Motorcar Parts of America Inc (MPAA) 2009 Q3 法說會逐字稿

Welcome to the Motorcar Parts of America fiscal 2009 Q3 conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Gary Maier with Maier & Company. Please go ahead, sir.

Thank you, Melissa, and thank you, everyone, for joining us. Before we begin I would like to turn the call over to Selwyn Joffe, Chairman, President, and Chief Executive Officer, and David Lee, the Company's Chief Financial Officer.

Let me remind everyone of the Safe Harbor statement included in today's press release. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements including statements made during the course of today's call. Such forward-looking statements are based on the Company's current expectations and beliefs concerning future developments and their potential affects on the Company. There can be no assurance that future developments affecting the Company will be those anticipated by Motorcar Parts of America. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve significant risks and uncertainties, some of which are beyond the control of the Company and subject to change based upon various factors. For a more detailed discussion of some of the risks and uncertainties, I refer you to the various SEC filings.

With that said, I would like to begin the call and turn it over to Selwyn.

Thank you. I appreciate you joining us today for our fiscal 2009 third quarter conference call. Let me begin by saying that aside from the noncash charges we reported in today's fiscal third quarter release, which I will discuss our performance highlights our continued success in growing the business and capitalizing on the Company's strong position with the automotive aftermarket industry. Within the automotive industry, the aftermarket parts segments is a bright spot. Consumers are delaying new car purchases and we provide nondiscretionary automotive aftermarket parts and we work hard to distinguish our business from the OEMs that have been severely impacted by the economic downturn.

In fact, there have been recent stories on the positive outlook for several large automotive retailers, a majority of which are our customers of Motorcar Parts. We have available capacity, a low cost manufacturing structure, less than one times EBITDA in debt, and numerous new and existing business growth opportunities which I will also discuss in a moment. With regard to the noncash charge related to goodwill, obviously, car and stock market conditions have had a significant impact not only on Motorcar Parts but on other companies across a broad section of industries and market capitalizations. Our low market capitalization relative to our book value resulted in the goodwill write down. David will discuss this in more detail in a moment. Achieving a fair valuation in the marketplace lately has been challenging for all companies, but we will not let this be a distraction.

Our focus is on growing our business, communicating our developments and milestones, and providing the investment community with proper information to make intelligent investment decisions. Our 27% sales increase for the quarter was certainly encouraging, as was our 35% increase in gross profit, which David will discuss further in a moment. Many of you appreciate as we take advantage of our capacity at our facility in Mexico, which I will say is currently operating at approximately 50% capacity, we were able to increase overhead absorption and gain operating leverage that falls right to the bottom line. Our prospects for new business overall continue to be positive.

As I indicated in our call last quarter, we are packing and shipping a substantial majority of our product requirements in Mexico, and we are working to further increase shipping of product directly from Mexico to many of our leading customers in the United States. These developments will contribute to further cost savings moving forward, and greatly enhance our leadership position within our consolidating industry. David will now discuss our financials, and I will come back for additional comments, and then we will open up the call to questions.

Thank you, Selwyn.

As announced this morning, net sales for the fiscal 2009 third quarter ended December 31, '08 were $35.8 million compared with $28.2 million for the same period last year, which represents an increase of 27%, as Selwyn has highlighted. This increase in net sales was primarily due to higher sales to existing customers and sales to new customers resulting from our acquisitions earlier this fiscal year. Gross profit for the fiscal 2009 third quarter increased 35.3% to $10.1 million from $7.5 million for the same period a year ago. Gross margin was 28.3% for the fiscal 2009 third quarter, compared with 26.6% a year earlier, due primarily to increased sales, lower manufacturing costs and increased operating efficiencies, which were partially offset by the impact of the significant reduction in scrap metal commodity prices in the fiscal 2009 third quarter. Proceeds from scrap sales are recorded in cost of goods sold, and as a result of lower prices, had a less favorable impact on the third quarter compared with the prior year third quarter.

Third quarter scrap sales were approximately $0.5 million less or 1.4% impact on gross margin than the prior year third quarter, and approximately $1 million less or 2.8% impact on the gross margin, than the average of the prior three quarters. Additionally, based on current inventory levels and managing cash flows, third quarter production was approximately 20% less compared to the prior year third quarter, which resulted in lower overhead absorption and decreased profit margins. General and administrative expenses decreased 1.1% despite a noncash charge of $1.35 million, or $0.07 per diluted share, due to a significant decline in the value of the Mexican peso which affects foreign exchange currency contract,s as noted in today's news release, to $5.46 million from $5.52 million a year ago. This was due to the decrease in audit and other professional services fees, compensation and related expenses, and other G&A expenses. What this means is that G&A expenses for this quarter decreased by approximately $1.3 million after adjusting prior year third quarter for a noncash $95,000 charge related to foreign exchange currency contracts.

Let me take a moment to explain how our foreign exchange contracts work. We enter into forward foreign exchange contracts to exchange US dollars for Mexican pesos at a fixed rate in the future, in order to reduce the impact of foreign currency fluctuations. This is a fixed hedging program. We do not engage in currency speculation. We do not hold or issue financial instruments for trading purposes. The forward foreign contracts are designated for forecast of expenditure requirements to fund the overseas operations in Mexico and expire in a year or less. While the contracts are in effect, there are fluctuations in how we value them based on mark to market calculations, but the overall impact has a net zero-dollar impact.

As we utilize current contracts and enter into new forward peso foreign exchange contracts, we will continue to see the benefits of the strengthening of the US dollar in the effect on the peso exchange rate, which were less than 11 to 1 a year ago and now has increased to over 14 to 1. This will result in a reduction to costs, to the cost of operating our Mexico facility as we go forward. Sales and marketing expenses increased $731,000 to $1.6 million from $824,000 in the same quarter of fiscal 2008, due primarily to the addition of sales employees which resulted from our acquisition of AIM, increased trade show, and advertising expenses. In the prior year, we had a very modest boost at our main industry trade show, but this year we decided new business opportunities justified the additional expense. Based on the response from current and perspective customers as well as the trade media, we believe we made the right decision.

