Table of Contents

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
At February 21, 2017, the registrant had issued and outstanding an aggregate of 20,141,941 shares of Common Stock.
 


Table of Contents

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



Table of Contents

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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I -
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
    
Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
June 30, 2016
 
December 31, 2015
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,243

 
$
2,827

Accounts receivable, net of allowance $426 and $460
 
6,968

 
6,834

Inventories, net
 
33,227

 
38,892

Prepaid expenses and other current assets
 
911

 
545

Total current assets
 
42,349

 
49,098

Property and equipment
 
13,860

 
13,103

Accumulated depreciation and amortization
 
(2,570
)
 
(1,494
)
Property and equipment, net
 
11,290

 
11,609

Goodwill
 
37,575

 
76,812

Intangible assets, net
 
34,313

 
33,786

Indemnification receivables
 
2,562

 
5,078

Other non-current assets
 
3,481

 
3,455

TOTAL ASSETS
 
$
131,570

 
$
179,838

 
 
 
 
 
LIABILITIES
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,700

 
$
3,456

Accrued expenses
 
2,361

 
2,847

Contingent consideration liabilities - current
 
8,972

 
9,345

Current debt under credit facility, net of issuance costs
 
21,673

 
793

Other current liabilities
 
2,164

 
1,728

Total current liabilities
 
38,870

 
18,169

Deferred warranty revenue, net of current portion
 
435

 
227

Long-term related party obligations, net of current portion
 
1,086

 
2,071

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

 
19,645

Contingent consideration liabilities, net of current portion
 

 
6,085

Deferred income tax liabilities
 
11,784

 
15,624

Reserve for uncertain tax positions
 
3,075

 
5,733

Other non-current liabilities
 
2,862

 
2,500

Total non-current liabilities
 
19,242

 
51,885

TOTAL LIABILITIES
 
58,112

 
70,054

 
 
 
 
 
COMMITMENTS AND CONTINGENCIES
 

 

SHAREHOLDERS’ EQUITY
 
 
 
 
Common stock, $0.001 par value; 30,000,000 shares authorized; 19,956,907 and 19,926,868 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively
 
20

 
20

Additional paid-in capital
 
138,424

 
136,398

Accumulated other comprehensive loss
 
(2,630
)
 
(4,247
)
Accumulated deficit
 
(70,756
)
 
(30,787
)
Total Fenix Parts, Inc. shareholders’ equity before noncontrolling interest
 
65,058

 
101,384

Noncontrolling interest
 
8,400

 
8,400

Total shareholders’ equity
 
73,458

 
109,784

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
131,570

 
$
179,838


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

5

Table of Contents

Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
 

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands, except share data)
 
2016
 
2015
 
2016
 
2015
Net revenues
 
$
34,234

 
$
11,471

 
$
66,416

 
$
11,471

Cost of goods sold
 
20,760

 
10,008

 
37,842

 
10,008

Gross profit
 
13,474

 
1,463

 
28,574

 
1,463

Selling, general and administrative expenses
 
12,241

 
6,764

 
24,605

 
6,713

Outside service and professional fees
 
1,156

 
864

 
3,341

 
3,413

Depreciation and amortization
 
1,155

 
709

 
2,362

 
709

Change in fair value of contingent consideration liabilities
 
(2,977
)
 
809

 
(6,982
)
 
809

Change in indemnification receivable
 
427

 

 
2,516

 

Goodwill impairment
 

 

 
45,300

 

Operating income (loss)
 
1,472

 
(7,683
)
 
(42,568
)
 
(10,181
)
 
 
 
 
 
 
 
 
 
Interest expense
 
(500
)
 
(22
)
 
(755
)
 
(22
)
Other income (expense), net
 
151

 
(1,573
)
 
243

 
(1,704
)
Income (loss) before income tax benefit
 
1,123

 
(9,278
)
 
(43,080
)
 
(11,907
)
Benefit for income taxes
 
(270
)
 
(5,304
)
 
(3,111
)
 
(5,304
)
Net income (loss)
 
$
1,393

 
$
(3,974
)
 
$
(39,969
)
 
$
(6,603
)
 
 
 
 
 
 
 
 
 
Earnings (loss) per share available to common shareholders:
 
 
 
 
 
 
Basic
 
$
0.07

 
$
(0.33
)
 
$
(1.92
)
 
$
(0.91
)
Diluted
 
$
0.07

 
$
(0.33
)
 
$
(1.92
)
 
$
(0.91
)
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
19,799,664

 
11,388,524

 
19,732,005

 
7,003,537

Diluted
 
19,971,437

 
11,388,524

 
19,732,005

 
7,003,537

 
 
 
 
 
 
 
 
 
Dividends paid
 
$
0.00

 
$
0.00

 
$
0.00

 
$
0.00

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
1,393

 
$
(3,974
)
 
$
(39,969
)
 
$
(6,603
)
Foreign currency translation adjustment
 
(9
)
 
(705
)
 
1,617

 
(705
)
Net comprehensive income (loss)
 
$
1,384

 
$
(4,679
)
 
$
(38,352
)
 
$
(7,308
)
The accompanying notes to the unaudited condensed consolidated financial statements are an integral part of these statements.

6

Table of Contents

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

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

 
$
20

 
$
136,398

 
$
(4,247
)
 
$
(30,787
)
 
$
8,400

 
$
109,784

Leesville retention bonus
 

 

 
790

 

 

 

 
790

Share based awards
 
30,039

 

 
1,236

 

 

 

 
1,236

Foreign currency translation adjustment
 

 

 

 
1,617

 

 

 
1,617

Net loss
 

 

 

 

 
(39,969
)
 

 
(39,969
)
Balance as of June 30, 2016
 
19,956,907

 
$
20

 
$
138,424

 
$
(2,630
)
 
$
(70,756
)
 
$
8,400

 
$
73,458

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


7

Table of Contents

Fenix Parts, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Six months ended June 30,
(In thousands)
 
2016
 
2015
Cash flows from operating activities
 
 
 
 
Net loss
 
$
(39,969
)
 
$
(6,603
)
Adjustments to reconcile net loss to net cash used in operating activities
 

 
 
Depreciation and amortization
 
2,877

 
710

Share-based compensation expense
 
2,026

 
478

Non-cash rent expense
 
463

 
(61
)
Deferred income taxes
 
(629
)
 
(5,324
)
Deferred warranty revenue
 
515

 

Reversal of reserves for uncertain tax positions
 
(2,658
)
 
11

Reduction in indemnification asset
 
2,516

 

Amortization of inventory fair value mark up
 
1,402

 
2,717

Lower value of acquired inventory
 
(1,777
)
 

Retrospective inventory opening balance sheet adjustment
 
(2,221
)
 

Change in fair value of contingent consideration liabilities
 
(6,982
)
 
809

Make whole provision for pre-IPO investors
 

 
1,827

Goodwill impairment
 
45,300

 

Change in assets and liabilities
 
 
 
 
Accounts receivable
 
(174
)
 
(4,099
)
Inventories
 
(2,259
)
 
(701
)
Prepaid expenses and other current assets
 
(319
)
 
(254
)
Accounts payable
 
220

 
(1,055
)
Accrued expenses
 
629

 
1,005

Other current liabilities
 
(977
)
 
3,791

Net cash used in operating activities
 
(2,017
)
 
(6,749
)
Cash flows from investing activities
 
 
 
 
Capital expenditures
 
(535
)
 
(70
)
Purchases of companies, net of cash acquired
 
(149
)
 
(85,761
)
Net cash used in investing activities
 
(684
)
 
(85,831
)
Cash flows from financing activities
 
 
 
 
Net proceeds from initial public offering
 

 
101,289

Net proceeds from other issuances of common stock
 

 
250

Borrowings on revolving credit line
 
1,615

 
10,000

Payments on term loan
 
(375
)
 
(125
)
Debt issuance cost
 
(52
)
 
