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Motorcar Parts of America Inc (MPAA) Q1 2020 Earnings Call Transcript

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Motorcar Parts of America Inc (NASDAQ: MPAA)
Q1 2020 Earnings Call
Aug 8, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, and welcome to the Motorcar Parts of America Fiscal 2020 First Quarter Results Conference Call.

[Operator Instructions]

I will now like to introduce your host for today's call, Gary Maier. You may begin.

Gary Maier -- Investor Relation

Thank you, Yolanda, and 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 the ongoing risks and uncertainties of the company's business, please refer to the various filings with the Securities and Exchange Commission.

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

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Okay. Thanks, Gary. I appreciate everyone joining us today. As I stated in our fiscal year-end call, we are reaching in an exciting inflection point. Our business has grown, our product lines are expanding and our global footprint is rapidly evolving to support strategic growth. The financial results for the quarter, while disappointing on the bottom line, were in line with our expectations. We now expect to start seeing sequential improvement in margins, profits and cash flow. We are focused on the future with clear visibility for tangible value creation. While the company has grown, we have incurred front-loaded expenditures to pave the way for an exciting future. We have invested upfront in adding human and capital infrastructure to support growth and to facilitate transformational value creation.

We have strategically invested to expand our current product capacity and to launch a full-brake products offering, which will begin shipping this quarter. The market for our complete product portfolio is substantial, and we expect to gain our fair share. The footprint we have created will be extremely efficient and this along with our expanded team of professionals will allow us to continue our leading position in the industry, in particular, as a remanufacturer. Before I continue and discuss our diagnostics business, let me summarize 3 key steps we have taken and the progress we are making to increase profitability in the near term. Number one, we will increase the absorption of overhead that has resulted from our newly expanded capacity.

We have new business that starts shipping this quarter and continued growth in our existing business, along with visibility for additional new business that will result in substantial increased sales to support the incremental overhead absorption. Number two, we are making significant progress to relocate operations from high-cost locations to lower-cost locations, leveraging our expanded Mexico and Malaysia capacity. Number three, we have implemented price increases, which become effective the latter half of that second quarter. Let me reiterate, what we expect in the upcoming quarters. Firstly, a solid increase in sales substantially scaling up starting in our second quarter. Number two, higher sequentially adjusted gross margins and operating income for the second quarter and increased year-over-year adjusted gross margins and operating income for the back half of the fiscal year. And number three, positive cash flows from operations starting in the third quarter.

Let me now discuss our diagnostic and testing business. This business is emerging and gaining traction. While our OEM alternate and starter production testers have long been in the industry standards, our new aftermarket benchtop tester is fast moving in that direction. The electrodiagnostics market for automotive electrical vehicles and electrification of the aerospace market is also quickly evolving. In the short term, while we have good positive gross margins, sales are not yet adequate to absorb the related operating expenses, and hence, we are experiencing some operating losses. However, we have visibility and believe these businesses are quickly scalable and will benefit from growth in equipment sales and thereafter, software and maintenance service revenue. We expect these businesses to turn the corner in the fourth quarter of this fiscal year.

We are enthusiastic about the opportunities for our electric vehicle technology and are particularly encouraged by a recent order from NASA, announced last month, for emulation equipment to be utilized for the development of hybrid elective aircraft testing applications. As sales for combustion engine diagnostic equipment, including benchtop testers are progressing well. And service and software solutions will also provide additional opportunities as our installed base grows. Overall, the company has become a major multiproduct supplier to the North American automotive aftermarket and a leader in rotating electrical and electric vehicle diagnostics. From a company, which previously had a single focus on aftermarket remanufactured, alternators and starters, just several years ago. This represents a significant change in our value creation opportunity. The launch of a brake caliper program, which we announced earlier this week, represents an important new product category for us.

It complements our strategic focus on expanding our nondiscretionary under-the-call product line. Our brake caliper program now allows us of offer customers a complete line of braking system products. We have made investments to get to this inflection point, supported by the completion of the company's new state-of-the-art 410,000 square-foot distribution facility and great progress on our 317,000 square-foot extension of our remanufacturing capacity in Tijuana. In addition, we have added to our manufacturing capacity in Malaysia. Let me take a moment to discuss our heavy-duty business, which we acquired late in the fiscal year. Dixie Electric has a solid and growing customer base, innovative products, enhanced heavy-duty expertise and a dedicated team of professionals.

