Motorcar Parts of America Inc (MPAA) 2010 Q2 法說會逐字稿

Good day everyone, and welcome to the Motorcar Parts of America fiscal 2010 second quarter results conference calls. Just a reminder that this call is being recorded.

At this time I would like to turn the conference over to Mr Gary S Maier. Go ahead sir.

Thank you, Danielle. And thank you everyone for joining us. Before we he begin and I 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 conference call. Such forward-looking statements are based on the Company's current expectations and beliefs concerning future developments and their potential effects 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 these forward-looking statements. The 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 ongoing risks and uncertainties of the Company's business, I refer you to the Company's various filings with the Securities and Exchange Commission. With that said, I would like to begin the call and turn it over to Selwyn to begin.

Thanks, Gary. Appreciate you all joining us today for our fiscal 2010 second quarter conference call. I will start by talking about sales. Sales for our second quarter were very strong. We experienced record revenue for the quarter. This increase is due to net sales from existing and new customers as well as new customers acquired as a result of our acquisition of certain assets of Reliance. Sales in the second quarter are very encouraging, and in conjunction with our bottom line performance underscore that our strategic initiatives are working. Our mix of customers between the do it your self and the do it for me market is quite favorable now and should bode well for good, consistent, organic growth as we move forward.

For our new shareholders let me take a moment to highlight the key dynamics of our business. There are approximately 240 million vehicles on the road in North America today. Of these vehicles, approximately 130 million are at least nine years old, which represents the high demand age segment for our products. The number of vehicles in these categories has been increasing in recent years and is expected to continue to grow over the next few years. We believe that sales for our category are and will continue to be influenced by the following positive factors, the car population moving from the four to seven-year age bracket to the eight to 11 year age bracket is growing by 12% in the aggregate and in conjunction with this 12% growth, replacement rates for these cars for alternators and starters in the eight to 11 year age category are growing by more than 100%. In addition, we believe that the number of vehicles remaining on the road will increase, fueled mostly by the fact that we believe that the car population that is 12 years or older will continue to grow as a result of less people scrapping their vehicles. The replacement rate for alternators in the 12-year-old plus category is more than twice that of vehicles in the eight to 11-year-old category. These numbers are based on data from IMR reports. In addition, we are beginning to see an increase in miles driven again for the first time since 2007. Industry dynamics such as consumers delaying new car purchases and the miles driven on replacement rate data that I've just mentioned will bode well for sales of alternators and starters going forward, regardless of our current recessionary climate. Consumers may delay certain repairs but replacing an alternator or starter is not an option. The addition of new business also helps our optimism for near-term growth. We believe our Company is well situated with the available production capacity to capitalize on sales growth opportunities.

While gross margin for the quarter was impacted by several factors noted in our press release and our 10-Q, including decreased scrap metal revenues, we are encouraged that on a sequential quarterly basis margins are improving, reaching 27.4% compared with 21.9% in the fiscal 2010 first quarter. Our margin seems to be setting in quite well for now. The 27.4% reported margin was negatively impacted by 1.5% for reduced scrap contributions compared with last year's second quarter, which is directly as a result of lower metal costs, not our production methodology, in addition gross margins were negatively impacted by 3.1% due to a write-down of our inventory as a result of our ability to produce goods at lower cost than our standards. So this is good news for us actually going forward. In addition, we are actively pursuing production and purchasing efficiencies to further enhance our margins. Gross margins going forward should be positively impacted by increasing sales volume which will drive productivity in our factories. As I mentioned last quarter, cash flow from operations is expected to be positive going forward. Supported by an improved financial outlook for one of our large customers as well as an improving factoring environment for another customer. We announced last week that we entered into a new $45 million credit facility with Union Bank and BB&T replacing and supplementing a previous $40 million credit facility which is about to expire. The new credit facility enhances the Company's balance sheet and provides greater financial flexibility to grow our business. Both organically and through synergistic acquisitions. David will now discuss our financials, then I will return to make some additional comments followed by a Q-and-A session.

