Motorcar Parts of America Inc (MPAA) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by and welcome to the Motorcar Parts of America's fiscal 2015 second-quarter results call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to turn the conference to our host, Mr. Gary Maier. Sir, you may begin.

Thank you, Eric. Thanks everyone for joining us today for the call. Before I 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, I'd like to remind everyone of the Safe Harbor statement included in today's press release.

The Private Securities Litigation Reform Act of 1995 provides the 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 effects on the Company. There can be no assurance that future developments affecting the Company will be those anticipated by the Company. Actual results may differ from those projected in these forward-looking statements.

Forward-looking statements involve significant risks and uncertainties, some of which are beyond the control of the Company and are subject to change based upon various factors. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. For a more detailed discussion of some of the ongoing risks and uncertainties of the Company's business I refer you to various filings with the Securities and Exchange Commission.

I would now like to begin the call and turn it over to Selwyn Joffe.

Thank you, Gary, I appreciate you all joining us today. The first half of 2015 was an exciting period for the Company reflecting growth and continued momentum in our base rotating electrical business, further success in expanding wheel hubs and initial partial quarterly sales contributions from our newly launched brake master cylinder business.

On an adjusted basis, net sales for the quarter climbed 21.7% to $81.4 million from $66.9 million a year ago. The adjustment primarily reflects the cost of lifting previous supply inventory relating to the new business that the Company began shipping in the second quarter.

Our net income on an adjusted basis almost doubled to $10.2 million from $5.3 million. Even with a 14.4% increase in the diluted weighted average shares outstanding, our diluted earnings per share increased to $0.60 per share from $0.30 per year earlier representing a 67% increase. Current economic conditions along with the continued aging of the car fleet continue to provide strong demand for our products. Pressure from fuel prices on miles driven should also diminish as fuel prices come down.

As I have highlighted on previous calls, data from Polk shows the average age of vehicles is 11.4 years. In addition, as the number of cars in the 12-plus-year-old category continues to grow, the replacement rates for these vehicles increase significantly. Current expectations are that the average age of light vehicles will increase and this should be a long-term trend. This continues to bode well for us.

We began shipping brake master cylinders in late July, which represents our second product line expansion following the introduction of wheel hubs in June of 2013. We expect initial revenues from our newest product on an annual run rate basis to be approximately $8 million to $10 million and further ramp up as we continue to grow market share.

To put our overall potential in perspective, industry sources estimate the market size for our products to be approximately $3.8 billion at the consumer level and the remaining market for hard parts to be approximately $106 billion.

We have a multi-pronged strategy for growth. First, we are focused on growing revenue in our existing product lines. Second, we will continue to introduce additional product lines that make strategic sense. We are committed to achieving service and quality levels that exceed expectations and believe that this will allow us to successfully grow our business in this and our other categories.

I compliment the work of all of our team members who are successfully executing our business in these exciting and very competitive times. In addition, our new product team continues to be actively at work looking for the next parts for us to introduce. I believe they are well on their way with some exciting ideas.

We supply more than 20,000 stores and our customers continue to gain share in both the DIY and the DIFM/professional installer market. We continue to see opportunities to leverage our award-winning customer service and product quality to enhance share both for rotating electrical wheel hubs and now brake master cylinders.

In short, the outlook for the Company's growth prospects continues to be very positive. In total, we expect our revenues for this fiscal year ending March 31, 2015 to show strong growth supported by the strength of business on all fronts. As I have previously stated, we have been awarded significant new business in all of our product lines with varying dates for shipments to begin.

While we expect continued strong revenues in this fiscal year, our run rate at year end should be even greater. I reiterate business is stronger than ever for us and we expect our excellent organic growth to continue.

David will now discuss our financials.

Thank you, Selwyn. We are pleased to announce record results for the fiscal 2015 second quarter, adjusted for customer allowances associated with inventory purchases related to new business gains. As Selwyn briefly mentioned, adjusted net sales for the fiscal second quarter were $81.4 million, a $14.5 million or 21.7% increase compared with the prior year second quarter. Adjusted earnings per share for the second quarter were $0.60 which is up 67% over the prior year's comparative quarter after reflecting a 14.4% increase in the fully diluted shares outstanding and adjusted EBITDA was approximately $20.6 million which is up 51.5% over the prior year's comparative quarter.

