Keystone: Company’s Future Tied to Legal Case on Patents

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For Keystone Automotive Industries Inc., a distributor of parts used by auto repair shops, the action of late has taken place not on the road but in the courtroom and it’s been a roller-coaster ride.


The Pomona company is trying to break the hold of the Big Three automakers on the collision repair parts industry. Last month, the company lost a round in its legal tussle with Ford Motor Co. over Ford’s allegations that it had infringed on the automaker’s design patents. A federal administrative law judge with the International Trade Commission ruled that Keystone had violated design patents on parts for Ford’s F150 truck.


The ruling sent Keystone’s stock price tumbling 15 percent to $30 per share. The company warned that should Ford ultimately prevail on appeal, it could open the floodgates for Ford and other automakers to challenge upstart companies like Keystone that have been trying to strengthen their foothold in the $16 billion collision repair parts industry. Currently, the major automakers known in the trade as original equipment manufacturers or OEMs control more than 50 percent of the U.S. market for parts used by auto repair shops.


Keystone Chief Executive Richard Keister said the company plans to put up a “vigorous fight” against Ford. “It’s certainly our thought that we are not going to be bullied around by the monopolistic tactics used by the OEMs,” Keister told investment analysts in a conference call last fall.


For its part, Ford issued a statement saying it brought the action to protect its vehicle designs from foreign copying.


“The verdict by the ITC is an important milestone in design patent law,” said Kristen Kinley, a Ford spokeswoman. “The ITC recognized that vehicle design, including the design of vehicle components, is protected from unauthorized copying.”


The decision is to be reviewed by the full commission, which must decide the matter by March 5; in any event, the case is likely to end up in the federal courts. Kinley said Ford “will vigorously defend any appeal.”


Contrast this with a year earlier, when Keystone was on the winning side of another major courtroom battle, this time with insurance giant State Farm Mutual Automobile Insurance Co. The Illinois Supreme Court reversed a lower court ruling that had awarded more than $1 billion to State Farm policyholders that had filed a class action suit seeking to halt the use of generic parts in auto repairs. In response to the 1999 lower court ruling, State Farm, the nation’s largest auto insurer, had stopped using generic auto parts.


After the high court reversal, investors turned bullish on the generic auto repair parts industry and Keystone’s stock nearly doubled, topping out at $46 a share in March.


All this courtroom turmoil, analysts say, has masked key developments for Keystone on the ground. First and foremost, these analysts note that auto repair shops have become increasingly open to the use of generic parts, which can be up to 50 percent cheaper than parts from the major automakers. Typically, these parts are made offshore and shipped into the U.S. for distribution.


Indeed, in Keystone’s most recent earnings statement for the company’s second quarter ended in September, same-store sales rose 15 percent year-over-year.



Greater acceptance

“We’re seeing greater acceptance of non-OEM parts at the body shops,” said John Lawrence, auto industry analyst with Morgan Keegan & Co. Inc. “First the shops try out the products, then they step up their orders, which is why the same-store sales have done so well.”


Lawrence said this underlying acceptance is the main reason why he remains bullish on the company’s immediate prospects, despite the recent adverse ruling on the Ford truck patents. “Given the uncertainty regarding future actions by other manufacturers and the many chances for appeal, we believe the fundamentals for Keystone remain in place,” he wrote in a report the day after the ruling was announced.


That view was seconded by another auto industry analyst, Craig Kennison, with Robert W. Baird & Co. But Kennison did say that if the case dragged on, litigation costs could eat into some of Keystone’s profits.


Keystone CEO Keister downplayed the impact of the Ford ruling on company performance, saying the seven parts in question in the Ford truck case represent less than 1 percent of the company’s total of $628 million in sales.


Meanwhile, analysts are watching another key development: Keystone’s attempt to modernize its parts distribution network. In the past, Keystone imported parts and then had them sit in warehouses for weeks before shipping them out all at once to its repair shop customers.


But this setup meant that parts were not often available when auto repair shops needed them not a good situation when the repair shops are under pressure from auto insurance companies to speed up their repair turnaround times.


So, last year, the company began rolling out a hub-and-spoke distribution system, with more frequent parts shipments.


“Instead of carrying quantities of 20 or 30 of a part number every four weeks, we can get two or three of a part number to our clients each day. It’s much better for their turnover and inventory,” Keister told investors in the recent conference call. The key is to make sure that when the repair shop needs a part, they either have it on hand or can have it shipped to them the next day, he said.


But the transition has not been without problems. It has proven more challenging than expected to set up the warehouses that serve as hubs. Also, Keister said the dramatic increase in the price of fuel last spring and summer hit the company hard.


“When you’re hit with rising fuel costs, the prudent thing to do is to have fewer truck trips. This came at precisely the moment we were trying to increase truck trips. It’s proven a difficult balancing act,” he said.


Keister said the switch would take longer than originally expected. “We want to make sure we get it right.”


Keystone has also been trying to build out its national client base. Last May, the company began shifting much of its administrative operations to Nashville to be closer to the majority of its clients.


At the same time, Keystone is looking to fill in some gaps in its client network of 25,000 body shops, especially on the West Coast and in the intermountain states. “We’re on the lookout for acquisitions of major (generic parts) players in these areas,” Keister told investors.


But much still hinges on the outcome of the Ford case and any subsequent cases as Keystone tries to solidify its foothold on the collision repair market. If Keystone ultimately loses its appeals, the gains it has made in penetrating this market could come to a screeching halt. That prospect could keep Keystone stock volatile for quite some time.

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Howard Fine
Howard Fine is a 23-year veteran of the Los Angeles Business Journal. He covers stories pertaining to healthcare, biomedicine, energy, engineering, construction, and infrastructure. He has won several awards, including Best Body of Work for a single reporter from the Alliance of Area Business Publishers and Distinguished Journalist of the Year from the Society of Professional Journalists.

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