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


FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018.

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to


Commission File Number: 001-36102

Knowles Corporation
(Exact name of registrant as specified in its charter)

Delaware
90-1002689
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
1151 Maplewood Drive
 
Itasca, Illinois
60143
(Address of principal executive offices)
(Zip Code)

(630) 250-5100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ  No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes þ  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

The number of shares outstanding of the registrant’s common stock as of October 31, 2018 was 90,204,226.




Knowles Corporation
Form 10-Q
Table of Contents

 
 
Page
 
 
 
 
 
 
 
 
 





Table of Contents


PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

KNOWLES CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except share and per share amounts)
(unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues
$
236.2


$
196.0

 
$
603.1

 
$
528.7

Cost of goods sold
146.4

 
121.7

 
374.7

 
326.8

Impairment charges

 

 

 
1.4

Restructuring charges - cost of goods sold

 
0.2

 
0.1

 
3.9

Gross profit
89.8

 
74.1

 
228.3

 
196.6

Research and development expenses
25.2

 
21.9

 
75.4

 
70.6

Selling and administrative expenses
34.5

 
32.0

 
107.4

 
99.3

Impairment charges

 

 

 
19.9

Restructuring charges
0.5

 
0.9

 
1.4

 
4.2

Operating expenses
60.2

 
54.8

 
184.2

 
194.0

Operating earnings
29.6

 
19.3

 
44.1

 
2.6

Interest expense, net
4.0

 
5.1

 
12.1

 
15.4

Other expense (income), net
0.3

 
(0.7
)
 
0.5

 
2.0

Earnings (loss) before income taxes and discontinued operations
25.3

 
14.9

 
31.5

 
(14.8
)
Provision for income taxes
43.1

 
4.4

 
45.3

 
10.6

(Loss) earnings from continuing operations
(17.8
)
 
10.5

 
(13.8
)
 
(25.4
)
Earnings from discontinued operations, net
1.6

 
5.2

 
1.9

 
8.2

Net (loss) earnings
$
(16.2
)
 
$
15.7

 
$
(11.9
)

$
(17.2
)
 
 
 
 
 
 
 
 
(Loss) earnings per share from continuing operations:
 
 
 
 
 
 
 
Basic
$
(0.20
)

$
0.12

 
$
(0.15
)

$
(0.28
)
Diluted
$
(0.20
)
 
$
0.12

 
$
(0.15
)
 
$
(0.28
)
 
 
 
 
 
 
 
 
Earnings per share from discontinued operations:
 
 
 
 
 
 
 
Basic
$
0.02

 
$
0.06

 
$
0.02

 
$
0.09

Diluted
$
0.02

 
$
0.05

 
$
0.02

 
$
0.09

 
 
 
 
 
 
 
 
Net (loss) earnings per share:
 
 
 
 
 
 
 
Basic
$
(0.18
)
 
$
0.18

 
$
(0.13
)
 
$
(0.19
)
Diluted
$
(0.18
)
 
$
0.17

 
$
(0.13
)
 
$
(0.19
)
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
90,171,928

 
89,469,996

 
89,988,254


89,270,103

Diluted
90,171,928

 
90,373,112

 
89,988,254


89,270,103



See accompanying Notes to Consolidated Financial Statements

1

Table of Contents


KNOWLES CORPORATION 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(in millions)
(unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net (loss) earnings
$
(16.2
)
 
$
15.7

 
$
(11.9
)
 
$
(17.2
)
 
 
 
 
 
 
 
 
Other comprehensive (loss) earnings, net of tax
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation
(7.7
)
 
4.9

 
(10.4
)
 
25.0

 
 
 
 
 
 
 
 
Employee benefit plans:
 
 
 
 
 
 
 
Amortization or settlement of actuarial losses and prior service costs
0.1

 

 
0.4

 

Net change in employee benefit plans
0.1

 

 
0.4

 

 
 
 
 
 
 
 
 
Changes in fair value of cash flow hedges:
 
 
 
 
 
 
 
Unrealized net (losses) gains arising during period
(1.1
)
 
0.8

 
(2.3
)
 
2.4

Net losses (gains) reclassified into earnings
0.9

 
(0.4
)
 