Research and development expenses increased $213,000 to $515,000 from $302,000 in the same quarter of fiscal 2008, due primarily related to an increase in expenses in connection with our heavy duty after market initiative. Recently, we initiated some strategic changes to the Company's sales organization to capitalize on opportunities for heavy duty applications, with the added benefit of annualized savings of $400,000. Impairment of goodwill was $2.1 million for the third quarter. We account for goodwill under the guidance set forth in FASB 142, goodwill and other intangible assets, which specifies that goodwill and indefinite lived intangibles should not be amortized We evaluate goodwill for impairment annual basis or more frequently if events or circumstances occur that would indicate a reduction in fair value of the Company. The Company's market capitalization in the third quarter of fiscal 2009 as someone noted, was impacted by the current stock market conditions, which represented a possible triggering effect on potential goodwill impairment. Accordingly, we performed an interim goodwill impairment test in according with FASB 142. Due to the book value of the Company exceeding the fair value using the last quarter market capitalization, the Company determined the goodwill was impaired, resulting in a noncash charge. This write down results in the Company no longer having any goodwill on its books.

Operating income for the fiscal 2009 third quarter was $509,000 compared with $842,000 a year ago. The third quarter reflects the impact of a noncash goodwill impairment charge of $2.1 million or $0.11 per diluted share and a noncash charge of $1.35 million or $0.07 per diluted share, recorded in general and administrative expenses to adjust for a significant decline in the value of the Mexican peso, which affects foreign exchange currency contracts as we discussed. The total of these two noncash charges for the third quarter is $3.4 million. In evaluating operating performance, the Company considers the impact of other noncash expenses items in the third quarter operations, including inventory writedowns of $240,000 FAS 123 R stock compensation expense of $59,000. In addition, depreciation and amortization for the quarter was approximately $781,000. Adjusted for the noncash expenses mentioned above, EBITDA for the third quarter was approximately $5 million, which reflect it is lower level of scrap sales proceeds and lower overhead absorption due to lower production volumes.

In addition taking into account the same adjustment, earnings per share would be approximately $0.16. Net of interest income, interest expense for the quarter was $1.2 million, down from $1.3 million in the prior year. This was attributable to a lower balance of receivables being factored, and the decrease in short term interest rates. As a result of the items noted above, the Company reported a net loss for its fiscal 2009 third quarter of $314,000 or $0.03 per share, compared with a net loss of $183,000 or $0.02 approximate per share for the comparable period a year earlier. As of December 31st, 2008, our balance sheet had $878,000 in cash, $157.8 million in total assets, and $14.4 million in borrowings on a line of credit leaving $22.6 million available after reflecting our standard letters of credit. During the third quarter, the Company generated $5.9 million in net cash flows from operating activities, which resulted in a net pay down on the revolver loan of $3.2 million.

The Company pulled back production levels, which affected profitability which helped generate good cash flow. During the nine months of fiscal 2009, short term borrowings under our line of credit were used to pay down our accounts payable balances, acquire certain assets of AIM and SunCoast payments and to offset certain customer accounts receivable, which are no longer factored. Shareholders equity was $95.1 million at December 31, 2008.

I will now turn the call back to Selwyn, who will make a few additional comments before we open the call to questions.

Thanks, David.

As I mentioned in previous quarters and earlier calls, we are actively seeking new business and growth opportunities, but only if these opportunities are profitable, priced right to reflect commodity prices, and provide a fair return to our shareholders. We continue to remain optimistic about our prospects for expanding the Company's presence in both the do it yourself and the do it for me markets. In the professional installer market, we continue to make inroads by leveraging our quality built brand name. Our expectations for new customer revenue growth, which are based on current commitments, should increase our annual revenue run rate by approximately $20 million during the first part of our next fiscal year. While we have these commitments, we are still evaluating and working on the timing of when this new business will begin shipping.

Overall, however, our new business visibility remains strong. This increased demand will help with absorbing the overhead costs, as well as growing our top line. In addition, other factors that could have strong potential for us in the future are the declining value of the Mexican peso, moderate oil prices, and an aging fleet on the roads. We are also planning to enhance our growth by the launch of our heavy duty product lines. In summary, we continue to believe that long term market statistics for our industry are favorable, while oil prices and driving patterns are important components to our business and aging vehicle population is particularly critical. There is why we say we don't lose a sale, it is only delayed. We know now that over the next 10 years, a significant percentage of the 240 million vehicles on the road today will have both an alternator and a starter replaced.

While economic conditions like we are experiencing today are very challenging, they in fact are very helpful to us. In today's environment, we are feeling the cause of being sold, we are experiencing an increasing population of old motor vehicles reaching high replacement rates with alternators and starters. This should bode well for our business. Let me give you an example of this. The number of cars approaching the 8 to 11-year-old category will increase by 26% over the next three years. It is also important to understand that replacement rates going from the four to seven-year-old category have replacement rates on average of 1.74% and go up by approximately 140% when they reach the age 8 to 11-year-old vehicle category. They will go to 4.17% from the 1.74%. That's the 140% growth.

In addition, we believe that less cars in the 12-plus year old category, will be scrapped and those replacement rates increase over the 8 to 11-year-old vehicles by 63%, to approximately 6.8% per annum. These rates apply approximately equally to both alternators and starters. I appreciate your interest in Motorcar Parts. I'm happy to answer any questions that you may have, and now will turn it over to you for caller questions.

Melissa, we're ready.

Thank you. (Operator Instructions). We will go first to Tony Cristello with BB&T Capital Markets.

Thank you. Good afternoon, gentlemen.

