Motorcar Parts of America Inc (MPAA) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Motorcar Parts of America Third Quarter Earnings Conference Call. My name is Akia, and I'll be your operator for today.

[OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's call, Miss Elaine Ketchmere with CCG Investor Relations. Please proceed, ma'am.

Thanks, Akia.

You're welcome.

Good afternoon, and welcome everyone to Motorcar Parts of America's Third Quarter Fiscal 2007 Conference Call. With us today is MPA's Chairman, President and CEO, Selwyn Joffe, and CFO, Mervyn McCulloch.

Before I turn the call over to them, please remember that in this call, management's remarks contain forward-looking statements, which are subject to risks and uncertainties. And management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995.

These statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today, including risks and uncertainties related to fluctuations in demand for MPA's alternators and starters, the company's ability to maintain and expand its relationships with existing customers, the company's ability to effectively grow its presence in the traditional warehouse market, variability in gross margins due to customer pricing pressures, fluctuations in the cost in customer returns of cores and other factors, increases in working capital required as a result of increased volumes of business and risks relating to the company's expansion of its offshore manufacturing operations.

Examples of forward-looking statements include statements related to MPA's anticipated or projected revenues, gross margins and liquidity needs. We would like to encourage all our listeners to review a more detailed discussion of the risks and uncertainties related to these forward-looking statements that is contained in the company's filings with the Securities and Exchange, and in particular in its Forms 10-K. Any projections as to that company's future financial performance represent management's estimates as of today, February 23, 2007. MPA assumes no obligation to update these projections in the future due to changing market conditions or otherwise.

And now, with those formalities out of the way, it's my pleasure over to MPA's CEO, Selwyn Joffe.

Thanks Elaine, good afternoon -- good afternoon, everyone. It is afternoon for everyone at this point. Thank you for listening to our conference call today. Today's call will be a little bit unique. In keeping with MPA's commitment to lean efficiency, we are going to be rebroadcasting our presentation as of two days ago, which I believe thoroughly reviews all of our quarterly and year-to-date results.

And after that, presentation, both Merv McCulloch, our Chief Financial Officer, and myself will be online to answer any questions that you may have. For those of you who are seeing us for the second time, I apologize. But, I do believe this is the most thorough presentation, and the most efficient way to communicate consistent information to the street at this point in time.

So with that, I'll begin the presentation and look forward to answering any questions afterwards.

[REBROADCAST BEGINS]

Welcome, everybody. I appreciate having such a big crowd. I will announce that we are now officially 100% current in all of our filings, which has been quite a challenge for us. The presentation of our growth I'm about to deliver is subject to all the Safe Harbor provisions. And you can take a moment and just look through the Safe Harbor statement.

We'll start off with a quick equity snapshot of where we are. We've been publicly traded since 1994. We trade on the pink sheet, MPAA.PK, most current price I believe is $13.45. I haven't seen the price today. We have approximately 8.3 million shares outstanding, a market capitalization of 112 million. We have a float of about 6.1 million. Our trailing 12-month revenues are $133.1 million.

Our price to adjusted earnings was 13.45, price to sales trailing 12-month is 0.84, price to book, the most recent quarter is $2.21 -- 2.21 times, market cap to adjusted EBITDA trailing 12 months was 5.45. Our adjusted trailing 12-month number is 20.6, and we'll be walking through the relevant adjustments.

A quick overview of who we are, we are one of the leading remanufacturers of alternators and starters, probably in the world, but definitely in North America. We have corporate headquarters in Torrance, California, which is about 20 minutes south of the LAX Airport. We have other facilities in Nashville, Tennessee. It's the major, single [pick] distribution center that we run. We have three warehouses, both on the east and the west coast in addition to Nashville. We have a major manufacturing -- new manufacturing facility in Mexico, just across the border in Tijuana, and that is also in the process -- we are in the process of completing a new distribution center our of the same facility.

We also have factory -- two factories in Malaysia, one dedicated to alternators, one dedicated to starters. And we have a buying and an administrative office in Singapore, and I am happy to say that all of these factories are now peer certified. And we'll talk about that a little bit later. We have approximately 1,900 employees, and in the last year, we've moved -- been able to move 1,100 of that 1,900 people offshore as part of our offshore initiatives.

Some of the investment considerations, we've had continuing overall double-digit sales growth, both organic and new business. We've been able to pick up new business from our existing customers as well as new business from new customers, and we'll talk a little bit about the significant growth that we've just recently gone through.

We have approximately 25% share of the do-it-yourself rotating electrical parts aftermarket, and that's generally viewed as the retail market. And we'll talk a little bit in more detail as to how the market breaks down in the future slides. And we continue to have an expanding presence in the do-it-for-me, which is the professional installed market through our own brand, and we also supply a major OE aftermarket supplier in the marketplace, which is a high-growth customer.

We're successfully increasing our offshore manufacturing capabilities. We'll be talking about our initiatives into Mexico and Malaysia, which has been successful so far, and we expect to continue to go on that way. And we expect to leverage our new volume at some lower production costs in the future, based on using these offshore facilities.

