STONERIDGE INC - Quarter Report: 2014 June (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 June 30, 2014

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.

xYes ¨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).

xYes ¨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 xNo

The number of Common Shares, without par value, outstanding as of July 30, 2014 was 28,244,331.

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 LOSS

(Unaudited)

The Company has combined comprehensive loss from continuing operations and comprehensive loss from discontinued operations herein.

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

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The Company has combined cash flows from continuing operations and cash flows from discontinued operations within the operating, investing and financing categories.

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 six months ended June 30, 2014 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 2013 Form 10-K.

During the second quarter of 2014, the Company entered into an asset purchase agreement to divest its Wiring business. The Wiring business is classified as held for sale and its activities as discontinued operations in accordance with the applicable accounting standards for all periods presented in the Company’s financial statements. Therefore, the Wiring business is excluded from both continuing operations and segment results for all periods presented. All previously reported financial information has been revised to conform to the current presentation.. The Wiring business designs and manufactures wiring harness products and assembles instruments panels principally to the commercial, agricultural and off-highway vehicle markets.

(2)  Recently Issued Accounting Standards

Accounting Standards Adopted

In July 2013, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update (“ASU”) No. 2013-11, “Income Taxes (Topic 740)”, which requires entities to present in the financial statements an unrecognized tax benefit, or a portion of an unrecognized tax benefit as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward except to the extent such items are not available or not intended to be used at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position. In such instances, the unrecognized tax benefit is required to be presented in the financial statements as a liability and not be combined with deferred tax assets. This standards update is effective for fiscal years beginning after December 15, 2013. This standards update was adopted on January 1, 2014 which did not have a material impact on our condensed consolidated financial statements.

In April 2014, FASB issued ASU No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360)”, which amends the definition of a discontinued operation in ASC 205-20 and requires entities to provide additional disclosures about discontinued operations as well as disposal transactions that do not meet the discontinued-operations criteria. The new guidance changes the definition of a discontinued operation and requires discontinued operations treatment for disposals of a component or group of components that represents a strategic shift that has or will have a major impact on an entity’s operations or financial results. The ASU is effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014. Early adoption is permitted. The Company adopted the standard in May 2014 and is applying it prospectively to new disposals and new classifications of disposal groups as held for sale including the Wiring business. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which clarifies existing accounting literature relating to how and when a company recognizes revenue. Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. This standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016. As such, the Company will adopt this standard in the first quarter of fiscal year 2017. Early adoption is prohibited. The Company is in the process of determining the impact, if any, the adoption of this standard ASU will have on its condensed consolidated financial statements.

(3) Discontinued Operations

Wiring Business

On May 26, 2014, the Company entered into an asset purchase agreement to sell substantially all of the assets and liabilities of the former Wiring segment to Motherson Sumi Systems Ltd., an India-based manufacturer of diversified products for the global automotive industry and a limited company incorporated under the laws of the Republic of India, and MSSL (GB) LIMITED, a limited company incorporated under the laws of the United Kingdom (collectively, “Motherson”) for $65,700 in cash and the assumption of certain related liabilities of the Wiring business. The final price to be paid is subject to working capital and other customary adjustments.

In the second quarter of 2014 the Company recorded a charge of $1,000 ($660 after tax) to adjust the carrying value of the Wiring assets to their estimated fair value less cost to sell, based on the terms of the agreement. The charge is included in loss on disposal, net of tax within discontinued operations in the condensed consolidated statements of operations.

On August 1, 2014, the Company completed the sale of substantially all of the assets and liabilities of its Wiring business to Motherson for $71,400 in cash, and consisted of $65,700 stated purchase price, a $2,600 working capital adjustment, and $3,100 wiring business cash on the closing date, which is subject to final working capital and other customary adjustments. The Company also entered into a transition services agreement with Motherson for the period July through December 2014 associated with information systems, accounting, administrative and support services as well as production in Estonia and China. In addition, the Company’s Electronics segment will have ongoing sales to the Wiring business acquired by Motherson.

The total assets and liabilities that are included as held for sale in our condensed consolidated balance sheet as of June 30, 2014 are approximately $106,347 and $33,084, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

The following tables display summarized activity in our condensed consolidated statements of operations for discontinued operations during the three and six months ended June 30, 2014 and 2013, related to the Wiring business.

