# Motorcar Parts of America Inc: Form 10-Q for the period ended Dec 31, 2008

- Company: [Motorcar Parts of America Inc](/companies/mpaa.md) (CIK 918251)
- Form: 10-Q
- Filed: 2009-02-09
- Accepted by EDGAR: Feb 9, 2009, 06:01 ET
- Period: 2008-12-31
- Accession: 0000950134-09-002111
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/918251/000095013409002111/v51267e10vq.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/918251/000095013409002111/

## Management's discussion and analysis

As filed, 43,534 characters.

The following discussion and analysis presents factors that we believe are relevant to an assessment and understanding of our consolidated financial position and results of operations. This financial and business analysis should be read in conjunction with our March 31, 2008 audited consolidated financial statements included in our Annual Report on Form 10-K filed with the SEC on June 16, 2008.

### 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, including the increasing customer pressure for lower prices and more favorable payment and other terms, our ability to renew the contract with our largest customer that expired in August 2008 and the terms of any such renewal or to continue our relationship with this customer on an otherwise equally satisfactory basis, the increasing demands on our working capital, including 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 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 or economic instability in any of the foreign countries where we conduct operations, unforeseen increases in operating costs 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 and heavy duty applications, and distribute them throughout the United States and Canada. We sell to most of the largest auto parts retail chains and customers in the United States and Canada and to a major U.S. automobile manufacturer. We also distribute our products via a reseller in the Middle East, Africa and Japan. Growth of the after-market for remanufactured alternators and starters is driven by replacement rates. We believe that replacement rates generally increase with increases in miles driven and the age of registered vehicles. Vehicles eight years old or older have replacement rates for alternators and starters that are significantly higher than vehicles that are less than eight years old. Our business has focused on the do-it-yourself market, customers who buy remanufactured alternators and starters at an auto parts retail store and install the parts themselves as well as the do-it-for-me market, also known as the professional installer market.

On May 16, 2008, we completed the acquisition of certain assets of Automotive Importing Manufacturing, Inc. (“AIM”), specifically its operation which produced new and remanufactured alternators and starters for imported and domestic passenger vehicles. These products are sold under Talon, Xtreme and other brand names. We believe the acquisition of AIM expands our customer base and product line, including the addition of business in heavy duty alternator and starter applications.

On August 22, 2008, we completed the acquisition of certain assets of Suncoast Automotive Products, Inc. (“SCP”), specifically its operation which produced new and remanufactured alternators and starters for the automotive, industrial and heavy duty aftermarkets. These products were sold under the SCP brand name. We believe the acquisition of SCP enhances our market share in North America.

### Results of Operations for the Three Months Ended December 31, 2008 and 2007

The following discussion and analysis should be read in conjunction with the financial statements and notes thereto appearing elsewhere herein.

The following table summarizes certain key operating data for the periods indicated:

|  | Three Months Ended December 31, 2008 | 2007 |
| --- | ---: | ---: |
| Gross profit percentage | 28.3% | 26.6% |
| Cash flow provided by operations | $5,898,000 | $3,862,000 |
| Finished goods turnover (annualized) (1) | 5.1 | 4.6 |
| Annualized return on equity (2) | (1.4)% | (1.5)% |

(1) Annualized finished goods turnover for the fiscal quarter is calculated by multiplying cost of sales for the quarter by 4 and dividing the result by the average between beginning and ending non-core finished goods inventory values, for the fiscal quarter. We believe this provides a useful measure of our ability to turn production into revenues.

(2) Annualized return on equity is computed as net income for the fiscal quarter multiplied by 4 and dividing the result by beginning shareholders’ equity. Annualized return on equity measures our ability to invest shareholders’ funds profitably.

