# Motorcar Parts of America Inc: Form 10-K for the period ended Mar 31, 2009 - Company: [Motorcar Parts of America Inc](/companies/mpaa.md) (CIK 918251) - Form: 10-K - Filed: 2009-06-15 - Accepted by EDGAR: Jun 15, 2009, 06:11 ET - Period: 2009-03-31 - Accession: 0000950123-09-013860 - Inline XBRL: no - Main document: https://www.sec.gov/Archives/edgar/data/918251/000095012309013860/v52876e10vk.htm - All documents and exhibits: https://www.sec.gov/Archives/edgar/data/918251/000095012309013860/ ## Business As filed, 23,008 characters. ### General We remanufacture alternators and starters for imported and domestic cars and light trucks in addition to heavy duty, agricultural and industrial applications and distribute them predominantly throughout the United States and Canada. Our business for heavy duty, agricultural and industrial applications is in its early stages and does not represent a significant portion of our business. Our line of light duty alternators and starters are sold to most of the largest auto parts retail chains in the United States and Canada, including AutoZone, Pep Boys, and O’Reilly Automotive (including CSK Automotive) and various traditional warehouses for the professional installers. We believe auto parts retail chains in total, currently account for approximately 35% of the North American after-market for remanufactured alternators and starters. We believe that demand for after-market remanufactured alternators and starters is in part driven by the number of vehicle miles driven and the age of vehicles. According to industry statistics, the average age of vehicles on the road in North America is increasing, while miles driven in North America decreased each month from January 2008 through March 2009. We believe this is primarily the result of the slowdown in the U.S. economy during this period. Historically, our business has focused on the do-it-yourself (“DIY”) market, customers who buy remanufactured alternators and starters at an auto parts store and install the parts themselves. We believe that the do-it-for-me (“DIFM”) market, also known as the professional installer market, is an attractive opportunity for growth. We believe 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 professional installer market segment and (2) we sell our products under private label and our Quality-Built®, Talon®, Xtreme® and other brand names directly to suppliers that focus on professional installers. In addition, we sell our products to original equipment manufacturers for distribution to the professional installer both for warranty replacement and their general after-market channels. While we continually seek to diversify our customer base, we currently derive, and have historically derived, a substantial portion of our sales from a small number of large customers. During fiscal 2009, 2008 and 2007, sales to our five largest customers constituted approximately 92%, 94% and 96%, respectively, of our net sales. To mitigate the risk associated with this concentration of sales, we have increasingly sought to enter into longer-term customer agreements with our major customers. These longer-term agreements typically require us to commit a significant amount of our working capital to build inventory and increase production. In addition, they typically include marketing and other allowances that adversely impact near-term revenue and may require us to incur certain changeover expenses. To offset the pricing pressure and costs associated with our agreements with our largest customers, we have moved almost all our U.S. remanufacturing operations to lower cost facilities in Mexico and Malaysia. During fiscal 2009, 2008 and 2007, approximately 98%, 91% and 64%, respectively, of our total production was produced by our subsidiaries in Mexico and Malaysia. We expect to maintain production of remanufactured units that require specialized service and/or rapid turnaround in our U.S. facility for the near term. In addition, we are nearing completion of the transition of our warehousing and shipping/receiving operations from our U.S. facility to our facility in Mexico. During fiscal 2009, we acquired certain assets of Automotive Importing Manufacturing, Inc. (“AIM”) and Suncoast Automotive Products, Inc. (“SCP”), specifically the operations which produced new and remanufactured alternators and starters for imported and domestic passenger vehicles, and for the industrial and heavy duty after-markets. These products are sold under Talon®, Xtreme®, and other brand names. We believe these acquisitions expand our customer base and product line, including the addition of business in heavy duty alternator and starter applications, and expand our market share in North America. ### Company Products Our total net sales is primarily derived from sales of replacement alternators and starters for imported and domestic cars and light trucks. Alternators and starters are non-elective replacement parts in all makes and models of vehicles because they are required for a vehicle to operate. Currently, approximately 95% of our units are sold for resale under customer private labels. The balance is sold under our Quality-Built® , Talon®, Xtreme®, and other brand names. Our alternators and starters are produced to meet or exceed original manufacturer specifications. We remanufacture alternators and starters for virtually all imported and domestic vehicles sold in the United States and Canada. Remanufacturing creates a supply of parts at a lower cost to the end user than newly manufactured parts and makes available automotive parts which are no longer being manufactured as new. Our remanufactured parts are sold at competitively lower prices than most new replacement parts. We recycle nearly all materials in keeping with our focus of positively impacting the environment. Nearly all parts, including metal from the Used Cores, and corrugated packaging are recycled. The technology and the specifications for the components used in our products, particularly alternators, have become more advanced in response to the installation in vehicles of an increasing number of electrical components such as navigation systems, steering wheel-mounted electronic controls, keyless entry devices, heated rear windows and seats, high-powered stereo systems and DVD players. As a result of this increased electrical demand, alternators require more advanced technology and higher grade components and per unit sales prices of replacement alternators have increased accordingly. The increasing complexity of cars and light trucks and the number of different makes and models of these vehicles have resulted in a significant increase in the number of different alternators and starters required to service imported and domestic cars and light trucks. In addition to the over 3,000 stock keeping units (“SKUs”) for heavy duty and a variety of agricultural and industrial applications, we carry over 4,500 SKUs which cover applications for most imported and domestic cars and light trucks sold in the United States and Canada. ### Customers: Customer Concentration Our products are marketed throughout the United States and Canada. Currently, we serve three of the four largest retail automotive chain stores with an aggregate of approximately 7,900 retail outlets as well as a diverse group of automotive warehouse distributors. We are substantially dependent upon sales to our major customers. During fiscal 2009, 2008 and 2007, sales to our five largest customers constituted approximately 92%, 94%, and 96%, respectively, of our net sales, and sales to our largest customer AutoZone, constituted 49%, 53% and 64%, respectively, of our net sales. Any meaningful reduction in the level of sales to any of these customers, deterioration of any customer’s financial condition or the loss of a customer could have a materially adverse impact upon us. ### Customer Arrangements; Impact on Working Capital We have or are renegotiating long-term agreements with many of our major customers. Under these agreements, which typically have initial terms of at least four years, we are designated as the exclusive or primary supplier for specified categories of remanufactured alternators and starters. Because of the very competitive nature of the market for remanufactured starters and alternators and the limited number of customers for these products, our customers have sought and obtained price concessions, significant marketing allowances and more favorable delivery and payment terms in consideration for our designation as a customer’s exclusive or primary supplier. These incentives differ from contract to contract and can include (i) the issuance of a specified amount of credits against receivables in accordance with a schedule set forth in the relevant contract, (ii) support for a particular customer’s research or marketing efforts provided on a scheduled basis, (iii) discounts granted in connection with each individual shipment of product and (iv) other marketing, research, store expansion or product development support. We have also entered into agreements to purchase certain customers’ Remanufactured Core inventory and to issue credits to pay for that inventory according to a schedule set forth in the agreement. These contracts typically require that we meet ongoing performance, quality and fulfillment requirements. An agreement with one customer grants the customer the right to terminate the agreement at any time for any reason. Our contracts with major customers expire at various dates through December 2012. These longer-term agreements strengthen our customer relationships and business base. The increased demand for product that we have experienced has caused a significant increase in our inventories, accounts payable and personnel. Customer demands that we purchase their Remanufactured Core inventory have also been a significant and an additional strain on our available working capital. The marketing and other allowances we typically grant our customers in connection with our new or expanded customer relationships adversely impact the near-term revenues, profitability and associated cash flows from these arrangements. However, we believe the investment we make in these new or expanded customer relationships will improve our overall liquidity and cash flow from operations over time. ### Competition The after-market for remanufactured alternators and starters is highly competitive. Our most significant competitors are a division of Remy International, Inc. and BBB Industries. We also compete with several medium-sized remanufacturers and a large number of smaller regional and specialty remanufacturers. Overseas manufacturers, particularly those located in China, are increasing their operations and could become a significant competitive force in the future. We believe that the reputation for quality and customer service that a supplier enjoys are significant factors in a customer’s purchase decision. We believe that these factors favor our company, which provides quality replacement automotive products, rapid and reliable delivery capabilities as well as promotional support. We believe that our ability to provide efficient delivery distinguishes us from many of our competitors and provides a competitive advantage. Price and payment terms are very important competitive factors. For the most part, our products have not been patented nor do we believe that our products are patentable. We seek to protect our proprietary processes and other information by relying on trade secret laws and non-disclosure and confidentiality agreements with certain of our employees and other persons who have access to that information. ### Company Operations **Production Process.** Our remanufacturing process begins with the receipt of used alternators and starters, commonly known as “Used Cores”, from our customers or core brokers. The Used Cores are evaluated for inventory control purposes and then sorted by part number. Each Used Core is completely disassembled into its fundamental components. The components are cleaned in a process that employs customized equipment and cleaning materials in accordance with the required specifications of the particular component. All components known to be subject to major wear and those components determined not to be reusable or repairable are replaced by new components. Non-salvageable components of the Used Core are sold as scrap. After the cleaning process is complete, the salvageable components of the Used Core are inspected and tested as prescribed by our ISO TS 16949 approved quality control program, which is implemented throughout the production process. ISO TS 16949 is an internationally recognized, world class, automotive quality system. Upon passage of all tests, which are monitored by designated quality control personnel, all the component parts are assembled in a work cell into a finished product. Inspection and testing are conducted at multiple stages of the remanufacturing process, and each finished product is inspected and tested on equipment designed to simulate performance under operating conditions. Finished products are either stored in our warehouse facility or packaged for immediate shipment. To maximize remanufacturing efficiency, we store component parts ready for assembly in our warehousing facilities. Our management information systems, including hardware and software, facilitate the remanufacturing process from Used Cores to finished products. We continue to explore opportunities for improving efficiencies in our remanufacturing process. In the last few years, we have reorganized our remanufacturing processes to combine product families with similar configurations into dedicated factory work cells. This remanufacturing process, known as “lean manufacturing”, replaced the more traditional assembly line approach we had previously utilized and eliminated a large number of inventory moves and the need to track inventory movement through the remanufacturing process. This new process impacted all of our production in California and Malaysia and has been used at our Mexico facility since the beginning of operations. Because of this “lean manufacturing” approach, we have significantly reduced the time it takes to produce a finished product. **Offshore Remanufacturing.** The majority of our remanufacturing operations and core sorting functions are now conducted at our facilities in Mexico and Malaysia. We also operate a shipping and receiving warehouse and testing facility in Singapore. In fiscal 2009, 2008 and 2007, our foreign operations produced approximately 98%, 91% and 64%, respectively, of our total unit production. In addition, we are nearing completion of the transition of our remaining warehousing, shipping and packing operations from our U.S. facility to our facility in Mexico. **Used Cores and Other Raw Materials.