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MOTORCAR PARTS AMERICA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis presents factors that Motorcar Parts of America, Inc. and its subsidiaries ("our," "we" or "us") believe are relevant to an assessment and understanding of our consolidated financial position and results of operations. This financial and business analysis should be read in conjunction with our March 31, 2014 audited consolidated financial statements included in our Annual Report on Form 10-K filed with the SEC on June 16, 2014, as amended by the Form 10-K/A filed with the SEC on July 29, 2014. Disclosure Regarding Private Securities Litigation Reform Act of 1995 This report contains certain forward-looking statements with respect to our future performance that involve risks and uncertainties. Various factors could cause actual results to differ materially from those projected in such statements. These factors include, but are not limited to: the bankruptcy of the Fenco Entities and related contingent liabilities, concentration of sales to certain customers, changes in the financial condition of or our relationship with any of our major customers, the increasing customer pressure for lower prices and more favorable payment and other terms, lower revenues than anticipated from new and existing contracts, the increasing demands on our working capital, the significant strain on working capital associated with large inventory purchases from customers, any meaningful difference between expected production needs and ultimate sales to our customers, our ability to obtain any additional financing we may seek or require, our ability to achieve positive cash flows from operations, potential future changes in our previously reported results as a result of the identification and correction of errors in our accounting policies or procedures or the potential material weaknesses in our internal controls over financial reporting, our failure to meet the financial covenants or the other obligations set forth in our credit agreement and the lenders' refusal to waive any such defaults, increases in interest rates, the impact of high gasoline prices, consumer preferences and general economic conditions, increased competition in the automotive parts industry including increased competition from Chinese and other offshore manufacturers, difficulty in obtaining Used Cores and component parts or increases in the costs of those parts, political, criminal or economic instability in any of the foreign countries where we conduct operations, currency exchange fluctuations, unforeseen increases in operating costs, and other factors discussed herein and in our other filings with the SEC. Management Overview We are a leading manufacturer, remanufacturer, and distributor of aftermarket automotive parts for import and domestic cars, light trucks, heavy duty, agricultural and industrial applications. We sell our products predominantly in North America to the largest auto parts retail and traditional warehouse chains and to major automobile manufacturers for both their aftermarket programs and their OES programs. Our products include rotating electrical products such as alternators and starters and wheel hub assemblies and bearings. The aftermarket for automobile parts is divided into two markets. The first market is the DIY market, which is generally serviced by the large retail chain outlets. Consumers who purchase parts from the DIY channel generally install parts into their vehicles themselves. In most cases, this is a less expensive alternative than having the repair performed by a professional installer. The second market is the professional installer market, commonly known as the DIFM market. This market is serviced by the traditional warehouse distributors, the dealer networks, and the commercial divisions of retail chains. Generally, the consumer in this channel is a professional parts installer. Our products are distributed to both the DIY and DIFM markets. The DIFM market is growing faster and is an attractive opportunity for growth. We are positioned to benefit from this market opportunity in three ways: (i) our auto parts retail customers are expanding their efforts to target the DIFM market, (ii) we sell our products under private label and our own brand names directly to suppliers that focus on professional installers, and (iii) we sell our products to original equipment manufacturers for distribution to the professional installer both for warranty replacement and their general aftermarket channels. We have been successful in growing sales to this market. We have positioned ourselves to take advantage of multiple growth strategies including growing our product lines both with existing and potential new customers and by introducing new product lines. We have recently obtained commitments for a significant amount of new business on existing product lines which we expect to begin shipping in the later part of the current fiscal year; however, such commitments are subject to adjustments and other modifications in accordance with the terms of the respective customer contracts, and accordingly, in the event of any such adjustment or modifications, actual sales volumes from such commitments may differ from volumes currently anticipated by us. 21 -------------------------------------------------------------------------------- Table of Contents We have two operating segments: (i) wheel hub assemblies and bearings and (ii) rotating electrical products which consist of alternators and starters. In accordance with the authoritative accounting guidance for segment reporting, we have determined that these operating segments meet the criteria for aggregation and accordingly we have one reportable segment for purposes of recording and reporting our financial results. Results of Operations for the Three Months Ended June 30, 2014 and 2013 The following discussion and analysis should be read in conjunction with the financial statements and notes thereto appearing elsewhere herein. The following table summarizes certain key operating data of our continuing operations for the periods indicated: Three Months Ended June 30, 2014 2013 Gross profit percentage 28.3 % 31.9 % Cash flow provided by (used in) continuing operations $ 2,637,000 $ (3,072,000 ) Finished goods turnover (annualized) (1) 5.9 7.2 -------------------------------------------------------------------------------- (1) Annualized finished goods turnover for the fiscal quarter is calculated by multiplying cost of sales for the quarter by 4 and dividing the result by the average between beginning and ending non-core finished goods inventory values for the fiscal quarter. We believe this provides a useful measure of our ability to turn our inventory into revenues. Net Sales and Gross Profit The following table summarizes net sales and gross profit of our continuing operations for the three months ended June 30, 2014 and 2013: Three Months Ended June 30, 2014 2013 Net sales $ 62,975,000 $ 50,245,000 Cost of goods sold 45,159,000 34,231,000 Gross profit 17,816,000 16,014,000 Cost of goods sold as a percentage of net sales 71.7 % 68.1 % Gross profit percentage 28.3 % 31.9 % Net Sales. Our net sales for the three months ended June 30, 2014 increased by $12,730,000, or 25.3%, to $62,975,000 compared to net sales for the three months ended June 30, 2013 of $50,245,000. The increase in net sales was due to both the growth in sales of our rotating electrical products and the full quarter impact of the introduction of our new wheel hub products. We began selling wheel hub products in late June 2013. Cost of Goods Sold/Gross Profit. Our cost of goods sold as a percentage of net sales increased during the three months ended June 30, 2014 to 71.7% from 68.1% for the three months ended June 30, 2013, resulting in a corresponding decrease in our gross profit to 28.3% for the three months ended June 30, 2014 from 31.9% for the three months ended June 30, 2013. The decrease in our gross profit for the three months ended June 30, 2014, was due to full quarter impact in the first quarter of fiscal 2015 of wheel hub products, which currently have a lower margin than rotating electrical products. In addition, we incurred special upfront allowances of $442,000 in connection with new business and $189,000 of start-up costs incurred during the three months ended June 30, 2014 related to the introduction of our new product line. 22 -------------------------------------------------------------------------------- Table of Contents Operating Expenses The following table summarizes operating expenses of our continuing operations for the three months ended June 30, 2014 and 2013: Three Months Ended June 30, 2014 2013 General and administrative $ 5,392,000 $ 9,632,000 Sales and marketing 1,826,000 1,731,000 Research and development 522,000 549,000 Percent of net sales General and administrative 8.6 % 19.2 % Sales and marketing 2.9 % 3.4 % Research and development 0.8 % 1.1 % General and Administrative. Our general and administrative expenses for the three months ended June 30, 2014 were $5,392,000, which represents a decrease of $4,240,000, or 44.0%, from general and administrative expenses for the three months ended June 30, 2013 of $9,632,000. The decrease in general and administrative expenses was primarily due to (i) a gain of $1,114,000 recorded during the three months ended June 30, 2014 due to the change in the fair value of the warrant liability compared to a loss of $1,570,000 recorded during the three months ended June 30, 2013, (ii) a $233,000 gain recorded during the three months ended June 30, 2014 due to the change in the fair value of the forward foreign exchange contracts compared to a loss of $733,000 recorded during the three months ended June 30, 2013, (iii) a $560,000 decrease in legal expenses, and (iv) a $580,000 decrease in professional services related to the discontinued subsidiary. These decreases in general and administrative expense were partly offset by $373,000 of increased share-based compensation expense. Sales and Marketing. Our sales and marketing expenses for the three months ended June 30, 2014 increased $95,000, or 5.5%, to $1,826,000 from $1,731,000 for the three months ended June 30, 2013. The increase was due primarily to increased employee-related costs. Research and Development. Our research and development expenses decreased by $27,000, or 4.9%, to $522,000 for the three months ended June 30, 2014 from $549,000 for the three months ended June 30, 2013, due primarily to decreased professional services partly offset by increased travel and