STONERIDGE INC - Quarter Report: 2017 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, 2017

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, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 October 27, 2017 was 28,171,209.

STONERIDGE, INC. AND SUBSIDIARIES

Forward-Looking Statements

Portions of this quarterly report contain “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this report and include statements regarding the intent, belief or current expectations of the Company, our directors or officers with respect to, among other things, our (i) future product and facility expansion, (ii) acquisition or divestiture strategy, (iii) investments and new product development, (iv) growth opportunities related to awarded business, and (v) expectations related to current and future market conditions. Forward-looking statements may be identified by the words “will,” “may,” “should,” “designed to,” “believes,” “plans,” “projects,” “intends,” “expects,” “estimates,” “anticipates,” “continue,” and similar words and expressions. The forward-looking statements in this report are subject to risks and uncertainties that could cause actual events or results to differ materially from those expressed in or implied by the statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, among other factors:

In addition, the forward-looking statements contained herein represent our estimates only as of the date of this filing and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, whether to reflect actual results, changes in assumptions, changes in other factors affecting such forward-looking statements or otherwise.

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.

(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 (“U.S. GAAP”) 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, 2017 are not necessarily indicative of the results to be expected for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's 2016 Form 10-K. 

On January 31, 2017, the Company acquired Exploitatiemaatschappij Berghaaf B.V. (“Orlaco”), an electronics business which designs, manufactures and sells camera-based vision systems, monitors and related products. The acquisition was accounted for as a business combination, and accordingly, the Company’s condensed consolidated financial statements herein include the results of Orlaco from the acquisition date to September 30, 2017. See Note 3 to the condensed consolidated financial statements for additional details regarding the Orlaco acquisition.

The Company had a 74% controlling interest in PST Electronica Ltda. (“PST”) from December 31, 2011 through May 15, 2017. On May 16, 2017, the Company acquired the remaining 26% noncontrolling interest in PST, which was accounted for as an equity transaction. As such, PST is now a wholly owned subsidiary. See Note 15 to the condensed consolidated financial statements for additional details regarding the acquisition of PST’s noncontrolling interest.

Also, see Note 2 for the impact of the adoption of various accounting standards on the condensed consolidated financial statements herein.

(2)  Recently Issued Accounting Standards

Recently Adopted Accounting Standards

In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”, which amends and simplifies existing guidance in order to allow companies to more accurately present the economic effects of risk management activities in the financial statements.  As early adoption is permitted, the Company adopted this standard in the third quarter of 2017, which did not have a material impact on its condensed consolidated financial statements. 

In May 2017, FASB issued ASU 2017-09, “Compensation-Stock Compensation (Topic 718)”, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions or the classification of the award changes as a result of the change in terms or conditions. If an award is not probable of vesting at the time a change is made, the new guidance clarifies that no new measurement date will be required if there is no change to the fair value, vesting conditions, and classification. As early adoption is permitted, the Company adopted this standard in the second quarter of 2017, which did not have a material impact on its condensed consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment (Topic 350)”. It eliminates Step 2 from the goodwill impairment test. As a result, an entity should recognize an impairment charge for the amount by which the carrying amount of goodwill exceeds the reporting unit's fair value, not to exceed the carrying amount of goodwill.  The Company adopted this standard on January 1, 2017, which did not have a material impact on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718)”, which is intended to simplify several aspects of the accounting for share-based payment award transactions including how excess tax benefits should be classified in the Company’s condensed consolidated financial statements. The new standard simplifies the treatment of share based payment transactions by recognizing the impact of excess tax benefits or deficiencies related to exercised or vested awards in income tax expense in the period of exercise or vesting. The new standard also modifies the diluted earnings per share calculation using the treasury stock method by eliminating the excess tax benefits or deficiencies from the calculation. These changes have been recognized prospectively.  The presentation of excess tax benefits in the condensed statement of consolidated cash flows was also modified to be included with other income tax cash flows as an operating activity.  The Company adopted this standard as of January 1, 2017 utilizing the prospective transition method for excess tax benefits in the condensed consolidated statement of cash flows. The Company had unrecognized tax benefits related to share-based payment awards of $1,729 as of December 31, 2016, which upon adoption was recorded in other long-term assets with a corresponding increase to retained earnings associated with the cumulative effect of the accounting change.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory”, which requires that inventory be measured at the lower of cost or net realizable value.  Prior to the issuance of the new guidance, inventory was measured at the lower of cost or market. Replacing the concept of market with the single measurement of net realizable value is intended to reduce cost and complexity. The Company adopted this standard as of January 1, 2017, which did not have a material impact on the its condensed consolidated financial statements or disclosures.

Accounting Standards Not Yet Adopted 

In January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business”.  It revises the definition of a business and provides a framework to evaluate when an input and a substantive process are present in an acquisition to be considered a business. This guidance is effective for annual periods beginning after December 15, 2017.  The Company expects to adopt this standard as of January 1, 2018, which is not expected to have a material impact on its condensed consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments (Topic 230)”, which provides guidance on the presentation and classification of certain cash receipts and cash payments in the statement of cash flows in order to reduce diversity in practice.  This ASU is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted. The Company is currently evaluating the impact of adopting this standard on its condensed consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”, which will require that a lessee recognize assets and liabilities on the balance sheet for all leases with a lease term of more than twelve months, with the result being the recognition of a right of use asset and a lease liability.  The amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  The Company expects to adopt this standard as of January 1, 2019.  The Company is currently evaluating the impact of adopting this standard on its condensed consolidated financial statements, which will require right of use assets and lease liabilities be recorded in the condensed consolidated balance sheet for operating leases.