** The majority of our Used Cores are obtained from customers using our core exchange program. The core exchange program consists of the following steps: - Our customers purchase from us a remanufactured unit to be sold to their consumer. - Our customers offer their consumers a credit to exchange their used unit (Used Core) at the time the consumer purchases a remanufactured unit. - We, in turn, offer our customers a credit to send us these Used Cores. The credit reduces our accounts receivable. Our customers are not obligated to send us all the Used Cores exchanged by their consumers. We have historically purchased approximately 15% to 20% of our Used Cores in the open market from core brokers who specialize in buying and selling Used Cores. Although the open market is not a primary source of Used Cores, it is a critical source for meeting our raw material demands. Not all Used Cores are reusable. Remanufacturing consumes, on average, more than one Used Core for each remanufactured unit produced. Although the yield rates depend upon both the product and customer specifications, our overall average yield rates are about 84%. We use about 120 Used Cores to provide sufficient salvageable components to complete 100 remanufactured products. During the fiscal year ended March 31, 2009, we purchased approximately 20% of our Used Cores from core brokers. The price of a finished product sold to our customers is generally comprised of an amount for remanufacturing (“unit value”) and an amount separately invoiced for the Remanufactured Core included in the product (“Remanufactured Core charge”). The Remanufactured Core charge is equal to the credit we offer to induce the customer to use our core exchange program and send back the Used Cores to us. In accordance with our net-of-core-value revenue recognition policy, at the time a sale is recorded, we only recognize as revenue the unit value of the finished product. We also record as long-term core inventory the cost of Remanufactured Cores included in the finished goods that are shipped to customers and that we expect to be sent back to us as part of the core exchange program. During fiscal 2009, approximately 95% of the Remanufactured Cores we shipped as part of finished goods were replaced by similar Used Cores sent back to us under our core exchange program, resulting in the issuance of credits equal to the related Remanufactured Core value. Other materials and components used in remanufacturing are purchased in the open market. Our main supplier provided approximately 25%, 20% and 22% of our raw materials purchased during the fiscal years ended March 31, 2009, 2008 and 2007, respectively, and we rely on that supplier’s ability to provide us with raw materials in a timely and cost effective manner; however, that supplier is not our sole supplier of raw materials. No other supplier provided more than 10% of our raw material needs during these periods. The ability to obtain Used Cores, materials and components of the types and quantities we need is essential to our ability to meet demand. **Return Rights.** Under our customer agreements and general industry practice, our customers are allowed stock adjustments when their inventory of certain product lines exceeds the anticipated sales to end-user consumers. Customers have various contractual rights for stock adjustments which range from 3%-5% of total units sold. In some instances, we allow a higher level of returns in connection with a significant update order. In addition, we allow customers to return goods to us that their end-user consumers have returned to them. This general right of return is allowed regardless of whether the returned item is defective. We seek to limit the aggregate of stock adjustment and other customer returns to less than 20% of unit sales. Stock adjustment returns do not occur at any specific time during the year. As is standard in the industry, we only accept returns from on-going customers. If a customer ceases doing business with us, we have no further obligation to accept additional product returns from that customer. Similarly, we accept product returns and grant appropriate credits from new customers from the time the new customer relationship is established. This obligation to accept returns from new customers does not result in decreased liquidity or increased expenses since we only accept one returned product for each unit sold to the new customer. In each case, the return must be received by us in the original box of the unit sold. We provide for the anticipated returns of inventory in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 48, *Revenue Recognition When Right of Return Exists (“*SFAS No. 48”) by reducing revenue and cost of sales for the unit value of goods sold based on a historical return analysis and information obtained from customers about current stock levels and anticipated stock adjustment returns. **Sales, Marketing and Distribution.** We offer one of the widest varieties of alternators and starters available to the market, and we market and distribute our products throughout the United States and Canada. Our products for the automotive retail chain market are primarily sold under our customers’ private labels. Since fiscal 2004, we have expanded our sales efforts beyond automotive retail chains to include warehouse distribution centers serving professional installers. Our products are sold under private label and our own Quality-Built® , Talon®, Xtreme®, and other brand names. Products are shipped from our facilities in Torrance, California, and Tijuana, Mexico, and from our fee warehouse facilities in Edison, New Jersey and Springfield, Oregon. We publish, for print and electronic distribution, a catalog with part numbers and applications for our alternators and starters along with a detailed technical glossary and informational database. We believe that we maintain one of the most extensive catalog and product identification systems available to the market. **Employees.** As of March 31, 2009, we had 256 employees in the United States, as compared to 311 at March 31, 2008, substantially all of whom were located in Torrance, California. Of our U.S.-based employees, 83 are administrative personnel of which 24 are sales personnel. In addition, at March 31, 2009, we employed 325 persons in Singapore and Malaysia, as compared to 336 persons at March 31, 2008, and 1,154 persons at our remanufacturing facility located in Tijuana, Mexico, as compared to 1,100 persons at March 31, 2008. A union represents all hourly employees at our Mexico facility. All other employees, including our employees in Torrance, California, are non-union. We consider our relations with our employees to be satisfactory. ### Seasonality of Business Due to their nature and design, as well as the limits of technology, alternators and starters traditionally have failed when operating in extreme conditions. During the summer months, when the temperature typically increases over a sustained period of time, alternators were more likely to fail. Similarly, during winter months, starters were more likely to fail. This seasonality impact has been diminished by the improvement in the quality of alternators and starters and does not currently have a material impact on our sales. ### Governmental Regulation Our operations are subject to federal, state and local laws and regulations governing, among other things, emissions to air, discharge to waters, and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. We believe that our businesses, operations and facilities have been and are being operated in compliance in all material respects with applicable environmental and health and safety laws and regulations, many of which provide for substantial fines and criminal sanctions for violations. Potentially significant expenditures, however, could be required in order to comply with evolving environmental and health and safety laws, regulations or requirements that may be adopted or imposed in the future. ### Evaluation of Strategic Options We are continuing to evaluate strategic options that we might pursue to enhance shareholder value. These could include an acquisition of another company or a sale of our company to a third party. There is no assurance, however, that we will enter into any transaction as a result of our efforts in this regard. ## Risk factors As filed, 15,466 characters. *While we believe the risk factors described below are all the material risks currently facing our business, additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. Our financial condition or results of operations could be materially and adversely impacted by these risks, and the trading price of our common stock could be adversely impacted by any of these risks. In assessing these risks, you should also refer to the other information included in or incorporated by reference into this Form 10-K, including our consolidated financial statements and related notes thereto appearing elsewhere or incorporated by reference in this* #### Form 10-K. ***We rely on a few major customers for a significant majority of our business, and the loss of any of these customers, significant changes in the prices, marketing allowances or other important terms provided to any of our major customers or adverse developments with respect to the financial condition of any of our major customers would reduce our net income and operating results.*** Our sales are concentrated among a few major customers. During fiscal 2009, sales to our five largest customers constituted 92% of our net sales, and sales to our largest customer constituted 49% of our net sales. Because our sales are concentrated, and the market in which we operate is very competitive, we are under ongoing pressure from our customers to offer lower prices, extended payment terms, increased marketing allowances and other terms more favorable to these customers. These customer demands have put continued pressure on our operating margins and profitability, resulted in periodic contract renegotiation to provide more favorable prices and terms to these customers and significantly increased our working capital needs. In addition, this customer concentration leaves us vulnerable to any adverse change in the financial condition of any of our major customers. The loss or significant decline of sales to any of our major customers would reduce our net income and adversely affect our operating results. ***The costs associated with expansion of our offshore remanufacturing and logistic activities has put downward pressure on our near-term operating results. These activities also expose us to increased political and economic risks and place a greater burden on management to achieve quality standards.*** To respond to customer and competitive pressures while maintaining or improving gross margins over time, we have moved an increasing portion of our remanufacturing operations to lower cost countries outside the United States. While the remanufacturing costs in Mexico are lower than those we have incurred in our Torrance, California facility, we experienced various but decreasing inefficiencies associated with our Mexican operations that adversely impacted our operating results during the fiscal years ended March 31, 2009, 2008 and 2007. The expansion of our overseas operations, especially our operations in Tijuana, Mexico, also increases our exposure to political, criminal or economic instability in the host countries and to currency fluctuations. ***The complexity associated with the accounting for our operating results may continue to result in fluctuations in our reported operating results.*** Because we receive most Used Cores, a critical remanufacturing component, through the core exchange program with our customers and we offer marketing allowances and other incentives that impact revenue recognition, the accounting for our operations is more complex than that for many businesses the same size or larger. We previously cited and have now remediated our accounting treatment in accordance with generally accepted accounting principles that resulted in restatements to our financial statements. Steps taken to correct the previously issued financial statements included a review of authoritative accounting literature and consultation with accounting experts at the SEC and with external accountants. Upon completion of this review, we corrected our treatment related to accounting for core inventory and revenue recognition. ***Interruptions or delays in obtaining component parts could impair our business and adversely affect our operating results.*** In our remanufacturing processes, we obtain Used Cores, primarily through the core exchange program with our customers, and component parts from third-party manufacturers. Historically, the level of Used Core returns from customers together with purchases from core brokers have provided us with an adequate supply of this key component. If there was a significant disruption in the supply of Used Cores, whether as a result of increased Used Core acquisitions by existing or new competitors or otherwise, our operating activities would be materially and adversely impacted. In addition, a number of the other components used in the remanufacturing process are available from a very limited number of suppliers. In fiscal 2009, we purchased 25% of our raw materials from a single supplier. We are, as a result, vulnerable to any disruption in component supply, and any meaningful disruption in this supply would materially and adversely impact our operating results. ***Increases in the market prices of key component raw materials could negatively impact our profitability.*** In light of the long-term, continuous pressure on pricing which we have experienced from our major customers, we may not be able to recoup the higher prices which raw materials, particularly aluminum and copper, may command in the market-place. We believe the impact of higher raw material prices, which is outside our control, is mitigated to some extent because we recover a substantial portion of our raw materials from Used Cores returned to us by our customers through the core exchange program. However, we are unable to determine what adverse impact, if any, sustained raw material price increases may have on our profitability. ***Substantial and potentially increasing competition could reduce our market share and significantly harm our financial performance.*** While we believe we are well-positioned in the market for remanufactured alternators and starters, this market is very competitive. In addition, other overseas manufacturers, particularly those located in China, are increasing their operations and could become a significant competitive force in the future. We may not be successful competing against other companies, some of which are larger than us and have greater financial and other resources at their disposal. Increased competition could put additional pressure on us to reduce prices or take other actions which may have an adverse effect on our operating results. ***Our financial results are affected by alternator and starter failure rates that are outside our control.