Good day, ladies and gentlemen, and welcome to the Motorcar Parts of America Fiscal 2018 First Quarter Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. Gary Maier with Investor Relations. Mr. Maier, you may begin.

Thank you. Thank you, everyone, for joining us for the call today. Before I 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 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, please refer to the various filings filed with the Securities and Exchange Commission. With that, I’d like to begin the call – turn the call over to Selwyn.

Thanks, Gary. Appreciate everyone joining us today. As highlighted in our earnings press release this morning, despite industry-wide softness due to various widely discussed factors, we achieved record sales for first quarter. Many in the industry have pointed to an unusually mild winter resulting in weaker demand. We believe this softness is temporary. The fact is the outlook for non-discretionary parts should be strong, and we expect to increase sales activity as our fiscal year evolves. Our current product categories represent approximately $4.7 billion of the estimated $125 billion U.S. automotive hard parts aftermarket industry. Therefore, we still have a lot of growth opportunities available. Furthermore, with our recent D&V Electronics acquisition, a new market opportunity has been added, which greatly expands our growth potential. We are fortunate to have a global footprint that enables the company to maintain a competitive cost structure for our existing product lines and to effectively pursue new product line expansion opportunities based on sound economics and quality. An additional strategy for growth is our focus on acquiring companies and developing and offering innovative state-of-the-art technologies. Our acquisition of D&V Electronics last month, which I just mentioned, is a prime example. D&V, which is a highly regarded designer and manufacturer of leading-edge tester systems, provides a unique opportunity to participate in the approximately $5 billion per annum global automotive testing market. D&V is uniquely compatible with Motorcar Parts of America in that it is a recognized leader in diagnostics for alternators, starters and stop-start technology testing systems. These testers are used predominantly in the manufacturing environment. D&V also has a leading benchtop testing capability for these product categories. We believe that the North America market for benchtop testers exceeds $100 million just in automotive parts outlets alone. This is due in large part to new…

Thank you, Selwyn. I will now review the financial highlights for the fiscal 2018 first quarter, reflecting, as Selwyn noted, record sales for our first quarter. Before I begin, I encourage everyone to read the 8-K filed this morning with respect to our June 30, 2017, earnings press release for more detailed explanations of the results, including reconciliation of GAAP to non-GAAP financial measures, and the 10-Q, which will be filed later today. Net sales increased 11.3% to $95.1 million for the first quarter from $85.4 million from the prior year fiscal first quarter. The $9.7 million increase in our net sales was primarily attributable to higher sales of rotating electrical products. Adjusted net sales increased 1.3% to $95.1 million for the first quarter from $93.8 million net sales for the prior year. The adjusted net sales increase of $1.2 million was due to the following. Rotating electrical net sales increased $4.2 million to $74.1 million for the first quarter from $69.9 million for the prior year, which was partially offset by a decrease in net sales of wheel hub assemblies and bearings of $1.6 million to $17.2 million for the first quarter from $18.8 million a year earlier due in part to softer demand. Net sales for break master cylinders were $2.5 million for the first quarter compared with $5.1 million a year ago due primarily to timing of update orders. To clarify, update orders from customers represent product line expansion and the introduction of new SKUs. These orders are received intermittently throughout the year. The master cylinders update order will be in the second quarter of this fiscal year compared to the first quarter of the prior fiscal year. Additionally, the combined net sales for the first quarter for brake power boosters, which we started shipping in August…

Thank you, David. We’re excited by the multiproduct line growth in our business despite what we believe to be some short-term industry challenges and look forward to continued success. As I stated earlier, we have significant new business commitments, which will predominantly begin shipping in our second half of the current fiscal year, and as such, our growth run rate at the end of the should exceed our annual guided growth rate for fiscal year 2018. Let me reiterate, we are focused on gaining market share in our existing product lines. In addition, we are focused on efficient deployment of capital, which may include stock buybacks, acquisitions and new product line launches, among other things. We remain dedicated to manage growth and continue to focus on enhancements to our infrastructure and making investments in resources to support our customers and grow value for our shareholders. The company continues to focus on its award-winning customer service programs. We are busy and we are working on a number of exciting initiatives. Our financial position remains strong, and our capacity for further accretive growth is excellent. As always, I wanted to thank all 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 services we provide. The energy of our team is exciting to watch as we push forward to execute our plans. Our success and accomplishments are due to this incredible team. In addition, we welcome the great D&V team to our family. We appreciate everybody’s interest in Motorcar Parts of America, and now we’ll open up the call for questions.