So, what is green manufacturing? Most people think it's rebuilt of whatever. Remanufacturing is taking the old unit, the alternator or the old core that has -- the unit that's failed or the starting unit that's failed. We tear it down into its very basic components. Every component is immediately cleaned, evaluated. Every single unit, every single component is remanufactured to OE quality standards or better. We have the benefit of hindsight of seeing what the failures have been for the last ten years of these products, so we have the ability to remanufacture and meet the specs.

Certain componentry in various products is replaced with new, and depending on the spec of the customer requirements, you have a great product, in many cases, as good or better than the OE quality standard and at more affordable prices. Each one of our units has every single component is checked and every single finished good is checked. In fact, we have triple checks on every single operating piece of the equipment.

Many people want to know why we exist. The simple answer for that is, is when a car is made in 2005, generally that alternator's -- will fail, probably in 2010 and 2011, 2012. At that point in time, the new alternator's not made anymore. There's now a 2011. You're Toyota Camry looks like it's got a bullet nose, and the power requirements are different. It has to take off and fly over other cars and all sorts of things.

So the point is, is that these alternators change every year, and the OE manufacturer has to regear up to make new product each year for the new applications, but they don't make if five, six, seven, eight, nine, ten years in arrears. So, there is no other way for the product to get into the marketplace, other than to be remanufactured. There has been some development where you have some offshore manufacturers, who for the most part, are knocking off original equipment parts, and they're making it new. And that's a very, very small part of the marketplace.

And research shows it's 8.4% of the total. I would question that as to even if it's that large. But, in our category, we've been relatively immune to China. China really is focused on making new products. And the cost of material is such -- so significantly greater than the remanufactured cost in making product that even with free labor, they couldn't compete with the remanufactured unit. So, in addition to that then, you've got the timeline of getting enough cores and whatever, so we're a category, without getting into much detail with our limited time, that is relatively immune from Chinese competitive threats.

Our new business is relatively small. We do about 5% of our total revenues in selling new parts. We have a reputation for quality, service and value. MPA, we view as a B2B brand, as a business brand. We go to market, not only selling alternators and starters, but providing a full program for our customers. We put ourselves in our customers' positions to try and think for them and provide them the best possible product.

We provide them sales, marketing, creative development and support. We have engineering production capabilities that are state-of-the-art with root cores labs, durability test labs, failure mode analysis. We conduct vendor-managed inventory for most of our large customers. We are the leading edge of CPFR, real-time inventory control systems, starting with the customer and coming back into our systems, real-time inventory tracking within our systems.

And sorting systems, we have state-of-the-art core sorting systems at 2,800 parts with 220,000 applications. We have electronic data that are automatically using infrared eyes that are there to detect these parts and separate them into their categories. So, for those of you who've visited, you'll -- you would see that it's pretty impressive.

We've most recently, and most recently being a week ago, received an award for the most innovative product of the year. We just launched a high-amp alternator with flashing lights for the [tuner] market, and we won an award for that. It was kind of fun, actually a great piece of art more than anything. We've also received many awards from our customers. Most of the awards that have -- we appreciated from our customers are reorders.

And those are the most significant awards. We fill our customers' orders by at least 97%. Not filling an order is not an option in our company at any expense. I will tell you if you looked at the mentality of MPA, the customer comes first, no matter what the cost is. So, we've received customer value-enhancement awards, quality leadership awards, etcetera, etcetera.

So, it's a lot about -- a little bit about core induction. We have just recently built a whole new core induction facility in Mexico. It currently is operating in California. There's about 150 people that work in the facility in California. That'll be moved offshore by June of this year, and it will be in the state-of-the-art with the -- state-of-the-art, even greater enhanced identification technology than we're using today. So, we look forward to that, for that'll make us more efficient, and it will be able to help us leverage the indirect labor cost that we're experiencing in ramping down our California facilities.

I talked about our ability to have real-time inventory management. Most of you've seen the Federal Express and the UPS guys with their hand-held communicators. Our people in our factory have these hand-held communicators that any time a product is moved from one location to another, we track where it goes. So, we know where it sits. We have a state-of-the-art, ship-direct program.

We supply a large OE supplier where they never ever touch the product. Orders come through electronically to us. They're hand picked, and we guarantee delivery on any part that exists for any vehicle, car or light truck on the road, guaranteed to deliver in 24 hours. So, it's a pretty significant challenge, that.

We also now have a state-of-the-art cataloging capabilities. We've developed a catalog for almost every one of our major customers, and we believe that the catalogs that we've put on the marketplace are the leading catalogs in the industry.

We've talked about, in the past, our successful offshore -- increasing our offshore manufacturing capabilities. We have taken our production -- currently today, two-thirds of all of our production is coming from offshore facilities. I've given guidance in the past that 90% of the production should be offshore by March. We still feel very comfortable that we will accomplish that.