(438
)
Proceeds from other debt financing
 

 
213

Net cash provided by financing activities
 
1,188

 
111,189

Effect of foreign exchange fluctuations on cash and cash equivalents
 
(71
)
 
(18
)
Increase (decrease) in cash and cash equivalents
 
(1,584
)
 
18,591

Cash and cash equivalents, beginning of period
 
2,827

 
453

Cash and cash equivalents, end of period
 
$
1,243

 
$
19,044

Supplemental cash flow disclosures:
 
 
 
 
Cash paid for interest
 
$
523

 
$
8

Noncash transactions:
 
 
 
 
Equity issued for purchases of Subsidiaries
 
$

 
$
33,733

Accrued future consideration for acquisitions
 
$

 
$
8,620

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

8

Table of Contents

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

Note 1. Description of Business and Financial Condition

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

Liquidity and Financial Condition
Since its inception in January 2014, Fenix’s primary sources of ongoing liquidity are cash flows from operations, cash provided by bank borrowings, proceeds from private stock sales, and the $101.3 million in net proceeds from its initial public offering (“IPO”) of common stock completed in May 2015. The Company has incurred operating losses since its inception and expects to continue to report operating losses for the foreseeable future as it integrates the subsidiaries it has acquired (see Note 3 below) and amortizes asset write-ups and intangibles assets established at acquisition. Fenix may never become profitable if it cannot successfully integrate and grow the acquired operations and reduce the level of outside professional fees that have been incurred during 2015 and 2016. During the year ended December 31, 2015, the Company recorded a net loss of $26.0 million, and cash used in operating activities was $15.8 million. For the three and six months ended June 30, 2016, the Company recorded net income of $1.4 million and net loss of $40.0 million, respectively. The six month period includes an impairment of goodwill of $45.3 million (see Note 10 below), somewhat offset by the favorable impact on costs of goods sold attributable to an adjustment to the value assigned to acquired inventories (see Note 3 below) and reductions in the estimated fair value of contingent consideration liabilities (see Note 5 below). As of June 30, 2016, Fenix had an accumulated deficit of $70.8 million.

Effective December 31, 2015, the Company entered into a $35 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 replaced the original Credit Facility with BMO Harris Bank N.A. (the “Original Credit Facility”). The Amended Credit Facility contained substantially the same terms as the Original Credit Facility except for adjustments to covenants which are discussed in Note 4, below. Previous borrowings under the Original Credit Facility remained outstanding under the Amended Credit Facility, and the term remained as five years from the date of the Original Credit Facility, expiring on May 19, 2020. The Credit Facility was further amended on June 27, 2016 and August 19, 2016, with retroactive effect to March 31, 2016 and June 30, 2016, respectively, pursuant to which certain financial covenant calculations, which are described in Note 4, below, were further clarified and amended. As of June 30, 2016, after classifying all the Credit Facility debt as a current liability as discussed further below, the Company had working capital of $3.5 million, including cash and cash equivalents of $1.2 million. As of June 30, 2016, the Company owed $22.1 million under the Amended Credit Facility (consisting of a term loan with a balance of $9.3 million and a revolving credit facility with a balance of $12.8 million), and had $6.4 million in outstanding standby letters of credit. 

The Credit Facility is secured by a first-priority perfected security interest in substantially all of the Company’s assets as well as all of the assets and the stock of its domestic subsidiaries, which also guaranty the borrowings, and 66% of the stock of its direct Canadian Subsidiary, Fenix Canada (other than its exchangeable preferred shares). The Credit Facility contains financial covenants with which the Company must comply which are described further in Note 4. Compliance with the financial covenants is measured quarterly and determines the amount of additional available credit, if any, that will be available in the future. The Credit Facility also contains other customary events of default, including the failure to pay any principal, interest or other amount when due, violation of certain of the Company’s affirmative covenants or any negative covenants or a breach of representations and warranties and, in certain circumstances, a change in control. Upon the occurrence of an event of default, payment of indebtedness may be accelerated and the lending commitments may be terminated. As of June 30, 2016 and September 30, 2016, the Company was in breach of the Credit Facility’s Borrowing Base and Total Leverage Ratio requirements as defined in Note 4, as well as the requirement for timely delivery of certain quarterly certificates and reports. As a result, all of the Credit Facility debt is reported in the accompanying balance sheet as a current liability at June 30, 2016 and there can be no further borrowings of any availability under the Credit Facility until such defaults are rectified or waived.

Ability to Continue as a Going Concern
The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates continuity of operations, realization of assets and the satisfaction of liabilities in the normal

9

Table of Contents

course of business. As such, the accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets and their carrying amounts, or the amount and classification of liabilities that may result should the Company be unable to continue as a going concern.
 
As of June 30, 2016 and September 30, 2016, the Company was in breach of certain financial covenants contained in the Credit Facility. The failure to operate within the requirements of these financial covenants was due primarily to (i) lower asset values as a result of reductions during 2016 to the aggregate estimated fair value of inventory acquired as part of the purchase of Subsidiaries, which have reduced the Company’s borrowing base, (ii) limits on certain non-cash adjustments to calculate EBITDA for covenant compliance, including the $2.0 million correction of goodwill impairment discussed in Note 2 below, and (iii) EBITDA during the third quarter of 2016 that was lower than forecasted because of a decline of approximately 5% in quarterly net revenues (as compared to a Company record level of net revenues for the quarter ended June 30, 2016) and higher operating expenses, including significant accounting, legal and other fees, primarily as a result of the transition to a new public accounting firm beginning in July 2016 and the SEC inquiry discussed in Note 11, which have forced the Company to incur significant accounting and legal fees during the second half of 2016.

Management has been and remains highly focused on maximizing cash flows from operations and, to the extent possible under the circumstances, minimizing the cost of outsourced professional fees. Although scrap metal prices, which declined by more than 20% on average from the second to the third quarter of 2016, have increased since September 30, 2016, and the Company’s expectation is that the current high level of professional fees should decline after the first quarter of 2017, the Company still may not be able to comply with all the financial covenants contained in its Credit Facility in future periods unless those requirements are waived or amended or unless the Company can obtain new subordinated debt or equity financing. The Board of Directors and management continue to evaluate alternative strategies and capital structures, but there are no guarantees these discussions or negotiations will be successful. If the Company is unable to ultimately reach agreement with its lender, obtain waivers, find acceptable alternative financing or obtain equity contributions, the Company’s Credit Facility lender could elect to declare some or all of the amounts outstanding under the facility to be immediately due and payable. If this happens, the Company does not currently have sufficient liquidity to pay the then current portion of the Credit Facility. In addition, the Company has significant obligations under contingent consideration agreements related to certain acquired companies as described in Note 5, and it will need access to additional credit to be able to satisfy these obligations.
 
As a result of the above, substantial doubt exists regarding the ability of the Company to continue as a going concern, which contemplates continuity of operations, realization of assets and the satisfaction of liabilities in the normal course of business within one year from the date of this filing.

Note 2. Basis of Presentation and Significant Accounting Policies

Basis of Presentation
These unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures typically included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of Fenix Parts, Inc. and the notes thereto as of and for the year ended December 31, 2015. The Company continues to follow the accounting policies set forth in those consolidated financial statements, including its inventory accounting policy, which is reiterated as follows: Inventories consist entirely of recycled OEM and aftermarket products, including car hulls and other materials that will be sold as scrap and, to a lesser extent, used cars and motorcycles for resale. Inventory costs for recycled OEM parts are established using a retail method of accounting.  Parts are dismantled from purchased vehicles and a retail price is assigned to each dismantled part. The total retail price of the inventoried parts is reduced by the estimated balance of parts that will be subsequently sold for scrap or discounted to a reduced expected selling price.   These scrap and discount estimates are significant and require application of complex assumptions and judgments that are subject to change from period to period. The cost assigned to the salvaged parts and scrap is determined using the average cost-to-sales percentage at each operating facility and applying that percentage to the facility’s inventory at expected selling prices. The average cost-to-sales percentage is derived from each facility’s historical sales and actual cost paid for salvage vehicles purchased at auction or procured from other sources. The Company also capitalizes direct labor and overhead costs incurred to dismantle salvaged parts and prepare the parts for sale. With respect to self-service inventories, costs are established by calculating the average sales price per vehicle, including its scrap value and part value, applied to the total vehicles on-hand. Inventory costs for aftermarket parts, used cars and motorcycles for resale are established based upon the price the Company pays for these items. All inventory is recorded at the lower of cost or market value. The market value of the Company's inventory is determined based on the nature of the inventory and anticipated demand. If actual demand differs from the Company's earlier estimates, reductions to inventory carrying value are made in the period such determination is made.