In May 2014, the FASB issued ASU 2014-09 “Revenue from Contracts with Customers”, which is the new comprehensive revenue recognition standard that will supersede existing revenue recognition guidance under U.S. GAAP. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to a customer in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. To achieve this principle, an entity identifies the contract with a customer, identifies the separate performance obligations in the contract, determines the transaction price, allocates the transaction price to the separate performance obligations and recognizes revenue when each separate performance obligation is satisfied. This ASU allows for both retrospective and prospective methods of adoption.  The new standard will become effective for annual and interim periods beginning after December 15, 2017. Currently, the Company does not expect the adoption of this standard to have a material impact on its results of operations or financial position; however, the Company expects expanded disclosures consistent with the requirements of the new standard. In particular, the Company does not expect any changes to how it accounts for reimbursable pre-production costs, currently accounted for as a reduction of costs incurred.  However, the Company continues to evaluate its contracts with customers analyzing the impact, if any, on revenue from the sale of production parts, particularly in regards to material rights, variable consideration and the impact of termination clauses on the timing of revenue recognition. The Company will adopt this standard January 1, 2018 and expects to use the modified retrospective transition method. Under the modified retrospective method, the Company would recognize the cumulative effect of initially applying the standard as an adjustment to opening retained earnings at the date of initial application.

(3) Acquisition of Orlaco

On January 31, 2017, Stoneridge B.V., an indirect wholly-owned subsidiary of Stoneridge, Inc., entered into and closed an agreement to acquire Orlaco. Orlaco designs, manufactures and sells camera-based vision systems, monitors and related electronic products primarily to the heavy off-road machinery, commercial vehicle, lifting crane and warehousing and logistics industries.  Stoneridge and Orlaco jointly developed the MirrorEye mirror replacement system, which is a system solution to improve the safety and fuel economy of commercial vehicles.  The MirrorEye system integrates Orlaco’s vision processing technology and Stoneridge’s driver information capabilities as well as the combined software capabilities of both businesses. The acquisition of Orlaco enhances the Stoneridge’s Electronics segment global technical capabilities in vision systems and facilitates entry into new markets.

The aggregate consideration for the Orlaco acquisition was €74,939 ($79,675), which included customary estimated adjustments to the purchase price. The Company paid €67,439 ($71,701) in cash, and €7,500 ($7,974) is held in an escrow account for a period of eighteen months to secure the payment obligations of the seller under the terms of the purchase agreement. The purchase price is subject to certain customary adjustments set forth in the purchase agreement. The escrow amount will be transferred promptly following the completion of the escrow period. The Company may also be required to pay an additional amount up to €7,500 as contingent consideration (“earn-out consideration”) if certain performance targets are achieved during the first two years.

The acquisition date fair value of the total consideration transferred consisted of the following:

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the acquisition date (including measurement period adjustments).  The purchase price and associated allocation is preliminary pending completion of the valuation of acquired inventory, property, plant and equipment, intangible assets and deferred income taxes and may be subsequently adjusted to reflect final valuation results and purchase price adjustments. Based upon information obtained, certain of the fair value amounts previously estimated were adjusted during the measurement period.  These measurement period adjustments related to updated valuation reports and appraisals received from our external valuation specialists, as well as revisions to internal estimates. The changes in estimates recorded at September 30, 2017 include an increase in inventory of $265; an increase in intangible assets of $113; a decrease in other long-term assets of $684; an increase in other current liabilities of $29; a decrease in accounts receivable of $201 and a decrease in earn-out consideration of $1,007. The measurement period and working capital adjustments resulted in a decrease to goodwill of $727.

Assets acquired and liabilities assumed were recorded at estimated fair values based on management's estimates, available information, and reasonable and supportable assumptions. Also, the Company utilized a third-party to assist with certain estimates of fair values, including:

These fair value measurements are classified within Level 3 of the fair value hierarchy. See Note 6 for details on fair value hierarchy.

Goodwill is calculated as the excess of the fair value of consideration transferred over the fair market value of the identifiable assets and liabilities and represents the future economic benefits arising from other assets acquired that could not be separately recognized. The goodwill is not deductible for income tax purposes.

Of the $38,739 of acquired identifiable intangible assets, $27,518 was provisionally assigned to customer lists with a 15-year useful life; $5,142 was provisionally assigned to trademarks with a 20-year useful life; and $6,079 was provisionally assigned to technology with a 7-year weighted-average useful life.

The Company recognized $1,259 of acquisition related costs in the condensed consolidated statement of operations as a component of selling, general and administrative (“SG&A”) expense for the nine months ended September 30, 2017.

Included in the Company's statement of operations for the three and nine months ended September 30, 2017 are post-acquisition sales of $18,502 and $46,956, and net income of $1,254 and $1,299, respectively, related to Orlaco which are included in results of the Electronics segment. The Company’s statement of operations also included $0 and $1,636 of expense in cost of goods sold (“COGS”) for the three and nine months ended September 30, 2017, respectively, associated with the step-up of the Orlaco inventory to fair value and the $1,823 and $3,926 fair value adjustment for earn-out consideration in SG&A expenses for the three and nine months ended September 30, 2017, respectively.

