STONERIDGE INC - Quarter Report: 2013 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2013

Commission file number: 001-13337

STONERIDGE, INC.

(Exact name of registrant as specified in its charter)

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.

x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

¨ Yes x No

The number of Common Shares, without par value, outstanding as of October 25, 2013 was 28,483,366.

STONERIDGE, INC. AND SUBSIDIARIES

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

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

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

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

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

(1) Basis of Presentation

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 “SEC”). 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 SEC's rules and regulations. The results of operations for the three and nine months ended September 30, 2013 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 year ended December 31, 2012.

Certain prior period amounts have been reclassified to conform to their 2013 presentation in the condensed consolidated financial statements due to a change in reportable segments in the fourth quarter of 2012.

(2) Inventories

Inventories are valued at the lower of cost (using either the first-in, first-out ("FIFO") or average cost methods) or market. The Company evaluates and adjusts as necessary its excess and obsolescence reserve at a minimum on a quarterly basis. Excess inventories are quantities of items that exceed anticipated sales or usage for a reasonable period. The Company has guidelines for calculating provisions for excess inventories based on the number of months of inventories on hand compared to anticipated sales or usage. Management uses its judgment to forecast sales or usage and to determine what constitutes a reasonable period.

Inventory cost includes material, labor and overhead. Inventories consisted of the following:

Inventory valued using the FIFO method was $70,903 and $57,004 at September 30, 2013 and December 31, 2012, respectively. Inventory valued using the average cost method was $48,073 and $39,028 at September 30, 2013 and December 31, 2012, respectively.

(3) Financial Instruments and Fair Value Measurements

Financial Instruments

A financial instrument is cash or a contract that imposes an obligation to deliver, or conveys a right to receive cash or another financial instrument. The carrying values of cash and cash equivalents, accounts receivable and accounts payable are considered to be representative of fair value because of the short maturity of these instruments. The estimated fair value of the Company's senior secured notes with a face value of $175,000 (fixed rate debt) at September 30, 2013 and December 31, 2012 was $190,313 and $188,895, respectively, and was determined using market quotes classified as Level 2 input within the fair value hierarchy.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

Derivative Instruments and Hedging Activities

On September 30, 2013, the Company had open foreign currency forward contracts, fixed price commodity contracts and an interest rate swap. These contracts are used solely for hedging and not for speculative purposes. Management believes that its use of these instruments to reduce risk is in the Company's best interest.  The counterparties to these financial instruments are financial institutions with investment grade credit ratings.

Foreign Currency Exchange Rate Risk

The Company conducts business internationally and therefore is exposed to foreign currency exchange rate risk. The Company uses derivative financial instruments as cash flow and fair value hedges to mitigate its exposure to fluctuations in foreign currency exchange rates by reducing the effect of such fluctuations on foreign currency denominated transactions and exposures. The currencies hedged by the Company during 2013 and 2012 include the euro, Swedish krona and Mexican peso.

In certain instances, the foreign currency forward contracts do not qualify for hedge accounting or are not designated as hedges, and therefore are marked to market with gains and losses recognized in the Company's condensed consolidated statement of operations as a component of other (income) expense, net.

The Company's foreign currency forward contracts offset a portion of the gains and losses on the underlying foreign currency denominated transactions as follows:

Mexican peso-denominated Foreign Currency Forward Contracts – Cash Flow Hedge

The Company holds Mexican peso-denominated foreign currency forward contracts with underlying notional amounts at September 30, 2013 totaling $57,125 compared to $36,500 at December 31, 2012. These cash flow hedges expire ratably on a monthly basis as follows:

These contracts were executed to hedge forecasted transactions and are accounted for as cash flow hedges. As such, the effective portion of the unrealized gain or loss is deferred and reported in the Company's condensed consolidated balance sheets as a component of accumulated other comprehensive loss. The Company's expectation is that the cash flow hedges will be highly effective in the future. The effectiveness of the transactions has been and will be measured on an ongoing basis using regression analysis and forecasted future Mexican peso purchases.

Euro-denominated and Swedish krona-denominated Foreign Currency Forward Contracts

As of September 30, 2013, the Company held a foreign currency forward contract with an underlying notional amount of $13,293 to reduce the exposure related to the Company's euro-denominated intercompany loans. This contract expires in December 2013. During 2012, the Company also held a foreign currency forward contract to reduce the exposure related to the Company's Swedish krona-denominated intercompany loan. This contract expired on November 30, 2012. The euro-denominated and Swedish krona-denominated foreign currency forward contracts were not designated as hedging instruments. For the three and nine months ended September 30, 2013 the Company recognized a loss of $489 and $404, respectively, in the condensed consolidated statement of operations as a component of other (income) expense, net related to the euro-denominated contracts. For the three and nine months ended September 30, 2012, the Company recognized a loss of $655 and $97, respectively, related to the euro-denominated and Swedish krona-denominated contracts.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

Commodity Price Risk - Cash Flow Hedge

Because copper is a significant raw material in certain products, the Company entered into fixed price commodity contracts with a financial institution to fix the cost of a portion of the Company's copper purchases to mitigate the risk of future price volatility and, consequently, reducing fluctuations in gross margins.