*** Our operating results are affected by alternator and starter failure rates. These failure rates are impacted by a number of factors outside our control, including alternator and starter designs that have resulted in greater reliability and consumers driving fewer miles as a result of both high gasoline prices and the slowdown in the U.S. economy. A reduction in the failure rates of alternators or starters would adversely affect our sales and profitability. ### Our operating results may continue to fluctuate significantly. We have experienced significant variations in our annual and quarterly results of operations. These fluctuations have resulted from many factors, including shifting customer demands, shifts in the demand and pricing for our products and general economic conditions, including changes in prevailing interest rates. Our gross profit percentage fluctuates due to numerous factors, some of which are outside our control. These factors include the timing and level of marketing allowances provided to our customers, differences between the level of projected sales to a particular customer and the actual sales during the relevant period, pricing strategies, the mix of products sold during a reporting period, fluctuations in the level of Used Core returns during the period, and general market and competitive conditions. ### Our bank may not waive future defaults under our credit agreement. Over the past several years, we have violated a number of the financial and other covenants contained in our bank credit agreement. To this point, the bank has been willing to waive these covenant defaults and to do so without imposing any significant cost or penalty on us. If we fail to meet the financial covenants or the other obligations set forth in our bank credit agreement in the future, there is no assurance that the bank will waive any such defaults. ***Our level of indebtedness and the terms of our indebtedness could adversely affect our business and liquidity position.*** Our indebtedness may increase substantially from time to time for various reasons, including fluctuations in operating results, marketing allowances provided to customers, capital expenditures and possible acquisitions. Our indebtedness could materially affect our business because (i) a portion of our cash flow must be used to service debt rather than finance our operations, (ii) it may eventually impair our ability to obtain financing in the future, and (iii) it may reduce our flexibility to respond to changes in business and economic conditions or take advantage of business opportunities that may arise. ***Our largest shareholder has the ability to influence all matters requiring the approval of our Board of Directors and our shareholders.*** As of June 8, 2009, Mel Marks, our founder and member of our Board of Directors, beneficially owned 11.0% of our outstanding common stock. As a result of his holdings, Mel Marks has the ability to exercise substantial influence over us and his interests may conflict with the interests of other shareholders. ### Our stock price may be volatile and could decline substantially. Our stock price may decline substantially as a result of the volatile nature of the stock market and other factors beyond our control. The stock market has, from time to time, experienced extreme price and volume fluctuations. Many factors may cause the market price for our common stock to decline, including (i) our operating results failing to meet the expectations of securities analysts or investors in any quarter, (ii) downward revisions in securities analysts’ estimates, (iii) market perceptions concerning our future earnings prospects, (iv) public sales of a substantial number of shares of our common stock, and (v) adverse changes in general market conditions or economic trends. ***Our failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our business and the price of our common stock.*** Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”) requires our management to assess the effectiveness of our internal control over financial reporting at the end of each fiscal year and certify whether or not internal control over financial reporting is effective. Our independent accountants are also required to express an opinion with respect to the effectiveness of our internal controls. We expect our SOX compliance work will continue to require significant commitment of management time and the incurrence of significant general and administrative expenses. ### Unfavorable currency exchange rate fluctuations could adversely affect us. We are exposed to market risk from material movements in foreign exchange rates between the U.S. dollar and the currencies of the foreign countries in which we operate. As a result of our growing operations in Mexico, our primary risk relates to changes in the rates between the U.S. dollar and the Mexican peso. To mitigate this currency risk, we enter into forward foreign exchange contracts to exchange U.S. dollars for Mexican pesos. The extent to which we use forward foreign exchange contracts is periodically reviewed in light of our estimate of market conditions and the terms and length of anticipated requirements. The use of derivative financial instruments allows us to reduce our exposure to the risk that the eventual net cash outflow resulting from funding the expenses of the foreign operations will be materially affected by changes in the exchange rates. We do not engage in currency speculation or hold or issue financial instruments for trading purposes. These contracts expire in a year or less. Any change in the fair value of foreign exchange contracts is accounted for as an increase or decrease to general and administrative expenses in current period earnings. ***We may continue to make strategic acquisitions of other companies or businesses and these acquisitions introduce significant risks and uncertainties, including risks related to integrating the acquired businesses and achieving benefits from the acquisitions.*** In order to position ourselves to take advantage of growth opportunities, we have made, and may continue to make, strategic acquisitions that involve significant risks and uncertainties. These risks and uncertainties include: (i) the difficulty in integrating newly-acquired businesses and operations in an efficient and effective manner, (ii) the challenges in achieving strategic objectives, cost savings and other benefits from acquisitions, (iii) the potential loss of key employees of the acquired businesses, (iv) the risk of diverting the attention of senior management from our operations, (v) risks associated with integrating financial reporting and internal control systems, (vi) difficulties in expanding information technology systems and other business processes to accommodate the acquired businesses, and (vii) future impairments of goodwill of an acquired business. ***Deteriorating conditions in the global credit markets and macroeconomic factors could adversely affect our financial condition and results of operations.*** Over the past year, significant deterioration in the financial condition of financial institutions has resulted in a severe loss of liquidity and availability in global credit markets and in higher short-term borrowing costs, and more stringent borrowing terms. Recessionary conditions in the global economy threaten to cause further tightening of the credit markets, more stringent lending standards and terms, and higher volatility in interest rates. The persistence of these conditions could have a material adverse effect on our borrowings and the availability, terms and cost of such borrowings. In addition, further deterioration in the U.S. economy could adversely affect our corporate results, which could adversely affect our operating results. ### Uncertainty surrounding General Motors’ filing for bankruptcy protection. We have been notified by General Motors (“GM”) and the Bankruptcy Court that we are an “Essential Vendor” to GM. As such, we expect that we will receive uninterrupted payment of our pre- and post-filing GM receivables. Inevitably, we anticipate some uncertainty surrounding GM as the bankruptcy process proceeds, and there can be no assurance that actions taken by other interested parties, including consumers, will not have a continuing detrimental effect on our relationship or level of continuing business with GM. ## Properties As filed, 1,846 characters. We lease all of the real property used in our operations. We presently lease approximately 147,000 square feet of warehouse, production and administrative space in Torrance, California. The present term of the lease expires March, 31, 2012 and we have the option to extend the lease for an additional five years beginning April 1, 2012. We also lease approximately 4,005 square feet adjacent to our main Torrance facility that is used as additional office and record storage space. The lease on this second building has terms which coincide with the lease on the main Torrance building. On October 28, 2004, we entered into a build-to-suit lease covering approximately 125,000 square feet of industrial premises in Tijuana, Mexico. The lease has a term of 10 years from the date the facility was available for occupancy, and we have an option to extend the lease term for two additional 5-year periods. In May 2005, we took possession of these premises. In April 2006, we leased an additional 61,000 square feet adjoining our existing space. On October 18, 2006, we entered into an amendment to lease an adjacent 125,000 square feet. This space was occupied in January 2007 and is used for core receiving, sorting and storage related functions. All amendments have the same essential terms as the original lease. In addition, we occupy approximately 63,000 square feet of leased remanufacturing, warehousing, and office space facilities under seven separate leases, which expire on various dates through May 14, 2012, in Singapore and Malaysia. We also lease approximately 2,067 square feet of office space in Nashville, Tennessee under a lease that expires on May 31, 2012. We believe the above mentioned facilities are sufficient to satisfy our foreseeable warehousing, production, distribution and administrative office space requirements. ## Legal proceedings As filed, 754 characters. On July 22, 2008, we retired 108,534 shares of our common stock which had been pledged by a former officer and director in satisfaction of a $682,000 shareholder note receivable we recorded in connection with the reimbursement amount owed to us by that former officer and director for certain previously advanced legal fees and costs, plus interest accrued from January 15, 2008 through July 22, 2008. The remaining shares pledged as collateral for this amount were released to the former officer and director. We are subject to various other lawsuits and claims in the normal course of business. Management does not believe that the outcome of these matters will have a material adverse effect on its financial position or future results of operations. ## Management's discussion and analysis As filed, 81,554 characters. ### 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 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 of the type we have increasingly made, our ability to obtain any additional financing we may seek or require, our ability to achieve 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 the 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 bank credit agreement and the bank’s 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, the bankruptcy of a major customer and other factors discussed herein and in our other filings with the SEC. ### Management Overview We remanufacture alternators and starters for imported and domestic cars and light trucks in addition to heavy duty, agricultural and industrial application and distribute them predominantly throughout the United States and Canada. Our business for heavy duty, agricultural and industrial applications is in its early stages and does not represent a significant portion of our business. Our line of light duty alternators and starters are sold to most of the largest auto parts retail chains in the United States and Canada, including AutoZone, Pep Boys, and O’Reilly Automotive (including CSK Automotive) and various traditional warehouses for the professional installers. We believe auto parts retail chains in total, currently account for approximately 35% of the North American after-market for remanufactured alternators and starters. We believe that demand for after-market remanufactured alternators and starters is in part driven by the number of vehicle miles driven and the age of vehicles. According to industry statistics, the average age of vehicles on the road in North America is increasing, while miles driven in North America decreased each month from January 2008 through March 2009. We believe this is primarily the result of the slowdown in the U.S. economy during this period. Historically, our business has focused on the do-it-yourself (“DIY”) market, customers who buy remanufactured alternators and starters at an auto parts store and install the parts themselves. We believe that the do-it-for-me (“DIFM”) market, also known as the professional installer market, is an attractive opportunity for growth. We believe 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 professional installer market segment and (2) we sell our products under private label and our Quality-Built®, Talon®, Xtreme® and other brand names directly to suppliers that focus on professional installers. In addition, we sell our products to original equipment manufacturers for distribution to the professional installer both for warranty replacement and their general after-market channels. While we continually seek to diversify our customer base, we currently derive, and have historically derived, a substantial portion of our sales from a small number of large customers. During fiscal 2009, 2008 and 2007, sales to our five largest customers constituted approximately 92%, 94% and 96%, respectively, of our net sales. To mitigate the risk associated with this concentration of sales, we have increasingly sought to enter into longer-term customer agreements with our major customers. These longer-term agreements typically require us to commit a significant amount of our working capital to build inventory and increase production. In addition, they typically include marketing and other allowances that adversely impact near-term revenue and may require us to incur certain changeover expenses. To offset the pricing pressure and costs associated with our agreements with our largest customers, we have moved almost all our remanufacturing operations from our U.S. facility to lower cost facilities in Mexico and Malaysia. During fiscal 2009, 2008 and 2007, approximately 98%, 91% and 64%, respectively, of our total production was produced at our facilities in Mexico and Malaysia. We expect to maintain production of remanufactured units that require specialized service and/or rapid turnaround at our U.S. facility for the near term. In addition, we are nearing completion of the transition of our warehousing and shipping/receiving operations from our U.S. facility to our facilities in Mexico. During fiscal 2009, we acquired certain assets of AIM and SCP, specifically the operations which produced new and remanufactured alternators and starters for imported and domestic passenger vehicles, and for the industrial and heavy duty after-markets. We believe these acquisitions expand our customer base and product line, including the addition of business in heavy duty alternator and starter applications, and expand our market share in North America. We operate in one business segment pursuant to SFAS No. 131, *Disclosures about Segments of Enterprise and Related Information.