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EX-32 - EXHIBIT 32 - Fenix Parts, Inc.fenx-20160930xex32.htm
EX-31.2 - EXHIBIT 31.2 - Fenix Parts, Inc.fenx-20160930xex312.htm
EX-31.1 - EXHIBIT 31.1 - Fenix Parts, Inc.fenx-20160930xex311.htm
EX-10.2 - EXHIBIT 10.2 - Fenix Parts, Inc.fenx-20160930xex102.htm

 
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________________________ 
FORM 10-Q
 _______________________________________ 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from                      to                     
Commission File Number 001-37382
 _______________________________________ 
FENIX PARTS, INC.
(Exact name of Registrant as specified in its charter)
 _______________________________________ 
 
Delaware
 
46-4421625
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer 
Identification Number)
 
 
 
One Westbrook Corporate Center, Suite 920
Westchester, Illinois
 
60154
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s telephone number, including area code: 708-407-7200
 _______________________________________  
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period and the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
x
  
Smaller reporting company
 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
At March 24, 2017, the registrant had issued and outstanding an aggregate of 20,141,941 shares of Common Stock.
 



CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report includes “forward-looking statements” within the meaning of the federal securities laws, which involve risks and uncertainties. Forward-looking statements include all statements that do not relate solely to historical or current facts, and you can identify forward-looking statements because they contain words such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “intends,” “trends,” “plans,” “estimates,” “projects” or “anticipates” or similar expressions that concern our strategy, plans, expectations or intentions. All statements made relating to our estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and financial results are forward-looking statements. These forward-looking statements are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, it is very difficult to predict the effect of known factors, and, of course, it is impossible to anticipate all factors that could affect our actual results. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be realized. Important factors could affect our results and could cause results to differ materially from those expressed in our forward-looking statements, including but not limited to the factors discussed in the section entitled “Risk Factors” in Fenix Parts Inc.’s annual report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (“SEC”).




FENIX PARTS, INC.
FORM 10-Q
TABLE OF CONTENTS
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I -
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
    
Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
September 30, 2016
 
December 31, 2015
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
783

 
$
2,827

Accounts receivable, net of allowance $431and $460
 
6,349

 
6,834

Inventories, net
 
32,224

 
38,892

Prepaid expenses and other current assets
 
803

 
545

Total current assets
 
40,159

 
49,098

Property and equipment
 
13,865

 
13,103

Accumulated depreciation and amortization
 
(3,056
)
 
(1,494
)
Property and equipment, net
 
10,809

 
11,609

Goodwill
 
37,438

 
76,812

Intangible assets, net
 
33,296

 
33,786

Indemnification receivables
 
2,297

 
5,078

Other non-current assets
 
3,419

 
3,455

TOTAL ASSETS
 
$
127,418

 
$
179,838

 
 
 
 
 
LIABILITIES
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,112

 
$
3,456

Accrued expenses
 
4,365

 
2,847

Contingent consideration liabilities - current
 
7,516

 
9,345

Current portion of long-term debt
 
21,401

 
793

Other current liabilities
 
2,310

 
1,728

Total current liabilities
 
38,704

 
18,169

Deferred warranty revenue, net of current portion
 
503

 
227

Long-term related party obligations, net of current portion
 
918

 
2,071

Long-term debt under credit facility, net of current portion
 

 
19,645

Contingent consideration liabilities, net of current portion
 

 
6,085

Deferred income tax liabilities
 
9,639

 
15,624

Reserve for uncertain tax positions
 
2,808

 
5,733

Other non-current liabilities
 
3,048

 
2,500

Total non-current liabilities
 
16,916

 
51,885

TOTAL LIABILITIES
 
55,620

 
70,054

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

SHAREHOLDERS’ EQUITY
 
 
 
 
Common stock, $0.001 par value; 30,000,000 shares authorized; 19,991,907 and 19,926,868 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
 
20

 
20

Additional paid-in capital
 
138,820

 
136,398

Accumulated other comprehensive loss
 
(2,915
)
 
(4,247
)
Accumulated deficit
 
(72,527
)
 
(30,787
)
Total Fenix Parts, Inc. shareholders’ equity before noncontrolling interest
 
63,398

 
101,384

Noncontrolling interest
 
8,400

 
8,400

Total shareholders’ equity
 
71,798

 
109,784

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
127,418

 
$
179,838



5


The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.

6


Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands, except share data)
 
2016
 
2015
 
2016
 
2015
Net revenues
 
$
32,515

 
$
27,275

 
$
98,931

 
$
38,745

Cost of goods sold
 
21,348

 
20,584

 
59,190

 
30,592

Gross profit
 
11,167

 
6,691

 
39,741

 
8,153

Selling, general and administrative expenses
 
12,962

 
14,579

 
37,567

 
21,272

Outside service and professional fees
 
1,742

 
3,575

 
5,083

 
6,988

Depreciation and amortization
 
1,138

 
1,077

 
3,500

 
1,786

Change in fair value of contingent consideration liabilities
 
(1,411
)
 
(1,022
)
 
(8,393
)
 
(193
)
Change in indemnification receivable
 
266

 

 
2,782

 

Goodwill impairment
 

 

 
45,300

 

Operating loss
 
(3,530
)
 
(11,518
)
 
(46,098
)
 
(21,700
)
 
 
 
 
 
 
 
 
 
Interest expense
 
(437
)
 
(78
)
 
(1,192
)
 
(100
)
Other income (expense), net
 
165

 
26

 
408

 
(1,678
)
Loss before income tax benefit
 
(3,802
)
 
(11,570
)
 
(46,882
)
 
(23,478
)
Benefit for income taxes
 
(2,031
)
 
(5,022
)
 
(5,142
)
 
(10,326
)
Net loss
 
$
(1,771
)
 
$
(6,548
)
 
$
(41,740
)
 
$
(13,152
)
 
 
 
 
 
 
 
 
 
Loss per share available to common shareholders:
 
 
 
 
 
 
Basic and Diluted
 
$
(0.08
)
 
$
(0.33
)
 
$
(2.00
)
 
$
(1.10
)
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic and Diluted
 
19,988,809

 
19,475,046

 
19,818,231

 
11,206,390

 
 
 
 
 
 
 
 
 
Dividends paid
 
$
0.00

 
$
0.00

 
$
0.00

 
$
0.00

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
 
 
 
 
 
 
 
 
 
Net loss
 
$
(1,771
)
 
$
(6,548
)
 
$
(41,740
)
 
$
(13,152
)
Foreign currency translation adjustment
 
(285
)
 
(2,256
)
 
1,332

 
(2,961
)
Net comprehensive loss
 
$
(2,056
)
 
$
(8,804
)
 
$
(40,408
)
 
$
(16,113
)
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.

7


Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
 

 
 
Common Stock
 
Additional  paid-in
capital
 
Accumulated
other
comprehensive
loss
 
Accumulated
deficit
 
Noncontrolling
interest
 
Total
shareholders
equity
(In thousands, except share data)
 
Shares
 
Amount
 
Balance at December 31, 2015
 
19,926,868

 
$
20

 
$
136,398

 
$
(4,247
)
 
$
(30,787
)
 
$
8,400

 
$
109,784

Leesville retention bonus
 

 

 
790

 

 

 

 
790

Share based awards
 
65,039

 

 
1,632

 

 

 

 
1,632

Foreign currency translation adjustment
 

 

 

 
1,332

 

 

 
1,332

Net loss
 

 

 

 

 
(41,740
)
 

 
(41,740
)
Balance as of September 30, 2016
 
19,991,907

 
$
20

 
$
138,820

 
$
(2,915
)
 
$
(72,527
)
 
$
8,400

 
$
71,798

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.


8


Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Nine Months Ended September 30,
(In thousands)
 
2016
 
2015
Cash flows from operating activities
 
 
 
 
Net loss
 
$
(41,740
)
 
$
(13,152
)
Adjustments to reconcile net loss to net cash used in operating activities
 

 
 
Depreciation and amortization
 
4,260

 
2,156

Share-based compensation expense
 
2,422

 
1,496

Non-cash rent expense
 
689

 

Deferred income taxes
 
(2,774
)
 
(10,423
)
Deferred warranty revenue
 
725

 
665

Reversal of reserves for uncertain tax positions
 
(2,927
)
 
57

Reduction in indemnification receivables
 
2,782

 

Amortization of inventory fair value mark up
 
1,402

 
6,952

Lower value of acquired inventory
 
(1,777
)
 

Retrospective inventory opening balance sheet adjustment
 
(2,221
)
 

Change in fair value of contingent consideration liabilities
 
(8,393
)
 
(193
)
Make whole provision for pre-IPO investors
 

 
1,827

Goodwill impairment
 
45,300

 

Change in assets and liabilities
 
 
 
 
Accounts receivable
 
470

 
(4,241
)
Inventories
 
(1,294
)
 
270

Prepaid expenses and other current assets
 
(458
)
 
(26
)
Accounts payable
 
(364
)
 
(537
)
Accrued expenses
 
1,501

 
(510
)
Other current liabilities
 
265

 
2,965

Net cash used in operating activities
 
(2,132
)
 
(12,694
)
Cash flows from investing activities
 
 
 
 
Capital expenditures
 
(586
)
 
(114
)
Purchases of companies, net of cash acquired
 
(149
)
 
(87,807
)
Net cash used in investing activities
 
(735
)
 
(87,921
)
Cash flows from financing activities
 
 
 
 
Net proceeds from initial public offering
 

 
101,279

Net proceeds from other issuances of common stock
 

 
250

Borrowings on revolving credit line
 
1,615

 
10,000

Payments on term loan
 
(625
)
 
(250
)
Debt issuance cost
 
(102
)
 
(438
)
Proceeds from other debt financing
 

 
213

Net cash provided by financing activities
 
888

 
111,054

Effect of foreign exchange fluctuations on cash and cash equivalents
 
(65
)
 
(41
)
Increase (decrease) in cash and cash equivalents
 
(2,044
)
 
10,398

Cash and cash equivalents, beginning of period
 
2,827

 
453

Cash and cash equivalents, end of period
 
$
783

 
$
10,851

Supplemental cash flow disclosures:
 
 
 
 
Cash paid for interest
 
$
771

 
$
64

Cash paid for income taxes
 
$
436

 
$

Noncash transactions:
 
 
 
 
Equity issued for purchases of Subsidiaries
 
$

 
$
34,320

Accrued future consideration for acquisitions
 
$

 
$
8,620

The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.

9


Fenix Parts, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Description of Business and Financial Condition

Description of Business
Fenix Parts, Inc. and subsidiaries (the “Company” or “Fenix”) are in the business of automotive recycling, which is the recovery and resale of original equipment manufacturer (“OEM”) and aftermarket parts, components and systems, such as engines, transmissions, radiators, trunks, lamps and seats (referred to as “products”) reclaimed from damaged, totaled or low value vehicles. The Company purchases its vehicles primarily at auto salvage auctions. Upon receipt of vehicles, the Company inventories and then dismantles the vehicles and sells the recycled products. The Company’s customers include collision repair shops (body shops), mechanical repair shops, auto dealerships and individual retail customers. The Company also generates a portion of its revenue from the sale as scrap of the unusable parts and materials, from the sale of used cars and motorcycles, and from the sale of extended warranty contracts.

Liquidity and Financial Condition
Since its inception in January 2014, Fenix’s primary sources of ongoing liquidity are cash flows from operations, cash provided by bank borrowings, proceeds from private stock sales, and the $101.3 million in net proceeds from its initial public offering (“IPO”) of common stock completed in May 2015. The Company has incurred operating losses since its inception and expects to continue to report operating losses for the foreseeable future as it integrates the subsidiaries it has acquired (see Note 3 below) and amortizes asset write-ups and intangibles assets established at acquisition. Fenix may never become profitable if it cannot successfully integrate and grow the acquired operations and reduce the level of outside professional fees that have been incurred during 2015 and 2016. During the year ended December 31, 2015, the Company recorded a net loss of $26.0 million, and cash used in operating activities was $15.8 million. For the three and nine months ended September 30, 2016, the Company recorded a net loss of $1.8 million and $41.7 million, respectively. The nine month period includes an impairment of goodwill of $45.3 million (see Note 10 below), somewhat offset by the favorable impact on costs of goods sold attributable to an adjustment to the value assigned to acquired inventories (see Note 3 below) and reductions in the estimated fair value of contingent consideration liabilities (see Note 5 below). As of September 30, 2016, Fenix had an accumulated deficit of $72.5 million.

Effective December 31, 2015, the Company and its subsidiaries entered into a $35 million amended and restated senior secured credit facility with BMO Harris Bank N.A. and its Canadian affiliate, Bank of Montreal (the “Amended Credit Facility” or “Credit Facility”) (see Note 4 below for further details) which replaced the original Credit Facility with them (the “Original Credit Facility”). The Amended Credit Facility contained substantially the same terms as the Original Credit Facility except for adjustments to covenants which are discussed in Note 4, below. Previous borrowings under the Original Credit Facility remained outstanding under the Amended Credit Facility, and the term remained as five years from the date of the Original Credit Facility, expiring on May 19, 2020. The Credit Facility was further amended on June 27, 2016 and August 19, 2016, with retroactive effect to March 31, 2016 and June 30, 2016, respectively, pursuant to which certain financial covenant calculations, which are described in Note 4, below, were further clarified and amended. As of September 30, 2016, after classifying the Credit Facility debt as a current liability as discussed further below, the Company had working capital of $1.5 million, including cash and cash equivalents of $0.8 million. As of September 30, 2016, the Company owed $21.8 million under the Amended Credit Facility (consisting of a term loan with a balance of $9.0 million and a revolving credit facility with a balance of $12.8 million), and had $6.4 million in outstanding standby letters of credit. 

The Credit Facility is secured by a first-priority perfected security interest in substantially all of the Company’s assets as well as all of the assets and the stock of its domestic subsidiaries, which also guaranty the borrowings, and 66% of the stock of its direct Canadian Subsidiary, Fenix Canada (other than its exchangeable preferred shares). The Credit Facility contains financial covenants with which the Company must comply which are described further in Note 4. Compliance with the financial covenants is measured quarterly and determines the amount of additional available credit, if any, that will be available in the future. The Credit Facility also contains other customary events of default, including the failure to pay any principal, interest or other amount when due, violation of certain of the Company’s affirmative covenants or any negative covenants or a breach of representations and warranties and, in certain circumstances, a change in control. Upon the occurrence of an event of default, payment of indebtedness may be accelerated and the lending commitments may be terminated.

As of June 30, 2016, September 30, 2016 and December 31, 2016, the Company was in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements and the Borrowing Base requirement for repaying over-advances (which were created by establishing lower acquired inventory values as described in Note 3 that reduced the applicable borrowing base), as well as the requirement for timely delivery of certain quarterly certificates and reports. The financial covenants are defined in Note 4. As a result, all of the Credit Facility debt is reported in the accompanying condensed consolidated balance sheet as a current liability at September 30, 2016 and there can be no further borrowings of any availability under the Credit Facility until

10


such defaults are rectified or waived. On March 27, 2017, the Company and its subsidiaries entered into a Forbearance Agreement to the Credit Facility (the "Forbearance Agreement") with BMO Harris Bank N.A and its Canadian affiliate, Bank of Montreal. Pursuant to the Forbearance Agreement, the banks agreed to forbear from exercising their rights and remedies under the Credit Facility with respect to the above described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur. The Forbearance Agreement also permits the Company to add the quarterly interest payment otherwise due for the first quarter of 2017 to the principal amount of debt outstanding and defer a $250,000 principal payment due on March 31, 2017 to the end of the forbearance period.

Ability to Continue as a Going Concern
The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates continuity of operations, realization of assets and the satisfaction of liabilities in the normal course of business. As such, the accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets and their carrying amounts, or the amount and classification of liabilities that may result should the Company be unable to continue as a going concern.
 
The Company is in breach of certain financial covenants contained in the Credit Facility as described above and in Note 4. The failure to operate within the requirements of these financial covenants as of September 30, 2016 was due primarily to (i) lower asset values as a result of reductions during 2016 to the aggregate estimated fair value of inventory acquired as part of the purchase of Subsidiaries, which have reduced the Company’s borrowing base, (ii) limits on certain non-cash adjustments to calculate EBITDA for covenant compliance, and (iii) EBITDA during the third quarter of 2016 that was lower than forecasted because of a decline of approximately $1.7 million in quarterly net revenues (as compared to a Company record level of net revenues for the quarter ended June 30, 2016) and higher cost of goods sold and operating expenses, including significant accounting, legal and other fees, primarily as a result of the transition to a new public accounting firm beginning in July 2016 and the SEC inquiry discussed in Note 11, which have forced the Company to incur significant accounting and legal fees during the second half of 2016.

Management has been and remains highly focused on maximizing cash flows from operations and, to the extent possible under the circumstances, minimizing the cost of outsourced professional fees. Although scrap metal prices, which declined by more than 20% on average from the second to the third quarter of 2016, have increased since September 30, 2016, the Company’s expectation is that the current high level of professional fees should decline after the first half of 2017, the Company still may not be able to comply with all the financial covenants contained in its Credit Facility in future periods unless those requirements are waived or amended or unless the Company can obtain new subordinated debt or equity financing. The Board of Directors of the Company has engaged a financial advisor to advise the Board and Company management to assist in pursuing a range of potential strategic and financial transactions that will provide the Company with improved liquidity and maximize shareholder value. The financial advisor will identify and evaluate potential alternatives including debt or equity financing, a strategic investment into the Company or a business combination, and is reporting directly to a special committee of independent directors established to oversee and coordinate these activities. The Board has not set a definitive timetable for completion of this process. There can be no assurance that this process will result in a transaction or other strategic alternative of any kind.

On March 27, 2017, the Company entered into the Forbearance Agreement described above. If the Company is unable to reach further agreement with its lenders to obtain waivers or amendments to the existing Credit Facility, find acceptable alternative financing, obtain equity contributions, or arrange a business combination, after the forbearance period (and during the forbearance period in the event of any new defaults other than those anticipated defaults enumerated in the Forbearance Agreement), the Company’s Credit Facility lenders could elect to declare some or all of the amounts outstanding under the facility to be immediately due and payable. If this happens, the Company does not expect to have sufficient liquidity to pay the outstanding Credit Facility debt. In addition, the Company has significant obligations under contingent consideration agreements related to certain acquired companies as described in Note 5, and it will need access to additional credit to be able to satisfy these obligations.
 
As a result of the above, substantial doubt exists regarding the ability of the Company to continue as a going concern, which contemplates continuity of operations, realization of assets and the satisfaction of liabilities in the normal course of business within one year from the date of this filing.

