2018 | ANNUAL REPORT
B I L E
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G O R I T H M S – K N DEVELOPED & 3RD PA
P R O C E S S ING – OPEN PLATF
A C OUSTICS
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M O B I L E
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T O O U R S T O C K H O L D E R S
For Knowles, 2018 was a year of meaningful progress against our strategy
to increase exposure to growth markets and diversify our products and
customers. This enabled Knowles to deliver 11 percent revenue growth
with strong operating leverage — ahead of the expectations we had in the
beginning of the year and well above the growth rates we saw in most of
the end markets we serve. In Audio, our strong yearly results reflect the
benefits of our transformation from an acoustic component supplier to an
audio solutions provider. This transformation has allowed us to migrate our
product portfolio to higher-value solutions and enabled us to increase our
content per device, and capitalize on the positive macro trends around audio
and edge processing across Mobile, Ear and IoT applications. In Precision
Devices, we saw robust demand for our differentiated solutions across
defense, industrial and automotive end markets. Sales grew across every
Knowles business unit in 2018, demonstrating the benefits and shareholder
value created by the business mix and strategy we have in place.
Mobile
The 2018 Mobile market was characterized by softening demand trends,
particularly in the second half of the year. That said, we increased sales into
the mobile market on a year-over-year basis due to improved audio input
performance and processing being moved to the edge of the network,
driving more microphones per device, adoption of higher performance
mics, and implementations of new intelligent audio solutions. Sales to
Chinese OEMs reached all-time record levels, up over 70 percent from
2017. This growth was driven by robust demand for higher performance
microphones and an increase in new intelligent audio design wins. For
example, we announced that both OPPO and Vivo adopted our smart
microphones in their flagship handsets, giving these OEMs the ability to
customize, add new features and differentiate their smartphones in the
market. This is driving significantly higher audio content per device for
us through higher ASPs and greater share, while increasing the need for
additional high-performance MEMS microphones. We grew sales to our
largest customer in 2018 compared to the prior year, fueled by significant
increases in microphone sales to non-handset products. I believe continued
multi mic adoption and additional intelligent audio design wins will help us
outgrow the mobile market again in 2019.
Ear
Our growth in the Ear market in 2018 was driven by higher volumes of
wireless headsets, the increasing number of microphones per headset
and the implementation of higher performance microphones. Our hearing
health business also contributed to our year-over-year growth. I continue
to be very optimistic about the growth prospects in the Ear market given
our long and successful history of solving challenges in hearing aids, and
our broad range of solutions, including microphones, balanced armature
speakers, smart mics and audio processors. Additionally, we are seeing
that personal voice assistants, such as Amazon’s Alexa and Google’s
Assistant, are accelerating development for ear-worn devices and placing
greater importance on voice input. In the future, we expect that AI-enabled
headsets will be able to automatically improve speech recognition in noisy
environments and to understand not just our words but the context in
which we speak them. We see continued convergence in the technology
requirements between consumer headsets and hearing aid devices for high
performance audio solutions that are extremely low power, with very small
footprints. We are uniquely positioned to address the needs of this market
and see a potential of $10 of content per device, as we focus on enabling
feature-rich consumer products.
loT
In the IoT market, we continue to see countless new product launches of
voice-enabled devices. Amazon and Google voice assistants continue to
battle to gain voice control of consumers’ connected homes, appliances
and cars. In China, we are also benefiting from strong growth in Ear and
IoT demand. All of these devices need microphones and many highlight
the important trend of processing being moved from the cloud to the edge
of the network to improve data privacy, security, contextual awareness and
latency and reduce total cost. Customers recognize that our audio solutions
are optimized to deliver the best performance for these types of tasks,
which has resulted in strong design activity across all types of IoT devices
for our microphones and audio processors. As expected, sales into the Ear
and IoT markets represented over 20 percent of total microphone sales in
2018 up from 7 percent in 2016. We made a conscious effort over the past
several years to diversify microphone revenues, and in 2019 we expect this
trend to continue with more than 25 percent of our microphone sales to
be into these markets.
Precision Devices
Our Precision Devices business had an outstanding 2018, with record
revenues and operating profits. We saw strong demand for our differentiated
products across multiple end markets. That demand drove higher sales, and
an acquisition supplemented robust organic growth. We continued to grow
across defense, medical, telecom, and automotive end markets in 2018, and
we believe we are positioned for growth in key solutions for electric vehicles
and 5G infrastructure over the next several years.
2019 & Beyond
As we enter 2019, all of our businesses are well positioned for continued
growth. In Audio, the macro trends around better performance and
edge processing remain favorable and are enabling us to expand our
total available market and grow our business. We expect to benefit from
increasing sales in our Ear and IoT markets and growth in Hearing Heath.
In addition, I expect 2019 to be a strong year for our Intelligent Audio
business — contributing 2 to 4 percent of total company revenue growth
on top of sales in our core businesses. Longer term, I believe our family
of audio processors opens up an incremental $1 billion available market
for us, while driving increased market share and higher dollar content in
our core acoustics business. In Precision Devices, we continue to execute
our playbook and drive strong revenue growth and operating margin
improvement, both organically and through tuck in acquisitions. I expect
the growth in both segments will drive total company revenue with
strong operating leverage in 2019.
At Knowles, our corporate commitment to acting in an ethical and
responsible way is central to our mission. Our focus on environmental
and social responsibility, transparency and engagement guides our
decision-making processes and keeps us accountable as we continuously
improve all aspects of our business. We have successfully diversified our
end market exposure and customer base, developed industry-leading
solutions and driven top line growth. We look forward to building on
our momentum to deliver higher-value solutions across our business units
while improving gross margins and driving enhanced shareholder value.
Sincerely,
Jeffrey Niew
President and CEO
F O R W A R D L O O K I N G S T A T E M E N T S
This Annual Report contains “forward-looking statements” within the meaning
of the safe harbor provisions of the United States Private Securities Litigation
Reform Act of 1995. Forward looking statements include all statements other
than those of historical fact or statements that pertain to future financial and
business performance and conditions and other financial and business matters.
These statements are based on management’s current estimates, projections,
assumptions and expectations and are subject to numerous risks, uncertainties
and other unpredictable or uncontrollable factors which may cause actual
results or performance to differ materially from the Company’s expectations.
Some of the risks, uncertainties and other factors that could cause actual results
to differ materially from those expressed in the forward-looking statements are
detailed in the “Risk Factors” section of, and elsewhere in, our accompanying
2018 Annual Report on Form 10-K and in our other filings with the SEC. Knowles
Corporation undertakes no obligation to update any such statements.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018.
or
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
(State or other jurisdiction of incorporation or organization)
90-1002689
(I.R.S. Employer Identification No.)
1151 Maplewood Drive
Itasca, Illinois
(Address of principal executive offices)
60143
(Zip Code)
(630) 250-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, par value $0.01 per share
Name of each exchange on which registered
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes
No
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
No
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
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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
Accelerated filer
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
Emerging growth company
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
No
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of the close of
business on June 29, 2018 was approximately $1,359,000,000. The number of outstanding shares of the registrant’s common stock
as of February 14, 2019 was 90,216,613.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information contained in the registrant's Proxy Statement for its 2019 Annual Meeting of Stockholders is incorporated by
reference into Part III hereof.
Table of Contents
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Executive Officers of the Registrant
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Selected Financial Data
Management's Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
Exhibits and Financial Statement Schedules
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
Item 16.
SIGNATURES
Form 10-K Summary
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3
ITEM 1. BUSINESS
PART I
Unless the context otherwise requires, references in this Annual Report on Form 10-K to “Knowles,” the “Company,” “we,” “our,”
or “us” refer to Knowles Corporation and its consolidated subsidiaries.
Our Company
We are a market leader and global provider of advanced micro-acoustic, audio processing, and precision device solutions, serving
the mobile consumer electronics, communications, medical, defense, aerospace, and industrial markets. We use our 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. We are also the leader
in acoustics components used in hearing aids and have a strong position in high-end capacitors. Our focus on our customers,
combined with our unique technology, proprietary manufacturing techniques, rigorous testing, and global scale, enables us to
deliver innovative solutions that optimize the user experience. Knowles, founded in 1946 and headquartered in Itasca, Illinois, has
approximately 8,000 employees in 11 countries around the world.
Our Strategy
Our primary focus has been to position the Company to benefit from the positive trends we are seeing in our Audio segment. With
products ranging from mobile phones to headsets, and from smart speakers to household appliances, voice-powered interactions
are emerging as a critical and necessary feature. Consumers want to engage with technology through natural, spoken commands,
across the mobile, ear, and IoT markets, and original equipment manufacturers (“OEMs") are racing to develop and deploy the
technology to enable it. Our unique capabilities in acoustics, digital signal processing, and algorithms place us in a competitive
position to enable voice and audio input.
We have been focused on strategically positioning the business to support these broader trends around audio input including the
acquisition of Audience, Inc. ("Audience") in 2015, which brought us essential digital signal processing and algorithm capabilities,
and the divestiture of our low-margin speaker and receiver product line ("Speaker and Receiver Product Line") in 2016. During
this time, we have also invested significantly in our core MEMS microphone and hearing health businesses to maintain our
leadership positions and optimize our manufacturing footprint across our business units.
In our Precision Devices segment, we continue to drive higher sales growth and improved operating margins through both organic
initiatives and acquisitions. In 2017, we reshaped our portfolio by divesting our timing device business ("Timing Device Business")
to increase our focus on growth platforms in Precision Devices where we have strong market positions and attractive margin
profiles, including industrial, medical, defense, automotive, and telecom applications.
Our Business Segments
In January 2017, the Company changed its internal reporting to drive growth in our core business. Given the changes in the
allocation of resources and in its internal reporting structure, the Company now reports two segments, Audio and Precision Devices
("PD"). As a result of this change, transducer products used in hearing health and premium headset applications were moved from
the historical Specialty Components segment into the new Audio segment, which includes the historical Mobile Consumer
Electronics segment. The capacitor products formerly in the Specialty Components segment are now included in the PD segment.
• Audio Segment
Our Audio group designs and manufactures innovative audio products, including microphones and balanced armature speakers,
audio processors, and software and algorithms used in applications that serve the mobile, ear, and IoT markets. Locations include
the sales, support, and engineering facilities in North America, Europe, and Asia, as well as the manufacturing facilities in Asia.
• PD Segment
Our PD group specializes in the design and delivery of highly engineered capacitors and radio frequency ("RF") devices for
technically demanding applications. Our devices are used in applications including power supplies, radar, medical implants, and
satellites, serving the industrial, defense, aerospace, medical, telecommunications, and automotive markets. Locations include
the sales, support, engineering, and manufacturing facilities in North America, Europe, and Asia.
4
We sell our products directly to OEMs and to their contract manufacturers and suppliers and to a lesser extent through distributors
worldwide. Our products by segment on a continuing operations basis are as follows:
• Audio - Includes analog and digital MEMS microphones, electret condenser microphones, smart microphones, ultrasonic
sensors, acoustic processors, and balanced armature speakers.
• PD - Includes capacitors and filters.
Market Trends
In our Audio segment, we have seen an inflection point with voice being embraced as a primary user interface across consumer
electronic devices. Voice assistants are proliferating throughout a variety of applications from mobile phones to headsets, and from
smart speakers to household appliances. Consumers want to engage with technology through natural, spoken commands, across
the mobile, ear, and IoT markets, and OEMs are racing to develop and deploy the technology to enable it. Our core capabilities in
acoustics, digital signal processing, and algorithms are unparalleled and place us in an ideal position to enable voice and audio
input.
Within the hearing aid market, sales are largely driven by aging demographics, healthcare spending, increasing affluence in emerging
markets, and government subsidies.
Our Precision Devices segment sells multi-layer ceramic capacitors, electromagnetic interference filters, high reliability capacitors,
single layer capacitors, precision variable capacitors, and thin film devices across diverse end markets, including industrial, defense,
aerospace, medical, and telecommunications markets. Portions of this segment face much greater exposure to capital investment
cycles and government spending, both direct and indirect, as some of these end markets are largely dependent on project upgrades,
expansion, and government contracts.
Geographic Trends
We strive to maintain our manufacturing facilities in close proximity to our direct customers. In the case of Audio, we currently
operate 5 facilities in Asia to serve the contract manufacturers who build OEM equipment on behalf of our end-customers. These
contract manufacturers are largely based in China, Taiwan, India, Singapore, Indonesia, and Vietnam. Although end-user demand
for consumer electronics and hearing aids is global and marketing activities occur globally, the majority of our manufacturing is
located in Asia, primarily in China, Malaysia, and the Philippines.
In the case of PD, we operate 5 facilities in North America and 1 facility in Asia for the manufacturing of capacitors that support
our global customers, as well as their suppliers and contract manufacturers.
Competitive Landscape
Success in the electronic components industry is primarily driven by innovation and flexibility as customers compete to gain a
share of the growing consumer device market. We compete across handset, wearables, and other consumer platforms to deliver
superior acoustic performance through customized products. Our investments in research and development enable us to capture
new design wins across consumer OEMs. Our ability to balance and shift between full and semi-automation is key to our ability
to optimize our operations and operating expenses. Additionally, it is important for suppliers to have flexibility and quick time-
to-market to meet clients’ needs. Notably, according to industry estimates, the product cycle for mobile handsets has shortened
over recent years. Key competitors include:
• Audio - AAC Technologies, Goertek, Sonion, and Synaptics; and
• PD - AVX Corporation, Kemet, and Murata.
In the Audio segment, our investments in research and development enable us to continually introduce new products with higher
performance. Our customers are adopting these higher value microphones to improve the overall audio performance of their devices
which in turn improves the end user experience. Typically our new products have higher average selling prices than the products
they are replacing. Once introduced, the pricing for these products trend lower, as is typical in the consumer electronics market.
5
For products that were introduced more than 18 months ago, we strive to offset anticipated price erosion through bill of material
cost reductions, yield improvements, equipment efficiency, and movement to lower-cost manufacturing locations.
In the PD segment, the end markets tend to be more stable. We see a highly fragmented set of competitors across capacitor products
for a diverse set of end markets including industrial, defense, aerospace, medical, and telecommunications.
Customers, Sales, and Distribution
We serve customers in the mobile consumer electronics, industrial, defense, aerospace, medical, and telecommunications markets.
Our customers include some of the largest OEMs and operators in these markets. In addition, many of our OEM customers outsource
their manufacturing to Electronic Manufacturing Services (“EMS”) companies. Other customers include global mobile phone
manufacturers, hearing aid manufacturers, and many of the largest global EMS companies, particularly in China.
The Company's customers that accounted for 10% or more of total revenues were as follows:
Apple Inc.
Samsung Electronics Co., Ltd.
* Less than 10% of total revenues.
Revenues
Years Ended December 31,
2018
2017
2016
19%
*
19%
10%
20%
12%
The following table details our sales by geographic location for the years ended December 31, 2018, 2017, and 2016. These results
do not necessarily indicate the geographies where our products are deployed or where end-customer demand is originated.
(in millions)
Asia
Europe
Other Americas
Other
Subtotal non-United States
United States
Total
Years Ended December 31,
2017
2016
2018
$
605.4
$
560.8
$
85.8
3.6
5.5
700.3
126.6
72.3
4.4
5.4
642.9
101.3
$
826.9
$
744.2
$
578.7
75.1
3.1
5.5
662.4
93.3
755.7
We manufacture and develop our products as well as maintain sales and technical customer support offices in North America,
Europe, and Asia. In our PD segment, we supplement our direct sales force with external sales representatives and distributors.
Our global distribution center is located in Penang, Malaysia. Our worldwide sales force provides geographically specific support
to our customers and specialized selling of product lines to various customer bases. For further detail and for additional disclosures
regarding sales and property, plant, and equipment, net, by geographic location, see Note 17. Segment Information to our
Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
Raw Materials
We use a wide variety of raw materials, primarily metals, and semi-processed or finished components. Commodity pricing for
various metals, such as palladium, gold, brass, stainless steel, and copper, fluctuates. As a result, our operating results are exposed
to such fluctuations. Although some cost increases may be recovered through increased prices to customers, if commodity prices
trend upward, we attempt to control such costs through fixed-price contracts with suppliers and various other programs.
We rely on highly specialized suppliers or foundries for critical materials, components, or subassemblies that are used in our
products which, in some cases, may be sole sourced from such suppliers or foundries or, such suppliers or foundries may also be
a strategic supplier to one of our competitors or a customer. The loss of any single supplier has not had a material impact on
operating profits. However, should an event occur which affects the ability or willingness of any supplier or foundry to continue
to deliver materials or components to us in a timely manner, we may not be able to identify or qualify an alternative supplier in a
6
timely manner which, in any such period and future periods, could have a material adverse impact on our results of operations.
See Item 1A. Risk Factors for additional information regarding risks related to our business.
Research and Development
We concentrate our research and development efforts on the design and development of new products for each of our principal
markets. We also fund certain other emerging product and technology opportunities. Expenditures for research and development
in fiscal years 2018, 2017, and 2016 were $100.6 million, $93.4 million, and $92.0 million, respectively. Our future success is
highly dependent upon our ability to develop complex new products, transfer new products to volume production, introduce them
into the marketplace in a timely fashion, and have them selected for design into our customers’ products at competitive prices.
Our future success may also depend on increasing acoustic content in our customers’ products including assisting our customers
with integration of our products and software into their new products and providing support from the concept stage through design,
launch, and production ramp.
Intellectual Property and Intangible Assets
We rely on patent, copyright, trademark, and trade secret laws to protect our intellectual property, products, and technology. Our
U.S. patents expire in calendar years 2019 through 2037. While our patents are an important element of our success, our business
as a whole is not dependent on any one patent or group of patents. We do not anticipate any material effect on our business due to
any patents expiring in 2019, and we continue to obtain new patents through our ongoing research and development. We have
maintained U.S. federal trademark registrations for KNOWLES, Knowles logo designs, along with various other trademarks.
These U.S. registrations may be renewed as long as the marks continue to be used in interstate commerce. We have also filed or
obtained foreign registration for these marks in other countries or jurisdictions where we conduct, or anticipate conducting,
international business. To complement our own research and development efforts, we have also licensed and expect to continue
to license, a variety of intellectual property and technologies important to our business from third parties. See Item 1A. Risk Factors
for additional information regarding risks related to our business.
Seasonality
In general, our businesses tend to have higher revenues in the third and fourth quarters of each fiscal year. This is particularly true
of those businesses that serve the consumer electronics market. Our businesses tend to have short product cycles due to the highly
technical nature of the industries they serve which can result in new OEM product launches that can impact quarterly revenues,
earnings, and cash flow.
Environmental and Social Responsibility Matters
As a socially responsible company, we strive to align our business practices and policies with the needs of our key stakeholders,
and to that end we have developed environmental, social, and governance policies which can be accessed at our website,
www.knowles.com.
Our operations are governed by a variety of international, national, state, and local environmental laws. These regulations include
limitations on discharge of pollutants to the air, water, and soil; manufacturing chemical use and handling restrictions; and
requirements with respect to the treatment, transport, storage, and disposal of solid and hazardous wastes. We are committed to
continued compliance and believe our operations generally are in substantial compliance with these laws.
We are dedicated to the preservation and improvement of our global environment. We have established a Green Materials Policy,
pursuant to which we have established a Green Materials Standard. Our products are in compliance with the European Union
Restriction of Hazardous Substances ("EU RoHS") and Waste Electrical and Electronic Equipment ("WEEE") directives. This
standard is based on the list of substances identified in the Joint Industry Guide-101 Standard which is endorsed by the Electronic
Industry Association, the Joint Electronics Device Engineering Council, and the Japan Green Procurement Survey Standardization
Initiative associations as well as the Sony Standard-00259. As part of Knowles’s commitment to social responsibility and compliance
with Rule 13p-1 under the Securities Exchange Act of 1934, as amended, (the "Exchange Act") it is our goal to only use 3TG
minerals in our products that do not directly or indirectly finance or benefit armed groups in the Democratic Republic of the Congo
region.
7
Employees
We currently employ approximately 8,000 persons across our facilities in 11 countries. Approximately 78% of our employees are
located in Asia. We are subject to various local, national, and multi-national laws and regulations relating to our relationships with
our employees. Our workforce in the United States is not unionized. We believe we generally have good relationships with
employees and their representative organizations.
Other Information
Knowles was incorporated in Delaware on June 12, 2013. The address of our principal executive offices is 1151 Maplewood Drive,
Itasca, Illinois 60143. Our telephone number is 630-250-5100.
We post our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to
these reports on the "Financial Information - SEC Filings” link on the Investor Relations section of our website, www.knowles.com.
We post each of these reports on the website as soon as reasonably practicable after the report is filed with or furnished to the
Securities and Exchange Commission ("SEC"). The information on our website is not incorporated into this Form 10-K.
ITEM 1A. RISK FACTORS
Cautionary Statement Concerning Forward-Looking Statements
This Annual Report on Form 10-K contains certain statements regarding business strategies, market potential, future financial
performance, future action, results, and any other statements that do not directly relate to any historical or current fact which are
“forward-looking” statements within the meaning of the Securities Act of 1933, as amended (the "Securities Act"), the Exchange
Act, and the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “anticipate,” “project,” “estimate,”
“budget,” “continue,” “could,” “intend,” “may,” “plan,” “potential,” “predict,” “seek,” “should,” “will,” “would,” “expect,”
“objective,” “forecast,” “goal,” “guidance,” “outlook,” “effort,” “target,” and similar expressions, among others, generally identify
forward-looking statements, which speak only as of the date the statements were made.
In particular, information included under the sections entitled “Business,” “Risk Factors,” and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” contain forward-looking statements.
Readers are cautioned that the matters discussed in these forward-looking statements are subject to risks, uncertainties, assumptions,
and other factors that are difficult to predict and which could cause actual results to differ materially from those projected, anticipated,
or implied in the forward-looking statements. Where, in any forward-looking statement, an expectation or belief as to future results
or events is expressed, such expectation or belief is based on the current plans and expectations of management and expressed in
good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will be achieved
or accomplished. Many factors that could cause actual results or events to differ materially from those anticipated include those
matters described under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition
and Results of Operations.” We caution you not to place undue reliance on these forward-looking statements, which speak only
as of the date of this Annual Report on Form 10-K and Knowles does not assume any obligation to update any forward-looking
statement as a result of new information, future events, or otherwise, except as required by applicable law. All forward-looking
statements, expressed or implied, included in this Annual Report on Form 10-K are expressly qualified in their entirety by this
cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral
forward-looking statements that we may make or persons acting on our behalf may issue.
You should consider each of the following factors as well as the other information in this Annual Report on Form 10-K, including
our financial statements and the related notes, in evaluating our business and our prospects. The risks and uncertainties described
below are not the only ones we face. In general, we are subject to the same general risks and uncertainties that impact many other
companies such as general economic, industry, and/or market conditions and growth rates; possible future terrorist threats or armed
conflicts and their effect on the worldwide economy; and changes in laws or accounting rules. Additional risks and uncertainties
not presently known to us or that we currently consider immaterial may also impair our business operations. If any of these risks
occur, our business and financial results could be harmed. In that case, the trading price of our common stock could decline.
8
Risks Related To Our Business
We depend on the mobile handset market for a significant portion of our revenues, and any downturn or slower than expected
growth in this market could significantly reduce our revenues and adversely impact our operating results.
Our Audio segment accounted for 83% of our consolidated revenues for the year ended December 31, 2018, and the mobile handset
market accounted for approximately 35% of our consolidated revenues. While other markets such as mobile headsets, wearables,
and IoT are gaining in significance, we expect that a substantial portion of our consolidated revenues will continue to be attributable
to the mobile handset market, which is cyclical and characterized by continuous and rapid technological change, product
obsolescence, price erosion, evolving standards, short product life cycles, and significant fluctuations in product supply and demand.
Moreover, the mobile handset market may not continue to grow at the rate experienced in recent years or may decline for reasons
outside of our control including competition among market participants, market saturation, and global economic conditions. The
mobile handset market has experienced and may experience periodic downturns which may be characterized by diminished product
demand, production overcapacity, high inventory levels, and accelerated erosion of average selling prices. Given that the strength
of the mobile handset market is a primary driver of revenues for our Audio segment, any downturn in the mobile handset market
could have a material adverse effect on our business and operating results. In addition, a decline in global economic conditions,
particularly in China and other geographic regions with high concentrations of mobile handset users, could have adverse, wide-
ranging effects on demand for our products or technologies, the products and services of our customers or licensees, particularly
OEM handset manufacturers, the solvency of key suppliers, failures by counterparties, and negative effects on mobile handset
inventories. In addition, our customers’ ability to purchase or pay for our products and services and their customers’ ability to
upgrade their mobile handsets could be adversely affected by economic conditions, leading to a reduction, cancellation, or delay
of orders for our products or services.
We derive the majority of our Audio revenues from MEMS microphones sold to the mobile handset market and a significant
reduction in our sales of MEMS microphones could significantly reduce our revenues and adversely impact our operating
results.
Within our Audio segment, revenues are generated primarily from the sales of our MEMS microphones. Sales of MEMS
microphones accounted for approximately 60% of our total revenues for fiscal 2018. We expect that a substantial portion of our
revenues will continue to be attributable to sales of MEMS microphones and any weakening of demand, loss of market share, or
other factors adversely affecting our levels and the timing of our sales of MEMS microphones, including our customers’ product
release cycles, market acceptance, product competition, the performance and reliability of our MEMS microphones, and economic
and market conditions could cause our Audio revenues to substantially decline, which may have a material adverse effect on our
operating results.
Our largest segment, Audio, derives a significant portion of its revenues from a limited number of OEM customers. If revenues
derived from these customers decrease or the timing of such revenues fluctuates, our operating results could be adversely
affected.
Our Audio segment derives a significant portion of revenues from a small number of OEM customers. For 2018, Audio top five
customers accounted for approximately 45% of Audio’s revenues. For the year ended December 31, 2018, Apple Inc. accounted
for approximately 23% of Audio’s revenues and 19% of total company revenues. The mobile handset industry is also subject to
intense competition that could result in decreased demand and/or declining average selling prices for our products and those of
our OEM customers. The loss of any one of Audio’s top customers or a reduction in the purchases of Audio’s products by such
customers would reduce our total revenues and may have a material adverse effect on our operating results, and any delay of a
significant volume of purchases by any one of our top customers, even if only temporary, would reduce our revenues in the period
of the delay and may have a material adverse effect on our operating results. Further, concentration of market share among a few
companies and the corresponding increase in purchasing power of these companies may result in lower prices for our products
which, if not offset by a sufficient increase in the volume, or favorable changes in the mix, of purchases of our products, could
have a material adverse effect on our revenues and margins. In addition, the timing, volume, and mix of purchases by our significant
customers may be impacted by the timing of such customers’ new or next generation product introductions, and the timing of such
introductions may have a material adverse effect on our operating results. Accordingly, if current market and industry dynamics
continue, our Audio segment’s revenues will continue to depend largely upon, and be impacted by the timing, volume, and mix
of future purchases by a limited number of our OEM customers.
9
If we are unable to continue to offset erosion of average selling prices in our Audio segment our gross margins may be adversely
affected.
Like most technology sectors, the mobile handset industry has traditionally experienced an erosion of average selling prices due
to a number of factors, including intense competition, component pricing trends, changes in demand mix, excess inventories, and
rapid obsolescence resulting from technology advances. Within our Audio segment, while average selling prices vary significantly
on a product to product basis, we have generally been successful with largely offsetting price erosion by shifting our product mix
to new, higher end or higher performance microphones and gradually shifting customers from analog microphones to higher value
digital microphones. To offset average selling price erosion, we must either continue to be successful with these initiatives or
increase our selling prices. If we are unable to continue to offset average selling price erosion, the average selling prices of our
products may decrease and our future operating results may be materially adversely affected.
We rely on highly specialized suppliers for a variety of highly engineered or specialized components, and other inputs which
we may not be able to readily identify alternatives or substitutes in the event of a supply disruption or capacity constraint at or
by any of these suppliers, which could have a material adverse impact on our results of operations.
Certain of our businesses rely on highly specialized suppliers or foundries for critical materials, components, or subassemblies
that are used in our products. In some cases, such suppliers or foundries may be our sole source of supply or, such suppliers or
foundries may also be a strategic supplier to one of our competitors or a customer. In either of these cases, should an event occur
which affects the ability or willingness of any of such supplier or foundry to continue to deliver materials or components to us in
a timely manner, we may not be able to identify or qualify an alternative supplier in a timely manner which, in any such period
and future periods, could have a material adverse effect on our results of operations. Potential events or occurrences which could
cause business or supply disruptions or affect the ability or willingness of a supplier or foundry to continue to supply us include
changes in market strategy, the acquisition of, sale, or other change in control or ownership structure of a supplier or foundry,
strategic divestiture, bankruptcy, insolvency or other financial difficulties, business disruptions, operational issues, or capacity
constraints at a supplier or foundry.
Global markets for our products are highly competitive and subject to rapid technological change. If we are unable to develop
new products and compete effectively in these markets, our financial condition and operating results could be materially
adversely affected.
We compete in highly competitive, technology-based, industries that are highly dynamic as new technologies are developed and
introduced. Our competitors may introduce products that are as or more technologically advanced than our products or launch
new products faster than we can, which may result in a loss of market share or revenue by us. If we are unable to anticipate or
match our competitors’ development or launch of new products, identify customer needs and preferences on a timely basis, or
successfully launch or ramp production of our new products, our business and operating results may be materially adversely
affected.
We operate in the highly competitive mobile handset industry, which requires us to invest significant capital in developing,
qualifying, and ramping production of new products without any assurance of product sales which could negatively impact
our operating results and profits.
A significant portion of our consolidated revenues are derived from acoustic components and audio solutions, including software,
that are required to go through extensive customer qualification processes before being selected by customers for inclusion in their
end products. In order to meet the product launch schedules of our top customers, we may invest capital and devote substantial
resources, including design, engineering, sales, marketing, and programming efforts, based on non-binding forecasts provided by
these customers, without any assurance that our products will be designed into a customer’s product or qualified by the customer.
In such cases, if our product is not designed into or qualified by the customer, we may not recover or realize any return on the
capital that we invested and our operating results may be materially adversely affected.
In addition, the time required and costs incurred by us to ramp-up production for new products can be significant. Certain non-
recurring costs and expenditures for tooling and other equipment may not be reusable in manufacturing products for other customers
or different products for the same customer. Product ramps typically involve greater volumes of scrap and risks to execution such
as higher costs due to inefficiencies and delays in production, all of which can have a material adverse effect on our operating
results.
10
Our foreign operations, supply chain, and footprint optimization strategies are each subject to various risks that could materially
adversely impact our results of operations and financial position.
Many of our manufacturing operations, research and development operations, vendors, and suppliers are located outside the United
States and if we are unable to successfully manage the risks associated with our global operations, our results of operations and
financial position could be negatively impacted. These risks include:
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labor unrest and strikes, particularly in Asia, where the majority of our manufacturing operations are located;
earthquakes, floods, and other natural disasters or catastrophic events, particularly in Asia, where the majority of our
manufacturing operations are located;
acts of terrorism or armed conflicts;
government embargoes, trade restrictions, and import and export controls; and
transportation delays and interruptions.
Given that many of our manufacturing operations are located outside the United States, a border tax, if enacted, could have a
material adverse effect on our operating results.
Global economic conditions and changes in U.S. and International Trade Policy could materially adversely impact our business,
results of operations, and financial position.
The global economic instability of the past few years has caused, among other things, declining consumer and business spending,
volatile raw material prices, instability in credit markets, high unemployment, fluctuating interest and exchange rates, and other
challenges. The Company's business and operating results have been adversely affected by these global economic conditions and
remain vulnerable to future adverse impacts. In particular, our sales to customers in China continue to be impacted by the recent
economic slowdown in China. Any continued or prolonged economic deceleration in China may have a material adverse effect
on our sales to customers in China, our operating results, and our financial condition.
