Nature of Business Operations

Power Solutions International, Inc. (“Power Solutions,” “PSI” or “the Company”), a Delaware corporation, is a global producer and distributor of a broad range of high-performance, certified low-emission power systems, including alternative-fueled power systems for original equipment manufacturers (“OEMs”) of off-highway industrial equipment and certain on-road vehicles and large custom-engineered integrated electrical power generation systems.

The Company’s customers include large, industry-leading and multinational organizations. The Company’s products and services are sold predominantly to customers throughout North America as well as to customers located throughout the Pacific Rim and Europe. The Company’s power systems are highly engineered, comprehensive systems which, through the Company’s technologically sophisticated development and manufacturing processes, including its in-house design, prototyping, testing and engineering capabilities and its analysis and determination of the specific components to be integrated into a given power system (driven in large part by emission standards and cost considerations), allow the Company to provide its customers with power systems customized to meet specific OEM application requirements, other technical customers’ specifications and requirements imposed by environmental regulatory bodies.

The Company’s power system configurations range from a basic engine integrated with appropriate fuel system components to completely packaged power systems that include any combination of cooling systems, electronic systems, air intake systems, fuel systems, housings, power takeoff systems, exhaust systems, hydraulic systems, enclosures, brackets, hoses, tubes and other assembled componentry. The Company also designs and manufactures large, custom engineered integrated electrical power generation systems for both standby and prime power applications. The Company purchases engines from third-party suppliers and produces internally-designed engines, all of which are then integrated into its power systems.

Of the other components that the Company integrates into its power systems, a substantial portion consist of internally designed components and components for which it coordinates significant design efforts with third-party suppliers, with the remainder consisting largely of parts that are sourced off-the-shelf from third-party suppliers. Some of the key components (including purchased engines) embody proprietary intellectual property of the Company’s suppliers. As a result of its design and manufacturing capabilities, the Company is able to provide its customers with a power system that can be incorporated into a customer’s specified application. In addition to the certified products described above, the Company sells diesel, gasoline and non-certified power systems and aftermarket components.

In March 2017, the Company executed a share purchase agreement (the “SPA”) with Weichai America Corp., a wholly owned subsidiary of Weichai Power Co., Ltd. (HK2338, SZ000338) (herein collectively referred to as “Weichai”). Under the terms of the SPA, Weichai invested $60.0 million in the Company purchasing a combination of newly issued Common and Preferred Stock as well as a stock purchase warrant (the “Weichai Warrant”).

Stock Ownership and Control

With the exercise of the Weichai Warrant in April 2019, Weichai owns a majority of the outstanding shares of the Company's Common Stock. As a result, Weichai is able to exercise control over matters requiring stockholders’ approval, including the election of the Directors, amendment of the Company’s Charter and approval of significant corporate transactions. This control could have the effect of delaying or preventing a change of control of the Company or changes in management and will make the approval of certain transactions impractical without the support of Weichai.

Weichai entered into an Investor Rights Agreement (the “Rights Agreement”) with the Company upon execution of the SPA. The Rights Agreement provides Weichai with representation on the Company’s Board of Directors (the “Board”) and management representation rights. Weichai currently has three representatives on the Board. According to the Rights Agreement, with Weichai exercising the Weichai Warrant and becoming the majority owner of the outstanding shares of the Company's Common Stock calculated on a fully-diluted as-converted basis (excluding certain excepted issuances), the Company is obligated to appoint to the Board an additional individual designated by Weichai, and Weichai thereafter has the right to nominate for election four Directors and any additional number of designees necessary to ensure that its designees constitute the majority of the Directors serving on the Board. According to the Rights Agreement, during any period when the Company is a “controlled company” within the meaning of the NASDAQ Stock Market (“NASDAQ”) Listing Rules, it will take such measures as to avail itself of the “controlled company” exemptions available under Rule 5615 of the NASDAQ Listing Rules of Rules 5605(b), (d) and (e).

Going Concern Considerations

The Company’s management has concluded that, due to uncertainties surrounding the Company’s ability to amend or refinance its current debt agreements and the uncertainty as to whether it will have sufficient liquidity to fund its business activities, substantial doubt exists as to its ability to continue as a going concern within one year after the date that these financial statements are issued. The Company’s plans to alleviate the substantial doubt about its ability to continue as a going concern may not be successful, and it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.