Note 2. Basis of Presentation and Significant Accounting Policies

Basis of Presentation
These unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures typically included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

11


These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of Fenix Parts, Inc. and the notes thereto as of and for the year ended December 31, 2015. The Company continues to follow the accounting policies set forth in those consolidated financial statements, including its inventory accounting policy, which is reiterated as follows: Inventories consist entirely of recycled OEM and aftermarket products, including car hulls and other materials that will be sold as scrap and, to a lesser extent, used cars and motorcycles for resale. Inventory costs for recycled OEM parts are established using a retail method of accounting.  Parts are dismantled from purchased vehicles and a retail price is assigned to each dismantled part. The total retail price of the inventoried parts is reduced by the estimated balance of parts that will be subsequently sold for scrap or discounted to a reduced expected selling price.   These scrap and discount estimates are significant and require application of complex assumptions and judgments that are subject to change from period to period. The cost assigned to the salvaged parts and scrap is determined using the average cost-to-sales percentage at each operating facility and applying that percentage to the facility’s inventory at expected selling prices. The average cost-to-sales percentage is derived from each facility’s historical sales and actual cost paid for salvage vehicles purchased at auction or procured from other sources. The Company also capitalizes direct labor and overhead costs incurred to dismantle salvaged parts and prepare the parts for sale. With respect to self-service inventories, costs are established by calculating the average sales price per vehicle, including its scrap value and part value, applied to the total vehicles on-hand. Inventory costs for aftermarket parts, used cars and motorcycles for resale are established based upon the price the Company pays for these items. All inventory is recorded at the lower of cost or market value. The market value of the Company's inventory is determined based on the nature of the inventory and anticipated demand. If actual demand differs from the Company's earlier estimates, reductions to inventory carrying value are made in the period such determination is made.

Management believes that these interim consolidated financial statements include all adjustments, normal and recurring in nature, that are necessary to present fairly the consolidated financial position of the Company as of September 30, 2016 and the results of its operations and cash flows for the period ended September 30, 2016. Interim results are not necessarily indicative of annual results. All significant intercompany balances and transactions have been eliminated. The consolidated Company represents a single operating segment.

The unaudited condensed consolidated financial statements included herein reflect only Fenix’s operations and financial position before the IPO and concurrent acquisitions of eleven founding companies, which are referred to in these notes as the “Founding Companies,” on May 19, 2015. The operations of the Founding Companies and three subsequently acquired companies are reflected in the consolidated statements of operations from their respective dates of acquisitions. The Company sometimes refers to the Founding Companies and subsequently acquired companies in these notes as the “Subsidiaries.”

Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The Company uses estimates in accounting for, among other items, inventory valuation using the retail method of accounting and reserves for potentially excess and unsalable inventory, contingent consideration liabilities, uncertain tax positions and certain other assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates require the application of complex assumptions and judgments, often because they involve matters that are inherently uncertain and will likely change in subsequent periods. The impact of any change in estimates is included in earnings in the period in which the estimate is adjusted.

Reclassifications
Reclassifications of prior period amounts have been made to conform to the current period presentation. These reclassifications have no impact on net loss, total assets or shareholders’ equity as previously reported.

Correction of Immaterial Errors
The Company previously incorrectly presented the net value of its above and below market long-term leases in its balance sheet. The Company assessed the materiality of this misstatement on prior periods’ financial statements in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99, Materiality, codified in ASC No. 250, Presentation of Financial Statements, and concluded that the misstatement was not material to any prior annual or interim periods. In the current period, the Company has corrected this immaterial error such that below market leases are recorded in other non-current assets and above market leases are recorded in other non-current liabilities as shown in the table below.

12


(In thousands)
December 31, 2015
Previous presentation
 
Other non-current assets
$
1,218

Current presentation
 
Other non-current assets
$
3,388

Other non-current liabilities
$
2,170


Recent Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount. The new rules will be effective for the Company in the first quarter of 2020. The Company does not expect the adoption of the new accounting rules to have a material impact on the Company’s financial condition, results of operations and cash flows.

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250), this amendment states that registrants should consider additional qualitative disclosures if the impact of an issued but not yet adopted ASU is unknown or cannot be reasonably estimated and to include a description of the effect of the accounting policies that the registrant expects to apply, if determined. Transition guidance included in certain issued but not yet adopted ASUs was also updated to reflect this update. The Company does not expect the adoption of the new accounting rules to have a material impact on the Company’s financial condition, results of operations and cash flows.

In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business, which clarifies the definition of “a business” to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard introduces a screen for determining when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contribute to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect this new guidance to have a material impact on its consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (Topic 230) (a consensus of the Emerging Issues Task Force).  ASU 2016-15 addresses eight specific cash flow issues and applies to all entities, including both business entities and not-for-profit entities that are required to present a statement of cash flows under ASC 230, Statement of Cash Flows. The amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  Early adoption is permitted, including adoption in an interim period. The Company has not yet adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduces a new forward-looking approach, based on expected losses, to estimate credit losses on certain types of financial instruments, including trade receivables, which will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. This ASU also expands disclosure requirements. ASU 2016-13 is effective for the Company beginning the first quarter of 2020 with early adoption permitted. The Company is currently evaluating the impact of adoption of ASU 2016-13 on its consolidated financial statements and related financial statement disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU changes the accounting for certain aspects of share-based payment awards to employees and requires the recognition of the income tax effects of awards in the income statement when the awards vest or are settled, thus eliminating additional paid in capital pools. The guidance also allows for the employer to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting. In addition, the guidance allows for a policy election to account for forfeitures as they occur rather than on an estimated basis. This pronouncement is effective for fiscal years and interim periods beginning after December 15, 2016, with early adoption permitted. The Company adopted ASU 2016-09 effective April 1, 2016 and all forfeitures have been applied when they occurred.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13). The new standard establishes a right-of-use (ROU) model that requires a lessee to record an ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income

13


statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. While the Company is currently evaluating the effect this standard will have on its consolidated financial statements and timing of adoption, we expect that upon adoption, the Company will recognize ROU assets and lease liabilities and those amounts could be material.

In September 2015, FASB issued ASU No. 2015-16, Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments, which simplifies the accounting for adjustments made to provisional amounts recognized in business combinations. The amendments require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments also require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to provisional amounts, calculated as if the accounting had been completed at the acquisition date. The ASU also requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The Company adopted ASU 2015-16 effective January 1, 2016, resulting in the recognition of adjustments to goodwill as described in Note 3.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This update outlines a single, comprehensive model for accounting for revenue from contracts with customers. In August 2015, the FASB deferred the effective date by one year to January 1, 2018, while providing the option to early adopt the standard on the original effective date of January 1, 2017. The Company plans to adopt this update on January 1, 2018. The guidance can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is currently evaluating the adoption alternatives, which include utilizing a bottom-up approach to analyze the standard’s impact on our contract portfolio, comparing historical accounting policies and practices to the new standard to identify potential differences from applying the requirements of the new standard to its contracts. The Company has not yet selected a transition method and is currently evaluating the impact it may have on its consolidated financial statements and related disclosures.

Note 3. Acquisitions

2015 Acquired Companies
On May 19, 2015, Fenix closed on combinations with the eleven Founding Companies and subsequently during 2015 acquired three companies, all of which are engaged in the business of automotive recycling. Of the total purchase consideration of $154.6 million, $110.9 million was paid in cash, $35.3 million represents stock consideration issued in the acquisitions and potentially issuable under contingent consideration agreements, and $8.4 million represents discounted cash payments to be made up to 15 years after the acquisitions. The total purchase consideration includes adjustments identified through May 2016, as part of working capital true-ups and other contractual adjustments to the purchase consideration, which resulted in a net increase in the goodwill previously reported of $0.1 million.

The table below summarizes the approximate fair values of the aggregate assets acquired and liabilities assumed at the respective dates of acquisitions, and incorporates the provisional adjustments in measurement since they were previously reported at December 31, 2015 through September 30, 2016. These estimates and assumptions as they relate to the two companies acquired in October 2015 are subject to additional changes during the purchase price measurement period and could change materially as the Company finalizes the valuations of these assets and liabilities. The measurement period is one year from the date of the acquisition.

14


(In thousands)
 
Opening Balance Sheet as Previously Reported
 
Adjustments For the Three Months Ended March 31, 2016
 
Adjusted Opening Balance Sheet
Cash and other current assets
 
$
8,666

 
$

 
$
8,666

Inventories
(i)
47,794

 
(10,722
)
 
37,072

Property and equipment
(ii)
13,235

 

 
13,235

Other non-current assets
(iii)
5,271

 

 
5,271

Intangible assets
(iv)
37,396

 
1,710

 
39,106

Current liabilities
 
(7,572
)
 

 
(7,572
)
Reserve for uncertain tax positions
 
(5,760
)
 

 
(5,760
)
Deferred income taxes, net
(v)
(24,168
)
 
3,758

 
(20,410
)
Non-current liabilities
 
(422
)
 

 
(422
)
Total net identifiable assets acquired
 
74,440

 
(5,254
)
 
69,186

Goodwill
 
80,023

 
5,403

 
85,426

Total net assets acquired
 
$
154,463

 
$
149

 
$
154,612


During the three months ended March 31, 2016, the Company reduced the aggregate estimated value of the acquired inventories by $10.7 million to reflect the most recent historical information available regarding excess and unsaleable parts acquired as well as sales discounts given to sell certain acquired parts. This inventory adjustment resulted in a $1.7 million increase in intangible assets (customer relationships), a $3.8 million reduction in deferred income taxes and a $5.3 million increase in goodwill. In accordance with ASU No. 2015-16, which is discussed in Note 2 above, the adjustment also resulted in a reduced charge to cost of goods sold during the nine months ended September 30, 2016 of approximately $4.0 million consisting of $2.2 million for the opening inventory mark up to fair value (see (i) below) and approximately $1.8 million, related to the lower value of acquired inventories sold between the respective acquisition dates and December 31, 2015. The $2.2 million adjustment to the opening inventory markup had a related $1.0 million deferred tax liability. The $2.2 million and the $1.0 million were previously recorded through the prior period operations and were adjusted through the operations for the nine months ended September 30, 2016 within the cost of goods sold and the tax benefit line items, respectively.

Included in the fair value allocation reflected in the table above are the various valuations described below which are primarily based on Level 3 inputs:

(i)
Inventory was marked up to 90% of its estimated selling price representing the inventory’s fair market valuation, with selling costs and related profit margin estimated at all companies to be 10%. This fair value adjustment to inventory, after a reduction of approximately $2.2 million for the opening balance sheet adjustment described above, totaled approximately $7.8 million, of which $1.4 million was amortized as an additional charge recorded in cost of goods sold during the nine months ended September 30, 2016. This fair value mark up adjustment was completely amortized through September 30, 2016 as the acquired inventory was expected to be sold within six to nine months.
(ii)
Assumptions for property and equipment valuation, which are based on cost and market approaches, are based primarily on data from industry databases and dealers on current costs of new equipment and information about the useful lives and age of the equipment. The remaining useful life of property and equipment was determined based on historical experience using such assets, and varies from 1 - 6 years depending on the acquired company and nature of the assets. All property and equipment is being depreciated using the straight-line method.
(iii)
The Company may recover amounts from the former owners of certain of the acquired companies if the Company is required to make certain income tax or other payments as defined in the relevant acquisition agreements after the acquisition. In the case of the Founding Companies, the Company’s right to these tax related indemnifications is generally subject to a threshold of 1% of the purchase price, a cap of 40% of the purchase price paid for each individual acquisition and a survival period of three years from the date of their acquisition. During the three and nine months ended September 30, 2016, the Company reversed $0.3 million and $2.8 million, respectively, of indemnification receivables through a charge in the accompanying consolidated statement of operations, as the statute of limitations expired on the tax-related indemnity as discussed further in Note 9 below.
(iv)
The table below summarizes the aggregate gross intangible assets recorded:
(In thousands)
 
Trade names
$
6,122

Customer relationships
31,308

Covenants not to compete
1,676

Total
$
39,106


15


Amortization expense for intangible assets was $0.9 million and $0.8 million for the three months ended September 30, 2016 and 2015, respectively, and $2.7 million and $1.2 million for the nine months ended September 30, 2016 and 2015, respectively.
(v)
The Company recorded deferred income taxes relating to the difference between financial reporting and tax basis of assets and liabilities acquired in the acquisitions in nontaxable transactions. The Company also eliminated historical deferred income taxes of the companies acquired in taxable transactions.

Pro Forma Results
The following table shows the combined pro forma net revenues and net loss of the Company as if acquisitions of all of its Subsidiaries had occurred on January 1, 2015: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
 
2015
 
 
2015
Net revenues
 
$
32,211

 
 
$
95,598

Net loss
 
$
(7,461
)
 
 
$
(10,500
)

Pro forma combined net revenues consisted of:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
 
2015
 
 
2015
Recycled OE parts and related products
 
$
27,762

 
 
$
82,430

Other ancillary products (scrap)
 
4,449

 
 
13,168

Total
 
$
32,211

 
 
$
95,598


Significant adjustments to the historical revenues of the Subsidiaries include the elimination of sales between acquired companies, for which there is a corresponding decrease in pro forma cost of goods sold, and the elimination of revenue from the sale of warranties that are not recognized by Fenix in the post-acquisition periods.

The cost of goods sold impact of the subsequent sale of acquired inventories written-up from historic cost basis to fair value is reflected for pro forma reporting purposes in the same manner as reported in the accompanying condensed consolidated financial statements and is not adjusted back to January 1, 2015, as it does not have a continuing impact on the Company. As a result, pro forma gross profit and net income in the periods immediately following the acquisitions are substantially lower than the pre-acquisition periods.

Significant adjustments to expenses include eliminating the effects of shares transferred from founding investors to later investors, incremental amortization of acquired intangible assets, rent expense associated with leases with the former owners of the acquired companies, compensation related to certain bonuses paid to owners and employees and related income tax effects.

Note 4. Bank Credit Facility

Amended and Restated Credit Facility
Effective December 31, 2015, the Company and its subsidiaries entered into a $35 million amended and restated senior secured credit facility with BMO Harris Bank N.A. and its Canadian affiliate, Bank of Montreal (the “Amended Credit Facility” or “Credit Facility”) which replaced the original Credit Facility with them (the “Original Credit Facility”). The Amended Credit Facility contained substantially the same terms as the Original Credit Facility except for adjustments to covenants which are discussed below. Previous borrowings under the Original Credit Facility remained outstanding under the Amended Credit Facility. The Credit Facility was further amended on June 27, 2016 and August 19, 2016, with retroactive effect to March 31, 2016 and June 30, 2016, respectively, pursuant to which certain financial covenant calculations, which are described below, were further clarified and amended.

The Credit Facility consists of $25.0 million as a revolving credit facility, allocated $20.0 million in U.S. Dollar revolving loans, with a $7.5 million sublimit for letters of credit, and $5.0 million in Canadian Dollar revolving loans, with a $2.5 million sublimit for letters of credit. The Company borrowed the remaining $10.0 million as a term loan concurrently with its IPO in May 2015. Proceeds of the credit facility can be used for capital expenditures, working capital, permitted acquisitions, and general corporate purposes. The term of the revolving credit facility and the term loan facility is 5 years from the date of the Original Credit Facility

16


with each expiring on May 19, 2020. The Amended Credit Facility and both subsequent amendments were determined to be modifications under ASC 470-50 of the Original Credit Facility that was entered into at the time of the IPO.

The Credit Facility is secured by a first-priority perfected security interest in substantially all of the Company’s assets as well as all of the assets of its U.S. subsidiaries, which also guaranty the borrowings. In addition, the Company pledged all of the stock in its U.S. Subsidiaries as security and 66% of the stock of its direct Canadian Subsidiary, Fenix Canada (other than its exchangeable preferred shares).

The Company’s U.S. Dollar borrowings under the Amended Credit Facility bear interest at fluctuating rates, at the Company’s election in advance for any applicable interest period, by reference to the “base rate”, “Eurodollar rate” or “Canadian Prime Rate” plus the applicable margin within the relevant range of margins provided in the Credit Facility. The base rate is the highest of (i) the rate BMO Harris Bank N.A. announces as its “prime rate,” (ii) 0.50% above the rate on overnight federal funds transactions or (iii) the London Interbank Offered Rate (LIBOR) for an interest period of one month plus 1.00%. The applicable margin is determined quarterly based on the Company’s Total Leverage Ratio, as described below. The borrowings were subject to interest rates ranging from 3.57% - 4.98% at September 30, 2016.

The Canadian Dollar borrowings under the Amended Credit Facility bear interest at fluctuating rates, at the Company’s election in advance for any applicable interest period, by reference to the “Canadian Prime Rate” plus the applicable margin within the relevant range of margins provided in the Amended Credit Facility. The Canadian Prime Rate is the higher of (i) the rate the Bank of Montreal announces as its “reference rate,” or (ii) the Canadian Dollar Offered Rate (CDOR) for an interest period equal to the term of any applicable borrowing plus 0.50%. The applicable margin is determined quarterly based on the Company’s Total Leverage Ratio, as described below. The maximum and initial margin for interest rates after March 31, 2016 on Canadian borrowings under the Credit Facility is 2.75% on base rate loans.

The Credit Facility contains customary events of default, including the failure to pay any principal, interest or other amount when due, violation of certain of the Company’s affirmative covenants or any negative covenants or a breach of representations and warranties and, in certain circumstances, a change of control. Upon the occurrence of an event of default, payment of indebtedness may be accelerated and the lending commitments may be terminated.
The Credit Facility also contains financial covenants with which the Company must comply on a quarterly or annual basis, which have been amended since entering into the Original Credit Facility, including a Total Funded Debt to EBITDA Ratio (or “Total Leverage Ratio”, as defined). Total Funded Debt as it relates to the Total Leverage Ratio is defined as all indebtedness (a) for borrowed money, (b) for the purchase price of goods or services, (c) secured by assets of the Company or its Subsidiaries, (d) for any capitalized leases of property, (e) for letters of credit or other extensions of credit, (f) for payments owed regarding equity interests in the Company or its Subsidiaries, (g) for interest rate, currency or commodities hedging arrangements, or (h) for any guarantees of any of the foregoing as of the end of the most recent fiscal quarter. Consistent with the Original Credit Facility, Permitted Acquisitions are subject to bank review and a maximum Total Leverage Ratio, after giving effect to such acquisition. The Company must also comply with a minimum Fixed Charge Coverage Ratio. Fixed charge coverage is defined as the ratio of (a) EBITDA less unfinanced capital expenditures for the four trailing quarterly periods to (b) fixed charges (principal and interest payments, taxes paid and other restricted payments); except that for the first three quarters of 2016, for the purposes of determining this ratio, EBITDA will be calculated based on a multiple of the then current EBITDA, instead of using the EBITDA for the prior four quarters. A similar annualization adjustment will be made for unfinanced capital expenditures for the same period. EBITDA includes after tax earnings with add backs for interest expense, income taxes, depreciation and amortization, share-based compensation expenses, and other additional items as outlined in the Credit Facility. In addition, the Credit Facility covenants include a minimum net worth covenant, which was revised effective March 31, 2016. Net worth is defined as the total shareholders’ equity, including capital stock, additional paid in capital, and retained earnings after deducting treasury stock. The Amended Credit Facility includes a mandatory prepayment clause requiring certain cash payments when EBITDA exceeds defined requirements for the most recently completed fiscal year. These prepayments will be applied first to outstanding term loans and then to the revolving credit.

