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, and brake power boosters. The company reports one operating segment and sells primarily in North America. This unaudited Form 10-Q covers the three and six months ended September 30, 2016, within fiscal 2017.
Financial Highlights
| Metric | Three Months Ended September 30, 2016 | Three Months Ended September 30, 2015 | Six Months Ended September 30, 2016 | Six Months Ended September 30, 2015 |
|---|---|---|---|---|
| Net sales | $108.8 million | $91.7 million | $194.2 million | $177.5 million |
| Gross profit | $30.7 million | $21.8 million | $51.0 million | $47.8 million |
| Gross margin | 28.2% | 23.8% | 26.3% | 26.9% |
| Operating income | $17.2 million | $0.3 million | $30.4 million | $11.9 million |
| Net income | $9.1 million | $(1.4) million | $16.7 million | $0.5 million |
| Diluted EPS | $0.47 | $(0.08) | $0.86 | $0.03 |
| Cash flow from operations | $(8.5) million | $15.8 million | $(22.3) million | $19.2 million |
For the second quarter, sales increased 18.7%, operating income rose substantially, and gross margin expanded by 440 basis points. For the six-month period, sales increased 9.4%, but gross margin declined by 60 basis points and operating cash flow turned negative.
Balance Sheet, Debt, and Liquidity
- At September 30, 2016, cash and cash equivalents were $5.5 million, short-term investments were $2.2 million, working capital was $3.9 million, and the current ratio was 1.03:1.
- Total assets were $437.7 million and shareholders’ equity was $228.8 million, compared with $413.4 million and $210.8 million, respectively, at March 31, 2016.
- Inventory totaled $72.2 million, inventory unreturned was $10.2 million, and long-term core inventory was $251.0 million. Inventory growth was used to support anticipated sales growth.
- The company had $19.0 million outstanding under its revolving facility and $21.9 million of term-loan principal outstanding. Approximately $100.1 million was available under the revolving facility, subject to borrowing-base adjustments.
- The credit facility matures in June 2020 and is secured by substantially all company assets. The company was in compliance with its covenants; the senior leverage ratio was 0.46 versus a maximum of 2.50, and the fixed-charge coverage ratio was 1.37 versus a minimum of 1.05.
- Receivables discounted under customer programs totaled $167.7 million for the six months, with $4.4 million of related interest expense and an annualized weighted-average discount rate of 2.8%.
Material Changes Versus the Prior Comparable Period
- Quarterly gross margin improved primarily from lower per-unit costs and better overhead absorption. Six-month margin was pressured by $11.96 million of customer allowances and initial return and stock-adjustment accruals related to new business.
- General and administrative expense declined 45.8% in the quarter and 54.4% year to date, primarily because the prior-year periods included substantial legal expense, including a $9.25 million litigation settlement accrual related to discontinued subsidiaries.
- The six-month period included a $4.8 million gain from the change in fair value of the supplier warrant, compared with a $1.7 million loss in the prior-year period. The warrant liability was $10.9 million at September 30, 2016.
- Interest expense declined year to date because the prior-year period included a $5.1 million write-off of debt issuance costs. Quarterly interest expense increased due to higher receivable-discounting costs and higher revolving borrowings.
- Operating cash flow deteriorated from positive $19.2 million to negative $22.3 million, driven mainly by increased accounts receivable, customer payments related to new business, higher inventory, and payments associated with customer allowances.
- The company acquired certain assets and liabilities of ZOR Industries USA LLC on July 21, 2016 for an initial purchase price of $0.6 million, adding turbochargers. Brake power boosters began selling in August 2016.
- The company early adopted new share-based compensation guidance, recording an $0.9 million cumulative-effect adjustment to retained earnings and deferred tax assets.
Guidance, Outlook, Risks, and Unusual Items
Management stated that available cash, short-term investments, receivable-discounting programs, revolving-facility availability, and other sources are expected to satisfy working-capital, debt repayment, capital lease, and capital expenditure requirements for the next 12 months. Fiscal 2017 capital expenditures are expected to be approximately $4 million to $5 million, excluding additional amounts potentially required for expansion in Mexico.
- Liquidity is relatively tight, with only $5.5 million of cash, a 1.03:1 current ratio, and negative year-to-date operating cash flow, although substantial borrowing capacity remains available.
- Receivable-discounting programs may not continue and would become more expensive if interest rates rise, customer payment periods lengthen, or utilization increases.
- Customer concentration is significant: three customers represented 85% of quarterly sales and 85% of six-month sales; the largest customer represented 45% and 48%, respectively.
- Core inventory and customer-return obligations are material. Warranty-return accruals increased to $13.7 million at September 30, 2016 from $10.8 million at September 30, 2015.
- Key risks include customer loss or delayed payments, pricing pressure, working-capital demands, availability and cost of used cores, foreign-exchange exposure, competition, covenant compliance, interest-rate increases, cyber risks, and execution of new products and acquisitions.
- The company used forward foreign-currency contracts with a notional value of $27.0 million and recorded a $1.2 million loss from those contracts in the six-month period.
- No material changes were reported to litigation matters or risk factors from the fiscal 2016 Form 10-K. Management stated that disclosure controls were effective as of September 30, 2016.
Investor Verification Checklist
- Verify whether negative operating cash flow and inventory growth normalize as new business ramps.
- Assess the sustainability of quarterly gross-margin improvement after customer allowances, returns, and launch costs.
- Monitor customer concentration, accounts-receivable aging, discount-program availability, and collection periods.
- Reconcile revolving borrowings, borrowing-base availability, interest rates, and compliance with leverage and fixed-charge covenants.
- Evaluate the financial contribution and integration progress of turbochargers and brake power boosters.
- Separate recurring operating performance from unusual items, including the prior-year legal accrual, warrant fair-value gains or losses, and accounting changes.
- Review the company’s planned Mexico expansion, fiscal 2017 capital expenditures, and potential need for additional financing or capital leases.