Further, rising international trade tensions, new or increased tariffs and trade wars among countries have and may continue to
impact the global economy and the trade policies of the United States. The Trump Administration has indicated and demonstrated
its intent to alter the United States’ government’s approach to international trade policy using many tactics at its disposal including
the renegotiation, termination or threatened termination, or renegotiation of certain existing bilateral or multi-lateral trade
agreements and treaties with, the imposition of tariffs on a wide range of products and other goods manufactured in, China, countries
in Europe, and other countries and the imposition of sanctions on countries and companies that it has concluded are directly or
indirectly dodging United States’ trade sanctions. Given that the majority of our largest manufacturing facilities are located in
China and Southeast Asia, trade policy changes in the United States, China or other countries, such as the tariffs and sanctions
currently proposed, implemented, and threatened by the Trump Administration, present particular risks for us that could adversely
impact our results of operations and financial condition. New or increased tariffs implemented in China are having an adverse
effect on a small percentage of our capacitor products, tariffs announced but not yet implemented could have an adverse effect on
our other products, and threatened tariffs could adversely affect all of our products. We cannot predict future foreign trade policy
in the United States or other countries, the terms of any new or renegotiated trade agreements or treaties, or tariffs or the impact
of such matters on our business. A trade war involving the United States is likely to negatively impact world trade and the world
economy in various ways and, consequently, have a material adverse effect on our results of operations and financial condition.
To the extent that tariffs, trade restrictions, or sanctions imposed by the United States or other countries increase the price of, affect
customer demand for, affect our ability to supply our products, or create adverse tax consequences, in the United States or other
countries, our business and our operating results may be adversely affected. As a result, changes in international trade policy,
changes in trade agreements, the imposition of tariffs or sanctions by the United States or other countries could materially adversely
affect our results of operations and our financial condition.
Our success depends on our ability to attract and retain key employees, and if we are unable to attract and retain such qualified
employees, our business and our ability to execute our business strategies may be materially impaired.
Our future success depends largely on the continued service and efforts of our executive officers and other key management and
technical personnel and on our ability to continue to identify, attract, retain, and motivate them, particularly in an environment of
cost reductions and a general move toward more performance-based compensation for executives and key management.
11
Implementing our business strategy also requires specialized engineering and other talent, as our revenues are highly dependent
on technological and product innovations. Competition for such experienced technical personnel in our industry and where we
are located is intense, and we cannot assure that we can continue to recruit and retain such personnel. For example, there is
substantial competition in China for experienced engineers and technical personnel where most of our operations are located and
for machine learning and software engineers in California and India where we primarily conduct research and development for
our software and intelligent audio products, which may make it difficult for us to recruit and retain key employees. If we are
unable to attract and retain such qualified employees, our business and our ability to execute our business strategies may be
materially impaired.
Our revenues, operating profits, and cash flows could be materially adversely affected if we are unable to protect or obtain
patent and other intellectual property rights or if intellectual property litigation is successful against us.
We employ various measures to maintain, protect, and defend our intellectual property, including enforcing our intellectual property
rights in various jurisdictions and forums throughout the world. However, policing unauthorized use of our products, technologies,
and proprietary information is difficult and time consuming and these measures may not prevent our intellectual property from
being challenged, invalidated, copied, disclosed, or circumvented. We also may not be successful in litigation or other actions to
enforce our intellectual property rights, particularly in countries where intellectual property rights are not highly developed or
protected. Litigation, if necessary, may result in retaliatory legal proceedings alleging infringement by us of intellectual property
owned by others. We have had and may in the future have difficulty in certain circumstances in protecting or enforcing our
intellectual property rights, including collecting royalties for use of certain patents included in our patent portfolio in certain foreign
jurisdictions due to, among other things: policies of foreign governments; challenges to our licensing practices under such
jurisdictions’ competition laws; failure of foreign courts to recognize and enforce judgments of contract breach and damages issued
by courts in the United States; and/or challenges pending before foreign patent authorities as to the validity of our patents and
those owned by competitors and other parties.
The expense of protecting, defending, and enforcing our intellectual property, or defending claims that our products, technology,
or manufacturing processes infringe the intellectual property rights of others, can vary significantly period to period and, in any
given period, could have a material adverse effect on our operating results. In addition, in any period, we may have liability for
damages arising out of adverse judgments for intellectual property claims that may have a material adverse effect on our operating
results and financial condition.
We have invested and continue to make strategic investments and acquisitions that, if not successful, could have a material
adverse effect on our financial results.
We engage in strategic transactions and make strategic investments including investments in emerging technology companies and
intellectual property which are focused on growth by positioning the Company for expansion into new markets, territories or
technologies, exploiting new or growing customer or market opportunities and developing new technologies and products. Such
acquisitions and strategic investments naturally entail significant risks and uncertainties, some of which are beyond our control.
We may not, for example, be able to retain key employees, customers, or suppliers of acquired companies, derive value from
acquired technology or assets and we may experience delays in achieving cost synergies or higher than expected costs in
implementing them. In addition, due to our inexperience with certain adjacent or complimentary technologies and doing business
in certain geographic regions that may be served by acquired businesses, we may underestimate the costs or overestimate the
benefits that we expect to realize from such acquisitions or investments, and we may not achieve them. We cannot, therefore,
provide assurance that each of our acquisitions or strategic investments will be accretive or generate anticipated financial returns.
If, for any of these or for unforeseen reasons, our strategic acquisitions or investments fail to meet our expectations or forecasts,
our business and results of operations may be materially adversely affected.
12
Our stock price has been and may continue to be volatile and may fluctuate significantly which may adversely impact investor
confidence and increase the likelihood of securities class action litigation.
Our common stock price has experienced substantial volatility in the past and may remain volatile in the future. Volatility in our
stock price can be driven by many factors including divergence between our actual or anticipated financial results and published
expectations of analysts or the expectations of the market, market conditions in our industry, announcements that we, our
competitors, our vendors, or our customers may make regarding their operating results, technological innovations, and the gain
or loss of customers, or key opportunities. During 2018, our closing stock price ranged from a high of $18.13 per share to a low
of $11.00 per share. Our common stock is also included in certain market indices, and any change in the composition of these
indices to exclude our company may adversely affect our stock price. Increased volatility in the financial markets and/or overall
economic conditions may reduce the amounts that we realize in the future on our cash equivalents and/or marketable securities
and may reduce our earnings as a result of any impairment charges that we record to reduce recorded values of marketable securities
to their fair values.
Further, securities class action litigation is often brought against a public company following periods of volatility in the market
price of its securities. Due to changes in our stock price, we may be the target of securities litigation in the future. Securities
litigation could result in substantial uninsured costs and divert management’s attention and our resources.
Our effective tax rate may fluctuate which will impact our future financial results.
Our effective tax rate may be adversely impacted by, among other things, changes in the mix of our earnings among countries
having differing statutory tax rates, changes in the valuation of deferred tax assets, or changes in tax laws where we operate,
including the resulting tax effects of the Tax Cuts and Jobs Act (“Tax Reform Act”). We cannot give any assurance as to the stability
or predictability of our effective tax rate in the future because of, among other things, uncertainty regarding the tax laws and
policies of the countries where we operate.
The estimated effects of applicable tax laws, including current interpretation of the Tax Reform Act and recently proposed
regulations on the Section 965 deemed repatriation tax on U.S. persons with foreign earnings accumulated offshore, have been
incorporated into our financial results. The U.S. Treasury Department, Internal Revenue Service, and other standard-setting bodies
could interpret or issue future legislation or guidance which impact how provisions of the Tax Reform Act will be applied or
otherwise administered that is different from our interpretation, which could have a material adverse impact on our effective tax
rate as well as our future financial results and tax payments.
Further, our tax returns are subject to periodic reviews or audits by domestic and international authorities, and these audits may
result in adjustments to our provision for taxes or allocations of income or deductions that result in tax assessments different from
amounts that we have estimated. We regularly assess the likelihood of an adverse outcome resulting from these audits to determine
the adequacy of our provision for taxes. There can be no assurance as to the outcome of these audits or that our tax provisions will
not change materially or be adequate to satisfy any associated tax liability. If our effective tax rates were to increase or if our tax
liabilities exceed our estimates and provisions for such taxes, our financial results could be adversely affected.
Our effective tax rate is favorably impacted by tax holidays granted to us by certain foreign jurisdictions, which lowers the tax
rates we are subject to for a period of time as compared to the countries' statutory tax rates. These tax holidays are subject to the
satisfaction of certain conditions, including exceeding certain annual thresholds of operating expenses and gross sales. If we fail
to satisfy such conditions, our effective tax rate may be materially adversely impacted. For additional detail, see Note 12. Income
Taxes to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data." Moreover, tax
rates and laws in the countries where we operate may change, or tax reforms may be enacted domestically or in foreign jurisdictions
which adversely affect our liquidity, cash flows, and future reported financial results or our ability to continue to structure and
conduct our business as is done currently.
We are subject to potentially material liability for breaches of confidentiality agreements with certain of our top customers.
We have entered into non-disclosure agreements with several of our top customers which require us not to disclose and to protect
certain information regarding, among other things, aspects of those customers’ businesses plans, products, and technology. These
confidentiality agreements, in some cases, impose strict liability on us in the event of any breach of these agreements by us or our
employees or agents and, should such a breach occur, any resulting damage award or settlement could have a material adverse
effect on our operating results and financial condition.
13
Our business and operations could suffer in the event of security breaches or other unauthorized disclosures.
We have taken and continue to actively take measures to protect the various proprietary information, algorithms, source code, and
confidential data relating to both our and our customers’ business and products that is stored on our computer networks, servers,
and peripheral devices, as well as on servers owned or managed by third party vendors whom we leverage. Such data and information
remains vulnerable to cyber attacks, cyber breaches, theft, or other unauthorized disclosure which, if successful, could result in
loss of valuable intellectual property, disclosure of confidential customer or commercial data, disclosure of government classified
information, or system disruptions and subject us to civil liability and fines or penalties, damage our brand and reputation or
otherwise harm our business, any of which could be material. Should any security breach result in the disclosure of certain of our
customers’ or business partners’ confidential information, we may incur liability to such customers or business partners under
confidentiality agreements that we are party to with such parties. In addition, delayed sales, lower margins, or lost customers
resulting from security breaches or network disruptions could materially reduce our revenues, materially increase our expenses,
damage our reputation, and have a material adverse effect on our stock price.
There is also a danger of industrial espionage, unauthorized disclosures, theft of information or assets (including source code), or
damage to assets by people who have gained unauthorized access to the Company's facilities, systems, or information. Such
breaches, misuse, or other disruptions could lead to unauthorized disclosure of confidential or proprietary information or improper
usage or sale of the Company's products or intellectual property without compensation and theft, manipulation, and destruction
of private and proprietary data, which could result in defective products, production downtimes, lost revenue, or damage to our
reputation, and have a material adverse effect on our stock price.
Our net exposure to exchange rate fluctuations could have a material adverse effect on our results of operations.
We conduct a significant amount of business outside the United States and adverse movements in currency exchange rates,
particularly the Malaysian ringgit, the Chinese renminbi (yuan), and the Philippine peso, may, in any period or periods, could have
a material adverse effect on our business and our operating results due to a number of factors, including, among others:
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our products are manufactured and sold outside the United States which increases our net exposure to changes in foreign
exchange rates;
our products, which are typically sold in U.S. dollars, may become less price-competitive outside the United States as
a result of unfavorable foreign exchange rates;
certain of our revenues that are derived from customer sales denominated in foreign currencies could decrease;
our foreign suppliers may raise their prices if they are impacted by currency fluctuations, resulting in higher than expected
costs and lower margins;
the cost of materials, products, services, and other expenses outside the United States could be materially impacted by
a weakening of the U.S. dollar; and
a sustained weakening of the U.S. dollar for an extended period could have a material adverse impact on our operating
results and financial position.
14
Our products are complex and could contain defects, which could result in material costs to us and harm our business.
Our products are complex and could contain defects, which could result in material costs to us. Product development in the markets
we serve is becoming more focused on audio signal processing for improved audio performance and to enable intelligent and more
sophisticated audio solutions. The increasing complexity of our products increases the risk that we or our customers or end users
could discover latent defects or subtle faults after significant volumes of product have been shipped. This could result in material
costs and other adverse consequences to us including, but not limited to: loss of customers, reduced margins, damage to our
reputation, a material product recall, replacement costs for product warranty and support, payments to our customers related to
recall claims as a result of various industry or business practices, a delay in recognition or loss of revenues, loss of market share,
or failure to achieve market acceptance, and a diversion of the attention of our engineering personnel from our product development
efforts. In addition, any defects or other problems with our products could result in financial losses or other damages to our
customers who could seek damages from us for their losses. A product liability or warranty claim brought against us, even if
unsuccessful, would likely be time consuming and costly to defend. In particular, the sale of systems and components that are
incorporated into mobile handsets for the global mobile phone industry involves a high degree of risk that such claims may be
made. Due to the complex nature of our products, quality and reliability issues may be identified after significant volumes of a
product have been shipped to a large customer. While we have attempted to contractually limit our financial exposure with many
of our customers for such claims, a warranty or product liability claim against us in excess of our available insurance coverage
and established reserves, or a determination that we have liability or an obligation to cover the costs of a customer product recall,
could have a material adverse effect on our business, results of operations, and financial condition.
In addition, our products are typically sold to customers at prices that are significantly lower than the cost of the customer’s products
in which they are incorporated. Given that a defect in one of our products could give rise to failures in the products that incorporate
them, we may face claims for damages that are disproportionate to the revenues we receive from the products involved and because
we are self-insured for matters relating to product quality a significant claim(s) could have a material adverse effect on our financial
position. Moreover, to the extent a defect in one of our products is caused by a defective component supplied to us by a third party,
we may, nonetheless, be liable to the customer and be unsuccessful in seeking indemnification from that third party.
Our goodwill, other intangible assets, or long-lived assets may become impaired, which could result in a significant charge to
earnings.
We hold significant amounts of goodwill, other intangible assets, and long-lived assets, and the balances of these assets could
increase in the future if we acquire other businesses. At December 31, 2018, the balance of our goodwill, other intangible assets,
and long-lived assets was $1.2 billion and the total market value of the Company’s outstanding shares was $1.2 billion. Under
generally accepted accounting principles in the United States ("U.S. GAAP"), we review our goodwill, other intangible assets,
and long-lived assets for impairment when events or changes in circumstances indicate the carrying value of such goodwill, other
intangible assets, or long-lived assets may not be recoverable. In addition, we test goodwill and other indefinite-lived intangible
assets for impairment annually. Factors that may be considered a change in circumstances, indicating that the carrying value of
our goodwill, other intangible assets, or long-lived assets may not be recoverable, include, but are not limited to, a sustained decline
in stock price and market capitalization, significant negative variances between actual and expected financial results, reduced
future cash flow estimates, adverse changes in legal factors, failure to realize anticipated synergies from acquisitions, and slower
growth rates in our industry. We may be required to record a significant charge to earnings in our financial statements during the
period in which any impairment of our goodwill, other intangible assets, or long-lived assets is determined to exist, negatively
impacting our results of operations. If our market capitalization was to fall below the book value of our total stockholders’ equity
for a sustained period, we may conclude that the fair value of certain of our intangible or long-lived assets is materially impaired.
In this case, we would be required under U.S. GAAP to record a non-cash charge to our earnings which could have a material
adverse effect on our business, results of operations, and financial condition.
Our credit agreement requires us to comply with certain financial covenants and our failure to comply could have a material
adverse effect on our financial condition.
The credit agreement governing our revolving credit facility contains covenants requiring us to, among other things, maintain a
minimum ratio of consolidated EBITDA to consolidated interest expense and a maximum ratio of consolidated total indebtedness
to consolidated EBITDA. In the past, we have obtained amendments from the lenders under the credit agreement which have
allowed us to comply with the financial covenants, but there can be no assurance that in the future the lenders will agree to such
amendments, and our inability to comply with the covenants could result in an event of default which, if not cured or waived,
could have a material adverse effect on our business, financial condition, and operating results.
15
We are subject to counterparty risk with respect to the convertible note hedge transactions.
As discussed in Note 11. Borrowings to our audited Consolidated Financial Statements under Item 8, "Financial Statements and
Supplementary Data", we issued convertible senior notes and concurrently entered into convertible note hedge transactions and
separate warrants. The option counterparties are financial institutions, and we are subject to the risk that one or more of the option
counterparties may default under the convertible note hedge transactions. Our exposure to the credit risk of the option counterparties
will not be secured by any collateral. If any of the option counterparties become subject to insolvency proceedings, we will become
an unsecured creditor in those proceedings with a claim equal to our exposure at that time under our transactions with such
counterparties. Our exposure will depend on many factors but, generally, the increase in our exposure will be correlated to the
increase in the market price and in the volatility of our common stock. In addition, upon a default by the option counterparties,
we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We
can provide no assurances as to the financial stability or viability of the option counterparties.
There are risks associated with our indebtedness, which could have a material adverse effect on our financial condition.
Our outstanding indebtedness and any additional indebtedness we incur may have negative consequences, including:
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requiring us to use cash to pay the principal of and interest on our indebtedness, thereby reducing the amount of cash
flow available for other purposes;
limiting our ability to obtain additional financing for working capital, capital expenditures, acquisitions, stock
repurchases, dividends, or other general corporate and other purposes;
limiting our flexibility in planning for, or reacting to, changes in our business and our industry; and
increasing our vulnerability to interest rate fluctuations to the extent a portion of our debt has variable interest rates.
Our ability to make payments of principal and interest on our indebtedness depends upon our future performance, which is subject
to general economic conditions, industry cycles, and financial, business, and other factors, many of which are beyond our control.
If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to, among
other things: refinance or restructure all or a portion of our indebtedness; reduce or delay planned capital or operating expenditures;
or sell selected assets. Such measures might not be sufficient to enable us to service our debt. In addition, any such financing,
refinancing, or sale of assets might not be available on economically favorable terms or at all, and if prevailing interest rates at
the time of any such financing and/or refinancing are higher than our current rates, interest expense related to such financing and/
or refinancing would increase. If there are adverse changes in the ratings assigned to our debt securities by credit rating agencies,
our borrowing costs, our ability to access debt in the future, and/or the terms of the financing could be adversely affected.
Risks Related to Our Corporate Governance
Our business could be negatively affected as a result of the actions of activist or hostile stockholders.
Our business could be negatively affected as a result of stockholder activism, which could cause us to incur significant expense,
hinder execution of our business strategy, and impact the trading value of our securities. Stockholder activism, which could take
many forms or arise in a variety of situations, has been increasing in publicly traded companies in recent years and we are subject
to the risks associated with such activism. Stockholder activism, including potential proxy contests, requires significant time and
attention by management and the Board of Directors, potentially interfering with our ability to execute our strategic plan.
Additionally, such stockholder activism could give rise to perceived uncertainties as to our future direction, adversely affect our
relationships with key executives and business partners, and make it more difficult to attract and retain qualified personnel. Also,
we may be required to incur significant legal fees and other expenses related to activist stockholder matters. Any of these impacts
could materially and adversely affect our business and operating results. Further, the market price of our common stock could be
subject to significant fluctuation or otherwise be adversely affected by stockholder activism.
16
Certain provisions in our certificate of incorporation, by-laws, and Delaware law may prevent or delay an acquisition of the
Company, which could decrease the trading price of our common stock.
Each of our certificate of incorporation, our by-laws, and Delaware law, as currently in effect, contain provisions that are intended
to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the
bidder and to encourage prospective acquirers to negotiate with our Board of Directors rather than to attempt a hostile takeover.
These provisions include, among others:
o
o
o
o
o
o
the inability of our stockholders to call a special meeting or act by written consent;
rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings;
the right of our Board of Directors to issue preferred stock without stockholder approval;
the classification of our Board of Directors and a provision that stockholders may only remove directors for cause, in
each case until our 2021 annual meeting of stockholders;
the ability of our directors, without a stockholder vote, to fill vacancies on our Board of Directors (including those
resulting from an enlargement of the Board of Directors); and
the requirement that stockholders holding at least 80% of our voting stock are required to amend certain provisions in
our certificate of incorporation and our by-laws.
In addition, current Delaware law includes provisions which limit the ability of persons that, without prior board approval, acquire
more than 15% of the outstanding voting stock of a Delaware corporation from engaging in any business combination with that
corporation, including by merger, consolidation, or purchases of additional shares, for a three-year period following the acquisition
by such persons of more than 15% of the corporation’s outstanding voting stock.
In light of present circumstances, we believe these provisions taken as a whole protect our stockholders from coercive or otherwise
unfair takeover tactics by requiring potential acquirers to negotiate with our Board of Directors and by providing our Board of
Directors with more time to assess any acquisition proposal. These provisions are not intended to make us immune from takeovers
or prevent the removal of incumbent directors. However, these provisions could delay or prevent an acquisition that our Board of
Directors determines is not in the best interests of the Company and all of our stockholders.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
17
ITEM 2. PROPERTIES
Our corporate headquarters is located in Itasca, Illinois. We maintain technical customer support offices and operating facilities
in North America, Europe, and Asia. Our principal manufacturing locations for the Audio segment are located in China, Malaysia,
and the Philippines. Our principal manufacturing locations for the PD segment are located in the U.S, Asia, and the Dominican
Republic.
The number, type, location, and size of the properties used by our continuing operations as of December 31, 2018 are shown in
the following chart:
Number and nature of facilities:
Manufacturing and Distribution
Other Facilities (principally sales, research and development, and headquarters)
Square footage (in 000s):
Owned
Leased (1)
Locations:
Asia
North America
Europe
Total
11
13
630
905
14
8
2
(1) Expiration dates on leased facilities range from 1 to 9 years.
We believe that our owned and leased facilities are well-maintained and suitable for our operations.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in various legal proceedings and claims arising in the ordinary course of our business, including
those related to intellectual property, which may be owned by us or others. We own many patents covering products, technology,
and manufacturing processes. Some of these patents have been and may continue to be challenged by others. In appropriate cases,
we have taken and will take steps to protect and defend our patents and other intellectual property, including through the use of
legal proceedings in various jurisdictions around the world. Such steps have resulted in and may continue to result in retaliatory
legal proceedings, including litigation or other legal proceedings in various jurisdictions and forums around the world alleging
that we infringe on patents owned by others. The costs of investigations and legal proceedings, particularly multi-forum litigation,
relating to the enforcement and defense of our intellectual property, may be substantial. Additionally, in multi-forum disputes, we
may incur adverse judgments with regard to certain claims in certain jurisdictions and forums while still contesting other related
claims against the same opposing party in other jurisdictions and forums. Although the ultimate outcome of any legal proceeding
or claim cannot be predicted with certainty, based on present information, including management’s assessment of the merits of
each claim, we do not expect that any asserted or unasserted legal proceedings or claims, individually or in the aggregate, will
have a material adverse effect on our cash flow, results of operations, or financial condition.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
18
EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth information regarding our executive officers, as of February 19, 2019.
Name
Age Position
Jeffrey S. Niew
John S. Anderson
Christian U. Scherp
Raymond D. Cabrera
Daniel J. Giesecke
Thomas G. Jackson
Michael S. Polacek
Air A. Bastarrica, Jr.
52
55
53
52
51
53
55
39
President & Chief Executive Officer
Senior Vice President & Chief Financial Officer
President, Performance Audio
Senior Vice President, Human Resources & Chief Administrative Officer
Senior Vice President & Chief Operating Officer
Senior Vice President, General Counsel & Secretary
President, Intelligent Audio
Vice President, Controller
Jeffrey S. Niew has served as President & Chief Executive Officer since September 2013 and as a member of our Board of Directors
since February 2014. From November 2011 until the Separation in February 2014, Mr. Niew served as a Vice President of Dover
Corporation and as President and Chief Executive Officer of Dover Communication Technologies. Mr. Niew joined Knowles
Electronics LLC (“Knowles Electronics”) in May 2000 and became Chief Operating Officer in January 2007, President in January
2008, and President and Chief Executive Officer in February 2010. Prior to joining Knowles Electronics, Mr. Niew was employed
by Littelfuse, Inc., from 1995 to 2000, where he held various positions in product management, sales, and engineering in the
Electronic Products group and by Hewlett-Packard Company, from 1988 to 1994, where he served in various engineering and
product management roles in the Optoelectronics Group in California.
John S. Anderson has served as Senior Vice President & Chief Financial Officer since December 2013. From January 2013 until
the Separation in February 2014, Mr. Anderson served as Vice President and Chief Financial Officer of Dover Communication
Technologies. Previously, Mr. Anderson served as Vice President and Chief Financial Officer of Dover Energy (from August 2010
to January 2013) and Vice President and Chief Financial Officer of Dover Fluid Management (from October 2009 to August 2010).
Previous experience includes the roles of Corporate Controller and Director Financial Planning & Analysis for Sauer-Danfoss Inc.
(from October 2004 to October 2009) and Director of Finance and Controller for Borg Warner Turbo Systems GmbH (from August
2002 to October 2004).
Christian U. Scherp has served as President, Performance Audio since July 2015 and prior thereto he was Co-President, Mobile
Consumer Electronics - Speakers and Receivers (from September 2012 to June 2015). Prior to joining Knowles Electronics,
Mr. Scherp served as the Global Head of Sales for the Consumer Devices business of TE Connectivity, a manufacturer of
connectivity and sensor platforms (from November 2011 to August 2012). Additional previous experience includes the following
roles at Conexant Systems: Executive Vice President of Sales (from January 2011 to June 2011), Co-President, WW Sales,
Marketing, Program Management (from July 2009 to December 2010), and President (from 2008 to 2009).
Raymond D. Cabrera has served as Senior Vice President, Human Resources & Chief Administrative Officer since February 2014.
From November 2011 until the Separation in February 2014, Mr. Cabrera served as Vice President, Human Resources of Dover
Communication Technologies. Previously, Mr. Cabrera served in the following capacities at Knowles: as Vice President, Human
Resources and Chief Administrative Officer (from January 2004 to November 2011), Vice President, Human Resources (from
March 2000 to January 2004), and Director, Human Resources (from June 1997 to March 2000) of Knowles Electronics.
Daniel J. Giesecke has served as Senior Vice President & Chief Operating Officer since February 2014. From January 2012 until
the Separation in February 2014, Mr. Giesecke served as Vice President, Global Operations of Dover Communication Technologies.
Previously, Mr. Giesecke served as Vice President, Advanced Manufacturing Engineering, Knowles Electronics (from February
2009 to January 2012), Senior Director, Advanced Manufacturing Engineering, Knowles Electronics (from January 2008 to
February 2009), Director of Engineering Operations, Knowles Electronics (from November 2003 to January 2008), and various
operations, supply chain, and engineering positions since he joined Knowles Electronics in 1995.
19
Thomas G. Jackson has served as Senior Vice President, Secretary since February 2014 and effective April 1, 2014, General
Counsel. Prior to joining Knowles, Mr. Jackson served as Vice President and Assistant General Counsel at Jabil Circuit, Inc., a
provider of electronic manufacturing services (from March 2012 to December 2013). In addition, he served as Vice President,
General Counsel and Secretary at P.H. Glatfelter Company, a manufacturer of specialty papers and fiber-based engineered materials
(from June 2008 to November 2011) and as its Assistant General Counsel, Assistant Secretary, and Director of Compliance (from
September 2006 to June 2008).
Michael S. Polacek has served as President, Intelligent Audio since February 2017. Prior to joining Knowles, Mr. Polacek was a
partner with Eachwin Capital, L.P., a management investment firm, from December 2012 to January 2017 and served as a strategic
adviser for KKR Private Equity during 2012. In addition, he held numerous management and other senior positions, including
Senior Vice President, Corporate Development and Key Market Segments at National Semiconductor, a semiconductor
manufacturer, from 1992 to 2011.
Air A. Bastarrica, Jr. has served as Vice President, Controller since July 6, 2018. Mr. Bastarrica has been with the Company since
2012 and has held numerous financial leadership roles including Director, Finance-Performance Audio (MCE and HHT) (2016 to
2018), Director, Finance-Hearing Health Technologies (2015 to 2016), and Manager, Corporate Financial Planning and Analysis
(2012 to 2015). Previously, Mr. Bastarrica held several financial positions at Navistar Inc. from 2000 to 2012 in Brazil and the
United States.
20
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER
PURCHASES OF EQUITY SECURITIES
PART II
Market Information
Our common stock is listed on the New York Stock Exchange ("NYSE") under the ticker symbol “KN”.
Dividends
Since our common stock began trading on the NYSE, we have not paid cash dividends and we do not anticipate paying a cash
dividend on our common stock in the immediate future. Any determination to pay dividends in the future will be at the discretion
of our Board of Directors and will depend on many factors, such as our financial condition, earnings, capital requirements, debt
service obligations, industry practice, legal requirements, regulatory constraints, and other factors that the Board of Directors
deems relevant. Our ability to pay dividends will depend on our ongoing ability to generate cash from operations and access to
the capital markets.
Holders
The number of holders of record of our common stock as of February 14, 2019 was approximately 982.
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
None.
21
Performance Graph
This performance graph does not constitute soliciting material, is not deemed filed with the SEC, and is not incorporated by
reference in any of our filings under the Securities Act or the Exchange Act, whether made before or after the date of this Annual
Report on Form 10-K and irrespective of any general incorporation language in any such filing, except to the extent we specifically
incorporate this performance graph by reference therein.
Data Source: NYSE
*Total return assumes reinvestment of dividends.
During the year ended December 31, 2018, the Company’s S&P index was changed to the S&P Small Cap 600 Index from the
S&P Mid Cap 400 Index. The graph assumes $100 invested on March 3, 2014, the date our common stock began "regular way"
trading on the NYSE, in Knowles Corporation common stock, the S&P Small Cap 600 Index, the S&P Mid Cap 400 Index, and
the PHLX / Semiconductor Sector Index.
22
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data on a continuing operations basis as derived from our audited Consolidated
Financial Statements.
The selected financial data includes costs of Knowles’ businesses, which include the allocation of certain corporate expenses from
our Former Parent through the date of the Separation. We believe that these allocations were made on a reasonable basis. The
selected historical financial data for the period prior to the Separation may not be indicative of our future performance as an
independent publicly traded company. The selected financial data should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included under Item 7 and the Consolidated Financial Statements
and accompanying notes included under Item 8, "Financial Statements and Supplementary Data."
Statement of Earnings Data (1)
(in millions, except share and per share amounts)
2018
2017
2016
2015 (2)
2014
Years Ended December 31,
Revenues
Gross profit (3)
Interest expense, net (4)
(Benefit from) provision for income taxes
Earnings from continuing operations
Basic earnings per share from continuing operations
Diluted earnings per share from continuing operations
Basic shares outstanding (5)
Diluted shares outstanding (5)
Balance Sheet Data
(in millions)
Total assets
Total third party debt and lease obligations (4)(6)
Other Data (1)
(in millions)
EBIT (7)
Depreciation and amortization
Capital expenditures
$
826.9
$
744.2
$
755.7
$
753.6
$
322.6
16.0
(4.5)
65.6
0.73
0.72
$
$
$
286.0
20.6
12.9
6.5
0.07
0.07
$
$
$
295.7
20.4
8.3
19.8
0.22
0.22
$
$
$
281.6
12.7
3.2
17.4
0.20
0.20
$
$
$
785.0
308.6
6.6
8.4
111.0
1.31
1.30
90,050,051
89,329,794
88,667,098
86,802,828
85,046,042
91,194,747
90,490,007
89,182,967
86,992,254
85,292,959
As of December 31,
2018
2017
2016
2015 (2)
2014
1,547.9
170.6
2018
77.1
52.4
80.1
$
$
$
$
$
1,549.8
207.4
$
$
1,515.0
313.8
$
$
1,696.4
447.5
Years Ended December 31,
2017
2016
2015 (2)
40.0
53.8
49.5
$
$
$
48.5
69.0
32.2
$
$
$
33.3
72.4
36.8
$
$
$
$
$
1,998.4
404.3
2014
126.0
70.1
59.2
$
$
$
$
$
$
$
$
(1) On July 7, 2016, the Company completed the sale of its Speaker and Receiver Product Line. On November 28, 2017, the
Company completed the sale of its Timing Device Business. All amounts presented are on a continuing operations basis. For
additional information, refer to Note 2. Disposed and Discontinued Operations to our Consolidated Financial Statements under
Item 8, "Financial Statements and Supplementary Data."
(2) On July 1, 2015, the Company completed its acquisition of all of the outstanding shares of common stock of Audience. The
Consolidated Statements of Earnings and Consolidated Balance Sheets include the results of operations, net assets acquired,
and depreciation and amortization expense related to Audience since the date of acquisition.
23
(3) On January 1, 2018, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update
(“ASU”) 2017-07 related to the presentation of net periodic pension and post-retirement benefit cost on a retrospective basis.
The standard requires components of net benefit cost other than service cost to be presented separately from the service cost
component and outside of any subtotal of operating income. The impacts of the reclassifications on gross profit were decreases
of $0.3 million, $0.2 million, $0.2 million, and nil for the years ended December 31, 2017, 2016, 2015, and 2014, respectively.
For additional information, refer to Note 1. Summary of Significant Accounting Policies to our Consolidated Financial
Statements under Item 8, “Financial Statements and Supplementary Data.”