The Company also is subject to a limitation on its indebtedness based on quarterly calculations of a Borrowing Base.  The Borrowing Base is determined based upon Eligible Receivables and Eligible Inventory and is calculated separately for the United States and Canadian borrowings.  If the total amount of principal outstanding for revolving loans, term loans, letters of credit and other defined obligations is in excess of the Borrowing Base, then the Company is required to repay the difference or be in default of the Credit Facility. 

As of September 30, 2016, the Company owed $21.8 million under the Credit Facility as shown in the table below. The Company also had $6.4 million outstanding in standby letters of credit under the Credit Facility related to the contingent consideration agreement with the former owners of the Canadian Founding Companies and the Company’s property and casualty insurance

17


program. As of September 30, 2016, for reasons described in Note 1, the Company was in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements, as well as the requirement for repaying over-advances (which were created by establishing lower acquired inventory values as described in Note 3 that reduced the applicable borrowing base), as well as the requirement for timely delivery of certain quarterly certificates and reports. The financial covenants are defined above in this Note. Since the Company is in default as of the date that this Third Quarter report on Form 10-Q is being filed, all of the Credit Facility debt is reported in the accompanying condensed consolidated balance sheet as a current liability and there can be no further borrowings of any availability under the Credit Facility until such defaults are rectified or waived.

On March 27, 2017, the Company and its subsidiaries entered into a Forbearance Agreement to the Credit Facility (the "Forbearance Agreement") with BMO Harris Bank N.A. and its Canadian affiliate, Bank of Montreal. Pursuant to the Forbearance Agreement, the banks agreed to forbear from exercising their rights and remedies under the Credit Facility with respect to the above-described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur. The Forbearance Agreement also permits the Company to add the quarterly interest payment otherwise due for the first quarter of 2017 to the principal amount of debt outstanding and defer a $250,000 principal payment due on March 31, 2017 to the end of the forbearance period.

The Board of Directors of the Company has engaged a financial advisor to advise the Board and Company management and to assist in pursuing a range of potential strategic and financial transactions that will provide the Company with improved liquidity and maximize shareholder value. The financial advisor will identify and evaluate potential alternatives including debt or equity financing, a strategic investment into the Company or a business combination, and is reporting directly to a special committee of independent directors established to oversee and coordinate these activities. The Board has not set a definitive timetable for completion of this process. There can be no assurance that this process will result in a transaction or other strategic alternative of any kind.

If the Company is unable to reach further agreement with its lenders to obtain waivers or amendments to the existing Credit Facility, find acceptable alternative financing, obtain equity contributions, or arrange a business combination, after the forbearance period (and during the forbearance period in the event of any new defaults other than those anticipated defaults enumerated in the Forbearance Agreement), the Company’s Credit Facility lenders could elect to declare some or all of the amounts outstanding under the facility to be immediately due and payable. If this happens, the Company does not expect to have sufficient liquidity to pay the outstanding Credit Facility debt.

Maturities of Credit Facility
The following is a summary of the components of the Company’s Credit Facility debt and amounts outstanding at September 30, 2016 and December 31, 2015:
(In thousands)
September 30, 2016
 
December 31, 2015
Obligations:
 
 
 
Term loan
$
9,000

 
$
9,625

Revolving credit facility
12,815

 
11,200

Total debt
21,815

 
20,825

Less: long-term debt issuance costs

 
(299
)
Less: short-term debt issuance costs
(414
)
 
(88
)
Total debt, net of issuance costs
21,401

 
20,438

Less: current maturities, net of debt issuance costs
(21,401
)
 
(793
)
Long-term debt, net of issuance costs
$

 
$
19,645


There have been no additional borrowings under the Credit Facility since September 30, 2016.

Scheduled maturities, which the Company continues to follow, are as follows for the periods ending September 30; however, as described above, the Company is in default under the Credit Facility and the lenders could elect to declare some or all of the amounts shown below as immediately due and payable and therefore all the debt is classified as a current liability in the accompanying condensed consolidated balance sheet.

18


(In thousands)
2017
 
2018
 
2019
 
2020
 
Total
Revolving credit facility
$

 
$

 
$

 
$
12,815

 
$
12,815

Term loan
1,000

 
1,000

 
1,000

 
6,000

 
9,000

Debt issuance costs
(113
)
 
(113
)
 
(113
)
 
(75
)
 
(414
)
Total
$
887

 
$
887

 
$
887

 
$
18,740

 
$
21,401


Debt Issuance Costs
As noted above, the Company entered into the Amended Credit Facility effective December 31, 2015 and a first amendment effective as of March 31, 2016, that was deemed under ASC 470 to be a modification of the Original Credit Facility. As such, debt issuance costs will continue to be amortized over the remaining term of the Amended Credit Facility. As the termination date of the Amended Credit Facility is the same as the Original Credit Facility, this did not change the continuing impact of previous debt issuance costs.

In connection with the original agreement, the Company incurred $438,000 in original debt issuance costs during 2015 and an additional $50,000 and $102,000 in amendment charges during the three and nine months ended September 30, 2016, which are netted against the term loan balance and are being amortized over the term of the Original Credit Facility. The amortized debt issuance costs are recognized as interest expense in the condensed consolidated statement of operations and amounted to $28,000 and $75,000 for the three and nine months ended September 30, 2016, respectively.

Note 5. Contingent Consideration Liabilities

As part of the consideration for three of the Founding Companies, the Company entered into contingent consideration agreements with certain of the selling shareholders, as described in the paragraphs below. Under the terms of the contingent consideration agreements, additional consideration will be payable to the former owners if specified future events occur or conditions are met, such as meeting profitability or earnings targets. The fair value of the aggregate contingent consideration was initially estimated as $10.2 million and recorded in the consolidated financial statements at the acquisition date based on independent valuations considering the Company’s initial projections for the relevant Founding Companies, the respective target levels, the relative weighting of various future scenarios and a discount rate of approximately 5.0%. Management periodically reviews the amount of contingent consideration that is likely to be payable under current operating conditions and has since adjusted the initial liability as deemed necessary, with such subsequent adjustments being recorded through the consolidated statement of operations as an operating charge or credit. In the event that there is a range of possible outcomes, the Company applies a probability approach to determine the estimated obligation to be recorded at the end of an accounting period.

For the combination with Jerry Brown, Ltd. (“Jerry Brown”), the Company is required to pay (a) up to an additional $1.8 million if the business achieved certain revenue targets during the twelve-month period beginning June 2015, and (b) an additional uncapped amount if the business exceeds certain EBITDA levels during 2016. Based on an evaluation of the likelihood of meeting these performance targets, the Company recorded a liability for the acquisition date fair value of the contingent consideration of $2.5 million and increased this liability by $5.1 million during 2015 based on substantial operating improvements and management’s budget for Jerry Brown for 2016. Based on results actually achieved during 2016, EBITDA is now estimated to be less than the previously developed budget and, accordingly, the estimated fair value of the contingent liability was reduced by $3.8 million, resulting in a credit to income which is reflected in the condensed consolidated statement of operations for the nine months ended September 30, 2016, of which $1.4 million was recorded during the three months ended September 30, 2016. As of September 30, 2016, the total contingent consideration liability attributable to the Jerry Brown acquisitions was (a) $1.8 million for achieving the revenue target, which management and the former owners of Jerry Brown agree was fully earned and is currently due and payable, and (b) $2.0 million estimated for the EBITDA target which will be determined in 2017. The Company is in negotiations with the former owners of Jerry Brown to schedule payment of currently due amounts and expects to fund these and future determined payments to the former owners of Jerry Brown, to the extent they are ultimately deemed earned, through cash generated from operations or, if necessary and available, through draws on the revolving Credit Facility or through other sources of capital that may be available.

The combination agreements for Eiss Brothers, Inc. (“Eiss Brothers”) and End of Life Vehicles Inc., Goldy Metals Incorporated, and Goldy Metals (Ottawa) Incorporated (collectively, “the Canadian Founding Companies”) provide for a holdback of additional consideration which will be payable, in part or in whole, only if certain performance targets are achieved. The maximum amount of additional consideration that can be earned by the former owners of Eiss Brothers is $0.2 million in cash plus 11,667 shares of Fenix common stock, of which none, some or all will be released from escrow depending upon the EBITDA of Eiss Brothers during the twelve-month period beginning June 2015. The maximum amount of additional consideration that can be earned and is subject to holdback for the Canadian Founding Companies is $5.9 million in cash, secured by a letter of credit under our Credit

19


Facility, plus 280,000 Exchangeable Preferred Shares currently held in escrow, of which, none, some or all will be released to the Canadian Founding Companies depending on their combined revenues from specific types of sales for the twelve-month period beginning June 2015. Based on management’s evaluation of the likelihood of meeting these performance targets for these two acquisitions, a liability of $7.8 million was recorded at the acquisition date for the fair value of the aggregate contingent consideration, which included the present value of the estimated cash portion and the then-current value of the Fenix common stock and the Exchangeable Preferred Shares held in escrow. While management’s estimate of the operating results for Eiss Brothers has not changed since its acquisition, the contingent consideration liability for the Canadian Founding Companies was reduced during the nine months ended September 30, 2016 in accordance with FASB ASC No. 805 “Business Combinations,” which requires the Company to estimate contingent consideration at fair value using possible outcomes. As the amount of the contingent consideration is currently in dispute, the Company has recorded the estimated contingent consideration liability for the Canadian Founding Companies as of September 30, 2016 based on the result of its assessment of the possible outcomes. These contingent consideration liabilities are also subject to mark-to-market fluctuations based on changes in the trading price of Fenix common stock and, with respect to the Canadian Founding Companies, currency remeasurement. As a result of all these factors, the estimated fair value of the aggregate contingent liability due to the former owners of Eiss Brothers and the Canadian Founding Companies was reduced by $0.0 million and $4.2 million, and an exchange rate gain of $0.0 million and $0.5 million was recognized in the condensed consolidated statement of operations for the three and nine months ended September 30, 2016, respectively. The Company expects to fund any cash payments to the former owners of the Canadian Founding Companies, to the extent they are ultimately deemed earned, through draws on the bank letter of credit, which is considered Funded Debt under the Total Leverage Ratio required under the Credit Facility.

The period for calculating all contingent consideration liabilities was complete as of September 30, 2016, except for Jerry Brown’s uncapped EBITDA contingency. The Company is currently in negotiations with the former owners of the Canadian Founding Companies regarding the calculation of contingent consideration earned, if any, and the parties have begun the process of submitting this calculation to binding arbitration.

Note 6. Common Stock and Preferred Shares

Fenix was formed and initially capitalized in January 2014 by a group of investors, including the Chief Executive and the Chief Financial Officers, who paid nominal cash consideration for an aggregate of 1.8 million shares of Fenix common stock. In March and April 2014, Fenix issued and sold an aggregate of 402,000 shares of common stock for a purchase price of $5.00 per share. During the period of September 2014 through May 2015, Fenix issued and sold an aggregate of 546,927 shares of common stock for an ultimate purchase price of $6.50 per share. Of these shares, 20,000 were issued to certain investors for no cash consideration in order to effectively convert their $7.50 per share investments to $6.50 per share investments. Such issuances resulted in a charge to other income (expense), net in January 2015 of $131,000.

The Company completed its IPO on May 19, 2015. The Company raised approximately $110.4 million in gross proceeds from the IPO by selling 13.8 million shares at $8.00 per share and netted $101.3 million in the IPO after paying the underwriter’s discount and other offering costs.

The agreements that relate to the common stock sales in March, April and September 2014 included provisions that obligated the holders of the common stock issued in January 2014 to compensate the investors in the later sales if the IPO price of Fenix common stock was less than $10.00 per share. As the IPO price was $8.00 per share, the initial investors transferred 237,231 of their shares to the later investors equal in value to the aggregate difference in value between the IPO price of $8.00 per share and $10.00 per share, resulting in a charge of $1.7 million to other expense as of the IPO date. The later investors were also granted registration rights.

Effective May 19, 2015, the Company issued 1,050,000 exchangeable preferred shares of Fenix’s subsidiary, Fenix Parts Canada, Inc. (“Exchangeable Preferred Shares”) as acquisition consideration valued at the public offering price of common stock of $8.00 per share. Because these shares do not entitle the holders to any Fenix Canada dividends or distributions, no earnings or losses of Fenix Canada are attributable to those holders. These shares are exchangeable on a 1-for-1 basis for shares of the Company’s common stock. The single share of special voting stock is entitled to vote on any matter submitted to a vote of holders of the Company’s common stock a number of votes equal to the number of Exchangeable Preferred Shares of Fenix Parts Canada, Inc. issued to the former shareholders of the Canadian Founding Companies. The share of special voting stock is intended to provide the former shareholders of the Canadian Founding Companies the equivalent voting rights in Fenix common stock they would have received if the combination agreement for the Canadian Founding Companies had required Fenix to issue shares of Fenix common stock instead of Exchangeable Preferred Shares. The share of special voting stock is held in a voting trust for the benefit of the former shareholders of the Canadian Founding Companies, and the trustee of the voting trust will vote the share of special voting stock in accordance with the beneficiaries’ directions. Neither the holder of the share of special voting stock nor the

20


beneficiaries of the share of special voting stock is entitled to receive any dividends or other distributions that Fenix may make in respect of shares of the Company’s common stock.

Note 7. Share-Based Compensation

Fenix’s 2014 Incentive Stock Plan (the “Plan”) was adopted by the Board of Directors in November 2014 and went into effect January 6, 2015 after it was approved by the Company’s shareholders. The Plan was amended by the Board of Directors and restated effective July 8, 2015 and again in November 2015, effective December 1, 2015. The Plan permits grants of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards (in the form of equity bonuses), and other awards (which may be based in whole or in part on the value of the Company’s common stock). Directors, salaried employees, and consultants of the Company and its commonly-controlled affiliates are eligible to participate in the Plan, which is administered by the Compensation Committee of the Company’s Board of Directors. The number of shares originally reserved for share-based awards under the Plan equaled 2,750,000 shares. No awards were granted prior to the IPO. As of September 30, 2016, the Company had 312,250 shares available for share-based awards under the Plan. The Plan requires that each restricted stock unit and each share of restricted stock awarded reduce shares available by two shares.

Share-based compensation is included in selling, general and administrative expenses in the consolidated statements of operations. The components of share-based compensation were as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Stock options
 
$
308

 
$
520

 
$
1,242

 
$
582

Restricted stock grants
 
88

 
78

 
340

 
78

Leesville bonus shares
 

 
547

 
790

 
832

Other restricted or unregistered share issuances
 

 

 
50

 
217

Total share-based compensation
 
$
396

 
$
1,145

 
$
2,422

 
$
1,709


Stock Options
Stock options granted to employees under the Plan typically have a 10-year life and vest in equal installments on each of the first four anniversary dates of the grant, although certain awards have been made with a shorter vesting period. The Company calculates stock compensation expense for employee option awards based on the grant date fair value of the award, less actual annual forfeitures, and recognizes expense on a straight-line basis over the service period of the award. Stock options granted to non-executive directors vest on the first anniversary of the award date. Stock compensation expense for these awards to non-executive directors is based on the grant date fair value of the award and is recognized on a straight-line basis over the one-year service period of the award.

The Company uses the Black-Scholes option pricing model to estimate the grant date fair value of employee and director stock options. The principal variable assumptions utilized in valuing options and the methodology for estimating such model inputs include: (1) risk-free interest rate – an estimate based on the yield of zero–coupon treasury securities with a maturity equal to the expected life of the option; (2) expected volatility – an estimate based on the historical volatility of similar companies’ common stock for a period equal to the expected life of the option; (3) expected life of the option – an estimate based on industry historical experience including the effect of employee terminations; and (4) expected dividend yield - an estimate of cash dividends. The Company does not currently intend to pay cash dividends and thus has assumed a 0% dividend yield. In accordance with ASU No. 2016-09, all forfeitures were applied when they occurred. The forfeitures as noted below first occurred in the three months ended September 30, 2016.

Based on the results of the model, the fair value of the stock options granted during the first nine months of 2016 ranged from $1.20 to $1.54 per share using the following assumptions:
Expected dividend yield
 
%
Risk-free interest rate
 
1.1 - 1.85%

Expected volatility
 
30.0
%
Expected life of option
 
6.3 years


Stock option activity for the nine months ended September 30, 2016 was as follows:

21


 
 
Number
of
Options
 
Weighted-
Average
Exercise Price
Per Share
 
Weighted-
Average
Remaining
Contractual
Term in Years
 
Aggregate
Intrinsic
Value
Outstanding on December 31, 2015
 
1,596,297

 
$
9.02

 
 
 
 
Granted
 
482,750

 
4.04

 
 
 
 
Exercised
 

 

 
 
 
 
Expired or forfeited
 
(6,000
)
 
9.60

 
 
 
 
Outstanding on September 30, 2016
 
2,073,047

 
$
7.86

 
8.98
 
$
8,700

Exercisable on September 30, 2016
 
699,390

 
$
9.17

 
8.73
 
$


At September 30, 2016, there was $2.9 million of unrecognized compensation costs related to stock option awards to be recognized over a weighted average period of 3.2 years.

Restricted Stock Units
Restricted stock units (RSUs) granted to employees and directors vest over time based on continued service (typically, for employees, vesting over a four or five year period in equal annual installments). Such time-vested RSUs are valued at fair value based on the closing price of Fenix common stock on the date of grant. Compensation cost is amortized on a straight-line basis over the requisite service period.

A summary of restricted stock unit activity for the nine months ended September 30, 2016 is as follows:
 
 
Number of Awards
 
Weighted-
Average
Grant Date Fair Value Per Share
Unvested restricted stock units at December 31, 2015
 
150,000

 
$
9.68

Granted
 
29,332

 
4.23

Forfeited
 

 

Vested
 
54,332

 
7.66

Unvested restricted stock units at September 30, 2016
 
125,000

 
$
9.28


At September 30, 2016, there was $1.1 million of unrecognized compensation costs related to restricted stock units to be recognized over a weighted average period of 3.0 years.

The Company’s Director Compensation Policy provides that non-employee directors may elect to receive shares of fully-vested restricted stock in lieu of cash compensation based on the average closing price of the Company’s common stock during the period of service. During the nine months ended September 30, 2016, the Company issued 19,332 fully-vested restricted shares to the directors making such election for the period of service from January 1, 2016 to May 24, 2016 (date of the Annual Meeting) and recorded compensation expense of approximately $0.1 million. During the three months ended September 30, 2016, the Company issued no restricted shares to the directors.

