Motorcar Parts of America, Inc. (MPAA) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Motorcar Parts of America Fiscal 2012 Second Quarter Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Gary Maier.

Thank you, Jovan, and thank you, everyone, for joining us for the call today. 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 the 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, I refer you to the various filings with the Securities and Exchange Commission. With that said, I would now like to begin the call and turn it over to Selwyn Joffe.

Thank you, Gary. I appreciate you joining us today for our fiscal 2012 second quarter conference call. I especially want to thank everybody for their patience and support during the past several months as we've resolved the reconciliation of certain matters related to Fenco's financial reporting, and we've completed the company's fiscal 2012 second quarter 10-Q, which will be filed this afternoon. We anticipate trying to follow up on the third quarter as soon as possible and believe we'll be current by the fourth -- by the -- filing our 10-K for the fourth quarter. We knew when we completed the acquisition that the financial reporting systems of Fenco were legacy systems, but we were, however, surprised at how long the systems took to be updated to reflect net-of-core accounting. All right, so let me move on and talk about our operating results. As highlighted in today's earnings release, we continue to post solid earnings for the company's rotating electrical segment, reflecting record earnings and sales growth. On a consolidated basis, sales climbed 163% to $107.6 million from $41 million a year ago. This growth is derived from a broad range of product categories, including driveline, steering, brakes and rotating electrical. We are optimistic about these categories that we are in, and we expect both organic and market share growth to continue. As you may have read, we recently closed several unprofitable product lines and are extremely focused on sales growth, margin enhancement, strengthening the supply chain to meet the strong demand for our current product offerings. We are continuing to target a run rate of at least $20 million of EBITDA within a 2-year period from the Fenco acquisition. In a few moments, David will walk you through some of the key financial adjustments related to the Fenco transition, which we discuss in detail in today's earnings release. As highlighted in the release, excluding Fenco's operating results and certain other related expenses discussed in our release, earnings per share would have been $0.32 per diluted share for our rotating electrical segment. This clearly indicates that our base business, starters and alternators, remains strong and continues to benefit from strong market dynamics, such as an aging vehicle population now with the average age -- vehicle age of approximately 11 years old. As a result, we should see additional benefits to our business in both rotating electrical and the under-the-car product segments. Equally exciting for us is that adjusted EBITDA this quarter was approximately $10 million, consisting of $9.5 million for the rotating electrical segment and approximately $500,000 for the under-the-car segment. On an annualized basis, this represents approximately $38 million of adjusted EBITDA. For the 6 months, adjusted EBITDA was approximately $19 million, of which $2.6 million was earned from the under-the-car segment. Annualizing the 5-month period for the under-the-car product segment, adjusted EBITDA would be $6.24 million. As per our previous guidance, we expect to essentially complete the transition of Fenco by May 2013, which will be 2 years from the acquisition. Let me take a moment to bring you up to date on the Fenco transition. Our first challenge was to increase product fill rates for the under-the-car products, which were not at satisfactory levels prior to our acquisition of the business. Today, our customer service levels and our product quality are successfully and significantly improved. We're implementing enhanced lean manufacturing procedures at our Monterrey, Mexico facility, which involves hiring and training almost all of our factory employees. This is expected to increase productivity and quality, which will further enhance our gross margins. We have also been successful in eliminating unprofitable product lines, and we are in the final process of selling down the remaining inventory in these product lines. When the sale of this inventory is completed, these product lines will be classified as discontinued in our financial statements. We have made progress in reducing our warehousing costs and expect to realize the benefits of these arrangements beginning in our current fiscal 2012 fourth quarter. Other initiatives underway include ERP integration, adding key product category management people, along with enhanced cataloging capabilities, and implementing additional core sorting improvements. As I've stated many times, our financial strength, manufacturing excellence and value-added customer services remain the cornerstone of our success, and we expect to leverage these qualities in our organization systems to produce solid growth and profitability in all of our product segments. We remain excited about our overall growth opportunities for fiscal 2012 and beyond. In short, our base business is strong, and we'll continue to capitalize on our competitive strengths for the benefit of both rotating electrical products and under-the-car products. For those of you new to our story, there are numerous qualities that distinguish Motorcar Parts of America, qualities that will serve us well moving forward as we integrate and grow our Fenco operation: our low-cost production model and reputation for quality, our ability to produce and ship product efficiently with fill rates unsurpassed in the industry, available capacity to increase production with very little incremental cost in our various product lines, our ability to leverage our overall production and overhead absorption, an international footprint that today includes China that allows us to take advantage of international opportunities, the ability to attract new business and maintain long-term customer relationships. As I mentioned during our last quarter call, both Motorcar Parts and Fenco serve many of the same customers, and there are numerous synergies on which we can capitalize, which will be beneficial to us and, as importantly, to our customers. Areas such as offshore production and management systems, product delivery, streamlined ordering, product education programs, sales training and the like are important value-added considerations. We continue to be committed to rational pricing and continuously evaluating the company's cost structure and our entire operating metric. We continue to focus on annual and long-term growth and profitability, and we expect that this discipline will greatly enhance the Fenco business moving forward. David will now discuss our financials, and then I'll make some additional comments, and we can follow that up with a question-and-answer session.