On a comparative basis, second-quarter results benefited from the introduction of the new brake master cylinder product line in late July 2014. Additionally, second-quarter results were impacted by various factors including customer allowances associated with inventory purchases related to new product lines and additional business which I will discuss further when I review the financial results.

Let me now review the financial results for the second quarter. Net sales were $70.8 million for the second quarter compared with $66.2 million for the prior-year comparative quarter. As previously mentioned, second-quarter results were negatively impacted by customer allowances associated with inventory purchases and returns related to new product lines and additional business.

During the second quarter, net sales were reduced by $10.5 million in connection with purchases of inventories which are one-time charges in connection with being awarded additional business for new and existing product lines.

For the prior-year second quarter, net sales were impacted by $700,000 in returns and customer allowances in connection with introducing the wheel hubs product line. After adjusting for the impact of customer allowances associated with the inventory purchases and returns related to new product lines and additional business, net sales increased by $14.5 million or 21.7% to $81.4 million for the fiscal second quarter from net sales of $66.9 million for the prior period a year earlier.

The increase in adjusted net sales of $14.5 million was due to an increase in net sales of the rotating electrical business of $5.7 million or 9.8% during the three months ended September 30, 2014 compared with the same period of the prior year; an increase in net sales of wheel hub assemblies and wheel hub bearings of $6.1 million or 69.8% to $14.9 million for the second quarter compared with $8.8 million for the prior year second quarter; and sales of the new brake master cylinders product line of $2.7 million which was launched in late July 2014.

The gross profit percentage was 26% for the second quarter which was negatively impacted by the inventory purchases and returns previously mentioned compared with 29.8% for the prior year; adjusted for the $10.5 million of inventory purchases and returns related to new product lines and additional business which were recorded as a reduction of net sales; and the related cost of the inventory purchases related to new product lines and additional business of $465,000 which are recorded in cost of goods sold, adjusted gross margin for the three months ended September 30, 2014 was 35%.

The increase in the adjusted gross margin was due to lower per unit costs due to better absorption of manufacturing overhead and product mix. Adjusted gross profit for the second quarter increased by $7.8 million or 37.5% to $28.5 million from $20.7 million a year ago adjusted for various items as previously explained.

General and administrative expenses increased $851,000 to $6.1 million after adjusting for non-cash mark to market net losses, expenses related to discontinued subsidiaries, severance, FAS 123(R) non-cash stock compensation expense. The increase in general and administrative expenses include incentive compensation, business development costs for new product lines and incremental expenses related to our growth.

Adjusted operating income for the fiscal 2015 second quarter increased by $7.1 million or 54.8% to $20 million from $12.9 million a year ago. These adjustments reflect the negative impact of customer allowances associated with inventory purchases and returns related to new product lines and additional business, discontinued subsidiaries expenses and other costs previously explained.

EBITDA for the second quarter increased by $7 million or 51.5% to $20.6 million from $13.6 million a year ago adjusted for various items as previously explained.

Depreciation and amortization expense was $615,000 for the second quarter. For the trailing 12 months ended September 30, 2014, adjusted EBITDA is $61.4 million.

Interest expense was $3.3 million for the second quarter compared with $4.7 million for the prior year second quarter or a decrease of $1.3 million primarily due to lower bank interest rates. Income tax expense was approximately 49% for the three months ended September 30, 2014. The income tax rates were higher than the Federal statutory rate primarily due to state income taxes. In addition, the income tax rate for the three months ended September 30, 2014 includes the required adjustments to reflect the appropriate six-month rate for fiscal 2015 and the impact of certain nondeductible expenses.

Net income for the second quarter increased by 91% to $10.2 million or $0.60 per diluted share from $5.3 million or $0.36 per diluted share a year ago adjusted for the items explained above. Earnings per share increased 67% over the comparative quarter last year. These results also reflect a 14.4% increase in the weighted average number of diluted shares outstanding.

