Motorcar Parts of America, Inc. (MPAA) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Motorcar Parts of America's Fiscal 2012 Year-End Results. [Operator Instructions] As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Gary Maier, Investor Relations for Motorcar Parts of America. Please begin.

Thank you, Sean. Thank you, everyone, for joining us for today's call. Before we begin and I turn the call over to Selwyn Joffe, Chairman, President and Chief Executive Officer; and David Lee, the company's Chief Financial Officer, I would 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 company's various filings with the Securities and Exchange Commission. I would now like to turn the call over to Selwyn Joffe and begin.

Okay. Thank you, Gary. I appreciate you joining us today for our fiscal 2012 fourth quarter and year-end conference call. I especially want to thank you for your continued patience and support as we completed the company's fiscal 2012 year-end 10-K, which will be filed later today. The completion of our year-end results was challenging, and we appreciate your patience during this period. We're working diligently to become current and compliant with our financial reporting as quickly as possible. We anticipate that we'll be current with our filings no later than December 26 of this year, and we hope sooner than that. Now that the year-end audit is complete, we expect that the preparation and completion of the Forms 10-Q will be a far more efficient process. Going forward, we are on track to transition the legacy accounting systems of Fenco to the Motorcar Parts platform beginning in the current third quarter. Consequently, we expect to file our required financial reports on a timely basis beginning with the December 31 quarter. Due to the delayed filing, we will need to structure this call to address the reported results, which are now 6 months old and also focus on bringing you up-to-date on our current business. Let me first give you a review of the March 31 year-end results. For our rotating electrical business, we experienced record revenues for both the quarter and the year of $51.9 million and $178.6 million, respectively. This compares with $42.8 million and $161 million in the respective periods a year ago, representing an increase of 21% and 10.7%, respectively. Net income and EBITDA for rotating electrical for the quarter were also a record, $3.7 million and $10.3 million, respectively, and net income and EBITDA for rotating electrical for the year was a record $13 million and $32.1 million, respectively, adjusted for certain items that David will discuss later. Let me take a moment to give you some insight into our anticipated performance for our rotating electrical business for the 6-month period ended this Sunday. We expect record sales and record net income for those segments, along with record EBITDA, which we expect to be in the high teens. Now we'll switch to the undercar segment. With respect to the undercar segment, there is clearly more noise in the numbers. We reported revenues of $49.6 million for the quarter and $185.1 million for the year ended March 2012. Net loss and a negative EBITDA for the undercar product segment for the quarter was $19 million and $5 million, respectively. Net loss and negative EBITDA for the undercar product segment for the year was $62.8 million and $11.5 million, respectively. Obviously, this is unacceptable and does not reflect most of our cost-cutting transition initiatives which began in February. Prior to this, we were focused on enhancing customer service levels. Notwithstanding results for the quarter and year, our transition initiatives related to the Fenco acquisition are in progress, despite the dated information in today's release relative to the status of the turnaround. Let me take a few minutes to walk you through key initiatives that are involved in getting the transition completed. A large portion of these have been completed and the others are all in progress. At this point in time, we have good visibility into the completion of the turnaround. Firstly, we are eliminating nonprofitable sales. We believe we are now substantially complete with this initiative. In conjunction with this, we have exited the clutch business and some unprofitable business in our steering and brake business. The result of this is a downsized Fenco but one with profitable customer relationships and product lines. We are committed to growing the Fenco business in 3 strategic areas: steering, brakes and driveline or better known as wheel hubs and bearings. Each of these categories represent growth opportunities for Fenco. We expect the resized business before any growth to be approximately $150 million in annualized revenue. This will start to be reflected in the current quarter we are in. Secondly, we have previously eliminated unprofitable business, specifically the CV axle business and the many other small product lines at Fenco BNM [ph]. We have also reduced sales expenses, primarily through the reassignment of sales responsibilities to in-house reps from outside. This was completed in June. We are consolidating warehouses. This is a large initiative which will result in significant savings. This initiative is underway and is being handled carefully to avoid any interruption in customer service levels. We are reducing our reliance on third-party logistics providers. This process has already begun and is expected to be successful. We've reduced corporate overhead and expect to continue to do that. We have had our rift, have given notice for the balance of the rift. The last portion of this reduction relates to the new ERP system, which will go live in October and will be predominantly staffed out of our Torrance facility. In summary, we believe these initiatives when fully implemented will result in EBITDA of approximately $15 million. We expect that this will all be complete by May as we originally planned. We note that this $15 million EBITDA is less than our initial projection of $20 million, reflecting the updated operating model. On a combined basis or on a consolidated basis, we expect EBITDA run rates at the end of May to be in the low $50 million range, with net debt peaked at $120 million by year end and then starting to be reduced and paid down. I would also like to highlight that we have significantly improved our capital resources. Liquidity levels for the rotating electrical segment are as follows: Cash, we have cash of approximately $30 million after our investment into Fenco and a completely undrawn revolver of $20 million. At Fenco, with our new facility and strategic supply arrangement, we have enhanced our liquidity. We currently have outstanding debt of $42 million on a $55 million revolver, and we believe we have adequate capital to complete our plan. A few background comments are in order. From the beginning of the acquisition in May 2011, we made a strategic decision to focus on enhancing customer satisfaction, which meant turning our resources and priorities to enhancing the customer relationship. This effort was most costly and was a result -- and resulted in increased fill rates but significant capital challenges. In a few moments, David will walk you through some of the key financial indicators relating to the Fenco transition. We're happy to say that those capital restrictions have now been addressed, and David will walk you through the financial results and will discuss them in detail in today -- the detail of today's earnings release. Both the rotating electrical and the undercar product segment should continue to benefit from the strong market dynamics of the aftermarket business, particularly, as I've noted many times, the aging vehicle population. With the average age vehicle of approximately 11 years, industry experts have speculated that there's been some softness in the market as a result of mild winter -- of the previous mild winter but expect over time the effect of the weather to normalize. We believe, however, that the fundamentals are still strong. In addition, we are particularly excited with the growth in both our brake and driveline businesses, in which we see strong opportunity for double-digit growth from existing customers. We continue to see strong opportunities on our rotating electrical segments, and we remain focused on being a supplier of components that are critical to vehicles in operation. As a result, we should see additional benefits to our business, particularly as we get closer to realizing the positive contributions from our efforts to improve the performance of the undercar product segment. In short, our rotating electrical business is strong, and our undercar parts are in transition. We'll continue to capitalize and utilize our MPA operating model and strengths for the benefit of both rotating electrical and undercar products. For those of you new to our business, there are numerous qualities that distinguish Motorcar Parts of America, qualities that will serve us well in moving forward as we integrate and grow our Fenco operation: a 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 little incremental cost in our various product lines; our ability to leverage our overall production and overhead absorption; an international footprint 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 previous calls, both our product segments have many of the same customers, and there are numerous synergies in which we can capitalize, which will be beneficial to us as well as 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 are 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 discipline will greatly enhance the Fenco business moving forward. David will now discuss our financials, and I will then make some additional comments, and then we'll open it up to Q&A. So David, go ahead.