We anticipate success as it benefits from investments in the sales team expansion and enhancements to manufacturing marketing and merchandising and other synergistic opportunities since we acquired them. In short, we are now well positioned for sustainable growth, enhanced profitability and improved cash flow. And we look forward to sharing news about our milestones and our wins through the fiscal year. Fiscal 2020 guidance. We remain encouraged by the outlook for our current and expanded product lines and the benefits from our strategic investments to support our current and future growth. We will update guidance as appropriate as the fiscal year evolves. At this point, we are maintaining our adjusted net sales guidance for fiscal year 2020 ended March 31, to be between $550 million and $552 million, representing between 16% and 18% growth year-over-year, significantly ramping up in the second half of the year. Adjusted gross margin for 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. I should mention that the company has instituted much-deserved price increases across all existing product lines beginning in the latter part of this year. To highlight our overall positive outlook, I refer you to our investor presentation on our website, which shows some macro industry charts, including a chart related to the expansion of the car part, sweet spot for repairs. We are now seeing the back end of lower new product sales from recession years and the prime parts replacement time frame. Essentially, the number of prime replacement age vehicles is growing. These statistics further support our company's and industry's optimism for growth over the next several years.

And I will now turn the call over to David to review the results for the fiscal first quarter.

David Lee -- Chief Financial Officer

Thank you, Selwyn. To begin, I encourage everyone to read the 8-K filed this morning, with respect to our June 30, 2019 earnings press release for more detailed explanation of the results, including reconciliation of GAAP to non-GAAP financial measures and the 10-Q. Let me take a moment to review the financial highlights for the fiscal '20 first quarter, reflecting record sales for the first quarter on a reported and adjusted basis. The results for the quarter and gross margin were primarily impacted by 4 items totaling $8.5 million.

First, noncash expenses of $5.7 million, including a writedown of $4.6 million associated with the quarterly revaluation for cores on customer shelves, and $1.1 million of amortization related to the premium for core buybacks. It is important to recognize that even though the core value for cores and customer 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 $1.4 million associated with the move into the New Mexico facilities to support the company's anticipated growth. Third, net tariff cost of $1.1 million for products sold before cost increases were passed through to customers. And fourth, cost accrual of $426,000 related to a pending resolution of a previously canceled customer contract.

Net sales for fiscal '20 first quarter increased 19.1% to $109.1 million from $91.7 million for the same period a year earlier, reflecting sales increases of both hard parts and diagnostic products. Adjusted net sales for the fiscal '20 first quarter increased 15.7% to $108.6 million from $93.8 million a year earlier. Gross profit for the fiscal '20 first quarter was $17.6 million compared with $16.4 million a year earlier. Gross profit as a percentage of net sales for the fiscal '20 first quarter was 16.1% compared with 17.8% a year earlier. Adjusted gross profit for fiscal '20 first quarter was $26.2 million compared with $22.9 million a year ago. Adjusted gross profit as a percentage of adjusted net sales for the three months was 24.1% compared with 24.4% a year earlier, impacted by a lower overhead absorption, relative to the expanded capacity. Total operating expenses increased $1.1 million to $19.3 million for the first quarter from $18.2 million for the prior year due impart to operating expenses for the new requisitions in December 2018 and January 2019.

Adjusted operating expenses increased by $3.7 million to $17.8 million for the first quarter from $14.1 million for the prior year. This increase in adjusted operating expenses was due in part to $1.5 million expenses for newly acquired assets of E&M Power in December 2018 and Dixie Electronics in January 2019 and $1.6 million in professional fees. The balance of approximately $600,000 is related to increases in both personnel and infrastructure expenditures to accommodate our anticipated growth. As mentioned previously, due primarily to the several items impacting gross margin that I discussed, operating loss was $1.7 million for the fiscal '20 first quarter compared with the operating loss of $1.9 million for the prior year first quarter. Adjusted operating income was $8.4 million for the first quarter compared with $8.8 million for the prior year.

Our adjusted EBITDA was $10.7 million for the first quarter compared with $10.2 million for the period a year ago. Depreciation and amortization expense was $2.4 million for the first quarter. Interest expense was $6.2 million for the first quarter compared with $5.1 million last year. The increase in interest expense was due primarily to increased average outstanding borrowings, in connection with our growth initiatives as we build inventory levels to support anticipated higher sales. In addition, interest expense increased due to higher sales level to customers that utilized an accounts receivable discount program. The income tax benefits for the first quarter was $1.7 million compared with income tax benefit of $1.4 million for the prior year period. Net loss for fiscal '20 first quarter was $6.2 million or $0.33 per share, reflecting the previously mentioned items impacting the quarter compared with net loss of $5.5 million or $0.29 per share a year ago. Adjusted net income for fiscal '20 first quarter was $1.7 million or $0.09 per diluted share compared with $3 million or $0.16 per diluted share a year earlier.

