Business Context and Reporting Period
Motorcar Parts of America, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2011, the first quarter of fiscal 2012. The company remanufactures, manufactures and distributes automotive replacement parts in North America, including alternators and starters and, following the May 6, 2011 acquisition of Fenco, under-the-car products such as steering components, brake calipers, clutches, water pumps and related parts.
The Fenco acquisition expanded the company from one reportable segment to two: rotating electrical and under-the-car product line. Because Fenco was acquired during the quarter, current and prior-period results are not directly comparable.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 |
|---|---|---|
| Net sales | $71.3 million | $36.2 million |
| Gross profit | $13.1 million | $11.5 million |
| Gross margin | 18.4% | 31.9% |
| Operating income | $1.4 million | $5.4 million |
| Income before taxes | $(0.5) million | $3.8 million |
| Net income (loss) | $(2.4) million | $2.5 million |
| Diluted earnings (loss) per share | $(0.19) | $0.21 |
| Cash flow from operations | $(26.4) million | $0.1 million |
| Capital expenditures | $0.4 million | $0.2 million |
Sales increased 96.7%, primarily from $32.2 million of Fenco sales and $3.6 million of growth in the existing rotating electrical business. Consolidated gross margin declined because the under-the-car segment generated only a 1.8% gross margin and included $2.7 million of cost of goods sold from the fair-value step-up of acquired inventory. Rotating electrical gross margin was 32.1%, compared with 31.9% in the prior-year quarter.
Operating expenses increased to $11.7 million from $6.1 million, including $0.4 million of acquisition costs, higher general and administrative expenses, amortization of acquired intangibles and Fenco-related costs. Income tax expense was $1.8 million despite the consolidated pretax loss, because tax benefits on Fenco losses were not recognized as recoverability was not considered more likely than not.
Financial Position, Debt and Liquidity
| Balance Sheet Metric | June 30, 2011 | March 31, 2011 |
|---|---|---|
| Cash | $1.3 million | $2.5 million |
| Short-term investments | $0.3 million | $0.3 million |
| Total assets | $449.1 million | $191.9 million |
| Total liabilities | $330.3 million | $74.7 million |
| Shareholders’ equity | $118.8 million | $117.2 million |
| Working capital | $(88.5) million | $1.4 million |
Total debt, excluding capital lease obligations, was approximately $83.1 million at June 30, 2011, consisting principally of $66.1 million of revolving borrowings and $17.0 million of term loans. The Parent Company revolving facility had $18.5 million outstanding and $26.1 million available, including a $10.0 million borrowing reserve at quarter-end. The Fenco revolving facility had $47.6 million outstanding and $4.25 million available under its borrowing base.
Management stated that cash from operations, receivable discount programs, available revolver capacity, cash and short-term investments were expected to satisfy working capital, lease, term-loan repayment and capital expenditure needs for the following twelve months. The company discounted $47.4 million of receivables during the quarter at a 3.1% annualized weighted-average discount rate, producing $1.3 million of interest expense.
Material Changes Versus the Prior Comparable Period
- Fenco was acquired on May 6, 2011 for consideration of approximately $4.9 million in company common stock, consisting of 360,000 shares. Preliminary purchase accounting recorded $4.4 million of goodwill and approximately $48.4 million of net intangible assets.
- Sales nearly doubled, but operating income fell 74.2% and the company moved from net income to a net loss.
- Operating cash flow declined from $0.1 million provided to $26.4 million used, driven primarily by Fenco inventory growth and reductions in accounts payable and accrued liabilities.
- Inventory increased substantially, including non-core inventory of $108.5 million and long-term core inventory of $184.1 million at June 30, 2011.
- Revolving debt increased from zero at March 31, 2011 to $66.1 million at quarter-end, principally to support the acquired business and working capital.
- The company issued 360,000 shares for the acquisition, increasing shares outstanding compared with March 31, 2011.
- Comprehensive loss was $3.4 million, including a $1.0 million foreign-currency translation loss.
Outlook, Commentary, Risks and Unusual Items
Management expected fiscal 2012 capital expenditures of approximately $4.8 million for both segments. It identified opportunities to expand product lines, increase market presence and grow in the professional installer market, but did not provide formal revenue or earnings guidance.
- Fenco integration, systems standardization and internal-control assessment were ongoing. Management excluded Fenco from its June 30, 2011 internal-control assessment under the SEC’s one-year acquisition transition guidance.
- The Fenco purchase-price allocation remained preliminary and could change materially as valuations were finalized.
- Fenco’s under-the-car segment had a $31.2 million operating cash outflow and a 1.8% gross margin during the period included in the consolidated results.
- The company relies heavily on major customers; one customer represented 40% of quarterly sales. Receivable discount programs may not continue and expose the company to higher interest expense if rates, utilization or payment periods increase.
- Debt agreements contain financial covenants and maturities beginning in 2012. The company was in compliance with Parent Company covenants, while Fenco was either in compliance or had obtained waivers as of June 30, 2011.
- In July 2011, the Parent Company credit amendment eliminated the $10.0 million borrowing reserve and temporarily permitted Fenco to be excluded from certain covenant calculations for the June and September 2011 quarters.
- Additional risks include customer concentration, working-capital intensity, availability and cost of used cores, foreign-exchange exposure, reliance on foreign suppliers and third-party manufacturers, import disruptions, competition and the ability to maintain positive operating cash flow.
Investor Verification Checklist
- Verify the final Fenco purchase-price allocation, goodwill, intangible valuations and remaining inventory fair-value step-up.
- Assess whether the under-the-car segment can improve its gross margin and operating cash flow after acquisition-related adjustments.
- Review borrowing-base availability, covenant compliance, waivers and the October 2012 Fenco facility maturity.
- Monitor inventory levels, core-return accruals, customer returns and the company’s ability to convert working capital into cash.
- Evaluate the sustainability of receivable discount programs and concentration with major customers.
- Confirm progress in integrating Fenco and incorporating its financial reporting and internal controls into the company’s annual assessment.