Stoneridge - 10-Q quarterly report FY

The accompanying condensed consolidated financial statements have been prepared by Stoneridge, Inc. (the “Company”) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). The information furnished in the condensed consolidated financial statements includes normal recurring adjustments and reflects all adjustments, which are, in the opinion of management, necessary for a fair presentation of such financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the Commission’s rules and regulations. The results of operations for the nine months ended September 30, 2008 are not necessarily indicative of the results to be expected for the full year.

Although the Company believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2007.

The Company has reclassified the presentation of certain prior-period information to conform to the current presentation.

Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (“LIFO”) method for approximately 64% and 66% of the Company’s inventories at September 30, 2008 and December 31, 2007, respectively, and by the first-in, first-out (“FIFO”) method for all other inventories. Inventory cost includes material, labor and overhead. Inventories consist of the following:

The Company’s foreign currency forward contracts had a notional value of $8,239 and $8,551 at September 30, 2008 and December 31, 2007, respectively. At September 30, 2008, the purpose of the foreign currency forward contracts is to reduce the exposure related to the Company’s British pound-denominated receivables. At December 31, 2007, the Company also used forward currency contracts to reduce the exposure related to the Company’s Mexican peso- and Swedish krona-denominated receivables. The estimated fair value of the existing contracts at September 30, 2008 and December 31, 2007, per quoted market sources, was approximately $760 and $(28), respectively. For the nine months ended September 30, 2008, the Company recognized an $854 gain related to these contracts in the condensed consolidated statement of operations as a component of other expense (income), net. In 2007, the Company used foreign currency option contracts to reduce the exposure to the Mexican peso. The Company’s foreign currency option contracts expired as of December 31, 2007.

To mitigate the risk of future price volatility and, consequently, fluctuations in gross margins, the Company has entered into fixed price commodity swaps with a bank to fix the cost of a portion of its copper purchases. In December 2007, we entered into a fixed price swap contract for 1.0 million pounds of copper, which will last through December 2008. In September 2008, we entered into a fixed price swap contract for 1.4 million pounds of copper, which will last from January 2009 to December 2009. Because these contracts were executed to hedge forecasted transactions, the contracts are accounted for as cash flow hedges. The unrealized gain or loss for the effective portion of the hedge is deferred and reported in the Company’s condensed consolidated balance sheets as a component of accumulated other comprehensive income. The Company deems these cash flow hedges to be highly effective. The effectiveness of the transactions has been and will be measured on an ongoing basis using regression analysis. The ineffectiveness of the transactions is measured using the dollar-offset test. The fair value of the fixed price commodity swap contract, per quoted market sources, was approximately $32 and $57 at September 30, 2008 and December 31, 2007, respectively. For the nine months ended September 30, 2008, the Company recognized a $523 gain related to these contracts in the condensed consolidated statement of operations as a component of cost of goods sold.

The following table presents the Company’s assets that are measured at fair value on a recurring basis and that are categorized using the fair value hierarchy. As of September 30, 2008 the Company does not have liabilities that are measured at fair value. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value.

The components of comprehensive income (loss), net of tax are as follows:

Accumulated other comprehensive income, net of tax is comprised of the following:

The Company had $183.0 million and $200.0 million of senior notes outstanding at September 30, 2008 and December 31, 2007, respectively. During 2008, the Company purchased and retired $17.0 million in face value of the senior notes. The outstanding senior notes bear interest at an annual rate of 11.50% and mature on May 1, 2012. The senior notes are redeemable, at the Company’s option, at 103.833 percent of the principal amount until April 30, 2009. The senior notes will remain redeemable at various levels until the maturity date. Interest is payable on May 1 and November 1 of each year.

On November 2, 2007, the Company entered into an asset-based credit facility, which permits borrowing up to a maximum level of $100.0 million. At September 30, 2008, there were no borrowings on this asset-based credit facility. The available borrowing capacity on this credit facility is based on eligible current assets, as defined. At September 30, 2008, the Company had borrowing capacity of $67.8 million based on eligible current assets. The asset-based credit facility does not contain financial performance covenants; however, restrictions include limits on capital expenditures, operating leases and dividends. The asset-based credit facility expires on November 1, 2011. The credit facility provides that a commitment fee of 0.25% is due on the unused balance and that interest is payable quarterly at either (i) the higher of the prime rate or the Federal Funds rate plus 0.50%, plus a margin of 0.00% to 0.25% or (ii) LIBOR plus a margin of 1.00% to 1.75%, depending upon the Company’s undrawn availability, as defined. 