The consolidated financial statements included herein have been prepared assuming that the Company will continue as a going concern and contemplating the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company’s ability to continue as a going concern is dependent on generating profitable operating results, having sufficient liquidity, maintaining compliance with the covenants and other requirements under the Wells Fargo Credit Agreement (the “Wells Fargo Credit Agreement”) with Wells Fargo Bank, N.A. (“Wells Fargo”) and the Unsecured Senior Notes (the “Unsecured Senior Notes”), and refinancing or repaying the indebtedness outstanding under those agreements. The current Wells Fargo Credit Agreement maturity date is the earlier of March 31, 2021, or 60 days prior to the final maturity of the Unsecured Senior Notes, which currently mature on June 30, 2020, resulting in a current maturity date of May 1, 2020 for the Wells Fargo Credit Agreement.

Based on the Company’s current forecasts, without additional financing, the Company anticipates that it will not have sufficient cash and cash equivalents to repay the Unsecured Senior Notes by May 1, 2020. Management plans to seek additional liquidity from other lenders before May 1, 2020 to avoid acceleration of the Wells Fargo Credit Agreement. There can be no assurance that the Company’s management will be able to successfully complete a financing on acceptable terms or repay this outstanding indebtedness, when required or if at all. The consolidated financial statements included in this Form 10-K do not include any adjustments that might result from the outcome of the Company’s efforts to address these issues.

Furthermore, if the Company cannot raise capital on acceptable terms, it may not, among other things, be able to:


•	Continue to expand the Company’s research and product investments and sales and marketing organization;


•	Expand operations both organically and through acquisitions; and


•	Respond to competitive pressures or unanticipated working capital requirements.

Basis of Presentation and Consolidation

The Company is filing this Annual Report on Form 10-K for the year ended December 31, 2018, which contains audited consolidated financial statements as of and for the years ended December 31, 2018 and 2017.

The consolidated financial statements include the accounts of Power Solutions International, Inc. and its wholly owned subsidiaries. The Company’s consolidated financial statements were prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and include the assets, liabilities, sales and expenses of all wholly owned subsidiaries and majority-owned subsidiaries in which the Company exercises control. All intercompany balances and transactions have been eliminated in consolidation.

The Company operates as one business and geographic operating segment. Operating segments are defined as components of a business that can earn revenues and incur expenses for which discrete financial information is available that is evaluated on a regular basis by the chief operating decision maker (“CODM”). The Company’s CODM is its principal executive officer, who decides how to allocate resources and assess performance. A single management team reports to the CODM, who manages the entire business. The Company’s CODM reviews Consolidated Statements of Operations to make decisions, allocate resources and assess performance, and the CODM does not evaluate the profit or loss from any separate geography or product line.

Immaterial Revision to Prior Year Period Financial Statements

Subsequent to the issuance of the 2017 financial statements, a misclassification was identified within the Company's Consolidated Balance Sheet related to the product warranty accrual. The Company previously presented the product warranty accrual within current liabilities as a component of Other accrued liabilities on the Consolidated Balance Sheets. After further evaluation, the Company determined it appropriate to reflect the portion of the Company’s product warranty accrual that is expected to be settled beyond the twelve months following the respective balance sheet date to other noncurrent liabilities. The Company assessed the materiality of the misclassification considering both qualitative and quantitative factors and determined that as of and for the year ended December 31, 2017, the three-month period ended March 31, 2017, the six-month period ended June 30, 2017, and the nine-month period ended September 30, 2017, the adjustments were immaterial. The Company has decided to correct the prior year presentation to also provide comparability to the 2018 financial statements.

The adjustments had no impact to total liabilities, total cash flows from operating activities, the Consolidated Statements of Operations, or the Statements of Convertible Preferred Stock and Stockholders' (Deficit) Equity.

The effects of the adjustments on the line items within the Company’s Consolidated Balance Sheet at December 31, 2017 and Consolidated Statement of Cash Flows for the year ended December 31, 2017, are as follows:

Consolidated Balance Sheet



(in thousands)	December 31, 2017 (As Previously Reported)		Adjustment			December 31, 2017 (As Revised)
Other accrued liabilities	$	38,362	$	(4,042	)	$	34,320
Total current liabilities	126,654		(4,042		)	122,612
Other noncurrent liabilities	8,351		4,042			12,393