* ### Critical Accounting Policies We prepare our consolidated financial statements in accordance with generally accepted accounting principles in the United States, or GAAP. Our significant accounting policies are discussed in detail below and in Note 2 in the Notes to Consolidated Financial Statements. In preparing our consolidated financial statements, we use estimates and assumptions for matters that are inherently uncertain. We base our estimates on historical experiences and reasonable assumptions. Our use of estimates and assumptions affects the reported amounts of assets, liabilities and the amount and timing of revenues and expenses we recognize for and during the reporting period. Actual results may differ from our estimates. Our remanufacturing operations require that we acquire Used Cores, a necessary raw material, from our customers and offer our customers marketing and other allowances that impact revenue recognition. These elements of our business give rise to accounting issues that are more complex than many businesses our size or larger. In addition, the relevant accounting standards and issues continue to evolve. As a result, certain of our previously issued financial statements have been restated to reflect changes in our application of GAAP. ### Inventory #### Non-core Inventory Non-core inventory is comprised of non-core raw materials, the non-core value of work in process and the non-core value of finished goods. Used Cores, the Used Core value of work in process and the Remanufactured Core portion of finished goods are classified as long-term core inventory as described below under the caption “Long-term Core Inventory.” Non-core inventory is stated at the lower of cost or market. The cost of non-core inventory approximates average historical purchase prices paid, and is based upon the direct costs of material and an allocation of labor and variable and fixed overhead costs. The cost of non-core inventory is evaluated at least quarterly during the fiscal year and adjusted as necessary to reflect current lower of cost or market levels. These adjustments are determined for individual items of inventory within each of the three classifications of non-core inventory as follows: Non-core raw materials are recorded at average cost, which is based on the actual purchase price of raw materials on hand. The average cost is updated quarterly. This average cost is used in the inventory costing process and is the basis for allocation of materials to finished goods during the production process. Non-core work in process is in various stages of production, is on average 50% complete and is valued at 50% of the cost of a finished good. Non-core work in process inventory historically comprises less than 3% of the total non-core inventory balance. Finished goods cost includes the average cost of non-core raw materials and allocations of labor and variable and fixed overhead. The allocations of labor and variable and fixed overhead costs are determined based on the average actual use of the production facilities over the prior twelve months which approximates normal capacity. This method prevents the distortion in allocated labor and overhead costs that would occur during short periods of abnormally low or high production. In addition, we exclude certain unallocated overhead such as severance costs, duplicative facility overhead costs, and spoilage from the calculation and expense them as period costs as required in Financial Accounting Standards Board (“FASB”) Statement No. 151, *Inventory Costs, an amendment of Accounting Research Bulletin (“ARB”) No. 43, Chapter 4 (“*SFAS No. 151”). For the fiscal years ended March 31, 2009 and 2008, costs of approximately $2,019,000 and $1,599,000, respectively, were considered abnormal and thus excluded from the cost calculation and charged directly to cost of sales. We record an allowance for potentially excess and obsolete inventory based upon recent sales history, the quantity of inventory on-hand, and a forecast of potential use of the inventory. We review inventory on a monthly basis to identify excess quantities and part numbers that are experiencing a reduction in demand. In general, part numbers with quantities representing a one to three-year supply are partially reserved for at rates based upon management’s judgment and consistent with historical rates. Any part numbers with quantities representing more than a three-year supply are reserved for at a rate that considers possible scrap and liquidation values and may be as high as 100% of cost if no liquidation market exists for the part. The quantity thresholds and reserve rates are subjective and are based on management’s judgment and knowledge of current and projected industry demand. The reserve estimates may, therefore, be revised if there are changes in the overall market for our products or market changes that in management’s judgment, impact our ability to sell or liquidate potentially excess or obsolete inventory. We apply the guidance provided by the Emerging Issues Task Force (“EITF”) Issue No. 02-16, *Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor (“*EITF No. 02-16”), by recording vendor discounts as a reduction of inventories that are recognized as a reduction to cost of sales as the inventories are sold. #### Inventory Unreturned Inventory Unreturned represents our estimate, based on historical data and prospective information provided directly by the customer, of finished goods shipped to customers that we expect to be returned, under our general right of return policy, after the balance sheet date. Because all cores are classified separately as long term assets, the inventory unreturned balance includes only the added unit value of a finished good. The return rate is calculated based on expected returns within the normal operating cycle of one year. As such, the related amounts are classified in current assets. Inventory unreturned is valued in the same manner as our finished goods inventory. #### Long-term Core Inventory Long-term core inventory consists of: - Used Cores purchased from core brokers and held in inventory at our facilities, - Used Cores returned by our customers and held in inventory at our facilities, - Used Cores returned by end-users to customers but not yet returned to us are classified as Remanufactured Cores until they are physically received by us, - Remanufactured Cores held in finished goods inventory at our facilities; and - Remanufactured Cores held at customer locations as a part of the finished goods sold to the customer. For these Remanufactured Cores, we expect the finished good containing the Remanufactured Core to be returned under our general right of return policy or a similar Used Core to be returned to us by the customer, in each case, for credit. Long-term core inventory is recorded at average historical purchase prices determined based on actual purchases of inventory on hand. The cost and market value of Used Cores for which sufficient recent purchases have occurred are deemed the same as the purchase price for purchases that are made in arms length transactions. Long-term core inventory recorded at average historical purchase prices is primarily made up of Used Cores for newer products related to more recent automobile models or products for which there is a less liquid market. We must purchase these Used Cores from core brokers because our customers do not have a sufficient supply of these newer Used Cores available for the core exchange program. Approximately 15% to 20% of Used Cores are obtained in core broker transactions and are valued based on average purchase price. The average purchase price of Used Cores for more recent automobile models is retained as the cost for these Used Cores in subsequent periods even as the source of these Used Cores shifts to our core exchange program. Long-term core inventory is recorded at the lower of cost or market value. In the absence of sufficient recent purchases, we use core broker price lists to assess whether Used Core cost exceeds Used Core market value on an item by item basis. The primary reason for the insufficient recent purchases is that we obtain most of our Used Core inventory from the customer core exchange program. Commencing in the fourth quarter of fiscal 2007, we reclassified all of our core inventories to a long-term asset account. The determination of the long-term classification was based on our view that the value of the cores is not consumed or realized in cash during our normal operating cycle, which is one year for most of the cores recorded in inventory. According to ARB No. 43, current assets are defined as “assets or other resources commonly identified as those which are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.” We do not believe that core inventories, which we classify as long-term, are consumed because the credits issued upon the return of Used Cores offset the amounts invoiced when the Remanufactured Cores included in finished goods were sold. We do not expect the core inventories to be consumed, and thus we do not expect to realize cash, until our relationship with a customer ends, a possibility that we consider remote based on existing long-term customer agreements and historical experience. However, historically for approximately 4.5% of finished goods sold, our customer will not send us a Used Core to obtain the credit we offer under our core exchange program. Therefore, based on our historical estimate, we derecognize the core value for these finished goods upon sale, as we believe they have been consumed and we have realized cash. We realize cash for only the core exchange program shortfall of approximately 4.5%. This shortfall represents the historical difference between the number of finished goods shipped to customers and the number of Used Cores returned to us by customers. We do not realize cash for the remaining portion of the cores because the credits issued upon the return of Used Cores offset the amounts invoiced when the Remanufactured Cores included in finished goods were sold. We do not expect to realize cash for the remaining portion of these cores until our relationship with a customer ends, a possibility that we consider remote based on existing long-term customer agreements and historical experience. For these reasons, we concluded that it is more appropriate to classify core inventory as a long-term asset. #### Long-term Core Inventory Deposit The long-term core inventory deposit account represents the value of Remanufactured Cores we have agreed to purchase from customers, which are held by the customers and remain on the customers’ premises. The purchase is made through the issuance of credits against that customer’s receivables either on a one time basis or over an agreed-upon period. The credits against the customer’s receivable are based upon the Remanufactured Core purchase price previously established with the customer. At the same time, we record the long-term core inventory deposit for the Remanufactured Cores purchased at its cost, determined as noted under Long-term Core Inventory. The long-term core inventory deposit is stated at the lower of cost or market. The cost is established at the time of the transaction based on the then current cost, determined as noted under Long-term Core Inventory. The difference between the credit granted and the cost of the long-term core inventory deposit is treated as a sales allowance reducing revenue as required under EITF Issue No. 01-9, *Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products) (“*EITF No. 01-9”). When the purchases are made over an agreed-upon period, the long-term core inventory deposit is recorded at the same time the credit is issued to the customer for the purchase of the Remanufactured Cores. At least annually, and as often as quarterly, reconciliations and confirmations are performed to determine that the number of Remanufactured Cores purchased, but retained at the customer locations, remains sufficient to support the amounts recorded in the long-term core inventory deposit account. At the same time, the mix of Remanufactured Cores is reviewed to determine that the aggregate value of Remanufactured Cores in the account has not changed during the reporting period. We evaluate the cost of Remanufactured Cores supporting the aggregate long-term core inventory deposit account each quarter. If we identify any permanent reduction in either the number or the aggregate value of the Remanufactured Core inventory mix held at the customer location, we will record a reduction in the long-term core inventory deposit account during that period. ### Revenue Recognition We recognize revenue when our performance is complete, and all of the following criteria established by Staff Accounting Bulletin No. 104, *Revenue Recognition (“*SAB No. 104”), have been met: - Persuasive evidence of an arrangement exists, - Delivery has occurred or services have been rendered, - The seller’s price to the buyer is fixed or determinable, and - Collectibility is reasonably assured. For products shipped free-on-board (“FOB”) shipping point, revenue is recognized on the date of shipment. For products shipped FOB destination, revenues are recognized on the estimated or actual date of delivery. We include shipping and handling charges in the gross invoice price to customers and classify the total amount as revenue in accordance with EITF No. 00-10, *Accounting for Shipping and Handling Fees and Costs*. Shipping and handling costs are recorded in cost of sales. #### Revenue Recognition; Net-of-Core-Value Basis The price of a finished product sold to customers is generally comprised of separately invoiced amounts for the Remanufactured Core included in the product (“Remanufactured Core value”) and for the value added by remanufacturing (“unit value”). The unit value is recorded as revenue based on our then current price list, net of applicable discounts and allowances. Based on our experience, contractual arrangements with customers and inventory management practices, approximately 95% of the remanufactured alternators and starters we sell to customers are replaced by similar Used Cores sent back for credit by customers under our core exchange program. In accordance with our net-of-core-value revenue recognition policy, we do not recognize the Remanufactured Core value as revenue when the finished products are sold. We generally limit the number of Used Cores sent back under the core exchange program to the number of similar Remanufactured Cores previously shipped to each customer. #### Revenue Recognition and Deferral — Core Revenue Full price Remanufactured Cores: When we ship a product, we invoice certain customers for the Remanufactured Core value portion of the product at full Remanufactured Core sales price but do not recognize revenue for the Remanufactured Core value at that time. For these Remanufactured Cores, we recognize core revenue based upon an estimate of the rate at which our customers will pay cash for Remanufactured Cores in lieu of sending back similar Used Cores for credits under our core exchange program. Nominal price Remanufactured Cores: We invoice other customers for the Remanufactured Core value portion of product shipped at a nominal Remanufactured Core price. Unlike the full price Remanufactured Cores, we only recognize revenue from nominal Remanufactured Cores not expected to be replaced by a similar Used Core sent back under the core exchange program when we believe that we have met all of the following criteria: - We have a signed agreement with the customer covering the nominally priced Remanufactured Cores not expected to be sent back under the core exchange program, and the agreement must specify the number of Remanufactured Cores our customer will pay cash for in lieu of sending back a similar Used Core under our core exchange program and the basis on which the nominally priced Remanufactured Cores are to be valued (normally the average price per Remanufactured Core stipulated in the agreement). - The contractual date for reconciling our records and customer’s records of the number of nominally priced Remanufactured Cores not expected to be replaced by similar Used Cores sent back under our core exchange program must be in the current or a prior period. - The reconciliation must be completed and agreed to by the customer. - The amount must be billed to the customer. 