form10q.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

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

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2012

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

FOR THE TRANSITION PERIOD FROM       TO

Commission File No. 001-33861

MOTORCAR PARTS OF AMERICA, INC.
(Exact name of registrant as specified in its charter)

New York
 
11-2153962
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
2929 California Street, Torrance, California
 
90503
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (310) 212-7910

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.
Yes R 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer £
Accelerated filer R
Non-accelerated filer £
Smaller reporting company £
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes £ No R

There were 14,551,854 shares of Common Stock outstanding at February 12, 2013.
 


 
 

 

MOTORCAR PARTS OF AMERICA, INC.

TABLE OF CONTENTS

 
Page 
PART I — FINANCIAL INFORMATION
 
4
4
5
6
7
8
25
45
45
PART II — OTHER INFORMATION
 
Item 1A. Risk Factors
47
47
47
Item 6. Exhibits
48
50

 
MOTORCAR PARTS OF AMERICA, INC.

GLOSSARY

The following terms are frequently used in the text of this report and have the meanings indicated below.

“Used Core” — An automobile part which has been used in the operation of a vehicle. Generally, the Used Core is an original equipment (“OE”) automobile part installed by the vehicle manufacturer and subsequently removed for replacement. Used Cores contain salvageable parts which are an important raw material in the remanufacturing process. We obtain most Used Cores by providing credits to our customers for Used Cores returned to us under our core exchange program. Our customers receive these Used Cores from consumers who deliver a Used Core to obtain credit from our customers upon the purchase of a newly remanufactured automobile part. When sufficient Used Cores cannot be obtained from our customers, we will purchase Used Cores from core brokers, who are in the business of buying and selling Used Cores. The Used Cores purchased from core brokers or returned to us by our customers under the core exchange program, and which have been physically received by us, are part of our raw material or work in process inventory included in long-term core inventory.

“Remanufactured Core” — The Used Core underlying an automobile part that has gone through the remanufacturing process and through that process has become part of a newly remanufactured automobile part. The remanufacturing process takes a Used Core, breaks it down into its component parts, replaces those components that cannot be reused and reassembles the salvageable components of the Used Core and additional new components into a remanufactured automobile part. Remanufactured Cores are included in our on-hand finished goods inventory and in the remanufactured finished good product held for sale at customer locations. Used Cores returned by consumers to our customers but not yet returned to us continue to be classified as Remanufactured Cores until we physically receive these Used Cores. All Remanufactured Cores are included in our long-term core inventory or in our long-term core inventory deposit.
 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MOTORCAR PARTS OF AMERICA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets

   
December 31, 2012
   
March 31, 2012
 
ASSETS
 
(Unaudited)
       
Current assets:
           
Cash
  $ 25,070,000     $ 32,617,000  
Short-term investments
    383,000       342,000  
Accounts receivable — net
    5,171,000       20,036,000  
Inventory— net
    85,822,000       95,071,000  
Inventory unreturned
    14,127,000       9,819,000  
Deferred income taxes
    3,834,000       3,793,000  
Prepaid expenses and other current assets
    6,942,000       6,553,000  
Total current assets
    141,349,000       168,231,000  
Plant and equipment — net
    13,484,000       12,738,000  
Long-term core inventory — net
    160,862,000       194,406,000  
Long-term core inventory deposits
    27,610,000       26,939,000  
Long-term deferred income taxes
    2,151,000       1,857,000  
Goodwill
    68,356,000       68,356,000  
Intangible assets — net
    20,856,000       22,484,000  
Other assets
    7,974,000       6,887,000  
TOTAL ASSETS
  $ 442,642,000     $ 501,898,000  
LIABILITIES AND SHAREHOLDERS'  EQUITY
               
Current liabilities:
               
Accounts payable
  $ 118,716,000     $ 126,100,000  
Accrued liabilities
    12,836,000       19,379,000  
Customer finished goods returns accrual
    30,164,000       21,695,000  
Other current liabilities
    2,493,000       2,331,000  
Current portion of term loan
    4,800,000       500,000  
Current portion of capital lease obligations
    287,000       414,000  
Total current liabilities
    169,296,000       170,419,000  
Term loan, less current portion
    89,428,000       84,500,000  
Revolving loan
    49,729,000       48,884,000  
Deferred core revenue
    10,357,000       9,775,000  
Customer core returns accrual
    49,739,000       113,702,000  
Other liabilities
    3,748,000       751,000  
Capital lease obligations, less current portion
    61,000       248,000  
Total liabilities
    372,358,000       428,279,000  
Commitments and contingencies
               
Shareholders' equity:
               
Preferred stock; par value $.01 per share, 5,000,000 shares authorized; none issued
    -       -  
Series A junior participating preferred stock; par value $.01 per share, 20,000 shares authorized; none issued
    -       -  
Common stock; par value $.01 per share, 20,000,000 shares authorized; 14,526,717 and 12,533,821 shares issued; 14,493,197 and 12,519,421 outstanding at December 31, 2012 and March 31, 2012, respectively
    145,000       125,000  
Treasury stock, at cost, 33,520 and 14,400 shares of common stock at December 31, 2012 and March 31, 2012, respectively
    (189,000 )     (89,000 )
Additional paid-in capital
    115,355,000       98,627,000  
Additional paid-in capital-warrant
    -       1,879,000  
Accumulated other comprehensive loss
    (1,128,000 )     (884,000 )
Accumulated deficit
    (43,899,000 )     (26,039,000 )
Total shareholders' equity
    70,284,000       73,619,000  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
  $ 442,642,000     $ 501,898,000  

The accompanying condensed notes to consolidated financial statements are an integral part hereof.
 
 
MOTORCAR PARTS OF AMERICA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
 
 
2012
   
2011
   
2012
   
2011
 
                         
Net sales
  $ 116,275,000     $ 84,097,000     $ 316,930,000     $ 262,223,000  
Cost of goods sold
    92,232,000       85,678,000       264,052,000       241,792,000  
Gross profit (loss)
    24,043,000       (1,581,000 )     52,878,000       20,431,000  
Operating expenses:
                               
General and administrative
    12,779,000       10,155,000       35,536,000       29,773,000  
Sales and marketing
    2,687,000       3,369,000       10,130,000       9,019,000  
Research and development
    807,000       453,000       1,704,000       1,270,000  
Impairment of plant and equipment
    -       1,031,000       -       1,031,000  
Acquisition costs
    -       -       -       713,000  
Total operating expenses
    16,273,000       15,008,000       47,370,000       41,806,000  
Operating income (loss)
    7,770,000       (16,589,000 )     5,508,000       (21,375,000 )
Interest expense, net
    5,889,000       3,262,000       17,135,000       8,565,000  
Income (loss) before income tax expense
    1,881,000       (19,851,000 )     (11,627,000 )     (29,940,000 )
Income tax expense
    946,000       1,976,000       6,233,000       5,631,000  
                                 
Net income (loss)
  $ 935,000     $ (21,827,000 )   $ (17,860,000 )   $ (35,571,000 )
Basic net income (loss) per share
  $ 0.06     $ (1.74 )   $ (1.25 )   $ (2.86 )
Diluted net income (loss) per share
  $ 0.06     $ (1.74 )   $ (1.25 )   $ (2.86 )
Weighted average number of shares outstanding:
                               
Basic
    14,463,782       12,517,269       14,283,080       12,417,292  
Diluted
    14,525,613       12,517,269       14,283,080       12,417,292  

The accompanying condensed notes to consolidated financial statements are an integral part hereof.
 

MOTORCAR PARTS OF AMERICA, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
 
 
2012
   
2011
   
2012
   
2011
 
                         
Net income (loss)
  $ 935,000     $ (21,827,000 )   $ (17,860,000 )   $ (35,571,000 )
Other comprehensive income (loss), net of tax:
                               
Unrealized gain (loss) on short-term investments
    4,000       9,000       6,000       (17,000 )
Foreign currency translation
    104,000       (389,000 )     (250,000 )     (835,000 )
Total other comprehensive income (loss), net of tax
    108,000       (380,000 )     (244,000 )     (852,000 )
Comprehensive income (loss)
  $ 1,043,000     $ (22,207,000 )   $ (18,104,000 )   $ (36,423,000 )

The accompanying condensed notes to consolidated financial statements are an integral part hereof.
 