The following unaudited pro forma information reflects the Company’s condensed consolidated results of operations as if the acquisition had taken place on January 1, 2016. The unaudited pro forma information is not necessarily indicative of the results of operations that the Company would have reported had the transaction actually occurred at the beginning of these periods, nor is it necessarily indicative of future results.

(4) Inventories

Inventories are valued at the lower of cost (using either the first-in, first-out (“FIFO”) or average cost methods) or net realizable value. The Company evaluates and adjusts as necessary its excess and obsolescence reserve 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 $56,861 and $37,765 at September 30, 2017 and December 31, 2016, respectively. Inventory valued using the average cost method was $21,782 and $22,352 at September 30, 2017 and December 31, 2016, respectively.

(5) Goodwill and Intangibles

Goodwill

Goodwill was $38,224 and $931 at September 30, 2017 and December 31, 2016, respectively, all of which relates to the Electronics segment. The increase in goodwill is related to the Orlaco acquisition as further discussed in Note 3. Goodwill is not amortized, but instead is tested for impairment at least annually, or earlier when events and circumstances indicate that it is more likely than not that such assets have been impaired.

Intangibles

The Company recorded amortization expense of $1,711 and $869 related to finite-lived intangible assets for the three month period ended September 30, 2017 and 2016, respectively, and $4,750 and $2,402 for the nine month period ended September 30, 2017 and 2016, respectively.  The Company currently estimates annual amortization expense to be $6,500 for 2017 and $6,800 for 2018, 2019, 2020 and 2021.  

(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. 

Derivative Instruments and Hedging Activities

On September 30, 2017, the Company had open foreign currency forward contracts which 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 manage its exposure to fluctuations in foreign currency exchange rates by reducing the effect of such fluctuations on foreign currency denominated intercompany transactions, inventory purchases and other foreign currency exposures. The currencies hedged by the Company during 2017 and 2016 included the euro and Mexican peso. In addition, the Company hedged the U.S. dollar against the Swedish krona and euro on behalf of its European subsidiaries in 2016.

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

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 (income), 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

At September 30, 2017 and December 31, 2016, the Company held foreign currency forward contracts with underlying notional amounts of $1,187 and $1,601, respectively, to reduce the exposure related to the Company's euro-denominated intercompany loans. The current contract expires in June 2018. The euro-denominated foreign currency forward contract was not designated as a hedging instrument. The Company recognized a loss of $36 and a gain of $1 for the three months ended September 30, 2017 and 2016, respectively, in the condensed consolidated statements of operations as a component of other expense (income), net related to the euro-denominated contract. For the nine months ended September 30, 2017 and 2016, the Company recognized a loss of $164 and $38 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 notional amounts at September 30, 2017 of $1,399 which expire ratably on a monthly basis from October 2017 through December 2017, compared to a notional amount of $5,699 at December 31, 2016. 

The Company evaluated the effectiveness of the Mexican peso-denominated foreign currency forward contracts held as of September 30, 2017 and December 31, 2016 and concluded that the hedges were highly effective.

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

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

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

The net deferred gain of $237 on the cash flow hedge derivatives will be reclassified from other comprehensive income (loss) to the condensed consolidated statements of operations through December 2017.  

Fair Value Measurements

The Company’s assets and liabilities 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. Fair values estimated using Level 1 inputs consist of quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Fair values estimated using Level 2 inputs, other than quoted prices, are observable for the asset or liability, either directly or indirectly and include among other things, quoted prices for similar assets or liabilities in markets that are active or inactive as well as inputs other than quoted prices that are observable. For forward currency contracts, inputs include foreign currency exchange rates. Fair values estimated using Level 3 inputs consist of significant unobservable inputs.

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 inputs used.

The following table sets forth a summary of the change in fair value of the Company’s Level 3 financial liabilities related to earn-out consideration that are measured at fair value on a recurring basis.

The earn-out considerations related to Orlaco and PST are recorded within other long-term liabilities on the condensed consolidated balance sheet.

The increase in fair value of earn-out consideration related to the Orlaco acquisition is primarily due to actual performance exceeding forecasted performance as well as the reduced time from the current period end to the payment date and foreign currency. The increase in fair value of earn-out consideration for PST was due to the reduced time from the current period end to the payment date, which was partially offset by foreign currency translation. The fair value of the Orlaco and PST earn-out consideration is based on forecasted EBITDA during the performance periods.

There were no transfers in or out of Level 3 from other levels in the fair value hierarchy for the nine months ended September 30, 2017.

Except for the fair value of assets acquired and liabilities assumed related to the Orlaco acquisition discussed in Note 3, there were no non-recurring fair value measurements for the periods presented.

(7) Share-Based Compensation

Compensation expense for share-based compensation arrangements, which is recognized in the condensed consolidated statements of operations as a component of SG&A expenses, was $1,648 and $1,699 for the three months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017 total share-based compensation was $5,713 compared to $4,587 for the nine months ended September 30, 2016. The nine months ended September 30, 2017 included expenses related to higher attainment of performance based awards and accelerated expense associated with the retirement of eligible employees. The nine months ended September 30, 2016 included expenses related to modification of the retirement notice provisions of certain awards.

