EX-99.1 7 d602430dex991.htm EX-99.1 EX-99.1
Table of Contents

Exhibit 99.1

LOGO

Dear Dover Corporation Stockholder:

In May 2013, we announced plans to spin-off certain of our communication technologies businesses into a stand-alone, publicly traded company. Upon completion of the spin-off, the new company, Knowles Corporation, will be an independent, global technology and market leader in the communication technologies industry. Knowles will have significant product breadth in acoustic components, including MEMs microphones, speakers, receivers and transducers, as well as a competitive position in communication infrastructure components. Dover will remain a market leader in energy, engineered systems and the printing and identification businesses.

The separation of these businesses is consistent with our strategy to create value by identifying and building leading brands and positions in growth markets. This transaction will provide both Knowles and Dover with greater flexibility to focus on and pursue their respective growth strategies.

As an independent company, Knowles will continue to build on its long track record of success. At the same time, Dover will continue to execute on its long-term strategy and commitment to industry leadership through innovation and focus on its key end markets while continuing to consistently return capital to its stockholders through dividends and share repurchases.

The separation will be in the form of a pro rata distribution of all of the outstanding shares of Knowles’ common stock to holders of Dover’s common stock. Each Dover stockholder will receive one share of Knowles’ common stock for every two shares of Dover’s common stock held on                     , the record date for the distribution. Stockholder approval of the distribution is not required, and you do not need to take any action to receive shares of Knowles’ common stock to which you are entitled as a Dover stockholder. In addition, you do not need to pay any consideration or surrender or exchange your Dover common stock in order to receive shares of Knowles’ common stock.

The separation will provide Dover stockholders with ownership interests in both Dover and Knowles. Over time, we believe that the two companies, each with its own business and financial characteristics, will appeal to different investor bases. We expect that, for U.S. federal income tax purposes, the distribution of shares of Knowles’ common stock in the separation will be tax-free to Dover stockholders, except with respect to cash received in lieu of fractional shares.

I encourage you to read the attached information statement, which is being provided to all holders of Dover’s common stock as of             . The information statement describes the separation in detail and contains important business and financial information about Knowles.

As ever, we remain committed to working on building long-term stockholder value. This step is a positive one for our businesses, our stockholders and our customers.

Sincerely,

Robert A. Livingston

President and Chief Executive Officer

Dover Corporation


Table of Contents

 

LOGO

Dear Future Knowles Stockholder:

I am delighted to welcome you as a future stockholder of our company, Knowles Corporation, which will soon begin independently operating as an established communication technologies industry leader.

Our portfolio of market-leading products positions us very well for continued success. Knowles’ business model is distinctly different from Dover’s diversified model and, as such, we expect each entity to attract a different investor base. As a result of the separation of Knowles from Dover, investors will be able to evaluate the distinct merits, performance and future prospects of Knowles.

I encourage you to learn more about Knowles by reading the attached information statement. Knowles intends to apply to have its common stock authorized for listing on the New York Stock Exchange under the symbol “KN.”

Although we will be operating independently, we are very proud of our historical connection to Dover, and excited about the equally great future we see ahead of us as a stand-alone entity.

All of us at Knowles have been given a unique opportunity to create a new public company with a strong heritage of success based on technology that enhances people’s ability to communicate with each other. We believe that with the continued momentum in our business, in particular the significant growth in the mobile device market coupled with our commitment to product innovation, operational excellence and the strength of our people globally, we will build upon our success. We are truly excited with our prospects and know that we will continue to serve our customers and our new stockholders very well.

Sincerely,

Jeffrey S. Niew

President and Chief Executive Officer

Knowles Corporation


Table of Contents

Information contained herein is subject to completion or amendment. A Registration Statement on Form 10 relating to these securities has been filed with the U.S. Securities and Exchange Commission under the U.S. Securities Exchange Act of 1934, as amended, but has not yet become effective.

 

Preliminary and Subject to Completion, dated December 24, 2013

INFORMATION STATEMENT

Knowles Corporation

Common Stock

(par value $0.01 per share)

 

 

This information statement is being furnished in connection with the distribution by Dover Corporation (“Dover”) to its stockholders of all of the outstanding shares of common stock of Knowles Corporation (“Knowles”), a wholly owned subsidiary of Dover that will hold directly or indirectly the assets and liabilities associated with certain of Dover’s communication technologies businesses. To implement the distribution, Dover will distribute all of the shares of Knowles’ common stock on a pro rata basis to the Dover stockholders in a manner that is intended to be tax-free in the United States.

If you are a holder of Dover’s common stock on                     , the record date for the distribution, you will be entitled to receive one share of Knowles’ common stock for every two shares of Dover’s common stock that you hold at the close of business on such date. You will receive cash in lieu of any fractional shares of Knowles’ common stock which you would have received after application of the above ratio. As discussed under “The Separation and Distribution—Trading Between the Record Date and Distribution Date,” if you sell your Dover common stock in the “regular-way” market after the record date and before the separation, you also will be selling your right to receive shares of Knowles’ common stock in connection with the separation. Knowles expects the shares of its common stock to be distributed by Dover to you on                     . Knowles refers to the date of the distribution of Knowles’ common stock as the “distribution date.”

No vote of Dover stockholders is required for the distribution. Therefore, you are not being asked for a proxy, and you are requested not to send Dover a proxy, in connection with the distribution. You do not need to pay any consideration, exchange or surrender your existing Dover common stock or take any other action in order to receive your shares of Knowles’ common stock.

There is no current trading market for Knowles’ common stock, although Knowles expects that a limited market, commonly known as a “when-issued” trading market, will develop on or shortly before the record date for the distribution, and Knowles expects “regular-way” trading of Knowles’ common stock to begin on the first trading day following the completion of the separation. Knowles intends to apply to have its common stock authorized for listing on the New York Stock Exchange under the symbol “KN.”

 

 

In reviewing this information statement, you should carefully consider the matters described under the section entitled “Risk Factors” beginning on page 25.

 

 

Neither the U.S. Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this information statement is truthful or complete. Any representation to the contrary is a criminal offense.

This information statement does not constitute an offer to sell or the solicitation of an offer to buy any securities.

 

 

The date of this information statement is                     .

Dover first mailed this information statement to Dover stockholders on or about                     .


Table of Contents

TABLE OF CONTENTS

 

     Page  

INFORMATION STATEMENT SUMMARY

     1   

QUESTIONS AND ANSWERS ABOUT THE SEPARATION AND DISTRIBUTION

     8   

SUMMARY OF THE SEPARATION AND DISTRIBUTION

     16   

SUMMARY HISTORICAL AND PRO FORMA FINANCIAL DATA

     22   

RISK FACTORS

     25   

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

     42   

DIVIDEND POLICY

     43   

SELECTED HISTORICAL COMBINED FINANCIAL DATA

     44   

UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

     47   

CAPITALIZATION

     55   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     56   

BUSINESS

     81   

MANAGEMENT

     90   

COMPENSATION DISCUSSION AND ANALYSIS

     99   

CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS

     134   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     142   

THE SEPARATION AND DISTRIBUTION

     143   

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES

     148   

DESCRIPTION OF INDEBTEDNESS

     152   

DESCRIPTION OF KNOWLES’ CAPITAL STOCK

     153   

WHERE YOU CAN FIND MORE INFORMATION

     158   

INDEX TO FINANCIAL STATEMENTS

     F-1   

Presentation of Information

Except as otherwise indicated or unless the context otherwise requires, the information included in this information statement, including the combined financial statements of Knowles, which are comprised of the assets and liabilities of certain of Dover’s communication technologies businesses, assumes the completion of all the transactions referred to in this information statement in connection with the separation and distribution. Unless the context otherwise requires, references in this information statement to “Knowles Corporation,” “Knowles,” “we,” “us,” “our” and “our company” refer to Knowles Corporation and its consolidated subsidiaries. References in this information statement to “Dover” refers to Dover Corporation, a Delaware corporation, and its combined subsidiaries (other than Knowles Corporation and its combined subsidiaries), unless the context otherwise requires or as otherwise specified herein.

This information statement is being furnished solely to provide information to Dover stockholders who will receive shares of Knowles’ common stock in the distribution. It is not and is not to be construed as an inducement or encouragement to buy or sell any of Knowles’ securities or any securities of Dover. This information statement describes Knowles’ business, Knowles’ relationship with Dover and how the spin-off affects Dover and its stockholders, and provides other information to assist you in evaluating the benefits and risks of holding or disposing of Knowles’ common stock that you will receive in the distribution. You should be aware of certain risks relating to the spin-off, Knowles’ business and ownership of Knowles’ common stock, which are described under the section entitled “Risk Factors.”

 

i


Table of Contents

INFORMATION STATEMENT SUMMARY

The following is a summary of material information discussed in this information statement. This summary may not contain all the details concerning the separation or other information that may be important to you. To better understand Knowles’ separation from Dover and Knowles’ businesses and financial position, you should carefully review this entire information statement. This information statement describes the businesses to be transferred to Knowles by Dover in the separation as if the transferred businesses were Knowles’ businesses for all historical periods described. References in this information statement to Knowles’ historical assets, liabilities, products, businesses or activities are generally intended to refer to the historical assets, liabilities, products, businesses or activities of the transferred businesses as the businesses were conducted as part of Dover and its subsidiaries (or any prior owners) prior to the separation.

Knowles

Knowles engages in the design and manufacture of innovative products and components which serve the mobile consumer electronics, medical technology, telecommunications infrastructure, military/space and other industrial end markets. Knowles is currently owned by Dover, a global, diversified industrial manufacturer. Knowles is part of Dover’s Communication Technologies segment, and was built through a series of acquisitions (including Knowles Electronics, Vectron International, Novacap, Syfer, Dielectric, Voltronics and Sound Solutions) and internal growth initiatives spanning the last 20 years. Dover recently announced the spin-off of Knowles into a separate, publicly-traded company. Knowles has a leading position in MicroElectroMechanical Systems (“MEMs”) microphones, speakers and receivers which are used in mobile handsets, smartphones and tablets within the consumer electronics market. Knowles is also a leading manufacturer of transducers used in the hearing health segment of the medical technology market and has a strong position in oscillator (timing devices) and capacitor components which serve the telecommunication infrastructure, military/space and other industrial markets.

Knowles’ Strengths

Knowles believes that the following competitive strengths will enable it to continue to expand on its industry leading position serving the communication technologies industry:

Leader in the communication technologies industry. Knowles has built an industry-leading enterprise in terms of brand recognition, technology and market presence in communication technologies. Based on market share, Knowles is a leading supplier of acoustic components to all major handset OEMs and hearing aid OEMs. Knowles also has a strong position in supplying oscillators and capacitors to customers in the telecommunications infrastructure, military/space and other industrial markets. Dynamic research and fast product development cycles, and high-volume, scalable manufacturing capabilities are characteristics that Knowles has developed and intends to continue to build upon.

Market leading product innovation. Knowles invests significant resources in research and development and brings significant application expertise with capabilities to quickly and effectively design, develop and manufacture new products to meet its customers’ needs. Knowles maintains design centers in multiple locations in North America, Europe and Asia, which enables Knowles to attract the best talent in every region of the world. Knowles has increased its spending by over 50% to support its research and development functions over the last three years and spends an average of 6.5% to 7.5% of revenue on an annual basis on projects intended to preserve and extend its technological advantage.