22 Deferral of Core Revenue. As noted previously, we have in the past and may in the future agree to buy back Remanufactured Cores from certain customers. The difference between the credit granted and the cost of the Remanufactured Cores bought back is treated as a sales allowance reducing revenue as required under EITF No. 01-9. As a result of the ongoing Remanufactured Core buybacks, we have now deferred core revenue from these customers until there is no expectation that sales allowances associated with Remanufactured Core buybacks from these customers will offset core revenues that would otherwise be recognized once the criteria noted above have been met. At March 31, 2009 and 2008, Remanufactured Core revenue of $5,934,000 and $2,927,000, respectively, was deferred. #### Revenue Recognition; General Right of Return We allow our customers to return goods to us that their end-user customers have returned to them, whether the returned item is or is not defective (warranty returns). In addition, under the terms of certain agreements with our customers and industry practice, our customers from time to time are allowed stock adjustments when their inventory of certain product lines exceeds the anticipated sales to end-user customers (stock adjustment returns). We seek to limit the aggregate of customer returns, including warranty and stock adjustment returns, to less than 20% of unit sales. In some instances, we allow a higher level of returns in connection with a significant update order. We provide for such anticipated returns of inventory in accordance with SFAS No. 48, *Revenue Recognition When Right of Return Exists,* by reducing revenue and the related cost of sales for the units estimated to be returned. Our allowance for warranty returns is established based on a historical analysis of the level of this type of return as a percentage of total unit sales. Stock adjustment returns do not occur at any specific time during the year, and the expected level of these returns cannot be reasonably estimated based on a historical analysis. Our allowance for stock adjustment returns is based on specific customer inventory levels, inventory movements and information on the estimated timing of stock adjustment returns provided by our customers. ### Sales Incentives We provide various marketing allowances to our customers, including sales incentives and concessions. Marketing allowances related to a single exchange of product are recorded as a reduction of revenues at the time the related revenues are recorded or when such incentives are offered as determined in accordance with EITF No. 01-9. Other marketing allowances, which may only be applied against future purchases, are recorded as a reduction to revenues in accordance with a schedule set forth in the relevant contract. Sales incentive amounts are recorded based on the value of the incentive provided. ### Goodwill We account for goodwill under the guidance set forth in SFAS No. 142, *Goodwill and Other Intangible Assets (“*SFAS No. 142”), which specifies that goodwill and indefinite-lived intangibles should not be amortized. We evaluate goodwill for impairment on an annual basis or more frequently if events or circumstances occur that would indicate a reduction in fair value of the Company. Such indicators include, but are not limited to, events or circumstances such as a significant adverse change in the business climate, unanticipated competition, a loss of key personnel, adverse legal or regulatory developments, or a significant decline in the market price of our common stock. In addition, we identified a single reporting unit (the Company itself) in accordance with SFAS No. 142, as we had not identified any components of the Company beneath the one operating segment described in Note 1 in the Notes to Consolidated Financial Statements. The goodwill impairment test is a two-step impairment test. In the first step, we compare the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to the reporting unit, goodwill is not impaired and therefore we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill. Our market capitalization in the third quarter of fiscal 2009 decreased significantly, which represented a possible triggering event for potential goodwill impairment. Accordingly, we performed an interim goodwill impairment test in accordance with SFAS No. 142. For the third quarter 2009 interim impairment test, we determined the fair value of the reporting unit based on an equal weighting of: (1) a market capitalization approach, (2) a discounted cash flow analysis, and (3) a market approach. The market capitalization is calculated by multiplying the average share price of our common stock for the last 30 days prior to the measurement date by the number of outstanding common shares and adding a control premium. The discounted cash flow analysis establishes fair value by estimating the present value of the projected future cash flows of reporting unit and applying a 3% terminal growth rate. The present value of estimated discounted future cash flows is determined using significant estimates of revenue and costs for the reporting unit, driven by assumed growth rates, as well as appropriate discount rates. The discount rate of 15% was determined using a weighted-average cost of capital that incorporates long-term government bonds, effective cost of debt, and the cost of equity of similar guideline companies. The market approach is calculated using market multiples and comparable transaction data for guidelines companies. The guideline information was based on publicly available information. A valuation multiple was selected based on a financial benchmarking analysis that compared the reporting unit’s benchmark result with the guideline information. In addition to these financial considerations, qualitative factors such as business descriptions, market served, and profitability were considered in the ultimate selection of the multiple used to estimate a value on a minority basis. A control premium was applied to the minority basis value to arrive at the reporting unit’s estimated fair value on a controlling basis. The selection and weighting of the various fair value techniques may result in a higher or lower fair value. Judgment is applied in determining the weightings that are most representative of fair value. Management has performed a sensitivity analysis on its significant assumptions and has determined that a change in its assumptions within selected sensitivity testing levels would not impact its conclusion. Based on this interim assessment, we concluded that, as of December 31, 2008, the carrying value of our reporting unit exceeded its fair value under step one of the test and proceeded to step two. Under step two, we determined that goodwill was fully impaired as the carrying value of $2,191,000, including the fourth quarter adjustment of $100,000, exceeded the implied fair value of zero, and therefore recorded a pre-tax, non-cash goodwill impairment charge of $2,191,000 as disclosed in the Consolidated Statements of Operations in the third quarter of fiscal 2009. After recording the impairment charge, we had no goodwill remaining on our Consolidated Balance Sheet as of March 31, 2009. ### Income Taxes We account for income taxes in accordance with guidance issued by the FASB in SFAS No. 109, *Accounting for Income Taxes*, which requires the use of the liability method of accounting for income taxes. The liability method measures deferred income taxes by applying enacted statutory rates in effect at the balance sheet date to the differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. The resulting asset or liability is adjusted to reflect changes in the tax laws as they occur. A valuation allowance is provided to reduce deferred tax assets when it is more likely than not that a portion of the deferred tax asset will not be realized. The primary components of our income tax provision (benefit) are (i) the current liability or refund due for federal, state and foreign income taxes and (ii) the change in the amount of the net deferred income tax asset, including the effect of any change in the valuation allowance. Realization of deferred tax assets is dependent upon our ability to generate sufficient future taxable income. In evaluating this ability, management considers our long-term agreements with each of our major customers that expire at various dates through December 2012 and our Remanufactured Core purchase obligations with certain customers that expire at various dates through July 2011. Based on our forecast of our future operating results, we believe that it is more likely than not that future taxable income will be sufficient to realize the recorded deferred tax assets. We periodically compare our forecasts to actual results, and there can be no assurance that the forecasted results will be achieved. On April 1, 2007 we adopted the Provisions of FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes (“*FIN 48”). ### Financial Risk Management and Derivatives We are exposed to market risk from material movements in foreign exchange rates between the U.S. dollar and the currencies of the foreign countries in which we operate. As a result of our growing operations in Mexico, our primary risk relates to changes in the rates between the U.S. dollar and the Mexican peso. To mitigate this currency risk, we enter into forward foreign exchange contracts to exchange U.S. dollars for Mexican pesos. The extent to which we use forward foreign exchange contracts is periodically reviewed in light of our estimate of market conditions and the terms and length of anticipated requirements. The use of derivative financial instruments allows us to reduce our exposure to the risk that the eventual net cash outflow resulting from funding the expenses of the foreign operations will be materially affected by changes in the exchange rates. We do not engage in currency speculation or hold or issue financial instruments for trading purposes. We had foreign exchange contracts with an aggregate U.S. dollar equivalent notional value (and materially the same nominal fair value) of $7,224,000 and $7,303,000 at March 31, 2009 and 2008, respectively. These contracts generally expire in a year or less. Any changes in the fair value of foreign exchange contracts are accounted for as an increase or decrease to general and administrative expenses in current period earnings. For the fiscal years ended March 31, 2009 and 2008, the net effect of the foreign exchange contracts was to increase general and administrative expenses by $1,194,000 and to decrease general and administrative expenses by $152,000, respectively. ### Share-based Payments Effective April 1, 2006, we adopted SFAS No. 123 (revised 2004), *Share-Based Payment, (“*SFAS No. 123(R)”) using the modified prospective application method of transition for all our stock-based compensation plans. The modified prospective application method of transition requires that stock-based compensation expense be recorded for all new and unvested stock options that are ultimately expected to vest as the requisite service is rendered from April 1, 2006 forward. Accordingly, while reported results for subsequent fiscal years reflect the adoption of SFAS No. 123(R), prior year amounts have not been restated to reflect the impact of SFAS No. 123(R). ### Fair Value Measurements In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements (“*SFAS No. 157”). SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It also established a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurement. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 was effective for fiscal years beginning after November 15, 2007. However, a FASB Staff Position issued in February 2008, delayed the effectiveness of SFAS No. 157 for one year, but only as applied to nonfinancial assets and nonfinancial liabilities. The adoption of SFAS No. 157 on April 1, 2008 did not have an impact on our financial position, results of operations or cash flows. We will adopt the provisions of SFAS No. 157 as it relates to nonfinancial assets and nonfinancial liabilities on April 1, 2009. The adoption is not expected to have any material impact on our financial position, results of operations or cash flows. The hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The classification of fair value measurements within the hierarchy is based upon the lowest level of input that is significant to the measurement. The three levels are defined as follows: - Level 1 — Valuation is based upon quoted prices (unadjusted) in active markets for identical assets or liabilities. - Level 2 — Valuation is based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. - Level 3 — Valuation is based upon unobservable inputs that are significant to the fair value measurement. 