Thank you, Selwyn. Net sales for the fiscal 2010 second quarter ended September 30, 2009 were $39.4 million, compared with $36.4 million for the same period last year, an increase of $3 million. This increase was fueled by net sales to new customers acquired in the recent acquisition of Reliance Automotive and other increases in net sales from both existing and other new customers. In addition, net sales for the quarter benefited from the recognition of $845,000 of previously deferred core revenue. Gross profit for the fiscal 2010 second quarter was $10.8 million or 27.4% gross margin, compared with $11.9 million, or 32.7% gross margin for the same period a year ago. Gross margin for the second quarter was impacted by inventory write-downs of $1.2 million or 3.1% impact the current second quarter gross margin, compared with the prior year second quarter inventory write-down of approximately $300,000, or 0.8% impact to the prior year second quarter gross margin. This inventory adjustment reflects a write-down of inventory as a result of our ability to produce goods at lower cost than our standards. This second quarter standard inventory revaluation write-down will reduce cost of goods sold going forward. Additionally, packaging costs increase as a percentage of sales, primarily due to a one-time changeover related to new customers and a one-time cost of a switch in packaging related to one of our largest customers. Also, we experienced a reduction in scrap metal prices compared with the prior year second quarter, which resulted in decreased scrap metal revenues to offset material costs. Further more, the prior year's second quarter margin was favorably impacted by a reduction of the inventory obsolescence reserve of $453,000, compared with the current year's second quarter which we recorded a reserve of $354,000. Manufacturing, labor, and overhead costs were lower in the second quarter compared with the prior year. To recap, the second quarter's profit margin was $27.4 million. As explained above, the standard inventory revaluation write-down was $1.2 million, or 3.1% impact to the profit margin, which when added to the 27.4% margin results in a second quarter profit margin of 30.5%.

General and administrative expenses decreased $1.3 million or 26.5% to $3.7 million for the second quarter, from $5 million a year ago. This decrease was primarily due to a net gain of $699,000, recorded due to the changes in the fair value of foreign exchange contracts, $179,000 of decreased professional services fees, $115,000 of decreased stock compensation, stock-based compensation, $87,000 of decreased G&A expenses at our off-shore locations, and $48,000 of decreased travel expenses. Sales and marketing expenses decreased $191,000 to $1.5 million for the second quarter from $1.3 million in the same quarter of fiscal 2009 due primarily to the addition of employees as a result of our acquisition of Reliance and increased catalog expenses. As a percentage of revenue, sales and marketing expenses were relatively flat at less than 4%. Research and development expenses decreased $247,000, or 42.5%, to $334,000 for the second quarter from $581,000 in the same quarter of fiscal 2009, due primarily related to lower consulting fees, compensation, and travel.

Operating income for the fiscal 2010 second quarter was $5.3 million, compared with $5 million a year ago. In evaluating operating performance the Company considers the impact of noncash expense items on the second quarter operations, including the inventory write-downs previously discussed, FAS 123R stock compensation expense of $42,000, and noncash gain of $139,000 reflecting the impact of mark to market accounting for foreign exchange currency contracts based on the fluctuation and the value of the Mexican peso. In addition depreciation and amortization for the quarter was approximately $827,000. Adjusted for the noncash items mentioned above, and severance costs of approximately $34,000, EBITDA for the second quarter was approximately $7.3 million before reflecting the gain on the Reliance acquisition. During the three months ended September 30, 2009, we recorded a gain of $1.331 million or $0.07 per diluted share in connection with the acquisition of Reliance as the estimated fair value of the net assets acquired exceeded the fair value of the consideration transferred. Net of interest income, interest expense for the quarter was $974,000, compared with approximately $1.15 million in the prior year, primarily due to a decrease in factored receivables and lower interest rates on our line of credit balance. As a result of the items noted above the Company reported net income for its fiscal 2010 second quarter of $3.4 million or $0.28 per share, compared with $2.3 million or $0.19 per share for the comparable period a year earlier. As of September 30, 2009, our balance sheet had $1.6 million in cash, $167.2 million in total assets, and $23.7 million in borrowings or line of credit, leaving $13.9 million available after reflecting outstanding letters of credit. And of this, $7.5 million was reserved for use in the event that our largest customer discontinued its current practice of having our receivables factored.