Operational excellence. Knowles has a proven track record of executing operational improvements, through cost reductions, increased yields and improving capacity utilization. Knowles’ diversified operations include high-volume scalable production capabilities, fully automated production lines and labor-intensive assembly processes. Knowles maintains major manufacturing facilities in three countries which are integrated through a centralized operating and supply chain.

 

 

1


Table of Contents

Well-established, collaborative relationships with leading customers. Knowles’ close relationship with its customers enables it to develop critical expertise regarding its customers’ requirements and needs. Knowles uses that expertise and application knowledge, coupled with its research and development to design differentiated products that are used to enhance the end users’ acoustic interface with their mobile devices or ensure performance in mission critical applications. Knowles’ products have been designed into multiple generations of its customers’ products.

Executive management team with proven history of success. Knowles’ CEO and his direct reports and the core operational team have worked together for a significant number of years. The executive management team has driven Knowles’ strong history of profitability and cash flow generation, and demonstrated a proven ability to execute under multiple ownership structures, including private equity and as part of the segment company structure within Dover. In addition to Jeffrey Niew, who will be Knowles’ President and Chief Executive Officer after the separation, Knowles’ named executive officers include John Anderson, Michael Adell, Raymond Cabrera and Gordon Walker, who have all held senior positions of responsibility at Dover prior to the separation. For more information regarding the named executive officers and other members of the management team of Knowles, see “Management.”

Strong financial performance allows Knowles to exceed customer demands. The Knowles business model has evolved as its end markets have developed and grown over the years. Its strong history of profitability and cash flow generation, supported by a strong and flexible balance sheet, will enable Knowles to continue to invest in new products and technology at a rapid pace in order to meet and exceed customer demands.

Knowles’ Strategies

The spin-off will allow Knowles to pursue a focused and a more aggressive growth strategy as it will have sole discretion to fund those opportunities it deems value-enhancing, rather than having to compete for capital from its parent company. Dynamic research and development, fast product cycles, customer interest in the telecommunications industry and high-volume manufacturing are characteristics that Knowles has developed and intends to continue to enhance.

Risks Associated with Knowles’ Business

An investment in Knowles’ common stock is subject to a number of risks, including risks relating to the separation and distribution. The following list of risk factors is not exhaustive. Please read the information in the section entitled “Risk Factors” for a more thorough description of these and other risks.

 

    Knowles is subject to risks relating to its existing international operations and to expanding its global business.

 

    If Knowles is not able to anticipate, adapt to, and capitalize on technological developments, it may not be able to sustain or grow its current level of revenues, operating profits, or cash flows.

 

    Knowles’ products must undergo lengthy and expensive qualification processes without any assurance of product sales. The costs associated with new product introductions and imbalances between customer demand and capacity could negatively impact Knowles’ operating results and profits.

 

    Knowles could lose customers or generate lower revenue, operating profits and cash flows if there are significant increases in the cost of raw materials or if Knowles is unable to obtain raw materials.

 

    Knowles relies on sole source and limited source suppliers for certain supplies of critical raw materials and components.

 

    Customer requirements and new regulations may increase Knowles’ expenses and impact the availability of certain raw materials, which could adversely affect its revenue and operating profits.

 

 

2


Table of Contents
    Knowles’ effective tax rate may fluctuate and it could be subject to additional tax liabilities, including in the event of repatriation of Knowles’ overseas earnings to fund Knowles’ significant liquidity needs.

 

    Knowles’ revenue, operating profits and cash flows could be adversely affected if Knowles’ businesses are unable to protect or obtain patent and other intellectual property rights.

 

    Knowles depends on a limited number of customers for a substantial portion of its revenues, and the loss of, or a significant reduction in orders from, any key customer could significantly reduce Knowles’ revenues and adversely impact its operating results.

 

    Some of Knowles’ businesses are subject to the cycles inherent in the consumer electronics industry.

 

    Knowles may not achieve some or all of the expected benefits of the separation, and the separation may adversely affect Knowles’ business.

 

    Knowles has no history operating as an independent publicly-traded company, and Knowles’ historical and pro forma financial information is not necessarily representative of the results that it would have achieved as a separate, publicly-traded company and therefore may not be a reliable indicator of its future results.

 

    Knowles’ exposure to exchange rate fluctuations on cross-border transactions and the translation of local currency results into U.S. dollars could negatively impact its results of operations.

The Separation and Distribution

On May 23, 2013, Dover announced its intention to pursue a plan to separate certain of its communication technologies businesses from the remainder of its businesses, including Dover’s energy, engineered systems and printing and identification businesses.

In furtherance of this plan, on                      , Dover’s Board of Directors approved the distribution of all of Knowles’ issued and outstanding shares of common stock on the basis of one share of Knowles’ common stock for every two shares of Dover’s common stock held on the record date of                     .

Knowles’ Post-Separation Relationship with Dover

In connection with the separation and distribution, Knowles and Dover will enter into various agreements to effect the separation and provide a framework for their relationship after the separation. These agreements include, among others, a separation and distribution agreement, a transition services agreement, a tax matters agreement and an employee matters agreement. The assets and liabilities allocated to Knowles are those reflected in the Knowles consolidated financial statements included in this information statement and those assets and liabilities which will be transferred as of the effective date of the spin-off, as discussed in the pro forma financials included in this information statement.

Below is a summary of certain material terms of each of the primary separation agreements—for additional information, see the sections entitled “Risk Factors—Risks Related to the Separation” and “Certain Relationships and Related Person Transactions.”

The Separation and Distribution Agreement. This agreement sets forth the principal transactions necessary to separate Knowles from Dover and is the primary document that will govern Knowles’ relationship with Dover after the completion of the distribution (except for those matters expressly covered by the other agreements described below).

 

   

Transfer of Assets and Assumption of Liabilities. This agreement provides for the allocation of assets and liabilities between Dover and Knowles. In general, the assets allocated to Knowles are assets of

 

 

3


Table of Contents
 

Dover and its subsidiaries (including Knowles and its subsidiaries) used exclusively in the operation of the Knowles business, with all other assets being allocated to Dover. Subject to certain exceptions, the liabilities are allocated under this agreement to each party to the extent related to such party’s business or assets.

 

    The Distribution. Prior to the distribution, Knowles will distribute to Dover as a stock dividend, or the shares held by Dover in Knowles will be split prior to the distribution, so that, in either case, Dover holds a sufficient number of shares of Knowles’ common stock to effect the distribution as described in this information statement. Dover will cause its agent to distribute to Dover stockholders as of the applicable record date all the issued and outstanding shares of Knowles’ common stock based on the distribution ratio of one share of Knowles’ common stock for every two shares of Dover’s common stock.

 

    Conditions. This agreement includes the conditions that must be satisfied or waived by Dover in its sole discretion before the distribution may occur. For further information regarding these conditions, see the section entitled “The Separation and Distribution—Conditions to the Distribution.”

 

    Indemnification and Releases. This agreement will contain cross-indemnities in which Dover and Knowles will indemnify each other for damages or losses caused by a breach of any separation agreement or in connection with any liabilities allocated to each party. The indemnification provisions are principally designed to place financial responsibility for the obligations and liabilities of Knowles’ business with Knowles and financial responsibility for the obligations and liabilities of Dover’s business with Dover. Except for liabilities allocated to the parties in the separation agreements and certain other exceptions, Dover and Knowles will release and forever discharge each other and each of their subsidiaries and affiliates from all liabilities existing or arising from any acts or events occurring or failing to occur, or alleged to have occurred or to have failed to occur, or any conditions existing or alleged to have existed on or before the separation.

 

    Term/Termination. Prior to the distribution date, Dover has the unilateral right to terminate or modify this agreement. After the effective time of the distribution, the term of this agreement is indefinite and it may only be terminated with the prior written consent of Dover and Knowles.

Transition Services Agreement. In connection with the separation, Knowles and Dover will enter into a transition services agreement pursuant to which Dover will agree to provide Knowles with various services, including those relating to human resources, benefits administration, pension administration, payroll, technology, tax, compliance and information technology services. Knowles does not currently expect to provide any services to Dover pursuant to the agreement. The cost of each service provided under the agreement will be based on either a flat fee or an allocation of the cost incurred by the service provider. The fees payable under the agreement are generally intended to allow the service provider to recover all of its direct and indirect costs in providing the services, generally without profit. Knowles anticipates that the aggregate payments it will make to Dover under the agreement for all services to be provided to Knowles thereunder will be between $200,000 and $500,000. The services provided under the agreement will have an initial term of between six and twelve months. Upon the expiration of the initial term of any service, the recipient will have a one-time right to extend the initial term for an additional period of six months. Any service provided under the agreement may be terminated under certain circumstances (including due to material uncured breach, at the election of the service recipient at any time or at the election of the provider in the event such provider no longer employs the individuals needed to perform the services). The entire agreement will terminate on the earliest to occur of (a) the latest date on which any service is to be provided under the agreement, and (b) the date on which the provision of all services has been terminated by the parties. In addition, if either party materially breaches its obligations under the agreement and such breach is not cured within 30 days’ notice, the non-breaching party may terminate the agreement in its entirety or may choose to terminate the individual service as to which the uncured breach relates.

 

 

4


Table of Contents

Tax Matters Agreement. In connection with the separation, Dover and Knowles will enter into a tax matters agreement which will govern Dover’s and Knowles’ respective rights, responsibilities and obligations after the distribution with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and other matters regarding taxes. In general, each party is responsible for its own taxes after the separation (except that, under certain circumstances, Knowles will be responsible for certain taxes imposed on Dover arising out of the separation and related transactions). In addition, in order to preserve the tax treatment of the separation and distribution, this agreement includes certain restrictions on Knowles activities during the two-year period after the distribution. After the effective time of the distribution, the term of this agreement is indefinite and it may only be terminated with the prior written consent of Dover and Knowles.

Employee Matters Agreement. In connection with the separation, Knowles and Dover will also enter into an employee matters agreement which will allocate assets, liabilities and responsibilities relating to employee compensation and benefit plans and programs and other related matters in connection with the separation, including the treatment of outstanding incentive awards and certain retirement and welfare benefit obligations, both in and outside of the United States. Prior to the effective time of the distribution, the employee matters agreement may be terminated if the separation and distribution agreement is terminated. After the effective time of the distribution, the employee matters agreement may not be terminated except by an agreement in writing signed by each of the parties.

Reasons for the Separation

Knowles currently is a wholly owned subsidiary of Dover that was formed to hold certain of Dover’s communication technologies businesses. The separation of Knowles from Dover and the distribution of Knowles’ common stock are intended to provide you with equity investments in two separate companies that will be able to focus on each of their respective businesses. Dover’s Board of Directors believes that separating the Knowles businesses from the remainder of Dover’s businesses is in the best interests of Dover and its stockholders for a number of reasons, including that:

 

    The separation will allow each company to more effectively pursue its own distinct operating priorities and strategies, and will enable the management of both companies to pursue separate opportunities for long-term growth and profitability, and to recruit, retain and motivate employees pursuant to compensation policies which are appropriate for their respective lines of business.

 

    The separation will permit each company to concentrate its financial resources solely on its own operations, providing greater flexibility to invest capital in its business in a time and manner appropriate for its distinct strategy and business needs. This will facilitate a more efficient allocation of capital.