As of June 30, 2019, trailing 12 months of adjusted EBITDA was $74.3 million and the average equity and net debt balance was $385 million, resulting in a 19.3% return on invested capital on a pre-tax basis. Our method of calculating ROI fee is to divide trailing 12 months adjusted EBITDA by the average equity and net debt balance for the 12-month period. As Selwyn noted, we have expanded our Mexico operations and launched new brake categories with the expectation of significant revenue growth from both new and existing product lines. At June 30, 2019, we had net bank debt of approximately $151 million. Total cash availability under revolver credit facility was approximately $84 million at June 30, 2019, based on a total $238.6 million revolver credit facility and subject to certain limitations. At June 30, 2019, the company had approximately $694 million in total assets. Current assets were $371 million and current liabilities were $302 million.

This reflects the adoption of the new lease accounting announcement, which requires balance sheet recognition of a lease asset and a lease liability for all of leasing. Net cash used in operating activities during the fiscal '20 first quarter was $18.4 million, primarily due to a $31 million increase in inventory, renewed business and growth and also impacted by payments made to customers of $4.1 million, the core buybacks made in connection with new businesses. We anticipate increased cash flows from reductions in inventory related to existing product line in the latter half of this fiscal year. In addition, we expect to generate positive cash flows from operations in the second half of the year. Contributing to this, there will be a reduction in payments 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 1 to 5 in this morning's earnings press release.

I will now open the call for questions, and Selwyn will then provide some closing remarks.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Chris Van Horn with B. Riley. Your line is open.

Chris Van Horn -- B. Riley -- Analyst

Good morning. Thanks for taking my call.

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Thanks Chris.

Chris Van Horn -- B. Riley -- Analyst

You cited record sales in the hard parts category. And I think you said despite relative softness throughout the industry, can you just give us a little bit -- it sounds like you're probably taking share. And is there any specific product line that jumps out of you? Or anything to maybe cite from the term softness?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Yes. So I think, let me just talk about the softness first. I mean, I think that listening to all the different public statements from our customers and other suppliers, I think that we've had some headwinds in the DIY business. I think most of it is driven by -- well, the feeling is, most of it is driven by raining weekends, sequential raining weekends that have been pretty tough. We think it's -- we -- again, we -- I continue to say that the fundamental metrics of our industry is strong. And we think that's a temporary phenomenon, and we are seeing some of that change as I speak. Our growth is driven in certainly from, this is all existing product lines. None of the new product line revenue is reflected yet in this growth.

I think it's reflected of market share gains that we've made through the end of last year. And our customers perhaps performing well still weaker than what could be if the industry was stronger, still outperforming our competitor with those customers. So I think that's what it really boils down to. We expected this type of revenue. We also expected the net income numbers for the quarter. I will tell you that just forgetting about new business for a second that the existing business we expect to continue to scale as the year goes on. And then we're going to see some further growth from the addition of the new business. And timing is a little unpredictable, Chris, right now. But the fundamentals, the outlook and the momentum are very positive for us right now.

Chris Van Horn -- B. Riley -- Analyst

Got it. Okay. And it sounds like the momentum is going to kind of translate into the gross margin throughout the year. Can you give us a perspective on what you might be able to finish the year in terms of run rate. Would it be something north at that 27%, or is that kind of your target that you think you might hit by the end of the year?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Yes. So a lot of it depends on the product mix, but if you look at what happened in the fourth quarter of last year, as we get to these higher revenue rates, we're certainly around 29% gross margin range we've got a lot of moving parts still. And while we already see the inflection beginning now, I think you won't see the -- I think you can see those marginal levels, but you won't see the effect of all the initiatives we've undertaken until you get through till the end of March.

I mean, having said that, please don't read into the fact that I think things are going to get worse, they are going to get much better through the end of March, but we won't be 100% complete with all of the restructuring of our cost centers, logistic centers, production centers, model in terms of Chinese versus Malaysia versus Mexico sourcing, that all sort of comes through the majority of that will be done by the end of March. A little bit left in the small part after that, but the significant majority will be done by that. So I will say that run rates, as we get to the end of the year, should reflect what they were last year. Just pouring product mix, we have a lot of initiatives going on in a lot of different product lines, all existing now, that can affect, it's likely one way or another.