Our facilities in Mexico, while being less than a year old, are producing product at a cheaper cost than we ever produced at our most efficient rate in Torrance, California as of this date. And our inefficiencies over the last 12 months -- over the last nine months in the number of units that we've produced while we're training people is around $2.8 million to $3 million just in unit cost inefficiencies of where we are today versus what it cost us to get to that point now. And we expect that to become more and more efficient as you have a more stable labor force that learns how to produce the product and they become more productive, really, in the number of units they can produce until now.

We are moving our core induction facility into the Tijuana facility. We've already taken the building. The facility is built. The core sortation equipment is in the facility. We've begun training people, and we should start some test runs, probably tomorrow or the next day in terms of getting that done. And we expect that to be another three to four-month exercise in getting that completely moved into the Tijuana facility.

The next step is, we've also taken and built out a distribution facility there where product will now go directly from our Mexico facilities directly to our large, major customers. And they are embracing this idea. We're working with them to put together the transition plan. I don't have exact timing that I can announce yet publicly, because we're working with each customer to make sure that all the nuances of moving the shipping effort offshore happens. So, there's a significant amount of laborers that are involved in handling product in our California facility in a day.

Because of this move to offshoring, we actually handle the product in California, which is our highest wage rate, three to four times more than what we're used to handling. So, if you look at the numbers that we're producing today, we're probably 400% inefficient in our logistics model, based on the fact that our production model is moved offshore. But that, in this next year, will be changed as well.

The market opportunity, it's approximately $1.2 billion. It's divided about 50/50 between alternators and starters, and also importantly, it's divided about 50/50 in terms of do-it-yourselfers and professional installers. We drive a -- in the US, there's over 230 million vehicles on the road. I just received a report yesterday that 130 million vehicles today are ten years old. And what's significant about in this report is that in the older days where the life of the car was between five and seven years, you generally could plan on one replacement in the lifecycle of the car. As these cars have a longer lifecycle, the moving parts may require more than one replacement.

And so, what we're going through is that a temporary down -- a temporary flattening of the total industry, because the quality of the units are getting better. And so, the replacement is being pushed slightly off, that what we see for the future is that you're going to have multiple replacements. And this is going to be back-loaded, and we anticipate some significant growth in the industry going forward.

There's no technology out there that is a threat to what we do. Hybrid technology currently uses generators, which are also remanufacturable. Starters are a little bit less, but the prognosis for what we understand from the industry is that combustion engines are the future whether they're gaseous fuels of some type, whether it's going to be -- where we feel the market's going, which would mean that no alternator and starter technology are greatly changed.

It's a pretty -- a very competitive market, dominated by a few players. There's a little graph here that shows the sort of market share. This is a recent report by Frost & Sullivan. And really, if you look at that, there's three main -- there's four main players. One of the main players is a captive player and only supplies a sister company, really does not compete significantly in the marketplace. And the other players here, we are at 22%, Remy's at 26%, and [B2B Industries] at 13%, mainly comprising of the three major players. There's no significant player in other category, although there is probably some small acquisition opportunity in the other category.

There's a tremendous barrier to entry. There's not a manual that you could learn how to make this stuff. It's not new. Every unit, which you tear down is different. So, there's not only a science to remanufacturing, but there's an art to remanufacturing. We have a database of every single alternator and core -- alternator and starter core that's out in the marketplace. It's available real time, so our entire work force, the build spec, what can be replaced, how you deal with different components, what can be modified, what can be consolidated, how the part numbers fit together, and it's very, very subtle.

The other side of it is that the contracts that we have with our customers, we have a significant investment, which we'll see in our use of cash where we've invested in inventory that sits on the shelf of our customers, which would make it very expensive for someone to replace us at any of our customers. And last but not least, the amount of inventory that you have to carry to be able to guarantee supply of 220,000 applications with a 24-hour time period would make it crazy for someone to even to think about going into this business. We happen to be in it, and we're good at it. And we have a great position, and that's what makes us attractive. I think I've addressed everything in this slide.

And some of those to-market statistics, I think the most significant thing that I mentioned earlier about how I see multiple replacements is going to accelerate the market for the future, average age of a car in North America today is about 9.1 years. I recently saw a study the other day that things are moving up into the ten-year category now. The number of cars and trucks is 257 million.

Again, we talked about 130 million vehicles that are ten years old. And we drive in the US. We love driving. We drive 2.9 trillion miles a year, and we spend a lot of our time at the gas station as a result of that. But, we also spend a lot of our time taking our cars into repair shops and getting the extra parts. And that's why the parts and aftermarket category is such a strong, growing category. So --.

Our bread and butter is the retail market. We have a significant share of that. We have long-term agreements with almost every major retailer in the country. We are very optimistic about our position in the marketplace, because the retailers have done a great job of capturing the do-it-yourself market for themselves. But, now they're looking and focusing on the commercial market.

If you look at all their public reports, they're focus is on commercial sales. And we feel that they will be successful like the Home Depots and the Office Depots of the world who are going into the commercial, not only supplying the do-it-yourselfer, but the professional builder.