The Company has fixed price commodity contracts at September 30, 2013 with an aggregate notional amount of 1,937 pounds compared to an aggregate notional amount of 2,436 pounds at December 31, 2012. These cash flow hedges expire ratably on a monthly basis as follows:

All of these contracts represent a portion of the Company's forecasted copper purchases. These contracts were executed to hedge a portion of forecasted transactions and the contracts are accounted for as cash flow hedges. The unrealized gain or loss for the effective portion of these hedges is deferred and reported in the Company's condensed consolidated balance sheets as a component of accumulated other comprehensive loss while the ineffective portion is reported in the condensed consolidated statements of operations. The effectiveness of the transactions is measured on an ongoing basis using regression analysis and forecasted future copper purchases. Based upon the results of the regression analysis, the Company has concluded that these cash flow hedges are highly effective.

Interest Rate Risk - Fair Value Hedge

The Company has a fixed-to-floating interest rate swap agreement (the "Swap") with a notional amount of $45,000 to hedge its exposure to fair value fluctuations on a portion of its senior secured notes. The Swap was designated as a fair value hedge of the fixed interest rate obligation under the Company's $175,000 9.5% senior secured notes due October 15, 2017. The critical terms of the Swap are aligned with the terms of the senior secured notes, including maturity of October 15, 2017, resulting in no hedge ineffectiveness. 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 an asset or liability as applicable, with the offset to the carrying value of the senior secured notes.

Under the Swap, the Company pays a variable interest rate equal to the six-month London Interbank Offered Rate ("LIBOR") plus 7.2% and it receives a fixed interest rate of 9.5%. The Swap requires semi-annual settlements on April 15 and October 15. The difference between amounts to be received and paid under the Swap is recognized as a component of interest expense, net on the condensed consolidated statements of operations.

The Swap reduced interest expense by $222 and $241 for the three months ended September 30, 2013 and 2012, respectively, and by $644 and $634 for the nine months ended September 30, 2013 and 2012, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

The notional amounts and fair values of derivative instruments in the condensed consolidated balance sheets are as follows: 

Amounts recorded for the cash flow hedges in other comprehensive income and in net income for the three months ended September 30, 2013 and 2012 are as follows: 

Amounts recorded for the cash flow hedges in other comprehensive income (loss) and in net income for the nine months ended September 30, 2013 and 2012 are as follows: 

Gains and losses reclassified from other comprehensive income (loss) into net income were recognized in cost of goods sold in the Company's condensed consolidated statements of operations.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

The net deferred losses of $229 on the cash flow hedge derivatives will be reclassified from other comprehensive income (loss) to the condensed consolidated statements of operations through December 2014.  The Company has measured the ineffectiveness of the forward currency and commodity contracts and any amounts recognized in the condensed consolidated financial statements were immaterial for the three and nine months ended September 30, 2013 and 2012.

Fair Value Measurements

The following table presents our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the three levels of the fair value hierarchy based on the reliability of the inputs used.

(4) Share-Based Compensation

Total compensation expense for share-based compensation arrangements recognized in the condensed consolidated statements of operations as a component of selling, general and administrative expenses was $1,419 and $1,122 for the three months ended September 30, 2013 and 2012, respectively. Of these amounts, $59 and $(105) for the three months ended September 30, 2013 and 2012, respectively, were related to the Long-Term Cash Incentive Plan "Phantom Shares" discussed in Note 10. For the nine months ended September 30, 2013 and 2012, total compensation expense recognized in the condensed consolidated statements of operations for share-based compensation arrangements was $4,142 and $3,583, respectively. Of these amounts, $213 and $(35) for the nine months ended September 30, 2013 and 2012, respectively, were related to the Long-Term Cash Incentive Plan "Phantom Shares" discussed in Note 10.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

(5) Debt

 Revolving Credit Facilities

On November 2, 2007, the Company entered into an asset-based credit facility (the "Credit Facility"), which permits borrowing up to a maximum level of $100,000. The Company entered into an Amended and Restated Credit and Security Agreement and a Second Amended and Restated Credit and Security Agreement (the "Second Amended and Restated Agreement") on September 20, 2010 and December 1, 2011, respectively. The Second Amended and Restated Agreement extended the termination date of the Credit Facility to December 1, 2016, increased the borrowing base by increasing the sublimit on eligible inventory located at Mexican facilities and made changes to certain covenants relating to, among other things, guarantees, investments, capital expenditures and permitted indebtedness. The Credit Facility requires a commitment fee of 0.375% on the unused balance. 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.

