Business Context and Reporting Period
Motorcar Parts of America, Inc. filed its Form 10-K for the fiscal year ended March 31, 2013. The filing includes fourth-quarter fiscal 2013 results and comparative fiscal 2012 results. The company manufactures, remanufactures, and distributes aftermarket automotive parts through two segments: rotating electrical products, primarily alternators and starters, and the undercar product line, operated through Fenco.
Comparability is significantly affected by the May 2011 acquisition of Fenco. Subsequent to year-end, Fenco lost control of its operations and filed for Chapter 7 bankruptcy on June 10, 2013. Fenco was still consolidated at March 31, 2013.
Key Financial Metrics
| Metric | Fiscal 2013 | Fiscal 2012 |
|---|---|---|
| Net sales | $406.3 million | $363.7 million |
| Gross profit | $55.7 million | $27.7 million |
| Gross margin | 13.7% | 7.6% |
| Operating income (loss) | $(88.8) million | $(27.5) million |
| Net income (loss) | $(91.5) million | $(48.5) million |
| Diluted loss per share | $(6.39) | $(3.90) |
| Cash flow from operations | $(31.1) million | $(38.5) million |
| Capital expenditures | $4.0 million | $1.6 million |
- Rotating electrical sales increased 19.4% to $213.2 million, with a 32.5% gross margin versus 31.8% in fiscal 2012.
- Undercar sales increased 4.3% to $193.1 million, but the segment generated a negative 7.0% gross margin and a $135.3 million net loss.
- Fiscal 2013 included $84.7 million of non-cash impairment charges, consisting of $68.4 million for goodwill and $16.3 million for intangible assets related to the undercar segment.
- General and administrative expense included specific charge-off accruals of $52.6 million for Fenco debt, $27.4 million for Fenco-related receivables, and $1.8 million for intercompany balances.
- Interest expense increased to $24.4 million from $14.3 million.
- The company recorded a $21.7 million income tax benefit, primarily associated with Fenco-related charge-offs.
Liquidity, Debt, and Balance Sheet
- Cash declined to $19.4 million from $32.6 million. Consolidated working capital was negative $67.1 million, compared with negative $2.2 million in the prior year.
- Rotating electrical had $19.3 million of cash and $32.7 million of working capital at March 31, 2013, while Fenco had only $88,000 of cash and a $104.5 million working-capital deficit.
- Consolidated debt obligations totaled approximately $143.3 million, including an $84.0 million term loan and Fenco debt classified as in default.
- Fenco had $49.3 million outstanding under its revolving facility and $10.0 million under its term loan, and exceeded borrowing capacity by $5.8 million.
- The parent revolving facility had no outstanding balance and approximately $18.9 million of availability at year-end, subject to borrowing-base and other restrictions.
- Shareholders’ equity declined to a deficit of $3.5 million from positive equity of $73.6 million.
- Receivables discounted under customer programs totaled $289.5 million, with $6.9 million of related discount expense recorded as interest.
Material Changes Versus the Prior Comparable Period
- Sales increased 11.7%, driven primarily by new and expanded rotating electrical customer programs.
- Gross margin improved by 6.1 percentage points, largely because of a $50.8 million reduction in Fenco’s obligation to provide credits for a major customer’s remanufactured cores. The related gross-profit benefit was approximately $19.1 million and is unusual.
- Despite higher sales and gross profit, operating and net losses widened because of Fenco’s continuing losses, impairment charges, Fenco-related charge-offs, higher interest expense, inventory reserves, and restructuring costs.
- Cash used in operations improved by $7.4 million but remained negative. The improvement primarily reflected inventory reductions and changes in Fenco’s core inventory and accrual balances.
- Excess and obsolete inventory reserves increased to $25.0 million from $11.3 million.
- Fenco’s net loss increased from $62.8 million to $135.3 million, and its accumulated deficit reached approximately $198.1 million.
- The company issued 1.936 million common shares in a private placement for gross proceeds of approximately $15.0 million.
Guidance, Outlook, Risks, and Unusual Items
Management stated that its future focus will exclude Fenco and remain centered on the rotating electrical business. Management views the market opportunity favorably because North America has more than 240 million vehicles, with an average age exceeding 10 years, and older vehicles generally require more alternator and starter replacements. Management believes the rotating electrical segment has strong liquidity, which may be enhanced by tax benefits from the Fenco investment write-off.
- Ernst & Young issued an unqualified audit opinion that included an explanatory paragraph expressing substantial doubt about the company’s ability to continue as a going concern because of Fenco’s losses, liquidity deficiency, covenant violations, and significance to the consolidated company.
- Fenco’s Chapter 7 filing and anticipated deconsolidation create uncertainty regarding asset recoverability, liability classification, customer relationships, and future consolidated results.
- The company remains highly dependent on a small number of customers: its three largest customers represented approximately 72% of fiscal 2013 sales, and AutoZone represented approximately 41%.
- The company faces pressure for lower prices, marketing allowances, extended payment terms, and customer core purchases, all of which increase working-capital requirements.
- After July 1, 2014, a supplier may require settlement of up to $8.0 million of Fenco obligations in cash or common stock. Related guarantees could expose the company to as much as $22.0 million of cash obligations and potential issuance of up to 2.6 million shares, subject to the agreement’s terms.
- The parent financing agreement requires continued covenant compliance and, under a June 2013 amendment, specified minimum liquidity levels of $25.0 million, $26.0 million, and $27.0 million on specified dates in June, July, and August 2013.
- Management reported that the prior Fenco material weakness in internal control over financial reporting was remediated as of March 31, 2013; investors should distinguish this conclusion from the substantial doubt qualification related to going concern.
- Fiscal 2014 capital expenditures were expected to be approximately $2.0 million to $3.0 million, although the filing does not provide broader earnings or revenue guidance.
Most Important Facts to Verify
- Whether Fenco was fully deconsolidated in fiscal 2014 and the resulting treatment of its debt, assets, liabilities, and bankruptcy claims.
- Whether the rotating electrical segment generated positive operating and free cash flow after separation from Fenco.
- Compliance with the parent-company liquidity and financial covenants and the status of lender waivers.
- Actual cash recoveries, if any, from Fenco-related debt, receivables, intercompany balances, and investments.
- The extent to which the unusual $50.8 million core-obligation revenue recognition affected ongoing revenue and margin comparability.
- Customer concentration, contract renewals, pricing concessions, marketing allowances, and continued access to receivable discount programs.
- Potential dilution or cash requirements arising from supplier guarantees, warrants, and other equity-linked obligations.