We will now highlight the results for the six months ended September 30, 2014. Adjusted net sales increased $27 million or 22.9% to $144.8 million compared with $117.8 million for the prior six months period. Net income adjusted for the items previously noted and summarized in the financial tables exhibits of this morning's earnings press release was $14.9 million or $0.91 per share compared with $8.6 million or $0.58 per share for the prior year six-month period which represent a net income increase of $6.3 million or 73.8%.

Adjusted EBITDA was $32.4 million for the six months ended September 30, 2014 compared with $23.4 million for the prior-year six-month period which represents an increase of $9 million or 38.5%. At September 30, 2014, we had an $89 million term loan, zero borrowings on the revolver credit facility, and approximately $89 million cash resulting in zero net bank debt. There was availability of approximately $38.9 million on the $40 million revolver credit facility, reflecting approximately $1.1 million of outstanding letters of credit.

At September 30, 2014, the Company had approximately $377 million in total assets. Current assets were $170 million and current liabilities were $91 million. In early September 2014, the Company completed the public offering of 2,760,000 shares of common stock raising approximately net $67 million.

Cash flows provided by operations during the three months ended September 30, 2014 was approximately $10 million primarily due to increased profits and collections of accounts receivable.

I will now walk you through the income statement exhibits in our press release distributed this morning which we believe will make it far easier to understand the various expenses and adjustments for the second quarter ended September 30, 2014.

If you can take a moment to turn to the income statement exhibits in the press release starting with Exhibit 1, we can begin.

So when you eliminate the effect of all expenses related to discontinued subsidiaries and other one-time and non-cash expenses highlighted in today's earnings press release, for the three months ended September 30, 2014, adjusted net sales was $81,385,000; adjusted net income was $10,172,000; adjusted diluted earnings per share was $0.60; adjusted gross margin was 35%; and adjusted EBITDA was $20.6 million.

Exhibits 2 through 7 are the reconciliation tables to reconcile the reported results to the adjusted results including net sales, net income, earnings per share, gross profit, gross margins and EBITDA.

We will now go over the adjusted net sales calculation for the second quarter so please turn to Exhibit 2.

Starting with reported net sales of $70,840,000 for the three months ended September 30, 2014, we adjust for the initial returns accrual set up for the master, new brake master cylinders of $560,000; customer allowances associated with inventory purchases related to new product lines and additional business of $9,985,000, which results in adjusted net sales of $81,385,000.

We will now go over the adjusted net income calculation for the second quarter, so please turn to Exhibit 3.

Starting with reported net income of $1,475,000 or $0.09 earnings per share for the three months ended September 30, 2014, we adjust for the initial returns accrual set up for the new brake master cylinders of $560,000; customer allowances associated with inventory purchases related to new product lines and additional business of $9,985,000; cost of inventory purchases related to new product lines and additional business of $465,000; discontinued subsidiaries legal and other costs of $1,353,000; non-cash share-based compensation expense of $600,000; mark to market non-cash losses related to warrants and forward contracts of $1,750,000; and a tax effect of the above of $5,086,000 which results in adjusted net income of $10,172,000 or $0.60 earnings per share.

Exhibit 4 is the adjusted net income calculation for the six months ended September 30, 2014 of $14,891,000 or $0.91 earnings per share.

Exhibit 5 is a reconciliation of adjusted gross profit and gross margin percentage for the three months ended September 30, 2014. Starting with reported gross profit of $18,420,000 or 26% gross margin percentage, we adjust for the initial returns accrual set up for the new brake master cylinders of $560,000; customer allowances associated with inventory purchases related to new product lines and additional business of $9,985,000 and the related costs of the inventory purchases related to new product lines and additional business of $465,000, which results in adjusted gross profit of $28,500,000 or 35% gross margin percentage.

Exhibit 6 is the adjusted gross profit and gross margin percentage calculation for the six months ended September 30, 2014 of $47,678,000 and 32.9% respectively.

Finally we will go over Exhibit 7 which is the adjusted EBITDA reconciliation. Starting with net income of $1,475,000 for the three months ended September 30, 2014, we adjusted for results from discontinued operations, add back interest expense, income tax expense, depreciation and amortization, the initial returns accrual set up for the new brake master cylinders, customer allowances associated with inventory purchases related to new product lines and additional business, the related costs, discontinued subsidiaries, legal and other costs, non-cash share-based compensation expense and mark-to-market non-cash losses related to warrants which results in adjusted EBITDA of $20,630,000.