10

Table of Contents


Management believes that these interim consolidated financial statements include all adjustments, normal and recurring in nature, that are necessary to present fairly the consolidated financial position of the Company as of June 30, 2016 and the results of its operations and cash flows for the periods ended June 30, 2016 and 2015. Interim results are not necessarily indicative of annual results. All significant intercompany balances and transactions have been eliminated. The consolidated Company represents a single operating segment.

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

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

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

Correction of Immaterial Errors
The Company previously incorrectly presented the net value of its above and below market long-term leases in its balance sheet. The Company assessed the materiality of this misstatement on prior periods’ financial statements in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99, Materiality, codified in ASC No. 250, Presentation of Financial Statements, and concluded that the misstatement was not material to any prior annual or interim periods. In the current period, the Company has corrected this immaterial error such that above market leases are recorded in other non-current assets and below market leases are recorded in non-current liabilities as shown in the table below.
(In thousands)
December 31, 2015
Previous presentation
 
Other non-current assets
$
1,218

Current presentation
 
Other non-current assets
$
3,388

Other non-current liabilities
$
2,170


In the first quarter of 2016, the Company failed to eliminate a portion of sales and purchases between certain subsidiaries. In addition, subsequent to reporting first quarter results, the Company determined that its first quarter adjustment of $7.3 million to reduce the aggregate estimated fair value of inventory acquired as part of the purchase of its Subsidiaries should have been $10.7 million. This fair value adjustment also has an impact on the previously reported goodwill impairment and income tax expense. Finally, the Company determined that the $2.5 million income recorded in the first quarter of 2016 for the estimated change in fair value of contingent consideration should have been $1.5 million higher due to the decline in scrap metal prices and decreased volume at the Company’s Canadian locations which are subject to the contingent consideration agreement. The Company assessed the materiality of these misstatements on prior periods’ financial statements in accordance with SAB No. 99, Materiality, codified in ASC No. 250, Presentation of Financial Statements, and concluded that the misstatements, individually and in the aggregate, were not material to the preceding interim period. In the current period, the Company has corrected these immaterial errors such that net revenues and costs and expenses for the three months ended March 31, 2016, as adjusted below reflect the proper amount of (i) intercompany sales eliminations, (ii) costs related to the adjustment to the aggregate estimated fair value of acquired inventory and goodwill impairment, and (iii) changes in contingent consideration liabilities. See Note 3 for further discussion regarding the adjustment to the estimated fair value of inventory acquired and the impact on cost of goods sold.

11

Table of Contents


Three Months Ended March 31, 2016
 
 
 
 
(In thousands)
As Previously Reported
 
Additional Elimination
 
 Acquired Inventory Fair Value Adjustment
 
Contingent Consideration Adjustment
 
As Adjusted
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
Net revenues
$
32,795

 
$
(613
)
 
$

 
 
 
$
32,182

 
$
34,234

 
$
66,416

Cost of goods sold
18,329

 
(613
)
 
(634
)
 
 
 
17,082

 
20,760

 
37,842

Change in fair value of contingent consideration liabilities
(2,505
)
 
 
 
 
 
(1,500
)
 
(4,005
)
 
(2,977
)
 
(6,982
)
Goodwill impairment
43,300

 
 
 
2,000

 
 
 
45,300

 

 
45,300

Benefit for income taxes
(3,320
)
 
 
 
479

 
 
 
(2,841
)
 
(270
)
 
(3,111
)

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

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

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

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

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

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

12

Table of Contents

The Company adopted ASU 2016-09 effective April 1, 2016 as there have been no forfeitures or exercises, this standard has not had an effect on these unaudited condensed financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13). The new standard establishes a right-of-use (ROU) model that requires a lessee to record an ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Early adoption of the amendment in the update is permitted. While the Company is currently evaluating the effect this standard will have on its consolidated financial statements and timing of adoption, we expect that upon adoption, the Company will recognize ROU assets and lease liabilities and those amounts could be material.

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

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


Note 3. Acquisitions

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

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

13

Table of Contents

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

 
$

 
$

 
$
8,666

Inventories
(i)
47,794

 
(7,260
)
 
(3,462
)
 
37,072

Property and equipment
(ii)
13,235

 

 

 
13,235

Other non-current assets
(iii)
5,271

 

 

 
5,271

Intangible assets
(iv)
37,396

 
1,620

 
90

 
39,106

Current liabilities
 
(7,572
)
 

 

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

 

 
(5,760
)
Deferred income taxes, net
(v)
(24,168
)
 
2,386

 
1,372

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

 

 
(422
)
Total net identifiable assets acquired
 
74,440

 
(3,254
)
 
(2,000
)
 
69,186

Goodwill
 
80,023

 
3,648

 
1,755

 
85,426

Total net assets acquired
 
$
154,463

 
$
394

 
$
(245
)
 
$
154,612


During the three months ended March 31, 2016, the Company reduced the aggregate estimated value of the acquired inventories by $7.3 million to reflect the most recent historical information available regarding excess and unsaleable parts acquired as well as sales discounts given to sell certain acquired parts. This inventory adjustment resulted in a $1.6 million increase in intangible assets (customer relationships), a $2.4 million reduction in deferred income taxes and a $3.3 million increase in goodwill. In accordance with ASU No. 2015-16 which is as discussed in Note 2 above, the adjustment also resulted in a reduced charge to cost of goods sold during the three months ended March 31, 2016 of approximately $3.4 million consisting of $2.1 million for the opening inventory mark up to fair value (see (i) below) and $1.3 million related to the lower value of acquired inventories sold between the respective acquisition dates and December 31, 2015. The $2.1 million adjustment to the opening inventory markup had a related $0.8 million deferred tax liability.

During the three months ended June 30, 2016, the Company reduced the aggregate estimated value of the acquired inventories by an additional $3.5 million to more accurately reflect excess and unsaleable parts acquired as well as sales discounts given to sell certain acquired parts. As the information necessary to make these determinations was available through March 2016, the additional reduction of $3.5 million in the estimated value of acquired inventories should have been recorded in the consolidated financial statements as of and for the three months ended March 31, 2016. See Note 2 for further information on the correction of this immaterial error. This additional inventory adjustment also resulted in a $0.1 million increase in intangible assets (customer relationships), a $1.4 million reduction in deferred income taxes and a $2.0 million increase in goodwill. In accordance with ASU No. 2015-16 which is discussed in Note 2 above, this additional adjustment to acquired inventories also resulted in an additional reduction to cost of goods sold applied to the three months ended March 31, 2016 of approximately $0.6 million consisting of $0.1 million for the opening inventory mark up to fair value (see (i) below) and $0.5 million related to the lower value of acquired inventories sold between the respective acquisition dates and December 31, 2015. The $2.2 million aggregate adjustment to the opening inventory markup had a related $1.0 million deferred tax liability. The $2.2 million and the $1.0 million were previously recorded through the prior period operations and were recorded through the operating results as adjusted for the three months ended March 31, 2016 within the cost of goods sold and the tax benefit line items, respectively.