(8) Debt

Debt consisted of the following at September 30, 2017 and December 31, 2016:

Revolving Credit Facility

On November 2, 2007, the Company entered into an asset-based 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 on September 20, 2010 and December 1, 2011, respectively.

On September 12, 2014, the Company entered into a Third Amended and Restated Credit Agreement (the “Amended Agreement” or “Credit Facility”). The Amended Agreement provides for a $300,000 revolving credit facility, which replaced the Company’s existing $100,000 asset-based credit facility and includes a letter of credit subfacility, swing line subfacility and multicurrency subfacility. The Amended Agreement also has an accordion feature which allows the Company to increase the availability by up to $80,000 upon the satisfaction of certain conditions. The Amended Agreement extended the termination date to September 12, 2019 from December 1, 2016. On March 26, 2015, the Company entered into Amendment No. 1 to the Amended Agreement which modified the definition of Consolidated EBITDA to allow for the add back of cash premiums and other non-cash charges related to the amendment and restatement of the Amended Agreement and the early extinguishment of the Company’s 9.5% Senior Secured Notes. Consolidated EBITDA is used in computing the Company’s leverage ratio and interest coverage ratio which are covenants within the Amended Agreement. On February 23, 2016, the Company entered into Amendment No. 2 to the Amended Agreement which amended and waived any default or potential defaults with respect to the pledging as collateral additional shares issued by a wholly owned subsidiary and newly issued shares associated with the formation of a new subsidiary. On August 12, 2016, the Company entered into Amendment No. 3 to the Amended Agreement which extended of the expiration date of the Agreement by two years to September 12, 2021, increased the borrowing sub-limit for the Company’s foreign subsidiaries by $30,000 to $80,000, increased the basket of permitted loans and investments in foreign subsidiaries by $5,000 to $30,000, and provided additional flexibility to the Company for certain permitted corporate transactions involving its foreign subsidiaries as defined in the Agreement. As a result of Amendment No. 3, the Company capitalized deferred financing costs of $339, which will be amortized over the remaining term of the Credit Facility. On January 30, 2017, the Company entered into Consent and Amendment No. 4 to the Amended Agreement which amended certain definitions, schedules and exhibits of the Credit Facility, consented to a Dutch Reorganization, and consented to the Orlaco acquisition. As a result of Amendment No. 4, the Company capitalized deferred financing costs of $61, which will be amortized over the remaining term of the Credit Facility.

Borrowings under the Amended Agreement bear interest at either the Base Rate, as defined, or the LIBOR Rate, at the Company’s option, plus the applicable margin as set forth in the Amended Agreement. The Company is also subject to a commitment fee ranging from 0.20% to 0.35% based on the Company’s leverage ratio. The Amended Agreement requires the Company to maintain a maximum leverage ratio of 3.00 to 1.00, and a minimum interest coverage ratio of 3.50 to 1.00 and places a maximum annual limit on capital expenditures. The Amended Agreement also contains other affirmative and negative covenants and events of default that are customary for credit arrangements of this type including covenants which place restrictions and/or limitations on the Company’s ability to borrow money, make capital expenditures and pay dividends.

Borrowings outstanding on the Credit Facility were $126,000 and $67,000 at September 30, 2017 and December 31, 2016, respectively. Borrowings increased under the Credit Facility to fund the Orlaco acquisition described in Note 3 during the first quarter of 2017 which were partially offset by subsequent voluntary principal repayments.

The Company was in compliance with all Credit Facility covenants at September 30, 2017 and December 31, 2016.

The Company also has outstanding letters of credit of $3,367 and $3,399 at September 30, 2017 and December 31, 2016, respectively.

Debt

PST maintains several long-term notes used for working capital purposes which have fixed interest rates. As of September 30, 2017 PST did not have any short-term obligations. The weighted-average interest rates of long-term debt of PST at September 30, 2017 was 11.7%.  Depending on the specific note, interest is payable either monthly or annually. Principal repayments on PST debt at September 30, 2017 are as follows: $4,373 from October 2017 through September 2018, $1,211 from October 2018 through December 2018, $2,685 in 2019, $629 in 2020, and $577 in 2021. PST was in compliance with all debt covenants at September 30, 2017 and December 31, 2016.

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 $2,455 and $2,196, at September 30, 2017 and December 31, 2016, respectively. At September 30, 2017 and December 31, 2016, there was no balance outstanding on this overdraft credit line.

(9) Earnings Per Share

Basic earnings per share was computed by dividing net income by the weighted-average number of Common Shares outstanding for each respective period. Diluted earnings per share was calculated by dividing net income by the weighted-average of all potentially dilutive Common Shares that were outstanding during the periods presented. As the Company adopted ASU 2016-09 on January 1, 2017 utilizing the prospective transition method, the weighted-average dilutive Common Shares calculation excludes the excess tax benefit from the treasury stock method for the three and nine months ended September 30, 2017, while the calculation includes the excess tax benefits using the treasury stock method for the three and nine months ended September 30, 2016.

Weighted-average Common Shares outstanding used in calculating basic and diluted earnings per share were as follows:

There were no performance-based restricted Common Shares outstanding at September 30, 2017 or 2016. There were 781,977 and 843,140 performance-based right to receive Common Shares outstanding at September 30, 2017 and 2016, respectively. These right to receive Common Shares are included in the computation of diluted earnings per share based on the number of Common Shares that would be issuable if the end of the quarter were the end of the contingency period.