And we believe that these retailers have got the wherewithal to resource at the distribution network and the supply base where they will become successful in the commercial market. And then, we will organically grow exponentially with them into the commercial marketplace. And we're very excited about that. We're very active with all of our customers trying to help them get to that position as well.

In addition to that, we have the largest aftermarket -- independent aftermarket supplier as a customer, and fairly recently, we added on additional applications that they gave us as an exclusive customer. And we're continuing to grow our professional market business, independent of the retailers at a very significant rate. So, we're optimistic about our growth into the professional install market and within the retail market in addition to that.

We're getting [inaudible] significant overall sales growth. We've increased market share with our retail customers. We've also increased market share for professional installer channels. We have developed end sales for our own brand, our Quality Built brand, which is growing but very steady. I would say we sign small customers up on a -- as frequent basis as weekly. And then, it adds up. We have a tremendous inventory base, some for good reasons, some for not so good reasons. We've built -- over-built our inventory levels as we transition our production.

As I've said to you, not supplying customers is not an option for this company and so, we over-built inventory to make sure that we never missed a shipment, period. I think if anyone's talked to our customers, you'd find that they didn't even know that we went through a transition. So -- and that was the name of the game. We're now in a position where we'll starting reducing our inventory levels, which will regenerate some cash for us. And we should see that in the next -- really, starting in the next quarter and in the next 12-month period.

From a sales leadership perspective, I think we've been the fastest growing in the industry. And on an independent basis, we have 31% year-over-year growth in sales from a nine-month as of 12/31/06. We have a cumulative aggregate growth rate of 18.4% over the last three years. In August of this year, we added two new accounts. Those new accounts represent $30 million of additional new net business to us, which is a significant amount of growth, just over and above that.

Our company changed in August, significantly, by adding these two new customers and leveraging our production facilities. While we were transitioning into a new facility, we ended up landing huge amounts of new business, so it became a little tricky to manage all of this. And as you will see in some of the numbers, we went through a little bit of a wobble, they're very easily identifiable and right now, that has been resolved. And we're now through that.

There's been a tremendous increase in late-model, unit pricing. So, while there's pricing pressure in the marketplace, as you launch new product offering into in the marketplace, they're much more sophisticated units and average price point is higher. We are the leaders in the industry in having early coverage. We have significant core arrangements, and we're the first to get cores in the marketplace. And we believe that for the future, that brings us a leg -- puts us a leg ahead of anybody else.

We continue to grow with our major automotive companies since the launch of business last year. We're now doing US, Canada, Africa and the Middle East and continuing to talk about further worldwide coverage for them. We produce all domestic and import makes and models for cars and light trucks. And we supply a number -- a new retail customer 100% of their requirements in both domestic and import. And they've since switching to us, have experienced some significant sales growth, based on certainly their effort and our efforts.

We have a continued expectation for growth, as I mentioned. I think we have the best customers. We're positioned on the right side of the industry, and we think organically with our customer base that we'll continue to grow. We also will continue to be aggressive in picking up new customers. And this is -- part of our strategy is to focus on getting market share.

Focused a little bit on the professional install and do-it -- the do-it-for-me market, do these in excess of 3% revenues, we expect at least $10 million of incremental revenue this year from them. We began the program in June of 2004. We have 100% North America sales rep coverage. The product has been very well accepted, warranty rates are very low. Customers are very happy with the product. It's a very difficult business to grow fast, as most of the customers are small. But, we -- as I had mentioned earlier, every week, we sign up new customers.

The offshore production, I'm trying to rush. We're getting close to question time. So, I've only got a few minutes. I apologize for speaking so fast, but we have a lot to talk about, and I still want to get to the numbers. I mentioned earlier, there's about $2.8 million of manufacturing inefficiencies in the units. We're at 90%. By the end of March, we'll be offshore. The shipping and logistics model will be offshore, the cores, by the end of June. Shipping, I cannot give you guidance on yet. But, once this is all complete, the whole business model of the company will be transitioned, and we'll experience double-digit revenue growth and double-digit margin growth.

I'm not even going to talk about logistics. I want to get to the numbers, and I don't want to run out of time. But, the whole new logistics system is being set up in Mexico. They are a number -- there are hundreds and hundreds of people that will be transitioned from a US payroll to an offshore payroll, resulting in significant savings for the future, but inefficiencies in the process of transitioning there.

We have a great management team. Everyone's got lots of experience with the all fancy sort of meetings that we have. And we're really focused, and we love our company. We're passionate about it. I won't talk more about it. That's that. Getting to the numbers, okay, sales growth, a little bit adjusted, and you can see the graph. In the fiscal 2006, we were at adjusted revenue of about $112 million in annualized revenue. I will tell you that we're currently at an annual run rate of $150 million since this was done. So, that will give you some guidance for next year.