Consolidated Statement of Cash Flows



	Year-Ended
(in thousands)	December 31, 2017 (As Previously Reported)			Adjustment			December 31, 2017 (As Revised)
Changes in operating assets and liabilities:
Accrued expenses	$	6,029		$	1,810		$	7,839
Other noncurrent liabilities	(5,260		)	(1,810		)	(7,070		)

The effects of the adjustments on the line items within the Company’s unaudited Consolidated Balance Sheet and Statement of Cash Flows as of and for the three-month period ended March 31, 2017, the six-month period ended June 30, 2017, and the nine-month period ended September 30, 2017, are as follows:

Consolidated Balance Sheet (unaudited)



(in thousands)	March 31, 2017 (As Previously Reported)		Adjustment			March 31, 2017 (As Revised)
Other accrued liabilities	$	35,234	$	(6,425	)	$	28,809
Total current liabilities	119,318		(6,425		)	112,893
Other noncurrent liabilities	13,328		6,425			19,753



(in thousands)	June 30, 2017 (As Previously Reported)		Adjustment			June 30, 2017 (As Revised)
Other accrued liabilities	$	35,379	$	(5,269	)	$	30,110
Total current liabilities	116,281		(5,269		)	111,012
Other noncurrent liabilities	12,438		5,269			17,707



(in thousands)	September 30, 2017 (As Previously Reported)		Adjustment			September 30, 2017 (As Revised)
Other accrued liabilities	$	41,393	$	(4,098	)	$	37,295
Total current liabilities	136,940		(4,098		)	132,842
Other noncurrent liabilities	13,312		4,098			17,410

Consolidated Statement of Cash Flows (unaudited)



	Three Months Ended
(in thousands)	March 31, 2017 (As Previously Reported)			Adjustment			March 31, 2017 (As Revised)
Changes in operating assets and liabilities:
Accrued expenses	$	2,432		$	(571	)	$	1,861
Other noncurrent liabilities	(121		)	571			450



	Six Months Ended
(in thousands)	June 30, 2017 (As Previously Reported)			Adjustment			June 30, 2017 (As Revised)
Changes in operating assets and liabilities:
Accrued expenses	$	3,242		$	584		$	3,826
Other noncurrent liabilities	(894		)	(584		)	(1,478		)



	Nine Months Ended
(in thousands)	September 30, 2017 (As Previously Reported)			Adjustment			September 30, 2017 (As Revised)
Changes in operating assets and liabilities:
Accrued expenses	$	8,867		$	1,755		$	10,622
Other noncurrent liabilities	(821		)	(1,755		)	(2,576		)

Reclassifications

Certain amounts recorded in the prior-period consolidated financial statements presented have been reclassified to conform to the current-period financial statement presentation. These reclassifications had no effect on previously reported results of operations.

Concentrations

The following table presents customers individually accounting for more than 10% of the Company’s net sales:

The following table presents customers individually accounting for more than 10% of the Company’s accounts receivable:



	As of December 31,
	2018		2017
Customer A	15	%	18	%
Customer B	**		13	%
Customer C	25	%	**

The following table presents suppliers individually accounting for more than 10% of the Company’s purchases:


**	Less than 10% of the total

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates and assumptions include the valuation of allowances for uncollectible receivables, inventory reserves, warranty reserves, Weichai warrants, stock-based compensation, evaluation of goodwill, other intangibles, plant and equipment for impairment, and determination of useful lives of long-lived assets. Actual results could materially differ from those estimates.

Cash and Cash Equivalents

Cash equivalents consist of short-term, highly liquid investments that mature within three months or less. Such investments are stated at cost, which approximates fair value. The Company’s revolving credit agreement with Wells Fargo currently includes a “lockbox” arrangement that receives all receipts and from which the Company can request increases in the revolver borrowings. See Note 6. Debt for additional information regarding the Wells Fargo Credit Agreement.

Stock-Based Compensation

The Company accounts for stock-based compensation expense based on the grant date fair value of the award with the cost recognized over the requisite service period, which is generally the vesting period of the respective award. See Note 12. Stock-Based Compensation for additional information.

Research and Development

Research and development (“R&D”) expenses are expensed when incurred. R&D expenses consist primarily of wages, materials, testing and consulting related to the development of new engines, parts and applications. These costs were $26.8 million and $18.4 million for 2018 and 2017, respectively.

Income Taxes

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to be settled or realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The Company records net deferred tax assets to the extent that it believes these assets will more likely than not be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies and results of recent operations. As of December 31, 2018 and 2017, the Company had a valuation allowance of $44.4 million and $32.0 million, respectively.

