SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________________________
FORM 10-K
 _______________________________________
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015
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. ID)
 
 
 
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
_______________________________________
Title of Each Class
 
Name of each exchange on which registered
Common Stock, par value $.001 per share
 
NASDAQ Global Market
Securities registered pursuant to Section 12(g) of the Act: None
________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ¨     No   x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x
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 that the registrant was required to submit and post such files).    Yes   x     No   ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x  (Do not check if a smaller reporting company)
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

As of June 30, 2015, the aggregate market value of common stock outstanding held by stockholders who were not affiliates of the registrant was approximately $100 million (based on the closing sale price on the NASDAQ Global Market on such date).
The number of outstanding shares of the registrant's common stock as of April 14, 2016 was 19,926,868.

Documents Incorporated by Reference
Portions of the registrant's proxy statement for the 2016 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the registrant’s fiscal year ended December 31, 2015, are incorporated by reference in Part III of this Form 10-K .
 


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PART I

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K 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 expected or projected 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. Some of these risks, uncertainties, and other factors are set forth elsewhere in this Annual Report on Form 10-K and in other documents we have filed with the SEC and include, among other things:

Our relatively short operating history and our ability to successfully integrate into one entity our operating subsidiaries ("Subsidiaries"), and those subsidiaries we may acquire;
Our ability to successfully locate and acquire additional businesses that provide recycled OEM automotive products and our ability to successfully integrate acquired companies with our business;
Our success in managing internal growth;
Variations in the number of vehicles sold, vehicle accident rates, miles driven and the age of vehicles in accidents;
Competition from vehicle replacement part companies, including but not limited to those that provide recycled parts;
Our ability to maintain our relationships with auto body shops, insurers, other customers and with auction companies from which we purchase our salvage vehicles;
Our compliance and our Subsidiaries' past compliance with environmental laws and regulations and federal, state and local operating and permitting requirements;
The known environmental liabilities at our Toronto, Ontario facility associated with groundwater and surface water contamination as a result of historical releases and a petroleum hydrocarbon spill in November 2010;
Potential for significant impairment of goodwill and intangibles;
Fluctuations in the prices of scrap metal and other metals;
Changes in the exchange rate for the Canadian Dollar
Changes in the national, provincial or state laws and regulations affecting our business;
Disruptions in the information technology systems on which our business relies;
Our ability to satisfy our debt obligations and to operate in compliance with our financing agreements;
Material weaknesses in our internal control over financial reporting; and
Other factors discussed under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business”.

Given these risks and uncertainties, you are cautioned not to place undue reliance on our forward-looking statements. Projections and other forward-looking statements included in this filing have been prepared based on assumptions, which we believe to be reasonable, but not in accordance with GAAP or any guidelines of the SEC. Actual results may vary, perhaps materially. All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Except as required by federal securities laws, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Any such forward-looking statements, whether made in this Annual Report on Form 10-K or elsewhere, should be considered in the context of the various disclosures made by us about our businesses including, without limitation, the risk factors discussed above. For further discussion of these and other factors that could impact our future results, performance or transactions, please carefully read “Risk Factors.”


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ITEM 1.     BUSINESS
As used in this Annual Report on Form 10-K, references to “Fenix” refer to Fenix Parts, Inc. solely, and references to the “Company,” “our”, “we”, “us” and similar terms refer to Fenix Parts, Inc., together with our Subsidiaries, as defined below.
OVERVIEW

We are in the business of auto recycling, which is the recovery and resale of original equipment manufacturer (“OEM”) parts, components and systems, (referred to as “products”) such as engines, transmissions, radiators, trunks, lamps and seats reclaimed from damaged, totaled or low value vehicles. We purchase our vehicles primarily at auto salvage auctions. Upon receipt of vehicles, we inventory and then dismantle the vehicles and sell the recycled components. Our customers include collision repair shops (body 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, the sale of aftermarket parts, and from the sale of extended warranty contracts.

We provide customers with high quality recycled OEM products, extensive inventory and product availability, responsive customer service and fast delivery. We operate a hub and spoke distribution network allowing us to efficiently move products among our locations and expedite delivery to our customers. We distribute a variety of products to collision and mechanical repair shops, including recycled OEM products, as well as aftermarket, refurbished and remanufactured parts. Collectively, we refer to these products as alternative parts because they are not new OEM products.

History
Fenix was founded on January 2, 2014 to acquire and combine companies in the automobile recycling and resale industry. Fenix Parts Canada, Inc. (“Fenix Canada”), a wholly-owned subsidiary of Fenix, was established on September 24, 2014 primarily to facilitate the acquisition and combination of companies in the automobile recycling and resale industry in Canada. Through November 2014, Fenix and Fenix Canada entered into Combination Agreements to acquire (in transactions referred to as the “Combinations”) eleven corporate entities that operate eight businesses (the “Founding Companies”), contingent upon, among other things, the closing of an initial public offering (“IPO”). On May 19, 2015, Fenix completed the IPO and closed on the Combinations with the Founding Companies, including those Founding Companies that are designated as accounting co-predecessors, Don’s Automotive Mall, Inc., Gary’s U-Pull It, Inc., and Horseheads Automotive Recycling, Inc. (collectively, the “Beagell Group”); and Standard Auto Wreckers Inc., End of Life Vehicles Inc., Goldy Metals Incorporated, and Goldy Metals (Ottawa) Incorporated (collectively, “Standard”). The aggregate consideration paid by Fenix in the Combinations (the "Combination Consideration") is detailed in Note 3, Business Combinations, to the consolidated financial statements in this document. Fenix raised the cash portion of the Combination Consideration in its IPO as well as from additional funding from indebtedness. The operations of the Founding Companies are reflected in the consolidated statements of operations from the date of acquisition on May 19, 2015 to December 31, 2015. During the third quarter and fourth quarter of 2015, Fenix acquired three additional automobile recycling companies ("Subsequent Acquisitions"). Our Founding Companies and Subsequent Acquisitions represent our operating subsidiaries ("Subsidiaries"). These are also reflected in the consolidated statements of operations from their respective dates of acquisition to December 31, 2015.

Products
The recycled OEM products that we sell include mechanical parts used to repair or replace worn or damaged components, such as engines and transmissions, and collision repair parts used to repair vehicles typically involved in a collision, such as door assemblies, trunk lids, lights, fenders and other products. These products are “insurance quality,” which means of a quality that is acceptable for use in a repair paid for by an insurance company. Many consumers and repair facilities use recycled OEM products because they are less expensive than new OEM products and are perceived to be of higher quality and fit than products made by non-OEM manufacturers, known as aftermarket products. Recycled OEM products often are sold as assemblies, which shorten repair times and help reduce labor costs. In addition, insurance companies are increasingly influencing repair facilities to use recycled OEM products as a lower cost alternative to new OEM products.
Typically, damaged, totaled or low value vehicles acquired by insurance companies are resold through auto salvage auctions. Some insurance companies mandate that recycled OEM products be no older than the vehicle they are used to repair; thus, the majority of the vehicles we acquire are not more than ten years old. We employ software-based inventory management systems to determine what vehicles to purchase and at what price, based upon our estimation of the demand for the products on the vehicle, the prices we can obtain for those products and the final scrap value of the vehicle.


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Customers
Our customers include collision and mechanical repair shops, auto dealerships and individual retail customers. Competition for sales is based primarily on product availability, delivery times and price. Our ability to deliver insurance quality recycled OEM products on a same or next day basis is a critical service requirement of our customers. Customers can find and purchase our parts in many ways including searching our websites, by telephone (speaking with one of our sales professionals) or in-person at one of our fulfillment centers. We apply a coordinated regional approach to our inventory management and distribution activities, which allows us to increase the availability of our products and efficiently meet demand within the markets we serve. In 2015, we sold products to more than 12,000 customers. For the year ended December 31, 2015, there were no significant customers that accounted for more than 10% of total revenues.

Industry
The Auto Care Association (“ACA”) estimates that the U.S. automotive aftermarket was approximately $255 billion in 2015. We operate in the U.S. collision and mechanical repair products market, a subset of the U.S. automotive aftermarket. According to ACA, the U.S. collision and mechanical repair products market was approximately $63 billion in 2015.

The automotive recycling industry is highly fragmented, with few multi-facility operators. According to the Automotive Recyclers Association (“ARA”), there are an estimated 9,000 vehicle recycling facilities in the United States and Canada. We believe that there is only one direct competitor with more than 1% market share within the automotive recycling industry. We believe this competitor has less than 10% market share.

The automotive recycling industry obtains its insurance quality recycled OEM products from damaged, totaled or low value vehicles purchased at salvage auctions. In 2015, there were over 300 salvage auctions in the U.S. and Canada at which over 2.5 million damaged, totaled or low value vehicles were sold on behalf of automobile insurance companies and other sellers to licensed buyers, such as the Company.

The industry’s direct customers are collision and mechanical repair shops that use recycled OEM products in vehicle repairs. The industry also indirectly serves insurance companies as they pay for the majority of repairs to insured vehicles and thus have significant influence over the repair process. As insurance companies seek more cost effective repair solutions, collision repair shops are utilizing more recycled OEM products due to their attractive value proposition. Presently, many major U.S. insurance companies are encouraging collision repair shops to reduce costs, thus influencing them to utilize recycled OEM products in the repair of damaged vehicles.

In addition, automotive recycling is considered environmentally responsible, as more than 85% by weight of the materials from processed vehicles are typically reclaimed or recycled. We also believe that many environmentally conscious consumers will prefer a recycled product and over time government regulation will continue to favor environmentally friendly solutions.

Competition
Buyers of vehicle replacement products have the option to purchase from primarily five sources: new products produced by OEM's; new products produced by companies other than the OEMs, which are commonly referred to as aftermarket products; recycled OEM products produced by automobile recyclers obtained from salvage vehicles; used automotive products that have been refurbished; and used automotive products that have been remanufactured. We view all suppliers of vehicle replacement products as our competitors. While we compete with all parts suppliers, there are few automobile recyclers with regional distribution networks like Fenix’s that can reach the majority of customers within the optimum delivery time. We have begun to distinguish ourselves from other suppliers primarily through our broad recycled OEM product selection, which encompasses popular and hard-to-find items or products, our distribution network, and stock management systems, as well as through our service. We compete on the basis of product breadth and depth, rapid and dependable delivery, marketing initiatives, support services, and price.

COMPETITIVE STRENGTHS

Favorable Industry Dynamics
We believe that demand for recycled OEM products is highly stable and marked by consistent long-term growth due to a number of favorable trends, including the number of vehicles on the road (commonly referred to as the “car parc”), the increasing miles driven and the number and age of drivers. Additionally, we believe the utilization of recycled OEM products over the last decade has continued to increase given the inherent favorable pricing and product availability of recycled OEM products relative to other replacement products.


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Competitive Market Position
We believe that we operate the second largest network of automotive recycling companies in the eastern region of North America (U.S. and Canada) with twelve full-service and four self-service recycling locations, two of which are co-located at existing full-service facilities. We believe the strength of our regional network, our customer relationships and our extensive inventory of insurance quality recycled OEM automotive products give us a competitive advantage and create high barriers to entry.

Extensive Inventory and Distribution Platform with Broad Customer Reach
Our extensive inventory of insurance quality recycled OEM automotive products and our distribution infrastructure give us the ability to help our customers reduce repair cycle time by delivering our products typically the same or next day. In order to increase the availability of our products, we maintain an extensive inventory and have developed a coordinated regional approach to inventory management and distribution. Our network enables us to reach three of the ten largest cities in North America by population. This customer base exceeds 12,000 customers with no one customer accounting for more than 3% of our consolidated revenue in 2015.

Dynamic Vehicle Procurement Process
A critical component of our success and growth is our ability to identify and value the products that can be recycled from a salvage vehicle. We have developed a scalable, data-driven approach, utilizing real-time sales and inventory information, which allows us to procure vehicles in a cost-efficient manner, optimize the dismantling process and profitably sell these products to our customers.

Deep Industry Expertise
We benefit from the industry expertise and deep customer relationships that have been established at the Subsidiaries over the course of their history as standalone businesses. Our key management personnel at most of the Subsidiaries have served an average of 20 years in the automotive recycling industry and many have held senior leadership positions in key industry trade groups, such as the ARA.

Experienced Management Team
Our senior management has significant experience operating and growing automotive and logistics-based businesses. Prior to joining Fenix, our Chief Executive Officer, Kent Robertson, held several senior leadership positions at Stericycle, Inc. (“Stericycle”), a national reverse logistics and regulated waste management company. Mr. Robertson had more than 20 years of experience managing multi-line decentralized distribution and services businesses at Stericycle and at American Medical Disposal, Inc., a company he co-founded in 1990, which was acquired by Stericycle in 2001. Under Mr. Robertson’s leadership, Stericycle successfully acquired and integrated over 70 acquisitions. Our Chief Financial Officer, Scott Pettit, has significant automotive industry, public company, acquisition and integration experience, including serving from 2001 to 2007 as the Chief Financial Officer of Insurance Auto Auctions, Inc. Our Executive Vice President, David Gold, was the President and is the former co-owner of Standard Auto Wreckers, Inc., one of our Subsidiaries. A third-generation automobile recycler, Mr. Gold has over 20 years’ experience in our industry and is the President-elect of the ARA. Our Chief Operating Officer, Art Golden, has nearly 30 years' experience in various leadership roles, including; logistics, planning, warehousing, and field operations. Prior to joining Fenix, Mr. Golden served for 22 years at Stericycle most recently as Area Director of Operations, where he was responsible for overseeing operations in the northeastern region of the U.S. Our Executive Vice President, Supply Chain, John Blaseos, has over 16 years' experience in continuous improvement and supply chain. Most recently with Stericycle, Mr. Blaseos will lead vehicle purchasing, transportation and logistics, pricing and process improvement.

Attractive Financial Model
We believe our highly variable cost structure, low requirements for capital expenditures (in 2015, our maintenance capital expenditures were less than 1% of revenues) and the stability of the collision and mechanical repair products market combine to give our business the potential to deliver strong results through a variety of business cycles. We believe that these factors will allow us to produce significant free cash flow and enable us to continue to fund our growth.

Organizational Structure
We operate on a decentralized basis with an emphasis on regional and local market execution supported by corporate coordination. Local management teams operate the businesses and leverage their relationships with customers and suppliers. At the same time, certain administrative functions are centralized on a regional and, in certain circumstances, a national basis, including but not limited to corporate strategy and acquisitions, accounting and related functions, marketing, human resources, information technology and systems support and environmental compliance.


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STRATEGY

We believe that execution of our business strategies will allow us to grow our business and enhance shareholder value:

Enhance and Build our Network through Acquisitions
The acquisition of other OEM automotive products recycling businesses is a key element of our strategy. This will increase our customer base, grow our distribution network and expand our inventory and warehouse capacity. There are currently an estimated 9,000 facilities in the automotive recycling industry, and we believe an ample number of attractive acquisition candidates. Since our initial public offering and the acquisition of the Founding Companies, we have acquired three businesses operating in geographic areas that fit within our strategic growth plan. We use a disciplined approach to identify and evaluate acquisition candidates and intend to pursue acquisitions to increase customer and route density within our network and expand into new geographic markets.

Organically Grow Market Share and Unit Volume
We have identified initiatives to increase vehicle processing throughput, inventory and product availability, thereby growing revenue, volume and market share. These initiatives include:

Expand Dismantling Capacity. We operate 67 dismantling bays within our full-service auto recycling facilities. We plan to add dismantling bays within our current facility structure to support inventory demand with minimal capital expense or regulatory involvement. We can also add shifts to increase dismantling utilization. We believe these initiatives will help us increase dismantling capacity and productivity, thereby increasing inventory and product availability.

Develop an Integrated Technology Platform. We currently utilize third-party software solutions to support our business. We believe this software is sufficient for our current needs, but we are working to implement an integrated technology platform to support our future growth. We believe that any associated cost would be offset through improvements in salvage vehicle procurement, production management, part pricing, inventory management, marketing, sales, logistics and compliance.

Enhance Sales Force Effectiveness. We maintain our sales specialists in their local markets to preserve high levels of service and existing customer relationships. We continue to provide our sales force with enhanced training and additional resources to reach new markets and customers.

Expand our Logistics Capacity. We continue to expand our logistics capacity to meet the delivery expectations of our customers (typically the same or next day). We may invest in additional infrastructure, including trucks, employees or transfer hubs, to expand in existing markets and into adjacent markets.

Increase our Margins and Enhance Operating Efficiencies
We have identified certain best practices among our Subsidiaries that improve salvage vehicle procurement and dismantling, enhance product delivery and maximize the value of end-of-life vehicles. We have begun to implement these best practices across our network to improve our operating margins and those of any subsequently acquired businesses. Further, we believe an integrated operating platform within geographic areas creates opportunities for economies of scale as we grow.

INTELLECTUAL PROPERTY

We own various trade names as a result of the acquisitions of the Subsidiaries. We do not believe that our business is materially dependent on any single or group of related trade names.

EMPLOYEES

As of December 31, 2015, the Company had approximately 651 employees at our recycled parts facilities and approximately 14 employees at our corporate headquarters. We enjoy good relations with our employees and are not party to any labor management agreement.

RELATED PARTIES
Please refer to Note 10, Related Party Transactions, to the consolidated financial statements in this document for information about our related parties and corresponding transactions with them. Additionally, see the more detailed information relating to this subject under the caption “Certain Relationships and Related Transactions” in our definitive Proxy Statement to be distributed in connection with our 2016 Annual Meeting of Shareholders.