Chris Van Horn -- B. Riley -- Analyst

Got it. Thank you for that color. One more for me, and I'll jump back in the queue. On the brake caliper program, could you maybe describe, is it multiple customers? Is it private label? Or do you have a specific brand? And then anything you can give us in terms of margin profile for that?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Yes. We would like to be a little -- I don't mean to be evasive, but I think it's a little early, so I don't want to get too granular. We have significant revenue commitments, leave it at that as far as identifying how many customers, I'll leave that out for now. It is scaling. We actually, in fact, started shipping today. So certainly not planned to be today, but first shipments went out the door today or going out the door today. It is going to be a ramp-up. It's not instant where you have all those volume right in day 1, but the outlook for that category is extremely positive for us based on existing commitments and a lot of the initiatives going on. I also would say that the margin profile is potentially the same as rotating electrical margin profile, it's a remanufacturing profile, the cost of getting into that business are little higher upfront. We're experiencing that, but the margin profile is positive.

And we think that it will not be -- as it -- when it ramps, it will not be dilutive to our gross margins. And we think it hopefully will be accretive. And so we think it's good category. It also is the first step. I think we've previously announced rotors and friction. And we've been quite calculated in how we're launching those other categories, but now that we have a full-line offering, I think our sales offering is going to be very powerful. We will offer both private label and the private brand. At this point, I prefer not to talk about the private brand, but there are customers in both arenas that we will be servicing.

Chris Van Horn -- B. Riley -- Analyst

Thank you so much for your time.

Operator

Our next question comes from the line of Scott Stember with CL King.

Scott Stember -- CL King -- Analyst

Good morning and thanks for taking my questions. So maybe just a little about the market, again. You talked about some softness, but it sounds like, at least your experience is more on the -- again on the do-it-yourself type. If you look at the, I guess, what's more key to your business, the do-it-for-me side, maybe just talk about what you're seeing there? And maybe just retail versus the wholesale channel, have you seen any material changes or differences over the last quarter or 2?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Yes. Look, I think, Scott, I leave that sort of an analysis to the retailers and the traditional people. So I'm not going to answer for my customers in terms of what they see. But I will tell you, general in the industry, I believe and I only believe those based on factual statistics that the market will continue to get stronger. Number of cars on the road continues to grow. And I'm talking about combustion engine cars. Replacement rates are stable, it's not getting better. Average age continues to go up, miles driven remain stable or positive. And so it's only a question of timing. And so the entire market, the entire market should go up unless statistics are lying. And I don't believe anyone in our industry believes that.

It's a little tumultuous right now. There's a lot of activity with Chinese supply and tariffs. And I think that may have a short-term effect on the DIY relative to the discretionary purchases. That nondiscretionary while they may want to put it off, certainly it's nondiscretionary. And we believe that there's necessary price inflation in the category. And that it will not affect volume of replacements from nondiscretionary parts at all. So I mean in terms of the breakdown of professional in DIY, I mean, the cars are getting more complicated. All the customers believe the professional market has probably outgrown the DIY as a percentage, but having said that, no one believes that DIY is going away. That's for sure.

Scott Stember -- CL King -- Analyst

Okay. Great. And this -- the ducktailing of your comments on tariffs. The implementation of List 4 at 10%, does that have any impact on your business? And if so, has that been accounted for the price increases you've put through already?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Yes. The line is not very clear, but I think the question was the latest round of 10%, is that what you were referring to, Scott?

Scott Stember -- CL King -- Analyst

Yes, yes. I'm talking about List 4.

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Okay. Yes. Okay. So that has no effect. I mean we have had increased all of our products to subject to the first rounds of tariff increases on us. And I will tell you that we have passed through 100% of the tariff increases to the marketplace. And so that is happening -- that has happened and that is happening. We have no idea what's going to happen next on the tariffs, but it certainly looks like they're here to stay for a little bit. So we'll have to see. I think at the end of the day for us, quite frankly, we're in a good position to adjust to the tariff headwinds created by China, just based on our significant footprints in Mexico and Malaysia.