The Company records uncertain tax positions in accordance with accounting guidance, on the basis of a two-step process whereby (i) it determines whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is greater than 50 percent likely to be realized upon ultimate settlement with the related tax authority. Tax benefits related to uncertain tax positions taken or expected to be taken on a tax return are recorded when such benefits meet a more-likely-than-not threshold. Otherwise, these tax benefits are recorded when a tax position has been effectively settled, which means that the appropriate taxing authority has completed its examination even though the statute of limitations remains open, or the statute of limitation has expired. Interest and penalties related to uncertain tax positions are recognized as part of income tax expense and are accrued beginning in the period that such interest and penalties would be applicable under relevant tax law until such time that the related tax benefits are recognized. As of December 31, 2018 and 2017, the Company had an unrecognized tax benefit of $1.4 million and $1.3 million, respectively, for uncertain tax positions excluding interest and penalties.

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act included a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. federal corporate income tax rate from 34 percent to 21 percent for tax years beginning after December 31, 2017. The Tax Act also provides for the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as prospective changes beginning in 2018, including repeal of the domestic manufacturing deduction and additional limitations on executive compensation. The Company recognized the income tax effects of the Tax Act in its 2017 financial statements. The Company analyzed the Tax Act, and remeasured its U.S. deferred tax balances to reflect the new U.S. corporate income tax rate as of December 31, 2017.

Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable represent amounts billed to customers and not yet collected. Trade accounts receivable are recorded at the invoiced amount, which approximates net recoverable value, and generally do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the existing accounts receivable and is established through a charge to Selling, general and administrative expenses. The allowance is primarily determined based on historical collection experience and reviews of customer creditworthiness. Trade accounts receivable and the allowance for doubtful accounts are reviewed on a regular basis. When necessary, an allowance for the full amount of specific accounts deemed uncollectible is recorded. Accounts receivable losses are deducted from the allowance and the account balance is written off when the customer receivable is deemed uncollectible. Recoveries of previously written off balances are recognized when received. An allowance associated with anticipated future sales returns is also included in the allowance for doubtful accounts.

Insurance Recoveries

The Company records insurance recoveries related to amounts recorded as estimated losses on events covered by the Company’s insurance policies when management determines that the recovery is probable and the amount can be reasonably determined.

Inventories

Inventories are stated at the lower of cost or net realizable value, which approximates current replacement cost. Cost is principally determined using the first-in, first-out method and includes material, labor and manufacturing overhead. It is the Company’s policy to review inventories on a continuing basis for obsolete, excess and slow-moving items and to record valuation adjustments for such items in order to eliminate non-recoverable costs from inventory. Valuation adjustments are recorded in an inventory reserve account and reduce the cost basis of the inventory in the period in which the reduced valuation is determined. Inventory reserves are established based on quantities on hand, usage and sales history, customer orders, projected demand and utilization within a current or future power system. Specific analysis of individual items or groups of items is performed based on these same criteria, as well as on changes in market conditions or any other identified conditions.

Inventories consist of the following:



(in thousands)	As of December 31,
Inventories	2018			2017
Raw materials	$	90,877		$	71,732
Work in process	2,390			4,535
Finished goods	18,077			16,684
Total inventories	111,344			92,951
Inventory allowance	(5,730		)	(6,227		)
Inventories, net	$	105,614		$	86,724

Activity in the Company’s inventory allowance was as follows:



(in thousands)	For the Year Ended December 31,
Inventory Allowance	2018			2017
Balance at beginning of period	$	6,227		$	10,082
Charged to expense	2,153			421
Write-offs	(2,650		)	(4,276		)
Balance at end of year	$	5,730		$	6,227

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:



(in thousands)	As of December 31,
Prepaid Expenses and Other Current Assets	2018		2017
Insurance proceeds receivable	$	15,989	$	10,563
Prepaid expenses	3,260		3,710
Contract assets	2,926		—
Other	742		86
Total	$	22,917	$	14,359

Estimated insurance recoveries related to litigation reserves in Other accrued liabilities are reflected as assets in the Company’s Consolidated Balance Sheets when it is determined that the receipt of such amounts is probable, and the amount can be reasonably determined.

Property, Plant and Equipment

Property, plant and equipment is carried at cost and presented net of accumulated depreciation and impairments. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Property, plant and equipment is evaluated periodically to determine if an adjustment to depreciable lives is warranted. Such evaluation is based principally on the expected utilization of the long-lived assets.