Hi.

A couple of questions. One, I think you noted in your remarks that production was down by 20% in the third quarter; is that correct?

Yes.

Now, is that a function of I am assuming a function of demand via your customers or is there something else going on there that is sort of driving those production levels lower?

At the end of day all demand is a function of -- all production is a function of demand, but when we completed this transition to Mexico, one of the key things that the company wanted to do was to prove out that it could hit the cost metric that we thought it should accomplish. And as a result, we sacrificed the balance sheet a little bit to produce what we thought would be normalized production levels and we have built some excess inventory. And so over the last quarters, what we were able to do is to build less product and still have 98 to 99% fill rates. I think you will start seeing now, Tony, that we will ramp up production because we anticipate starting shipping , a new significant customer starting in the first quarter of the next fiscal. So, it is a little bit of a function of us manipulating, trying to see where the sweet spot is getting the right returns are out of the plan. I believe we will take that production up over 20% in the next three months.

Okay. And when you look at the demand aspect of the equation, this has been a tough operating environment for the aftermarket and there certainly are some themes developing right now that would bode well for your business as well as others in the aftermarket. I am just wondering are you seeing anything from a trend standpoint today that would say, hey our business for the, this next quarter is starting to look better just because demand is picking up, or is it more as you, I guess I am trying to.

On the market. Let me try to read, I look at all of the statistics and every statistic shows that we shall see a little, in the near future we should see an acceleration of demand for our products. At the current levels we are at, while we are seeing small growth, I don't see the actual statistics kicking in yet. I do anticipate it coming in. We've had a couple of customers managing inventory for quarter ends that are affecting us a little bit in this quarter. But when I look at register sales, I mean they're solid, but I don't see the growth we expect to see.

Okay. So that potential is out there, it is just not, at least right right now, coming through in the numbers we see.

I think I do believe, and our industry believes, it is coming.

Okay. The other sort of line of questions I had was pertaining to scrap sales and I understand all throughout 2008 commodity costs and scrap costs continued to escalate at probably unreasonable and unattainable or unsustainable I should say levels. And you talked about that hurting the margins in this quarter. And I am wondering, is that something now that we have to anniversary for another three quarters for one? And then two, on the pricing side of things, obviously, I would expect there to be some deflation as scrap prices expect me have come in. Does that also, do we have to take that into consideration for the next three quarters?

Let me try to answer it in two pieces. That's a great question. First of all, what we are seeing is sort of the pendulum. We saw copper and aluminum prices really spike to very high numbers and then drop to extraordinarily low numbers. So again we expect it to be more moderate. However, we don't believe in the near term to accomplish the same scrap level of revenue that we had. Now having said that, what we experience is that immediately, when the scrap metal prices drop, everyday that we sell scrap, we don't get the immediate realization of the extra profit. On the other side of the equation, our inventory will come down in terms of our costs, but that takes longer because we have to go through the inventory we have on our shelf and it is always a little bit delayed in terms of getting price reductions for components and as supply, as it goes through their inventory levels, and of course they're not anxious to drop prices quickly, but we are seeing raw material costs purchasing prices absolutely. And we should see at the end of the day there should be a net zero effect. But the timing of it is is that you have got this delay as you work through your inventory.

Okay. And so when I think about your call, you have got product on the shelves right now that you were buying raw materials for at much higher levels that you have to sell through. The question is are your customers willing to take that higher price today or next month given the fact they know where raw materials stand today.

I think from our perspective, we've had some customer requests and reduced pricing based on metal pricing coming down, we have resisted that saying that really for us it is a net zero, it doesn't matter if the they go up or down, we end up being in the same place. That has gone away. In fact, there's not a real reason to give a price reduction or a price increase at this point in time, because we remanufacture, our yield very high in terms of what we remanufacture and our scrap, scrap offsets our component costs. So, we get, what we gain on one side we lose on the other. At the end of day, there's a timing difference but at the end of the day, it is a net zero game.

Is it consistent to think that where prices were, where they bottom and where they are now, we have seen a little bit of stabilization?

I think there should be stabilization, yeah. I mean one of the things that we are debating is whether you can sell the scrap right now because prices are so low. If we are able to store it and sell it in more favorable times, there's no reason. We have the capacity, there's no reason for such small gains on copper and aluminum. And so we're debating, we're looking at that, and we're consulting with experts on metal prices right now to see what we should be doing with our metal.

Okay. And maybe one last question, you've had the Mexico facilities up and running, you have talked about it being at 50% utilization, I'm assuming you get incremental, significant incremental leverage if that moves up to 60 or 70%. How are you handling the, the processing, the customer, how do the sort of checklist of things from a customer service standpoint, a return standpoint, and just production compare now that you have you've had it up and running versus how that process compared here in the States when you were doing it that way.

That's an excellent question. I think our -- I don't want to get into too much detail because there's a lot o of competitive information in that, but I would say our labor components, of production is probably reduced by about 40%.

Okay, okay. And have you --

That includes, and that includes, that's skewed by the fact we have additional overhead in these factories.

Right.

So if you looked at it direct without the overheads it is much greater than that, but there is a lot of extra overhead that you incur by being offshore.

Have you been able to maintain, obviously there's a difference in barrier and such with producing in Mexico versus the States. Have you been able to maintain returns and customer service at the same levels you had here in the States versus what you have now.

We think so. Fill rates are excellent. We have no issues with, with being in Mexico at all.

Okay. Great. Okay. Thanks, guys. I will let someone else have it. Thank you.

We will take our next question from Mitchell Sacks with Grand Slam.

Two things. I missed the numbers on the scrap metal. You were talking, I missed the number, what were the impacts for the quarter? What was the impact.

Third quarter compared to previous third quarter in the prior year our scrap sales were $0.5 million less, which impacted the margin by approximately 1.4%. And it was $1 million less compared to the previous three quarters average, which is approximately a 2.8% impact on the margin.