Leesville Bonus Shares
The Company issued 271,112 restricted shares of common stock as part of the closing of the Leesville acquisition for post-combination services of certain Leesville employees. The shares fully vested on May 13, 2016, twelve months after the grant date.

Employee Stock Purchase Plan
At the Company’s Annual Meeting on May 24, 2016, the Company’s shareholders approved the Employee Stock Purchase Plan (“ESP Plan”) effective June 1, 2016. The number of shares authorized for purchase under the ESP Plan is 750,000. The first offering period commenced on July 1, 2016.

Note 8. Loss Per Share

Basic loss per common share is computed by dividing net loss available to common shares by the weighted average common shares outstanding during the period using the two-class method. The Fenix Canada preferred shares do not entitle the holders to any dividends or distributions and therefore, no earnings or losses of Fenix Canada are attributable to those holders. However, these shares are considered participating securities and therefore share in the Company’s net income (loss) of the period since

22


being issued on May 19, 2015. Diluted income (loss) per share includes the impact of outstanding common share equivalents as if those equivalents were exercised or converted into common shares if such assumed exercise or conversion is dilutive.

The calculations of loss per share are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands except share data)
2016
 
2015
 
2016
 
2015
Basic loss per common share:
 
 
 
 
 
 
 
Net loss
$
(1,771
)
 
$
(6,548
)
 
$
(41,740
)
 
$
(13,152
)
Net loss allocable to Fenix Canada preferred shares
(88
)
 
(168
)
 
(2,100
)
 
(862
)
Net loss available to common shares
$
(1,683
)
 
$
(6,380
)
 
$
(39,640
)
 
$
(12,290
)
Weighted-average common shares outstanding
19,988,809

 
19,475,046

 
19,818,231

 
11,206,390

Basic loss per common share
$
(0.08
)
 
$
(0.33
)
 
$
(2.00
)
 
$
(1.10
)

The Company has 11,667 common shares and 280,000 shares of Fenix Canada exchangeable preferred stock held in escrow relating to contingent consideration agreements relating to certain acquired companies. These shares are not included in basic loss per share or in the shares used to calculate the net loss attributable to Fenix Canada preferred shares and will not be included until the contingencies relating to their issuance have been determined, and some, all or none of these shares have been issued. Outstanding stock options and unvested restricted stock units described in Note 7 above are not included in the computation of diluted loss per share for any periods during which the inclusion of such equity equivalents would be anti-dilutive. The Leesville bonus shares described in Note 7 above are included in the weighted-average common shares outstanding for the 2016 periods.

Note 9. Income Taxes

For interim periods, the Company estimates its effective tax rate for the full year and records an interim provision or benefit, as applicable, at such rate.  The Company’s effective tax rate (benefit) of 11.0% for the nine months ended September 30, 2016, differs from the U.S. federal statutory rate of 34% due primarily to the goodwill impairment, for which no tax benefit was recorded as described further in Note 10. Other items impacting the effective tax rate include the reversal of $2.9 million in reserves for uncertain tax positions as described below, state income taxes, differences between U.S. and Canadian income tax rates, changes in the indemnification receivable and the contingent consideration liability which are not tax deductible, and the effect of a valuation allowance recorded for Canadian deferred tax assets. The effective tax rate (benefit) for the nine months ended September 30, 2015 was 44.0%.

The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. The Company’s uncertain tax position reserves at September 30, 2016, including related accrued interest and penalties of approximately $1.0 million, all relate to tax positions assumed as part of the acquisitions in 2015. These tax reserves are reviewed periodically and adjusted in light of changing facts and circumstances, such as progress of tax audits, lapse of applicable statutes of limitations, and changes in tax law. Under certain conditions, payments made by the Company, including interest and penalties, for assumed uncertain tax positions are indemnified by the former owners of the Subsidiaries for a period of three years from the acquisition in the case of the Founding Companies and for the period of the applicable statute of limitations in the case of the later-acquired companies. As of December 31, 2015, the Company had approximately $5.7 million of uncertain tax position reserves. During the nine months ended September 30, 2016, the statute of limitations lapsed without audit for certain tax returns filed by acquired companies for which reserves for uncertain tax positions and indemnification receivables had been established. As a result, the Company reversed $2.9 million of uncertain tax position reserves, which included $1.4 million of accrued interest and penalties, as a credit to the income tax benefit in the condensed consolidated statement of operations. As of September 30, 2016, the remaining uncertain tax position reserves amounted to $2.8 million. Correspondingly, the indemnification receivables were reduced by $2.8 million through a charge to operating expenses, and there is a remaining indemnification receivable of $2.3 million recorded in the condensed consolidated balance sheet as of September 30, 2016. If a reserved uncertain tax position results in an actual liability and the Company is unable to collect on or enforce the related indemnification provision or if the actual liability occurs after the applicable indemnity period has expired, there could be a material charge to the Company’s consolidated financial results and reduction of cash resources.

Note 10. Goodwill and Intangible Assets

Goodwill represents the excess of the cost of an acquired business over the net of the amounts assigned to assets acquired and liabilities assumed. Changes in the carrying amount of goodwill were as follows:

23


(In thousands)
 
 
Balance as of December 31, 2015
 
$
76,812

Purchase accounting allocation adjustments (see Note 3)
 
5,403

Exchange rate effects
 
523

Impairment charge
 
(45,300
)
Balance as of September 30, 2016
 
$
37,438


Pursuant to the provisions of FASB ASC Topic 350, “Intangibles - Goodwill and Other,” goodwill is required to be tested at the reporting unit level for impairment annually or whenever indications of impairment arise. Management has determined the Company operates as one operating segment and one reporting unit, Automotive Recycling, and all the goodwill is considered attributable to that reporting unit for impairment testing. The Company performed its annual goodwill impairment test for 2015 as of October 1, 2015, also updated as of December 31, 2015, and management determined that no impairment of goodwill existed at either date.

During the first quarter of 2016, the Company’s stock price declined 32% from $6.79/share at December 31, 2015 to $4.60/share at March 31, 2016, and management performed step 1 of the two-step impairment test and determined that potential impairment of the reporting unit existed at March 31, 2016, since book value at such date no longer exceeded the carrying amount. As such, management applied the second step of the goodwill impairment test and, with consideration of a third party valuation report, calculated an estimated fair value as a hypothetical purchase price for the reporting unit to determine the resulting “implied” goodwill (computed by estimating the fair value of the reporting unit and comparing that estimated fair value to the reporting unit’s carrying value). An excess of a reporting unit’s recorded goodwill over its “implied” goodwill is reported as an impairment charge.

The Company’s reporting unit fair value estimates are established using weightings of the Company’s market capitalization and a discounted future cash flow methodology. Management believes that using the two methods to estimate fair value limits the chances of an unrepresentative valuation. Nonetheless, these valuations are subject to significant subjectivity and assumptions as discussed further below.

The Company considers its current market capitalization compared to the sum of the estimated fair values of its business in conjunction with each impairment assessment. As part of this consideration, management recognizes that the Company’s market capitalization at March 31, 2016, or at any specific date, may not be an accurate representation of fair value for the following reasons:

The long-term horizon of the valuation process versus a short-term valuation using current market conditions; and
Control premiums reflected in the reporting unit fair values but not in the Company’s stock price.

In addition to market capitalization analysis the Company re-performed a discounted future cash flow analysis for the purpose of determining the amount of goodwill impairment. Such analysis relies on key assumptions, including, but not limited to, the estimated future cash flows of the reporting unit, weighted average cost of capital (“WACC”), and terminal growth rates of the Company. The determination of fair value is highly sensitive to differences between estimated and actual cash flows and changes in the WACC and related discount rate used to evaluate the fair value of the reporting unit. In evaluating the key variables this time, management (i) reduced the estimated future cash flows based upon actual results achieved during the three months ended March 31, 2016 and revised projections, and (ii) concluded that the Company’s WACC and terminal growth rates were 13% and 3%, respectively, as compared to 10% and 3% used in the test at October 1, 2015.

Based on the result of this second step of the goodwill impairment analysis as of March 31, 2016, combining the market capitalization and discounted cash flow methodologies, the Company recorded a $45.3 million non-cash charge to reduce the carrying value of goodwill. The Canadian Founding Companies were acquired in 2015 in an asset purchase, and the tax benefit associated with the portion of this charge related to the Canadian Founding Companies was offset by a valuation allowance because of the uncertainties associated with generating future taxable income in Canada.

While management believes that the estimates and assumptions underlying the valuation methodology are reasonable, different estimates and assumptions could result in substantially different outcomes. The table below presents the decrease in the fair value of the reporting unit given a one percent increase in the discount rate or a one percent decrease in the long-term assumed annual revenue growth rate. A 10% change in the weighting of the discounted cash flow approach and the market approach would not have had a significant effect on the fair value of the reporting unit.

24


 
Decrease in Fair Value of Reporting Unit
(in thousands)
Discount Rate - Increase by 1%
$
11,000

Long-term Growth Rate - Decrease by 1%
$
6,000

A goodwill impairment analysis requires significant judgments, estimates and assumptions, and the results of the impairment analysis described above are as of a point in time - March 31, 2016. Future events that could result in further interim assessments of goodwill and a potential further impairment include, but are not limited to, (i) a further decline in the Company’s stock price below the valuation used to compute the impairment at March 31, 2016, (ii) significant underperformance relative to historical or projected future operating results and/or reductions in estimated future sales growth rates, (iii) further reduction in scrap prices, (iv) further reduction in the Canadian exchange rate, (v) an increase in the Company’s weighted average cost of capital, (vi) significant increases in vehicle procurement costs, (vii) significant changes in the manner of or use of the assets or the strategy for the Company’s overall business, (viii) variation in vehicle accident rates or other significant negative industry trends, (ix) changes in state or federal laws, (x) a significant economic downturn, or (xi) changes in other variables that can materially impact the Company’s business.

Intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill. The Company’s intangible assets, net of accumulated amortization, totaled $35.1 million at March 31, 2016 and $33.3 million at September 30, 2016, and consist of trade names, non-competition agreements and customer relationships. The Company, in conjunction with its third party valuation expert, used various techniques in estimating the initial fair value of acquired intangible assets. These valuations are primarily based on the present value of the estimated net cash flows expected to be derived from the intangible assets, discounted for assumptions such as future customer attrition. Management evaluates the intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Therefore, changes such as higher or earlier-than-expected customer attrition may result in higher future amortization charges or an impairment charge for intangible assets. As part of the goodwill impairment analysis discussed above, the Company also reviewed intangible assets and did not identify any impairment as of March 31, 2016.

After considering qualitative indicators at September 30, 2016 that caused the Company to revisit the possibility of further impairment for goodwill and for intangible assets, the Company performed step 1 of the two-step impairment test and concluded that no further impairment for goodwill and intangible assets was appropriate at September 30, 2016. Expected second and third quarter results and market capitalization were considered as part of the March 31, 2016 analysis, and actual results and other key factors did not deviate from management’s expectations in such a way that would call into question the realizability of goodwill and other long lived assets as of September 30, 2016.

Note 11. Commitments and Contingencies

Operating Leases
Rental expense for operating leases was approximately $1.0 million and $2.6 million during the three and nine months ended September 30, 2016, respectively. The Company incurred rent expense of $1.0 million and $1.2 million for the three and nine months ended September 30, 2015, respectively. The Company leases properties from the former owners of the Subsidiaries and other related parties. The Company did not enter into any new leases during the nine months ended September 30, 2016.

Legal, Environmental and Related Contingencies
From time to time, the Company is subject to litigation related to normal business operations. The Company maintains insurance for normal business risks and seeks to vigorously defend itself in litigation. The Company also is subject to a variety of environmental and pollution control laws and regulations incident to the ordinary course of business. Management currently expects that the resolution of any potential contingencies arising from compliance with these laws and regulations will not materially affect the Company’s financial position, results of operations or cash flows.

SEC Inquiry
In September 2016, the Company received a subpoena from the Chicago Regional Office of the SEC requiring the production of various documents, which were all provided during December 2016 and January 2017. The SEC inquiry appears to be focused on the Company’s change during 2016 in its independent registered public accounting firm, its previously announced business combinations and related goodwill impairment charge, the effectiveness of its internal controls over financial reporting and its inventory valuation methodology. The Company’s receipt of a subpoena from the SEC does not mean that it has violated securities laws. Although the Company has incurred substantial legal fees and other costs associated with production of the documents required by the SEC and may incur further costs before this inquiry is concluded, management does not believe that the inquiry

25


will ultimately have a material impact on the Company’s financial condition, results of operations or cash flow, but cannot predict the duration or outcome of the inquiry.

Class Action Lawsuit
In January 2017, a class action lawsuit entitled Beezley v. Fenix Parts, Inc. et al, was filed in the United States District Court for the District of New Jersey against the Company, Kent Robertson, its President and Chief Executive Officer, and Scott Pettit, its Chief Financial Officer (the “Defendants”). The lawsuit was filed on behalf of purchasers of the Company’s shares from May 14, 2015 through October 12, 2016. The complaint asserts that all defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and SEC Rule 10b-5 and that Messrs. Robertson and Pettit violated Section 20(a) of the Exchange Act. The complaint asserts that the defendants made false and/or misleading statements and/or failed to disclose that: (1) the Company had an inadequate inventory valuation methodology; (2) the Company had an inadequate methodology to calculate goodwill impairment; (3) the Company was engaging and/or had engaged in conduct that would result in an SEC investigation; and (4) as a result, the defendants’ statements about the Company’s business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times. The plaintiffs seek class certification, an award of unspecified damages, an award of reasonable costs and expenses, including attorneys' fees and expert fees, and other further relief as the Court may deem just and proper. The Company believes that the allegations contained in the complaint are without merit and, in conjunction with its insurance carrier, intends to vigorously defend itself against all claims asserted therein. A reasonable estimate of the amount of any possible loss or range of loss, after applicable insurance coverage, cannot be made at this time and, as such, the Company has not recorded an accrual for any possible loss.

Note 12. Fair Value Measurements

Fair Value Measurements of financial assets and liabilities are defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market at the measurement date (exit price). The Company is required to classify fair value measurements in one of the following categories:
 
Level 1 - inputs which are defined as quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
 
 
 
Level 2 - inputs which are defined as inputs other than quoted prices included within Level 1 that are observable for the assets or liabilities, either directly or indirectly.
 
 
 
Level 3 - inputs which are defined as unobservable inputs for the assets or liabilities. Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.


The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.


Certain assets and liabilities are required to be recorded at fair value on either a recurring or non-recurring basis. At 
September 30, 2016, the fair value of contingent consideration, which is a recurring fair value measurement, was valued in the consolidated financial statements using Level 3 inputs. The Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses are carried at cost, which are Level 1 as they approximate fair value due to the short-term maturity of these instruments.

The Company’s debt, classified as Level 2, is carried at cost and approximates fair value due to its variable interest rates, which are consistent with the interest rates in the market. The Company may be required, on a non-recurring basis, to adjust the carrying value of the Company’s property and equipment, intangible assets, goodwill and contingent consideration. When necessary, these valuations are determined by the Company using Level 3 inputs. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence that impairment may exist (see
Note 5 above for further details related to contingent consideration fair value estimates and related adjustments recorded in the consolidated financial statements).


26


Beagell Group (Designated Accounting Co-Predecessor)
UNAUDITED CONDENSED COMBINED STATEMENT OF OPERATIONS
(In thousands)
 
Period from
January 1, 2015 to May 18, 2015
Net revenues
 
$
11,107

Cost of goods sold
 
7,395

Gross profit
 
3,712

Operating expenses
 
3,184

Income from operations
 
528

Other income
 
64

Income before income tax expense
 
592

Income tax expense
 
76

Net income
 
$
516

Net income attributable to noncontrolling interest
 
279

Net income attributable to Beagell Group
 
$
237



27


Beagell Group
UNAUDITED CONDENSED COMBINED STATEMENT OF CASH FLOWS
(In thousands)
 
Period from
January 1, 2015 to May 18, 2015
Cash flows from operating activities
 
 
Net income
 
$
516

Adjustments to reconcile net income to net cash provided by operating activities
 
 
Depreciation and amortization expense
 
277

Provision for uncertain tax positions
 
86

Gain on disposal of property and equipment
 
(61
)
Change in assets and liabilities
 
 
Accounts receivable
 
(135
)
Inventories
 
114

Prepaid expenses and other current assets
 
(104
)
Account payable
 
233

Accrued expenses and other liabilities
 
(306
)
Deferred warranty revenue
 
(143
)
Net cash provided by operating activities
 
477

Cash flows from investing activities
 
 
Proceeds from disposal of property and equipment
 
161

Premium payments on life insurance policies
 
594

Payments made on related party receivables
 
333

Capital expenditures
 
(285
)
Net cash provided in investing activities
 
803

Cash flows from financing activities
 
 
Payments of debt
 
(26
)
Shareholder distributions
 
(1,859
)
Net cash used in financing activities
 
(1,885
)
Decrease in cash and cash equivalents
 
(605
)
Cash and cash equivalents, beginning of period
 
2,770

Cash and cash equivalents, end of period
 
$
2,165

Supplemental cash flow disclosures
 
 
Cash paid for income taxes
 
$
5



28


Beagell Group
NOTES TO UNAUDITED CONDENSED COMBINED FINANCIAL STATEMENTS

Note 1. Nature of Operations
The Beagell Group (the “Company”) includes three commonly-controlled companies: Don’s Automotive Mall, Inc. (“Don’s”), Gary’s U-Pull It, Inc. (“Gary’s”) and Horseheads Automotive Recycling, Inc. (“Horseheads”). The Company’s primary business is auto recycling, which is the recovery and resale of original equipment manufacturer (“OEM”) and aftermarket parts, components and systems, such as engines, transmissions, radiators, trunks, lamps and seats (referred to as “products”) reclaimed from damaged, totaled or low value vehicles. The Company purchases its vehicles primarily at auto salvage auctions. Upon receipt of vehicles, the Company inventories and then either a) dismantles the vehicles and sells the recycled components at its full-service facilities or b) allows retail customers to directly dismantle, recover and purchase recycled parts at its self-service facilities. In addition, the Company purchases recycled OEM and related products from third parties for resale and distribution to its customers. The Company’s customers include collision repair shops (body shops), mechanical repair shops, auto dealerships and individual retail customers. The Company also generates a portion of revenue from the sale of scrap of the unusable parts and materials and from the sale of extended warranties.
Don’s sells recycled OEM products through its two full-service dismantling and distribution facilities located in Binghamton, New York and Pennsburg, Pennsylvania. Gary’s and Horseheads sell recycled OEM products through their self-service facilities in Binghamton and Elmira, New York, respectively. Each of the three commonly-controlled companies is a New York corporation.