employee-related costs. Interest Expense Interest Expense, net. Our interest expense, net for the three months ended June 30, 2014 decreased $512,000, or 13.0%, to $3,413,000 from $3,925,000 for the three months ended June 30, 2013. The decrease in interest expense was due primarily to lower interest rates on our increased long-term debt outstanding. In addition, our prior year interest expense included interest on certain vendor payables. These decreases were partly offset by increased interest payments on factored receivables due to a larger balance of receivables factored during the three months ended June 30, 2014 as compared to June 30, 2013. Provision for Income Taxes Income Tax. Our income tax expense from continuing operations was $2,714,000, or an effective tax rate of 40.7%, and $74,000, or an effective tax rate of 41.8% during the three months ended June 30, 2014 and 2013, respectively. The income tax rates were higher than the federal statutory rate primarily due to state income taxes, which were partially offset by the benefit of lower statutory tax rates in foreign taxing jurisdictions. In addition, our income tax rates for three months ended June 30, 2014 were positively impacted by a non-taxable gain in connection with the fair value adjustment on the warrants compared to a non-deductible loss for the three months ended June 30, 2013. 23 -------------------------------------------------------------------------------- Table of Contents Income (Loss) from Discontinued Operations Income (Loss) from Discontinued Operations. Our income from discontinued operations was $100,877,000 during the three months ended June 30, 2013 and consisted of (i) a $118,095,000 gain on the deconsolidation of the discontinued subsidiary, including an income tax benefit of $1,374,000, (ii) a loss of approximately $20,464,000 in connection with the guarantee of obligations to certain suppliers of the discontinued subsidiary partly offset by income tax benefits of $9,156,000, and (iii) net sales of approximately $14,140,000 and the resulting loss of approximately $5,910,000 incurred by the discontinued subsidiary from April 1, 2013 to May 31, 2013. Liquidity and Capital Resources Overview At June 30, 2014, we had working capital of $17,631,000, a ratio of current assets to current liabilities of 1.2:1, and cash of $24,692,000, compared to working capital of $22,077,000, a ratio of current assets to current liabilities of 1.2:1, and cash of $24,599,000 at March 31, 2014. During the three months ended June 30, 2014, we used cash generated primarily from the use of our receivable discount programs with certain of our major customers to pay our accounts payable balances and to make the quarterly principal term loan payments. During fiscal 2014, we filed a universal shelf registration statement on Form S-3 (File No. 333-190966), which was declared effective on May 9, 2014, for the proposed offering from time to time of up to $100,000,000 of our securities, including common stock, preferred stock, and debt securities. The securities may be offered by us from time to time at amounts, prices, interest rates, and other terms to be determined at the time of the offering. We believe our cash on hand, short-term investments, use of receivable discount programs, amounts available under our Financing Agreement, and other sources are sufficient to satisfy our expected future working capital needs, repayment of the current portion of our term loans, capital lease commitments, and capital expenditure obligations over the next twelve months. Cash Flows Cash flows from our continuing operations as reflected in the consolidated statement of cash flows for the three months ended June 30, 2014 and 2013 are summarized as follows: Three Months Ended June 30, 2014 2013 Cash provided by (used in): Operating activities from our continuing operations $ 2,637,000 $ (3,072,000 ) Investing activities from our continuing operations (621,000 ) (391,000 ) Financing activities from our continuing operations (1,933,000 ) (664,000 ) Effect of exchange rates on cash 10,000 (28,000 ) Net increase (decrease) in cash from our continuing operations $ 93,000 $ (4,155,000 ) Additional selected cash flow data: Depreciation and amortization $ 633,000 $ 733,000 Capital expenditures (610,000 ) (381,000 ) Net cash provided by operating activities from continuing operations was $2,637,000 during the three months ended June 30, 2014 compared to net cash used in operating activities of $3,072,000 during the three months ended June 30, 2013. The significant changes in our operating activities from continuing operations were due primarily to higher collections of accounts receivable which were used to pay down our accounts payable balances. 