As Selwyn mentioned earlier, we entered into a new $45 million credit facility in October which increased availability by an additional $5 million. During the second quarter, the Company used approximately $245,000 in net cash flows from operating activities. Accounts payable and accrued liabilities increased approximately $4.3 million due in part to increases in payable days outstanding. Additionally, net income for the second quarter was $3.4 million. Offsetting the cash generated from account payable increase and net income are accounts receivable increases of approximately $4.7 million primarily due to sales to new customers. As discussed previously, in September 2009, one of our customers reinstated the use of its receivable discount program which had been suspended in May 2008. Additionally, inventory and related account increased $2.5 million. Along with the item -- above items, other increases and decreases contributed to net cash used in operating activities during the second quarter. I will now turn the call back to Selwyn who will make a few additional comments before we open the call for questions.

As I stated earlier in the call and last quarter, new business and growth opportunities are continuing to gain momentum. Previously we announced receiving new business, and I must say after one year of planning to absorb this business with the customer, I am delighted to say that we have finally begun to receive orders and will begin shipping product this quarter as we fully ramp up for this customer. We continue to focus on opportunities to gain business from existing customers as well as adding new business 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 build brand name. In addition we are focused on making appropriate acquisitions such as Reliance. This acquisition added another top automotive retailer and leading traditional warehouses to our customer base. This will further help with leveraging our operating capacity in Mexico. Our infrastructure is in place to grow our business and to increase our margins. We continue to focus on adding sensibly priced volume to our top line and leveraging as many operating efficiencies as we can. We believe we are well positioned with our offshore footprint to be competitive in all facets of our product offerings. In summary, we the to believe that long-term market statistics are favorable, while oil prices and driving patents are important components to our business and aging vehicle population is particularly critical. In today's environment, where fewer new cars are being sold, we are experiencing an increasing population of old motor vehicles reaching high replacement rates for alternators and starters. This should bode well for our business over the long term. And, of course, it compliments our strategic growth opportunities.

In short, we are optimistic about our revenue potential going forward. On the operations front, we have cut costs. Since March we have reduced G&A costs related to acquisitions, accounting, logistics and financial personnel and reduced the annual expense runrate by more than $900,000. We have also eliminated more than half a million dollars from indirect expense in cogs. Lastly, we have eliminated more than $200,000 from sales and marketing and $100,000 from R&D. The aggregate year to date savings is approximately $1.7 million. In conclusion, the outlook for our Company is positive and I look forward to reporting further developments in the second half. I appreciate your interest in Motorcar Parts and I am happy to answer any questions you may have.

(Operator Instructions) And our first question today will come from Rick Hoss Roth Capital Partners.

Question on Reliance. Being some what familiar with that company, knowing that Advanced Auto Parts is a customer, or was a customer of theirs, are you able to comment on the incremental contribution from Reliance from, say, a key customer, and then your thoughts on where that could go?

Well, clearly Advanced a customer of Reliance, that was certainly was a key motivating factor for the acquisition of Reliance. We have taken over that business. In transition of that business to the MPA infrastructure. We're excited to be doing business with the one top retail that we're not doing business with right now. We're not doing business with before. And we hope to show them the job that we can do. Certainly it's a major potential. At this point we're happy to be -- to have them as a customer.

Okay. And then, Selwyn, can you comment on what you're seeing October, November thus far?

Yes, I think we're off to a nice, solid start. It looks to me like our revenue base is solidified and seems much more consistent and predictable right now. October was solid. It was not a record October but very solid. We have continuing positive expectations for the quarter, for this quarter.

Okay. And would you -- can you comment on the second quarter being maybe high for the year, or do you have optimism that you could see a quarter that would be higher in revenue than the second?