0.2

 
1.3

Total cash flow hedges
(0.2
)
 
0.4

 
(2.1
)
 
3.7

 
 
 
 
 
 
 
 
Other comprehensive (loss) earnings, net of tax
(7.8
)
 
5.3

 
(12.1
)
 
28.7

 
 
 
 
 
 
 
 
Comprehensive (loss) earnings
$
(24.0
)
 
$
21.0

 
$
(24.0
)
 
$
11.5


See accompanying Notes to Consolidated Financial Statements


2

Table of Contents


KNOWLES CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except share and per share amounts)
(unaudited)

 
September 30, 2018
 
December 31, 2017
Current assets:
 
 
 
Cash and cash equivalents
$
68.6

 
$
111.7

Receivables, net of allowances of $0.5 and $0.7
148.4

 
137.7

Inventories, net
154.1

 
125.6

Prepaid and other current assets
12.2

 
19.9

Total current assets
383.3

 
394.9

Property, plant, and equipment, net
201.3

 
183.0

Goodwill
887.9

 
884.9

Intangible assets, net
58.3

 
53.5

Other assets and deferred charges
34.1

 
31.8

Assets of discontinued operations
0.2

 
1.7

Total assets
$
1,565.1

 
$
1,549.8

 
 
 
 
Current liabilities:
 

 
 

Accounts payable
$
82.7

 
$
85.6

Accrued compensation and employee benefits
34.9

 
31.2

Other accrued expenses
25.3

 
28.2

Federal and other taxes on income
4.6

 
6.6

Total current liabilities
147.5

 
151.6

Long-term debt
187.9

 
192.6

Other liabilities
104.6

 
67.9

Liabilities of discontinued operations
0.2

 
5.6

Commitments and contingencies (Note 15)


 


Stockholders' equity:
 
 
 
Preferred stock - $0.01 par value; 10,000,000 shares authorized; none issued

 

Common stock - $0.01 par value; 400,000,000 shares authorized; 90,180,960 and 89,491,471 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
0.9

 
0.9

Additional paid-in capital
1,539.9

 
1,523.1

Accumulated deficit
(303.8
)
 
(291.9
)
Accumulated other comprehensive loss
(112.1
)
 
(100.0
)
Total stockholders' equity
1,124.9

 
1,132.1

Total liabilities and stockholders' equity
$
1,565.1

 
$
1,549.8


See accompanying Notes to Consolidated Financial Statements


3

Table of Contents


KNOWLES CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in millions)
(unaudited)

 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
Total Stockholders' Equity
Balance at December 31, 2017
$
0.9

 
$
1,523.1

 
$
(291.9
)
 
$
(100.0
)
 
$
1,132.1

Net loss

 

 
(11.9
)
 

 
(11.9
)
Other comprehensive loss, net of tax

 

 

 
(12.1
)
 
(12.1
)
Stock-based compensation expense

 
20.8

 

 

 
20.8

Common stock issued for exercise of stock options

 
0.5

 

 

 
0.5

Tax on restricted stock unit vesting

 
(4.5
)
 

 

 
(4.5
)
Balance at September 30, 2018
$
0.9

 
$
1,539.9

 
$
(303.8
)
 
$
(112.1
)
 
$
1,124.9

 
See accompanying Notes to Consolidated Financial Statements


4

Table of Contents


KNOWLES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(unaudited)
 
Nine Months Ended September 30,
 
2018
 
2017
Operating Activities
 
 
 
Net loss
$
(11.9
)
 
$
(17.2
)
Adjustments to reconcile net loss to cash from operating activities:
 
 
 
Depreciation and amortization
39.7

 
44.4

Stock-based compensation
20.8

 
18.6

Impairment of intangibles

 
16.2

Non-cash interest expense and amortization of debt issuance costs
5.7

 
5.5

Impairment charges on fixed and other assets

 
5.4

Loss (gain) on disposal of fixed assets
0.2

 
(0.2
)
Deferred income taxes
(0.9
)
 
(0.6
)
Gain on sale of business
(1.6
)
 

Other, net
(2.4
)
 
5.5

Cash effect of changes in assets and liabilities (excluding effects of foreign exchange):
 
 
 