MOTORCAR PARTS OF AMERICA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
   
Nine Months Ended
 
 
 
December 31,
 
Cash flows from operating activities:
 
2012
   
2011
 
Net loss
  $ (17,860,000 )   $ (35,571,000 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation
    2,363,000       4,074,000  
Amortization of intangible assets
    1,628,000       1,464,000  
Amortization of deferred financing costs
    1,249,000       65,000  
Amortization of finished goods inventory step-up valuation
    -       5,598,000  
Loss due to change in fair value of warrant liability
    825,000       -  
Provision for inventory reserves
    1,154,000       804,000  
Provision for customer payment discrepancies
    1,096,000       114,000  
Provision for doubtful accounts
    357,000       (28,000 )
Deferred income taxes
    4,000       (313,000 )
Share-based compensation expense
    965,000       35,000  
Impact of tax benefit on APIC pool from stock options exercised
    15,000       84,000  
Loss on disposal of assets
    40,000       17,000  
Impairment of plant and equipment
    -       1,031,000  
Changes in current assets and liabilities:
               
Accounts receivable
    13,412,000       3,596,000  
Inventory
    10,517,000       (30,803,000 )
Inventory unreturned
    (4,308,000 )     1,809,000  
Prepaid expenses and other current assets
    (795,000 )     4,065,000  
Other assets
    (223,000 )     (176,000 )
Accounts payable and accrued liabilities
    (14,073,000 )     17,914,000  
Customer finished goods returns accrual
    8,469,000       (2,562,000 )
Deferred core revenue
    582,000       623,000  
Long-term core inventory
    31,122,000       (16,706,000 )
Long-term core inventory deposits
    (671,000 )     (674,000 )
Customer core returns accrual
    (63,963,000 )     541,000  
Other liabilities
    366,000       (349,000 )
Net cash used in operating activities
    (27,729,000 )     (45,348,000 )
Cash flows from investing activities:
               
Purchase of plant and equipment
    (3,026,000 )     (1,068,000 )
Change in short term investments
    (31,000 )     (29,000 )
Net cash used in investing activities
    (3,057,000 )     (1,097,000 )
Cash flows from financing activities:
               
Borrowings under revolving loan
    70,971,000       128,267,000  
Repayments under revolving loan
    (70,126,000 )     (89,598,000 )
Proceeds from term loan
    10,000,000       10,000,000  
Repayments of term loan
    (250,000 )     (1,500,000 )
Deferred financing costs
    (799,000 )     -  
Payments on capital lease obligations
    (314,000 )     (452,000 )
Exercise of stock options
    73,000       320,000  
Excess tax benefit from employee stock options exercised
    3,000       255,000  
Impact of tax benefit on APIC pool from stock options exercised
    (15,000 )     (84,000 )
Cash used to net share settle equity awards
    (163,000 )     -  
Repurchase of common stock
    (100,000 )     -  
Proceeds from issuance of common stock
    15,005,000       1,000  
Stock issuance costs
    (1,034,000 )     -  
Net cash provided by financing activities
    23,251,000       47,209,000  
Effect of exchange rate changes on cash
    (12,000 )     (108,000 )
Net increase (decrease) in cash
    (7,547,000 )     656,000  
Cash — Beginning of period
    32,617,000       2,477,000  
Cash — End of period
  $ 25,070,000     $ 3,133,000  
                 
Supplemental disclosures of cash flow information:
               
Cash paid during the period for:
               
Interest
  $ 17,105,000     $ 7,643,000  
Income taxes
    8,068,000       2,796,000  
Non-cash investing and financing activities:
               
Common stock issued in business acquisition
  $ -     $ 4,946,000  
Warrants issued in connection with debt
    1,625,000       -  

The accompanying condensed notes to consolidated financial statements are an integral part hereof.
 
 
MOTORCAR PARTS OF AMERICA, INC. AND SUBSIDIARIES
Condensed Notes to Consolidated Financial Statements
December 31, 2012
(Unaudited)

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended December 31, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2013. This report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended March 31, 2012, which are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on September 28, 2012.

The accompanying consolidated financial statements have been prepared on a consistent basis with, and there have been no material changes to, the accounting policies described in Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements that are presented in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

1. Company Background and Organization

Motorcar Parts of America, Inc. and its subsidiaries (the “Company” or “MPA”) is a leading manufacturer, remanufacturer, and distributor of aftermarket automobile parts. These replacement parts are sold for use on vehicles after initial vehicle purchase. These automotive parts are sold to automotive retail chain stores and warehouse distributors throughout North America and to major automobile manufacturers.

The Company obtains used automobile parts, commonly known as Used Cores, primarily from its customers under the Company’s core exchange program. It also purchases Used Cores from vendors (core brokers). The customers grant credit to the consumer when the used part is returned to them, and the Company in turn provides a credit to the customers upon return to the Company. These Used Cores are an essential material needed for the remanufacturing operations.

The Company has remanufacturing, warehousing and shipping/receiving operations for automobile parts in North America and Asia. In addition, the Company utilizes various third party warehouse distribution centers in North America.

Pursuant to the guidance provided under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), the Company has two reportable segments, rotating electrical and undercar product line, based on the way the Company manages, evaluates and internally reports its business activities.

New Accounting Pronouncements

Comprehensive Income

In June 2011, the FASB issued guidance which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. This guidance eliminates the option to present components of other comprehensive income as a part of the statement of equity. This guidance should be applied, retrospectively, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Other than the change in presentation, the Company has determined the changes from the adoption of this guidance on April 1, 2012 did not have an impact on its consolidated financial position and the results of operations.
 

Testing Goodwill for Impairment

In September 2011, the FASB issued an amendment which gives an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step goodwill impairment test is unnecessary. If an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then it is required to perform the first step of the two-step goodwill impairment test. If the carrying value of the reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this guidance on April 1, 2012 did not have any impact on the Company’s consolidated financial position and the results of operations.

2. Acquisition

On May 6, 2011, the Company purchased (i) all of the outstanding equity of FAPL, (ii) all of the outstanding equity of Introcan, Inc., a Delaware corporation (“Introcan”), and (iii) 1% of the outstanding equity of Fapco S.A. de C.V., a Mexican variable capital company (“Fapco”) (collectively, “Fenco”). Since FAPL owned 99% of Fapco prior to these acquisitions, the Company now owns 100% of Fapco.

The unaudited pro forma information presented is for illustrative purposes only and is not necessarily indicative of the results of operations that would have been realized if the acquisition had been completed on the date indicated, nor is it indicative of future operating results. The following historical financial information has been adjusted to give effect to pro forma events that are (i) directly attributable to the acquisition, (ii) factually supportable, and (iii) with respect to statements of operations, expected to have a continuing impact on the combined results, including the amortization of the fair value of the identifiable intangible assets and the cost of goods sold impact related to the fair value step-up of inventory acquired. The unaudited pro forma information does not reflect any operating changes, associated cost savings or additional costs that the Company may achieve or incur with respect to the combined companies.

The unaudited pro forma financial information presented below for the nine months ended December 31, 2011 assumes the acquisition had occurred on April 1, 2011. Financial information presented below for the nine months ended December 31, 2012 represents actual results of operations for the period.

   
Nine Months Ended
 
   
December 31,
 
 
 
2012
   
2011
 
             
Net sales
  $ 316,930,000     $ 288,757,000  
Operating income (loss)
    5,508,000       (23,019,000 )
Loss before income tax expense
    (11,627,000 )     (32,377,000 )
Net loss
    (17,860,000 )     (38,215,000 )
Basic net loss per share
  $ (1.25 )   $ (3.08 )
Diluted net loss per share
  $ (1.25 )   $ (3.08 )

3. Goodwill

The Company had $68,356,000 of goodwill in connection with its undercar product line segment as of December 31, 2012 and March 31, 2012. There were no changes to goodwill this quarter.

Based on the interim goodwill impairment analysis performed for September 30, 2012, the Company concluded that it was not more likely than not that the fair value of its undercar product line segment was less than its carrying amount. The Company did not identify any indicators of impairment at December 31, 2012 and concluded that goodwill was not impaired.
 

4. Intangible Assets

Rotating Electrical Product Line

The following is a summary of the intangible assets attributable to the Company’s rotating electrical product line segment subject to amortization at December 31, 2012 and March 31, 2012.

     
December 31, 2012
   
March 31, 2012
 
 
Weighted
Average
Amortization
Period
 
Gross Carrying
Value
   
Accumulated
Amortization
   
Gross Carrying
Value
   
Accumulated
Amortization
 
Intangible assets subject to amortization
                         
Trademarks
9 years
  $ 553,000     $ 318,000     $ 553,000     $ 262,000  
Customer relationships
12 years
    6,464,000       2,582,000       6,464,000       2,096,000  
Non-compete agreements
4 years
    257,000       198,000       257,000       160,000  
Total
11 years
  $ 7,274,000     $ 3,098,000     $ 7,274,000     $ 2,518,000  

Undercar Product Line

The following is a summary of the undercar product line segment’s intangible assets subject to amortization at December 31, 2012 and March 31, 2012.

