Motorcar Parts of America, Inc. (MPAA) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Motorcar Parts of America Fiscal 2020 Second Quarter Results. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I will now like to introduce your host for today, Gary Maier, Investor Relations. You may begin.

Thank you, Tanya. Thanks, everyone, for joining us for the call today. Before I begin, 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 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. And actual results may differ from those projected in these forward-looking statements. These 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 these ongoing risks and uncertainties of the company's business, please refer to the various filings with the Securities and Exchange Commission. I'd like now to turn the call over to Selwyn Joffe to begin.

Alright, thank you, Gary. I appreciate everyone joining us today. Before I begin, I'd like to recognize and thank the great MPAA team members for their ongoing commitment and excellence to servicing our customers and shareholders with outstanding performance. It is a pleasure to receive the ongoing positive feedback from our customer base, reconfirmed at the recent AAPEX Trade Show last week and to see how the extraordinary efforts of the team are resulting in positive returns. Thank you. Okay. We're excited about the results for the quarter, which highlights the benefits from the progress of our strategic initiatives. We believe that our initiatives once complete will results in even further upside enhancing our scalability in our financial performance. Let me update you on the progress of the initiatives that are outlined on last quarter’s conference call to improve profitability. The first thing I discussed was that we would increase the absorption that has resulted from our newly extended capacity. We have made significant inroads on this initiative. We have increased the absorption of overhead that has resulted from our newly expanded distribution center by relocating and growing our hard parts business, including the launch of our new brake caliper line. Brake calipers began shipping in the middle of the second quarter and we have continued growth in our existing business. As an aside, we have visibility for additional new business that will result in substantial increased sales to further absorb this overhead. The second initiative I discussed were the relocation of operations from high cost to lower cost locations, leveraging our capacity in Mexico and Malaysia. We have substantially completed our transition into our new consolidated distribution facility in Mexico. There are still two remaining facilities in Mexico which are at various stages of completion. We expect one to begin incremental operations in our 2020 fiscal fourth quarter and the other by the end of the second quarter of fiscal 2021. With respect to Malaysia, our facility expansion has been substantially completed. This'll allow us to increase capacity and productivity for our existing product lines. Finally, we implemented price increases which became effective in the latter half of the second quarter. As we enter the second half of fiscal 2020 we are well positioned to benefit from our investments for continued growth. Our global footprint is nearing completion to support expansion across multiple non-discretionary off the market hard parts, further solidifying our position as a valued premier supplier in North America. Let me now discuss that diagnostic and testing business which is emerging and gaining traction, while, our OEM alternator and starter production testers have long been in the industry standard, our new aftermarket benchtop tester is heading in the same direction. Our outlook for the benchtop tester is exciting and rapidly evolving. We expect significant revenue generation opportunities over the next few years. The diagnostics market for automotive electric vehicles and the electrification of the aerospace market is also quickly evolving. We have received purchase orders from a number of highly respected global companies in both the automotive and aerospace industries. In addition, our strategic partnerships within the space of fast evolving, we recently announced a strategic relationship with OPAL-RT this has enhanced the scope of our services relative to developing the electric powertrain for electric vehicles that will leverage the D&V’s expertise in advanced high-powered automotive testing. D&V power amplifiers and emulators will be available with OPAL-RT’s real time simulation, offering customers greatly increased accuracy in test capabilities. , : Overall, the company has become a major multi-product supplier to the North American aftermarket – automotive aftermarket and a leader in all of its product categories. We are also fast expanding our presence in electric vehicle diagnostics with our cutting edge offerings. All of those represent significant value creation opportunities. In short, we are now well positioned for sustainable growth, enhanced profitability and positive cash flow from operations which we expect in the second half of this year. We look forward to sharing news about our milestones through the fiscal year. We remain encouraged by the outlook for our current and expanding product lines and the benefits from our strategic investments to support our current and future growth. Let me reiterate what we expect for fiscal 2020 based on the timing and completion of various initiatives and the ramp up of our new caliper business, continued year-over-year sales increases, high adjusted gross margins and operating income and last but certainly not least positive cash flow from operations in the second half of this fiscal year. We are maintaining our adjusted net sales guidance for fiscal year 2020 for now and the amounts that to be between $552 million and $562 million representing between 16% and 18% growth year-over-year. Adjusted gross margin for the fiscal year 2020 is expected to be approximately 27% impacted by product mix. As we discussed profitability and operating cash flow are expected to improve on a year-over-year basis. To highlight overall positive outlook, I refer you to an investor presentation on our website, which shows macro industry charts including a chart related to the expansion of the car park sweet spot for repairs. We are now seeing the backend of lower new cost sales from recession years in the prime parts replacement timeframe. Essentially, the number of prime placement age vehicles is growing. These statistics further support our company’s and our industries optimism for growth over the next several years. I will now turn the call over to David to review the results for the fiscal second quarter.