 

    Dover’s Board of Directors believes that Dover’s businesses and Knowles’ businesses appeal to different types of investors with different industry focuses, investment goals and risk profiles. Dover and Knowles have different investment and business characteristics, including different opportunities for growth, capital structures, business models and financial returns. The separation will enable investors to evaluate the merits, performance and future prospects of each company’s businesses and to invest in each company separately based on these distinct characteristics.

 

    The separation will create an independent equity structure that will afford Knowles direct access to capital markets and will facilitate the ability to capitalize on its unique growth opportunities and effect future acquisitions utilizing, among other types of consideration, shares of its common stock. Furthermore, an independent structure should enable each company to provide equity incentive compensation arrangements for its key employees that are directly related to the market performance of each company’s common stock. Dover’s Board of Directors believes such equity-based compensation arrangements should provide enhanced incentives for performance, and improve the ability for each company to attract, retain and motivate qualified personnel.

 

 

5


Table of Contents

Dover’s Board of Directors considered a number of potentially negative factors in evaluating the separation, including risks relating to the creation of a new public company, possible increased administrative costs and one-time separation costs, but concluded that the potential benefits of the separation outweighed these factors. For more information, see the sections entitled “The Separation and Distribution—Reasons for the Separation” and “Risk Factors” included elsewhere in this information statement.

Description of New Knowles’ Indebtedness

In connection with the spin-off, Knowles expects to enter into a $200 million five-year senior secured revolving credit facility, as well as a $300 million five-year senior secured term loan facility. Negotiation of these agreements is ongoing and subject to the completion of definitive documentation. Both facilities are to be used for general corporate purposes and to finance a cash payment to Dover immediately prior to the spin-off. Although the definitive documents relating to these facilities are expected to permit a cash payment to Dover of up to $450 million, Knowles currently expects that the payment to Dover prior to the spin-off will be between $370 million and $420 million and that the amount of debt incurred under these facilities, as of the distribution date, will be between $370 million and $420 million. For purposes of preparing the post-distribution capitalization and unaudited pro forma combined financial statements included elsewhere in this information statement, Knowles has assumed, based on its best current estimates, that $400 million of debt will be drawn under these facilities as of the distribution date and that the payment to Dover prior to the spin-off will be in the amount of $400 million. Knowles will provide the final amount of the expected payment to Dover and the final amount of the expected debt to be incurred under these facilities (and the corresponding updates to the post-distribution capitalization and pro forma financial information included elsewhere in this information statement) in a subsequent amendment to this information statement. See the sections entitled “Description of Indebtedness,” ”Capitalization” and “Unaudited Pro Forma Combined Financial Information.”

Knowles’ Material Separation Payments and Costs

In connection with the spin-off, the only material payments to be made by Knowles to Dover prior to the distribution date relate to (i) the settlement of intercompany net notes payable and (ii) any dividends or other payments to be made as part of the reorganization step plan, which may include the use of proceeds from third party debt incurred by Knowles before the spin-off. The intercompany net notes payable due to Dover, totaling $542.5 million, $528.8 million and $1,419.4 million at September 30, 2013, December 31, 2012 and December 31, 2011, respectively, will be settled through a reorganization step plan. Knowles intends to settle these notes prior to the distribution date, and the related interest expense amounts are not necessarily representative of interest payments related to the future third party debt of Knowles. In addition to the settlement of intercompany net notes payable, Knowles intends to incur third party debt before the distribution to facilitate a payment to Dover prior to the spin-off. As a result, upon completion of the distribution, Knowles will not have any intercompany net notes payable due to Dover and its only indebtedness for borrowed money will be the third party debt incurred in connection with the spin-off. Although the definitive documents relating to Knowles future third party debt are expected to permit a cash payment to Dover of up to $450 million, Knowles currently expects that the payment to Dover prior to the spin-off will be between $370 million and $420 million. For purposes of preparing the post-distribution capitalization and unaudited pro forma combined financial statements included elsewhere in this information statement, Knowles has assumed, based on its best current estimates, that $400 million of debt will be drawn under these facilities as of the distribution date and that the payment to Dover prior to the spin-off will be in the amount of $400 million. Knowles will provide the final amount of the expected payment to Dover and the final amount of the expected debt to be incurred under these facilities (and the corresponding updates to the post-distribution capitalization and pro forma financial information included elsewhere in this information statement) in a subsequent amendment to this information statement. See the sections entitled “Description of Indebtedness,” “Capitalization” and “Unaudited Pro Forma Combined Financial Information.”

 

 

6


Table of Contents

Dover has informed Knowles that Dover expects to incur and pay one-time costs associated with the separation, including legal and advisory costs, in the range of $60.0 to $70.0 million. In connection with the spin-off, Knowles expects to incur one-time costs, including costs relating to entering into third party financing arrangements and other matters, in the range of $             to $            .

Corporate Information

Knowles was incorporated in Delaware on June 12, 2013 for the purpose of holding certain of Dover’s communication technologies businesses in connection with the separation and distribution described herein. Prior to Dover’s contribution of the several component businesses to Knowles, which is occurring over a period of several months prior to the distribution, Knowles will have had no operations. The address of Knowles’ principal executive offices is 1151 Maplewood Drive, Itasca, Illinois 60143. Knowles’ telephone number is 630-250-5100.

Knowles also maintains an Internet site at www.                    .com. Knowles’ website and the information contained therein or connected thereto shall not be deemed to be incorporated herein.

 

 

7


Table of Contents

QUESTIONS AND ANSWERS ABOUT THE SEPARATION AND DISTRIBUTION

 

What is Knowles and why is Dover separating Knowles’ business and distributing Knowles’ stock?

Knowles currently is a wholly owned subsidiary of Dover that was formed to hold certain of Dover’s communication technologies businesses. The separation of Knowles from Dover and the distribution of Knowles’ common stock are intended to provide you with equity investments in two separate companies that will be able to focus on each of their respective businesses. Dover and Knowles expect that the separation will result in enhanced long-term performance of each business for the reasons discussed in the sections entitled “The Separation and Distribution—Background” and “The Separation and Distribution—Reasons for the Separation.”

 

Why am I receiving this document?

Dover is delivering this document to you because you are a holder of Dover’s common stock. If you are a holder of Dover’s common stock on                     , the record date for the distribution, you will be entitled to receive one share of Knowles’ common stock for every two shares of Dover’s common stock that you hold at the close of business on such date. This document will help you understand how the separation and distribution will affect your investment in Dover and your investment in Knowles after the separation.

 

How will the separation of Knowles from Dover work?

The separation will be accomplished through a series of transactions in which (i) the equity interests of the entities that hold assets and liabilities of certain of Dover’s communication technologies businesses will be transferred to Knowles, (ii) other assets and liabilities will be assigned to or assumed by Knowles and (iii) Dover will then distribute all of the outstanding shares of common stock of Knowles to Dover’s stockholders on a pro rata basis as a distribution.

 

Why is the separation of Knowles structured as a distribution?

Dover believes that a tax-free distribution of shares in the United States of Knowles to the Dover stockholders is an efficient way to separate certain of its communication technologies businesses in a manner that is expected to create long-term benefits and value for Dover, Knowles and their respective stockholders.

 

What is the record date for the distribution?

The record date for the distribution will be                     .

 

When will the distribution occur?

It is expected that all of the shares of Knowles’ common stock will be distributed by Dover on             , to holders of record of Dover’s common stock at the close of business on             , the record date. However, no assurance can be provided as to the timing of the distribution or that all conditions to the distribution will be met.

 

Why is no stockholder vote required to approve the distribution and its material terms?

Delaware law does not require a stockholder vote to approve the distribution because the distribution does not constitute a transfer of all or substantially all of the assets of Dover.

 

What do stockholders need to do to participate in the distribution?

Stockholders of Dover as of the record date will not be required to take any action to receive Knowles’ common stock in the distribution, but you are urged to read this entire information statement carefully. No stockholder approval of the distribution is

 

 

8


Table of Contents
 

required. You are not being asked for a proxy. You do not need to pay any consideration, exchange or surrender your existing Dover common stock or take any other action to receive your shares of Knowles’ common stock. Please do not send in your Dover stock certificates.

 

Will I receive physical certificates representing shares of Knowles’ common stock following the separation?

No. Following the separation, Knowles will not issue physical certificates representing shares of Knowles’ common stock. If you own Dover’s common stock as of the close of business on the record date, Dover, with the assistance of Computershare Inc. and Computershare Trust Company, N.A., together the distribution agent, will electronically distribute shares of Knowles’ common stock to you or to your brokerage firm on your behalf by way of direct registration in book-entry form. Computershare Inc. or Computershare Trust Company, N.A. will mail you a book-entry account statement that reflects your shares of Knowles’ common stock, or your bank or brokerage firm will credit your account for the shares.

 

  Following the distribution, stockholders whose shares are held in book-entry form may request that their shares of Knowles’ common stock held in book-entry form be transferred to a brokerage or other account at any time, without charge.

 

How many shares of Knowles’ common stock will I receive in the distribution?

Dover will distribute to you one share of Knowles’ common stock for every two shares of Dover’s common stock held by you as of the record date. Based on approximately              million shares of Dover’s common stock outstanding as of             , a total of approximately              million shares of Knowles’ common stock will be distributed. For additional information on the distribution, see the section entitled “The Separation and Distribution.”

 

Will Knowles issue fractional shares of its common stock in the distribution?

No. Knowles will not issue fractional shares of its common stock in the distribution. Fractional shares that Dover stockholders would otherwise have been entitled to receive will be aggregated and sold in the public market by the distribution agent. The aggregate net cash proceeds of these sales will be distributed pro rata (based on the fractional share such holder would otherwise be entitled to receive) to those stockholders who would otherwise have been entitled to receive fractional shares. Recipients of cash in lieu of fractional shares will not be entitled to any interest on the amounts of payment made in lieu of fractional shares. The receipt of cash in lieu of fractional shares generally will be taxable to the recipient stockholders for U.S. federal income tax purposes as described in the section entitled “Material U.S. Federal Income Tax Consequences.”

 

What are the conditions to the distribution?

The distribution is subject to a number of conditions, including, among others:

 

    The U.S. Securities and Exchange Commission (“SEC”) will have declared effective the registration statement of which this information statement forms a part, and no stop order relating to the registration statement will be in effect.

 

 

9


Table of Contents
    The New York Stock Exchange (“NYSE”) will have approved the listing of Knowles’ common stock, subject to official notice of issuance.

 

    Dover will have received either (i) a private letter ruling from the Internal Revenue Service (“IRS”) together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Internal Revenue Code of 1986, as amended (the “Code”) or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code.

 

    All permits, registrations and consents required under the securities or blue sky laws of states or other political subdivisions of the United States or of other foreign jurisdictions in connection with the distribution will have been received.

 

    No order, injunction, or decree issued by any court of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the separation, distribution or any of the related transactions will be in effect.

 

    The reorganization of Dover and Knowles businesses prior to the separation and distribution will have been effectuated.

 

    Knowles will have entered into certain agreements in connection with the separation and distribution and certain financing arrangements prior to or concurrent with the separation.

 

    No events or developments shall have occurred or exist that, in the sole and absolute judgment of the Dover Board of Directors, make it inadvisable to effect the distribution or would result in the distribution and related transactions not being in the best interest of Dover or its stockholders.