Receivables, net
(8.5
)
 
(4.1
)
Inventories, net
(29.7
)
 
(35.8
)
Prepaid and other current assets
(2.6
)
 
(0.8
)
Accounts payable
(1.7
)
 
(4.4
)
Accrued compensation and employee benefits
2.6

 
(5.4
)
Other accrued expenses
(4.8
)
 
5.2

Accrued taxes
33.4

 
(3.9
)
Other non-current assets and non-current liabilities
1.0

 
2.7

Net cash provided by operating activities
39.3

 
31.1

 
 
 
 
Investing Activities
 

 
 

Proceeds from the sale of business
10.0

 

Additions to property, plant, and equipment
(58.0
)
 
(43.4
)
Acquisitions of business (net of cash acquired)
(18.0
)
 
(2.5
)
Proceeds from the sale of property, plant, and equipment

 
0.5

Net cash used in investing activities
(66.0
)
 
(45.4
)
 
 
 
 
Financing Activities
 

 
 

Payments under revolving credit facility
(10.0
)
 

Borrowings under revolving credit facility

 
15.0

Tax on restricted stock unit vesting
(4.5
)
 
(4.9
)
Payments of capital lease obligations
(1.3
)
 
(1.2
)
Payment of consideration owed for acquisitions
(1.0
)
 

Net proceeds from exercise of stock-based awards
0.5

 
3.3

Principal payments on term loan debt

 
(7.2
)
Net cash (used in) provided by financing activities
(16.3
)
 
5.0

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(0.1
)
 
0.8

 
 
 
 
Net decrease in cash and cash equivalents
(43.1
)
 
(8.5
)
Cash and cash equivalents at beginning of period
111.7

 
63.4

Add: Cash and cash equivalents at beginning of period from discontinued operations

 
2.8

Less: Cash and cash equivalents at end of period from discontinued operations

 
(3.7
)
Cash and cash equivalents at end of period
$
68.6

 
$
54.0

 
 
 
 
Supplemental information - cash paid for:
 
 
 
Income taxes
$
10.3

 
$
8.8

Interest
$
5.4

 
$
7.3


See accompanying Notes to Consolidated Financial Statements

5


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 


1. Basis of Presentation

Description of Business - Knowles Corporation (NYSE:KN) is a market leader and global supplier of advanced micro-acoustic, audio processing, and precision device solutions, serving the mobile consumer electronics, communications, medical, military, aerospace, and industrial markets. The Company uses its leading position in micro-electro-mechanical systems ("MEMS") microphones and strong capabilities in audio processing technologies to optimize audio systems and improve the user experience in mobile, ear, and Internet of Things ("IoT") applications. Knowles is also the leader in acoustics components used in hearing aids and has a strong position in high-end capacitors. The Company's focus on its customers, combined with its unique technology, proprietary manufacturing techniques, rigorous testing, and global scale, enable the Company to deliver innovative solutions that optimize the user experience. References to "Knowles," "the Company," "we," "our," and "us" refer to Knowles Corporation and its consolidated subsidiaries.

Financial Statement Presentation - The accompanying unaudited interim Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") for quarterly reports on Form 10-Q and do not include all of the information and note disclosures required by U.S. generally accepted accounting principles (“GAAP” or “U.S. GAAP”) for complete financial statements. These unaudited interim Consolidated Financial Statements should therefore be read in conjunction with the Consolidated Financial Statements and Notes thereto for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K.

The accompanying unaudited interim Consolidated Financial Statements have been prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions that affect amounts reported in the Consolidated Financial Statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may differ from those estimates. The unaudited interim Consolidated Financial Statements reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for a fair statement of results for these interim periods.

On January 19, 2018, the Company acquired substantially all of the assets of Compex Corporation ("Compex"), a capacitors manufacturer. See Note 3. Acquisitions for additional information related to the transaction.

On November 28, 2017, the Company completed the sale of its high-end oscillators business ("Timing Device Business"). In accordance with Accounting Standards Codification ("ASC") 205-20, Presentation of Financial Statements - Discontinued Operations, the results of operations and related assets and liabilities for the Timing Device Business have been reclassified as discontinued operations for all periods presented. See Note 2. Disposed and Discontinued Operations for additional information related to the transaction.