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FACILITIES
We lease an office building in Westchester, Illinois, which serves as our corporate headquarters. This facility will meet our growth requirements for the foreseeable future.     
We have twelve full-service recycling facilities, concentrated in the Northeastern and Southeastern United States and Southeastern Canada. These locations include Bayville, NJ, Binghamton, NY, Forest City, NC, Greensboro, NC, Niagara Falls, NY, Pennsburg, PA, Rahway, NJ, Ottawa, Ontario, Port Hope, Ontario, Queensbury, NY, Watertown, NY, and Jacksonville, FL. Our full-service recycling facilities have a total of 67 bays for dismantling of vehicles and approximately 567,000 square feet of indoor warehouse space and approximately 235 acres of total storage. Our facilities employ state-of-the art environmental systems for removing fluids prior to dismantling. We have four self-service locations, two of which are co-located with full-service facilities. Our self-service locations are in Binghamton, NY, Elmira, NY, Ottawa, Ontario and Scarborough, Ontario. At these locations, we allow retail customers to directly dismantle, recover and purchase recycled OEM products. Our self-service recycling facilities have approximately 62,000 square feet of indoor storage space and are situated on approximately 46 acres.


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ITEM 1A.     RISK FACTORS
Risks Relating to Our Business

We have limited combined operating history, and there are risks associated with the acquisition of our Subsidiaries that could adversely affect the results of our operations.

We were founded in January 2014, and we combined with each of our Founding Companies simultaneously with, and as a condition to, the sale of the shares in our initial public offering in May 2015. Since that time, we have acquired three additional subsidiaries. While we have operated as a combined business with the Subsidiaries since each of their acquisitions, there can be no assurance that we will be able to fully integrate the operations of our Subsidiaries successfully or to institute the necessary systems and procedures, including accounting and financial reporting systems, to manage the combined enterprise on a profitable basis and to report the results of operations of the combined entities on a timely basis. In addition, there can be no assurance that our management team will be able to successfully manage the combined entity and effectively implement our operating or growth strategies. Our success will depend on management’s ability to integrate our current Subsidiaries and any companies we may acquire in the future into one organization. Our inability to successfully integrate the companies we acquire and to coordinate and integrate certain operational, administrative, financial and information technology systems would have a material adverse effect on our financial condition and results of operations.

If our efforts to locate and attract desirable companies in the business of providing recycled OEM automotive products are not successful or if we are unable to acquire desirable companies on commercially reasonable terms, our growth prospects will be adversely affected.

One of our principal growth strategies is to increase our revenue through the acquisition of additional businesses within our industry. We face competition in our pursuit to acquire additional businesses, which limits the number of available companies for sale and may lead to higher acquisition prices. When we identify desirable companies, their owners may not be willing to sell their companies at all or on terms that we have determined to be commercially reasonable. If our efforts to locate and acquire desirable companies are not successful, our growth prospects will be adversely affected.

Our ability to acquire additional businesses may require financing that we are unable to obtain or to obtain on acceptable terms.

The timing, size and success of our acquisition efforts and the associated capital commitments cannot be readily predicted. We have used and intend to continue to use our cash and common stock as consideration for future acquisitions of companies. If our common stock does not maintain a sufficient market value or potential acquisition candidates are unwilling to accept common stock as part of the consideration for the sale of their businesses, we may be required to utilize more of our cash resources, including obtaining additional capital through our existing line of credit or through alternative financing. However, there can be no assurance that our line of credit will have available or adequate capacity to support our acquisition strategy or we will be able to obtain financing if and when it is needed or that it will be available on terms that we deem acceptable. Under our credit facility, permitted acquisitions are subject to bank review and our meeting certain financial ratios, after giving effect to such acquisition. We believe that our cash and cash equivalents, cash provided by operating activities and funds available from bank borrowings are not likely to be sufficient for future acquisitions, and that we may need to raise additional funds through public or private financing, or other arrangements. There can be no assurance that additional funding, or refinancing of our credit facility, if needed, will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may be costly and involve further restrictive covenants. Failure to raise capital if and when needed could have a material adverse impact on our acquisition strategy and on our business, operating results, and financial condition.

We may not be able to successfully integrate future acquisitions or generate sufficient revenues from future acquisitions, which could cause our business to suffer.

Assuming that we are able to finance the acquisition of a company or a division of a company, there can be no assurance that we will be able to profitably manage such business or successfully integrate such business without substantial costs, delays or other operational or financial problems. There can be no assurance that the businesses we may acquire in the future will achieve anticipated revenues and earnings. Additionally:

the key personnel of an acquired business may decide not to work for us;
 
changes in management at an acquired business may impair its relationships with employees and customers;
  
we may be unable to maintain uniform standards, controls, procedures and policies among acquired businesses;
 

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we may be held liable for environmental risks and liabilities as a result of our acquisitions, some of which we may not have discovered during our due diligence;
 
our ongoing business may be disrupted or receive insufficient management attention; and
 
we may not be able to realize the cost savings or other financial benefits we anticipated.
 
Some or all of these factors could have a material adverse effect on our business, financial condition and results of operations.

If we are not able to manage our internal growth, the results of our operations will be adversely affected.

We will attempt to grow our revenues through internal growth as well as through acquisitions. There can be no assurance that our systems, procedures and controls will be adequate to support our operations as they expand. Any future growth will also impose significant additional responsibilities on members of experienced management. Furthermore, as we grow, our ability to increase productivity and profitability will be limited by our ability to employ, train and retain skilled personnel to handle critical tasks within our operations and provide services to our customers and partners. There can be no assurance that we will be able to maintain an adequate skilled labor force necessary to operate efficiently or that our labor expenses will not increase as a result of a shortage in the supply of skilled personnel. To the extent that we are unable to manage our growth efficiently and effectively, or are unable to attract and retain skilled personnel, our financial condition and results of operations will be materially adversely affected.

If the number of vehicles involved in accidents declines or the number of cars being repaired declines, our business could suffer.

Our business depends on vehicle accidents and mechanical failures for both the demand for repairs using our products and the supply of recycled, remanufactured and refurbished parts. The number and/or severity of accidents and mechanical failures is influenced by factors including, but not limited to, the number of vehicles on the road, the number of miles driven, the ages of drivers, the occurrence and severity of certain weather conditions, the congestion of traffic, the use of cellular telephones and other electronic equipment by drivers, the use of alcohol and drugs by drivers, the effectiveness and extent of adoption of accident avoidance systems in newer vehicles, the reliability of new OEM parts, and the condition of roadways. Increases in fuel prices may cause the number of vehicles on the road, the number of miles driven, and the need for mechanical repairs and maintenance to decline, as motorists seek alternative transportation options. Mild weather conditions, particularly during winter months, tend to result in a decrease in vehicle accidents. Additionally, a number of states and municipalities have adopted, or are considering adopting, legislation banning the use of handheld cellular telephones or other electronic devices while driving, and such restrictions could lead to a decline in accidents.

Systems designed to help drivers avoid accidents, including but not limited to impact warning or avoidance systems, lane and vehicle recognition systems and driverless vehicle guidance systems are becoming more prevalent and more technologically sophisticated. To the extent manufacturers install or are mandated by law to install accident avoidance systems in their vehicles, the number and severity of accidents could decrease, which could have a material adverse effect on our business.

We depend upon the services of our management team.

Our success depends, in part, upon the continuing contributions of our executive officers and key employees at the management level. This includes, in part, continuing efforts from many of the executives and managers of the current Subsidiaries, whose reputations and client relationships have contributed significantly to the success of those companies. Although we have employment and noncompetition agreements with certain of our key executive officers and managers, there is no guarantee that they will not leave. The loss of the services of any of our executive officers or managers, or our failure to attract other executive officers or managers could have a material adverse effect on our business or our business prospects. If we lose the services of any of our key employees at the operating or regional level, we may not be able to replace them with similarly qualified personnel, which could harm our business.

We face intense competition from local, regional, national and internet-based automotive products providers, and this competition could negatively affect our business.

The recycled vehicle replacement parts and automotive recycling industries are highly competitive and are served by local owner-operated companies, several large regional companies and internet-based parts providers. Additionally, in certain regions of the country where we operate, local automotive recycling companies have formed cooperative inventory sharing programs. We currently participate in certain of these programs, but may elect not to in the future, and as a public company, we may not qualify to participate in certain of them. One such cooperative disqualified us from participation because our Subsidiaries were no longer independently owned. We could also face additional competition in the future from others entering the market, such as OEMs,

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insurance companies, new parts producers other than OEMs, sometimes referred to as “aftermarket” suppliers, and industry consolidators. Some of our current and potential competitors may have more operational expertise and greater financial, technical, manufacturing, distribution and other resources, longer operating histories, lower cost structures and better key relationships in the insurance and automotive industries. As a result, they may be able to provide products that we are unable to supply, sell their products at lower costs or serve customers we are unable to serve.

If we fail to maintain or adequately replace our relationships with auto body shops, insurers and other customers, through which we make a significant portion of our revenue, our revenue will be adversely affected.

The majority of our products and services are sold to collision repair shops, also known as body shops, and mechanical repair shops. Additionally, we indirectly rely on insurance companies to help drive demand, as insurance companies are increasingly influencing repair facilities to use recycled OEM products as a lower cost alternative to new OEM products. We also generate a portion of our revenue from scrap sales to metal recyclers. If we are not able to continue our current or similar arrangements with these body shops, mechanical repair shops, insurers and scrap metal recyclers, the volume of our sales, revenue and profitability will be materially adversely affected.

An adverse change in our relationships with auction companies could increase our expenses and hurt our relationships with our customers.

Our inventory primarily consists of vehicles offered at salvage auctions operated by companies that own auction facilities in numerous locations across the U.S. We do not typically have contracts with these auction companies. A small number of companies control a large percentage of the salvage auction market in the U.S. and Canada. We acquire substantially all of our salvage autos from two of these auction companies. If either of these companies prohibited us from participating in its auctions, began competing with us, or significantly raised its fees, our business could be adversely affected through higher costs or the resulting potential inability to service our customers. Moreover, we face competition in the purchase of vehicles from direct competitors, rebuilders, exporters and others.

We are subject to environmental regulations and incur costs relating to environmental matters.

Our operations, both in the U.S. and Canada, are subject to national, state, provincial and local environmental, health and safety laws and regulations governing, among other things:
 
the emission and discharge of wastes, chemicals, contaminants and other hazardous materials into the ground, air, or water;
 
the exposure to hazardous materials; and
 
the generation, handling, storage, use, treatment, identification, reporting, record-keeping, transportation and disposal of industrial by-products, waste water, storm water, solid and hazardous wastes, petroleum products and hazardous materials.

We are in the process of implementing environmental management systems that are designed to facilitate and support our compliance with these requirements and to address current outstanding environmental and operating permit issues. However, if we violate or fail to comply with these laws or regulations we could be fined or otherwise sanctioned by regulators.

Contamination resulting from vehicle recycling processes can include air, soil, surface water and ground water contamination from the release, storage, transportation, or disposal of motor oil, gasoline, or other petroleum products, antifreeze, transmission fluid, waste solvents, chlorofluorocarbons from air conditioners, other hazardous materials, or metals such as aluminum, cadmium, chromium, lead and mercury. Contamination can migrate on-site or off-site which can increase the risk and the amount of any potential liability.

In connection with the acquisition of our current Subsidiaries and other future acquisitions, we may assume the liabilities of the companies we acquire. Contamination at properties owned or operated by the Subsidiaries or companies we acquire in the future may result in liability for us under environmental laws and regulations for the full amount of assessment and remediation-related costs, including those for the investigation and cleanup of contaminated soil, surface water and ground water, building contamination, and impacts to human health, and damages to natural resources. Under certain environmental laws, including but not limited to the Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, we and our directors and officers could be held responsible for all of the costs relating to any contamination at, or migrating to or from, the Subsidiaries’ or any newly acquired company’s past or present facilities and at third-party waste disposal sites. These laws often impose liability even if the owner or operator did not know of, or was not responsible for causing, any such contamination. The costs of complying

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with environmental laws and regulations and any claims concerning noncompliance or liability with respect to contamination in the future could have a material adverse effect on our financial condition or operating results.

Environmental laws are complex, change frequently and have tended to become more stringent over time. Significant capital and operating costs may be incurred at any time to keep our operations in compliance with environmental, health and safety laws and regulations. If it is not economical to make those expenditures, or if we violate any of these laws and regulations, it may be necessary to restrict or modify our operations, which could have a material adverse effect on our business, financial condition and results of operations.

One of our Subsidiaries is the subject of environmental claims.

Groundwater and surface water contamination has been detected at the facility in Toronto, Ontario that we acquired as lessee when we acquired the assets of Goldy Metals Incorporated ("GMI"), as a result of historical releases and a petroleum hydrocarbon spill in November 2010. Since November 2010, the Ontario Ministry of the Environment issued a series of regulatory orders under Ontario’s Environmental Protection Act that required the owner of GMI to investigate and remediate all areas that were contaminated by the spill and to take protective and remedial actions related to its property and operations as well as adjacent areas. We believe GMI has been and is taking necessary steps to remediate the surface water and groundwater contamination. Furthermore, we did not assume this liability and GMI, its shareholder and certain affiliates have agreed to indemnify us for a period of three years from the date of Combination against any liability that may be imposed on us as a result of this contamination. However, as the successor to GMI’s business and lessee of the facility, we may become legally responsible for this liability, and we and our directors and officers may be responsible under national and provincial laws and regulations for the assessment, delineation, control, clean-up, remediation, monitoring and verification of, or as a result of, any environmental contamination at that site and any affected off-site areas. The owner of GMI and certain of its affiliates have agreed, pursuant to the Combination Agreements, to continue to be responsible for the costs of an additional storm water management, control and discharge system following the completion of the Combinations. However, there can be no assurance that the owner of GMI or its affiliates will perform their obligations under such agreements and their failure to perform would require us to undertake these environmental obligations. 

The site and operations in Toronto have been operating since the 1960s. During the last decade, the surrounding parkland and agricultural area, as well as the site itself, have been designated part of a new federal urban park. Accordingly, there has been continual governmental, quasi-governmental, and non-governmental body environmental oversight and intervention, including various enforcement initiatives. We anticipate that this will continue.

The Province of Ontario has filed a civil lawsuit against GMI and the owner of the land on which the Toronto, Ontario facility is located claiming damages of Canadian Dollars ("CAD") $10.5 million plus pre- and post-judgment interest and court costs, for alleged historical and spill-related contamination as well as for alleged property encroachment damage. The lawsuit is currently in the pre-discovery stage. We did not assume this liability, and GMI, its owner and certain affiliates have agreed to indemnify us, subject to certain limits as defined in the Combination agreements, for a period of three years from the date of Combination against any liability that may be imposed on us as a result of this liability. However, we may become legally responsible for this liability as the successor to GMI’s business and lessee of the facility. We cannot assure you that we will not become responsible for this liability, or that GMI and its owner or their affiliates will have the capacity to indemnify us in the event we become responsible for this liability in whole or in part. Our responsibility for this liability in whole or in significant part could have a material adverse effect on our results of operations and financial position.

Prior to the Combinations, GMI was also charged by the Province of Ontario for causing or permitting an oil spill in Toronto which allegedly impaired a nearby creek. This matter was settled through a guilty plea on consent, with GMI paying a penalty of CAD $94,000. A future charge and conviction under the same or other environmental statute in Ontario could result in the imposition of a minimum fine of CAD $100,000 per day plus a 25% surcharge, up to a maximum of CAD $10 million. We did not assume this liability, and GMI, its owner and certain affiliates have agreed to indemnify us for a period of three years from the date of Combination against any liability that may be imposed on us as a result of this liability. However, we may become legally responsible for this liability as the successor to GMI’s business and lessee of the facility. We cannot assure you that we will not become responsible for this liability, or that GMI, and its shareholder or their affiliates will have the capacity to indemnify us in the event we become responsible for this liability in whole or in part. Our responsibility for this liability in whole or in significant part could have a material adverse effect on our results of operations and financial position.

GMI is also the subject of further regulatory orders relating to sedimentation monitoring and control in the creek, rehabilitating the creek area that was diverted in 2011 as well as assessing, preventing, treating and controlling off-site groundwater and surface water discharges. To address these orders, GMI intends to implement a new surface water control, management and discharge system.


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Governmental agencies may refuse to grant or renew our operating licenses and environmental and other permits.

Our current Subsidiaries and future subsidiaries must receive certain licenses and permits from state and local governments to conduct their operations, including but not limited to permits required by environmental laws. We may face unexpected delays in obtaining the necessary permits and approvals required by environmental and other laws in connection with our facilities. If we violate or fail to obtain or comply with any permits required by environmental or other laws, we could be fined or otherwise sanctioned by regulators. Furthermore, when we develop or acquire a new facility, we must seek the approval of state and local units of government and satisfy applicable siting laws and regulations. Governmental agencies often resist the establishment of an automotive recycling facility in their communities. There can be no assurance that future approvals or transfers will be granted. In addition, there can be no assurance that we will be able to maintain and renew the licenses and permits we and our Subsidiaries currently hold.

We have a large amount of goodwill as a result of the acquisition of our Subsidiaries, and if such goodwill becomes impaired, our earnings would be adversely affected.

As of December 31, 2015, we had recorded goodwill of $76.8 million. Goodwill represents the excess of the amount we pay for our acquisitions over the fair value of the acquired net assets. We have substantial goodwill related to our acquisitions of our Subsidiaries. As we implement our business acquisition strategy, we will be required to account for similar premiums paid on future acquisitions in the same manner. We do not amortize acquired goodwill but instead we test it for impairment on an annual basis in the fourth quarter and between annual tests if events and circumstances indicate that it is more likely than not that the fair value of our one reporting unit is less than its carrying value. The goodwill impairment test is based upon a fair value approach comparing fair value of our reporting unit to its carrying value, which as of our annual measurement date of October 1, 2015 was an 8.5% margin; we, accordingly, concluded that we did not incur any impairment. Further, there were no events or indicators of goodwill impairment as of year-end that would call into question the analysis as of October 1, 2015.

