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 brake master cylinders. The company sells primarily in North America through retail chains, warehouse distributors, and automobile manufacturers. This Form 10-Q covers the three and nine months ended December 31, 2015, within the fiscal year ending March 31, 2016. The company reports one operating segment.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2015 | Prior Year | Nine Months Ended Dec. 31, 2015 | Prior Year |
|---|---|---|---|---|
| Net sales | $94.0 million | $84.0 million | $271.5 million | $217.8 million |
| Gross profit | $28.9 million | $24.4 million | $76.7 million | $60.7 million |
| Gross margin | 30.7% | 29.1% | 28.3% | 27.9% |
| Operating income | $16.7 million | $8.9 million | $28.7 million | $25.2 million |
| Net income | $7.7 million | $2.9 million | $8.3 million | $8.4 million |
| Diluted earnings per share | $0.41 | $0.16 | $0.44 | $0.49 |
| Cash flow from operating activities | $(9.2) million | $(9.7) million | $10.0 million | $2.9 million |
Quarterly operating margin was approximately 17.8% and net margin was approximately 8.2%. Nine-month operating margin was approximately 10.5% and net margin was approximately 3.0%. Quarterly results benefited from higher sales, improved gross margin, and a $5.8 million litigation settlement gain. Nine-month net income was pressured by a $9.25 million litigation settlement accrual and a $5.1 million debt issuance cost write-off.
Balance Sheet, Liquidity, and Debt
- Cash and cash equivalents were $13.7 million at December 31, 2015, compared with $61.2 million at March 31, 2015. Short-term investments were $1.5 million.
- Current assets were $115.6 million versus current liabilities of $116.8 million, resulting in negative working capital of approximately $1.2 million and a current ratio of 0.99:1.
- Long-term core inventory increased to $236.2 million from $189.0 million, primarily reflecting inventory held at customer locations to support higher sales.
- Term-loan principal was $24.2 million, net of debt issuance costs, and the company had $7.0 million outstanding under its revolving facility. Approximately $91.5 million was available under the revolving facility, subject to adjustments.
- The company entered into a new $125.0 million senior secured credit facility in June 2015, maturing June 3, 2020. The facility is secured by substantially all company assets.
- The company was in compliance with its debt covenants at December 31, 2015. The reported senior leverage ratio was 0.42 versus a maximum of 2.50, and fixed-charge coverage was 1.67 versus a minimum of 1.10.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 11.9%; nine-month sales increased 24.7%, driven by new rotating-electrical business that began shipping in January 2015 and the launch of remanufactured brake master cylinder products in July 2015.
- Quarterly gross margin increased 160 basis points, while nine-month gross margin increased 40 basis points, reflecting lower per-unit costs and better overhead absorption from higher production and purchasing volumes.
- Quarterly general and administrative expense declined 30.3% to $8.8 million, primarily because of the $5.8 million litigation settlement gain, lower legal expense, and more favorable foreign-exchange and warrant fair-value adjustments. These benefits were partly offset by $4.4 million of additional bad-debt expense tied to a customer bankruptcy.
- Nine-month general and administrative expense increased 37.9% to $38.4 million, primarily because of the $9.25 million M&T Bank litigation settlement accrual, increased bad-debt expense, growth-related staffing, and warrant valuation losses.
- Operating cash flow improved to $10.0 million for the nine-month period from $2.9 million, but total cash declined by $47.5 million because of debt repayments, capital expenditures, acquisition spending, and working-capital investment.
- The company completed the $3.2 million acquisition of OE Plus, Ltd. in May 2015. The acquisition added goodwill and intangible assets and included potential contingent payments of up to $2.0 million over four years.
- Receivables discounted through customer bank programs increased to $248.4 million from $198.1 million, while related discount expense increased to $5.2 million from $3.7 million.
Guidance, Outlook, Risks, and Unusual Items
- Management expects fiscal 2016 capital expenditures of approximately $4.0 million for equipment, information technology, and leasehold improvements.
- Management stated that cash, short-term investments, receivable discount programs, available credit, and other sources should be sufficient for expected working-capital needs, debt repayments, capital leases, and capital expenditures over the next twelve months.
- Key risks include significant customer concentration, customer financial distress, pressure for lower prices and favorable payment terms, substantial working-capital requirements, dependence on receivable discount programs, availability and cost of Used Cores, competition from offshore manufacturers, foreign-exchange exposure, and the need to maintain debt covenants.
- Customer A represented 49% of quarterly sales and 48% of nine-month sales. Customer B represented 16% and 19%, respectively, while Customer C represented 16% and 18%, respectively.
- The company recorded a $9.25 million net accrual for settlement of litigation involving M&T Bank and the discontinued subsidiaries; the related $18.5 million settlement was paid in full during the quarter, with approximately half funded by insurers.
- The company received a net $5.8 million payment from settlement of litigation involving the acquisition of FAPL and related Ontario employment litigation. The Ontario actions were dismissed.
- The Supplier Warrant liability was $13.5 million at December 31, 2015, and fair-value changes produced a $3.0 million nine-month general and administrative loss.
- Bad-debt expense increased materially following the bankruptcy filing of one customer. The filing does not identify the customer by name.
- Foreign-currency contracts had a $19.5 million notional value at December 31, 2015. The company recorded a $0.1 million nine-month loss from these contracts.
- Disclosure controls and procedures were deemed effective as of December 31, 2015, and management reported no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether the company can sustain sales growth from new customer programs without further significant product returns, allowances, warranty costs, or core-inventory charges.
- The recoverability and turnover of the $236.2 million long-term core inventory balance and the related customer-held inventory.
- Future liquidity requirements given the $13.7 million cash balance, negative working capital, customer concentration, and dependence on receivable discount programs.
- Compliance with the senior secured credit facility’s leverage and fixed-charge coverage covenants as working-capital needs and sales conditions change.
- The magnitude and timing of additional bad-debt expense related to customer financial distress.
- The assumptions and volatility underlying the $13.5 million Supplier Warrant liability and potential future fair-value losses.
- The financial contribution and contingent consideration obligations associated with the OE Plus acquisition.
- The effect of litigation settlements, insurance recoveries, debt refinancing, and the $5.1 million debt issuance cost write-off when assessing recurring earnings.