25 The following table summarizes the valuation of our short-term investments and financial instruments by the above SFAS No. 157 categories as of March 31, 2009: | Assets | Fair Value at March 31, 2009 | Fair Value Measurements Using Inputs Considered as Level 1 | Level 2 | Level 3 | | --- | ---: | ---: | ---: | ---: | | Short-term investments | $335,000 | $335,000 | — | — | | **Liabilities** | | | | | | Deferred compensation | 335,000 | 335,000 | — | — | | Forward foreign currency exchange contracts | 1,048,000 | — | $1,048,000 | — | Our short-term investments, which fund our 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 us 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 fiscal years ended March 31, 2009 and 2008, an increase of $1,194,000 and a decrease of $152,000, respectively, in general and administrative expenses was recorded due to the change in the value of the forward foreign currency exchange contracts subsequent to entering into the contracts. The fair value adjustments of $1,048,000 are included in other current liabilities in the Consolidated Balance Sheet at March 31, 2009. In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities (“S*FAS No. 159”). SFAS No. 159 permits companies to choose to measure at fair value certain financial instruments and other items that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS No. 159 on April 1, 2008 and elected not to measure any additional financial instruments or other items at fair value. ### New Accounting Pronouncements In December 2007, the FASB issued SFAS No. 141(R), *Business Combinations (“*SFAS No. 141(R)”). SFAS No. 141(R) applies to any transaction or other event that meets the definition of a business combination. Where applicable, SFAS No. 141(R) establishes principles and requirements for how the acquirer recognizes and measures identifiable assets acquired, liabilities assumed, non-controlling interest in the acquiree and goodwill or gain from a bargain purchase. In addition, SFAS No. 141(R) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. In April 2009, the FASB issued FSP 141(R)-1, *Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, (“*FSP 141(R)-1”), which modified the guidance in SFAS No. 141(R) related to contingent assets and contingent liabilities. Also in December 2007, the FASB issued Statement No. 160, *Non-controlling Interests in Consolidated Financial Statements (“*SFAS No. 160”). This Statement amends Accounting Research Bulletin No. 51, *Consolidated Financial Statements,* to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 141(R), as modified by FSP 141(R)-1, and SFAS No. 160 are required to be adopted simultaneously and are effective for the first annual reporting period beginning on or after December 15, 2008 with earlier adoption being prohibited. We will adopt both SFAS No. 141(R), as modified by FSP 141(R)-1, and SFAS No. 160 on April 1, 2009. There are currently no non-controlling interests in the Company’s subsidiaries, therefore the adoption of SFAS No. 160 is not expected to have any impact. The adoption of SFAS No. 141(R), as modified by FSP 141(R)-1, will change our accounting treatment for business combinations on a prospective basis. In March 2008, the FASB issued Statement No. 161, *Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133 (“*SFAS No. 161”). SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The guidance in SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We adopted SFAS No. 161 on January 1, 2009, which did not have any material impact on our Consolidated Financial Statements. See Note 12 in the Notes to the Consolidated Financial Statements for required disclosures related to derivative instruments and hedging activities. In April 2009, the FASB issued FASB Staff Position (“FSP”) No. 107-1 and APB 28-1, *Interim Disclosures about Fair Value of Financial Instruments (“*FSP 107-1 and APB 28-1”). FSP 107-1 and APB 28-1 require that publicly traded companies include the fair value disclosures required by SFAS No. 107 in their interim financial statements and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, and must be applied prospectively. We do not expect the adoption of FSP 107-1 and APB 28-1 on April 1, 2009 to have any material impact on our consolidated financial statements and required disclosures. In April 2009, the FASB issued FSP FAS 157-4, *Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“*FSP 157-4”). FSP 157-4 provides guidance regarding how to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability when compared with normal market activity for the asset or liability. In such situations, an entity may conclude that transactions or quoted prices may not be determinative of fair value, and may adjust the transactions or quoted prices to arrive at the fair value of the asset or liability. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, and must be applied prospectively. We do not expect the adoption of FSP 157-4 on April 1, 2009 to have any material impact on our consolidated financial statements and required disclosures. In May 2009, the FASB issued SFAS No. 165, *Subsequent Events (“*SFAS No. 165”). SFAS No. 165 establishes standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. Entities are required to disclose the date through which subsequent events have been evaluated and the basis for that date. SFAS No. 165 is effective on a prospective basis for interim and annual periods ending after June 15, 2009. We do not expect the adoption of SFAS No. 165 on June 30, 2009 to have any material impact on our consolidated financial statements and required disclosures. ### Subsequent Events At March 31, 2009, we were not in compliance with certain of our Credit Agreement covenants requiring us to: (i) achieve EBITDA of not less than $4,500,000 for the fiscal quarter ended March 31, 2009 and (ii) achieve total EBITDA of not less than $19,500,000 for the four consecutive fiscal quarters ended March 31, 2009. In June 2009, our bank provided us with a waiver of these covenant defaults. In addition, in conjunction with the June 2009 waiver, we entered into a sixth amendment to the Credit Agreement, dated as of June 8, 2009, with our bank. This amendment, among other things: (i) created a borrowing reserve in the amount of $7,500,000 to be reserved by our bank against our Revolving Loan commitment amount and available in the event our largest customer is no longer having the receivables owed to us factored; (ii) amended our EBITDA covenant to require a minimum EBITDA of not less than $2,900,000 for the fiscal quarter ending June 30, 2009 and to $4,000,000 for each fiscal quarter thereafter; (iii) amended our trailing twelve month EBITDA covenant to require a minimum trailing twelve month EBITDA of not less than: (a) $12,500,000 for the four consecutive fiscal quarters ending June 30, 2009, (b) $11,250,000 for the four consecutive fiscal quarters ending September 30, 2009, (c) $12,500,000 for the four consecutive fiscal quarters ending December 31, 2009 and (d) $17,000,000 for the four consecutive fiscal quarters ending March 31, 2010 and thereafter; and (iv) amended our leverage ratio covenant to require that we maintain a leverage ratio of not greater than (x) 2.25 to 1.00 for the fiscal quarter ending June 30, 2009, (y) 2.50 to 1.00 for the fiscal quarter ending September 30, 2009, and (z) 2.00 to 1.00 for the fiscal quarter ending December 31, 2009 and thereafter. ### Results of Operations The following table summarizes certain key operating data for the periods indicated: | | Fiscal Years Ended March 31, 2009 | 2008 | 2007 | | --- | ---: | ---: | ---: | | Gross profit | 29.3% | 27.9% | 15.6% | | Cash used in operations | $(11,078,000) | $(10,039,000) | $(9,313,000) | | Finished goods turnover (1) | 4.4 | 4.6 | 5.3 | | Finished goods turnover, excluding POS inventory (2) | — | — | 6.7 | | Return on equity (3) | 4.2% | 9.6% | (10.4)% | (1) Finished goods turnover is calculated by dividing the cost of goods sold for the year by the average between beginning and ending non-core finished goods inventory values, for each fiscal year. We believe that this provides a useful measure of our ability to turn production into revenue. The finished goods turnover ratio in fiscal 2007 was positively impacted by the termination of the POS agreement in August 2006. (2) Finished goods turnover, excluding POS inventory is calculated by dividing the cost of goods sold for the fiscal year by the average between beginning and ending non-core finished goods inventory values excluding pay-on-scan inventory. We believe that this provides a useful measure of our ability to manage the inventory which is within our physical control. This POS arrangement was terminated in August 2006. (3) Return on equity is computed as net income for the fiscal year divided by shareholders’ equity at the beginning of the fiscal year and measures our ability to invest shareholders’ funds profitably. Following is our results of operation, reflected as a percentage of net sales: | | Fiscal Years Ended March 31, 2009 | 2008 | 2007 | | --- | ---: | ---: | ---: | | Net sales | 100.0% | 100.0% | 100.0% | | Cost of goods sold | 70.7 | 72.1 | 84.4 | | Gross profit | 29.3 | 27.9 | 15.6 | | Operating expenses: | | | | | General and administrative | 14.4 | 14.8 | 13.3 | | Sales and marketing | 3.9 | 2.6 | 3.0 | | Research and development | 1.5 | 1.0 | 1.1 | | Impairment of goodwill | 1.6 | — | — | | Operating income (loss) | 7.9 | 9.5 | (1.8) | | Interest expense — net of interest income | 3.1 | 4.1 | 4.3 | | Income tax expense (benefit) | 1.9 | 2.0 | (2.5) | | Net income (loss) | 2.9 | 3.4 | (3.6) | ### Fiscal 2009 Compared to Fiscal 2008 *Net Sales*. Net sales in fiscal 2009 increased by $1,529,000, or 1.1%, to $134,866,000 compared to net sales in fiscal 2008 of $133,337,000. This increase was primarily due to sales to new customers resulting from our acquisitions during fiscal 2009. We experienced a significant decrease in our net sales in the fourth quarter of fiscal 2009. Our net sales in the fourth quarter of fiscal 2009 decreased by $5,973,000, or 16.6%, compared to the same period of the prior year reflecting the impact of changes in the purchasing and return patterns of our existing customers. In addition to the impact of general economic conditions, sales in the fourth quarter of fiscal 2009 were impacted by (i) an inventory reduction program initiated by one of our largest customers in the fourth quarter of fiscal 2009, which we believe resulted in a temporary reduction in sales to that customer and (ii) by a significant drop in sales to a customer as a result of an understanding to delay shipments because of an uncertain financial future. Although we expect our business to continue uninterrupted with this customer, there can be no assurance that actions taken by other interested parties, including consumers, will not have a continuing detrimental effect on our relationship or level of continuing business with this customer. *Cost of Goods Sold/Gross Profit.* Cost of goods sold as a percentage of net sales decreased in fiscal 2009 to 70.7% from 72.1% in fiscal 2008, resulting in a corresponding increase in our gross profit percentage of 1.4% to 29.3% in fiscal 2009 from 27.9% in fiscal 2008. This increase in our gross profit percentage was primarily due to: (i) the lower per unit manufacturing costs resulting from the increased utilization of our Mexico and Malaysia facilities, and (ii) the reversal of a $1,307,000 accrual related to the customs duties claims during fiscal 2009, for which the accrual was initially recorded during fiscal 2008. These decreases were partially offset by increases in certain period costs, and a reduction in scrap metal prices that resulted in less revenue for our scrap metal during fiscal 2009 compared to fiscal 2008. Our gross profit in the fourth quarter of fiscal 2009 decreased by $5,256,000, or 46.6%, compared to the same period of the prior year primarily reflecting (i) customer purchasing and return patterns, (ii) a reduction in scrap metal prices that resulted in less revenue for our scrap metal, and (iii) increases in certain period costs in the fourth quarter of fiscal 2009 compared to the same period of the prior year. *General and Administrative.* Our general and administrative expenses for fiscal 2009 were $19,479,000, which represents a decrease of $267,000, or 1.4%, from general and administrative expenses for fiscal 2008 of $19,746,000. The decrease in general and administrative expenses was primarily due to the following: (i) $712,000 of decreased audit and other professional services fees, (ii) $544,000 of decreased stock-based compensation, and (iii) $393,000 of decreased severance and other related expenses. These decreases in general and administrative expenses were partially offset by a net increase of $1,346,000 of expense recorded due to the changes in the value of foreign exchange peso contracts during fiscal 2009. *Sales and Marketing*. Our sales and marketing expenses for fiscal 2009 increased $1,786,000, or 51.7%, to $5,242,000 from $3,456,000 for fiscal 2008. This increase was due primarily to the following: (i) $723,000 of increased compensation expense due primarily to the addition of employees which resulted from our acquisition of AIM, (ii) $479,000 of increased trade show and advertising expenses, (iii) $211,000 of increased travel-related expenses, and (iv) $204,000 of increased consulting fees. *Research and Development.* Our research and development expenses increased by $726,000, or 57.3%, to $1,993,000 in fiscal 2009 from $1,267,000 in fiscal 2008. The increase was primarily related to an increase in compensation, consulting fees and travel-related expenses in connection with our heavy duty after-market initiative related to alternators and starters. *Impairment of Goodwill*. During fiscal 2009, we determined that goodwill was fully impaired as the carrying value of $2,191,000, including the fourth quarter adjustment of $100,000, exceeded the implied fair value of zero, and therefore we recorded a pre-tax, non-cash goodwill impairment charge of $2,191,000 as disclosed in the Consolidated Statements of Operations in the third quarter of fiscal 2009. After recording the impairment charge, we had no goodwill remaining on our Consolidated Balance Sheet as of March 31, 2009. *Interest Expense.* Our interest expense, net of interest income, in fiscal 2009 was $4,196,000. This represents a decrease of $1,252,000 over interest expense, net of interest income, of $5,448,000 in fiscal 2008. This decrease was primarily attributable to a lower balance of receivables being factored during fiscal 2009 compared to fiscal 2008. During fiscal 2009, interest expense incurred on the higher average outstanding balances on our line of credit was offset by lower interest rates. *Income Tax*. In fiscal 2009, we recorded income tax expense of $2,589,000 compared to income tax expense of $2,696,000 in fiscal 2008. This decrease was primarily due to lower pre-tax income partly offset by higher book income tax rates in fiscal 2009 compared to the prior year. ### Fiscal 2008 Compared to Fiscal 2007 *Net Sales*. Net sales in fiscal 2008 increased by $8,747,000, or 7.0%, excluding the positive impact on our fiscal 2007 net sales of $11,733,000 associated with the termination of our POS arrangement in August 2006. Including the impact of the termination of our POS arrangement, our net sales decreased by $2,986,000 or 2.2%, to $133,337,000 from the net sales in fiscal 2007 of $136,323,000. *Cost of Goods Sold/Gross Profit.* Cost of goods sold as a percentage of net sales decreased in fiscal 2008 to 72.1% from 84.4% in fiscal 2007, resulting in a corresponding increase in our gross profit percentage to 27.9% in fiscal 2008 from 15.6% in fiscal 2007. The increase in the gross profit percentage in fiscal 2008 was primarily due to the lower per unit manufacturing costs resulting from improvements in manufacturing efficiencies at our Mexican facility, the transition of majority of remanufacturing to our Mexico facility, and the greater utilization of production at our operation in Malaysia. In addition, our gross profit percentage was favorably impacted by the decrease in customer allowances which had a positive impact on our net sales in fiscal 2008. Our gross profit increase was partly offset by the recording of customs duties accrual of $1,836,000 in fiscal 2008. *General and Administrative.