Testing for impairment of goodwill involves an estimation of the fair value of our net assets and involves a high degree of judgment and subjectivity. There are numerous risks that may cause the fair value of a reporting unit to fall below its carrying amount, which could lead to the measurement and recognition of goodwill impairment. These risks include, but are not limited to, adverse changes in the business climate, a sustained decline in our market capitalization, significant negative variances between actual and expected results, and lowered expectations of future financial results. Significant judgments inherent in these analyses include assumptions about appropriate sales growth rates, weighted average cost of capital (“WACC”) and the amount of expected future net cash flows. The judgments and assumptions used in the estimate of fair value are generally consistent with the projections and assumptions that are used in current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions. The determination of fair value is highly sensitive to differences between estimated and actual cash flows and changes in the related discount rate used to evaluate the fair value of the reporting unit where the goodwill resides. Based on the discounted cash flow valuation at October 1, 2015, a 1% increase in the WACC, terminal growth rate decrease by 0.5%, shortfall against budgeted revenue and gross profit in excess of 2% or changes in other significant variables in the future could potentially result in impairment. If we have any significant impairment to our goodwill, it would have a material adverse effect on our reported financial results for the period in which the charge is taken. Further, the factors leading to the impairment could result in a decrease in the market price of our common stock. For further information regarding the impairment testing done in 2015, see Note 12, Goodwill, to the consolidated financial statements in this document.

Our annual and quarterly performance may fluctuate.

Our revenue, cost of salvage vehicles and operating results have fluctuated on a quarterly and annual basis in the past and on a consolidated basis have fluctuated and can be expected to continue to fluctuate in the future as a result of a number of factors, some of which are beyond our control. Future factors that may affect our operating results include, but are not limited to, the following:
 
fluctuations in the market value of salvage and used vehicles;
 
the availability of salvage vehicles at an attractive price;
 
variations in vehicle accident rates;
 
changes in state or federal laws or regulations affecting our business;
 
our ability to successfully integrate in a timely manner and manage our acquisitions;
 
severity of weather and seasonality of weather patterns;
 

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the amount and timing of operating costs and capital expenditures relating to the maintenance and expansion of our business, operations and infrastructure; and
 
declines in asset values, including but not limited to Goodwill impairment.
 
declines in scrap metal prices
 
declines in the value of the Canadian Dollar relative to the US dollar.

Due to the foregoing factors, our operating results in one or more future periods can be expected to fluctuate and period-to-period comparisons of our results of operations should not be relied upon as indications of future performance. These fluctuations in our operating results may cause our results to fall below the expectations of public market analysts and investors, which could cause our stock price to decline.

Fluctuations in the prices of metals could adversely affect our financial results.

Our operations generate scrap metal. After we dismantle a salvage vehicle for parts and after vehicles have been used in our self-service business, any remaining metal is sold to processors and brokers of metal and the remaining vehicle hulks are sold to scrap processors. In addition, we receive vehicles from various sources, which we sell at scrap metal market rates calculated on a per-ton basis. The price of scrap metal has historically fluctuated, sometimes significantly, due to market factors. In addition, buyers may stop purchasing metal entirely due to excess supply. To the extent that the price of metal decreases materially, our revenue from such sales will be adversely impacted and a write-down of our inventory value could be required. Despite our recent experience with declining purchase prices on vehicles as a result of reduced commodity prices, there can be no assurance that our vehicle purchasing costs will continue to decrease by a corresponding amount or at the same rate as the scrap metal prices decline, and there may be a delay between the scrap metal price reductions and any vehicle purchasing cost reductions.

We operate in Canada, which exposes us to foreign exchange and other risks.

We have operations in Canada. Our Canadian operations expose us to additional risks associated with international business, which has had an adverse effect on our business, results of operations, and financial condition. We collect revenues and incur costs at our Canadian operations in Canadian dollars. The significant decline in the value of the Canadian dollar against the U.S. dollar from 2014 to 2015 has had an adverse effect on our reported results of operations and financial condition in 2015, and could have a similar effect in the future. In addition to foreign exchange exposure, we are subject to foreign tax, foreign employment laws and regulations and other foreign and domestic laws.

If we experience problems with our fleet of trucks, our business could be harmed.

We operate a fleet of trucks throughout our network to deliver products to our customers and transfer hubs. We are subject to the risks associated with providing trucking services, including inclement weather, disruptions in the transportation infrastructure, availability and price of fuel, and liabilities arising from accidents to the extent we are not covered by insurance. In addition, our failure to deliver parts in a timely and accurate manner could harm our customer relationships and reputation, which could have a material adverse effect on our business.

We rely on information technology in critical areas of our operations, and a disruption relating to such technology could harm our business.

We rely on information technology for significant aspects of our business, including our financial reporting, accounting, accounts payable, payroll, procurement, inventory control, customer selling and billing, sales analysis, vehicle tracking and profitability reporting, as well as an electronic exchange system for identifying and locating parts at other selected recyclers and facilitating brokered sales to fill customer orders for items not in stock. Any disruption relating to our information systems and hardware could seriously harm our operations.

We may not be able to sell our products due to existing or new laws prohibiting or restricting the sale of recycled automotive products.

Some jurisdictions have enacted laws prohibiting or severely restricting the sale of certain recycled automotive products that we provide, such as airbags. Additional jurisdictions could enact similar laws or could prohibit additional automotive products we sell. Restrictions on the products we are able to sell could decrease our revenue and have an adverse effect on our business and operations.


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Risks Relating to Our Common Stock and Financial Structure

Future sales of our common stock or other securities may depress our stock price.

We and our stockholders may sell shares of common stock or other equity, debt or instruments which constitute an element of our debt and equity (collectively, “securities”) in the future. We may also issue shares of common stock under our stock plan or in connection with future acquisitions. We cannot predict the size of future issuances of securities or the effect, if any, that future issuances and sales of shares of our common stock or other securities will have on the price of our common stock. Sales of substantial amounts of common stock (including shares issued in connection with an acquisition), the issuance of debt securities, or the perception that such sales or issuances could occur, may cause the price of our common stock to fall.

Our stock price could be volatile and could expose us to securities class action litigation.

The price of our common stock could be extremely volatile and may fluctuate substantially due to the following factors, some of which are beyond our control:

variations in our operating results;
variations between our actual operating results and the expectations of securities analysts, investors and the financial community;
announcements of developments affecting our business or expansion plans by us or others; and
conditions and trends in the auto parts industry and the economy as a whole.

In addition, stock market volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies.  Downturns in the stock market may cause the price of our common stock to decline.  Additionally, the market price for our common stock has been in the past, and in the future may be, adversely affected by allegations made or reports issued by short sellers, analysts or others regarding our business model, our management or our financial accounting.

In the past, securities class action litigation often has been instituted against companies following periods of volatility in the market price of their securities. This type of litigation, if directed at us, could result in substantial costs and a diversion of management’s attention and resources.

We have a substantial amount of indebtedness, which could have a material adverse effect on our financial condition and our ability to obtain financing in the future and to execute our business strategy.

As of December 31, 2015, we had approximately $20.8 million of debt outstanding under our senior secured credit facility, consisting of $11.2 million under our revolving line of credit and $9.6 million under our term loan. We also have a letter of credit for $5.9 million secured under the facility. In addition, we have contingent consideration arrangements with the former owners of three acquired businesses that could result in substantial future cash obligations in 2016 and 2017 as described in Management's Discussion and Analysis of Financial Condition and Results of Operations - "Liquidity and Capital Resources" and as estimated and recorded in the accompanying consolidated balance sheet as of December 31, 2015. The credit facility contains operating restrictions and financial covenants that can restrict our business and limit our access to additional borrowings. Compliance under the financial covenants is measured each quarter and determines how much in additional borrowings, if any, are available to us. At December 31, 2015, we had approximately $4.7 million of additional borrowing capacity under the revolving facility - $2.9 million in U.S. Dollars and $2.4 million that can be drawn in Canadian Dollars. Our significant amount of debt, limited borrowing capacity and our debt service and contingent consideration obligations could limit our ability to satisfy our obligations, limit our ability to operate our business, execute our expansion strategy and impair our competitive position. Moreover, our failure to comply with the covenants and restrictions in our Credit Facility could result in an event of default, which would permit our lender to call for the immediate repayment of the entire amount we owe under our Credit Facility, among other remedies. The acceleration of our obligations under our Credit Facility would have a material adverse effect on our business.


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We have assumed uncertain tax positions as part of the Combinations.
We assumed the uncertain tax positions of certain Founding Companies as part of the Combinations and have recorded reserves for these positions, including related interest and penalties, of approximately $5.7 million as of December 31, 2015. If the settlement of any unrecognized tax reserves is different than that accrued, it would impact our effective tax rate. Under certain conditions, payments made by us, including interest and penalties, for assumed uncertain tax positions are indemnified by the previous owners of the Subsidiaries for a period of three years from the Combinations and we have an indemnification receivable of $5.1 million recorded in the balance sheet as of December 31, 2015. If a reserved uncertain tax position results in an actual liability and we are unable to collect on or enforce the related indemnification provision or if the actual liability occurs after the three-year indemnity period has expired, there could be a material charge to our consolidated financial results and reduction of cash resources.
Our officers and directors and the stockholders and former equity interest holders of the Subsidiaries and their affiliates exercise significant control over us.

As of December 31, 2015, our executive officers and directors and the stockholders and former equity interest holders of the Subsidiaries and their immediate family members beneficially own, in the aggregate, approximately 26% of our outstanding common stock. As a result, these stockholders are able to exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent someone from acquiring or merging with us. These stockholders may have interests that are different from yours.

Provisions in our certificate of incorporation and bylaws, Delaware law and our loan documents could discourage a takeover that stockholders may consider favorable.

Our amended and restated certificate of incorporation and amended and restated bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable because they, among other things:

authorize our board of directors, without stockholder approval, to issue up to 100,000 shares of undesignated preferred stock;

do not provide for cumulative voting in the election of directors;

establish supermajority voting requirements in order to amend certain provisions in our certificate of incorporation; and

prohibit stockholders from calling a special meeting of stockholders.

As a Delaware corporation, we are also subject to the Delaware anti-takeover provisions contained in Section 203 of the Delaware General Corporation Law. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on this provision to prevent or delay an acquisition of us. In addition, our credit agreement provides that a change of control is an event of default, which could impede an acquisition, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer for our common stock, which, under certain circumstances, could reduce the price of our common stock.

We do not intend to pay dividends.

We have never declared or paid any cash dividends on our capital stock and do not intend to pay dividends in the foreseeable future. We intend to invest our future earnings, if any, to fund our growth. We cannot assure you that you will receive a return on your investment when you sell your shares or that you will not lose the entire amount of your investment.

Our internal controls have been determined to not be effective, and we may not succeed in establishing and maintaining effective internal controls, which may adversely affect investor confidence in our Company and, as a result, the value of our common stock.

Our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting for all of our Subsidiaries and Fenix. In an effort to remediate deficiencies in our internal controls, we are in the process of adding personnel to our accounting staff, standardizing financial reporting policies and procedures and upgrading our internal accounting systems. In addition, we have implemented steps to establish a company-wide system of uniform account classifications, and are migrating all operations to common information systems. However, this is a significant task and an integral part of our integration

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plan for acquired businesses. The integration is still in progress and may require substantial resources at significant cost over an extended period of time to complete. If we fail to establish and thereafter maintain effective controls over financial reporting, our ability to accurately report on our financial results on a timely basis will be adversely affected.

When we cease to be an “emerging growth company” as defined under the JOBS Act, our auditors will be required to express an opinion on the effectiveness of our internal controls. Additionally, our principal executive and financial officers of the Company will be required to certify in the Company's annual and quarterly filings (i) that such reports are accurate and complete and that we have established and maintained adequate internal control over financial reporting, or, (ii) if we have not established and maintained adequate internal controls, that such officers have disclosed to our auditors and our audit committee all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect our ability to record, process, summarize and report financial information. If we are unable to certify that our internal control over financial reporting is effective, or if our auditors are unable to express an opinion on the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would cause the price of our common stock to decline.

The requirements of being a public company strain our resources, increase our costs and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner.

As a public company with listed equity securities, we must comply with certain laws, regulations and requirements, including corporate governance provisions of the Sarbanes-Oxley Act, related regulations of the Securities and Exchange Commission (the “SEC”) and the requirements of the NASDAQ Global Market, with which we were not required to comply as a private company. Complying with these statutes, regulations and requirements occupies a significant amount of the time of our board of directors and management and results in significant costs and expenses, which will increase after we are no longer an emerging growth company under the JOBS Act. Among the actions we have taken or are in the process of taking are to:
  
institute comprehensive corporate governance and compliance functions;
 
design, establish, evaluate and maintain a system of internal control over financial reporting in compliance with the requirements of Section 404(a) of the Sarbanes-Oxley Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board;
 
comply with rules promulgated by the NASDAQ Global Market;
 
prepare and distribute periodic public reports in compliance with our obligations under the federal securities laws;
 
establish internal policies, such as those relating to disclosure controls and procedures and insider trading;
  
involve and retain outside counsel and accountants in connection with these activities; and
 
establish an investor relations function.

Due to the historic decentralized cash basis financial reporting at the Subsidiaries, complex accounting required by the acquisitions of Subsidiaries and our lack of effective controls over financial reporting, we have incurred accounting and auditing fees that are very high for a public company of our size. In addition, these complexities have resulted in our inability to file two quarterly reports on Form 10-Q and a Form 10-K in a timely manner. Continued high accounting and auditing costs could have a material adverse effect on our financial condition, and continued late filing of routine securities filings could undermine investors’ confidence in our Company.

We are an emerging growth company and our reliance on the reduced disclosure requirements applicable to emerging growth companies may make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions and relief from various reporting requirements that are applicable to other public companies, but are not applicable to emerging growth companies. In particular, while we are an emerging growth company, we are not required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, we are subject to reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and we are not required to hold nonbinding advisory votes on executive compensation or shareholder approval of any golden parachute payments not previously approved. We have taken advantage of certain reduced disclosure obligations and may elect to take advantage of other reduced burdens in future filings. Investors may find our common stock less attractive when we rely on these exemptions and relief. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may decline and/or become more volatile.


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ITEM 1B.     UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

Our properties are described in the Facilities section in Item 1 of this Annual Report on Form 10-K, and such description is incorporated by reference into this Item 2. Our properties are sufficient to meet our present needs, and we do not anticipate any difficulty in securing additional space to conduct operations or additional office space, as needed, on terms acceptable to us.

ITEM 3.     LEGAL PROCEEDINGS

None.

ITEM 4.     MINE SAFETY DISCLOSURES

Not applicable.


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PART II

ITEM 5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SHARES

Market
Our common shares have been traded since May 2015 on the NASDAQ Global Market ("NASDAQ"). The trading symbol is FENX.

Prices
The table below sets forth the high and low sales prices during each calendar quarter since May 14, 2015, the date the IPO closed.

2015
High
 
Low
Fourth Quarter
$
8.50

 
$
5.40

Third Quarter
$
10.94

 
$
6.65

Second Quarter
$
11.92

 
$
8.59


Dividends
We have never paid cash dividends on our common shares and have no current plan to do so in the foreseeable future. The declaration and payment of dividends on our common shares are subject to the discretion of our Board of Directors. The decision of the Board of Directors to pay future dividends will depend on general business conditions, the effect of a dividend payment on our financial condition, and other factors the Board of Directors may consider relevant. In addition, our bank credit agreement requires us to obtain bank approval prior to paying a dividend. The current policy of the Board of Directors is to reinvest earnings in operations to promote future growth.

Holders
Based on information from our transfer agent and from banks and brokers as of April 14, 2016, there were approximately 87 registered stockholders and beneficial holders of our common shares. The number of registered stockholders does not include beneficial owners whose shares are held in the names of banks, brokers, nominees or other fiduciaries.

Transfer Agent
The transfer agent and registrar for our common shares is American Stock Transfer & Trust Company, LLC, 6201 15th Avenue, Brooklyn, NY 11219.

Securities Authorized for Issuance Under Equity Compensation Plans.
See our disclosure below in “Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”


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Performance Graph
The following graph compares our total return to stockholders per common share by quarter for the period of May 14, 2015, the date the IPO closed, through December 31, 2015, to that of the NASDAQ Composite Index and the following group of peer companies (the “Peer Group”): LKQ Inc., Copart, Inc.; Genuine Parts, Inc; Dorman Products Inc., and Advanced Auto Parts Inc. for the period beginning on May 14, 2015 (which was the date of the Company’s IPO) and ending on December 31, 2015. The stock price performance in the following graph is not necessarily indicative of future stock price performance. The graph assumes that the value of an investment in each of the Company’s common stock, the NASDAQ Stock Market (U.S.) Index and the Peer Group was $100 on May 14, 2015.
 
5/14/2015
 
6/30/2015
 
9/30/2015
 
12/31/2015
Fenix Parts, Inc.
$
100

 
$
128

 
$
86

 
$
86

NASDAQ Stock Market (U.S.) Index
$
100

 
$
98

 
$
90

 
$
99

Peer Group
$
100

 
$
101

 
$
108

 
$
98


This stock performance information is "furnished" and shall not be deemed to be "soliciting material" or subject to Rule 14A, shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, and shall not be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this report and irrespective of any general incorporation by reference language in any such filing, except to the extent that it specifically incorporates the information by reference.

Recent Sales of Unregistered Securities

The Company was formed and initially capitalized in January 2014 when an aggregate of 1.8 million shares of our common stock were issued and sold to five investors for the nominal cash consideration of $0.001 per share.

In March and April 2014, we issued and sold an aggregate of 402,000 shares of common stock to 13 investors for a purchase price of $5.00 per share.

During the period from September 2014 through May 14, 2015, we issued and sold an aggregate of 546,927 shares of common stock to 37 investors for an ultimate purchase price of $6.50 per share.

All share and price per share numbers above have been adjusted to reflect the 2,000-for-1 common stock split that occurred immediately prior to the closing of our initial public offering.


