MOTORCAR PARTS OF AMERICA INC annual report, FY2018

Motorcar Parts of America, Inc. — Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended March 31, 2018. The supplied metadata references “2017 Q4,” but the 10-K reports fiscal 2018 annual and quarterly results. Motorcar Parts of America manufactures, remanufactures, and distributes aftermarket automotive, light truck, heavy-duty, industrial, and agricultural parts, including rotating electrical products, wheel hubs, brake master cylinders, turbochargers, brake power boosters, and diagnostic equipment. The company operates as one reportable segment and sells primarily through major North American automotive retailers, warehouse distributors, professional installers, and original-equipment service channels.

Financial performance and key metrics

Metric	Fiscal 2018	Fiscal 2017	Change
Net sales	$428.1 million	$421.3 million	Up 1.6%
Gross profit	$105.9 million	$115.0 million	Down 8.0%
Gross margin	24.7%	27.3%	Down 260 basis points
Operating income	$49.6 million	$68.0 million	Down 27.0%
Net income	$16.3 million	$37.6 million	Down 56.6%
Diluted EPS	$0.84	$1.93	Down 56.5%
Cash flow from operations	$(13.9) million	$(5.3) million	Greater use of cash
Capital expenditures	$9.9 million	$4.9 million	Up materially

Interest expense increased to $15.4 million from $13.1 million, reflecting higher borrowings, increased use of receivable discount programs, and a $0.2 million debt issuance cost write-off. Income tax expense was $17.9 million, producing a 52.3% effective tax rate; this included a $4.9 million noncash deferred-tax remeasurement charge and a $0.5 million transition-tax charge related to the Tax Cuts and Jobs Act.

At March 31, 2018, cash and cash equivalents were $13.0 million and short-term investments were $2.8 million. Working capital was negative $46.3 million, compared with negative $20.7 million in the prior year, and the current ratio was 0.74:1.00. Total assets were $494.5 million and shareholders’ equity was $275.0 million.

Debt, liquidity, and working capital

• Outstanding debt included $54.0 million under the revolving facility and $17.0 million net carrying value under the term loan. Revolving and term loan interest rates were 4.52% and 4.42%, respectively, at March 31, 2018.
• Approximately $65.1 million was available under the existing revolving facility, subject to borrowing-base and other adjustments. The company was in compliance with its debt covenants; its senior leverage ratio was 0.89 versus a maximum of 2.50, and its fixed-charge coverage ratio was 1.34 versus a minimum of 1.15.
• Receivable discount programs covered $357.2 million of receivables, with a 3.3% weighted-average discount rate and $11.2 million of related interest expense.
• Long-term core inventory increased to $301.7 million from $262.9 million. Total inventory, including non-core inventory and unreturned inventory, increased as the company prepared for anticipated higher sales and expanded customer relationships.
• Accrued core payments increased to $35.0 million from $24.1 million, primarily because of core purchases associated with new business.

On June 5, 2018, after the reporting date, the company entered into a new credit facility consisting of a $200.0 million revolving facility and a $30.0 million term loan, both maturing June 5, 2023, secured by substantially all company assets. Management stated that available liquidity, receivable discount programs, and other sources were expected to cover working capital, debt repayment, lease, and capital expenditure needs for the next 12 months.

Material changes versus the prior comparable period

• Sales increased modestly, supported by rotating electrical products, brake power boosters, and the July 2017 acquisition of D&V Electronics, which added diagnostic equipment for conventional, hybrid, and electric-vehicle applications.
• Profitability declined substantially. Gross margin fell to 24.7% because of customer allowances and initial return accruals for new business, higher returns, lower overhead absorption, Mexico expansion transition costs, inventory step-up amortization, and a $9.1 million revaluation of remanufactured cores held at customer locations.
• Customer allowances recorded as reductions of revenue increased to $107.2 million from $96.4 million. Allowances under long-term contracts totaled $24.8 million, and allowances related to single product exchanges totaled $79.8 million.
• Operating expenses rose to $56.2 million from $47.1 million, reflecting growth initiatives, acquisition-related expenses, higher sales and marketing costs, and increased research and development spending.
• Cash used in operations increased to $13.9 million, driven by inventory expansion, increased core purchases, lower operating results, higher tax payments, and lower accounts payable.
• The company repurchased $9.3 million of common stock during fiscal 2018, including 208,081 shares in the fourth quarter. As of March 31, 2018, $8.4 million remained available under the $20.0 million authorization.
• The company completed exercise of a supplier warrant for $4.0 million in cash, eliminating a warrant liability that had been $11.9 million at March 31, 2017.

Guidance, outlook, commentary, risks, and unusual items

Management did not provide specific revenue or earnings guidance in the filing. It expected continued investment in growth initiatives and approximately $17.0 million of fiscal 2019 capital expenditures, primarily supporting expansion in Mexico. A new 410,000-square-foot Tijuana distribution center began shipping selected products in the first quarter of fiscal 2019 and was expected to become fully operational during fiscal 2019.

The company planned to adopt ASC 606 revenue recognition on April 1, 2018 using the full retrospective method. Management did not expect a material impact on previously reported revenue, but anticipated balance-sheet reclassifications and possible changes in the timing of core-related revenue. Estimated fiscal 2018 revenue would decrease by less than $0.4 million under the preliminary adoption assessment.

• Customer concentration is substantial: AutoZone represented 41% of fiscal 2018 sales, and the four largest customers represented 88%. Changes in customer pricing, allowances, payment terms, financial condition, or business relationships could materially affect results.
• The business requires significant working capital for inventory, core purchases, customer allowances, and extended payment terms. Negative working capital and recurring operating cash outflows heighten liquidity risk.
• Core inventory valuation, customer returns, inventory obsolescence, and revenue allowances depend heavily on management estimates. Excess and obsolete inventory reserves increased to $6.7 million from $4.1 million.
• International operations and offshore suppliers expose the company to currency, political, labor, shipping, tariff, import, quality, and supply-chain risks. Approximately 13% of fiscal 2018 expenses were denominated in currencies other than the U.S. dollar.
• Competition, customer price pressure, raw-material costs, availability of Used Cores, product failure rates, and fluctuations in vehicle miles driven and vehicle age may affect margins and demand.
• Variable-rate debt and receivable discounting create interest-rate exposure. A 1% increase in interest rates was estimated to increase annual interest expense by approximately $0.7 million on net debt.
• The Tax Cuts and Jobs Act amounts were provisional at year-end and could change as guidance and the company’s analysis developed.
• The company reported no material unresolved staff comments, no material legal proceedings, and no material changes to internal control during the fourth quarter. Management and Ernst & Young concluded that internal control over financial reporting was effective.

Most important facts for investors to verify

• Whether the new June 2018 credit facility materially improved borrowing capacity and whether subsequent borrowing-base or covenant conditions restrict liquidity.
• Progress and return on investment from the Mexico expansion and the D&V diagnostic-equipment acquisition.
• Trends in gross margin after customer allowances, returns, core revaluations, and start-up or transition costs normalize.
• Whether operating cash flow turns positive as inventory growth and core purchases moderate.
• Actual customer concentration, renewal status, pricing, allowance, and payment terms under major contracts, particularly with AutoZone and the other largest customers.
• Changes to core inventory valuation, return estimates, excess and obsolete reserves, and ASC 606 retrospective results.
• Final tax accounting under the Tax Cuts and Jobs Act and any impact on the effective tax rate or deferred tax assets.
• Fiscal 2019 capital expenditures, debt levels, receivable discounting costs, and available liquidity relative to contractual obligations of $237.2 million.