Clark Automotive Parts Inc.
Clark Automotive Parts, Inc. (the “Company”) operates in the passenger car and light
truck segment of the automotive aftermarket distribution industry. The economic cycles and
industry trends within the automotive parts manufacturing industry are highly correlated with
the cycles and trends of the automotive aftermarket manufacturing industry. To assist you in
your analysis of the Company a summary of the automotive parts manufacturing industry is
included with the analysis of the aftermarket distribution industry.
Automotive Parts Manufacturing and Distribution1
The auto parts manufacturing market is highly fragmented with companies ranging in
size from mom-and-pop shops to large multinational corporations. There are four basic lines
of business within auto parts manufacturing: original equipment manufacturing (OEM),
replacement parts manufacturing, distribution, and rubber fabrication. This analysis focuses
solely on replacement parts manufacturing and distribution.
Replacement Parts Manufacturer Market
This market involves the manufacture of parts that replace or supplement parts that
were originally included in the vehicle. Companies that serve this market can be independent
or subsidiaries of automobile manufacturers. In addition, some participate in the original
equipment market as well as replacement market.
Do-it-Yourself (DIY) Market
The Automotive Aftermarket Industry Association reported that from 1994 to 2000 the
percentage of total U.S. households performing light, medium or heavy-duty maintenance
has not changed. However, the percentage of DIY households with female DIYers has
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increase from 27 percent to 34 percent of the total. Nearly half of all U.S. households contain
at least one automotive DIYer despite a sharp decline between 1994 and 2000 in the 25 to 44
year-old “prime” DIY age group. Two-thirds of the DIYers or DIFMers (do- it-for-me)
choose after market service facilities over new car dealership because of trust, convenience,
guarantee and cost.
The sale of automotive parts accessories and maintenance items is highly competitive in
many areas, including name recognition, product availability, customer service, store location
and price, with many competitors. Many companies compete in both do-it-yourself (DIY)
and commercial customers. Suppliers include national and regional auto parts chains,
independently owned parts stores, wholesalers and jobbers, car washes and auto dealers, in
addition to discount and mass merchandise stores, department stores, hardware stores,
supermarkets, drugstores and home stores that sell aftermarket vehicle parts and supplies,
chemicals, accessories, tools and maintenance parts. Many companies compete on the basis
of customer service, including the knowledge and expertise of merchandise selection and
availability, price, product, warranty, store layouts and location.
Replacement Parts Manufacturer Market Trends
The largest automakers have established a trend of spinning off their in- house parts
manufacturing units. These moves will only strengthen the already cutthroat competitive
environment. Additionally, the long-term trend is for the number of older model cars to
increase. This trend favors parts suppliers, but at the same time, the quality of original
equipment has increased steadily which limits the growth of this segment (3% is projected
growth rate next year while gross margins should continue to average around 20%).
Replacement Parts Distribution
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These market players simply distribute the parts and accessories which are used to
replace or supplement original automotive parts. This market is highly fragmented but there
are some large industry players, including public companies. Distribution usually involves
getting the part to the end user, either through middlemen or jobbers, or directly to the end
user.
Wholesalers have traditionally employed a three-step or full-service distribution
process. This process involves the part manufacturer delivering to warehouse distributors
who, in turn, deliver the parts to local jobbers who sell the parts to end users for installation.
This type of distribution allows jobbers to provide parts to local area professionals such as
service stations, garages, and major accounts in a timely and efficient manner.
Recently, the three-step distribution process has begun to be replaced with a two-step,
or direct, distribution process, which allows direct distributors to eliminate a level of
distribution. Accordingly, a large jobber may purchase directly from manufacturers and sell
directly to professional installers, or a warehouse distributor may skip the jobber level and
sell parts directly to installers. The two-step process has evolved as a way to decrease capital
needs and to halt the problems of shrinking margins. This process has proven successful in
major metropolitan areas, where there are higher concentrations of professional installers.
Replacement Parts Distribution Trends
One of the largest challenges for distributors is to be able to deliver the right part to
the right place in a timely and cost effective manner. This problem is only increasing as the
car market expands into every area of the globe. In addition, the quality of original
equipment has steadily increased which limits sales and distribution of replacement parts.
The wildcard in terms of growth is how the Clean Air requirements from the U.S.