(4) On January 27, 2014, we, as a borrower, entered into a $200.0 million five-year senior secured revolving credit facility with a
group of lenders, as well as a $300.0 million five-year senior secured term loan facility pursuant to a Credit Agreement ("Original
Credit Agreement"), which are referred to collectively as the “Prior Credit Facilities.” In connection with the Separation, we
incurred $100.0 million of borrowings under the revolving credit facility and $300.0 million of borrowings under the term loan
facility, in each case to finance a cash payment to our Former Parent immediately prior to the Separation. On December 31,
2014, we amended our Prior Credit Facilities to increase the amount of the revolving credit facility in the Original Credit
Agreement to $350.0 million but incurred no additional borrowings. On July 1, 2015, we amended our Prior Credit Facilities
to facilitate our ability to consummate the Audience acquisition. We funded the cash portion of the consideration through a
drawdown of our existing revolving credit facility and cash on hand. On February 9, 2016, the Company entered into a third
amendment to its Prior Credit Facilities in connection with the Company’s decision to sell the Speaker and Receiver Product
Line, which also included permanent reduction by the Company of the aggregate revolving commitment under the Original
Credit Agreement from $350.0 million to $300.0 million. On April 27, 2016, the Company entered into a fourth amendment
to its Prior Credit Facilities in connection with the Company's offering of the 3.25% Convertible Senior Notes due November
1, 2021 (the "Notes"). On October 11, 2017, the Company entered into a Revolving Credit Facility Agreement (the "New Credit
Facility"). The new agreement is being used for working capital and other general corporate purposes of the Company, including
refinancing of indebtedness under the Company’s Prior Credit Facilities. The New Credit Facility contains a five-year senior
secured revolving credit facility providing for borrowings in aggregate principal amount of up to $400.0 million. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of Operations—Borrowings" section for additional
information related to our debt.
(5) On July 1, 2015, the Company issued 3.2 million shares to former stockholders of Audience and for the conversion of vested
in-the-money Audience stock options. The Company also converted unvested in-the-money Audience stock options and
restricted stock units for an aggregate of 461,371 shares of its common stock. On February 28, 2014, in connection with the
Separation, Former Parent stockholders received one share of Knowles common stock for every two shares of Former Parent's
common stock held as of the record date. Basic and diluted earnings per common share and the average number of common
shares outstanding for the periods prior to the Separation were calculated using the number of Knowles common shares
outstanding immediately following the Separation. See Note 18. Earnings per Share to our Consolidated Financial Statements
under Item 8, "Financial Statements and Supplementary Data" for information regarding earnings per common share.
(6) Also includes current portion of long-term debt and capital lease obligations.
(7) We use the term “EBIT” throughout this Annual Report on Form 10-K, defined as net earnings plus (i) interest expense, net
and (ii) income taxes. EBIT is not presented in accordance with accounting principles generally accepted in the United States
of America ("GAAP" or "U.S. GAAP") and may not be comparable to similarly titled measures used by other companies. We
use EBIT as a supplement to our GAAP results of operations in evaluating certain aspects of our business, and our Board of
Directors and executive management team focus on EBIT as a key measure of our performance for business planning purposes.
This measure assists us in comparing performance between various reporting periods on a consistent basis, as this measure
removes from operating results the impact of items that, in our opinion, do not reflect our core operating performance. We
believe that our presentation of EBIT is useful because it provides investors and securities analysts with the same information
that we use internally for purposes of assessing our core operating performance. For a reconciliation of EBIT to net earnings,
the most directly related GAAP measure, please see the Statement of Earnings Data table above. The Company does not consider
EBIT to be a substitute for the information provided by GAAP financial results.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The discussion and analysis presented below refer to and should be read in conjunction with our audited Consolidated Financial
Statements and related notes under Item 8. "Financial Statements and Supplementary Data." The following discussion contains
forward-looking statements. The matters discussed in these forward-looking statements are subject to risks, uncertainties, and
other factors that could cause actual results to differ materially from those made, projected, or implied in the forward-looking
statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Form
10-K, particularly in “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements.”
Management’s discussion and analysis, which we refer to as “MD&A,” of our results of operations, financial condition, and cash
flows should be read together with the audited Consolidated Financial Statements and accompanying notes included under Item
8. "Financial Statements and Supplementary Data," to provide an understanding of our financial condition, changes in financial
condition, and results of our operations. We believe the assumptions underlying the Consolidated Financial Statements are
reasonable. However, the Consolidated Financial Statements included herein may not necessarily reflect our results of operations,
financial position, and cash flows in the future.
As discussed in Note 2. Disposed and Discontinued Operations to our audited Consolidated Financial Statements under Item 8,
"Financial Statements and Supplementary Data", we completed the sale of our high-end oscillators business ("Timing Device
Business") in the fourth quarter of 2017 and the sale of our speaker and receiver product line ("Speaker and Receiver Product
Line") in the third quarter of 2016. Accordingly, the results of operations and related assets and liabilities for the Timing Device
Business and the Speaker and Receiver Product Line have been reclassified as discontinued operations for all periods presented.
Unless otherwise indicated, discussion within this MD&A and elsewhere within this Annual Report Form 10-K refers to results
from continuing operations.
Our Business
We are a market leader and global provider of advanced micro-acoustic, audio processing, and precision device solutions, serving
the mobile consumer electronics, communications, medical, defense, aerospace, and industrial markets. We use our 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. We are also the leader
in acoustics components used in hearing aids and have a strong position in high-end capacitors. Our focus on the customer, combined
with our unique technology, proprietary manufacturing techniques, rigorous testing, and global scale, enables us to deliver
innovative solutions that optimize the user experience. References to "Knowles," the "Company," "we," "our," or "us" refer to
Knowles Corporation and its consolidated subsidiaries, unless the context otherwise requires.
Our Business Segments
We are organized into two reportable segments based on how management analyzes performance, allocates capital, and makes
strategic and operational decisions. These segments were determined in accordance with Accounting Standards Codification
("ASC") 280, Segment Reporting, and are comprised of (i) Audio and (ii) PD. The segments are aligned around similar product
applications serving our key end markets, to enhance focus on end market growth strategies.
• Audio Segment
Our Audio group designs and manufactures innovative audio products, including microphones and balanced armature
speakers, audio processors, and software and algorithms used in applications that serve the mobile, ear, and IoT markets.
Locations include the sales, support, and engineering facilities in North America, Europe, and Asia, as well as the
manufacturing facilities in Asia.
•
PD Segment
Our PD group specializes in the design and delivery of highly engineered capacitors and RF devices for technically
demanding applications. Our devices are used in applications including power supplies, radar, medical implants, and
satellites, serving the industrial, defense, aerospace, medical, telecommunications, and automotive markets. Locations
include the sales, support, engineering, and manufacturing facilities in North America, Europe, and Asia.
We sell our products directly to original equipment manufacturers ("OEMs") and to their contract manufacturers and suppliers
and to a lesser extent through distributors worldwide.
25
On January 19, 2018, we acquired substantially all of the assets of Compex Corporation ("Compex") for $18.7 million. The acquired
business provides single layer electronic components to the telecommunicaton, fiber optics, defense, and aerospace markets. This
acquisition's operations are included in the PD segment. For additional information, refer to Note 3. Acquisitions to our Consolidated
Financial Statements under Item 8, "Financial Statements and Supplementary Data."
On November 28, 2017, we completed the sale of the Timing Device Business, part of the PD segment, for $130.0 million, plus
purchase price adjustments for a net amount of $135.1 million. For additional information, refer to Note 2. Disposed and
Discontinued Operations to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
On January 11, 2017, we 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 2018, with
the remaining $0.2 million to be paid in the first quarter of 2019. This acquisition's operations are included in the PD segment.
On July 7, 2016, we completed the sale of our Speaker and Receiver Product Line for $45.0 million in cash, less purchase price
adjustments, for a net amount received of $40.6 million. For additional information, refer to Note 2. Disposed and Discontinued
Operations to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
Results of Operations for the Year Ended December 31, 2018 compared with the Years Ended December 31, 2017 and
2016
In addition to the GAAP financial measures included herein, we have presented certain non-GAAP financial measures. We use
non-GAAP measures as supplements to our GAAP results of operations in evaluating certain aspects of our business, and our
executive management team and Board of Directors focus on non-GAAP items as key measures of our performance for business
planning purposes. These measures assist us in comparing our performance between various reporting periods on a consistent
basis, as these measures remove from operating results the impact of items that, in our opinion, do not reflect our core operating
performance. We believe that our presentation of non-GAAP financial measures is useful because it provides investors and
securities analysts with the same information that we use internally for purposes of assessing our core operating performance.
The Company does not consider these non-GAAP financial measures to be a substitute for the information provided by GAAP
financial results. For a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial
measures, see the reconciliation included herein.
(in millions, except per share amounts)
Revenues
Gross profit
Non-GAAP gross profit
Earnings from continuing operations before interest and income taxes
Adjusted earnings from continuing operations before interest and income taxes
(Benefit from) provision for income taxes
Non-GAAP provision for income taxes
Earnings from continuing operations
Non-GAAP net earnings from continuing operations
Earnings per share from continuing operations - diluted
Non-GAAP diluted earnings per share from continuing operations
26
Years Ended December 31,
2018
826.9
322.6
327.0
77.1
117.2
(4.5)
13.0
65.6
94.5
0.73
1.01
$
$
$
$
$
$
$
$
$
$
$
2017
744.2
286.0
299.9
40.0
110.6
12.9
14.9
6.5
81.2
0.07
0.88
$
$
$
$
$
$
$
$
$
$
$
2016
755.7
295.7
302.0
48.5
99.7
8.3
3.2
19.8
80.5
0.22
0.89
$
$
$
$
$
$
$
$
$
$
$
Revenues
2018 Versus 2017
Revenues for the year ended December 31, 2018 were $826.9 million, compared with $744.2 million for the year ended
December 31, 2017, an increase of $82.7 million or 11.1%. This change was due to an increase in Audio revenues of $44.8
million primarily due to higher shipments of MEMS microphones to Chinese OEMs and key North American OEMs. In addition,
we had higher shipments of intelligent audio solutions and hearing health transducers, partially offset by lower average selling
prices on mature products, lower royalties as a result of a settlement in 2017, and lower shipments to a key Korean OEM. PD
revenues had an increase of $37.9 million primarily due to higher capacitor product shipments for the defense, industrial, and
automotive markets, as well as increased revenues related to our acquisition of Compex.
2017 Versus 2016
Revenues for the year ended December 31, 2017 were $744.2 million, compared with $755.7 million for the year ended
December 31, 2016, a decrease of $11.5 million or 1.5%. This change was due to a decrease in Audio revenues of $24.5 million
primarily due to lower average selling prices on mature products in the Audio segment. In addition, shipments of hearing health
transducers decreased from the prior year as we have been more disciplined with our pricing. The decreases were partially
offset by the $13.6 million of revenue from a settlement of a royalty dispute and higher shipments of MEMS microphones to
the IoT market. PD revenues had an increase of $13.0 million primarily due to higher capacitor product shipments for the
defense, medical, and automotive markets, as well as increased revenues related to our capacitors acquisition in January 2017,
partially offset by lower pricing.
Cost of Goods Sold
2018 Versus 2017
Cost of goods sold ("COGS") for the year ended December 31, 2018 was $503.9 million, compared with $452.8 million for
the year ended December 31, 2017, an increase of $51.1 million or 11.3%. This increase was primarily due to higher volume
from MEMS microphones, capacitor products, and intelligent audio solutions. In addition, there were unfavorable foreign
currency exchange rate changes and higher ramp costs associated with new product launches at our largest customer, partially
offset by material cost savings, productivity initiatives, lower production transfer costs, and a settlement of a supplier warranty
claim.
2017 Versus 2016
COGS for the year ended December 31, 2017 was $452.8 million, compared with $458.2 million for the year ended December
31, 2016, a decrease of $5.4 million or 1.2%. This decrease was primarily due to favorable impacts from productivity initiatives
and foreign exchange rate changes, partially offset by lower fixed overhead absorption. In addition, we experienced higher
capacitor and MEMS microphone shipment volume to the IoT market, along with increases in both production transfer costs
and restructuring charges.
27
Impairment Charges
In 2017 we recorded total impairment charges of $21.3 million, which relates to a specific product line within the Audio
segment. We concluded that the projected cash flows from this product line were not sufficient to recover the carrying value
of the associated long-lived assets. Total impairment charges of $1.4 million were classified as COGS and $19.9 million were
classified as Operating expenses. For additional information on impairments of long-lived assets, refer to Note 4. Impairments
to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
Restructuring Charges
We undertake restructuring programs from time to time to better align our operations with current market conditions. Such
activities include facility consolidations, headcount reductions, and other measures to further optimize operations. It is likely
that we will have restructuring charges in the future as we continue to consolidate our manufacturing footprint. Details regarding
restructuring programs undertaken during the reporting period are as follows:
2018
During the year ended December 31, 2018, we recorded restructuring charges of $2.1 million. The charges consist primarily
of actions associated with rationalizing the workforce and transferring certain operations of capacitors manufacturing to other
existing facilities in order to optimize operations. Charges of $0.4 million were classified as COGS and charges of $1.7 million
were classified as Operating expenses.
2017
During the year ended December 31, 2017, we recorded restructuring charges of $10.2 million. The charges consist primarily
of actions associated with rationalizing the workforce and the continued transfer of our hearing health manufacturing into a
lower-cost Asian manufacturing facility. Charges of $4.0 million were classified as COGS and charges of $6.2 million were
classified as Operating expenses.
2016
During the year ended December 31, 2016, we recorded restructuring charges of $10.1 million comprised primarily of actions
associated with the integration of Audience. Other charges related to actions associated with lowering operating expenses and
the continued expenses for the transfer of our capacitors business into existing, lower-cost Asian manufacturing facilities.
Charges of $1.5 million were classified as COGS and charges of $8.6 million were classified as Operating expenses.
Gross Profit and Non-GAAP Gross Profit
2018 Versus 2017
Gross profit for the year ended December 31, 2018 was $322.6 million, compared with $286.0 million for the year ended
December 31, 2017, an increase of $36.6 million or 12.8%. Gross profit margin (gross profit as a percentage of revenues) for
the year ended December 31, 2018 was 39.0%, compared with 38.4% for the year ended December 31, 2017. The gross profit
and margin increased primarily due to higher shipment volumes. In addition, there were material cost savings, productivity
initiatives, lower production transfer costs, a settlement of a supplier warranty claim, and reduced restructuring charges. The
increases were partially offset by lower average selling prices on mature products, a settlement of a royalty dispute in 2017,
foreign currency exchange rate changes, and higher ramp costs associated with new product launches at our largest customer.
Non-GAAP gross profit for the year ended December 31, 2018 was $327.0 million, compared with $299.9 million for the year
ended December 31, 2017, an increase of $27.1 million or 9.0%. Non-GAAP gross profit margin (non-GAAP gross profit as
a percentage of revenues) for the year ended December 31, 2018 was 39.5%, as compared with 40.3% for the year ended
December 31, 2017. Non-GAAP gross profit increased primarily due to higher shipment volumes. In addition, there were
material cost savings, productivity initiatives, and a settlement of a supplier warranty claim. The increases were partially offset
by lower average selling prices on mature products, a settlement of a royalty dispute in 2017, foreign currency exchange rate
changes, and higher ramp costs associated with new product launches at our largest customer. Non-GAAP gross profit margin
decreased primarily due to a settlement of a royalty dispute in 2017.
28
2017 Versus 2016
Gross profit for the year ended December 31, 2017 was $286.0 million, compared with $295.7 million for the year ended
December 31, 2016, a decrease of $9.7 million or 3.3%. Gross profit margin for the year ended December 31, 2017 was 38.4%,
compared with 39.1% for the year ended December 31, 2016. The gross profit and margin decreased primarily due to lower
average selling prices on mature products, lower fixed overhead absorption, higher production transfer costs, and increased
restructuring charges. The decreases were partially offset by favorable impacts from productivity initiatives, a settlement of a
royalty dispute, and foreign currency exchange rate changes.
Non-GAAP gross profit for the year ended December 31, 2017 was $299.9 million, compared with $302.0 million for the year
ended December 31, 2016, a decrease of $2.1 million or 0.7%. Non-GAAP gross profit margin for the year ended December
31, 2017 was 40.3%, as compared with 40.0% for the year ended December 31, 2016. The Non-GAAP gross profit decreased
primarily due to lower average selling prices on mature products and lower fixed overhead absorption. The decrease was
partially offset by favorable impacts from productivity initiatives, a settlement of a royalty dispute, and foreign currency
exchange rate changes. Non-GAAP gross profit margin increased slightly as non-GAAP gross profit remained relatively
consistent with prior year while revenues decreased $11.5 million.
Research and Development Expenses
2018 Versus 2017
Research and development expenses for the years ended December 31, 2018 and 2017 were $100.6 million and $93.4 million,
respectively. Research and development expenses as a percentage of revenues for the years ended December 31, 2018 and
2017 were 12.2% and 12.6%, respectively. The increase in research and development expenses was driven by compensation
increases and an increase in new product development spending.
2017 Versus 2016
Research and development expenses for the years ended December 31, 2017 and 2016 were $93.4 million and $92.0 million,
respectively. Research and development expenses as a percentage of revenues for the years ended December 31, 2017 and
2016 were 12.6% and 12.2%, respectively. The increase in research and development expenses was driven by compensation
increases, partially offset by lower headcount.
Selling and Administrative Expenses
2018 Versus 2017
Selling and administrative expenses for the year ended December 31, 2018 were $142.5 million, compared with $126.6 million
for the year ended December 31, 2017, an increase of $15.9 million or 12.6%. Selling and administrative expenses as a percentage
of revenues for the year ended December 31, 2018 were 17.2%, compared with 17.0% for the year ended December 31, 2017.
The increase in selling and administrative expenses was primarily driven by incentive compensation increases, an increase in
legal fees, and the acquisition of Compex, partially offset by lower intangible amortization costs. The increase in legal fees
was primarily due to a settlement of a royalty dispute in 2017.
2017 Versus 2016
Selling and administrative expenses for the year ended December 31, 2017 were $126.6 million, compared with $149.9 million
for the year ended December 31, 2016, a decrease of $23.3 million or 15.5%. Selling and administrative expenses as a percentage
of revenues for the year ended December 31, 2017 were 17.0%, compared with 19.8% for the year ended December 31, 2016.
The decrease in selling and administrative expenses and as a percentage of revenues was primarily driven by lower intangible
amortization costs, benefits of our cost reduction initiatives, and a reduction in legal fees. The reduction in legal fees was driven
by a settlement of a royalty dispute, which included a $5.6 million allocation against previously incurred expenses.
29
Earnings and Adjusted Earnings from Continuing Operations Before Interest and Income Taxes
2018 Versus 2017
Earnings before interest and income taxes ("EBIT") from continuing operations for the year ended December 31, 2018 was
$77.1 million, compared with $40.0 million for the year ended December 31, 2017, an increase of $37.1 million or 92.8%.
EBIT margin (EBIT from continuing operations as a percentage of revenues) for the year ended December 31, 2018 was 9.3%,
as compared with 5.4% for the year ended December 31, 2017. This increase was primarily due to higher gross profit and the
absence of impairment charges in 2018, partially offset by higher operating expenses due to incentive compensation increases,
an increase in legal fees due to a settlement of a royalty dispute in 2017, and the acquisition of Compex.
Adjusted earnings before interest and income taxes ("Adjusted EBIT") from continuing operations for the year ended December
31, 2018 was $117.2 million, compared with $110.6 million for the year ended December 31, 2017, an increase of $6.6 million
or 6.0%. Adjusted EBIT margin (adjusted EBIT from continuing operations as a percentage of revenues) for the year ended
December 31, 2018 was 14.2%, as compared with 14.9% for the year ended December 31, 2017. This Adjusted EBIT increase
was primarily due to higher gross profit, partially offset by higher operating expenses due to compensation increases, an increase
in legal fees due to a settlement of a royalty dispute in 2017, and the acquisition of Compex. The Adjusted EBIT margin decrease
is primarily due to a settlement of a royalty dispute in 2017, and higher operating expenses due to incentive compensation
increases.
2017 Versus 2016
EBIT from continuing operations for the year ended December 31, 2017 was $40.0 million, compared with $48.5 million for
the year ended December 31, 2016, a decrease of $8.5 million or 17.5%. EBIT margin for the year ended December 31, 2017
was 5.4%, as compared to 6.4% for the year ended December 31, 2016. This decrease was primarily due to lower gross profit
and higher impairment charges in Operating expense, partially offset by lower intangible amortization costs, benefits of our
operating cost reduction initiatives, and the reduction in legal fees driven by a settlement of a royalty dispute.
Adjusted EBIT from continuing operations for the year ended December 31, 2017 was $110.6 million, compared with $99.7
million for the year ended December 31, 2016, an increase of $10.9 million or 10.9%. Adjusted EBIT margin for the year ended
December 31, 2017 was 14.9%, as compared with 13.2% for the year ended December 31, 2016. The increase is primarily due
to lower non-GAAP operating expenses, driven by our operating cost reduction initiatives, and the reduction in legal fees driven
by a settlement of a royalty dispute.
Interest Expense, net
2018 Versus 2017
Interest expense, net for the year ended December 31, 2018 was $16.0 million, compared with $20.6 million for the year ended
December 31, 2017, a decrease of $4.6 million or 22.3%. The decrease in interest expense is primarily due to lower outstanding
borrowings. For additional information on borrowings and interest expense, refer to Note 11. Borrowings to our Consolidated
Financial Statements under Item 8, "Financial Statements and Supplementary Data."
2017 Versus 2016
Interest expense, net for the year ended December 31, 2017 was $20.6 million, compared with $20.4 million for the year ended
December 31, 2016, an increase of $0.2 million or 1.0%. The increase in interest expense is primarily due to non-cash interest
expense related to the Company's issuance of $172.5 million aggregate principal amount of 3.25% convertible senior notes
due November 1, 2021 in a private placement in May 2016 (the "Notes") and higher interest rates, partially offset by lower
outstanding borrowings. For additional information on borrowings and interest expense, refer to Note 11. Borrowings to our
Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
30
(Benefit from) Provision for Income Taxes and Non-GAAP Provision for Income Taxes
2018 Versus 2017
The effective tax rate ("ETR") for the year ended December 31, 2018 was a 7.4% benefit, compared with a 66.5% provision
for the year ended December 31, 2017. The change in the ETR is primarily due to the mix of earnings by taxing jurisdictions
and the Tax Reform Act. As a result of the Internal Revenue Service ("IRS") approval for an entity classification election
received during the fourth quarter of 2018, we recorded a $17.8 million reduction to our transition tax liability.
The ETR for the years ended December 31, 2018 and 2017 was favorably impacted by two tax holidays granted to us by
Malaysia. For additional information on these tax holidays, see Note 12. Income Taxes to our Consolidated Financial Statements
under Item 8, “Financial Statements and Supplementary Data."
The non-GAAP ETR for the year ended December 31, 2018 was a 12.1% provision, compared with a 15.5% provision for the
year ended December 31, 2017. The change in the non-GAAP ETR was due to the mix of earnings by taxing jurisdictions.
The ETR and non-GAAP ETR deviate from the statutory U.S. federal income tax rate, mainly due to the taxing jurisdictions
in which we generate taxable income or loss, the favorable impact of our tax holidays in Malaysia, and judgments as to the
realizability of our deferred tax assets. A significant portion of our pre-tax income is not subject to tax as a result of our tax
holidays in Malaysia, subject to our satisfaction of certain conditions that we expect to continue to satisfy. Unless extended or
otherwise renegotiated, our existing tax holidays in Malaysia will expire December 31, 2021. During 2016, the Company
applied for and received final approval to modify the terms of its main tax holiday in Malaysia, reducing the rate to 7.2% versus
the statutory rate of 24.0%, effective January 1, 2017 through December 31, 2021. The U.S. operations were in a cumulative
loss position as of December 31, 2018 and 2017, respectively. Based on this, and other relevant information, the Company
concluded that tax losses and deferred tax assets generated in the U.S. would not be benefited currently or in the future.
2017 Versus 2016
The ETR for the year ended December 31, 2017 was a 66.5% provision, compared with a 29.5% provision for the year ended
December 31, 2016. The change in the ETR is primarily due to the mix of earnings by taxing jurisdictions, the change to the
terms of our tax holiday in Malaysia, and the Tax Reform Act. We recorded a provisional tax benefit of $11.7 million related
to the reassessment of the beginning of the year valuation allowance, and a $5.6 million provisional benefit related to the
remeasurement of our net deferred tax liability as a result of the Tax Reform Act. We also recorded a provisional tax expense
of $56.0 million, net of expected foreign tax credits, related to the deemed repatriation of unremitted earnings for foreign
subsidiaries, which was partially offset by the use of existing tax attributes primarily consisting of net operating loss
carryforwards and research and development tax credits.
The ETR for the years ended December 31, 2017 and 2016 was favorably impacted by two tax holidays granted to us by
Malaysia. The ETR for the year ended December 31, 2017 was unfavorably impacted by losses incurred in jurisdictions with
zero tax benefit recorded. The ETR for the year ended December 31, 2016 was unfavorably impacted by valuation allowances
recorded in certain jurisdictions, primarily the U.S. and the United Kingdom ("U.K").
The non-GAAP ETR for the year ended December 31, 2017 was a 15.5% provision, compared with a 3.8% provision for the
year ended December 31, 2016. The change in the non-GAAP ETR was due to the mix of earnings by taxing jurisdictions.
The ETR and non-GAAP ETR deviate from the statutory U.S. federal income tax rate, mainly due to the taxing jurisdictions
in which we generate taxable income or loss, the favorable impact of our tax holidays in Malaysia, and judgments as to the
realizability of our deferred tax assets.
Earnings (Loss) from Discontinued Operations, net
2018 Versus 2017
The earnings from discontinued operations was $2.1 million net of tax for the year ended December 31, 2018, compared with
earnings of $61.8 million for the year ended December 31, 2017. The change in discontinued operations was primarily driven
by the sale of our Timing Device Business on November 28, 2017, for which we recognized a $62.3 million pre-tax gain in
2017 and a $1.8 million favorable purchase price adjustment in 2018.
31
2017 Versus 2016
The earnings from discontinued operations was $61.8 million net of tax for the year ended December 31, 2017 compared with
a loss of $62.1 million for the year ended December 31, 2016 . The earnings in 2017 primarily relates to the $62.3 million pre-
tax gain on sale of our Timing Device Business. The 2016 loss was primarily related to the high unabsorbed fixed costs in our
Speaker and Receiver Product Line due to lower production activity and the $25.6 million pre-tax loss on the sale of our Speaker
and Receiver Product Line.
Diluted Earnings per Share from Continuing Operations and Non-GAAP Diluted Earnings per Share from Continuing
Operations
2018 Versus 2017
Diluted earnings per share from continuing operations was $0.72 for the year ended December 31, 2018, compared with $0.07
for the year ended December 31, 2017. The increase in diluted earnings per share was primarily due to higher EBIT.
Non-GAAP diluted earnings per share from continuing operations for the year ended December 31, 2018 was $1.01, compared
with $0.88 for the year ended December 31, 2017. The increase in non-GAAP diluted earnings per share was primarily due to
higher Adjusted EBIT.
2017 Versus 2016
Diluted earnings per share from continuing operations was $0.07 for the year ended December 31, 2017, compared with $0.22
for the year ended December 31, 2016. The decrease in diluted earnings per share was primarily due to lower EBIT.
Non-GAAP diluted earnings per share from continuing operations for the year ended December 31, 2017 was $0.88, compared
with $0.89 for the year ended December 31, 2016. The decrease in non-GAAP diluted earnings per share was mainly driven
by higher adjusted EBIT, which was more than offset by a higher effective tax rate.
32
Reconciliation of GAAP Financial Measures to Non-GAAP Financial Measures (1)
(in millions, except share and per share amounts)
Gross profit
Stock-based compensation expense
Impairment charges
Restructuring charges
Production transfer costs (2)
Other (3)
Non-GAAP gross profit
Earnings from continuing operations
Interest expense, net
(Benefit from) provision for income taxes
Earnings from continuing operations before interest and income taxes
Stock-based compensation expense
Intangibles amortization expense
Impairment charges
Restructuring charges
Production transfer costs (2)
Other (3)
Adjusted earnings from continuing operations before interest and income taxes
Interest expense, net
Interest expense, net non-GAAP reconciling adjustments (4)
Non-GAAP interest expense
(Benefit from) provision for income taxes
Income tax effects of non-GAAP reconciling adjustments (5)
Non-GAAP provision for income taxes
Earnings from continuing operations
Non-GAAP reconciling adjustments (6)
Interest expense, net non-GAAP reconciling adjustments (4)
Income tax effects of non-GAAP reconciling adjustments (5)
Non-GAAP net earnings from continuing operations
Diluted earnings per share from continuing operations
Earnings per share non-GAAP reconciling adjustment
Non-GAAP diluted earnings per share from continuing operations
Years Ended December 31,
2018
2017
2016
$
322.6
$
286.0
$
295.7
1.6
—
0.4
2.2
0.2
$
$
327.0
65.6
16.0
(4.5)
77.1
27.0
6.5
—
2.1
2.6
1.9
117.2
16.0
6.3
9.7
$
$
$
(4.5) $
17.5
13.0
65.6
40.1
6.3
17.5
94.5
0.72
0.29
1.01
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
1.8
1.4
4.0
6.7
—
299.9
6.5
20.6
12.9
40.0
24.7
7.3
21.3
10.2
6.8
0.3
110.6
20.6
6.1
14.5
12.9
2.0
14.9
6.5
70.6
6.1
2.0
81.2
0.07
0.81
0.88
$
$
$
$
$
$
$
$
$
$
$
1.5
0.3
1.5
3.0
—
302.0
19.8
20.4
8.3
48.5
20.9
18.2
0.5
10.1
3.0
(1.5)
99.7
20.4
4.4
16.0
8.3
(5.1)
3.2
19.8
51.2
4.4
(5.1)
80.5
0.22
0.67
0.89
Diluted average shares outstanding
Non-GAAP adjustment (7)
Non-GAAP diluted average shares outstanding (7)
91,194,747
90,490,007
89,182,967
2,046,989
1,959,801
1,758,522
93,241,736
92,449,808
90,941,489
33
(1) In addition to the GAAP financial measures included herein, Knowles has presented certain non-GAAP financial measures
that exclude certain amounts that are included in the most directly comparable GAAP measures. Knowles believes that non-
GAAP measures are useful as supplements to its GAAP results of operations to evaluate certain aspects of its operations
and financial performance, and its management team primarily focuses on non-GAAP items in evaluating Knowles'
performance for business planning purposes. Knowles also believes that these measures assist it with comparing its
performance between various reporting periods on a consistent basis, as these measures remove from operating results the
impact of items that, in Knowles' opinion, do not reflect its core operating performance. Knowles believes that its presentation
of non-GAAP financial measures is useful because it provides investors and securities analysts with the same information
that Knowles uses internally for purposes of assessing its core operating performance.
(2) Production transfer costs represent duplicate costs incurred to migrate manufacturing to facilities primarily in Asia. These
amounts are included in the corresponding Gross profit and Earnings from continuing operations before interest and income
taxes for each period presented.
(3) In 2018, Other expenses in Gross profit and Operating expenses represent expenses related to acquisitions and the remaining
Other expenses represent an adjustment to pre-spin-off pension obligations. In 2017, Other primarily represents expenses
related to the acquisition of certain assets of a capacitors manufacturer. In 2016, Other primarily represents a gain on the
sale of investment related to a non-controlling interest in a MEMs timing device company, partially offset by expenses
related to the Audience acquisition.
(4) Under GAAP, certain convertible debt instruments that may be settled in cash (or other assets) upon conversion are required
to be separately accounted for as liability (debt) and equity (conversion option) components of the instrument in a manner
that reflects the issuer’s nonconvertible debt borrowing rate. Accordingly, for GAAP purposes we are required to recognize
imputed interest expense on the Company’s $172.5 million of convertible senior notes due 2021 that were issued in a private
placement in May 2016. The imputed interest rate is 8.12% for the convertible notes due 2021, while the actual coupon
interest rate of the notes was 3.25%. The difference between the imputed interest expense and the coupon interest expense
is excluded from management’s assessment of the Company’s operating performance because management believes that
this non-cash expense is not indicative of its core, ongoing operating performance.
(5) Income tax effects of non-GAAP reconciling adjustments are calculated using the applicable tax rates in the jurisdictions
of the underlying adjustments. Adjustments are also made to exclude certain impacts of the Tax Reform Act and the resulting
consequences that were accounted for as uncertain tax positions.