Following is our unaudited results of operations, reflected as a percentage of net sales:

|  | Three Months Ended December 31, 2008 | 2007 |
| --- | ---: | ---: |
| Net sales | 100.0% | 100.0% |
| Cost of goods sold | 71.7 | 73.4 |
| Gross profit | 28.3 | 26.6 |
| Operating expenses: |  |  |
| General and administrative | 15.3 | 19.6 |
| Sales and marketing | 4.3 | 2.9 |
| Research and development | 1.4 | 1.1 |
| Impairment of goodwill | 5.8 | — |
| Operating income | 1.5 | 3.0 |
| Interest expense — net of interest income | 3.4 | 4.5 |
| Income tax expense (benefit) | (1.1) | (0.8) |
| Net loss | (0.8) | (0.7) |

*Net Sales*. Net sales for the three months ended December 31, 2008 increased by $7,620,000, or 27%, to $35,802,000 compared to net sales for the three months ended December 31, 2007 of $28,182,000. This increase was primarily due to higher sales to our existing customers, and to a lesser extent, sales to new customers resulting from our acquisitions.

*Cost of Goods Sold/Gross Profit.* Cost of goods sold as a percentage of net sales decreased during the three months ended December 31, 2008 to 71.7% from 73.4% for the three months ended December 31, 2007, resulting in a corresponding increase in our gross profit of 1.7% to 28.3% for the three months ended December 31, 2008 from 26.6% for the three months ended December 31, 2007. The increase in the gross profit percentage, as compared to the three months ended December 31, 2007, was primarily due to (i) the lower per unit manufacturing costs resulting from the transition of a majority of remanufacturing operations from the United States to our Mexico and Malaysia facilities, and (ii) the recording of an additional customs duties accrual of $245,000 during the three months ended December, 31, 2007. This increase in gross profit was partially offset by a reduction in scrap metal prices that resulted in less revenue for our scrap metal compared to the three months ended December 31, 2007.

*General and Administrative.* Our general and administrative expenses for the three months ended December 31, 2008 were $5,460,000, which represents a decrease of $60,000, or 1.1%, from general and administrative expenses for the three months ended December 31, 2007 of $5,520,000. This decrease in general and administrative expenses during the three months ended December 31, 2008 was partially offset by a net increase of $1,252,000 of expense recorded due to the changes in the value of foreign exchange contracts. The decrease in general and administrative expenses was primarily due to the following: (i) a decrease in our discretionary incentive compensation of $83,000, (ii) a decrease in audit and other professional services fees of $368,000, (iii) a decrease in compensation expense of $102,000, which resulted from the closure of our administrative offices during the December 2008 year-end holiday period, (iv) a decrease in stock-based compensation of $208,000, (v) a decrease in expenses related to the listing of our common stock on NASDAQ of $91,000, (vi) a decrease in bad debt expense of $111,000, (vii) a decrease in severance and other related expenses of $102,000, and (viii) a decrease in expenses related to the closure and sub-lease of our warehouse facility in Nashville, TN, of $109,000.

*Sales and Marketing*. Our sales and marketing expenses for the three months ended December 31, 2008 increased $731,000, or 88.7%, to $1,555,000 from $824,000 for the three months ended December 31, 2007. This increase was due primarily to the addition of employees which resulted from our acquisition of AIM, increased trade show and advertising expenses, an increase in travel related expenses, and an increase in consulting fees.

*Research and Development*. Our research and development expenses increased by $213,000, or 70.5%, to $515,000 for the three months ended December 31, 2008 from $302,000 for the three months ended December 31, 2007. The increase was primarily related to an increase in compensation, consulting fees and travel related expenses in connection with our continued heavy duty aftermarket initiative related to alternators and starters.

*Impairment of 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 using the two-step method in accordance with SFAS No. 142, *Goodwill and Other Intangible Assets.* Based on this interim assessment, we concluded that goodwill impairment existed in an amount equal to the carrying value of $2,091,000 and recorded a non-cash pre-tax impairment charge of $2,091,000 for the three months ended December 31, 2008. See Note 3 in the Notes to Consolidated Financial Statements for further details.