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Environmental Protection Agency will affect the market. Some part manufacturers have not
yet been supplied with enough information to build and service the newly required parts.
This could negatively affect sales and distribution trends in the future.
Selected reports from Value Line are attached.
Company Overview
Clark Automotive Parts, Inc. was founded in 1970 by John L. Clark. Currently, the
Company’s executive offices are located in Atlanta, Georgia. Clark Automotive is primarily
engaged in the distribution of automotive aftermarket products to jobbers and professional
installers located in the Southeast and Midwest regions of the United States. The Company
operates in the passenger car and light truck segment of the automotive aftermarket
distribution industry. The Company conducts its business through ten full-service
distribution centers and eight direct distribution centers. The Company also owns 50 jobbing
stores located in the Southeast region.
Until the mid-1990s, the Company operated solely in the Southeast and had achieved
operating results at par with industry norms. In 1997 (coinciding with the appointment of
John Clark’s son, Spencer Clark, as Clark Automotive’s CEO), the Company implemented a
strategy to significantly expand its operations. By 2001, the Company had expanded its
operations to include one large jobber and three distribution centers in the Midwest. In
addition, the Company completed the acquisition of Jones Automotive Warehouse, Inc.
(“Jones Automotive”) in 2000 (the “Jones Acquisition”). Jones Automotive operated three
full-service distribution centers and two direct distribution centers. In addition, Jones
Automotive operated 49 jobbing stores through its wholly-owned subsidiary, Advanced
Automotive, Inc. (“Advanced Automotive”). All of the Jones Automotive distribution
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centers and jobbing stores operated in the Southeast region. For financial reporting purposes,
Jones distribution centers have been integrated with the other distribution centers.
For a number of reasons that will be discussed below, Clark Automative according to
management began to experience financial troubles in 2001. Over the next two years, the
Company’s operations and financial condition continued to deteriorate. On January 15,
2003, the Company filed a petition for relief under Chapter 11 of Bankruptcy Code in the
United States Bankruptcy Court for the Northern District of Georgia.
A number of factors lead to the filing by the Company of the bankruptcy petition.
The first factor was a significant increase in financial leverage. The Company’s expansion
(both the addition of new distribution centers in the Midwest and the Jones Acquisition) was
financed predominately with the long-term and subordinated debt. Prior to this expansion,
the Company maintained a capital structure in line with industry norms. On average,
Companies within the automotive aftermarket distribution industry maintain a capital
structure of 70% equity and 30% debt based on market values. At the peak of Southeast’s
expansion program, the Company’s liabilities approached or exceeded the value of its assets.
The second factor was the Company’s unsuccessful efforts to expand into the
Midwest market. While the automotive aftermarket distribution industry is highly
competitive, competition is particularly keen in the Midwest region, and the three distribution
centers and one jobber established in this region never generated sufficient earnings to cover
the related debt service.
The third factor was that the Company overpaid for its acquisition of Jones
Automotive. The Company got caught up in a bidding war with a key competitor and
adopted a “win at all costs” attitude towards the Jones Acquisition. Furthermore, many of
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the Company’s executives had unrealistic expectations regarding the level of synergies that
could be realized through the integration of Jones Automotive into the existing business.
The fourth factor was that the Company created some discord with existing jobbers
when they acquired Jones Automotive. As noted above Jones Automotive owned 50 jobbers
in the Southwest region. Some of the jobbers supplied by Clark Automotive resented the fact
that, as a result of the Jones Acquisition, their supplier was now competing against them. As
a result, Clark Automotive lost some of its key accounts.
The fifth factor was that the Company implemented an ERP (Enterprise Resource
Planning) system during their expansion phase. The Company was still experiencing
significant computer “down time” and processing errors at the time the bankruptcy petition
was filed. The primary processing errors were lost orders and orders that contained
erroneous product codes. Not withstanding the existing problems, the Company’s systems
consultants had made considerable progress in resolving many of the system’s problems and
were of the opinion that, by the summer of 2004, the Company’s ERP system would be fully
operational.
Finally, the sixth factor leading to the Chapter 11 Proceeding was that the Company
was behind the curve in making the transition from a full-service distribution process (or
three-step process) to the direct distribution process (or two-step process).
The historical financial statements for the Company are contained in Exhibits 1
through Exhibits 3.