Wiring intercompany sales were $1,669 and $2,198 for the three months ended June 30, 2014 and 2013, respectively, and $3,544 and $3,801 for the six months ended June 30, 2014 and 2013, respectively.

Wiring intercompany purchases were $7,510 and $6,736 for the three months ended June 30, 2014 and 2013, respectively, and $15,290 and $13,401 for the six months ended June 30, 2014 and 2013, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

The following table displays a summary of the Wiring assets and liabilities held for sale as of June 30, 2014 and December 31, 2013.

(4) Goodwill

The Company conducts its annual goodwill impairment test for its majority owned subsidiary, PST Eletrônica Ltda. (“PST”) on October 1, and did so in 2013 without a need to expand the impairment test to step two of Accounting Standards Codification (“ASC”) 350 as PST’s calculated fair value exceeded its carrying value by approximately 10.0% and no indicators of impairment were identified as disclosed in the Company’s 2013 Form 10-K.

During the second quarter of 2014 however, indicators of potential impairment required the Company to conduct an interim impairment test. Those indicators included a decline in recent operating results and lower growth expectations primarily due to the weakening of the Brazilian economy and automotive market. In accordance with ASC 350, the Company completed step one of the impairment analysis and concluded that, as of June 30, 2014, the fair value of the PST reportable segment was below its carrying value, including goodwill. As such, step two of the impairment test was initiated in accordance with ASC 350.

Due to its time intensive nature, the step two analysis has not been completed as of the date of this filing. In accordance with ASC 350, the Company has recorded its best estimate of $29,300 as a non-cash goodwill impairment charge (of which $6,436 was attributable to noncontrolling interest) as of June 30, 2014 which is included in the Company’s condensed consolidated statements of operations. The Company expects to complete the step two analysis in the third quarter of 2014.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

The change in the carrying amount of goodwill is as follows:

(5) 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 $40,442 and $33,220 at June 30, 2014 and December 31, 2013, respectively. Inventory valued using the average cost method was $56,684 and $46,308 at June 30, 2014 and December 31, 2013, respectively.

(6) 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 June 30, 2014 and December 31, 2013 was $186,603 and $190,100, respectively, and was determined using market quotes classified as Level 2 input within the fair value hierarchy.

Derivative Instruments and Hedging Activities

On June 30, 2014, 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.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

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 intercompany transactions and other foreign currency exposures. The currencies hedged by the Company during 2014 and 2013 include the euro 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 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:

Euro-denominated Foreign Currency Forward Contract

As of June 30, 2014 and December 31, 2013, the Company held a foreign currency forward contract with underlying notional amounts of $13,279 and $13,335, respectively, to reduce the exposure related to the Company's euro-denominated intercompany loans. This contract expires in September 2014. The euro-denominated foreign currency forward contract was not designated as a hedging instrument. For the three months ended June 30, 2014 and 2013, the Company recognized a gain of $86 and a loss of $278, respectively, in the condensed consolidated statement of operations as a component of other expense, net related to the euro-denominated contract. For the six months ended June 30, 2014 and 2013, the Company recognized a gain of $25 and $85, respectively, related to this contract.

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 June 30, 2014 totaling $22,500 which expire ratably on a monthly basis from July through December 2014, compared to $45,000 at December 31, 2013. 

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 cash flow hedges are highly effective and the Company expects them to remain highly effective in future periods. The effectiveness of the transactions has been and will be measured on an ongoing basis using regression analysis and forecasted future Mexican peso purchases.

The Company evaluated the effectiveness of the Mexican peso-denominated foreign currency forward contracts as of June 30, 2014. As a result of the sale of the Wiring business, the Company forecasts that it will purchase Mexican pesos to fulfill only two of the five hedge contracts for the period August 2014 through December 2014. As the purchase of Mexican pesos related to three of the five hedge contracts is not probable, these three hedges attributed to the Wiring business have been de-designated at June 30, 2014 and the associated unrecognized $320 gain at that date has been recorded in discontinued operations in the Company’s condensed consolidated statements of operations for the three and six months ended June 30, 2014. The previous unrecognized gains on the de-designated hedge contracts have been reclassified from accumulated other comprehensive loss.