Thank you, Selwyn. To begin, I encourage everyone to read the 8-K filed this morning with respect to our September 30, 2019 earnings press release. For more detailed explanations of the results including reconciliation of GAAP to non-GAAP financial measures in the 10 Q. Let me take a moment to review the financial highlights for the fiscal 2020 second quarter reflecting record sales for the quarter and six months on a reported and adjusted basis. Net sales for the fiscal 2020 second quarter increased 17.5% to $150.4 million from $127.9 million for the same period a year earlier, reflecting sales increases for both the hard parts and diagnostic products. Tariff cost pass-through contributed approximately 3.6% of the sales growth for the second quarter. Adjusted net sales for the fiscal year 2020 second quarter increased 16.4% to $151.4 million from $130.2 million a year earlier. Gross profit for the fiscal 2020 second quarter was $36.6 million compared with $25.7 million a year earlier. Gross profit as a percentage of net sales for the fiscal 2020 second quarter was 24.3% compared with a $20.1% a year earlier. Adjusted gross profit for the fiscal 2020 second quarter was $42.9 million compared with $36 million a year ago. Adjusted gross profit as a percentage of adjusted net sales for the three months was 28.3% compared with 27.6% a year earlier. The results for the quarter end gross margin were primarily impacted by two items totaling $6.3 million. First, noncash expenses of $4 million including a write-down of a $2.9 million associated with the quarterly revaluation for cores on customers' shelves and $1.1 million of amortization related to the premium for core buy backs. It is important to recognize that even though the core value for cores and customer's shelves may be written down on our balance sheet, we are entitled to a full contractual price refund in the event that the relationship with our customer is terminated. Second transition costs of 2.3 million associated with the move into the new facilities in Mexico support the company's anticipated growth. Total operating expenses increased by $6.6 million to $21.9 million for the second quarter from $15.3 million for the prior year. This increase was impacted by a noncash $663,000 loss for the quarter compared with a noncash gain of $1.9 million for the prior year recorded due to the change in the fair value of the forward foreign currency exchange contract. A noncash loss of $1.1 million due to the re-measurement of foreign currency denominated lease liabilities and $1.5 million of operating expenses attributable to our fiscal 2019 acquisitions. Adjusted operating expenses increased by $4.1 million to $19 million for the second quarter from $14.9 million for the prior year. This increase in adjusted operating expenses was due in part to $1.6 million expenses attributable to our fiscal 2019 acquisitions, $489,000 expenses in connection with our internal control remediation efforts and approximately $367,000 of increased depreciation and amortization. Additionally, approximately $400,000 is related to increases in both personnel and infrastructure expenditures to accommodate our anticipated growth. Operating income was $14.7 million for the fiscal 2020 second quarter compared with operating of $10.4 million for the prior year second quarter. Our adjusted operating income was $23.9 million for the second quarter compared with $21.1 million for the prior year. Adjusted EBITDA was $26 million for the second quarter compared with $22.5 million for the period a year ago. Depreciation and amortization expense was $2.2 million for the second quarter. Interest expense was $6.5 million for the second quarter compared with $5.7 million last year. The increase in interest expense was due primarily to increased average outstanding borrowings to support our growth initiatives. Income tax assessed for the second quarter was $2 million compared with income tax expense of $1.2 million for the prior year period. Net income for the fiscal 2020 second quarter was $6.2 million or $0.32 per diluted share, compared with net income of $3.5 million or $0.18 per diluted share a year ago. Adjusted net income for the fiscal 2020 second quarter was $13 million or $0.68 per diluted share compared with $11.5 million or $0.60 per diluted share by a year earlier. Let me now discuss the results for the six months ended September 30, 2019. Net sales for the fiscal 2020 six months period, increased 18.2% to $259.5 million compared with net sales of $219.6 million for the prior year six months. Adjusted net sales for the six months increased 16.1% to $260 million compared with $224 million for last year. Gross profits for the fiscal 2020 six months period was $54.2 million compared with $42.1 million a year earlier. Gross profit as a percentage of net sales for the fiscal year 2020 first half was 20.9% compared with 19.2% a year earlier. Adjusted gross profit for the fiscal 2020 six month period was $69.1 million compared with $58.9 million a year ago. Adjusted gross profit as a percent of adjusted net sales for the six months was 26.6% compared with 26.3% a year earlier. Net income for the six months period was $38,000 or zero cents per share compared with net loss of $2 million or $0.10 cents per share a year ago. Adjusted net income for the six months was $14.7 million compared with $14.6 million for the prior year six months. And adjusted diluted earnings per share were at $0.76 compared with $0.75 per diluted share last year. Adjusted EBITDA was at $36.7 million for the six month period compared with $32.8 million a year earlier. As of September 30, 2019, trailing 12 months adjusted EBITDA was $77.8 million and the average equity and net debt balance was $407 million resulting in a 19.1% return on invested capital on a pretax basis. Our method of calculating ROIC is divide trailing 12 months adjusted EBITDA by the average equity and net debt balance for the 12 month period. I should point out that we have just begun to realize the benefits of expanding our Mexico operations and the launch of our new brake categories with the expectation of significant revenue growth from both new and existing product lines. As of September 30, 2019, we have net bank debt of approximately $163.5 million. Total cash availability on the revolver credit facility was approximately $80.5 million at September 30, 2019 based on a total of $239 million revolver credit facility as subject to certain limitations. At September 30, 2019 the company had approximately $713 million in total assets. Current assets were $376 million and current liabilities were $304 million, this reflects the adoption of the new lease accounting pronouncement, which requires balance sheet recognition of a lease asset and a lease liability for all leases. We are particularly pleased with the reduction in inventory during the second quarter reflecting the progress we are making in our transition to Mexico. Net cash used in operating activities during this fiscal 2020 – fiscal year 2020 second quarter was $8.4 million, primarily due to a $25.2 million increase in accounts receivable, reflecting record sales for the second quarter, partially offset by a reduction of inventory of $8.2 million and net income of $6.2 million. We expect to generate positive cash flows from operating activities in the second half of the fiscal year. Contributing to this, there will be reduction in payment for core buybacks from our existing business, which will help generate stronger operating cash flow. For the reconciliation of non-GAAP financial measures, please refer to exhibits one through seven in this morning's earnings press release. I will now open the call for questions, and Selwyn will then provide some closing remarks.

