Dorman Products, Inc. — Q2 2019 Form 10-Q
Reporting period: Thirteen weeks ended June 29, 2019; comparable quarter ended June 30, 2018. Year-to-date figures cover 26 weeks. Amounts are in U.S. dollars.
Business context
Dorman supplies replacement automotive parts and fasteners, primarily to the North American aftermarket. Growth is supported by new product development and acquisitions, including Flight Systems, acquired in August 2018. During the first half of 2019, the company introduced 3,053 products, including 963 described as “New to the Aftermarket.” It also consolidated facilities, including moving operations into its new Portland, Tennessee distribution center.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $254.2 million | $238.1 million | $498.0 million | $465.4 million |
| Gross profit | $87.1 million | $92.7 million | $174.6 million | $181.3 million |
| Gross margin | 34.3% | 38.9% | 35.1% | 39.0% |
| Operating income | $27.2 million | $42.8 million | $57.0 million | $82.8 million |
| Net income | $21.5 million | $34.3 million | $44.9 million | $65.0 million |
| Diluted EPS | $0.66 | $1.03 | $1.37 | $1.95 |
Q2 sales increased 7%, while net income declined about 37%. First-half sales rose 7%, while net income fell about 31%. Chassis sales grew to $80.7 million in Q2 from $70.3 million, while powertrain sales were broadly flat. Management attributed sales growth to acquisitions (about 2%), tariffs (about 3%) and, for the first half, a new chassis program with a major retailer.
Margins weakened as tariff costs were passed through, acquired businesses carried lower margins, Portland consolidation caused duplication and start-up costs, and sales mix shifted toward lower-margin seasonal categories. Management estimated Q2 gross-margin effects of about 100 basis points from tariffs, 60 basis points from acquisitions and 50 basis points from duplicated Portland overhead. First-half estimates were about 120, 80 and 40 basis points, respectively, with additional pressure from consolidation inefficiencies and mix.
Cash flow, liquidity and capital
- First-half operating cash flow was $36.5 million, down from $45.6 million. Capital spending was $17.3 million, versus $11.4 million; cash used in investing activities totaled $17.3 million.
- Cash and cash equivalents were $38.4 million at June 29, 2019, compared with $43.5 million at December 29, 2018. Working capital was $509.8 million, up from $488.1 million.
- There were no borrowings on the $100 million revolving credit facility; approximately $99.2 million was available after letters of credit. The facility expires in December 2022. The filing reports no outstanding debt borrowings.
- The company sold $355.1 million of receivables through customer-sponsored programs in the first half, versus $282.1 million a year earlier. Associated financing costs rose to $9.3 million from $6.7 million. Management says it can sell additional receivables, but extended customer payment terms may increase cash needs and financing costs.
- Share repurchases used $24.3 million of cash in the first half. The company reported $750.3 million of shareholders’ equity at period end.
- Management believes available capital is adequate for ongoing cash needs for at least the next 12 months, subject to risks including lower demand, extended payment terms and contingencies.
Outlook, risks and unusual items
- No specific numerical sales or earnings guidance is provided. Management expected higher costs to continue through 2019 as Portland facility consolidation proceeded. It expected to mitigate tariffs primarily through customer price increases and supplier concessions, while warning tariffs could raise reported sales but reduce gross and operating margins.
- First-half site-consolidation and integration costs included $2.8 million of acquisition integration and accelerated-depreciation costs and $10.2 million of start-up inefficiencies and duplicated facility costs. These amounts were recorded across cost of goods sold and SG&A.
- The company disclosed a voluntary prior disclosure to U.S. Customs and Border Protection concerning historical import classifications. Management considers unpaid duties and interest probable, but cannot reasonably estimate the amount; payment was expected in late 2019 or early 2020. The outcome could materially affect cash flows and period results, though it was not expected to be material to financial position.
- Chinese tariffs increased to 25% for qualifying shipments departing on or after May 10, 2019. Other stated risks include customer pricing and payment-term pressure, supplier and foreign-currency exposure, competition, product quality, and quarterly sales fluctuations.
- The company corrected an immaterial prior-period error in the balance-sheet classification of accrued customer rebates and returns, moving the amount from an offset to receivables to a current liability. The correction did not affect reported income or equity.
- Ordinary-course legal matters were assessed as immaterial, taking account of insurance. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Investor verification priorities
- Track the customs disclosure: final duty and interest estimate, payment timing and cash-flow impact.
- Assess whether Portland consolidation costs and operating inefficiencies subside as planned, and whether margins recover.
- Verify tariff pass-through and supplier concessions against actual costs and customer pricing pressure.
- Evaluate reliance on receivables sales, their increasing financing costs, and inventory growth supporting product launches and facility transitions.
- Review the final purchase accounting for Flight Systems and the performance of acquired operations, which management said remained provisional.