Okay. Can you talk a little bit about the competitive situation? We know that one of your come competitors, Delco Remy, does a lot of OEM business, and another competitor, BB, is very leveraged. Can you talk about the competitive situation, what you're seeing, what you feel is happening in the market there?

Well, again, those are both private companies so I am not familiar with their financial condition. But the market, I think the market is, is fairly settled right now. I don't see much, you know, in terms of major upheavals anywhere across the market. I mean I think with we are well positioned to compete. We have low leverage. We make a good product. We have probably the largest offering in the marketplace in terms of number of SKUs, probably the most up to date cataloging services in the industry. I think our sales team is probably, and our vendor-managed inventory, category management, marketing support, programs are industry leading. So we see opportunity for us to grow organically by picking up new business. As far as commenting on the competitors, they're around and they're tough to compete with. We just, it just continues on, but I don't see, what I do see is a lot more moderation in the competitive environment. I think all three companies based on the economic conditions are far more sensitive as to how aggressive they are in the marketplace.

Thanks. Congratulations on the quarter.

We appreciate it.

We'll take our next question from Rick Hoss with Roth Capital Partners.

Morning, gentlemen. How are you?

Hi, Rick.

A couple of top line questions and then a G&A question for you. First, can you break out or give us at least give us an appreciation of how much growth was organic versus acquisitive in the quarter.

I can tell you that the third quarter was impacted more by the increase in sales from existing customers, and less so from the acquisitions earlier this fiscal year. Right now we haven't had a full year of experience with the new acquisition customers. So, we want to re-evaluate after a full year of sales to see exactly where we are versus what we were projecting, but the largest component of the increase in the third quarter was due to increases in existing customer sales.

So it would be safe to say that you had positive organic growth.

Absolutely.

Okay. And then, the CS alternator, the impact there, is that still winding down, do we need to keep that in mind?

It still continues to drop. The drops have come down percentage wise because the base continues to come down as well. What we are moving into some of the newer application of CS, and we are starting to see failures in that area. So, I think there is going to be some further decline, but not as dramatically as we are seeing it now.

Okay. Something that is just another moving part then.

Yeah.

Okay.

Another, hopefully a nonmoving part, Rick.

Exactly.

So we can replace it.

Now, there's no mention of guidance, I don't know if that was just an omission, or I don't know what your stance is on that.

The only guidance we have given is the incremental revenue for the year. There's so many variables right now in the business we are holding off from giving any further guidance. The only general guidance that we are giving is that we feel optimistic about the economy and how it relates to our business. And we feel like we are in a great position to continue to capture market share, build profitability, and the situation with, obviously with the peso is very important. More than two-thirds of our production is in Mexico. So that's going to bode well for margins in the future as well. As long as we can get that capacity up, I think David, I don't know if you mentioned it or not but if you look at maybe you can comment on the gross margin effect on the capacity, the overhead absorption.

Simple math would be, for every $1 million more you can absorb in the quarter it is about 3% impact on the margin.

Right.

Okay. Okay. But as far as the guidance you gave last quarter, the 135 to 140 top line, based on what we have done for last nine months, you would just need 30 to 35, which would be flat to down from this quarter.

Right.

That's still fair?

Yeah. I think we are sticking with that guidance. The last fourth quarter we had was very strong. This quarter is, we are seeing inventory management in a couple of our customers, we expect it to come back strong toward the end of the quarter as it did last quarter. It is a little early, I don't want to speculate on the full quarter based on the short amount of experience so far. But conservative, we think the guidance is still in effect.

Okay. But don't get crazy with it.

No.

The G&A it looked like backing out the effect of the write down $1.3 million below the year comparable; is that correct? Did I do that.

Yes.

Can you tell me where that came from? It sounds like a very impressive number.

This morning we also filed our 10-Q, which goes through the detail of each expense item. The largest decrease would be in audit and related professional services fees, decreases in compensation and related expenses. In the third quarter of the prior year, we had some costs related to coming out of our lease of our Laverne, Tennessee warehouse. Also had costs last year, in the current quarter of getting on to NASDAQ. With those costs no longer recurring, we were able to save about $1.3 million compared to prior year third quarter.

If I look at this number at 5.5, the one filed today, I take out my 1.3 out of that, can we see further reductions in G&A, or are we as tight as we can run the show?

We are always looking for opportunities to cut costs and I think there's still additional opportunity. It is something that is very high on our priority list, and especially in light of again economic conditions to be as efficient as possible and while I don't think it is going be be a crazy number I think there's opportunity still.

Okay. Perfect. Appreciate the time, thanks, guys.

Thanks.

Thank you.

We will take our next question from [Alec Chevnevsky with Granite Point Capital.]

Hello. I would like to understand the hedging a little bit better. You are in a contract to be buying Mexican peso. Do I understand that correctly? You want to be low on the peso to offset your operating costs; is that the way to look at it?

We buy out about nine months, we buy about 75% of our peso, anticipated peso requirements about nine months into the future, so that we fundamentally know what the metric is going forward. Any fluctuation in the market positive or negative is going to be smoothed over over that nine month period. And as we went through the last quarter, and David can give you much more detail. We probably used pesos at an exchange rate of around 11 to 1. As we get through August, is that what we get to, David, we should start seeing pesos at 14.

October.

In October, we should start seeing our pesos translate at about 14 to 1. So as we go down each month now we should see margin accretion based on the peso translation.

Right. So you are taking the $1.2 million write off, whatever it is, but you will baking that back by being able to use cheaper pesos. Is that the way to think about it?

Correct.

So we haven't seen the offset of that. What we have seen is the cost of the contract but the offset is still to come in coming quarters; am I understanding that correctly?

Yes, absolutely correct.