On May 19, 2015, all three commonly-controlled companies were purchased by Fenix Parts, Inc. for an approximate purchase price of $34.5 million, subject to working capital and other adjustments. The Lessors (as defined below) were not purchased, but the owners of the Lessors entered into lease agreements with Fenix Parts, Inc. for certain properties on which the Company conducts its automotive recycling business.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation
These unaudited condensed combined financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, without audit, pursuant to the rules and regulations of United States Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures typically included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed combined financial statements should be read in conjunction with the audited combined financial statements of the Beagell Group and the notes thereto as of and for the year ended December 31, 2014 included in Fenix Parts, Inc.’s prospectus dated May 14, 2015. The Company continues to follow the accounting policies set forth in those combined financial statements. Management believes that these combined interim financial statements include all adjustments, normal and recurring in nature, that are necessary to present fairly the results of its operations and cash flows for the period from January 1, 2015 to May 18, 2015. Interim results are not necessarily indicative of annual results. All significant intercompany balances and transactions have been eliminated.

The combined financial statements include the accounts of D&B Holdings, LLC and BBHC, LLC - the lessors of the premises from which Don’s operates, Beagell Properties, LLC - the lessor of the premises from which Gary’s operates, and Don’s Independent Salvage Company, LLC - the lessor of the premises from which Horseheads operates (collectively, “the Lessors”). Each of the Lessors are substantially owned by the Company’s shareholders. The Company has determined that each of the Lessors are variable interest entities because the holders of the equity investment at risk in these entities do not have the obligation to absorb their expected losses or receive their residual returns. Furthermore, the Company has determined that it is the primary beneficiary of each Lessor because the Company has the power to direct the activities that most significantly impact the Lessors’ economic performance, namely the operation and maintenance of the significant assets of the Lessors. Accordingly, and pursuant to consolidation requirements under GAAP, the Company consolidates the Lessors. All intercompany transactions are eliminated in consolidation. All of the Lessors operating results are attributable to the noncontrolling interests in the Company’s combined statements of operations and all of their shareholders’ equity is reported separately from the Company’s shareholders’ equity in the Company’s combined balance sheet and combined statements of shareholders’ equity.

Use of Estimates
The preparation of the Company’s combined financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the combined financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

29


Revenue Recognition
The Company recognizes revenue from the sale of vehicle replacement products and scrap when they are shipped or picked up by the customers and ownership has transferred, subject to an allowance for estimated returns and discounts that management estimates based upon historical information. Management analyzes historical returns (often pursuant to standard warranties on the sold products) and allowances activity by comparing the items returned to the original invoice amounts and dates. The Company uses this information to project future returns and allowances on products sold. If actual returns and allowances deviate from the Company’s historical experience, there could be an impact on its operating results in the period of occurrence.

The Company presents taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue on the combined statements of operations and are shown as a current liability on the combined balance sheets until remitted. Revenue also includes amounts billed to customers for shipping and handling.

Revenue from the sale of separately priced extended warranty contracts is reported as deferred revenue and recognized ratably over the term of the contracts. Revenue from such extended warranty contracts was approximately $189,000 for the period from January 1, 2015 to May 18, 2015.

Cost of Goods Sold
Cost of goods sold primarily includes a) amounts paid for the purchase of vehicles, scrap, parts for resale and related products, b) related auction, storage and towing fees, and c) other costs of procurement and dismantling, primarily labor and overhead allocable to dismantling operations.

Operating Expenses
Operating expenses are primarily comprised of a) salaries and benefits of employees that are not related to the procurement and dismantling of vehicles, b) facility costs such as rent, utilities, insurance, repairs and taxes not allocated to dismantling operations, c) selling and marketing costs, d) costs to distribute the Company’s products and scrap and e) other general and administrative costs.

Income Taxes
Each of the three commonly-controlled companies has elected to operate under Subchapter S of the Internal Revenue Code. Accordingly, the shareholders report their share of the Company’s federal and most state taxable income or loss on their respective individual income tax returns. The Lessors are taxed as partnerships and therefore no provision for federal and state corporate taxes are recorded for the Lessors.

The Company recognizes the benefits of uncertain tax positions taken or expected to be taken in tax returns in the provision for income taxes only for those positions that are more likely than not to be realized. The Company follows a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. The Company’s policy is to include interest and penalties associated with income tax obligations in income tax expense.

Reclassifications
Reclassifications of prior period amounts have been made to conform to the current period presentation. The reclassifications have no impact on net income, cash flows, total assets or shareholders’ equity as previously reported.

Note 3. Commitments and Contingencies

Operating Lease
The Company is obligated under a non-cancelable operating lease for corporate office space, warehouse and distribution facilities. The facilities are owned by certain shareholders of the Company. In 2015, the entity holding the leased assets was consolidated, and there was no rental expense recognized for the period from January 1, 2015 to May 18, 2015.

30


Note 4. Income Taxes
Each of the Company’s commonly-controlled entities described in Note 2 have elected to operate under Subchapter S of the Internal Revenue Code. The Company’s primary uncertain tax position arises from uncertainties regarding the continued qualifications of one of the entities for that Subchapter S election and the related reserve was approximately $2,017,000 at May 18, 2015. It is reasonably possible that the amount of benefits from this uncertain tax position will significantly increase or decrease in the next twelve months; however, no estimate of the range of the amount of the increase or decrease can be readily made.
In addition to the uncertain tax positions described above, the Company has other uncertain tax positions related to the timing of certain deductions for income tax purposes. The related basis differences caused by this timing of deductions for income tax purposes and the timing of expense recognition for financial reporting purposes are reported by the Company’s equity holders. However, interest and penalties are separately recorded for all uncertain tax positions as part of income tax expense and amounted to approximately $24,000 for the period from January 1, 2015 to May 18, 2015. The Company had accumulated interest and penalties of approximately $373,000 as of May 18, 2015, which are included in the reserve for uncertain tax positions on the combined balance sheets.
The Company is generally no longer subject to examination in primary tax jurisdictions for tax years through 2011. The Company is not currently subject to any audits or examinations.

Note 5. Employee Benefit Plans
The Company provides a defined contribution plan covering eligible employees, which includes a matching contribution. Matching Company contributions to this plan was approximately $37,000 for the period January 1, 2015 to May 18, 2015.


31


Standard (Designated Accounting Co-Predecessor)
UNAUDITED CONDENSED COMBINED STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands)
 
Period from
January 1, 2015 to May 18, 2015
Net revenues
 
$
8,914

Cost of goods sold
 
5,996

Gross profit
 
2,918

Operating expenses
 
3,385

Loss from operations
 
(467
)
Other income, net
 
302

Loss before income tax expense
 
(165
)
Income tax provision
 
79

Net loss
 
(244
)
Net loss attributable to noncontrolling interest
 
(15
)
Net loss attributable to Standard
 
$
(229
)
Net loss
 
$
(244
)
Foreign currency translation adjustments, net of tax
 
(366
)
Net comprehensive income (loss)
 
(610
)
Net comprehensive income (loss) attributable to noncontrolling interest
 
(17
)
Net comprehensive income (loss) attributable to Standard
 
$
(593
)



32


Standard
UNAUDITED CONDENSED COMBINED STATEMENT OF CASH FLOWS
(In thousands)
 
Period from
January 1, 2015 to May 18, 2015
Cash flows from operating activities
 
 
Net loss
 
$
(244
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
Depreciation and amortization expense
 
302

Deferred income tax benefit
 
(194
)
Provision for uncertain tax positions
 
69

Insurance proceeds
 
150

Gain on fire
 
(51
)
Loss on disposal of property and equipment
 
15

Change in assets and liabilities
 
 
Accounts receivable
 
(216
)
Inventories
 
(12
)
Prepaid expenses and other current assets
 
(432
)
Accounts payable
 
(306
)
Accrued expenses and other current liabilities
 
343

Net cash used in operating activities
 
(576
)
Cash flows from investing activities
 
 
Capital expenditures
 
(119
)
Insurance Proceeds
 
109

Other
 
61

Net cash provided by investing activities
 
51

Effect of foreign exchange fluctuations on cash
 
559

Net increase in cash and cash equivalents
 
34

Cash and cash equivalents, beginning of period
 
1,354

Cash and cash equivalents, end of period
 
$
1,388

Supplemental cash flow disclosure
 
 
Cash paid for income taxes
 
$
9



33


Standard
NOTES TO UNAUDITED CONDENSED COMBINED FINANCIAL STATEMENTS
Note 1. Nature of Operations
Standard (the “Company”) includes four commonly-controlled companies: Standard Auto Wreckers, Inc. (“Standard Auto”), End of Life Vehicles Inc. (“End of Life Vehicles”), Goldy Metals (Ottawa) Incorporated (“Goldy Metals Ottawa”) and Goldy Metals Incorporated (“Goldy Metals Toronto”). The Company’s primary business is auto recycling, which is the recovery and resale of original equipment manufacturer (“OEM”) and aftermarket parts, components and systems, such as engines, transmissions, radiators, trunks, lights and seats (referred to as “products”) reclaimed from damaged, totaled or low value vehicles. The Company purchases its vehicles primarily at auto salvage auctions. Upon receipt of vehicles, the Company inventories and then a) dismantles the vehicles and sells the recycled components at its full-service facilities or b) allows retail customers to directly dismantle, recover and purchase recycled parts at its self-service facilities. In addition, the Company purchases recycled OEM parts and related products from third parties for resale and distribution to its customers. The Company’s customers include collision repair shops (body shops), mechanical repair shops, auto dealerships and individual retail customers. The Company also generates a portion of revenue from the sale as scrap of the unusable parts and materials and from the sale of extended warranty contracts.
Standard Auto is incorporated in New York, and End of Life Vehicles, Goldy Metals Ottawa and Goldy Metals Toronto all operate in Canada and are incorporated in the Province of Ontario. Collectively, the Company has three full-service dismantling and distribution facilities located in Niagara Falls, New York; Scarborough, Ontario; and Ottawa, Ontario. The Ottawa facility runs a self-service operation adjacent to its full-service operations, and Goldy Metals Toronto has a second self-service operation in Scarborough, Ontario. End of Life Vehicles is a website based solution for individuals to arrange for an environmentally responsible disposal of their vehicle.
On May 19, 2015, each of the commonly-controlled companies described above was acquired by Fenix Parts, Inc. (“Fenix”) for an approximate purchase price of $46.6 million, subject to working capital and other adjustments. The acquisition did not include the capital stock of Dalana Realty, Inc. (“Dalana Realty”), Standard Auto Wreckers (Port Hope), Inc. (“Port Hope”), or Standard Auto Wreckers (Cornwall) Inc., which was formed by one of the Company shareholders in 2013 to acquire property in Cornwall, Ontario to allow for future expansion. The owner of these entities, who also owned Standard prior to the acquisition by Fenix, entered into lease agreements with Fenix for certain properties on which Fenix conducts its automotive recycling business.

Note 2. Summary of Significant Accounting Policies

Basis of Preparation
These unaudited condensed combined financial statements were prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures typically included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed combined financial statements should be read in conjunction with the audited combined financial statements of Standard and the notes thereto as of and for the year ended December 31, 2014 included in Fenix Parts, Inc.’s prospectus dated May 14, 2015. The Company continues to follow the accounting policies set forth in those combined financial statements. Management believes that these combined interim financial statements include all adjustments, normal and recurring in nature, that are necessary to present fairly the results of its operations and cash flows for the period from January 1, 2015 to May 18, 2015. Interim results are not necessarily indicative of annual results. All significant intercompany balances and transactions have been eliminated.

The combined financial statements include the accounts of Dalana Realty, the lessor of the premises from which Standard Auto operates. Dalana Realty and Standard Auto share common ownership. In April 2014, Port Hope, an Ontario corporation, was formed by one of the Company’s shareholders to hold new property to be used as a full-service dismantling and distribution facility in Port Hope, Ontario, to replace the Goldy Metals Toronto’s full-service operations in Scarborough which were not restarted after a fire at the facility in March 2014. The combined financial statements also include the accounts of Port Hope.

The Company has determined Dalana Realty and Port Hope are variable interest entities (“VIEs”) because the holders of the equity investment at risk do not have the obligation to absorb its expected losses or receive its residual returns. Furthermore, the Company has determined it is the primary beneficiary of the VIEs because the Company has the power to direct the activities that most significantly impact Dalana Realty’s and Port Hope’s economic performance. The Company consolidates Dalana Realty and Port Hope. All intercompany transactions are eliminated in consolidation, and the VIE’s operating results are attributable to the noncontrolling interest in the Company’s combined statements of operations and all of its shareholder’s equity is reported separately from the Company’s shareholders’ equity in the Company’s combined balance sheets and statements of shareholders’ equity.


34


Use of Estimates
The preparation of the Company’s combined financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the combined financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents
Standard Auto includes cash and investments having an original maturity of three months or less at the time of acquisition in cash and cash equivalents.

Foreign Currency
The assets and liabilities of End of Life Vehicles, Goldy Metals Ottawa, Goldy Metals Toronto and Port Hope, whose functional currency is the Canadian dollar, are translated into US dollars at period-end exchange rates prior to combination. Income and expense items are translated at the average rates of exchange prevailing during the period. The adjustments resulting from translating the Company’s financial statements are reflected as a component of accumulated other comprehensive income within shareholders’ equity. Foreign currency transaction gains and losses are recognized in net earnings based on differences between foreign exchange rates on the transaction date and the settlement date. Transaction gains $5,600 for the period January 1, 2015 to May 18, 2015, and are included in operating expenses on the consolidated statements of operations.

Revenue Recognition
The Company recognizes revenue from the sale of vehicle replacement products and scrap when they are shipped or picked up by the customers and ownership has transferred, subject to an allowance for estimated returns and discounts that management estimates based upon historical information. Management analyzes historical returns (often pursuant to standard warranties on the sold products) and allowances activity by comparing the items to the original invoice amounts and dates. The Company uses this information to project future returns and allowances on products sold. If actual returns and allowances deviate significantly from the Company’s historical experience, there could be an impact on its operating results in the period of occurrence.
The Company presents taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue on the combined statements of operations and are shown as current liabilities on the combined balance sheets until remitted. Revenue also includes amounts billed to customers for shipping and handling.
Revenue from the sale of separately priced extended warranty contracts is reported as deferred revenue and recognized ratably over the term of the contracts or over five years for life-time warranties. Revenue from such extended warranty contracts was approximately $98,000 for the period January 1, 2015 to May 18, 2015.
Net revenues were reported by the Company’s Canadian entities of approximately $7,336,000 for the period from January 1, 2015 to May 18, 2015.

Cost of Goods Sold
Cost of goods sold primarily includes a) amounts paid for the purchase of vehicles and parts for resale, b) related auction, storage and towing fees, and c) other costs of procurement and dismantling, primarily labor and overhead allocable to dismantling operations.

Operating Expenses
Operating expenses are primarily comprised of a) salaries and benefits of employees that are not related to the procurement and dismantling of vehicles, b) facility costs such as rent, utilities, insurance, repairs and taxes not allocated to dismantling operations, c) selling and marketing costs, d) costs to distribute products and scrap and e) other general and administrative costs.

Income taxes
Income taxes are accounted for under the asset and liability method where deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax basis and for tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company evaluates the realizability of its deferred tax assets by assessing its valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization include historical cumulative losses, the forecast of future taxable income and available tax planning strategies that could be implemented

35


to realize the net deferred tax assets. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.
The Company recognizes the benefits of uncertain tax positions taken or expected to be taken in tax returns in the provision for income taxes only for those positions that are more likely than not to be realized. The Company follows a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. The Company policy is to include interest and penalties associated with income tax obligations in income tax expense.

Reclassifications
Reclassifications of prior period amounts have been made to conform to the current period presentation. The reclassifications have no impact on net income, cash flows, total assets or shareholders’ equity as previously reported.

Note 3. Commitments and Contingencies

Leases
Goldy Metals Toronto pays rent to one of the shareholders under a month to month lease agreement. Lease expense under this operating lease was approximately $24,000 for the period from January 1, 2015 to May 18, 2015.

Note 4. Income Taxes
For the period from January 1, 2015 to May 18, 2015, the effective tax rate was (48.10)%. The effective tax rate differs from the statutory rate due to the impact of foreign tax rates and changes in uncertain tax positions.
The Company’s gross reserve for uncertain tax positions related to foreign and domestic matters, including penalties and interest, as of May 18, 2015 was approximately $499,000. The Company believes that it has adequately provided for all uncertain tax positions. The Company is generally no longer subject to examination in the Company’s primary tax jurisdiction for tax years through 2011. The Company is not currently subject to any audits or examinations. It is reasonably possible that new issues may be raised by tax authorities and that these issues may require increases in the balance of the reserve for uncertain tax positions.

Note 5. Fire at Toronto Facility
On March 3, 2014, a fire occurred at the Goldy Metals Toronto facility located in Scarborough, Ontario. The fire destroyed the dismantling facility and a substantial portion of the location’s inventory. For the periods from January 1, 2015 to May 18, 2015 the Company did not incur any additional charges but received insurance recoveries of approximately $259,000, which was recognized as income when received. If any additional proceeds are received they are expected to be insignificant.


36


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-looking Statements
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The following discussion includes forward-looking statements that involve certain risks and uncertainties. For additional information regarding forward-looking statements and risk factors, see “Forward-looking statements” and Part II, Item 1A. “Risk Factors.”

Critical Accounting Policies and Estimates
Our accounting policies require us to apply methodologies, estimates and judgments that have a significant impact on the results we report in our consolidated financial statements. In our 2015 Annual Report on Form 10-K, we discussed those material policies that we believe are critical and require the use of complex judgment in application. There have been no changes to our critical accounting policies since that time.

We use estimates in accounting for, among other items, inventory valuation and reserves for potentially excess and unsalable inventory, contingent consideration liabilities, uncertain tax positions and certain other assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates require the application of complex assumptions and judgments, often because they involve matters that are inherently uncertain and will likely change in subsequent periods. The impact of any change in estimates is included in earnings in the period in which the estimate is adjusted.

Liquidity and Ability to Continue as a Going Concern
Our unaudited condensed consolidated financial statements have been prepared assuming we continue as a going concern, which contemplates continuity of operations, realization of assets and the satisfaction of liabilities in the normal course of business. As such, the accompanying unaudited condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets and their carrying amounts, or the amount and classification of liabilities that may result should we be unable to continue as a going concern.

As of June 30, 2016, September 30, 2016 and December 31, 2016, we were in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements and the Borrowing Base requirement for repaying over-advances as well as the requirement for timely delivery of certain quarterly certificates and reports. On March 27, 2017, we entered into a Forbearance Agreement to the Credit Facility (the "Forbearance Agreement") with BMO Harris Bank N.A and its Canadian affiliate, Bank of Montreal. Pursuant to the Forbearance Agreement, the banks agreed to forbear from exercising their rights and remedies under the Credit Facility with respect to the above described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur.