Clark Automotive achieved operating performance in line with industry standards in
1998 and 1999 (not shown in the comparative financial statements). Subsequent to 1999, the
Company’s operating performance began to deteriorate, with significant erosion of
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profitability occurring in 2001 and 2002 (see the Company’s financial statements reproduced
in Exhibit 1 through Exhibit 3).
Operating in Chapter 11
In 2003, subsequent to the filing of the bankruptcy petition, the Company began to
reverse some negative trends by stabilizing gross profit margins and reducing selling, general
and administrative expenses on a percentage of sales bases. Stabilization of gross profit
margins was primarily achieved through the elimination of some unprofitable customer
segments, product lines and distribution locations. Further enhancement of the Company’s
gross profit margins should resume in the year 2005 as a result of the Company’s continued
efforts to increase penetration into more profitable customer segments, product lines, and
locations.
Another factor contributing to the stabilization of the Company’s gross margins was
the implementation of a new computer system. While the Company experienced significant
cost overruns and processing problems in the early stages of their ERP (enterprise resource
planning) implementation, 2 by mid-2002 many of the “bugs” had been worked out of the
system. On a go- forward basis, the Company views their “state-of-the-art” information
system as one of their competitive advantages. Among other things, the new system employs
an Internet interface that links directly to the Company’s inventory and purchasing systems.
Accordingly, when a customer logs on to the Company’s web site, the system retrieves a
detailed product listing, which includes the customer’s pricing structure. Once the product is
ordered, the order information is transmitted to the warehouse for order fulfillment and is
posted to the Company’s inventory system. Purchasing is notified when inventory of a
particular product reaches a certain level so the Company can place an order for additional
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product with its vendors. The new ERP system is linked directly with the information
systems of the Company’s primary vendors so that purchases can be filed more
expeditiously.
Improvements in selling, general and administrative expenses were, and will continue
to need improve ments through reduction of work force, and various other cost cutting
measures.
Company management has indicated that, not only will the trend of declining sales
reverse in the year 2004, but its top line growth will also exceed overall industry growth rates
for at least the next five years. Justification for the Company’s sales estimates are as follows:
1. The elimination of unprofitable operations.
2. The Company’s expansion efforts will be directed to higher growth markets.
3. The automotive aftermarket distribution industry has begun to experience some
“shake out.” The shake out will alleviate a limited amo unt of competitive
pressure in certain locations. Furthermore, it is anticipated the Company will be
able to expand operations through the procurement of distribution facilities that
have become available due to the insolvency of the smallest distributors.
4. The enhanced information system will enable the Company to increase customer
satisfaction by increasing fill rates, reducing delivery times, and providing sales
and customer service representatives with more information regarding product
availability and order status. The Company believes increased customer
satisfaction will, in time, equate to increased sales. In addition to the benefits
discussed above, the Company believes their enhanced computer system will
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enable it to better identify and target customer segments, product lines and
distribution locations with the highest growth potential.
The income tax rate has been calculated under the assumption that the Company will
be taxed at a federal income tax rate of 34.0% and a state income tax rate of 5.0%. The
effective rate is 37.3% due to the fact that state income taxes are deductible for federal
income tax purposes.
Working capital requirements are assumed to be 8.0% of the increase in sales. In
other words, for every $1.00 increase in sales, the Company will invest in $0.08 of working
capital. Working capital requirements have been estimated based on the historical changes in
sales relative to the historical changes in inventory, trade receivables and trade payables for
the Company, as well as pub licly traded companies operating in the same industry.
The cash flow projections prepared by management for 2004-2008 are included in
Exhibit 4 along with the estimated depreciation and capital expenditures.
Requirements
1. Determine the Cost of Capital.
2. Determine the value of Clark Automotive
a. Discounted cash flow method
b. EBITDA method
3. Divide the debt into the following classes
a. Secured
b. Bank debt
c. Unsecured (balance)
4. Develop the term sheet for a plan showing the following headings
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Consideration
Claim Percent
Class Cash New Debt Equity
Amount Recovery
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Endnotes
1
Standard & Poor's Industry Surveys: Autos & Auto Parts, Public company 10-K filed and
the Automotive Aftermarket Industry Association website (www.aftermarket.org).
2
Problems associated with the implementation of the ERP system represented one of the
factors that contributed to the Company’s bankruptcy.
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Labels: Auto Part