I will now turn the call back to Selwyn.

Thank you, David. Exciting results. I wanted to take this opportunity to thank the MPA team. We are relentlessly pursuing making our customers do better than our competitors' customers. The team continues to be passionate about building shareholder value and as the second half of the fiscal year evolves, we will continue to focus on growing our business and working with our customers to grow their businesses through superior product quality and value added customer service. In addition to growing our existing business, we will continue to look for additional product line opportunities. We remain optimistic about our existing business and excited about new business that we have received in each of our product lines.

We will now open the call to questions.

(Operator Instructions). Steve Dyer, Craig-Hallum.

Good morning. Terrific quarter, guys. The gross margin in particular was exceptional and I know you have kind of always talked about that 27% to 30% range but pretty consistently are well above that including this quarter. How do you think about that in general going forward?

That is a good question, Steve. I think the key things that affect the gross margin are number one, overhead absorption and certainly with the amount of new business and volume that we continue to take on, we have scalable capacity. And so the improved overhead absorption is certainly helping our margins and I expect that to continue as long as our business continues to grow in our core categories that we are in right now.

The other thing that affected us positively for the quarter was really the product mix. And generally late-model applications are generally more profitable than the early model applications. Many early model applications, there is just no profit at all in but you have to offer a full line.

So on the flow we did well. That mix can vary dramatically quarter by quarter. So while I think the long-term outlook is that the professional installer market has significant growth ahead of it and generally the professional installer market calls for later model applications and our customers are all focused on growing in the commercial professional installer market as well as DIY but they are growing incrementally in the professional installer side -- I think that will bode us well.

But I think assuming that these margins are constant would not be accurate. I think the six-month average is probably a more accurate margin to operate off and I do think we will see some big margin quarters but I think you will see some that have lower margin.

I think we've also stated in the past really, return on invested capital is where we are focused. We believe we've been successful in really generating over 45% return on invested capital. We certainly, we look at a threshold of around 35%, but really to the extent we can accomplish those returns we are a little less focused on gross margins just because there are so many product lines. We expect to launch additional product lines and those margins fluctuate fairly significantly between product lines. So that's a bit of a long-winded answer but hopefully that gets you something.

Yes. Thank you. That is very helpful. And thank you, David, for explaining basically the contra-revenue for the core purchases. Would you anticipate the December quarter to have a material impact as well or does this quarter pretty much cover it?

Let me clarify that as well. To answer your question firstly is that we don't anticipate much in the third quarter. The other reason, the reason that it was actually relatively high compared to any other product acquisition cost we've had in the past, is there is a differentiation in what type of business you get. To the extent that we pick up a competitor's product line that was a branded line in our competitors and we convert that line into a house line brand, we would have to lift all of that competitive branded inventory.

And so that happened and so that was a little bit of an extraordinary situation. Normally if they are both house brands, the lift is much more insignificant, it's more cleaning up the inventory rather than switching out the inventory. And so I think that negatively affected us for the quarter. In addition to that as part of some of our growth in rotating electrical we had to expense some core buyback and that expense -- actually if we ever lose the business, we get that money back. So it's sort of like a long-term deposit but that will continue on. But I think the significant branded inventory probably will be reduced as we go forward.

Great. Helpful. Thank you. A couple of more. As you look at the December quarter and I know you don't provide guidance but halfway or so through the quarter now, are you sort of seeing the normal seasonality there where December it ends up being down a bit from September?

Yes. We expect the third quarter is always a lighter quarter than the second. Relative to the third quarter, it is a good quarter but we certainly don't expect to see the same revenues in the third quarter. The fourth quarter we expect to see significant revenue growth. We have very significant new business starting in the fourth quarter. But the third quarter is a strong quarter relative to third quarters but certainly not relative to the second quarter.