In terms of margins, we've had some increasing margins. If you looked at the growth, it's tapered off in the last fiscal period, most of that due to tremendous inefficiencies of having multiple facilities covering and making sure that we can ship. The metrics for the offshore facilities are far better than what you see in terms of the numbers. And we expect to start seeing those unfold in the quarters as we go along through the next quarter and [aft].

We've had a tremendous amount of noise in how we do business with our customers, which has affected our numbers basically [inaudible]. We're also now an accelerated filer, and we're -- feel pleased to be part of the Sarbane-Oxley effort, okay, which are costing us $1 million a quarter right now. So, in terms of adjustments, you'll be seeing that as well. We are on the tail end of being 404 compliant, and hopefully, that'll make us a better company for the money we're spending.

For the nine-month actual quarters, I think we've filed all of our results. I think people can go to this. I'd like to talk a little bit about the adjustments in the numbers. And that way, you can get a better feel for the operating metric of where we are today. Total revenues for the 12/31 nine-month [stub] are $118.3 million. We've adjusted revenue down here for an extraordinary pick-up in the reversal of our [POS] deal, which we used to do. We've now reversed out of that.

And so, this was an adjustment down of those revenues. And we're looking at operating income on an adjusted basis right now for the nine-month period of about 16.6. [DA] runs about $2 million a year, so if you look at it, that's another $1.5 million in EBITDA on that for the nine months there.

Most of the adjustments that you -- we talk about in the numbers include front-loaded marketing allowances in conjunction with the new customer that we recently landed and a couple of new customers and different -- actually transactions. But, they're all over as of the end of January. So, that noise will barely affect the fourth quarter. And then from then on, there should be not affect of that.

In addition to that, we have recently accrued for significant stock adjustments, which are returns from the customer, which come back in lieu of huge update orders. We've taken the expense for the stock adjustments in the current quarter and we'll be shipping -- in the last quarter, and we'll be shipping out significant new revenues in the -- this quarter that we're in. In fact, February will be an all-time record in terms of shipments for the company.

We're also for the first time -- are expensing 123R stock-option expenses, non-cash. And of course, we are restating. We're very good at restating our financials. I apologize for that, but apparently core accounting is extremely complicated. And we continue to run and evolve, and as much as I make a joke of it, we take it very, very seriously. And we're committed.

We've embellished our finance department tremendously with five CPAs in the group, and a lot of accounting reporting, accounting -- accounting reporting experience. I think if you talked our auditors, you'd find out that accounting for cores is not that straightforward. It's a lot easier to produce and to supply than to account. So -- but, we are learning, and we're getting there. And we're committed to making sure that we have stable financial reports in the marketplace. We are 100% current today.

For the quarter end, which should just give you a little more of a snapshot, although I think really what we've been through in the restatement, we have so many catch-up items in the -- and changes of policy that I don't believe it's 100% indicative of our metric. I would say that today on an ongoing run rate, our EBITDA run rate should certainly in the $23 million to $24 million range on an ongoing basis.

And again, the quick snapshot of the quarter, $33 million in revenues versus 30 before. And as reported, if you look at adjusted, we have 36 versus 30. We offset all of the sales allowances, stock adjustments, all of these expenses are offset from sales and that's why you see the sales number moving around as much. The 10-Q and the 10-K detail all of these adjustments in much more detail, but we looked at [$0.15] for third quarter in earnings and I think we had about 85% adjusted earnings per share for the year.

Cash and short-term investments of about 800,000 in cash, current ratio 1.3 to 1, working capital 21.7 -- [13.7] million in stockholders' equity, 23.9 in [debt]. We recently repurchased and restructured our POS arrangement, in conjunction with that we've taken on $20 million of inventory, and taken it out of the current asset classification has become long-term asset. So that's affected our current ratios a little bit, the details of that transaction are also now public documents.

We will continue to build strong sales, we are optimistic about landing more customers and bigger customers. We have good market share today, 25% of the $600 million [do-it-yourself], we believe we're on our way to getting that in a professional installer, we believe we will expand our margins, and we expect to leverage these margins -- the new growth with our new margin ratios in the following year.

So with that, I'll open it up to any questions.

[REBROADCAST ENDS]

Is the line open now for questions? If anyone has any questions, Mervyn and myself will attempt to answer them. So Operator, if you could open up the line for questions.

[OPERATOR INSTRUCTIONS]

And our first question comes from the line of Mitchell Sacks with Grand Slam. Please proceed.

Hello?

Hi Mitch, we can hear you now.

Yes okay, sorry about that, guys. A couple questions on Mexico and then kind of going forward. Can you just talk to us about Mexico in terms of where you are in terms of looking at a second shift and where you are in terms of moving logistics down there?

Yes. We're in an interesting position. I think our plans starting 18 months specifically outlined how many units we were going to be producing in Mexico literally by week and almost by day. And we've actually been able to accomplish almost the transition 100% on plan. One of the interesting challenges we had obviously is that we had far more units to produce in total as a company, so while Mexico continues to produce the number of units we expected it to produce, there's still more production in Torrance which is making up for the extra demand in product.

