Motorcar Parts of America, Inc. (MPAA) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Motorcar Parts of America fiscal 2016 second quarter results conference call. [Operator Instructions] I would now like to introduce your host for today's conference call, Mr. Gary Maier, you may begin.

Thank you, Kevin, and thanks everyone for joining us for Motorcar Parts of America's fiscal 2016 second quarter conference call. Before we 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 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 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 the company's various filings with the Securities and Exchange Commission. With that said, I'd now like to begin the call and turn the call over to Selwyn Joffe.

Thank, Gary. Good morning, everybody. I appreciate you joining us today. Results for the second quarter and half year of fiscal 2016 were very solid for us and we are well-positioned for continued growth in the second half. We're experiencing continued strength in all of our product lines, which consist of rotating electrical, wheel hubs and our emerging brake master cylinder product line. I should mention that we recently expanded our brake master cylinder product line with the introduction of remanufactured units in the second quarter. This will allow us to provide full line coverage. We continue to be excited about our business opportunities in all of our product lines. As we announced two weeks ago in an 8-K filing, we resolved pending and threatened litigation with M&T Bank, and the trustee and the bankruptcy case relating to former subsidiaries. The agreement allows us to move forward and avoid the time expense and inconvenience of protracted litigation. We incurred a one-time $9.3 million expense, net of insurance recovery, for the company's litigation settlement in the June 2013 bankruptcy cases related to discontinued subsidiaries. And as a result, we reported a net loss of $1.4 million or $0.08 per share for the fiscal 2016 second quarter. However, on an adjusted basis, net income climbed 15.9% to $11.8 million or $0.62 per diluted share from $10.2 million or $0.60 per diluted share a year ago. David will discuss the financial results in more detail in a moment. On an adjusted basis, net sales climbed 25% to $101.7 million from $81.4 million in the same period a year ago. For the benefit of our new shareholders, I should mention that favorable economic conditions and a number of other factors are providing tailwinds to the aftermarket hard parts business in total. Miles driven have increased, as a result of lower unemployment and less expense of fuel prices. For the last month for the first time, miles driven have increased above pre-recession numbers. In addition, despite the growth of new car sales, the average age of vehicles in operation has grown. The average age of vehicles now exceeds eleven-and-a-half years. As the vehicles get older, the number of replacement parts needed continues to grow to support their maintenance. Additionally, the increase of new car sales to pre-recession levels will contribute to an increased age car population, resulting in accelerated growth for our replacement parts. These factors bode well for both the current and future business for both our parts and all hard parts in the automotive aftermarket industry. In particular, as the number of cars in the 12-plus year old category continues to grow, the failure rates for parts in these vehicles increased significantly, resulting in increased parts replacement. Current expectations are that the average age of vehicles will continue to increase and reach approximately 12 years by 2016. Since we focus on non-discretionary parts that require increased levels of replacement as vehicles age, we anticipate continued growth as we move forward. To put our overall potential in perspective, industry sources estimate the market size in the U.S.A. and Canada for our current products to be approximately $3.8 billion at the consumer level. The remaining potential in these markets for hard parts is estimated to be $106 billion, which should provide us with a lot of opportunity to introduce new parts and grow our business. We are proud that our service and quality levels continue to exceed expectations, and we believe this in part has allowed us to gain further market share in all of our product categories. Today, we supply more than 23,000 stores and our customers continue to gain share in both the DIY and the professional installer markets. We expect this will continue to grow, as we further leverage our award winning customer service and product quality to enhance market share gains with a growing lineup of non-discretionary categories. In summary, the company's growth perspectives continue to be very positive, business is strong and we expect our solid growth to continue. I will now turn the call over to David to review the results for the second fiscal quarter in more detail, and then end with my perspectives on our outlook, before we take questions. David, will now discuss the financials.