(6) The Non-GAAP reconciling adjustments are those adjustments made to reconcile Earnings from continuing operations
before interest and income taxes to Adjusted earnings from continuing operations before interest and income taxes.
(7) The number of shares used in the diluted per share calculations on a non-GAAP basis excludes the impact of stock-based
compensation expense expected to be incurred in future periods and not yet recognized in the financial statements, which
would otherwise be assumed to be used to repurchase shares under the GAAP treasury stock method.
34
Segment Results of Operations for the Year Ended December 31, 2018 Compared with the Years Ended December 31, 2017
and 2016
Audio
(in millions)
Revenues
Operating earnings
Other income, net
Percent of
Revenues
15.4%
$
$
2018
682.2
105.1
(0.6)
Earnings from continuing operations before
interest and income taxes
$
105.7
15.5%
Stock-based compensation expense
Intangibles amortization expense
Impairment charges
Restructuring charges
Production transfer costs (1)
Other
13.4
4.7
—
1.4
1.0
—
Years Ended December 31,
$
$
$
Percent of
Revenues
2017
637.4
11.9%
11.9%
75.8
(0.3)
76.1
11.5
6.5
21.3
8.1
6.3
—
$
$
$
Percent of
Revenues
2016
661.9
13.4%
13.4%
88.4
(0.4)
88.8
9.7
18.0
0.5
7.1
1.0
0.1
Adjusted earnings from continuing operations
before interest and income taxes
$
126.2
18.5%
$
129.8
20.4%
$
125.2
18.9%
(1) Production transfer costs represent duplicate costs incurred to migrate manufacturing to existing facilities in Asia. These
amounts are included in earnings from continuing operations before interest and income taxes for each period presented.
Revenues
2018 Versus 2017
Audio revenues were $682.2 million for the year ended December 31, 2018, compared with $637.4 million for the year ended
December 31, 2017, an increase of $44.8 million or 7.0%. Revenues increased primarily due to higher shipments of MEMS
microphones to Chinese OEMs and key North American OEMs. In addition, we had higher shipments of intelligent audio solutions
and hearing health transducers, partially offset by lower average selling prices on mature products, lower royalties as a result of
a settlement in 2017, and lower shipments to a key Korean OEM.
2017 Versus 2016
Audio revenues were $637.4 million for the year ended December 31, 2017, compared with $661.9 million for the year ended
December 31, 2016, a decrease of $24.5 million or 3.7%. Revenues decreased primarily due to lower average selling prices on
mature products in the Audio segment. In addition, shipments of hearing health transducers decreased from the prior year as we
have been more disciplined with our pricing. The decreases were partially offset by the $13.6 million of revenue from a settlement
of a royalty dispute and higher shipments of MEMS microphones to the IoT market and higher shipments of MEMS microphones
to the IoT market.
35
Earnings and Adjusted Earnings from Continuing Operations Before Interest and Income Taxes
2018 Versus 2017
Audio EBIT from continuing operations was $105.7 million for the year ended December 31, 2018, compared with $76.1 million
for the year ended December 31, 2017, an increase of $29.6 million or 38.9%. EBIT margin for the year ended December 31, 2018
was 15.5%, compared to 11.9% for the year ended December 31, 2017. The increase was primarily due to higher shipment volumes,
the absence of impairment charges in 2018, material cost savings, productivity initiatives, reduced restructuring charges, lower
production transfer costs, and a settlement of a supplier warranty claim. The increases were partially offset by lower average selling
prices on mature products, a settlement of a royalty dispute in 2017, foreign currency exchange rate changes, and higher ramp
costs associated with new product launches at our largest customer.
Audio Adjusted EBIT was $126.2 million for the year ended December 31, 2018, compared with $129.8 million for the year ended
December 31, 2017, a decrease of $3.6 million or 2.8%. Adjusted EBIT margin for the year ended December 31, 2018 was 18.5%,
compared with 20.4% for the year ended December 31, 2017. The decrease was primarily due to lower average selling prices on
mature products, a settlement of a royalty dispute in 2017, foreign currency exchange rate changes, and higher ramp costs associated
with new product launches at our largest customer. The decreases were partially offset by higher shipment volumes, material cost
savings, productivity initiatives, and a settlement of a supplier warranty claim. The Adjusted EBIT margin decreased primarily
due to a settlement of a royalty dispute in 2017.
2017 Versus 2016
Audio EBIT from continuing operations was $76.1 million for the year ended December 31, 2017, compared with $88.8 million
for the year ended December 31, 2016, a decrease of $12.7 million or 14.3%. EBIT margin for the year ended December 31, 2017
was 11.9%, compared to 13.4% for the year ended December 31, 2016. The decrease was primarily due to lower average selling
prices on mature products, higher impairments of long-lived assets, lower fixed overhead absorption, higher production transfer
costs, increased stock-based compensation, and higher restructuring charges. These decreases were partially offset by benefits
from our productivity initiatives, $19.2 million received from a settlement of a royalty dispute, lower amortization expenses,
benefits of our operating cost reduction initiatives, favorable impacts from foreign currency exchange rate changes, and higher
shipments of MEMS microphones.
Audio Adjusted EBIT was $129.8 million for the year ended December 31, 2017, compared with $125.2 million for the year ended
December 31, 2016, an increase of $4.6 million or 3.7%. Adjusted EBIT margin for the year ended December 31, 2017 was 20.4%,
compared with 18.9% for the year ended December 31, 2016. The increase was primarily due to benefits from our productivity
initiatives, $19.2 million received from a settlement of a royalty dispute, benefits of our operating cost reduction initiatives,
favorable impacts from foreign currency exchange rate changes, and higher shipments of MEMS microphones. These increases
were partially offset by lower average selling prices on mature products and lower fixed overhead absorption.
36
Precision Devices
(in millions)
Revenues
Operating earnings
Other expense (income), net
Earnings from continuing operations before
interest and income taxes
Stock-based compensation expense
Intangibles amortization expense
Restructuring charges
Production transfer costs (1)
Other (2)
Adjusted earnings from continuing operations
before interest and income taxes
Years Ended December 31,
Percent of
Revenues
2018
144.7
19.1%
27.7
0.2
27.5
19.0%
$
$
$
$
$
$
Percent of
Revenues
2017
106.8
17.2%
18.4
(0.8)
19.2
18.0%
Percent of
Revenues
2016
93.8
13.0%
12.2
(0.2)
12.4
13.2%
$
$
$
0.8
1.8
0.5
1.6
1.7
0.4
0.8
0.1
0.5
0.1
0.3
0.2
1.4
2.0
0.1
$
33.9
23.4%
$
21.1
19.8%
$
16.4
17.5%
(1) Production transfer costs represent duplicate costs incurred to migrate manufacturing to existing facilities. These amounts are
included in earnings from continuing operations before interest and income taxes for each period presented.
(2) In 2018, Other represents expenses related to acquisitions and an adjustment to pre-spin-off pension obligations.
Revenues
2018 Versus 2017
PD revenues were $144.7 million for the year ended December 31, 2018, compared with $106.8 million for the year ended December
31, 2017, an increase of $37.9 million or 35.5%. Revenues increased primarily due to higher capacitor product shipments for the
defense, industrial, and automotive markets, as well as increased revenues related to our acquisition of Compex.
2017 Versus 2016
PD revenues were $106.8 million for the year ended December 31, 2017, compared with $93.8 million for the year ended December
31, 2016, an increase of $13.0 million or 13.9%. Revenues increased due to higher capacitor product shipments primarily for the
defense, medical, and automotive markets, as well as increased revenues related to our capacitors acquisition in January 2017,
partially offset by lower pricing.
Earnings and Adjusted Earnings from Continuing Operations Before Interest and Income Taxes
2018 Versus 2017
PD EBIT from continuing operations was $27.5 million for the year ended December 31, 2018, compared with $19.2 million for
the year ended December 31, 2017, an increase of $8.3 million or 43.2%. EBIT margin for the year ended December 31, 2018
was 19.0%, compared with 18.0% for the year ended December 31, 2017. The increases were primarily due to higher gross profit
as a result of increased shipments and our acquisition of Compex, partially offset by higher operating expenses due to compensation
increases and our acquisition of Compex. In addition, an unfavorable adjustment was recorded to a pre-spin-off pension obligation
in the second quarter of 2018.
37
PD Adjusted EBIT was $33.9 million for the year ended December 31, 2018, compared with $21.1 million for the year ended
December 31, 2017, an increase of $12.8 million or 60.7%. Adjusted EBIT margin for the year ended December 31, 2018 was
23.4%, compared with 19.8% for the year ended December 31, 2017. The increases were primarily due to higher gross profit as
a result of increased shipments and our acquisition of Compex, partially offset by higher operating expenses due to compensation
increases and our acquisition of Compex.
2017 Versus 2016
PD EBIT from continuing operations was $19.2 million for the year ended December 31, 2017, compared with $12.4 million for
the year ended December 31, 2016, an increase of $6.8 million or 54.8%. EBIT margin for the year ended December 31, 2017
was 18.0%, compared with 13.2% for the year ended December 31, 2016. The increases were primarily due to benefits from
increased shipments, productivity initiatives, lower restructuring charges, and production transfer costs, along with realized cost
savings from our production transfers to lower-cost Asian manufacturing facilities, partially offset by lower pricing and increased
operating expenses.
PD Adjusted EBIT was $21.1 million for the year ended December 31, 2017, compared with $16.4 million for the year ended
December 31, 2016, an increase of $4.7 million or 28.7%. Adjusted EBIT margin for the year ended December 31, 2017 was
19.8%, compared with 17.5% for the year ended December 31, 2016. The increases were primarily due to benefits from increased
shipments, productivity initiatives, and realized cost savings from our production transfers to lower-cost Asian manufacturing
facilities, partially offset by lower pricing and increased operating expenses.
Financial Condition
Historically, we have generated and expect to continue to generate positive cash flow from operations. Our ability to fund our
operations and capital needs will depend on our ongoing ability to generate cash from operations and access to capital markets.
We believe that our future cash flow from operations and access to capital markets will provide adequate resources to fund our
working capital needs, dividends (if any), capital expenditures, and strategic investments. We have secured a revolving line of
credit in the United States from a syndicate of commercial banks to provide additional liquidity. Furthermore, if we were to require
additional cash above and beyond our cash on the balance sheet, the free cash flow generated by the business, and availability
under our revolving credit facility, we would most likely seek to raise long-term financing through the U.S. debt or bank markets.
In May 2016, we sold the Notes and concurrently entered into convertible note hedge transactions and separate warrants. The
Notes will mature in November 2021, unless earlier repurchased by us or converted pursuant to their terms. The Notes are unsecured,
senior obligations and interest is payable semiannually in arrears. The Notes will be convertible into cash, shares of our common
stock, or a combination thereof, at our election. We have primarily used the net proceeds to reduce borrowings outstanding under
our term loan facility. For additional information, refer to Note 11. Borrowings to our Consolidated Financial Statements under
Item 8, "Financial Statements and Supplementary Data."
On July 7, 2016, we completed the sale of our Speaker and Receiver Product Line for $45.0 million in cash, less purchase price
adjustments for a net amount received of $40.6 million. We used the net proceeds to reduce borrowings outstanding under our
revolving credit facility. Refer to Note 2. Disposed and Discontinued Operations to our Consolidated Financial Statements under
Item 8, "Financial Statements and Supplementary Data" for additional information.
On January 11, 2017, we 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 2017. An additional $1.0 million was paid during the year ended December 31,
2018, with the remaining $0.2 million to be paid in the first quarter of 2019. This acquisition's operations are included in the PD
segment. Refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, "Financial Statements and
Supplementary Data" for additional information.
On October 11, 2017, we entered into the New Credit Facility. Refer to Note 11. Borrowings to our Consolidated Financial
Statements under Item 8, "Financial Statements and Supplementary Data" for additional information.
On November 28, 2017, we completed the sale of the Timing Device Business, part of the PD segment, for $130.0 million, subject
to purchase price adjustments. Refer to Note 2. Disposed and Discontinued Operations to our Consolidated Financial Statements
under Item 8, "Financial Statements and Supplementary Data" for additional information.
38
On January 19, 2018, we acquired substantially all of the assets of Compex Corporation ("Compex") for $18.7 million. The acquired
business provides single layer electronic components to the telecommunicaton, fiber optics, defense, and aerospace markets. This
acquisition's operations are included in the PD segment. For additional information, refer to Note 3. Acquisitions to our Consolidated
Financial Statements under Item 8, "Financial Statements and Supplementary Data."
Our ability to make payments on and to refinance our indebtedness, as well as any debt that we may incur in the future, will depend
on our ability in the future to generate cash from operations and financings. Due to the global nature of our operations, a significant
portion of our cash is generated and held outside the United States. Our cash and cash equivalents totaled $73.5 million and $111.7
million at December 31, 2018 and 2017, respectively. Of these amounts, cash held by our non-U.S. operations totaled $55.3 million
and $75.7 million as of December 31, 2018 and 2017, respectively.
To the extent we repatriate these funds to the U.S., we may be required to pay income taxes in certain U.S. states and applicable
foreign withholding taxes on those amounts during the period when such repatriation occurs. Management will continue to reassess
our need to repatriate the earnings of our foreign subsidiaries.
Cash Flow Summary
Cash flows from operating, investing, and financing activities as reflected in our Consolidated Statements of Cash Flows are
presented on a consolidated basis (including discontinued operations). Cash flows are summarized in the following table:
(in millions)
Net cash flows provided by (used in):
Operating activities
Investing activities
Financing activities
Effect of exchange rate changes on cash and cash equivalents
Net (decrease) increase in cash and cash equivalents
Operating Activities
Years Ended December 31,
2018
2017
2016
$
$
$
98.5
(88.0)
(48.6)
(0.1)
(38.2) $
92.9
$
69.5
(117.9)
1.0
45.5
$
107.5
5.9
(109.9)
(0.6)
2.9
Cash provided by operating activities in 2018 increased $5.6 million compared to 2017. The increase is primarily due to improved
earnings before income taxes and discontinued operations, which was largely driven by higher revenues. In addition, while our
inventory balances have increased from 2017, we have invested at a lower rate when compared to the prior year. Our lower
investment rate in inventories is primarily the result of completing our transfer of certain hearing health production from China
to our facility in the Philippines, partially offset by the increased PD production to support our growth in shipments. The increases
were partially offset by the timing of payments to satisfy our accounts payable obligations, payments against our restructuring
obligations, an increase in cash taxes paid, and the settlement of a warranty claim.
Cash provided by operating activities in 2017 decreased $14.6 million compared to 2016, primarily due to a higher investment in
inventory, partially offset by an increase in accounts payables. During 2017, inventories increased to support the launch of new
handsets at our largest customer and in conjunction with the transfer of certain hearing health production from China to our facility
in the Philippines.
Investing Activities
Cash provided by and used in investing activities results primarily from cash inflows from the sale of businesses and outflows for
capital expenditures, acquisitions, and investment activity.
Capital spending. Capital expenditures, primarily to support capacity expansion, innovation, and cost savings, were $80.1 million,
$51.6 million, and $38.7 million for the years ended December 31, 2018, 2017, and 2016, respectively. The largest drivers of the
capital expenditures have been related to ongoing investments in MEMS manufacturing capacity expansion to support growth in
the handset, ear, and IoT markets, investments in new product launches, and manufacturing footprint optimization projects.
39
Sales of business, acquisitions, and investments. We received escrow proceeds of $10.0 million from the prior year sale of our
Timing Device Business and acquired Compex during 2018. We received net proceeds of $123.1 million from the sale of our
Timing Device Business and acquired certain assets of a capacitors manufacturer during 2017. We received net proceeds of $40.6
million from the sale of our Speaker and Receiver Product Line during 2016.
Financing Activities
Cash used in financing activities during 2018 is primarily related to the net payments under our revolving credit facility of $41.7
million and the $4.7 million payment of taxes related to net share settlement of equity awards. Cash used in financing activities
during 2017 is primarily related to the $118.5 million principal payment on our term loan and the $5.1 million payment of taxes
related to net share settlement of equity awards, partially offset by net borrowings under our revolving credit facility of $5.7 million
and the $3.3 million of proceeds received for option exercises. Cash used in financing activities during 2016 primarily related to
$166.5 million in principal payments on our term loan, a $44.5 million purchase of convertible note hedges, $100.0 million in net
payments on our revolving credit facility, and $6.7 million of debt issuance costs, partially offset by proceeds of $172.5 million
from the issuance of the Notes and the $39.1 million of proceeds from the issuance of warrants. For additional information on our
debt, see Note 11. Borrowings to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary
Data."
Liquidity and Capital Resources
Free Cash Flow
In addition to measuring our cash flow generation and usage based upon the operating, investing, and financing classifications
included in the Consolidated Statements of Cash Flows, we also measure free cash flow and free cash flow as a percentage of
revenues. Free cash flow is calculated as cash flow provided by operating activities less capital expenditures. Our management
believes these measures are useful in measuring our cash generated from operations that is available to repay debt, pay dividends,
fund acquisitions, and repurchase Knowles’ common stock. Free cash flow and free cash flow as a percentage of revenues are not
presented in accordance with GAAP and may not be comparable to similarly titled measures used by other companies in our
industry. As such, free cash flow and free cash flow as a percentage of revenues should not be considered in isolation from, or as
an alternative to, any other liquidity measures determined in accordance with GAAP.
Our businesses tend to have stronger revenues in the third and fourth quarters of each fiscal year. This is particularly true of those
businesses that serve the consumer electronics market. Our businesses tend to have short product cycles due to the highly technical
nature of the industries they serve, which can result in new OEM product launches that can impact quarterly revenues, earnings,
and cash flow.
The following table reconciles our free cash flow to cash flow provided by operating activities:
(in millions)
Free Cash Flow
Cash flow provided by operating activities
Less: Capital expenditures
Free cash flow
Free cash flow as a percentage of revenues
Years Ended December 31,
2017
2016
2018
$
$
$
$
98.5
(80.1)
18.4
2.2%
92.9
(51.6)
41.3
$
$
107.5
(38.7)
68.8
5.5%
9.1 %
In 2018, we generated free cash flow of $18.4 million, representing 2.2% of revenues, compared to free cash flow in 2017 of $41.3
million, representing 5.5% of revenues, and free cash flow in 2016 of $68.8 million, or 9.1% of revenues. The decrease in free
cash flow in 2018 compared to 2017 was primarily due to increased capital expenditures to support our manufacturing capacity
expansion. The decrease in free cash flow in 2017 compared to 2016 was primarily due to increased capital expenditures to support
our manufacturing capacity expansion and a higher investment in inventories.
In 2019, we expect capital expenditures to be in the range of 6.0% to 8.0% of revenues.
40
Contingent Obligations
We are involved in various legal proceedings, claims, and investigations arising in the normal course of business. Legal contingencies
are discussed in Note 14. Commitments and Contingent Liabilities to our Consolidated Financial Statements under Item 8, "Financial
Statements and Supplementary Data."
Contractual Obligations and Off-Balance Sheet Arrangements
A summary of our contractual obligations and commitments as of December 31, 2018 and the years when these obligations are
expected to be due is as follows:
(in millions)
Debt (1)
Operating leases (2)
Purchase obligations (3)
Capital leases (4)
Post-retirement benefits (5)
Total obligations
Total
Less than 1
Year
1-3 Years
3-5 Years
More than 5
Years
Payments Due by Period
$
181.5
$
— $
172.5
$
9.0
$
45.8
78.0
14.1
3.1
9.7
78.0
2.3
3.1
18.1
—
4.6
—
14.2
—
4.6
—
$
322.5
$
93.1
$
195.2
$
27.8
$
—
3.8
—
2.6
—
6.4
(1) Relates to the maturity of indebtedness under our New Credit Facility due in October 2022 and our Notes due in November
2021. Does not give effect to any early repayment of or future amounts which may be drawn under the New Credit Facility.
(2) Represents off-balance sheet commitments related to operating leases. See Note 14. Commitments and Contingent Liabilities
to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
(3) Represents off-balance sheet commitments for purchase obligations related to open purchase orders with our vendors.
(4) Represents obligations related to capital leases. See Note 14. Commitments and Contingent Liabilities to our Consolidated
Financial Statements under Item 8, "Financial Statements and Supplementary Data."
(5) Amounts represent estimated contributions under our subsidiary's non-U.S. defined benefit pension plans. See Note 15.
Employee Benefit Plans to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary
Data."
Borrowings
In May 2016, we issued $172.5 million aggregate principal amount of 3.25% convertible senior notes due November 1, 2021,
unless earlier repurchased by us or converted pursuant to their terms. Interest is payable semiannually in arrears on May 1 and
November 1 of each year, commencing on November 1, 2016. The Notes are governed by an indenture (the "Indenture") between
us, as issuer, and U.S. Bank National Association as trustee. Upon conversion, we will pay or deliver cash, shares of our common
stock or a combination of cash and shares of common stock, at our election. The initial conversion rate is 54.2741 shares of common
stock per $1,000 principal amount of Notes. The initial conversion price is $18.4250 per share of common stock. The conversion
rate will be subject to adjustment upon the occurrence of certain specified events but will not be adjusted for accrued and unpaid
interest. In addition, upon the occurrence of a make-whole fundamental change (as defined in the Indenture), we may be required,
in certain circumstances, to increase the conversion rate by a number of additional shares for a holder that elects to convert the
Notes in connection with such make-whole fundamental change.
On October 11, 2017, Knowles entered into the New Credit Facility which contains a five-year senior secured revolving credit
facility providing for borrowings in an aggregate principal amount at any time outstanding not to exceed $400.0 million. The New
Credit Facility replaced the Company's Prior Credit Facilities discussed in Note 11. Borrowings to our Consolidated Financial
Statements under Item 8, "Financial Statements and Supplementary Data." Up to $100.0 million of the New Credit Facility will
be available in Euro, Sterling, and other currencies requested by the Company and agreed to by each Lender and up to $50.0
million of the New Credit Facility will be made available in the form of letters of credit denominated in any currencies agreed by
the issuing bank. The New Credit Facility serves as refinancing of indebtedness under and terminates the Prior Credit Facilities.
41
At any time during the term of the New Credit Facility, the Company will be permitted to increase the commitments under the
New Credit Facility or to establish one or more incremental term loan facilities under the New Credit Facility in an aggregate
principal amount not to exceed $200.0 million for all such incremental facilities.
Commitments under the New Credit Facility will terminate, and loans outstanding thereunder will mature, on October 11, 2022;
provided, that if all the Company’s 3.25% Convertible Senior Notes Due November 1, 2021 have not been repaid, refinanced and/
or converted to common stock of the Company by April 30, 2021, then the commitments under the New Credit Facility will
terminate, and the loans outstanding thereunder will mature, on such earlier date.
The interest rates under the New Credit Facility will be, at the Borrowers’ option (1) LIBOR (or, in the case of borrowings under
the New Credit Facility denominated in Euro, EURIBOR) plus the rates per annum determined from time to time based on the
Company's total indebtedness to Consolidated EBITDA ratio as of the end of and for the most recent period of four fiscal quarters
for which financial statements have been delivered (the “Applicable Rate”); or (2) in the case of borrowings denominated in U.S.
dollars, alternate base rate (“ABR”); provided, however, that any swingline borrowings shall bear interest at the rate applicable to
ABR borrowings or, prior to the purchase of participations in such borrowings by the Lenders, at such other rate as shall be agreed
between the Company and the swingline lender.
The interest rate under the New Credit Facility is variable based on LIBOR at the time of the borrowing and the Company’s leverage
as measured by a total indebtedness to Consolidated EBITDA ratio. Based upon the Company’s total indebtedness to Consolidated
EBITDA ratio, the Company’s borrowing rate could range from LIBOR + 1.25% to LIBOR + 2.25%. In addition, a commitment
fee accrues on the average daily unused portion of the New Credit Facility at a rate of 0.20% to 0.35%.
We have the right to prepay borrowings under the facilities and to reduce the unutilized portion of the New Credit Facility, in each
case, at any time without premium or penalty (except for Eurodollar breakage fees, if any). We are required to prepay borrowings
under the term facility with 100% of the net cash proceeds of sales or dispositions of assets or other property (including, among
others, the proceeds of issuances of equity interests by subsidiaries), subject to certain reinvestment rights and other exceptions.
As we are exposed to market risk for changes in interest rates based on the structure of our indebtedness, we 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 starting in January 2016 and ending in July 2018. 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 facilities contain customary covenants, which include, among others, limitations or restrictions on the incurrence of
indebtedness, the incurrence of liens, entry into sales and leaseback transactions, mergers, transfers of all or substantially all assets,
transactions with affiliates, and certain transactions limiting the ability of subsidiaries to pay dividends, in each case, subject to
certain exceptions. The New Credit Facility includes requirements, to be tested quarterly, that the Company maintains (i) a minimum
ratio of Consolidated EBITDA to consolidated interest expense of 3.25 to 1.0, (the "Interest Coverage Ratio"), (ii) a maximum
ratio of Consolidated total indebtedness to Consolidated EBITDA of 3.75 to 1.0 ("the Leverage Ratio"), and (iii) a maximum ratio
of senior secured indebtedness to Consolidated EBITDA of 3.25 to 1.0 (the "Senior Secured Leverage Ratio"). For these ratios,
Consolidated EBITDA and consolidated interest expense are calculated using the most recent four consecutive fiscal quarters in
a manner defined in the New Credit Facility. At December 31, 2018, the Company was in compliance with these covenants and
it expects to remain in compliance with all of its debt covenants over the next twelve months.
Risk Management
We are exposed to certain market risks which exist as part of our ongoing business operations, including changes in currency
exchange rates, the dependence on key customers, price volatility for certain commodities, and changes in interest rates. We do
not engage in speculative or leveraged transactions and do not hold or issue financial instruments for trading purposes.
Foreign Currency Exposure
We conduct business through our subsidiaries in many different countries and fluctuations in currency exchange rates could have
a significant impact on the reported results of operations, which are presented in U.S. dollars. A significant and growing portion
of our products are manufactured in lower-cost locations and sold in various countries. Cross-border transactions, both with external
parties and intercompany relationships, could result in increased foreign exchange exposures. A weakening of foreign currencies
relative to the U.S. dollar would adversely affect the U.S. dollar value of the Company’s foreign currency-denominated sales, but
would be beneficial to the cost of materials, products, and services purchased overseas. A strengthening of foreign currencies
relative to the U.S. dollar would positively affect the U.S. dollar value of the Company’s foreign currency-denominated sales, but
42
would have a negative effect on the cost of materials, products, and services purchased overseas. Our foreign currency exposure
is primarily driven by changes in the Chinese renminbi (yuan), the Malaysian ringgit, and the Philippine peso. Based on our current
sales and manufacturing activity, a sustained 10% weakening of the U.S. dollar for a period of one year would reduce our operating
results by approximately $16.7 million pre-tax. See Note 10. Hedging Transactions and Derivative Instruments to our Consolidated
Financial Statements under Item 8, "Financial Statements and Supplementary Data" for information on the Company's hedges of
foreign currency exchange rate risk.
Dependence on Key Customers; Concentration of Credit
The loss of any key customer and our inability to replace revenues provided by a key customer may have a material adverse effect
on our business and financial condition. For the years ended December 31, 2018, 2017, and 2016, Apple Inc. accounted for
approximately 19%, 19%, and 20% of our total revenues, respectively. For the years ended December 31, 2017 and 2016, Samsung
Electronics Co., Ltd. accounted for approximately 10% and 12% of our total revenues, respectively. No other customer accounted
for more than 10% of total revenues during these periods. If a key customer fails to meet payment obligations, our operating results
and financial condition could be adversely affected.
Commodity Pricing
We use a wide variety of raw materials, primarily metals, and semi-processed or finished components, which are generally available
from a number of sources. While the required raw materials are generally available, commodity pricing for various precious metals,
such as palladium, gold, brass, stainless steel, and copper, fluctuates. As a result, our operating results are exposed to such
fluctuations. Although some cost increases may be recovered through increased prices to customers if commodity prices trend
upward, we attempt to control such costs through fixed-price contracts with suppliers and various other programs, such as our
global supply chain activities.
Interest Rates
Borrowings under our New Credit Facility are at variable interest rates. A hypothetical 100 basis point change in interest rates
affecting our external variable rate borrowings as of December 31, 2018 would impact our operating results by $0.1 million on a
pre-tax basis.
Critical Accounting Policies
Our Consolidated Financial Statements are based on the application of GAAP. GAAP requires the use of estimates, assumptions,
judgments, and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenues, and
expense amounts we report. These estimates can also affect supplemental information contained in our public disclosures, including
information regarding contingencies, risk, and our financial condition. The significant accounting policies used in the preparation
of our Consolidated Financial Statements are discussed in Note 1. Summary of Significant Accounting Policies to the Consolidated
Financial Statements under Item 8, "Financial Statements and Supplementary Data." The accounting assumptions and estimates
discussed in the section below are those that we consider most critical to an understanding of our financial statements because
they inherently involve significant judgments and estimates. We believe our use of estimates and underlying accounting assumptions
conforms to GAAP and is consistently applied. We review valuations based on estimates for reasonableness on a consistent basis.
Revenue Recognition: We adopted ASC 606, Revenue from Contracts with Customers, on January 1, 2018 using the modified
retrospective (cumulative effect) transition method. Under this transition method, results for reporting periods beginning January
1, 2018 or later are presented under ASC 606, while prior period results continue to be reported in accordance with previous
guidance. We did not recognize a cumulative effect adjustment to retained earnings as of January 1, 2018 as the impact of the
standard on the Consolidated Financial Statements was not material. As described below, the analysis of contracts under ASC 606
supports the recognition of revenue at a point in time, resulting in revenue recognition timing that is materially consistent with
our historical practice of recognizing revenue when title and risk of loss pass to the customer.
Revenue is recognized when control of the promised goods or services is transferred to the customer in an amount that reflects
the consideration we expect to be entitled to in exchange for those goods or services. The majority of our revenue is generated
through the manufacture and sale of a broad range of specialized products and components. For product and component sales,
each good sold to a customer typically represents a distinct performance obligation. Our performance obligation to provide goods
to a customer is typically satisfied at a point in time upon completion of the shipping process as indicated by the terms of the
contract, at which point control is transferred to the customer and revenue is recognized. We have no significant arrangements
43
with multiple performance obligations. Remaining performance obligations consist of the aggregate amount of the total transaction
price that is unsatisfied or partially satisfied. As of December 31, 2018, our total remaining performance obligations are immaterial.
We recognize sales-based royalty revenue under third-party license agreements as the related sales are made by licensees.
The terms of a contract or historical business practice can give rise to variable consideration, including customer discounts, rebates,
and returns. We estimate variable consideration using either the expected value or most likely amount method. We include estimated
amounts in the transaction price to the extent it is probable that a significant reversal of revenue will not occur in a subsequent
reporting period. Our estimates of variable consideration are based on all reasonably available information (historical, current,
and forecasted). Rebates are recognized over the contract period based on expected revenue levels. Sales discounts and rebates
totaled $8.1 million, $9.1 million, and $8.7 million for the years ended December 31, 2018, 2017, and 2016, respectively. Returns
and allowances totaled $7.7 million, $8.5 million, and $5.1 million for the years ended December 31, 2018, 2017, and 2016,
respectively.
Inventories: Inventories are stated at the lower of cost or net realizable value, determined on the first-in, first-out ("FIFO") basis.
The value of inventory may decline as a result of surplus inventory, price reductions, or technological obsolescence. It is the
Company’s policy to carry reserves against the carrying value of inventory when items have no future demand (obsolete inventory)
and additionally, where inventory items on hand have demand, yet have insufficient forecasted activity to consume the entire stock
within a reasonable period. It is the Company’s policy to carry reserves against the carrying value of such at-risk inventory items
after considering the nature of the risk and any mitigating factors.
Goodwill and Indefinite-Lived Intangible Assets: Goodwill represents the excess of purchase consideration over the fair value of
the net assets of businesses acquired. Goodwill and certain other intangible assets deemed to have indefinite lives (primarily
trademarks) are not amortized. Instead, goodwill and indefinite-lived intangible assets are tested for impairment at least annually,
or more frequently if there are events or circumstances indicating the carrying value of individual reporting units or assets may
exceed their respective fair values on a more likely than not basis. The Company performs its annual impairment assessment in
the fourth quarter of each year on October 1. Recoverability of goodwill is measured at the reporting unit level. Following the sale
of the Timing Device Business on November 28, 2017, the Company has three reporting units. The goodwill balances associated
with the Mobile Consumer Electronics ("MCE"), Hearing Health Technologies ("HHT"), and Capacitors reporting units were
$722.1 million, $137.8 million, and $28.0 million, respectively, as of December 31, 2018.
