Business Context and Reporting Period
Motorcar Parts of America, Inc. manufactures, remanufactures, and distributes aftermarket automotive parts, including rotating electrical products, wheel hubs and bearings, brake master cylinders, turbochargers, brake power boosters, and diagnostic equipment. The company reports one operating segment and sells primarily in North America.
This unaudited Form 10-Q covers the three and nine months ended December 31, 2017, within the fiscal year ending March 31, 2018. The comparable periods ended December 31, 2016.
In July 2017, the company acquired D&V Electronics Ltd., a developer of diagnostic systems and electric-vehicle power-train and battery technology. Management stated that the acquisition was not significant to consolidated results.
Financial Performance and Key Metrics
| Metric | Three Months Ended Dec. 31, 2017 | Three Months Ended Dec. 31, 2016 | Nine Months Ended Dec. 31, 2017 | Nine Months Ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net sales | $100.1 million | $112.6 million | $307.0 million | $306.8 million |
| Gross profit | $22.5 million | $32.4 million | $75.5 million | $83.4 million |
| Gross margin | 22.5% | 28.7% | 24.6% | 27.2% |
| Operating income | $4.9 million | $20.1 million | $34.0 million | $50.6 million |
| Net income (loss) | $(6.8) million | $11.1 million | $7.1 million | $27.8 million |
| Diluted EPS | $(0.36) | $0.57 | $0.37 | $1.43 |
Third-quarter sales decreased 11.1% year over year, primarily because of lower replenishment orders and customer inventory-reduction initiatives in rotating electrical products. Nine-month sales were essentially flat.
Operating expenses increased to $17.6 million in the quarter from $12.2 million and to $41.5 million for the nine months from $32.8 million. Increases reflected employee and offshore operating costs, acquisition-related expenses, higher sales and marketing spending, research and development, legal costs, and foreign-exchange losses.
The effective tax rate was unusually high at 816.4% for the quarter and 69.3% for the nine months, principally because of a one-time $6.3 million non-cash charge to revalue deferred tax assets and liabilities and a $0.5 million transition-tax charge related to the Tax Cuts and Jobs Act.
Cash Flow, Liquidity, Debt, and Capital Resources
- Cash used in operating activities was $9.8 million for the nine months, compared with $20.8 million used in the prior-year period. Third-quarter operating cash flow was negative $1.7 million versus positive $1.5 million.
- Cash used in investing activities was $10.0 million, including $5.0 million for the D&V acquisition and $4.8 million for capital expenditures.
- Cash provided by financing activities was $20.8 million, primarily reflecting net borrowings under the revolving facility.
- Cash and cash equivalents were $10.0 million at December 31, 2017, compared with $9.0 million at March 31, 2017. Short-term investments were $2.8 million.
- Working capital was negative $40.6 million, with a current ratio of 0.74:1.00, compared with negative $20.7 million and 0.86:1.00 at March 31, 2017.
- Outstanding revolving debt was $36.0 million, compared with $11.0 million at March 31, 2017. Term-loan principal outstanding was $18.0 million, with $3.1 million classified as current.
- The senior secured credit facility has total commitments of $145.0 million and matures June 3, 2020. Revolving availability was $83.1 million at December 31, 2017, subject to adjustments.
- The company was in compliance with its debt covenants. The senior leverage ratio was 0.63 versus a maximum of 2.50, and the fixed-charge coverage ratio was 1.64 versus a minimum of 1.15.
- Receivables discounted under customer programs totaled $263.8 million during the nine months, generating $7.9 million of interest expense. The annualized weighted-average discount rate increased to 3.2% from 2.9%.
- Management stated that available cash, short-term investments, receivable discount programs, credit-facility availability, and other sources should be sufficient for expected needs over the next 12 months.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales declined $12.5 million, while nine-month sales increased only $0.1 million.
- Gross margin fell 620 basis points in the quarter and 260 basis points for the nine months. Drivers included customer allowances, higher returns, lower production volume and overhead absorption, product mix, Mexico expansion costs, inventory step-up costs, and core inventory revaluations.
- Third-quarter operating income declined 75.7%, and the company reported a quarterly net loss compared with prior-year net income.
- Inventory increased to $81.0 million from $67.5 million, while long-term core inventory increased to $296.3 million from $262.9 million. Management linked increased borrowing partly to inventory accumulation for anticipated higher sales.
- Accounts receivable, net declined to $3.3 million from $26.0 million because of significantly larger customer allowance, return, and core-return offsets.
- The Supplier Warrant was exercised in September 2017 for $4.0 million and is no longer outstanding. The company recorded a $2.3 million fair-value gain during the nine months, compared with a $5.7 million gain in the prior-year period.
- The company repurchased $4.5 million of common stock during the nine months. As of December 31, 2017, $8.1 million remained under the $15.0 million authorization; the authorization was increased to $20.0 million on February 2, 2018.
Guidance, Outlook, Risks, and Unusual Items
- Management attributed weak quarterly rotating-electrical sales to temporary customer replenishment and inventory-reduction actions and reported year-over-year market-share growth in that product category.
- Fiscal 2018 capital expenditures were expected to be approximately $7.5 million for current operations and approximately $11.0 million for the Mexico expansion.
- The company expects to adopt ASC 606 revenue recognition on April 1, 2018. It does not expect a significant effect on previously reported revenue, but anticipates potentially significant reclassifications of certain balance-sheet assets and liabilities. Quantitative effects had not yet been determined.
- The company expects the future lease standard to significantly increase reported long-term assets and liabilities when adopted in fiscal 2020.
- Key risks include customer concentration, customer payment delays and allowances, working-capital demands from core and finished-goods inventory, dependence on receivable discount programs and secured borrowing, interest-rate increases, foreign-currency volatility, availability and cost of used cores, competition, execution of Mexico expansion, acquisition integration, and potential control or accounting issues.
- Five largest customers represented approximately 91% of quarterly sales and 90% of nine-month sales based on the disclosed percentages. The filing states that there were no material changes to previously disclosed litigation or risk factors.
- Foreign-currency forward contracts had a notional value of $29.3 million at December 31, 2017, and generated a $1.8 million quarterly loss and a $1.1 million nine-month loss in general and administrative expense.
Important Facts for Investors to Verify
- Whether customer inventory reductions and lower replenishment orders reverse, and whether rotating-electrical sales recover.
- Whether gross margins improve after customer allowances, returns, product-mix effects, core revaluations, and Mexico transition costs.
- Whether inventory growth converts into sales and operating cash flow without requiring materially greater borrowing.
- The sustainability and cost of receivable discount programs, including exposure to higher rates or extended payment terms.
- The final quantitative impact and transition method for ASC 606, especially the treatment of core returns and related contractual assets and liabilities.
- Progress, required capital, and returns from the Mexico expansion and the D&V acquisition.
- Potential changes to the provisional Tax Cuts and Jobs Act charges and the resulting effective tax rate.
- Continued compliance with secured-credit-facility covenants and maintenance of adequate borrowing availability.