And a more general question about the state of the industry consolidation, I mean when I talked to you in the past, you talked about competitive, the financial problems, what is happening, has the world changed in the last three months what have you seen in terms of foreigners trying to get into the market, existing competitors, what is the world looking like to you right now.

As far as the world, the, there has been no change in terms of the come competitive environment being more aggressive at all for us. If anything it has been lighter. We don't see much in the foreign -- a lot of the Chinese suppliers are having huge problems with banking relations in China. We don't see any threat, imminent threat there. Our competitors again are far more leveraged than we are. I think in this marketplace, I can only assume that's challenging for them. And so I think very little has changed other than I think that we sit in a great opportunity with a great opportunity to continue to grow our business, both organically from our existing customer growth, we think we'll pick up new growth and we think we will have extended margins based on the growth because of the overhead absorption, and in addition to that, we think we'll have margin growth because of the peso translation.

In terms of your, the possibility of your doing any acquisition, does the world look right for you to want to do something?

One of the things that we debate internally day in and day out is whether to focus on building this cash flow. And really hunkering down in this environment. Our relationship with our bank is excellent. Continues to be excellent. We just extended our line of credit. We debate as to what values or acquisitions would make sense versus at some point accumulating enough cash to buy our own stock. We are a pretty existing acquisition ourselves. So I can't give you a definitive answer because every day, we look at it. And every day, it depends on the opportunity.

Given your liquidity now, that you would have no liquidity, if you didn't do an acquisition for example, you would have no near term liquidity needs for a while;

Not at all. We have gone through the extended customer terms. We have gone through Mexico transition now. We have one challenge that lingers in the background, is that our offshore suppliers are experiencing some challenges with their banking relationships. We are busy managing through that on a day-to-day basis, but overall, fundamentally, we should start generating some nice cash flow.

Okay. Thank you. Thanks a lot.

Thank you.

We will take our next question from [Erwin Friedman], Investor.

Hi, Selwyn. Good quarter. I have a question regarding capacity. We run one shift in Mexico.

Correct.

The percentage of capacity is based on that one shift. If we got busy and did acquisitions, and we took in the manufacturing could we be running three shifts?

The facility is designed to run 24/7.

If that is the case, where does that percentage come from. If it is 50% of one shift, what is the capacity of three shifts?

The first shift is far more efficient than the second and third shifts always. And so.

That's in the beginning when there's training and so on and so forth, to perfect the situation. I have been there.

If you assume full production in each shift, but when I say 50% I do what I would call conservative practical near term capacity analysis.

I hear you, but if the company, based on if we do acquisitions and we can make the product less expensively and more efficiently. Put something in my head as to what could be.

What could be if we could pull off acquisitions at the right price and put them through this facility, it could be an extraordinarily lucrative opportunity for us.

That's what I am asking.

No question about it. By the way we have a very scalable production model in Malaysia. While we always talk about the Mexico facility, we have two fantastic plants in Malaysia with very low cost production metrics that are very scalable as well. Capacity is not our issue, it is now capturing market share with the right economic model.

Thank you very much.

Thank you.

We will take our next question from [Dimitri Kernakovisky with First World Share Securities].

Hey guys, good quarter.

Thank you. Hi Dimitri.

Most of my questions have been answered just a couple of more things. What was behind the increase in for the quarter?

User to Dimitry can you get closer to the phone. We couldn't hear what you said.

Sure. What caused the receivables to go up for quarter?

Receivables compared to September 30 actually came down but if you compare to March 31 our prior year fiscal year end one customer who were factoring with no longer offers factoring, so with that customer, we've not had to go to payment terms. As a result, AR has increased but compared to September 30 we reduced AR and generated cash.

Okay. Got it. And then, you talked about the overhead absorption and I think you said 3% for $1 million revenue increase per quarter.

Yes.

Does that mean for each $1 million revenue increase in the quarter your gross margin goes up by 3% or what does that mean?

The math I am doing is for every $1 million divided by our net sales is approximately 3%. So for every $1 million absorbed in overhead, it will increase our margins.

But the million he is referring to is the $1 million in overhead not $1 million in revenue. It will increase our margin by 3% not $1 million in additional sales.

Okay. So how do you define $1 million of overhead absorption?

What we do is we know every quarter how many units we produce, how much we sell and we track how much dollars per unit we absorb versus how much per dollar we don't absorb and that differential we apply to the units sold and produced and calculate the absorption would be and we know based on 20% less production in the third quarter compared to the previous year that it was at least $1 million of overhead not absorbed in the current third quarter contributing to the lower margin. Once the volume comes back as someone mentioned, we can absorb more overhead, adding to increased profit margin.

So essentially just to recap, on the last trailing average we had $2 million less absorption on the trailing quarters. No, no compared to the trailing quarters, the average of the last two quarters?

Compared with the previous year third quarter, there was approximately $2 million less absorbed.

Okay. That relates to what percentage of the margin.

So for every $1 million it is about 3%. So $2 million.

Okay.

Talking more.

Okay.

So I think when you to the arithmetic, the low 30% margins are are very much still intact especially as we grow the business with upside opportunity on that.

Got you. And then just one more thing, you mentioned dealing with offshore suppliers and them having trouble with their banks, what sort of components and supplies do you get offshore and how much of your supply chain is based offshore?

The world today a lot of electronic components come from offshore, not many from the United States unfortunately. I would have the say the vast majority of componentry comes from offshore. The vast majority of our componentry, the suppliers are very secure and don't have problems and some of the more specialty ones we have issues with. We are working programs with letters of credit. We have had open terms in the past. We have a lot of availability on letters of credit.

So we have been able to secure extending our terms with LCs. Our goal is to extend the days outstanding on our payables and we would like to shorten the days outstanding on receivables. So on that is a good model. We still today are have excess days outstanding on payables over receivables. So that leads to favorable cash flow, but we again, we have it under control but it is something we keep watching. The banking situation while it is bad here seems to be far worse in China.