Commodity Price Risk - Cash Flow Hedge

To mitigate the risk of future price volatility and, consequently, fluctuations in gross margins, 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 as copper is a significant raw material.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

The Company has fixed price commodity contracts at June 30, 2014 with an aggregate notional amount of 1,237 pounds, which expire on a monthly basis over the period from July 2014 through March 2015, compared to an aggregate notional amount of 1,582 pounds at December 31, 2013.

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 the 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, if any, 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.

The Company evaluated the effectiveness of the copper fixed price commodity contracts as of June 30, 2014. As a result of the sale of the Wiring business, the Company forecasts that it will not purchase the quantities of copper to fulfill the two hedge contracts for the period August 2014 through December 2014. As the purchase of copper quantities related to these hedge contracts is not probable, the contracts primarily associated with the Wiring segment not expected to be fulfilled have been de-designated at June 30, 2014 and the associated unrecognized $77 gain at that date has been recorded in discontinued operations in the Company’s condensed consolidated statements of operations for the three and six months ended June 30, 2014. The previous unrecognized gains have been reclassified from accumulated other comprehensive loss.

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 $206 and $191 for the three months ended June 30, 2014 and 2013, respectively, and by $431 and $422 for the six months ended June 30, 2014 and 2013, 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 were as follows: 

Amounts recorded for the cash flow hedges in other comprehensive income (loss) and in net income (loss) for the three months ended June 30 are as follows: 

Amounts recorded for the cash flow hedges in other comprehensive income (loss) and in net income (loss) for the six months ended June 30 are as follows:

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

The net deferred gain of $19 on the cash flow hedge derivatives will be reclassified from other comprehensive income (loss) to the condensed consolidated statements of operations through December 2014.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

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.

As described in Note 4 the Company performed an interim assessment for impairment of the PST goodwill as of June 30, 2014.

In step one the Company used an income approach to estimate the fair value of PST. The income approach utilized a discounted cash flow valuation technique which incorporates the Company's projected future estimates of after-tax cash flows attributable to its future growth rates, terminal value amounts and the weighted average cost of capital. The Company determined that the carrying value of the PST reporting unit exceeded its estimated fair value.

In performing a preliminary step two evaluation the Company recorded its best estimate of the implied fair value of PST’s goodwill resulting in an impairment charge of $29,300 at June 30, 2014. This charge had no impact on the Company's cash flows or compliance with debt covenants.

The primary factors contributing to the goodwill impairment charge were a significant weakening of the Brazilian economy and automotive market in the first half of 2014 which decreased consumer demand for PST’s products, and increased competition. As such, the Company’s sales for the first half of 2014 declined, and estimated growth rates were lowered which negatively impacted future cash flows.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

The fair value measurement of the reporting unit under the step one analysis and the step two analysis in their entirety are classified as Level 3 inputs. The estimates and assumptions underlying the fair value calculations used in the Company's impairment test are uncertain by their nature and can vary significantly from actual results. Factors that management must estimate include, but are not limited to, industry and market conditions, sales volume and pricing, raw material costs, capital expenditures, working capital changes, cost of capital, debt-equity mix and tax rates. The estimates and assumptions that most significantly affect the fair value calculation are sales volume and the associated cash flow assumptions, market growth and weighted average cost of capital. The estimates and assumptions used in the estimate of fair value are consistent with those the Company uses in its internal planning.

(7) 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 $1,137 and $1,336 for the three months ended June 30, 2014 and 2013, respectively. Of these amounts, $0 and $(2) were related to the Long-Term Cash Incentive Plan “Phantom Shares” discussed in Note 12 for the three months ended June 30, 2014 and 2013, respectively.  For the six months ended June 30, 2014 and 2013, total compensation expense recognized in the condensed consolidated statements of operations for share-based compensation arrangements was $2,300 and $2,723, respectively. Of these amounts, $0 and $154 for the six months ended June 30, 2014 and 2013, respectively, were related to the Long-Term Cash Incentive Plan "Phantom Shares" discussed in Note 12.

(8) Debt

Debt consisted of the following at June 30, 2014 and December 31, 2013:

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

Revolving Credit Facility

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. There were no borrowings outstanding at June 30, 2014 and December 31, 2013.

The available borrowing capacity on the Credit Facility is based on eligible current assets, as defined. The Company had undrawn borrowing capacity of approximately $85,446 and $71,072 at June 30, 2014 and December 31, 2013, 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 June 30, 2014 and December 31, 2013.