(10) Changes in Accumulated Other Comprehensive Loss by Component

Changes in accumulated other comprehensive loss for the three months ended September 30, 2017 and 2016 were as follows:

Changes in accumulated other comprehensive loss for the nine months ended September 30, 2017 and 2016 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, product liability, tax audits, patent infringement, employment-related matters and environmental matters. The Company establishes accruals for matters which it believes that losses are probable and can be reasonably estimable. 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 effect 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 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. As the remedial action plan has been approved by the Florida Department of Environmental Protection, groundwater remediation began in the fourth quarter of 2015. During the three and nine months ended September 30, 2017 and 2016, environmental remediation costs incurred were immaterial. At September 30, 2017 and December 31, 2016, the Company accrued a remaining undiscounted liability of $267 and $446, respectively, related to future remediation costs. At September 30, 2017 and December 31, 2016, $218 and $370, respectively, were recorded as a component of accrued expenses and other current liabilities in the condensed consolidated balance sheets while the remaining amount was recorded as a component of other long-term liabilities. Costs associated with the recorded liability will be incurred to complete the groundwater remediation, with the balance relating to monitoring costs to be incurred over multiple years. The recorded liability is based on assumptions in the remedial action plan. 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.

During the third quarter of 2017, the Company resolved a legal proceeding, Verde v. Stoneridge, Inc. et al., that was pending in the United States District Court for the Eastern District of Texas, Cause No. 6:14-cv-00225- KNM.  The Plaintiff filed this putative class action against the Company and others on March 26, 2014.  The Plaintiff had alleged that the Company was involved in the vertical chain of manufacture, distribution, and sale of a control device (“CD”) that was incorporated into a Dodge Ram truck purchased by Plaintiff in 2006.  Plaintiff had alleged that the Company breached express warranties and indemnification provisions by supplying a defective CD that was not capable of performing its intended function.  In May 2017, the District Court denied Plaintiff’s motion for class certification. On October 2, 2017, the Company and Plaintiff agreed to settle this matter, and the Plaintiff filed a motion with the Court requesting dismissal of the matter with prejudice. The settlement amount was $3.

Royal v. Stoneridge, Inc. et al. is a legal proceeding currently pending in the United States District Court for the Western District of Oklahoma, Case No. 5:14-cv-01410-F.  Plaintiffs filed this putative class action against the Company, Stoneridge Control Devices, Inc., and others on December 19, 2014.  Plaintiffs allege that the Company was involved in the vertical chain of manufacture, distribution, and sale of a CD that was incorporated into Dodge Ram trucks purchased by Plaintiffs between 1999 and 2006.  Plaintiffs allege that the Company and Stoneridge Control Devices, Inc. breached various express and implied warranties, including the implied warranty of merchantability.  Plaintiffs also seek indemnity from the Company and Stoneridge Control Devices, Inc.  The putative class consists of all owners of vehicles equipped with the subject CD, which includes various Dodge Ram trucks and other manual transmission vehicles manufactured from 1997–2007, which Plaintiffs allege is more than one million vehicles.  Plaintiffs seek recovery of economic loss damages associated with inspecting and replacing the allegedly defective CD, diminished value of the subject CDs and the trucks in which they were installed, and attorneys’ fees and costs.  On September 28, 2017, the Company reached an agreement with Plaintiffs to settle the matter. Under the terms of the settlement, which remains subject to approval by the Court, the Company will provide a replacement CD to each member of the settlement class who files a claim form with evidence of eligibility to participate. The terms of the proposed settlement do not require the Company to provide members of the settlement class with any cash payments or to reimburse any installation costs associated with replacement of the CDs. Counsel for Plaintiffs and the settlement class will file a motion with the Court requesting an award of attorneys’ fees and costs in an amount not to exceed $375, and the Company has agreed not to object to any request that does not exceed $375 and to pay the amount of any award that does not exceed $375. Counsel for Plaintiffs and the settlement class will also file a motion requesting incentive payments to each of the three named Plaintiffs in an amount not to exceed $5 each, and the Company has agreed not to object to any request that does not exceed $15 total and to pay the amount of any award that does not exceed $15 total. The total cost of the settlement remains uncertain because it is difficult to predict how many members of the proposed settlement class will request a replacement CD. The Company believes the likelihood of loss is probable and reasonably estimable (although not certain), and therefore a liability of $525 for these claims has been recorded as a component of accrued expenses and other current liabilities at September 30, 2017.

On May 24, 2013, the State Revenue Services of São Paulo issued a tax deficiency notice against PST 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 rendered 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$99,100 ($31,300) which is comprised of Value Added Tax – ICMS of R$13,200 ($4,200) interest of R$74,500 ($23,500) and penalties of R$11,400 ($3,600).

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. The Company 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 reasonably possible, but not probable, although it may take years to resolve.  As a result of the above, as of September 30, 2017 and December 31, 2016, 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. There have been no significant changes to the facts and circumstances related to this notice for the three months ended September 30, 2017.

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 R$34,900 ($11,000) and R$31,800 ($9,800) at September 30, 2017 and December 31, 2016, respectively. An unfavorable outcome on these contingencies 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 existing and future claims on products sold as of the balance sheet dates. These accruals are based on several factors including past experience, production changes, industry developments and various other considerations including insurance coverage. The Company can provide no assurances that it will not experience material claims 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 in the condensed consolidated balance sheets. Product warranty and recall included $3,481 and $2,617 of a long-term liability at September 30, 2017 and December 31, 2016, respectively, which is included as a component of other long-term liabilities in the condensed consolidated balance sheets.

