be a non-event, which is very good.

Robert Smith (Investment Adviser)

Thanks. Thanks for taking my questions. Good luck.

Eric Sills (President and CEO)

Thank you, Robert.

Operator (participant)

Thank you. We'll go next to Scott Stember with Roth MKM. Please go ahead. Scott, we still have you muted.

Eric Sills (President and CEO)

Yeah, we'll, we'll follow up with Scott if he's not able to, to ask his question here.

Operator (participant)

Understood. Thank you. Once again, if you would like to ask a question, please press star one at this time. We'll pause just another moment. We have no further questions at this time. I'll turn it back to management for any closing remarks.

Eric Sills (President and CEO)

Okay, we want to thank everyone for participating in our conference call today. We understand there was a lot of information presented, and we'll be happy to answer any follow-up questions you may have. Our contact information is available on our press release or investor relations website. We hope you have a great day. Thank you.

Operator (participant)

This does conclude today's Standard Motor Products second quarter 2023 earnings call and webcast. You may disconnect your line at this time, and have a wonderful day.