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The following table describes the issuance of unregistered options to purchase common stock and restricted stock units that have been issued by us to date under our Amended and Restated 2014 Incentive Stock Plan (the "2014 Stock Plan"). The grants were made to individuals who were either employees, officers or directors of the Company. In all cases, the per share exercise price of the options or the per share value of the restricted stock units, as applicable, was based on the per share price on the date of the grant, except that the options granted on May 13, 2015 were based on the per share price of our common stock in the initial public offering. These stock option and restricted stock unit grants were exempt from registration under the Securities Act pursuant to Section 4(a)(2) thereof on the basis that the transaction did not involve a public offering.
Date of Grant
 
Type of Security
 
Number of Securities
 
Exercise Price
 
Number of Grantees
May 13, 2015
 
Options
 
550,000
 
$
8.00

 
6
June 15, 2015
 
Options
 
40,000
 
$
10.69

 
1
July 8, 2015
 
Options
 
615,754
 
$
9.66

 
14
July 8, 2015
 
Restricted Stock Units
 
130,000
 
$
9.66

 
12
July 9, 2015
 
Options
 
140,000
 
$
9.82

 
2
July 9, 2015
 
Restricted Stock Units
 
20,000
 
$
9.82

 
1
August 14, 2015
 
Options
 
2,543
 
$
9.83

 
1
August 24, 2015
 
Options
 
163,000
 
$
9.60

 
38
August 25, 2015
 
Options
 
40,000
 
$
9.41

 
1
September 14, 2015
 
Options
 
5,000
 
$
8.72

 
1
November 17, 2015
 
Options
 
40,000
 
$
5.98

 
1

Effective December 31, 2015, we issued an aggregate of 2,868 shares of unregistered common stock to five of our outside directors in lieu of cash compensation for their service as directors of the Company. The shares were issued as restricted stock units under our 2014 Stock Plan. The number of shares issued was determined by dividing the dollar amount of the cash compensation each such director was entitled to receive for his service during 2015 by the average closing price of our common stock on NASDAQ for the period beginning on May 14, 2015 (the date our initial public offering closed) and ending on December 31, 2015. These restricted stock units were exempt from registration under the Securities Act pursuant to Section 4(a)(2) thereof on the basis that the transaction did not involve a public offering.

During June 2015, the Company issued a total of 20,000 unregistered shares of its common stock to two current employees in payment of their fees for pre-Combination services when they were consultants to the Company. The awards were valued at approximately $217,000, based on the share price on the date of the grant. The foregoing grants were exempt from registration under the Securities Act pursuant to Section 4(a)(2) thereof on the basis that the transaction did not involve a public offering.

Since our initial public offering, we have issued unregistered common stock as part of the purchase price in connection with our acquisition of three automotive recycling businesses. The table below lists the name of the businesses acquired, the dates of issuance and the number of shares issued. The number of shares issued to the sellers in each case was determined by dividing the agreed upon non-cash portion of the purchase price by the average closing price of our common stock on NASDAQ for the thirty trading days immediately prior to the acquisition closing. These shares were exempt from registration under the Securities Act pursuant to Section 4(a)(2) thereof on the basis that the transaction did not involve a public offering.
Business Acquired
 
Date of Issuance of Shares
 
Number of Shares
Ocean County Auto Wreckers, Inc.
 
August 14, 2015
 
59,709
Butler Auto Sales and Parts Inc.
 
October 7, 2015
 
106,918
Tri-City Auto Salvage, Inc.
 
October 9, 2015
 
42,363

Use of Proceeds from Initial Public Offering
On May 14, 2015, we priced the initial public offering of our common stock. Under our Registration Statement, we registered, issued and sold 13,800,000 shares of our common stock, including 1,800,000 shares issued pursuant to the exercise of the underwriters’ over-allotment option, at a price to the public of $8.00 per share for an aggregate offering of $110.4 million. The offering closed on May 19, 2015, and the underwriters’ exercise of their overallotment option closed on May 22, 2015.

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BMO Capital Markets and Stifel acted as joint book-running managers for the offering. BB&T Capital Markets and Barrington Research acted as co-managers.
We received net proceeds in the offering, including net proceeds from the exercise of the underwriters’ option, of approximately $101.3 million after deducting underwriting discounts and commissions of approximately $7.7 million and offering-related expenses of approximately $1.4 million. The offering-related expenses included approximately $350,000 in legal fees paid to our counsel, Johnson and Colmar, one of whose partners is our assistant secretary. With this exception, all of our offering-related expenses were direct or indirect payments to persons other than (i) directors, officers or any of their associates; (ii) persons owning 10% or more of our common stock; or (iii) affiliates.
A portion of the net proceeds received in the offering, along with $10 million borrowed as a term loan, was used to fund the approximately $93.5 million cash portion of the consideration paid in the combinations with the Founding Companies, which includes $6.8 million in cash for working capital, incremental inventory and capital expenditure adjustments required under the combination agreements with the Founding Companies. During the third quarter of 2015, approximately $2.6 million of cash was used to purchase Ocean County Auto Wreckers, Inc. ("Ocean County"). During October, 2015, approximately $6.2 million of the net proceeds from the initial public offering was used to fund a portion of the purchase price paid for Butler Auto Sales and Parts, Inc. (“Butler”) and Tri-City Auto Salvage, Inc. (“Tri-City”). The residual balance of the net proceeds of the initial public offering has been used for general corporate purposes.

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ITEM 6 – FENIX PARTS, INC. SELECTED FINANCIAL DATA

Selected financial data is presented below as of the end of and for each of the years ended December 31. The selected financial data should be read in conjunction with the consolidated financial statements as of and for the years ended December 31, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report and the schedules thereto (dollars in thousands, except per share data).
 
 
Fenix Parts Inc.
 
December 31
Statement of Operations Data:
2015
 
2014
Total revenues
$
68,946

 
$

Cost of goods sold
53,559

 

Gross profit
15,387

 

Operating loss
(30,843
)
 
(4,747
)
Net loss
$
(26,042
)
 
$
(4,747
)
Net loss available to common shares
$
(24,820
)
 
$
(4,747
)
Basic and diluted loss per share available to common shareholders
$
(1.86
)
 
$
(2.22
)
Weighted-average basic shares outstanding
13,333

 
2,143

 
 
 
 
Other Data:
 
 
 
Net cash provided by (used in):
 
 
 
Operating activities
(15,752
)
 
(3,166
)
Investing activities
(105,554
)
 

Financing activities
123,743

 
3,619

 
Fenix Parts Inc.
 
December 31,
Balance Sheet Data:
2015
 
2014
Cash and cash equivalents
$
2,827

 
$
453

Working capital
30,598

 
(1,128
)
Total assets
177,668

 
849

Total debt including current portion
20,638

 

Total Fenix Parts, Inc. shareholders’ equity (deficit) before noncontrolling interest
101,384

 
(1,128
)


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ITEM 6A – BEAGELL GROUP AND STANDARD (DESIGNATED ACCOUNTING CO-PREDECESSORS) SELECTED FINANCIAL DATA

Selected financial data for the Beagell Group and Standard are presented below for the fiscal year ended December 31, 2014 and the period of January 1, 2015 to May 18, 2015. The selected financial data should be read in conjunction with the respective Beagell Group and Standard combined financial statements as of and for the period ended May 18, 2015 and as of and for the year ended December 31, 2014, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report and the schedules thereto (dollars in thousands).
 
Beagell Group
(Designated accounting predecessor)   
 
Standard
(Designated accounting predecessor)   
 
Period From January 1, 2015 to May 18, 2015
 
Year Ended December 31, 2014
 
Period From January 1, 2015 to May 18, 2015
 
Year Ended December 31, 2014
 
 
 
 
Statement of Operations Data:
 
 
 
 
 
 
 
Total revenues
$
11,107

 
$
30,598

 
$
8,914

 
$
31,126

Gross profit
3,712

 
10,701

 
2,918

 
11,409

Operating income (loss)
528

 
2,393

 
(467
)
 
1,885

Net income (loss)
516

 
2,242

 
(245
)
 
2,043

 
 
 
 
 
 
 
 
Other Data:
 
 
 
 
 
 
 
Net cash provided by (used in):
 
 
 
 
 
 
 
Operating activities
477

 
2,915

 
(576
)
 
2,267

Investing activities
803

 
32

 
51

 
(2,183
)
Financing activities
(1,885
)
 
(1,897
)
 

 
(246
)


 
Beagell Group
(Designated accounting predecessor)   
Standard
(Designated accounting predecessor)   
 
May 18, 2015
 
December 31, 2014
 
May 18, 2015
 
December 31, 2014
Balance Sheet Data:
 
 
 
 
 
 
 
Cash and cash equivalents
$
2,165

 
$
2,770

 
$
1,388

 
$
1,354

Working capital
8,561

 
9,158

 
9,359

 
9,583

Total assets
14,503

 
16,001

 
21,554

 
22,009

Total debt including current portion
104

 
130

 

 

Shareholders’ equity
10,648

 
11,990

 
15,689

 
16,302



    

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ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (dollars in thousands)
The following is an analysis of the Company’s results of operations, liquidity and capital resources and should be read in conjunction with the consolidated financial statements and notes related thereto included in this Form 10-K. To the extent that the following Management’s Discussion and Analysis contains statements which are not of a historical nature, such statements are forward-looking statements which involve risks and uncertainties. These risks include, but are not limited to the risks and uncertainties discussed in “Item 1A Risk Factors” in this Annual Report on Form 10-K. The following discussion and analysis should be read in conjunction with the “Forward Looking Statements” and “Item 1A Risk Factors” each included in this Annual Report on Form 10-K.
Financial Statement Components

Sources of Revenue
Our combined sales consist of revenues from: (i) recycled OEM and related products, and (ii) other related and ancillary sources. Our recycled OEM and related products revenue is generated from the sale of recycled OEM and related products to collision repair shops and mechanical repair shops, parts suppliers and individual retail customers through centralized distribution facilities. Our recycled OEM and related products include mechanical parts used to repair worn or damaged components, such as engines, transmissions, transfer cases, air conditioning compressors and knee assemblies, and collision repair parts used to repair vehicles typically involved in a collision, such as doors, lids, gates, front and rear bumpers, and headlights. In addition, we purchase recycled OEM and related products from third parties for resale and distribution to our customers. For the years ended December 31, 2015 and 2014, recycled OEM and related product sales revenue represented approximately 86% and 82%, respectively, of our combined revenues as reported on an unaudited pro forma basis.

Other ancillary revenues primarily include the disposal of end of life vehicles, related scrap sales and the sale of extended warranties. We obtain scrap as a byproduct from the vehicles that have been used in both full-service and self-service recycling operations. The sale of scrap includes catalytic converters, fluids, wheels and tires, copper wiring, cores and crushed hulls. Other ancillary revenues related to the disposal of end of life vehicles and related scrap sales will vary based on fluctuations in commodity prices and the volume of materials sold. Other ancillary revenues also include the sale of extended warranty contracts for certain mechanical products. For the years ended December 31, 2015 and 2014, revenue from other ancillary sources represented approximately 14% and 18%, respectively, of our combined net revenues as reported on an unaudited pro forma basis.

Under the acquisition method of accounting, the deferred revenue associated with the extended warranty contracts acquired were determined to be negligible and the balance was effectively written-off as of the date of acquisition for all acquired companies. New warranty contract sales subsequent to the acquisition date are deferred and recognized ratably over the term of the contracts, or five years in the case of lifetime warranties.

The demand for our products and services is influenced by several factors, including the number of vehicles on the road, the number of miles being driven, the number and age of drivers, the frequency and severity of vehicle accidents, the age profile of vehicles in accidents, availability and pricing of new OEM parts and local weather conditions.

There is no standard price for many of our products, but rather a pricing structure that varies based upon such factors as product availability, quality, demand, new OEM product prices, the age and mileage of the vehicle from which the part was obtained and competitor pricing.

Cost of Goods Sold
Our cost of goods sold for recycled OEM and related products includes the price we pay for the vehicles we purchase and, where applicable, auction, storage and towing fees. We acquire vehicles for dismantling from several sources, including auto salvage auctions and from the public. The cost assigned to recycled OEM parts reflects the historic average cost to sales percentage at each of our facilities and applying that percentage to the facility’s inventory and cost of goods sold. The cost does not reflect the current cost to procure or replace that inventory. The average cost to sales percentage is derived from each facility’s historical vehicle profitability for salvage vehicles purchased at auction or from contracted rates for salvage vehicles acquired under certain direct procurement arrangements. Prices for vehicles may be impacted by a variety of factors, including the demand and pricing trends for used vehicles, the number of vehicles designated as “total losses” by insurance companies, the production level of new vehicles, and the status of laws regulating the titling of “total loss” vehicles and the bidders of vehicles at auction.


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Our cost of goods sold includes the price we pay to third parties for recycled OEM and related products purchased for resale. These products are purchased to supplement our inventory for sale to our customers. In addition to the aforementioned material costs, our cost of goods sold also includes costs, such as labor and other overhead, we incurred to acquire, dismantle, and ready those parts for sale. Labor and other overhead to purchase and dismantle vehicles accounted for approximately 13% of our cost of goods sold during the year ended December 31, 2015.

Under the acquisition method of accounting, inventories acquired are adjusted to fair value as of the date of acquisition. The incremental adjustment of inventory to fair value is amortized through cost of goods sold based on the average utilization of the acquired inventory. The cost of goods sold impact of the fair value amortization amounted to $8.6 million for the year ended December 31, 2015.

Some of our mechanical products are sold with a warranty against defects which could result in product returns. We record the estimated returns reserves at the time of sale using historical returns information to project future returns and related expenses.

Expenses
Our expenses primarily consist of costs of operations and distribution. These costs include (1) wages for the operating management, facility and distribution personnel, related incentive compensation and employee benefits; (2) costs to occupy and operate the facilities including rent, utilities, insurance and taxes; (3) costs to distribute parts, including freight, vehicle expenses and repairs and maintenance related to our facilities and equipment; and (4) other facility expenses. Our distribution and operations expenses are integral to the operation of each facility and primarily include our costs to prepare and deliver our products to our customers. These costs include labor costs for drivers, fuel, third party freight costs, local delivery and transfer truck leases or rentals and related repairs and maintenance, insurance, and supplies. The costs included in facility expenses that do not relate to vehicle purchasing and to the dismantling process, are classified below the gross margin line on our statement of operations.

Our selling and marketing expenses primarily include salary, commission and other incentive compensation expenses for sales personnel, advertising, promotion and marketing costs, telephone and other communication expenses, credit card fees and bad debt expense. Most of our product sales personnel are paid on a commission basis. The size and quality of our sales force are critical to our ability to respond to our customers’ needs and increase our sales volume.

Our general and administrative expenses primarily include the costs of our corporate offices and field support services center that provide field management, treasury, accounting, legal, payroll, business development, human resources and information systems functions. These costs include wages and benefits for corporate, regional and administrative personnel, share-based compensation and other incentive compensation, IT system support and maintenance expenses, accounting, auditing, legal and other professional fees, supplies and changes in fair value of contingent consideration obligations.

Critical Accounting Policies and Estimates

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and assumptions especially as it relates to Revenue Recognition, Allowance for Doubtful Accounts, Inventories, Business Combinations, Goodwill, Intangible Assets, and Contingent Consideration. We believe that the following accounting policies (see Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements in this document) involve a higher degree of judgment and complexity and are deemed critical. We discuss our critical accounting policies with the Audit Committee and the Board of Directors.

Revenue Recognition
For our recycled OEM and related products, we recognize and report revenue from the sale of recycled OEM and related products when they are shipped or picked up by the customers and ownership has transferred, subject to an allowance for estimated returns (often pursuant to standard warranties on sold products) discounts and allowances, that management estimates based upon historical information. We analyze historical returns and allowances activity by comparing the items to the original invoice amounts and dates. We use this information to project future returns and allowances on products sold. If actual returns and allowances are higher than our historical experience, there would be an adverse impact on our operating results in the period of occurrence. For an additional fee, we also sell extended warranty contracts for certain mechanical products. Revenue from these contracts is deferred and recognized ratably over the term of the contracts, or five years in the case of lifetime warranties.

For our other ancillary revenue, we recognize revenue from the sale of scrap, cores and other metals when ownership has transferred, which typically occurs upon delivery to the customer.


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Allowance for Doubtful Accounts
The allowance for doubtful accounts is management’s best estimate of the amount of credit losses in accounts receivable. In order to control and monitor the credit risk associated with our customer base, we review the credit worthiness of our customers on a recurring basis. Factors influencing the level of scrutiny include the level of business the customer has with us, the customer’s payment history and the customer’s financial stability. Receivables are considered past due if payment is not received by the date agreed upon with the customer, which is normally 30 days. Representatives of our management team review all past due accounts on a bi-weekly basis to assess collectability. At the end of each reporting period, the allowance for doubtful accounts balance is reviewed relative to management’s collectability assessment and is adjusted if deemed necessary through a corresponding charge or credit to bad debts expenses, which is included in selling, general, and administrative expenses in the consolidated statements of operations. Bad debt write-offs are made when management believes it is probable a receivable will not be recovered.

Inventories
Our recycled OEM and related product inventory cost is established based upon the price we pay for a vehicle, including auction, storage and towing fees, as well as expenditures for buying and dismantling vehicles. After dismantling, the cost assigned to salvaged parts and scrap is determined using the average cost to sales percentage at each 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 vehicle profitability for salvage vehicles purchased at auction or acquired under other arrangements.

All inventory is recorded at the lower of cost or market. The market value of our inventory is determined based on the nature of the inventory and anticipated demand. If actual demand differs from our earlier estimates, reductions to inventory carrying value would be necessary in the period such determination is made.