*Interest Expense.* Our interest expense, net of interest income, for the three months ended December 31, 2008 was $1,203,000. This represents a decrease of $54,000, or 4.3%, over interest expense, net of interest income, of $1,257,000 for the three months ended December 31, 2007. This decrease was primarily attributable to a lower balance of receivables being factored during the three months ended December 31, 2008 compared to the three months ended December 31, 2007. The decrease in interest expense, net of interest income, was partially offset by an increase in interest expense on our line of credit due to higher average outstanding balances during the three months ended December 31, 2008 compared to the three months ended December 31, 2007.

*Income Tax*. For the three months ended December 31, 2008 and 2007, we recognized income tax benefit of $380,000 and $232,000, respectively. The income tax benefit recorded for the three months ended December 31, 2008, primarily reflects the income tax effect of goodwill impairment at income tax rates not offset by lower statutory tax rates in foreign taxing jurisdictions. For the three months ended December 31, 2007, we recognized income tax benefit as a result of utilization of our fiscal 2007 net operating loss carryforward. At March 31, 2008, we no longer had any federal net operating loss carryforwards.

### Results of Operations for the Nine Months Ended December 31, 2008 and 2007

The following discussion and analysis should be read in conjunction with the financial statements and notes thereto appearing elsewhere herein.

The following table summarizes certain key operating data for the periods indicated:

|  | Nine Months Ended December 31, 2008 | 2007 |
| --- | ---: | ---: |
| Gross profit percentage | 31.9% | 26.6% |
| Cash flow used in operations | $(4,673,000) | $(11,898,000) |
| Finished goods turnover (annualized) (1) | 4.5 | 4.8 |
| Annualized return on equity (2) | 7.4% | 5.2% |

(1) Annualized finished goods turnover for the nine months ended December 31, 2008 and 2007 is calculated by multiplying cost of sales for each nine month period by 1.33 and dividing the result by the average between beginning and ending non-core finished goods inventory values, for each nine month period. We believe this provides a useful measure of our ability to turn production into revenues.

(2) Annualized return on equity is computed as net income for the nine months ended December 31, 2008 and 2007 multiplied by 1.33 and dividing the result by beginning shareholders’ equity. Annualized return on equity measures our ability to invest shareholders’ funds profitably.

Following is our unaudited results of operations, reflected as a percentage of net sales:

|  | Nine Months Ended December 31, 2008 | 2007 |
| --- | ---: | ---: |
| Net sales | 100.0% | 100.0% |
| Cost of goods sold | 68.1 | 73.4 |
| Gross profit | 31.9 | 26.6 |
| Operating expenses: |  |  |
| General and administrative | 13.9 | 15.4 |
| Sales and marketing | 3.7 | 2.6 |
| Research and development | 1.5 | 0.9 |
| Impairment of goodwill | 2.0 | — |
| Operating income | 10.8 | 7.7 |
| Interest expense — net of interest income | 3.0 | 4.6 |
| Income tax expense | 3.0 | 1.2 |
| Net income | 4.8 | 1.9 |

*Net Sales*. Net sales for the nine months ended December 31, 2008 increased by $7,501,000, or 7.7%, to $104,944,000 compared to net sales for the nine months ended December 31, 2007 of $97,443,000. This increase was primarily due to higher net sales to our existing customers and sales to new customers resulting from both our acquisitions and sales efforts.

*Cost of Goods Sold/Gross Profit.* Cost of goods sold as a percentage of net sales decreased during the nine months ended December 31, 2008 to 68.1% from 73.4% for the nine months ended December 31, 2007, resulting in a corresponding increase in our gross profit of 5.3% to 31.9% for the nine months ended December 31, 2008 from 26.6% for the nine months ended December 31, 2007. The increase in the gross profit percentage, as compared to the nine months ended December 31, 2007, was primarily due to (i) the lower per unit manufacturing costs resulting from the transition of a majority of remanufacturing operations from the United States to our Mexico and Malaysia facilities, and (ii) the reversal of a $1,307,000 accrual related to the customs duties claims during the nine months ended December 31, 2008, for which the accrual was initially recorded during the nine months ended December 31, 2007.