The available borrowing capacity on the Credit Facility is based on eligible current assets, as defined. At September 30, 2013 and December 31, 2012, the Company had undrawn borrowing capacity of approximately $83,636 and $74,060, respectively. The Credit Facility contains financial performance covenants which would only constrain the Company’s borrowing capacity if our undrawn availability falls below $20,000. Other restrictions include limits on capital expenditures, operating leases, dividends and investment activities in negative covenants which limit investment activities to $15,000 minus certain guarantees and obligations.

The Company was in compliance with all Credit Facility covenants at September 30, 2013 and December 31, 2012.

On October 13, 2009, the Company's consolidated subsidiary, BCS, entered into a master revolving note (the "BCS Revolver"), subject to an annual renewal, which permitted borrowing up to a maximum level of $3,000. The BCS Revolver was paid off and the agreement was terminated in February 2013.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

Debt

On October 4, 2010, the Company issued $175,000 of senior secured notes which are included as a component of long-term debt, net on the condensed consolidated balance sheets. These senior secured notes bear interest at an annual rate of 9.5% and mature on October 15, 2017. The senior secured notes were issued to the original purchasers at a 2.5% discount for which the remaining balance at September 30, 2013 and December 31, 2012 was $2,878 and $3,296, respectively. The senior secured notes are redeemable in full, at the Company's option, beginning October 15, 2014 at 104.75%. Interest payments are payable on April 15 and October 15 of each year. The senior secured notes indenture limits the amount of the Company and its restricted subsidiaries' indebtedness, restricts certain payments and includes various other non-financial restrictive covenants. The senior secured notes are guaranteed by all of the Company's existing domestic restricted subsidiaries. All other restricted subsidiaries that may guarantee any indebtedness of the Company or the guarantors will also guarantee the senior secured notes. The Company was in compliance with all note covenants at September 30, 2013 and December 31, 2012.

Our consolidated subsidiary PST Eletrônica Ltda. ("PST") maintains several term notes used for working capital purposes including a new term loan (the "PST note") entered into on March 19, 2013 for 25,000 Brazilian real which had a U.S. dollar equivalent outstanding balance of $11,236 at September 30, 2013. The PST note matures on February 2, 2016 with interest payable monthly at a fixed interest rate of 5.5%. PST's other short-term and long-term notes also have fixed interest rates. Depending on the specific note, interest is payable either monthly or annually. The noncurrent portion of the PST long-term notes at September 30, 2013 is $14,032 and mature as follows: $1,717 in 2014, $6,854 in 2015, $2,131 in 2016 and $1,110 annually in 2017 through 2019. As of September 30, 2013 and December 31, 2012, PST was in compliance with all note covenants.

On August 29, 2012, the Company's wholly-owned subsidiary located in Suzhou, China entered into a term loan for 9,000 Chinese yuan which matured in August 2013. On August 21, 2013, the subsidiary entered into a new term loan for 9,000 Chinese yuan (the "Suzhou note"). The U.S. dollar equivalent outstanding loan balance was $1,470 and $1,445 at September 30, 2013 and December 31, 2012, respectively. The Suzhou note is included on the condensed consolidated balance sheets as a component of current portion of long-term debt. Interest is payable quarterly at 125.0% of the one-year lending rate published by The People's Bank of China.

The Company's wholly-owned subsidiary located in Stockholm, Sweden, has an overdraft credit line which allows overdrafts on the subsidiary's bank account up to a maximum level of 20,000 Swedish krona, or $3,111 and $3,075,

at September 30, 2013 and December 31, 2012, respectively. At September 30, 2013 and December 31, 2012, there was no balance outstanding on this overdraft credit line.

(6) Net Income Per Share

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

Actual weighted-average Common Shares outstanding used in calculating basic and diluted net income per share were as follows:

Options not included in the computation of diluted net income per share to purchase 20,000 and 64,000 Common Shares at an average price of $15.73 and $12.05 per share, respectively, were outstanding at September 30, 2013 and 2012, respectively. These outstanding options were not included in the computation of diluted net income per share because their respective exercise prices were greater than the average closing market price of Company Common Shares.