Thank you, Selwyn. As mentioned in MPA's fiscal 2012 fourth quarter and fiscal year 2012 earnings release this morning, results of operations for the period ended March 31, 2012, were impacted by the operations of Fenco, which is the undercar product line segment as the integration strategy progresses. The net loss for Fenco was a result of higher returns as a percentage of sales, legacy aggressive product pricing, higher customer allowances, higher overhead costs throughout North America and high manufacturing costs due in part to the under-absorption of overhead on our lower production levels. As we integrate the Fenco business, we are addressing pricing and the efficiency of all of our operations, including production, warehousing and logistics as part of the turnaround strategy for Fenco. We have already made progress in each of these areas. In addition to the overall negative contribution on our undercar product line sales, our gross profit was also significantly impacted by our decision to close the production facility related to the CV axle product line in December 2011. The negative gross profit impact to the closure was $10.85 million for fiscal 2012. Of course, this closure will result in enhanced overall margins moving forward. We will further discuss below the impact to the gross profit for the undercar product line segment of prioritizing customer fill rates, including higher cost inventory purchases and freight expenses. Additionally, we will further discuss the impact of a loss from other product lines not supported, additional production costs, contractual customer penalties, unique current period customer allowances and rebates, non-cash purchase accounting inventory step-up adjustment and nonrecurring professional fees related to the integration. While in the middle of the integration process for Fenco and the undercar product line segment, as Selwyn mentioned earlier, MPA's rotating electrical business continues to be strong with record results for the fourth quarter and full year -- full fiscal year 2012. Rotating electrical net sales for the 3 months ended March 31, 2012, was a record high $51.9 million, and EBITDA adjusted was $10 million for the fourth quarter. Rotating electrical net sales for the 12 months ended March 31, 2012, was a record high $178.6 million, and EBITDA adjusted was $33 million for the 12-month period. We'll now review the financial results for the period ended March 31, 2012. Net sales for the fiscal 2012 fourth quarter ended March 31, 2012, were $101.5 million compared with $42.8 million for the same period last year, an increase of $58.7 million. The increase in consolidated net sales was primarily due to our May 6, 2011, acquisition of Fenco, which resulted in additional net sales of $49.6 million; and an increase in net sales of $9.1 million or 21%, primarily to the existing customers in our rotating electrical product line. Once again, the rotating electrical net sales for the fourth quarter was a record high $51.9 million. Gross profit for the fiscal 2012 fourth quarter was $7.3 million or 7.2% gross margin compared with $14 million or 32.7% gross margin for the same period a year ago. The gross profit percentage in our rotating electrical product line very slightly decreased to 32.5% from 32.7% during the 3 months ended March 31, 2012. Productivity in our rotating electrical manufacturing facilities continues to be excellent. During the 3 months ended March 31, 2012, the gross profit percentage in the undercar product line segment was impacted 17.4% by recording of contractual customer penalties of $3.5 million, premium cost inventory purchases and freight expenses of approximately $300,000 to increase customer fill rates, additional production costs of $1.2 million, unique current period customer allowances and rebates of $2.1 million, loss from CV axle and other product lines not supported to be sold of $3.4 million, and a non-cash purchase accounting inventory step-up adjustment in connection with the May 6, 2011, acquisition of Fenco of negative $1.8 million. Excluding the above-mentioned adjustments, the undercar product line segment negative gross profit margin was 1.9%. We believe that with the implementation of our transition plan, including addressing future pricing and the efficiency of the manufacturing operations and implementing cost-saving initiatives for production, warehousing, distribution and logistics, the gross margin percentage for the undercar product line will substantially increase. General and administrative expenses increased net $4.1 million to $9.1 million for the fourth quarter, of which $5.3 million is the undercar segment. This resulted in a net decrease in G&A expenses for the rotating electrical segment of $1.2 million, primarily due to gains recorded due to the changes in the fair value of forward foreign currency exchange contracts of $923,000 during the fourth quarter compared to prior year's fourth quarter gain of $139,000. Undercar product line segment general and administrative expenses includes $2.1 million of professional and related fees related to the integration process. Sales and marketing expenses increased $2 million to $3.8 million for the fourth quarter compared with $1.8 million for the same quarter of fiscal 2011. The increase in our rotating electrical business was $72,000. Undercar product segment sales and marketing expenses were $1.9 million for the fourth quarter. Substantial progress has already been made to reduce these costs. Acquisition costs for the prior year fourth quarter of $879,000 were in connection with the May 6 acquisition of Fenco. Operating income for the fiscal 2012 fourth quarter for the rotating electrical segment was $9.4 million compared with $6.4 million a year ago, both figures before non-cash gain recorded