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

(12) Business Realignment and Corporate Headquarter Relocation

Business Realignment

The Company regularly evaluates the performance of its businesses and cost structures, including personnel, and makes necessary changes thereto in order to optimize its results.  The Company also evaluates the required skill sets of its personnel and periodically makes strategic changes.  As a consequence of these actions, the Company incurs severance related costs which are referred to as business realignment charges.

Business realignment charges by reportable segment were as follows:

Business realignment charges classified by statement of operations line item were as follows:

Corporate Headquarter Relocation

In March 2016, the Company announced the relocation of its corporate headquarters from Warren, Ohio to Novi, Michigan. As a result, the Company incurred relocation costs of $726 and $998 for the three and nine months ended September 30, 2016 which were recorded within SG&A expenses in the condensed consolidated statements of operations.

In connection with the headquarter relocation, the Company was approved for a Michigan Business Development Program grant of up to $1,400 based upon the number of new jobs created in Michigan through 2021.  As a result of the attainment of the first milestone, grant income of $338 was recognized for the nine months ended September 30, 2017 within SG&A expense in the condensed consolidated statements of operations.

(13) Income Taxes

The Company computes its consolidated income tax provision each quarter based on a projected annual effective tax rate, as required. The Company is required to reduce deferred tax assets by a valuation allowance if, based on all available evidence, it is considered more likely than not that some portion or all of the benefit of the deferred tax assets will not be realized in future periods. The Company also records the income 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.

When a company maintains a valuation allowance in a particular jurisdiction, no net income tax expense (benefit) will typically be provided on income (loss) for that jurisdiction on an annual basis. Jurisdictions with projected income that maintain a valuation allowance typically will form part of the projected annual effective tax rate calculation discussed above. However, jurisdictions with a projected loss for the year that maintain a valuation allowance are excluded from the projected annual effective income tax rate calculation. Instead, the income tax expense (benefit) for these jurisdictions is computed separately.

The actual year to date income tax expense (benefit) is the product of the most current projected annual effective income tax rate and the actual year to date pre-tax income (loss) adjusted for any discrete tax items. The income tax expense (benefit) for a particular quarter, except for the first quarter, is the difference between the year to date calculation of income tax expense (benefit) and the year to date calculation for the prior quarter.

Therefore, the actual effective income tax rate during a particular quarter can vary significantly based upon the jurisdictional mix and timing of actual earnings compared to projected annual earnings, permanent items, earnings for those jurisdictions that maintain a valuation allowance, tax associated with jurisdictions excluded from the projected annual effective income tax rate calculation and discrete items.

The Company recognized income tax expense of $3,809 and $919 for U.S. federal, state and foreign income taxes for the three months ended September 30, 2017 and 2016, respectively.  The increase in income tax expense for the three months ended September 30, 2017 compared to the same period for 2016 was primarily related to the release of the U.S. federal, certain state and foreign valuation allowances in the fourth quarter of 2016 that were previously recorded against certain deferred tax assets. The effective tax rate increased to 32.1% in the third quarter of 2017 from 8.4% in the third quarter of 2016 primarily due the continued strong performance of the U.S. operations, which due to a full valuation allowance positively impacted the effective tax rate in 2016, as well as the impact in the third quarter of 2017 of the non-deductible fair value adjustment to earn-out considerations related to the Orlaco and PST acquisitions.

The Company recognized income tax expense of $13,569 and $3,114 from continuing operations for U.S. federal, state and foreign income taxes for the nine months ended September 30, 2017 and 2016, respectively. The increase in tax expense for the nine months ended September 30, 2017 compared to the same period for 2016 was primarily due to the release of the U.S. federal, certain state and foreign valuation allowances in the fourth quarter of 2016 that were previously recorded against certain deferred tax assets. The effective tax rate increased to 34.2% in the first nine months of 2017 from 10.3% in the first nine months of 2016 primarily due to the continued strong performance of the U.S. operations, which due to a full valuation allowance, favorably impacted the effective tax rate in 2016, as well as the impact in 2017 of the non-deductible fair value adjustment to earn-out considerations related to the Orlaco and PST acquisitions.

(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.

The Company has three reportable segments, Control Devices, Electronics, and PST, which also represent 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 and includes the recently acquired Orlaco business which designs and manufactures camera-based vision systems, monitors and related products using its vision processing technology. 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 2016 Form 10-K. The Company's management evaluates the performance of its reportable segments based primarily on revenues from external customers and operating income. Inter-segment sales are accounted for on terms similar to those to third parties and are eliminated upon consolidation.

The financial information presented below is for our three reportable operating segments and includes adjustments for unallocated corporate costs and intercompany eliminations, where applicable.  Such costs and eliminations do not meet the requirements for being classified as an operating segment. Corporate costs include various support functions, such as information technology, corporate finance, legal, executive administration and human resources.

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

The following tables present net sales and long-term assets 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 markets. 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 $9,475 and $7,952 at September 30, 2017 and December 31, 2016, respectively. Equity in earnings of Minda included in the condensed consolidated statements of operations was $465 and $307, for the three months ended September 30, 2017 and 2016, respectively. Equity in earnings of Minda included in the condensed consolidated statements of operations was $1,200 and $603, for the nine months ended September 30, 2017 and 2016, respectively.  