The impairment assessment compares the fair value of each reporting unit to its carrying value. Impairment is measured as the
amount by which the carrying value of a reporting unit exceeds its fair value. Fair value is estimated using a discounted cash flow
approach that includes the Company’s market participant assumptions, projections of future cash flows based on historical
performance and future estimated results, determinations of appropriate discount rates, and other assumptions which are considered
reasonable and inherent in the discounted cash flow analysis. Significant assumptions used in the assessment include forecasted
revenue and terminal growth rates, profit margins, income taxes, and the Company's weighted average cost of capital. These
assumptions require significant judgment and actual results may differ from estimated amounts. The fair value of all of the
Company’s reporting units exceeded the carrying values by at least 50%, resulting in no goodwill impairment charges. Potential
circumstances that could have a negative effect on the fair value of our reporting units include, but are not limited to, lower than
forecasted growth rates or profit margins and changes in the weighted average cost of capital. A reduction in the estimated fair
value of the reporting units could trigger an impairment in the future. The Company cannot predict the occurrence of certain events
or changes in circumstances that might adversely affect the carrying value of goodwill and intangible assets.
In testing its other indefinite-lived intangible assets for impairment, the Company uses a relief from royalty method to calculate
and compare the fair value of the intangible asset to its carrying value. This method estimates the fair value of trademarks by
calculating the present value of royalty income that could hypothetically be earned by licensing the trademark to a third party. Any
excess of carrying value over the estimated fair value is recognized as an impairment loss. No impairment of indefinite-lived
intangibles was indicated for the years ended December 31, 2018, 2017, or 2016.
See Note 7. Goodwill and Other Intangible Assets to our Consolidated Financial Statements under Item 8, "Financial Statements
and Supplementary Data" for additional information on goodwill and indefinite-lived intangible assets.
44
Other Intangible and Long-Lived Assets: Other intangible assets with determinable lives consist primarily of customer relationships,
unpatented technology, patents, and trademarks and are amortized over their estimated useful lives, historically ranging from 5 to
15 years. We rely on patents and proprietary technology, and seek patent protection for products and production methods. We
capitalize external legal costs incurred in the defense of our patents when we believe that a significant, discernible increase in
value will result from the defense and a successful outcome of the legal action is probable. These costs are amortized over the
remaining estimated useful life of the patent, which is typically 7 to 10 years. We assess future economic benefit and/or the
successful outcome of legal action related to patent defense, which involves considerable management judgment and a different
outcome could result in material write-offs of the carrying value of these assets. We capitalized no legal costs related to the defense
of our patents during the years ended December 31, 2018, 2017, and 2016.
Long-lived assets (including intangible assets with determinable lives) are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be recoverable. If an indicator of impairment exists for any
grouping of assets, an estimate of undiscounted future cash flows is produced and compared to its carrying value. If an asset is
determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value as determined
by an estimate of discounted future cash flows.
We recorded no impairments during the year ended December 31, 2018. During the years ended December 31, 2017 and 2016,
we recorded impairments and other charges related to continuing operations of $21.3 million and $0.5 million, respectively. During
the year ended December 31, 2017, we recorded pre-tax impairment charges of $5.1 million related to fixed assets and $16.2
million related to intangible assets resulting from an updated strategic plan that 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. See Note 4. Impairments to our Consolidated Financial Statements under Item 8, "Financial Statements and
Supplementary Data" for additional details.
Income Taxes and Deferred Tax Balances: We record a provision for income taxes for the anticipated tax consequences of the
reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities
for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and
liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax
rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized
or settled. A valuation allowance is recorded to reduce deferred tax assets to the net amount that is more likely than not to be
realized.
We establish valuation allowances for our deferred tax assets if, based on all available positive and negative evidence, it is more
likely than not that some portion or all of the deferred tax assets will not be realized. In making such assessments, significant
weight is given to evidence that can be objectively verified. The assessment of the need for a valuation allowance requires
considerable judgment on the part of management with respect to the benefits that could be realized from future taxable income,
as well as other positive and negative factors.
We have evaluated our deferred tax assets for each of the reporting periods, including an assessment of cumulative income over
the prior three-year period. Since we are in a cumulative loss position in the U.S., there is significant negative evidence that impairs
the ability to rely on projections of future income. Due to a lack of significant positive evidence and cumulative losses in the
respective prior three-year periods, a valuation allowance was required for the 2018, 2017, and 2016 periods. The valuation
allowance was reduced in 2017 as a result of income recognized under the Internal Revenue Code Section 965 tax on foreign
deferred earnings and changes to the net operating loss carryforward periods, allowing the use of existing deferred tax liabilities
to reduce existing valuation allowances.
We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will
be sustained on examination by the taxing authorities based on the technical merits of the position. Adjustments are made to these
reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent
that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for
income taxes in the period in which such determination is made and could have a material impact on our financial condition and
operating results. The provision for income taxes includes the effects of any reserves that are believed to be appropriate, as well
as the related net interest and penalties. The effective tax rates on a continuing operations basis for 2018, 2017, and 2016 were a
7.4% benefit, 66.5% provision, and 29.5% provision, respectively.
45
On December 22, 2017, the Tax Reform Act was enacted, which significantly changed U.S. tax law by, among other things, lowering
corporate income tax rates, implementing a territorial tax system, and imposing a repatriation tax on deemed repatriated earnings
of foreign subsidiaries. The Tax Reform Act permanently reduces the U.S. corporate income tax rate from a maximum of 35% to
a flat 21% rate, effective January 1, 2018. The Tax Reform Act also provided for a one-time deemed repatriation of post-1986
undistributed foreign subsidiary E&P through the year ended December 31, 2017. The Global Intangible Low-Taxed Income
("GILTI") provisions of the Tax Reform Act also require us to include in our U.S. income tax return foreign subsidiary earnings
in excess of an allowable return on the foreign subsidiary’s tangible assets. We were subject to the GILTI provisions beginning in
2018. As we have elected to account for GILTI tax in the period in which it is incurred, we did not provide any deferred tax impacts
of GILTI in our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S.
GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including
computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. We recognized
provisional tax impacts related to deemed repatriated earnings, the change in beginning of year valuation allowance, and the benefit
for the remeasurement of deferred tax assets and liabilities as of December 31, 2017. During the fourth quarter of 2018, we finalized
our accounting for the effects of the Tax Reform Act under SAB 118. We recorded a $17.8 million reduction to the transition tax
liability due to the impact of an IRS approval for an entity classification received during the fourth quarter of 2018. These amounts
are included in our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."
Although our accounting for the effects of the Tax Reform Act is finalized under SAB 118, there may be future adjustments based
on potential changes in the interpretation of the Tax Reform Act, its supporting regulations, and subsequent guidance that may be
issued. The impact of any such adjustments, which could have a material impact on the Consolidated Financial Statements, will
be recognized in the period the changes arise or the related regulations are enacted. We are in the process of evaluating the final
regulations on Section 965, which were released by the IRS on January 15, 2019, and will recognize any related impact in the first
quarter of 2019.
Accruals and Reserves: We have accruals and reserves that require the use of estimates and judgment with regard to risk exposure
and ultimate liability. We estimate losses under these programs using certain factors, which include but are not limited to, actuarial
assumptions, our experience, and relevant industry data. We review these factors quarterly and consider the current level of accruals
and reserves adequate relative to current market conditions and experience. We have established liabilities for restructuring
activities, in accordance with appropriate accounting principles. These liabilities, for both severance and exit costs, require the use
of estimates. Though we believe that these estimates accurately reflect the anticipated costs, actual results may be different than
the estimated amounts.
Stock-Based Compensation: The principal awards issued under the stock-based compensation plans include stock options, restricted
stock units ("RSUs"), and performance share units ("PSUs"). The cost for such awards is measured at the grant date based on the
fair value of the award. The value of the portion of the award that is expected to ultimately vest is generally recognized as expense
on a straight-line basis, generally over the explicit service period and is included in Cost of goods sold, Research and development
expenses, and Selling and administrative expenses in the Consolidated Statements of Earnings, depending on the functional area
of the underlying employees. The cost related to PSUs is recognized based on the expected attainment of performance targets.
Changes in estimates that impact the number of shares expected to vest are recognized prospectively through cumulative
adjustments.
We use the Black-Scholes valuation model to estimate the fair value of stock options granted to employees. The fair value of each
RSU granted is equal to the share price at the date of the grant. The fair value of PSUs is determined by using a binomial model
simulation. At the time of grant, we estimate forfeitures, based on historical experience, in order to estimate the portion of the
award that will ultimately vest. See Note 13. Equity Incentive Program to our Consolidated Financial Statements under Item 8,
"Financial Statements and Supplementary Data" for additional information related to our stock-based compensation.
46
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this section is incorporated by reference to the section “Risk Management,” included in Item 7 of
this Annual Report on Form 10-K.
47
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE
Page
49
51
52
53
54
55
56
94
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Earnings
Consolidated Statements of Comprehensive Earnings
Consolidated Balance Sheets
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Financial Statement Schedule - Schedule II, Valuation and Qualifying Accounts
48
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Knowles Corporation:
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Knowles Corporation and its subsidiaries (the “Company”) as
of December 31, 2018 and 2017, and the related consolidated statements of earnings, comprehensive earnings, stockholders’ equity
and cash flows for each of the three years in the period ended December 31, 2018, including the related notes and schedule of
valuation and qualifying accounts for each of the three years in the period ending December 31, 2018 (collectively referred to as
the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of
December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position
of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years
in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America.
Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control
over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in
Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express
opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based
on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States)
(PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and
the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether
due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement
of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial
reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits
also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide
a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
49
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 19, 2019
We have served as the Company’s auditor since 2013.
50
KNOWLES CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except share and per share amounts)
Years Ended December 31,
2018
2017
2016
$
826.9
$
503.9
744.2
$
452.8
Revenues
Cost of goods sold
Impairment charges
Restructuring charges - cost of goods sold
Gross profit
Research and development expenses
Selling and administrative expenses
Impairment charges
Restructuring charges
Operating expenses
Operating earnings
Interest expense, net
Other expense (income), net
Earnings before income taxes and discontinued operations
(Benefit from) provision for income taxes
Earnings from continuing operations
Earnings (loss) from discontinued operations, net
Net earnings (loss)
Earnings per share from continuing operations:
Basic
Diluted
Earnings (loss) per share from discontinued operations:
Basic
Diluted
Net earnings (loss) per share:
Basic
Diluted
$
$
$
$
$
$
$
—
0.4
322.6
100.6
142.5
—
1.7
244.8
77.8
16.0
0.7
61.1
(4.5)
65.6
2.1
67.7
$
0.73
0.72
0.02
0.02
0.75
0.74
$
$
$
$
$
$
1.4
4.0
286.0
93.4
126.6
19.9
6.2
246.1
39.9
20.6
(0.1)
19.4
12.9
6.5
61.8
68.3
0.07
0.07
0.69
0.68
0.76
0.75
$
$
$
$
$
$
$
755.7
458.2
0.3
1.5
295.7
92.0
149.9
0.2
8.6
250.7
45.0
20.4
(3.5)
28.1
8.3
19.8
(62.1)
(42.3)
0.22
0.22
(0.70)
(0.69)
(0.48)
(0.47)
Weighted-average common shares outstanding:
Basic
Diluted
90,050,051
91,194,747
89,329,794
90,490,007
88,667,098
89,182,967
See accompanying Notes to Consolidated Financial Statements
51
KNOWLES CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(in millions)
Net earnings (loss)
Other comprehensive (loss) earnings, net of tax
Foreign currency translation
Employee benefit plans:
Years Ended December 31,
2018
2017
2016
$
67.7
$
68.3
$
(42.3)
(9.9)
27.1
0.8
Actuarial (losses) gains and prior service costs arising during period
Amortization or settlement of actuarial losses and prior service costs
Net change in employee benefit plans
Changes in fair value of cash flow hedges:
Unrealized net (losses) gains arising during period
Net losses reclassified into earnings
Total cash flow hedges
(0.7)
0.5
(0.2)
(2.0)
1.1
(0.9)
0.7
0.6
1.3
3.4
0.3
3.7
Other comprehensive (loss) earnings, net of tax
(11.0)
32.1
(5.6)
0.5
(5.1)
(2.5)
0.9
(1.6)
(5.9)
Comprehensive earnings (loss)
$
56.7
$
100.4
$
(48.2)
See accompanying Notes to Consolidated Financial Statements
52
KNOWLES CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except share and per share amounts)
Current assets:
Cash and cash equivalents
Receivables, net of allowances of $0.6 and $0.7
Inventories, net
Prepaid and other current assets
Total current assets
Property, plant, and equipment, net
Goodwill
Intangible assets, net
Other assets and deferred charges
Assets of discontinued operations
Total assets
Current liabilities:
Accounts payable
Accrued compensation and employee benefits
Other accrued expenses
Federal and other taxes on income
Total current liabilities
Long-term debt
Deferred income taxes
Other liabilities
Liabilities of discontinued operations
Commitments and contingencies (Note 14)
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; 90,212,779
and 89,491,471 shares issued and outstanding at December 31, 2018 and
2017, respectively
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive loss
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
December 31, 2018 December 31, 2017
$
73.5
$
140.3
140.1
11.1
365.0
211.7
887.9
56.7
26.6
—
111.7
137.7
125.6
19.9
394.9
183.0
884.9
53.5
31.8
1.7
1,547.9
$
1,549.8
$
77.2
40.2
20.1
4.3
141.8
158.1
2.1
34.3
—
—
0.9
1,545.9
(224.2)
(111.0)
1,211.6
85.6
31.2
28.2
6.6
151.6
192.6
—
67.9
5.6
—
0.9
1,523.1
(291.9)
(100.0)
1,132.1
1,549.8
$
1,547.9
$
See accompanying Notes to Consolidated Financial Statements
53
KNOWLES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in millions)
Common
Stock
Additional
Paid-In
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Loss
Total
Stockholders'
Equity
Balance at January 1, 2016
$
0.9
$ 1,449.9
$
(317.9) $
(126.2) $
1,006.7
Net loss
Other comprehensive loss, net of tax
Purchase of convertible note hedges
Issuance of warrants
Equity component of the convertible notes issuance, net
Stock-based compensation expense
Tax on restricted stock unit vesting
Balance at December 31, 2016
Net earnings
Other comprehensive earnings, net of tax
Stock-based compensation expense
Common stock issued for exercise of stock options
Tax on restricted stock unit vesting
Balance at December 31, 2017
Net earnings
Other comprehensive loss, net of tax
Stock-based compensation expense
Common stock issued for exercise of stock options
Tax on restricted stock unit vesting
Balance at December 31, 2018
—
—
—
—
—
—
—
$
0.9
—
—
—
—
—
$
0.9
—
—
—
—
—
$
0.9
—
—
(44.5)
39.1
35.3
(42.3)
—
—
—
—
—
(5.9)
—
—
—
(42.3)
(5.9)
(44.5)
39.1
35.3
21.5
(1.5)
$ 1,499.8
$
—
—
(360.2) $
—
—
(132.1) $
21.5
(1.5)
1,008.4
—
—
25.1
3.3
(5.1)
$ 1,523.1
$
—
—
27.0
0.5
(4.7)
$ 1,545.9
$
68.3
—
—
—
—
32.1
—
—
—
(291.9) $
—
(100.0) $
67.7
—
—
—
—
(11.0)
—
—
—
(224.2) $
—
(111.0) $
68.3
32.1
25.1
3.3
(5.1)
1,132.1
67.7
(11.0)
27.0
0.5
(4.7)
1,211.6
See accompanying Notes to Consolidated Financial Statements
54
KNOWLES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Years Ended December 31,
2017
2016
2018
$
67.7
$
68.3
$
(42.3)
Operating Activities
Net earnings (loss)
Adjustments to reconcile net earnings (loss) to cash from operating activities:
Depreciation and amortization
Stock-based compensation
Impairment of intangibles
Non-cash interest expense and amortization of debt issuance costs
Loss on disposal of fixed assets
Impairment charges on fixed and other assets
(Gain) loss on sale of business
Deferred income taxes
Other, net
Cash effect of changes in assets and liabilities (excluding effects of foreign exchange):
Receivables, net
Inventories, net
Prepaid and other current assets
Accounts payable
Accrued compensation and employee benefits
Other accrued expenses
Accrued taxes
Other non-current assets and non-current liabilities
Net cash provided by operating activities
Investing Activities
Proceeds from the sale of business
Proceeds from the sale of property, plant, and equipment
Proceeds from the sale of investments
Additions to property, plant, and equipment
Acquisitions of business (net of cash acquired)
Net cash (used in) provided by investing activities
Financing Activities
Payments under revolving credit facility
Borrowings under revolving credit facility
Principal payments on term loan debt
Proceeds from issuance of convertible senior notes
Proceeds from issuance of warrants
Purchase of convertible note hedges
Debt issuance costs
Payment of consideration owed for acquisitions
Payments of capital lease obligations
Tax on restricted stock unit vesting
Net proceeds from exercise of stock-based awards
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Add: Cash and cash equivalents at beginning of period from discontinued operations
Less: Cash and cash equivalents at end of period from discontinued operations
Cash and cash equivalents at end of period
Supplemental information - cash paid during the year for:
Income taxes
Interest
$
$
$
52.4
27.0
—
7.6
0.2
—
(1.6)
8.7
(2.8)
(0.3)
(15.7)
(1.3)
(6.3)
7.9
(8.8)
(5.1)
(31.1)
98.5
10.0
0.1
—
(80.1)
(18.0)
(88.0)
(47.7)
6.0
—
—
—
—
—
(1.0)
(1.7)
(4.7)
0.5
(48.6)
(0.1)
(38.2)
111.7
—
—
73.5
18.0
9.0
$
$
$
57.3
25.1
16.2
7.6
—
5.5
(62.3)
(30.1)
4.9
2.4
(34.0)
(8.4)
4.9
(0.9)
7.3
0.9
28.2
92.9
123.1
0.5
—
(51.6)
(2.5)
69.5
(185.0)
190.7
(118.5)
—
—
—
(1.7)
—
(1.6)
(5.1)
3.3
(117.9)
1.0
45.5
63.4
2.8
—
111.7
13.1
11.3
$
$
$
73.7
21.5
—
5.6
—
0.9
25.6
4.0
(3.2)
35.9
21.9
(1.2)
(26.6)
(0.7)
(9.6)
5.3
(3.3)
107.5
40.6
2.0
2.0
(38.7)
—
5.9
(132.0)
32.0
(166.5)
172.5
39.1
(44.5)
(6.7)
—
(2.3)
(1.5)
—
(109.9)
(0.6)
2.9
61.3
2.0
(2.8)
63.4
4.2
12.2
See accompanying Notes to Consolidated Financial Statements
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Background - Knowles Corporation (NYSE:KN) is a market leader and global provider of advanced micro-acoustic, audio
processing, and precision device solutions, serving the mobile consumer electronics, communications, medical, defense, 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. Our common stock began trading under the ticker symbol “KN” on the New York Stock Exchange (the
“NYSE”) on March 3, 2014.
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"). On July
7, 2016, the Company completed the sale of its speaker and receiver product line (“Speaker and Receiver Product Line”). 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 and Speaker and Receiver
Product Line have been reclassified as discontinued operations for all periods presented. See Note 2. Disposed and Discontinued
Operations for additional information related to the transactions.
In January 2017, the Company changed its allocation of resources and internal reporting structure to facilitate delivering growth
in its core business. Following these changes, the Company's two reportable segments are Audio and Precision Devices ("PD").
See Note 17. Segment Information for additional information related to the Company’s segments.
Financial Statement Presentation - The Consolidated Financial Statements included in this Annual Report on Form 10-K are
presented in conformity with U.S. generally accepted accounting principles ("U.S. GAAP").
Use of Estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates
and assumptions that affect the amounts reported in the accompanying financial statements and disclosures. These estimates may
be adjusted due to changes in future economic, industry, or customer financial conditions, as well as changes in technology or
demand. Estimates are used in accounting for, among other items, allowances for doubtful accounts receivable, inventory reserves,
restructuring reserves, warranty reserves, pension and post-retirement plans, stock-based compensation, corporate allocations,
useful lives for depreciation and amortization of long-lived assets, future cash flows associated with impairment testing for goodwill,
indefinite-lived intangible assets and other long-lived assets, deferred tax assets, uncertain income tax positions, changes in tax
laws, and contingencies. Actual results may ultimately differ from estimates, although management does not believe such differences
would materially affect the financial statements in any individual year. Estimates and assumptions are periodically reviewed and
the effects of revisions are reflected in the Consolidated Financial Statements in the period that they are determined.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand, demand deposits, and temporary cash investments
with original maturities less than three months.
Allowance for Doubtful Accounts – The Company maintains allowances for estimated losses as a result of customers' inability
to make required payments. Management evaluates the aging of the accounts receivable balances, the financial condition of its
customers, historical trends, and the time outstanding of specific balances to estimate the amount of accounts receivable that may
not be collected in the future and records the appropriate provision.
Inventories – Inventories are stated at the lower of cost or net realizable value, determined on the first-in, first-out ("FIFO") basis.
The value of inventory may decline as a result of surplus inventory, price reductions, or technological obsolescence. It is the
Company’s policy to carry reserves against the carrying value of inventory when items have no future demand (obsolete inventory)
and additionally, where inventory items on hand have demand, yet have insufficient forecasted activity to consume the entire stock
within a reasonable period. It is the Company’s policy to carry reserves against the carrying value of such at-risk inventory items
after considering the nature of the risk and any mitigating factors.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prepaid and Other Current Assets – Prepaid and other current assets at December 31, 2017 includes $10.0 million held in escrow
related to the sale of the Timing Device Business that was received during the third quarter of 2018. The remaining balance at
December 31, 2018 and 2017 is made up of prepaid insurance, supplier prepayments, prepaid licensing fees, and other miscellaneous
prepaid assets, none of which are individually significant.
Property, Plant, and Equipment - Property, plant, and equipment includes the historic cost of land, buildings, equipment, and
significant improvements to existing plant and equipment or, in the case of acquisitions, a fair market value appraisal of such assets
completed at the time of acquisition. Property, plant, and equipment also includes the cost of purchased software. Expenditures
for maintenance, repairs, and minor renewals are expensed as incurred. When property or equipment is sold or otherwise disposed
of, the related cost and accumulated depreciation is removed from the respective accounts, and the gain or loss realized on disposition
is reflected in earnings. The Company historically depreciates its assets on a straight-line basis over their estimated useful lives
as follows: buildings and improvements 5 to 31.5 years; machinery and equipment 1.5 to 7 years; furniture and fixtures 2 to 5
years; vehicles 3 to 5 years; and software 3 to 5 years.
Derivative Instruments - The Company uses derivative financial instruments to hedge its exposures to various risks, including
interest rate and foreign currency exchange rate risk. The Company does not enter into derivative financial instruments for
speculative purposes and does not have a material portfolio of derivative financial instruments. Derivative financial instruments
used for hedging purposes must be designated and effective as a hedge of the identified risk exposure at inception of the contract.
The Company recognizes all derivatives as either assets or liabilities on the Consolidated Balance Sheets and measures those
instruments at fair value. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the
derivatives is recorded as a component of other comprehensive earnings and subsequently recognized in net earnings when the
hedged items impact earnings.
Goodwill and Indefinite-Lived Intangible Assets - Goodwill represents the excess of purchase consideration over the fair value
of the net assets of businesses acquired. Goodwill and certain other intangible assets deemed to have indefinite lives (primarily
trademarks) are not amortized. Instead, goodwill and indefinite-lived intangible assets are tested for impairment at least annually,
or more frequently if there are events or circumstances indicating the carrying value of individual reporting units or assets may
exceed their respective fair values on a more likely than not basis. The Company performs its annual impairment assessment in
the fourth quarter of each year on October 1. Recoverability of goodwill is measured at the reporting unit level. Following the sale
of the Timing Device Business on November 28, 2017, the Company has three reporting units. The goodwill balances associated
with the Mobile Consumer Electronics ("MCE"), Hearing Health Technologies ("HHT"), and Capacitors reporting units were
$722.1 million, $137.8 million, and $28.0 million, respectively, as of December 31, 2018.
The impairment assessment compares the fair value of each reporting unit to its carrying value. Impairment is measured as the
amount by which the carrying value of a reporting unit exceeds its fair value. Fair value is estimated using a discounted cash flow
approach that includes the Company’s market participant assumptions, projections of future cash flows based on historical
performance and future estimated results, determinations of appropriate discount rates, and other assumptions which are considered
reasonable and inherent in the discounted cash flow analysis. Significant assumptions used in the assessment include forecasted
revenue and terminal growth rates, profit margins, income taxes, and the Company's weighted average cost of capital. These
assumptions require significant judgment and actual results may differ from estimated amounts. The fair value of all of the
Company’s reporting units exceeded the carrying values by at least 50%, resulting in no goodwill impairment charges. Potential
circumstances that could have a negative effect on the fair value of our reporting units include, but are not limited to, lower than
forecasted growth rates or profit margins and changes in the weighted average cost of capital. A reduction in the estimated fair
value of the reporting units could trigger an impairment in the future. The Company cannot predict the occurrence of certain events
or changes in circumstances that might adversely affect the carrying value of goodwill and intangible assets.
In testing its other indefinite-lived intangible assets for impairment, the Company uses a relief from royalty method to calculate
and compare the fair value of the intangible asset to its carrying value. This method estimates the fair value of trademarks by
calculating the present value of royalty income that could hypothetically be earned by licensing the trademark to a third party. Any
excess of carrying value over the estimated fair value is recognized as an impairment loss. No impairment of indefinite-lived
intangibles was indicated for the years ended December 31, 2018, 2017, or 2016.
See Note 7. Goodwill and Other Intangible Assets for additional information on goodwill and indefinite-lived intangible assets.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Intangible and Long-Lived Assets - Other intangible assets with determinable lives consist primarily of customer
relationships, unpatented technology, patents, and trademarks and are amortized over their estimated useful lives, historically
ranging from 5 to 15 years. The Company relies on patents and proprietary technology, and seeks patent protection for products
and production methods. The Company capitalizes external legal costs incurred in the defense of its patents when it believes that
a significant, discernible increase in value will result from the defense and a successful outcome of the legal action is probable.
These costs are amortized over the remaining estimated useful life of the patent, which is typically 7 to 10 years. The Company’s
assessment of future economic benefit and/or the successful outcome of legal action related to patent defense involves considerable
management judgment and a different outcome could result in material write-offs of the carrying value of these assets. The Company
capitalized no legal costs related to the defense of its patents during the years ended December 31, 2018, 2017, and 2016.
Long-lived assets (including intangible assets with determinable lives) are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be recoverable. If an indicator of impairment exists for any
grouping of assets, an estimate of undiscounted future cash flows is produced and compared to its carrying value. If an asset is
determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value as determined
by an estimate of discounted future cash flows.
The Company recorded no impairments during the year ended December 31, 2018. During the years ended December 31, 2017
and 2016, the Company recorded impairments and other charges related to its continuing operations of $21.3 million and $0.5
million, respectively. See Note 4. Impairments for additional details.
Foreign Currency - Assets and liabilities of non-U.S. subsidiaries, where the functional currency is not the U.S. dollar, are translated
into U.S. dollars at year-end exchange rates. Revenue and expense items are translated using weighted-average yearly exchange
rates. Foreign currency translation gains and losses are included as a component of Accumulated other comprehensive loss. Assets
and liabilities of an entity that are denominated in currencies other than an entity’s functional currency are re-measured into the
functional currency using end of period exchange rates or historical rates where applicable to certain balances. Gains and losses
related to these re-measurements are recorded within the Consolidated Statements of Earnings as a component of Other expense
(income), net.
Revenue Recognition - The Company adopted ASC 606, Revenue from Contracts with Customers, on January 1, 2018 using the
modified retrospective (cumulative effect) transition method. Refer to the Recently Adopted Accounting Standards section below
for additional information.
Stock-Based Compensation – The principal awards issued under the stock-based compensation plans include stock options,
restricted stock units ("RSUs"), and performance share units ("PSUs"). The cost for such awards is measured at the grant date
based on the fair value of the award. The value of the portion of the award that is expected to ultimately vest is generally recognized
as expense on a straight-line basis, generally over the explicit service period and is included in Cost of goods sold, Research and
development expenses, and Selling and administrative expenses in the Consolidated Statements of Earnings, depending on the
functional area of the underlying employees. The cost related to PSUs is recognized based on the expected attainment of performance
targets. Changes in estimates that impact the number of shares expected to vest are recognized prospectively through cumulative
adjustments.
The Company uses the Black-Scholes valuation model to estimate the fair value of stock options granted to employees. The fair
value of each RSU granted is equal to the share price at the date of the grant. The fair value of each PSU is determined using a
binomial model simulation. At the time of grant, the Company estimates forfeitures, based on historical experience, in order to
estimate the portion of the award that will ultimately vest. See Note 13. Equity Incentive Program for additional information related
to the Company’s stock-based compensation.
Income Taxes - The Company records a provision for income taxes for the anticipated tax consequences of the reported results
of operations using the asset and liability method. Under this method, the Company recognizes deferred tax assets and liabilities
for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and
liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax
rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized
or settled. The Company offsets and presents deferred tax liabilities and assets, as well as any related valuation allowance, as a
single non-current amount on the Consolidated Balance Sheets on a jurisdictional basis.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company establishes valuation allowances for its deferred tax assets if, based on all available positive and negative evidence,
it is more likely than not that some portion or all of the deferred tax assets will not be realized. In making such assessments,
significant weight is given to evidence that can be objectively verified. The assessment of the need for a valuation allowance
requires considerable judgment on the part of management with respect to the benefits that could be realized from future taxable
income, as well as other positive and negative factors. Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax-planning strategies in making this assessment.
The Company recognizes tax benefits from uncertain tax positions only if it believes that it is more likely than not that the tax
position will be sustained on examination by the taxing authorities based on the technical merits of the position. Adjustments are
made to these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate.
To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the
provision for income taxes in the period in which such determination is made and could have a material impact on the Company's
financial condition and operating results. The provision for income taxes includes the effects of any reserves that are believed to
be appropriate, as well as the related net interest and penalties.
On December 22, 2017, the U.S. bill commonly referred to as the Tax Cuts and Jobs Act ("Tax Reform Act") was enacted, which
significantly changed U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax
system, and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform Act permanently
reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. The Tax Reform
Act also provided for a one-time deemed repatriation of post-1986 undistributed foreign subsidiary earnings and profits ("E&P")
through the year ended December 31, 2017. The Global Intangible Low-Taxed Income ("GILTI") provisions of the Tax Reform
Act also require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return
on the foreign subsidiary’s tangible assets. The Company was subject to the GILTI provisions beginning in 2018. The Company
has elected to account for GILTI tax in the period in which it is incurred, and therefore has not provided any deferred tax impacts
of GILTI in its Consolidated Financial Statements.
On December 22, 2017, the Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin No. 118 (“SAB
118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available,
prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of
the Tax Reform Act. The Company recognized provisional tax impacts related to deemed repatriated earnings, the change in
beginning of year valuation allowance, and the benefit for the remeasurement of deferred tax assets and liabilities as of December
31, 2017. During the fourth quarter of 2018, the Company finalized its accounting for the effects of the Tax Reform Act under
SAB 118. The Company recorded a $17.8 million reduction to the net transition tax liability due to the impact of an Internal
Revenue Service ("IRS") approval for an entity classification received during the fourth quarter of 2018.
During the third quarter of 2018, the Company recorded an uncertain tax position of $36.0 million related to consequences of the
Tax Reform Act. As a result of the IRS approval for an entity classification received during the fourth quarter of 2018, the Company
recognized a $36.0 million benefit related to the release of the uncertain tax position.
Although the Company’s accounting for the effects of the Tax Reform Act is finalized under SAB 118, there may be future
adjustments based on potential changes in the interpretation of the Tax Reform Act, its supporting regulations, and subsequent
guidance that may be issued. The impact of any such adjustments, which could have a material impact on the Consolidated Financial
Statements, will be recognized in the period the changes arise or the related regulations are enacted. The Company is in the process
of evaluating the final regulations on Section 965, which were released by the IRS on January 15, 2019, and will recognize any
related impact in the first quarter of 2019.
Research and Development Costs – Research and development costs, including qualifying engineering costs, are expensed when
incurred.
