Background and Basis of Presentation | 1. BACKGROUND AND BASIS OF PRESENTATION Background CommScope Holding Company, Inc., along with its direct and indirect subsidiaries (CommScope or the Company), is a global provider of infrastructure solutions for the core, access and edge layers of communication networks. The Company’s solutions and services for wired and wireless networks enable high-bandwidth data, video and voice applications. CommScope’s global leadership position is built upon innovative technology, broad solution offerings, high-quality and cost-effective customer solutions, and global manufacturing and distribution scale. Basis of Presentation The Condensed Consolidated Balance Sheet as of September 30, 2017, the Condensed Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2017 and 2016, and the Condensed Consolidated Statements of Cash Flows and Stockholders’ Equity for the nine months ended September 30, 2017 and 2016 are unaudited and reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for a fair presentation of the interim period financial statements. The results of operations for these interim periods are not necessarily indicative of the results of operations to be expected for any future period or the full fiscal year. The unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and are presented in accordance with the applicable requirements of Regulation S-X. Accordingly, these financial statements do not include all of the information and notes required by U.S. GAAP for complete financial statements. The significant accounting policies followed by the Company are set forth in Note 2 within the Company’s audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 (the 2016 Annual Report). There were no changes in the Company’s significant accounting policies during the three or nine months ended September 30, 2017. These interim condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements. Prior to January 1, 2017, the Company consolidated the operating results of the acquired BNS business based on the BNS fiscal reporting calendar that resulted in a reporting lag of one day for the year ended December 31, 2016. The BNS business results included thirteen weeks for the three months ended September 30, 2017 compared to fourteen weeks for the comparable period in 2016. Effective January 1, 2017, the reporting lag was eliminated as a result of system conversions that were part of the BNS integration. The elimination of the reporting lag represents a change in accounting principle which the Company believes to be preferable because it provides more current information to the users of its financial statements. The Company determined that it was impracticable to apply the effects of the lag elimination to financial reporting periods prior to January 1, 2017. The cumulative effect of not retroactively applying this change in accounting, however, was immaterial as of January 1, 2017. Therefore, the Company reported the cumulative effect of the change in accounting principle in net income for the nine months ended September 30, 2017 and did not retrospectively apply the effects of this change to prior periods. Concentrations of Risk and Related Party Transactions Net sales to Anixter International Inc. and its affiliates (Anixter) accounted for 12% and 11% of the Company’s total net sales during the three and nine months ended September 30, 2017, respectively. Net sales to Anixter accounted for 11% of the Company’s total net sales during the three and nine months ended September 30, 2016. Sales to Anixter primarily originate within the CommScope Connectivity Solutions (CCS) segment. Other than Anixter, no direct customer accounted for 10% or more of the Company’s total net sales for the three or nine months ended September 30, 2017 or 2016. Accounts receivable from Anixter and Verizon Communications Inc. (Verizon) each represented approximately 11% of accounts receivable as of September 30, 2017. Other than Anixter and Verizon, no direct customer accounted for 10% or more of the Company’s accounts receivable as of September 30, 2017. Product Warranties The Company recognizes a liability for the estimated claims that may be paid under its customer warranty agreements to remedy potential deficiencies of quality or performance of the Company’s products. These product warranties extend over periods ranging from one to twenty-five years from the date of sale, depending upon the product subject to the warranty. The Company records a provision for estimated future warranty claims as cost of sales based upon the historical relationship of warranty claims to sales and specifically identified warranty issues. The Company bases its estimates on assumptions that are believed to be reasonable under the circumstances and revises its estimates, as appropriate, when events or changes in circumstances indicate that revisions may be necessary. Such revisions may be material. The following table summarizes the activity in the product warranty accrual, included in other accrued liabilities: Three Months Ended Nine Months Ended September 30, September 30, 2017 2016 2017 2016 Product warranty accrual, beginning of period $ 20,283 $ 18,356 $ 21,631 $ 17,964 Provision for warranty claims 284 3,435 4,515 7,954 Warranty claims paid (2,033 ) (106 ) (7,751 ) (4,517 ) Foreign exchange (62 ) 92 77 376 Product warranty accrual, end of period $ 18,472 $ 21,777 $ 18,472 $ 21,777 Commitments and Contingencies The Company is either a plaintiff or a defendant in certain pending legal matters in the normal course of business. Management believes none of these legal matters will have a material adverse effect on the Company’s business or financial condition upon final disposition. In addition, the Company is subject to various federal, state, local and foreign laws and regulations governing the use, discharge, disposal and remediation of hazardous materials. Compliance with current laws and regulations has not had, and is not expected to have, a materially adverse effect on the Company’s financial condition or results of operations. Asset Impairments Goodwill is tested for impairment annually or at other times if events have occurred or circumstances exist that indicate the carrying value of the reporting unit may exceed its fair value. There were no goodwill impairments identified during the three and nine months ended September 30, 2017. During the nine months ended September 30, 2016, the Company recorded a $15.3 million