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

Hey, it’s actually Greg Palm on for Steve. Thanks for taking our questions.

Hey, Greg.

Hi.

So I’m curious to get your thoughts maybe on the overall industry, where we are from when we last talked. I guess it was in mid-June. What are the industry drivers? What’s going on, whether that’s consumer shifting to more online purchases? What’s the inventory situation out there? Any impact of weather, et cetera?

Yes. I mean, just as an update, I mean, things continue to be a little soft. I mean, there’s no question about that. We don’t believe it’s relative to any shift in market share between online and retail, and we just don’t believe that at this point. And we believe the weather has an effect. But there – through my career in this industry, and I’ve been involved in quite – for quite some time, we see this troughs. If you look at the car population slide, which we referred to, you can see that there’s a disproportionate amount of vehicles growing in the 12-plus-year category and a little bit of a reduction in the vehicles in the 8 to 11 category. And so I think as you watch the aging, I think, of these vehicles over the next years, the market will come back at an even greater pace. And I think the adjustment for just normalizing sales will come, I mean, I hope soon, but I can’t predict that. I will say that if you look at repair rates and you do the arithmetic, it appears right now that perhaps the average selling price of the amount of repairs that’s been done in the market may be a little lower than it’s been historically. And you can see that the car population in the 12-plus category has gone up disproportionately, and generally, the cost of those units is a little lower because the vehicle is a lot older. And so perhaps, that has – that’s having a little bit of an effect. Having said that, if that’s the case, I mean, then the future looks rosy in terms of being able to grow margins and grow revenue for everybody, whether it be online, retail or whoever sells the product, including the suppliers, hopefully. So wish I could give you much more intelligence, but I think it’s just a matter of the demand is going to be there, it’s just a question of when it turns.

Yes. No, that’s good color. I mean, any color on the guidance, I guess? Maybe I missed it, but I didn’t hear whether there was an update there or reiteration or whatnot.

Yes. Well, we haven’t – well, again, we haven’t updated. We stand by existing guidance. And so we continue to build share. Now whether that will translate into its maximum optimal levels immediately, because of the softness, that may not happen. But as soon as these levels come back, you’ll see a disproportionate jump in our growth. And so we’re ready. We are not concerned. We continue to go by business as usual. We continue to be very aggressive in supporting our customers’ initiatives, and we continue to be very optimistic about our business, quite frankly, from a long-term outlook. I mean, I’m not commenting on the next quarter, so please don’t read into that. But on overall outlook, yes.

Totally understand. Shifting gears to the acquisition. It looks to be fairly small, but how should we be thinking about the potential revenue impact there, synergies? And just curious, from a customer standpoint, are those OEMs, aftermarket, repair industry? Any color would be helpful.

Right. So I’ll break it down into two categories: the aftermarket, first; and then the OEM. The aftermarket – this is a company that has a history of producing sort of the state-of-the-art blue-chip testing devices for rotating electrical. That’s really their base DNA. And we believe that they’re well positioned and, with our help, extremely well positioned for significant growth in the retail traditional environment, I mean. And right now, the retail traditional environment, I mean, I can’t tell you exactly how many testers they have, but there’s more than 30,000 testers out there that all have got to be upgraded or replaced. There are not a lot of competitors in this space, and I believe their technology is the best in the industry. So I think there’s some very significant upside in that. I mean, of course, we don’t have that yet, but we are optimistic about the outlook in that area. In addition, with the significant investments they’ve made in personnel that understand new-age energy generation, which is really the electrification of the vehicle, they are very active with some of the world’s leading carmakers in designing test equipment for them, for the electrification of vehicles and batteries – including batteries. So that will be Phase 2 of their growth in my opinion, but it positions us well within that sector. And then as that sector gets older and ages, it becomes the aftermarket, and certainly, we would hope to have the state-of-the-art electric motor testers for the retailers and whatever is needed in the aftermarket in the future. So we are very excited. We think it adds to our technology base. Their technology working with the OEs are very proprietary so that remains very secretive at this point in time, and we will not interfere with that at all. And – but on the aftermarket, I think there’s best practices, and we ourselves are pretty sophisticated developers of diagnostic equipment. And I think the addition of D&V and the brainpower of our engineers with their engineers and their management team and I think there’s a lot of opportunity for both companies, D&V and MPA, in those.

Yes, that’s great. And it sounds like a pretty big market. Curious, are there a handful of leaders? How fragmented is it? Is there a consolidation opportunity? Is that even part of the future strategy here or not?