Non-cash Investing Activities - Purchases of property, plant, and equipment included in accounts payable at September 30, 2018 and 2017 were $8.0 million and $3.4 million, respectively. These non-cash amounts are not reflected as outflows to Additions to property, plant, and equipment within investing activities of the Consolidated Statements of Cash Flows for the respective periods.

Reclassifications - Certain amounts in prior periods have been reclassified to conform to the current period presentation. See Note 17. Recent Accounting Standards for additional information.

2. Disposed and Discontinued Operations

Management and the Board of Directors periodically conduct strategic reviews of the Company's businesses.

On November 28, 2017, the Company completed the sale of its Timing Device Business, part of the Precision Devices ("PD") segment, to Microsemi Corporation for $130.0 million, plus purchase price adjustments for a net amount of $135.1 million. The Company recorded a gain of $63.9 million as a result of the sale, which included $0.4 million of gain amounts reclassified from Accumulated other comprehensive loss into earnings related to currency translation adjustments. The purchase price included $10.0 million held in escrow that was received during the third quarter of 2018 and was previously recorded in the Prepaid and other current assets line on the Consolidated Balance Sheets.

On July 7, 2016, the Company completed the sale of its speaker and receiver product line ("Speaker and Receiver Product Line"). The Speaker and Receiver Product Line had no effect on the Company's results of operations for the three and nine months ended September 30, 2018.

6


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 


The results of operations and financial positions of the Timing Device Business and Speaker and Receiver Product Line have been reclassified to discontinued operations for all periods presented as these disposals represent strategic shifts that have a major effect on the Company's results of operations.

Summarized results of the Company's discontinued operations are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2018
 
2017
 
2018
 
2017
Revenues
$

 
$
25.7

 
$

 
$
76.9

Cost of goods sold

 
16.6

 

 
50.9

Impairment charges

 
0.3

 

 
0.3

Gross profit

 
8.8

 

 
25.7

Research and development expenses

 
2.0

 

 
6.2

Selling and administrative expenses

 
4.9

 
(0.2
)
 
14.0

Restructuring charges

 

 

 
0.2

Operating expenses (income)

 
6.9

 
(0.2
)
 
20.4

Other expense (income), net

 
0.6

 
(0.2
)
 
1.6

Gain on sale of business (1)
(1.6
)
 

 
(1.6
)
 

Earnings from discontinued operations before taxes (2)
1.6

 
1.3

 
2.0

 
3.7

(Benefit from) provision for income taxes

 
(3.9
)
 
0.1

 
(4.5
)
Earnings from discontinued operations, net of tax
$
1.6

 
$
5.2

 
$
1.9

 
$
8.2

(1) The Company recorded a change in estimated purchase price adjustments of $1.8 million during the three months ended September 30, 2018.
(2) The Company's policy is to not allocate interest expense to discontinued operations unless it is directly attributable to the operations. The results of operations of the Timing Device Business and Speaker and Receiver Product Line did not have any such interest expense in the periods presented.


Assets and liabilities of discontinued operations are summarized below:
(in millions)
September 30, 2018
 
December 31, 2017
Assets of discontinued operations:
 
 
 
Receivables
$

 
$
1.2

Prepaid and other current assets
0.2

 
0.5

Total current assets
0.2

 
1.7

Total assets (1)
$
0.2

 
$
1.7

 
 
 
 
Liabilities of discontinued operations:
 
 
 
Accounts payable
$
0.2

 
$
0.1

Other current liabilities

 
5.5

Total current liabilities
0.2

 
5.6

Total liabilities (1)
$
0.2

 
$
5.6

(1) In connection with the sale of the Timing Device Business, the Company retained certain obligations related to employees of the Timing Device Business. This arrangement results in maintaining asset and liability balances, which are expected to be settled during the current fiscal year.

7


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 


The following table presents the depreciation, amortization, and capital expenditures related to discontinued operations:
 
Nine Months Ended September 30,
(in millions)
2018
 
2017
Depreciation
$

 
$
2.2

Amortization of intangible assets

 
1.1

Capital expenditures

 
2.1



There were capital expenditures of nil and $0.2 million included in accounts payable at September 30, 2018 and 2017, respectively.