     
December 31, 2012
   
March 31, 2012
 
 
Weighted
Average
Amortization
Period
 
Gross Carrying
Value
   
Accumulated A
mortization
   
Gross Carrying
Value
   
Accumulated
Amortization
 
Intangible assets subject to amortization
                         
Trademarks
20 years
  $ 11,159,000     $ 918,000     $ 11,159,000     $ 500,000  
Customer relationships
10 years
    7,680,000       1,267,000       7,680,000       691,000  
Non-compete agreements
2 years
    144,000       118,000       144,000       64,000  
Total
16 years
  $ 18,983,000     $ 2,303,000     $ 18,983,000     $ 1,255,000  

Consolidated amortization expense for acquired intangible assets for the three and nine months ended December 31, 2012 and 2011 is as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
 
 
2012
   
2011
   
2012
   
2011
 
                         
Amortization expense
  $ 543,000     $ 495,000     $ 1,628,000     $ 1,464,000  


The consolidated aggregate estimated future amortization expense for intangible assets subject to amortization is as follows:

Year Ending March 31,
 
 
 
2013 - remaining 3 months
  $ 544,000  
2014
    2,070,000  
2015
    1,996,000  
2016
    1,675,000  
2017
    1,592,000  
Thereafter
    12,979,000  
Total
  $ 20,856,000  

5. Accounts Receivable — Net

Included in accounts receivable — net are significant offset accounts related to customer allowances earned, customer payment discrepancies, customer fill rate penalties, returned goods authorizations (“RGA”) issued for in-transit unit returns, estimated future credits to be provided for Used Cores returned by the customers and potential bad debts. Due to the forward looking nature and the different aging periods of certain estimated offset accounts, they may not, at any point in time, directly relate to the balances in the open trade accounts receivable.

Accounts receivable — net is comprised of the following:

   
December 31, 2012
   
March 31, 2012
 
Accounts receivable — trade (1)
  $ 74,003,000     $ 83,937,000  
Allowance for bad debts
    (1,350,000 )     (968,000 )
Customer allowances earned (1)
    (21,723,000 )     (25,322,000 )
Customer payment discrepancies
    (1,850,000 )     (280,000 )
Customer fill rate penalties (1)
    (7,938,000 )     (7,827,000 )
Customer returns RGA issued
    (9,507,000 )     (5,875,000 )
Customer core returns accruals
    (26,464,000 )     (23,629,000 )
Less: total accounts receivable offset accounts
    (68,832,000 )     (63,901,000 )
Total accounts receivable — net
  $ 5,171,000     $ 20,036,000  

(1)           Amounts shown above as customer allowances earned and customer fill rate penalties include $9,072,000 and $7,827,000, respectively, at March 31, 2012 which have been reclassified from accounts receivable – trade to conform to the fiscal 2013 presentation.

Warranty Returns

The Company allows its customers to return goods to the Company that their end-user customers have returned to them, whether the returned item is or is not defective (warranty returns). The Company accrues an estimate of its exposure to warranty returns based on a historical analysis of the level of this type of return as a percentage of total unit sales. Amounts charged to expense for these warranty returns are considered in arriving at the Company’s net sales. At December 31, 2012, the warranty return accrual of $4,795,000 on the credits issued for the returns received was included under the customer returns RGA issued in the above table of accounts receivable – net and the warranty return estimate of $7,969,000 was included in customer finished goods returns accrual in the consolidated balance sheets.
 

Change in the Company’s warranty return accrual is as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
   
2012
   
2011
   
2012
   
2011
 
Balance at beginning of period
  $ 10,258,000     $ 7,324,000     $ 9,023,000     $ 8,969,000  
Charged to expense (1)
    16,860,000       15,421,000       52,438,000       46,047,000  
Amounts processed (1)
    (14,354,000 )     (15,180,000 )     (48,697,000 )     (47,451,000 )
Balance at end of period
  $ 12,764,000     $ 7,565,000     $ 12,764,000     $ 7,565,000  

(1)           Amounts shown above as warranty claims processed and charged to expense for the three and nine months ended December 31, 2011 have been reclassified to conform to the current year presentation.

6. Inventory

Inventory is comprised of the following:

   
December 31, 2012
   
March 31, 2012
 
Non-core inventory
           
Raw materials
  $ 34,772,000     $ 31,560,000  
Work-in-process
    577,000       153,000  
Finished goods
    57,932,000       72,171,000  
      93,281,000       103,884,000  
Less allowance for excess and obsolete inventory
    (7,459,000 )     (8,813,000 )
Total
  $ 85,822,000     $ 95,071,000  
Inventory unreturned
  $ 14,127,000     $ 9,819,000  
Long-term core inventory
         
Used cores held at the Company's facilities
  $ 41,753,000     $ 47,206,000  
Used cores expected to be returned by customers
    5,816,000       5,542,000  
Remanufactured cores held in finished goods
    25,396,000       25,751,000  
Remanufactured cores held at customers' locations
    91,107,000       118,402,000  
      164,072,000       196,901,000  
Less allowance for excess and obsolete inventory
    (3,210,000 )     (2,495,000 )
Total
  $ 160,862,000     $ 194,406,000  
Long-term core inventory deposits
  $ 27,610,000     $ 26,939,000  


7. Major Customers

The Company’s largest customers accounted for the following total percentage of net sales and accounts receivable — trade:

   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
Sales
 
2012
   
2011
   
2012
   
2011
 
Customer A
    37 %     48 %     37 %     45 %
Customer B
    17 %     11 %     16 %     9 %
Customer C (1)
    14 %     12 %     19 %     13 %

Accounts receivable - trade
 
December 31, 2012
   
March 31, 2012
 
Customer A
    31 %     31 %
Customer B
    5 %     8 %
Customer C (1)
    9 %     21 %

(1)           The Company discontinued supplying its undercar products to customer C but has retained the rotating electrical product line sales to this customer. The percentage of net sales for this customer for the three and nine months ended December 31, 2012 excludes the recognition of approximately $50,783,000 in revenue from the reduction in the Companys obligation to provide a credit for this major customer’s Remanufactured Cores.

The Company’s largest suppliers accounted for the following total percentage of raw materials purchases:

   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
Significant supplier purchases
 
2012
   
2011
   
2012
   
2011
 
Supplier A
    4 %     7 %     14 %     11 %

8. Debt

The Company has the following outstanding credit agreements.

Parent Company Credit Agreement

The Company has a financing agreement (the “Parent Company Financing Agreement”) with a syndicate of lenders, Cerberus Business Finance, LLC, as collateral agent, and PNC Bank, National Association, as administrative agent (the “Parent Company Loans”). The Parent Company Loans consist of: (i) term loans aggregating $75,000,000 (the “Parent Company Term Loans”) and (ii) revolving loans of up to $20,000,000, subject to borrowing base restrictions and a $10,000,000 sublimit for letters of credit (the “Parent Company Revolving Loans,”). The Parent Company Loans mature on January 17, 2017. The lenders hold a security interest in substantially all of the assets of the Company’s rotating electrical segment. The Parent Company Financing Agreement only permits the Company to invest up to $20,000,000 in Fenco, which it has done as of December 31, 2012.

In May 2012, the Company entered into a second amendment to the Parent Company Financing Agreement (the “Second Amendment”) and borrowed an additional $10,000,000, for an aggregate of $85,000,000 (the “Amended Parent Company Term Loans”) in term loans. The Second Amendment, among other things, modified the interest rates per annum applicable to the Amended Parent Company Term Loans. The Amended Parent Company Term Loans will bear interest at rates equal to, at the Company’s option, either LIBOR plus 8.5% or a base rate plus 7.5%.

The Amended Parent Company Term Loans require quarterly principal payments of $250,000 beginning on October 1, 2012 and increase to $600,000 per quarter on April 1, 2013 and to $1,350,000 on October 1, 2013 until the final maturity date. Among other things, the Second Amendment provides for certain amended financial covenants, and requires that the Company maintain cash and cash equivalents of up to $10,000,000 in the aggregate until its obligations with respect to a significant supplier have ceased.
 

In August 2012, the Company entered into a third amendment and waiver to the Parent Company Financing Agreement (the “Third Amendment”) which, among other things, (i) permitted the Company to enter into the Fenco Credit Line described below, (ii) to make additional investments in Fenco in an aggregate amount not to exceed $20,000,000 at any time outstanding, (iii) added additional reporting requirements regarding financial reports and material notices under the Fenco Credit Line described below, and (iv) removed the Second Amendment requirement that the Company maintain cash and cash equivalents of up to $10,000,000.

In December 2012, the Company entered into a fourth amendment to the Parent Company Financing Agreement (the “Fourth Amendment”), which, among other things, permitted the Company to repurchase shares pursuant to the stock repurchase agreement with Mel Marks, the Company’s founder, a member of the Board of Directors of the Company and consultant to the Company, and Melmarks Enterprises LLLP, a limited liability limited partnership controlled by Mr. Marks.

The Parent Company Financing Agreement, as amended, among other things, requires the Company to maintain certain financial covenants including a maximum senior leverage ratio, a minimum fixed charge coverage ratio, and minimum consolidated earnings before interest, income tax, depreciation and amortization expenses (“EBITDA”). The Company was in compliance with all financial covenants and reporting requirements under the Parent Company Financing Agreement, as amended, as of December 31, 2012.