Sure. Okay. And then you've talked over time and I know a significant component of the growth story here is new product lines and I hate to be talking about the

next one because you just launched brake master cylinder. But how do you think about timing on the next one? I am sure it's a 2015 event but any color around first half of the year, second half of the year, etc.?

I wish I could give you more color on that. I mean, we are optimistic. We have a couple of new product lines that we are excited about. How fast they're going to roll out I am really not sure. I do believe that we should have something in this fiscal year. I think we are probably at least six months away from that though.

Okay, sounds good. Thanks. Congrats again, guys.

Matt Koranda, ROTH Capital.

Thanks for taking my questions. Just on the inventory piece, can you just talk about how that flows through the financial statements going forward or do you anticipate selling off the inventory that you've repurchased? And how does it hit the financial statements on a go forward basis?

On a go forward basis if we sell that inventory, it is recorded as a sale, like any other normal sale.

Now this is inventory that we have lifted so we don't anticipate a big pickup. Obviously we would not have written it off if we didn't think it had no value. So I don't anticipate that you are going to have a big pickup from the inventory. I wouldn't assume that. As far as the way it hits the P&L, I am going to turn it over to David how you account for the return.

So we've already, in the September numbers we have already accrued for what we believe the value is so going forward if we sell in a normal course whatever is sold is recorded to sales and cost is cost of goods sold.

Okay. So any reason to anticipate the margin profile would be substantially different from any of your core business?

No, this is inventory that again we have written it off because that is where we believe the value is and there is not -- we don't anticipate a pickup from it.

Okay, great. And then on the brake master cylinders it looks like some nice revenue there. Could you talk about how many customers contributed to that $2.7 million in revenues for the quarter? And then are there additional customers you anticipate adding by year end of fiscal 2015 and what run rate do think would be reasonable to exit the year?

I think again generally we try not to get granular on customers just because I don't think it is fair to our customers. I mean that is a launch to one customer but we expect to have multiple customers in this product line.

I don't know what that revenue number is. It is very early. I mean we just launched it probably a couple of months ago now. So a little early to tell. I will tell you that the interest in our product line is very high. And so in terms of giving you guidance and what that will do I think we said like $8 million to $10 million in our first year. We expect to pick up -- our run rate we expect to be significantly higher than that by the end of the year.

Okay. Great. That is helpful. And then one more here on brake master cylinder. I think you guys had mentioned in the past potential for reman activity. Could you talk to us about your latest thinking around that?

Yes, we continue again, it applies to every product line. We continue to evaluate build versus purchase and so we would look, we have coverage. I would tell you with new products we probably have coverage for 98% of the line, so 98% certainly of the volume. So the need for reman is probably not critical but if it makes sense then we will reman, if not we won't. We don't have a definitive answer at this point on that.

Okay, that is helpful and I will jump back in queue, guys. Thanks.

Jimmy Baker, B. Riley & Co.

Thanks for taking my question. This is actually Sarkis in for Jimmy and congratulations on the quarter, guys.

So to go to my first question. One of your competitors recently disclosed that it intends to walk away from about $80 million of annual business at a large aftermarket customer. And then BBB indicated it won $20 million of new business in its presentation to lenders. Can you confirm you were awarded the balance of that?

Again, I don't like to get into specific customers. I mean we have significant new business. They didn't mention the customer by name. I would assume that is the business we have gotten but we really don't like to go into the details on a per customer basis. I would tell you we picked up north of $50 million of new business and so the arithmetic probably adds up but I just can't comment on any customer specific stuff.

Okay. But I suppose with regards to typical seasonality in calendar year 2015, do we think about any type of seasonality or any type of unusual ramp for that piece of business?

Well, we expect to begin, I think we have mentioned this, we expect to start shipping over $50 million in new business in the fourth quarter. It just happens to be when it came in. I don't think it has anything to do with seasonality. So we're going to see a big bump in our fourth-quarter revenues and big increases in ramp up in our production and everything related to that.

The business continues to be less seasonal than it has been although the third quarter, the December quarter, generally is a little softer. There's a lot of holidays in there, there are a lot of days that people won't work on their vehicle because of weather and family events and so the third quarter generally is lower for us.