24 -------------------------------------------------------------------------------- Table of Contents Net cash used in investing activities of continuing operations was $621,000 and $391,000 during the three months ended June 30, 2014 and 2013, respectively, and primarily related to the purchase of equipment for our manufacturing and warehousing facilities and office equipment. Net cash used in financing activities of continuing operations was $1,933,000 and $664,000 during the three months ended June 30, 2014 and 2013, respectively. This change was due mainly to the increased quarterly principal payments required by our Term Loans. Capital Resources Debt We are party to the following credit agreements. Financing Agreement We are party to a financing agreement, as amended, (the "Financing Agreement"), with a syndicate of lenders, Cerberus Business Finance, LLC ("Cerberus"), as collateral agent, and PNC Bank, National Association, as administrative agent. The loans made thereunder (the "Loans") consist of: (i) term loans aggregating $95,000,000 (the "Term Loans") and (ii) revolving loans of up to $30,000,000, subject to borrowing base restrictions and a $10,000,000 sublimit for letters of credit (the "Revolving Loans"). The Loans mature on November 6, 2018. In connection with the Financing Agreement, the lenders were granted a security interest in substantially all of our assets. In addition, we have the right, subject to meeting certain conditions, to repurchase up to $10,000,000 of our equity interests. In June 2014, we entered into a first amendment to the Financing Agreement (the "First Amendment"), pursuant to which (i) the Revolving Loans were increased by $10,000,000 to $40,000,000 (the "Amended Revolving Loans"), (ii) the maximum amount of capital expenditures was increased to $7,000,000 for fiscal 2015, and $4,000,000 for each of fiscal 2016 and 2017, and (iii) certain other amendments and modifications were made. The Term Loans require quarterly principal payments of $2,100,000 and bear interest at rates equal to, at our option, either LIBOR (subject to a 1.50% LIBOR floor) plus 5.25% or a reference rate plus 4.25%. The Amended Revolving Loans bear interest at rates equal to, at our option, either LIBOR plus 2.50% or a reference rate plus 1.00%. The interest rate on our Term Loans using the LIBOR option was 6.75% at June 30, 2014 and March 31, 2014, respectively. The interest rate on our revolving loans using the LIBOR option was 2.66% at June 30, 2014 and March 31, 2014, respectively. We may reduce or terminate the commitments of the lenders to make the Amended Revolving Loans or prepay the Term Loans in whole or in part, but such prepayments are subject to a prepayment penalty of 2.00% times the sum of the reduction of the revolving credit commitment plus the principal amount of any prepayment of the Term Loans through January 18, 2015. The Financing Agreement, among other things, requires us to maintain certain financial covenants including a maximum senior leverage ratio, a minimum fixed charge coverage ratio, and minimum consolidated earnings before interest, income tax, depreciation and amortization expenses ("EBITDA"). We were in compliance with all financial covenants under the Financing Agreement as of June 30, 2014. 25 -------------------------------------------------------------------------------- Table of Contents The following table summarizes the financial covenants required under the Financing Agreement as of June 30, 2014: Financial covenants Calculation as of required per the June 30, 2014 Financing Agreement Maximum senior leverage ratio 1.74 3.30 Minimum fixed charge coverage ratio 1.80 1.05 Minimum consolidated EBITDA $ 58,014,000 $ 31,750,000 We had borrowed $10,000,000 under the revolving loans at June 30, 2014 and March 31, 2014, respectively. We had reserved $476,000 for standby letters of credit for workers' compensation insurance and $917,000 for commercial letters of credit as of June 30, 2014. As of June 30, 2014, $28,607,000, subject to certain adjustments, was available under the Amended Revolving Loans. WX Agreement In August 2012, we entered into the WX Agreement with the Supplier and the discontinued subsidiary. Under the terms of the WX Agreement, the Supplier agreed to provide a revolving credit line for purchases of automotive parts and components by the discontinued subsidiary. In connection with the WX Agreement, we issued the Supplier Warrant to the Supplier to purchase up to 516,129 shares of our common stock for an initial exercise price of $7.75 per share exercisable at any time after August 22, 2014 and on or prior to September 30, 2017. The exercise price is subject to adjustments, among other things, for sales of common stock by us at a price below the exercise price. The fair value of the Supplier Warrant using the Monte Carlo simulation model was $8,933,000 and $10,047,000 at June 30, 2014 and March 31, 2014, respectively. This amount is recorded as a warrant liability which is included in other liabilities in the accompanying consolidated balance sheets. During the three months ended June 30, 2014 and 2013, a gain of $1,114,000 and a loss $1,140,000, respectively, were recorded in general and administrative expenses due to the change in the fair value of this warrant liability. Receivable Discount Programs We use receivable discount programs with certain customers and their respective banks. Under these programs, we have options to sell those customers' receivables to those banks at a discount to be agreed upon at the time the receivables are sold. These discount arrangements allows us to accelerate collection of customers' receivables. While these arrangements have reduced our working capital needs, there can be no assurance that these programs will continue in the future. Interest expense resulting from these programs would increase if interest rates rise, if