Non-cash Investing Activities - Purchases of property, plant, and equipment included in accounts payable at December 31, 2018,
2017, and 2016 were $7.1 million, $8.5 million, and $1.5 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 years have been reclassified to conform to the current year presentation. Refer to the
Recently Adopted Accounting Standards section below for additional information.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recently Issued Accounting Standards
In August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-14 to
amend disclosure requirements related to defined benefit pension and other postretirement plans. The standard is effective for
public business entities for fiscal years beginning after December 15, 2020. Early adoption is permitted and retrospective application
of the guidance is required. The Company has not yet determined the impact of the standard on its disclosures or its adoption date.
In February 2018, the FASB issued ASU 2018-02, which allows the reclassification from accumulated other comprehensive income
to retained earnings of stranded tax effects resulting from the Tax Reform Act. The standard also requires certain disclosures
concerning stranded tax effects regardless of the election with respect to stranded tax effects resulting from the Tax Reform Act.
The standard is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal
years. The standard should be applied either in the period of adoption or retrospectively to each period (or periods) in which the
effects of the Tax Reform Act were recognized. The Company has elected to reclassify the stranded tax effects resulting from the
Tax Reform Act upon adoption of the standard on January 1, 2019, the impact of which will not be significant.
In February 2016, the FASB issued ASU 2016-02 and issued subsequent amendments to the initial guidance within ASU 2018-01,
ASU 2018-10, ASU 2018-11, and ASU 2018-20, which are collectively referred to as "ASC 842." This guidance requires a lessee
to recognize a lease liability and right-of-use asset for all leases, including operating leases, with a term greater than 12 months.
The guidance also provides clarification surrounding the presentation of the effects of leases in the statement of earnings. This
standard is effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within
those fiscal years. Prior to the issuance of ASU 2018-11 in July 2018, the standard required a modified retrospective transition
method under which the guidance would be applied at the beginning of the earliest comparative period presented in the financial
statements. ASU 2018-11 allows entities to elect an additional transition method under which the guidance would be applied as
of the adoption date. The Company will adopt the standard under this new transition method that will not require comparative
period financial statements to be recast.
The standard includes a number of optional practical expedients that entities may elect to apply. The Company will elect the
transition package of practical expedients for leases that commenced before the adoption date, which among other things, allows
the Company to carry forward historical lease classifications. The Company will also elect the practical expedient to not separate
nonlease components from lease components, which may increase lease liabilities and right-of-use assets through the inclusion of
payments for nonlease components such as maintenance.
The Company is finalizing its evaluation of the impact of the standard on its Consolidated Financial Statements, accounting
processes, internal controls, and disclosures. The impact of adoption will depend on the lease portfolio as of the transition date
and the Company's accounting policy elections. The Company expects to recognize $40 million to $45 million of operating lease
liabilities and $37 million to $42 million of operating lease right-of-use assets on its Consolidated Balance Sheets upon adoption
of the standard. The standard is not expected to have any other material impacts on the Consolidated Financial Statements. The
adoption date for the standard is January 1, 2019.
Recently Adopted Accounting Standards
In August 2017, the FASB issued ASU 2017-12 with the objective of improving the financial reporting of hedging relationships
to better portray the economic results of an entity’s risk management activities in its financial statements and simplify the application
of hedge accounting guidance. The standard is effective for public business entities for fiscal years beginning after December 15,
2018, and interim periods within those fiscal years. The standard requires adoption on a modified retrospective basis for hedging
relationships existing as of the adoption date and on a prospective basis for the amended presentation and disclosure requirements.
The Company elected to early adopt the standard as of January 1, 2018. Adoption of the standard did not result in a cumulative
effect adjustment to retained earnings as of January 1, 2018 as the Company had no cumulative ineffectiveness recognized under
its hedging relationships existing as of the adoption date. See Note 10. Hedging Transactions and Derivative Instruments for detail
on the Company's prospective adoption of the amended presentation and disclosure requirements. The adoption of this standard
had no other impact on the Consolidated Financial Statements.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In May 2017, the FASB issued ASU 2017-09 that provides guidance about when a change to the terms or conditions of a share
based payment award must be accounted for as a modification. The new guidance requires modification accounting if the fair
value, vesting condition, or classification of an award is not the same immediately before and after a change to the terms and
conditions of the award. This standard is effective for public business entities for fiscal years beginning after December 15, 2017,
and interim periods within those fiscal years. The Company prospectively adopted this guidance on January 1, 2018, which had
no impact on the Consolidated Financial Statements.
In March 2017, the FASB issued ASU 2017-07 primarily to improve the presentation of net periodic pension and post-retirement
benefit cost. The new guidance requires that an employer report the service cost component in the same line item or items as other
compensation costs arising from services rendered by the pertinent employees during the period. The other components of net
benefit cost are required to be presented in the statement of earnings separately from the service cost component and outside of
any subtotal of operating income. This standard is effective for public business entities for fiscal years beginning after December
15, 2017, and interim periods within those fiscal years. The Company adopted this guidance on January 1, 2018 using a retrospective
approach for the presentation of net benefit cost components. For the year ended December 31, 2017, net benefit income other
than service cost of $0.3 million previously presented in both the Cost of goods sold and Selling and administrative expenses lines
on the Consolidated Statements of Earnings has been reclassified to the Other expense (income), net line. For the year ended
December 31, 2016, net benefit income other than service cost of $0.2 million previously presented in the Cost of goods sold line
on the Consolidated Statements of Earnings has been reclassified to the Other expense (income), net line. The adoption of this
standard had no other impact on the Consolidated Financial Statements. See Note 15. Employee Benefit Plans for additional
information related to the Company’s pension and post-retirement plans.
In January 2017, the FASB issued ASU 2017-01, which requires a reporting entity to clarify the definition of a business with the
objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or
disposals) of assets or liabilities. This standard is effective for public business entities for annual periods beginning after December
15, 2017, including interim periods within those periods. The Company prospectively adopted this guidance on January 1, 2018,
which had no impact on the Consolidated Financial Statements.
In August 2016, the FASB issued ASU 2016-15 with the objective of reducing the existing diversity in practice in how certain
cash receipts and cash payments are presented and classified in the statement of cash flows. The new guidance requires evaluation
of cash receipts and payments on the basis of the nature of the underlying cash flows and provides clarity for categorization for
specific transactions. This standard is effective for public business entities for fiscal years beginning after December 15, 2017,
and interim periods within those fiscal years. The Company retrospectively adopted this guidance on January 1, 2018, which had
no impact on the Consolidated Financial Statements.
In January 2016, the FASB issued ASU 2016-01, which requires a company to present separately in other comprehensive income
the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk if the
entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This
standard is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within
those fiscal years. The Company adopted this guidance on a modified retrospective basis as of January 1, 2018, which had no
impact on the Consolidated Financial Statements.
In May 2014, the FASB issued ASU 2014-09 and issued subsequent amendments to the initial guidance within ASU 2015-14,
ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20, which are collectively referred to as "ASC 606." The core principal
of the guidance is to provide a comprehensive revenue recognition model that requires a company to recognize revenue to depict
the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for
those goods or services. The guidance also requires additional disclosure about the nature, amount, timing, and uncertainty of
revenue and cash flows arising from customer contracts. The standard is effective for annual and interim periods beginning after
December 15, 2017.
On January 1, 2018, the Company adopted ASC 606 using the modified retrospective (cumulative effect) transition method. Under
this transition method, results for reporting periods beginning January 1, 2018 or later are presented under ASC 606, while prior
period results continue to be reported in accordance with previous guidance. The Company did not recognize a cumulative effect
adjustment to retained earnings as of January 1, 2018 as the impact of the standard on the Consolidated Financial Statements was
not material. As described below, the analysis of contracts under ASC 606 supports the recognition of revenue at a point in time,
resulting in revenue recognition timing that is materially consistent with our historical practice of recognizing revenue when title
and risk of loss pass to the customer.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue is recognized when control of the promised goods or services is transferred to the customer in an amount that reflects
the consideration the Company expects to be entitled to in exchange for those goods or services. The majority of the Company’s
revenue is generated through the manufacture and sale of a broad range of specialized products and components. For product and
component sales, each good sold to a customer typically represents a distinct performance obligation. The Company’s performance
obligation to provide goods to a customer is typically satisfied at a point in time upon completion of the shipping process as
indicated by the terms of the contract, at which point control is transferred to the customer and revenue is recognized. The Company
has no significant arrangements with multiple performance obligations. Remaining performance obligations consist of the aggregate
amount of the total transaction price that is unsatisfied or partially satisfied. As of December 31, 2018, our total remaining
performance obligations are immaterial. The Company recognizes sales-based royalty revenue under third-party license agreements
as the related sales are made by licensees.
The terms of a contract or historical business practice can give rise to variable consideration, including customer discounts, rebates,
and returns. The Company estimates variable consideration using either the expected value or most likely amount method. We
include estimated amounts in the transaction price to the extent it is probable that a significant reversal of revenue will not occur
in a subsequent reporting period. Our estimates of variable consideration are based on all reasonably available information
(historical, current, and forecasted). Rebates are recognized over the contract period based on expected revenue levels. Sales
discounts and rebates totaled $8.1 million, $9.1 million, and $8.7 million for the years ended December 31, 2018, 2017, and 2016,
respectively. Returns and allowances totaled $7.7 million, $8.5 million, and $5.1 million for the years ended December 31, 2018,
2017, and 2016, respectively.
The Company elected to account for shipping and handling activities that occur after control of the related good transfers to the
customer as fulfillment activities rather than evaluating such activities as performance obligations. As a result, all shipping and
handling costs related to contracts with customers are recognized in the Cost of goods sold line on the Consolidated Statements
of Earnings, which is consistent with our historical practice. Additionally, the Company elected to apply the practical expedient
allowing incremental costs of obtaining a contract to be expensed as incurred if the amortization period of the resulting asset would
have been less than one year. These costs primarily consist of sales commissions and the Company has no such significant costs
exceeding the one year limit for applying the practical expedient.
Receivables, net from contracts with customers were $128.6 million and $127.0 million as of December 31, 2018 and January 1,
2018, respectively. See Note 17. Segment Information for disclosures regarding the disaggregation of revenues.
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 PD segment, 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 for $45.0 million in cash, less purchase
price adjustments for a net amount received of $40.6 million. The Company recorded a loss of $25.6 million as a result of the sale,
which included $26.9 million of loss amounts reclassified from Accumulated other comprehensive loss into earnings related to
currency translation adjustments.
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.
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summarized results of the Company's discontinued operations are as follows:
(in millions)
Revenues
Cost of goods sold
Impairment charges
Restructuring charges - cost of goods sold
Gross profit
Research and development expenses
Selling and administrative expenses
Restructuring charges
Years Ended December 31,
2018
2017
2016
$
— $
—
—
—
—
—
—
—
$
92.2
61.5
0.4
0.1
30.2
7.7
18.5
0.2
156.4
136.1
0.4
8.9
11.0
15.1
26.9
3.4
Operating expenses
Other (income) expense, net
(Gain) loss on sale of business (1)
Earnings (loss) from discontinued operations before taxes (2)
45.4
(0.9)
25.6
(59.1)
3.0
(Benefit from) provision for income taxes
Earnings (loss) from discontinued operations, net of tax
(62.1)
(1) The Company recorded a change in estimated purchase price adjustments related to the Timing Device Business of $1.8 million
—
(0.2)
(1.6)
1.8
(0.3)
2.1
1.3
(62.3)
64.8
3.0
26.4
61.8
$
$
$
during the third quarter of 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)
Assets of discontinued operations:
Receivables
Prepaid and other current assets
Total current assets
Total assets (1)
Liabilities of discontinued operations:
Accounts payable
Other current liabilities
Total current liabilities
December 31, 2017
$
$
$
1.2
0.5
1.7
1.7
0.1
5.5
5.6
Total liabilities (1)
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. As these arrangements were settled during the year ended December 31, 2018, there were no
assets and liabilities of discontinued operations as of December 31, 2018.
$
The following table presents the depreciation, amortization, and capital expenditures related to discontinued operations:
(in millions)
Depreciation
Amortization of intangible assets
Capital expenditures
Years Ended December 31,
2017
2016
$
$
2.3
1.2
2.1
3.3
1.4
6.5
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
There was no depreciation, amortization of intangible assets, or capital expenditures related to discontinued operations during the
year ended December 31, 2018. There were no capital expenditures in accounts payable at December 31, 2018 or 2017. Capital
expenditures included in accounts payable at December 31, 2016 were $0.1 million.
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 $12.6 million and $3.4 million, respectively,
from the date of acquisition through December 31, 2018.
The table below represents the final allocation of the purchase price to net assets acquired as of January 19, 2018:
(in millions)
Cash
Receivables
Inventories
Property, plant, and equipment
Customer relationships
Unpatented technologies
Trademarks and other amortized intangible assets
Other assets
Goodwill
Assumed current liabilities
Total purchase price
$
$
0.2
1.7
2.1
2.0
7.3
2.0
0.4
0.2
3.0
(0.2)
18.7
The Company recorded a purchase price adjustment related to property, plant, and equipment during the year ended December 31,
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.
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.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
(in millions, except share and per share amounts)
Revenues from continuing operations:
As reported
Pro-forma
Earnings from continuing operations:
As reported
Pro-forma
Basic earnings per share from continuing operations:
As reported
Pro-forma
Diluted earnings per share from continuing operations:
As reported
Pro-forma
Other Acquisition
Years Ended December 31,
2018
2017
826.9
$
827.5
744.2
755.7
$
$
$
65.6
66.3
0.73
0.74
0.72
0.73
6.5
7.4
0.07
0.08
0.07
0.08
$
$
$
$
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 year ended December 31, 2017. An additional $1.0 million was paid
during the year ended December 31, 2018, with the remaining $0.2 million to be paid in the first quarter of 2019. The financial
results of this acquisition were included in the Consolidated Financial Statements from the date of acquisition within the PD
segment. In connection with the acquisition, the Company recorded an intangible asset of $3.3 million related to customer
relationships that will be amortized over an estimated useful life of 5 years. Pro-forma financial information has not been provided
as the acquisition did not have a material impact on the Consolidated Statements of Earnings.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. There were no asset impairments recorded during the year ended December 31, 2018. 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. 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.
During the year ended December 31, 2016, the Company identified asset impairments within the Audio segment of $0.5 million,
which are primarily related to restructuring actions to focus research and development efforts on the design of new products in
our core business. The Company recorded $0.3 million within Impairment charges in Gross profit and $0.2 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)
Raw materials
Work in progress
Finished goods
Subtotal
Less reserves
Total
December 31, 2018 December 31, 2017
$
$
70.8
30.2
65.3
166.3
(26.2)
140.1
$
$
65.9
21.3
60.8
148.0
(22.4)
125.6
6. Property, Plant, and Equipment, net
The following table details the major components of property, plant, and equipment, net:
(in millions)
Land
Buildings and improvements
Machinery, equipment, and other
Subtotal
Less accumulated depreciation
Total
December 31, 2018 December 31, 2017
$
$
7.5
$
102.3
499.9
609.7
(398.0)
211.7
$
7.7
103.2
441.1
552.0
(369.0)
183.0
Depreciation expense totaled $45.9 million, $46.5 million, and $50.8 million for the years ended December 31, 2018, 2017, and
2016, respectively. There were no fixed asset impairments recorded during the year ended December 31, 2018. The Company
recorded fixed asset impairments of $5.1 million and $0.5 million for the years ended December 31, 2017 and 2016, respectively.
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Goodwill and Other Intangible Assets
The changes in the carrying value of goodwill by reportable segment for the years ended December 31, 2018 and 2017 are as
follows:
(in millions)
Balance at January 1, 2017
Foreign currency translation
Balance at December 31, 2017
Acquisition
Balance at December 31, 2018
Audio
Precision Devices
Total
846.6
$
25.0
$
13.3
859.9
—
—
25.0
3.0
859.9
$
28.0
$
871.6
13.3
884.9
3.0
887.9
$
$
The gross carrying value and accumulated amortization for each major class of intangible assets are as follows:
(in millions)
Amortized intangible assets:
Trademarks
Patents
Customer relationships
Unpatented technologies
Other
Total
Unamortized intangible assets:
Trademarks
Total intangible assets, net
December 31, 2018
December 31, 2017
Gross
Carrying
Amount
Accumulated
Amortization
Gross
Carrying
Amount
Accumulated
Amortization
$
0.5
$
0.2
$
0.3
$
40.8
10.6
4.4
0.2
56.5
32.0
56.7
$
26.9
2.0
2.7
—
31.8
$
40.8
3.3
2.4
—
46.8
32.0
53.5
0.2
22.2
0.7
2.2
—
25.3
Total amortization expense for the years ended December 31, 2018, 2017, and 2016 was $6.5 million, $7.3 million, and $18.2
million, respectively. Amortization expense is primarily recorded in Selling and administrative expenses in the Consolidated
Statements of Earnings. Amortization expense for the next five years, based on current intangible balances, is estimated to be as
follows:
(in millions)
2019
2020
2021
2022
2023
$
6.4
6.4
6.3
1.1
1.0
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Other Accrued Expenses and Other Liabilities
The following table details the major components of other accrued expenses:
(in millions)
Sales volume rebates
Accrued short-term capital leases
Accrued taxes other than income taxes
Accrued insurance
Restructuring and exit costs
Hedging liability
Warranty
Other (1)
December 31, 2018 December 31, 2017
$
$
4.7
2.4
2.1
1.6
0.9
0.6
0.5
7.3
4.7
2.5
2.4
1.9
4.8
—
2.1
9.8
Total
28.2
(1) Represents accrued commissions (non-employee) and other miscellaneous accruals, none of which are individually significant.
20.1
$
$
The following table details the major components of other liabilities:
(in millions)
December 31, 2018 December 31, 2017
Deferred compensation, including defined benefit plans
$
Long-term capital leases
Unrecognized tax benefits
Restructuring and exit costs
Transition tax liability (1)
Other
Total
(1) See Note 1. Summary of Significant Accounting Policies for additional information.
$
Warranty Accruals
$
17.0
10.1
3.5
0.2
—
3.5
34.3
$
18.7
12.3
6.5
0.3
25.9
4.2
67.9
Estimated warranty program claims are provided for at the time of sale. Amounts provided for are based on historical costs and
adjusted for new claims. The changes in the carrying amount of product warranties were as follows:
(in millions)
Beginning balance, January 1
Provision for warranties
Settlements made
Other adjustments, including currency translation
Ending balance, December 31
9. Restructuring and Related Activities
Years Ended December 31,
2018
2017
$
$
2.1
$
0.4
(1.9)
(0.1)
0.5
$
1.0
2.8
(1.3)
(0.4)
2.1
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 year ended December 31, 2018, the Company recorded restructuring charges of $0.4 million within Gross profit,
primarily for actions associated with transferring certain operations of capacitors manufacturing to other existing facilities in order
to further optimize operations in the PD segment. The Company also recorded restructuring charges of $1.7 million within Operating
expenses, primarily for actions associated with rationalizing the workforce.
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 2017, the Company recorded restructuring charges of $4.0 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. The Company also recorded restructuring charges
of $6.2 million within Operating expenses, primarily for actions associated with rationalizing the workforce.
During the year ended December 31, 2016, the Company recorded restructuring charges of $10.1 million, primarily for actions
associated with the integration of Audience Inc., which is reported as part of the Audio segment, and actions associated with
rationalizing the workforce. These actions were substantially complete as of December 31, 2016. In addition, the Company recorded
residual charges related to the transfer of a portion of the capacitors business into existing, lower-cost Asian manufacturing facilities,
which are reported as part of the PD segment. These charges included severance pay and benefits of $7.5 million and contract
termination costs of $2.6 million, of which $1.5 million were classified within Gross profit and $8.6 million were classified within
Operating expenses.
The following table details restructuring charges incurred by reportable segment for the periods presented:
(in millions)
Audio
Precision Devices
Corporate
Total
Years Ended December 31,
2018
2017
2016
$
$
1.4
0.5
0.2
2.1
$
$
$
8.1
0.1
2.0
10.2
$
7.1
1.4
1.6
10.1
The following table details the Company’s severance and other restructuring accrual activity:
(in millions)
Balance at January 1, 2016
Restructuring charges
Payments
Balance at December 31, 2016
Restructuring charges (1)
Payments
Other, including foreign currency
Balance at December 31, 2017
$
$
$
Severance Pay and
Benefits
Contract Termination
and Other Costs
Total
7.7
$
1.1
$
$
7.5
(12.8)
2.4
8.4
(6.5)
0.4
$
2.6
(3.3)
0.4
1.8
(1.8)
—
4.7
$
0.4
$
8.8
10.1
(16.1)
2.8
10.2
(8.3)
0.4
5.1
Payments
Restructuring charges
2.1
(6.0)
(0.1)
Other, including foreign currency
Balance at December 31, 2018
1.1
(1) During the year ended December 31, 2017, the Company reversed $1.2 million of previously recorded restructuring charges
2.1
(5.9)
(0.1)
0.8
—
(0.1)
—
0.3
$
$
$
in Gross profit due to subsequent developments that impacted the previously estimated amounts.
The severance and restructuring accruals are recorded in the following line items on the Consolidated Balance Sheets:
(in millions)
December 31, 2018 December 31, 2017
Other accrued expenses
Other liabilities (1)
Total
(1) This line represents the long-term portion of the charges associated with lease obligations, net of reasonably obtainable sublease
0.9
0.2
1.1
5.1
4.8
0.3
$
$
$
$
income.
69
10. Hedging Transactions and Derivative Instruments
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 December 31, 2018 and 2017, the notional value of the derivatives related to currency forward contracts, principally the
Chinese yuan, Malaysian ringgit, and Philippine peso, was $41.6 million and $17.9 million, respectively.
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 December 31, 2018 and 2017, the notional value of the derivatives related to
economic hedging was $19.8 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.
70
Fair Value Measurements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 1. Summary of Significant Accounting Policies for
additional information on the adoption of this standard.
The fair values of derivative instruments held by the Company are as follows (in millions):
Hedge Type
Contract Type
Balance Sheet Line
Derivatives designated as hedging instruments
Derivative Assets (Liabilities)
December 31, 2018 December 31, 2017
Cash flow hedges
Foreign exchange contracts
Prepaid and other current assets
$
Cash flow hedges
Foreign exchange contracts
Other accrued expenses
0.2
$
(0.6)
Derivatives not designated as hedging instruments
Economic hedges
Foreign exchange contracts
Prepaid and other current assets
0.2
0.6
—
—
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):
Hedge Type
Cash flow hedges
Cash flow hedges
Contract Type
2018
2017
2016
Foreign exchange contracts
$
(2.5) $
Interest rate contracts
0.1
$
3.6
0.3
(2.5)
(0.7)
Years Ended December 31,
The table above excludes a tax benefit of $0.4 million, tax expense of $0.5 million, and a tax benefit of $0.7 million for the years
ended December 31, 2018, 2017, and 2016, respectively.
71
The pre-tax impact of derivatives on the Consolidated Statements of Earnings is as follows (in millions):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Hedge Type
Contract Type
Years Ended December 31,
2018
2017
2016
Cost of
goods
sold
Interest
expense,
net
Other
expense
(income),
net
Interest
expense,
net
Other
expense
(income),
net
Interest
expense,
net
Other
expense
(income),
net
Total amounts per Consolidated Statements of Earnings
$
503.9 $
16.0 $
0.7
$
20.6 $
(0.1) $
20.4 $
(3.5)
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
Cash flow hedges
Interest rate contracts
1.4
—
—
—
—
—
—
0.8
(0.3)
—
—
1.3
(0.3)
—
Effect of derivatives not designated as hedging instruments
Amount of loss (gain) recognized in earnings:
Economic hedges
Foreign exchange contracts
—
—
0.9
—
(0.3)
—
2.0
11. Borrowings
Borrowings (net of debt issuance costs, debt discount, and amortization) consist of the following:
(in millions)
3.25% convertible senior notes
Revolving credit facility
Total
Less current maturities (1)
Total long-term debt
December 31, 2018 December 31, 2017
$
$
149.1
$
9.0
158.1
—
158.1
$
141.9
50.7
192.6
—
192.6
(1) There are no required principal payments due under the 3.25% convertible senior notes or the revolving credit facility until
maturities in November 2021 and October 2022, respectively.
Total debt principal payments over the next five years are as follows:
(in millions)
2019
2020
2021
2022
2023
Debt principal payments
$
— $
— $
172.5
$
9.0
$
—
3.25% Convertible Senior Notes Due November 1, 2021
In May 2016, the Company issued $172.5 million aggregate principal amount of 3.25% convertible senior notes due November
1, 2021 (the "Notes"), unless earlier repurchased by the Company or converted pursuant to their terms. Interest is payable
semiannually in arrears on May 1 and November 1 of each year and commenced on November 1, 2016.
The Notes are governed by an Indenture (the "Indenture") between the Company, as issuer, and U.S. Bank National Association
as trustee. Upon conversion, the Company will pay or deliver cash, shares of the Company's common stock, or a combination of
cash and shares of common stock, at the Company's election. The initial conversion rate is 54.2741 shares of common stock per
$1,000 principal amount of Notes. The initial conversion price is $18.4250 per share of common stock. The conversion rate will
be subject to adjustment upon the occurrence of certain specified events but will not be adjusted for accrued and unpaid interest.
In addition, upon the occurrence of a make-whole fundamental change (as defined in the Indenture), the Company may be required,
in certain circumstances, to increase the conversion rate by a number of additional shares for a holder that elects to convert its
Notes in connection with such make-whole fundamental change.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to the close of business on the business day immediately preceding August 1, 2021, the Notes will be convertible only under
the following circumstances:
during any calendar quarter and only during such calendar quarters, if the last reported sale price of the Company’s common
stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the
last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on
each applicable trading day;
during the five business day period after any 10 consecutive trading day period (the “measurement period”) in which the
trading price per $1,000 principal amount of Notes was less than 98% of the product of the last reported sale price of the
Company’s common stock and the conversion rate on each such trading day; or
upon the occurrence of specified corporate events.
On or after August 1, 2021 until the close of business on the second scheduled trading day immediately preceding the maturity
date, holders may convert all or any portion of their Notes, in multiples of $1,000 principal amount, at the option of the holder
regardless of the foregoing circumstances. As of December 31, 2018, no event has occurred that would permit the conversion of
the Notes. The Notes are the Company’s senior unsecured obligations.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying
amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated
convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting
the fair value of the liability component from the face value of the Notes as a whole. The excess of the principal amount of the
liability component over its carrying amount is amortized to interest expense over the term of the Notes. The equity component
is not remeasured as long as it continues to meet the conditions for equity classification.
In accounting for the transaction costs related to the Notes issuance, the Company allocated the total amount incurred to the liability
and equity components based on their relative values. Issuance costs attributable to the liability component, totaling $5.0 million,
are being amortized to interest expense over the term of the Notes, and issuance costs attributable to the equity component, totaling
$1.3 million, were netted with the equity component in stockholders' equity. Additionally, the Company recorded a deferred tax
asset of $0.5 million on a portion of the equity component transaction costs which are deductible for tax purposes and immediately
recorded a valuation allowance against this deferred tax asset.
The Notes consist of the following:
(in millions)
Liability component:
Principal
Less debt issuance costs and debt discount, net of amortization
Total
Less current maturities (1)
Long-term portion
December 31, 2018
December 31, 2017
$
$
$
172.5
(23.4)
149.1
—
149.1
$
172.5
(30.6)
141.9
—
141.9
Equity component (2)
(1) There are no required principal payments due until maturity in November 2021.
(2) Recorded in the Consolidated Balance Sheets within additional paid-in capital, inclusive of the $1.3 million of issuance costs
in equity.
29.9
29.9
$
$
The total estimated fair value of the Notes at December 31, 2018 was $178.2 million. The fair value was determined based on the
closing trading price of the Notes as of the last trading day of 2018.
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth total interest expense recognized related to the Notes:
(in millions)
3.25% coupon
Amortization of debt issuance costs
Amortization of debt discount
Total
Note Hedges
Years Ended December 31,
2018
2017
2016
$
$
$
5.6
0.9
6.3
$
5.6
0.9
5.8
12.8
$
12.3
$
3.7
0.6
3.6
7.9
To minimize the impact of potential economic dilution upon conversion of the Notes, the Company entered into convertible note
hedge transactions (the “Note Hedges”) with respect to its common stock. In the second quarter of 2016, the Company paid an
aggregate amount of $44.5 million for the Note Hedges. The Note Hedges will expire upon maturity of the Notes. The Note Hedges
are intended to offset the potential dilution upon conversion of the Notes and/or offset any cash payments the Company is required
to make in excess of the principal amount upon conversion of the Notes in the event that the market value per share of the Company's
common stock, as measured under the Note Hedges, is greater than the strike price of the Note Hedges, which initially corresponds
to the initial conversion price of the Notes and is subject to anti-dilution adjustments substantially similar to those applicable to
the conversion rate of the Notes. The Note Hedges are separate transactions entered into by the Company, and are not part of the
Notes or the Warrants, and have been accounted for as part of additional paid-in capital. Holders of the Notes do not have any
rights with respect to the Note Hedges.
Warrants
In addition to the Note Hedges, in the second quarter of 2016, the Company entered into warrant transactions, whereby the Company
sold warrants to acquire shares of the Company's common stock at a strike price of $21.1050 per share (the “Warrants”). The
Company received aggregate proceeds of $39.1 million from the sale of the Warrants. If the market price per share of the Company's
common stock for the reporting period, as measured under the Warrants, exceeds the strike price of the Warrants, the Warrants
could have a dilutive effect on the Company's common stock, unless the Company elects, subject to certain conditions, to settle
the Warrants in cash. The Warrants are separate transactions entered into by the Company, and are not part of the Notes or the Note
Hedges, and have been accounted for as part of additional paid-in capital. Holders of the Notes and Note Hedges do not have any
rights with respect to the Warrants.
Revolving Credit Facility
Revolving credit facility borrowings consist of the following:
(in millions)
$400.0 million revolving credit facility due October 2022
Less current maturities (1)
Long-term portion
(1) There are no required principal payments due until maturity in October 2022.
December 31, 2018 December 31, 2017
$
$
9.0
—
9.0
$
$
50.7
—
50.7
On October 11, 2017, the Company entered into a Revolving Credit Facility Agreement (the "New Credit Facility"). The New
Credit Facility contains a five-year senior secured revolving credit facility providing for borrowings in an aggregate principal
amount at any time outstanding not to exceed $400.0 million. Up to $100.0 million of the New Credit Facility will be available
in Euro, Sterling, and other currencies requested by the Company and agreed to by each Lender and up to $50.0 million of the
New Credit Facility will be made available in the form of letters of credit denominated in any currencies agreed by the issuing
bank.
The New Credit Facility serves as refinancing of indebtedness and terminates the Company's Amended and Restated Credit
Agreement dated as of January 27, 2014, as amended and restated as of December 31, 2014 and supplemented from time to time
(“Prior Credit Facilities”).
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At any time during the term of the New Credit Facility, the Company will be permitted to increase the commitments under the
New Credit Facility or to establish one or more incremental term loan facilities under the New Credit Facility in an aggregate
principal amount not to exceed $200.0 million for all such incremental facilities.
Commitments under the New Credit Facility will terminate, and loans outstanding thereunder will mature, on October 11, 2022;
provided, that if all the Company’s Notes have not been repaid, refinanced, and/or converted to common stock of the Company
by April 30, 2021, then the commitments under the New Credit Facility will terminate, and the loans outstanding thereunder will
mature, on such earlier date.
The interest rates under the New Credit Facility will be, at the Borrowers’ option (1) LIBOR (or, in the case of borrowings under
the New Credit Facility denominated in Euro, EURIBOR) plus the rates per annum determined from time to time based on the
total leverage ratio of the Company as of the end of and for the most recent period of four fiscal quarters for which financial
statements have been delivered (the “Applicable Rate”); or (2) in the case of borrowings denominated in U.S. dollars, alternate
base rate (“ABR”); provided, however, that any swingline borrowings shall bear interest at the rate applicable to ABR borrowings
or, prior to the purchase of participations in such borrowings by the Lenders, at such other rate as shall be agreed between the
Company and the swingline lender.
The interest rate under the New Credit Facility is variable based on LIBOR at the time of the borrowing and the Company’s leverage
as measured by a total indebtedness to Consolidated EBITDA ratio. Based upon the Company’s total indebtedness to Consolidated
EBITDA ratio, the Company’s borrowing rate could range from LIBOR + 1.25% to LIBOR + 2.25%. In addition, a commitment
fee accrues on the average daily unused portion of the New Credit Facility at a rate of 0.20% to 0.35%.
