Good day, ladies and gentlemen, and welcome to the Motorcar Parts of America Fiscal 2018 Third Quarter Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Gary Maier, Investor Relations. Sir, you may begin.

Thank you, Amanda. Thank you, everyone, for joining us for the call this morning. 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 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 these risks and uncertainties, I refer you to the various filings with the Securities and Exchange Commission. I would now like to begin the call and turn it over to Selwyn for his remarks.

Thank you, Gary. Got a little bit of a congestion, so I apologize for that upfront. But I appreciate everyone joining us today. Clearly, we were disappointed in our third quarter performance. I assure you, this in no way diminishes our outlook and our optimism for our business in the current fourth quarter and for our next fiscal year. I'd like to begin by discussing some of the details regarding the dynamics of this quarter -- of this past quarter. In the month of October, and very early in November, there were clear indications of a pickup in sales. Some of you may recall comments I made last quarter regarding my optimism for growth in the third quarter. Unfortunately, after mid-November, there was a significant dip in sales through December, which was also highlighted in the public presentation recently made by one of our large customers. This industry decline in demand contributed to our lowest sales levels. In addition, we expected that customer inventory reduction initiatives would end earlier than they did. Thus, orders for new shipments were deferred into the current fourth quarter, resulting in a decline in replenishment orders of approximately 9% for the third quarter. Consequently, we reduced our production for the December quarter by 7%, compared with the preceding second quarter. The effect of the third quarter production cuts on overhead absorption and consequently gross margin, was approximately a negative 2%. Due to these factors, in particular the sales impact in November and December, we are revising adjusted net sales guidance as provided in today's press release to between $434 million and $440 million for this year, ending March 31, 2018. Our adjusted gross margin target remains between 27.5% to 30.5%. We expect these margins to be at the higher end as revenues return. We are…

Thank you, Selwyn. I will now review the financial highlights for the fiscal 2018 third quarter. Before I begin, I encourage everyone to read the 8-K filed this morning with respect to our December 31, 2017, earnings press release for more detailed explanations of our results, including reconciliation of GAAP to non-GAAP financial measures, and the 10-Q, which will be filed later today. Net sales were $100.1 million for the third quarter, compared with $112.6 million for the prior year fiscal third quarter. The sales and profit performance for the prior fiscal 2017 third quarter reflects the benefits of recognizing a $9.3 million revenue pickup due to a change in estimate for stock adjustment returns. Adjusted net sales were $103.4 million for the third quarter compared with $112.9 million net sales for the prior year. Excluding the $9.3 million revenue pickup due to a change in estimate for our stock adjustment returns for the prior fiscal third quarter, the adjusted net sales decrease of approximately $200,000 was due to the following, rotating electrical net sales decreased $2.7 million to $79.5 million for the third quarter from $82.2 million for the prior year, reflecting slower-than-expected sales due to unusually soft demand in the industry and customer inventory reduction programs. Wheel hub assemblies and bearings net sales increased $2.4 million to $19.1 million for the third quarter from $16.7 million a year earlier. Brake master cylinder net sales decreased $1.2 million to $1.8 million for the third quarter from $3.1 million a year ago. Additionally, the combined net sales for the third quarter for brake part boosters, turbochargers and testers increased $1.3 million to $2.9 million from $1.6 million in the prior year. The prior year had no tester sales. Gross profit for the third quarter was $22.5 million compared with $32.4…

[Operator Instructions]. Our first question comes from the line of Matt Koranda of Roth Capital.

It looks like the implied Q4 guidance that you guys gave sort of suggests maybe one or few things. So the new business ramp-up in the rotating electrical category, I guess, maybe is a little less steep than you thought, or maybe its underlying growth rates for existing programs a little slower than expected. Could you just kind of parse that out and help us understand what's driving the implied guide for Q4?