Okay. But in the grand scheme of things, the new components that you purchased was a relatively small part of what you did because you remanufacture.

Exactly. Exactly.

Okay. Got you. Thanks, guys.

Thanks.

We will take our next question from Bob Sales from LMK Capital Management.

Hi. First question, how in dollars, what is your quarterly operating expenses or COGS expenses that are paid in the Mexican peso? In other words, how many dollars out do you hedge per quarter?

As Selwyn alluded to, we have two-thirds of production at our Mexico facility, and what we do is we forecast how much is needed each month and buy approximately 75% of the pesos needed under these contracts.

Right. But there's some fixed, I am just trying to dissect within COGS, there's your core costs which are I don't think you pay pesos for those, and there's some overhead depreciation and amortization which I assume are dollars as well. How many outbound pesos do you have each quarter that you're actively hedging. If you don't have it that's fine we can deal with it later.

So on an average, a month we have approximately 9 million in pesos. So, that is approximately 75% of our monthly need.

Okay. That makes sense. Do you continue to hedge if it is January, February time frame or do you continue to hedge pesos for the last part of '09, and in other words, are you hedging at this devalued peso price as we speak? Absolutely.

We are buying, we have just recently bought pesos at over 15 to 1 in our future contracts.

Got you. Great. And then was Delco a customer this quarter?

AC Delco you mean.

Yes. Do you divulge what percent.

No, we generally don't talk about names.

Fair enough. I think that's all I you have for now. Nice job with difficult curve balls thrown at you.

We will take our next question from Michelle Tennant with RRH.

Hi, guys.

Hey, Seth.

I am trying to get a handle on margins and this overhead absorption, what is missing for me in prior discussions is how overhead is absorbed as top line is increased. Actually -- that's the one, the thing I am observing and maybe I am paying attention to the wrong thing is the top line figure.

Let me stop you, let go to small sections.

Sure.

It doesn't, the revenue does not affect how overhead is absorbed at all. It is zero affect. What affects how it is absorbed and how many units we produce in that factory. To the extent we have a great sales quarter and pull back production we still have less overhead absorption. In Mexico, it is in the number of units produced in that facility absorbed by the fixed overhead that's in that facility.

Super. So what I should take from the earlier discussion is there was a plan on production and tied to that was a certain amount of overhead and that plan, the word missed I don't want to use but the plan was, the actuals were different?

Well, we expected, well first of all let me take back. We built capacity. What we sell is capacity.

Yep.

So we built in excess capacity when we designed the facility for growth. The plan that is a little different for us is that the new business that we have committed is taking slower before it begins shipping. So as a result of that, we pulled back production for the delay of the new business shipments. But is it operating on plan? Mexico is operating with the exact metric that we thought it was going to do. It is going do better now with the currency translation.

I understand that completely. I just -- it is actually my comparison shouldn't be to plan of course. The information you are giving is versus quarters like last quarter and sequential. So, your production plan was for less this quarter than last quarter, hence resulting in less overhead absorption.

Correct, correct.

So let's move forward. Now I think you said that new business is supposed to come in Q1 of the first fiscal year.

Correct.

That's not this quarter, that's next quarter.

Right but we will begin, we received as a matter of fact this morning statistics on what we should begin ramping up for. So we will begin again this is not P&L revenue, it is production planning right now. So we will begin ramping up our production once we get comfortable that in fact the shipping time line is real and that the mix of the requirement of that customer is real then we will start ramping up our production and as a result of that, the overhead in Mexico will be absorbed and that doesn't affect sales but it will be absorbed and margins should expand.

Super. So just looking forward at margins, okay. We are down two quarters in a row on margins. This, where you see things at the moment should we be expecting this to be the bottom in margins or it seems to me from this discussion it should be except that scrap prices continue to collapse and that might be overcome by the cost of goods sold reductions.

I think the next quarter you can see these margins being maybe slightly softer or equivalent. We are not sure yet, depending on what this ramp up will lead to. But we should see the margins come back into the 32, 33% range or even higher.

That's why I am a little confused in that 32, 33% was based on some scrap metal rates. To get back to those scrap metal rates, isn't it going to take longer for cost of goods sold.

It will but what will happen is again through our inventory, and the material cost is also expected to come down. Right. The material costs will come down.

Right.

Scrap.

So it seems to me this is a two or three quarter come back to your low 30s number? No.

It may come back quicker than that based on the production volume not based ton scrap.

Okay.

Certainly on the scrap it could be two, three, even four quarters based ton scrap situation. That I don't know, I mean with metal prices and demand for copper and numbers down, the whole world is a little crazy right now, so it is hard to forecast the metal prices the one thing we see is good revenue volume coming on board which means that that will drive production which means that will drive overhead absorption. And on top of that with as these pesos start kicking in that should more than absorb the loss in the scrap volume.

If everything goes right, mid-30s at the end of the year. But we are certainly that's a time delay there, I guess.

Yes. I think we will keep the street up today. We have a public investor conference next week or the week after.

When we go to top line increases, how much of that was from acquisitions?

Approximately $1.5 million was from acquisitions. The remaining was from organic existing customer growth.

Okay. So that is super on the organic growth. The acquisitions were they online the whole quarter?

Yeah. We had some full quarter, yes they are.

Is that a good run rate or did they suffer.

to be honest one of them is a little softer, but with we are, at this point we have no worries on it. So nothing significant so what we anticipated.

Okay. Now in terms of anticipation how much top line did we anticipate adding through these two acquisitions or did you not state.

We had announced that the annualized run rate would be about $6 million for one and $4 million for other. But we have you know still a full year before we can really determine where we are.

One of them is more mature than the other, the bigger one, the first one is right on track, the second one is a little softer but we expect that to be right on track as well. I think that the second acquisition is I think what they or what we experienced is that before we bought it there was a lot of pipeline fill.