Repairs and maintenance costs are charged directly to expense as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated.

Estimated useful lives by each type of asset category are as follows:



		Years
Buildings		Up to 39
Leasehold improvements		Lesser of (i) expected useful life of improvement or (ii) life of lease (including likely extension thereof)
Machinery and equipment		1 to 10

Intangible Assets

The Company’s intangible assets include customer relationships, developed technology, trade names and trademarks. Intangible assets are amortized on an accelerated basis over a period of time that approximates the pattern over which the Company expects to gain the estimated economic benefits, and such period generally ranges between 3 years and 15 years. The useful life of intangible assets is assessed and assigned based on the facts and circumstances specific to the acquisition.

Impairment of Long-Lived Assets

The Company assesses potential impairments to its long-lived assets or asset groups, excluding goodwill, which is separately tested for impairment, whenever events indicate that the carrying amount of such assets may not be recoverable. Long-lived assets are evaluated for impairment by comparing the carrying value of the asset or asset group with the estimated future net undiscounted cash flows expected to result from the use of the asset or asset group, including cash flows from disposition. If the future net undiscounted cash flows are less than the carrying value, an impairment loss is calculated. An impairment loss is determined by the amount that the asset’s or asset group’s carrying value exceeds its estimated fair value. Estimated fair value is generally measured by discounting estimated future cash flows. If an impairment loss is recognized, the adjusted balance becomes the new cost basis and is depreciated (amortized) over the remaining useful life. The Company also periodically reassesses the useful lives of its long-lived assets due to advances and changes in technologies.

In the fourth quarter of 2018, the Company recognized an impairment charge of $2.2 million related to developed technology.

Goodwill

Goodwill represents the excess of the cost of an acquired business over the amounts assigned to the net acquired assets. Goodwill is not amortized but is tested for impairment at the reporting unit level, on an annual basis or more frequently, if events occur or circumstances change indicating potential impairment. The Company annually tests goodwill for impairment on October 1st.

In evaluating goodwill for impairment, the Company may first assess qualitative factors to determine whether it is more likely than not (i.e., there is a likelihood of more than 50%) that the Company’s fair value is less than its carrying amount. Qualitative factors that the Company considers include, but are not limited to, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events. If the Company bypasses the qualitative assessment, or if the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the Company performs a two-step goodwill impairment test to identify potential goodwill impairment and measures the amount of goodwill impairment it will recognize, if any.

In the first step of the two-step goodwill impairment test, the Company compares the estimated fair value of the reporting unit with its related carrying value. The Company has two reporting units: PSI and Professional Power Products, Inc. (“3PI”). If the estimated fair value exceeds the carrying amount, no further analysis is needed. If, however, the reporting unit’s estimated fair value is less than its carrying amount, the Company proceeds to the second step and calculates the implied fair value of goodwill to determine whether any impairment is required.

The Company calculates its estimated fair value using the income and market approaches when feasible, or an asset approach when neither the income nor the market approach has sufficient data. For the income approach, a discounted cash flow method, the Company uses internally developed discounted cash flow models that include the following assumptions, among others: projections of revenues, expenses and related cash flows based on assumed long-term growth rates and demand trends, expected future investments to grow new units, and estimated discount rates. The Company based these assumptions on its historical data and experience, third-party appraisals, industry projections, and micro and macro general economic condition projections and expectations. The market approach, also called the Guideline Public Company Approach, compares the value of an entity to similar publicly traded companies. The asset approach estimates the selling price the unit could achieve under assumed market conditions.

If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

During the years ended December 31, 2018 and 2017, the estimated fair value of the reporting units exceeded the carrying value; as such, no impairment charges were recognized.

Other Accrued Liabilities

Other accrued liabilities consisted of the following:



(in thousands)	As of December 31,
Other Accrued Liabilities	2018		2017 (As Revised)
Accrued product warranty^*	$	9,767	$	8,585
Litigation reserves ^**	16,139		12,137
Contract liabilities (deferred revenue)	4,897		2,822
Accrued compensation and benefits	4,520		2,593
Professional services	27		1,974
Accrued interest expense	1,175		686
Other	9,175		5,535
Total	$	45,700	$	34,332


*	The Company recorded adjustments to reflect a portion of the accrued product warranty liability previously in Other accrued expenses at December 31, 2017 to correct the presentation error and to conform to the current period presentation. See above for additional discussion of the adjustment.