 

  Dover and Knowles cannot assure you that any or all of these conditions will be met. The fulfillment of the foregoing conditions does not create any obligations on Dover’s part to effect the distribution, and Dover’s Board of Directors has reserved the right, in its sole discretion, to abandon, modify or change the terms of the distribution, including by accelerating or delaying the timing of the consummation of all or part of the distribution, at any time prior to the distribution date. For a more complete discussion of all of the conditions to the distribution, see the section entitled “The Separation and Distribution—Conditions to the Distribution.”

 

What is the expected date of completion of the separation?

The completion and timing of the separation are dependent upon a number of conditions. It is expected that the shares of Knowles’ common stock will be distributed by Dover after the close of trading on                      to the holders of record of Dover’s common stock at

 

 

10


Table of Contents
 

the close of business on the record date. However, no assurance can be provided as to the timing of the separation or that all conditions to the separation will be met.

 

Can Dover decide to cancel the distribution of Knowles’ common stock even if all the conditions have been met?

Yes. Until the distribution has occurred, Dover has the unilateral and sole and exclusive right to terminate the distribution for any reason, even if all of the conditions are satisfied. See the section entitled “The Separation and Distribution—Conditions to the Distribution.”

 

What if I want to sell my Dover common stock or my Knowles common stock?

You should consult with your financial advisors, such as your stockbroker, bank or tax advisor.

 

What is “regular-way” and “ex-distribution” trading?

Beginning on or shortly before the record date and continuing up to and through the distribution date, it is expected that there will be two markets in Dover’s common stock: a “regular-way” market and an “ex-distribution” market. Shares of Dover’s common stock that trade in the “regular-way” market will trade with an entitlement to shares of Knowles’ common stock distributed pursuant to the distribution. Shares that trade in the “ex-distribution” market will trade without an entitlement to shares of Knowles’ common stock distributed pursuant to the distribution.

 

  If you decide to sell any shares of your Dover common stock before the distribution date, you should make sure your stockbroker, bank or other nominee understands whether you want to sell your Dover common stock with or without your entitlement to Knowles’ common stock pursuant to the distribution.

 

Where will I be able to trade shares of Knowles’ common stock?

Knowles intends to apply to list its common stock on the NYSE under the symbol “KN.” Knowles anticipates that trading in shares of its common stock will begin on a “when-issued” basis on or shortly before the record date and will continue up to and through the distribution date and that “regular-way” trading in Knowles’ common stock will begin on the first trading day following the completion of the separation. If trading begins on a “when-issued” basis, you may purchase or sell Knowles’ common stock up to and through the distribution date, but your transaction will not settle until after the distribution date. Knowles cannot predict the trading prices for its common stock before, on or after the distribution date.

 

What will happen to the listing of Dover’s common stock?

Dover’s common stock will continue to trade on the NYSE under the symbol “DOV” after the distribution.

 

Will the number of shares of Dover’s common stock that I own change as a result of the distribution?

No. The number of shares of Dover’s common stock that you own will not change as a result of the distribution.

 

What are the material U.S. federal income tax consequences of the separation and the distribution?

It is a condition to the completion of the distribution that Dover receive either (i) a private letter ruling from the IRS together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution

 

 

11


Table of Contents
 

will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. Accordingly, and so long as the distribution so qualifies, for U.S. federal income tax purposes, no gain or loss will be recognized by you, and no amount will be included in your income, upon the receipt of shares of Knowles’ common stock pursuant to the distribution. You will, however, recognize gain or loss for U.S. federal income tax purposes with respect to cash received in lieu of a fractional share of Knowles’ common stock.

 

  For more information regarding the potential U.S. federal income tax consequences to Knowles, Dover and to you of the separation and distribution, see the section entitled “Material U.S. Federal Income Tax Consequences.”

 

What are the material state, local and foreign income tax consequences of the separation and distribution?

Neither the private letter ruling from the IRS (if obtained) nor an opinion of tax counsel will address the state, local or foreign income tax consequences of the separation and the distribution. You should consult your tax advisor about the particular state, local and foreign tax consequences of the distribution to you, which consequences may differ from those described in the section entitled “Material U.S. Federal Income Tax Consequences.”

 

How will I determine my tax basis in the Knowles shares I receive in the distribution?

For U.S. federal income tax purposes, your aggregate tax basis in the common shares that you hold in Dover and the Knowles common stock received in the distribution (including any fractional share interest in Knowles’ common stock for which cash is received) will equal the aggregate tax basis in the Dover common shares held by you immediately before the distribution, allocated between your Dover common shares and the Knowles common stock (including any fractional share interest in Knowles’ common stock for which cash is received) you receive in the distribution in proportion to the relative fair market value of each on the distribution date.

 

  You should consult your tax advisor about the particular consequences of the distribution to you, including the application of federal, state, local and foreign tax laws.

 

What will Knowles’ relationship be with Dover following the separation?

Following the separation and distribution, the relationship between Knowles and Dover will be governed by, among others, a separation and distribution agreement, a transition services agreement, a tax matters agreement and an employee matters agreement. These agreements will provide for the allocation between Knowles and Dover of Dover’s and Knowles’ assets, employees, liabilities and obligations (including employee benefits and tax-related assets and liabilities) attributable to periods prior to, at and after Knowles’ separation from Dover. For additional information regarding these

 

 

12


Table of Contents
 

agreements, see the sections entitled “Risk Factors—Risks Related to the Separation” and “Certain Relationships and Related Person Transactions.”

 

Will I have appraisal rights in connection with the separation and distribution?

No. Holders of Dover’s common stock are not entitled to appraisal rights in connection with the separation and distribution.

 

Are there risks associated with owning Knowles’ common stock?

Yes. Ownership of Knowles’ common stock is subject to both general and specific risks relating to Knowles’ businesses, the industry in which it operates, its ongoing contractual relationships with Dover and its status as a separate, publicly-traded company. Ownership of Knowles’ common stock is also subject to risks relating to the separation, including that following the separation, Knowles’ business will be less diversified than Dover’s business prior to the separation. These risks are described in the “Risk Factors” section of this information statement beginning on page 25. You are encouraged to read that section carefully.

 

Who will manage Knowles after the separation?

Knowles benefits from having in place a management team with an extensive background in the communication technologies business. Led by Jeffrey Niew, who will be Knowles’ President and Chief Executive Officer after the separation, Knowles’ management team possesses deep knowledge of, and extensive experience in, its industry. In addition to Mr. Niew, the other named executive officers of Knowles are:

 

    John S. Anderson, Knowles Senior Vice President & Chief Financial Officer

 

    Michael A. Adell, Co-President, Mobile Consumer Electronics—Microphone Products

 

    Raymond D. Cabrera, Knowles Senior Vice President, Human Resources & Chief Administrative Officer

 

    Gordon A. Walker, Co-President, Specialty Components—Acoustic Products

 

  For more information regarding Knowles’ named executive officers and other members of its management team, see the section entitled “Management.”

 

Does Knowles plan to pay dividends?

The timing, declaration, amount of and payment of any dividends following the separation by Knowles is within the discretion of its Board of Directors and will depend upon many factors, including Knowles’ financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of Knowles’ debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its Board of Directors. Moreover, if Knowles determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. See the section entitled “Dividend Policy.”

 

 

13


Table of Contents

Will Knowles incur any debt prior to or at the time of the distribution?

In connection with the spin-off, Knowles expects to enter into a $200 million five-year senior secured revolving credit facility, as well as a $300 million five-year senior secured term loan facility. Negotiation of these agreements is ongoing and subject to the completion of definitive documentation. Both facilities are to be used for general corporate purposes and to finance a cash payment to Dover immediately prior to the spin-off. Although the definitive documents relating to these facilities are expected to permit a cash payment to Dover of up to $450 million, Knowles currently expects that the payment to Dover prior to the spin-off will be between $370 million and $420 million and that the amount of debt incurred under these facilities, as of the distribution date, will be between $370 million and $420 million. For purposes of preparing the post-distribution capitalization and unaudited pro forma combined financial statements included elsewhere in this information statement, Knowles has assumed, based on its best current estimates, that $400 million of debt will be drawn under these facilities as of the distribution date and that the payment to Dover prior to the spin-off will be in the amount of $400 million. Knowles will provide the final amount of the expected payment to Dover and the final amount of the expected debt to be incurred under these facilities (and the corresponding updates to the post-distribution capitalization and pro forma financial information included elsewhere in this information statement) in a subsequent amendment to this information statement. See the sections entitled “Description of Indebtedness,” “Capitalization” and “Unaudited Pro Forma Combined Financial Information.”

 

Who will be the distribution agent, transfer agent and registrar for the Knowles common stock?

The distribution agent for Knowles’ common stock will be Computershare Inc. and Computershare Trust Company, N.A. The transfer agent and registrar for Knowles’ common stock will be Computershare Trust Company, N.A. For questions relating to the transfer or mechanics of the stock distribution, you should contact:

Computershare Trust Company, N.A.

250 Royall St.

Canton, MA 02021

Tel: 1-888 -567-8341

 

  If your shares of Dover’s common stock are held by a bank, broker or other nominee, you may call the Corporate Secretary of Dover at (630) 541-1540.

 

Where can I find more information about Dover and Knowles?

If you have any questions relating to Dover, you should contact:

Dover Corporation

Investor Relations

3005 Highland Parkway

Downers Grove, Illinois 60515

(630) 541-1540

 

 

14


Table of Contents
  After the distribution, Knowles stockholders who have any questions relating to Knowles should contact Knowles at:

Knowles Corporation

Investor Relations

1151 Maplewood Drive

Itasca, Illinois 60143

(630) 250-5100

 

 

15


Table of Contents

SUMMARY OF THE SEPARATION AND DISTRIBUTION

The following is a summary of the material terms of the separation, distribution and other related transactions.

 

Distributing company

Dover Corporation, a Delaware corporation. After the distribution, Dover will not own any shares of Knowles’ common stock.

 

Distributed company

Knowles Corporation, a Delaware corporation, is a wholly owned subsidiary of Dover that was formed in 2013 and that, at the time of the distribution, will hold, through its subsidiaries, assets and liabilities of certain of Dover’s communication technologies businesses. After the distribution, Knowles will be an independent, publicly-traded company.

 

Record date

The record date for the distribution is the close of business on                     .

 

Distribution date

It is expected that all of the shares of Knowles’ common stock will be distributed by Dover on             , to holders of record of Dover’s common stock at the close of business on             , the record date. However, no assurance can be provided as to the timing of the distribution or that all conditions to the distribution will be met.

 

Distributed securities

All of the shares of Knowles’ common stock owned by Dover, which will be 100% of Knowles’ common stock outstanding immediately prior to the distribution. Based on the approximately             million shares of Dover’s common stock outstanding on             , and applying the distribution ratio of one share of Knowles’ common stock for every two shares of Dover’s common stock, Dover will distribute approximately             million shares of Knowles’ common stock to Dover stockholders who hold Dover’s common stock as of the record date. The number of shares that Dover will distribute to its stockholders will be reduced to the extent that cash payments are to be made in lieu of the issuance of fractional shares of Knowles’ common stock, as described below.

 

Distribution ratio

Each holder of Dover’s common stock will receive one share of Knowles’ common stock for every two shares of Dover’s common stock held on                     , the record date. Cash will be distributed in lieu of fractional shares, as described below.