Our Board of Directors has engaged a financial advisor to advise the Board and management and to assist in pursuing a range of potential strategic and financial transactions that will provide us with improved liquidity and maximize shareholder value. The financial advisor will identify and evaluate potential alternatives including debt or equity financing, a strategic investment into us or a business combination, and is reporting directly to a special committee of independent directors established to oversee and coordinate these activities. The Board has not set a definitive timetable for completion of this process. There can be no assurance that this process will result in a transaction or other strategic alternative of any kind.

If we are unable to reach further agreement with its lenders to obtain waivers or amendments to the existing Credit Facility, find acceptable alternative financing, obtain equity contributions, or arrange a business combination, after the forbearance period (and during the forbearance period in the event of any new defaults other than those anticipated defaults enumerated in the Forbearance Agreement), the Company’s Credit Facility lenders could elect to declare some or all of the amounts outstanding under the facility to be immediately due and payable. If this happens, we do not expect to have sufficient liquidity to pay the outstanding Credit Facility debt. In addition, we have significant obligations under contingent consideration agreements related to certain acquired companies, and we will need access to additional credit to be able to satisfy these obligations. These matters, including our ability to continue as a going concern, are more fully discussed below under Liquidity and Capital Resources.

Carrying Values and Impairment of Goodwill
Goodwill represents the excess of the cost of an acquired business over the net of the amounts assigned to assets acquired and liabilities assumed. Pursuant to the provisions of FASB ASC Topic 350, “Intangibles - Goodwill and Other,” goodwill is required

37


to be tested at the reporting unit level for impairment annually or whenever indications of impairment arise. Management has determined we operate as one operating segment and one reporting unit, Automotive Recycling, and all the goodwill is considered attributable to that reporting unit for impairment testing. Pursuant to our policy, we performed the annual goodwill impairment test as of October 1, 2015, updated the test as of December 31, 2015, and determined that no impairment of goodwill existed at either date.

During the first quarter of 2016, our stock price declined 32% from $6.79/share at December 31, 2015 to $4.60/share at March 31, 2016. Management performed step 1 of the two-step impairment test and determined that potential impairment of the reporting unit existed at March 31, 2016, since book value at such date no longer exceeded the carrying amount. As such, management applied the second step of the goodwill impairment test and, with consideration of a third party valuation report and using the methodology and assumptions explained in Note 10 to the condensed consolidated financial statements, calculated a goodwill impairment of $45.3 million that was recorded in the three months ended March 31, 2016 and is reflected in the accompanying consolidated statement of operations for the nine months ended September 30, 2016.

A goodwill impairment analysis requires significant judgments, estimates and assumptions, and the results of our impairment analysis are as of a point in time - March 31, 2016. Future events that could result in further interim assessments of goodwill and a potential further impairment include, but are not limited to, (i) a further decline in our stock price below the valuation used to compute the impairment at March 31, 2016, (ii) significant underperformance relative to historical or projected future operating results and/or reductions in estimated future sales growth rates, (iii) further reduction in scrap prices, (iv) further reduction in the Canadian exchange rate, (v) an increase in our weighted average cost of capital, (vi) significant increases in our vehicle procurement costs, (vii) significant changes in the manner of or use of the assets or the strategy for our overall business, (viii) variation in vehicle accident rates or other significant negative industry trends, (ix) changes in state or federal laws, (x) a significant economic downturn, or (xi) changes in other variables that can materially impact our business.

Intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill. Our intangible assets, net of accumulated amortization, totaled $35.1 million at March 31, 2016 and $33.3 million at September 30, 2016, and consist of trade names, non-competition agreements and customer relationships. Our third party valuation experts use various techniques in estimating the initial fair value of acquired intangible assets. These valuations are primarily based on the present value of the estimated net cash flows expected to be derived from the intangible assets, discounted for assumptions such as future customer attrition. Management evaluates the intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Therefore, changes such as higher or earlier-than-expected customer attrition may result in higher future amortization charges or an impairment charge for intangible assets. As part of the goodwill impairment analysis discussed above, we also reviewed intangible assets and did not identify any impairment as of March 31, 2016.

After considering qualitative indicators at September 30, 2016 that caused us to revisit the possibility of further impairment for goodwill and for intangible assets, we concluded that no further impairment for goodwill and intangible assets was appropriate at September 30, 2016. Expected second and third quarter results and market capitalization were considered as part of our March 31, 2016 analysis, and actual results and other key factors did not deviate from our expectations in such a way that would call into question the realizability of goodwill and other long lived assets as of September 30, 2016.

Recent Accounting Pronouncements
Refer to Note 2 “Recent Accounting Pronouncements” in the notes to the unaudited consolidated financial statements for Fenix Parts, Inc., included in this Form 10-Q.

Fenix Parts, Inc.
(in thousands, except percentages and per share amounts)

Overview
We are in the business of automotive recycling, which is the recovery and resale of OEM and aftermarket parts, components and systems, such as engines, transmissions, radiators, trunks, lamps and seats (referred to as “products”) reclaimed from damaged, totaled or low value vehicles. We purchase vehicles primarily at auto salvage auctions. Upon receipt of vehicles, we inventory and then dismantle the vehicles and sell the recycled products. Our customers include collision repair shops, mechanical repair shops, auto dealerships and individual retail customers. We also generate a portion of our revenue from the sale as scrap of the unusable parts and materials, from the sale of used cars and motorcycles, and from the sale of extended warranty contracts.

We were founded on January 2, 2014 (“inception”) for the purpose of effecting the combinations with the Founding Companies and the IPO. We had no automotive recycling operations before May 2015, during which time we had two employees. From

38


inception to May 19, 2015, we incurred various legal, accounting, auditing and administrative costs in preparation for the IPO, the combinations and for operation as a publicly-traded company upon consummation of these transactions. After May 18, 2015, our results include the operations of the acquired companies.

Consolidated Results of Operations for the Three Months Ended September 30, 2016 and 2015
(in thousands, except percentages)
Three Months Ended September 30, 2016
 
Percent of Net Revenues
 
Three Months Ended September 30, 2015
 
Percent of Net Revenues
Net revenues
$
32,515

 
100.0
 %
 
$
27,275

 
100.0
 %
Cost of goods sold
21,348

 
65.7
 %
 
20,584

 
75.5
 %
Gross profit
11,167

 
34.3
 %
 
6,691

 
24.5
 %
Selling, general and administrative expenses
12,962

 
39.9
 %
 
14,579

 
53.5
 %
Outside service and professional fees
1,742

 
5.4
 %
 
3,575

 
13.1
 %
Depreciation and amortization
1,138

 
3.5
 %
 
1,077

 
3.9
 %
Change in fair value of contingent consideration liabilities
(1,411
)
 
(4.3
)%
 
(1,022
)
 
(3.7
)%
Change in indemnification receivable
266

 
0.8
 %
 

 
 %
Operating loss
(3,530
)
 
(10.9
)%
 
(11,518
)
 
(42.2
)%
Interest expense
(437
)
 
(1.3
)%
 
(78
)
 
(0.3
)%
Other income, net
165

 
0.5
 %
 
26

 
0.1
 %
Loss before income tax benefit
(3,802
)
 
(11.7
)%
 
(11,570
)
 
(42.4
)%
Benefit for income taxes
(2,031
)
 
(6.2
)%
 
(5,022
)
 
(18.4
)%
Net loss
$
(1,771
)
 
(5.4
)%
 
$
(6,548
)
 
(24.0
)%

The following table shows the combined unaudited pro forma net revenues and net loss for us as if the acquisition of all subsidiaries had occurred on January 1, 2015. These unaudited pro forma amounts presented are not necessarily indicative of either the actual consolidated results had the acquisition occurred as of January 1, 2015 or of future operating results:
 
 
(Unaudited)
 
 
Three Months Ended September 30,
 
Difference
(in thousands, except percentages)
 
2016 as Reported
 
2015 Pro Forma
 
$
 
%
Net revenues
 
$
32,515

 
$
32,211

 
$
304

 
0.9
 %
Net loss
 
$
(1,771
)
 
$
(7,461
)
 
$
5,690

 
(76.3
)%


39


Pro forma net revenues consisted of:
 
 
(Unaudited)
 
 
Three Months Ended September 30,
 
Difference
(in thousands, except percentages)
 
2016 as Reported
 
2015 Pro Forma
 
$
 
%
Recycled OE parts and related products
 
$
27,694

 
$
27,762

 
$
(68
)
 
(0.2
)%
Other ancillary products (scrap)
 
4,821

 
4,449

 
372

 
8.4
 %
Total
 
$
32,515

 
$
32,211

 
$
304

 
0.9
 %

Pro Forma Adjustments (Unaudited)
Significant adjustments to the historical revenues of the Subsidiaries include the elimination of sales between acquired companies, for which there is a corresponding decrease in pro forma cost of goods sold, and the elimination of revenue from the sale of warranties that are not recognized by us in the post-acquisition periods.

Significant adjustments to expenses include eliminating the effect of shares transferred from founding investors to later investors, incremental amortization of acquired intangible assets, rent expense associated with leases with the former owners of the Subsidiaries, compensation related to certain bonuses paid to owners and employees and related income tax effects.

The cost of goods sold impact of the subsequent sale of acquired inventories written-up from historic cost basis to fair value is reflected for pro forma reporting purposes in the same period as reflected in the accompanying condensed consolidated financial statements, and is not adjusted back to January 1, 2015 as it does not have a continuing impact on us. As a result, pro forma gross profit margins in the periods immediately following the acquisitions are substantially lower than the pre-acquisition periods.

Net Revenues
Net revenues for the three months ended September 30, 2016 were $32.5 million. This represents a 19.0% increase over net revenues for the three months ended September 30, 2015 of $27.3 million. This change is a result of only having automotive recycling operations for the Founding Companies for a full quarter in 2015 along with Ocean County, which was acquired half way through August 2015. Butler and Tri-City were acquired in the fourth quarter of 2015. Net revenues of $32.5 million represents a 0.9% increase from unaudited pro forma combined net revenues for the three months ended September 30, 2015 of $32.2 million. Of this increase, $(0.1) million was attributable to sales of OE parts and related products and $0.4 million was attributable to sales of scrap.

Because of the significant increase in the value of the U.S Dollar against the Canadian Dollar during 2015, in the fourth quarter of 2015 and continuing into 2016, we substantially reduced shipments of parts from our U.S. facilities into the Canada markets, resulting in lower revenue at our Canadian facilities as they sought to develop Canadian sources to acquire vehicles and product for recycling. Continued changes in exchange rates could result in ongoing changes to operational and financial performance of the Canadian operations that could adversely affect our future reported results of operations.

Cost of Goods Sold
Our cost of goods sold for the three months ended September 30, 2016 amounted to $21.3 million, or 65.7% of net revenues and a gross profit percentage of 34.3%. This represents a 3.4% increase over cost of goods sold for the three months ended September 30, 2015 of $20.6 million. This change is a result of only having automotive recycling operations for the Founding Companies for a full quarter in 2015 along with Ocean County, which was acquired half way through August 2015. Butler and Tri-City were acquired in the fourth quarter of 2015. Costs of goods sold for the three months ended September 30, 2016 and 2015 includes $0.0 million and $4.3 million, respectively, attributable to post-acquisition amortization of higher inventory values from applying the purchase method of accounting to the acquired inventories of the Subsidiaries. As of September 30, 2016, there was no remaining unamortized fair value inventory adjustment as the acquired inventory was expected to be sold within six to nine months. Depreciation of $0.2 million was included in cost of goods sold during the three months ended September 30, 2016.

As mentioned above, our results of operations are exposed to market risk related to price fluctuation in scrap metal and other metals. Market prices of these metals affect the amount that we pay for our inventory, in addition to the revenue that we generate from sales of these metals. As both our revenue and costs are affected by the price fluctuations, we have a natural hedge against price changes. However, there is typically a lag between the effect on our revenue from metal price fluctuations and the corresponding effect on cost of goods sold. Our cost of goods sold for recycled OEM and related products reflects the historic average cost to acquire such products, including the price to purchase vehicles, auction, storage and towing fees, and expenditures for buying and dismantling vehicles.


40


Selling, General and Administrative Expenses
Our selling, general and administrative expenses for the three months ended September 30, 2016 amounted to $13.0 million, or 39.9% of net revenues. This represents a (11.0)% decrease over selling, general and administrative expense for the three months ended September 30, 2015 of $14.6 million. Selling, general and administrative expenses consisted of (i) selling and marketing expenses, (ii) general and administrative expenses, and (iii) amortization of $0.4 million and $1.2 million of non-cash share-based compensation during the three months ended September 30, 2016 and 2015, respectively.

Outside Service and Professional Fees
Our outside service and professional fees for the three months ended September 30, 2016 amounted to $1.7 million, or 5.4% of net revenues. This represents a (52.8)% decrease over outside service and professional fees for the three months ended September 30, 2015 of $3.6 million. Outside service and professional fees consisted primarily of auditing, valuation reports and opinions, tax consulting, and legal fees for the three months ended September 30, 2016 and 2015. For the three months ended September 30, 2015, outside service and professional fees included costs related to establishing the accounting valuations for the acquisitions of the Founding Companies and for outside accounting services as we had not yet recruited and staffed an internal accounting department. For the three months ended September 30, 2016, outside service and professional fees included costs related to the transition to a new external audit firm.

Depreciation and amortization expense
Our depreciation and amortization not directly attributable to cost of goods sold for the three months ended September 30, 2016 amounted to $1.1 million, or 3.5% of net revenues. This represents no change over depreciation and amortization expense for the three months ended September 30, 2015 of $1.1 million. Depreciation and amortization consisted primarily of amortization of intangible assets established in connection with acquisitions.

Change in fair value of contingent consideration liabilities
Our estimated fair value of contingent consideration liabilities decreased by $1.4 million for the three months ended September 30, 2016, resulting in income equal to 4.3% of net revenues. This compares to a decrease in the estimated fair value of contingent consideration liabilities and resulting income recorded for the three months ended September 30, 2015 of $1.0 million. The change during the three months ended September 30, 2016 primarily results from the reduction by $1.5 million of the estimated contingent consideration for Jerry Brown, Ltd. (“Jerry Brown”) in September 2016 in accordance with FASB ASC No. 805 “Business Combination,” which requires us to fair value our contingent consideration liabilities using possible outcomes. The change during the three months ended September 30, 2015 resulted because of mark-to-market fluctuations based on changes in the trading price of Fenix common stock and, with respect to the Canadian Founding Companies, currency remeasurement.

Interest expense and other income (expense), net
Our interest expense, primarily related to our Credit Facility, was $0.4 million for the three months ended September 30, 2016. Our interest and other income, net for the three months ended September 30, 2016, amounted to $0.2 million of income. Combined, these items were 0.8% of net revenues.

Benefit for income taxes
We recorded an income tax benefit of $2.0 million during the three months ended September 30, 2016, an effective rate of 53.4% of the pretax loss reported in the period. This represents a 60.0% decrease as compared to the income tax benefit for the three months ended September 30, 2015 of $5.0 million, which was based on a larger pretax loss. The effective rate differs from the U.S. federal statutory rate due to the reversal of $0.3 million of reserves for uncertain tax positions during the third quarter of 2016, and the effects of state and Canadian income taxes and non-deductible income and expense items reported in the statement of operations.

Net loss
Net loss for the three months ended September 30, 2016 and 2015 was $1.8 million and $6.5 million, respectively. This represents a 72.3% decrease which results from the matters described above.

Consolidated Results of Operations for the Nine Months Ended September 30, 2016 and 2015


41


(in thousands, except percentages)
Nine Months Ended September 30, 2016
 
Percent of Net Revenues
 
Nine Months Ended September 30, 2015
 
Percent of Net Revenues
Net revenues
$
98,931

 
100.0
 %
 
$
38,745

 
100.0
 %
Cost of goods sold
59,190

 
59.8
 %
 
30,592

 
79.0
 %
Gross profit
39,741

 
40.2
 %
 
8,153

 
21.0
 %
Selling, general and administrative expenses
37,567

 
38.0
 %
 
21,272

 
54.9
 %
Outside service and professional fees
5,083

 
5.1
 %
 
6,988

 
18.0
 %
Depreciation and amortization
3,500

 
3.5
 %
 
1,786

 
4.6
 %
Change in fair value of contingent consideration liabilities
(8,393
)
 
(8.5
)%
 
(193
)
 
(0.5
)%
Change in indemnification receivable
2,782

 
2.8
 %
 

 
 %
Goodwill impairment
45,300

 
45.8
 %
 

 
 %
Operating loss
(46,098
)
 
(46.5
)%
 
(21,700
)
 
(56.0
)%
Interest expense
(1,192
)
 
(1.2
)%
 
(100
)
 
(0.3
)%
Other income (expense), net
408

 
0.4
 %
 
(1,678
)
 
(4.3
)%
Loss before income tax benefit
(46,882
)
 
(47.4
)%
 
(23,478
)
 
(60.6
)%
Benefit for income taxes
(5,142
)
 
(5.2
)%
 
(10,326
)
 
(26.7
)%
Net loss
$
(41,740
)
 
(42.2
)%

$
(13,152
)
 
(33.9
)%

The following table shows the combined unaudited pro forma net revenues and net loss for us as if the acquisition of all subsidiaries had occurred on January 1, 2015. These unaudited pro forma amounts presented are not necessarily indicative of either the actual consolidated results had the acquisition occurred as of January 1, 2015 or of future operating results:
 
 
(Unaudited)
 
 
Nine Months Ended September 30,
 
Difference
(in thousands, except percentages)
 
2016 as Reported
 
2015 Pro Forma
 
$
 
%
Net revenues
 
$
98,931

 
$
95,598

 
$
3,333

 
3.5
%
Net loss
 
$
(41,740
)
 
$
(10,500
)
 
$
(31,240
)
 
297.5
%

Pro forma net revenues consisted of:
 
 
(Unaudited)
(in thousands, except percentages)
 
Nine Months Ended September 30,
 
Difference
 
 
2016 as Reported
 
2015 Pro Forma
 
$
 
%
Recycled OE parts and related products
 
$
84,732

 
$
82,430

 
$
2,302

 
2.8
%
Other ancillary products (scrap)
 
14,199

 
13,168

 
1,031

 
7.8
%
Total
 
$
98,931

 
$
95,598

 
$
3,333

 
3.5
%

Pro Forma Adjustments (Unaudited)
Significant adjustments to the historical revenues of the Subsidiaries include the elimination of sales between acquired companies, for which there is a corresponding decrease in pro forma cost of goods sold, and the elimination of revenue from the sale of warranties that are not recognized by us in the post-acquisition periods.

Significant adjustments to expenses include eliminating the effect of shares transferred from founding investors to later investors, incremental amortization of acquired intangible assets, rent expense associated with leases with the former owners of the Subsidiaries, compensation related to certain bonuses paid to owners and employees and related income tax effects.