to the changes in the fair value of forward foreign currency exchange contracts, Fenco-related and professional expenses. Operating loss for the undercar segment was approximately $6 million after adjusting for contractual customer penalties, premium inventory purchases and freight expenses, additional production costs, unique current period customer allowances and rebates, loss from product lines not supported, professional fees related to the integration of Fenco and a non-cash purchase accounting inventory step-up adjustment in connection with the May 6, 2011, acquisition. As a result, EBITDA for the fourth quarter for the undercar segment was negative $5 million, with depreciation and amortization expense of $980,000. EBITDA for the fourth quarter for the rotating electrical segment was a record high $10.25 million adjusted for various non-cash items and Fenco-related costs explained above. In addition, depreciation and amortization for the rotating electrical segment for the quarter was approximately $832,000. Net of interest income, interest expense was $5.7 million for the fourth quarter compared with $1.1 million for the prior year fourth quarter, primarily due to adding interest expense for the undercar product line segment since the May 6 acquisition of Fenco. For fiscal 2012 fourth quarter, the rotating electrical product line segment recorded income tax expense of $2.1 million. The company reported a net loss for its fiscal 2012 fourth quarter of $12.9 million or $1.03 loss per share compared with net income of $2.4 million or $0.19 per diluted share for the comparable period a year earlier. Excluding contractual customer penalties, premium inventory purchases and premium freight expenses, additional production costs, unique current period customer allowance and rebates, loss from CV axle and other product lines not supported, a non-cash purchase accounting inventory step-up, the non-cash loss recorded due to the changes in the fair value of forward foreign exchange contracts and Fenco-related G&A expenses, net income for the fiscal 2012 fourth quarter would have been a negative $0.32 per share, which includes rotating electrical earnings per share of $0.30 per diluted share. To recap for the full fiscal year 2012, rotating electrical net sales were $178.6 million compared with $161.3 million for the same period last year, an increase of $17.3 million or 10.7%. The rotating electrical segment reported net income for its fiscal 2012 of $14.3 million compared with net income of $12.2 million for the prior fiscal year. Fiscal year 2012 EBITDA for the rotating electrical segment was $33 million before non-cash loss recorded due to the changes in the fair value of forward foreign currency exchange contracts, Fenco-related and professional expenses and non-cash standard inventory revaluation write-downs of approximately $900,000. For the undercar segment for the period from May 6, 2011, through March 31, 2012, net sales were $185.1 million. Net loss was $62.8 million, which includes contractual customer penalties, intersegment costs, premium inventory purchases and freight expenses, additional production costs, unique customer -- period customer allowances and rebates, loss from product lines not supported, professional fees related to the integration of Fenco and non-cash purchase accounting inventory step-up adjustment in connection with the May 6, 2011, acquisition. Undercar segment EBITDA adjusted for the items above -- noted above was negative $11.6 million. At March 31, 2012, our balance sheet had $32.6 million in cash and $502 million in total assets. Motorcar Parts of America's rotating electrical segment and Fenco's undercar segment have separate bank credit facilities. MPA's rotating electrical segment had a $75 million term loan, 0 borrowings on the revolving credit facility as of March 31, 2012, under the new financing agreement and approximately $32 million cash resulting in net debt of $43 million. Fenco had a $10 million term loan and $49 million borrowings on the $50 million revolving credit facility at March 31, 2012. In April 2012, Motorcar Parts of America raised $15 million in the pipe, netting approximately $14 million after fees. Additionally, in May 2012, Motorcar Parts of America added $10 million to the term loan, increasing to a total of $85 million. Subsequent to the fiscal year ended March 31, 2012, MPA paid approximately $16 million to a Fenco vendor in connection with the prior consignment arrangement. Additionally, MPA invested $20 million in Fenco since March 31, 2012. So currently, MPA's rotating electrical segment has an $85 million term loan, 0 borrowings on the revolving credit facility and approximately $30 million cash, resulting in net debt of $55 million. Currently, Fenco has a $10 million term loan and approximately $42 million borrowings on the $55 million revolving credit facility. On August 22, 2012, Fenco signed a multifaceted strategic cooperation agreement with one of the world's largest automobile manufacturers of new undercar products, including a $20 million trade line of credit for Fenco, joint sourcing and quality commitments as well as expected joint product development and marketing initiatives. The agreement greatly enhances the liquidity of Fenco and should provide a strong strategic alliance for new product development for both our undercar and underhood product lines. In conjunction with this agreement, M&T Bank, the current lender for Fenco, extended the Fenco line of credit maturity until October 2014 that increases line of credit by $5 million. During the 3 months ended March 31, 2012, the rotating electrical segment generated $8.3 million of cash flow from operations based on $6 million net income, and the undercar segment used $1.5 million of cash flow from