But we expect to see a solid third quarter related to third quarters and certainly a much enhanced fourth quarter. I don't know if I am answering your questions but does that deal with your question?

Yes, that's generally helpful. And then I guess if we can speak to maybe the product lines for that business piece and perhaps the length of the supply agreement?

The supply agreement, we don't comment on any supply agreements. I mean generally our supply agreement relates if we do the job right and we are competitively priced and we take care of our customers' needs, that is our supply agreement. It's forever. If you don't do that, it will last a day and a half.

So I mean the supply agreements are not what we are focused on, it's customer service. So all of our supply agreements are filed publicly that we have but really the truth of the matter is the length of the supply agreements to us is irrelevant. I mean it is really the quality of service that we provide that we believe makes us viable for our customers.

Okay, that's helpful. Thanks for that. And on to my next question. It's not often that we see a company drive more than 20% sales growth while sales and marketing expense is actually down year-over-year. Can you talk about what you are doing to be more efficient there and also how should we think about operating expenses in general as your business momentum continues to build?

Yes, I think the sales expenses -- I mean are down -- I mean they shouldn't really be down, they may fluctuate around this level but the reality is we are leveraging our relationships within a channel and so we are able to have someone who -- a team of people that deal with one product line, that can deal with two product lines. We have an infrastructure that's quite scalable and able to manage significantly more than they have been historically and they have done a great job of scaling their expenses.

I think you will see incremental sales costs go up as we grow but certainly not at the rate that we grow. I mean we have a whole base fundamental team of people that support the specialists across the board. So that base team is leveraged quite significantly as you grow your revenue.

But again we should see some scale as we develop new products, we've got new product engineering, new product sales specialists, new category management specialists so we will see some incremental scaling but not nearly as significant as the growth in revenue.

Okay. And given the dynamics, would you care to comment on what that incremental growth in that line would be?

Well I don't know. We have talked, that is a tough one as well. We have been experiencing over 20% growth for the first six months and certainly our targets would be to try and continue with that. It just depends on when the new product line entries will be. It will depend on success of landing new customers. There are quite a lot of variables in that.

I think our organic categories are strong, I mean rotating electrical is a 3% to 5% growth. We think master cylinders is at least that and we think that organic growth in wheel hubs is at least 10% to 12%.

So that is our base line and anything we can do to enhance that obviously we are going to try.

Okay, great. Thanks for answering my questions. I will hop back into the queue.

Chris Brown, Aristides.

Yes, gentlemen, I just had a follow-up on the customer allowances. I'm still trying to understand this. So you come up with a new part and you say to retailer A, we want to supply you and retailer A says, great, we want you to supply us. Is the situation that they have a branded part basically And so you bought the inventory of that branded part and then the delta between what you paid them for that inventory of branded parts and what you think it's worth was $9.985 million? Is that correct?

That is correct.

Okay. Can you say what you actually paid them for the parts and what you think the value was?

Well, again I don't want to get into that, that is somebody else's proprietary information but I can tell you that's substantially all the inventory we wrote off.

Got you. Got you. Okay.

When you get stuff back it is not in the same condition as new, it is not in the mix that anybody else wants. It is just very difficult to liquidate it and we are going to try to liquidate it but it is very difficult.

Got you. So $10 million upfront seems like a pretty good deal for the retailer. What kind of sales volume do you guys expect that you are going to get in exchange for having given up that $10 million concession?

Our return is going to be north of 35% on that investment.

So basically the revenue that you get off of that will be more than 35% a year of the $9.985 million, is that correct?

Right, it will.

Okay, fantastic. Thank you very much

(Operator Instructions). Andy Kurita, Kettle Hill.

I still don't understand this inventory issue. I am sorry, I may be a bit dense. In the pro forma sales of $10 million, did you receive any cash or did any product transfer title from you to the customer?

Of a $10 million we received, that is just a regular sale and then we got a return so instead of expensing that as a cost of new business it is an expense as an offset to sales and that is the differential. So the $10 million revenue was there. It's just as a credit for that return of inventory.

The $10 million -- so I still don't understand. So you booked a sale of the same product?