Thank you, Selwyn. In summary, adjusted net sales for the fiscal 2016 second quarter ended September 30, 2015, reached a record high of $101.7 million compared with $81.4 million for the prior year second quarter, which represents an increase of $20.4 million or 25%. As Selwyn just mentioned, adjusted net income for the fiscal 2016 second quarter reached a record high of $11.8 million compared with $10.2 million for the prior year second quarter, which represents an increase of $1.6 million or 15.9%. And adjusted earnings per share for the second quarter were $0.62 compared with $0.60 for the prior year second quarter, even with a 12.6% increase in fully diluted shares outstanding. Adjusted EBITDA climbed to a record high of $22.7 million compared with $20.6 million for the prior year second quarter, which represents an increase of $2.1 million or 9.9%. On a comparative basis, second quarter results reflect continued benefit from the additional rotating electrical business that started during the fiscal 2015 fourth quarter. Let me now review the financial results in more detail for the second quarter. Net sales were $91.7 million for the second quarter compared with $70.8 million for the prior year comparative quarter, which represents an increase of $20.8 million or 29.4%. Second quarter results were impacted by the following: $3.4 million of returns of prior supplier products associated with new remanufactured brake master cylinder business that substantially began shipping in the second quarter; $3.4 million of allowances in connection with core inventory purchases for remanufactured brake master cylinder products for the same new business just mentioned; and $3.3 million of returns of prior supplier products and allowances for rotating electrical that substantially began shipping in the second quarter. After adjusting for these allowances as well as comparable customer allowances related to new business in the prior year, net sales increased by $20.4 million or 25% to $101.7 million compared with net sales of $81.4 million for the prior period a year earlier. The increase in adjusted net sales of $20.4 million was due to: an increase in rotating electrical net sales of $17.1 million or 26.7% to $80.8 million for the second quarter compared with $63.8 million for the prior year second quarter; an increase in net sales of wheel hub assemblies and bearings of $2.2 million or 14.9% to $17.1 million for the second quarter compared with $14.9 million for the prior year second quarter; and increase in net sales of brake master cylinders of $1.1 million or 39.9% to $3.8 million for the second quarter compared with $2.7 million for the prior year second quarter. We launched the brake master cylinder line in late July 2014. The gross profit percentage was 23.8% for the second quarter compared with 26% for the prior year. Adjusted for the previously mentioned customer allowances related to new business, adjusted gross margin for the three months ended September 30, 2015, was 30.9% compared with 35% for the prior year. As you know that the quarter gross margin in the second quarter, a year ago, was an unusually strong 35%. In dollar terms, adjusted for customer returns allowances related to new business, gross profit for the current second quarter was $31.4 million compared with $28.5 million for the prior year second quarter, which represents an increase of $2.9 million or 10.2%. General and administrative expenses increased $211,000 to $6.3 million after adjusting for, non-cash mark-to-market net gains and losses, one-time $9.3 million expense for the litigation settlement net of insurance recoveries into June 2013 bankruptcy cases relating to discontinued subsidiaries, discontinued subsidiaries legal fees and other costs and FAS 123R non-cash stock compensation. The increase in general and administrative expenses was primarily due to growth and increased business activities and professional fees. Sales and marketing expenses increased $795,000 to $2.6 million, primarily due to an increase in staff to support our growth initiatives, increased commissions and increased advertising expenses. Adjusted operating income for the fiscal 2016 second quarter was $21.9 million compared to the prior year second quarter of $20 million, which represents an increase of $1.9 million or 9.6%. Adjusted EBITDA for the second quarter was $22.7 million compared with $20.6 million for the prior year second quarter, which represents an increase of $2.1 million or 9.9%. Depreciation and amortization expense was $740,000 for the second quarter. For the trailing 12 months ended September 30, 2015, adjusted EBITDA was $77.4 million. Interest expense was $2.6 million for the second quarter compared with $3.3 million for the prior year second quarter. We entered into a new credit facility on June 3, 2015, which resulted in a decrease in interest expense, due to lower interest rates and lower average outstanding balances on our loans. This was partially offset by higher balance of receivables discounted during the three months ended September 30, 2015, compared with the three months ended September 30, 2014. Income tax benefit was approximately 39% for the three months ended September 30, 2015. Adjusted net income for the second quarter increased $1.6 million or 15.9% to $11.8 million or $0.62 per diluted share compared with $10.2 million or $0.60 per diluted share a year ago. Earnings per share reflects a 12.6% increase in the weighted average number of diluted shares outstanding due to public offering of 2,760,000 shares of common stock in September 2014. I would now like to highlight the results for the six months ended September 30, 2015. On an adjusted basis, net sales increased $43.6 million or 30.1% to $188.4 million from $144.8 million for the prior six month period. Net income adjusted, for the items previously noted and summarized in the financial table exhibits of this morning's earnings press release, was $20.1 million or $1.07 per share compared with $14.9 million or $0.90 per share a year earlier, which represents a $5.3 million or 35.3% increase. Adjusted EBITDA was $40.4 million for the six months ended September 30, 2015, compared with $32.4 million a year earlier, which represents an increase of $8 million or 24.6%. At September 30, 2015, we had a $25 million term loan, borrowings of $15 million under revolving credit facility and approximately $31.7 million in cash, resulting a net bank debt of approximately $8.3 million. There was availability of approximately $82.6 million on the $100 million revolving credit facility, after reflecting approximately $2.4 million of outstanding letters of credit. Total cash and availability on the revolver credit facility was approximately $114 million at September 30, 2015. In June, we entered into a new $125 million credit facility with PNC Bank consisting of $100 million revolver and $25 million term loan. Loans outstanding under the new credit facility bear interest at the company's option, at the domestic rate or at the LIBOR rate plus, in each case, an applicable per annum margin. The current applicable LIBOR interest rate for both the revolver and the term loan is 2.95%, consisting of LIBOR of 0.2% plus a margin of 2.75%. At September 30, 2015, the company had approximately $396 million in total assets, current assets were $133 million and current liabilities were $137 million. Cash flows provided by operations during the six months ended September 30, 2015, were approximately $19.2 million. For the reconciliation of non-GAAP financial measures, please refer to the Exhibits 1 through 7 in this morning's earnings press release. I will now turn the call back to Selwyn.