Basic net income (loss) per share was computed by dividing net income (loss) by the weighted-average number of Common Shares outstanding for each respective period. Diluted net income (loss) per share was calculated by dividing net income (loss) by the weighted-average of all potentially dilutive Common Shares that were outstanding during the periods presented.

Actual weighted-average shares outstanding used in calculating basic and diluted net income (loss) per share are as follows:

As of September 30, 2008, 628,275 performance-based restricted shares were outstanding. These shares were not included in the computation of diluted net income (loss) per share because not all vesting conditions were achieved as of September 30, 2008. These shares may or may not become dilutive based on the Company’s ability to exceed future earnings thresholds.

In January 2005, the Company announced restructuring initiatives related to the rationalization of certain manufacturing facilities in Europe and North America. These restructuring initiatives were completed in 2007.

On October 29, 2007, the Company announced restructuring initiatives to improve manufacturing efficiency and cost position by ceasing manufacturing operations at its Sarasota, Florida, and Mitcheldean, United Kingdom, locations. In the third quarter of 2008, the Company announced restructuring initiatives at our Canton, Massachusetts, location. These rationalizations are part of the Company’s cost reduction initiatives. In connection with these initiatives, the Company recorded restructuring expenses of $4,828 for the three months ended September 30, 2008. Restructuring expenses for the nine months ended September 30, 2008 were $11,005. Restructuring expenses that were general and administrative in nature were included in the Company’s condensed consolidated statements of operations as restructuring charges, while the remaining restructuring related expenses were included in cost of goods sold.

The expenses related to the restructuring initiatives announced on October 29, 2007 that belong to the Electronics reportable segment include the following:

The expenses related to the restructuring initiatives announced on October 29, 2007 that belong to the Control Devices reportable segment include the following:

All restructuring expenses, except for asset-related charges, result in cash outflows. Severance costs relate to a reduction in workforce. Other associated costs include premium direct labor, inventory and equipment move costs, relocation expenses, increased inventory carrying costs and miscellaneous expenditures associated with exiting business activities. No fixed-asset impairment charges were incurred because assets are being transferred to other locations for continued production.

In the ordinary course of business, the Company is involved in various legal proceedings and workers’ compensation and product liability disputes. The Company is of the opinion that the ultimate resolution of these matters will not have a material adverse effect on the results of operations, cash flows or the financial position of the Company.

Amounts accrued for product warranty and recall claims are established based on the Company’s best estimate of the amounts necessary to settle existing and probable future claims on products sold as of the balance sheet dates. These accruals are based on several factors including past experience, production changes, industry developments and various other considerations. The Company can provide no assurances that it will not experience material claims in the future or that it will not incur significant costs to defend or settle such claims beyond the amounts accrued or beyond what the Company may recover from its suppliers.

The following provides a reconciliation of changes in product warranty and recall liability for the nine months ended September 30, 2008 and 2007:

The Company has a single defined benefit pension plan that covers certain employees in the United Kingdom and a postretirement benefit plan that covers certain employees in the U.S. The components of net periodic benefit cost under the defined benefit pension plan are as follows:

The Company previously disclosed in its financial statements for the year ended December 31, 2007 that it expected to contribute $259 to its defined benefit pension plan in 2008. Of this amount, contributions of $194 have been made to the defined benefit pension plan as of September 30, 2008.

The Company recognized a provision for income taxes of $855, or 174.1% of pre-tax income, and $381, or 12.7% of pre-tax income, for federal, state and foreign income taxes for the three months ended September 30, 2008 and 2007, respectively. The Company recognized a provision for income taxes of $10,029, or 48.0% of pre-tax income, and $2,234, or 18.0% of pre-tax income, for federal, state and foreign income taxes for the nine months ended September 30, 2008 and 2007, respectively. The increase in the effective tax rate for both the three and nine months ended September 30, 2008 compared to similar periods in 2007 was primarily attributable to the costs incurred to restructure the Company’s United Kingdom operations. As the Company does not believe that the related tax benefit of those losses will be realized, a valuation allowance was recorded against the deferred tax assets associated with those foreign losses. In addition, the effective tax rate was unfavorably impacted due to the expiration of the federal research and development tax credit at December 31, 2007.