I think, Rick, what we do is we added, we landed -- we got awarded some new business about a year, and we're finally ramping that business up this quarter. We think over the next -- certainly it will take us couple of quarters to get through that ramp-up. We believe that will add to our customer -- to our revenue base nicely. We think our existing customer base is strong. I think the overall environment in the aftermarket is very strong right now. And so we expect revenues -- whether they will be higher or not in a quarter, I can't comment on that necessarily with much accuracy, but I certainly expect them to be strong for the rest of the year.

Last question, the new credit facility, as far as I understand it, it allows a stock buyback, if you're able to hit certain covenants. Is that correct?

That is correct, yes. I mean, think the stock buyback is on a base covenant. There's no incremental covenant, David, am I correct?

There is a leverage ratio that if you the achieve, there's more available.

I think we now got up to $5 million for stock buybacks.

David, I think I missed it. As far as the factoring allowable, which I'm assuming is O'Reilly, so O'Reilly now is allowing you to factor, or are they not, and has it been done yet, and are you expecting to do it?

So as I mentioned, it started up again in September in 2009.

So we'll continue to factor with O'Reilly. That should have a nice positive impact on our cash flows.

Okay. So it's just in the beginning phases of it.

It just started.

Perfect. Gentlemen, thanks a lot.

Thank you.

And our next question will come from Mitchell Sacks with Grand Slam.

Nice quarter. Can you talk me through the gross margin number? I was writing furiously trying to keep up with it. You talked about 3.1% reduction due to the write-down, which brings you back over 30% gross margin. How do you think about that going forward in terms of trying to predict what's going to be GAAP gross margin?

One of the things Mitch that is good news and bad news. This gross margin is continuously being -- for the most part, continuously been affected by the inventory write-downs. The inventory write-downs are essentially write-down on our ending inventory based on the fact that we were able to produce finished goods cheaper than we were carrying our finished goods on our balance sheet for. That could be as a result of direct labor, indirect labor, material costs, across the board for whatever goes into cogs. So from an operating metric, when we evaluate the productivity of the factory, the factories are working fabulously well right now. Our operating margin without the effect of these write-downs is above 30% today. When these write-downs stop, obviously we will have maximized and slowed down, come close to maximizing our efficiencies in the plants And then you should see GAAP margins being reported at high levels.

You still have a lot of capacity that in plant, so as you ramp capacity and absorb more fixed costs, I would assume this is going to go on for awhile then.

That is possible. As we ramp capacity, the overhead absorption, of course, goes up, and we get more efficient. We do have some nice capacity available still from new business. So, there may be this continuing write-down of inventory again from an operating metric. We're very happy with the operating metric without regard to the cash write-down on the inventories. We believe the low 30s is really -- where we should be, which gives the customer a fair price and us fair opportunity to make good profits.

Super. I guess there's a question I tend to ask often. Have you finally hit the inflexion point in your business in terms of bringing it to the next level?

I think with an existing revenue base, we should consistently report nice numbers. The only fluctuations are in massive ramp-ups, and God forbid any loses, but we feel very good with the solid base of business that we've got now to have a good, solid operating story. We've essentially -- there's no offshore story left to -- it is still the inventory write-down which causes some affect. Gains and losses on currency are still there, but again they were 100% noncash and end up being zero at the end of the day. So yes, from a base operating perspective, the Company is in a great position, the cost structure is in place and we expect profitability to continue on.

Super, thanks very much.

Next in queue we have Dimitri Cornasofskia with First Wilshire Securities Management.

Hi, Selwyn and David. How are you?

We're doing great, thanks, Demetri.

Congratulations on a great quarter. Could you just talk about the ramp up of this new customer. You mentioned you were starting to ship product. Over how many quarters due you expect the ramp-up to complete, and what would you say is the incremental revenue?

The ramp up, a lot of, in the case of this particular customer, which I did not want to name, a lot of it will depend on the logistics, because they have a lot of warehouses. We expect to ramp up over the next two to two and a half quarters, and we expect a minimum of $6 million of additional revenue on an annualized basis from that, hopefully more, but conservatively speaking, that's what we're estimating.