There was no outstanding balance on the Parent Company Revolving Loans at December 31, 2012 and March 31, 2012. As of December 31, 2012, $15,137,000 was available under the Parent Company Revolving Loans. The Company had reserved $626,000 of the Parent Company Revolving Loans for standby letters of credit for workers’ compensation insurance and $2,178,000 for commercial letters of credit as of December 31, 2012.

In connection with the Second Amendment, the Company issued a warrant (the “Cerberus Warrant”) to Cerberus Business Finance, LLC. Pursuant to the Cerberus Warrant, Cerberus Business Finance, LLC, may purchase up to 100,000 shares of the Company’s common stock for an initial exercise price of $17.00 per share for a period of five years. The exercise price is subject to adjustments, among other things, for sales of common stock by the Company at a price below the exercise price. As a result of the issuance of the Supplier Warrant in August 2012 (as described below) at an initial exercise price of $7.75 per share, the exercise price of the Cerberus Warrant was reduced to $7.75 per share. As the exercise price of the Cerberus Warrant was reduced, the number of shares of the Company’s common stock that may be purchased upon the exercise of the Cerberus Warrant was increased to 219,355 so that the aggregate exercise price of the Cerberus Warrant after the adjustment is the same as the aggregate exercise price prior to the adjustment. The fair value of the Cerberus Warrant using the Monte Carlo simulation model was $607,000 at May 24, 2012 and $571,000 at December 31, 2012. This amount was recorded as a warrant liability which is included in other liabilities in the consolidated balance sheet at December 31, 2012.During the three and nine months ended December 31, 2012, a loss of $214,000 and a gain of $36,000, respectively, was recorded in general and administrative expenses due to the change in the fair value of the warrant liability.

Fenco Credit Agreement

The Company’s wholly-owned subsidiaries, FAPL and Introcan, as borrowers (the “Fenco Borrowers”), entered into an amended and restated credit agreement, dated May 6, 2011 (the “Fenco Credit Agreement”) with Manufacturers and Traders Trust Company as lead arranger, M&T Bank as lender and administrative agent and the other lenders from time to time party thereto (the “Fenco Lenders”). Pursuant to the Fenco Credit Agreement, the Fenco Lenders have made available to the Fenco Borrowers a revolving credit facility in the maximum principal amount of $50,000,000 (the “Fenco Revolving Facility”) and a term loan in the principal amount of $10,000,000 (the “Fenco Term Loan”). The availability of the Fenco Revolving Facility is subject to a borrowing base calculation consisting of eligible accounts receivable and eligible inventory.

In August 2012, Fenco entered into a second amendment to the Fenco Credit Agreement (the “Fenco Second Amendment”) with the Fenco lenders which, among other things, (i) extended the maturity date to October 6, 2014, (ii) amended the maximum amount of the revolving facility to (y) $55,000,000 for the period up to and including December 31, 2012 and (z) $50,000,000 for the period on or after January 1, 2013 through October 6, 2014, (iii) replaced the repayment schedule and the amounts for the term loan to require quarterly principal payments of $500,000 beginning on June 30, 2013 and increasing to $1,000,000 per quarter beginning December 31, 2013 through September 30, 2014, with the remaining unpaid principal amount being due on the final maturity date, (iv) provided for certain mandatory prepayments of the term loan, and (v) revised certain financial covenants regarding minimum EBITDA, minimum fixed charge coverage, unused borrowing availability under the Fenco revolving credit facility, and maximum capital expenditures.  The maturity date may be accelerated upon the occurrence of an insolvency event or event of default under the Fenco Credit Agreement.
 

The outstanding balance on the Fenco Revolving Facility was $49,729,000 and $48,884,000 at December 31, 2012 and March 31, 2012, respectively. As of December 31, 2012, approximately $712,000 was reserved for standby commercial letters of credit and $136,000 was reserved for certain expenses. In addition, $300,000 of this Fenco Revolving Facility was reserved for Canadian operations use. As of December 31, 2012, approximately $3,761,000 was available under the Fenco Revolving Facility. The Fenco Lenders hold a security interest in substantially all of the assets of the undercar product line segment.

The Fenco Borrowers may receive advances under the Fenco Revolving Facility by any one or more of the following options: (i) swingline advances in Canadian or US dollars; (ii) Canadian dollar prime-based loans; (iii) US dollar base rate loans; (iv) LIBOR loans; or (v) letters of credits.

The Fenco Term Loan bears interest at the LIBOR plus an applicable margin. Outstanding advances under the Revolving Facility bear interest as follows:

 
(i)
in respect of swingline advances in Canadian dollars and Canadian dollar prime-based loans, at the reference rate announced by the Royal Bank of Canada plus an applicable margin;
 
(ii)
in respect of swingline advances in US dollars and US dollar base rate loans, at a base rate (which shall be equal to the highest of (x) M&T Bank’s prime rate, (y) the Federal Funds Rate plus ½ of 1%, or (z) the one month LIBOR) plus an applicable margin;
 
(iii)
in respect of LIBOR loans, at the LIBOR plus an applicable margin.

The Fenco Credit Agreement, as amended, among other things, requires the Fenco Borrowers to maintain certain financial covenants. As of December 31, 2012, the Fenco Borrowers were in compliance with all financial covenants and reporting requirements under the Fenco Credit Agreement.

Neither the Parent Company Financing Agreement nor the Fenco Credit Agreement contain any cross default provisions with respect to the other agreement.

Strategic Cooperation Agreement

In August 2012, the Company entered into a revolving credit agreement (the “Agreement”) with Wanxiang America Corporation (the “Supplier”) and Fenco. Under the terms of the Agreement, the Supplier agreed to provide a revolving credit line for purchases of automotive parts and components by Fenco in an aggregate principal amount not to exceed $22,000,000 (the “Fenco Credit Line”), of which $2,000,000 will only be available for accrued interest and other amounts payable (the “Obligations”). Payment for all purchases will be due and payable 120 days after the date of the bill of lading. Any amounts remaining unpaid following the due date will bear interest at a rate of 1% per month. The Fenco Credit Line will mature on July 31, 2017. Among other things, the Agreement requires that Fenco, on an annual basis, purchase at least approximately $33,000,000 of new automotive parts and components. After July 1, 2014, the Supplier has the right to settle up to $8,000,000 (the “Receivable Sale Option”) of the Company’s outstanding Obligations in exchange, at the Company’s option, for (i) shares of the Company’s common stock valued at $7.75 per share, subject to certain adjustments, or (ii) cash in an amount equal to 135% of the amount of the outstanding Obligations sold to the Company. Any outstanding Obligations settled by the Supplier will reduce the Fenco Credit Line. The Obligations under the Agreement are guaranteed by the Company and certain of its subsidiaries.
 

In connection with this Agreement, the Company also issued a warrant (the “Supplier Warrant”) to the Supplier to purchase up to 516,129 shares of the Company’s common stock for an initial exercise price of $7.75 per share exercisable at any time after two years from August 22, 2012 and on or prior to September 30, 2017. The exercise price is subject to adjustments, among other things, for sales of common stock by the Company at a price below the exercise price. Any outstanding Obligations settled by the Supplier will reduce the Fenco Credit Line. The Company is obligated to issue no more than an aggregate of 1,032,258 shares of its common stock in connection with the Receivable Sale Option and Supplier Warrant. The Obligations under this Agreement are subordinated to the Company’s obligations under the Parent Company Financing Agreement. The fair value of the Supplier Warrant using the Monte Carlo simulation model was $1,018,000 at August 22, 2012, and $1,879,000 at December 31, 2012. This amount was recorded as a warrant liability which is included in other liabilities in the consolidated balance sheet at December 31, 2012. During the three and nine months ended December 31, 2012, a loss of $668,000 and $861,000, respectively, was recorded in general and administrative expenses due to the change in the fair value of the warrant liability.

9. Accounts Receivable Discount Programs

Both of the Company’s segments use receivable discount programs with certain customers and their respective banks. Under these programs, the Company may sell those customers’ receivables to those banks at a discount to be agreed upon at the time the receivables are sold. These discount arrangements allow the Company to accelerate collection of customers’ receivables.

The following is a summary of the Company’s accounts receivable discount programs:

   
Nine Months Ended
 
   
December 31,
 
 
 
2012
   
2011
 
             
Receivables discounted
  $ 229,314,000     $ 197,019,000  
Weighted average days
    316       314  
Annualized weighted average discount rate
    2.8 %     2.9 %
Amount of discount as interest expense
  $ 5,525,000     $ 4,984,000  
 
10. Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share includes the effect, if any, from the potential exercise or conversion of securities, such as stock options and warrants, which would result in the issuance of incremental shares of common stock.

The following presents a reconciliation of basic and diluted net income (loss) per share.