utilization of these discounting arrangements expands or if the discount period is extended to reflect more favorable payment terms to customers. The following is a summary of the receivable discount programs from continuing operations: Three Months Ended June 30, 2014 2013 Receivables discounted $ 68,608,000 $ 44,208,000 Weighted average days 337 332 Annualized weighted average discount rate 2.0 % 2.4 % Amount of discount as interest expense $ 1,292,000 $ 978,000 Off-Balance Sheet Arrangements At June 30, 2014, we had no off-balance sheet financing or other arrangements with unconsolidated entities or financial partnerships (such as entities often referred to as structured finance or special purpose entities) established for purposes of facilitating off-balance sheet financing or other debt arrangements or for other contractually narrow or limited purposes. 26 -------------------------------------------------------------------------------- Table of Contents Capital Expenditures and Commitments Capital Expenditures Our capital expenditures were $610,000 and $381,000 for the three months ended June 30, 2014 and 2013, respectively. Our capital expenditures were primarily related to the purchase of equipment for our manufacturing and warehousing facilities and office equipment. We expect our fiscal year 2015 capital expenditures to be in the range of $3,000,000 to $7,000,000 depending on the timing of initiatives primarily related to our purchases of equipment, information technology, and leasehold improvements to our current facilities. We expect to use our working capital and incur additional capital lease obligations to finance these capital expenditures. Related Party Transactions There have been no material changes to our related party transactions that are presented in our Annual Report on Form 10-K for the year ended March 31, 2014, which was filed on June 16, 2014. Litigation There have been and may be additional claims filed against us by the trustee and some or all of the creditors in connection with the bankruptcy proceedings involving the Fenco Entities. For example, the trustee has notified our insurance companies that it may have claims for wrongful acts, breach of fiduciary duty, civil conspiracy, aiding and abetting, negligence and conversion. We are also a defendant in a case in Ontario Superior Court and in a case in the District Court for the District of Delaware claiming that we are liable for amounts due by the Fenco Entities to their employees under U.S. and Canadian law. Any litigation to determine the validity of these claims, regardless of their merit or resolution, may be costly and time consuming and divert the efforts and attention of our management from our business strategy. Any adverse judgment or settlement by us of these claims will also result in additional expense. We are also subject to various other legal proceedings arising in the normal course of conducting business. Management does not believe that the outcome of these matters will have a material adverse impact on its financial position or future results of operations. Critical Accounting Policies There have been no material changes to our critical accounting policies and estimates that are presented in our Annual Report on Form 10-K for the year ended March 31, 2014, which was filed on June 16, 2014, except as discussed below. New Accounting Pronouncements Income Taxes In July 2013, the FASB issued guidance that requires entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the tax law and the Company intends to use the deferred tax asset for that purpose. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2013. The adoption of this standard did not have any impact on our financial position, results of operations or cash flows. Discontinued Operations In April 2014, the FASB issued guidance on reporting discontinued operations. The new guidance changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. Under the new guidance, a discontinued operation is defined as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has or will have a major effect on an entity's operations and financial results. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. The adoption of this guidance is not expected to have a material impact on our financial position, results of operations or cash flows. 27 -------------------------------------------------------------------------------- Table of Contents Revenue Recognition In May 2014, the FASB issued an amendment to the accounting guidance related to revenue recognition. The amendment was the result of a joint project between the FASB and IASB to clarify the principles for recognizing revenue and to develop common revenue standards for U.S. GAAP and IFRS. To meet those objectives, the FASB is amending the FASB ASC and creating a new Topic 606, Revenue from Contracts with Customers, and the IASB is issuing IFRS 15, Revenue from Contracts with Customers. The new guidance is effective prospectively for annual periods beginning after December 15, 2016, and interim periods within those years. Early application is not permitted. We are evaluating the impact the adoption of this guidance will have on our consolidated financial statements. 28 -------------------------------------------------------------------------------- Table of Contents |