[Operator Instructions] Our first question comes from the line of Justin Clare with ROTH Capitals. Your line is open.

Hi everyone. Thanks for taking my questions.

Hi, Justin.

So I guess just first off in terms of your fiscal 2020 revenue guidance, it seems like the guidance implies revenues for Q3 and Q4 that could be kind of in line with Q2 around $150 million, just want to see, this is how we should be thinking about it or if there's some potential upside here, because I know, you have been ramping up new business.

Hey, Justin, we don't want to get ahead of our SKUs, Justin that's a good question. But we're very comfortable with sustaining our 16% plus growth rate in the third quarter and then we should see exponentially additional growth in the fourth quarter. We've got a lot of large initiatives that we probably need to be shipped in the fourth quarter as opposed to the third quarter, but I don't want to get ahead of our SKUs right now, but we're very comfortable with that guidance.

Okay, great. And then I know you've been rolling out price increases, just wanted to see where you are in that process. I think you were starting price increases kind of midway through Q2 so should we see those increases reflected fully in Q3?

Yes, yes.

Okay, great. And then in terms of your capacity utilization, you're adding a significant amount of capacity here in Mexico and Malaysia. Can you speak to how you are seeing utilization trending ahead? Is this something that we'll continue to improve this year and into next year? And then if you could speak to how that could benefit your profitability in both?

