MOTORCAR PARTS OF AMERICA INC annual report, FY2017

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

Reporting period: Fiscal year ended March 31, 2017. The request references 2016 Q4; the filing is an annual report and includes fourth-quarter fiscal 2017 results for the quarter ended March 31, 2017. The company manufactures, remanufactures, and distributes aftermarket automotive parts through one reportable segment, primarily in North America.

Financial performance and position

Metric	FY2017	FY2016	Change
Net sales	$421.3 million	$369.0 million	+14.2%
Gross profit	$115.0 million	$100.9 million	+14.0%
Gross margin	27.3%	27.4%	Down 0.1 percentage point
Operating income	$68.0 million	$38.3 million	+77.6%
Net income	$37.6 million	$10.6 million	+255.7%
Diluted EPS	$1.93	$0.55	+251%
Cash flow from operations	$(5.3) million	$15.3 million	Declined $20.6 million
Capital expenditures	$4.9 million	$3.7 million	Increased

Fourth-quarter fiscal 2017 net sales were $114.4 million, gross profit was $31.6 million, operating income was $17.4 million, and net income was $9.8 million. Diluted EPS was $0.50.
Cash and cash equivalents declined to $9.0 million from $21.9 million. Short-term investments were $2.1 million.
Working capital remained negative at $(20.7) million, although it improved from $(24.4) million. The current ratio was 0.86 to 1.00.
Total assets were $436.1 million and shareholders’ equity was $248.7 million at March 31, 2017.
Non-core inventory increased to $67.5 million from $58.1 million. Long-term core inventory increased to $262.9 million from $241.1 million, reflecting growth and customer inventory requirements.
Operating cash flow was pressured by higher accounts receivable, inventory investment, payments for new business, and the reduction in the customer returns accrual.

Debt and liquidity

The company had a $125 million senior secured credit facility, consisting of a revolving facility and term loans, maturing June 3, 2020. Substantially all assets secure the facility.
At March 31, 2017, the company had $11.0 million outstanding under the revolving facility and $20.0 million of net term loans. Revolving availability was $108.1 million, subject to borrowing-base adjustments and reserves.
The term loan and revolving facility interest rates were 3.29% and 3.55%, respectively. The company was in compliance with all debt covenants; its senior leverage ratio was 0.29 versus a maximum of 2.50, and its fixed-charge coverage ratio was 1.56 versus a minimum of 1.05.
Receivable discount programs accelerated collections on $352.4 million of receivables at a 2.9% weighted-average discount rate, generating $9.7 million of interest expense.
Management stated that cash, investments, receivable discount programs, credit availability, and other sources were sufficient for expected working capital, debt repayment, lease, and capital expenditure needs over the following 12 months.

Material changes versus the prior comparable period

Sales growth occurred across existing product lines. Rotating electrical products remained the largest category at 78.6% of sales; wheel hubs represented 18.5% and brake master cylinders 2.9%.
Turbochargers were added through the July 2016 acquisition of ZOR Industries for $705,000. Brake power boosters began selling in August 2016.
General and administrative expense fell 37.3% to $31.1 million, primarily because fiscal 2016 included substantial litigation, bad-debt, and warrant-related charges. Fiscal 2017 included a $3.8 million warrant fair-value gain.
Sales and marketing expense increased 21.7% to $12.1 million, while research and development expense increased 27.1% to $3.8 million, reflecting growth investments.
Interest expense declined 19.4% to $13.1 million, principally because fiscal 2016 included a $5.1 million write-off of debt issuance costs and because of lower average debt balances and rates.
The effective tax rate declined to 31.5% from 52.1%, helped by the non-taxable warrant gain and $748,000 of excess tax benefits from early adoption of share-based compensation guidance.
A change in the estimate for anticipated stock adjustment returns increased sales by $9.3 million, cost of sales by $5.2 million, operating income by $4.1 million, and net income by $2.6 million, or $0.14 basic EPS and $0.13 diluted EPS.
The company repurchased and retired 69,659 shares for approximately $2.0 million. At year-end, $12.6 million remained available under the $15 million authorization.

Outlook, contingencies, and key risks

Management expected fiscal 2018 capital expenditures of approximately $7.5 million and approximately $11 million of additional investment for a new 410,000-square-foot distribution center in Tijuana, Mexico. The facility was expected to be completed during the latter part of fiscal 2018.
An April 2017 credit-facility amendment increased the borrowing-base limit for Mexican inventory, expanded certain EBITDA add-backs and permitted baskets, and increased the annual permitted dividend and repurchase limit.
Customer concentration is substantial: the four largest customers represented 87% of fiscal 2017 sales, and AutoZone represented 44%. Loss of a major customer or deterioration in its financial condition could materially affect results and liquidity.
Long-term customer contracts require significant pricing concessions, marketing allowances, favorable payment terms, and customer inventory investments. Allowances recorded as reductions of revenue totaled $96.4 million in fiscal 2017, and future contractual marketing allowances totaled $39.3 million.
Core inventory and customer-held remanufactured cores are classified as long-term assets. The company’s ability to obtain Used Cores and recover value from customer-held cores is critical to operations and working capital.
Major risks include negative working capital, weak operating cash flow, inventory obsolescence, customer returns, competition, raw-material and component availability, offshore operations, foreign currency exposure, import and logistics disruptions, cyber incidents, and lender covenant requirements.
Forward foreign-exchange contracts had a notional value of $26.9 million at year-end. A 10% adverse exchange-rate movement would have increased general and administrative expense by approximately $2.5 million based on the company’s disclosed sensitivity.
The company adopted certain accounting updates, including share-based compensation, inventory measurement, cash-flow classification, and noncurrent deferred-tax classification. It was evaluating the future impact of revenue-recognition standard ASC 606 and expected the lease standard to significantly increase reported assets and liabilities.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported no material weakness, and ordinary-course litigation was not expected to have a material adverse effect.

Investor verification items

Verify whether operating cash flow improves as inventory, customer allowances, and core-related working capital investments normalize.
Assess the sustainability of fiscal 2017 earnings after excluding the $4.1 million operating-income benefit from the stock-adjustment return estimate and the $3.8 million warrant fair-value gain.
Monitor AutoZone and other major-customer concentration, contract renewals, pricing concessions, payment terms, and future marketing allowances.
Reconcile the reported negative working capital with the substantial long-term core inventory balance and evaluate the liquidity implications of the company’s core-exchange accounting.
Track execution and funding of the Tijuana distribution-center expansion, including the expected $11 million investment and related lease obligations.
Review future covenant compliance, revolving-facility availability, receivable discount-program usage, and exposure to variable interest rates.
Evaluate the effects of ASC 606 and the new lease accounting standard when adopted; the filing does not provide a clear quantified estimate of their eventual financial statement impact.