The New Credit Facility includes requirements, to be tested quarterly, that the Company maintains (i) a minimum ratio of
Consolidated EBITDA to consolidated interest expense of 3.25 to 1.0, (the "Interest Coverage Ratio"), (ii) a maximum ratio of
Consolidated total indebtedness to Consolidated EBITDA of 3.75 to 1.0 (the "Leverage Ratio"), and (iii) a maximum ratio of senior
secured indebtedness to Consolidated EBITDA of 3.25 to 1.0 (the "Senior Secured Leverage Ratio"). For these ratios, Consolidated
EBITDA and consolidated interest expense are calculated using the most recent four consecutive fiscal quarters in a manner defined
in the New Credit Facility. At December 31, 2018, the Company was in compliance with these covenants and it expects to remain
in compliance with all of its debt covenants over the next twelve months.
On January 27, 2014, the Company entered into a $200.0 million five-year senior secured revolving credit facility as well as a
$300.0 million five-year senior secured term loan facility pursuant to a Credit Agreement (the "Original Credit Agreement"), which
are referred to collectively as the Prior Credit Facilities.
On December 31, 2014, the Company amended its Prior Credit Facilities to (i) increase the amount of the revolving credit facility
in the Original Credit Agreement to $350.0 million from $200.0 million, (ii) increase the amount of the letter of credit subfacility
in the Original Credit Agreement to $50.0 million from $25.0 million, (iii) eliminate the swing line subfacility in the amount of
up to $35.0 million in the Original Credit Agreement, and (iv) reduce to $100.0 million from $250.0 million the amount of additional
incremental revolving or term loans in the Original Credit Agreement. All other terms and conditions of the Prior Credit Facilities
remained essentially the same.
On February 9, 2016, the Company entered into a third amendment to its Prior Credit Facilities that includes a permanent reduction
by the Company of the aggregate revolving commitment under the Prior Credit Facilities from $350.0 million to $300.0 million.
On April 27, 2016, the Company entered into a fourth amendment to its Prior Credit Facilities to permit the Company to execute
the offering of the Notes and the related transactions.
The weighted-average interest rate on the Company's borrowings under the New Credit Facility and Prior Credit Facilities was
3.56%, 3.58%, and 3.23% for the years ended December 31, 2018, 2017, and 2016, respectively. The weighted-average interest
rate on the Company's borrowings under the New Credit Facility and Prior Credit Facilities for the years ended December 31,
2018, 2017, and 2016 includes interest expense related to the monthly interest rate swap settlements that ended in July 2018. The
weighted-average commitment fee on the revolving lines of credit was 0.24%, 0.36%, and 0.39% for the years ended December 31,
2018, 2017, and 2016, respectively.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest expense and interest income for the years ended December 31, 2018, 2017, and 2016 were as follows:
(in millions)
Interest expense(1)
Interest income
20.5
(0.1)
Interest expense, net
20.4
(1) During 2017, the Company wrote off $0.4 million of debt issuance costs related to the Prior Credit Facilities to interest expense
upon entering into the New Credit Facility. During 2016, the Company wrote off $0.7 million of debt issuance costs to interest
expense in connection with the third amendment to its Prior Credit Facilities.
16.6
(0.6)
16.0
20.8
(0.2)
20.6
$
$
$
$
$
$
Years Ended December 31,
2018
2017
2016
See Note 10. Hedging Transactions and Derivative Instruments for information on derivatives used to manage interest rate risk.
12. Income Taxes
The components of earnings before income taxes and discontinued operations were:
(in millions)
Domestic
Foreign
Total earnings before income taxes and discontinued operations
Years Ended December 31,
2017
2016
2018
$
$
(34.1) $
95.2
61.1
$
402.7
(383.3)
19.4
$
$
(51.1)
79.2
28.1
Income tax (benefit) expense for the years ended December 31, 2018, 2017, and 2016 is comprised of the following:
(in millions)
Current:
U.S. Federal
State and local
Foreign
Total current tax (benefit) expense
Deferred:
U.S. Federal
State and local
Foreign
Total deferred tax expense (benefit)
Total income tax (benefit) expense
Years Ended December 31,
2018
2017
2016
$
$
$
$
(25.0) $
0.1
11.6
(13.3) $
$
7.8
0.2
0.8
8.8
(4.5) $
28.9
$
0.1
11.7
40.7
$
(26.8) $
—
(1.0)
(27.8)
12.9
$
—
0.1
6.8
6.9
0.8
0.2
0.4
1.4
8.3
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The reconciliation of the U.S. Federal income tax rate to the Company’s effective income tax rate was as follows:
U.S. Federal income tax rate
State and local taxes, net of Federal income tax benefit
Foreign operations tax effect
Research and experimentation tax credits
Valuation allowance
Tax contingencies
Tax holiday
Foreign taxes
Non-deductible and non-taxable interest
Stock-based compensation
Other, principally non-tax deductible items (1)
Transition tax
Tax reform
Years Ended December 31,
2018
2017
2016
21.0 %
0.4 %
4.0 %
(5.0)%
22.9 %
(4.3)%
(24.3)%
0.9 %
1.4 %
3.1 %
3.2 %
(28.9)%
(1.7)%
35.0 %
(0.2)%
27.0 %
(11.6)%
60.8 %
6.6 %
(78.0)%
(5.0)%
(0.8)%
9.3 %
13.5 %
89.7 %
(85.3)%
35.0 %
1.1 %
(22.5)%
(6.6)%
69.6 %
(0.6)%
(64.2)%
2.8 %
3.2 %
9.6 %
1.9 %
— %
— %
Prior period items
Effective income tax rate
29.5 %
(1) Includes income tax expense related to the Malaysian tax consequences of the intra-entity intellectual property sale between
the U.S. and Malaysia that increases the effective income tax rate by 18.5% for the year ended December 31, 2017.
66.5 %
(0.1)%
(7.4)%
0.2 %
5.5 %
The Company’s effective tax rate is favorably impacted by two tax holidays granted to us by Malaysia effective through December
31, 2021. These tax holidays are subject to the Company’s satisfaction of certain conditions, including investment or sales thresholds,
which the Company expects to maintain. During 2016, the Company applied for and received final approval to modify the terms
of its main tax holiday in Malaysia, reducing the rate to 7.2% versus the statutory rate of 24.0%, effective January 1, 2017 through
December 31, 2021. If the Company fails to satisfy such conditions, the Company’s effective tax rate may be significantly adversely
impacted. The continuing operations benefit of these incentives for the years ended December 31, 2018, 2017, and 2016 is estimated
to be $13.3 million, $13.8 million, and $16.3 million, respectively. The continuing operations benefit of the tax holidays on a per
share basis for the years ended December 31, 2018, 2017, and 2016 was $0.15, $0.15, and $0.18, respectively.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the Company’s deferred tax assets and liabilities included the following:
(in millions)
Deferred tax assets:
December 31, 2018 December 31, 2017
Accrued compensation, principally post-retirement, and other employee benefits $
15.1
$
Accrued expenses, principally for state income taxes, interest, and warranty
Net operating loss and other carryforwards
Inventories, principally due to reserves for financial reporting purposes and
capitalization for tax purposes
Convertible Note Hedges
Plant and equipment, principally due to differences in depreciation
Total gross deferred tax assets
Valuation allowance
Total deferred tax assets
Deferred tax liabilities:
$
Intangible assets, principally due to different tax and financial reporting bases and
amortization lives
$
Debt discount on convertible notes
Other liabilities
Total gross deferred tax liabilities
Net deferred tax asset
Classified as follows in the Consolidated Balance Sheets:
Other assets and deferred charges (non-current deferred tax assets)
Deferred income taxes (non-current deferred tax liabilities)
Net deferred tax asset
$
$
$
4.6
155.9
3.9
5.7
9.4
194.6
(131.2)
63.4
$
(8.7) $
(4.4)
(37.2)
(50.3)
13.1
$
15.2
(2.1)
13.1
$
$
13.7
5.9
115.6
3.6
7.3
9.6
155.7
(99.7)
56.0
(10.3)
(5.7)
(17.6)
(33.6)
22.4
22.4
—
22.4
The Company recorded valuation allowances of $131.2 million and $99.7 million at December 31, 2018 and 2017, respectively,
against deferred tax assets from continuing operations as the Company believes it is more likely than not that these assets will not
be realized. The Company recorded a $1.0 million benefit due to the reassessment of the beginning of year valuation allowance
primarily related to United Kingdom ("U.K.") operations. Management believes that it is more likely than not that the Company
will realize the benefits of the remaining deferred tax assets. The amount of the deferred tax asset is considered realizable, however,
it could be adjusted if estimates of future taxable income during the carryforward period are reduced or increased or if objective
negative evidence in the form of cumulative losses is no longer present, requiring that additional weight be given to subjective
evidence such as our projections for growth.
At December 31, 2018, the Company had $30.8 million of Federal net operating losses that are available, of which $11.9 million
will expire in the next 5 to 10 years and $18.9 million will expire in the next 10 to 20 years. There are $96.6 million of State net
operating losses that are available between 2019 and 2036. There are $379.3 million of non-U.S. net operating loss carryforwards,
of which $0.7 million will expire within the next 5 years, $1.9 million will expire in the next 10 to 20 years, and $376.7 million
can be carried forward indefinitely.
The Company has $18.7 million of U.S. federal research and development credits that begin to expire in 2020 and $14.6 million
of foreign tax credits that begin to expire in 2027. In addition, the Company has $16.8 million of state credits, of which $2.4 million
will expire between 2019 and 2034 if unused, and $14.4 million can be carried forward indefinitely.
The Company has not provided for deferred taxes on the undistributed earnings of its international subsidiaries totaling
approximately $1.4 billion. Such earnings are reinvested in foreign jurisdictions and it is currently intended that they will continue
to be reinvested indefinitely. Our Malaysian principal subsidiary is our primary source of foreign earnings and cash. Any future
decision to distribute cash from this subsidiary to the U.S. should not result in a material amount of U.S. or foreign taxes.
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unrecognized Tax Benefits
The Company records interest and penalties associated with unrecognized tax benefits as a component of income tax expense.
During the years ended December 31, 2018 and 2017, the Company recorded a potential interest benefit of $0.3 million and $1.1
million, respectively. The Company recorded $0.3 million of potential interest expense during the year ended December 31, 2016.
There was no accrued interest at December 31, 2018. Total accrued interest at December 31, 2017 and 2016 of $0.4 million and
$1.4 million, respectively, was included in Other liabilities on the Consolidated Balance Sheets. During the years ended December
31, 2018 and 2017, the Company recorded potential penalty expense of $0.1 million and $0.2 million, respectively. Total accrued
penalties at December 31, 2018 and 2017 of $0.3 million and $0.2 million, respectively, were included in Other liabilities on the
Consolidated Balance Sheets. There was no recorded potential penalty expense or accrued penalties at December 31, 2016.
The Company's tax returns are routinely audited by the tax authorities in the relevant jurisdictions. For tax years before 2017, the
Company is no longer subject to U.S. federal income tax examination. For tax years before 2013, the Company’s Malaysian
subsidiaries are no longer subject to examination. It is reasonably possible that the gross amount of unrecognized tax benefits will
decrease by $0.1 million during the next twelve months. Included in the balance of total unrecognized tax benefits at December 31,
2018 are potential benefits of $3.5 million, which if recognized, would affect the effective rate on earnings from continuing
operations. Given the Company's current valuation allowance position, no benefit is expected to result from the reversal of any
uncertain tax position associated with the acquired attributes.
Unrecognized tax benefits at January 1, 2016
Reductions for tax positions due to lapsed statutes of limitations
Foreign exchange fluctuations
Unrecognized tax benefits at December 31, 2016
Additions based on tax positions related to the current year
Additions for tax positions of prior years
Reductions for tax positions due to lapsed statutes of limitations
Tax reform
Foreign exchange fluctuations
Unrecognized tax benefits at December 31, 2017
Additions based on tax positions related to the current year
Additions for tax positions of prior years
Reductions for tax positions due to lapsed statutes of limitations
Settlements
Unrecognized tax benefits at December 31, 2018
$
$
$
$
12.8
(0.5)
(0.5)
11.8
2.6
0.6
(1.3)
(1.5)
0.3
12.5
0.1
0.3
(2.5)
(0.3)
10.1
See Note 1. Summary of Significant Accounting Policies for additional information related to the impact of the Tax Reform Act.
13. Equity Incentive Program
The following table summarizes the stock-based compensation expense recognized by the Company for the periods presented:
(in millions)
Pre-tax stock-based compensation expense
Cost of goods sold
Research and development expenses
Selling and administrative expenses
Total pre-tax stock-based compensation expense
Tax benefit
Total stock-based compensation expense, net of tax
Years Ended December 31,
2018
2017
2016
$
$
1.6
7.8
17.6
27.0
—
$
1.8
6.1
16.8
24.7
—
$
27.0
$
24.7
$
1.5
4.7
14.7
20.9
—
20.9
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Compensation expense for stock-based awards is measured based on the fair value of the awards as of the date the stock-based
awards are granted and adjusted to the estimated number of awards that are expected to vest. Forfeitures are estimated based on
historical experience at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates.
Compensation costs for stock-based awards are amortized over their service period.
Prior to the Separation in 2014, Knowles employees participated in our Former Parent's incentive stock program. Adopted in
connection with the Separation, the Knowles' Corporation 2014 Equity and Cash Incentive Plan (the "Plan") provided for the
conversion of certain awards granted under our Former Parent's equity incentive program to Knowles equity awards and authorized
the grant of several different forms of benefits, including stock options, RSUs, PSUs, and stock-settled appreciation rights
("SSARs"). In general, each award is subject to the same terms and conditions as were in effect prior to the Separation, except
that our Former Parent's performance shares converted to time-based RSUs. In addition, the Company made a grant comprised of
both stock options and time-based RSUs that vest 50% on the third and fourth anniversaries from the date of the grant. The Company
also made grants of both stock options and time-based RSUs that vest evenly over each of the first three years following the date
of the grant. The Company elected to use the straight-line method to attribute the expense over the service period of the awards.
Stock Options and SSARs
The fair value of stock options granted by the Company was estimated on the date of grant using a Black-Scholes option-pricing
model based on the assumptions shown in the table below.
Risk-free interest rate
Dividend yield
Expected life (years)
Volatility
2018
2.59%
—%
4.5
41.2%
Fair value at date of grant
$4.83
to
$6.59
2017
2016
1.73%
to
1.93%
1.04%
to
1.25%
—%
4.5
to
to
33.2%
$5.02
38.8%
$6.73
37.0%
$3.76
—%
4.5
to
to
39.6%
$4.83
The determination of expected volatility is based on a blended peer group volatility for companies in similar industries, stage of
life, and with similar market capitalization since there is not sufficient historical volatility data for Knowles common stock over
the period commensurate with the expected term of stock options, as well as other relevant factors. The risk-free interest rate is
based on U.S. government issues with a remaining term equal to the expected life of the stock options. The expected term is the
period over which our employees are expected to hold their options. It is based on the simplified method from the SEC’s safe
harbor guidelines. The Company does not currently anticipate paying dividends over the expected term.
The exercise price per share for the stock options granted by the Company was equal to the closing price of Knowles' stock on the
NYSE on the date of the grant. The period during which options granted by the Company were exercisable was fixed by Knowles'
Compensation Committee of the Board of Directors at the time of grant. Generally, stock options vest one-third on each of the
first three anniversaries of the grant date and expire 7 years from the grant date.
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the Company's SSAR and stock option activity for the year ended December 31, 2018.
SSARs
Stock Options
Number of
Shares
Weighted-
Average
Exercise
Price
Aggregate
Intrinsic
Value
Weighted-
Average
Remaining
Contractual
Term
(Years)
Number of
Shares
Weighted-
Average
Exercise
Price
Aggregate
Intrinsic
Value
Weighted-
Average
Remaining
Contractual
Term
(Years)
(in millions, except share and per share amounts)
Outstanding at
December 31, 2017
850,516
$
21.54
Granted
Exercised
Forfeited
Expired
—
(30,624)
—
(37,897)
—
12.26
—
22.79
Outstanding at
December 31, 2018
781,995
$
21.85
$
Exercisable at
December 31, 2018
781,995
$
21.85
$
4,901,739
$
963,692
(44,326)
(120,458)
(229,154)
18.36
14.34
11.02
15.54
21.63
—
—
3.1
5,471,493
$
17.64
$
3.4
3.1
3,517,954
$
19.31
$
2.2
4.1
3.5
The aggregate intrinsic value in the table above represents the difference between the Company's closing stock price on
December 31, 2018 and the exercise price of each SSAR and stock option, multiplied by the number of in-the-money awards.
There was no unrecognized compensation expense related to SSARs at December 31, 2018. Unrecognized compensation expense
related to stock options not yet exercisable at December 31, 2018 was $5.8 million. This cost is expected to be recognized over a
weighted-average period of 1.3 years.
Other information regarding the exercise of SSARs and stock options is listed below:
(in millions)
SSARs
Fair value of SSARs that are exercisable
Aggregate intrinsic value of SSARs exercised
Stock Options
Cash received by Knowles for exercise of stock options
Aggregate intrinsic value of options exercised
Years Ended December 31,
2018
2017
2016
$
$
1.8
0.1
0.5
0.2
$
1.9
0.2
3.3
1.1
1.9
0.1
—
—
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RSUs
The following table summarizes the Company's RSU balances for the year ended December 31, 2018:
Unvested at December 31, 2017
Granted
Vested
Forfeited
Unvested at December 31, 2018
Share units
Weighted-
average grant
date fair value
2,202,576
$
1,707,911
(1,036,207)
(427,849)
2,446,431
$
16.54
14.28
16.95
14.84
15.12
RSUs generally vest based on the passage of time. RSUs have a three year vesting schedule and vest one-third on each of the first
three anniversaries of the grant date. At December 31, 2018, $23.1 million of unrecognized compensation expense related to RSUs
is expected to be recognized over a weighted-average period of 1.3 years.
PSUs
In February 2018 and 2017, the Company granted PSUs to senior management. In each case, the awards will cliff vest three
years following the grant date and the number of PSUs that may be earned and vest is based on the Company's revenues and
stock price performance over a three year performance period. PSUs will be settled in shares of the Company's common stock.
Depending on the Company's overall performance relative to revenues and stock price, the size of the PSU awards are subject
to adjustment, up or down, resulting in awards at the end of the performance period that can range from 0% to 225% of the initial
grant value. The Company will ratably recognize the expense over the applicable service period for each grant of PSUs and
adjust the expense as appropriate. The fair value of the PSUs is determined by using a Monte Carlo simulation.
The following table summarizes the Company's PSU balances for the year ended December 31, 2018:
Unvested at December 31, 2017
Granted
Vested
Forfeited
Unvested at December 31, 2018
Share units
Weighted-
average grant
date fair value
176,000
$
381,967
—
—
15.32
13.78
—
—
557,967
$
14.27
At December 31, 2018, $6.3 million of unrecognized compensation expense related to PSUs is expected to be recognized over a
weighted-average period of 1.9 years.
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Commitments and Contingent Liabilities
From time to time, the Company is involved in various legal proceedings and claims arising in the ordinary course of its business,
including those related to intellectual property, which may be owned by it or others. The Company owns many patents covering
products, technology, and manufacturing processes. Some of these patents have been and may continue to be challenged by others.
In appropriate cases, the Company has taken and will take steps to protect and defend its patents and other intellectual property,
including through the use of legal proceedings in various jurisdictions around the world. Such steps have resulted in and may
continue to result in retaliatory legal proceedings, including litigation or other legal proceedings in various jurisdictions and forums
around the world alleging infringement by the Company of patents owned by others. The costs of investigations and legal
proceedings, particularly multi-forum litigation, relating to the enforcement and defense of the Company’s intellectual property,
may be substantial. Additionally, in multi-forum disputes, the Company may incur adverse judgments with regard to certain claims
in certain jurisdictions and forums while still contesting other related claims against the same opposing party in other jurisdictions
and forums. Although the ultimate outcome of any legal proceeding or claim cannot be predicted with certainty, based on present
information, including management’s assessment of the merits of the particular claim, the Company does not expect that any
asserted or unasserted legal proceedings or claims, individually or in the aggregate, will have a material adverse effect on its cash
flow, results of operations, or financial condition.
Intellectual Property Infringement Claims
The Company may, on a limited customer specific basis, provide contractual indemnities for certain losses that arise out of claims
that its products infringe on the intellectual property of others. Historically, the Company has not made significant payments under
such indemnity arrangements. The Company’s legal accruals were not significant at December 31, 2018 and 2017.
Lease Commitments
The Company leases certain facilities and equipment under operating leases, many of which contain renewal options. Total rental
expense for all operating leases, net of sublease rental income, was $7.3 million, $6.8 million, and $7.8 million for the years ended
December 31, 2018, 2017, and 2016, respectively. Total sublease rental income was $2.3 million, $2.2 million, and $1.3 million
for the years ended December 31, 2018, 2017, and 2016, respectively. Contingent rentals under the operating leases were not
significant.
In September 2013, the Company entered into an agreement for two new facilities and related equipment in China. The lease for
one of the facilities and related equipment began in the fourth quarter of 2014. The Company took possession of the second facility
and remaining equipment in 2015. The facilities are reflected in the operating leases and the equipment is reflected in the capital
leases in the table below.
The aggregate future minimum lease payments for capital leases, operating leases, and rental commitments as of December 31,
2018 are as follows:
(in millions)
2019
2020
2021
2022
2023
2024 and thereafter
Total minimum lease payments
Less sublease rental income
Net minimum lease payments
Less imputed interest
Present value of capital lease obligations
Capital Leases
Operating Leases
$
$
$
$
2.3
2.3
2.3
2.3
2.3
2.6
14.1
—
14.1
(1.6)
12.5
9.7
9.3
8.8
8.1
6.1
3.8
45.8
(8.8)
37.0
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Employee Benefit Plans
Knowles sponsors its own defined contribution plan. The Company's expense relating to the defined contribution plan was $6.8
million, $6.4 million, and $6.1 million for the years ended December 31, 2018, 2017, and 2016, respectively.
Knowles sponsors four defined benefit pension plans to certain non-U.S. employees. The two plans in the U.K. and the plan in
Taiwan are closed to new participants; however, all active participants in these plans continue to accrue benefits. The balance for
the plan in the Philippines, which is open to new participants, has been included as of December 31, 2018. These plans are considered
direct obligations of the Company and have been recorded within the accompanying Consolidated Financial Statements.
The Company does not have any other post-retirement employee benefit plans other than the plans mentioned above and the non-
qualified supplemental retirement plan discussed below.
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Non-U.S. Defined Benefit Pension Plans
Obligations and Funded Status
The following tables summarize the balance sheet impact, including the benefit obligations, assets, and funded status associated
with the Company's four defined benefit plans for non-U.S. participants at December 31, 2018 and 2017.
(in millions)
Change in benefit obligation:
Benefit obligation at beginning of year
Service cost
Interest cost
Benefits paid
Actuarial (gain) loss
Plan amendments (1)
Currency translation and other (2)
Benefit obligation at end of year
Change in plan assets:
Fair value of plan assets at beginning of year
Actual return on plan assets
Company contributions
Benefits paid
Currency translation and other
Fair value of plan assets at end of year
Funded status
Amounts recognized in the Consolidated Balance Sheets consist of:
Other assets and deferred charges
Other liabilities
Funded status
Accumulated other comprehensive loss:
Net actuarial losses
Prior service cost
Deferred taxes
Total accumulated other comprehensive loss, net of tax
Net amount recognized
December 31,
2018
2017
$
57.9
$
0.4
1.3
(1.5)
(3.8)
1.0
(1.6)
53.7
51.8
(1.2)
1.9
(1.5)
(3.2)
47.8
(5.9) $
$
1.0
(6.9)
(5.9) $
$
18.0
1.3
(3.8)
15.5
9.6
$
$
$
$
$
$
52.4
0.3
1.5
(1.5)
0.5
0.3
4.4
57.9
43.8
4.4
1.5
(1.5)
3.6
51.8
(6.1)
0.4
(6.5)
(6.1)
18.4
0.3
(3.6)
15.1
9.0
Accumulated benefit obligation
57.0
(1) On October 26, 2018, the U.K. High Court of Justice issued a ruling in a case related to equalization of pension plan participant
benefits for the gender effects of Guaranteed Minimum Pensions. As a result of this ruling, the Company recorded an estimated
increase to benefit obligations for its U.K defined benefit pension plans of $1.0 million during the year ended December 31,
2018.
52.6
(2) The Company recorded an increase in liabilities of $1.3 million related to pre-spin-off pension obligations during the year ended
$
$
December 31, 2018.
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pension plans with accumulated benefit obligations in excess of plan assets consisted of the following at December 31, 2018 and
2017:
(in millions)
Projected benefit obligation
Accumulated benefit obligation
Fair value of plan assets
Net Periodic Benefit Cost (Income)
Components of the net periodic benefit cost (income) were as follows:
(in millions)
Service cost
Interest cost
Expected return on plan assets
$
$
December 31,
2018
2017
$
31.2
31.0
24.7
35.3
34.8
28.8
Years Ended December 31,
2018
2017
2016
$
$
0.4
1.3
(2.8)
0.5
0.3
1.5
(2.7)
0.5
0.2
1.6
(2.4)
0.3
Amortization of recognized actuarial loss
Other (1)
Total net periodic benefit cost (income)
(1) The Company recorded an adjustment related to pre-spin-off pension obligations during the year ended December 31, 2018.
—
(0.4) $
1.3
0.7
—
(0.3)
$
$
In accordance with ASU 2017-07, the components of net periodic benefit cost (income) other than service cost are presented in
the Other expense (income), net line on the Consolidated Statements of Earnings. The service cost component is presented within
the Cost of goods sold, Research and development expenses, and Selling and administrative expenses lines on the Consolidated
Statements of Earnings based on the nature of services performed by the related employees. The Company expects to amortize an
actuarial loss of $0.5 million from accumulated other comprehensive loss into net periodic benefit cost (income) during the year
ended December 31, 2019.
Assumptions
The Company determines actuarial assumptions on an annual basis. The actuarial assumptions used for the Company’s four defined
benefit plans for non-U.S. participants will vary depending on the applicable country and as such, the tables below include these
assumptions by country, as well as in total.
The assumptions used in determining the benefit obligations were as follows:
Discount rate
Philippines
Taiwan
United Kingdom
Weighted-average
Average wage increase
Philippines
Taiwan
United Kingdom
Weighted-average
December 31,
2018
2017
8.25%
1.25%
2.80%
2.78%
6.00%
4.25%
4.40%
4.41%
—
1.25%
2.44%
2.40%
—
4.00%
4.50%
4.46%
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The assumptions used in determining the net periodic benefit cost (income) were as follows:
Discount rate
Taiwan
United Kingdom
Weighted-average
Average wage increase
Taiwan
United Kingdom
Weighted-average
Expected return on plan assets
Taiwan
United Kingdom
Weighted-average
Years Ended December 31,
2018
2017
2016
1.25%
2.44%
2.40%
4.00%
4.50%
4.46%
1.50%
5.75%
5.64%
1.50%
2.64%
2.60%
4.00%
4.60%
4.55%
1.75%
5.90%
5.80%
1.10%
3.90%
3.72%
4.00%
4.25%
4.16%
1.50%
6.50%
6.42%
The Company’s discount rate assumption is determined by developing a yield curve based on high quality corporate bonds with
maturities matching the plans’ expected benefit payment streams. The plans’ expected cash flows are then discounted by the
resulting year-by-year spot rates.
Plan Assets
The primary financial objective of the plans is to secure participant retirement benefits. Accordingly, the key objective in the plans’
financial management is to promote stability and, to the extent appropriate, growth in the funded status. Related and supporting
financial objectives are established in conjunction with a review of current and projected plan financial requirements.
As it relates to the funded defined benefit pension plans, the Company’s funding policy is consistent with the funding requirements
of applicable local non-U.S. laws. The Company is responsible for overseeing the management of the investments of the plans’
assets and otherwise ensuring that the plans’ investment programs are in compliance with applicable local law, other relevant
legislation, and related plan documents. Where relevant, the Company has retained professional investment managers to manage
the plans’ assets and implement the investment process. The investment managers, in implementing their investment processes,
have the authority and responsibility to select appropriate investments in the asset classes specified by the terms of their applicable
prospectus or investment manager agreements with the plans.
The assets of the plans are invested to achieve an appropriate return for the plans consistent with a prudent level of risk. The asset
return objective is to achieve, as a minimum over time, the passively managed return earned by market index funds, weighted in
the proportions outlined by the asset class exposures identified in the plans’ strategic allocation. The expected return on assets
assumption used for pension expense is developed through analysis of historical market returns, statistical analysis, current market
conditions, and the past experience of plan asset investments.
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Measurements
The fair values of plan assets by asset category within the ASC 820 hierarchy were as follows at December 31, 2018 and 2017:
December 31, 2018
December 31, 2017
Total
Fair
Value
Total
Fair
Value
1.9
Level 1
Level 2
Level 3
Level 1
(in millions)
Asset category:
Fixed income investments (1) $
Common stock funds (1)
Real estate funds
Cash and equivalents
Other
Total
(1) During the year ended December 31, 2018, one of the Company's U.K. plans shifted its investment strategy from common stock
—
—
—
—
— $
—
—
—
—
— $
21.9
3.5
1.0
10.4
51.8
13.4
3.6
0.8
3.6
39.9
13.4
3.6
1.1
9.3
47.8
21.9
3.5
0.9
3.6
42.6
—
—
0.3
5.7
7.9
—
—
0.1
6.8
9.2
Level 2
Level 3
— $
— $
12.7
15.0
20.4
18.5
2.3
$
$
$
$
$
$
$
$
$
$
$
funds to fixed income investments to align with participant risk profiles.
See Note 10. Hedging Transactions and Derivative Instruments for additional information on the fair value hierarchy. There were
no significant transfers between Level 1 and Level 2 assets during the years ended December 31, 2018 and 2017.
Fixed income investments include government and municipal securities and corporate bonds, which are valued based on yields
currently available on comparable securities of issuers with similar credit ratings.
Common stock funds consist of mutual funds and collective trusts. Mutual funds are valued by obtaining quoted prices from
nationally recognized securities exchanges. Collective trusts are valued using Net Asset Value (the "NAV") as of the last business
day of the year. The NAV is based on the underlying value of the assets owned by the fund minus its liabilities and then divided
by the number of shares outstanding. The value of the underlying assets is based on quoted prices in active markets.
The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective
of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other
market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments
could result in a different fair value measurement at the reporting date.
Future Estimates
Benefit Payments
Estimated future benefit payments to retirees, which reflect expected future service, are as follows:
(in millions)
2019
2020
2021
2022
2023
2024-2028
Contributions
$
1.9
1.7
1.7
1.8
1.8
11.5
Generally, annual contributions are made at such times and in such amounts as required by law and agreed with the trustees of the
non-U.S. defined benefit plans. The Company estimates it will pay $3.1 million during the year ended December 31, 2019 related
to contributions to these plans. This amount may vary based on updated funding agreements with the Trustees of these plans.
88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Non-qualified Supplemental Retirement Plan
Knowles provides to certain management employees, through non-qualified plans, supplemental retirement benefits in excess of
qualified plan limits imposed by federal tax law. Effective December 31, 2013, the Company's participants no longer accrue
benefits. The net amounts recognized on the balance sheet at December 31, 2018 and 2017 are shown in the table below:
(in millions)
Accrued compensation and employee benefits
Other liabilities
Total accumulated other comprehensive loss, net of tax
Net amount recognized
December 31,
2018
2017
$
$
(0.9) $
(0.8)
—
(1.7) $
(0.2)
(1.6)
0.2
(1.6)
The actuarial gain arising during the year ended December 31, 2018 was $0.1 million ($0.1 million net of tax). The amortization
of prior service cost included in net periodic pension cost (income) during the year ended December 31, 2018 was $0.1 million
($0.1 million net of tax).