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 June 30, 2014 and December 31, 2013 was $2,428 and $2,732, respectively. The Company may redeem up to 10.0% of the senior secured notes at 103.0% prior to October 15, 2014. The senior secured notes are also 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.

PST maintains several short-term and long-term notes used for working capital purposes that have fixed interest rates. The weighted-average interest rates of short-term and long-term debt of PST at June 30, 2014 were 9.9% and 4.9%, respectively.  Depending on the specific note, interest is payable either monthly or annually. The PST notes at June 30, 2014 mature as follows: $19,539 in 2014, $3,595 in 2015, $2,359 in 2016, $1,168 in 2017 and approximately $1,124 annually in 2018 and 2019. 

On August 21, 2013, the Company's wholly-owned subsidiary located in Suzhou, China entered into a term loan for 9,000 Chinese yuan which matured in February 2014. On February 25, 2014, 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 $1,451 and $1,487 at June 30, 2014 and December 31, 2013, respectively. The Suzhou note is included on the condensed consolidated balance sheets as a component of current portion of long-term debt. The term loan matures in August 2014 with interest payable quarterly at 132.0% of the one-year lending rate published by The People's Bank of China, which was 7.39% at June 30, 2014.

The Company was in compliance with all note covenants at June 30, 2014 and December 31, 2013.

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 $2,992 and $3,107, at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014 and December 31, 2013, there was no balance outstanding on this bank account.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(9) Earnings (Loss) Per Share

Basic earnings (loss) per share was computed by dividing net income by the weighted-average number of Common Shares outstanding for each respective period. Diluted earnings (loss) per share was calculated by dividing net income (loss) attributable to Stoneridge, Inc. by the weighted-average of all potentially dilutive Common Shares that were outstanding during the periods presented.  However, for all periods in which the Company recognized a net loss, the Company did not recognize the effect of the potential dilutive securities as their inclusion would be anti-dilutive.

Weighted-average Common Shares outstanding used in calculating basic and diluted net income (loss) per share were as follows:

At June 30, 2013, options not included in the computation of diluted earnings per share to purchase 20,000 Common Shares at an average price of $15.73 per share were outstanding. These outstanding options were not included in the computation of diluted earnings per share because their respective exercise prices were greater than the average closing market price of Company Common Shares and the effect would be anti-dilutive. There were no outstanding options at June 30, 2014.

There were 466,650 and 663,750 performance-based restricted Common Shares outstanding at June 30, 2014 and 2013, respectively. There were also 374,400 performance-based right to receive Common Shares outstanding at June 30, 2014. These restricted and right to receive Common Shares were not included in the computation of diluted earnings per share because all vesting conditions have not been achieved as of June 30, 2014 and 2013. These shares may become dilutive based on the Company’s ability to meet or exceed future performance targets.

(10) Changes in Accumulated Other Comprehensive Loss by Component

Changes in accumulated other comprehensive loss for the three months ended June 30, 2014 and 2013 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 six months ended June 30, 2014 and 2013 were as follows:

(11)  Commitments and Contingencies

In the ordinary course of business, the Company is subject to a broad range of claims and legal proceedings that relate to contractual allegations, tax audits, patent infringement, product liability and employment-related matters. Although it is not possible to predict with certainty the outcome of these matters, the Company is of the opinion that the ultimate resolution of these matters will not have a material adverse affect on its consolidated results of operations or financial position.

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. Ground water remediation will begin in the third quarter of 2014, as the remedial action plan has been approved by the Florida Department of Environmental Protection. During the three and six months ended June 30, 2014 and 2013, environmental remediation costs incurred were immaterial. At June 30, 2014 and December 31, 2013, the Company had accrued an undiscounted liability of $944 related to future remediation. At June 30, 2014 and December 31, 2013, $715 and $683, respectively, was recorded as a component of accrued expenses and other current liabilities on the condensed consolidated balance sheets while the remaining amount was 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. Although the Company sold the Sarasota facility and related property in December 2011, 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.