Well, look, the guidance includes at the low end an all-time record for fourth quarter revenue. So we're happy to be able to sort of get back to that type of a discussion. Replenishment rates while are evolving right now. We're certainly seen them move in the right direction and the weather is a significant contributor to, I think, helping those replenishment rates. I think the inventory reduction programs for the most part, have come to an end or are coming to an end. I still think that some -- a couple of customers have got caught with more inventory based on the November-December slowdown than they would have liked to have had. But I think that's going to reverse out as they sell-through. And I think the setup going into the next fiscal year is going to be very strong. So we sell products on a need basis and we can't accelerate demand. I mean, it's when your car fails. But we're seeing a direct effect from the weather on increasing orders. And I just don't believe within the -- in the March quarter, we'll be able to pick up the complete loss of the November-December revenue. I think that will get picked up over the next 6 months, but it's not going to come right back in the March quarter. I think the update orders have been fairly cautious because there's been some uncertainty in what the demand will be, so I think update orders, while replenishment is up double digits, the update orders are pretty much flat with last year. Which is fine, because updates can continuously be added even on a monthly basis. So -- but I think as renewed confidence comes back into the marketplace, which clearly I'm hearing and seeing based on the ordering rates, I think we've hit a pivot point and we're back to just starting to see where historical levels of replenishment are coming back.

Okay, that's helpful. What's a reasonable growth rate to expect if we look at fiscal '19 on revenue, excluding new business? So if we kind of just look at the existing programs you have in replenishment orders. I guess, if I look at the most recent same-store sales guides from some of your customers, it implies, sort of, low single digit growth rates, but obviously, there's the inventory reduction initiatives that you referenced, sell in. And then you have cold weather items that definitely help swing in your favor. So what's the right way to think about the underlying growth rate on existing programs with your existing customers?

Yes. So we haven't heard from all the customers about the new plans for opening new stores. But we certainly heard yesterday from one major customer opening up 200 additional new stores. There's going to be a lot of new stores opened this next year. I think, again, the vibrancy of the market is going to turn and I think the new store openings will continue because of that. So besides the same-store sales growth, I think you have new store growth. I think there's share opportunity for us within all of our customers. Certainly, with a number of our product lines which are still very small. We still -- I don't want to get too much ahead of our skis because we haven't -- I'm not -- we haven't really decided on what formal revenue guidance we are going to give for next year, but we still think double-digit increases are where we target. We've got a lot of great things happening in the company. I think the quarter is not indicative of the momentum that's going on internally. So we're sticking with the same story we've had for a while. I think low double digits is something that we want to get to and maybe it's a little optimistic, but I don't think too optimistic.

Okay. And then just a quick one more and then I'll jump back in queue. The long-term core inventory, I think, sequentially was up about $30 million. Is that all related to the new rotating electrical business that you are ramping on? Or is there other stuff in there that maybe feeds into fiscal '19 as well?

For the first most part, it's all the new rotating electrical business. There's an accrual for the full purchase and then we pay it off of a number of years, and so the full accrual is in there for that new business. And that's been part of our disappointment is that we've had some expense relating to that new business without having seen the benefit of the ramp-up of that new business. But that -- I think that -- I believe that's all behind us at this point.

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

You talked -- Selwyn, you touched on the car park a little bit. Can you remind us what the sweet spot is in terms of vehicle age and what you expect that number of vehicles in that window to do over the next year or two?

Yes. I think, 2008 through 2011, we had some reduced new car sales. I think at this point, if you look at sort of a seven-year sweet spot on rotating electrical, and let's just say it's the same for all product lines because it varies very little, I think, between them on the ones we have right now -- on the product lines we have right now. But I think it's 270 million vehicles, those 2008 to 2011 are hitting the old, aged categories. And the new evolving categories of the 4- to 7-year-old is -- we record new product sales, new car sales. And so, I think we're at the beginning of seeing a reversal of the prime spot growth. There's a significant number of cars that are stuck in the 12-plus category, that continues to go up with the '08 to '11. We're going to see that grow, and certainly on the 4 to 7, which is coming out of warranty, there's going to be significant growth in that, which sets the stage for a couple of things, because there's a lot of new technology, in particular in rotating electrical, that's making the average price points of those alternators and starters much higher. And then you've got higher-voltage applications, line applications, applications that got a lot more technology that's going to have, hopefully, see some inflation in the category as well. So I don't think there's only unit growth. I think there's going to be some price growth.

Great. And then as you think about your non-rotating electrical products, stuff launched over the last couple of years, seems like some of that stuff is ramped a little bit slower than maybe, I guess, I would have anticipated. Is that -- do you share in that thinking? Or is this what you anticipated? And then how should we think about growth of those other categories going forward?