operating activities, primarily due to inventory reductions. During the 12 months ended March 31, 2012, the rotating electrical segment generated $15.5 million of cash flow from operations based on $14.3 million net income for the 12-month period. For the period from May 6 through March 31, 2012, the undercar product line segment used approximately $54 million of cash from operations, primarily consisting of loss from operations due to the negative impact of product lines that have since been discontinued and aggressive legacy sales prices, higher customer allowances being provided and higher manufacturing costs in part to the under-absorption overhead on lower production levels. As explained previously, as we integrate the Fenco business, we are addressing future pricing and the efficiency of the manufacturing operations and implementing cost-saving initiatives for production, warehousing, distribution as part of the turnaround strategy for Fenco. I will now walk you through the income statement exhibits in our press release distributed this morning, which we believe will make it far easier to understand the various expenses and adjustments for the fourth quarter and fiscal year ended March 31, 2012. If you can take a moment to turn to the income statement exhibit in the press release starting with the last page, we can begin. The income statement exhibit on the last 2 pages of the earnings press release present the 3 months ended and 12 months ended March 31, 2012, fourth quarter results of operations for the rotating electrical segment. So the last page of the earnings release, when you eliminate the effect of Fenco-related costs, non-cash loss recorded due to the changes in the fair value of foreign currency exchange contracts and intersegment interest income, diluted earnings per share was $1.04 for the 12 months ended March 31, 2012, for the rotating electrical segment. It's calculated by taking the reported earnings per share of $1.15 and reducing net sales for intersegment revenue of $1.9 million and adjusting for Fenco-related G&A expenses of $2.5 million, non-cash loss recorded due to the changes in the fair value of forward foreign currency exchange contract of $476,000, sales and marketing Fenco-related costs of $238,000, professional fees, acquisition costs of $713,000, interest segment interest income of $2.5 million and a 39% tax rate. So by subtracting the above-mentioned items to the reported $1.15 per diluted share results in $1.04 per diluted share for the 12 months ended December 31, 2012, 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 12 months ended December 31, 2012. Starting with operating income of $26,574,000 and adjusting for the impact of intersegment revenue, Fenco-related and non-cash items as previously mentioned and depreciation and amortization expense of $3,466,000, rotating electrical EBITDA is $32.1 million. In addition, adjusted further for the non-cash standard inventory revaluation write-downs of approximately $900,000, FAS 123(R) non-cash stock compensation expenses and severance costs totaling $70,000 and other Fenco-related costs, rotating electrical EBITDA for the 12 months ended March 31, 2012, was approximately $33 million. Now please turn 2 pages forward to the earnings press release showing both the rotating electrical segment and undercar product line segment results of operations for the 12 months ended March 31, 2012. Consolidated operating results for the 12 months ended March 31, 2012, which includes the period from May 7 through March 31 -- for the undercar product line segment was impacted by Fenco-related expenses and non-cash expenses, which were highlighted in the adjustments column. To recap once again, these adjustments include: contractual customer penalties and unique current period customer allowances and rebates of $7.9 million; higher costs inventory purchases and premium freight expenses of $3.3 million; additional production costs of $5.1 million; the effects of non-cash fair value purchase accounting on Fenco's opening balance sheet for inventory step-up adjustment of $3.7 million; Fenco-related G&A, bank financing and legal costs, as well as professional and related fees related to the integration strategy totaling $6.2 million; foreign exchange loss of $476,000; sales and marketing Fenco-related costs of $238,000; impairment of plant and equipment of $1,031,000 related to the write-off of the carrying amount of plant and equipment at the CV axle production facility that was closed; and other professional fees of $713,000. Additionally, the loss from undercar product lines, which we do not plan to support, is approximately $11.9 million, which includes the cost impact of the closure of the CV axle production facility. So by adding the above-mentioned items to the reported loss of $3.90 per share, results in loss of $0.84 per share for the 12 months ended March 31, 2012, for the consolidated rotating electrical and undercar product line segments. Additionally, at the bottom of the exhibit, there's a calculation for EBITDA for the 12 months ended March 31, 2012, which includes from May 7 through March 31 for the undercar product line segment. Starting with consolidated operating loss of $27,487,000 and adjusting for the impact of Fenco-related and non-cash items as previously mentioned and depreciation and amortization expense of approximately $7.4 million, consolidated EBITDA for the 12 months ended March 31, 2012, is $20.6 million. After further adjusting for approximately $1 million for non-cash standard revaluation write-downs and other adjustments explained above, EBITDA for the 12 months ended March 31, 2012, was approximately $21.5 million. I will now turn the call back to Selwyn, who will make a few additional comments before we open the call to questions.