PST Eletrônica Ltda.

The Company had a 74% controlling interest in PST from December 31, 2011 through May 15, 2017. On May 16, 2017, the Company acquired the 26% noncontrolling interest in PST for $1,500 in cash along with earn-out consideration. The Company will be required to pay additional earn-out consideration, which is not capped, based on PST’s financial performance in either 2020 or 2021. The preliminary estimated fair value of the earn-out consideration as of the acquisition date was $10,400, which was subsequently adjusted to $10,180, and was based on discounted cash flows utilizing forecasted EBITDA in 2020 and 2021. This fair value measurement is classified within Level 3 of the fair value hierarchy. The transaction was accounted for as an equity transaction, and therefore no gain or loss was recognized in the statement of operations or comprehensive income. The noncontrolling interest balance on the May 16, 2017 acquisition date was $14,458, of which $31,453 and ($16,995) was related to the carrying value of the investment and foreign currency translation, respectively, and accordingly these amounts were reclassified to additional paid-in capital and accumulated other comprehensive loss, respectively.

The following table sets forth a summary of the change in noncontrolling interest:

PST has dividends payable to former noncontrolling interest holders of $22,143 Brazilian real ($7,004) at September 30, 2017, which includes the dividend declared on May 16, 2017 of $9,610 Brazilian real ($3,092) and $1,691 Brazilian real ($535) in monetary correction. The dividend is payable on or before January 1, 2020, and is subject to monetary correction based on the Brazilian consumer price inflation index. The dividend payable related to PST is recorded within other long-term liabilities on the condensed consolidated balance sheet.

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

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

On January 31, 2017, the Company acquired Exploitatiemaatschappij Berghaaf B.V. (“Orlaco”). As such, the Company’s condensed consolidated financial statements herein include the results of Orlaco from the acquisition date to September 30, 2017. On May 16, 2017, the Company also acquired the remaining 26% noncontrolling interest in PST.

Segments

We are 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 produces electronic instrument clusters, electronic control units and driver information systems and includes the newly acquired Orlaco business, which designs and manufactures camera-based vision systems, monitors and related products using its vision processing technology.

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.

Third Quarter Overview

Net income attributable to Stoneridge, Inc. of $8.0 million, or $0.28 per diluted share, for the three months ended September 30, 2017, decreased by $2.3 million, or $0.08 per diluted share, from $10.3 million, or $0.36 per diluted share, for the three months ended September 30, 2016, primarily due to a $2.9 million higher income tax expense as a result of the valuation allowance release in the fourth quarter of 2016.  Gross profit increased by $12.8 million due to higher sales in all of our segments, the inclusion of the acquired Orlaco business, lower material and overhead costs as a percentage of sales and operating improvements.  The higher gross profit was partially offset by an increase in selling, general and administrative and design and development costs of $9.5 million and $1.8 million, respectively, primarily attributable to the acquired Orlaco business within our Electronics segment.

Net sales increased by $29.7 million, or 17.1%, compared to the third quarter of 2016 due to higher sales in each of our segments.  The increase in sales in our Control Devices segment was primarily due to increased volume in the China automotive market while the increase in sales in our Electronics segment relates substantially to the Orlaco business acquired on January 31, 2017.  Also, PST sales mostly increased due to higher monitoring product and service revenues.

At September 30, 2017 and December 31, 2016, we had cash and cash equivalents balances of $50.8 million and $50.4 million, respectively. The increase during the first nine months of 2017 was primarily due to cash flows from operations and net debt financing offset by capital expenditures and cash paid for business acquisition. At September 30, 2017 and December 31, 2016 we had $126.0 million and $67.0 million, respectively, in borrowings outstanding on our $300.0 million Credit Facility. The increase in the Credit Facility balance during the first nine months of 2017 was the result of borrowing to fund the Orlaco acquisition with a partial offset in voluntary principal payments.

Outlook

In the third quarter of 2017, the Company continued to drive financial performance through top-line growth that exceeded our underlying markets and continued operating efficiency improvement which contributed to higher, sustainable long-term margins.  Sales of our emission sensor products were strong and continued to contribute to the Company’s growth, particularly in the China market.  Also, the acquired Orlaco business performed well contributing to the growth in our Electronics segment.  The Company continues to benefit from its focus on a product portfolio with embedded intelligence.  The Company believes that focusing on intelligence products that address industry megatrends will have a positive impact on both our top-line growth and underlying margins. 

We expect sales growth in our North American automotive vehicle market in 2017 related to recent product launches by our Control Devices segment despite an expected decrease of 0.6 million production units in the North American automotive vehicle market to 17.2 million units in 2017. We also expect sales growth in our China automotive market in 2017 related to our sensor products.

The North American commercial vehicle market declined in 2016, however in 2017 we expect it to remain at approximately the same level as 2016. We also expect the European commercial vehicle market in 2017 to remain at approximately the same level as 2016.

Our PST segment revenues and operating performance have begun to improve in the second half of 2017 due to the stabilization of the Brazilian economy and the automotive and consumer markets we serve. In October 2017, the International Monetary Fund (“IMF”) forecasted the Brazil gross domestic product to grow 0.7% in 2017 and 1.5% in 2018. As the Brazilian economy improves, we expect favorable movements in our served market channels that would result in improved financial performance for PST.