There were 663,750 and 635,850 performance-based restricted Common Shares outstanding at September 30, 2013 and 2012, respectively. Substantially all of these performance-based restricted Common Shares were not included in the computation of diluted net income per share because the performance-based vesting conditions have not been achieved as of September 30, 2013 and 2012. These performance-based restricted Common Shares may or may not become dilutive based on the Company's ability to meet or exceed future performance targets.

(7) Changes in Accumulated Other Comprehensive Loss by Component

Changes in accumulated other comprehensive loss for the three months ended September 30, 2013 and 2012 were as follows:

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

Changes in accumulated other comprehensive loss for the nine months ended September 30, 2013 and 2012 were as follows:

(8) Restructuring and Business Realignment Charges

On October 29, 2007, the Company announced restructuring initiatives to improve manufacturing efficiency and cost position by ceasing manufacturing operations at its Sarasota, Florida (Control Devices reportable segment) and Mitcheldean, United Kingdom (Electronics reportable segment) locations. During 2008 and 2009, in response to the depressed conditions in the North American and European commercial and automotive vehicle markets, the Company continued and expanded the restructuring initiatives in the Control Devices and Electronics reportable segments. While the initiatives were completed in 2009 in regards to the Control Devices reportable segment, in 2010 the Company continued restructuring initiatives within the Electronics reportable segment and recorded amounts related to its cancelled lease in Mitcheldean, United Kingdom. During the third quarter of 2012, the Company finalized a settlement agreement to modify the terms of and the obligation associated with the property consistent with previous estimates.

In connection with the Electronics segment restructuring initiative, the Company recorded lease related restructuring charges during the three months ended September 30, 2013 and 2012 of $116 and $90, respectively, as part of selling, general and administrative expense. For the nine months ended September 30, 2013 and 2012, the Company recorded $348 and $160, respectively, related to this restructuring initiative. At September 30, 2013 and December 31, 2012, the only remaining restructuring related accrual pertains to the cancelled property lease in Mitcheldean, United Kingdom, for which the Company has accrued $762 and $765, respectively, on the condensed consolidated balance sheets of which $417 and $419, respectively, is a component of other long-term liabilities.

In response to a change in customer demand, the PST segment incurred business realignment charges of $0 and $1,646 for the three and nine months ended September 30, 2012, respectively, of which $0 and $729, respectively, was recorded in cost of goods sold with the remainder recorded in selling, general and administrative expenses. The charges consisted primarily of severance costs related to workforce reductions. The PST segment had no business realignment charges during the three and nine months ended September 30, 2013.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

(9)  Commitments and Contingencies

In the ordinary course of business, the Company is involved in various legal proceedings, 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 affect on the results of operations, cash flows or the financial position of the Company.

As a result of environmental studies performed at the Company's former facility located in Sarasota, Florida, the Company became aware of soil and groundwater contamination at the Company site. The Company engaged an environmental engineering consultant to assess the level of contamination and to develop a remediation and monitoring plan for the site. Soil remediation at the site was completed during the year ended December 31, 2010. Groundwater remediation at the site is expected to begin by the end of 2013, upon state regulatory approval of a remedial action plan. During the three and nine months ended September 30, 2013 and 2012, environmental remediation costs incurred were immaterial. At September 30, 2013 and December 31, 2012, the Company had accrued an undiscounted liability of $1,340 related to future remediation. At September 30, 2013 and December 31, 2012, $733 was recorded as a component of accrued expenses and other current liabilities on the condensed consolidated balance sheets while the remaining amounts were recorded as a component of other long-term liabilities. A majority of the costs associated with the recorded liability will be incurred at the start of the groundwater remediation, with the balance relating to monitoring costs to be incurred over multiple years. The recorded liability is based on assumptions of the proposed remedial action plan. In December 2011, the Company sold the Sarasota facility and related property. However, the liability to remediate the site contamination remains the responsibility of the Company. Due to the ongoing site remediation, the closing terms of the sale agreement included a requirement for the Company to maintain a $2,000 letter of credit for the benefit of the buyer.

On May 24, 2013, the State Revenue Services of São Paulo issued a tax deficiency notice against PST, our 74% owned consolidated subsidiary, claiming that the vehicle tracking and monitoring services it provides should be classified as communication services, and therefore subject to the State Value Added Tax – ICMS. The State Revenue Services assessment imposed the 25.0% ICMS tax on all revenues of PST related to the vehicle tracking and monitoring services during the period from January 2009 through December 2010. The Brazilian real (“R$”) and U.S. dollar equivalent (“$”) of the aggregate tax assessment is approximately R$92,500 ($41,500) which is comprised of Value Added Tax – ICMS of R$13,200 ($5,900), interest of R$11,400 ($5,100) and penalties of R$67,900 ($30,500).