3. Acquisitions

On January 19, 2018, the Company acquired substantially all of the assets of Compex for $16.0 million, plus purchase price adjustments for a net amount of $18.7 million. The asset purchase agreement relating to the acquisition provided for a $0.6 million post-closing working capital adjustment that settled on April 2, 2018 as well as a $1.0 million holdback that will be paid eighteen months from the completion of the acquisition and is recorded in the Other accrued expenses line on the Consolidated Balance Sheets. The acquired business provides single layer electronic components to the telecommunication, fiber optics, defense, and aerospace markets. The transaction was accounted for under the acquisition method of accounting and the results of operations are included in the Consolidated Financial Statements from the date of acquisition in the PD segment. Included in the Consolidated Statements of Earnings are Compex's revenues and earnings before income taxes of $9.5 million and $2.6 million, respectively, from the date of acquisition through September 30, 2018.

The table below represents the final allocation of the purchase price to net assets acquired as of January 19, 2018:
(in millions)
Cash
$
0.2

Receivables
1.7

Inventories
2.1

Property, plant, and equipment
2.0

Customer relationships
7.3

Unpatented technologies
2.0

Trademarks and other amortized intangible assets
0.4

Other assets
0.2

Goodwill
3.0

Assumed current liabilities
(0.2
)
Total purchase price
$
18.7



The Company recorded a purchase price adjustment related to property, plant, and equipment during the nine months ended September 30, 2018, resulting in an increase to goodwill of $0.1 million. The adjustment did not impact the Consolidated Statements of Earnings.

Compex Intangible Assets Recorded

Customer relationships, unpatented technologies, and trademarks will be amortized over estimated useful lives of 10 years, 8 years, and 5 years, respectively. The fair value for customer relationships was determined using the excess earnings method under the income approach. The fair values of unpatented technologies and trademarks were determined using the relief from royalty method under the income approach. The fair value measurements of intangible assets are based on significant unobservable inputs, and thus represent Level 3 inputs. Significant assumptions used in assessing the fair values of intangible assets include discounted future cash flows, customer attrition rates, and royalty rates.


8


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 

The excess of the total purchase price over the total fair value of the identifiable assets and liabilities was recorded as goodwill. The goodwill recognized is primarily attributable to the assembled workforce and synergies. None of the goodwill resulting from this acquisition is tax deductible. Goodwill has been allocated to the PD segment, which is the segment expected to benefit from the acquisition.

Impact of Compex Acquisition and Pro-forma Summary

The following unaudited pro-forma summary presents consolidated financial information as if Compex had been acquired on January 1, 2017. The unaudited pro-forma financial information is based on historical results of operations and financial positions of the Company and Compex. The pro-forma results include estimated amortization of definite-lived intangible assets and the estimated depreciation expense of the fixed asset step-up to fair value. The pro-forma results exclude transaction costs and the estimated cost of the inventory step-up to fair value.

The unaudited pro-forma financial information does not necessarily represent the results that would have occurred had the acquisition occurred on January 1, 2017. In addition, the unaudited pro-forma information should not be deemed to be indicative of future results.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions, except share and per share amounts)
2017
 
2018
 
2017
Revenues from continuing operations:
 
 
 
 
 
As reported
$
196.0

 
$
603.1

 
$
528.7

Pro-forma
198.6

 
603.7

 
537.3

Earnings (loss) from continuing operations:


 
 
 
 
As reported
$
10.5

 
$
(13.8
)
 
$
(25.4
)
Pro-forma
10.3

 
(13.1
)
 
(24.4
)
Basic earnings (loss) per share from continuing operations:


 
 
 
 
As reported
$
0.12

 
$
(0.15
)
 
$
(0.28
)
Pro-forma
0.12

 
(0.15
)
 
(0.27
)
Diluted earnings (loss) per share from continuing operations:


 
 
 
 
As reported
$
0.12

 
$
(0.15
)
 
$
(0.28
)
Pro-forma
0.11

 
(0.15
)
 
(0.27
)


Other Acquisition

On January 11, 2017, the Company completed an acquisition of certain assets of a capacitors manufacturer for cash consideration of $3.7 million, of which $2.5 million was paid during the first quarter of 2017. An additional $1.0 million was paid during the nine months ended September 30, 2018, with the remaining $0.2 million to be paid by the first quarter of 2019. This acquisition's operations are included in the PD segment. The financial results of this acquisition were included in our Consolidated Financial Statements beginning January 11, 2017. Pro-forma financial information has not been provided as the acquisition did not have a material impact on the Consolidated Statements of Earnings.