Thank you, Selwyn. Net sales for the fiscal 2012 second quarter ended September 30, 2011, were $107.6 million compared with $41 million for the same period last year, an increase of $67 million or 163%. The increase in net sales was due primarily to our May 6, 2011, acquisition of Fenco, which resulted in additional net sales of $61.9 million, or 151%, and an increase in net sales to customers of $4.8 million, or 11.6%, primarily due to existing customers in our rotating electrical segment. Gross profit for the fiscal 2012 second quarter was $15.3 million, or 14.2% gross margin, compared with $12.7 million, or 30.9% gross margin, for the same period a year ago. I would like to point out that the gross profit percentage in the rotating electrical segment increased to 32.4% from 30.9% during the second quarter due primarily to lower per-unit manufacturing costs. During the 3 months ended September 30, 2011, the gross profit percentage in the under-the-car product line segment was impacted 8.7% by recording of contractual customer penalties of $896,000, intersegment costs of $836,000, higher-cost inventory purchases and freight expenses of $1.4 million to increase customer fill rates, additional production and nonrecurring costs of $1.6 million and an inventory step-up adjustment in connection with the May 6, 2011, acquisition of Fenco of $705,000. Excluding the above-mentioned adjustments, the under-the-car product line segment gross profit margin was 8.6%. We believe that with the implementation of our transition plan, the gross margin percentage for the under-the-car product line will substantially increase. General and administrative expenses increased $8.2 million to $11.8 million for the second quarter, of which $4.8 million is for the under-the-car segment. This resulted in a net increase in G&A expenses for the rotating electrical segment of $3.4 million. Of the $3.4 million, $1.8 million is noncash foreign exchange contract charges, and $1.2 million is acquisition-related G&A bank financing fees and legal expenses. After adjusting for these unusual expenses, rotating electrical general and administrative expenses increased by approximately $400,000 primarily due to professional fees. Sales and marketing expenses increased $2 million to $3.2 million for the second quarter compared with $1.2 million for the same quarter of fiscal 2011. The increase of $696,000 for our rotating electrical business was due primarily to the reversal of commission expenses during the prior year in connection with our acquisition of Reliance Automotive as certain thresholds were not met, increased employee-related expenses and increased travel incurred in connection with our Fenco operations. Under-the-car product line segment sales and marketing expenses were $1.3 million for the second quarter. Acquisition costs were $309,000 for the second quarter, consisting of legal fees, due diligence costs and other professional fees in connection with the Fenco acquisition. Operating income for the fiscal 2012 second quarter for the rotating electrical segment increased 8% to $8 million before noncash loss recorded due to the change in the fair value of forward foreign currency exchange contracts and Fenco-related G&A and professional expenses, compared with $7.4 million a year ago before noncash gain recorded due to the changes in the fair value of forward foreign currency exchange contracts. Operating loss for the under-the-car segment was approximately $552,000 after adjusting for contractual customer penalties, intersegment costs, higher-cost inventory purchases and freight expenses, additional production and nonrecurring costs and an inventory step-up adjustment in connection with the May 6, 2011, acquisition of Fenco. EBITDA for the second quarter was approximately $10 million, which is comprised of $9.5 million EBITDA for rotating electrical segment and approximately $500,000 EBITDA for the under-the-car product line segment, adjusted for various noncash items and Fenco-related costs explained above, as well as standard inventory revaluation write-downs of $636,000 due to lower remanufacturing costs and severance and FASB 123(R) noncash stock compensation expenses totaling $23,000. In addition, depreciation and amortization for the quarter was approximately $2.5 million. Net of interest income, interest expense was $3.4 million for the second quarter compared with $1.7 million for the prior year second quarter. For the fiscal '12 second quarter, the rotating electrical product line segment recorded income tax expense of $1.7 million, or a 36.2% effective rate, which includes 2.2% tax adjustment of $104,000 in the quarter due to fiscal year-to-date transaction costs incurred in connection with the company's acquisition of Fenco. The company reported a net loss for its fiscal '12 second quarter of $5.6 million, or $0.45 loss per share, compared with $3.5 million, or $0.29 per diluted share, for the comparable period a year earlier. Excluding contractual customer penalties, higher-cost inventory purchases and premium freight expenses, additional production and nonrecurring costs, noncash inventory step-up adjustment, the noncash loss recorded due to the changes in the fair value of forward foreign currency exchange contracts, Fenco-related G&A expenses, net income for the fiscal 2012 second quarter would have been $0.04 per share, which includes rotating electrical EPS of $0.32 per diluted share. At September 30, 2011, our balance sheet had $1.2 million in cash and $493 million in total assets. Motorcar Parts of America and Fenco have separate bank credit facilities. MPA had a $6.5 million term loan and $37.5 million borrowings on the revolving credit facility, leaving $6.6 million available after reflecting outstanding letters of credit pursuant to the old MPA financing agreement. Fenco had a $10 million term loan and $47.7 million borrowings on its $50 million revolving credit facility. Subsequent to the second quarter ending September 30, 2011, in January 2012, MPA entered into a new financing agreement, including a $75 million term loan and an asset revolving credit facility of $20 million. Post-closing of the new MPA credit facility on January 18, 2012, MPA's cash balance was approximately $24 million with a 0 borrowings on the revolving credit facility for net borrowings of approximately $50 million. During the 6 months ended September 30, 2011, the rotating electrical segment generated $4.1 million of cash flow from operations. For the period from May 6 to September 30, 2011, the under-the-car product line segment used approximately $49 million of cash from operations, primarily consisting of an increase -- of an inventory increase of approximately $19 million, which contributed to significantly increasing fill rates, and accounts payable paydown of $17.1 million, which increased the supply chain to enhance inventory levels to increase fill rates. I would now like to walk you through the income statement exhibits in our press release distributed this morning, which we believe will make it far easier to understand the various expenses and adjustments for the second quarter and fiscal year-to-date ended September 30, 2011. If you can take a moment to turn to the income statement exhibits in the press release starting with the last page, we can begin. The income statement exhibits on the last 2 pages of the earnings press release present the 3 months ended and 6 months ended September 30, 2011, second quarter results of operations for the rotating electrical segment. So on the last page of the earnings release, when you eliminate the effect of Fenco-related costs, noncash loss recorded due to the changes in the fair value of forward foreign currency exchange contracts and intersegment interest income, diluted earnings per share was $0.54 for the 6 months ended September 30, 2011, for the rotating electrical segment. It's calculated by taking the reported earnings per share of $0.42 and reducing net sales for intersegment revenue of $1.6 million and eliminated Fenco-related G&A expenses of $2.2 million, noncash loss recorded due to the changes in the fair value of forward foreign currency exchange contracts of $1.9 million, sales and marketing Fenco-related costs of $126,000, professional fees, acquisition costs of $713,000, intersegment interest income of $945,000 and tax adjustment of $112,000. So by adding the above-mentioned items, totaling $0.12 per diluted share, to the reported $0.42 per diluted share results in $0.54 per diluted share for the 6 months ended September 30, 2011, for the rotating electrical segment. Additionally, at the bottom of the exhibit for the rotating electrical segment, there was a calculation for EBITDA for the 6 months ended September 30, 2011. Starting with operating income of $10,272,000 and adjusting for the impact of intersegment revenue, Fenco-related and noncash items as previously mentioned, and depreciation and amortization of $1,777,000, rotating electrical EBITDA is $15.4 million. In addition, adjusted further for the noncash standard inventory write-downs of $1 million and FASB 123(R) noncash stock compensation expenses and severance costs totaling $41,000, rotating electrical EBITDA for the 6 months ended September 30, 2011, was approximately $16.4 million. Now please turn 2 pages forward to the earnings press release showing both the rotating electrical segment and under-the-car product line segment results of operations for the 6 months ended September 30, 2011. Consolidated operating results for the 6 months ended September 30, 2011, which includes the period from May 7 to September 30 for the under-the-car product line segment, was impacted by Fenco-related expenses and noncash expenses, which are highlighted in the adjustments column. To recap once again, these adjustments include contractual customer penalties of $1 million; higher-cost inventory purchases and premium freight expenses of $1.6 million; additional production and nonrecurring costs of $2.5 million; the effects of fair value purchase accounting on Fenco's opening balance sheet for inventory step-up adjustment of $3.4 million; Fenco-related G&A, bank financing and legal costs of $2.6 million; foreign exchange loss of $1.9 million; sales and marketing Fenco-related costs of $126,000; and other professional fees of $713,000. The income tax expense reflects an additional 1.4% tax in the 6-month period due to certain nondeductible acquisition costs of $112,000. Additionally, the loss from the under-the-car product lines, which we do not plan to continue to sell or support in the future, is approximately $2.7 million. So by adding the above-mentioned items to the reported loss of $0.96 per share results in $0.22 per share for the 6 months ended September 30, 2011, for the combined rotating electrical and under-the-car product line segments. Additionally, at the bottom of the exhibit, there is a calculation for EBITDA for the 6 months ended September 30, 2011, which again includes from May 7 through September 30 for the under-the-car product line segment. Starting with consolidated operating loss of $2.96 million and adjusting for the impact of Fenco-related and noncash items as previously mentioned, and depreciation and amortization expense of approximately $4.4 million, consolidated EBITDA for the 6 months ended September 30, 2011, is $18 million. After further adjusting for $1 million noncash standard inventory revaluation write-downs mentioned above, EBITDA for the 6 months ended September 30, 2011, was approximately $19 million. I will now turn the call back to Selwyn, who will take a few additional comments before we open the call to questions.