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

(i)
Inventory was marked up to 90% of its estimated selling price representing the inventory’s fair market valuation, with selling costs and related profit margin estimated at all Subsidiaries to be 10%. This fair value mark up adjustment to inventory, after a reduction of $2.2 million for the opening balance sheet adjustment described above, totaled approximately $7.8 million, of which $0.5 million and $1.4 million was amortized as an additional charge recorded in cost of goods sold during the three and six months ended June 30, 2016, respectively. This fair value mark up adjustment was completely amortized through June 30, 2016 as the acquired inventory was expected to be sold within six to nine months.
(ii)
Assumptions for property and equipment valuation, which are based on cost and market approaches, are primarily data from industry databases and dealers on current costs of new equipment and information about the useful lives and age of the equipment. The remaining useful life of property and equipment was determined based on historical experience using such assets, and varies from 1 - 6 years depending on the acquired company and nature of the assets. All property and equipment is being depreciated using the straight-line method.
(iii)
The Company may recover amounts from the former owners of certain of the acquired companies if the Company is required to make certain income tax or other payments as defined in the relevant acquisition agreements after the acquisition. In the case of the Founding Companies, the Company’s right to these tax related indemnifications is generally subject to

14

Table of Contents

a threshold of 1% of the purchase price, a cap of 40% of the purchase price paid for each individual acquisition and a survival period of three years from the date of their acquisition. During the three and six months ended June 30, 2016, the Company reversed $0.4 million and $2.5 million, respectively, of indemnification receivables through a charge in the accompanying consolidated statement of operations, as the statute of limitations expired on the tax-related indemnity as discussed further in Note 9 below.
(iv)
The table below summarizes the aggregate gross intangible assets recorded:
(In thousands)
 
Trade names
$
6,122

Customer relationships
31,308

Covenants not to compete
1,676

Total
$
39,106

Amortization expense for intangible assets was $0.9 million and $0.4 million for the three months ended June 30, 2016 and 2015, respectively, and $1.8 million and $0.4 million for the six months ended June 30, 2016 and 2015, respectively.
(v)
The Company recorded deferred income taxes relating to the difference between financial reporting and tax basis of assets and liabilities acquired in the acquisitions in nontaxable transactions. The Company also eliminated historical deferred income taxes of the companies acquired in taxable transactions.

Pro Forma Results
The following table shows the combined pro forma net revenues and net loss of the Company as if all acquisitions of its Subsidiaries had occurred on January 1, 2015: 
(In thousands)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
 
2015
Net revenues
 
$
31,999

 
 
$
63,387

Net loss
 
$
(199
)
 
 
$
(3,039
)

Pro forma combined net revenues consisted of:
(In thousands)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2015
 
 
2015
Recycled OE parts and related products
 
$
27,349

 
 
$
54,668

Other ancillary products (scrap)
 
4,650

 
 
8,719

Total
 
$
31,999

 
 
$
63,387


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

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

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

Note 4. Bank Credit Facility

Amended and Restated Credit Facility
Effective December 31, 2015, the Company entered into a $35 million amended and restated senior secured credit facility with BMO Harris Bank N.A. (the “Amended Credit Facility” or “Credit Facility”) which replaced the original Credit Facility with BMO Harris Bank N.A. (the “Original Credit Facility”). The Amended Credit Facility contained substantially the same terms as the

15

Table of Contents

Original Credit Facility except for adjustments to covenants which are discussed below. Previous borrowings under the Original Credit Facility remained outstanding under the Amended Credit Facility. The Credit Facility was further amended on June 27, 2016 and August 19, 2016, with retroactive effect to March 31, 2016 and June 30, 2016, respectively, pursuant to which certain financial covenant calculations, which are described below, were further clarified and amended.

The Credit Facility consists of $25.0 million as a revolving credit facility, allocated $20.0 million in U.S. Dollar revolving loans, with a $7.5 million sublimit for letters of credit, and $5.0 million in Canadian Dollar revolving loans, with a $2.5 million sublimit for letters of credit. The Company borrowed the remaining $10.0 million as a term loan concurrently with its IPO in May 2015. Proceeds of the credit facility can be used for capital expenditures, working capital, permitted acquisitions, and general corporate purposes. The term of the revolving credit facility and the term loan facility is 5 years from the date of the Original Credit Facility with each expiring on May 19, 2020. The Amended Credit Facility and both subsequent amendments were determined to be modifications under ASC 470-50 of the Original Credit Facility that was entered into at the time of the IPO.

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

The Company’s U.S. Dollar borrowings under the Amended Credit Facility bear interest at fluctuating rates, at the Company’s election in advance for any applicable interest period, by reference to the “base rate”, “Eurodollar rate” or “Canadian Prime Rate” plus the applicable margin within the relevant range of margins provided in the Credit Facility. The base rate is the highest of (i) the rate BMO Harris Bank N.A. announces as its “prime rate,” (ii) 0.50% above the rate on overnight federal funds transactions or (iii) the London Interbank Offered Rate (LIBOR) for an interest period of one month plus 1.00%. The applicable margin is determined quarterly based on the Company’s Total Leverage Ratio, as described below. The borrowings were subject to interest rates ranging from 3.57% - 4.66% at June 30, 2016.

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

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

16

Table of Contents


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

As of June 30, 2016, the Company owed $22.1 million under the Credit Facility as shown in the table below. The Company also had $6.4 million outstanding in standby letters of credit under the Credit Facility related to the contingent consideration agreement with the former owners of the Canadian Founding Companies and the Company’s property and casualty insurance program. As of June 30, 2016 and September 30, 2016, for reasons described in Note 1, the Company was in breach of the Credit Facility’s Borrowing Base and Total Leverage Ratio requirements, as well as the requirement for timely delivery of certain quarterly certificates and reports for the second and third quarter of 2016. Since the Company is in default as of the date that this Second Quarter report on Form 10-Q is being filed, all of the Credit Facility debt is reported in the accompanying balance sheet as a current liability and there can be no further borrowings of any availability under the Credit Facility until such defaults are rectified or waived.

The Company’s Board of Directors and management continue to evaluate alternative strategies and capital structures, but there are no guarantees these discussions or negotiations will be successful. If the Company is unable to reach agreement with its lender, obtain waivers, find acceptable alternative financing or obtain equity contributions, its lender could elect to declare some or all of the amounts outstanding under the Credit Facility to be immediately due and payable. If this happens, the Company does not currently have sufficient liquidity to pay the then current portion of the Credit Facility.

Maturities of Credit Facility
The following is a summary of the components of the Company’s Credit Facility debt and amounts outstanding at June 30, 2016 and December 31, 2015:
(In thousands)
June 30, 2016
 
December 31, 2015
Obligations:
 
 
 
Term loan
$
9,250

 
$
9,625

Revolving credit facility
12,815

 
11,200

Total debt
22,065

 
20,825

Less: long-term debt issuance costs
(292
)
 
(299
)
Less: short-term debt issuance costs
(100
)
 
(88
)
Total debt, net of issuance costs
21,673

 
20,438

Less: current maturities, net of debt issuance costs
(21,673
)
 
(793
)
Long-term debt, net of issuance costs
$

 
$
19,645


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

Scheduled maturities, which the Company continues to follow, are as follows for the periods ending June 30; however, as described above, the Company is in default under the Credit Facility and the lender could elect to declare some or all of the amounts shown below as immediately due and payable and therefore all the debt is classified as a current liability in the accompanying balance sheet.
(In thousands)
2017
 
2018
 
2019
 
2020
 
Total
Revolving credit facility
$

 
$

 
$

 
$
12,815

 
$
12,815

Term loan
1,000

 
1,000

 
1,000

 
6,250

 
9,250

Debt issuance costs
(113
)
 
(113
)
 
(113
)
 
(53
)
 
(392
)
Total
$
887

 
$
887

 
$
887

 
$
19,012

 
$
21,673


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

17

Table of Contents


In connection with the original agreement, the Company incurred $438,000 in original debt issuance costs during 2015 and an additional $52,000 in amendment charges during the three months ended June 30, 2016, which are netted against the term loan balance and are being amortized over the term of the Original Credit Facility. The amortized debt issuance costs are recognized as interest expense in the condensed consolidated statement of operations and amounted to $25,000 and $47,000 for the three and six months ended June 30, 2016, respectively.