Got it. What's the typical seasonality in revenue? Right now we are going into the colder part of the year. Are you expecting more cars to break, which should help you, or do you think it's been pretty normalized?

I think we have two dynamics. The alternators generally fail from high heat, and starters generally fail from cold. So the seasonality, we had tremendous seasonality failures of CS alternators in the past. The number of vehicles that have CS alternators is declining, so as a result of that we are absorbing increased revenues with a decline in category in CS, but it also makes our business less seasonal. It's now much flatter. There are some effects based on when customers do the update orders, but I think as we go down the line most customers are flattening out their updates over the year as well. So I think seasonality has become much less of a factor.

And then what are you seeing in raw material costs right now?

Well, the raw material prices have come down, because metal prices have come down. I think when you see these inventory write-downs, you are starting to reflect on these raw material prices being reduced. We're seeing it tick up a little bit in some metal costs. Over time we may see that come back. Again, I think we have the hedge on our scrap prices with raw material purchases. In the near term, in the next couple quarters, I certainly don't believe raw material will be an issue for us.

Thanks a lot.

(Operator Instructions) We'll hear from Tony Cristello with BB&T Capital Markets.

Thank you, good afternoon. I'm sorry, can you hear me okay?

Yes, good. How are you?

I'm doing okay. When you look at the Reliance and the integration there, is there anything that you had to do from a cost standpoint that would have impacted margins that were obviously masked from the -- that you didn't discuss? The second point, if I missed it, I apologize what is the run rate on that new piece of business?

Okay. Let me deal with margins a little bit. Obviously, any time you have an acquisition, there's more time spent on integrating different areas. I think some of the Reliance costs through the integration are reflected in the G&A. I think the gross margin effect is fairly nominal, even though the packaging piece was certainly as a result of that, changing packaging and reintegrating sales and marketing expenses up a little bit because we have kept the sales infrastructure for Reliance in place. We have eliminated -- we didn't buy any of the assets or any of the production, so we really didn't have the challenge of integrating any production or operations from that perspective. We expect the run rate, switching gears to the revenue to be an incremental $10 million on an annualized basis. So -- which we've begun shipping and preliminary estimates seem that they're holding.

Is that pretty much an early -- takes a little bit longer to get to that run rate, or did you see a couple million dollar in revenue from Reliance's quarter?

$1.5 million was the bump in the quarter on revenue from Reliance.

Then I guess the balance of your -- in terms of the revenue overall, how should we look about -- or look at the core business from an organic growth standpoint? Are we seeing --

Our base major customers are fundamentally doing better. We see volume increases in most of them. Obviously there are some gyrations between them, but fundamentally our base business we feel is very strong. And so everything we add on is additive. We have seen a reduction in CS sales, which I think everybody in the industry is seeing. So despite absorbing probably 25% to 30% declines in the CS category, revenue continues to grow for us. So all of our customers, without mentioning names, all the major retailers and major do it for me customers we have, seem to be holding their own and growing.

Have you been effective in holding price, or is the competitive landscape such that it's been a little more challenging from that front even though volumes are up?

I think we certainly have have not reduced prices anywhere. So there's always competitive pressures but we continue to try and hold up pricing.

Okay. When you look at the gross margin side of things, obviously the first half of last year, the June and September quarters, which we just anniversaried, there obviously is a difference between the two. I guess the question is, are those levels that we saw in the first half of last year once again achievable, or do we think, given where scrap price is and some of the other things that were going on, were those a bit inflated, and how should we think about he business, in terms of utilization, that's ultimately the key driver. Where is your facility now, in terms of utilization, and what do we need to see it at to really get those margins up?

So let me try. There's a lot in that question. Let me first address the prior year, then I'll address ongoing metrics, then I'll try and address utilization. So in terms of the prior year, there was some major pickups in the prior year that were reflect in gross margin. I think significantly, we had a pickup in obsolescence reserve in one of the quarters. We had a customs reversal, customs accrual reversal where we won our customs case and that was a significant pickup in that margin.