Yes, so as we were – I think I had just in summary, I'll sort of go through it again, the distribution centers up and running. We certainly feel that we can get to operating, I wouldn't say capacity, but our real operating efficiencies in terms of overhead absorption now in the next – in the next six months and we were actually operating quite well already out of it now. There's two new buildings. Malaysia is completed, so there'll be incremental capacity there, that capacity, again will scale almost the manufacturing guys would always disagree with me, but we'll scale very quickly. I mean it's, we have a lot of SKUs, so it's always challenging to scale and speed that I would like us to scale, but that'll be imminent as well. And then when I say imminent within the six month period, next six months. And now last but not least is the New Mexico facilities and production facilities, and as of now we have demand, to take up all our capacity as we scale it. It'll not be fully absorbed for some times, so it’s hard to describe but this new footprint, basically the way we operate is not that we have a whole bunch of extra space, we utilize all the space in the buildings based on lean manufacturing principles. And so – as we have more demand for our product, we can utilize those buildings more efficiently by adding employees into the lean manufacturing model. We expect that, as fast as we can ramp, we should have business to absorb capacity, I mean, that's a long-winded answer because there's no short, real simple answer to that. But we should see, I do think there's some work to be done, so I don't want anyone, everyone to get ahead of themselves but we do have some work to be done still in Mexico. They're very big initiatives, but there's very big demand behind those initiatives. And again, I'll reiterate, we've got a fabulous operating team and I think they're going to do a great job and the pain should be fairly small.

Okay, great. Thanks for the detail. I'll pass it on.

Thank you. Our next question comes from the line of Chris Van Horn with B. Riley FBR. Your line is open.

Good morning everyone. Thanks, for taking my call.

Hi Chris, how you are doing?

Good. So when I look at your guidance of 27% on the gross margin line, it seems to be roughly flattish with what you were able to do last year. And I'm just curious on puts and takes on that number.

Yes, there's a lot of ramp up cost in that, there's a lot of new product costs in that. Again there is still some inefficiencies in the gross margins, so again – once these things settles and the complete transition is done, there should be an uptick in a few points out of that. But again, we're being, I think we're being realistic cautious right now, but there's definitely upside as we go further down, I mean obviously competitive issues are things we're going to have to keep monitoring and the tariff situations, but just as a matter – as a side product, Chris, maybe I'll just go into that for a second. I believe that that the expansion of Malaysia and Mexican operations are going to further allow us to have more flexibility around the import tariffs. So there may be some headwinds in terms of getting in and out of those Chinese product lines, but again, I don't want to get ahead of us, but I think that as time goes on you will see margin improvement, because the efficiency of the new footprint is expected to be a very positive for us.

Okay. Makes sense. And then on the revenue growth, it seems like even at the midpoint, you're going to return to this kind of mid-double digit teen range here, and I was just curious, could you break out what – is there anything that's overly contributing, I imagine its market share gains, it's new product introductions, maybe there's a little bit of a price component, but is there anything that really stands out that's going to drive that?

No, I think the great news about everything is that everything is performing right now. We think hard parts in general is – I mean obviously we’ve got a new product line, we think that next year that should break out more, but for this year it's our existing product lines of diagnostics, just across the board we're seeing some just fundamental base increases. And we are all benefiting a little bit from, as David mentioned, I think 3.5% from the tariff, tariff pass-through’s but which by the way that's a headwind on gross margins as well. So it's a pick-up in revenue, but that it's a pass through. So our gross margin percentage is anomaly affected by that. But now it's across the board, I think we hope, and we remain optimistic about seeing growth in all of our categories. And we certainly expect to see – right now we've got headwinds in our diagnostic business in terms of profitability, so we hope to see that turn in the fourth quarter as well. We’ve got a lot of great orders that are coming in and we expect to ship them in the March quarter. So by then we should have that – again, that'll further add to margins for next year.

Okay. Okay. Thanks for the color there. Then last for me, I think you can mention to us on the heavy-duty truck side, I know you're kind of still transitioning there, but anything that you're seeing from a demand perspective and maybe from a market share perspective there?

Well, I think that's another great question. I think the heavy-duty integration is a tough one, I mean it's not a business that even though it's rotating electrical, it's not a business that we were previously in. We have a good team up in Toronto. I think we now announced at the trade show that our customers can order seamlessly heavy-duty product and light-duty products out of our new distribution warehouse in Mexico. And I think that's going to help the heavy-duty initiative for our existing channels significantly. And we are ramping up infrastructure and systems, and all around making a big push for the actual heavy-duty category and channel. And I'm optimistic that we can pull it off, but it's still some work to be done there. But short term, I think we're going to see gains just because having the product, which can be consolidated into existing orders, out of our existing distribution warehouse will help our customers make the decision to buy their heavy-duty needs from us.