The historical cost basis of inventories acquired in conjunction with all business combinations includes an adjustment to record the inventory at its fair value on the date of acquisition. This incremental adjustment of inventory to fair value is amortized through cost of goods sold based on the average utilization of the acquired inventory. The acquisitions of the Subsidiaries contributed a $10.0 million increase in our recycled OEM and related products inventory during 2015, of which, approximately $8.6 million was amortized through cost of goods sold. As of December 31, 2015, the unamortized fair value inventory adjustment is approximately $1.4 million. See Note 3, Business Combinations, to the consolidated financial statements in this document for further information on our acquired inventory.

Business Combinations
We record our acquisitions under the acquisition method of accounting, under which acquisition purchase price is allocated to the identifiable assets acquired and liabilities assumed based upon their respective fair values. We utilize management estimates and, in some instances, independent third-party valuation firms to assist in determining the fair values of the identifiable assets acquired, liabilities assumed and contingent consideration granted. Such estimates and valuations required us to make significant assumptions, including projections of future events and operating performance. The purchase price allocation is subject to change during the measurement period, which is limited to one year subsequent to the acquisition date. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. Transaction and restructuring costs associated with a business combination are expensed as incurred.

Assessment of Potential Impairments of Goodwill
We are required to assess our goodwill for impairment at least annually for our one reporting unit. We may elect to first do a qualitative assessment to determine whether it is more likely than not that our reporting unit’s fair value is in excess of its carrying value. If not, or if we elect to not perform a qualitative assessment, we then perform a quantitative impairment test. The first step of the quantitative test includes estimating the fair value of the reporting unit and comparing that estimated fair value to the reporting unit’s carrying value. If fair value exceeds carrying value, then no impairment is deemed to exist. Otherwise, we proceed to the second step and use that estimated fair value as a hypothetical purchase price for the reporting unit to determine the resulting “implied” goodwill (computed similarly to how goodwill is computed under acquisition accounting described above). An excess of a reporting unit’s recorded goodwill over its “implied” goodwill is reported as an impairment charge. We performed our initial goodwill impairment test in the fourth quarter of fiscal year 2015 and will perform between annual tests whenever events or circumstances indicate that an impairment may exist. We are required to evaluate events and circumstances that may affect the performance of the reporting unit and the extent to which the events and circumstances may impact the future cash flows of the reporting unit.


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Our reporting unit fair value estimates are established using weightings of the results of a discounted cash flow methodology and our market capitalization. We believe that using two methods to determine fair value limits the chances of an unrepresentative valuation. Nonetheless, these valuations are subject to significant subjectivity and assumptions, including estimates of future sales growth rates, gross margin patterns, changes in operating expenses, terminal values, discount rates and comparable companies. Changes in such assumptions or estimates may require us to record goodwill impairment charges. We completed our annual goodwill impairment review as of October 1, 2015, which was before the acquisitions of Tri-City and Butler, using our forecasted plan. Since Fenix operates in just one operating segment and one reporting unit, Auto Recycling, all the recorded goodwill is considered attributable to that reporting unit and impairment is tested accordingly.

We determined that it was necessary to perform a quantitative assessment of our goodwill for the purpose of determining whether a goodwill impairment existed at October 1, 2015.  When conducting this analysis, we identified the three steps below as integral to our analysis.
1.
We engaged third party valuation experts with a detailed understanding of our automotive recycling business, to perform a valuation.  The fair value was defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at October 1, 2015.

2.
In our disaggregated forecast, we evaluated whether the financial performance realized in 2015 was a result of discrete matters that are considered highly unlikely to recur in the future or whether the matters were systemic in nature that might result in a downturn of the business.

3.
We prepared a discounted cash flow analysis over a five year period so as to derive a reasonable view of the cash flows that the business would generate from 2016-2020.

Inherent in our analysis is the reliance on key assumptions, including, but not limited to, the cash flows of the reporting unit, weighted average cost of capital (“WACC”), and terminal growth rates of the Company.  In evaluating the key variables, we concluded our WACC and terminal growth rates were approximately 10% and 3%, respectively. With all other assumptions remaining constant, to the extent that either the WACC increases by 1.0% or the terminal growth rate decreases by 0.5%, proceeding to step 2 of the impairment analysis, as indicated in ASC Topic 350, Intangibles - Goodwill and Other, would be necessary.


As part of our annual budget process and in light of the operating losses incurred in 2015, management prepared its 2016 forecast and provided a long-term prospective view of the various locations, which provided insight into the future growth assumptions for the business. To the extent that there is volatility in our stock price, a significant economic downturn, further reduction in scrap prices, further reduction in the Canadian exchange rate, variation in vehicle accident rates, change in state or federal laws, significant increases in vehicle procurement costs or changes in other variables that can materially impact our business, we may need to evaluate goodwill for impairment in between the annual measurement period if events and circumstances indicate that it is more likely than not the asset is impaired.

As a result of the quantitative analysis, where the fair value was computed, it was calculated that the fair value of our business exceeded the carrying value of goodwill on the balance sheet by approximately
8.5%. We will continue to monitor the actual results of our operations against our long-term plan and re-evaluate goodwill as required in between the annual measurement period if events and circumstances indicate that it is more likely than not the asset is impaired. The determination of fair value is highly sensitive to differences between estimated and actual cash flows and changes in the related discount rate used to evaluate the fair value of the reporting unit where the goodwill resides. Based on the discounted cash flow valuation at October 1, 2015, a 1% increase in the WACC, terminal growth rate decrease by 0.5%, shortfall against budgeted revenue and gross profit in excess of 2% or changes in other significant variables in the future could potentially result in impairment.


We also consider current market capitalization compared to the sum of the estimated fair values of our business in conjunction with each impairment assessment. As part of this consideration, management recognizes that our market capitalization may not be an accurate representation of our 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 our stock price.

As of the October 1, 2015 valuation date, the fair value of our reporting unit was approximately $157.0 million, which was derived using the income approach and our market capitalization. Since this amount was greater than carrying value, management concluded that the recorded goodwill is not impaired.


Further, there were no qualitative events or indicators through December 31, 2015 that supported changing our conclusion as of December 31, 2015.

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Impairment of Long-Lived Assets and Amortizable Intangible Assets
We evaluate the carrying value of intangible assets, such as trade names and customer relationships, and other long lived assets for impairment whenever indicators of impairment exist. We test these assets for recoverability by comparing the net carrying value of the asset or asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset or asset group. If the assets are recoverable, an impairment loss does not exist and no loss is recorded. If the assets are not recoverable, an impairment loss is recognized for any deficiency of the asset or asset group’s fair value compared to their carrying value. Although we base cash flow forecasts on assumptions that are consistent with plans and estimates we use to manage our business, there is significant judgment in determining the cash flows attributable to these assets, including markets and market share, sales volumes and mix, capital spending and working capital changes.

Income Taxes
We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax bases of our assets and liabilities and for certain tax credit carryforwards. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. Judgment is required in addressing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, we believe it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. We consider all available positive and negative evidence when assessing the likelihood of future realization of our deferred tax assets, including recent cumulative earnings experience, expectations of future taxable income, the ability to carryback losses and other relevant factors.

The Company files income tax returns in the United States and Canada. The Company is not currently subject to any income tax examinations; however, tax returns of Fenix for 2014 (year of inception) and 2015 (consolidated after the Combination) and tax returns of the acquired Subsidiaries for tax years 2012 through pre-acquisition periods in 2015 remain open under the statute of limitations.

The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. To the extent we prevail in matters for which liabilities have been established, or are required to pay amounts in excess of our liabilities, our effective tax rate in a given period may be materially reduced or increased, respectively.

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 liability 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, which may require periodic adjustments and which may not accurately forecast actual outcomes. The Company’s uncertain tax position reserves, including related interest and penalties of $2.4 million, were approximately $5.7 million as of December 31, 2015 and all related to tax positions taken on returns prior to the individual acquisitions of Subsidiaries. The Company’s right to indemnification under certain of the combination agreements related to these uncertain tax positions is subject to a threshold of 1% of the purchase price, a cap of 40% of the purchase price paid for each individual acquisition. These indemnifications are subject to a three year limitation from date of the Combination. See Note 6, "Income Taxes" for further information on our uncertain tax positions. Our policy is to include interest and penalties associated with income tax obligations in income tax expense.

Undistributed earnings of the Company's Canadian subsidiaries are considered to be indefinitely reinvested, and accordingly no provision for U.S. income taxes has been provided thereon. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to adjustment for foreign tax credits) and potential withholding taxes payable in Canada. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable due to the complexities associated with its hypothetical calculation; however, unrecognized foreign tax credits would be available to reduce materially any U.S. liability.

Share-based Compensation
We recognize compensation expense for employee equity awards ratably over the requisite service period of the awards. For the equity award grants, there was no estimated annual forfeiture rate applied to 2015 grants due to the lack of historical forfeiture experience to date. We will continue to review and assess our estimated forfeiture rate assumption for reasonableness at least annually and potentially quarterly as more information and forfeiture experience becomes available.


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We utilize the Black-Scholes option-pricing model to estimate the fair value of stock option awards. Determining the fair value of stock options using the Black-Scholes model requires judgement, including estimates for (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 comparable company Common Shares for a period equal to the expected life of the option; and (3) expected life of an option – an estimate based on historical experience including the effect of employee terminations.

If future forfeitures differ significantly from actual results, share-based compensation expense could be impacted.

Recently Adopted Accounting Standards
In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity , which amends FASB Accounting Standards Codification (“ASC”) Topic 205, Presentation of Financial Statements , and FASB ASC Topic 360, Property, Plant, and Equipment. This standard amends the definition of a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. This guidance is effective on a prospective basis for annual periods beginning on or after December 15, 2014. The Company adopted this standard effective January 1, 2015. Adoption did not have any impact on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-3 which amends ASC Topic 835, Interest, to require presentation of certain debt issuance costs as a direct deduction from the carrying amount of a debt liability, consistent with debt discounts. The Company early adopted this ASU for the period ended June 30, 2015 and debt issuance costs have been netted against our term note obligations in the consolidated financial statements since that date.

In November 2015, the FASB issued ASU No. 2015-17 which amends ASC 740, Income Taxes, to require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The Company early adopted this ASU on a retrospective basis for the year ended December 31, 2015. All deferred income taxes are recorded as noncurrent at December 31, 2015 and 2014. The deferred taxes as of December 31, 2014 were fully reserved for with a valuation allowance that was reversed upon the successful completion of the IPO in May 2015.

Recently Issued Accounting Standards
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The guidance in this update, as amended, supersedes nearly all existing revenue recognition guidance under U.S. GAAP and creates a single, principle-based revenue recognition framework that is codified in a new FASB ASC Topic 606. The core principle of this guidance is for the recognition of revenue to depict the transfer of goods or services to customers at an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The new revenue standard is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those years. Early adoption is permitted only as of annual reporting periods beginning after December 31, 2016. The new standard allows for either full retrospective or modified retrospective adoption. The Company is currently evaluating the transition method that will be elected and the potential effects of the adoption of the new standard on its consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15 which amends ASC Topic 205, Presentation of Financial Statements, to describe management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. This guidance will be effective for our fiscal year ended December 31, 2016. The Company does not expect adoption of this ASU to have a material impact on its consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis, which modifies the evaluation of Variable Interest Entities ("VIE"), and affects the consolidation analysis of reporting entities involved with VIEs. This guidance for public entities is effective for fiscal years beginning after December 15, 2016 with early adoption permitted. The Company is currently evaluating the impact of adopting the new standard.

In July 2015, FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, to reduce the complexity in accounting for inventory. This ASU requires entities to measure inventory at the lower of cost or net realizable value. This guidance for public entities is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of adopting the new standard.


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In September 2015, FASB issued ASC No. 2015-16, 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 is currently evaluating the impact of adopting the new standard.

In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a 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 statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. 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 we are still evaluating the impact of our pending adoption of the new standard on our consolidated financial statements, we expect that upon adoption we will recognize ROU assets and lease liabilities and that the amounts could be material.

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

Overview
We are in the business of auto recycling, which is the recovery and resale of OEM, components and systems, such as engines, transmissions, radiators, trunks, lamps and seats 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 components. The Company’s customers include collision repair 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, the sale of aftermarket parts, and from the sale of extended warranty contracts.

Fenix was founded on January 2, 2014 for the purpose of effecting the Combinations and IPO. Fenix had no automobile recycling operations before May 2015 during which time it had two employees. From Inception to May 19, 2015, Fenix incurred various legal, accounting, auditing and administrative costs in preparation for its IPO, the Combinations and for its operation as a publicly-traded company upon consummation of these transactions. After May 18, 2015, Fenix’s results include the operations of the Founding Companies and Subsequent Acquisitions.


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Results of Operations – 2015 versus 2014
(in thousands, except percentages)
Year Ended 
 December 31, 2015
 
Percent of Net Revenues
 
Period from
January 2, 2014 (Inception) to
December 31, 2014
Net revenues
$
68,946

 
100.0
 %
 
$

Cost of goods sold
53,559

 
77.7
 %
 

Gross profit
15,387

 
22.3
 %
 

Selling, general and administrative
28,346

 
41.1
 %
 
232

Outside service and professional fees
9,091

 
13.2
 %
 
4,515

Depreciation and amortization
2,743

 
4.0
 %
 

Change in fair value of contingent consideration liabilities
6,050

 
8.8
 %
 

Operating loss
(30,843
)
 
(44.8
)%
 
(4,747
)
Interest expense
(263
)
 
(0.4
)%
 

Other (expense) income, net
(1,959
)
 
(2.8
)%
 
1

Total other expense, net
(2,222
)
 
(3.2
)%
 
1

Loss before income tax benefit
(33,065
)
 
(48.0
)%
 
(4,747
)
Benefit for income taxes
7,023

 
10.2
 %
 

Net loss
$
(26,042
)
 
(37.8
)%
 
$
(4,747
)

The following table shows the combined unaudited pro forma net revenues and net loss of Fenix Parts, Inc. as if the acquisition of all Subsidiaries had occurred on January 1, 2014. These unaudited pro forma amounts presented are not necessarily indicative of either the actual consolidated results had the acquisition occurred as of January 1, 2014 or of future operating results:
 
 
(Unaudited)
(in thousands, except percentages)
 
Year Ended December 31,
 
Difference
 
 
2015
 
2014
 
$
 
%
Net revenues
 
$
126,897

 
$
132,802

 
$
(5,905
)
 
(4.4
)%
Net loss
 
$
(23,716
)
 
$
(4,594
)
 
$
(19,122
)
 
416.2
 %

Pro forma net revenues consisted of:
 
 
(Unaudited)
(in thousands, except percentages)
 
Year Ended December 31,
 
Difference
 
 
2015
 
2014
 
$
 
%
Recycled OEM parts
 
$
109,658

 
$
108,361

 
$
1,297

 
1.2
 %
Scrap, warranty and other ancillary items
 
17,239

 
24,441

 
(7,202
)
 
(29.5
)%
Total
 
$
126,897

 
$
132,802

 
$
(5,905
)
 
(4.4
)%

Pro Forma Adjustments (Unaudited)
Significant adjustments to the historical revenues of the Subsidiaries include the elimination of sales among Subsidiaries, 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-IPO periods.

Significant adjustments to expenses include 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 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 audited consolidated financial statements, and is not adjusted back to January 1, 2014 as it does not have a continuing impact on the Company. As a result, pro forma gross profit margins in the periods immediately following the acquisitions are substantially lower than the pre-acquisition periods.


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Net Revenues
Net revenue for the year ended December 31, 2015, was $68.9 million, reflecting our automobile recycling operations from May 19, 2015 to December 31, 2015. On an unaudited pro forma combined basis assuming the acquisition of all current Subsidiaries occurred on January 1, 2014, net revenues for the years ended December 31, 2015 and 2014 were $126.9 million and $132.8 million, respectively, representing a 4.4% decrease. Revenues in the year ended December 31, 2015, as compared to the same period in 2014, have been adversely impacted by lower prices received for scrap sales and lower reported revenues at the Canadian operations because of a stronger U.S. Dollar.

Fenix is subject to risks and uncertainties relating to the price of scrap metal. While sales of scrap metal represent a small portion of our overall revenues, the decline of approximately 66% from 2014 to 2015 in market prices for scrap autobodies (as per the American Metal Market Index) had an adverse effect on reported revenues in 2015. Continued weakness in metals prices could 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 we have substantial operations in Canada doing business in Canadian Dollars, Fenix is also subject to risks and uncertainties relating to foreign currency exchange rates. During 2015, the Canadian Dollar depreciated approximately 15% against the U.S. Dollar, and this had the effect of reducing reported and pro forma revenues in the year ended December 31, 2015 as compared to pro forma revenues for the year ended December 31, 2014. The continued strengthening in the U.S. Dollar relative to the Canadian Dollar could adversely affect our future reported results of operations.

Cost of Goods Sold
Our cost of goods sold for the year ended December 31, 2015 amounted to $53.6 million, or 77.7% of revenue and a gross profit percentage of 22.3%. Cost of goods sold for 2015 includes $8.6 million, or 12.5% of net revenues, attributable to post-acquisition amortization of higher inventory values from applying the purchase method of accounting to the acquired inventories of the Subsidiaries. Without the impact of this acquisition accounting step up in initial inventory values, cost of goods sold as a percentage of net revenues was 65.2% and gross profit percentage was 34.8% for the year ended December 31, 2015. As of December 31, 2015, the remaining unamortized fair value inventory adjustment is approximately $1.4 million and will be fully amortized in 2016. Cost of goods sold for the year ended December 31, 2015 also includes approximately $0.8 million of depreciation and amortization.

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 the 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. The cost does not reflect the current cost to procure or replace that inventory, as we calculate inventory and cost of goods sold on an average cost to sales percentage, derived from each facility’s historical vehicle profitability for salvage vehicles purchased at auction or acquired under other arrangements. Because of the significant drop in the value of scrap metal throughout 2015 and, in particular in the fourth quarter of 2015, the cost of goods sold reflected in our consolidated financial statements is higher than the current cost to replace that same inventory.