   
Three Months Ended
   
Nine Months Ended
 
 
 
December 31,
   
December 31,
 
 
 
2012
   
2011
   
2012
   
2011
 
Net income (loss)
  $ 935,000     $ (21,827,000 )   $ (17,860,000 )   $ (35,571,000 )
Basic shares
    14,463,782       12,517,269       14,283,080       12,417,292  
Effect of dilutive stock options and warrants
    61,831       -       -       -  
Diluted shares
    14,525,613       12,517,269       14,283,080       12,417,292  
Net income (loss) per share:
                               
Basic
  $ 0.06     $ (1.74 )   $ (1.25 )   $ (2.86 )
Diluted
  $ 0.06     $ (1.74 )   $ (1.25 )   $ (2.86 )
 
 
The effect of dilutive options and warrants excludes (i) 1,500,933 shares subject to options and 735,484 shares subject to warrants with exercise prices ranging from $5.83 to $15.06 per share for the three months ended December 31, 2012, (ii) 1,648,183 shares subject to options and 735,484 shares subject to warrants with exercise prices ranging from $1.80 to $15.06 per share for the nine months ended December 31, 2012, and (iii) 1,442,284 shares subject to options and 546,283 shares subject to warrants with exercise prices ranging from $1.80 to $15.06 per share for the three and nine months ended December 31, 2011 — all of which were anti-dilutive.

11. Income Taxes

The Company recorded income tax expenses for the three and nine months ended December 31, 2012 and 2011. This is primarily due to the federal and state income tax provision on pretax income in the U.S. and not recognizing income tax benefits related to the net losses of Fenco’s Canadian operations for the three and nine months ended December 31, 2012 and 2011 due to the recoverability of these tax benefits not being deemed by the Company to be more likely than not to be realized. In addition, for the three and nine months ended December 31, 2012, the Company recorded $28,000 and $126,000, and for the three and nine months ended December 31, 2011, the Company recorded $141,000 and $281,000, respectively, of income tax expense specifically related to the Fenco subsidiaries located in Mexico, a separate tax jurisdiction.

The income tax expenses reflect effective income tax rates of 50.3% and negative 10.0% for the three months ended December 31, 2012 and 2011, respectively. The income tax expenses reflect effective income tax rates of negative 53.6% and negative 18.8% for the nine months ended December 31, 2012 and 2011, respectively. The income tax expenses, excluding the net losses of Fenco’s Canadian operations, reflect effective income tax rates of 33.0% and 36.9% for the three and nine months ended December 31, 2012, respectively. The income tax expenses, excluding the net losses of Fenco’s Canadian operations, reflect income tax rates of 37.7% and 39.3% for the three and nine months ended December 31, 2011, respectively. The income tax rate for the three months ended December 31, 2012 includes required adjustments to reflect the appropriate nine month rate for fiscal 2013. The income tax rates for all other periods were higher than the federal statutory rates primarily due to state income taxes, which were partially offset by the benefit of lower statutory tax rates in foreign taxing jurisdictions.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states and foreign jurisdictions with varying statutes of limitations.

12. Financial Risk Management and Derivatives

Purchases and expenses denominated in currencies other than the U.S. dollar, which are primarily related to the Company’s facilities overseas, expose the Company to market risk from material movements in foreign exchange rates between the U.S. dollar and the foreign currency. The Company’s primary risk exposure is from changes in the rate between the U.S. dollar and the Mexican peso related to the operation of the Company’s facilities in Mexico. The Company enters into forward foreign currency exchange contracts to exchange U.S. dollars for Mexican pesos in order to mitigate this risk. The Company also enters into forward foreign currency exchange contracts to exchange U.S. dollars for Chinese yuan in order to mitigate the risk related to its purchases and payments to its Chinese vendors. The extent to which forward foreign currency exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific purchase requirements to fund those overseas facilities and purchases.

The Company enters into forward foreign currency exchange contracts in order to reduce the impact of foreign currency fluctuations and not to engage in currency speculation. The use of derivative financial instruments allows the Company to reduce its exposure to the risk that the eventual cash outflow resulting from funding the expenses of the foreign operations and purchases will be materially affected by changes in exchange rates. The Company does not hold or issue financial instruments for trading purposes. The forward foreign currency exchange contracts are designated for forecasted expenditure requirements to fund foreign operations and purchases.

The Company had forward foreign currency exchange contracts with a U.S. dollar equivalent notional value of $16,708,000 and $13,494,000 at December 31, 2012 and March 31, 2012, respectively. These contracts generally expire in a year or less, at rates agreed at the inception of the contracts. The counterparty to this derivative transaction is a major financial institution with investment grade or better credit rating; however, the Company is exposed to credit risk with this institution. The credit risk is limited to the potential unrealized gains (which offset currency fluctuations adverse to the Company) in any such contract should this counterparty fail to perform as contracted. Any changes in the fair values of forward foreign currency exchange contracts are reflected in current period earnings and accounted for as an increase or offset to general and administrative expenses.
 

The following table shows the effect of the Company’s derivative instruments on its consolidated statements of operations:
 
    Gain (Loss) Recognized within General and Administrative Expenses  
    Three Months Ended   Nine Months Ended  
Derivatives Not Designated as
  December 31,   December 31,  
Hedging Instruments
  2012   2011   2012   2011  
                           
Forward foreign currency exchange contracts
  $
  20,000
  $
488,000
  $
 360,000
  $
(1,399,000)
 

The fair value of the forward foreign currency exchange contracts of $239,000 is included in prepaid expenses and other current assets in the consolidated balance sheet at December 31, 2012. The fair value of the forward foreign currency exchange contracts of $121,000 is included in other current liabilities in the consolidated balance sheet at March 31, 2012.

13. Fair Value Measurements

The following table summarizes the Company’s financial assets and liabilities measured at fair value, by level within the fair value hierarchy as of December 31, 2012 and March 31, 2012:

   
December 31, 2012
   
March 31, 2012
 
         
Fair Value Measurements
         
Fair Value Measurements
 
         
Using Inputs Considered as
         
Using Inputs Considered as
 
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
   
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Assets
                                               
Short-term investments                                                                
Mutual funds
  $ 383,000     $ 383,000       -       -     $ 342,000     $ 342,000       -       -  
Prepaid expenses and other current assets                                                                
Forward foreign currency exchange contracts
    239,000       -     $ 239,000       -       -       -       -       -  
                                                                 
Liabilities
                                                               
Other current liabilities
                                                               
Deferred compensation
    383,000       383,000       -       -       342,000       342,000       -       -  
Forward foreign currency exchange contracts
    -       -       -       -       121,000       -     $ 121,000       -  
Other liabilities
                                                               
Warrant liability
    2,450,000       -       -     $ 2,450,000       -       -       -       -  

The Company’s short-term investments, which fund its deferred compensation liabilities, consist of investments in mutual funds. These investments are classified as Level 1 as the shares of these mutual funds trade with sufficient frequency and volume to enable the Company to obtain pricing information on an ongoing basis.

The forward foreign currency exchange contracts are primarily measured based on the foreign currency spot and forward rates quoted by the banks or foreign currency dealers. During the three months ended December 31, 2012 and 2011, a gain of $20,000 and $488,000, respectively, was recorded in general and administrative expenses due to the change in the value of the forward foreign currency exchange contracts subsequent to entering into the contracts. During the nine months ended December 31, 2012 and 2011, a gain of $360,000 and a loss of $1,399,000, respectively, was recorded in general and administrative expenses due to the change in the value of the forward foreign currency exchange contracts subsequent to entering into the contracts.

The Company estimates the fair value of the warrant liability using level 3 inputs and the Monte Carlo simulation model at each balance sheet date. This amount is recorded as a warrant liability which is included in other liabilities in the consolidated balance sheet at December 31, 2012. Any subsequent changes in the fair value of the warrant liability will be recorded in current period earnings as a general and administrative expense. During the three and nine months ended December 31, 2012, a loss of $882,000 and $825,000, respectively, was recorded in general and administrative expenses due to the change in the fair value of the warrant liability.
 

The assumptions used to determine the fair value of the Cerberus Warrant and the Supplier Warrant recorded as warrant liability were:

   
December 31, 2012
 
 
 
Cerberus Warrant
   
Supplier Warrant
 
             
Risk free interest rate
    0.63 %     0.68 %
Expected life in years
    4.40       4.75  
Expected volatility
    54.85 %     55.20 %
Dividend yield
    -       -  
Probability of future financing
    0 %     0 %

The risk free interest rate used was based on U.S. treasury-note yields with terms commensurate with the remaining term of the warrants. The expected life is based on the remaining contractual term of the warrants and the expected volatility is based on the Company’s daily historical volatility over a period commensurate with the remaining term of the warrants.