Yeah.

Okay. I understand clearly. Thank you very much for your time.

Thank you.

We will take our next question from Nelson Obus with Wynnefield Capital.

Most of my questions have been answered, but I am curious if I assume it is a FASB thing that required you to write down your book value.

Yeah.

It is a new pronouncement. If you look around you will see a lot of -- Time Warner just had a huge write down. I think the US Airway acquisition was a writedown. Essentially what it is, Nelson, is if you are market cap does not go up based on the acquisition then your book value is higher than your market cap, there's no rational for having goodwill if that's the case. That's what the SEC is focused on.

They're focusing on market reaction and not operations. My question then is it is nice if they moved into the realm sov the psychological. Maybe if they done a better job regulating we wouldn't have this problem but the question is in the stock price goes up does that get reversed.

Once you take a write down it never comes back, never comes back. It is a one time hit and it is gone.

Okay. That was my question. Thanks.

We will take our next question from Steve Emerson with Emerson Investment Group.

Well, congrats on being refreshingly upbeat in this wonderful economy. I didn't hear, but this new customer coming on, are we having to buy out their inventory and how much do we have to extend our credit lines et cetera to accomplish this?

First there's going be some expenditures rolling it in ramp up but there's no buy backs and or anything like that, no. And as far as tapping the credit line, we will need to build a little bit of inventory but we are over inventoried right now. It is going to be marginal.

Okay. Can you fill us in on your, if the AutoZone renegotiation, which is coming up, will that be pretty much an extension of what is in place?

It is difficult for me to comment on one customer.

Okay.

Again the only thing I would say generically is that we are comfortable that our relationship is strong with all customers right now. And we don't anticipate anything major changing with any of them.

Okay. And then when is it reasonable to assume that your margins should finally stabilize based on today's scrap and today's peso? What would be the early and what would be the range September-quarter, nine month lags? How can, how should we look at when we might see a good, clean quarter in your view?

I was hoping this quarter would be a good clean quarter until we realized we had these noncash items. We have a history of these popping up. I apologize, most of it is out of our control but I believe that again I think this quarter, we should see comparable margins to what we saw last quarter and then we should see growth in our margins. It should stabilize if we don't count on any commodity increase that maybe one quarter pushed out. We should start seeing it going into the first quarter.

So into the June-quarter and if not the June-quarter the September-quarter?

Right.

And this would be what kind of objectives would you have.

Normalized margin for us today with sort of the volumes that we are anticipating is in this 33, 33% range. Okay.

33, 32 to 34% range.

Okay. Can you perhaps give us insight into what kind of operating income that would generate or margin that would generate, or flesh it out a little more beyond gross margin? Obviously these are not projections mainly just metrics or -- If you did you know based on what we have said is that we expect revenues to be up $20 million run rate. We talked about normalized margins around 33%. That's sort of it.

Okay.

Sort of says it. I don't see my major changes in G&A.

Okay. And that --

We have reduced G&A fairly substantially but no major change.

And that $20 million then we should bulk that up another $8 million or $10 million to the acquisitions so more like $30 million.

We have experienced now six months of actual revenue of the acquisitions six months I would maybe bulk that up by half of the $10 million, maybe five.

So 20 plus five. Now is there any head wind, are you seeing any price pressure due to the lower cost of raw materials right now et cetera? I assume there are other competitors in Mexico. Is there a revenue, I guess there is, is there a price pressure, and then how much on top of that growth should we see from the aging?

Well, that is first that's -- Let me divide that into two questions. Pressure is always customers are extremely aggressive right now, and trying to milk wherever the profits where ever they can. We think the competitive environment is that we are, pricing pressures will not be extreme because I think all of the competitors are, have given what they can give. So, I think I think pricing pressures will be moderate. But of course always, always an issue although we think we are comfortable on the pricing scenarios. So just don't assume any price increase, just keep the price.

The price increases, no. Okay.

And what was the second part? I'm sorry. I had a senior moment.

Please, I will out senior you any day.

I'm glad you forgot too.

No, no. How much, okay. We are looking at $20 million from the new customer run rate, $5 million from annualizing the acquisitions and then what kind of increase range from aging of the vehicle fleet?

That's it. That is the unknown. If you look at the statistics we see 26% of the 4 to 7. We see 26% growth in the 8 to 11 year category and we see 100% growth in the replacement rate of that category. And again, it's hard to extrapolate that out, but it looks like you shall see between 3 and 5% organic growth. It should be just from aging of the population right now.

Excellent. Thank you. And I think that would be in time for a good market with good earnings.

All right. Thank you. We look forward to, unfortunately we don't encourage a poor economy, but hopefully we can ben it from it.

We will take our next question from Gary Simon with UVE Partners.

Hi. Good morning, and again congratulations on the quarter. When you take out the noncash expenses and the FASB rulings, you did very well compared to last year and wow continue the up trend. But can we focus on the single largest asset on the balance sheet which is the inventory and how even though you slowed down production and then acting to increase it because of the new customer does that impact or get more revenue you and more inventory.

Let's talk about inventory in two separate categories and then I will give it to David, because he can handle this a lot better than I can, but the first thing to understand is there's a certain amount of inventory as our sales go up it will grow because it is on our customer shelf. So as we ship where we keep the call, all the callers under the accounting policies today remain on the balance sheet. As we grow, no matter what we do to control inventories within our system, as we grow from a revenue perspective that inventory will grow. The inventory we have on the shelves are the ones we can monitor and manage. That is where there's opportunity in managing the inventory. One thing we have as a company and I will let David get into the statistics but one thing we offer as a company is we guarantee shipment on all parts and so we are, while inventory from a financial perspective on the number of cars that we have, people say you have all of this inventory. The amount that we have makes us less vulnerable because we meet customer demands immediately, in the volumes we have it would be extremely difficult. So we are controlling to some extent the raw material that's critical to be a full service supplier, you can guarantee delivery of any part in any application in a very short period of time.