As of December 31, 2007, the Company provided a liability of $4,618, excluding interest and penalties, for unrecognized tax benefits related to various federal, state and foreign income tax matters. The liability for uncertain tax positions is classified as a non-current income tax liability unless it is expected to be paid within one year. At September 30, 2008 the Company has classified $1,032 as a current liability and $3,415 as a reduction to non-current deferred income tax assets. The liability for unrecognized tax positions decreased by $408 for the three months ended September 30, 2008 and decreased by $557 for the nine months ended September 30, 2008 resulting in a balance at September 30, 2008 of $4,061. Through a combination of anticipated state audit settlements and the expiration of certain statutes of limitation, the amount of unrecognized tax benefits could decrease by approximately $70 to $200 within the next 12 months.

If the Company’s tax positions are sustained by the taxing authorities in favor of the Company, approximately $3,907 would reduce the Company’s provision for income taxes.

The Company classifies interest expense and, if applicable, penalties which could be assessed related to unrecognized tax benefits as a component of income tax expense. For the nine months ended September 30, 2008 and 2007, the Company recognized approximately $52 and $6 of gross interest and penalties, respectively. The Company has accrued approximately $724 and $672 for the payment of interest and penalties at September 30, 2008 and December 31, 2007, respectively.

The Company conducts business globally and, as a result, the Company or a subsidiary of the Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the world. The following table summarizes the open tax years for each significant jurisdiction:

During the third quarter of 2007 the U.S. Internal Revenue Service commenced an examination of the Company’s 2005 federal income tax return. It is anticipated that this examination should be completed during the fourth quarter of 2008. The Company is also under examination for income and non-income tax filings in various state and foreign jurisdictions that should be completed at various times throughout 2008.

In May 2008, the FASB issued Financial Accounting Standard (FAS) No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” The statement is intended to improve financial reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are prepared in conformance with generally accepted accounting principles. Unlike Statement on Auditing Standards (SAS) No. 69, “The Meaning of Present in Conformity With GAAP,” FAS No. 162 is directed to the entity rather than the auditor. The statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with GAAP,” and is not expected to have any impact on the Company’s financial position, results of operations or cash flows.

The accounting policies of the Company’s reportable segments are the same as those described in Note 2, “Summary of Significant Accounting Policies” of the Company’s December 31, 2007 Form 10-K. The Company’s management evaluates the performance of its reportable segments based primarily on revenues from external customers, capital expenditures and income before income taxes. Inter-segment sales are accounted for on terms similar to those to third parties and are eliminated upon consolidation.

A summary of financial information by reportable segment is as follows:

The Company has a 50% equity interest in PST Eletrônica S.A. (“PST”), a Brazilian electronic system provider focused on security and convenience applications primarily for the vehicle and motorcycle industry. The investment is accounted for under the equity method of accounting. The Company’s investment in PST was $37,593 and $29,663 at September 30, 2008 and December 31, 2007, respectively.

Condensed financial information for PST is as follows:

The senior notes and the credit facility are fully and unconditionally guaranteed, jointly and severally, by each of the Company’s existing and future domestic wholly owned subsidiaries (Guarantor Subsidiaries). The Company’s non-U.S. subsidiaries do not guarantee the senior notes or the credit facility (Non-Guarantor Subsidiaries).

Presented below are summarized consolidating financial statements of the Parent (which includes certain of the Company’s operating units), the Guarantor Subsidiaries, the Non-Guarantor Subsidiaries and the Company on a condensed consolidated basis, as of September 30, 2008 and December 31, 2007 and for each of the three and nine months ended September 30, 2008 and 2007.

These summarized condensed consolidating financial statements are prepared under the equity method. Separate financial statements for the Guarantor Subsidiaries are not presented based on management’s determination that they do not provide additional information that is material to investors. Therefore, the Guarantor Subsidiaries are combined in the presentations on the subsequent pages.

Supplemental condensed consolidating financial statements (continued):

Supplemental condensed consolidating financial statements (continued):