goodwill impairment charge as a result of the change in its reportable segments. The impairment was recorded in the CCS segment. Property, plant and equipment and intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable, based on the undiscounted cash flows expected to be derived from the use and ultimate disposition of the assets. Assets identified as impaired are carried at estimated fair value. During the three months and nine months ended September 30, 2016, as a result of revisions to the business plan for a particular product line, the Company determined that certain intangible assets in the CCS segment were no longer recoverable and a $7.4 million impairment charge was recorded. There were no asset impairments identified during the three and nine months ended September 30, 2017. Income Taxes The effective income tax rate of 24.8% and 23.6% for the three and nine months ended September 30, 2017, respectively, was lower than the statutory rate of 35.0% primarily due to a reduction in tax expense related to the expiration of statutes of limitations on various uncertain tax positions. In addition, the effective income tax rate was favorably impacted by $0.4 million and $13.5 million of excess tax benefits related to equity-based compensation awards for the three and nine months ended September 30, 2017, respectively. Such benefits, which were previously reflected in additional paid-in capital, are now recognized in income tax expense as a result of the adoption of Accounting Standards Update (ASU) No. 2016-09. See the discussion under Recent Accounting Pronouncements for further information regarding the adoption of this new accounting guidance. Offsetting these decreases for the three and nine months ended September 30, 2017 was the effect of the provision for state income taxes. The effective income tax rate of 11.4% and 24.6% for the three and nine months ended September 30, 2016, respectively, was lower than the statutory rate of 35.0% primarily due to a reduction in tax expense related to the expiration of statutes of limitations on various uncertain tax positions and the release of valuation allowances related to certain foreign deferred tax assets. The effective income tax rate was also favorably affected by the impact of earnings in foreign jurisdictions that the Company does not plan to repatriate. These earnings are generally taxed at rates lower than the United States (U.S.) statutory rate. Offsetting these decreases for the nine months ended September 30, 2016 was the effect of the provision for state income taxes as well as the goodwill impairment for which only partial tax benefits were recorded. Earnings Per Share Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is based on net income divided by the weighted average number of common shares outstanding plus the effect of potentially dilutive common shares using the treasury stock method. Potentially dilutive common shares include outstanding equity-based awards (stock options, restricted stock units and performance share units). Certain outstanding equity-based awards were not included in the computation of diluted earnings per share because the effect was either antidilutive or the performance conditions were not met (1.7 million shares and 1.3 million shares for the three and nine months ended September 30, 2017, respectively, and 1.4 million shares and 1.5 million shares for the three and nine months ended September 30, 2016, respectively). During the three and nine months ended September 30, 2017, the Company repurchased 2.3 million shares and 4.8 million shares, respectively, of its common stock. The Company did not repurchase any of its common stock during the three and nine months ended September 30, 2016. See Note 11 for more information on the share repurchase programs. The following table presents the basis for the earnings per share computations (in thousands, except per share data): Three Months Ended Nine Months Ended September 30, September 30, 2017 2016 2017 2016 Numerator: Net income for basic and diluted earnings per share $ 51,157 $ 93,831 $ 140,183 $ 168,372 Denominator: Weighted average common shares outstanding - basic 191,824 192,719 192,973 192,275 Dilutive effect of equity-based awards 3,991 3,879 4,414 3,866 Weighted average common shares outstanding - diluted 195,815 196,598 197,387 196,141 Earnings per share: Basic $ 0.27 $ 0.49 $ 0.73 $ 0.88 Diluted $ 0.26 $ 0.48 $ 0.71 $ 0.86 Recent Accounting Pronouncements Adopted During the Nine Months Ended September 30, 2017 The Company adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, The Company also adopted ASU No. 2016-15, Cash Flow Classification of Certain Cash Receipts and Cash Payments Issued but Not Adopted In March 2017, the Financial Accounting Standards Board (FASB) issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test of Goodwill Impairment In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments In February 2016, the FASB issued ASU No. 2016-02, Leases supersedes the current leasing guidance in Topic 840, Leases. Under the new guidance, lessees are required to recognize assets and lease liabilities for the rights and obligations created by leased assets previously classified as operating leases In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (except those accounted for under the equity method of accounting) In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers The Company has completed an impact assessment and determined that adoption of the standard will likely result in an acceleration of when revenues are recognized for certain contracts containing multiple performance obligations. These contract revenues are currently accounted for using the multi-element guidance and are primarily for certain metro cell, distributed antenna system (DAS) and small cell solutions within the CommScope Mobility Solutions (CMS) segment. These multi-element revenue contracts represented less than 2% of total net sales for the three and nine months ended September 30, 2017. Due to the short-term nature of most of the contracts, the impact to the Company’s consolidated financial statements at adoption will be based on customer-specific contract terms in effect at that time and could be significant. The Company is in the process of implementing the necessary changes to its accounting policies, processes, internal controls and information systems that will be required to meet the new standard’s reporting and disclosure requirements. 2 |