The cost of goods sold impact of the subsequent sale of acquired inventories written-up from historic cost basis to fair value is reflected for pro forma reporting purposes in the same period as reflected in the accompanying condensed consolidated financial statements and is not adjusted back to January 1, 2015 as it does not have a continuing impact on the us. As a result, pro forma gross profit margins in the periods immediately following the acquisitions are substantially lower than the pre-acquisition periods.

42



Net Revenues
Net revenues for the nine months ended September 30, 2016 were $98.9 million. This represents a 156% increase over net revenues for the nine months ended September 30, 2015 of $38.7 million. This change is a result of Fenix only having automotive recycling operations from May 19, 2015 through September 30, 2015, in the prior year. In addition, Butler and Tri-City were acquired in the fourth quarter of 2015 and are not included in the prior year net revenues. Net revenues of $98.9 million represents a 3.5% increase over unaudited pro forma combined net revenues for the nine months ended September 30, 2015 of $95.6 million. Of this increase, $2.3 million was attributable to sales of OE parts and related products and $1.0 million was attributable to sales of scrap.

We are subject to risks and uncertainties relating to the price of scrap metal, which can fluctuate significantly from period to period. While sales of scrap metal represent a small portion of our overall revenues, significant fluctuations have been experienced in metal prices over the past 21 months which have had an effect on our reported revenues including a decline of approximately 22% in average market prices for scrap auto bodies from the nine months ended September 30, 2015 to the nine months ended September 30, 2016 (as per the American Metal Market Index, 2015 = $162/ton; 2016 = $126/ton), which had an adverse effect on reported revenues during the nine months ended September 30, 2016. Continued weakness in metals prices could continue to adversely affect our revenues and profits. This trend should be viewed in light of the partially offsetting effect of lower metals prices on our cost of acquiring vehicles for recycling.

Because of the significant increase in the value of the U.S Dollar against the Canadian Dollar during 2015, in the fourth quarter of 2015 and continuing into 2016, we substantially reduced shipments of parts from our U.S. facilities into the Canada markets resulting in lower revenue at our Canadian facilities as they sought to develop Canadian sources to acquire vehicles and product for recycling. Continued changes in exchange rates could result in ongoing changes to operational and financial performance of the Canadian operations that could adversely affect our future reported results of operations.

Cost of Goods Sold
Our cost of goods sold for the nine months ended September 30, 2016 amounted to $59.2 million, or 59.8% of net revenues and a gross profit percentage of 40.2%. This represents a 93.5% increase over cost of goods sold for the nine months ended September 30, 2015 of $30.6 million. This change is a result of Fenix only having automotive recycling operations from May 19, 2015 through September 30, 2015, in the prior year. In addition, Butler and Tri-City were acquired in the fourth quarter of 2015 and are not included in the prior year net revenues and cost of goods sold. However, included in the cost of goods sold for the nine months ended September 30, 2016 is a benefit of $2.2 million from retrospective adjustments to reduce the value of acquired inventories in the business combinations and $1.8 million in lower value of acquired inventory for periods prior to December 31, 2015. These credits to cost of goods sold, recorded as of March 31, 2016, were partially offset by the impact of post-acquisition amortization of the higher inventory values that resulted from applying the purchase method of accounting of $1.4 million in the nine months ended September 30, 2016 as compared to $7.0 million in the nine months ended September 30, 2015. As of September 30, 2016, there was no remaining unamortized fair value inventory adjustment as the acquired inventory was expected to be sold within six to nine months. Depreciation of $0.8 million was included in cost of goods sold during the nine months ended September 30, 2016.

As mentioned above, our results of operations are exposed to market risk related to price fluctuations in scrap metal and other metals. Market prices of these metals affect the amount that we pay for our inventory, in addition to the revenue that we generate from sales of these metals. As both our revenue and costs are affected by the price fluctuations, we have a natural hedge against price changes. However, there is typically a lag between the effect on our revenue from metal price fluctuations and the corresponding effect on cost of goods sold. Our cost of goods sold for recycled OEM and related products reflects the historic average cost to acquire such products, including the price to purchase vehicles, auction, storage and towing fees, and expenditures for buying and dismantling vehicles.

Selling, General and Administrative Expenses
Our selling, general and administrative expenses for the nine months ended September 30, 2016 amounted to $37.6 million, or 38.0% of net revenues. This represents a 76.5% increase over selling, general and administrative expense for the nine months ended September 30, 2015 of $21.3 million. This change is a result of Fenix only having automotive recycling operations from May 19, 2015 through September 30, 2015, in the prior year. Selling, general and administrative consisted of (i) selling and marketing expenses, (ii) general and administrative expenses, and (iii) amortization of $2.4 million and $1.5 million of non-cash share-based compensation during the nine months ended September 30, 2016 and 2015, respectively.

Outside Service and Professional Fees
Our outside service and professional fees for the nine months ended September 30, 2016 amounted to $5.1 million, or 5.1% of net revenues. This represents a 27.1% decrease from outside service and professional fees for the nine months ended September 30,

43


2015 of $7.0 million. Outside service and professional fees consisted primarily of auditing, valuation reports and opinions, tax consulting, and legal fees for the nine months ended September 30, 2016, also included significant fees incurred in conjunction with our transition to a new audit firm. For the nine months ended September 30, 2015, outside service and professional fees included costs related to finalizing the audits and establishing the accounting valuations for the acquisitions of the Founding Companies and for outside accounting services as we had not yet recruited and staffed an internal accounting department.

Depreciation and amortization expense
Our depreciation and amortization not directly attributable to cost of goods sold for the nine months ended September 30, 2016 amounted to $3.5 million, or 3.5% of net revenues. This represents a 94.4% increase over depreciation and amortization for the nine months ended September 30, 2015 of $1.8 million. This change is a result of only having automotive recycling operations from May 19, 2015 through September 30, 2015 in the prior year. Depreciation and amortization consisted primarily of amortization of intangible assets established in connection with acquisitions.

Change in fair value of contingent consideration liabilities
Our estimated fair value of contingent consideration liabilities decreased by $8.4 million for the nine months ended September 30, 2016, resulting in income equal to 8.5% of net revenues. This compares to a decrease in estimated fair value of contingent consideration liabilities and resulting income recorded during the nine months ended September 30, 2015 of $0.2 million. The change during 2016 primarily results because the estimated contingent consideration liability for the Canadian Founding Companies was reduced by $4.2 million during the nine months ended September 30, 2016 in accordance with FASB ASC No. 805 “Business Combinations,” which requires that we estimate contingent consideration at fair value using probable outcomes. As the amount of the contingent consideration is currently in dispute, we recorded the estimated contingent consideration liability for the Canadian Founding Companies as of September 30, 2016 based on the result of our assessment of the possible outcomes. During the nine months ended September 30, 2016, we also reduced the estimated contingent consideration liability by $3.8 million because of differences between actual and budgeted performance at Jerry Brown. In addition, since some of the contingent consideration is payable in shares of stock, movements in our stock price during the respective periods and currency remeasurement decreased the contingent consideration liabilities during the nine months ended September 30, 2016 and 2015.

Change in indemnification receivable
Our fair value of the indemnification receivable decreased by $2.8 million for the nine months ended September 30, 2016, resulting in an expense equal to 2.8% of net revenues. The expense was attributable to the reduction in the receivable from former owners related to the indemnification for uncertain tax positions, recorded as a benefit under income taxes.

Goodwill Impairment
Based on the result of the first step of the goodwill impairment analysis, we determined that the fair value of our reporting unit was less than its carrying value as of March 31, 2016 and, as such, we applied the second step of the goodwill impairment test. Based on the result of this second step of the goodwill impairment analysis, we recorded a $45.3 million non-cash pretax charge to reduce the carrying value of goodwill in March 2016.

Interest expense and other income (expense), net
Our interest expense, primarily related to our Credit Facility, was $1.2 million for the nine months ended September 30, 2016. Our other income for the nine months ended September 30, 2016 was $0.4 million. Other income (expense), net for the nine months ended September 30, 2015 was $1.7 million of expense, primarily attributable to a $1.8 million charge for the make whole provision for pre-IPO investors.

Benefit for income taxes
We recorded an income tax benefit of $5.1 million during the nine months ended September 30, 2016, an effective rate of 11.0% of the pretax loss reported in the period. This represents a 50.5% decrease as compared to the income tax benefit for the nine months ended September 30, 2015 of $10.3 million. The benefit recorded during the nine months ended September 30, 2016 includes a $2.9 million reversal of uncertain tax positions. In addition, no tax benefit was recorded for the goodwill impairment in 2016 as the tax benefit associated with the portion of this charge related to the Canadian Founding Companies was offset by a valuation allowance because of the uncertainties associated with generating future taxable income in Canada. In addition to the items discussed above, the effective rate in the nine months ended September 30, 2016 and 2015 differs from the U.S. federal statutory rate due to the effects of the state and Canadian income taxes and non-deductible income and expense items reported in the statement of operations.

Net loss
Net loss for the nine months ended September 30, 2016 and 2015 was $41.7 million and $13.2 million, respectively. This represents a 215.9% decrease which results from the matters described above.


44


Predecessor Companies
For the period ended June 30, 2015, Beagell Group and Standard were fully consolidated and included in the condensed consolidated financial statements. For the period from January 1, 2015 to May 18, 2015, Beagell Group had net revenues of $11.1 million and net income of $0.5 million, and Standard had net revenues of $8.9 million and net loss of $0.2 million.

Liquidity and Capital Resources
As discussed more fully in Note 4 to the accompanying unaudited condensed consolidated financial statements, effective December 31, 2015, we entered into a $35 million amended and restated senior secured credit facility with BMO Harris Bank N.A. and its Canadian affiliate, Bank of Montreal (the “Credit Facility”), which replaced the original Credit Facility with them (the “Original Credit Facility”).  The Amended Credit Facility contained substantially the same terms as the Original Credit Facility except for adjustments to covenants which are discussed below. Previous borrowings under the Original Credit Facility remained outstanding under the Amended Credit Facility. The Credit Facility was further amended on June 27, 2016 and August 19, 2016, with retroactive effect to March 31, 2016 and June 30, 2016, respectively, pursuant to which certain financial covenant calculations, which are described below, were further clarified and amended. The Credit Facility consists of $25.0 million that is available as a revolving credit facility, allocated $20.0 million in U.S. Dollar revolving loans, with a $7.5 million sublimit for letters of credit, and $5.0 million in Canadian revolving loans, with a $2.5 million sublimit for letters of credit. The remaining $10.0 million was drawn as a term loan as part of the IPO in May 2015.

The Credit Facility is secured by a first-priority perfected security interest in substantially all of our assets and the stock of our domestic subsidiaries, which also guaranty the borrowings, and 66% of the stock of our direct Canadian Subsidiary, Fenix Canada (other than its exchangeable preferred shares). The Credit Facility contains customary events of default, including the failure to pay any principal, interest or other amount when due, violation of certain of our affirmative covenants or any negative covenants or a breach of representations and warranties and, in certain circumstances, a change of control. Upon the occurrence of an event of default, payment of indebtedness may be accelerated and the lending commitments may be terminated.

The Credit Facility also contains financial covenants with which we must comply on a quarterly or annual basis, which have been amended since entering into the Original Credit Facility, including a Total Funded Debt to EBITDA Ratio (or “Total Leverage Ratio”, as defined). Total Funded Debt as it relates to the Total Leverage Ratio is defined as all indebtedness (a) for borrowed money, (b) for the purchase price of goods or services, (c) secured by assets of the Company or its Subsidiaries, (d) for any capitalized leases of property, (e) for letters of credit or other extensions of credit, (f) for payments owed regarding equity interests in the Company or its Subsidiaries, (g) for interest rate, currency or commodities hedging arrangements, or (h) for any guarantees of any of the foregoing as of the end of the most recent fiscal quarter. Consistent with the Original Credit Facility, Permitted Acquisitions are subject to bank review and a maximum Total Leverage Ratio, after giving effect to such acquisition. We must also comply with a minimum Fixed Charge Coverage Ratio. Fixed charge coverage is defined as the ratio of (a) EBITDA less unfinanced capital expenditures for the four trailing quarterly periods, dividends, repurchases and other restricted payments, cash taxes, and cash interest to (b) fixed charges (principal and interest payments, taxes paid and other restricted payments); except that for the first three quarters of 2016, for the purposes of determining this ratio, EBITDA will be calculated based on a multiple of the then current EBITDA, instead of using the EBITDA for the prior four quarters. A similar annualization adjustment will be made for unfinanced capital expenditures for the same period. EBITDA includes after tax earnings with add backs for interest expense, income taxes, depreciation and amortization, share-based compensation expenses, and other additional items as outlined in the Credit Facility. In addition, the Credit Facility covenants include a minimum net worth covenant, which was revised effective March 31, 2016. Net worth is defined as the total shareholders’ equity, including capital stock, additional paid in capital, and retained earnings after deducting treasury stock. The amended Credit Facility includes a mandatory prepayment clause requiring certain cash payments when EBITDA exceeds defined requirements for the most recently completed fiscal year. These prepayments will be applied first to outstanding term loans and then to the revolving credit.

The Company is subject to a limitation on its indebtedness based on a quarterly calculation of a Borrowing Base.  The Borrowing Base is determined based upon a ratio of Eligible Receivables and Eligible Inventory and its calculated separately for the United States and Canadian borrowings.  If the amount of principal outstanding for Revolving Loans, Term Loans, Swing Loans and Letter of Credit Obligations combined is in excess of the redetermined quarterly amount, then the Company will have to repay the difference or be in default of the Credit Facility.  As of September 30, 2016, the Company was in default of this Borrowing Base requirement.

As of September 30, 2016, the Company had working capital of $1.5 million, including cash and cash equivalents of $0.8 million. As of September 30, 2016, the Company owed $21.8 million under the Amended Credit Facility (consisting of a term loan with a balance of $9.0 million and a revolving credit facility with a balance of $12.8 million), and had $6.4 million in outstanding standby letters of credit. As of September 30, 2016, for reasons described in Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements we were in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements and the Borrowing Base requirement for repaying over-advances, as well as the requirement for timely delivery

45


of certain quarterly certificates and reports for the second, third and fourth quarters of 2016. Since we are in default as of the date that this Third Quarter report on Form 10-Q is being filed, all of the Credit Facility debt is reported in the accompanying condensed consolidated balance sheet as a current liability and there can be no further borrowings of any availability under the Credit Facility until such defaults are rectified or waived.

On March 27, 2017, we entered into a Forbearance Agreement to the Credit Facility (the "Forbearance Agreement") with BMO Harris Bank N.A. and its Canadian affiliate, Bank of Montreal. Pursuant to the Forbearance Agreement, the banks agreed to forbear from exercising their rights and remedies under the Credit Facility with respect to the above-described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur. The Forbearance Agreement also permits the Company to add the quarterly interest payment otherwise due for the first quarter of 2017 to the principal amount of debt outstanding and defer a $250,000 principal payment due on March 31, 2017 to the end of the forbearance period.

The Board of Directors of the Company has engaged a financial advisor to advise the Board and Company management and to assist in pursuing a range of potential strategic and financial transactions that will provide the Company with improved liquidity and maximize shareholder value. The financial advisor will identify and evaluate potential alternatives including debt or equity financing, a strategic investment into the Company or a business combination, and is reporting directly to a special committee of independent directors established to oversee and coordinate these activities. The Board has not set a definitive timetable for completion of this process. There can be no assurance that this process will result in a transaction or other strategic alternative of any kind.

If the Company is unable to reach further agreement with its lenders to obtain waivers or amendments to the existing Credit Facility, find acceptable alternative financing, obtain equity contributions, or arrange a business combination, after the forbearance period (and during the forbearance period in the event of any new defaults other than those anticipated defaults enumerated in the Forbearance Agreement), the Company’s Credit Facility lenders could elect to declare some or all of the amounts outstanding under the facility to be immediately due and payable. If this happens, the Company does not expect to have sufficient liquidity to pay the outstanding Credit Facility debt.

As a result of the above, substantial doubt exists regarding the ability of the Company to continue as a going concern, which contemplates continuity of operations, realization of assets and the satisfaction of liabilities in the normal course of business within one year from the date of this filing.
 
Prior to the IPO in May 2015, which provided approximately $101.3 million in net proceeds, our source of funding was sales of common stock to a small group of investors that provided $0.3 million in the nine months ended September 30, 2015.

Net cash used in operating activities totaled $2.1 million and $12.7 million for nine months ended September 30, 2016 and 2015, respectively.

Net cash used in investing activities totaled $0.7 million and $87.9 million for the nine months ended September 30, 2016 and 2015, respectively. Investing activities in the nine months ended September 30, 2016 included $0.6 million of capital expenditures, whereas investing activities in the nine months ended September 30, 2015 included the cash portion of the purchase price for the Founding Companies and Ocean County.

Net cash provided by financing activities totaled $0.9 million for the nine months ended September 30, 2016, representing additional borrowings net of repayments under the Credit Facility, and $111.1 million for the nine months ended September 30, 2015, primarily representing the net proceeds from the IPO and the term loan borrowing in connection with the IPO.

At present, our primary source of ongoing liquidity is cash flows from our operations. Payroll and the procurement of inventory are our largest operating uses of funds. We normally pay for vehicles acquired at salvage auctions and under some direct procurement arrangements at the time that possession is taken of the vehicles. We are unable to access any available credit under the Credit Facility unless and until we are able to reach agreement with our lenders to favorably resolve the current events of default.

Over the next 12 months, in addition to any working capital needs, a modest amount of necessary capital expenditures, and debt service on the term loan as discussed above, we are also likely to have a need for cash to satisfy certain contingent consideration liabilities, as described more fully in Note 5 to the accompanying unaudited condensed consolidated financial statements. As part of the consideration for three of the Founding Companies, we entered into contingent consideration agreements with certain of the selling shareholders under which additional consideration will be payable to the former owners in cash and stock if specified future events occur or conditions are met, such as meeting profitability or earnings targets. We have recorded a liability of $7.5 million for the estimated fair value of these contractual commitments in the accompanying condensed consolidated balance sheet as of September 30, 2016, which, if earned, would all be payable over the next 12 months. Approximately $0.6 million of this

46


potential liability is payable in stock (valued at the closing price of our common stock on September 30, 2016) and $2.9 million of the recorded liability is secured by a letter of credit totaling $5.9 million under our Credit Facility. The remainder would be payable in cash, of which $0.2 million is currently held in an escrow account as described below.