 

Fractional shares

Dover will not distribute any fractional shares of Knowles’ common stock to Dover stockholders. Fractional shares that Dover stockholders would otherwise have been entitled to receive will be aggregated and sold in the public market by the distribution agent. The aggregate net cash proceeds of these sales will be distributed pro rata (based on the fractional share such holder would otherwise be entitled to receive) to those stockholders who would otherwise have been entitled to receive fractional shares. Recipients of cash in lieu of fractional shares will not be entitled to any interest on the amounts of

 

 

16


Table of Contents
 

payment made in lieu of fractional shares. The receipt of cash in lieu of fractional shares generally will be taxable to the recipient stockholders for U.S. federal income tax purposes as described in the section entitled “Material U.S. Federal Income Tax Consequences.”

 

Distribution method

Knowles’ common stock will be issued only by direct registration form. “Direct registration form” refers to a method of recording share ownership when no physical share certificates are issued to stockholders, as is the case in this distribution.

 

Conditions to the distribution

The distribution is subject to a number of conditions, including, among others:

 

    The U.S. Securities and Exchange Commission (“SEC”) will have declared effective the registration statement of which this information statement forms a part, and no stop order relating to the registration statement will be in effect.

 

    The New York Stock Exchange (“NYSE”) will have approved the listing of Knowles’ common stock, subject to official notice of issuance.

 

    Dover will have received either (i) a private letter ruling from the IRS together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code.

 

    All permits, registrations and consents required under the securities or blue sky laws of states or other political subdivisions of the United States or of other foreign jurisdictions in connection with the distribution will have been received.

 

    No order, injunction, or decree issued by any court of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the separation, distribution or any of the related transactions will be in effect.

 

    The reorganization of Dover and Knowles businesses prior to the separation and distribution will have been effectuated.

 

    Knowles will have entered into certain agreements in connection with the separation and distribution and certain financing arrangements prior to or concurrent with the separation.

 

    No events or developments shall have occurred or exist that, in the sole and absolute judgment of the Dover Board of Directors, make it inadvisable to effect the distribution or would result in the distribution and related transactions not being in the best interest of Dover or its stockholders.

 

 

17


Table of Contents
  Dover and Knowles cannot assure you that any or all of these conditions will be met. The fulfillment of the foregoing conditions does not create any obligations on Dover’s part to effect the distribution, and Dover’s Board of Directors has reserved the right, in its sole discretion, to abandon, modify or change the terms of the distribution, including by accelerating or delaying the timing of the consummation of all or part of the distribution, at any time prior to the distribution date. For a more complete discussion of all of the conditions to the distribution, see the section entitled “The Separation and Distribution—Conditions to the Distribution.”

 

Knowles’ Post-Separation Relationship with Dover

Following the separation and distribution, Knowles and Dover will operate separately, each as an independent public company. Prior to the separation and distribution, Knowles and Dover will enter into agreements that will govern their relationship after the distribution, including, among others, a separation and distribution agreement, a transition services agreement, a tax matters agreement and an employee matters agreement. These agreements will provide for the allocation between Knowles and Dover of Dover’s and Knowles’ assets, employees, liabilities and obligations (including employee benefits and tax-related assets and liabilities) attributable to periods prior to, at and after Knowles’ separation from Dover.

 

  Forms of the primary separation agreements have been filed as exhibits to the registration statement on Form 10 of which this information statement is a part, and a summary of these agreements are contained in the section entitled “Certain Relationships and Related Person Transactions.” The terms of the agreements described the section entitled “Certain Relationships and Related Person Transactions” that will be in effect following the separation have not yet been finalized; changes to these agreements, some of which may be material, may be made prior to Knowles’ separation from Dover. No changes may be made after Knowles’ separation from Dover without Knowles’ consent. For additional risks associated with these agreements, see the section entitled “Risk Factors—Risks Related to the Separation.”

 

Description of Knowles’ Capital Stock

Knowles’ amended and restated certificate of incorporation and amended and restated by-laws will contain, and Delaware law contains, 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 Knowles’ Board of Directors rather than to attempt a hostile takeover. These provisions include, among others:

 

    the inability of Knowles’ 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;

 

 

18


Table of Contents
    the right of Knowles’ Board of Directors to issue preferred stock without stockholder approval;

 

    the division of Knowles’ Board of Directors into three approximately equal classes of directors, with each class serving a staggered three-year term;

 

    a provision that stockholders may only remove directors for cause;

 

    the ability of Knowles’ directors, and not stockholders, to fill vacancies (including those resulting from an enlargement of the Board of Directors) on Knowles’ Board of Directors;

 

    the requirement that stockholders holding at least 80% of Knowles’ voting stock are required to amend certain provisions in Knowles’ amended and restated certificate of incorporation and Knowles’ amended and restated by-laws; and

 

    Knowles will be subject to Section 203 of the Delaware General Corporation Law (“DGCL”) which provides that, subject to limited exceptions, persons that (without prior board approval) acquire, or are affiliated with a person that acquires, more than 15 percent of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliate becomes the holder of more than 15 percent of the corporation’s outstanding voting stock.

 

  For additional information regarding the material terms of Knowles’ capital stock that will be contained in the amended and restated certificate of incorporation and by-laws, see the section entitled “Description of Knowles’ Capital Stock.”

 

Stock exchange listing

Knowles intends to apply to have its shares of common stock listed on the NYSE under the symbol “KN.”

 

Knowles’ material separation payments and costs

In connection with the spin-off, the only material payments to be made by Knowles to Dover prior to the distribution date relate to (i) the settlement of intercompany net notes payable and (ii) any dividends or other payments to be made as part of the reorganization step plan, which may include the use of proceeds from third party debt incurred by Knowles before the spin-off. The intercompany net notes payable due to Dover, totaling $542.5 million, $528.8 million and $1,419.4 million at September 30, 2013, December 31, 2012 and December 31, 2011, respectively, will be settled through a reorganization step plan. Knowles intends to settle these notes prior to the distribution date, and the related interest expense amounts are not necessarily representative of interest payments related to the future third party debt of Knowles. In addition to the settlement of intercompany net notes payable, Knowles intends to incur third party

 

 

19


Table of Contents
 

debt before the distribution to facilitate a payment to Dover prior to the spin-off. As a result, upon completion of the distribution, Knowles will not have any intercompany net notes payable due to Dover and its only indebtedness for borrowed money will be the third party debt incurred in connection with the spin-off. Although the definitive documents relating to Knowles future third party debt are expected to permit a cash payment to Dover of up to $450 million, Knowles currently expects that the payment to Dover prior to the spin-off will be between $370 million and $420 million. For purposes of preparing the post-distribution capitalization and unaudited pro forma combined financial statements included elsewhere in this information statement, Knowles has assumed, based on its best current estimates, the $400 million of debt will be drawn under these facilities as of the distribution date and that the payment to Dover prior to the spin-off will be in the amount of $400 million. Knowles will provide the final amount of the expected payment to Dover and the final amount of the expected debt to be incurred under these facilities (and the corresponding updates to the post-distribution capitalization and pro forma financial information included elsewhere in this information statement) in a subsequent amendment to this information statement. See the sections entitled “Description of Indebtedness,” “Capitalization” and “Unaudited Pro Forma Combined Financial Information.”

 

  Dover has informed Knowles that Dover expects to incur and pay one-time costs associated with the separation, including legal and advisory costs, in the range of $60.0 to $70.0 million. In connection with the spin-off, Knowles expects to incur one-time costs, including costs relating to entering into new financing arrangements and other matters, in the range of $         to $        .

 

Dividend policy

The timing, declaration, amount of and payment of any dividends following the separation by Knowles is within the discretion of its Board of Directors and will depend upon many factors, including Knowles’ financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of Knowles’ debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its Board of Directors. Moreover, if Knowles determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. See the section entitled “Dividend Policy.”

 

Transfer agent

The transfer agent for Knowles’ common stock will be Computershare Trust Company, N.A.

 

U.S. federal income tax consequences

It is a condition to the completion of the distribution that Dover receive either (i) a private letter ruling from the IRS together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under

 

 

20


Table of Contents
 

Sections 368(a)(1)(D) and 355 of the Code or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. Accordingly, and so long as the distribution so qualifies, for U.S. federal income tax purposes, no gain or loss will be recognized by you, and no amount will be included in your income, upon the receipt of shares of Knowles’ common stock pursuant to the distribution. You will, however, recognize gain or loss for U.S. federal income tax purposes with respect to cash received in lieu of a fractional share of Knowles’ common stock. For more information regarding the potential U.S. federal income tax consequences to Knowles, Dover and to you of the separation and distribution, see the section entitled “Material U.S. Federal Income Tax Consequences.”

 

 

21


Table of Contents

SUMMARY HISTORICAL AND PRO FORMA FINANCIAL DATA

Set forth below are summary historical financial and other data. The combined balance sheet data as of December 31, 2012 and 2011 and the combined statements of earnings data for the years ended December 31, 2012, 2011 and 2010 have been derived from Knowles’ audited financial statements included elsewhere in this information statement. Knowles derived the selected historical combined financial data as of September 30, 2013 and for the nine months ended September 30, 2013 and 2012 from Knowles’ unaudited combined financial statements included elsewhere in this information statement. In the opinion of management, the unaudited combined financial statements as of September 30, 2013 and for the nine months ended September 30, 2013 and 2012 have been prepared on the same basis as the audited combined financial statements and include all adjustments, consisting only of ordinary recurring adjustments, necessary for a fair statement of the information for the periods presented. The historical financial data includes costs of Knowles’ businesses, which include the allocation of certain corporate expenses from Dover. Knowles believes these allocations were made on a reasonable basis. The summary financial information may not be indicative of Knowles’ future performance as an independent company. It should be read in conjunction with the discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the unaudited pro forma combined financial statements and corresponding notes, the audited combined financial statements and corresponding notes, and the unaudited interim combined financial statements and corresponding notes included elsewhere in this information statement.

Also set forth below are summary unaudited pro forma statement of earnings data for the nine-month period ended September 30, 2013 and the twelve-month period ended December 31, 2012, which assume that the separation occurred as of January 1, 2012. The summary unaudited pro forma balance sheet data as of September 30, 2013 assumes that the separation occurred as of September 30, 2013. The pro forma adjustments are based upon available information and assumptions that Knowles believes are reasonable. The summary unaudited pro forma financial information does not purport to represent what the financial position or results of operations of Knowles would have been if Knowles had operated as an independent company during the periods presented or if the transactions described therein had actually occurred as of the dates indicated, nor does it project the financial position at any future date or the results of operations for any future period. Please see the notes to the unaudited pro forma combined financial statements included elsewhere in this information statement for a discussion of adjustments reflected in the pro forma combined financial statements.