Thank you, David. Obviously quite complicated to understand the under-the-car segment. But having said all of that, our proposition for our business remains exciting. Our rotating electrical business is strong, and the visibility we have to completing the transition plan for undercar parts is clear. We have made an excellent addition to our Fenco management team with the appointment of Scott Matrenec as president. Our reporting, while currently delinquent, is on track to being current, and we feel that operating the undercar business will be far more efficient with the implementation of the MPA ERP for Fenco. While the numbers are very noisy, we expect to see the results of our efforts more clearly starting in the fourth quarter of this fiscal year. While there are always challenges, we believe we are on the right track. We are committed to the highest levels of customer service throughout our organization and are excited about the future opportunities for Motorcar Parts of America, both in terms of the continued strength of our rotating electrical business and the opportunities both in our existing business and the growth opportunities in the undercar segment. In summary, long-term market statistics for our industry remain favorable, and we're excited about the opportunities. I appreciate your interest in Motorcar Parts, I appreciate your patience, 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, David, I just wanted to clarify on a couple of points. So I think you mentioned that you're bringing Fenco to about $150 million annual revenue run rate effective in the current quarter. Is that to imply the September quarter, so September quarter Fenco sales of, I don't know, roughly $38 million?

It should be a little higher than that, but it will taper down in the next quarter. We've made the changes -- significant changes during this quarter.