Thank you, David. As you can see, our proposition for our business continues to be exciting. We have increased our inventory levels to meet increased demand for our products and for new business, which continues to gain momentum. We continue to experience steady growth in both of our business segments. We are committed to the highest levels of customer service in line with our MPA standards. We are very excited about the future opportunities for Motorcar Parts, both in terms of the continued strength of our base business and the opportunities we expect to realize through the Fenco acquisition, by leveraging our strong customer relationships with their solid revenue base and a great selection of nondiscretionary under-the-car parts. Our Quality-Built brand name, serving the professional installer segment, continues to expand, and we remain focused on further leveraging key production advantages to expand our business even further. The Fenco acquisition and other potential complementary future transactions underscore management's commitment to growth and enhancing shareholder value. We expect to more than double our sales for this fiscal year, and we're working hard to complete the Fenco transition plan to grow earnings. In summary, the long-term market statistics for our industry remain favorable, and we are very excited about the opportunities. I appreciate your interest in Motorcar Parts, and I'm happy to answer any questions that you may have.

[Operator Instructions] Our first question comes from Jimmy Baker with B. Riley & Co.

Selwyn, the $20 million in EBITDA expectation for the under-the-car segment is down significantly from the prior commentary of $30 million. I'm just wondering what's driving that change. What's embedded in your Fenco gross margin assumption to get to that new EBITDA run rate? And then, of course, you've added some interest expense to the model here with the $75 million term loan. So do you care to update the $1 in EPS accretion expectation given the lower EBITDA and higher interest expense?

Okay, so let me take those in 2 pieces. The original guidance, we assumed the base EBITDA before transition in Fenco of approximately $5 million with an estimation of at least $20 million of transition savings. I think -- upon reflection and based on the last 5 months, I think we're looking at the base EBITDA being closer to breakeven. We feel the synergies and the transition savings on the first phase of our transition at $20 million to still be very clearly there. We have adopted a little bit of a change in how we're going to go about that transition. With successful renegotiation of our warehousing arrangements in the United States, we've been able to negotiate big savings without moving to Mexico immediately on the distribution, and that will result in a much quicker transition. And we still believe that, after Phase 2, that the $30 million may be accomplishable. But the guidance -- we're reducing our base level guidance by about $5 million. On the term loan, I mean, I think we've always talked about needing additional liquidity to complete the Fenco transition. And so that was just -- that was anticipated going forward. So -- and I think, Jimmy, the -- if you look at the momentum and the strength in both the base business and the new under-the-car parts business, I mean, we're seeing some tremendous growth in both of those businesses for us. And so while I want to be conservative, I think our optimism overall was not changed.