For the combination with Jerry Brown, we are required to pay (a) up to an additional $1.8 million if the business achieved certain revenue targets during the twelve-month period beginning June 2015, and (b) an additional uncapped amount if the business exceeds certain EBITDA levels during 2016. Based on an evaluation of the likelihood of meeting these performance targets, we recorded a liability for the acquisition date fair value of the contingent consideration of $2.5 million and increased this liability by $5.1 million during 2015 based on substantial operating improvements and management’s budget for Jerry Brown for 2016. Based on results actually achieved during the nine months ended September 30, 2016, EBITDA is now estimated to be less than the previously developed budget and, accordingly, the estimated fair value of the contingent liability was reduced by $3.8 million, resulting in a credit to income which is reflected in the condensed consolidated statement of operations for the nine months ended September 30, 2016, of which $1.5 million was recorded during the three months ended September 30, 2016. As of September 30, 2016, the total contingent consideration liability attributable to the Jerry Brown acquisition was (a) $1.8 million for achieving the revenue target, which management and the former owners of Jerry Brown agree was fully earned and is currently due and payable, and (b) $2.0 million estimated for the EBITDA target which will be determined in 2017. We are in negotiations with the former owners of Jerry Brown to schedule payment of currently due amounts, and we expect to fund these and future determined payments to the former owners of Jerry Brown, to the extent they are ultimately deemed earned, through cash generated from operations or, if necessary and available, through draws on the revolving Credit Facility or through other sources of capital that may be available.

The combination agreements for Eiss Brothers and the Canadian Founding Companies provide for a holdback of additional consideration which will be payable, in part or in whole, only if certain performance targets are achieved. The maximum amount of additional consideration that can be earned by the former owners of Eiss Brothers is $0.2 million in cash plus 11,667 shares of our common stock, of which none, some or all will be released from escrow depending upon the EBITDA of Eiss Brothers during the twelve-month period beginning June 2015. The maximum amount of additional consideration that can be earned and is subject to holdback for the Canadian Founding Companies is $5.9 million in cash, secured by a letter of credit under our Credit Facility, plus 280,000 Exchangeable Preferred Shares currently held in escrow, of which, none, some or all will be released to the Canadian Founding Companies depending on their combined revenues from specific types of sales for the twelve-month period beginning June 2015. Based on management’s evaluation of the likelihood of meeting these performance targets for these two acquisitions, a liability of $7.8 million was recorded at the acquisition date for the fair value of the aggregate contingent consideration, which included the present value of the estimated cash portion and the then-current value of the Fenix common stock and the Exchangeable Preferred Shares held in escrow. While management’s estimate of the operating results for Eiss Brothers has not changed since its acquisition, the contingent consideration for the Canadian Founding Companies was reduced in accordance with FASB ASC No. 805 “Business Combinations,” which requires that we estimate contingent consideration at fair value using probable outcomes. As the amount of the contingent consideration is currently in dispute, we recorded the estimated contingent consideration liability for the Canadian Founding Companies as of September 30, 2016 based on the result of the assessment of the possible outcomes. These contingent consideration liabilities are also subject to mark-to-market fluctuations based on changes in the trading price of our common stock and, with respect to the Canadian Founding Companies, currency remeasurement. As a result of all these factors, the estimated fair value of the aggregate contingent consideration liability due to the former owners of Eiss Brothers and the Canadian Founding Companies was reduced by $0.0 million and $4.2 million, and an exchange rate gain of $0.0 million and $0.5 million was recognized in the condensed consolidated statement of operations for the three and nine months ended September 30, 2016, respectively. We expect to fund any cash payments to the former owners of the Canadian Founding Companies, to the extent they are ultimately deemed earned, through draws on the bank letter of credit, which is considered Funded Debt under the Total Leverage Ratio required under our Credit Facility.

As of September 30, 2016, the periods for calculating all contingent consideration liabilities due under the combination agreements with Jerry Brown, Eiss Brothers and the Canadian Founding Companies are complete, except for Jerry Brown’s uncapped EBITDA contingency. We are currently in negotiations with the former owners of the Canadian Founding Companies regarding the calculation of contingent consideration earned, if any, and the parties have begun the process of submitting this calculation to binding arbitration.
 
Contractual Obligations and Commercial Commitments
There have been no material changes to the contractual table as discussed in our 2015 Annual Report on Form 10-K.

Off-Balance Sheet Arrangements
At September 30, 2016 and December 31, 2015, 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.

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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our results of operations are exposed to market risk related to price fluctuations in scrap metal and other metals. Market prices of these metals affect the amount that we pay for our inventory as well as the revenue that we generate from sales of these metals. As both our revenue and costs are affected by the price fluctuations, we have a natural hedge against the changes. However, there is typically a lag between the effect on our revenue from metal price fluctuations and inventory cost changes. Therefore, we can experience positive or negative gross margin effects in periods of rising or falling metal prices, particularly when such prices move rapidly. If market prices were to fall at a greater rate than our vehicle acquisition costs, we could experience a decline in our gross margins. We have not entered into any risk mitigation strategies, as any short term exposure would reverse in the long-term.

Our earnings are affected by changes in interest rates due to the fact that interest on our Credit Facility is calculated based upon a fluctuating base rate plus an applicable margin. The base rates for U.S. Dollar and Canadian Dollar borrowings are described in Note 4 to the accompanying unaudited condensed consolidated financial statements. The applicable margin is based on our “Total Leverage Ratio,” as defined in the Credit Facility, and increases as the leverage increases, also as more fully described in Note 4 to the accompanying unaudited condensed consolidated financial statements. At September 30, 2016, none of our variable interest rate debt under our Credit Facility is hedged. Using a sensitivity analysis, a 100 basis point movement in interest rates would change interest expense by $0.2 million over the next twelve months.
Our operations in Canada are also exposed to changes in the relationship between the U.S. dollar and the Canadian dollar. As both our revenue and costs are affected by the price fluctuations, we have a natural hedge against the changes. Canadian dollar fluctuations may also impact the financial results we report in U.S. dollars. Our operations in Canada represented approximately 14% of our total net revenue during the nine months ended September 30, 2016. At this relative distribution of net revenues, a 10% increase or decrease in the strength of the U.S. dollar against the Canadian dollar would result in a 1.4% change in our consolidated net revenues.

ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management establishes and maintains disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. This information is intended to be accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
We have evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2016, the end of the period covered by this report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective because of material weaknesses in our internal control over financial reporting. These material weaknesses were attributable to (A) our lack of (i) accounting personnel with an appropriate level of accounting knowledge, experience, and training commensurate with our complex accounting issues and financial reporting requirements, (ii) procedures to prepare, document and review areas of significant judgments and accounting estimates, including purchase accounting, contingent consideration, potential goodwill impairment and inventory valuation, (iii) timely and systematic review by management of account reconciliations and other analyses to appropriately document and support the recording of financial information, and (iv) thorough review of significant contracts for key accounting ramifications, as well as (B) undue reliance on the findings and conclusions of third-party specialists without an appropriate level of internal review, and (C) inadequate Information Technology General Controls, including limited segregation of duties and access rights controls over information systems at Subsidiaries without compensating corporate procedures and controls. The material weaknesses described above also reflect an overall material weakness in our control environment. Certain of these weaknesses were previously described in our annual report on Form 10-K for the year ended December 31, 2015 filed on April 14, 2016.

We acquired the Founding Companies on May 19, 2015 concurrently with the closing of the initial public offering of our common stock and subsequently during 2015 acquired three additional businesses. Since becoming a publicly-traded company, we have initiated and are continuing to recruit and hire additional accounting and financial personnel, establish policies and procedures for timely and accurate financial reporting, upgrade our internal accounting information systems, and make various other efforts to remediate these weaknesses in our internal control. Management understands and appreciates the need to rapidly establish an effective system of internal controls over financial reporting. Recent efforts in this regard include hiring a corporate controller and director of information technology, implementing steps to establish a company-wide system of uniform account classifications

48


and commencing a plan to migrate all operations to common information systems. However, implementing effective processes and systems for financial reporting is a significant task and an integral part of our integration plan for acquired businesses. The integration is still in progress and is likely to require substantial resources at significant cost over an extended period of time to complete.

Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except as described in “Evaluation of Disclosure Controls and Procedures” above with respect to the ongoing implementation of steps to remediate weaknesses.

PART II -
OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS

From time to time, we are subject to litigation related to normal business operations. We maintain insurance for normal business risks and seek to vigorously defend ourselves in litigation.

SEC Inquiry
In September 2016, we received a subpoena from the Chicago Regional Office of the SEC requiring the production of various documents, which were all provided during December 2016 and January 2017. The SEC inquiry appears to be focused on the change during 2016 in our independent registered public accounting firm, our previously announced business combinations and related goodwill impairment charge, the effectiveness of our internal controls over financial reporting and our inventory valuation methodology. Our receipt of a subpoena from the SEC does not mean that we have violated securities laws. Although we have incurred substantial legal fees and other costs associated with production of the documents required by the SEC and may incur further costs before this inquiry is concluded, management does not believe that the inquiry will ultimately have a material impact on our financial condition, results of operations or cash flow, but cannot predict the duration or outcome of the inquiry.

Class Action Lawsuit
In January 2017, a class action lawsuit entitled Beezley v. Fenix Parts, Inc. et al, was filed in the United States District Court for the District of New Jersey against Fenix Parts, Inc., Kent Robertson, its President and Chief Executive Officer, and Scott Pettit, its Chief Financial Officer (the “Defendants”). The lawsuit was filed on behalf of purchasers of our shares from May 14, 2015 through October 12, 2016. The complaint asserts that all defendants violated Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and SEC Rule 10b-5 and that Messrs. Robertson and Pettit violated Section 20(a) of the Exchange Act. The complaint asserts that we made false and/or misleading statements and/or failed to disclose that: (1) we had an inadequate inventory valuation methodology; (2) had an inadequate methodology to calculate goodwill impairment; (3) were engaging and/or had engaged in conduct that would result in an SEC investigation; and (4) as a result, our statements about our business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times. The plaintiffs seek class certification, an award of unspecified damages, an award of reasonable costs and expenses, including attorneys' fees and expert fees, and other further relief as the Court may deem just and proper. We believe that the allegations contained in the complaint are without merit and, in conjunction with our insurance carrier, intend to vigorously defend against all claims asserted therein. A reasonable estimate of the amount of any possible loss or range of loss, after applicable insurance coverage, cannot be made at this time and, as such, we have not recorded an accrual for any possible loss.

ITEM 1A.
RISK FACTORS

With the exception of the items noted below which have arisen in 2016 and 2017, there have been no material changes with respect to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

We and certain of our officers have been named as defendants in a securities class action lawsuit that could divert management's time and attention from our business and have a negative effect on our results of operations.

In January 2017, a class action lawsuit entitled Beezley v. Fenix Parts, Inc. et al, was filed in the United States District Court for the District of New Jersey against us, Kent Robertson, our President and Chief Executive Officer, and Scott Pettit, our Chief Financial Officer. The lawsuit was filed on behalf of purchasers of our shares from May 14, 2015 through October 12, 2016. The complaint alleges violations of the federal securities laws. For additional information with regard to allegations in the complaint,

49


see Note 11 to the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. The plaintiffs seek class certification, an award of unspecified damages, an award of reasonable costs and expenses, including attorneys' fees and expert fees, and other further relief as the Court may deem just and proper.

We believe that the allegations contained in the compliant are without merit and, in conjunction with our insurance carrier, intend to vigorously defend against the allegations in this complaint. Nonetheless, the lawsuit may result in costly and protracted litigation, which may require a significant commitment of our resources and time. The ultimate outcome of any litigation is uncertain and the outcome of this matter, whether favorable or unfavorable, could have a negative impact on our financial condition or results of operations due to defense costs, diversion of management resources and other factors.

We may incur additional costs in connection with an SEC inquiry, and an unfavorable outcome could damage our business and reputation and result in claims or additional proceedings against us. 

In September 2016, we received a subpoena from the Chicago Regional Office of the Securities and Exchange Commission (the “SEC”) requiring the production of various documents, which were all provided during December 2016 and January 2017. The SEC inquiry appears to be focused on our recent change in our independent registered public accounting firm, our previously announced business combinations and related goodwill impairment charge, the effectiveness of our internal controls over financial reporting and our inventory valuation methodology. We have incurred substantial legal fees and other costs associated with production of the documents required by the SEC and may incur further costs before this inquiry is concluded. We cannot predict the duration or outcome of the inquiry, and an unfavorable outcome could damage our business and reputation and result in claims or additional proceedings against us.

As a result of our failure to file Forms 10-Q for the quarters ended June 30 and September 30, 2016 by the deadline of February 13, 2017, Nasdaq has determined that our stock is subject to delisting.  If the hearing to be held on March 30, 2017 before the NASDAQ Hearings Panel is not ultimately successful, our stock will be delisted.  If it is delisted, our stock price and the liquidity of our common stock would be impacted.

As previously disclosed, on November 22, 2016, we received a delinquency letter from NASDAQ with regard to our non-compliance with NASDAQ Listing Rule 5250(c)(1) for failure to timely file our Quarterly Report on Form 10-Q for the period ended on September 30, 2016, which supplemented the delinquency letter with respect to our Quarterly Report on Form 10-Q for the period ended June 30, 2016. We were granted an exception to allow us to regain compliance with all delinquent filings until February 13, 2017. We did not file either our Quarterly Report for the period ended June 30, 2016 or the Quarterly Report for the period ended September 30, 2016 by NASDAQ’s deadline. As expected, we received a NASDAQ staff determination letter on February 14, 2017 indicating that we did not meet the terms of the exception and that our stock would be delisted unless we timely requested a hearing before the NASDAQ Hearings Panel.  The NASDAQ Hearings Panel granted our request for a hearing and for an extended stay of delisting, pending the hearing and issuance of a final Panel decision and we have now filed the above-described quarterly reports. If the hearing to be held on March 30, 2017 is not ultimately successful, we would be delisted by NASDAQ.  Furthermore, even if we are successful in avoiding delisting in connection with the current delinquencies, NASDAQ may be less willing to grant us additional exceptions to listing rules in the event of future delinquencies, thus putting us at greater risk of a future delisting.  A delisting from the NASDAQ Stock Market would result in negative publicity and have a material adverse effect on the trading volume of our stock and, likely, our stock price. A limited public market for our common shares may limit your ability to sell your shares and negatively impact our ability to raise capital in the future.

As of June 30, 2016, September 30, 2016 and December 31, 2016, we were in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements, the Borrowing Base requirement to repay over-advances and the requirement for timely delivery of certain quarterly certificates and reports.

We have obtained a Forbearance Agreement from our Credit Facility lenders underwhich they agreed to forbear from exercising their rights and remedies with respect to the above described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur. If we are unable to find alternative capital structures or are unable to otherwise cure these breaches during the forbearance period, our lenders under the Credit Facility may thereafter accelerate the obligations thereunder, and we will not be able to repay the obligations that become immediately due. For additional information, please see the discussion in Notes 1 and 4 to the condensed consolidated financial statements included herein.

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

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ITEM 3.
DEFAULTS UPON SENIOR SECURITIES

As of June 30, 2016, September 30, 2016 and December 31, 2016, the Company was in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements and the Borrowing Base requirement for repaying over-advances (which were created by establishing lower acquired inventory values as described in Note 3 to the condensed consolidated financial statements that reduced the applicable borrowing base), as well as the requirement for timely delivery of certain quarterly certificates and reports. On March 27, 2017, the Company and its subsidiaries entered into a Forbearance Agreement to the Credit Facility (the "Forbearance Agreement") with BMO Harris Bank N.A and its Canadian affiliate, Bank of Montreal. Pursuant to the Forbearance Agreement, the banks agreed to forbear from exercising their rights and remedies under the Credit Facility with respect to the above described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur.

The Board of Directors of the Company has engaged a financial advisor to advise the Board and Company management and to assist in pursuing a range of potential strategic and financial transactions that will provide the Company with improved liquidity and maximize shareholder value. The financial advisor will identify and evaluate potential alternatives including debt or equity financing, a strategic investment into the Company or a business combination, and is reporting directly to a special committee of independent directors established to oversee and coordinate these activities. The Board has not set a definitive timetable for completion of this process. There can be no assurance that this process will result in a transaction or other strategic alternative of any kind.

If the Company is unable to reach further agreement with its lenders to obtain waivers or amendments to the existing Credit Facility, find acceptable alternative financing, obtain equity contributions, or arrange a business combination, after the forbearance period (and during the forbearance period in the event of any new defaults other than those anticipated defaults enumerated in the Forbearance Agreement), the Company’s Credit Facility lenders could elect to declare some or all of the amounts outstanding under the facility to be immediately due and payable. If this happens, the Company does not expect to have sufficient liquidity to pay the outstanding Credit Facility debt.

See Item 1. Notes To Unaudited Condensed Consolidated Financial Statements - Note 1 for further discussion.

ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable

ITEM 5.
OTHER INFORMATION

As of June 30, 2016, September 30, 2016 and December 31, 2016, the Company was in breach of the Credit Facility’s Total Leverage Ratio and Fixed Charge Coverage Ratio requirements and the Borrowing Base requirement for repaying over-advances, as well as the requirement for timely delivery of certain quarterly certificates and reports. On March 27, 2017, the Company and its subsidiaries entered into a Forbearance Agreement to the Credit Facility (the "Forbearance Agreement") with their lenders, BMO Harris Bank N.A and its Canadian affiliate, Bank of Montreal. Pursuant to the Forbearance Agreement, the banks agreed to forbear from exercising their rights and remedies under the Credit Facility with respect to the above described defaults and any similar defaults during the forbearance period ending May 26, 2017, provided no other defaults occur. Other material provisions in the Forbearance Agreement include: (a) waiver of default rate interest (which is 200 basis points above the standard interest rate) if the loans outstanding under the Credit Facility are repaid by August 31, 2017, (b) imposition of a forbearance fee of $500,000 payable to the banks by August 31, 2017, but with a $150,000 discount if paid by July 31, 2017, (c) a requirement to comply with a mutually agreed upon thirteen week budget, (d) deferral of principal payments due on March 31, 2017 until the end of the forbearance period and the capitalization of interest accruing during such period, (e) a new minimum liquidity financial covenant during the forbearance period and (f) retaining a Chief Administrative Officer and Qualified Investment Banker satisfactory to the banks during the forbearance period.


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ITEM 6.
EXHIBITS
Exhibit
Number
 
Description of Exhibit
 
 
 
10.1
 
Second Amendment to Amended and Restated Multicurrency Credit Agreement and Waiver (Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed with the Securities and Exchange Commission on August 24, 2016).
 
 
 
10.2
 
Forbearance Agreement among Fenix Parts, Inc., Fenix Parts Canada, Inc., and their subsidiaries, BMO Harris Bank N.A. and Bank of Montreal

 
 
 
31.1
 
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32*
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101.INS
 
XBRL Instance Document.
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document.
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.
*
This certification is deemed not “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Fenix Parts, Inc.
 
 
 
Dated: March 28, 2017
By:
/s/ Kent Robertson
 
 
Kent Robertson
 
 
President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
By:
/s/ Scott Pettit
 
 
Scott Pettit
 
 
Chief Financial Officer
 
 
(Principal Financial Officer)


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