A summary of the change to the Company’s warrant liability, as measured at fair value on a recurring basis using significant unobservable inputs (Level 3) is presented below:

   
Three Months Ended
   
Nine Months Ended
 
 
 
December 31,
   
December 31,
 
 
 
2012
   
2011
   
2012
   
2011
 
                         
Beginning balance
  $ 1,568,000     $ -     $ -     $ -  
Newly issued
    -       -       1,625,000       -  
Total (gain) loss included in net loss
    882,000       -       825,000       -  
Warrants exercised
    -       -       -       -  
Net transfers in (out) of Level 3
    -       -       -       -  
Ending balance
  $ 2,450,000     $ -     $ 2,450,000     $ -  

During the three and nine months ended December 31, 2012, the Company had no significant measurements of assets or liabilities at fair value on a nonrecurring basis subsequent to their initial recognition.

The carrying amounts of cash, short-term investments, accounts receivable, accounts payable and accrued liabilities approximate their fair value due to the short-term nature of these instruments. The carrying amounts of the revolving loans, term loans and other long-term liabilities approximate their fair value based on current rates for instruments with similar characteristics.

14. Segment Information

The Company has two reportable segments, the rotating electrical segment and the undercar product line segment, based on the way the Company manages, evaluates and internally reports its business activities.

The rotating electrical segment is comprised of the Company’s alternator and starter business. This segment remanufactures, produces, and distributes alternators and starters for import and domestic cars, light trucks, heavy duty, agricultural and industrial applications. These replacement parts are sold for use on vehicles after initial vehicle purchase.

The undercar product line segment manufactures, remanufactures and distributes new and remanufactured aftermarket auto parts, including steering components, brake calipers, master cylinders, hub assembly and bearings, for virtually all passenger and truck vehicles.
 
 
The Company’s products are sold to automotive retail chain stores, warehouse distributors, and to major automobile manufacturers throughout North America.

During the third quarter of fiscal 2013, the Company discontinued supplying its products to a major non-profitable customer of the undercar product line segment. The net sales to this customer represented approximately 31.0% for six months ended September 30, 2012 and 20.8% for the year ended March 31, 2012 from the date of acquisition on May 6, 2011, of net sales for this segment. The Company has no further obligation to accept additional product returns from this customer. In accordance with the Company’s net-of-core revenue recognition policy, the Company recognized approximately $50,783,000 in revenue from the reduction in our obligation to provide a credit for this major customer’s Remanufactured Cores which were previously recorded as a customer core returns accrual and $31,649,000 of the related long-term core inventory previously recorded in the consolidated balance sheet was recognized as cost of goods sold during the nine months ended December 31, 2012.

The results of operations of Fenco have been included from the date of acquisition on May 6, 2011. Financial information relating to the Company’s reportable segments is as follows:

   
Three months ended December 31, 2012
 
   
Rotating
 
Undercar
         
Selected income statement data
 
Electrical
 
Product Line
 
Eliminations
 
Consolidated
 
                         
Net sales to external customers
  $ 50,658,000     $ 65,617,000     $ -     $ 116,275,000  
Gross profit
    16,326,000       7,717,000       -       24,043,000  
Operating income
    5,050,000       2,720,000       -       7,770,000  
Net income (loss)
    1,786,000       (851,000 )     -       935,000  

   
Three months ended December 31, 2011
 
   
Rotating
   
Undercar
             
Selected income statement data
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
                         
Net sales to external customers
  $ 41,895,000     $ 42,202,000     $ -     $ 84,097,000  
Intersegment revenue, net of cost
    241,000       -       (241,000 )     -  
Gross profit (loss)
    12,636,000       (14,217,000 )     -       (1,581,000 )
Operating income (loss)
    5,630,000       (22,219,000 )     -       (16,589,000 )
Net income (loss)
    3,028,000       (24,855,000 )     -       (21,827,000 )
 
   
Nine months ended December 31, 2012
 
   
Rotating
 
Undercar
         
Selected income statement data
 
Electrical
 
Product Line
 
Eliminations
 
Consolidated
 
                         
Net sales to external customers
  $ 155,109,000     $ 161,821,000     $ -     $ 316,930,000  
Gross profit
    51,241,000       1,637,000       -       52,878,000  
Operating income (loss)
    25,266,000       (19,758,000 )     -       5,508,000  
Net income (loss)
    10,656,000       (28,516,000 )     -       (17,860,000 )

   
Nine months ended December 31, 2011
 
   
Rotating
   
Undercar
             
Selected income statement data
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
                         
Net sales to external customers
  $ 126,648,000     $ 135,575,000     $ -     $ 262,223,000  
Intersegment revenue, net of cost
    1,853,000       -       (1,853,000 )     -  
Gross profit (loss)
    40,483,000       (20,052,000 )     -       20,431,000  
Operating income (loss)
    15,902,000       (37,277,000 )     -       (21,375,000 )
Net income (loss)
    8,280,000       (43,851,000 )     -       (35,571,000 )

 
   
December 31, 2012
 
   
Rotating
   
Undercar
             
Selected balance sheet data
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
                         
Current assets
  $ 108,879,000     $ 64,119,000     $ (31,649,000 )   $ 141,349,000  
Non-current assets
    218,217,000       139,141,000       (56,065,000 )     301,293,000  
Total assets
  $ 327,096,000     $ 203,260,000     $ (87,714,000 )   $ 442,642,000  
                                 
Current liabilities
  $ 69,913,000     $ 132,533,000     $ (33,150,000 )   $ 169,296,000  
Non-current liabilities
    95,569,000       157,111,000       (49,618,000 )     203,062,000  
Total liabilities
    165,482,000       289,644,000       (82,768,000 )     372,358,000  
                                 
Equity (deficit)
    161,614,000       (86,384,000 )     (4,946,000 )     70,284,000  
Total liabilities and equity
  $ 327,096,000     $ 203,260,000     $ (87,714,000 )   $ 442,642,000  

   
March 31, 2012
 
   
Rotating
   
Undercar
             
Selected balance sheet data
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
                         
Current assets
  $ 115,451,000     $ 81,778,000     $ (28,998,000 )   $ 168,231,000  
Non-current assets
    179,167,000       186,896,000       (32,396,000 )     333,667,000  
Total assets
  $ 294,618,000     $ 268,674,000     $ (61,394,000 )   $ 501,898,000  
                                 
Current liabilities
  $ 72,987,000     $ 126,430,000     $ (28,998,000 )   $ 170,419,000  
Non-current liabilities
    85,201,000       200,112,000       (27,453,000 )     257,860,000  
Total liabilities
    158,188,000       326,542,000       (56,451,000 )     428,279,000  
                                 
Equity (deficit)
    136,430,000       (57,868,000 )     (4,943,000 )     73,619,000  
Total liabilities and equity
  $ 294,618,000     $ 268,674,000     $ (61,394,000 )   $ 501,898,000  

   
Nine months ended December 31, 2012
 
   
Rotating
   
Undercar
             
Selected cash flow data
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
                         
Net cash used in operating activities
  $ (4,035,000 )   $ (23,694,000 )   $ -     $ (27,729,000 )
Net cash used in investing activities
    (1,656,000 )     (1,401,000 )     -       (3,057,000 )
Net cash provided by financing activities
    22,514,000       737,000               23,251,000  
Effect of exchange rate changes on cash
    (12,000 )     -       -       (12,000 )
Cash — Beginning of period
    32,379,000       238,000       -       32,617,000  
Cash — End of period
    24,863,000       207,000       -       25,070,000  
                                 
Additional selected financial data
                               
Depreciation and amortization
  $ 2,137,000     $ 1,854,000     $ -     $ 3,991,000  
Capital expenditures
    1,625,000       1,401,000       -       3,026,000  

 
   
Nine months ended December 31, 2011
 
   
Rotating
   
Undercar
             
Selected cash flow data
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
                         
Net cash provided by (used in) operating activities
  $ 7,124,000     $ (52,472,000 )   $ -     $ (45,348,000 )
Net cash used in investing activities
    (775,000 )     (322,000 )     -       (1,097,000 )
Net cash provided by financing activities
    39,209,000       8,000,000       -       47,209,000  
Effect of exchange rate changes on cash
    (108,000 )     -       -       (108,000 )
Cash — Beginning of period
    2,477,000       -       -       2,477,000  
Cash — End of period
    2,856,000       277,000       -       3,133,000  
                                 
Additional selected financial data
                               
Depreciation and amortization
  $ 2,634,000     $ 2,904,000     $ -     $ 5,538,000  
Capital expenditures
    746,000       322,000       -       1,068,000  

15. Equity Transaction

In April 2012, the Company entered into a Subscription Agreement and a Registration Rights Agreement to raise approximately $15,004,000 in gross proceeds and net proceeds of $13,970,000 after expenses through a private placement of its common stock. Pursuant to the terms of the Subscription Agreement, certain accredited investors purchased an aggregate of 1,936,000 shares of common stock in a private placement exempt from registration under the Securities Act in reliance upon Rule 506 of Regulation D, for a purchase price of $7.75 per share. The Company used the proceeds to enhance the integration of its Fenco acquisition and for general corporate purposes.