*General and Administrative.* Our general and administrative expenses for the nine months ended December 31, 2008 were $14,634,000, which represents a decrease of $400,000, or 2.7%, from general and administrative expenses for the nine months ended December 31, 2007 of $15,034,000. The decrease in general and administrative expenses was primarily due to the following: (i) $1,260,000 of decreased audit and other professional services fees, (ii) $526,000 of decreased severance and other related expenses, and (iii) $412,000 of decreased stock-based compensation. These decreases in general and administrative expenses were partially offset by a net increase of $1,675,000 of expense recorded due to the changes in the value of foreign exchange contracts during the nine months ended December 31, 2008.

*Sales and Marketing*. Our sales and marketing expenses for the nine months ended December 31, 2008 increased $1,360,000, or 53.3%, to $3,911,000 from $2,551,000 for the nine months ended December 31, 2007. This increase was due primarily to the addition of employees which resulted from our acquisition of AIM, increased trade show and advertising expenses, an increase in travel related expenses, and an increase in consulting fees.

*Research and Development*. Our research and development expenses increased by $706,000, or 82.9%, to $1,558,000 for the nine months ended December 31, 2008 from $852,000 for the nine months ended December 31, 2007. The increase was primarily related to an increase in compensation, consulting fees and travel related expenses in connection with our continued heavy duty aftermarket initiative related to alternators and starters.

*Impairment of 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 using the two-step method in accordance with SFAS No. 142, *Goodwill and Other Intangible Assets.* Based on this interim assessment, we concluded that goodwill impairment existed in an amount equal to the carrying value of $2,091,000 and recorded a non-cash pre-tax impairment charge of $2,091,000 for the nine months ended December 31, 2008. See Note 3 in the Notes to Consolidated Financial Statements for further details.

*Interest Expense.* Our interest expense, net of interest income, for the nine months ended December 31, 2008 was $3,169,000. This represents a decrease of $1,275,000, or 28.7%, over interest expense, net of interest income, of $4,444,000 for the nine months ended December 31, 2007. This decrease was primarily attributable to a lower balance of receivables being factored during the nine months ended December 31, 2008 compared to the nine months ended December 31, 2007.

*Income Tax*. For the nine months ended December 31, 2008 and 2007, we recognized income tax expense of $3,115,000 and $1,179,000, respectively. Income tax expenses for the nine months ended December 31, 2008 and 2007 reflect income tax rates higher than the federal statutory rates primarily due to state income taxes, which, except for the impact of the goodwill impairment charge, were partially offset by the benefit of lower statutory tax rates in foreign taxing jurisdictions. At March 31, 2008, we no longer had any federal net operating loss carryforwards.

### Liquidity and Capital Resources

### Overview

At December 31, 2008, we had negative working capital of $5,175,000, a ratio of current assets to current liabilities of 0.91:1, and cash of $878,000, 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, 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 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 re-instated 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 was $4,673,000 for the nine months ended December 31, 2008 compared to $11,898,000 for the nine months ended December 31, 2007. The most significant changes in operating activities for the nine months ended December 31, 2008 compared to the nine months ended December 31, 2007 were (i) an increase in net income attributable in part to the following: (x) higher net sales to our existing and new customers; (y) a reduction in costs resulting from the shift of remanufacturing operations to our Mexican and Malaysian facilities; and (z) the reversal of the customs duties accrual during the nine months ended December 31, 2008, for which the accrual was originally recorded during the nine months ended December 31, 2007; (ii) the reduction in cash resources due to one of our customer’s suspension of its receivable discount program to factor our accounts receivable; and (iii) a less significant reduction in our accounts payable and accrued liabilities for the nine months ended December 31, 2008 as compared to the nine months ended December 31, 2007, as the proceeds from our private placement were used to pay down accounts payable balances of $15,449,000 during the nine months ended December 31, 2007.

Additionally, as of March 31, 2008, we had no remaining net operating loss carry forwards. As net operating loss carry forwards for tax purposes are no longer available, we anticipate that our future cash flow will be impacted by our future tax payments.