Other Matters

As the Company no longer has a valuation allowance against its U.S. federal, certain state and foreign deferred tax assets, its effective tax rate will be higher in 2017 as compared to 2016. Actual cash taxes paid as a percentage of income in 2017 is expected to be consistent with historical amounts.

A significant portion of our sales are outside of the United States. These sales are generated by our non-U.S. based operations, and therefore, movements in foreign currency exchange rates can have a significant effect on our results of operations, which are presented in U.S. dollars. A significant portion of our raw materials purchased by our Electronics and PST segments are denominated in U.S. dollars, and therefore movements in foreign currency exchange rates can also have a significant effect on our results of operations. The U.S. dollar weakened significantly against the Swedish krona, euro and Brazilian real in 2016 favorably impacting our material costs and our reported results. The U.S. dollar continued to weaken against these currencies in the first nine months of 2017 favorably impacting our material costs and reported results.

We regularly evaluate the performance of our businesses and their cost structures, including personnel, and make necessary changes thereto in order to optimize our results.  We also evaluate the required skill sets of our personnel and periodically make strategic changes.  As a consequence of these actions, we incur severance related costs which we refer to as business realignment charges.

Because of the competitive nature of the markets we serve, we face pricing pressures from our customers in the ordinary course of business. 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 to date 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 September 30, 2017 Compared to Three Months Ended September 30, 2016

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 net sales increased primarily as a result of increased sales volume in the China automotive, commercial vehicle, agricultural and various other markets of $3.5 million, $1.0 million, $0.1 million and $0.7 million, respectively, during the third quarter of 2017. This was partially offset by a decrease in sales volume in the North American automotive market of $2.1 million.

Our Electronics segment net sales increased primarily due to increased sales of European and North American off-highway vehicle products of $15.3 million and $3.6 million, respectively, substantially related to the acquired Orlaco business as well as an increase in sales volume in our North American commercial vehicle products of $2.9 million and a favorable foreign currency translation of $1.5 million.

Our PST segment net sales increased primarily due to an increase in monitoring product and service revenues and higher products sales volume as well as a favorable foreign currency translation that increased sales by $0.6 million, or 2.7%.

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

The increase in North American net sales was primarily attributable to increased sales volume in our North American off-highway, commercial vehicle and various other markets of $3.6 million, $2.5 million and $0.6 million, respectively, which were offset by a decrease in sales volume in our North American automotive market of $2.1 million. The increase in net sales in South America was primarily due to an increase in monitoring product and service revenues, product sales volume as well as a favorable foreign currency translation that increased sales by $0.6 million. The increase in net sales in Europe and Other was primarily due to the increase in European off-highway vehicle product sales of $15.3 million substantially related to Orlaco as well as an increase in sales volume in our China automotive and European commercial vehicle markets of $3.5 million and $2.0 million, respectively. Additionally, sales were favorably impacted by foreign currency translation of $1.5 million offset by unfavorable pricing of $0.6 million.

Cost of Goods Sold and Gross Margin. Cost of goods sold increased by 13.6% primarily related to an increase in net sales. Our gross margin improved by 2.1% to 30.7% for the third quarter of 2017 compared to 28.6% for the third quarter of 2016. Our material cost as a percentage of net sales decreased by 0.6% to 50.1% for the third quarter of 2017 compared to 50.7% for the third quarter of 2016. The lower direct material costs in our Electronics and PST segments resulted from favorable foreign currency movements associated with U.S. dollar denominated purchases while direct material costs as a percent of sales in our Control Devices segment decreased due to the benefit of a favorable product mix. Also, our Electronics segment was benefited by lower direct material costs and overhead as a percent of sales associated with the acquired Orlaco business. Our Electronics segment overhead as a percentage of net sales decreased by 1.8% to 12.0% for the third quarter of 2017 compared to 13.8% for the third quarter of 2016.

Our Control Devices segment gross margin improved slightly due to an increase in sales and a decrease in overhead as a percentage of net sales.

Our Electronics segment gross margin improved primarily due to lower overhead costs as a percentage of sales resulting from the Orlaco acquisition as well as lower material costs resulting from favorable movement in foreign currency exchange rates and a favorable mix related to Orlaco product sales.

Our PST segment gross margin improved due to lower overhead and direct labor costs associated with 2016 business realignment actions as well as lower direct material costs related to a favorable movement in foreign currency exchange rates and a favorable sales mix related to monitoring service increases.

Selling, General and Administrative (“SG&A”). SG&A expenses increased by $9.5 million compared to the third quarter of 2016 primarily due to higher costs in our Electronics segment substantially related to the acquisition of Orlaco of $5.6 million which includes expense of $2.2 million for the increase in fair value of earn-out consideration. Our unallocated corporate, Control Devices and PST segment’s SG&A costs also increased. Unallocated corporate SG&A costs increased due to higher wages, incentive compensation and professional fees which were offset by lower headquarter relocation costs of $0.7 million. Control Devices SG&A costs increased due to higher wages and incentive compensation. PST SG&A costs increased during the current period due to expense for the fair value of earn-out consideration of $0.5 million, an unfavorable change in foreign currency exchange rates and higher incentive compensation, which were partially offset by lower business realignment costs of $0.2 million.

Design and Development (“D&D”). D&D costs increased by $1.8 million substantially due to higher D&D costs in our Electronics segment related to the acquired Orlaco business.

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