Okay. Got it. Thanks again for the time and congrats on the quarter.

Thank you very much. I appreciate all your support.

Thank you. Our next question comes from the line of Steve Dyer with Craig-Hallum. Your line is open.

Hey guys, Ryan Sigdahl on for Steve. Congrats on the nice quarter.

Thank you. Hey, how are you?

So just coming at gross margin guidance, I guess from another angle, but it implies that it will take a step down from Q2 here in the second half, despite overwhelmingly positive commentary. It seems like that, you'll see improving overhead absorption, efficiencies as you see facilities ramp, et cetera. So I guess what's the offset there to keep that’s going to constrain margins in the back half relative to the number you just put up here in Q2.

There's a lot of, a lot of update orders that go out in the fourth quarter, so you get some returns before you get update orders. And so we are just a little sensitive to – to the really, it's all about timing of the third and fourth and then you see a bigger jump in the fourth, I don't think they're going to decline that significantly in the third. But overall again, we're optimistic on gross margins, we don't want to get ahead of ourselves, but on a combined basis, we're comfortable, we should be at our guidance level at least and going into the next year. We should see once we get these facilities operating, we're expecting gross margin increases. Now again both depends on product mix and who knows what competitive force is out there, but, we have a pretty good insight into this.

Okay. And then one more on guidance on revenue, so similar revenue growth in Q3, 16% implies something like a $12 million sequential decline in revenue. Any way you can bridge it? I guess, was there any pull forward of shipments or anything into Q2, Q3?

Yes, so that's a good point. I think it's the same answer to the last question is when you, pre the update orders, you've got stuck we accrued for stock adjustment six months in advance. Anything we anticipate in six months, it's one of our fundamental policies. So the accruals against revenue for potential returns before the big stock adjustments, the big stock updates go out in the fourth quarter, they're still not 100% known, but we know that, there will be some. And so the accruals, we anticipate to go up but we also – again, we have more than significant offsetting revenues that come in the following order from that. So tough to break it down between two quarters, because of the amount of volume that's gone out, but that's really it – it's all timing really between quarters, third and fourth.

And then maybe just one quick point of clarification on the stock adjustments, are you saying that you're changing, because I presume that on a percent of sales on historically what you've seen. So are you increasing that accrual or is it just going up with as sales increase?

No, no, what happens is while there's an allowance to the customers for a certain amount, we don't have an accrual – we don't have a flat accrual policy. We accrue based on expectation. And so if we expect a certain amount of adjustments and we'll accrue that amount. And so the stock adjustments are not an even flat percent quarter-by-quarter. They are basically an accrual based on identified stock adjustments. So again, so that'll have to play out, we don't know that exact number yet until the quarter is over.

Got it. One for me, then I'll turn it over. AR was up, accounts receivable was up $25 million quarter-over-quarter, what caused that and do you expect that to normalize here in the second half? Thanks and good luck.

Thank you. This is David. So this has to do with the record sales that we had. We did have a lot of sales in the month of September, so that will all turn into cash in the subsequent third quarter.

Great. That's it for me.

Thank you.

Thank you. [Operator Instructions] I am not showing any further questions. I would now like to turn the call over to Selwyn Joffe for closing remarks.

Thank you. In summary, our investments are now starting to bear fruit. We've had many, we have many and had many growth opportunities and we have many growth opportunities ahead of us. And new business commitments are continuing supported by these expanding product lines – expanding line of products in both hard parts and diagnostics. We are proud of our more than 50 year history in the aftermarket industry and we are really committed to our vision of being the global leader for parts and solutions that move our world today and tomorrow. Again I want to thank all our team members for the commitments and customer centric focused on service. For their exceptional pride in all the products they sell and the customer services we provide. Their commitment to quality and service is reflected in the contributions that they make to their communities and our society, which is important to us. They are terrific and I'm proud to work with them. We appreciate your continued support and we thank you again for joining us for the call and we look forward to speaking with you when we host our fiscal 2020 third quarter conference call in February and at various conferences that we may attend. Thank you.

Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect. Everyone have a wonderful day.