There are a few competitors that, in our opinion, offer a product that’s worthy. And so the consolidation opportunity to me is less than the market share opportunity. I think the global manufacturing footprint continues to expand. With the resources we can provide to them, I think they can be far more effective in competing in the Eastern European and Chinese markets, where there’s a lot of new production spurning, and we believe that those markets are ripe for growth for them. I think it plays hand in hand with our capabilities in, certainly, the Chinese market and the Southeast Asian market so – in terms of a possibility to open up in the near future. So – and our team and our infrastructure can accelerate their efforts in those markets. They’re a little already, but not at the scale that they have the potential to be there. So I think just our footprint, along with our infrastructure and management infrastructure, can pave the way for them to move quicker without compromising any of the sort of leading-edge quality that they have.

All right, thanks. Appreciate all the color.

Thank you.

Thank you.

Thank you. Our next question comes from Matt Koranda with Roth Capital.

Good morning, guys.

Hey, Matt.

Just wondered if you could help out on a margin question I had. So on an adjusted basis, revenue is kind of flat to slightly up, and the mix of rotating electrical business this quarter versus last year’s quarter looks a little bit higher in terms of product revenue contribution. So that would generally indicate gross margin should be a little better, but they were lower year-over-year. I know you cited returns, but can you help us understand how that worked and impacted the gross margins this quarter? And then was there a change in the mix at all of the rotating electrical product that you sold this quarter that would have also kind of adversely impacted gross margins?

I would tell you – I’m going to let David handle this in more detail. But just to give you a little bit of color on the quarter, which – I don’t want to be stuck into this type of guidance, but I’ll give you some color, in that the month of April was extremely weak in the – for us, I mean, and I believe in the industry as well, but I don’t know that for a fact. And so our overhead absorption in April, we suffered significant margin decreases in it just because of the absorption of production in April, and then we saw nice returns back in May and June. But David can talk a little more about the returns in a little more granularity. But there was very unusual demand for the quarter, so that doesn’t help us.

So for the returns, returns are recorded as a reduction to gross sale, so higher returns and a higher return rate would reduce the net sales per unit. So that has an impact on gross margin percentage.

Okay, got it. So when we think net sales, it would have reduced your gross sales line item but not reduce your costs. So that’s where the impact comes from, from the returns?

Correct.

Correct.

Okay. All right. Got it. Inventory, just looking at that on the balance sheet this quarter. It seems a little higher than I would have expected. I think it’s around 111 days. Is this the high watermark for the year? And are we essentially just building up for new business toward the back half of the year? Just help us understand how that moves through the rest of the year.

Well, I think you’ve got – I mean, just to comment on where we are today in this report, is you sort of had the perfect storm. You’ve had a decline in demand and a big ramp-up in our potential demand. We picked up, we believe, fairly significant share in the rotating electrical category. So we’re ramping up for new business, but at the same time, we’ve had the softness. So you see, I think, a disproportionately high inventory. There’s a lot of effort now to pull back inventory without jeopardizing any of our fill rates. So hopefully, we’ll see – I think you may see it peak a little higher than this, not much higher, and then come back down.

Okay, got it. Then just one on long-term core inventory, if I could here. Just help me understand, how would the long-term core inventory line item on the balance sheet change as we move through the year? I know you have new business coming on sort of in the back half of the year. Is that already reflected in what’s in long-term core inventory currently? Or are we going to see more additions to that over the balance of the year?

Yes. So the new business in remanufacturing, you would see we would have to buy back cores, and you will see an increase in the long-term core inventory. We think, just as a rule of thumb, that the ratio of revenue to long-term core inventory in terms of returns is around 5:1. So I know you had mentioned that in your report yesterday. But you buy back the cores once. You pay for them over a period of time. You get long-term contracts generally when you buy back a core, and hopefully, you don’t lose that customer. And so the return on that core buyback is very high.

Okay, got it. Just maybe one or two more. Just help us understand sort of – I know you’ve reiterated your top line guidance, but if you can help us a bit with the gross margin outlook for the year. Where do we expect that to kind of move as we see demand pick up and that new business come online in the back half of the year? I know we’re kind of on the low end of the range you provided. Do we start to move toward the higher end of the range? Is that what we should safely sort of factor in for the remainder of the year?

Yes. I agree with everything you said except the safely part. I mean, we’re in an industry that’s gone through a little bit of adjustment in demand. So I mean, I don’t – I say that tongue in cheek. But as our volume increases, you should see the margins increase to the top end of the guidance levels we gave.