 

 

22


Table of Contents

(dollars in thousands)

 

    Pro Forma for
the nine months
ended
September 30,
    For the nine months ended
September 30,
    Pro Forma
for year
ended
December 31,
    For the years ended December 31,  
  2013     2013     2012     2012     2012     2011 (1)     2010  

Statement of Earnings Data:

             

Revenue

  $ 884,468      $ 884,468      $ 821,441      $ 1,117,992      $ 1,117,992      $ 983,318      $ 730,444   

Operating earnings

    101,809        101,809        95,253        136,064        136,064        146,404        141,527   

Operating margin

    11.5     11.5     11.6     12.2     12.2     14.9     19.4

Net earnings

    97,302        72,826        50,670        120,033        79,097        98,457        109,272   

Adjusted for:

             

Depreciation and amortization

  $ 98,372      $ 98,372      $ 83,449      $ 114,878      $ 114,878      $ 84,773      $ 54,385   

Interest expense (income), net and debt expense (2)

    6,006        36,184        44,764        8,545        56,470        39,892        20,253   

Provision for income taxes

    (913     (6,615     47        6,808        (181     7,099        7,535   

EBITDA (3)

  $ 200,767      $ 200,767      $ 178,930      $ 250,264      $ 250,264      $ 230,221      $ 191,445   

EBITDA margin (3)

    22.7     22.7     21.8     22.4     22.4     23.4     26.2
    Pro Forma as
of September 30,

2013
    As of
September 30,

2013
                As of December 31,        
            2012     2011 (1)        

Balance Sheet Data:

             

Total assets

  $ 2,124,691      $ 2,124,691          $ 2,044,529      $ 2,000,713     

Total third party debt

  $ 400,000        —              —          —       

Notes payable to Parent, net

    —          542,519            528,812        1,419,422     

Total Parent Company equity / Total net investment/Stockholders’ equity

    1,420,773        1,297,452            1,188,107        286,650     
          For the nine months ended
September 30,
          For the years ended December 31,  
                  2013                     2012                   2012     2011 (1)     2010  

Other Data:

             

Research and development

    $ 61,955      $ 57,571        $ 77,321      $ 65,895      $ 49,286   

Cash Flow Summary:

             

Net Cash Flows Provided by (Used In):

             

Operating activities

    $ 95,560      $ 79,169          189,556        182,926        154,645   

Investing activities

      (59,661     (63,567       (115,603     (917,033     (29,243

Financing activities

      41,953        (32,807       (90,037     759,693        (134,700

Free Cash Flow (4):

             

Cash flow provided by operating activities

      95,560        79,169          189,556        182,926        154,645   

Less: Capital expenditures

      59,488        97,339          145,647        96,314        32,920   

Free cash flow

      36,072        (18,170       43,909        86,612        121,725   

Free cash flow as a percentage of revenue

      4.1     (2.2 )%        3.9     8.8     16.7

 

(1) On July 4, 2011, Knowles completed the stock acquisition of the Sound Solutions business line from NXP Semiconductors N.V. (“NXP”). The combined statements of earnings and combined balance sheets include the results of operations, net assets acquired and depreciation and amortization expense related to Sound Solutions since the date of acquisition. See Note 4 of the notes to the combined financial statements for additional information related to this acquisition.
(2)

The pro forma interest expense (income), net and debt expense includes the removal of interest expense of $36.2 million for the nine months ended September 30, 2013 related to the intercompany net notes payable with Dover that will be settled prior to the distribution date.

 

 

23


Table of Contents
(3) Knowles uses the term “EBITDA” throughout this information statement, defined as net earnings plus (i) depreciation and amortization expense, (ii) interest expense and (iii) income taxes. EBITDA and EBITDA margin (defined as EBITDA as a percentage of revenue) are not presented in accordance with GAAP and may not be comparable to similarly titled measures. Knowles uses EBITDA and EBITDA margin as supplements to its GAAP results of operations in evaluating certain aspects of its business, and its Board of Directors and executive management team focus on EBITDA and EBITDA margin as key measures of Knowles’ performance for business planning purposes. These measures assist Knowles in 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 EBITDA and EBITDA margin 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. For a reconciliation of EBITDA to net earnings, the most directly related GAAP measure, please see the table above.
(4) In addition to measuring Knowles’ cash flow generation and usage based upon the operating, investing and financing classifications included in the combined statements of cash flows, Knowles also measures free cash flow and free cash flow as a percentage of revenue. Free cash flow is calculated as cash flow provided by operating activities less capital expenditures. Knowles’ management believes these measures are useful in measuring its cash generated from operations, and cash generated from operations as a percentage of revenue, 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 revenue are not presented in accordance with GAAP and may not be comparable to similarly titled measures used by other companies in Knowles’ industry. As such, free cash flow and free cash flow as a percentage of revenue should not be considered in isolation from, or as an alternative to, any other performance measures determined in accordance with GAAP. For a reconciliation of free cash flow to cash flow provided by operating activities, the most directly related GAAP measure, please see the table above.

 

 

24


Table of Contents

RISK FACTORS

You should carefully consider the following risks and other information in this information statement in evaluating Knowles and Knowles’ common stock. Any of the following risks could materially and adversely affect Knowles’ business, financial condition, results of operations and cash flows. The risk factors generally have been separated into three groups: risks related to Knowles’ business, risks related to the separation and risks related to Knowles’ common stock.

Risks Related to Knowles’ Business

Knowles’ results may be impacted by domestic and international economic, legal, currency, political and compliance conditions and uncertainties.

Worldwide economic and capital market conditions are beyond Knowles’ control, are highly unpredictable, and can have an adverse effect on Knowles’ revenue, earnings, cash flows and cost of capital. Knowles has significant operations in Austria, China, Germany, Malaysia, the Philippines, the United Kingdom and the United States. Knowles’ businesses may be adversely affected by disruptions in the financial markets or declines in economic activity both domestically and internationally in the countries where Knowles operates or from which it derives substantial revenues. These circumstances will also impact Knowles’ suppliers and customers in various ways which could have an impact on its business operations, particularly if global credit markets are not operating efficiently and effectively to support industrial commerce.

Knowles’ domestic and international sales and operations are subject to risks associated with changes in local government laws (including environmental and import/export laws), regulations and policies. Failure to comply with any of these laws could result in civil and criminal, monetary and non-monetary penalties and damage to Knowles’ reputation. In addition, Knowles cannot provide assurance that its costs of complying with new and evolving regulatory reporting requirements and current or future laws, including environmental protection, employment and health and safety laws, will not exceed Knowles’ estimates. In addition, Knowles has invested in certain countries, including the Philippines, Malaysia and China, that carry high levels of currency, political, compliance and/or economic risk. While these risks or the impact of these risks are difficult to predict, any one or more of them could adversely affect Knowles’ businesses and reputation.

Knowles is subject to risks relating to its existing international operations and to expanding its global business.

Many of Knowles’ manufacturing operations and suppliers are located outside the United States, and Knowles continues to focus on global markets as part of its growth strategy. Knowles’ international operations and global expansion strategy are subject to various risks, including:

 

    political, social and economic instability and disruptions;

 

    government embargoes or trade restrictions;

 

    the imposition of duties and tariffs and other trade barriers;

 

    import and export controls;

 

    transportation delays and interruptions;

 

    labor unrest and current and changing regulatory environments;

 

    increased compliance costs, including costs associated with disclosure requirements and related due diligence;

 

    the impact of loss of one or more of Knowles’ manufacturing facilities;

 

    difficulties in staffing and managing multi-national operations;

 

25


Table of Contents
    limitations on Knowles’ ability to enforce legal rights and remedies; and

 

    environmental liabilities arising from Knowles’ current, historical and future operations and manufacturing sites.

If Knowles is unable to successfully manage the risks associated with expanding its global business or adequately manage operational risks of its existing international operations, the risks could have a material adverse effect on Knowles’ growth strategy involving expansion into new geographical markets or its results of operations and financial position.

Knowles faces risks arising from the restructuring of its operations globally.

Knowles continuously evaluates its operations and cost structure relative to general economic conditions, market demands, tax rates, cost competitiveness and its geographic footprint. As a result of this ongoing evaluation, Knowles engages in restructuring activities from time to time and could restructure in the future. The restructuring process includes moving production between facilities or to new facilities, closing facilities, reducing staff levels, realigning Knowles’ business processes and reorganizing Knowles’ management.

Restructurings present significant potential risks that could adversely affect Knowles, including delays in finalizing the scope of, and implementing, the restructurings (including extensive consultations concerning potential workforce reductions and obtaining agreements from Knowles’ affected customers for the relocation of Knowles’ facilities in certain instances), the failure to achieve targeted cost savings, impacts on product quality and delivery interruptions, the failure to meet operational targets and customer requirements. These risks are further complicated by Knowles’ international footprint, which subject Knowles to various legal and regulatory requirements that govern the extent and speed of its ability to restructure its operations.

If Knowles is not able to anticipate, adapt to and capitalize on technological developments, it may not be able to sustain or grow its current level of revenues, operating profits, or cash flows.

Knowles sells its products in electronic and technology-based industries that are highly competitive, dynamic and constantly experiencing change as new technologies are developed. It is characteristic of such industries that sales prices for products decline over time following their introduction to market due to technological obsolescence and the introduction of new technologies. Downward pressure on product prices typically causes downward pressure on component prices as well. Knowles’ ability to compete depends on its ability to innovate successfully.

Knowles’ competitors may produce products that are more advanced than the products Knowles produces. If Knowles’ businesses are unable to anticipate their competitors’ development of new products and services, identify customer needs and preferences on a timely basis, or successfully introduce new products and services in response to such competitive factors, including new or enhanced products with higher margins to offset price declines, Knowles may experience lower revenue, operating profits and cash flows. In addition, if Knowles is unable to adapt to the rapid technological changes (which includes hiring and retaining top engineering talent), or for those products which are subject to declining average selling prices, Knowles is unable to increase its unit volumes, introduce new or enhanced products with higher margins and/or reduce manufacturing costs to offset price decreases in existing products, Knowles’ products could become obsolete or commoditized, and business and operating results may be materially adversely affected.

Knowles’ products must undergo lengthy and expensive qualification processes without any assurance of product sales. The costs associated with new product introductions and imbalances between customer demand and capacity could negatively impact Knowles’ operating results and profits.

A significant portion of Knowles’ revenue is derived from products that are required to go through extensive customer qualification processes before being selected by customers for inclusion in their products under

 

26


Table of Contents

development. Knowles devotes substantial resources, including design, engineering, sales, marketing and management efforts, to these qualification processes. Knowles’ products may not be designed into a customer’s product despite Knowles’ investment in the qualification process, which could adversely impact Knowles’ operating results and profits.

Even if Knowles’ products are designed into a customer’s product, the customer’s product may not be commercially successful, or the customer’s commercial plans for the product could change, which could adversely impact Knowles’ sales and operating results. Similarly, a modification to the product or manufacturing process, or the selection of a new supplier by Knowles, may require new qualification processes, which may result in delays, cause Knowles to forego sales for the remainder of the life of the customer’s product, and/or hold excess or obsolete inventory.

In addition, when Knowles’ customers introduce new products, the time required and costs incurred by Knowles to ramp up production 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 ramp-ups typically involve greater volumes of scrap, higher costs due to inefficiencies and delays in production, all of which can adversely impact Knowles’ operating results and profits.

Knowles’ operating results and profits could be adversely affected if Knowles is unable to balance customer demand for its products and capacity. If demand increases and Knowles is unable to increase its production capacity to meet the demand, or if there are unforeseen costs associated with adjusting its capacity levels, Knowles may not be able to achieve its financial targets. Conversely, if demand does not increase at the rate forecasted, Knowles may not be able to adequately absorb manufacturing expenses or overhead costs which could negatively impact its product margins. Additionally, if product demand decreases or Knowles fails to forecast demand accurately, it may be required to record impairments on its long-lived assets or record other charges.