9


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 

4. Impairments

The Company evaluates long-lived assets for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. During the second quarter of 2017, an updated strategic plan was completed for Audio segment product lines. The updated strategic plan identified a decline of future demand for a specific product line, which indicated projected future cash flows may not be sufficient to recover the carrying value of the associated unpatented technologies and property, plant, and equipment assets. The utilization of undiscounted future cash flows was used to determine recoverability of the long-lived assets. The fair value of the intangibles was determined through the use of discounted cash flows, and the fair value of fixed assets was determined using their liquidation value. As a result of this analysis, the Company concluded that the fair values of these long-lived assets were less than their respective carrying values as of June 30, 2017. The Company recorded total impairment charges of $21.3 million, of which $5.1 million was related to fixed assets and $16.2 million was related to intangible assets. The Company recorded $1.4 million of the charges within Impairment charges in Gross profit and recorded $19.9 million within the Impairment charges line item in Operating expenses within the Consolidated Statements of Earnings.

5. Inventories, net

The following table details the major components of inventories, net:
(in millions)
September 30, 2018
 
December 31, 2017
Raw materials
$
70.7

 
$
65.9

Work in progress
34.0

 
21.3

Finished goods
77.3

 
60.8

Subtotal
182.0

 
148.0

Less reserves
(27.9
)
 
(22.4
)
Total
$
154.1

 
$
125.6



6. Property, Plant, and Equipment, net

The following table details the major components of property, plant, and equipment, net:
(in millions)
September 30, 2018
 
December 31, 2017
Land
$
7.4

 
$
7.7

Buildings and improvements
101.2

 
103.2

Machinery, equipment, and other
485.2

 
441.1

Subtotal
593.8

 
552.0

Less accumulated depreciation
(392.5
)
 
(369.0
)
Total
$
201.3

 
$
183.0



Depreciation expense totaled $11.4 million and $11.9 million for the three months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 and 2017, depreciation expense totaled $34.8 million and $35.2 million, respectively.

During the nine months ended September 30, 2017, the Company recorded a $5.1 million impairment charge on fixed assets. See Note 4. Impairments for more information.

7. Goodwill and Other Intangible Assets

The changes in carrying value of goodwill by reportable segment for the nine months ended September 30, 2018 are as follows:
(in millions)
Audio
 
Precision Devices
 
Total
Balance at December 31, 2017
$
859.9

 
$
25.0

 
$
884.9

Acquisition

 
3.0

 
3.0

Balance at September 30, 2018
$
859.9

 
$
28.0

 
$
887.9




10


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 

The gross carrying value and accumulated amortization for each major class of intangible assets are as follows:
 
September 30, 2018
 
December 31, 2017
(in millions)
Gross Carrying
Amount
 
Accumulated
Amortization
 
Gross Carrying
Amount
 
Accumulated
Amortization
Amortized intangible assets:
 
 
 
 
 
 
 
Trademarks
$
0.5

 
$
0.2

 
$
0.3

 
$
0.2

Patents
40.8

 
25.7

 
40.8

 
22.2

Customer relationships
10.6

 
1.7

 
3.3

 
0.7

Unpatented technologies
4.4

 
2.6

 
2.4

 
2.2

Other
0.2

 

 

 

Total
56.5

 
30.2

 
46.8

 
25.3

Unamortized intangible assets:
 
 
 
 
 
 
 
Trademarks
32.0

 
 
 
32.0

 
 
Total intangible assets, net
$
58.3

 
 
 
$
53.5

 
 


Amortization expense totaled $1.7 million and $1.3 million for the three months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 and 2017, amortization expense was $4.9 million and $5.9 million, respectively. Amortization expense for the next five years, based on current intangible balances, is estimated to be as follows:
(in millions)
 
Q4 2018
$
1.6

2019
6.4

2020
6.4

2021
6.3

2022
1.1



8. Restructuring and Related Activities

Restructuring and related activities are designed to better align the Company's operations with current market conditions through targeted facility consolidations, headcount reductions, and other measures to further optimize operations.