Thanks, David. As you can tell, we remain extremely excited by the multi-product growth in our business and we look forward to continued success ahead. We continue to focus on gaining market share in our existing product lines as well as actively working to introduce new product lines. We remain dedicated to manage growth and to continue to focus on enhancements to our infrastructure and making investments in resources to support our customers. Our financial position is strong and our capacity for further growth is excellent and very scalable. Business continues to be good and we expect the momentum to continue. We reiterate our target fiscal 2016 sales guidance of approximately $380 million in adjusted sales. I want to thank all our team members for their commitment and customer-centric focus and service, and for their exceptional pride in all the products we sell and the customer services we provide. Our ongoing success and accomplishments are due to this incredible team. We appreciate your interest in Motorcar Parts of America, and now we'll welcome any questions you may have.

[Operator Instructions] Our first question comes from Steve Dyer with Craig-Hallum.

Selwyn, $380 million implies for the year -- obviously, doesn't flow-through even this quarter, it implies a pretty big fall off in the next two. And I'm missing a reason why that would be the case or are you just kind of trying to be conservative?

We're always trying to be conservative. I mean, the momentum in the business is strong right now. The momentum in the industry is strong, but again, we just try not to get ahead of our SKUs and that was our initial public target guidance. And again, business is strong, but we're going to stick to it.

Would you anticipate that's kind of the year to follow certain normal seasonality, in other words December is typically up a bit from September? And then depending on the winter weather than March, it tends to be up a bit even from that? Is there any reason why that would be the case?

Yes, normally December is a little lower, Steve. The third quarter is generally a little lower for us, and then the March quarter is very strong for us. And we expect the same thing to happen. So I think, again, all of our fundamentals are very strong. I am ecstatic about our momentum going into next year. I think that's going to be very strong. We have new products, I think I have mentioned before, that should be released in July. So again, we're being conservative, but there is no hidden fear here.

The adjustments for the new business this quarter, I'm just wondering, if you could let us know maybe what category or categories those are in, is that existing customers, new SKUs, or maybe a little bit more color around that?

Yes, so two main categories, both rotating electrical and master cylinders, really the two big ones at this quarter. New customers --well, on the rotating electrical, the expansion of existing customer share. So we're excited about that. We think that's going to be a real successful program. And on the master cylinders, the launch of the reman to an existing customer, which is a pretty nice chunk of business for us as well. So just got back from the show, the main APEC show and I think the fundamentals of an interest in all of our product lines was very strong.