Selling, General and Administrative Expenses
Our selling, general and administrative expenses for the year ended December 31, 2015 amounted to $28.3 million, or 41.1% of net revenues, and consists of (i) selling and marketing expenses and (ii) general and administrative expenses.

Outside Service and Professional Fees
Our outside service and professional fees for the year ended December 31, 2015 amounted to $9.1 million, or 13.2% of net revenues, and consists primarily of accounting, auditing, tax consulting, and legal professional fees.

Depreciation and amortization expense
Our depreciation and amortization not directly attributable to cost of goods sold for the year ended December 31, 2015 amounted to $2.7 million, or 4.0% of net revenues, and consists primarily of amortization of intangible assets established in connection with acquisitions.


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Change in fair value of contingent consideration liabilities
Our fair value of contingent consideration liabilities was increased by $6.0 million for the year ended December 31, 2015, resulting in a charge equal to 8.8% of revenue. The charge was attributable to an increase in the estimated contingent consideration that is likely to be paid to former shareholders of one Founding Company, which was offset by minor reductions in estimated contingent consideration attributable to two other Founding Companies.

Interest expense and other (expense) income, net
Our interest expense, primarily related to our bank credit agreement, was $0.3 million for the year ended December 31, 2015. Our interest and other (expense) income, net for the year ended December 31, 2015 amounted to $2.0 million, or 2.8% of revenue and consists primarily of a $1.8 million non-cash charge related to make whole provisions whereby certain of our shareholders were contractually required to deliver Fenix common shares to other of our shareholders when the offering price per share was below $10. The amount equals the number of shares transferred times the public offering price of $8 per share. See Note 7, Common Stock and Preferred Shares, to consolidated financial statements in this document for a further discussion of these transactions.

Benefit for income taxes
The Company’s effective tax rate was 21.2% and 0.0% for the years ended December 31, 2015 and 2014, respectively. The effective rate differs from the U.S. federal statutory rate due to the effects of the state and Canadian income taxes and non-deductible expenses reported in the statement of operations.

Net loss
Net loss for the years ended December 31, 2015 and 2014 was $26.0 million and $4.7 million, respectively. On an unaudited pro forma basis assuming the acquisition of all current Subsidiaries occurred on January 1, 2014, net loss for the years ended December 31, 2015 and 2014 was $23.7 million and $4.6 million, respectively. The increase in the pro forma net loss is primarily attributable to the aforementioned factors.

Included in net loss for the year ended December 31, 2015 are the following significant expense items (in thousands):
Amortization of inventory fair value adjustment
 
$
8,585

Change in fair value of contingent consideration
 
6,050

Depreciation and amortization expense
 
3,571

Share-based compensation expense
 
3,046

Make whole provision for pre-IPO investors
 
1,827

Outside service and professional fees
 
9,091


Liquidity and Capital Resources
Effective December 31, 2015, we entered into a $35.0 million amended and restated senior secured credit facility with BMO Harris Bank N.A.(the "Credit Facility") which replaces the original Credit Facility with BMO Harris Bank N.A. (the “Original Credit Facility”). The Credit Facility consists of $25.0 million that is available as a revolving credit facility, allocated $20.0 million in U.S. 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 has been drawn as a term loan. We have the right from time to time, as long as no default is occurring, to request an increase in the amount of the revolving line-of-credit by up to an aggregate of $20.0 million.

As of December 31, 2015, there was a $5.9 million letter of credit outstanding related to the Combinations and the balance due under the term loan and revolving credit facility was $9.6 million and $11.2 million, respectively. As of December 31, 2015, we had approximately $4.7 million in available borrowings ($2.9 million in U.S. Dollars and $2.4 million that can be drawn in Canadian Dollars) under the revolving line of credit after considering the applicable financial covenants and restrictions in the agreement as described further below. Compliance with the financial covenants and restrictions is measured quarterly and determines the amount of additional available credit, if any, that will be available to us. Proceeds of the Credit Facility can be used for capital expenditures, working capital, permitted acquisitions, and general corporate purposes. The Credit Facility is secured by substantially all of the Company’s assets and expires on May 19, 2020. Principal payments of approximately $0.9 million are due under the term loan during the year ending December 31, 2016.

Our U.S. borrowings under the Credit Facility bear interest at fluctuating rates determined quarterly, at our election in advance for any applicable interest period, by reference to the “base rate” plus the applicable margin within the relevant range of margins provided in the agreement. 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

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of one month plus 1.00%. The applicable margin is based on our Total Leverage Ratio, as described below. The borrowings were subject to interest rates of 2.50% at December 31, 2015. The maximum and initial margin for interest rates after December 31, 2015 on U.S. borrowings under the Credit Facility is 3.25% on LIBOR loans and 2.25% on base rate loans.

The Canadian borrowings under the Credit Facility bear interest at fluctuating rates determined quarterly, at our election in advance for any applicable interest period, by reference to the “Canadian base rate” plus the applicable margin within the relevant range of margins provided in the agreement. The Canadian base 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 based on our Total Leverage Ratio, as described below. The maximum and initial margin for interest rates after December 31, 2015 on Canadian borrowings under the Credit Facility is 2.25% 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 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 contains several financial covenants, which have been restated, with which we must comply on a quarterly or annual basis, 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 borrowed funds, outstanding standby letters of credit and bank guarantees 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, 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 up to a specified quarterly maximum, instead of using the EBITDA for the prior four quarters. 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. Net worth is defined as the total stockholder's equity, including capital stock, additional paid in capital, and retained earnings after deducting treasury stock. As of December 31, 2015, we were in compliance with all requirements specified by the amended and restated agreement.

Prior to the IPO in May 2015, our source of funding was sales of common stock to a small group of investors that provided $3.6 million in 2014 and $2.1 million in 2015. Our IPO provided approximately $101.3 million in net proceeds.

Net cash used in operating activities totaled $15.8 million and $3.2 million for the years ended December 31, 2015 and 2014, respectively. The 2015 period includes (i) substantial Fenix corporate costs, such as $9.1 million in outside service and professional fees for the entire year, and (ii) cash flows from the Founding Companies from May 19 to December 31, 2015, Ocean County from August 14 to December 31, 2015, Butler from October 7 to December 31, 2015 and Tri-City from October 9 to December 31, 2015. Of the revenue generated during 2015, our cash receipts differed by $4.8 million as Fenix did not purchase the receivables from the Founding Companies. The Company did purchase the receivables from the Subsequent Acquisitions. Additionally reflected was a reduction in cash as a result of the decrease in accrued expenses and other liabilities of $1.0 million, primarily related to a bonus accrued as part of the Combinations with the Founding Companies which was paid before December 31, 2015.

Net cash used in investing activities totaled $105.6 million and $0.0 million for the years ended December 31, 2015 and 2014, respectively. Investing activities in the year ended December 31, 2015 consisted of the cash used to purchase the Subsidiaries, and $0.3 million of capital expenditures associated with the automobile recycling operations after the acquisitions.

Net cash provided by financing activities totaled $123.7 million and $3.6 million for the years ended December 31, 2015 and 2014, respectively. During the year ended December 31, 2105, we raised $101.3 million in net proceeds from the IPO and borrowed a net of $20.8 million on our Credit Facility. Of the Credit Facility borrowings, $10.0 million was borrowed in May 2015 as a term loan (of which $0.4 million has been repaid through December 31, 2015), and the remainder was borrowed in the fourth quarter of 2015 under the revolving line-of-credit, primarily in connection with financing a portion of the purchase consideration in certain of the Subsequent Acquisitions.

Our primary sources of ongoing liquidity will be cash flows from our operations and available credit under the Credit Facility. The procurement of inventory is our largest operating use 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.


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As part of the consideration for three of the Founding Companies, we entered into contingent consideration agreements with certain of the selling shareholders. Under the terms of the contingent consideration agreements, additional payments will be made 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 of $10.2 million was recorded in the financial statements at the Combination 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%. Subsequent to the Combination, we periodically review the amount of contingent consideration that is likely to be payable under current operating conditions and will adjust the initial liability as deemed necessary, with such subsequent adjustments being recorded through the statement of operations as an operating credit or charge. At December 31, 2015, the fair value of the contingent consideration was determined to be approximately $15.4 million, with $9.3 million recorded as a current liability and $6.1 million as a long-term liability.

For the Combination with Jerry Brown, we are required to pay (a) up to an additional $1.8 million if the business achieves certain revenue targets during the twelve-month period beginning with the month following the month of closing of the Combinations 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 Combination date fair value of the contingent consideration of $2.5 million. Operations at Jerry Brown showed substantial improvement in the fourth quarter of 2015 and their budget for 2016, as developed in the fourth quarter of 2015, reflects further growth and improvement.  Accordingly, the initial fair value estimate of this contingent liability was increased by approximately $5.1 million in the fourth quarter of 2015. We expect to fund these payments to the former owners of Jerry Brown, to the extent they are ultimately deemed earned, through cash generated from operations or, if necessary, through draws on the revolving credit facility.

The Combination Agreements for Eiss Brothers and the Canadian Founding Companies provide for a holdback of additional Combination Consideration which will be payable, in part or in whole, only if certain performance hurdles 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 the form of a letter of credit under our Credit Facility plus 280,000 Exchangeable Preferred Shares, of which, none, some or all will be released to the former owners of the Canadian Founding Companies depending on their combined revenues from specific types of sales for the twelve-month period beginning June 2015. Based on our evaluation of the likelihood of meeting these performance targets, a liability of $7.5 million was recorded at the Combination date for the fair value of the contingent consideration, which included the present value of the cash portion and the then-current value of the Exchangeable Preferred Shares. The standby letter of credit under our Credit Facility for $5.9 million and the 280,000 Exchangeable Preferred Shares are being held in escrow. We expect to fund any cash payments to the former shareholders 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.

We intend to focus on internally growing our existing distribution and dismantling operations as well as evaluating targeted markets for expansion through selected business acquisitions. Future liquidity and capital requirements will depend upon numerous factors, but management believes that cash and cash equivalents, cash provided by operating activities and funds available from bank borrowings will be sufficient to meet our current operating and capital requirements, debt service obligations and payments under contingent consideration agreements, although such sources are not likely to be sufficient for future acquisitions. From time to time, we may need to raise additional funds through public or private financing, or other arrangements. There can be no assurance that additional funding, or refinancing of our Credit Facility, if needed, will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may be costly and involve further restrictive covenants. Failure to raise capital if and when needed could have a material adverse impact on our business, operating results, and financial condition.


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Table of Contents

Contractual Obligations and Commercial Commitments
Operating leases with the former owners of the Subsidiaries or their affiliates have terms of 15 years with options for additional renewals. The sublease for corporate office space has a term of May 1, 2015 to September 30, 2018. Cash payments for rent under these leases, future payments on debt (principal only) and consulting obligations, and future contingent consideration payments described above by year are:
 
Payments Due By Period
(in thousands)
Total
 
Less Than 1 Year
 
2-3 Years
 
4-5 Years
 
More Than 5 Years
Operating leases
$
39,613

 
$
2,078

 
$
4,409

 
$
4,819

 
$
28,307

Long-term debt
20,825

 
881

 
2,000

 
17,944

 

Consulting obligations
1,591

 
395

 
646

 
160

 
390

Related party debt
200

 
100

 
100

 

 

Contingent consideration liabilities
15,430

 
9,345

 
6,085

 

 

Total
$
77,659

 
$
12,799

 
$
13,240

 
$
22,923

 
$
28,697

Operating leases — See Note 10, Related Party Transactions, to the consolidated financial statements in this document for discussion of facility leases with the former owners of the Subsidiaries.
Long-term debt — Long-term debt consists of amounts owed under the Company's Credit Facility. See Note 4, Long-Term Obligations, to the consolidated financial statements in this document for a summary of the Company's amended and restated Credit Facility.
Consulting obligations — Consulting obligations reflect non-substantive (future performance not required) consulting arrangements with former owners as agreed to during the Combinations with the Founding Companies.
Related party debt— Related party debt consists of a note to former shareholders for the minority stake in Go Pull-it. See Note 4, Long-Term Obligations, to the consolidated financial statements in this document for a summary.
Contingent consideration liabilities — Represents the estimated fair value of contingent consideration arrangements with the former owners of three Founding Companies. Under these arrangements, the former owners of Standard and Eiss can earn up to an aggregate of $6.1 million in cash, 11,667 shares of Fenix common stock and 280,000 Exchangeable Preferred Shares. The former owners of Jerry Brown can earn up to an additional $1.8 million in cash if the business achieves certain revenue targets during the twelve-month period beginning with the month following the month of closing of the Combinations and an additional, uncapped amount if the business exceeds certain EBITDA levels during 2016. The fair value of the contingent consideration liabilities at the Combination date was based on independent valuations considering the Company’s 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%. Subsequent to the Combination, we periodically review the amount of contingent consideration that is likely to be payable under current operating conditions and adjust the initial liability as deemed necessary. The changes in the estimated fair value of this initial liability resulted in a net charge for $6.0 million, as reflected in the statement of operations for the year ended December 31, 2015.
Off-Balance Sheet Arrangements — We have a $5.9 million standby letter of credit outstanding at December 31, 2015 to support contingent consideration under the Combination Agreement for the Canadian Founding Companies. Other than this standby letter of credit and the operating lease commitments included above, we have no off-balance sheet arrangements that would have a current or future material effect on our financial condition, changes in financial condition, revenue, expense, results of operations, liquidity, capital expenditures or capital resources.
Inflation — We believe that inflation has not had a significant impact in the past and is not likely to have a significant impact in the foreseeable future on our results of operations.
Beagell Group

Overview
The Beagell Group, a co-predecessor, includes three commonly-controlled companies: Don’s, Gary’s and Horseheads. Don’s and Gary’s were founded in 1979 in Binghamton, New York, and Horseheads was founded in 1990 in Elmira, New York. Don’s sells recycled OEM products through its two full-service dismantling and distribution facilities located in Binghamton, New York and Pennsburg, Pennsylvania. As of May 18, 2015, Don’s operated a total of six dismantling bays and had approximately 81 full-time employees. Gary’s and Horseheads sell recycled OEM products through their self-service facilities in Binghamton and Elmira, New York. As of May 18, 2015, Gary’s and Horseheads together had approximately 39 employees.


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Results of Operations for the period from January 1, 2015 to May 18, 2015 Compared to the Year Ended December 31, 2014
Revenue decreased by $19.5 million, or 63.7% to $11.1 million for the period from January 1, 2015 to May 18, 2015 from $30.6 million for the year ended December 31, 2014. Cost of goods sold decreased by $12.5 million, or 62.8%, to $7.4 million for the period from January 1, 2015 to May 18, 2015 from $19.9 million for the year ended December 31, 2014. As a percentage of revenue, cost of goods sold increased to 66.6% of revenue for the period from January 1, 2015 to May 18, 2015 compared to 65.0% of revenue for the year ended December 31, 2014. Operating expenses decreased by $5.1 million, or 61.7%, to $3.2 million for the period from January 1, 2015 to May 18, 2015 from $8.3 million for the year ended December 31, 2014. The primary reason for these changes is the reduced number of days in the 2015 period compared to 2014.

Liquidity and Capital Resources
Prior to its acquisition by Fenix Parts on May 19, 2015, the primary source of ongoing liquidity for Beagell Group was cash flows from operations and the primary use of cash was the payment of distributions to the then-shareholders. Also, during the period from January 1, 2015 to May 18, 2015, $0.6 million in cash was provided by the liquidation of life insurance policies.

Standard Group

Overview
Standard Auto Wreckers, Inc., was founded in 2005, in Niagara Falls, New York; End of Life Vehicles Inc. was founded in 2007 in Toronto, Ontario; Goldy Metals Incorporated was founded in 1979 in Toronto, Ontario; and Goldy Metals (Ottawa) Incorporated was founded in 2013 in Ottawa, Ontario. We collectively refer to Standard Auto Wreckers, Inc. and its three Canadian affiliates as “Standard” and consider it a co-predecessor company.

Standard sells recycled OEM products through three full-service dismantling and distribution facilities located in Niagara Falls, New York; Port Hope, Ontario; and Ottawa, Ontario. As of May 18, 2015, Standard operated a total of 22 dismantling bays and had 191 full-time employees. Ottawa facilities run self-service operations adjacent to the full-service operation. An additional full-service dismantling and distribution facility with 12 dismantling bays were added in Port Hope, Ontario in 2014 to replace the Scarborough full-service operation and allow for the expansion of the self-service operation.

Results of Operations for the period from January 1, 2015 to May 18, 2015 Compared to the Year Ended December 31, 2014
Revenue decreased by $22.2 million, or 71.4%, to $8.9 million for the period from January 1, 2015 to May 18, 2015 from $31.1 million for the year ended December 31, 2014. Cost of goods sold decreased by $13.7 million, or 69.6%, to $6.0 million for the period from January 1, 2015 to May 18, 2015 from $19.7 million for the year ended December 31, 2014. As a percentage of revenue, cost of goods sold increased to 67.3% of revenue for the period from January 1, 2015 to May 18, 2015 compared to 63.3% of revenue for the year ended December 31, 2014. Operating expenses decreased by $6.1 million, or 64.5%, to $3.4 million for the period from January 1, 2015 to May 18, 2015 from $9.5 million for the year ended December 31, 2014. The primary reason for these changes is the reduced number of days in the 2015 period compared to 2014.

Liquidity and Capital Resources
Prior to its acquisition by Fenix Parts on May 19, 2015, the primary source of ongoing liquidity for Standard was cash flows from operations. As described in Note 7, Fire at Toronto Facility, to the combined financial statements in this document, a fire occurred at the Goldy Metals Toronto facility in March 2014 which destroyed the dismantling facility and a substantial portion of the location’s inventory. Standard received substantial insurance proceeds during the year ended December 31, 2014, which were primarily used to fund capital expenditures of $2.1 million during the period to build a new facility in Port Hope.