As of December 31, 2018 and 2017, litigation reserves primarily consisted of accruals for the settlement of the Securities Litigation, Federal Derivative Litigation, and the Cohen matter. The Company concluded that insurance recovery was probable related to $14.0 million of the litigation reserves and recognized full recovery of the settlement amounts in Prepaid expenses and other current assets. See Note 9. Commitments and Contingencies for additional information.

Warranty Costs

The Company offers a standard limited warranty on the workmanship of its products that in most cases covers defects for a defined period. Warranties for certified emission products are mandated by the U.S. Environmental Protection Agency (the “EPA”) and/or the California Air Resources Board (the “CARB”) and are longer than the Company’s standard warranty on certain emission-related products. The Company’s products also carry limited warranties from suppliers. The Company warranties generally apply to engines fully manufactured by the Company and to the modifications the Company makes to supplier base products. Costs related to supplier warranty claims are generally borne by the supplier and passed through to the end customer.

Warranty estimates are based on historical experience and represent the projected cost associated with the product. A liability and related expense are recognized at the time products are sold. The Company adjusts estimates when it is determined that actual costs may differ from initial or previous estimates.

The Company records adjustments to pre-existing warranties for changes in its estimate of warranty costs for products sold in prior fiscal years in the period in which new information is received and the information indicates that actual costs may differ from the Company’s initial or previous estimates. Such adjustments typically occur when claims experience deviates from historic and expected trends. During 2018, the Company recognized charges for adjustments to pre-existing warranties of $3.8 million.

When the Company identifies cost effective opportunities to address issues in products sold or corrective actions for safety issues, it initiates product recalls or field campaigns. As a result of the uncertainty surrounding the nature and frequency of product recalls and field campaigns, the liability for such actions is generally recorded when the Company commits to a product recall or field campaign. In each subsequent quarter after a recall or field campaign is initiated, the recorded warranty liability balance is analyzed, reviewed, and adjusted, if necessary, to reflect any changes in the anticipated average cost of repair or number of repairs to be completed prospectively.

When collection is reasonably assured, the Company also estimates the amount of warranty claim recoveries to be received from its suppliers. Warranty costs and recoveries are included in Cost of sales in the Consolidated Statements of Operations.

Accrued product warranty activities are presented below:



(in thousands)	For the Year Ended December 31,
Accrued Product Warranty	2018			2017
Balance at beginning of year	$	12,628		$	10,200
Current year provision	15,840			5,405
Changes in estimates for preexisting warranties ^*	3,842			—
Payments made during the period	(9,208		)	(2,977		)
Balance at end of year	$	23,102		$	12,628
Less: Current portion	9,767			8,585
Noncurrent accrued product warranty	13,335			4,043

Change in estimates for pre-existing warranties reflect changes in the Company’s estimate of warranty costs for products sold in prior periods. Such adjustments typically occur when claims experience deviates from historic and expected trends. The Company’s warranty liability is generally affected by failure rates, repair costs and the timing of failures. Future events and circumstances related to these factors could materially change the estimates and require adjustments to the warranty liability. In addition, new product launches require a greater use of judgment in developing estimates until historical experience becomes available. In the first quarter of 2018, the Company recorded charges for changes in estimates of $3.8 million, or $0.21 per diluted share.

Revenue Recognition

On January 1, 2018, the Company adopted the new revenue recognition guidance, Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”), on a modified retrospective basis. The comparative information for 2017 has not been restated and continues to be reported under ASC 605, Revenue Recognition (“ASC 605”). See Note 2. Revenue for additional information regarding the required disclosures related to the impact of adopting ASC 606 and a discussion of the Company’s policy related to revenue recognition.

During 2017, prior to the adoption of ASC 606, the Company recognized revenue upon transfer of title and risk of loss to the customer, typically when products are shipped, provided there is persuasive evidence of an arrangement, the sales price is fixed or determinable, and management believes collectibility is reasonably assured. Customer orders sometimes include multiple products that are delivered at different times. In these situations, revenue associated with the delivered components is recognized based on their relative stand-alone value which is generally considered to be the quoted price in the contract.

The Company classifies shipping and handling charges billed to customers as revenue. Shipping and handling costs paid to others are classified as a component of cost of sales when incurred.