Note 5. Contingent Consideration Liabilities

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

18

Table of Contents

operating charge or credit. In the event that there is a range of possible outcomes, the Company applies a probability approach to determine the estimated obligation to be recorded at the end of an accounting period.

For the combination with Jerry Brown, Ltd. (“Jerry Brown”), the Company is required to pay (a) up to an additional $1.8 million if the business achieved certain revenue targets during the twelve-month period beginning June 2015, and (b) an additional uncapped amount if the business exceeds certain EBITDA levels during 2016. Based on an evaluation of the likelihood of meeting these performance targets, the Company recorded a liability for the acquisition date fair value of the contingent consideration of $2.5 million and increased this liability by $5.1 million during 2015 based on substantial operating improvements and management’s budget for Jerry Brown for 2016. Based on results actually achieved during the first half of 2016, EBITDA is now estimated to be less than the previously developed budget and, accordingly, the estimated fair value of the contingent liability was reduced by $2.3 million, resulting in a credit to income which is reflected in the condensed consolidated statement of operations for the six months ended June 30, 2016, of which $0.9 million was recorded during the three months ended June 30, 2016. As of June 30, 2016, the total contingent consideration liability attributable to the Jerry Brown acquisition was (a) $1.8 million for achieving the revenue target, which management and the former owners of Jerry Brown agree was fully earned, and (b) $3.5 million estimated for the EBITDA target which will be determined in 2017. The Company expects 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 and available, through draws on the revolving Credit Facility or through other sources of capital that may be available.

The combination agreements for Eiss Brothers, Inc. (“Eiss Brothers”) and End of Life Vehicles Inc., Goldy Metals Incorporated, and Goldy Metals (Ottawa) Incorporated (collectively, “the Canadian Founding Companies”) provide for a holdback of additional consideration which will be payable, in part or in whole, only if certain performance targets are achieved. The maximum amount of additional consideration that can be earned by the former owners of Eiss Brothers is $0.2 million in cash plus 11,667 shares of Fenix common stock, of which none, some or all will be released from escrow depending upon the EBITDA of Eiss Brothers during the twelve-month period beginning June 2015. The maximum amount of additional consideration that can be earned and is subject to holdback for the Canadian Founding Companies is $5.9 million in cash, secured by a letter of credit under our Credit Facility, plus 280,000 Exchangeable Preferred Shares currently held in escrow, of which, none, some or all will be released to the Canadian Founding Companies depending on their combined revenues from specific types of sales for the twelve-month period beginning June 2015. Based on management’s evaluation of the likelihood of meeting these performance targets for these two acquisitions, a liability of $7.8 million was recorded at the acquisition date for the fair value of the aggregate contingent consideration, which included the present value of the estimated cash portion and the then-current value of the Fenix common stock and the Exchangeable Preferred Shares held in escrow. While management’s estimate of the operating results for Eiss Brothers has not changed since its acquisition, the contingent consideration liability for the Canadian Founding Companies was reduced during the six months ended June 30, 2016 in accordance with FASB ASC No. 805 “Business Combinations,” which requires the Company to estimate contingent consideration at fair value using possible outcomes. As the amount of the contingent consideration is currently in dispute, the Company has recorded the estimated contingent consideration liability for the Canadian Founding Companies as of June 30, 2016 based on the result of its assessment of the possible outcomes. These contingent consideration liabilities are also subject to mark-to-market fluctuations based on changes in the trading price of Fenix common stock and, with respect to the Canadian Founding Companies, currency remeasurement. As a result of all these factors, the estimated fair value of the aggregate contingent liability due to the former owners of Eiss Brothers and the Canadian Founding Companies was reduced by $2.1 million and $4.2 million, and an exchange rate gain of $0.0 million and $0.5 million was recognized in the condensed consolidated statement of operations for the three and six months ended June 30, 2016, respectively. The Company expects to fund any cash payments to the former owners of the Canadian Founding Companies, to the extent they are ultimately deemed earned, through draws on the bank letter of credit, which is considered Funded Debt under the Total Leverage Ratio required under the Credit Facility.

The period for calculating all contingent consideration liabilities was complete as of June 30, 2016, except for Jerry Brown’s uncapped EBITDA contingency. The Company is currently in negotiations with the former owners of the Canadian Founding Companies regarding the calculation of contingent consideration earned, if any, and the parties have agreed to extend the period for finalizing the calculation past the date of this filing to provide additional time for the parties to agree on the final consideration. If the parties are unable to ultimately agree, the matter will be subject to arbitration.

Note 6. Common Stock and Preferred Shares

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

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

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

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

Note 7. Share-Based Compensation

Fenix’s 2014 Incentive Stock Plan (the “Plan”) was adopted by the Board of Directors in November 2014 and went into effect January 6, 2015 after it was approved by the Company’s shareholders. The Plan was amended by the Board of Directors and restated effective July 8, 2015 and again in November 2015, effective December 1, 2015. The Plan permits grants of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards (in the form of equity bonuses), and other awards (which may be based in whole or in part on the value of the Company’s common stock). Directors, salaried employees, and consultants of the Company and its commonly-controlled affiliates are eligible to participate in the Plan, which is administered by the Compensation Committee of the Company’s Board of Directors. The number of shares originally reserved for share-based awards under the Plan equaled 2,750,000 shares. No awards were granted prior to the IPO. As of June 30, 2016, the Company had 754,000 shares available for share-based awards under the Plan. The Plan requires that each restricted stock unit and restricted stock award issued reduce shares available by two shares.

Share-based compensation is included in selling, general and administrative expenses in the consolidated statements of operations. The components of share-based compensation were as follows:
(In thousands)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Stock options
 
$
354

 
$
62

 
$
934

 
$
62

Restricted stock grants
 
165

 

 
252

 

Leesville bonus shares
 
249

 
285

 
790

 
285

Other restricted or unregistered share issuances
 

 
131

 
50

 
131

Total share-based compensation
 
$
768

 
$
478

 
$
2,026

 
$
478



19

Table of Contents

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

The Company uses the Black-Scholes option pricing model to estimate the grant date fair value of employee and director stock options. The principal variable assumptions utilized in valuing options and the methodology for estimating such model inputs include: (1) risk-free interest rate – an estimate based on the yield of zero–coupon treasury securities with a maturity equal to the expected life of the option; (2) expected volatility – an estimate based on the historical volatility of similar companies’ common stock for a period equal to the expected life of the option; (3) expected life of the option – an estimate based on industry historical experience including the effect of employee terminations; and (4) expected dividend yield - an estimate of cash dividends. The Company does not currently intend to pay cash dividends and thus has assumed a 0% dividend yield. For the 2015 and 2016 equity award grants, there were no forfeitures applied due to the lack of historical forfeiture experience to date.

Based on the results of the model, the fair value of the stock options granted during the first six months of 2016 ranged from $1.20 to $1.54 per share using the following assumptions:
Expected dividend yield
 
%
Risk-free interest rate
 
1.3 - 1.85%

Expected volatility
 
30.0
%
Expected life of option
 
6.3 years


Stock option activity for the six months ended June 30, 2016 was as follows:
 
 
Number
of
Options
 
Weighted-
Average
Exercise Price
Per Share
 
Weighted-
Average
Remaining
Contractual
Term in Years
 
Aggregate
Intrinsic
Value
Outstanding on December 31, 2015
 
1,596,297

 
$
9.02

 
 
 
 
Granted
 
35,000

 
4.21

 
 
 
 
Exercised
 

 

 
 
 
 
Expired or forfeited
 

 

 
 
 
 
Outstanding on June 30, 2016
 
1,631,297

 
$
8.92

 
9.02
 
$
8,000

Exercisable on June 30, 2016
 
429,316

 
$
8.88

 
8.93
 
$


At June 30, 2016, there was $2.6 million of unrecognized compensation costs related to stock option awards to be recognized over a weighted average period of 3.0 years.