Okay. And then just one – sneaking one in on D&V. I think the net leverage stats that you guys gave in the prepared remarks, probably you paid about $16 million. Is that directionally accurate? And maybe just help us understand how you guys value the business and your diligence.

Yes. So it’s not material. So we haven’t disclosed it. It’s significantly less than that. We have put some working capital into – the acquisition price was less. We have put working capital into that business. The debt ratio we used was post acquisition. But I mean, at this point, we haven’t publicly disclosed what that amount is, so I’d rather not go down there. But it’s not material in terms of the capital investment, but I believe that the opportunity it provides will become very material to us.

Okay. I’ll jump back in queue.

Thanks.

Thank you. Our next question comes from Scott Stember with CL King.

Good afternoon, guys.

Hey, Scott.

Maybe we could just talk about a couple of the pieces of the business that were most impacted by weather. It seems that even though you guys had a 6% increase in rotating electric, that there still was some impact here. And also, on the wheel hubs, one of your bigger customers reported on their second call that the rotating electric, their sell-through rates actually started to pick up in the second quarter. Could you maybe just talk about, just on a more near-term basis or on a recovery standpoint, what you see there? I know that warmer weather certainly can help the rotating electrical business. Just tell us what you’re thinking on that.

Yes. So I think, again, we hope that the – that we’ll see some – I think we are seeing some pickup. I don’t think it’s as vibrant as we would like it to be. I know it’s not as vibrant as we’d like it to be. There definitely is some pickup of hardware that will help enormously for rotating electrical. The back half of this year is exactly – is where we expect to see most of that pickup come. I do think it’s in the process, but it’s not an instant pop right back. On wheel hubs, I mean, we certainly, I think, have missed the season. And while we have a lot of new market share coming into the fold in wheel hubs, I mean, we’ve definitely seen some decline there. And hopefully, we’ll get back into the normal course of regular winter weather, and these maintenance deferrals will catch up in really the fourth quarter, which should be an opportunity for the wheel hubs, apart from the first quarter of the following year, to see it pop back up. But that’s the category that’s certainly going to be the most hurt based on the mild winter because that’s much more seasonal relative to winter demand. On the others, they’re all pretty small, but I would tell you that there’s not a category we don’t have new business coming in. Every one of them will grow.

Got it. Just looking at sort of full year, you talked about significant new business coming in. Can you maybe just quantify the level of new business that you have coming in this year versus last year? Just generally speaking, high level, are we talking about an increase over a year ago? And maybe if it is, maybe just give us an idea of how much, just to sort of...

Yes. So I think – I mean, I think it’s all in our guidance. Unfortunately, the guidance gets a little confusing because there’s some softness in the base demand. So you don’t see the incremental pop as big as you would see it if there wasn’t a decline in the base amount. But we don’t really quantify the dollar amounts of new business versus – from one year to another. But they are solid. And not only are they solid in terms of the dollar opportunity, but we think the growth opportunity with that increased share is going to be strong from that business. So I’m sorry to be evasive but that’s – I mean, I think it’s all in our revenue guidance for now.

Got it. And just I know you guys aren’t guiding on a quarterly basis, you clearly said that the back half of the year is where things pick up. But just trying to get a sense for the quarter that we’re in right now, particularly that you had that seems like a couple million dollars of brake master cylinder business that got shifted into the second quarter. How should we be looking at this quarter, heading into or leading up to the back half of the year where most of the growth is supposed to be?

Well, clearly, it’ll be sequentially better than the first quarter. We are confident – very confident of that. We think it’s going to get stronger than – we think the industry is in some recovery mode, but I would not expect the big gains for this quarter that we normally would have had based on the share that we’ve had. So I would be – again, we believe that we’re going to see the significant bump in that third quarter and fourth quarter. So while we think it will be a good quarter, we’re not overly optimistic for huge jumps in the quarter. But we see recovery underway, but beginning – but slow.

Got it. And just last question on the margins again. David, maybe you could just go into a little bit more detail of the 370 basis points of decline that we’re seeing in the gross margin on an adjusted basis. Was that all due to returns? Or was part of that – maybe you could just flesh out how much of that was overhead – loss of overhead absorption versus returns.

It was mostly returns that had the largest impact. As Selwyn mentioned, there’s a little bit of absorption, but it’s mostly returns.

Mostly returns, okay. So I’m just trying to get a sense of where we can expect margins to go as we progress throughout the year. Clearly, this looks like the low watermark for the year in the first quarter.

Yes.

Yes. We think they should start inching towards the upper end of our range.