Any of these developments could have a material adverse impact on Knowles’ sales and operating results. In addition, to the extent a customer has a “dual source” strategy whereby customers may purchase products from more than one supplier, Knowles may realize lower sales from its products that are designed into the customer’s products.

Knowles could lose customers or generate lower revenue, operating profits and cash flows if there are significant increases in the cost of raw materials or if Knowles is unable to obtain raw materials.

Knowles purchases raw materials, sub-assemblies and components for use in manufacturing operations, which exposes it to volatility in prices for certain commodities. Significant price increases for these commodities could adversely affect operating profits for certain of Knowles’ businesses. While Knowles generally attempts to mitigate the impact of increased raw material prices by hedging or passing along the increased costs to customers, there may be a time delay between the increased raw material prices and the ability to hedge the price increase or increase the prices of products, or Knowles may be unable to increase the prices of products due to a competitor’s pricing pressure or other factors. In addition, the inability to obtain necessary raw materials could affect Knowles’ ability to meet customer commitments and satisfy market demand for certain products. Consequently, a significant price increase in raw materials, including certain rare earth materials, or their unavailability, may result in a loss of customers and adversely impact revenue, operating profits and cash flows.

Knowles and its suppliers rely upon certain rare earth materials that are necessary for the manufacturing of Knowles’ products, and Knowles’ business could be harmed if Knowles or its suppliers experience shortages or delays of these rare earth materials. Knowles and/or its suppliers acquire these materials from a number of countries, including China. More than 95% of the world’s current supply of rare earth materials comes from China, which has enacted a policy to reduce its exports because of its rising domestic demand and new environmental restrictions. Knowles cannot predict whether the government of China or any other nation will

 

27


Table of Contents

impose further regulations, quotas or embargoes upon these materials that would restrict their worldwide supply or increase their cost. If China or any other major supplier were to further restrict the supply available or increase the cost of the materials used in Knowles’ products, Knowles could experience a shortage in supply and an increase in production costs, which would harm Knowles’ operating results.

Knowles relies on sole source and limited source suppliers for certain supplies of critical raw materials and components.

Knowles’ operations depend on obtaining sufficient supplies of raw materials and components used in its manufacturing processes. In particular, certain of its businesses rely on wafer fabrication facilities or foundries which are limited source suppliers to provide silicon-based products that are critical components of Knowles’ products and to provide such products in sufficient quantities to meet Knowles’ production needs. Although Knowles has long-term supply arrangements with these foundries, they may experience financial difficulties, be unable to deliver product to Knowles in a timely manner, have insufficient capacity to meet Knowles’ requirements, or suffer business disruption resulting from damage to or destruction of their facilities due to natural disasters, and Knowles might not be able to secure an alternative source of supply in a timely manner. These events could have a material adverse impact on Knowles’ results of operations.

Customer requirements and new regulations may increase Knowles’ expenses and impact the availability of certain raw materials, which could adversely affect its revenue and operating profits.

Knowles’ businesses use parts or materials that are impacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act requirement for disclosure of the use of “conflict minerals” mined in the Democratic Republic of the Congo and adjoining countries. It is possible that some of Knowles’ customers will require “conflict free” metals in products purchased from Knowles. The supply chain due diligence and verification of sources may require several years to complete based on the current availability of origin information and the number of vendors. Knowles may not be able to complete the process in the time frame required because of the complexity of its supply chain. Other governmental social responsibility regulations also may impact Knowles’ suppliers, manufacturing operations and operating profits.

The need to find alternative sources for certain raw materials or products because of customer requirements and regulations may impact Knowles’ ability to secure adequate supplies of raw materials or parts, lead to supply shortages, or adversely impact the prices at which Knowles’ businesses can procure compliant goods.

Knowles’ effective tax rate may fluctuate and it could be subject to additional tax liabilities, including in the event of repatriation of Knowles’ overseas earnings to fund Knowles’ significant liquidity needs.

Knowles’ effective tax rate may be adversely impacted by changes in the mix of its earnings among countries with differing statutory tax rates, changes in the valuation allowance of deferred tax assets and changes in tax laws. Knowles cannot give any assurance as to what its effective tax rate will be in the future because of, among other things, uncertainty regarding the tax policies of the jurisdictions where Knowles operates. Further, Knowles’ tax returns are subject to periodic audits by domestic and international authorities. If these audits result in allocations of income or other tax assessments different from amounts estimated, then Knowles’ financial results may be adversely affected by unfavorable tax adjustments.

Knowles’ effective tax rate is favorably impacted by a significant tax holiday granted to Knowles by Malaysia. This tax holiday is subject to Knowles’ satisfaction of certain conditions, including exceeding certain annual thresholds of operating expenses and gross sales. Knowles expects to continue to satisfy all of the conditions to this tax holiday. If Knowles fails to satisfy such conditions, Knowles’ effective tax rate may be significantly adversely impacted. For additional detail, please see Note 11 of the notes to the Audited Combined Financial Statements included elsewhere in this information statement and Note 8 of the notes to the Unaudited Combined Financial Statements included elsewhere in this information statement.

 

28


Table of Contents

In addition, if Knowles encounters a significant need for liquidity domestically or at a particular location that it cannot fulfill through borrowings, equity offerings, or other internal or external sources, Knowles may experience unfavorable tax and earnings consequences due to cash repatriations. These adverse consequences would occur, for example, if the transfer of cash into the United States is taxed and no foreign tax credit is available to offset the U.S. tax liability, resulting in lower earnings. Foreign exchange ceilings imposed by local governments and the sometimes lengthy approval processes that foreign governments require for international cash transfers may delay Knowles’ internal cash transfers from time to time. These factors may cause Knowles to have an overall tax rate higher than other companies or higher than Knowles’ tax rates have been in the past.

Knowles’ revenue, operating profits and cash flows could be adversely affected if Knowles’ businesses are unable to protect or obtain patent and other intellectual property rights, or if intellectual property litigation is successful against Knowles.

Knowles’ businesses own patents, trademarks, licenses and other forms of intellectual property related to their products. Knowles’ businesses employ various measures to maintain and protect their intellectual property, including enforcing their intellectual property rights through litigation. While Knowles’ businesses have been successful to date in maintaining and protecting their intellectual property, these measures may not prevent their intellectual property from being challenged, invalidated, or circumvented and the businesses may not be successful in litigation or other actions to enforce their intellectual property rights, particularly in countries where intellectual property rights are not highly developed or protected. Unauthorized use of these intellectual property rights could adversely impact the competitive position of Knowles’ businesses and have a negative impact on revenue, operating profits and cash flows.

Any litigation to determine the validity of claims that Knowles’ products infringe or may infringe intellectual property rights of another business, including claims arising from Knowles’ contractual indemnification of Knowles’ customers, regardless of their merit or resolution, could be costly and divert the efforts and attention of management and technical personnel. Regardless of the merits of any specific claim, Knowles may not prevail in litigation because of the complex technical issues and inherent uncertainties in intellectual property litigation. If litigation were to result in an adverse ruling, Knowles could be required to:

 

    pay substantial damages;

 

    cease the manufacture, import, use, sale or offer for sale of infringing products or processes;

 

    discontinue the use of infringing technology;

 

    expend significant resources to develop non-infringing technology; and

 

    enter into royalty or license agreements for the licensed technology from the third party claiming infringement, which license may not be available on commercially reasonable terms.

Knowles’ operating results or financial condition may be materially adversely affected if Knowles, or one of its customers, were required to take any one or more of the foregoing actions.

In addition, if another supplier to one of Knowles’ customers, or a customer of Knowles itself, were found to be infringing upon the intellectual property rights of a third party, the supplier or customer could be ordered to cease the manufacture, import, use, sale or offer for sale of its infringing product(s) or process(es), any of which could result, indirectly, in a decrease in demand from Knowles’ customers for Knowles’ products. If such a decrease in demand for Knowles’ products were to occur, it could have an adverse impact on Knowles’ operating results and financial condition.

Knowles’ growth and results of operations may be adversely affected if Knowles is unsuccessful in its capital allocation and acquisitions program.

Knowles expects to pursue a strategy of acquiring value-creating add-on businesses that broaden Knowles’ existing position and global reach as well as, in the right circumstances, strategically pursuing larger acquisitions

 

29


Table of Contents

that could have the potential to either complement Knowles’ existing businesses or allow Knowles to pursue a new growth opportunity. However, there can be no assurance that Knowles will be able to find suitable businesses to purchase or that Knowles will be able to acquire such businesses on acceptable terms. If Knowles is unsuccessful in its acquisition efforts, then Knowles’ ability to grow could be adversely affected. In addition, a completed acquisition may underperform relative to expectations, may be unable to achieve synergies originally anticipated, or may expose Knowles to unexpected liabilities. Further, if Knowles fails to allocate capital appropriately, in respect of either Knowles’ acquisition program or organic growth in operations, Knowles could be overexposed in certain markets and geographies.

Additionally, Knowles may be required to record a significant charge to earnings if its goodwill or other intangible assets become impaired. Goodwill and purchased intangible assets with indefinite lives are not amortized, but are reviewed for impairment annually and more frequently when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Knowles assesses the recoverability of the unamortized balance of its definite-lived intangible assets when indicators of potential impairment are present. Factors that may indicate that the carrying value of goodwill or other intangible assets may not be recoverable include a decline in stock price and market capitalization and slower growth rates in Knowles’ industry. Knowles may be required to record a significant charge to earnings in its financial statements during the period in which any impairment of Knowles’ goodwill or other intangible assets is determined to exist.

These factors could potentially have an adverse impact on Knowles’ operating profits and cash flows.

Failure to attract, retain and develop personnel or to provide adequate succession plans for key management could have an adverse effect on Knowles’ operating results.

Knowles’ growth, profitability and effectiveness in conducting its operations and executing its strategic plans depend in part on Knowles’ ability to attract, retain and develop qualified personnel, align them with appropriate opportunities, and maintain adequate succession plans for key management positions. If Knowles is unsuccessful in these efforts, Knowles’ operating results could be adversely affected.

Knowles may face wage inflation and increased competition for Knowles’ employees in the countries where Knowles operates, which could increase Knowles’ employment costs and Knowles’ attrition.

Wage costs in Asia and other regions in which Knowles operates have historically been significantly lower than wage costs in developed countries. However, wage increases in these countries where Knowles operates may increase its costs, reduce Knowles’ profit margins and adversely affect Knowles’ business and results of operations. Knowles may not be able to pass these increased costs on to its customers by increasing the price Knowles charges for its products. If this occurs, Knowles’ profits may decline.

Competition in Asia and other regions in which Knowles operates for skilled-labor has increased, and Knowles expects this competition will continue to increase as additional companies enter the market and expand their operations. If the availability of skilled-labor decreases, it could affect the availability and the cost of employees and increase Knowles’ attrition rate, all of which may have an adverse effect on Knowles’ operating results.

Knowles’ business operations may be adversely affected by information systems interruptions or intrusion.