During the nine months ended September 30, 2018, the Company recorded restructuring charges of $0.1 million within Gross profit for actions associated with rationalizing the workforce in the Precision Devices segment. During the three and nine months ended September 30, 2018, the Company recorded restructuring charges of $0.5 million and $1.4 million, respectively, within Operating expenses primarily for actions associated with rationalizing the workforce.

During the three and nine months ended September 30, 2017, the Company recorded net restructuring charges of $0.2 million and $3.9 million within Gross profit for actions primarily associated with transferring certain operations of hearing health manufacturing to an existing, lower-cost Asian manufacturing facility. These charges were recorded within the Audio segment. During the three and nine months ended September 30, 2017, the Company also recorded restructuring charges of $0.9 million and $4.2 million within Operating expenses primarily for actions associated with rationalizing the workforce.

11


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 


The following table details restructuring charges incurred by reportable segment for the periods presented:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2018
 
2017
 
2018
 
2017
Audio (1)
$
0.3

 
$
0.6

 
$
1.1

 
$
6.0

Precision Devices

 

 
0.2

 
0.1

Corporate
0.2

 
0.5

 
0.2

 
2.0

Total
$
0.5

 
$
1.1

 
$
1.5

 
$
8.1


(1) During the nine months ended September 30, 2017, the Company reversed $0.9 million of previously recorded restructuring charges in Gross profit due to subsequent developments that impacted the previously estimated amounts.

The following table details the Company’s severance and other restructuring accrual activity:
(in millions)
Severance Pay and Benefits
 
Contract Termination and Other Costs
 
Total
Balance at December 31, 2017
$
4.7

 
$
0.4

 
$
5.1

Restructuring charges
1.5

 

 
1.5

Payments
(5.6
)
 
(0.1
)
 
(5.7
)
Balance at September 30, 2018
$
0.6

 
$
0.3

 
$
0.9



The severance and restructuring accruals are recorded in the following line items on the Consolidated Balance Sheets:
(in millions)
September 30, 2018
 
December 31, 2017
Other accrued expenses
$
0.7

 
$
4.8

Other liabilities (1) 
0.2

 
0.3

Total
$
0.9

 
$
5.1


(1) This line represents the long-term portion of the charges associated with lease obligations, net of reasonably obtainable sublease income.

9. Hedging Transactions and Derivative Instruments

The Company is affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company’s financial performance and are referred to as "market risks." The Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks, which are primarily foreign currency risk and interest rate risk related to ongoing business operations.

Cash Flow Hedging

The Company uses cash flow hedges to minimize the variability in cash flows of assets, liabilities, or forecasted transactions caused by fluctuations in foreign currency exchange rates or market interest rates. These derivatives, which are designated cash flow hedges, are carried at fair value. The changes in their fair values are recorded to Accumulated Other Comprehensive Income (Loss) ("AOCI") and reclassified in current earnings when the hedge contract matures or becomes ineffective.

To manage its exposure to foreign currency exchange rates, the Company has entered into currency deliverable forward contracts. These derivative instruments allow the Company to hedge portions of its forecasted intercompany sales, which are expected to occur within the next twelve months and are denominated in non-functional currencies. The Company maintains a foreign currency cash flow hedging program primarily to reduce the risk that the net U.S. dollar cash inflows from non-U.S. dollar sales and non-U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. At September 30, 2018 and December 31, 2017, the notional value of the derivatives related to currency forward contracts, principally the Chinese yuan, Malaysian ringgit, and Philippine peso, was $51.0 million and $17.9 million, respectively.


12


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 

To manage its exposure to market risk for changes in interest rates, the Company entered into an interest rate swap on November 12, 2014 to convert variable interest rate payments into a fixed rate on a notional amount of $100.0 million of debt for monthly interest payments that began in January 2016. The Company designated the swap as a cash flow hedge with re-measurement gains and losses recorded through AOCI. In December 2017, the Company entered into a partial termination of the interest rate swap and reduced the notional amount to $50.0 million. The interest rate swap ended in July 2018.