Pursuant to the Registration Rights Agreement, the Company agreed to file a registration statement with the SEC to register for resale the common stock sold in the private placement not later than 45 days after the closing of the private placement and to use commercially reasonable efforts to cause such registration statement to be declared effective, subject to certain exceptions, within 60 days of closing (or 120 days in the event of an SEC review). Failure to meet these deadlines and certain other events resulted in the Company’s payment to the purchasers of liquidated damages in the amount of 1.0% of the purchase price per 30-day period pending filing of the registration statement, effectiveness of the registration statement or other events, as applicable. On June 12, 2012, the Company filed a registration statement under the Securities Act of 1933 to register the shares of common stock; however, the registration statement was not declared effective in accordance with the deadlines in the Registration Rights Agreement and the Company began accruing liquidated damages starting on August 25, 2012. Liquidated damages may be settled either in cash or, at the option of the purchaser, in shares of the Company’s common stock. During the three and nine months ended December 31, 2012, the Company recorded $450,000 and $600,000, respectively, of general and administrative expense for the settlement of these liquidated damages. The registration statement was declared effective in time under applicable securities laws on January 7, 2013.

16. Stock Options

The Company granted options to purchase 632,800 and 6,000 shares of common stock during the nine months ended December 31, 2012 and 2011, respectively, of which 626,800 were granted during the three months ended December 31 2012. The cost associated with stock options is estimated using the Black-Scholes option-pricing model. The Black-Scholes option pricing model requires the input of subjective assumptions including the expected volatility of the underlying stock and the expected holding period of the option. These subjective assumptions are based on both historical and other information. Changes in the values assumed and used in the model can materially affect the estimate of fair value.
 

The table below summarizes the Black-Scholes option pricing model assumptions used to derive the weighted average fair value of the stock options granted during the periods noted.

   
Nine Months Ended
 
   
December 31,
 
 
 
2012
   
2011
 
Weighted average risk free interest rate
    1.16 %     2.30 %
Weighted average expected holding period (years)
    6.60       6.15  
Weighted average expected volatility
    44.25 %     39.02 %
Weighted average expected dividend yield
    -       -  
Weighted average fair value of options granted
  $ 2.92     $ 5.95  

A summary of stock option transactions for the nine months ended December 31, 2012 follows:

   
Number of
   
Weighted Average
 
 
 
Shares
   
Exercise Price
 
Outstanding at March 31, 2012
    1,462,284     $ 9.15  
Granted
    632,800     $ 6.47  
Exercised
    (26,500 )   $ 2.75  
Cancelled
    -     $ -  
Outstanding at December 31, 2012
    2,068,584     $ 8.41  

At December 31, 2012, options to purchase 1,648,183 share of common stock were exercisable at the weighted average exercise price of $8.89.

A summary of changes in the status of non-vested stock options during the nine months ended December 31, 2012 is presented below:

   
Number of
Shares
   
Weighted Average
Grant Date Fair
Value
 
Non-vested at March 31, 2012
    15,000     $ 4.18  
Granted
    632,800     $ 2.92  
Vested
    (227,399 )   $ 2.97  
Non-vested at December 31, 2012
    420,401     $ 2.94  

At December 31, 2012, there was $1,193,000 of total unrecognized compensation expense from stock-based compensation granted under the plans, which is related to non-vested shares. The compensation expense is expected to be recognized over a weighted average vesting period of 2.4 years.

17. Related Party Transactions

Stock Repurchase Agreement

In December 2012, the Company entered into a stock repurchase agreement (the “Stock Repurchase Agreement”) with Mel Marks, the Company’s founder, a member of the Company’s Board of Directors and consultant to the Company, and Melmarks Enterprises LLLP, a limited liability limited partnership controlled by Mr. Marks (the “Shareholders”), which, among other things, provides the Shareholders with the option to sell up to $300,000 of the Company’s common stock held by the Shareholders (the “Shares”), on or prior to February 28, 2013, at a purchase price that is 10% below the average daily closing price per share of the Company’s common stock for the five consecutive trading days immediately preceding the date of the notice of sale. In December 2012, the Company repurchased 19,120 shares at a total cost of approximately $100,000. See Note 18 – Subsequent Events – Stock Repurchase Agreement for additional information regarding this transaction.
 

Restricted stock

In connection with the employment agreement with Selwyn Joffe, the Company’s Chairman, President and Chief Executive Officer, dated May 18, 2012, the Company granted 51,167 shares of fully vested restricted stock with a fair value of $331,000 in December 2012. The Company withheld 25,137 shares based upon the Company’s closing stock price on the vesting date to settle Mr. Joffe’s minimum statutory obligation for the applicable income and other employment taxes.  The Company then remitted cash to the appropriate taxing authorities. Total payment for this tax obligation to the taxing authorities was $163,000 and is reflected as a financing activity within the consolidated statements of cash flows. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company. See Note 18 – Subsequent Events – Option Purchase Agreement for additional information regarding transactions with Mr. Joffe.

18. Subsequent Events

Stock Repurchase Agreement

In January 2013, the Company repurchased 33,827 shares of its common stock from the Shareholders pursuant to the Stock Repurchase Agreement at a total cost of approximately $200,000.

Option Purchase Agreement

In January 2013, the Company entered into an option purchase agreement (the “Option Purchase Agreement”) with Mr. Joffe. Pursuant to the Option Purchase Agreement, among other things, the Company would purchase Mr. Joffe’s options to purchase 101,500 shares of the Company’s common stock granted under the Company’s 1994 Stock Option Plan at a net purchase price of $454,675. This payment represents the difference per share of common stock between $6.87, the average closing price of the Company’s common stock for the five consecutive trading days preceding, and including the date of the Option Purchase Agreement, and the exercise price of the respective stock options, discounted five percent and multiplied by the total number of shares under Mr. Joffe’s stock options.

In connection with the Option Purchase Agreement, the Company entered into a fifth amendment to the Parent Company Financing Agreement (the “Fifth Amendment”), which among other things, permitted the Company to purchase Mr. Joffe’s stock options pursuant to the Option Purchase Agreement.

Fenco Purchases

In January 2013, the lenders under the Parent Company Financing Agreement consented to the purchase by the Company of up to $2,400,000 of inventory for Fenco from the Supplier and the sale of that inventory to Fenco from time to time on a cash-on-delivery basis.
 

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

The following discussion and analysis presents factors that Motorcar Parts of America, Inc. and its subsidiaries (“our,” “we” or “us”) believe are relevant to an assessment and understanding of our consolidated financial position and results of operations. This financial and business analysis should be read in conjunction with our March 31, 2012 audited consolidated financial statements included in our Annual Report on Form 10-K filed with the SEC on September 28, 2012.
 
Disclosure Regarding Private Securities Litigation Reform Act of 1995

This report contains certain forward-looking statements with respect to our future performance that involve risks and uncertainties. Various factors could cause actual results to differ materially from those projected in such statements. These factors include, but are not limited to: concentration of sales to certain customers, changes in our relationship with any of our major customers, the increasing customer pressure for lower prices and more favorable payment and other terms, the increasing demands on our working capital, the significant strain on working capital associated with large Remanufactured Core inventory purchases from customers, our ability to obtain any additional financing we may seek or require, our ability to maintain positive cash flows from operations, potential future changes in our previously reported results as a result of the identification and correction of errors in our accounting policies or procedures or potential material weaknesses in our internal controls over financial reporting, lower revenues than anticipated from new and existing contracts, our failure to meet the financial covenants or the other obligations set forth in our credit agreements and our lenders’ refusal to waive any such defaults, any meaningful difference between projected production needs and ultimate sales to our customers, increases in interest rates, changes in the financial condition of any of our major customers, the impact of high gasoline prices, the potential for changes in consumer spending, consumer preferences and general economic conditions, increased competition in the automotive parts industry, including increased competition from Chinese and other offshore manufacturers, difficulty in obtaining Used Cores and component parts or increases in the costs of those parts, political, criminal or economic instability in any of the foreign countries where we conduct operations, currency exchange fluctuations, unforeseen increases in operating costs, our ability to integrate our Fenco operations, and other factors discussed herein and in our other filings with the SEC.

Management Overview

We are a leading manufacturer, remanufacturer, and distributor of aftermarket automobile parts.

We historically have remanufactured alternators and starters for import and domestic cars, light trucks, heavy duty, agricultural and industrial applications. As a result of our May 2011 acquisition of the business formerly operated by FAPL, we also manufacture, remanufacture and distribute new and remanufactured steering components including rack and pinion, pumps and gears, brake calipers, master cylinders, and hub assembly and bearings for virtually all passenger and truck vehicles. We intend to focus our efforts in the near term on four major categories: rotating electrical, brakes, steering, and wheel hubs and bearings. All of these parts are non-discretionary.

We have two reportable segments, our existing product lines were included under the rotating electrical and the product lines from our FAPL acquisition were included under the undercar product line, based on the way we manage, evaluate and internally report our business activities.