But I think what's most important to note is that as you ramp up a new facility in Mexico, even though you have cheaper labor metrics going into it, you obviously have big productivity challenges because these are all new people learning how to remanufacture and learning the parts and the processes and the systems.

And if we do an evaluation as of 12/31 and look at what our average production costs are in Mexico on a go forward basis, on a per unit basis, they're approximately $2 a unit less than what we've been producing over the trailing 12-month numbers. So we've produced about 1.4 million units in Mexico so far, we have about $2 a unit in inefficiencies, so we feel like the Mexico metric built in already we've got about $2.8 million of forward-looking savings.

In addition to that, we currently have completed the core induction built out. We're in the final stages of its automation. The automation should be installed certainly within the next week, we're currently training people. We believe that we will be transitioning in the next three to four months another 130 people into Mexico out of our operations in the United States. And we also believe that we, with some new technology that we're investing in, and this is not proven yet but certainly we hope that we can be perhaps have more productivity in our core induction system, so we envision future savings there.

In the shipping and logistics the model is a little more complicated, but there's over 200 people that are involved in that, 2, 250, maybe even 300, and the facility has been predominantly built, or substantially built, there's some racking that still needs to go in. And we're working on a very specific transition plan with our customers to move that into direct shipment out of Mexico.

At this point in time I can't comment on the time lines for it, but its complete that result in additional savings. Obviously as we go through the transition both in cores and in shipping there will be costs associated with the transition, which we will attempt to capture and communicate to the Street.

Does that answer your question?

Yes I guess, so fiscal '08 there's still going to be a little bit of noise in the numbers just because you've got some more transition there, and then I guess fiscal '09, assuming that the business stays as is, you'll have a clean number in that fiscal year, correct?

Correct. And I think every year that you produce in a factory, certainly under the LEAN manufacturing concepts, you have continuous improvement. And so even on our existing production, we'll continue to see margin expansion and cost reductions just based on being more productive and having a better trade work force with more experience under their belt. So my expectation is to continue on with double-digit growth on the revenue side, and my expectation is to grow into the margin accretion over the next 12 months.

And I thought I heard on the call that you would say you're doing about 150 million run rate and that you were looking for another 10 additional quality built roughly in the next fiscal year?

Correct.

So it's sort of safe to use a baseline 160 number for fiscal '08?

Yes I don't want to comment on the actual number to use, but I mean our current run rate is around 150 and we do believe that we will pick up incremental revenue. And certainly indications are we should land 10 million in the quality built arena and we continue to be aggressive in the other areas as well.

Okay thanks a lot, I'll step aside. Thanks a lot.

Thanks, Mitch.

[OPERATOR INSTRUCTIONS]

And our next question comes from the line of [Rod Turney] with McCarthey Group Advisors. Please proceed.

Hello, Selwyn.

Hi Rod, how are you?

Good thank you, hope you're doing well.

Good.

You know we talked a lot about the cost savings we're getting in Mexico, a while back, maybe a couple years maybe not quite that long, our goal was operating margins in that 15% range. With all these cost savings I would guess that that number could be ratcheted up a little bit, but that also assumes that your customers are going to want part of that.

Right.

But what's the happy medium there? Are they going to want part of that margin expansion, that cost savings?

Well we continuously work with our customers to make sure that they have the most efficient pricing metric in the marketplace. We also believe that our customers respect our need to be profitable because as we develop profitability we are able to develop resources which can continue to help them.

And so I believe that the customers, while they are being aggressive, will also appreciate us being profitable. So I'm not sure exactly where it'll end up to be honest with you, Rod, but I do think they are respectful of what we're trying to accomplish as well as looking to be more efficient, so I think there's room for both of us to be gainful out of the move.

Okay. Well you had 14% operating income margins for the nine-month period, but I notice that the three-month period, and this is all adjusted of course, the three-month period ended 12/31 the margin was only 11%. Is that because December quarter is the lower volume quarter? Or is there other stuff in there that we should consider that might be extraordinary?

Yes I think that the December quarter, just with all the accounting changes, and I can't identify all of these but there's a fair amount of clean up in the accounting. I don't think it's completely indicative of our metric, I think the nine-month average is far more indicative of the metric. I also want to agree with you in that the third quarter is a little less efficient of a quarter because December and January are generally the two slowest months of the year.

And I will say that, while February will be a record month, January was a fairly slow month although up from the previous January. So these quarters are generally a little softer and then our summer quarter gets to be far more vibrant. So I expect the margin overall on the nine months to be more indicative of the metric and I think that we can enhance it going forward.

Okay. Now in your P&L adjustments you've adjusted for a lot of things, front loaded marketing, stock adjustments, over time, Sarbanes, the stock option expense, how much of that do you consider to be non-recurring?

Well let me try, as opposed to addressing whether it's non-recurring, some of it will continue on into the current quarter, so let me try and address them separately.

Okay.