* Our general and administrative expenses in fiscal 2008 were $19,746,000, which represents an increase of $1,561,000, or 8.6%, from the general and administrative expense in fiscal 2007 of $18,185,000. This increase was primarily due to increases in the following expenses: (i) $514,000 of increased severance and other related expenses, (ii) $1,001,000 of increased audit fees, (iii) $466,000 of increased general and administrative expenses at our Mexico facility due primarily to the ramp-up of activities at that facility, (iv) $109,000 of increased expenses related to the closure and sub-lease of our warehouse facility in Nashville, TN, and (v) $137,000 of expense related to listing of our common stock on NASDAQ. In addition, our general and administrative expenses in fiscal 2007 were reduced by the recording of the shareholder note receivable of $682,000 for reimbursement of indemnification costs. These increases in general and administrative expenses were partly offset by a decrease of (i) $505,000 in stock option compensation expense under SFAS No. 123 (revised 2004), “Share-Based Payment”, (ii) $152,000 as a result of gain recorded due to the changes in the net effect of the foreign exchange contracts, (iii) $211,000 as a result of net realized gain recorded from the redemption of short-term investments for the payment of deferred compensation liabilities in the fourth quarter of fiscal 2008, and (iv) $685,000 in consulting expenses primarily related to the SOX Section 404 requirements. *Sales and Marketing.* Our sales and marketing expenses in fiscal 2008 decreased $660,000 to $3,456,000 from $4,116,000 in fiscal 2007. This decrease was due primarily to decreases in (i) compensation related employee benefits of $398,000 due primarily to a reduction in head count, (ii) travel and entertainment expenses of $64,000, (iii) marketing expenses of $174,000, and (iv) consulting expenses of $72,000 related to changeover expenses incurred in fiscal 2007 in connection with a new customer. *Research and Development.* Our research and development expenses decreased by $190,000, or 13.0%, to $1,267,000 in fiscal 2008 from $1,457,000 in fiscal 2007. This decrease was primarily due to higher expenses incurred in fiscal 2007 related to the development of new diagnostic equipment for our Mexico and Malaysia facilities. *Interest Expense.* Our interest expense, net of interest income, in fiscal 2008 was $5,448,000. This represents a decrease of $465,000 over interest expense, net of interest income, of $5,913,000 in fiscal 2007. This decrease was primarily attributable to a decrease in the average outstanding balance on our line of credit and the decrease in short-term interest rates. This decrease was partly offset by the increase in the average days over which the receivables were factored as a result of the extended payment terms we have provided certain of our customers. *Income Tax*. In fiscal 2008, we recognized income tax expense of $2,696,000 compared to a income tax benefit of $3,432,000 in fiscal 2007. At March 31, 2008, we no longer had any federal net operating loss carry forward. As a result, we anticipate that our future cash flow will be more significantly impacted by our future tax payments. ### Liquidity and Capital Resources ### Overview At March 31, 2009, we had negative working capital of $3,569,000, a ratio of current assets to current liabilities of 0.94:1, and cash of $452,000, compared to working capital of $6,097,000, a ratio of current assets to current liabilities of 1.1:1, and cash of $1,935,000 at March 31, 2008. The change in working capital from March 31, 2008 is primarily the result of increased short-term borrowings under our line of credit, which were primarily used to acquire certain assets of AIM and SCP and to offset the reduction in cash resources due to one of our customer’s suspension of its receivable discount program to factor our accounts receivable, which was partially offset by decreased inventory due to our concerted effort to reduce inventory levels and by higher net sales. We have primarily financed our operations through the use of our Revolving Loan and the receivable discount programs we have with certain of our customers. In May 2008, one of these customers suspended the use of its receivable discount program, but has advised us that it may be in a position to re-open the use of this program sometime in the future. We cannot provide assurance that the program will be reinstated or that a similar program with another customer will be established or continued. We believe amounts available under our Credit Agreement and our cash and short term investments on hand are sufficient to satisfy our expected future working capital needs, capital lease commitments and capital expenditure obligations over the next twelve months. ### Cash Flows Net cash used in operating activities during fiscal 2009 and 2008 was $11,078,000 and $10,039,000, respectively. The most significant changes in operating activities during fiscal 2009 compared to fiscal 2008 were the reduction in cash resources due to one of our customer’s suspension of its receivable discount program to factor our accounts receivable partly offset by our concerted efforts to reduce our non-core inventory levels. Net cash used in investing activities was $9,846,000 and $1,476,000 during fiscal 2009 and 2008, respectively. The change primarily resulted from the acquisition of certain assets of AIM of $4,664,000, less the $500,000 holdback, the acquisition of certain assets of SCP of $4,320,000, less the $300,000 holdback and $722,000 note payable to SCP related to the acquisition. In addition, our capital expenditures during fiscal 2009 of $2,317,000 primarily related to IT equipment and improvements at our Torrance, California and offshore facilities. During fiscal 2008, we incurred capital expenditures of $1,962,000, which were primarily related to our Mexican facility and were partly offset by the redemption of short-term investments for the payment of deferred compensation liabilities. Net cash provided by financing activities was $19,732,000 and $12,821,000 during fiscal 2009 and 2008, respectively. During fiscal 2009, we borrowed amounts under our Revolving Loan to finance the acquisitions, and to offset the reduction in cash resources due to one of our customer’s suspension of its receivable discount program to factor our accounts receivable. In fiscal 2008, we completed a private placement of our common stock and warrants, which was substantially used to pay down borrowings under the line of credit and accounts payable balances. ### Capital Resources #### Equity Transaction On May 23, 2007, we completed the sale of 3,641,909 shares of our common stock and warrants to purchase up to 546,283 shares of our common stock at an exercise price of $15.00 per share. This sale was made through a private placement to accredited investors. The warrants are callable by us if, among other things, the volume weighted average trading price of our common stock as quoted by Bloomberg L.P. is greater than $22.50 for 10 consecutive trading days. In fiscal 2008, we charged approximately $3,156,000 of fees and costs related to this private placement to additional paid-in-capital. The fair value of the warrants at the date of grant was estimated to be approximately $4.44 per warrant using the Black-Scholes pricing model. The following assumptions were used to calculate the fair value of the warrants: dividend yield of 0%; expected volatility of 40.01%; risk-free interest rate of 4.58%; and an expected life of five years. #### Line of Credit On October 24, 2007, we entered into an amended and restated credit agreement (the “Credit Agreement”) with our bank. Under the Credit Agreement, the bank continues to provide us with a revolving loan (the “Revolving Loan”) of up to $35,000,000, including obligations under outstanding letters of credit, which may not exceed $7,000,000. In January 2008, we entered into an amendment to the Credit Agreement with our bank. This amendment extended the expiration date of our credit facility to October 1, 2009. In May 2008, our Credit Agreement was further amended to allow us to, among other things, borrow up to $15,000,000 under the Revolving Loan for the purpose of consummating certain permitted acquisitions. The aggregate consideration paid for any single permitted acquisition may not exceed $7,500,000, and the aggregate consideration paid for all permitted acquisitions made during the term of the Credit Agreement may not exceed $20,000,000. In August 2008, we entered into a third amendment to the Credit Agreement, which increased the amount of credit available under the Revolving Loan from $35,000,000 to $40,000,000. Pursuant to the terms of these amendments, we may continue to use the entire available amount under the Revolving Loan for working capital and general corporate purposes. In February 2009, we entered into a fourth amendment to the Credit Agreement with our bank. This amendment extended the expiration of the credit facility to April 15, 2010. Among other things, this amendment also increased the fee payable by us to our bank by 0.125% per annum on the unutilized amount of Revolving Loan and increased the applicable margin rate of the Revolving Loan. In April 2009, we entered into a fifth amendment to the Credit Agreement with our bank. This amendment, among other things, allows us to use usance (deferred payment) letters of credit and requires us to instruct that any purchaser of our accounts receivable is to remit payments directly to our bank. At March 31, 2009, we were not in compliance with certain of our Credit Agreement covenants requiring us to: (i) achieve EBITDA of not less than $4,500,000 for the fiscal quarter ended March 31, 2009 and (ii) achieve total EBITDA of not less than $19,500,000 for the four consecutive fiscal quarters ended March 31, 2009. In June 2009, our bank provided us with a waiver of these covenant defaults. In addition, in conjunction with the June 2009 waiver, we entered into a sixth amendment to the Credit Agreement, dated as of June 8, 2009, with our bank. This amendment, among other things: (i) created a borrowing reserve in the amount of $7,500,000 to be reserved by our bank against our Revolving Loan commitment amount and available in the event our largest customer is no longer having the receivables owed to us factored; (ii) amended our EBITDA covenant to require a minimum EBITDA of not less than $2,900,000 for the fiscal quarter ending June 30, 2009 and to $4,000,000 for each fiscal quarter thereafter; (iii) amended our trailing twelve month EBITDA covenant to require a minimum trailing twelve month EBITDA of not less than: (a) $12,500,000 for the four consecutive fiscal quarters ending June 30, 2009, (b) $11,250,000 for the four consecutive fiscal quarters ending September 30, 2009, (c) $12,500,000 for the four consecutive fiscal quarters ending December 31, 2009 and (d) $17,000,000 for the four consecutive fiscal quarters ending March 31, 2010 and thereafter; and (iv) amended our leverage ratio covenant to require that we maintain a leverage ratio of not greater than (x) 2.25 to 1.00 for the fiscal quarter ending June 30, 2009, (y) 2.50 to 1.00 for the fiscal quarter ending September 30, 2009, and (z) 2.00 to 1.00 for the fiscal quarter ending December 31, 2009 and thereafter. The bank holds a security interest in substantially all of our assets. At March 31, 2009, the balance of the Revolving Loan was $21,600,000. There was no outstanding balance on the Revolving Loan at March 31, 2008. Additionally, we had reserved $2,201,000 of the Revolving Loan for standby letters of credit for worker’s compensation insurance and $128,000 reserved for commercial letters of credit as of March 31, 2009. As of March 31, 2009, $16,071,000 was available under the Revolving Loan, and of this, $7,500,000 is reserved for use in the event our largest customer discontinues its current practice of having our receivables factored. The Credit Agreement (as amended), among other things, continues to require us to maintain certain financial covenants, including cash flow, fixed charge coverage ratio and leverage ratio and includes a number of restrictive covenants, including limits on capital expenditures and operating leases, prohibitions against additional indebtedness, payment of dividends, pledge of assets and loans to officers and/or affiliates. In addition, it is an event of default under the Credit Agreement if Selwyn Joffe is no longer our CEO. Borrowings under the Revolving Loan bear interest at either the bank’s reference rate or London Interbank Offered Rate (“LIBOR”) as selected by us for the applicable interest period plus, in each case, an applicable margin which is determined quarterly on a prospective basis as below: | | Leverage Ratio as of the End of the Fiscal Quarter | | | --- | --- | --- | | | **Greater Than or** | | | **Base Interest Rate Selected by us** | **Equal to 1.50 to 1.00** | **Less Than 1.50 to 1.00** | | Bank’s Reference Rate, plus | 1.25% per year | 1.0% per year | | Bank’s LIBOR Rate, plus | 2.5% per year | 2.25% per year | 32 Our ability to comply in future periods with the financial covenants in the Credit Agreement, as amended, will depend on our ongoing financial and operating performance, which, in turn, will be subject to economic conditions and to financial, business and other factors, many of which are beyond our control and will be substantially dependent on the selling prices and demand for our products, customer demands for marketing allowances and other concessions, raw material costs, and our ability to successfully implement our overall business strategy, including acquisitions. If a violation of any of the covenants occurs in the future, we would attempt to obtain a waiver or an amendment from our bank. No assurance can be given that we would be successful in this regard. #### Receivable Discount Programs Our liquidity has been positively impacted by receivable discount programs we have established with certain customers and their respective banks. Under these programs, we have the option to sell those customers’ receivables to those banks at a discount to be agreed upon at the time the receivables are sold. The discount under this program averaged 4.9% during fiscal 2009 and has allowed us to accelerate collection of receivables aggregating $72,299,000 by an average of 313 days. While these arrangements have reduced our working capital needs, there can be no assurance that these programs will continue in the future. These programs resulted in interest expense of $3,089,000 during fiscal 2009. Interest expense resulting from these programs would increase if interest rates rise, if utilization of these discounting arrangements expands or if the discount period is extended to reflect more favorable payment terms to customers. In May 2008, one of these customers suspended the use of its receivable discount program, but has advised us that it may be in a position to re-open the use of this program sometime in the future. We cannot provide assurance that the program will be reinstated or that a similar program with another customer will be established or continued. #### Off Balance Sheet Arrangements At March 31, 2009, we had no off-balance sheet financing or other arrangements with unconsolidated entities or financial partnerships (such as entities often referred to as structured finance or special purpose entities) established for purposes of facilitating off-balance sheet financing or other debt arrangements or for other contractually narrow or limited purposes. #### Multi-year Vendor Agreements We have or are renegotiating long-term agreements with many of our major customers. Under these agreements, which typically have initial terms of at least four years, we are designated as the exclusive or primary supplier for specified categories of remanufactured alternators and starters. In consideration for our designation as a customer’s exclusive or