Okay, okay. And then I believe you indicated that first half of fiscal '13, rotating electrical EBITDA was in the high teens. Did you give that metric for under-the-car? Has Fenco been EBITDA positive through the first 6 months of this fiscal year?

No, the numbers are so noisy. It's relating to the first 6 months of Fenco. It's difficult to give clear guidance on that. But I think that -- we clearly believe that we will be at the $50 million of EBITDA starting in May of the next fiscal year.

Okay. And do the changes in your strategy affect your kind of longer-term target of getting to a 20% gross margin for Fenco?

No. I think the near term -- the near-term target will be around 17%, 18% and growing to 20%, and then we can focus on taking it from there.

Okay, great. That's helpful. And just one more for me and I'll back out into the queue. What should we expect for the full year, fiscal year '13 interest expense? And could you maybe also provide some insight into your expectations for tax expense for the full year?

For the rotating electrical segment, interest expense will be approximately $13 million. For the undercar segment, interest expense should be about $8 million for a combined $21 million for fiscal '13. And for the tax rates, the rotating electrical segment should continue at approximately 39%.

[Operator Instructions] Our next question comes from Mitchell Sacks with Grand Slam.

Just to sort of continue on with the Fenco questions. So the resized business you're saying, is it going to be the $150 million run rate, and you were saying roughly $15 million of EBITDA. And that's the number where you're starting from, that's what you expect to do in the next fiscal year?

That's -- starting in May, we believe that the run rate will be $15 million.

Okay. In terms of CapEx, what is CapEx starting to look like? Where do we think that, that runs on a sort of normalized basis?

So there's 2 pieces. Obviously, there's transition CapEx and then the normalized CapEx.

So on the maintenance CapEx, it's going to be about $2 million for the rotating electrical and about $2 million for the undercar segment. There's going to be a little bit more CapEx for the undercar segment because we're in the process of finalizing the ERP implementation.

Do you have an idea what that might run?

We'll provide a final guidance once completed.

Okay. And then you talked about debt peaking at $120 million at calendar year end. That's $120 million net of the cash, is that what I'm understanding?

Can you repeat that, Mitch? Sorry.

No problem. I thought I understood that you said that the net debt would peak at about $120 million at year end. That's net of the cash of Motorcar Parts. Correct?

That is correct.

Okay. And then if you're doing the cash flow numbers that you're talking about with the interest expense and the CapEx as it sort of sits, do we -- do you have sort of a ballpark in terms of what you think you may be able to pay down over a calendar year just without getting too exact?

I don't have that computation but -- in front of me, but it's $21 million of interest. You have tax on CapEx of $4 million and then tax on the MPA earnings. We're talking about -- what would the tax be about?

I do want to point out that we see that the sales growing for -- for the rotating electrical segment, so we need to factor in the working capital requirements as we grow the business for the base business at MPA.

Yes. So what do we -- what was tax for the last quarter, MPA tax, 39%, what was the dollar amount?

For the year -- okay, so for the year, it should be approximately $8 million.

And then in terms of...

About $23 million before you talk about working capital adjustments and free cash flow. Okay. Go ahead. I'm sorry, Mitch.

No problem. In terms of working capital at Fenco, when does that start to normalize or come down to a lower level?

I think that's happened. Certainly with the reduced revenues that we're looking at, we think working capital is definitely -- is leveling off. Now there's obviously the capital that's required for the transition that will be spent between now and mostly April, March, April. But other than that, it's leveled off. I mean, the requirement for inventories reduced dramatically. We've eliminated unprofitable product lines. We've eliminated unprofitable customer sales relating to the undercar products. So we think that's happened.

Okay. And then final question and I'll get back in queue. With respect to the new relationship with the Chinese manufacturer, is that factored all into your thinking in terms of next year, or is there a potential upside to what that relationship brings?

Well, I think it's not only that relationship. I mean, I think we're talking about combined $350 million, $360 million company as a base level. We certainly believe there's a significant growth opportunity in the undercar product segments that we're in. We're very underutilized, we have lots of capacity, and we expect to see a lot of growth in those -- in the categories in undercar. In addition to that, we continue to grow our rotating electrical business and with a very, very solid operating metric. So we think it's just the beginning. I mean, getting through the transition has obviously been somewhat chaotic and noisy but quite frankly, once we get through this, I mean, the end is in sight. And once we get through it, I mean, there's a very, very significant market for parts and growth in our product lines. So we expect to continue to see growth in our rotating electrical, and I think you'll see even much greater growth in the undercar products with better margins.

Our next question comes from Jacob Muller of AYM Capital.

The interest expense again, I mean, it seems to have gone up a lot and it seems like a very high number on the size of debt that you're carrying. So can you explain the -- where that's all coming from?

So for both the rotating electrical and undercar segment, interest expense is comprised of interest on debt as well as factoring interest.