First of all, we always have some stock adjustments, but we had an extraordinary high quarter of stock adjustment expenses, but that in this current quarter we'll be seeing the revenue from it so we should not have stock adjustment issues in this quarter that are significant, I mean there always are in every quarter. As far as Sarbanes-Oxley we expect another quarter in the million dollar range on Sarbanes-Oxley.

On any of the up-front marketing allowances, which fundamentally are non-cash, we only have one month of this quarter where we experienced that and that would be the month of January and they're over at that point. And so we'll see a little bit of it in this quarter, but two-thirds of the quarter won't have any of that. And then 123R, that'll happen every quarter based on vesting as these options vest.

What would your estimate be on stock option expense per share per quarter or per year?

Looking a quarterly, Mervyn can correctly me, I think it was bout 300,000 for the quarter.

300,000 for the quarter.

And it also depends on how the stock price moves, right?

So we grant all our options one month in every year so in that month we grant and we take a bit of a hit like we took a rather large hit in the second quarter. So 300,000 is the run rate with the bump up depending on how much we issue as part of our annual option grants.

We don't expect the option grant to be as big as it's been historically though.

And that 300 is pre-tax right?

Yes.

Yes okay, all right. Well will Sarbanes-Oxley be a continuous $1 million per quarter?

No I think that at the end of this quarter we should be substantially through getting certified and putting all the appropriate controls as required by the 404 compliance. And then we'll have maintenance on SOX and I'm not sure what that number is, I would like to hold it at around 500 but it may be a little more than that. I mean I think we can give you more guidance as we get into future quarters as to what that'll actually cost.

I think you better divide into two, I think we can probably do maintenance on SOX ourselves for 500, but the audit fees are probably going to be another 500. So you're probably looking at about a million on SOX ongoing.

On an annualized basis.

On an annualize basis.

Okay on an annualized basis.

Yes.

Okay.

So we'll see it sort begin to drop off in the first quarter of next year and then obviously it should settle down to a more routine number. You know we've had six months to get SOX put in here, I don't think they thought it through when they gave that September measurement date. And doing SOX in six months requires a tremendous amount of activity and resources to get it done in that period of time. So that's why you're seeing those big bumpers, we're really moving very quickly to get this behind us.

Okay. I've also noticed in your 10-Q 10-K, 10-Q especially, that you used up a lot of cash over the last six months, nine months. Your bank lines are getting close to being fully tapped and you actually are not in compliance but I think you've got a waver. Talk a little bit about your capital resources going forward, your needs and your sources.

I think that is a correct observation, I think first of all we have a bank who has been cooperative and is certainly involved in our current operating metric. We have intentionally built inventory to a level that's higher than what would be our normal inventory rate to make sure that we don't miss any fill rate.

So we believe we have an opportunity over the next 12 months to reduce inventory levels by about $10 million, we're working to try and bring these inventory levels down this quarter. We're in a little bit of a catch 22 because as you ramp up a facility in Mexico and you try and bring down inventory levels, you may have some inefficiencies in production, so we're evaluating how to handle that best.

We also, from a CapEx perspective, have financed the building. We have been in compliance from a financial statement perspective, so we financed all of our CapEx out of pocket and haven't been able to tap any leases on equipment. And so we expect to have some capital come back us by entering into some operating leases. So we feel like we have it, while we would like a lot more breathing room, we feel like we do have it in our sights and under control.

So you don't expect to have to increase your line from 35?

At this point we think if we can get the operating leases in place we don't need to do that. We may want to do it just in terms of having the flexibility so that we can continue to be aggressive in the marketplace.

Yes, because I think you're getting a little bit of extra fees for the bank for not being in compliance and --.

Yes that is correct.

Okay. Any guidance for revenues or profitability going forward?

Yes as I mentioned earlier in the presentation, we're currently at $150 million run rate, we believe we can pick up another 10 million in professional installer business and we aggressively are pursuing more retail business. So I think that's a starting for guidance, I think if you look at that growth rate that's pretty significant. And in terms of EBITDA I think I mentioned, if we annualize our trailing nine-month EBITDA number, we're on about a $24 million EBITDA run rate today, adjusted of course, and we expect that to be the baseline of operations going forward, we expect to enhance on that.

Great. I think, Selwyn, at one point you mentioned that some of your customers are even asking, or at least exploring that opportunity to supply new products, different products. Is that still on the horizon?

Yes, I would not say that that's an immediate or a current initiative for us. We are focused on making sure that we become the leader in this category and making sure that we get this operating metric under control before we would stretch our resources any further. So while we will continue to plan for the future, our execution is focused on what we have today.

Yes your plate's full.

Yes it really is, yes.

All right, gentlemen, thank you. Good quarter, and good luck.

Thank you, very much.

And our next question comes from the line of [Jim Shuman] with [Costa Brava]. Please proceed.

Hey guys, how are you?

Hi Jim, how are you doing?

Good. I just wanted to clarify the big jump in the inventory on return, how much of that is a result of kind of the AutoZone reversal in the relationship there.