primary supplier, we typically provide the customer with a package of marketing incentives. These incentives differ from contract to contract and can include (i) the issuance of a specified amount of credits against receivables in accordance with a schedule set forth in the relevant contract, (ii) support for a particular customer’s research or marketing efforts provided on a scheduled basis, (iii) discounts granted in connection with each individual shipment of product and (iv) other marketing, research, store expansion or product development support. We have also entered into agreements to purchase certain customers’ Remanufactured Core inventory and to issue credits to pay for that inventory according to a schedule set forth in the agreements. These contracts typically require that we meet ongoing performance, quality and fulfillment requirements. Our contracts with major customers expire at various dates ranging through December 2012. There are Remanufactured Core purchase obligations with certain customers that expire at various dates through July 2011. In March 2005, we entered into an agreement with a major customer. As part of this agreement, our designation as this customer’s exclusive supplier of remanufactured imported alternators and starters was extended from February 28, 2008 to December 31, 2012. In addition to customary marketing allowances, we agreed to acquire the customer’s imported alternator and starter Remanufactured Core inventory by issuing $10,300,000 of credits over a five-year period. In the fourth quarter of fiscal 2008, the total credits to be issued was reduced to $9,940,000, resulting from the reconciliation of the number of Remanufactured Core inventory available at customer locations. The amount of credits issued is subject to adjustment if sales to the customer decrease in any quarter by more than an agreed upon percentage. The customer is obligated to purchase the Remanufactured or Used Cores in the customer’s inventory upon termination of the agreement for any reason. Currently, this agreement is being renegotiated pursuant to the sale or combination of two of our customers. As of March 31, 2009 and 2008, approximately $1,884,000 and $3,623,000, respectively, of credits remain to be issued. As we issue credits to this customer, we establish a long-term core inventory deposit account for the value of the Remanufactured Core inventory estimated to be on hand with the customer and subject to purchase upon termination of the agreement, and reduce revenue by the amount by which the credit exceeds the estimated Remanufactured Core inventory value. In the fourth quarter of fiscal 2005, we entered into a five-year agreement with one of the world’s largest automobile manufacturers to supply this manufacturer with a new line of remanufactured alternators and starters for the United States and Canadian markets. We expanded our operations and built-up our inventory to meet the requirements of this contract and incurred certain transition costs associated with this build-up. As part of the agreement, we also agreed to grant this customer $6,000,000 of credits that are issued as sales to this customer are made. Of the total credits, $3,600,000 was issued during fiscal 2006 and $600,000 was issued in the each of the second quarters of fiscal 2007, 2008, and 2009. The remaining $600,000 is scheduled to be issued in the second fiscal quarter of fiscal 2010. The agreement also contains other typical provisions, such as performance, quality and fulfillment requirements that we must meet, a requirement that we provide marketing support to this customer and a provision (standard in this manufacturer’s vendor agreements) granting the customer the right to terminate the agreement at any time for any reason. In July 2006, we entered into an agreement with a new customer to become its primary supplier of alternators and starters. This agreement was amended in January 2008 to extend the contract period through January 31, 2011. As part of this amendment, we also agreed to accelerate $2,300,000 of promotional allowances provided under this agreement. These promotional allowances otherwise would have been earned by the customer during the fourth quarter of fiscal 2008 and the first quarter of fiscal 2009. The longer-term agreements strengthen our customer relationships and business base. However, they also result in a continuing concentration of our revenue sources among a few key customers and require a significant increase in our use of working capital to build inventory and increase production. This increased production causes significant increases in our inventories, accounts payable and employee base, and customer demands that we purchase their Remanufactured Core inventory can be a significant strain on our available capital. In addition, the marketing and other allowances that we have typically granted our customers in connection with these new or expanded relationships adversely impact the near-term revenues and associated cash flows from these arrangements. However, we believe this incremental business will improve our overall liquidity and cash flow from operations over time. ### Capital Expenditures and Commitments Our capital expenditures were $2,674,000 in fiscal 2009, including the capital expenditures acquired under capital leases. A significant portion of these expenditures relate to our IT equipment and improvements at our production facilities. We expect our fiscal 2010 capital expenditure to be approximately $1.5 million. We expect to use our working capital and incur additional capital lease obligations to finance these capital expenditures. #### Contractual Obligations The following summarizes our contractual obligations and other commitments as of March 31, 2009, and the effect such obligations could have on our cash flow in future periods: | Contractual obligations | Payments Due by Period Total | Less than 1 year | 1 to 3 years | 4 to 5 years | More than 5 years | | --- | ---: | ---: | ---: | ---: | ---: | | Capital (finance) lease obligations (1) | $3,208,000 | $1,755,000 | $1,258,000 | $195,000 | $— | | Operating lease obligations (2) | 14,110,000 | 2,664,000 | 5,120,000 | 3,187,000 | 3,139,000 | | Core purchase obligations (3) | 3,131,000 | 2,892,000 | 168,000 | 50,000 | 21,000 | | Severance agreement and release (4) | 115,000 | 115,000 | — | — | — | | Line of credit | 21,600,000 | 21,600,000 | — | — | — | | Unrecognized tax benefits (5) | 128,000 | — | 128,000 | — | — | | Other long-term obligations (6) | 21,685,000 | 9,054,000 | 8,636,000 | 2,581,000 | 1,414,000 | | Total | $63,977,000 | $38,080,000 | $15,310,000 | $6,013,000 | $4,574,000 | (1) Capital Lease Obligations represent amounts due under finance leases of various types of machinery and computer equipment that are accounted for as capital leases. (2) Operating Lease Obligations represent amounts due for rent under our leases for office and warehouse facilities in California, Tennessee, Malaysia, Singapore and Mexico. (3) Remanufactured Core Purchase Obligations represent our obligations to issue credits to two large and several smaller customers for the acquisition of the customers’ core inventory. Our agreement with one of our major customer is being renegotiated pursuant to the sale or combination of two of our customers. (4) Severance agreement and release obligations represent our obligation for salaries and other related expenses. (5) We are unable to reliably estimate the timing of future payments related to uncertain tax positions; therefore, $859,000 of income taxes payable has been excluded from the table above. However, long-term income taxes payable, included on our balance sheet, includes these uncertain tax positions, reduced by the associated federal deduction for state taxes. (6) Other Long-Term Obligations represent commitments we have with certain customers to provide marketing allowances in consideration for supply agreements to provide products over a defined period. #### Customs Duties We received a request for information dated April 16, 2007 from the U.S. Bureau of Customs and Border Protection, or CBP, concerning the importation of products remanufactured at our Malaysian facilities. In response to the CBP’s request, we began an internal review, with the assistance of customs counsel, of our custom duties procedures. During this review process, we identified a potential exposure related to the omission of certain cost elements in the appraised value of used alternators and starters, which were remanufactured in Malaysia and returned to the United States since June 2002. We recorded an accrual for $1,836,000 as of March 31, 2008, representing the estimated maximum value of the probable claim. In February 2008, we paid approximately $278,000 to the CBP, which included the payment of duties, fees, and interest on the value of certain components that were used in the remanufacture of the products shipped back to us. On May 6, 2008, we paid an additional $126,000 to the CBP covering duties, fees and interest on the value of certain components that were used in the remanufacture of the products shipped back to us during the period from April 1, 2007 to March 31, 2008. These payments reduced the accrued liability recorded in connection with the claim. During the three months ended June 30, 2008, we received notification from the CBP stating that the prior disclosure had been reviewed and determined to be valid, therefore, no further penalties are likely to be assessed and the review was closed regarding remanufactured units shipped back to us from Malaysia. The accrual of $1,307,000 was reversed, reducing cost of goods sold for fiscal 2009. ## Market risk As filed, 3,840 characters. Our primary market risk relates to changes in interest rates and foreign currency exchange rates. Market risk is the potential loss arising from adverse changes in market prices and rates, including interest rates and foreign currency exchange rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes. As our overseas operations expand, our exposure to the risks associated with foreign currency fluctuations will continue to increase. Our primary interest rate exposure relates to our outstanding line of credit and receivables discount arrangements, which have interest costs that vary with interest rate movements. Our $40,000,000 credit facility bears interest at variable base rates equal to the LIBOR rate or the bank’s reference rate, at our option, plus a margin rate dependant upon our most recently reported leverage ratio. This obligation is the only variable rate facility we have outstanding. Based upon the $21,600,000 that was outstanding under our line of credit at March 31, 2009, an increase in interest rates of 1%, would have increased our annual net interest expense by $216,000. In addition, for each $100,000,000 of accounts receivable we discount over a period of 180 days, a 1% increase in interest rates would decrease our operating results by $500,000. We are exposed to foreign currency exchange risk inherent in our anticipated purchases and assets and liabilities denominated in currencies other than the U.S. dollar. We transact business in three foreign currencies which affect our operations: the Malaysian ringit, the Singapore dollar, and the Mexican peso. Our total foreign assets were $5,641,000 and $7,517,000 as of March 31, 2009 and 2008, respectively. In addition, as of March 31, 2009 and 2008, we had $787,000 and $854,000, respectively, due from our foreign subsidiaries. While these amounts are eliminated in consolidation, they impact our foreign currency translation gains and losses. In fiscal 2009 and 2008, we have experienced immaterial gains relative to our transactions involving the Malaysian ringit and the Singapore dollar. Based upon our current operations related to these two currencies, a change of 10% in exchange rates would result in an immaterial change in the amount reported in our financial statements. Our exposure to currency risks has increased since the expansion of our remanufacturing operations in Mexico. Since these operations will be accounted for primarily in pesos, fluctuations in the value of the peso are expected to have a growing level of impact on our reported results. To mitigate the risk of currency fluctuation between the U.S. dollar and the peso, in August 2005 we began to enter into forward foreign exchange contracts to exchange U.S. dollars for pesos. The extent to which we use forward foreign exchange contracts is periodically reviewed in light of our estimate of market conditions and the terms and length of anticipated requirements. The use of derivative financial instruments allows us to reduce our exposure to the risk that the eventual net cash outflow resulting from funding the expenses of the foreign operations will be materially affected by changes in exchange rates. These contracts generally expire in a year or less. Any changes in fair values of foreign exchange contracts are reflected in current period earnings. Based upon our forward foreign exchange contracts related to the peso, an increase of 10% in exchange rates at March 31, 2009 would have increased our general and administrative expenses by approximately $561,000. During fiscal 2009, we recorded an increase in general and administrative expenses of $1,194,000, while in fiscal 2008, we recorded a decrease in general and administrative expenses of $152,000 associated with these forward exchange contracts. ## Controls and procedures As filed, 3,019 characters. ### a. Evaluation of Disclosure Controls and Procedures We conducted an evaluation required by the Securities Exchange Act of 1934, as amended (“Exchange Act”), under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act, as of the end of the period covered by this Annual Report. Based on this evaluation, our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer concluded that our disclosure controls and procedures were effective. ### b. Inherent Limitations Over Internal Controls Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Management does not expect, however, that the Company’s internal controls will prevent or detect all errors and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of internal controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. ### c. Management’s Report on Internal Control Over Financial Reporting The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2009, based on the guidelines established in *Internal Control - Integrated Framework* issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the results of this evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of March 31, 2009. Ernst & Young LLP, the Company’s independent registered public accounting firm, assessed the effectiveness of our internal control over financial reporting as of March 31, 2009. Ernst & Young LLP, has issued an attestation report concurring with management’s assessment that is included on page 47 of this Annual Report. ### d. Changes in Internal Control Over Financial Reporting There were no changes in the Company’s internal control over financial reporting during the fourth quarter ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Filed Jun 15, 2009. Source: SEC EDGAR, the filing index for accession 0000950123-09-013860. Last ingested by Listed: Nov 10, 2026, 01:42 ET. No prices; not investment advice.