So a lot of the way the receivables work in the aftermarket is that our customers basically factor their payable, and we pay the discount rate. So it's not typical factoring but it's -- and what that does is it enables us to collect quicker, and the customers to get extended terms, and we get the benefit of the very low interest rates that they're able to get for the factoring.

And so most of that new factoring came at the back of the Fenco acquisition?

No, it's on both sides. It's in every segment, it's throughout the whole aftermarket. That's sort of just standard operating procedure across the board.

So it looks like the working capital that has gone up a lot since the acquisition relative to what it used to be or...

Well, it clearly has because of 2 things. I mean, when we walked into the acquisition, we had a big supply chain catch up, a lot of revenue, I mean, super revenue performance on really on products that for the -- some of them is nonprofitable. So I mean, our commitment is to the customer, and we think that our commitment to the customer ultimately relates to building value for the company. And so we ramped up working capital to support supply levels to the customer, and then ran into a little bit of a hiccup with the financing, a little bit of a shortstop there, and then got refinanced and with the pipe and the strategic cooperation agreement and now back to normal levels. So been a little tumultuous in that area relating to the working capital requirement. But that's stabilized and settled down dramatically at this point.

And as far as that $15 million charge that you mentioned, I mean, when will you be taking that?

$15 million charge, I think that maybe you're referring to the payable that we made, that was not a charge. That was just a -- it was a payable that MPA made, and it's paid and that's gone. We kept -- everything is reflective of after that already. There's no charge for that, P&L charge.

And around when I mean in the past, you had mentioned that a lot of these savings will be coming in pretty much on a linear basis. And now you mentioned that the first half year has been rather noisy. But when would you expect Fenco to be running at, let's say, breakeven or so on an EBITDA basis?

I would think next quarter, that is the next quarter. So we're in -- that will be the March quarter. Unfortunately, we were quoting numbers that are very aged. I mean, these numbers reflect operation 6 months ago, so a lot has changed since then.

Okay. So some color around...

I'd reiterate that I think the completion of the transition plan is very much in our sights right now, and so we're getting close to the end.

Our next question comes from George Berman with J.P. Turner and Company.

When do you think you'll catch up with the first quarter results?

It's hard to tell. We think that now that the audit's done, that the filing of the Qs will come fairly expeditiously. The latest we said we will file would be December 26. I mean, we were expecting to file it much earlier than that. George, I wish I could give you a date today, but we've just got this filed, and so we now got to turn our sights onto 2 things. I mean, the whole ERP integration go live will be in October. So starting the October quarter, everything will be on a new platform, and we've got to file the 2 Qs that are outstanding. But we believe with the amount of work and effort that's gone into looking at the numbers in the system for the audit, the year-end audit, that the quarter should be significantly easier to get done.

Okay. And looking at your finances here, under the assets, I show $68.3 million in goodwill and another $22.4 million in intangible assets. Do you expect that to be written down this year in part due to like a goodwill impairment charge or so?

I don't know the answer to that. I know that we just did a valuation in conjunction with this audit that was completed in the last few weeks. And the results were that there was no impairment. So we will continue to look at impairments on an annual basis. And to the extent that there's anything major on a quarterly basis, we'll look at it, but at this point, I don't know. I mean, I think that's something that's done by a very strict set of rules in terms of how they value this goodwill. And to be honest, I'm not sure exactly how it will end up. But I feel like the operating results of our company will hit the targets that we've given you.

And the intangible assets, what do they represent, compared to goodwill?

Both would represent customer relationships, trademarks, trade names. David, anything else?

Yes.

Those are the main things.

Okay. And you mentioned that there's a lot of synergies between customers of Fenwick and customers of Motor Parts. Can you quantify somehow what kind of savings you could expect to wring out of this joint operation now?

Yes, and I think we've already -- on the sales side, we've integrated the sales force. So there's a lot of savings there already. I mean, that's been completed. I think the key thing with the customers, they want to make sure and see the progress of the Fenco transition. If that Fenco transition pans out the way we expect it to be, and we expect it to follow the model of the rotating electrical, the MPA, that the customers will be excited at the opportunity to get that kind of service in undercar products. So we're well on our way to being there. We've got now product specialists in each one of those areas. We've got category specialists in each one of those areas, catalog specialists in those areas. So I think that whole piece is complete now. I mean, we've got a very strong combined sales force with tremendous product support for the customers. So that in itself is going to -- we believe, will result in accelerated growth as everybody as including the customers have faith in the transition completion.

Okay. Speaking about your income tax rate. You cannot utilize the tax loss generated with Fenco for Motorcar Parts?

