Dorman Products, Inc. — Q3 2011 Form 10-Q
Reporting period: Thirteen weeks ended September 24, 2011; year-to-date figures cover the thirty-nine weeks ended that date. Comparisons are with the corresponding 2010 periods. Amounts are in U.S. dollars.
Business context
Dorman supplies automotive replacement parts, fasteners and service-line products, primarily to the North American aftermarket. More than 90% of revenue comes from North America. Management cited strong product demand and new-product sales as drivers of growth, while warning that customer consolidation and demands for better pricing, product returns and extended payment terms remain ongoing pressures.
Financial performance
| Metric | Q3 2011 | Q3 2010 | 39 weeks 2011 | 39 weeks 2010 |
|---|---|---|---|---|
| Net sales | $134.2 million | $119.2 million | $390.2 million | $333.2 million |
| Gross profit | $46.6 million | $45.1 million | $138.8 million | $126.2 million |
| Gross margin | 34.7% | 37.9% | 35.6% | 37.9% |
| Operating income | $19.9 million | $20.5 million | $59.5 million | $55.3 million |
| Operating margin | 14.8% | 17.2% | 15.3% | 16.6% |
| Net income | $11.5 million | $12.8 million | $36.6 million | $33.9 million |
| Diluted EPS | $0.63 | $0.71 | $2.01 | $1.87 |
Q3 sales rose 12.6%, but net income fell about 10.3%. Gross margin contracted 3.2 percentage points, reflecting ScanTech-related inventory and other write-downs, higher obsolete-inventory provisions and unfavorable mix. Year-to-date sales rose 17.1% and net income about 8.0%, while gross margin declined 2.3 percentage points. Year-to-date operating income increased despite higher SG&A.
Cash, liquidity and debt
- Operating cash flow for the first 39 weeks was $30.6 million, versus $14.9 million in 2010. Investing activities used $14.9 million, chiefly for capital expenditures, versus $7.2 million in 2010.
- Cash was $45.6 million at September 24, 2011, up from $30.5 million at December 25, 2010. Working capital was $247.7 million.
- No borrowings were outstanding under the $30 million unsecured revolver, which expires in June 2013. After approximately $2 million of letters of credit, $28 million was available. The filing reports no outstanding long-term debt balance.
- Inventory increased to $129.0 million from $120.4 million at year-end. Management attributed the increase in cash use to sales growth; accounts payable also declined $3.4 million year to date.
- Dorman sold $149.7 million of receivables through customer-sponsored, non-recourse programs during the 39 weeks, versus $63.0 million a year earlier. Related financing costs were $2.7 million versus $1.2 million. Without sales, an additional $128.7 million of receivables would have been outstanding at quarter-end. Management said extended customer terms may require more cash or increase receivables-sale costs.
Outlook, risks and unusual items
- Dorman planned to exit ScanTech’s international business, transfer its North American operation to Pennsylvania and offer the international business for sale. Completion was expected by the end of Q3 fiscal 2012. The company recorded $2.9 million of inventory and tooling write-downs in cost of goods sold and $0.6 million of asset and employee-related charges in SG&A. Management estimated total pre-tax exit costs of approximately $5.0 million, including $3.5 million non-cash and $1.5 million cash costs, and anticipated approximately $3.0 million in net cash proceeds from asset sales. No tax benefit was expected on the recorded charges.
- Management said available capital should meet cash needs for at least the next 12 months. No specific sales or earnings guidance was provided. Results may fluctuate with customer order timing and new-product introductions.
- Risks highlighted include aftermarket competition and weak economic conditions; customer concentration, consolidation and payment-term extensions; cancellations or rescheduling of orders; dependence on new products and suppliers; foreign-currency-related input costs; inflation and transportation costs; product quality, legal and patent matters; and execution of ongoing information-technology initiatives.
- A 1 percentage-point increase in LIBOR was estimated to increase annual interest and receivables-sale financing costs by approximately $1.3 million, assuming balances and sale levels remained constant.
- Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting. Ordinary-course legal proceedings were not expected by management to have a material financial impact. The filing notes tax examinations and $2.2 million of unrecognized tax benefits, of which $1.4 million would affect the effective tax rate if recognized.
Important facts for investors to verify
- Whether sales growth and new-product demand continue, and whether customer pricing, returns and mix further pressure margins.
- How the ScanTech exit proceeds, including actual exit costs, asset-sale proceeds and timing relative to management’s estimates.
- Reliance on receivables-sale programs and the effect of further customer payment-term extensions on cash flow and financing expense.
- Inventory levels, obsolete-inventory provisions, transportation and commodity costs, and planned capital spending.
- Developments in tax examinations and uncertain tax positions, and the company’s compliance with revolver covenants.