Net cash used in investing activities was $9,030,000 and $1,497,000 during the nine months ended December 31, 2008 and 2007, 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 $1,014,000 note payable to SCP related to the acquisition. In addition, our capital expenditures for the nine months ended December 31, 2008 of $1,805,000 primarily related to IT equipment and improvements at our Torrance, California and offshore facilities. For the nine months ended December 31, 2007, we incurred capital expenditures of $1,357,000, which primarily were related to our Mexican production facility.

Net cash provided by financing activities was $13,034,000, and $13,408,000, during the nine months ended December 31, 2008 and 2007, respectively. During the nine months ended December 31, 2008, we borrowed amounts under our line of credit to finance the acquisitions, to pay down our accounts payable balances, 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 May 2007, 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

#### 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.

The bank holds a security interest in substantially all of our assets. At December 31, 2008, the balance of the Revolving Loan was $14,400,000. There was no outstanding balance on the Revolving Loan at March 31, 2008. Additionally, we had reserved $3,001,000 of the Revolving Loan for standby letters of credit for worker’s compensation insurance as of December 31, 2008. As of December 31, 2008, $22,599,000 was available under the Revolving Loan.

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.

We were in compliance with all financial covenants under the Credit Agreement as of December 31, 2008.

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 |

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 Program

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 4.8% during the nine months ended December 31, 2008 and has allowed us to accelerate collection of receivables aggregating $55,773,000 by an average of 315 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 costs of $2,318,000 during the nine months ended December 31, 2008. These interest costs would increase if interest rates rise, if utilization of these discounting arrangements expands and 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 re-instated or that a similar program with another customer will be established or continued.

#### Off-Balance Sheet Arrangements

At December 31, 2008, 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.

### Capital Expenditures and Commitments

### Capital Expenditures

Our capital expenditures were $2,162,000 for the nine months ended December 31, 2008, including the capital expenditures acquired under capital leases. A significant portion of these expenditures relate to IT equipment and improvements at our Torrance, California and offshore facilities. We expect our fiscal 2009 capital expenditure to be in the range of $2.5 million to $3.5 million. We expect to use our working capital and incur additional capital lease obligations to finance these capital expenditures.

### 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 also provided a prior disclosure letter dated June 5, 2007 to the customs authorities in order to obtain more time to complete our internal review process. This prior disclosure letter also provides us the opportunity to self report any underpayment of customs duties in prior years which could reduce financial penalties, if any, imposed by the CBP. Based on our review, we determined that it was probable the CBP would make a claim for additional duties, fees and interest on the value of remanufactured units shipped back to us from Malaysia. Therefore, we recorded an accrual for $1,836,000 as of March 31, 2008, representing the estimated maximum value of the probable claim.

On February 7, 2008, we responded to the CBP with the results of our internal review for products shipped back to us during the period from June 5, 2002 to March 31, 2007. In connection with this response, 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. During the three months ended June 30, 2008, the accrual of $1,307,000 was reversed, reducing cost of goods sold.

### Litigation

In December 2003, the SEC and the United States Attorney’s Office brought actions against Richard Marks, our former President and Chief Operating Officer. (Mr. Marks is also the son of Mel Marks, our founder, largest shareholder and member of our Board of Directors.) Mr. Marks ultimately pled guilty to several criminal charges in June 2005.

In June 2006, we entered into a Settlement Agreement and Mutual Release with Mr. Marks pursuant to which Mr. Marks agreed to pay us $682,000 as partial reimbursement of the legal fees and costs we had advanced in fiscal 2006 and 2005 pursuant our pre-existing indemnification agreements with Mr. Marks in connection with the investigations by the SEC and United States Attorney’s Office. In June 2006, we recorded a shareholder note receivable for the $682,000 Mr. Marks owed us. Mr. Marks pledged shares of our common stock to secure payment of the note. On July 22, 2008, we retired 108,534 shares of our common stock which had been pledged by Mr. Marks in satisfaction of the $682,000 shareholder note receivable plus interest accrued from January 15, 2008 through July 22, 2008, and the remaining shares pledged as collateral were released to Mr. Marks.

We are subject to various 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.

### Related Party Transactions

Our related party transactions primarily consist of employment and director agreements and stock option agreements.