Scott Stember -- CL King -- Analyst

Got it. And just lastly, I appreciate all the details on guidance. You alluded to a little bit, I guess, the ramp-up in the back half of the year. But just give us a little bit better idea maybe for the second quarter. It looks like sales, obviously, should be accelerating and the gross margin should be improving, but just trying to figure out how much of a step up there really will be from the second quarter into the back half of the year? Could you just give a little more granularity, that will be great?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Yes. I don't want to get into sort of the quarterly guidance. But I -- I mean there's going to be a significant increase in revenue. It's right on track with the way we think revenue guidance is on an annual basis. It'll accelerate even faster in the third and fourth quarter. I mean, clearly, you see that we've announced a new product line and that takes a little time to ramp-up. We also have some other initiatives that are ramping up through the start more significantly in the third and fourth, but we will see that increases in the second and this current quarter that we're in right now. So no, I think, the worst of the heavy lifting and I hope I don't keep my words here, but I think the worst of the heavy lifting is behind us. And I think that as we go through the year, we will give you more guidance. I mean we are a little cautious because of the slowness in the start for the industry, which I mentioned earlier. And so hopefully if we see a turn in that, we may have some upside. So hopefully that answers your question without getting into quarterly numbers.

Scott Stember -- CL King -- Analyst

No that's fine that's perfect. That's all I have. Thank you.

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Steve Dyer with Craig-Hallum.

Steve Dyer -- Craig-Hallum. -- Analyst

Thank you. Most of mine have been asked and answered. Just a couple of questions, I want to clarify on cash flow. I think you've talked about the second half of the year being positive from a cash flow from operations perspective. What kind of capex are you anticipating for this fiscal year?

David Lee -- Chief Financial Officer

We are anticipating about $20 million for fiscal '20.

Steve Dyer -- Craig-Hallum. -- Analyst

And so then I guess...

Selwyn Joffe -- Chairman, President and Chief Executive Officer

I will say, Steven, is that the positive cash flow will pay for that.

Steve Dyer -- Craig-Hallum. -- Analyst

So you anticipate as an entire company being free cash flow as defined by cash from ops less capex, free cash flow positive for the year or just the second half?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

We expect that this will be for the year from ops.

Steve Dyer -- Craig-Hallum. -- Analyst

Okay. So, obviously, the leverage ratio has crept up quite a bit here in the last couple of years to around 2x net leverage. I guess that's probably a safe number, if you anticipate bringing down debt as the year progresses? Or should we think differently?

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Okay. Thanks Steve. Yes. We believe that we -- through the end of this quarter, we will see some peeking and then everything will start coming down. We'll fund capex and start paying down debt and certainly, expect that positive cash flow will reduce debt as we go forward once we get completed with this capex and as a slight capex initiative. I think the other thing, Steve, I just want to add on if you don't mind, and I think this is important. I think we've now with the product lines that we have available to us right now, there is a huge amount of growth that's available to us to take advantage of. So the things I want to reiterate is that the base cash spend is get these last buildings completed.

And once that's done, then it's a matter of now starting to test the pipeline. And so the categories that we are in are billions of dollars. And so we think we've got a number of years of very strong growth, if we can do a good job within the categories that we have right now. We don't need to really look for other, not just like everyone, but we certainly don't need other categories and I'm not focused on other categories in order to grow our business. I mean, we've gone through a big transformation, we're getting toward the end of it. And we're now in the process once we get through that to start milking the benefits from that, paying down debt and creating value and profit.

Steve Dyer -- Craig-Hallum. -- Analyst

Okay. Thank you.

Operator

Thank you. I'm showing no further questions at this time. I will now like to turn the call back over to Selwyn Joffe for closing remarks.

Selwyn Joffe -- Chairman, President and Chief Executive Officer

Well, thank you. I appreciate everybody. In summary, I just want to say, our investments we believe are now starting to bear fruit. We have many growth opportunities ahead of us. New business commitments are continuing, supported by an expanding line of products, in both our nondiscretionary hard pars business and diagnostics. We are proud of our more-than-50-year history in the aftermarket industry. And all of us are committed to have vision of being global leader for parts and solutions that move our world today and tomorrow.

And as always, I want to thank all of our team members for their commitment and customer-centric focus on service and for their exceptional pride in all the products we sell and the customer service we provide. Their commitment to quality and service is also reflected in the wonderful contributions they made to their communities and our society. They are terrific and I'm proud to work with all of you. 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 fiscal 2020 second quarter conference call in November and at various conferences in the interim. Thank you.

Operator

[Operator Closing Remarks]

Duration: 35 minutes

Call participants:

Gary Maier -- Investor Relation

Selwyn Joffe -- Chairman, President and Chief Executive Officer

David Lee -- Chief Financial Officer

Chris Van Horn -- B. Riley -- Analyst

Scott Stember -- CL King -- Analyst

Steve Dyer -- Craig-Hallum. -- Analyst

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