The Company’s vehicle tracking and monitoring services are non-communication services, as defined under Brazilian tax law, subject to the municipal ISS tax, not communication services subject to state ICMS tax as claimed by the State Revenue Services of São Paulo. PST has, and will continue to collect the municipal ISS tax on the vehicle tracking and monitoring services in compliance with Brazilian tax law and will defend its tax position. PST has received a legal opinion that the merits of the case are favorable to PST, determining among other things that the imposition on the subsidiary of the State ICMS by the State Revenue Services of São Paulo is not in accordance with the Brazilian tax code. Management believes, based on the legal opinion of PST’s Brazilian legal counsel and the results of the Brazil Administrative Court's ruling in favor of another vehicle tracking and monitoring company related to the tax deficiency notice it received, the likelihood of loss is not probable although it may take years to resolve.  As a result of the above, as of September 30, 2013, no accrual has been recorded with respect to the tax assessment.  An unfavorable judgment on this issue for the years assessed and for subsequent years could result in significant costs to PST and adversely affect its results of operations.

In addition, PST has civil, labor and other tax contingencies for which the likelihood of loss is deemed to be reasonably possible, but not probable, by its legal advisors, and, therefore, no accrual has been recorded. Such contingencies amounted to $11,598 and $11,925 at September 30, 2013 and December 31, 2012.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

Product Warranty and Recall

Amounts accrued for product warranty and recall claims are established based on the Company's best estimate of the amounts necessary to settle future and existing 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 current portion of product warranty and recall is included as a component of accrued expenses and other current liabilities on the condensed consolidated balance sheets. Product warranty and recall included $249 and $494 of a long-term liability at September 30, 2013 and December 31, 2012, respectively, which is included as a component of other long-term liabilities on the condensed consolidated balance sheets.

The following provides a reconciliation of changes in product warranty and recall liability:

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

(10) Employee Benefit Plans

Long-Term Cash Incentive Plan

In March 2009, the Company adopted the Stoneridge, Inc. Long-Term Cash Incentive Plan ("LTCIP") and granted awards to certain officers and key employees. In May 2009, the LTCIP was approved by the Company's shareholders.

The 2010 awards under the LTCIP provided recipients with the right to receive an amount of cash equal to the fair market value of a specified number of Common Shares, without par value, of the Company ("Phantom Shares") three years from the date of grant depending on the Company's actual earnings per share performance for each fiscal year of 2010, 2011 and 2012 within the performance period. At December 31, 2012, the Company had a liability of $606 recorded for the 2010 LTCIP award included in accrued expenses and other current liabilities. The 2010 LTCIP awards vested and were paid in February 2013.

The 2013 awards under the LTCIP provided recipients with the right to receive an amount of cash equal to the fair market value of a specific number of Phantom Shares three years from the date of grant depending on the Company's actual earnings per share performance for each fiscal year of 2013, 2014, and 2015 within the performance period. The Company records an accrual for awards to be paid in the period earned based on anticipated achievement of the performance goal. If the participant voluntarily terminates employment or is discharged for cause, as defined in the LTCIP, the award is forfeited. The LTCIP accrual at September 30, 2013 for the 2013 awards was $60.

(11) Income Taxes

The Company adjusts its effective tax rate each quarter based on the estimated annual effective tax rate, as required. The Company also records the tax impact of certain discrete, unusual or infrequently occurring items, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected loss for the year where no tax benefit can be recognized are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings versus annual projections.

The Company recognized a provision for income taxes of $1,016, or 15.6% and $383, or 39.4% of income before income taxes, for federal, state and foreign income taxes for the three months ended September 30, 2013 and 2012, respectively. The increase in the tax provision was primarily due to higher income before income taxes in the current period compared to the same period for 2012. The decrease in the effective tax rate for the three months ended September 30, 2013 compared to the same period for 2012 was primarily attributable to the improved performance of PST and our European operations, which was partially offset by a decline in the performance of our North American operations.

The Company recognized a provision for income taxes of $3,160, or 16.3% and $717, or 40.9% of income before income taxes, for federal, state and foreign income taxes for the nine months ended September 30, 2013 and 2012, respectively. The increase in the tax provision was primarily due to higher income before income taxes compared to the same period in 2012. The decrease in the effective tax rate for the nine months ended September 30, 2013 compared to the same period for 2012 was primarily attributable to the improved performance of PST and our European operations, which was partially offset by a decline in the performance of our North American operations.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

(12) Segment Reporting

Operating segments are defined as components of an enterprise that are evaluated regularly by the Company's chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's chief operating decision maker is the chief executive officer.