Economic (Non-Designated) Hedging

In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency risk. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effectively economic hedges. The changes in fair value of these economic hedges are immediately recognized in earnings.

The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in non-functional currencies. The Company does not enter into these hedges for speculative reasons. These derivatives are carried at fair value with changes in fair value immediately recognized in earnings within Other expense (income), net. In addition, these derivative instruments minimize the impact of exchange rate movements on the Company’s balance sheet, as the gains or losses on these derivatives are intended to offset gains and losses from the reduction of the hedged assets and liabilities. At September 30, 2018 and December 31, 2017, the notional value of the derivatives related to economic hedging was $9.0 million and $6.4 million, respectively.

The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, or other financial indices. The Company does not view the fair values of its derivatives in isolation, but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets.

Fair Value Measurements

All derivatives are carried at fair value on the Company’s Consolidated Balance Sheets. ASC 820, Fair Value Measurement, establishes a fair value hierarchy that requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. ASC 820 establishes three levels of inputs that may be used to measure fair value as follows:

Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of assets or liabilities.

Level 3 - Unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The Company determines the fair values of its derivatives based on standard valuation models or observable market inputs such as quoted market prices, foreign currency exchange rates, or interest rates; therefore, the Company classifies the derivatives within Level 2 of the valuation hierarchy.

The Company early adopted Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") 2017-12 as of January 1, 2018. The standard requires adoption of the amended presentation and disclosure requirements on a prospective basis. With respect to presentation requirements, the Company began presenting the impact of foreign exchange contracts qualifying as cash flow hedges within the Cost of goods sold line on the Consolidated Statements of Earnings as of January 1, 2018. These amounts were classified in the Other expense (income), net line in prior periods. This change aligns the presentation of the impact of these hedges with the same line on the Consolidated Statements of Earnings that is used to present the earnings effect of the hedged item. With respect to disclosure requirements, the Company has enhanced the tabular disclosures below to align with the standard. See Note 17. Recent Accounting Standards for additional information on the adoption of this standard.

13


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
(unaudited)
 


The fair values of derivative instruments held by the Company are as follows (in millions):
 
 
 
Derivative Assets (Liabilities)
Hedge Type
Contract Type
Balance Sheet Line
September 30, 2018
 
December 31, 2017
Derivatives designated as hedging instruments
 
 
 
Cash flow hedges
Foreign exchange contracts
Prepaid and other current assets
$

 
$
0.6

Cash flow hedges
Foreign exchange contracts
Other accrued expenses
(1.9
)
 

 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
Economic hedges
Foreign exchange contracts
Other accrued expenses
(0.1
)
 



The pre-tax amount of unrealized (loss) gain recognized in accumulated other comprehensive loss on derivatives designated as hedging instruments is as follows (in millions):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Hedge Type
Contract Type
 
2018
 
2017
 
2018
 
2017
Cash flow hedges
Foreign exchange contracts
 
$
(1.3
)
 
$
0.9

 
$
(2.8
)
 
$
2.7

Cash flow hedges
Interest rate contracts
 

 

 
0.1

 
0.1


The table above excludes a tax benefit of $0.2 million and tax expense of $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and a tax benefit of $0.4 million and tax expense of $0.4 million for the nine months ended September 30, 2018 and 2017, respectively.

The pre-tax impact of derivatives on the Consolidated Statements of Earnings is as follows (in millions):
 
 
 
Three Months Ended September 30,
 
 
 
2018
 
2017
Hedge Type
Contract Type
 
Cost of goods sold
Interest expense, net
Other expense (income), net
 
Interest expense, net
Other expense (income), net
Total amounts per Consolidated Statements of Earnings
 
$
146.4

$
4.0

$
0.3

 
$
5.1

$
(0.7
)
 
 
 
 
 
 
 
 
 
Effect of derivatives designated as hedging instruments
Amount of loss (gain) reclassified from accumulated other comprehensive loss into earnings:
 
 
Cash flow hedges
Foreign exchange contracts
 
1.1



 

(0.5
)
Cash flow hedges
Interest rate contracts