ITEM 7A – 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 fall at a greater rate than our vehicle acquisition costs, as occurred during 2015 and especially in the fourth quarter of 2015, we experience a decline in our reported gross margins.


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Table of Contents

Our earnings are affected by changes in interest rates due to the fact that interest on our credit facility is calculated based upon a base rate plus an applicable margin. For our U.S. borrowings, 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 based on the Company's Total Leverage Ratio, as described below. The borrowings were subject to interest rates of 2.50% at December 31, 2015. The maximum and initial margin for interest rates after December 31, 2015 on U.S. borrowings under the Credit Facility is 3.25% on LIBOR loans and 2.25% on base rate loans.

The Canadian borrowings under the credit facility bear interest at fluctuating rates determined quarterly, at the Company’s election in advance for any applicable interest period, by reference to the “Canadian base rate” plus the applicable margin within the relevant range of margins provided in the Credit Facility. The Canadian base 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 based on the Company's Total Leverage Ratio, as described below. The maximum and initial margin for interest rates after December 31, 2015 on Canadian borrowings under the Credit Facility is 2.25% on base rate loans.

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. However, a substantial reduction in the value of the Canadian dollar against the U.S. dollar will result in reduced revenues and costs being reported in our financial statements and can impact the economics of cross-border trading of inventory between our U.S. and Canadian operations.


Table of Contents

ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Fenix Parts, Inc.
Westchester, IL

We have audited the accompanying consolidated balance sheets of Fenix Parts, Inc. as of December 31, 2015 and 2014 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the year ended December 31, 2015 and the period from January 2, 2014 (inception) to December 31, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fenix Parts, Inc. at December 31, 2015 and 2014, and the results of its operations and its cash flows for the year ended December 31, 2015 and the period from January 2, 2014 (inception) to December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA LLP
Chicago, IL
April 14, 2016



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Table of Contents

Fenix Parts, Inc.
CONSOLIDATED BALANCE SHEETS

 
December 31, 2015
 
December 31, 2014
ASSETS
 
 
 
CURRENT ASSETS
 
 
 
Cash and cash equivalents
$
2,826,870

 
$
453,047

Accounts receivable, net of allowance
6,834,047

 

Inventories
38,891,618

 

Prepaid expenses and other current assets
545,089

 
50,000

Deferred stock offering costs

 
346,369

Total current assets
49,097,624

 
849,416

PROPERTY AND EQUIPMENT
 
 
 
Leasehold improvements
1,528,086

 

Vehicles
3,132,684

 

Machinery and equipment
7,190,281

 

Office furniture and fixtures
825,507

 

Computer equipment and software
426,328

 

Accumulated depreciation and amortization
(1,493,895
)
 

Property and equipment, net
11,608,991

 

OTHER NON-CURRENT ASSETS
 
 
 
Goodwill
76,811,658

 

Intangible assets, net
33,785,718

 

Off market lease payments
1,217,569

 

Indemnification receivables
5,078,367

 

Other non-current assets
67,934

 

Total non-current assets
116,961,246

 

TOTAL ASSETS
$
177,667,861

 
$
849,416

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

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Table of Contents


CONSOLIDATED BALANCE SHEETS

 
December 31, 2015
 
December 31, 2014
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
 
 
 
CURRENT LIABILITIES
 
 
 
Account payable
$
3,456,346

 
$
1,673,259

Accrued expenses and other current liabilities
2,846,997

 
303,731

Sales return reserve
687,799

 

Deferred warranty revenue – current
545,684

 

Deferred rent
329,779

 

Contingent consideration liabilities - current
9,344,626

 

Current portion of long-term debt
793,138

 

Current portion of related party long-term debt
100,000

 

Current portion of non-substantive related party consulting fees
394,769

 

Total current liabilities
18,499,138

 
1,976,990

NON-CURRENT LIABILITIES
 
 
 
Deferred warranty revenue, net of current portion
226,811

 

Long-term related party debt, net of current portion
100,000

 

Long-term portion of non-substantive related party consulting fees
1,196,235

 

Long-term debt, net of current portion
19,644,692

 

Contingent consideration liabilities, net of current portion
6,084,999

 

Deferred income tax liabilities
15,624,178

 

Amounts due to related parties, net of current portion
774,720

 

Reserve for uncertain tax positions
5,733,480

 

Total non-current liabilities
49,385,115

 

TOTAL LIABILITIES
67,884,253

 
1,976,990

COMMITMENTS AND CONTINGENCIES

 

SHAREHOLDERS’ EQUITY (DEFICIT)
 
 
 
Common stock, $0.001 par value; 30,000,000 shares authorized; 19,926,868 and 2,429,333 shares issued and outstanding at December 31, 2015 and 2014, respectively
19,927

 
2,429

Additional paid-in capital
136,398,571

 
3,616,571

Accumulated other comprehensive loss
(4,246,811
)
 

Accumulated deficit
(30,788,079
)
 
(4,746,574
)
Total Fenix Parts, Inc. shareholders’ equity before noncontrolling interest
101,383,608

 
(1,127,574
)
Noncontrolling interest
8,400,000

 

Total shareholders’ equity (deficit)
109,783,608

 
(1,127,574
)
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
$
177,667,861

 
$
849,416

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


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Table of Contents

Fenix Parts, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

 
Year Ended 
 December 31, 2015
 
Period from
January 2, 2014 (Inception) to
December 31, 2014
Net revenues
$
68,945,959

 
$

Cost of goods sold
53,559,082

 

Gross profit
15,386,877

 

Selling, general and administrative
28,346,133

 
231,830

Outside service and professional fees
9,090,533

 
4,515,287

Depreciation and amortization
2,743,235

 

Change in fair value of contingent consideration liabilities
6,049,652

 

Operating loss
(30,842,676
)
 
(4,747,117
)
 
 
 
 
Interest expense
(262,861
)
 

Other (expense) income, net
(1,959,316
)
 
543

Total other expense, net
(2,222,177
)
 
543

Loss before income tax benefit
(33,064,853
)
 
(4,746,574
)
Benefit for income taxes
7,023,348

 

Net loss
(26,041,505
)
 
(4,746,574
)
Foreign currency translation adjustment
(4,246,811
)
 

Net comprehensive loss
$
(30,288,316
)
 
$
(4,746,574
)
Loss per share available to common shareholders
 
 
 
Basic & Diluted
$
(1.86
)
 
$
(2.22
)
Shares used in computing earnings per share
 
 
 
Basic & Diluted
13,332,691

 
2,142,994

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


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Table of Contents

Fenix Parts, Inc.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

 
Common Stock
 
Additional 
paid-in
capital
 
Accumulated
other
comprehensive
loss
 
Accumulated
deficit
 
Noncontrolling
interest
 
Total
shareholders
equity (deficit)
 
Shares
 
Amount
 
 
 
 
 
Balance at January 2, 2014 (inception)

 
$

 
$

 
$

 
$

 
$

 
$

Shareholder contributions
2,429,333

 
2,429

 
3,616,571

 

 

 

 
3,619,000

Net loss

 

 

 

 
(4,746,574
)
 

 
(4,746,574
)
Balance at December 31, 2014
2,429,333

 
$
2,429

 
$
3,616,571

 
$

 
$
(4,746,574
)
 
$

 
$
(1,127,574
)
Shareholder contributions prior to initial public offering
319,594

 
320

 
3,904,126

 

 

 

 
3,904,446

Net proceeds from initial public offering
13,800,000

 
13,800

 
101,264,806

 

 

 

 
101,278,606

Issuance of Fenix shares for Combination Consideration
3,083,962

 
3,084

 
24,567,621

 

 

 

 
24,570,705

Issuance of Fenix Canada preferred shares to non-controlling interest for Combination Consideration

 

 

 

 

 
8,400,000

 
8,400,000

Compensation for pre-IPO services
20,000

 
20

 
216,780

 

 

 

 
216,800

Leesville retention bonus
271,111

 
271

 
1,378,310

 

 

 

 
1,378,581

Share based compensation to employees and directors
2,868

 
3

 
1,450,357

 

 

 

 
1,450,360

Foreign currency translation adjustment

 

 

 
(4,246,811
)
 

 

 
(4,246,811
)
Net loss

 

 

 

 
(26,041,505
)
 

 
(26,041,505
)
Balance at December 31, 2015
19,926,868

 
$
19,927

 
$
136,398,571

 
$
(4,246,811
)
 
$
(30,788,079
)
 
$
8,400,000

 
$
109,783,608

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



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Table of Contents

Fenix Parts, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Year Ended 
 December 31, 2015
 
Period from
January 2, 2014
(Inception) to
December 31, 2014
Cash flows from operating activities
 
 
 
Net loss
$
(26,041,505
)
 
$
(4,746,574
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
Depreciation and amortization
3,571,454

 

Share-based compensation expense
3,045,741

 

Deferred income taxes
(8,661,579
)
 

Non-cash rent expense
567,041

 

Amortization of inventory fair value adjustment
8,584,615

 

Change in fair value of contingent consideration liabilities
6,049,652

 

Make whole provision for pre-IPO investors
1,827,085

 

Deferred warranty revenue
772,495

 

Change in assets and liabilities, net of acquired businesses
 
 
 
Accounts receivable
(4,760,069
)
 

Inventories
(276,302
)
 

Prepaid expenses and other assets
647,124

 
(396,369
)
Accounts payable
(806,157
)
 
1,673,259

Accrued expenses and other liabilities
(1,045,906
)
 
303,731

Due to related parties
774,720

 

Net cash used in operating activities
(15,751,591
)
 
(3,165,953
)
Cash flows from investing activities
 
 
 
Capital expenditures
(329,646
)
 

Purchases of companies, net of cash acquired
(105,224,232
)
 

Net cash used in investing activities
(105,553,878
)
 

Cash flows from financing activities
 
 
 
Proceeds from initial public offering
102,672,000

 

Stock offering costs for IPO
(1,393,394
)
 

Proceeds from other issuances of common stock
2,077,361

 
3,619,000

Borrowings on term loan and revolving credit line
21,200,000

 

Payments on term loan
(375,000
)
 

Debt issuance cost
(438,000
)
 

Net cash provided by financing activities
123,742,967

 
3,619,000

Effect of foreign exchange fluctuations on cash and cash equivalents
(63,675
)
 

Increase in cash and cash equivalents
2,373,823

 
453,047

Cash and cash equivalents, beginning of period
453,047

 

Cash and cash equivalents, end of period
$
2,826,870

 
$
453,047

Supplemental cash flow disclosures:
 
 
 
Cash paid for interest
$
229,000

 
$

Cash paid for income taxes
$
129,000

 
$

Noncash transactions:
 
 
 
Equity issued for purchases of the Subsidiaries
$
32,971,000

 
$

Accrued non-substantive consulting fees for acquisitions
$
1,787,000

 
$

Note related to Go Pull-it
$
200,000

 
$

Off market lease asset from acquisitions
$
1,538,000

 
$

Accrued contingent consideration for acquisitions
$
10,237,000

 
$

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

46


Fenix Parts, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts)

Note 1. Description of Business and Basis of Presentation

Description of Business
Fenix Parts, Inc. and subsidiaries (the “Company” or “Fenix”) is in the business of auto recycling, which is the recovery and resale of original equipment manufacturer ("OEM") parts, components and systems, such as engines, transmissions, radiators, trunks, lamps and seats reclaimed from damaged, totaled or low value vehicles. Fenix's operations are conducted through its subsidiaries, which are described below. 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 components. The Company’s customers include collision repair 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, the sale of aftermarket parts, and the sale of extended warranty contracts.

Fenix was founded on January 2, 2014, to acquire and combine companies in the automobile recycling and resale industry. Fenix Parts Canada, Inc. (“Fenix Canada”), a wholly-owned subsidiary of Fenix, was established on September 24, 2014 primarily to facilitate the acquisition and combination of companies in the automobile recycling and resale industry in Canada. Through November 2014, Fenix and Fenix Canada entered into Combination Agreements to acquire the eleven corporate entities that operate eight businesses (the "Founding Companies") which are detailed in Note 3, contingent upon, among other things, the closing of an initial public offering of common stock (the "IPO"). On May 19, 2015, Fenix completed the IPO and closed on the Combinations with the Founding Companies, including those Founding Companies that are designated as accounting co-predecessors. The aggregate Combination Consideration is also detailed in Note 3. Fenix raised the cash portion of the Combination Consideration in its IPO as well as from additional funding from indebtedness. During the third quarter and fourth quarter of 2015, Fenix acquired three additional automobile recycling companies ("Subsequent Acquisitions"). The Founding Companies and Subsequent Acquisitions represent Fenix's operating subsidiaries ("Subsidiaries") as defined and described in Note 3. The operations of the Founding Companies are reflected in the Consolidated Statements of Operations for 2015 from the date of acquisition on May 19, 2015. The Subsequent Acquisitions are reflected in the Consolidated Statements of Operations for 2015 from their respective dates of acquisition.

Liquidity and Financial Condition
Since its inception, Fenix's primary sources of ongoing liquidity are cash flows from operations, cash provided by borrowings and proceeds from private stock sales and the IPO. 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 following the IPO and amortizes asset write-ups and intangibles assets established at acquisition. Fenix may never become profitable if it cannot successfully integrate the Subsidiaries. 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. As of December 31, 2015, Fenix had an accumulated deficit of $30.8 million. Effective December 31, 2015, the Company has entered into a $35.0 million amended and restated senior secured credit facility with BMO Harris Bank N.A. (the "Amended Credit Facility" or "Credit Facility") (see Note 4 below for further details) which replaces the original Credit Facility with BMO Harris Bank N.A. (the “Original Credit Facility”). The Company's previous borrowings under the Original Credit Facility ($9.6 million of term loan and $11.2 million under the revolver) as well as a $5.9 million standby letter of credit as of December 31, 2015, remain outstanding under the Amended Credit Facility. As of December 31, 2015, the Company has working capital of $30.6 million, including cash and cash equivalents of $2.8 million, and has approximately $4.7 million in available borrowings ($2.9 million in U.S. Dollars and $2.4 million that can be drawn in Canadian Dollars) under its revolving line of credit after considering the applicable financial covenants and restrictions in the agreement. The term of the revolving credit facility and the term loan is five years from the date of the Original Credit Facility, expiring on May 19, 2020. While Fenix has been successful in securing financing to provide adequate funding for working capital purposes, compliance with the financial covenants and restrictions in the amended and restated senior secured credit facility is measured quarterly and determines the amount of additional available credit, if any, that will be available to us in the future. There is no assurance that management will be successful in integrating the business in a timely manner or in obtaining additional or replacement financing, if needed, to sufficiently fund future operations, repay existing debt or to implement its growth strategy. The Company's failure to execute on this strategy may have a material adverse effect on its business, results of operations and financial position.

Basis of Presentation
These consolidated financial statements include the accounts of Fenix Parts and its wholly owned Subsidiaries and were prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). All intercompany transactions have been eliminated. The consolidated Company represents a single operating segment.



Note 2. Summary of Significant Accounting Policies

Use of Estimates
The preparation of 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, certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the 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
The Company includes cash and investments having an original maturity of three months or less at the time of acquisition in cash and cash equivalents.

Accounts Receivable and Allowance for Doubtful Accounts
In the normal course of business, the Company extends credit to customers after a review of each customer’s credit history. The Company maintained a reserve for uncollectible accounts of approximately $460 and $0, at December 31, 2015 and 2014, respectively. The reserve is based upon management’s assessment of the collectability of specific customer accounts, the aging of the accounts receivable and historical experience. Receivables are written off once collection efforts have been exhausted. Recoveries of accounts receivable previously written off are recorded when received.

Inventories
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 based upon the price the Company pays for a vehicle, including auction, storage and towing fees, as well as expenditures for buying and dismantling vehicles. After dismantling, the cost assigned to the salvaged parts and scrap is determined using the average cost to sales percentage at the 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 vehicle profitability for salvage vehicles purchased at auction or procured from other sources. 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 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.

Foreign Currency Translation and Transactions
A majority of the revenues of the Company are generated in U.S. dollars (“dollars”). In addition, a substantial portion of the Company’s costs are incurred in dollars. Management believes that the dollar is the primary currency of the economic environment in which the Company operates. Thus, the functional and reporting currency of the Company including most of its subsidiaries is the dollar. Accordingly, monetary accounts maintained in currencies other than dollars are re-measured into dollars, with resulting gains and losses reflected in the Consolidated Statements of Operations, as appropriate. The assets and liabilities of Fenix Canada, whose functional currency is the Canadian dollar, are translated into U.S. dollars, the reporting currency, at period-end exchange rates. Income and expense items are translated at the average rates of exchange prevailing during the period. The adjustments resulting from translating the Canadian financial statements are reflected as a component of accumulated other comprehensive loss within shareholders’ equity (deficit). 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 or period end date.

Revenue Recognition
The Company recognizes revenue from the sale of vehicle replacement products and scrap and, to a lesser extent, used cars and motorcycles, 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 has recorded a sales return reserve for estimated returns and discounts of approximately $688 and $0 at December 31, 2015 and 2014, respectively.




48



The Company presents taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue and expenses on the consolidated statements of operations and are shown as current liabilities on the consolidated balance sheets until remitted. Revenue 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 $289 and $0 for the years ended December 31, 2015 and 2014, respectively.

The change in the deferred warranty liability for the year ended December 31, 2015 is summarized below:
(In thousands)
 
Beginning balance
$

Warranty sales
1,061

Revenue recognized
(289
)
Ending balance
$
772


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 or, in the case of car and motorcycle sales, to preparing the vehicle for sale.