I'm going to hand this over to Mervyn to answer, but let me just make a comment on that. The inventory and return [to cam] is kind of an interesting account, and I'm talking now as a non-guru on the GAAP numbers, which Mervyn will give you the GAAP guru discussion on inventory on return. When we ship out a unit we have an allowance for a unit to come back, but the reality is that every time a unit comes back another one goes out. So that number will hopefully continue to grow because that shows that we're shipping more and more units out and being further and further under returned. But I'll let Mervyn try and address your question.

Thank you.

Now if you look at the transaction that we had on the POS unwind, there's 20 million sitting on our balance sheet as a long-term asset, in effect that tranche action actually impacted that account, that's how it went from a few hundred thousand up to about 20 million.

That's the AutoZone POS right?

That is the transaction we did when we did the core buy back, it's actually mentioned in the papers. Now as far as the current asset is concerned, the unreturned inventory, unreturned cores, those are units that we expect to come back in the future. And this account is driven by two things, one is the amount of growth in business, as business grows this account will grow.

And secondly, we reduce this account by an expected percentage for what will not come back. And in periods when you go into a large under return which is much more than your percentage, this account will grow because you're not relieving enough, you can't recognize enough revenue. Because we know that we will go into states of over return, and the result is at that time that account will drop. So there are two drivers there, one is the under return rate running higher than our estimated rate that we use for revenue recognition, and secondly just the growth in business.

And your estimated rate is what?

4%.

4%. Okay great. Thank you.

Okay.

And our next question comes from the line of Richard Linhart with Opus Capital. Please proceed.

Thank you. A couple questions, the first one could you give us some guidance, with the new customers who have come on, without necessarily giving us a specific number, where do you expect the largest customer to fall as a percentage of fiscal year '08 sales?

In the 55% 60% range.

50 to 55. So still around the same level that it's been.

Well no, well depending on what time frame, but within the last two or three years the concentration of our largest customer has come down by 50%.

Oh okay. I guess I was just looking at '05 and '06. Okay. The long-term deposit, did you guys actually write a check for that? Or was it a credit when you converted the inventory from POS inventory to sold inventory last August?

Well it's the equivalent of writing a check. Basically we made a sale and gave a credit against that sale. So it cost us $20 million in cash.

Okay. And you had mentioned, someone at the conference the other day in the break out we were talking a little bit about it, that if you lost that customer they would write you a check I think you said for 40 million, could you explain that a little further?

Yes. We have in our contract, and this is with all of our customers, not particularly one customer, but any time we buy inventory or cores, to the extent that we have a termination of our business relationship, that customer would reimbursement us for the value of the cores that we've purchased. Now when we put them on our balance sheet we significantly write them down as a sale and some against sales. So while the asset may show 20 million in total, what we expect to receive if we're ever terminated from these customers would be $40 million in cash.

And if it's rolled over in '08 again, does that ever get paid back? Or does it stay as a permanent receivable?

We hope we never get it paid back, because as long as we do business with these customers it'll stay on as a receivable. That's in the long term asset category now.

Okay. Final question, in terms of the 24 million EBITDA run rate, are there any other adjustments or [technical difficulty]?

You know the line faded out, is anyone there? Operator?

Yes let me see if I can locate him.

Yes.

Hey Tom, can you hear me?

This is the first I can hear of anybody now.

Oh. Can you hear me now?

Yes this is Selwyn, I can hear you, who's this?

It's Richard Linhart still.

Okay Richard, you're back great. Yes you faded out, if you don't mind if you'd start from the beginning because we lost you pretty early on in your sentence.

Oh okay, sorry about that. Actually let me ask a different question. The front loaded marketing allowances, just looking over the '05 and '06, seem to be a number that's there in both years. Is that part of the ordinary course business? And if not, why isn't it? Why shouldn't we consider it part of the ordinary course?

Well I think the significant gains that we've picked up are themselves not in the ordinary course of business. I don't think it's usual to pick up the size of revenue in chunks that we have. Both of the significant gains in customers that we got were unique types of transactions. It's not normal necessarily in our business, although it may become normal if you pick up big chunks to have some up front loaded expenses.

When we look at picking up a new customer we look at an IRR, the total cash investment in getting the customer and what we think it'll yield. And we look at a cash and cash return. And so our philosophy is to make sure that we fund it adequately to be able to invest capital where we can get these sort of cash and cash returns and IRRs. So is it normal? No it's certainly not normal, there are not a lot of those customers. But could it happen again? It is a possibility if we had a chance to pick up another large customer.

Got it. Okay terrific, thank you.

Thank you.

[OPERATOR INSTRUCTIONS]

And there are no more questions in queue. I would now like to turn the call over to Selwyn Joffe for closing remarks.

I'd like to thank everybody for giving us the time in listening to our presentation, and we look forward to a profitable future and some good future calls. Thank you, very much.

Thank you for your participation in today's conference. This concludes the presentation, you may now disconnect. Good day.