And then, David, real quickly question on the core inventory. I notice long-term deposit is down significantly year-over-year. There is barely a balance there. Can you explain that a little bit, please?

Yes. The question, we're going to be filing our 10-Q later today and there will be more disclosure. Well, what happened was during the September 30, 2015 quarter, we completed a buyback program from a customer and as a result that balance that was there previously at March 31, 2015 about $26 million was reclassed to long-term core inventory.

I wondered if that was --

Yes, it was a reclass.

Our next question comes from Matt Koranda with ROTH Capital Partners.

Did I here you say, Selwyn, that you plan on launching new products, as in plural, in July? Are there multiple coming or just one?

Well, there will be multiple SKUs, over 3,000 of them, but one product line. So if I did say plural, I meant certainly at least one product line will come out.

And then in terms of the launch of brake master cylinder re-manufacturing, can you just give us an idea of the potential uplift on an annualized basis to revenues in that category?

Well, I think we've just launched it at the show, so we did land -- again, we had our one customer that we launched it with. I mean that's probably $10 million to $11 million opportunity there, but it's not so much how much reman brings, it's what reman adds to being able to have a full line. And so our target revenue for this category is over $50 million near-term target and we expect to reach that.

And then APECs, I know you mentioned, some good conversations coming out of the show last week, but could you talk maybe specifically about some of the discussions that you were having around the potential to add new product categories with customers, maybe beyond the new product line you have in July

Yes, I would say that we have one that, again, that's already signed up and that we're working on. And we have a number in the pipeline to launch, so we're active. I mean, I think that just generally coming out of the show, there is a sense of real optimism about our industry and real optimism of about the longevity of it with the growth in the vehicle population in total. And in particular, as cars are not coming off the road, they're coming on to the road very fast. I mean, our SARs are up pretty dramatically, but the cars are not being retired, so the fundamentals of the industry is strong. And I think the key categories, Matt, that we'll continue to focus on that we think a great add-ons to what we're doing right now. And there maybe even other categories that could stimulate growth even further. So I don't want to get ahead of myself, but I mean we here are very optimistic about where we're going. We see a lot of opportunity in new product development. Having said that, I would just say to be cautious. We're cautious. But we think there is a lot of growth for us right in this marketplace.

One more from me here, if I may. In terms of gross margin, I know there are a lot of puts and takes, you guys have lower copper and aluminum pricing that does negatively impact gross margins in the short-term, but you also have a devaluating peso that kind of benefits you on the manufacturing base there. Could you just talk about the puts and takes there for rotating electrical? And then also as you layer in more distribution business, what are the implications for gross margins? Maybe the second half of this year is just to make it -- keep the scope there here?

Right, I think, that's a great question. There are so many variables that are coming out. So there's always pricing pressure in our industry. We've got used to living with that. I think we're able to manage through that. We do have negative metal pricing. Metal pricing is hurting our margin significantly, because our scrap, the contribution from scrap revenue has diminished dramatically. Having said that, as of today, there is no fundamental changes really in our margins. By product line, our mix has changed. So I don't expect much change for the next six months in reported margins. They're right on track with on the high end of where we thought that'd be, we expect that to continue. There is no fundamental erosion. Between the pluses and all the minuses, I think we're sort of running on the spot on gross margins right now, without seeing much erosion at owned -- any erosion. But we have to play it out, I mean as we grow depending on which product lines grow and the mix changes that may affect our outcome. Some of the growth left in rotating electrical is some lower margin business, that our fundamental of existing margin shouldn't be affected by that, but incremental margin maybe a little bit lower in the rotating electrical, because we dominate the import section. The domestic applications have lower margins, mostly because the vehicles are much older and people can't really rationalize spending money on an old, old alternator on old starter, so you do have some less leaders in that area. But again, I think the optimistic view point is there is so many new vehicles that are coming on to the road that are going to be aging out and the average price points and the margins on those and the sophistication of those products is much better. So again, we think margin should be stable. I mean that's a long story for a short conclusion, but I do think we will hold up there margins in all of our product lines.