Yes, unfortunately, that net operating loss can only be used against income for Fenco in the Fenco entity. And as of historical, once we go forward and it becomes part of the same operating group, then hopefully there won't be too many more losses, but those losses could be offset. But in the meantime going forward, what will happen is net operating losses from the past will be offset -- Fenco will not be paying tax for a while. So we kind of offset the rotating electrical income.

Yes, all your motor parts manufacturing operations are in Mexico. What kind of operations do you carry in Canada in terms of manufacturing?

At this point in time, there's no manufacturing in Canada whatsoever. The last pieces that will remain in Canada will be supply chain, logistics and some category management and then the manage -- inventory people. The accounting has been -- will be consolidated and has been -- people will be notified that it will all be consolidated into the Torrance facility. And so Canada will be a much smaller -- significantly smaller operation. There's some excellent people there that will be part of the combined organization and that we intend to keep going, and that it's very little is from a -- no manufacturing. There's definitely a little bit of engineering and product support there, but that's all that's left.

Right. And they never had any U.S. manufacturing, right?

No. The U.S. -- well, they did. The CV axles were manufactured in New Hampshire, which we -- shut that down.

You closed those down.

Yes. So now all we have in the U.S. for Fenco is we have a tech center and distribution.

Yes, and the distribution, you're in the process of paring down significantly as well?

Right. And that's in the -- with the distribution, there's 3 facilities that are going to be pared down into splitting one facility of Fenco and utilizing the MPA distribution facility. So you'll have synergies in distribution. There's significant, significant savings there and that's -- that we have good visibility on.

Okay and then last question. The partnership here with the Chinese manufacturer, they extended a $20 million credit line that is on a certain service that is convertible into stock. Can you explain that a little bit?

Yes, let me -- everything feels like a million years ago in this company because so much is going on, on a day-to-day basis. But essentially, the relationship with the Chinese supply is that they, at any point in time, just to really summarize it significantly, could convert up to $8 million of payables into equity at $7.75 a share, or they could buy up to $5 million of incremental equity at $7.75 a share but in no case can they, under those terms, can they get more than $8 million of stock at $7.75.

Okay. So going forward that the share count should still stay reasonably low, right?

Well, I think we believe we have adequate capital.

Well, your debt pieces are nonconvertible, right?

The debt pieces are nonconvertible, correct.

Okay. And there are no major prepayment penalties either, right?

There is a prepayment penalty on the MPA debt, which is I think about $3 million or $4 million next year, I think, is there. It reduces as the term of the -- what is it, David?

After one year, it's 3%.

3%.

Our next question comes from Matt Sherwood with Cooper Creek.

Just had a quick sort of a housekeeping item. I know you said net debt should peak at $120 million, but that includes some sort of duplicative working capital at Fenco as you get the customer service levels up to where they need to be. What would -- how would you quantify the excess working capital?

I'm trying to understand the question. How would I -- help me understand a little bit better, Matt. I mean, David is looking at me as well like he's not understanding. Can you give us another shot at the question?

Well, I think your implication was one that, that will peak at $120 million. It should come down as you work down excess inventory, that you're building as part of this acquisition or excess working capital generally. And obviously, we talked about the $20 million level of free cash flow before any working capital contributions, but I thought that there's some excess inventory that you're carrying in your balance sheet when you have $120 million in net debt.

We've pared down some of the inventory, and we are continuing to pare it down, but let me let David take that.

As far as building it up to the $120 million, just to recap again, the rotating electrical currently has approximately $55 million in net debt, and the undercar segment has approximately $52 million in debt, so combined, currently about $107 million. That $107 million will build up to $120 million primarily to fund the transition and turnaround, this transition cost working with vendors. And once that is completed, as the company is generating positive cash flow, the combined basis, the net debt from its peak will start to come down.

Got you. So the net debt will come down through free cash flow, not through eliminating any sort of duplicative working capital inventory.

No, I think because that's -- quite honestly, we think that incorporated into this is going to -- we've got some growth and certainly identified growth in the rotating electrical, and we believe some new business coming at us in the undercar as well. So I don't believe the source of cash is working capital reduction. It's more free cash flow.

I'm not showing any other questions in the queue at this time. I'd like to turn it back over for closing comments.

Okay. Well, we thank everybody for their patience. We certainly again feel optimistic and excited about the opportunity for our business going forward. We think the numbers that are reflected in March obviously are old numbers. And as we move to what should be the norm and will be the norm on current reporting, we certainly expect to see significantly increased better performance from both entities. So we thank you, everybody, for your time.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.