During the fourth quarter of 2012, the Company changed its reportable segments in accordance with changes in financial information received and reviewed by the Company's chief operating decision maker. As a result, the Company's Wiring business unit is an operating segment for financial reporting purposes. Historically, the Wiring business unit was included in the Electronics operating segment. The Company has revised the consolidated segment information for 2012 to reflect this presentation.

The Company has four reportable segments: Electronics, Wiring, Control Devices and PST which also represents its operating segments. The Electronics reportable segment produces electronic instrument clusters, electronic control units and driver information systems. The Wiring reportable segment produces electrical power and signal distribution systems, primarily wiring harnesses and connectors and assembles instrument panels. The Control Devices reportable segment produces sensors, switches, valves and actuators. The PST reportable segment designs and manufactures electronic vehicle security alarms, convenience accessories, vehicle tracking devices and monitoring services and in-vehicle audio and video devices.

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, 2012 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.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

The following table presents net sales and long-term assets for each of the geographic areas in which the Company operates:

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data, unless otherwise indicated)

(Unaudited)

(13) Investments

Minda Stoneridge Instruments Ltd.

The Minda Stoneridge Instruments Ltd. ("Minda") joint venture at September 30, 2013 is an unconsolidated joint venture and is accounted for under the equity method of accounting. The Company has a 49% interest in Minda, a company based in India that manufactures electronics, instrumentation equipment and sensors primarily for the motorcycle and commercial vehicle market. The Company's investment in Minda recorded as a component of investments and other long-term assets, net on the condensed consolidated balance sheets, was $5,817 and $6,215 at September 30, 2013 and December 31, 2012, respectively. Equity in earnings of Minda included in the condensed consolidated statements of operations was $99 and $207, for the three months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, equity in earnings of Minda was $396 and $443, respectively.

PST Eletrônica Ltda.

The Company had a 74% controlling interest in PST for the three and nine months ended September 30, 2013 and 2012. Noncontrolling interest in PST decreased by $2,653 to $41,243 at September 30, 2013 due to a change in foreign currency translation of $3,706 and a dividend of $211 partially offset by a proportionate share of its net income of $1,264 for the nine months ended September 30, 2013. Comprehensive income related to the PST noncontrolling interest was $214 and $85 for the three months ended September 30, 2013 and 2012, respectively. Comprehensive loss related to the PST noncontrolling interest was $2,442 and $4,893 for the nine months ended September 30, 2013 and 2012, respectively.

(14)  Recently Issued Accounting Standards

Accounting Standards Adopted

In February 2013, the Financial Accounting Standards Board ("FASB") issued an accounting standards update requiring new disclosures about reclassifications from accumulated other comprehensive loss to net income. These disclosures may be presented on the face of the statements or in the notes to the consolidated financial statements. The standards update is effective for fiscal years beginning after December 15, 2012. We adopted this standards update on January 1, 2013 and revised our disclosures, see Note 7.

In December 2011, the FASB issued an accounting standards update requiring new disclosures about financial instruments and derivative instruments that are either offset by or subject to an enforceable master netting arrangement or similar agreement. The standards update is effective for fiscal years beginning after December 15, 2012. We adopted this standards update on January 1, 2013 which had no impact on our disclosures.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a global designer and manufacturer of highly engineered electrical and electronic components, modules and systems for the commercial, automotive, agricultural, motorcycle and off-highway vehicle markets.

Segments

We are primarily organized by products produced and markets served. Under this structure, our operations have been reported utilizing the following segments:

Electronics

This segment includes results of operations from the production of electronic instrument clusters, electronic control units and driver information systems.

Wiring

This segment includes results of operations that produce electrical power and signal distribution systems, primarily wiring harnesses and connectors and assembles instrument panels.

Control Devices

This segment includes results of operations that manufacture sensors, switches, valves and actuators.

PST

This segment includes results of operations that design and manufacture electronic vehicle alarms, convenience accessories, vehicle tracking devices and monitoring services and in-vehicle audio and video devices in South America.

In the fourth quarter of 2012, the Company changed its reportable segments in accordance with the manner in which the Company’s chief operating decision maker receives and reviews financial information to evaluate performance and allocate resources. As a result, the Company’s Wiring business unit is its own reporting segment for financial reporting purposes. Historically, the Wiring business unit was included in the Electronics reporting segment. The Company has revised the consolidated segment information for 2012 to reflect this change in presentation.