And next question comes from Jimmy Baker with B. Riley.

So you mentioned that you won, I think, a new customer for reman brake master cylinders in the quarter. I guess, just to be clear, was this an existing rotating electric customer? And can you say if it's one of the big three retailers without specifying which one?

Well, yes, it is one of the big three, and it is an -- I mean we have all of the retailers, so it is an existing customer in rotating electrical.

And I just wanted to expand on the $10 million charge for customer inventory purchases, I know in the September quarter of last year, you had a similar kind of extraordinary charge to buy competitive branded inventory of your customer shelves. Is that what happened again here that you lifted branded inventory? And did you also write this acquired inventory down to virtually zero?

So two different things in this scenario, in one case, we bought back branded inventory. In the rotating electrical, we bought back other branded inventory. And the other portion was a buyback of cores relating to the launch of the reman master cylinder program. We had to buy the cores on the customer shelf. Is that right, David?

Yes, that is correct.

So a little bit of a hybrid here, completely different categories, different situations. I mean the negative of our reporting is, is that as we grow and we expect these growth rates to continue, we do have to invest capital and taking out other people's inventory over the shelf. And when we do that, we do generally, Jimmy, we do write it off, I mean, to the extent that we think there is no value left enough, we get rid of it and we take a one-time hit. And to extend, we can liquidate, and that's great, but that's the noise in our numbers unfortunately. I mean, the good news is that that we're seeing so much opportunity in the return on invested capital. Generally, we're targeting north of 35% on ROIC. So while, this is hitting the P&L, we have a lot of liquidity to deploy right now. And to the extent we can get a return on that capital, at a cost of capital below 3%, if we can generate 30%-plus of total invested capital, we're all in. And less focused on the margin than the stability of the category and the cash flow that's generating, we have really strong six months of cash flow from operations and we think that will continue.

So just to break that down, again, are you able to utilize the reman core is on the -- or I should say, the core is on the brake master cylinder side of the business for remanning purposes. And then could you also utilize the core is inside of the branded rotating electrical product that you repurchased?

So all the cores that's still in the second, first is the product that we bought on the rotating electrical side, hopefully we could use this cores. Yes, we would remanufacture those. The product that we bought on the master cylinders is on the customer shelf. So we own it. If we ever lose that business, then we'd get that money back. So again, a little bit of a different situation on the master cylinders. And that's similar to sort of to our arrangement on rotating electrical cores owned on the customer shelf. So rotating electrical business we bought back that would come in, we would run it through our core sorting and we'd recover as cores.

And then, are you able to share, let's say, the approximate annual revenue and length of the two supply agreements you were awarded in conjunction with those purchases.

Not specifically, but I mean both of them are long-term agreements, three-to-five year agreements, and again, the return on capitals is annualized around 35%. But without getting too granular, our customers are not particularly excited about us. People can figure out who we got, and they're not too excited about us disclosing what kind of revenues they do by category.

So I mean you've pretty well alluded to this I think, but I mean, just without that disclosure it seems difficult, at least for us on our end to determine the ROI, or even I guess the true profitability of the business you're winning now once you exclude this initial cost of winning the business. So I guess, how do you think about that in terms of either a hurdle rate or how you account for the ongoing cost of winning business, as you continue to grow?

Can you repeat that, I missed that a little bit? Can you repeat that question, Jimmy, sorry? I missed the point, sorry.

So the question is just without the disclosure of sort of what you're winning from purchasing this competitive inventory or cores back, it's difficult to determine the ROI, or even if you think about it what you won in the past, its difficult for us to determine the profitability of that business today, because that cost of winning the business was excluded. So I guess, how do you think about that in terms of either accounting for the cost of winning the business or how you think about the hurdle rate when you're going in and bidding for this competitive inventory and the resulting new business as you continue to grow?