In September 2013, a legal proceeding was initiated by Actia Automotive (“Actia”) in a French court (the tribunal de grande instance de Paris) alleging infringement of its patents by the Company’s Electronics segment. Actia is seeking injunctive relief and monetary damages of approximately $19,000 resulting from such alleged infringement. The Company believes that its products did not infringe on any of the patents claimed by Actia, and the claim is without merit. Therefore it will vigorously defend itself against these allegations. The Company believes the likelihood of loss is not probable. As such, no liability has been recorded for this claim.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

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 ($42,000) which is comprised of Value Added Tax – ICMS of R$13,200 ($6,000), interest of R$11,400 ($5,200) and penalties of R$67,900 ($30,800).

The Company believes that the 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 the Company’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 June 30, 2014 and December 31, 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 the Company’s legal advisors in Brazil. As a result, no provision has been recorded with respect to these contingencies, which amounted to $14,787 and $11,469 at June 30, 2014 and December 31, 2013, respectively. An unfavorable outcome on this issue could result in significant cost to PST and adversely affect its results of operations.

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 $1,133 and $1,019 of a long-term liability at June 30, 2014 and December 31, 2013, respectively, which is included as a component of other long-term liabilities on the condensed consolidated balance sheets.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

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

(12) 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 Company granted awards under the LTCIP in 2013 which 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 a liability 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. There was no accrual recorded related to the LTCIP at June 30, 2014 for the 2013 or 2014 performance periods.

(13) 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 projected earnings.

The Company recognized a provision for income taxes of $90 and $775 for federal, state and foreign income taxes for the three months ended June 30, 2014 and 2013, respectively. The decrease in the tax provision was primarily due to lower income before income taxes in the current period compared to the same period for 2013 primarily due to the loss incurred by PST, which included a goodwill impairment charge of $29,300. The PST goodwill impairment charge does not generate a tax benefit as it is not deductible for Brazilian tax purposes. The decrease in tax related to PST was partially offset by an increase in tax due to the improved financial performance of our operations in Sweden and an increase in the effective tax rate related to our operations in Juarez, Mexico. The decrease in the effective tax rate for the three months ended June 30, 2014 to (0.3)% compared to the same period for 2013 of 10.8% was due to the impact of the nondeductible PST goodwill impairment.

The Company recognized a provision for income taxes of $385 and $1,466 for federal, state and foreign income taxes for the six months ended June 30, 2014 and 2013, respectively. The decrease in the tax provision was primarily due to lower income before income taxes in the current period compared to the same period for 2013 primarily due to the loss incurred by PST, which included a goodwill impairment charge of $29,300. The PST goodwill impairment charge does not generate a tax benefit as it is not deductible for Brazilian tax purposes. The decrease in tax related to PST was partially offset by an increase in tax due to the improved financial performance of our operations in Sweden and Juarez, Mexico. In addition, the decrease in tax expense was partially offset by discrete tax items related to certain foreign operations recorded during the current period. The decrease in the effective tax rate for the six months ended June 30, 2014 to (1.3)% compared to the same period for 2013 of 13.3% was due to a reduction in the rate related to the nondeductible PST goodwill impairment, which was offset by the impact of the discrete tax items discussed above. In addition, the effective tax rate decreased due to the recognition of a tax benefit on the PST operating loss which was partially offset by the tax impact of the increased profitability of the operations in Sweden and Juarez, Mexico.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(14) 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 second quarter of 2014 the Company entered into an asset purchase agreement to sell its Wiring business segment, which designs and manufactures wiring harness products and assembles instrument panels for sale principally to the commercial, agricultural and off-highway vehicle markets. As such, for all periods presented the Company has reported this business as held for sale and discontinued operations in the Company’s condensed consolidated financial statements and therefore has excluded it from the segment disclosures herein. See Note 3 for additional details.

The Company has three reportable segments: Control Devices, Electronics and PST which also represents its operating segments. The Control Devices reportable segment produces sensors, switches, valves and actuators. The Electronics reportable segment produces electronic instrument clusters, electronic control units and driver information systems. 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.

During the second quarter of 2014 the Company also changed its segment operating performance metric in accordance with changes in the financial information reviewed and performance measured by the Company’s chief operating decision maker. As a result, the Company now uses operating income for financial reporting purposes. Historically, the Company utilized income before income taxes. The Company has revised the consolidated segment information for all periods presented to reflect this presentation.

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 2013 Form 10-K. The Company's management evaluates the performance of its reportable segments based primarily on revenues from external customers, capital expenditures and operating income. 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 from continuing operations for each of the geographic areas in which the Company operates:

(15) Investments

Minda Stoneridge Instruments Ltd.