Okay, just the 2 pieces to that, that I didn't catch. The -- what's the embedded Fenco gross margin assumption in the $20 million EBITDA run rate? And are we still -- are you still thinking that if we were to just deduct, let's say, $5 million from EBITDA and then run that through the model, that you'd still get fairly close to your $1 in EPS accretion?

I think so. I'd rather talk about it pre-interest because depending on interest rates and depending on -- that affects EPS. And so from an operating income perspective pre-interest, I don't think we've -- the change is only the $5 million. And I think it's just trying to be conservative. I think the outlook in terms of what we can do with Fenco and the sales growth and the opportunities with all of their products and the margin growth have not changed for us.

Okay. And a pretty strong gross margin out of your legacy business. Just interested if you think those are sustainable. And then I guess -- well, I'll just pause and ask that.

Yes, I think that's sustainable. We're seeing nice growth in our -- in that business. And so we expect to see some benefits from overhead absorption as we go forward. That business is growing at a nice pace, both organically and with new customers.

Okay, you covered some of this in the prepared remarks, but I'm just trying to understand the revenue impact of the roll-off of some of these discontinued products, what the timing of that looks like. And what categories other than CV axles are you exiting?

Yes, we've basically exited a number of -- CV axles was the main product line. I mean, the others are small, leftover categories from the acquisition. The product categories that we'll focus on going forward will be in brakes, driveline, steering and clutch. And those are the 4 categories that we'll focus on. In terms of revenue, depletion will be no more. We're selling down CV axles. And reman clutch, we're out of the reman clutch business and some other small lines that don't add up to too much. But that's the change for now.

But you can't really quantify what those discontinued lines contributed to, let's say, the September quarter?

Yes, I think on the 5 months, it was a loss of approximately -- David, what is it, $2.6 million?

$2.6 million.

Yes, $2.6 million for the 5-month period. And so annualized, that -- you can annualize that. It's about $6 million about -- approximately of eliminated losses that we've taken out of the model so far. In addition to that, we'll be taking -- the warehousing savings will show up in this quarter, and a lot of other initiatives that are going on at the same time.

Okay, maybe I'll follow up on that off-line. But there is -- David, maybe for you. Some questions here as I try to reconcile your 6 months' results to the previously reported June quarter. It looks like besides the reduction in sales and increase in cost of goods sold, you also had some -- to restate some G&A and sales and marketing items. Is that correct? And what required that change?

There will be a 10-Q coming out later today that will actually have a footnote that shows originally reported and a column for adjusted. And there'll be remarks. So that will be coming out later today. The biggest part of the change was a change in the estimate in the fair value of the opening balance sheet and the purchase accounting. So if I can defer to -- if you have a chance to look at the Q, you will see in detail what lines have changed and by how much.

Our next question comes from the line of Larry Litton [ph] with Second Line Capital [ph].

I just also want to clarify some of the questions that have already been raised. Do I understand correctly that basically, the legacy business, in very rough terms, is a $40 million EBITDA rate? And then hopefully, in 12 months or so, the combined businesses would have a $60 million EBITDA rate?

Well, I think, let me -- on the big picture on the second front, I mean, that's certainly the target, to get to the $60 million EBITDA rate on a combined basis. I think today's trailing number on the base business is about $32 million, a little over $32 million. On an ongoing basis, we believe that, that $32 million is certainly on a growth mode. So not exactly accurate but not too far from...

Okay. And also again, for my simplistic thinking, the legacy business, the idea, again coming back to the prior question, the run rate had been $1. Originally, you were thinking about adding $1 to that, and now you're looking at maybe $0.70 to $1. Again, do I...

That's correct.

That's correct?

That is correct, yes.

Okay. And the working capital has changed dramatically, and there's something also in the balance sheet, something about core return accruals. Without getting into the details of that, or you can, but in 12 months' time, where do you see the total debt for the company?

I think the total debt should increase by $20 million. And then we should start generating significant cash to start paying down that debt. That will get us through the transition.