The Company may provide various sales incentives to its customers, including rebate opportunities and price incentives for attaining specified volumes during a particular quarter or year. The Company accrues for the expected amount of these sales incentives as a reduction of revenue at the time of the original sale and updates its accruals as needed based on the best estimate of the volume levels the customer will reach during the measurement period. The Company also from time to time offers incentives with respect to the launch of new products.

Recently Issued Accounting Pronouncements – Adopted

In January 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance requires disclosures to compare carrying values to fair values of financial assets and liabilities, with some exceptions. This guidance is effective for annual and interim periods in 2018 but was early adopted by the Company on January 1, 2017. The adoption of this ASU did not have an impact on the Consolidated Balance Sheets or the Consolidated Statements of Operations.

In May 2014, the FASB issued ASU 2014-09, which created ASC 606, Revenue from Contracts with Customers (Topic 606). See Note 2. Revenue, for the impact of adoption of ASC 606.

Recently Issued Accounting Pronouncements – Not Yet Adopted

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. This guidance requires the use of existing accounting guidance applicable to software developed for internal use to be applied to cloud computing service contracts’ implementation costs. The costs capitalized would be amortized over the life of the agreement, including renewal option periods likely to be used. This guidance is effective for fiscal 2020, with early adoption permitted. The Company does not plan to early adopt the guidance and plans to implement it upon the effective date. The Company does not anticipate that this guidance will have a material impact on its Consolidated Balance Sheet and Consolidated Statement of Operations.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which both reduces and expands selected disclosure requirements. The principal changes expected to impact the Company’s disclosure are requirements to disclose the range and weighted average of each of the significant unobservable items and the way the weighted average of a range is calculated for items in the “table of significant unobservable inputs.” The guidance also requires disclosure of changes in unrealized gains and losses in other comprehensive income and removes requirements regarding, among other items, disclosure of the valuation process for Level 3 measurements. This guidance is effective for all fiscal years and for interim periods within those years, beginning in fiscal 2020. The Company plans to implement the guidance when it becomes effective and does not currently anticipate that this guidance will have a material impact on its Consolidated Balance Sheet and Consolidated Statement of Operations.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment, which eliminated the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The ASU is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019; early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The amendments in this ASU are to be applied on a prospective basis. The Company currently plans on adopting the standard on January 1, 2020 when it becomes effective and does not expect the guidance to have a material impact on its financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which applies primarily to the Company’s accounts receivable impairment loss allowances. The guidance provides a revised model whereby the current expected credit losses are used to compute impairment of financial instruments. The new model requires evaluation of historical experience and various current and expected factors, which may affect the estimated amount of losses and requires determination of whether the affected financial instruments should be grouped in units of account. The guidance, as originally issued, was effective for fiscal years beginning after December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) Effective Dates, which deferred the effective dates of these standards for certain entities. Based on the guidance, the effective date of ASU 2016-13 is deferred for the Company until fiscal year 2023. The Company currently plans to adopt the guidance on January 1, 2023 when it becomes effective. The Company is continuing to assess the impact of the standard on its financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases, which created ASC Topic 842, Leases and superseded the existing guidance in ASC 840, Leases. The core principle of ASU 2016-02 is that an entity should recognize on its balance sheets assets and liabilities arising from a lease. In accordance with that principle, ASU 2016-02 required that a lessee recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying leased asset for the lease term. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will depend on the lease’s classification as a finance or operating lease. This new accounting guidance is effective for fiscal years beginning after December 15, 2018 under a modified retrospective approach, and early adoption is permitted. In July 2018, the FASB issued ASU 2018-11, which modified the transition guidance in ASU 2016-02 to provide preparers the option to adopt the ASU as of the effective date instead of adjusting prior periods under the modified retrospective approach. The Company will adopt the guidance effective January 1, 2019 and expects to elect to adopt the standard as of that date as provided for in ASU 2018-11.

The Company is finalizing its evaluation of the impact the adoption of this guidance will have on its financial statements. The Company completed an assessment of its portfolio of leases and has compiled a central repository of all active leases. It is also in the process of designing the future lease process and drafting a policy to address the new standard requirements. Key lease data elements are being evaluated. The Company has implemented a software solution to track and account for leases under ASU 2016-02 and is finalizing implementation of the solution. While the Company has not yet completed its evaluation of the impact the new lease accounting standard will have on its financial statements, the Company will recognize material right-of-use assets and lease liabilities for its operating leases in the Consolidated Balance Sheet upon the effective date.

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