I agree. I think they're slower than certainly we would have liked to have seen. But there's no lack of momentum in them. I think we're going to see significant growth in them. Some of them are smaller categories. I think some of our new product initiatives are going to accelerate the growth fairly significantly, which we hope to announce soon. And -- but there's going to be growth in all of those categories. I think, the new Mexico facility enables us to get everything under one roof. Customers have had challenges being able to combine purchase orders, so I think that's going to go away. And there's a lot of sales momentum going on in all of the product lines. We'd love to see it go faster, but there's enough there for some real growth, and we're seeing that.

Good. And then lastly for me, operating expenses jumped. Looks like they are on track for about 15-or-so percent this year. It's a lot faster than sales, and I know you guys were investing in some initiatives and so forth. Are we at a new level that feels safe for next year? Or do you expect to continue to grow that line?

The most significant part of the growth in operating expenses is the D&V acquisition. While it's run separately from us, it's consolidated. So D&V is a big part. And then the other side is the R&D expense. And we hope that with some of the new tax provisions, that will even give us further tax relief. But we are making -- it's not showing up in any numbers right now. We are making significant inroads into the electric vehicle market. And I think you're going to see some disproportionate growth coming out of our electric and hybrid vehicle technology. It's a little early, but I -- we've got some great things going on in that area, which is very exciting for us because it's a new world and it puts us on the cutting edge really, with the OEs and the electric vehicles. And we've had a number of the OE companies come back to us and tell us that we have the leading technology out there. I would tell you there are a very few OE car companies at this point in time who are not focused on having an offering in the electric vehicle space and certainly in the hybrid vehicle space. We are the -- one of leaders in belt start generator testing and diagnostics in the world. So -- and that relates to hybrid technology in a significant way. And also, stop/start technology. This whole stop/start technology is evolving. You had -- and I forget the statistics, but maybe, and I'm making these up, but if you had 10 stop/starts in a day on your alternator before, or your starter depending upon the technology that stop/start is using, you're probably going to have 100. At least 10x of that. And we are leading, again, in diagnostics…

Our next question comes from the line of Christopher Van Horn of B. Riley.

Just hoping, I know you said it with some conservatism baked in there and you talked a little bit about double-digit growth and I know there's a lot of factors there. But is that -- do you -- when you look at your planning process, do you include the potential for acquisitions? Or is that mainly what you're seeing in share gains and more on the organic side?

We've picked up a lot of business organically and that includes -- I think the question to me at that time was can we grow organically with this -- what are the growth rates. Again, it's aggressive, but I think we're well on track to come back. If replenishment rates have been down 9% or 10%, if we just get back to last fiscal year's replenishment rates, we've grown 9% to 10%. And if we've got -- and we know we've picked up significant new shares. So once that share kicks in, and it is right now, it should be very accomplishable. The big question that sits out there for everybody is, are these replenishment rates going to be sustainable over the next fiscal year? And I listen to the industry experts and I think most of them believe that based on the weather patterns that we've seen in this winter, and certainly you don't only get failures now, you get failures that come in the summer, because of the wear and tear of the harsh winter weather on the vehicle. So we haven't had a wheel hub season in three years. Wheel hubs are driven by salt on the road and snow and the last three years, we've had almost no snow. All of a sudden, we got snowstorms all over the place. So I think the wheel hub season should be better and it affects the whole vehicle. So if we get back to the basic fundamentals that we saw 12 months ago, the 10% growth rates should be very accomplishable. If we don't have the replenishment rates, we still continue to have organic growth and it'll be a little more difficult, but maybe we can still do that, [indiscernible] a little bit, but hopefully, that gives you a flavor.

No, no, absolutely. When you look at the share gains that you're seeing, any product line jump out at you as maybe surprising? Or just gaining a little bit more share than originally thought?

Well, look, rotating electrical continues to be amazing for us, and I thank all of our customers for their support and their commitment to us. We've continued to gain share there, and we are continuing to gain share. And so while many people have said, hey, you can't -- how much more can you grow? We continue to grow that business. And we have high expectations besides the share growth we've already allowed before incremental -- before even additional share growth. So the other product lines have been slower, but they just haven't popped. It's been tough to grow them in a more conservative market industry where people were not looking so much at the smaller categories, maybe focusing on the bigger categories. I think as we get more vibrant, and I certainly see a lot of momentum in the other categories, and so as a percentage, I think you'll see the other categories perform well as well. But they're coming off a lower base.