Third Quarter Overview

Stoneridge, Inc. had net income of $5.0 million, or $0.19 per diluted share for the third quarter of 2013, a $4.6 million, or $0.17 per diluted share increase from $0.4 million, or $0.02 per diluted share for the third quarter of 2012.

The increase in third quarter 2013 earnings compared to the third quarter of 2012 was primarily due to increased sales in our diversified served markets, a favorable change in mix of products sold, lower selling, general and administrative (“SG&A”) expenses, lower interest expense and less unfavorable currency losses on transactions denominated in a currency other than the functional currency of our subsidiaries.

Net sales increased by $9.7 million from increased production volumes and sales of new products in the North American automotive vehicle market and $6.3 million from higher sales to our European commercial vehicle customers. These net sales increases were partially offset by decreased sales volume to a North American commercial vehicle customer and the negative impact of unfavorable changes in foreign currency exchange rates, primarily related to PST, of approximately $4.7 million during the third quarter of 2013 when compared to the third quarter of 2012.

At September 30, 2013 and December 31, 2012, we maintained a cash and cash equivalents balance of $46.1 million and $44.6 million, respectively. As discussed in Note 5 to the condensed consolidated financial statements, at September 30, 2013 and December 31, 2012, we had no borrowings outstanding on our asset-based credit facility (the “Credit Facility”). We had undrawn borrowing capacity on the Credit Facility of $83.6 million and $74.1 million at September 30, 2013 and December 31, 2012, respectively.

Outlook

The North American commercial vehicle market weakened in the second half of 2012. The market continued to show weakness in the first nine months of 2013 which we expect will continue in the fourth quarter of 2013. If actual production is lower than forecasted it will negatively affect our Wiring and Electronics segments.

The improvement in the North American automotive vehicle market, the market share gains of our customers and sales of new products had a favorable effect on our Control Devices segment’s results. North American automotive vehicle production was 15.4 million units for 2012. For 2013, this production volume is forecasted to be in the range of 15.5 million to 16.2 million units. If this forecasted increase in production volume occurs it will favorably affect our Control Devices segment.

The European commercial vehicle market is expected to continue to improve in the fourth quarter of 2013. However, if actual production is lower than forecasted, it will negatively affect our Electronics segment.

Agricultural vehicle production decreased for the first half of of 2013 when compared to the first half of 2012 which unfavorably affected our Wiring segment. However, production increased in the third quarter of 2013. If production is lower than forecast it will negatively affect our Wiring segment.

Third quarter revenues of our PST segment increased in local Brazilian currency compared to the same period in 2012 which we believe will continue in the fourth quarter of 2013. However, any weakening of the Brazilian economy will have a negative effect on our results.

Due to the competitive nature of the markets we serve, in the ordinary course of business we face pricing pressures from our customers. In response to these pricing pressures we have been able to effectively manage our production costs by the combination of lowering certain costs and limiting the increase of others, the net impact of which has not been material. However, if we are unable to effectively manage production costs in the future to mitigate future pricing pressures, our results of operations may be adversely affected.

Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012

Condensed consolidated statements of operations as a percentage of net sales are presented in the following table (in thousands):

Net Sales. Net sales for our reportable segments, excluding inter-segment sales, are summarized in the following table (in thousands):

Our Electronics segment net sales increased primarily due to a $6.3 million increase in sales of our European commercial vehicle products resulting from higher volume and new product sales.  Also, the Electronics segment net sales were favorably affected by foreign currency fluctuations of approximately $0.8 million for the third quarter of 2013 when compared to the third quarter of 2012.

Our Wiring segment sales decreased due to volume decreases in our commercial vehicle products of $3.5 million primarily related to the loss of market share by a significant customer, which were partially offset by volume increases to our agricultural customers of $2.3 million.

Our Control Devices segment sales increased due to higher volume and new products primarily in our North American automotive vehicle market of $9.0 million during the third quarter of 2013 when compared to the third quarter of 2012.

Our PST segment sales decreased slightly despite a 12.5% sales increase in local Brazilian currency due to an unfavorable change in foreign currency translation of approximately $5.6 million, which reduced sales by 12.8%.

Net sales by geographic location are summarized in the following table (in thousands):

The North American geographic location consists of the results of our operations in the United States and Mexico.

The increase in North American net sales was primarily attributable to increased sales volume in our North American automotive vehicle market of $9.7 million which was partially offset by lower North American commercial vehicle sales of approximately $3.6 million. Our slight decrease in net sales in South America was primarily due to an unfavorable foreign currency translation which more than offset the higher sales volume. Our increase in net sales in Europe and Other was primarily due to increased sales of European commercial vehicle market products of $6.3 million and favorable foreign currency fluctuations.