No, no, no. We had sales of $81 million. We had real sales of $81 million. In connection with the new business that we took, we took a return of approximately 9-point something million dollars and that's booked as an offset to sales, as completely different inventory. It's inventory that we will scrap out and so they are unrelated. Just as that when you get a return of inventory it's a contra to sales, it's not an expensive new business the way we account for it.

Okay, so you book normal business and then you get -- and then the inventory was returned -- $9 million worth of inventory. How was that $10 million value of inventory determined?

Well we go out and we see what we can scrap it for and we make an estimate of what that value is. We give credit to the customer, that is the value of their inventory on their books so we give them a credit for that and then we book the value of that inventory and what we estimate we can scrap it at.

Okay, but there was only a cost of $500,000 in cost of goods against the $10 million of revenue. So what does that $500,000 represent?

That is hopefully what we can get for that inventory. Now we may be able to get more but we doubt it because when you get back inventory that is branded inventory, it is very difficult for us to resell. We are not in the business of selling somebody else's brand and so we scrap it.

But the effect on the non-GAAP numbers is it effectively a 95% gross margin that you are adding back? That's what I don't understand because it is $500,000 of costs associated with $10 million of sales so why is there a $9.5 million add back on the non-GAAP due to the inventory returned?

This is David. So I will explain it a different way. So someone mentioned that -- and as we are presenting in our earnings release, the regular recurring sales was $81 million for the quarter. During the quarter because of the inventory purchases, sales was reduced by approximately $10 million. So in our earnings tables we are adding back that $10 million to show what is the recurring run rate sales for that quarter. So that purchase of inventory has nothing to do with the $81 million of recurring business sales that we recognize.

And then the coverage is just a pickup because that is what that inventory will be valued so it is really a hit against sales that you are adding back.

So in the GAAP presentation, you took a $9.5 million -- I just don't understand why it is a 95% incremental gross margin we are adding back on this non-GAAP number.

The actual cost of the goods sold that we took back. (inaudible) numbers. Non-GAAP add back cost of goods sold. Only scrap now.

Okay. All right. I will follow-up with you guys later because I'm still a little confused about it. Thanks.

Chris Brown, Aristides.

Thank you. I was just wondering in the last few years have you taken other similar charges to these customer allowances that you gave this quarter.

There have been small ones. Again the reason this one was so significant is we picked up business for a premium brand and we took the return and put it in a different brand name into the customer. So this was an unusually large one because we have picked up premium business that's very expensive business and a very expensive inventory that we replaced.

So this is very unusual. I mean there are small ones that go on on a day to day basis but this one is unusual in that generally the business we picked up has been in sort of the house brands. This was a premium branded piece of business we picked up that we had to change out the inventory.

Are those small concessions, would those all be available in your annual filings or are those typically not reported?

I think they are all in the filings. David, do you want to --?

I think everything is in the filings. Later today the 10-Q for the September quarter will be filed. We will have more details in the MD&A discussion regarding these inventory purchases.

Great, thank you.

Paul Karos, Whitebox Advisors.

Is it fair, when you said the 35% return on the $10 million, that wasn't revenue, that was actually whatever your return on capital, right? So that would actually -- not revenue but -- because you were talking about some of the new business wins bigger than that. So it is really return on capital of 35% plus?

Return on invested capital is 35% which means that your revenues are significantly greater than that.

Yes, okay. I just wanted to make sure I understood that so that was actually the return on capital, not the revenue on that product. So is one way to think about this new business would just be to say it is almost like -- in a different company it might be like a one-time CapEx, what CapEx was to win the business -- they are not really related. Is that a fair way to look at it?

Yes, that's one, it is like paying a slotting fee or whatever. It is just that the cost of getting that business was cleaning out the competitors' inventory.

Yes, they say look will give you -- (multiple speakers)

I will tell you that if you don't clean it out, then what you have is a much slower ramp up, you don't get the revenue quicker, you are not doing the customers any favor because they've got the wrong inventory in there. And so our philosophy is clean up the inventory as soon as possible because that's one of the value added things that we offer.

We understand what inventory needs to be there, the customer values our input on what inventory needs to be there and that is all part of our whole category management process. So we are not big on delaying the hit. We are big on getting it over, clean up the inventory, get the right inventory so we can show the customer what we can do to help them.