There's a strong competitive advantage.

Very strong competitive advantage. The other side of it is we have to manage it because you want to be efficient from a finance perspective, so I will let David walk through some of the, you want to give the break down of what we have on the shelf as what's not on our shelf.

Also we will talk about the amount of inventory, David that is not shown on the balance sheet that in the event of loss of customers, this is an excess amount.

I will address all of those. I am looking at note 5 of the 10-Q we filed which breaks down the inventory into components. We first look at the inventory that is in our current assets, it actually came down from approximately $32.7 million at March 31, '08, down to $26.7 million at December 31, '08. So we saw a $6 million reduction in our current assets for inventory and most of that is due to our finished goods, unit portion that has come down as well as the raw materials. Now, in the noncurrent section of the balance sheet, the asset side, you see that long term core inventory actually increased considerably.

Right.

And there's four components to long term core inventory. The first is you know core is that we actually physically holding in increased approximately $4 million. That is going to be tied to as someone mentioned earlier about having the cores to be able to meet fill rates to satisfy customer demand as well as we have been talking about the increased business that is coming. So we need to be ready with cores to be able to supply the customer. Now, the other balance I wanted to talk to you about is the remanufacturing, how the customer locations, which is the largest increase within long term core inventory, that's what someone alluded to, the cores are on the customer shelves. We have more out on customer shelves, that are expected to come back. So, with the new core accounting adapted several years ago we have a provision for those to come back.

And finally, as someone mentioned the cores that are on the customer shelves that we own, and that is the long term core inventory deposit that is approximately $23.7 million at December 31. That represents the cores that we own in our customer shelves valued at our costs. But if for any reason, those cores needed to come to back because of a change in the relationship with the customer, they would be valued at the selling price. So that selling price is substantially higher than the costs that we have on our books. So what you don't see is the true value of those cores in the quarter and long term core inventory deposit of only $23.6 million.

Right, the liquidation value of that is probably closer to $50 million. It is not necessarily our cost. It is just that we continue to write down costs, the lower of cost to market.

Right.

So these we have taken hits with this these all the way along.

So this is just, this is ordinary course of business, I mean the more successful you are, the bigger this number is going to get.

That's one of the natures. If you buy, essentially the way I look at it internally is I look at what we invest in cores, and see how many times we can turn that core on the margin we make and the number of times we can turn that core and I look at a cash on cash return from that core. Now if you were able to turn your inventory as you did last time I think it was five times, you buy that core once and you turn that inventory five times, so your gross margin divided by the cost of that core is your cash on cash return and while we don't disclose that it is a very nice number.

I got it.

You have to dig into it.

$1 million worth of inventory.

In a different way than just as inventory. It is like the beer keg, how many times can you use that keg to supply the beer, you are really selling the beer. The core is the equivalent of the keg, it carries the finished good unit to the shelf. The thing that is changing our business is why working capital requirement has gone up the last five years, is that it used to be that the customer carried that core on his balance sheet, on their balance sheet and now that core on the new accounting methods remains on our balance sheet.

Is there a way to finance that inventory?

You should sit in our board meetings and sit in our finance meetings, we are racking our brains to figure out a way to finance cores and they are I think there's opportunity unfortunately, the markets today are on the debt side are very poor as you know, so probably not today, but we are working on many strategies in terms of financing those cores.

I see. All right. Thank you. Keep up the good work.

Thank you.

We will take our next question from George Burmann with Gunn Allen Financial.

Good afternoon, gentlemen. Congratulations. It looks like a very nice quarter taking the one time items out.

Thank you.

The you had mentioned the goodwill is not completely written off. There's no more to write off going forward; correct.

Correct.

And talking about the peso situation, you are entering these forward contracts to pencil out our profit margins so six, nine months ago you basically worked the then prevailing exchange rate into our profit margins; correct.

That's correct.

And going forward as of right now you mentioned the peso is now 15 or 14, 15 to 1 versus 11 to 1. That would increase your profit margins going forward tremendously; right.

Absolutely.

Are you having to share some of that with your clients, customers.

No, well we share it not directly, indirectly they're always asking for something. It should add to our margins. We continuously are sharing with our customers, George. I'm sure they're listening in on this call. So no I think it is just there's the ups and downs and that is something we are trying to normalize out.

Right.

And we should experience some increased margin.

the previous caller was asking about the core inventory, you own it when it is on the customer shelves but once it is sold by them, it is gone; right?

No because we are talking about the core portion of the unit. So the core portion of the unit will always be owned by us, because when they sell it, they get another one back, and that automatically becomes ours. If they don't return it we bill them and that's when we get cash. It is again like, so I think the easier way to understand it as I go back to my beer and beer keg, when you buy a keg of beer you pay a deposit for the keg and you pay a nonrefundable amount of money for the beer inside of it. When you bring that keg back after you drink the beer, you get your money back for the keg and it would come back to us essentially as the equivalent of the core we refill it with beer and it goes back on the shelf. It just recycles. We own that core in perpetuity, unless we terminate the relationship with the customer and vice versa, then they have to pay us the value of the cores on their shelf.

Okay.

In our industry when you terminate the customer the cores go to to new supplier, we are not obligated to take them back once you terminate a relationship. Essentially the down side is if you lose your customers which please God we don't we would get cash for all of those core.

Brilliant. Okay. Thank you very much. And good luck for the current and future quarters.

Thank you.

It appears we have no further questions at this time. I would like to turn the call back to our speakers for any additional or closing remarks.

Thank you for your time. We are committed to continue to pursue growth and profitability and managing our cash flows and I think we are in a nice position today and again I thank everybody for their time.

Once again that does conclude today's call. We do appreciate your participation. You may disconnect at this time.