During the nine months ended December 31, 2008, we paid Houlihan Lokey Howard & Zukin Capital, Inc. a $108,000 retainer for services and reimbursement of other out-of-pocket expenses. Scott J. Adelson, a member of our Board of Directors, is a Senior Managing Director for Houlihan Lokey Howard & Zukin Capital, Inc.

Except as noted above and in the Litigation discussion above, our related party transactions have not changed since March 31, 2008.

### Critical Accounting Policies

There have been no material changes to our critical accounting policies and estimates that are presented in our Annual Report on Form 10-K for the year ended March 31, 2008, except as discussed below.

### 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. 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.

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.

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. We determine the fair value of the reporting unit based on a weighting of: (1) a market capitalization approach applying a control premium, (2) a discounted cash flow analysis; and (3) a market approach using market multiples and comparable transaction data for guideline companies. The evaluation of goodwill requires us to use significant judgments and estimates, including but not limited to updated projected future revenues, cash flows, and discount rates. 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.

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 $2,091,000 exceeded the implied fair value of zero, and therefore recorded a pre-tax, non-cash goodwill impairment charge of $2,091,000 ($1,255,000 after tax or $0.11 per diluted share) as disclosed in the Consolidated Statements of Income. After recording the impairment charge, we had no goodwill remaining on our Consolidated Balance Sheet as of December 31, 2008.

### New Accounting Pronouncements

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.

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.

The following table summarizes the valuation of our short-term investments and financial instruments by the above SFAS No. 157 categories as of December 31, 2008:

| Assets | Fair Value at December 31, 2008 | Fair Value Measurements Using Inputs Considered as Level 1 | Level 2 | Level 3 |
| --- | ---: | ---: | ---: | ---: |
| Short-term investments | $298,000 | $298,000 | — | — |
| **Liabilities** |  |  |  |  |
| Deferred compensation | 298,000 | 298,000 | — | — |
| Forward foreign currency exchange contracts | 1,559,000 | — | $1,559,000 | — |

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 nine and three months ended December 31, 2008, an increase of $1,704,000 and $1,347,000, respectively, in general and administrative expenses was recorded due to the change in the value of foreign exchange contracts.

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.

On December 4, 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. 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) 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 do not currently have any non-controlling interests in our subsidiaries. Both SFAS No. 141(R) and SFAS No. 160 are adopted prospectively, therefore they do not have any current impact.

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 are currently assessing the impact of SFAS No. 161.

In May 2008, the FASB issued SFAS No. 162, *The Hierarchy of Generally Accepted Principles (“*SFAS No. 162”). SFAS No. 162, which became effective November 15, 2008, outlines the order of authority for the sources of accounting principles. The adoption of SFAS No. 162 did not have any impact on our consolidated financial statements and required disclosures.

## Market risk

As filed, 583 characters.

The recent turmoil in the credit and capital markets has increased the volatility associated with interest rates and foreign currency exchange rates. However, we continue to manage these risks as described in Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K as of March 31, 2008, which was filed on June 16, 2008.

For a further discussion of our market risk, refer to Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K as of March 31, 2008, which was filed on June 16, 2008.

## Controls and procedures

As filed, 2,142 characters.

### Disclosure Controls and Procedures

We carried out an evaluation required by the Securities Exchange Act of 1934 (the “1934 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) of the 1934 Act, as of the end of the period covered by this 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 to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.

Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as specified above. Management does not expect, however, that our disclosure controls and procedures will prevent or detect all error 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 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.

### Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 1,295 characters.

Our business and operations entail a variety of risks and uncertainties, including those described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2008, filed with the SEC on June 16, 2008. In addition, the following information amends and further updates our risk factors and should be read in conjunction with those prior disclosures.

***Deteriorating conditions in the global credit markets and macroeconomic factors could adversely affect our financial condition and results of operations.***

Over the past several months, 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.

Filed Feb 9, 2009.
Source: SEC EDGAR, the filing index for accession 0000950134-09-002111. Last ingested by Listed: Nov 10, 2026, 01:42 ET. No prices; not investment advice.