Okay. But in terms of -- then whatever that core return accruals are and whatever the working capital intensity of the business is, in 12 months, it will be normalized? Or is there a further dramatic rationalization program beyond that?

No, no. I think at that point, it becomes substantially normalized.

Okay. Capital spending again for the next 12 months, order of magnitude?

Actually fairly nominal. What is the capital expenditure?

Well, right now, we're in a maintenance mode. It's just a few million dollars.

Yes.

Okay. And then lastly, the interest -- what are -- what is your interest expense in total? I guess we know it. I think it's around $12 million pro forma or something like that. Is that all attached to the debt? And more to the point, what kind of interest rates are you paying?

No, no, it's not all attached to the debt because we factor the receivable under the supply contract receivable programs that our customers offer. And so the interest is a combination of both.

Can you break that down in terms of the factoring versus...

Well, the most of it is going to be the factoring interest. I would say about 2/3 of it is going to be coming from factoring, and the rest will come from the loan.

So does that mean -- does it mean our average rate on the loan is around 4%?

It's a little higher than that but not much higher.

Our next question comes from Graham Tanaka with Tanaka Capital Management.

Sorry I missed the first part. I was hoping you could maybe give us an indication what you think. I know that you had to scramble and it was hard to do the accounting, but you got it done through September. Through December, what do you think the quarter would look like in a more sort of steady-state basis? And then maybe...

Well, let me just give some general guidance. I mean, the December quarter is generally a softer quarter. This -- the December quarter in the industry was a soft quarter for reman products. And so you'll see a softer December quarter. The March quarter is a far more vibrant, actually very strong quarter. And so I think the combination will continue to show the strength in the entire business. And I think in terms of starting to see the effects of normalization, certainly on the Fenco transition, I still think we'll start seeing that come into the P&L in the first quarter of the next fiscal.

And what would be the sales, say, maybe to help take out the seasonality, year-to-year on the core business December quarter and March quarter? December versus December a year ago, and March quarter versus March quarter a year ago?

Just, Graham, I don't have that at the tip of my fingers, but I would tell you that, in general, we're expecting a 10% increase in revenues on our base business on a go-forward basis. And on the Fenco business, it's a little difficult to comment in that way because we're rationalizing the nonprofit -- nonprofitable items. But I will tell you that in the core categories that we're remaining in, the business is vibrant, very vibrant. And the business opportunities out there are vibrant as well.

So how much in annualized sales did you take out of in terms of the closed-down business?

I would -- again, I think that we're talking about a double in our total revenue. So if you were trying to build a model looking forward, I would be conservative and estimate in the $180 million range for the under-the-car parts business.

That's -- I just was wondering. So you took out about how much in terms of the CV and...

We've probably taken out -- between rationalization of customers and product lines, we've probably taken out close to $20 million, maybe a little more than that, in revenue.

And then you were saying that the -- because of various things -- I'm just wondering, when do you think you might get to your original target profit margin for the Fenco business?

I think we're off slightly. We were off by about $4 million on what we thought in terms of estimate. I'm not -- again, I'm being conservative. I'm not so sure we won't catch that up and surpass what we're talking about. But this is -- the way we've structured the transition today is that we feel like we'll get to these numbers quicker than we would have had we moved our entire model offshore. And then that way, we can get stability into our operating income quicker, less capital requirements. And then when we go to the next step, and I think that there was another question, can we get to the $30 million as time goes on? Absolutely.

So you think you can get your original cost reduction and cost reduced, but it might take what, how much longer?

I would say it may take another 6 to 10 months.

And just wondering if -- what's your cost situation, cost price relationships are in terms of purchased material costs and that kind of thing? Any inflation there or labor?

Well, you have gains and losses. I mean, there's some commodity price increases, there's some labor decreases that we're experiencing. So I think it's a net wash. I mean, our focus really on enhancing margins is to get the Fenco model transitioned into a more efficient place. And that's where the margin enhancement is coming from. There is a fairly messy logistics model. I mean, I think the new warehousing arrangement is going to be a significant enhancement for us, and there's opportunity to streamline and reduce our freight costs and certainly our production efficiencies in the plant. We've hired a number of new employees. We're training new employees. One of the MPA strengths is their knowledge of lean manufacturing. We're implementing that into Monterrey. And so while you're doing that -- Monterrey, Mexico, that is on the Fenco plant. So while you're doing that -- you have additional expenses while you're doing that, but it quickly results in far more productivity and margin expansion. So at the end of the day, I mean, can we get margins to where they are on the base business? Again, we think that that's a reasonable target, but over time.