The after-market for automobile parts is divided into two markets. The first market is the do-it-yourself (“DIY”) market, which is generally serviced by the large retail chain outlets. Consumers who purchase parts from the DIY channel generally install parts into their vehicles themselves. In most cases, this is a cheaper alternative than having the repair performed by a professional installer. The second market is the professional installer market, commonly known as the do-it-for-me (“DIFM”) market. This market is serviced by the traditional warehouse distributors, the dealer networks, and the commercial divisions of retail chains. Generally, the consumer in this channel is a professional parts installer.

Our products are distributed to both the DIY and DIFM markets and are distributed predominantly throughout North America. We sell our products to the largest auto parts retail and traditional warehouse chains and to major automobile manufacturers for both their aftermarket programs and their warranty replacement programs (“OES”). Demand and replacement rates for aftermarket remanufactured automobile parts generally increase with the age of vehicles and increases in miles driven.
 
 
Historically, the largest share of our business was in the DIY market. While that is still the case, our DIFM business is now a significant part of our business. In difficult economic times, we believe consumers are more likely to purchase lower cost replacement parts in both the DIY and DIFM markets. We focus on supplying both these channels with the most cost efficient replacement parts for the consumer to purchase.

The DIFM market is an attractive opportunity for growth. We are positioned to benefit from this market opportunity in two ways: (1) our auto parts retail customers are expanding their efforts to target the DIFM market and (2) we sell our products under private label and our Quality-Built®, Talon®, Xtreme®, Reliance™, Fenco™, Dynapak®, and other brand names directly to suppliers that focus on professional installers. In addition, we sell our products to OE manufacturers for distribution to the professional installer both for warranty replacement and their general aftermarket channels. We have been successful in growing sales to this market.

Undercar Product Line Turnaround Plan

Our top turnaround priority continues to be improvement of the financial performance of our undercar product line business to position it for sustained profitability and growth in the long-term. At the same time we are focused on reestablishing strong liquidity and bringing the level of customer service in our undercar business to the excellent level of customer service we have achieved and maintained in our rotating electrical business. We have been systematically and aggressively implementing our undercar product line turnaround plan since acquisition and at December 31, 2012, we are 20 months into a 24 month plan. This turnaround plan is built on the following elements: upgrading customer service levels; reviewing profitability of product offerings; improving manufacturing and logistics productivity; and implementing cost savings throughout the operating model including the implementation of an ERP system to support the undercar product line segment.

During the current quarter ended December 31, 2012, the following are some of the key steps taken toward our goal of sustained profitability and growth for the long-term. In performing these steps operating inefficiencies and transition costs were incurred, which we believe are non-recurring and that was especially true this quarter as we tackled some of the larger and more complex challenges. We will refer back to the impacts of these key steps noted below throughout our comparative analysis of the quarterly results of operations.

Customer Service Levels. During this quarter we continued to focus on improving or maintaining our customer service levels. The implementation of the new ERP system has provided better information to allow us to improve the fill rates in support of the customer requirements, but we still have not obtained our target levels and are aggressively working on this issue. To enhance customer service levels we have also voluntarily incurred additional premium freight charges and purchased material at prices in excess of normal cost.

During the third quarter of fiscal 2013, we agreed with several customers to evaluate their inventory offerings and developed a new mix of product to be offered by these customers, which we expect will result in better performance in future quarters for these customers and the undercar product line segment. In the current quarter ended December 31, 2012, however, this will require that we record an accrual to reserve for the inventory that will be returned to be replaced with the new product offerings.

Profitability of Product Offerings. In the quarter ended December 31, 2012, we continued the process of transitioning out of the CV axle, clutch and other smaller product lines. We are focused on our main product lines which include brakes, steering, and wheel hubs. The process of transitioning out of the discontinued product lines included sales of discontinued products to customers or others at reduced margins, the sale of components and packaging related to these product lines as scrap material, and the establishment of additional reserves to reduce the cost of the remaining inventory to market value.
 

In addition, we transitioned out of an unprofitable major customer relationship representing approximately 31% of our net sales of the undercar product line segment in the first six months of fiscal 2013. This step allowed us to recognize revenue from the reduction in our obligation to provide a credit for the customer’s Remanufactured Cores offset by the recognition of the cost of the Remanufactured Cores held at the customer’s location. By exiting a customer relationship for certain undercar product lines, we incurred some direct one-time transition costs, which impacted our manufacturing productivity by reducing our production requirements at the undercar product line segment’s facility in Mexico. The lower sales and production rates also impacted other accounting estimates, such as our excess and obsolescence reserve levels and our warranty reserve rates. The impacts on these accounting estimates will be reduced in future quarters as we adjust to our expected future production and sales environment.

Manufacturing and Logistics Productivity. Our transition plan for logistics is to consolidate multiple facilities into one facility in Pennsylvania. We will also utilize additional space in our Torrance facility for the distribution of the purchased finished goods products in our undercar product line segment. These facilities will be managed by our in-house personnel using the newly implemented ERP system. The transition plan for manufacturing includes implementing and maintaining lean manufacturing at our undercar product line facility located in Monterrey, Mexico.

We reached an agreement with one of our third-party logistics service providers located in Pennsylvania to terminate its services provided to the undercar product line segment effective November 5, 2012. Among other things, this agreement requires us to pay a termination fee of approximately $1,402,000, which was recorded in the second quarter of fiscal 2013. In addition, we agreed to pay a $95,000 per month all-inclusive rental fee to use the property for a period not to exceed eight months from the termination date. The transition of the purchased finished goods to the new facility in Torrance began in December 2012, and we expect that there will be additional expenses incurred until the transition is completed. Once completed, we expect that this will result in additional savings in logistics expenses.

Cost Savings In addition to the cost savings discussed above, part of our turnaround plan included centralizing the accounting functions previously performed in our office located in Toronto into our existing accounting function in Torrance. This was made possible by the extension of the current rotating electric ERP system to incorporate the undercar product line segment. The ERP system became operational at the beginning of the current quarter ending December 31, 2012. For a period of time during the quarter we incurred both costs to finalize the first and second quarter accounting functions in Toronto as well as incurring the ongoing accounting function costs related to the third quarter activity in Torrance. We believe that this transition has been substantially completed and will result in cost savings in future quarters.

Our implementation of our plan for Fenco has taken longer and cost more than initially anticipated. We anticipate continuing to adjust this turnaround plan as the various elements are implemented. We expect these and related initiatives will be substantially completed in the first quarter of fiscal 2014, but the impact of those initiatives may take longer to be reflected in our financial results. Our ability to successfully implement this plan and the timing of our implementation of this plan will depend on, among other things, our customer and vendor support and the financial resources that are or will become available for implementation of this plan, including capital or other support (if any) that we may provide to Fenco. Fenco continues to face capital and liquidity concerns, and we have only agreed to (and under the Parent Company Financing Agreement are only permitted to) support those in specific limited circumstances and cannot assure that we will do so in any other circumstances in the future or that Fenco will have or be able to obtain significant capital to implement its plan.
 
Results of Operations for the Three Months Ended December 31, 2012 and 2011

The following discussion and analysis should be read in conjunction with the financial statements and notes thereto appearing elsewhere herein.
 
 
The following table summarizes certain key operating data by segment for the periods indicated:

   
Rotating
   
Undercar
       
Three months ended December 31,
 
Electrical
   
Product Line
   
Consolidated
 
2012
                 
Gross profit percentage
    32.2 %     11.8 %     20.7 %
Cash flow used in operations
  $ (4,375,000 )   $ (8,811,000 )   $ (13,186,000 )
Finished goods turnover (annualized) (1)
    5.9       6.5       6.3  
Annualized return on equity (2)
    -       -       5.1 %
                         
2011
                       
Gross profit (loss) percentage
    30.0 %     (33.7 ) %     (1.9 ) %
Cash flow provided by (used in) operations
  $ 3,048,000     $ (3,162,000 )   $ (114,000 )
Finished goods turnover (annualized) (1)
    5.6       3.5       4.0  
Annualized return on equity (2)
    -       -       (74.5 ) %
 

(1) 
Annualized finished goods turnover for the fiscal quarter is calculated by multiplying cost of sales for the quarter by 4 and dividing the result by the average between beginning and ending non-core finished goods inventory values for the fiscal quarter. We believe this provides a useful measure of our ability to turn production into revenues.
 
(2) 
Annualized return on equity is computed as consolidated net income for the fiscal quarter multiplied by 4 and dividing the result by beginning consolidated shareholders’ equity. Annualized return on equity measures our ability to invest shareholders’ funds profitably.

Net Sales and Gross Profit

The following table summarizes net sales and gross profit by segment for the three months ended December 31, 2012 and 2011:

   
Rotating
   
Undercar
             
Three months ended December 31,
 
Electrical
   
Product Line
   
Eliminations
   
Consolidated
 
2012
                       
Net sales to external customers
  $ 50,658,000     $ 65,617,000     $ -     $ 116,275,000