Okay, makes sense. And the last one for me, and I'll pass it on. When you look at new product opportunities, I know you mentioned D&V and others. But do you -- similar to what you did with master cylinders and boosters, do you have complement -- complementary product categories you can go into that builds off of your strength and maybe wheel hubs, or turbo, or anything like that, is that what you were thinking about?

Absolutely. And we think we've got some great capabilities and great strength. And while I don't want to jump the gun, but we're excited about some evolving opportunities.

[Operator Instructions]. Our next question is from the line of Scott Stember of CL King.

So when you talked about, I guess, so far in January, the update versus replenishment orders, one was up 9 -- or one was up double digits, one was flat. Can you just maybe give that again? I missed that.

Yes. So I think the question, I think, was revolving around where we are for the quarter, because we reduced our guidance. I think the implied question was, how come you couldn't catch it up in the March quarter? But we're seeing replenishment rates up double digits, but we're seeing update orders flat with last year, which were good, by the way. So when I say flat, that doesn't mean they're bad, okay? So we've given the guidance and you can -- with a very simple arithmetic can see what we think we're going to do in the quarter. We should, on the low end, be at around $120 million. $121 million is a very simple arithmetic, which will be an all-time high for us. And then hopefully, we can beat that guidance, but -- on the low -- hopefully we can beat the low end. But the concept of reducing the guidance was that while we're experiencing higher replenishment now, we're coming off a lower base in the third quarter. And so that was -- I don't know if that explains this, Scott, or not.

No, not that's fine. And just going to the gross margin guidance, I just want to make sure I understand. You're saying the 27.5% to 30.5% for the full year that you expect the full year to be towards the higher end?

Look, if revenues come back and orders come back, we'll be at the higher end. I think I was -- I intentionally included some data on overhead absorption. And with 9% reduction in production levels, it cost us 2 margin points. And unfortunately, normally, we don't adjust production. We were level loaded. We run on a level-loaded production strategy. But the -- this year has been so crazy that we've had to make some adjustments to our production. And so, while we're down 9 points in production, it cost us two points in gross margin. If we can pick that up, we certainly think that -- as of now and again, we have no pricing changes, and so we should be towards the upper end of our guidance.

I guess what I was getting at is that if you go off of what you've done so far this year, and just assuming the high end of sales, that would assume that the fourth quarter gross margin is going to be probably around 35%. And if you go off of the other map of operating expenses and interest expense, would lead to a really, really nice quarter and rebound, which would offset much of the shortfall from the first 3 quarters. Am I thinking about that correctly?

I think you're too optimistic on the gross margin. I'd love to for that to be correct. But I think we would be back to more of the 30%, 30.5% gross margin levels, sort of the midpoint, but there is a theoretical possibility. We're ramping production dramatically. It takes time to ramp production a little bit so, but I wouldn't get too aggressive on the gross margins. I think, again, around the 30%, 30.5%, we feel very comfortable with going into the fourth quarter.

Great. And just one last question. David, you talked about the transition, I guess they'll be like a hybrid tax rate for the fourth quarter. What did you say that would be again for the fourth quarter?

That will be 35.5%. And that's for the full fiscal '18.

And then as we go into our new fiscal year which starts April 1, we expect that rate to drop to 25%.

That's correct.

Got it. And the third quarter was a flat 39% that you booked, adjusted?

The third quarter reflects the 35.5% tax rate, which is based on a proration of 39% for the first 9 months, and 25% for the last 3 months. The proration on that is 35.5% for full fiscal '18, including the third quarter.

I think one other thing I wanted to clarify, Scott, while you're around that. I know you're not asking this, but for everybody, really is, when we said the $8 million of incremental cash flow, we were just looking at that based on today's levels of business. Obviously, as we grow the business, that will go up.

And I'm showing no further questions at this time. I'd like to turn the conference back over to Selwyn Joffe for closing remarks.

Okay. Thank you so much, Amanda. As always, I want to thank all of our team members for their commitment and customer-centric focus on service, and for their exceptional pride in all the products we sell and the customer services we provide. The energy of our team remains sky-high as we push to execute our plans through some tough times but some exciting opportunities for the future. And we expect to build significant value for our shareholders and I thank them for their efforts there. Their commitment to quality and service is also reflected in the wonderful contributions they make to their communities and our society, and we appreciate their continued support. And we appreciate our shareholders' continued support. And We thank you again for joining us for the call. We look forward to speaking with you when we host our fiscal 2018 year-end call in June, and at various conferences, obviously, in the interim. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.