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

A summary of restricted stock units activity for the six months ended June 30, 2016 is as follows:

20

Table of Contents

 
 
Number of Awards
 
Weighted-
Average
Grant Date Fair Value Per Share
Unvested restricted stock units at December 31, 2015
 
150,000

 
$
9.68

Granted
 
29,332

 
4.23

Forfeited
 

 

Vested
 
19,332

 
4.00

Unvested restricted stock units at June 30, 2016
 
160,000

 
$
9.37


At June 30, 2016, there was $1.2 million of unrecognized compensation costs related to restricted stock units to be recognized over a weighted average period of 3.5 years.

The Company’s Director Compensation Policy provides that non-employee directors may elect to receive shares of fully-vested restricted stock in lieu of cash compensation based on the average closing price of the Company’s common stock during the period of service. During the three and six months ended June 30, 2016, the Company issued 19,332 fully-vested restricted shares to the directors making such election for the period of service from January 1, 2016 to May 24, 2016 (date of the Annual Meeting) and recorded compensation expense of approximately $0.1 million.

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

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

Note 8. Income (Loss) Per Share

Basic income (loss) per common share is computed by dividing net income (loss) available to common shares by the weighted average common shares outstanding during the period using the two-class method. The Fenix Canada preferred shares do not entitle the holders to any dividends or distributions and therefore, no earnings or losses of Fenix Canada are attributable to those holders. However, these shares are considered participating securities and therefore share in the Company’s net income (loss) of the period since being issued on May 19, 2015. Diluted income (loss) per share includes the impact of outstanding common share equivalents as if those equivalents were exercised or converted into common shares if such assumed exercise or conversion is dilutive.

The calculations of income (loss) per share are as follows:

21

Table of Contents

(In thousands except share data)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Basic Income (Loss) per Common Share:
 
 
 
 
 
 
 
Net income (loss)
$
1,393

 
$
(3,974
)
 
$
(39,969
)
 
$
(6,603
)
Net income (loss) allocable to Fenix Canada preferred shares
70

 
(175
)
 
(2,019
)
 
(239
)
Net income (loss) available to common shares
$
1,323

 
$
(3,799
)
 
$
(37,950
)
 
$
(6,364
)
Weighted-average common shares outstanding
19,799,664

 
11,388,524

 
19,732,005

 
7,003,537

Basic income (loss) per common share
$
0.07

 
$
(0.33
)
 
$
(1.92
)
 
$
(0.91
)
 
 
 
 
 
 
 
 
Diluted Income (Loss) per Common Share:
 
 
 
 
 
 
 
Net income (loss)
$
1,393

 
$
(3,974
)
 
$
(39,969
)
 
$
(6,603
)
Net income (loss) allocable to Fenix Canada preferred shares
78

 
(175
)
 
(2,019
)
 
(239
)
Net income (loss) available to common shares
$
1,315

 
$
(3,799
)
 
$
(37,950
)
 
$
(6,364
)
Dilution from stock options and unvested RSUs
171,773

 
0

 
0

 
0

Weighted-average common shares outstanding
19,971,437

 
11,388,524

 
19,732,005

 
7,003,537

Diluted income (loss) per common share
$
0.07

 
$
(0.33
)
 
$
(1.92
)
 
$
(0.91
)

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

Note 9. Income Taxes

For interim periods, the Company estimates its effective tax rate for the full year and records an interim provision or benefit, as applicable, at such rate.  The Company’s effective tax rate (benefit) of 7.2% for the six months ended June 30, 2016, differs from the U.S. federal statutory rate of 34% due primarily to the goodwill impairment, for which no tax benefit was recorded as described further in Note 10. Other items impacting the effective tax rate include the reversal of $2.7 million in reserves for uncertain tax positions as described below, state income taxes, differences between U.S. and Canadian income tax rates, changes in the indemnification receivable and the contingent consideration liability which are not tax deductible, and the effect of a valuation allowance recorded for Canadian deferred tax assets. The effective tax rate for the six months ended June 30, 2015 was 44.5%.

The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. The Company’s uncertain tax position reserves at June 30, 2016, including related accrued interest and penalties of approximately $1.4 million, all relate to tax positions assumed as part of the acquisitions in 2015. These tax reserves are reviewed periodically and adjusted in light of changing facts and circumstances, such as progress of tax audits, lapse of applicable statutes of limitations, and changes in tax law. Under certain conditions, payments made by the Company, including interest and penalties, for assumed uncertain tax positions are indemnified by the previous owners of the Subsidiaries for a period of three years from the acquisition in the case of the Founding Companies and for the period of the applicable statute of limitations in the case of the later-acquired companies. As of December 31, 2015, the Company had approximately $5.7 million of uncertain tax position reserves. During the six months ended June 30, 2016, the statute of limitations lapsed without audit for certain tax returns filed by acquired companies for which reserves for uncertain tax positions and indemnification receivables had been established. As a result, the Company reversed $2.7 million of uncertain tax position reserves, which included $1.0 million of accrued interest and penalties, as a credit to the income tax benefit in the condensed consolidated statement of operations. As of June 30, 2016, the remaining uncertain tax position reserves amounted to approximately $3.1 million. Correspondingly, the indemnification receivables were reduced by $2.5 million through a charge to operating expenses, and there is a remaining indemnification receivable of $2.6 million recorded in the balance sheet as of June 30, 2016. If a reserved uncertain tax position results in an actual liability and the Company is unable to collect on or enforce the related indemnification provision or if the actual liability occurs after the applicable indemnity period has expired, there could be a material charge to the Company’s consolidated financial results and reduction of cash resources.

Note 10. Goodwill and Intangible Assets


22

Table of Contents

Goodwill represents the excess of the cost of an acquired business over the net of the amounts assigned to assets acquired and liabilities assumed. Changes in the carrying amount of goodwill were as follows:
(In thousands)
 
 
Balance as of December 31, 2015
 
$
76,812

Purchase accounting allocation adjustments, as corrected (see Note 3)
 
5,648

Exchange rate effects
 
659

Balance before impairment
 
83,119

Impairment charge, as corrected (Note 2)
 
(45,300
)
Balance as of March 31, 2016
 
$
37,819

Exchange rate effects
 
1

Purchase accounting allocation adjustments (see Note 3)
 
(245
)
Balance as of June 30, 2016
 
$
37,575


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

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

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

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

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

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

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

23

Table of Contents


While management believes that the estimates and assumptions underlying the valuation methodology are reasonable, different estimates and assumptions could result in substantially different outcomes. The table below presents the decrease in the fair value of the reporting unit given a one percent increase in the discount rate or a one percent decrease in the long-term assumed annual revenue growth rate. A 10% change in the weighting of the discounted cash flow approach and the market approach would not have had a significant effect on the fair value of the reporting unit.
 
Decrease in Fair Value of Reporting Unit
(in thousands)
Discount Rate - Increase by 1%
$
11,000

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

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

Intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill. The Company’s intangible assets, net of accumulated amortization, totaled $35.2 million at March 31, 2016 and $34.3 million at June 30, 2016, and consist of trade names, non-competition agreements and customer relationships. The Company, in conjunction with its third party valuation expert, used various techniques in estimating the initial fair value of acquired intangible assets. These valuations are primarily based on the present value of the estimated net cash flows expected to be derived from the intangible assets, discounted for assumptions such as future customer attrition. Management evaluates the intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Therefore, changes such as higher or earlier-than-expected customer attrition may result in higher future amortization charges or an impairment charge for intangible assets. As part of the goodwill impairment analysis discussed above, the Company also reviewed intangible assets and did not identify any impairment as of March 31, 2016.