Selling, General, and Administrative ("SG&A") Expenses
SG&A expenses for the automobile recycling business 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. SG&A expenses for the periods presented also include corporate office costs. For the years ended December 31, 2015 and 2014, advertising and marketing expense amounted to approximately $688 and $0, respectively. Advertising costs are charged to expense as incurred.

Outside Services and Professional Fees
Outside services and professional fees include third-party costs related to legal matters, accounting and auditing, tax compliance and consultation, and acquisition due diligence.

Facility Leases/Deferred Rent
Fenix leases dismantling, distribution and warehouse facilities, as well as office space for corporate administrative purposes under operating leases. For scheduled rent escalation clauses during the lease terms or for rental payments commencing at a date other than the date of initial possession, Fenix records minimum rent expense on a straight-line basis over the terms of the leases in SG&A expenses and cost of goods sold, as applicable.
For leases entered into upon the closing of the acquisitions, any difference between contractual payments and then-current market rental rates is accounted for as a deferred rent asset or liability that served to reduce the aggregate combinations consideration by $1,538. These net assets are being amortized over the terms of the leases as additional rent expense as the cash rent payments differ from market rents. Accordingly, the consolidated statements of operations reflect the straight line market rental expense.
Concentrations of Risk
Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. The majority of cash and cash equivalents are maintained with several major financial institutions. The Company maintains its cash in bank deposit accounts which, at times, may exceed the insurance limits of the Federal Deposit Insurance Corporation. The Company has not experienced any losses in such accounts. Concentrations of credit risk with respect to accounts receivable are limited because a large number of customers make up the Company’s customer base. During 2015, no customer accounted for more than 1% of the Company's OEM parts revenue, and no single customer accounted for more than 10% of total net revenues. The Company controls credit risk through credit approvals, credit limits and monitoring procedures.

The Company primarily obtains its recycled OEM and related products from damaged, totaled or low value vehicles purchased at salvage auto auctions. Since the IPO, substantially all of the vehicle purchases from auction for dismantling were acquired at auctions run by two salvage auto auction companies.


49


Property and Equipment
Property and equipment are recorded at cost. Depreciation expense is calculated using the straight-line method over the estimated useful lives. Leasehold improvements are amortized over the shorter of the useful life of the related assets or the lease term. Expenditures for maintenance and repairs are charged against operations. Renewals and betterments that materially extend the useful life of an asset are capitalized. As property and equipment are sold or retired, the applicable cost and accumulated depreciation are removed from the accounts and any resulting gain or loss thereon is recognized.

The Company records depreciation expense within the depreciation and amortization line item within the consolidated statements of operations. Additionally, depreciation expense associated with the Company's dismantling and procurement operations is charged to inventories and then included in cost of goods sold in the consolidated statements of operations. Depreciation expense totaled approximately $1,518 and $0 for the years ended December 31, 2015 and 2014, respectively. Approximately $828 of total depreciation expense for the year ended December 31, 2015 was included in cost of goods sold and $690 was included within depreciation and amortization on the consolidated statements of operations.

Estimated useful lives of property and equipment acquired after May 19, 2015 are as follows:
Vehicles
5 years
Machinery and equipment
3-10 years
Leasehold improvements
10-15 years or term of lease, if shorter
Office furniture and fixtures
7 years
Computer equipment and software
5 years

For property and equipment the Company acquired in the acquisition of the Subsidiaries, the range of estimated remaining useful lives are as follows:
Vehicles
3-4 years
Machinery and equipment
4-6 years
Leasehold improvements
5-6 years or term of lease, if shorter
Office furniture and fixtures
4-6 years
Computer equipment and software
1-5 years

The Company evaluates the recoverability of the carrying amount of property and equipment and amortizable intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable based on an analysis of undiscounted cash flows. If the carrying value is greater than the undiscounted cash flows, impairments, if any, are reported at the lower of cost or fair value. There were no impairment charges related to long-lived assets during 2015.

Business Segment
Operating segments are components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision makers are its Chief Executive Officer and Chief Operating Officer. Since the acquisitions of the Subsidiaries, the Company operates and internally manages its business as a single operating segment, Automobile Recycling, as this is the only discrete financial information that is regularly reviewed by the chief operating decision makers. This segment provides for the recovery and resale of OEM parts, components and systems, such as engines, transmissions, radiators, trunks, lamps and seats reclaimed from damaged, totaled or low value vehicles, and the sale of ancillary items such as warranty contracts and scrap metal. Refer to Note 13 for Enterprise Wide Disclosures.


50


Goodwill
Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. In accordance with ASC 350, goodwill and other intangible assets, goodwill is not amortized. The Company is required to perform an annual impairment review, and more frequently under certain circumstances. Under the qualitative goodwill impairment assessment standard, management evaluates whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. For this analysis, management determined the Company only has one reporting unit, Automotive Recycling. If it is determined that it is more likely than not, the Company proceeds with the next step of the impairment test, which compares the fair value of the reporting unit to its carrying value. If the Company determines through the impairment process that goodwill has been impaired, the Company will record the impairment charge in its results of operations. The Company has elected to perform its annual evaluation of impairment as of October 1. There were no impairment charges related to goodwill during the post-Combination period ended December 31, 2015. See Note 12 for further disclosures regarding the Company's goodwill.

Intangible Assets
Intangible assets subject to amortization consist of trade names, customer relationships, and covenants not to compete. Amortization expense is calculated using the straight-line method over the estimated useful lives of the assets of: 5 years for trade names; and 5 years for covenants not to compete. Amortization expense is calculated using the accelerated method over the estimated useful life of the asset of 15 years for customer relationships. Off market lease payments are amortized as additional rent expense over the terms of the leases as described in Note 3.

The components of intangible assets are as follows at December 31, 2015:
(In thousands)
Gross Carrying Amount
 
Exchange Rate Effects
 
Accumulated Amortization
 
Net
Trade names
$
6,230

 
$
(197
)
 
$
(724
)
 
$
5,309

Customer relationships
29,456

 
(1,299
)
 
(1,121
)
 
27,036

Covenants not to compete
1,710

 
(61
)
 
(208
)
 
1,441

    Intangible assets, net
$
37,396

 
$
(1,557
)
 
$
(2,053
)
 
$
33,786

 
 
 
 
 
 
 
 
Off market lease payments
$
1,538

 
$
(83
)
 
$
(237
)
 
$
1,218


Amortization expense for intangible assets was $2,053 and $0 for the years ended December 31, 2015 and 2014, respectively. Additional rent expense related to incremental off market lease payments was $237 and $0 for the years ended December 31, 2015 and 2014, respectively.

The additional rent expense related to the incremental off market lease payments for the next five years is as follows:
(In thousands)
 
2016
$
328

2017
$
376

2018
$
304

2019
$
208

2020
$
140


The following table shows the estimated future amortization expense for intangible assets as of December 31, 2015 for the next five years:
(In thousands)
 
2016
$
3,342

2017
$
3,622

2018
$
3,877

2019
$
3,946

2020
$
2,980


51



Related Parties
The Company has defined, for financial reporting purposes, a "Related Party" as any (a) person who is or was (since the beginning of the last fiscal year for which the Company filed the S-1, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director, (b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the foregoing. See Note 10 for a discussion of transactions between the Company and related parties.

Contingent Consideration
The Company accounts for contingent consideration in a business combination in accordance with applicable guidance provided within the business combination rules. Under arrangements with the former owners of three Founding Companies, the former owners can earn additional cash and stock if certain performance measures are achieved subsequent to the combinations. The fair value of contingent consideration recorded in the financial statements at the Combination date is 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%. Subsequent to the Combination, management reviews the amounts of contingent consideration that are likely to be payable under current operating conditions and adjusts the initial liability as deemed necessary, with such subsequent adjustments being recorded through the statement of operations as a credit or charge. The total of all changes in the fair value of this initial liability was a $6,050 increase as reflected in the statement of operations for the year ended December 31, 2015. There is no corresponding tax benefit for these changes. See Note 3 for a further description of these arrangements.

Indemnification Receivables
In conjunction with the acquisition of the Subsidiaries, the Combinations agreements contained indemnifications from the former owners to cover, within defined limits, certain matters such as environmental and tax, for a period up to three years. As such, the Company recorded indemnification receivables, which represent recoverable amounts from the former owners of certain of the Subsidiaries if the Company is required to make certain income tax or other payments, as defined in the relevant combination agreements, for a period of three years after the Combinations.

The change in the Indemnification Receivables for the year ended December 31, 2015 is summarized below:
(In thousands)
 
Beginning balance
$

Indemnification receivables from acquisitions
5,124

Expense from change in indemnification asset
(46
)
Ending balance
$
5,078


Fair Value Measurements
Fair value 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 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 December 31, 2015, 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.

52


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 and goodwill. 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. There have been no impairment charges during 2015.

Stock Offering Costs
The Company incurred approximately $1,393 and $346 of legal, accounting, auditing and other costs directly related to its IPO through May 19, 2015 and December 31, 2014, respectively. The Company also incurred $7,728 of underwriting cost through May 19, 2015. Such costs were applied against the gross proceeds from the IPO upon its closing.

Share-based Compensation
The Company recognizes compensation expense for employee and director equity awards ratably over the requisite service period of the award, adjusted for estimated forfeitures. There was no estimated annual forfeiture rate applied to 2015 grants due to the lack of historical forfeiture experience to date. Management will continue to review and assess the estimated forfeiture rate assumption for reasonableness at least annually and potentially quarterly as more forfeiture information and experience becomes available. The Company utilizes the Black-Scholes option-pricing model to estimate the fair value of stock option awards. Determining the fair value of stock options using the Black-Scholes model requires judgement, including estimates for (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 comparable company Common Shares for a period equal to the expected life of the option; and (3) expected life of an option – an estimate based on historical experience including the effect of employee terminations.

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 carry forwards. 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. U.S. federal income taxes are not provided on undistributed earnings of Canadian subsidiaries as it is management's intent that such earnings will remain invested in these subsidiaries.

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 and records a valuation allowance against the deferred tax assets that are not more likely than not to be realized. 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 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 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 liability 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, which may require periodic adjustments and which may not accurately forecast actual outcomes. The Company's uncertain tax position reserves, including related interest and penalties of $2.4 million, were approximately $5.7 million as of December 31, 2015 and all related to tax positions taken on returns prior to the individual acquisitions of the Subsidiaries. The Company’s policy is to include interest and penalties associated with income tax obligations in income tax expense. The Company’s right to indemnification under certain of the combination agreements related to these uncertain tax positions is subject to a threshold of 1% of the purchase price, a cap of 40% of the purchase price paid for each individual acquisition. These indemnifications are subject to a three year limitation from date of the Combination.

Undistributed earnings of the Company's Canadian subsidiaries are considered to be indefinitely reinvested, and accordingly no provision for U.S. income taxes has been provided thereon. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to adjustment for foreign tax credits) and potential withholding taxes payable in Canada. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable due to the complexities associated with its hypothetical calculation; however, unrecognized foreign tax credits would be available to reduce materially any U.S. liability.


53


Loss Per Share
Basic loss per 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 as such, no earnings or losses of Fenix Canada are attributable to those holders. However, these shares are considered participating securities and therefore share in the net loss of the period since being issued on May 19, 2015. Diluted loss per share would include the impact of outstanding common share equivalents as if those equivalents were exercised or converted into common shares if such assumed exercise or conversion were dilutive. Contingently issuable shares are excluded from basic and diluted earnings per share until issuance is no longer contingent.

For the years ended December 31, 2015 and 2014, basic loss per share is equal to diluted loss per share because all outstanding stock awards are considered anti-dilutive during periods of net loss.

The following outstanding equity instruments as of December 31, 2015 are not included in the computation of diluted loss per share as the effect of including such stock options and restricted stock units in the computation would be anti-dilutive:
(In thousands, except per share amounts)
 
Year Ended 
 December 31, 2015
 
Period from
January 2, 2014 (Inception) to
December 31, 2014
Stock options
 
1,596,297

 

Restricted stock units
 
150,000

 

Leesville bonus shares
 
271,111

 


The calculations of loss per share for the years ended December 31, 2015 and 2014, are as follows:
(In thousands, except per share amounts)
 
Year Ended December 31,
 
 
2015
 
2014
Basic Loss per Common Share:
 
 
 
 
Net loss
 
$
(26,042
)
 
(4,747
)
Net loss allocable to Fenix Canada preferred shares
 
(1,222
)
 

Net loss available to common shares
 
$
(24,820
)
 
$
(4,747
)
Weighted-average common shares outstanding
 
13,333

 
2,143

Basic and diluted loss per common share
 
$
(1.86
)
 
$
(2.22
)

The Company issued 1,050,000 exchangeable preferred shares of Fenix’s subsidiary, Fenix Parts Canada, Inc. (“Exchangeable Preferred Shares”) as Combination 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. However, these shares do participate in the net income or loss of the consolidated company back to time of issuance upon being exercised for common stock.

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 with certain Subsidiaries. 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 until the issuance is no longer contingent on future events.

Recently Adopted Accounting Standards
In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity , which amends FASB Accounting Standards Codification (“ASC”) Topic 205, Presentation of Financial Statements , and FASB ASC Topic 360, Property, Plant, and Equipment . This standard amends the definition of a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. This guidance is effective on a prospective basis for annual periods beginning on or after December 15, 2014. The Company adopted this standard effective January 1, 2015. Adoption did not have any impact on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-3 which amends ASC Topic 835, Interest, to require presentation of certain debt issuance costs as a direct deduction from the carrying amount of a debt liability, consistent with debt discounts. The Company

54


early adopted this ASU for the period ended June 30, 2015 and approximately $438 of debt issuance costs was netted against its term note obligations in the consolidated financial statements at that date and approximately $387 at December 31, 2015.

In November 2015, the FASB issued ASU No. 2015-17 which amends ASC 740, Income Taxes, to require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The Company early adopted this ASU on a retrospective basis for the year ended December 31, 2015. All deferred income taxes are recorded as noncurrent at December 31, 2015 and 2014. The deferred taxes as of December 31, 2014 were fully reserved for with a valuation allowance that was reversed upon the successful completion of the IPO in May 2015.

Recently Issued Accounting Standards
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The guidance in this update, as amended, supersedes nearly all existing revenue recognition guidance under U.S. GAAP and creates a single, principle-based revenue recognition framework that is codified in a new FASB ASC Topic 606. The core principle of this guidance is for the recognition of revenue to depict the transfer of goods or services to customers at an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The new revenue standard is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those years. Early adoption is permitted only as of annual reporting periods beginning after December 31, 2016. The new standard allows for either full retrospective or modified retrospective adoption. The Company is currently evaluating the transition method that will be elected and the potential effects of the adoption of the new standard on its consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15 which amends ASC Topic 205, Presentation of Financial Statements, to describe management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. This guidance will be effective for the Company's fiscal year ended December 31, 2016. The Company does not expect adoption of this ASU to have a material impact on its consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis, which modifies the evaluation of Variable Interest Entities ("VIE"), and affects the consolidation analysis of reporting entities involved with VIEs. This guidance for public entities is effective for fiscal years beginning after December 15, 2016 with early adoption permitted. The Company is currently evaluating the impact of adopting the new standard.

In July 2015, FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, to reduce the complexity in accounting for inventory. This ASU requires entities to measure inventory at the lower of cost or net realizable value. This guidance for public entities is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of adopting the new standard.

In September 2015, FASB issued ASC No. 2015-16, 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 is currently evaluating the impact of adopting the new standard.

In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a 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 statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. 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 Fenix is still evaluating the impact of its pending adoption of the new standard on its consolidated financial statements, the Company expects that upon adoption will recognize ROU assets and lease liabilities and that the amounts could be material.
Note 3. Business Combinations

Founding Companies
On May 19, 2015, the Company closed on the Combinations with the Founding Companies, all of which are engaged in the business of automobile recycling. These Combinations were accounted for under the acquisition method of accounting. The Company acquired the stock of the U.S. Founding Companies for cash or a combination of cash and shares of its common stock, and acquired substantially all of the assets of End of Life Vehicles Inc., Goldy Metals Incorporated, Goldy Metals (Ottawa) Incorporated (collectively, "the Canadian Founding Companies") for cash or cash and shares of exchangeable preferred stock of Fenix Canada. The consideration for the Combinations was determined by arms-length negotiations between the Company and representatives of each Founding Company.

The Founding Companies include Don’s Automotive Mall, Inc., Gary’s U-Pull It, Inc., Horseheads Automotive Recycling, Inc. (collectively, the “Beagell Group”); Standard Auto Wreckers Inc., End of Life Vehicles Inc., Goldy Metals Incorporated, Goldy Metals (Ottawa) Incorporated (collectively, “Standard”); and Eiss Brothers, Inc. (“Eiss Brothers”), Green Oak Investments LLC dba GO Auto Recycling (“GO Auto”), Jerry Brown, Ltd (“Jerry Brown”) and Leesville Auto Wreckers, Inc. (“Leesville”). For accounting and reporting purposes, Fenix has been identified as the accounting acquirer and Beagell Group and Standard have been identified as accounting co-predecessors to Fenix.

The following table shows the calculation of the total Combination Consideration (the following dollar amounts in tables and notes are in thousands)
 
 
 
 
Beagell
Group
 
Standard
 
Eiss
Brothers
 
Go Auto
 
Jerry
Brown
 
Leesville
 
Total
Base Fenix share consideration
 
(a)
 
$
10,822

 
$

 
$
2,338

 
$
2,667

 
$
5,333

 
$
1,840

 
$
23,000

Base Fenix Canada share consideration
 
(b)
 

 
8,400

 

 

 

 

 
8,400

Base cash consideration
 
(c)
 
19,663

 
33,800

 
6,362

 
4,184

 
8,095

 
11,727

 
83,831

Working capital and other adjustments
 
(c)
 
1,161

 
1,762

 
810

 
(81
)
 
(1,377
)
 
1,132

 
3,407

Incremental inventory payments
 
(d)
 

 
450

 

 

 
550