16. Other Comprehensive Earnings (Loss)
The amounts recognized in other comprehensive (loss) earnings were as follows:
(in millions)
Foreign currency translation
Employee benefit plans
Changes in fair value of cash flow hedges
Total other comprehensive loss
(in millions)
Foreign currency translation
Employee benefit plans
Changes in fair value of cash flow hedges
Total other comprehensive earnings
(in millions)
Foreign currency translation
Employee benefit plans
Changes in fair value of cash flow hedges
Total other comprehensive loss
Year Ended December 31, 2018
Pre-tax
Tax
Net of tax
(9.9) $
(0.4)
(1.0)
(11.3) $
— $
0.2
0.1
0.3
$
(9.9)
(0.2)
(0.9)
(11.0)
Year Ended December 31, 2017
Pre-tax
Tax
Net of tax
27.1
$
1.3
4.4
32.8
$
— $
—
(0.7)
(0.7) $
27.1
1.3
3.7
32.1
Year Ended December 31, 2016
Pre-tax
Tax
Net of tax
$
0.8
(5.0)
(2.2)
(6.4) $
— $
(0.1)
0.6
0.5
$
0.8
(5.1)
(1.6)
(5.9)
$
$
$
$
$
$
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the changes in balances of each component of accumulated other comprehensive loss, net of tax
during the years ended December 31, 2018 and 2017:
(in millions)
Balance at December 31, 2016
Other comprehensive earnings, net of tax
Balance at December 31, 2017
Other comprehensive loss, net of tax
Balance at December 31, 2018
Cash flow
hedges
Employee
benefit plans
Cumulative
foreign
currency
translation
adjustments
$
$
(3.2) $
3.7
0.5
(0.9)
(0.4) $
(16.6) $
1.3
(15.3)
(0.2)
(15.5) $
(112.3) $
27.1
(85.2)
(9.9)
(95.1) $
Total
(132.1)
32.1
(100.0)
(11.0)
(111.0)
The following table summarizes the amounts reclassified from accumulated other comprehensive loss to earnings:
Statement of Earnings Line
2018
2017
2016
Years Ended December 31,
(in millions)
Pension and post-retirement benefit plans:
Amortization or settlement of actuarial losses
and prior service costs
Tax benefit
Net of tax
Other expense (income), net
(Benefit from) provision for income taxes
Cash flow hedges:
Net losses reclassified into earnings
Tax benefit
Various (1)
(Benefit from) provision for income taxes
$
Net of tax
(1) See Note 10. Hedging Transactions and Derivative Instruments for additional information.
17. Segment Information
$
$
$
0.6
(0.1)
0.5
1.4
(0.3)
1.1
$
$
$
$
0.6
—
0.6
0.5
(0.2)
0.3
$
$
$
$
0.5
—
0.5
1.0
(0.1)
0.9
In January 2017, the Company changed its allocation of resources and internal reporting structure to facilitate delivering growth
in its core business. The Company’s operating segments engage in business activities from which they earn revenues and incur
expenses, have discrete financial information available, and whose financial results are regularly reviewed and used by the chief
operating decision maker to evaluate segment performance, allocate resources, and determine management incentive compensation.
The Audio segment aggregates two operating segments into one reportable segment based on similar product applications serving
our key end markets. The PD segment has one operating segment, which equals its reportable segment. The realignment did not
change the composition of the Company’s reporting units for goodwill impairment testing purposes. Following these changes, the
Company's two reportable segments are as follows:
• Audio Segment
Our Audio group designs and manufactures innovative audio products, including microphones and balanced armature speakers,
audio processors, and software and algorithms used in applications that serve the mobile, ear, and IoT markets. Locations include
the sales, support, and engineering facilities in North America, Europe, and Asia, as well as the manufacturing facilities in Asia.
• PD Segment
Our PD group specializes in the design and delivery of highly engineered capacitors and radio frequency devices for technically
demanding applications. Our devices are used in applications including power supplies, radar, medical implants, and satellites,
serving the industrial, defense, aerospace, medical, telecommunications, and automotive markets. Locations include sales,
support, engineering, and manufacturing facilities in North America, Europe, and Asia.
90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company organizes its reportable segments based on how management analyzes performance, allocates capital, and makes
strategic and operational decisions. These segments were determined in accordance with ASC 280, Segment Reporting. The
segments are aligned around similar product applications serving our key end markets, to enhance focus on end market growth
strategies.
Information regarding the Company's reportable segments is as follows:
(in millions)
Revenues:
Audio
Precision Devices
Total revenues
Earnings from continuing operations before interest and income taxes:
Audio
Precision Devices
Total segments
Corporate expense / other
Interest expense, net
Earnings before income taxes and discontinued operations
(Benefit from) provision for income taxes
Earnings from continuing operations
Depreciation and amortization:
Audio
Precision Devices
Corporate
Total
Capital expenditures:
Audio
Precision Devices
Corporate
Total
Research and development:
Audio
Precision Devices
Corporate
Total
Years Ended December 31,
2018
2017
2016
682.2
144.7
826.9
$
$
637.4
106.8
744.2
105.7
$
27.5
133.2
56.1
16.0
61.1
(4.5)
65.6
$
76.1
19.2
95.3
55.3
20.6
19.4
12.9
6.5
$
$
$
$
41.5
$
45.2
$
7.8
3.1
5.6
3.0
52.4
$
53.8
$
68.2
10.8
1.1
80.1
$
$
43.6
$
5.4
0.5
49.5
$
94.5
$
89.0
$
5.8
0.3
4.2
0.2
100.6
$
93.4
$
661.9
93.8
755.7
88.8
12.4
101.2
52.7
20.4
28.1
8.3
19.8
61.4
4.3
3.3
69.0
27.8
3.1
1.3
32.2
89.2
2.7
0.1
92.0
$
$
$
$
$
$
$
$
$
$
91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information regarding assets of the Company's reportable segments:
(in millions)
Audio
Precision Devices
Corporate / eliminations
Discontinued operations
Total
Total Assets
December 31,
2018
2017
$
$
1,409.1
$
136.9
1.9
—
1,547.9
$
1,430.9
103.4
13.8
1.7
1,549.8
The following table details revenues by geographic location. Revenues are attributed to regions based on the location of the
Company's direct customer, which in some instances is an intermediary and not necessarily the end user. Long-lived assets are
comprised of net property, plant, and equipment. These assets have been classified based on the geographic location of where they
reside. The Company's businesses are based primarily in Asia, North America, and Europe.
(in millions)
Asia
United States
Europe
Other Americas
Other
Total
Revenues
Years Ended December 31,
Long-Lived Assets
December 31,
2018
2017
2016
2018
2017
$
605.4
$
560.8
$
578.7
$
160.9
$
126.6
85.8
3.6
5.5
101.3
72.3
4.4
5.4
93.3
75.1
3.1
5.5
49.8
0.9
0.1
—
144.9
37.2
0.9
—
—
$
826.9
$
744.2
$
755.7
$
211.7
$
183.0
The Company's customers that accounted for 10% or more of total revenues were as follows:
Apple Inc.
Samsung Electronics Co., Ltd.
* Less than 10% of total revenues.
Revenues
Years Ended December 31,
2018
2017
2016
19%
*
19%
10%
20%
12%
92
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. Earnings per Share
Basic and diluted earnings per share was computed as follows:
(in millions, except share and per share amounts)
2018
2017
2016
Years Ended December 31,
Earnings from continuing operations
Earnings (loss) from discontinued operations, net
Net earnings (loss)
Basic earnings (loss) per common share:
Earnings from continuing operations
Earnings (loss) from discontinued operations, net
Net earnings (loss)
Weighted-average shares outstanding
Diluted earnings (loss) per common share:
Earnings from continuing operations
Earnings (loss) from discontinued operations, net
Net earnings (loss)
$
$
$
$
$
$
65.6
2.1
67.7
0.73
0.02
0.75
$
$
$
$
6.5
61.8
68.3
0.07
0.69
0.76
$
$
$
$
19.8
(62.1)
(42.3)
0.22
(0.70)
(0.48)
90,050,051
89,329,794
88,667,098
0.72
0.02
0.74
$
$
0.07
0.68
0.75
$
$
0.22
(0.69)
(0.47)
Diluted weighted-average shares outstanding
91,194,747
90,490,007
89,182,967
For the years ended December 31, 2018, 2017, and 2016, the weighted-average number of anti-dilutive potential common shares
excluded from the calculation of diluted earnings per share above was 4,346,400, 3,944,160, and 5,080,023, respectively.
19. Quarterly Data (Unaudited)
(in millions, except per share amounts)
Continuing Operations
Net Earnings (Loss)
Quarter
2018
First
Second
Third
Fourth
2017
First
Second
Third
Fourth
Revenues
Gross
Profit
Earnings
(Loss)
Per Share -
Basic
Per Share -
Diluted
Earnings
(Loss)
Per Share -
Basic
Per Share -
Diluted
$
$
$
$
178.5
188.4
236.2
223.8
168.3
164.4
196.0
215.5
$
$
65.3
73.2
89.8
94.3
59.3
63.2
74.1
89.4
(0.4) $
4.4
(17.8)
79.4
(5.0) $
(30.9)
10.5
31.9
— $
— $
0.05
(0.20)
0.88
0.05
(0.20)
0.87
(0.06) $
(0.35)
0.12
0.36
(0.06) $
(0.35)
0.12
0.35
(0.3) $
4.6
(16.2)
79.6
(3.2) $
(29.7)
15.7
85.5
— $
0.05
(0.18)
0.88
(0.04) $
(0.33)
0.18
0.96
—
0.05
(0.18)
0.87
(0.04)
(0.33)
0.17
0.94
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. Subsequent Events
On January 3, 2019, the Company acquired substantially all of the assets of DITF Interconnect Technology, Inc. for $11.1 million,
subject to purchase price adjustments for working capital. The acquired business provides thin film components to the
telecommunication, industrial, medical, and defense markets. The acquisition’s operations will be included in the PD segment.
The transaction will be accounted for under the acquisition method of accounting. Further disclosure regarding the acquisition has
not been provided as the purchase price allocation was not complete prior to the issuance of these financial statements.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2018, 2017, and 2016
Allowance for Doubtful Accounts (in millions)
Year Ended December 31, 2018
Allowance for Doubtful Accounts
Year Ended December 31, 2017
Allowance for Doubtful Accounts
Year Ended December 31, 2016
Allowance for Doubtful Accounts
$
(1) Net of recoveries on previously reserved or written-off balances.
Balance at
Beginning
of Year
Charged to
Cost and
Expense (1)
Accounts
Written Off
Balance at
End of Year
$
$
0.7
1.5
1.5
(0.1)
— $
0.2
0.1
(1.0) $
(0.1) $
0.6
0.7
1.5
Deferred Tax Valuation Allowance (in millions)
Year Ended December 31, 2018
Deferred Tax Valuation Allowance
Year Ended December 31, 2017
Deferred Tax Valuation Allowance
Year Ended December 31, 2016
Deferred Tax Valuation Allowance
Balance at
Beginning
of Year
$
$
$
99.7
161.3
127.4
Additions
Reductions
Balance at
End of Year
31.5
—
33.9
— $
131.2
(61.6) $
99.7
— $
161.3
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
We conducted an evaluation, under the supervision and with the participation of management, including the chief executive officer
(“CEO”) and chief financial officer (“CFO”), of the effectiveness of the Company’s disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2018.
These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are
filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in
the SEC’s rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed
to ensure that this information is accumulated and communicated to management, including the principal executive and principal
financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.
94
Based on the evaluation, the CEO and CFO have concluded that these disclosure controls and procedures were effective as of
December 31, 2018.
(b) Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Under management’s supervision, an evaluation of the effectiveness of
the Company’s internal control over financial reporting was conducted based on the criteria set forth in Internal Control - Integrated
Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our
evaluation under the framework in Internal Control - Integrated Framework (2013) issued by the COSO, our management
concluded that our internal control over financial reporting was effective as of December 31, 2018.
PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm, has audited the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2018, as stated in their report which appears herein.
(c) Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the fourth quarter of 2018 that has
materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
(d) Inherent Limitations on Effectiveness of Controls
Our management, including the CEO and CFO, do not expect that our disclosure controls or our internal control over financial
reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide
only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must
reflect the fact that the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations
in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not
occur or that all control issues and instances of fraud, if any, will be detected. These inherent limitations include the realities that
judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also
be circumvented by the individual acts of some persons, by intentionally falsified documentation, by collusion of two or more
individuals within Knowles or third parties, or by management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed
in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future
periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies or procedures.
ITEM 9B. OTHER INFORMATION
Not applicable.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
PART III
The information with respect to the directors and the board committees of the Company and other corporate governance matters
required to be included pursuant to this Item 10 will be included in the Proxy Statement for its 2019 Annual Meeting of Stockholders
(the "2019 Proxy Statement") that will be filed with the SEC pursuant to Rule 14a-6 under the Exchange Act in accordance with
applicable SEC deadlines and is incorporated in this Item 10 by reference.
The information with respect to the executive officers of the Company required to be included pursuant to this Item 10 is included
under the caption “Executive Officers of the Registrant” in Part I of this Form 10-K and is incorporated in this Item 10 by reference.
The information with respect to Section 16(a) reporting compliance required to be included in this Item 10 will be included in our
2019 Proxy Statement and is incorporated in this Item 10 by reference.
95
The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal
accounting officer, and controller. A copy of this code of ethics can be found on our website at www.knowles.com. In the event
of any amendment to, or waiver from, the code of ethics affecting our principal executive officer, principal financial officer,
principal accounting officer, or controller, we will publicly disclose the amendment or waiver by posting the information on our
website or filing a Form 8-K with the SEC.
ITEM 11. EXECUTIVE COMPENSATION
The information with respect to executive compensation and the compensation committee required to be included pursuant to this
Item 11 will be included in our 2019 Proxy Statement and is incorporated in this Item 11 by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information regarding security ownership of certain beneficial owners and management that is required to be included pursuant
to this Item 12 will be included in our 2019 Proxy Statement and is incorporated into this Item 12 by reference.
Equity Compensation Plans
We currently maintain equity compensation plans that provide for the issuance of Knowles stock to directors, executive officers,
and other employees. The following table sets forth information regarding outstanding restricted stock units, SSARs, performance
share units, stock options, and shares available for future issuance under these plans as of December 31, 2018:
(a)
(b)
Number of
Securities to be
Issued Upon
Exercise of
Outstanding
Options, Warrants,
and Rights (1)
Weighted-Average
Exercise Price of
Outstanding
Options, Warrants,
and Rights
(c)
Number of
Securities
Remaining
Available for
Future Issuance
Under Equity
Compensation
Plans (Excluding
Securities
Reflected in
Column (a)) (2)
9,257,886
—
9,257,886
$
$
18.17
—
18.17
7,889,015
—
7,889,015
Plan Category
Equity compensation plans approved by stockholders
Equity compensation plans not approved by stockholders
Total
(1) Column (a) consists of shares issuable pursuant to outstanding restricted stock units, SSARs, performance share units, and
stock option awards under the Company’s 2018 Equity and Cash Incentive Plan, 2016 Equity and Cash Incentive Plan, and
2014 Equity and Cash Incentive Plan. Restricted stock units and performance share units are not reflected in the weighted-
average exercise price in column (b).
(2) Column (c) consists of shares available for future issuance under the 2018 Equity and Cash Incentive Plan. The 2018 Equity
and Cash Incentive Plan provides for stock options and SSAR grants, restricted stock awards, restricted stock unit awards,
unrestricted stock awards, performance share awards, cash performance awards, and deferred stock units. Shares subject to
stock options and SSARs will reduce the shares available for awards under the 2018 Equity and Cash Incentive Plan by one
share for every one share granted. Performance share awards, restricted stock, unrestricted stock, restricted stock units that
are settled in shares of common stock, and deferred stock units will reduce the shares available for awards under the 2018
Equity and Cash Incentive Plan by 1.75 shares for every one share awarded. Cash performance awards do not count against
the pool of available shares. The number of shares earned when an award is exercised, vested, or is paid out will count against
the pool of available shares, including shares withheld to pay taxes or an option’s exercise price. Shares subject to an award
under the 2018 Equity and Cash Incentive Plan, 2016 Equity and Cash Incentive Plan, and the 2014 Equity and Cash Incentive
Plan that are canceled, terminated, forfeited, or that expire will be available for reissuance under the 2018 Equity and Cash
Incentive Plan.
96
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information with respect to director independence, related party transaction policies and any reportable transaction, business
relationship, or indebtedness between the Company and the beneficial owners of more than 5% of Knowles common stock, the
directors or nominees for director of the Company, the executive officers of the Company, or the members of the immediate families
of such individuals that are required to be included pursuant to this Item 13 will be included in our 2019 Proxy Statement and is
incorporated in this Item 13 by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information with respect to the Company’s relationship with its independent registered public accounting firm and fees paid
thereto required to be included pursuant to this Item 14 will be included in our 2019 Proxy Statement and is incorporated in this
Item 14 by reference.
The information with respect to audit committee pre-approval policies and procedures required to be included pursuant to this
Item 14 will be included in our 2019 Proxy Statement and is incorporated in this Item 14 by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a) The following documents are filed as part of this report:
(1) Financial Statements:
• The financial statements are set forth under “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
(2) Financial Statement Schedules:
• The following financial statement schedule is set forth under “Item 8. Financial Statements and Supplementary Data” of
this Form 10-K. All other schedules have been omitted because they are not required, are not applicable or the required
information is included in the financial statements or the notes thereto.
• Schedule II - Valuation and Qualifying Accounts
(3) Exhibits
Exhibit
Number Description
3.1
3.2
3.3
3.4
3.5
3.6
3.7
4.1
Amended and Restated Certificate of Incorporation of Knowles Corporation, filed as Exhibit 3.1 to Registrant's
Current Report on Form 8-K dated February 28, 2014 and incorporated herein by reference thereto.
Amended and Restated By-laws of Knowles Corporation, filed as Exhibit 3.2 to Registrant's Current Report on Form
8-K dated February 28, 2014 and incorporated herein by reference thereto.
Certificate of Amendment of Amended and Restated Certificate of Incorporation of Knowles Corporation,
incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the
Commission on May 4, 2016.
Amendment No. 1 to Amended and Restated By-Laws of Knowles Corporation, incorporated herein by reference
to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed with the Commission on May 4, 2016.
Amendment No. 2 of the Amended and Restated By-Laws of Knowles Corporation adopted on August 1, 2017,
incorporated herein by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K filed with the
Commission on August 4, 2017.
Certificate of Amendment of Amended and Restated Certificate of Incorporation of Knowles Corporation, dated
May 1, 2018, filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the Commission on
May 2, 2018 and incorporated herein by reference thereto.
Amendment No. 3 of the Amended and Restated By-Laws of Knowles Corporation adopted on May 1, 2018, filed
as Exhibit 3.2 to the Registrant's Current Report on Form 8-K filed with the Commission on May 2, 2018 and
incorporated herein by reference thereto.
Indenture between Knowles Corporation and U.S. Bank National Association, as trustee, dated May 4, 2016 filed
as Exhibit 4.1 to Registrant’s Current Report on Form 8-K filed with the Commission on May 4, 2016 and incorporated
herein by reference thereto.
97
4.2
10.1
10.2
10.3†
10.4†
10.4.1†
10.4.2†
10.4.3†
10.4.4†
10.4.5†
10.4.6†
10.4.7†
10.5†
10.6†
10.7†
10.8†
10.9†
10.10
10.11
10.12
10.13
10.14
10.15
Form of 3.25% Convertible Senior Note due 2021 (included in Exhibit 4.1) filed as Exhibit 4.2 to Registrant’s Current
Report on Form 8-K filed with the Commission on May 4, 2016 and incorporated herein by reference thereto.
Transition Services Agreement dated February 28, 2014 by and between Dover Corporation and Knowles
Corporation, filed as Exhibit 10.3 to Registrant's Current Report on Form 8-K dated February 28, 2014 and
incorporated herein by reference thereto.
Tax Matters Agreement dated February 28, 2014 by and between Dover Corporation and Knowles Corporation, filed
as Exhibit 10.2 to Registrant’s Current Report on Form 8-K dated February 28, 2014 and incorporated herein by
reference thereto.
Senior Executive Change-in-Control Severance Plan, filed as Exhibit 10.8 to Registrant’s Current Report on Form
8-K dated February 28, 2014 and incorporated herein by reference thereto.
2014 Equity and Cash Incentive Plan, filed as Exhibit 10.4 to Registrant’s Current Report on Form 8-K dated February
28, 2014 and incorporated herein by reference thereto.
Form of Restricted Stock Unit Award Agreement, filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K
dated March 7, 2014 and incorporated herein by reference thereto.
Form of Award Grant Letter for Restricted Stock, filed as Exhibit 10.9 to Registrant’s Registration Statement on
Form 10 (File No. 001-36102) and incorporated herein by reference thereto.
Form of Award Grant Letter for Stock Settled Appreciation Rights, filed as Exhibit 10.10 to Registrant’s Registration
Statement on Form 10 (File No. 001-36102) and incorporated herein by reference thereto.
Form of Stock Option Award Agreement, filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K dated
March 7, 2014 and incorporated herein by reference thereto.
Form of Replacement SSAR Award Agreement, filed as Exhibit 10.3 to Registrant’s Current Report on Form 8-K
dated March 7, 2014 and incorporated herein by reference thereto.
Form of Replacement Restricted Stock Unit Award Agreement, filed as Exhibit 10.4 to Registrant’s Current Report
on Form 8-K dated March 7, 2014 and incorporated herein by reference thereto.
Nonemployee Director Deferral Program, filed as Exhibit 10.5.7 to Registrant's Annual Report on Form 10-K for
the year ended December 31, 2013 (File No. 001-36102) and incorporated herein by reference thereto.
Executive Deferred Compensation Plan, filed as Exhibit 10.6 to Registrant’s Current Report on Form 8-K dated
February 28, 2014 and incorporated herein by reference thereto.
Executive Severance Plan, filed as Exhibit 10.7 to Registrant’s Current Report on Form 8-K dated February 28, 2014
and incorporated herein by reference thereto.
Executive Officer Annual Incentive Plan, filed as Exhibit 10.5 to Registrant’s Current Report on Form 8-K dated
February 28, 2014 and incorporated herein by reference thereto.
First Amendment, dated as of May 4, 2015, to the Knowles Corporation Senior Executive Change in Control Severance
Plan filed as Exhibit 10.1 to Registrant's Current Report on Form 8-K dated May 4, 2015 and incorporated herein
by reference thereto.
First Amendment, dated as of May 4, 2015, to the Knowles Corporation 2014 Equity and Cash Incentive Plan filed
as Exhibit 10.17 to Registrant's Current Report on Form 10-K dated February 19, 2016 and incorporated herein by
reference thereto.
Purchase Agreement between Knowles Corporation and J.P. Morgan Securities LLC, as representative of the initial
purchasers named therein, dated April 28, 2016 filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K
filed with the Commission on May 4, 2016 and incorporated herein by reference thereto.
Convertible Note Hedge Confirmation between Knowles Corporation and HSBC Bank USA, National Association,
dated April 28, 2016 filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K filed with the Commission
on May 4, 2016 and incorporated herein by reference thereto.
Warrant Confirmation between Knowles Corporation and HSBC Bank USA, National Association, dated April 28,
2016 filed as Exhibit 10.3 to Registrant’s Current Report on Form 8-K filed with the Commission on May 4, 2016
and incorporated herein by reference thereto.
Convertible Note Hedge Confirmation between Knowles Corporation and JPMorgan Chase Bank, National
Association, London Branch, dated April 28, 2016 filed as Exhibit 10.4 to Registrant’s Current Report on Form 8-
K filed with the Commission on May 4, 2016 and incorporated herein by reference thereto.
Warrant Confirmation between Knowles Corporation and JPMorgan Chase Bank, National Association, London
Branch, dated April 28, 2016 filed as Exhibit 10.5 to Registrant’s Current Report on Form 8-K filed with the
Commission on May 4, 2016 and incorporated herein by reference thereto.
Convertible Note Hedge Confirmation between Knowles Corporation and Wells Fargo Bank, National Association,
dated April 28, 2016 filed as Exhibit 10.6 to Registrant’s Current Report on Form 8-K filed with the Commission
on May 4, 2016 and incorporated herein by reference thereto.
98
10.16
10.17
10.18
10.19
10.20
10.21
10.22
Warrant Confirmation between Knowles Corporation and Wells Fargo Bank, National Association, dated April 28,
2016 filed as Exhibit 10.7 to Registrant’s Current Report on Form 8-K filed with the Commission on May 4, 2016
and incorporated herein by reference thereto.
Convertible Note Hedge Confirmation between Knowles Corporation and HSBC Bank USA, National Association,
dated May 11, 2016 filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with the Commission on
May 13, 2016 and incorporated herein by reference thereto.
Warrant Confirmation between Knowles Corporation and HSBC Bank USA, National Association, dated May 11,
2016 filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K filed with the Commission on May 13, 2016
and incorporated herein by reference thereto.
Convertible Note Hedge Confirmation between Knowles Corporation and JPMorgan Chase Bank, National
Association, London Branch, dated May 11, 2016 filed as Exhibit 10.3 to Registrant’s Current Report on Form 8-K
filed with the Commission on May 13, 2016 and incorporated herein by reference thereto.
Warrant Confirmation between Knowles Corporation and JPMorgan Chase Bank, National Association, London
Branch, dated May 11, 2016 filed as Exhibit 10.4 to Registrant’s Current Report on Form 8-K filed with the
Commission on May 13, 2016 and incorporated herein by reference thereto.
Convertible Note Hedge Confirmation between Knowles Corporation and Wells Fargo Bank, National Association,
dated May 11, 2016 filed as Exhibit 10.5 to Registrant’s Current Report on Form 8-K filed with the Commission on
May 13, 2016 and incorporated herein by reference thereto.
Warrant Confirmation between Knowles Corporation and Wells Fargo Bank, National Association, dated May 11,
2016 filed as Exhibit 10.6 to Registrant’s Current Report on Form 8-K filed with the Commission on May 13, 2016
and incorporated herein by reference thereto.
10.23† Knowles Corporation 2016 Equity and Cash Incentive Plan, incorporated herein by reference to Appendix B to the
Registrant’s Definitive Proxy Statement on Schedule 14A filed with the Commission on March 15, 2016.
10.24†
10.25†
10.26†
10.27†
10.28†
10.29†
10.30†
10.31†
10.32
Form of Restricted Stock Unit Award Agreement dated May 2, 2016, filed as Exhibit 10.15 to Registrant's Quarterly
Report on Form 10-Q dated August 9, 2016 and incorporated herein by reference thereto.
Form of Stock Option Award Agreement dated May 2, 2016, filed as Exhibit 10.16 to Registrant's Quarterly report
on Form 10-Q dated August 9, 2016 and incorporated herein by reference thereto.
Addendum to Stock Option Agreement and Restricted Stock Award Agreement for Non-U.S Employees dated May
2, 2016, filed as Exhibit 10.17 to Registrant's Quarterly report on Form 10-Q dated August 9, 2016 and incorporated
herein by reference thereto.
Amendment Number Two to the Knowles Corporation 2014 Equity and Cash Incentive Plan, dated November 18,
2016, filed as Exhibit 10.36 to Registrant's Annual Report on Form 10-K dated February 21, 2017 and incorporated
herein by reference thereto.
Amendment Number One to the Knowles Corporation 2016 Equity and Cash Incentive Plan, dated November 18,
2016, filed as Exhibit 10.37 to Registrant's Annual Report on Form 10-K dated February 21, 2017 and incorporated
herein by reference thereto.
Form of Restricted Stock Unit Award Agreement, dated November 17, 2016, filed as Exhibit 10.38 to Registrant's
Annual Report on Form 10-K dated February 21, 2017 and incorporated herein by reference thereto.
Form of Stock Option Award Agreement, dated November 17, 2016, filed as Exhibit 10.39 to Registrant's Annual
Report on Form 10-K dated February 21, 2017 and incorporated herein by reference thereto.
Form of Performance Share Unit Award Agreement dated February 16, 2017, filed as Exhibit 10.1 to Registrant's
Quarterly report on Form 10-Q dated April 28, 2017 and incorporated herein by reference thereto.
Credit Agreement dated as of October 11, 2017, Knowles Corporation, JPMorgan Chase Bank, N.A. and the lenders
thereto, filed as Exhibit 10.1 to Registrant's Current Report on Form 8-K filed with the Commission on October 13,
2017 and incorporated herein by reference thereto.
10.33† Knowles Corporation Nonemployee Director Deferral Program filed as Exhibit 10.2 to Registrant's Quarterly report
on Form 10-Q dated October 30, 2017 and incorporated herein by reference thereto.
10.34
10.35†
10.36†
10.37†
Master Sale and Purchase Agreement among Knowles Corporation, Vectron International, Inc. and Microsemi
Corporation dated as of October 26, 2017, filed as Exhibit 10.3 to Registrant's Quarterly report on Form 10-Q dated
October 30, 2017 and incorporated herein by reference thereto.
Knowles Corporation 2018 Equity and Cash Incentive Plan, filed as Appendix B to the Registrant’s Definitive Proxy
Statement on Schedule 14A filed with the Commission on March 14, 2018 and incorporated herein by reference
thereto.
Form of Performance Award Agreement, filed as Exhibit 10.1 to Registrant's Quarterly report on Form 10-Q dated
April 30, 2018 and incorporated herein by reference thereto.
Form of Restricted Stock Unit Award Agreement, filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-
Q dated July 30, 2018 and incorporated herein by reference thereto.
99
10.38†
10.39†
21.1
23.1
31.1
31.2
32.1
101
Form of Stock Option Award Agreement, filed as Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q dated
July 30, 2018 and incorporated herein by reference thereto.
Form of Performance Award Agreement, filed as Exhibit 10.3 to Registrant's Quarterly report on Form 10-Q dated
July 30, 2018 and incorporated herein by reference thereto.
Subsidiaries of Knowles Corporation
Consent of PricewaterhouseCoopers LLP
Certificate of Principal Executive Officer Required Under Section 302 of the Sarbanes-Oxley Act of 2002
Certificate of Principal Financial Officer Required Under Section 302 of the Sarbanes-Oxley Act of 2002
Joint Certificate of the Principal Executive Officer and Principal Financial Officer Required Under Section 906 of
the Sarbanes-Oxley Act of 2002
The following materials from the Knowles Corporation Annual Report on Form 10-K for the year ended December
31, 2018 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Statements of Earnings,
(ii) Consolidated Statements of Comprehensive Earnings, (iii) Consolidated Balance Sheets, (iv) Consolidated
Statements of Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to the Consolidated Financial
Statements
†
Indicates the exhibit is a management contract or compensatory plan or arrangement
100
ITEM 16. FORM 10-K SUMMARY
None.
101
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.
SIGNATURES
KNOWLES CORPORATION
/s/ JEFFREY S. NIEW
Jeffrey S. Niew
President and Chief Executive Officer
Date: February 19, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ JEFFREY S. NIEW
Jeffrey S. Niew
/s/ JOHN S. ANDERSON
John S. Anderson
/s/ AIR A. BASTARRICA, JR.
Air A. Bastarrica, Jr.
Chief Executive Officer,
President and Director
(Principal Executive Officer)
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
Vice President, Controller
(Principal Accounting Officer)
February 19, 2019
February 19, 2019
February 19, 2019
/s/ DONALD MACLEOD
Chairman, Board of Directors
February 19, 2019
Donald Macleod
/s/ KEITH L. BARNES
Keith L. Barnes
/s/ HERMANN EUL
Hermann Eul
/s/ DIDIER HIRSCH
Didier Hirsch
/s/ RONALD JANKOV
Ronald Jankov
/s/ YE JANE LI
Ye Jane Li
/s/ RICHARD K. LOCHRIDGE
Richard K. Lochridge
/s/ CHERYL SHAVERS
Cheryl Shavers
Director
Director
Director
Director
Director
Director
Director
102
February 19, 2019
February 19, 2019
February 19, 2019
February 19, 2019
February 19, 2019
February 19, 2019
February 19, 2019
S T O C K H O L D E R S ’ I N F O R M A T I O N
CORPORATE
HEADQUARTERS
Knowles Corporation
1151 Maplewood Drive
Itasca, IL 60143
Phone: 1.630.250.5100
TRANSFER AGENT
Mail correspondence to:
Computershare Stockholder Services
P.O. Box 30170
College Station, TX 77842-3170
Online inquiries:
communications@knowles.com
www.computershare.com/investor
Tel: 1.800.331.9508
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
INVESTOR CONTACT
PricewaterhouseCoopers LLP
Knowles Corporation
Chicago, IL
STOCK LISTING
Investor Relations
1151 Maplewood Drive
Itasca, IL 60143
Knowles Corporation is traded on
Tel: 1.630.250.5100
The New York Stock Exchange
NYSE Symbol: KN
CORPORATE WEBSITE
Additional information can
be found at knowles.com
© 2019, Knowles Electronics, LLC, Itasca, IL USA. All Rights Reserved. Knowles and the logo are trademarks of Knowles Electronics, LLC.