Business Context and Reporting Period
Motorcar Parts of America, Inc. manufactures, remanufactures and distributes aftermarket automotive parts, including alternators, starters, wheel hubs and bearings, and new brake master cylinders. The company reports one operating segment and sells primarily in North America to automotive retailers, warehouse distributors and automobile manufacturers.
This Form 10-Q covers the three and nine months ended December 31, 2014, within fiscal 2015. The financial statements are unaudited. New brake master cylinder sales began in late July 2014, and significant new rotating electrical business began shipping in January 2015.
Financial Performance and Position
| Metric | Three Months Ended Dec. 31, 2014 | Prior Year | Nine Months Ended Dec. 31, 2014 | Prior Year |
|---|---|---|---|---|
| Net sales | $84.0 million | $65.6 million | $217.8 million | $182.0 million |
| Gross profit | $24.4 million | $21.9 million | $60.7 million | $57.6 million |
| Gross margin | 29.1% | 33.4% | 27.9% | 31.7% |
| Operating income | $8.9 million | $10.0 million | $25.2 million | $22.5 million |
| Net income | $2.9 million | $1.1 million | $8.4 million | $104.3 million |
| Diluted EPS | $0.16 | $0.07 | $0.49 | $6.98 |
| Operating cash flow from continuing operations | Not separately provided in the financial statements | Not separately provided | $2.9 million | $19.7 million |
Third-quarter sales increased 28.1%, while nine-month sales increased 19.7%. However, gross margin declined because of product mix, production ramp-up costs, product returns and allowances, warranty accruals, and other costs associated with new business. Third-quarter operating income declined despite higher sales, reflecting lower gross margin and higher general and administrative expenses.
Interest expense declined to $3.2 million in the quarter and $9.9 million year to date, primarily because of lower debt balances, lower interest rates and the absence of certain prior-year financing-cost write-offs. Effective tax rates were 49.1% for the quarter and 45.5% for the nine-month period.
At December 31, 2014, cash and cash equivalents were $76.7 million, compared with $24.6 million at March 31, 2014. Working capital was $68.3 million, with a current ratio of 1.7 to 1. Inventory, including long-term core inventory and deposits, remained substantial: non-core inventory was $58.5 million, long-term core inventory was $153.6 million, and core inventory deposits were $31.6 million.
Term-loan principal was $86.6 million, with $7.8 million classified as current. There were no revolving-loan borrowings; $38.9 million was available under the amended revolving facility, subject to adjustments. The term loans mature in November 2018 and bear interest at 6.75% under the LIBOR option. The company was in compliance with its financial covenants at December 31, 2014.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected the full-period contribution from wheel hubs, increased rotating electrical sales, new brake master cylinders and recognition of previously deferred remanufactured-core revenue.
- The company recognized $16.3 million of previously deferred core revenue and recorded a $3.7 million sales allowance for expected future core buybacks.
- Gross margin fell 430 basis points in the quarter and 380 basis points year to date. Nine-month gross profit included $6.6 million of returns-related charges, $2.9 million of core inventory allowances, a $0.6 million brake-master-cylinder warranty accrual, and other launch and start-up costs.
- Nine-month operating cash flow decreased to $2.9 million from $19.7 million. Cash was absorbed by inventory expansion for upcoming business, long-term core inventory investments and the reduction of deferred core revenue; the prior-year period benefited from a $16.5 million income-tax refund.
- The company issued 2.76 million common shares in September 2014 for $71.8 million of gross proceeds and $67.0 million net proceeds, increasing shares outstanding and materially strengthening liquidity.
- Prior-year net income included $100.9 million of income from discontinued operations, primarily a gain on deconsolidation of the Fenco subsidiary. The current period has no discontinued-operation income, making total net income comparisons misleading.
- The company revised prior-year diluted EPS for an immaterial treasury-stock-method calculation error. The revision did not affect net income, basic EPS, balance sheets or cash flows.
Outlook, Commentary, Risks and Unusual Items
Management expects fiscal 2015 capital expenditures of approximately $3 million to $7 million, primarily for equipment, information technology and leasehold improvements. Management believes cash, short-term investments, receivable-discount programs, revolving availability and other sources will fund expected working capital, debt service, lease and capital-expenditure requirements over the next twelve months.
Key operating risks include customer concentration, customer pressure for lower prices and extended payment terms, working-capital requirements driven by inventory and core purchases, dependence on receivable-discount programs, difficulty obtaining used cores, production and warranty issues associated with new products, foreign-exchange exposure, competition and the ability to maintain credit-agreement covenants.
Customer A represented 63% of quarterly sales and 57% of nine-month sales; Customer B represented 19% and 21%, respectively. The company discounted $198.1 million of receivables during the nine-month period at a 2.0% annualized weighted-average discount rate.
The company remains exposed to litigation and potential additional claims arising from the bankruptcy of the former Fenco entities, including claims involving fiduciary duties, supplier obligations, employee claims, WARN Act and ERISA matters. Management does not believe the known matters will materially affect financial position or future results, but adverse judgments or settlements could be significant.
Other unusual items include a $12.2 million fair value liability for a supplier warrant, a $2.2 million year-to-date loss from changes in that liability, and a $1.1 million year-to-date loss on foreign-currency contracts. The company had $18.7 million of foreign-currency contract notional exposure at December 31, 2014.
Important Facts for Investors to Verify
- Whether new rotating electrical, wheel hub and brake master cylinder programs improve revenue and margins after launch and ramp-up costs.
- The sustainability of the 27.9% nine-month gross margin and the magnitude of product returns, warranty accruals and core inventory allowances.
- Inventory levels, core buyback obligations and the company’s ability to convert inventory and receivables into operating cash flow.
- Continued availability and economics of receivable-discount programs, which supported liquidity but generated $3.7 million of interest expense year to date.
- Term-loan repayment requirements, covenant compliance and available revolving capacity.
- Potential financial exposure from Fenco-related bankruptcy litigation and other claims.
- The effect of the September equity issuance, dilution from options and warrants, and the $12.2 million supplier-warrant liability.
- The filing’s accounts-receivable presentation: net accounts receivable was shown as a negative $0.9 million at December 31, 2014 and reclassified into accrued liabilities, requiring review of the underlying offsets and customer-return estimates.