There were no indicators at June 30, 2016 that caused the Company to revisit the possibility of further impairment for goodwill and for intangible assets. Expected second quarter results and market capitalization were considered as part of the March 31, 2016 analysis, and actual results and other key factors did not deviate from management’s expectations in such a way that would call into question the realizability of goodwill and other long lived assets as of June 30, 2016.

Note 11. Commitments and Contingencies

Operating Leases
Rental expense for operating leases was approximately $0.8 million and $1.6 million during the three and six months ended June 30, 2016, respectively. The Company leases properties from the former owners of the Founding Companies and other related parties. The Company did not enter into any new leases during the six months ended June 30, 2016.

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

SEC Inquiry
In September 2016, the Company received a subpoena from the Chicago Regional Office of the SEC requiring the production of various documents, which were all provided during December 2016 and January 2017. The SEC inquiry appears to be focused on the Company’s change during 2016 in its independent registered public accounting firm, its previously announced business combinations and related goodwill impairment charge, the effectiveness of its internal controls over financial reporting and its

24

Table of Contents

inventory valuation methodology. The Company’s receipt of a subpoena from the SEC does not mean that it has violated securities laws. Although the Company has incurred substantial legal fees and other costs associated with production of the documents required by the SEC and may incur further costs before this inquiry is concluded, management does not believe that the inquiry will ultimately have a material impact on the Company’s financial condition, results of operations or cash flow, but cannot predict the duration or outcome of the inquiry.

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

Note 12. Fair Value Measurements

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


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


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

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

Beagell Group
UNAUDITED CONDENSED COMBINED STATEMENTS OF OPERATIONS
(In thousands)
Period from
April 1, 2015 to May 18, 2015
 
Period from
January 1, 2015 to May 18, 2015
Net revenues
$
4,050

 
$
11,107

Cost of goods sold
2,532

 
7,395

Gross profit
1,518

 
3,712

Operating expenses
1,417

 
3,184

Income from operations
101

 
528

Other income
63

 
64

Income before income tax expense
164

 
592

Income tax expense
19

 
76

Net income
$
145

 
$
516

Net income attributable to noncontrolling interest
103

 
279

Net income attributable to Beagell Group
$
42

 
$
237



25

Table of Contents

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

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

Provision for uncertain tax positions
 
86

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

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

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

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

Premium payments on life insurance policies
 
594

Payments made on related party receivables
 
333

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

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

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

Supplemental cash flow disclosures
 
 
Cash paid for income taxes
 
$
5



26

Table of Contents

Beagell Group
NOTES TO UNAUDITED CONDENSED COMBINED FINANCIAL STATEMENTS

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

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

Note 2. Summary of Significant Accounting Policies

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

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

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

27

Table of Contents

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

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

Revenue from the sale of separately priced extended warranty contracts is reported as deferred revenue and recognized ratably over the term of the contracts. Revenue from such extended warranty contracts was approximately $65,000 for the period from April 1, 2015 to May 18, 2015 and $189,000 for the period from January 1, 2015 to May 18, 2015.

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

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

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

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

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

Note 3. Commitments and Contingencies

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

28

Table of Contents

Note 4. Income Taxes
Each of the Company’s commonly-controlled entities described in Note 2 have elected to operate under Subchapter S of the Internal Revenue Code. The Company’s primary uncertain tax position arises from uncertainties regarding the continued qualifications of one of the entities for that Subchapter S election and the related reserve was approximately $2,017,000 at May 18, 2015. It is reasonably possible that the amount of benefits from this uncertain tax position will significantly increase or decrease in the next twelve months; however, no estimate of the range of the amount of the increase or decrease can be readily made.
In addition to the uncertain tax positions described above, the Company has other uncertain tax positions related to the timing of certain deductions for income tax purposes. The related basis differences caused by this timing of deductions for income tax purposes and the timing of expense recognition for financial reporting purposes are reported by the Company’s equity holders. However, interest and penalties are separately recorded for all uncertain tax positions as part of income tax expense and amounted to approximately $8,000 for the period from April 1, 2015 to May 18, 2015 and $24,000 for the period from January 1, 2015 to May 18, 2015. The Company had accumulated interest and penalties of approximately $373,000 as of May 18, 2015, which are included in the reserve for uncertain tax positions on the combined balance sheets.
The Company is generally no longer subject to examination in primary tax jurisdictions for tax years through 2011. The Company is not currently subject to any audits or examinations.

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


29

Table of Contents

Standard
UNAUDITED CONDENSED COMBINED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands)
Period from
April 1, 2015 to May 18, 2015
 
Period from
January 1, 2015 to May 18, 2015
Net revenues
$
3,318

 
$
8,914

Cost of goods sold
2,475

 
5,996

Gross profit
843

 
2,918

Operating expenses
1,347

 
3,385

Loss from operations
(504
)
 
(467
)
Other income, net
57

 
302

Loss before income tax expense
(447
)
 
(165
)
Income tax provision

 
79

Net loss
(447
)
 
(244
)
Net loss attributable to noncontrolling interest
11

 
(15
)
Net loss attributable to Standard
$
(458
)
 
$
(229
)
Net loss
$
(447
)
 
$
(244
)
Foreign currency translation adjustments, net of tax
562

 
(366
)
Net comprehensive income (loss)
115

 
(610
)
Net comprehensive income (loss) attributable to noncontrolling interest
12

 
(17
)
Net comprehensive income (loss) attributable to Standard
$
103

 
$
(593
)



30

Table of Contents

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

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

Insurance proceeds
 
150

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

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

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

Other
 
61

Net cash provided by investing activities
 
51

Effect of foreign exchange fluctuations on cash
 
559

Net increase in cash and cash equivalents
 
34

Cash and cash equivalents, beginning of period
 
1,354

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

Supplemental cash flow disclosure
 
 
Cash paid for income taxes
 
$
9



31

Table of Contents

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

Note 2. Summary of Significant Accounting Policies

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

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

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


32

Table of Contents

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

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

Foreign Currency
The assets and liabilities of End of Life Vehicles, Goldy Metals Ottawa, Goldy Metals Toronto and Port Hope, whose functional currency is the Canadian dollar, are translated into US dollars at period-end exchange rates prior to combination. Income and expense items are translated at the average rates of exchange prevailing during the period. The adjustments resulting from translating the Company’s financial statements are reflected as a component of accumulated other comprehensive income within shareholders’ equity. Foreign currency transaction gains and losses are recognized in net earnings based on differences between foreign exchange rates on the transaction date and the settlement date. Transaction gains were $5,100 for the period from April 1, 2015 to May 18, 2015 and $5,600 for the period January 1, 2015 to May 18, 2015, and are included in operating expenses on the consolidated statements of operations.

Revenue Recognition
The Company recognizes revenue from the sale of vehicle replacement products and scrap when they are shipped or picked up by the customers and ownership has transferred, subject to an allowance for estimated returns and discounts that management estimates based upon historical information. Management analyzes historical returns (often pursuant to standard warranties on the sold products) and allowances activity by comparing the items to the original invoice amounts and dates. The Company uses this information to project future returns and allowances on products sold. If actual returns and allowances deviate significantly from the Company’s historical experience, there could be an impact on its operating results in the period of occurrence.
The Company presents taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue on the combined statements of operations and are shown as current liabilities on the combined balance sheets until remitted. Revenue also includes amounts billed to customers for shipping and handling.
Revenue from the sale of separately priced extended warranty contracts is reported as deferred revenue and recognized ratably over the term of the contracts or over five years for life-time warranties. Revenue from such extended warranty contracts was approximately $48,000 for the period from April 1, 2015 to May 18, 2015 and $98,000 for the period January 1, 2015 to May 18, 2015.
Net revenues were reported by the Company’s Canadian entities of approximately $2,575,000 for the period from April 1, 2015 to May 18, 2015 and $7,336,000 for the period from January 1, 2015 to May 18, 2015.