Got it. That’s all I have. Thank you very much.

Thank you.

Thank you.

Thank you. Our next question comes from Christopher Van Horn with FBR Capital Markets.

Good morning, guys. Thanks for taking the call. Congrats on the quarter.

Thank you. Good morning.

Good morning.

I just had a question on some of the new business coming online. Is there a meaningful margin difference to some of your underlying core business? And if you could somehow quantify it, that would be great.

Yes. No, I mean, we – there’s always margin pressures in our business, I mean, which I’ve been saying probably now for 10 years. Very, very competitive, but the fundamentals of what we’re doing should not change our margins.

Okay. And then is – are the parts that are coming online and what you’re seeing in the marketplace, are you seeing that maintenance is still a bigger share, meaning the part gets replaced from a maintenance standpoint? Or is there like accidents or the rise in kind of vehicle incursions also helping volumes?

Yes. We – it’s very difficult for us to separate that. I would speculate, and I’m pretty sure I’m fairly accurate on this, is that our collision replacement business is nominal. I mean, that’s just not the channel we play in. Having said that, many of our customers do so, some of the repair centers. So I think the collision part of our business is probably not quantifiable right now. Certainly, we don’t sell through that channel and probably very, very small. When I talk about the opportunity, I exclude collision completely. I mean, I’m looking at replacement. All these parts continue to fail. There has been many discussions of how quality has gotten better over the years. That is true, and so your sweet spot sort of has moved up from a sort of 4 to 5-year sweet spot to 7 to 8-year sweet spot in terms of when the replacements really start getting active. Having said that, the vehicles are made better, and I believe that they’ll last longer, which many people speculate is bad for us. But I think that’s good for us because you’ll end up having higher replacement rates in a vehicle for the life of that vehicle because, fundamentally, the whole vehicle runs better and you don’t scrap that vehicle based on alternators, starter, brake master cylinder, et cetera. So I mean, I’m still talking around your point, but I don’t believe collision has anything to do with the numbers for us. And I’m talking about repair, and that’s my outlook.

Okay, that makes sense. And then finally, I know you’ve given a lot of great color on the guidance. I just have one other question. Is there a split that you kind of think about when looking at the puts and takes of those ranges in terms of what product mix is part of it versus just general volumes and general industry demand? Is there a mix that you’re kind of thinking about there?

Well, clearly, I mean, when we sort of give the range of margins, we’re looking at what we anticipate to be the mix, no question. We have a fairly good outlook on what the mix will be, barring some unusual event, both positive or negative. So I think mix is definitely part of it, it. But we have a fairly – at this point, have fairly good visibility through the end of the year on what that mix is going to be, more or less. Now it could be affected slightly up or down during a quarter based on timing of an order or return. But fundamentally, on the next six months, we’ve got a pretty good feel of what the mix is going to be.

Okay, great. Thanks again for the time.

Thank you.

Thank you.

Thank you. [Operator Instructions] We do have a follow-up question from Matt Koranda with Roth Capital.

Yes.

Hey guys, sorry, follow-up, but I don’t think anyone clarified, and I wasn’t able to clarify, but what’s driving the higher rate of returns this quarter? Is there a particular customer that returned more product? Or was it primarily in rotating electrical? Could you just provide a little more color on that?

Yes. I think – look, I think, in general, what happened is that the season was soft and most of the customers rolled inventory. We’re expecting a much stronger season, and we also have a policy of accruing for returns in advance. So we anticipate – when we look at what we anticipate, of course, we look at inventory levels and see what we anticipate as potential returns. And so that’s also in that returns number. The other side of it is, is that you’re going to get a fair amount of returns at a stable amount based on demand. And if your revenue number is lower, you’re going to – your returns rate is going to be higher as a percentage of the revenue. Our revenues theoretically should have been higher than what it was. And there are some customers that I think are taking advantage of this to pay down inventory, and there are others that, quite frankly, are looking at this as an opportunity to build inventory. So without getting to each customer’s strategy, which we certainly cannot do, there’s a mix of that – of responses to what’s happening in the marketplace right now.

All right, thank you. I’ll jump back in queue.

Thank you. I’m showing no further questions at this time. I will now turn the call back over to management for any additional remarks or closing comments.

Great. Well, again, I thank everybody for their interest in MPA, and appreciate you joining us for this call. And we look forward to speaking with you on either our conferences that we’ll be attending and our next fiscal quarter – second quarter fiscal 2018 conference call in November. And so I appreciate everybody’s interest. Thank you.

Thank you. Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect, and have a wonderful day.