Our next question comes from the line of Matt Sherwood with Cooper Creek Partners.

Quick question. Just trying to understand or clarify one of the previous questions on the debt balances. So once you get up to that additional $20 million that you were talking about, will there ultimately be a period where you'd take down inventory or take up payables in a way that the debt gets paid down relatively quickly?

Well, I think that the free cash flow from just the EBITDA becomes -- starts to fall out. And certainly, when we get to the $55 million, $60 million of EBITDA level, we start to generate significant amounts of cash and, certainly, we'll be able to pay down that debt.

Okay. So the cash -- the debt paydown will come from free cash flow as opposed -- you're not overbuilding inventory so you can get to service metrics in -- as a bridge to getting Fenco's logistics?

I think you do see a lot of that, but we're incorporating -- I'm incorporating that into the net $20 million. So, I mean, the paydown is going to -- I think there's inventory opportunity, yes, there is. I mean -- but one of the strengths of MPA, I mean, as a service provider is that our fill rates are historically excellent, and we're getting to that point across-the-board now. And so we did overspend on inventory, there's no question about that, and we do think we'll rationalize that inventory. But I still think -- let's assume that the paydown is coming from free cash flow.

Our next question comes from the line of Jimmy Baker with B. Riley & Co.

A follow-up. Just a couple points of clarification. One, on the debt, the rate of the debt. Were you speaking about kind of the September quarter? In other words, the old facility? And if so, what's kind of the pro forma interest rate expense, given the new term loan, that we can then just kind of layer on the factoring expense on top of that?

So the prior discussions were based on the September figures. So going forward, when you look at the combined weighted MPA and Fenco combined rate, it's going to be 6%, 7%.

Okay. And then I think in the prepared remarks, you mentioned that after the new term loan, you had $24 million in cash on the balance sheet. So plenty of liquidity, it would seem. And then as you kind of spoke about, it seems like working capital might actually be a source of cash rather than usage going forward. I just want to be clear that I'm right in that assumption and then also just understand your expectations, if any, for future needs for raising capital.

I think just the work -- there will be an increase in the working capital requirement as we complete the transition. That's the $20 million that we talked about. And then, I mean, we're always looking -- depending on what the opportunities are, growth rates, profitability, I mean, we'd be looking -- we're always looking at making sure that we have adequate means and adequate financing. And so I don't have the answer to where we'll be in terms of that in the future. But we do expect, again, for working capital requirements at Fenco to complete the transition to be less than $20 million, but $20 million is our sort of umbrella number.

Our next question comes from the line of Larry Litton [ph] with Second Line Capital [ph].

Obviously as outsiders, there's a lot of nervousness watching the transition and trying to figure it out. It's probably less so inside the company. Given your plan and desire to continue to build and make other acquisitions, are you at a comfort level that you might see acquisition opportunities over the next 12 months? Or are the next 12 months really focused towards this integration and then we'll be looking again beyond a year perhaps?

No, I mean, the focus right now is to complete the integration. We've got a lot on our plates. We think there's tremendous opportunity without further acquisition. Not to say that if something lands on our plate that is what we consider to be a great opportunity, we wouldn't look at it. But we're certainly focused very much on the project at hand on the transition and continue to feel very optimistic about the opportunities from it.

[Operator Instructions] And our next question comes from Robert Henderson with Rutabaga Capital.

Selwyn, just to clarify once more the debt. The way I look at your balance sheet now, including the current and long-term debt, you've got about $100 million in net debt on the balance sheet. And I think you said as of January, your net borrowings were $50 million. Is that correct?

Net borrowings at -- in the MPA entity of $50 million and about $57 million at the Fenco subsidiary.

At this time, I'm showing no further questions in the queue, and I'll turn it over to our speakers for any closing remarks.

And I thank everybody for their time. I appreciate the patience on the reporting. We certainly are as disturbed by you -- as you are by it, and we're working at getting the reporting back on time as fast as possible. I'm very optimistic that we've been through the worst of it. And we look forward to a great opportunity for the future, and I thank everybody for their time.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.