So I mean, again, we look at a threshold 35% return on invested capital. I mean we would also look at the strategic benefits of taking this category and where it lands up on the next category, but in general, if you look at our gross margins at 30.5% of what we reported and look at a $10 million capital outlay, I mean hopefully, we'd be producing close to $3.5 million, if it's a 35% return on that on an annualized basis. So it fluctuates, and it varies, because there's certain investments that you would make that may not be as lucrative, but they lead to getting another chunk of business in conjunction with it, that makes it more lucrative. And so again, in aggregate I would just say, on average, I would use our gross margins and use our adjusted number and our target rate of 35%, and generally that would be what we try to make on the new business. So that's more or less. And does that make any sense, I don't know?

That does makes sense, its helpful color. And just lastly, if I can sneak in a question just here on the capital structure going forward. I guess, how comfortable are you with not only where you're at today, but an increased level of leverage to finance some larger M&A, and I guess just how are you thinking about the M&A environment here?

Well, I think the M&A environment could be good. I think there is some euphoria in the market place, so multiples have gone up a little bit, but we're going to be very disciplined. We're looking for companies that are profitable. We are actively in the market looking at acquisitions. We do have an acquisitions group. We have almost no leverage today, and so we have plenty of capability of deploying leverage capital very safely, into the high return businesses. So we're actively, we're out there. We are not going to over leverage the company, but certainly 3x to 3.5x leverage ratio for us on $77 million to $80 million of EBITDA is not something we would be comfortable going to, so plenty of dry powder for some smaller acquisitions and certainly growing in some more dry powder for bigger ones.

Our next question comes from Les Sulewski with Sidoti.

David, just quickly on the accounting side. So you took the $9.3 million charge this quarter for the legal expense. Are we expecting further the kind of $1 million run rate from the discontinued subsidiaries legal costs that wean-off from now on?

Yes, we do expect that line item. Discontinued subsidiaries legal cost to start reducing, yes.

Selwyn, I guess, one other thing for AutoZone we've been hearing, they're running a number of tests and looking at inventory management changes. Any kind of color on that, how do you look at that impacting MPA?

Generally, we don't comment on individual customer's initiatives, but I mean everything AutoZone is doing we think is great at this point. So I think they are making the right moves. They've announced it publicly, so I think its okay for us to talk about it. But certainly, we think the more they do to grow their business, the better it is for us and the same for all of our customers. But no negatives there from us.

Our next question comes from Chris Brown with Aristides Capital.

I had a question for you on the return on invested capital. I want to make sure I understand this correctly. So when you make a $10 million outweigh to get new business or to expand your business, if I have a four-year contract and I am outlaying $10 million in year one to get a 35% return of invested capital, I need to make roughly about $8.3 million a year over the next four years. Is that what we're talking about?

No. We're looking at cash-on-cash pre-tax return on invested capital. So the $10 million investment on an annualized basis would be $3.5 million a year.

Do you get your $10 million back at the end of year fourth?

No. In some cases we do, in some we don't. I mean, so we factor that in. So we would look at a net present value. So hopefully we never lose the customer. I mean, we are not used to losing customers, we generally keep our customers. But in the event that we lost the customer after a contract and it was core buyback that set on the customer shelves, we would get all of our capital back, yes. So under that scenario it would be more significant.

So if you're outlaying $10 million, then you're getting $3.5 million per year for the next four years. And kind of the worse case scenario is you lose that customer at the end of year four, and then you get your $10 million back. Is that correct?

In the case of a reman product that we buy in the course of the customer shelves. And in cases where we buyback finished goods inventory or inventory that can't be used anymore, then we would expense it upfront and that would be -- we wouldn't be able to -- you lose the contract, you are unable to recover that. The different ways you pick up business.

So of the $10 million that you spent this quarter, how much of that would be the first store, where you could get it back at the end of a contract and how much of that falls into the second bucket, where potentially that would be at risk just to have inventory that you put [multiple speakers]?

I mean, just in general, it's hard to get too granular, but the $6 million of the $10 million we would never recover and the $4 million we recover.

And I'm not showing any further question at this time. I'd like to turn the call back over to our host. End of Q&A

Well, thank you everybody for your continued support and thank you again for joining us on the call. We look forward to our future and to speaking with you when we host our fiscal 2016 third quarter call in February 2016, and we expect to be speaking at various conferences in the interim. So thank you very much. Appreciate your time.