The Company has a 49% interest in Minda Stoneridge Instruments Ltd. (“Minda”), a company based in India that manufactures electronics, instrumentation equipment and sensors primarily for the motorcycle and commercial vehicle market. The investment is accounted for under the equity method of accounting. 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 $6,529 and $5,981 at June 30, 2014 and December 31, 2013, respectively. Equity in earnings of Minda included in the condensed consolidated statements of operations was $144 and $96, for the three months ended June 30, 2014 and 2013, respectively. Equity in earnings of Minda included in the condensed consolidated statements of operations was $382 and $297, for the six months ended June 30, 2014 and 2013, respectively.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

PST Eletrônica Ltda.

The Company has a 74% controlling interest in PST. Noncontrolling interest in PST decreased by $5,862 to $33,678 at June 30, 2014 due to a of proportionate share of its net loss of $8,199 including goodwill impairment for the six months ended June 30, 2014, which was partially offset by a favorable change in foreign currency translation of $2,337. Noncontrolling interest in PST decreased by $2,867 to $41,209 at June 30, 2013 due to an unfavorable change in foreign currency translation of $3,455 and a dividend of $211, partially offset by a proportionate share of its net income of $799 for the six months ended June 30, 2013. Comprehensive loss related to the PST noncontrolling interest was $6,230 and $3,468 for the three months ended June 30, 2014 and 2013, respectively. Comprehensive loss related to the PST noncontrolling interest was $5,863 and $2,656 for the six months ended June 30, 2014 and 2013, respectively.

(16) Subsequent Events

On August 1, 2014, the Company completed the sale of substantially all of the assets and liabilities of its Wiring business to Motherson for $71,400 in cash, which is subject to final working capital and other customary adjustments.

On August 1, 2014, the Company instructed the Trustee under the Indenture for the Company’s 9.5% senior secured notes to issue a notice of redemption of $17,500 (or 10.0%) of its senior secured notes at a premium of 103.0% of the principal amount which will result in a loss on redemption and acceleration of deferred financing costs and discount of approximately $800 in the third quarter of 2014. The redemption date is set for September 2, 2014.

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

Background

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

Segments

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

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

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

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.

During the second quarter of 2014 we entered into an asset purchase agreement to divest our Wiring business, which designs and manufactures wiring harness products and assembles instrument panels principally to the commercial, agricultural and off-highway vehicle markets. As such, this business is classified as discontinued operations in our condensed consolidated financial statements and no discussion and analysis of financial condition and results of operations is provided herein.

Second Quarter Overview

The Company had a net loss from continuing operations attributable to Stoneridge. Inc. of $21.3 million, or $(0.79) per diluted share for the second quarter of 2014, a $27.1 million, or $(1.00) per diluted share decrease from income of $5.8 million, or $0.21 per diluted share for the second quarter of 2013.

The decrease in second quarter earnings from continuing operations compared to the second quarter of 2013 was primarily due to lower earnings of our PST segment. PST recorded a goodwill impairment charge of $29.3 million (including $6.4 million attributable to noncontrolling interest) which had a negative impact of $0.85 per share attributable to Stoneridge, Inc. PST earnings were also negatively impacted by an unfavorable change in mix of products sold, lower sales resulting from weakness in the Brazilian economy and automotive market and an unfavorable change in foreign currency translation.

Net sales decreased by $7.7 million, or 4.6%, primarily due to lower product sales volume at our PST segment, which was partially offset by higher sales in our Electronics and Control Devices segments during the second quarter of 2014 compared to the second quarter of 2013.

Loss from discontinued operations was $0.5 million, or $(0.02) per diluted share for the second quarter of 2014, a $0.5 million, or $0.02 per diluted share decrease from income from discontinued operations of $0.0 million, or $0.00 per diluted share for the second quarter of 2013 primarily due to the estimated after-tax loss on disposal of the Wiring business of $1.1 million, in particular the write-down of the asset group to their estimated fair value and transaction costs. The decrease is also due to lower sales volume, which was partially offset by a $0.4 million gain recognized on the de-designation of certain Mexican peso and copper hedge contracts, a decrease in labor costs and lower general and administrative expenses.