There was a customer in which we accelerated the margin allowance.

Right, we had a acceleration of marking allowance so we didn't have the expense even flat for that quarter. So I think within the last year you did see some unusual accelerations into the margin. From an ongoing perspective, I think we looking at this 30% to 32% range as where we are today. These inventory write-downs, which are GAAP write-downs do affect the margin but they're noncash and you recoup them as you go forward. We think we will see accretion in GAAP reported gross margins, but really from an operating metric, we think the low 30% margin rate is where we will be on an ongoing basis. And last, but not least, the thing that will really affect our margins, which could increase them significantly, is utilization of our facility. And so we are at about 50% capacity, in our Mexican facility and even with that 50% we feel comfortable that the low 30s as an operating margin, but if we can increase utilization in that facility, we believe we can enhance the margins significantly.

So as we look forward in the next 12 months, getting back to that low 30s number, given your throughput today is achievable?

Very much so.

Okay. And then one last question is, as we think about the cost side, the G&A, the sales, research in R&D, is there any reason why we would think that any of those would have much variability to them on a going forward basis?

Under the base business, assuming no significant fluctuations in revenue basis, this cost structure should be very consistent, and obvious we continue to look for efficiencies. So yes, I think, again, under a stable state, which is where we are -- under this stable state where we are today, this cost structure is very manageable and very sustainable.

Great, thank.

Thank you.

Next we'll hear from Richard Schuster with Robeco.

You answered my questions. Good quarter.

Thank you, Richard.

(Operator Instructions) We'll hear from George Burmann with Gunn Allen Financial.

Thanks for taking my call. Congratulations for a great quarter.

Thank you, George.

The acquisition of Reliance would be reflected in your assets liabilities as of September 30, is that correct?

Yes, it's included in the intangible assets. We filed a 10-Q this morning. In one of notes we actually break out the detail of the intangible assets.

Could you give me a little color on how after such short time you book a gain on the acquisition?

That's a very good question. Under the GAAP rules, I forget what section, maybe, Kevin --

141

141 R, outlines exactly how you value your acquisition and your intangibles. Certainly we made the acquisition without looking at 141 R, then did the evaluation and it came in higher than the price we paid. You're supposed to book again, then would you amortize that gain over time, over the life of these intangible assets. I would just say from our perspective, we sort of disregard, quite frankly, the gain on the acquisition, and we'll disregard the amortization of it when we look at it. It's noncash GAAP stuff.

So there won't be any additional gains booked or will there?

I don't think you can book an additional gain. I think it's a one-time book. You may have some write-downs of that gain over time.

Considering utilization, the new customers coming in, add on from existing customers, do you have any intention of maybe expanding the operations into South America and maybe into Asia with exactly what you're doing and with the proliferation of cars being sold, for example, in China?

Yes, we are -- yes, we intend to certainly keep -- South America is probably a second priority at this time, but we are very active in the Chinese market at this point, evaluating alternatives.

Thank you very much. Good luck for the future.

Thanks, George.

Thank you.

And at this time there are no further questions. I do apologize. We do after follow up from Dimitri Cornasofskia.

Barely made it.

Okay.

Just going to follow up on the utilization. Could you give us some idea of, let's say utilization increases to 65% or 60%. How would that affect gross margins at current prices of raw materials and finished goods?

Unfortunately, I don't want to comment on that, because I think it's key competitive information, and the only thing I would say to you, as we ramp up production, those factories become more efficient and I can't quantify how much more efficient from a margin perspective for you, but certainly we'll enhance our margins as we go forward.

Fair enough. Thanks.

And with no further questions, I will turn the call back to our presenters for any additional or closing remarks.

I want to thank everybody for taking the time to listen to our presentation, and we look forward to future reporting as we go down this Road. Thank very much.

And that does conclude today's teleconference. Thank you all for your participation.

Thanks, Danielle.