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

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

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

33

Table of Contents

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

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

Note 3. Commitments and Contingencies

Leases
Goldy Metals Toronto pays rent to one of the shareholders under a month to month lease agreement. Lease expense under this operating lease was approximately $9,800 for the period from April 1, 2015 to May 18, 2015 and $24,000 for the period from January 1, 2015 to May 18, 2015.

Note 4. Income Taxes
For the period from April 1, 2015 to May 18, 2015 and January 1, 2015 to May 18, 2015, the effective tax rate was (0.06)% and (48.10)%, respectively. The effective tax rates differ from the statutory rate due to the impact of foreign tax rates and changes in uncertain tax positions.
The Company’s gross reserve for uncertain tax positions related to foreign and domestic matters, including penalties and interest, as of May 18, 2015 was approximately $499,000. The Company believes that it has adequately provided for all uncertain tax positions. The Company is generally no longer subject to examination in the Company’s primary tax jurisdiction for tax years through 2011. The Company is not currently subject to any audits or examinations. It is reasonably possible that new issues may be raised by tax authorities and that these issues may require increases in the balance of the reserve for uncertain tax positions.

Note 5. Fire at Toronto Facility
On March 3, 2014, a fire occurred at the Goldy Metals Toronto facility located in Scarborough, Ontario. The fire destroyed the dismantling facility and a substantial portion of the location’s inventory. For the periods from April 1, 2015 to May 18, 2015 and January 1, 2015 to May 18, 2015 the Company did not incur any additional charges but received insurance recoveries of approximately $52,000 and $259,000, respectively, which was recognized as income when received. If any additional proceeds are received they are expected to be insignificant.


34

Table of Contents

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

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

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

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

For reasons described in Note 1 of the Notes To Condensed Consolidated Financial Statements included in this filing, as of June 30, 2016 and September 30, 2016, we are in breach of the Borrowing Base and Total Leverage Ratio requirements as defined in our Credit Facility with BMO Harris Bank N.A., as well as the requirement for timely delivery of certain quarterly certificates and reports. As a result, all of the Credit Facility debt is reported in the accompanying balance sheet as a current liability at June 30, 2016 and there can be no further borrowings of any availability under the Credit Facility until such defaults are rectified or waived.

The Company’s Board of Directors and management continue to evaluate alternative strategies and capital structures, but there are no guarantees these discussions or negotiations will be successful. If the Company is unable to reach agreement with its lender, obtain waivers, find acceptable alternative financing or obtain equity contributions, the Company’s Credit Facility lender could elect to declare some or all of the amounts outstanding under the Credit Facility to be immediately due and payable. If this happens, we do not currently have sufficient liquidity to pay the then current portion of the Credit Facility. In addition, we have significant obligations under contingent consideration agreements related to certain acquired companies, and we will need access to additional credit to be able to satisfy these obligations. These matters, including our ability to continue as a going concern, are more fully discussed below under Liquidity and Capital Resources.

Carrying Values and Impairment of Goodwill
Goodwill represents the excess of the cost of an acquired business over the net of the amounts assigned to assets acquired and liabilities assumed. Pursuant to the provisions of FASB ASC Topic 350, “Intangibles - Goodwill and Other,” goodwill is required to be tested at the reporting unit level for impairment annually or whenever indications of impairment arise. Management has determined we operate as one operating segment and one reporting unit, Automotive Recycling, and all the goodwill is considered attributable to that reporting unit for impairment testing. Pursuant to our policy, we performed the annual goodwill impairment test as of October 1, 2015, updated the test as of December 31, 2015, and determined that no impairment of goodwill existed at either date.

During the first quarter of 2016, our stock price declined 32% from $6.79/share at December 31, 2015 to $4.60/share at March 31, 2016, and management performed step 1 of the two-step impairment test and determined that potential impairment of the reporting unit existed at March 31, 2016, since book value at such date no longer exceeded the carrying amount. As such,

35

Table of Contents

management applied the second step of the goodwill impairment test and, with consideration of a third party valuation report and using the methodology and assumptions explained in Note 10 to the condensed consolidated financial statements, calculated a goodwill impairment of $45.3 million that was recorded in the accompanying consolidated statement of operations for the three months ended March 31, 2016.

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

Intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill. Our intangible assets, net of accumulated amortization, totaled $35.2 million at March 31, 2016 and $34.3 million at June 30, 2016, and consist of trade names, non-competition agreements and customer relationships. Management, in conjunction with our third party valuation expert, used various techniques in estimating the initial fair value of acquired intangible assets. These valuations are primarily based on the present value of the estimated net cash flows expected to be derived from the intangible assets, discounted for assumptions such as future customer attrition. Management evaluates the intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Therefore, changes such as higher or earlier-than-expected customer attrition may result in higher future amortization charges or an impairment charge for intangible assets. As part of the goodwill impairment analysis discussed above, we also reviewed intangible assets and did not identify any impairment as of March 31, 2016.

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

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

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

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

We were founded on January 2, 2014 (“inception”) for the purpose of effecting the combinations with the Founding Companies and the IPO. We had no automotive recycling operations before May 2015, during which time we had two employees. From inception to May 19, 2015, we incurred various legal, accounting, auditing and administrative costs in preparation for the IPO, the combinations and for operation as a publicly-traded company upon consummation of these transactions. After May 18, 2015, our results include the operations of the acquired companies.

Consolidated Results of Operations for the Three Months Ended June 30, 2016 and 2015

36

Table of Contents

(in thousands, except percentages)
Three Months Ended June 30, 2016
 
Percent of Net Revenues
 
Three Months Ended June 30, 2015
 
Percent of Net Revenues
Net revenues
$
34,234

 
100.0
 %
 
$
11,471

 
100.0
 %
Cost of goods sold
20,760

 
60.6
 %
 
10,008

 
87.2
 %
Gross profit
13,474

 
39.4
 %
 
1,463

 
12.8
 %
Selling, general and administrative expenses
12,241

 
35.8
 %
 
6,764

 
59.0
 %
Outside service and professional fees
1,156

 
3.4
 %
 
864

 
7.5
 %
Depreciation and amortization
1,155

 
3.4
 %
 
709

 
6.2
 %
Change in fair value of contingent consideration liabilities
(2,977
)
 
(8.7
)%
 
809

 
7.1
 %
Change in indemnification receivable
427

 
1.2
 %
 

 
 %
Operating income (loss)
1,472

 
4.3
 %
 
(7,683
)
 
(67.0
)%
Interest expense
(500
)
 
(1.5
)%
 
(22
)
 
(0.2
)%
Other income (expense), net
151

 
0.4
 %
 
(1,573
)
 
(13.7
)%
Income (loss) before income tax benefit
1,123

 
3.3
 %
 
(9,278
)
 
(80.9
)%
Benefit for income taxes
(270
)
 
(0.8
)%
 
(5,304
)
 
(46.2
)%
Net income (loss)
$
1,393

 
4.1
 %
 
$
(3,974
)
 
(34.6
)%

The following table shows the combined unaudited pro forma net revenues and net loss for us as if the acquisition of all subsidiaries had occurred on January 1, 2015. These unaudited pro forma amounts presented are not necessarily indicative of either the actual consolidated results had the acquisition occurred as of January 1, 2015 or of future operating results:
 
 
(Unaudited)
(in thousands, except percentages)
 
Three Months Ended June 30,
 
Difference
 
 
2016 as Reported
 
2015 Pro Forma
 
$
 
%
Net revenues
 
$
34,234

 
$
31,999

 
$
2,235

 
7.0
 %
Net income (loss)
 
$
1,393

 
$
(199
)
 
$
1,592

 
(800.0
)%


37

Table of Contents

Pro forma net revenues consisted of:
 
 
(Unaudited)
(in thousands, except percentages)
 
Three Months Ended June 30,
 
Difference
 
 
2016 as Reported
 
2015 Pro Forma
 
$