At June 30, 2014 and December 31, 2013, we maintained a cash and cash equivalents balance of $45.8 million and $62.8 million, respectively. The decrease was primarily due to an increase in working capital levels. As discussed in Note 8 to the condensed consolidated financial statements, at June 30, 2014 and December 31, 2013, we had no borrowings outstanding on our asset-based credit facility (the “Credit Facility”). We had undrawn borrowing capacity on the Credit Facility of $85.4 million and $71.1 million at June 30, 2014 and December 31, 2013, respectively.

Outlook

The North American automotive vehicle market is expected to continue to have modest improvement 2014. For 2014, this production volume is forecasted to be in the range of 16.5 million to 17.0 million units, an increase from 16.2 million units in 2013. The improvement in the North American automotive vehicle market and sales of new products had a favorable effect on our Control Devices segment’s results for the first half of 2014 which we expect will continue for the remainder of the year.

The North American commercial vehicle market showed weakness throughout 2013, but has improved in the first half of 2014 which we believe will continue throughout the remainder of the year.

The European commercial vehicle market improved in the first half of 2014 which is expected to continue throughout 2014 and have a favorable impact on our Electronics segment.

Our PST segment revenues decreased in the first half of 2014 compared to 2013 due to a weakened Brazilian economy. The overall Brazilian economy grew less than 2.0% gross domestic product in the second quarter and its automotive industry has been weak. As there is significant uncertainty regarding the recovery of the Brazilian economy and automotive industry in the second half of 2014, PST has and will continue to realign its cost structure to mitigate the impact on earnings of possible continued lower product demand for the remainder of 2014. However, we remain optimistic for higher growth in the longer term.

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 would be adversely affected.

Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013

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 Control Devices segment sales increased primarily due to higher volume in our North American automotive and commercial vehicle markets of $1.8 million and $0.8 million, respectively, during the second quarter of 2014 when compared to the second quarter of 2013.

Our Electronics segment net sales increased primarily due to an increase in sales of our European and North American commercial vehicle products of $3.1 million and $1.0 million, respectively, resulting from higher volume and new product sales for the second quarter of 2014 when compared to the second quarter of 2013.

Our PST segment sales decreased primarily due to lower product volume in its aftermarket, audio and OEM channels and was negatively impacted by an unfavorable change in foreign currency translation which reduced sales by approximately $2.5 million or 5.4%.

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 and commercial vehicle markets within our Control Devices segment of $1.8 million and $0.8 million, respectively. Our decrease in net sales in South America was primarily due to lower PST product sales volume and was negatively impacted by an unfavorable foreign currency translation. Our increase in net sales in Europe and Other was primarily due to increased sales of European commercial vehicle market products of $3.1 million.

Cost of Goods Sold and Gross Margin. Cost of goods sold decreased by 1.5% primarily due to lower PST sales volume. Our material cost as a percentage of net sales increased to 48.1% for the second quarter of 2014 compared to 45.8% for the second quarter of 2013. Our gross margin decreased to 29.8% for the second quarter of 2014 compared to 32.0% for the second quarter of 2013 due to lower sales volume and higher material costs.

Our Control Devices segment gross margin increased slightly due to a favorable change in mix of products sold and the benefit of increased sales volume.

Our Electronics segment gross margin decreased slightly due to an unfavorable change in mix of products sold partially offset by the benefit of increased sales volume.

Our PST segment gross margin declined due to lower sales volume, an unfavorable change in mix of products sold, an increase in labor costs and business realignment charges of $0.3 million.

Selling, General and Administrative (“SG&A”) Expenses. SG&A expenses decreased by $0.3 million for the second quarter of 2014 compared to the prior year second quarter due to decreased sales commissions, design and development and other general and administrative costs in our PST segment, which were offset by higher design and development costs in our Electronics and Control Devices segments as well as higher general and administrative costs in our Electronics segment and $0.1 million in business realignment costs at PST .

Goodwill Impairment. The Company recorded a charge of $29.3 million for the quarter ended June 30, 2014 to a portion of the PST goodwill.  The impairment was the result of weakening of both the Brazilian economy and automotive market resulting in lower projected revenue growth and to a lesser extent increased competition. This non-cash impairment charge is more fully described in Note 4 to our condensed consolidated financial statements.

Operating Income (Loss). Operating income (loss) is summarized in the following table by continuing reportable segment (in thousands):