Cost of Goods Sold and Gross Margin. Cost of goods sold increased by 7.1% primarily due to a 6.5% increase in sales and was benefited by a favorable change in mix of products sold and lower material costs. Our material cost as a percentage of net sales improved to 51.9% for the third quarter of 2013 compared to 52.2% for the third quarter of 2012. Our gross margin decreased to 22.9% for the third quarter of 2013 compared to 23.4% for the third quarter of 2012 primarily due to higher labor costs in response to higher customer forecasted demand for which actual sales did not occur and higher premium freight, which were partially offset by lower material costs.

Our Electronics segment gross margin increased primarily due to an 18.7% increase in sales and benefited by a favorable change in mix of products sold.

Our Wiring segment gross margin declined due to increased labor costs in response to higher customer forecasted demand for which actual sales did not occur and an increase in premium freight, which were partially offset by lower raw material costs.

Our Control Devices segment gross margin increased due to a 12.7% increase in sales and a favorable change in mix of products sold. In addition, material costs were favorably impacted by lower component costs.

Our PST segment gross margin declined slightly due to unfavorable change in mix of products sold, an increase in component costs and an unfavorable foreign currency translation.

Selling, General and Administrative Expenses. SG&A expenses decreased by $1.8 million for the third quarter of 2013 compared to the prior year third quarter due to decreases in sales, general and administrative costs of $2.3 million which was offset by an increase product development expenses.

Interest Expense, net. Interest expense, net decreased by $0.3 million during the third quarter of 2013 when compared to the prior year third quarter primarily from reduced interest on our PST term notes and revolving credit facilities due to lower average outstanding loan balances.

Equity in Earnings of Investees. Equity earnings for Minda was $0.1 million for the third quarter of 2013 compared to $0.2 million for the third quarter of 2012.

Other (Income) Expense, net. We record certain foreign currency transaction and forward currency hedge contract gains and losses as a component of other (income) expense, net on the condensed consolidated statement of operations. Our results for the three months ended September 30, 2013 were favorably affected by approximately $0.3 million while our results for the three months ended September 30, 2012 were unfavorably affected by approximately $0.9 million due to the volatility in certain foreign exchange rates. Most of the unfavorable foreign currency loss for the third quarter of 2012 was related to the translation of PST’s U.S. dollar-denominated debt.

Income Before Income Taxes. Income (loss) before income taxes is summarized in the following table by reportable segment (in thousands):

Our Electronics segment income before income taxes increased primarily due to higher sales and favorable mix of products sold.

Our Wiring segment income before income taxes decreased primarily due to higher labor costs in response to higher customer forecasted demand for which actual sales did not occur and higher premium freight, which were partially offset by lower raw material costs.

Our Control Devices segment income before income taxes increased due to higher sales, a favorable change in mix of products sold and lower component costs.

Our PST segment increase in profitability is due to lower operating expenses, lower interest expense and a less unfavorable impact of the volatility in foreign exchange rates in the current quarter.

The decrease in income before income taxes from other corporate activities is primarily related to higher share-based compensation, partially offset by lower foreign currency losses.

Income before income taxes by geographic location is summarized in the following table (in thousands):

North American income before income taxes includes interest expense, net of approximately $3.9 million for each of the quarters ended September 30, 2013 and 2012, respectively.

Our North American results increased primarily as a result of increased sales in the North American automotive vehicle market, which were substantially offset by lower sales in our North American commercial vehicle market, higher labor costs in response to higher customer forecasted demand for which actual sales did not occur and higher premium freight costs in our Wiring segment during the third quarter of 2013 as compared to 2012. The increase in profitability in South America was primarily due to lower operating expenses, lower interest expense and a less unfavorable impact of volatility in foreign exchange rates. Our results in Europe and Other were favorably affected by our increased European commercial vehicle market sales during the current period.

Provision for Income Taxes. We recognized a provision for income taxes of $1.0 million, or 15.6% and $0.4 million, or 39.4% for federal, state and foreign income taxes for the third quarter of 2013 and 2012, respectively. The increase in the tax provision was primarily due to higher income before income taxes compared to the same period in 2012. The decrease in the effective tax rate for the three months ended September 30, 2013 compared to the same period for 2012 was primarily attributable to the impact of the improved performance of PST and our European operations which was partially offset by the decline in the performance of our North American operations.

Nine Months Ended September 30, 2013 Compared to Nine Months Ended September 30, 2012

Condensed consolidated statements of operations as a percentage of net sales are presented in the following table (in thousands):