Okay, so I get that. So basically for the retailer, it is a great thing because they get to clean stuff that. For you guys, it is just like any other capital investment decision what are we going to make return on capital on this $10 million and that is what you are seeing the -- at least 35% on return on invested capital on that $10 million. And so in other industries that would be -- it is a cost of -- instead of a cost of goods in a lot of cases, it is actually a capital spending number and now we are going to get a return on that over time assuming that of course you keep it for a long period of time to get that ROC.

Right, that is exactly what it is.

I get it. I just wanted to make sure I understood that. Thank you.

Matt Koranda, ROTH Capital

Two quick follow-ups. Was winning the new business, was it predicated on buying back the inventory or was that like your preference?

I mean some of the new business was predicated on taking this inventory out. I think the customer could have sold it through but again I think what I stated, our philosophy is if you bring us on as a supplier we want to make sure you've got the right inventory. That is part of what we offer and so if it doesn't make economic sense for us to pull the inventory and get it right, we wouldn't do a deal. And the reality is if we get that deal we don't want to be stuck with somebody else's legacy performance on retail sales to the shelf. Because every day a POS is critical to our customers and to us as category managers. So you will see that generally immediately when we get new business we make sure we evaluate what inventory level is, what the type of inventory is in there, where it is located, what the movement is on that inventory, what the price points are on the inventory, what is the brand recognition on that inventory, what is the key selling point to that inventory, how does it apply to DIY versus DIFM and on and on and on?

And to the extent that it doesn't meet MPA's criteria of what we think is best for the customer and the customer agrees with that, we will lift the inventory. To the extent we can't afford to do it, we would not take the business.

Okay, that is helpful. And then you mentioned maybe a small impact going forward for the remainder of fiscal 2015. Anyway you could kind of help us think about the magnitude of the impact in FQ3 and FQ4?

It is not going to be nearly as significant as this. It is much smaller, the amount of inventory.

Okay. All right.

Andy Kurita, Kettle Hill.

I think I understand it a little better so you shipped them new product that was worth $10 million and in exchange you received all of this inventory back? No cash changed hands (multiple speakers)

No, Andy, you have to separate -- forget -- the sales are $81 million in our regular course of business. It has got nothing to do with switching this inventory. The only thing that happens here is that we've taken back the inventory and that is an offset to sales but for nothing to do with equivalent inventory. So we ship in the regular course of business $81 million. It doesn't include -- it may include some inventory that replaces that, it may not. It's not a substitute of inventory. It's a lift of inventory to clean out their shelves so that when the program comes in they will be able to have the right inventory mix on their shelves.

Okay. So it is $10 million of inventory that you are taking back and that is the cost that they held it on their books for?

That was the price they sold it back to us at, yes, and we assume that's what they paid for it.

Okay, so you paid $10 million in cash? I just want to understand the -- .

Correct. Yes. We paid $10 million in cash for it. Absolutely.

Okay. So what is the $500,000 of cost of goods?

That will be the cost assigned to that $10 million.

That's the value of -- that is the recovery amount that we think we can scrap the inventory for. So it is a reduction of cost of goods I assume, right? That's the value of the scrap.

Okay. All right.

So that is what we think that $10 million is worth, $500,000 in terms of value of inventory to us. Now obviously it's premium inventory, it is good inventory but we are not in the business of selling that inventory and it is a fixed mix and so if we can get more halleluiah, but when we estimate what it is worth to us that is what it is worth to us.

Okay, so you took the inventory off your shelves, did you ship the inventory to replace it within this quarter?

It is not one for one, no. Not at all. No, this will just help us going forward.

Okay.

We first have got to get the inventory off of the shelves before you can put new inventory on the shelf.

Okay, thank you.

I am showing no further questions at this time. I would like to turn it back to management for closing remarks.

We appreciate your continued support and thank you again for joining us for the call. And we look forward to speaking with you when we host our third-quarter call in February and hopefully we will be at various conferences in the interim and certainly we are always available for questions. And we thank everybody for their interest.

Ladies and gentlemen, this does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone have a great day.