Knowles’ businesses rely on a number of information technologies to manage, store and support business activities. Knowles has put in place a number of systems, processes and practices designed to protect against intentional or unintentional misappropriation or corruption of Knowles’ systems and information, disruption of operations, or corruption of the software that supports its products. Disruptions or cybersecurity attacks, such as unauthorized access, malicious software, or other violations may lead to exposure of proprietary or confidential information as well as potential data corruption. Any intrusion may cause operational stoppages, violations of

 

30


Table of Contents

applicable law, diminished competitive advantages or reputational damages, and increased operational costs due to remedial activities. The theft or unauthorized use or publication of Knowles’ trade secrets and other confidential business information resulting from a breach of Knowles’ information systems could adversely affect Knowles’ competitive position and the value of Knowles’ investment in research and development.

Knowles’ reputation, ability to do business, and results of operations may be impaired by improper conduct by any of its employees, agents, or business partners.

While Knowles strives to maintain high standards, Knowles cannot provide assurance that its internal controls and compliance systems will always protect it from acts committed by employees, agents, or business partners that would violate U.S. and/or non-U.S. laws or fail to protect Knowles’ confidential information, including the laws governing payments to government officials, bribery, fraud, anti-kickback and false claims rules, competition, export and import compliance, money laundering and data privacy laws, as well as the improper use of proprietary information or social media. Any such violations of law or improper actions could subject Knowles to civil or criminal investigations in the U.S. and in other jurisdictions, could lead to substantial civil or criminal, monetary and non-monetary penalties and related stockholder lawsuits and could damage Knowles’ reputation.

Knowles’ exposure to exchange rate fluctuations on cross-border transactions and the translation of local currency results into U.S. dollars could negatively impact its results of operations.

Knowles conducts business through its 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 Knowles’ products are manufactured in lower-cost locations and sold in various countries. Cross-border transactions, both with external parties and intercompany relationships, result in increased exposure to changes in foreign exchange rates. Accordingly, significant changes in currency exchange rates, particularly the Malaysian Ringgit, the Euro, the Chinese Renminbi (Yuan) and the Philippine Peso, could cause fluctuations in the reported results of Knowles’ businesses’ operations that could negatively affect Knowles’ results of operations. A weakening of the U.S. dollar could adversely impact the cost of materials, products and services purchased outside the U.S. and therefore adversely affect Knowles’ results of operations. In addition, sales and expenses of Knowles’ non-U.S. businesses are translated into U.S. dollars for reporting purposes and therefore the weakening of the U.S. dollar could result in unfavorable translation effects.

Knowles depends on a limited number of customers for a substantial portion of its revenues, and the loss of, or a significant reduction in orders from, any key customer could significantly reduce Knowles’ revenues and adversely impact its operating results.

Knowles relies on several key customers. For fiscal 2012, Knowles’ top ten customers accounted for approximately 52% of total revenue. For the years ended December 31, 2012 and 2011, one customer, Apple, accounted for approximately 18% and 12%, respectively, of total revenue. No single customer accounted for more than 10% of Knowles’ revenue for the year ended December 31, 2010. Knowles expects that a substantial portion of its revenue will continue to be attributable to several key customers. If these customers decide not to buy Knowles’ products or to purchase lower volumes from Knowles because their own products are not commercially successful or for other reasons, Knowles’ revenues could substantially decline, which could have a material adverse effect on its results of operations.

The markets Knowles serves are concentrated, with a limited number of companies active in these markets. A concentrated market and reliance on a small number of customers gives those customers substantial purchasing power and leverage in negotiating contracts with Knowles. In addition, Knowles does not have long-term agreements or purchase orders with any of its customers, its customers have irregular and unpredictable ordering patterns, and its customers may not have regular, predictable product introduction schedules. A decision by any of Knowles’ major customers to decrease significantly the number of products purchased from Knowles could substantially reduce sales and have a material adverse effect on its business, financial condition and results of operations.

 

31


Table of Contents

Some of Knowles’ businesses are subject to the cycles inherent in the consumer electronics industry.

The consumer electronics industry 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. Markets or the markets for specific products incorporating Knowles’ solutions may not continue to grow or may decline for a number of reasons outside of Knowles’ control, including competition among companies and market saturation.

This industry experienced a significant downturn as part of the broader global recession in 2008 and 2009. Industry downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Future downturns could have a material adverse effect on Knowles’ business and operating results.

Costs related to product defects and errata may harm Knowles’ results of operations and business.

Adverse consequences associated with unexpected product defects and errata (deviations from published specifications) due to, for example, unanticipated problems in Knowles’ design and manufacturing processes, could include writing off or reserving the value of inventory of such products; disposing of products that cannot be fixed; recalling such products that have been shipped to customers; providing product replacements for, or modifications to, such products; and defending against litigation related to such products. The costs associated with these occurrences could be substantial and may temporarily increase Knowles’ expenses and lower its margins and profitability. In addition, Knowles’ reputation could be damaged as a result of such product defects and errata, and the demand for its products could be reduced.

Risks Related to the Separation

Knowles may not achieve some or all of the expected benefits of the separation, and the separation may adversely affect Knowles’ business.

Knowles may not be able to achieve the full strategic and financial benefits expected to result from the separation, or such benefits may be delayed or not occur at all. The separation and distribution is expected to provide the following benefits, among others:

 

    The separation will allow each company to more effectively pursue its own distinct operating priorities and strategies, and will enable the management of both companies to pursue separate opportunities for long-term growth and profitability, and to recruit, retain and motivate employees pursuant to compensation policies which are appropriate for their respective lines of business.

 

    The separation will permit each company to concentrate its financial resources solely on its own operations, providing greater flexibility to invest capital in its business in a time and manner appropriate for its distinct strategy and business needs.

 

    Dover’s Board of Directors believes that Dover’s businesses and Knowles’ businesses appeal to different types of investors with different industry focuses, investment goals and risk profiles; as such, the separation will enable investors to evaluate the merits, performance and future prospects of each company’s businesses and to invest in each company separately based on these distinct characteristics.

 

    The separation will create an independent equity structure that will afford Knowles direct access to capital markets and will facilitate the ability to capitalize on its unique growth opportunities and effect future acquisitions utilizing, among other types of consideration, shares of its common stock.

Knowles may not achieve these and other anticipated benefits for a variety of reasons, including, among others: (a) the separation will require significant amounts of management’s time and effort, which may divert management’s attention from operating and growing Knowles’ business; (b) following the separation, Knowles’ stock price may be more susceptible to market fluctuations and other events particular to one or more of

 

32


Table of Contents

Knowles’ products than if it were still a part of Dover; and (c) following the separation, Knowles’ business will be less diversified than Dover’s business prior to the separation. If Knowles fails to achieve some or all of the benefits expected to result from the separation, or if such benefits are delayed, the business, financial condition and results of operations and cash flows of Knowles could be adversely affected.

Knowles has no history operating as an independent publicly-traded company, and Knowles’ historical and pro forma financial information is not necessarily representative of the results that it would have achieved as a separate, publicly-traded company and therefore may not be a reliable indicator of its future results.

Knowles is being spun-off from Dover, its parent company, and has no operating history as a separate publicly-traded company. The historical information about Knowles in this information statement refers to Knowles’ business as part of Dover. Knowles’ historical and pro forma financial information included in this information statement is derived from the combined financial statements and accounting records of Dover. Accordingly, the historical and pro forma financial information included in this information statement does not necessarily reflect the financial condition, results of operations or cash flows that Knowles would have achieved as a separate, publicly-traded company during the periods presented or those that Knowles will achieve in the future primarily as a result of the factors described below:

 

    Knowles will need to make significant investments to replicate or outsource certain systems, infrastructure and functional expertise after its separation from Dover. These initiatives to develop Knowles’ independent ability to operate without access to Dover’s existing operational and administrative infrastructure will be costly to implement. Knowles may not be able to operate its business efficiently or at comparable costs, and its profitability may decline; and

 

    generally, Knowles has relied upon Dover for working capital requirements and other cash requirements, including in connection with Knowles’ previous acquisitions. Subsequent to the separation, Dover will not be providing Knowles with funds to finance Knowles’ working capital or other cash requirements. After the separation, Knowles’ access to and cost of debt financing may be different from the historical access to and cost of debt financing under Dover. Differences in access to and cost of debt financing may result in differences in the interest rate charged to Knowles on financings, as well as the amounts of indebtedness, types of financing structures and debt markets that may be available to Knowles, which could have an adverse effect on Knowles’ business, financial condition and results of operations and cash flows.

For additional information about the past financial performance of Knowles’ business and the basis of presentation of the historical combined financial statements and the unaudited pro forma combined financial statements of Knowles’ business, see the section entitled “Unaudited Pro Forma Combined Financial Statements,” “Selected Historical Combined Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical financial statements and accompanying notes included elsewhere in this information statement.

Dover may fail to perform under various transaction agreements that will be executed as part of the separation or Knowles may fail to have necessary systems and services in place when certain of the transaction agreements expire.

Knowles and Dover will enter into certain agreements, such as the separation and distribution agreement, a transition services agreement and those other agreements discussed in greater detail in the section entitled “Certain Relationships and Related Person Transactions—Agreements with Dover,” which will provide for the performance of services by each company for the benefit of the other for a period of time after the separation. Knowles will rely on Dover to satisfy its performance and payment obligations under these agreements. If Dover is unable to satisfy its obligations under these agreements, including its indemnification obligations, Knowles could incur operational difficulties or losses.

 

33


Table of Contents

If Knowles does not have in place its own systems and services, does not have agreements with other providers of these services when the transitional or long-term agreements terminate, or if Knowles does not implement the new systems or replace Dover’s services successfully, Knowles may not be able to operate its business effectively, which could disrupt its business and have a material adverse effect on its business, financial condition and results of operations. These systems and services may also be more expensive to install, implement and operate, or less efficient than the systems and services Dover is expected to provide during the transition period.

Potential indemnification liabilities to Dover pursuant to the separation and distribution agreement could materially and adversely affect Knowles’ business, financial condition, results of operations and cash flows.

The separation and distribution agreement, among other things, provides for indemnification obligations (for uncapped amounts) designed to make Knowles financially responsible for substantially all liabilities that may exist relating to its business activities, whether incurred prior to or after the separation. If Knowles is required to indemnify Dover under the circumstances set forth in the separation and distribution agreement, Knowles may be subject to substantial liabilities.

In connection with Knowles’ separation from Dover, Dover will indemnify Knowles for certain liabilities. However, there can be no assurance that the indemnity will be sufficient to insure Knowles against the full amount of such liabilities, or that Dover’s ability to satisfy its indemnification obligation will not be impaired in the future.

Pursuant to the separation and distribution agreement and certain other agreements with Dover, Dover will agree to indemnify Knowles for certain liabilities as discussed further in “Certain Relationships and Related Person Transactions—Agreements with Dover.” However, third parties could also seek to hold Knowles responsible for any of the liabilities that Dover has agreed to retain, and there can be no assurance that the indemnity from Dover will be sufficient to protect Knowles against the full amount of such liabilities, or that Dover will be able to fully satisfy its indemnification obligations. In addition, Dover’s insurers may attempt to deny coverage to Knowles for liabilities associated with certain occurrences of indemnified liabilities prior to the separation. Moreover, even if Knowles ultimately succeeds in recovering from Dover or such insurance providers any amounts for which Knowles is held liable, Knowles may be temporarily required to bear these losses. Each of these risks could negatively affect Knowles’ business, financial position, results of operations and cash flows.

Knowles will be subject to continuing contingent liabilities of Dover following the separation.

After the separation, there will be several significant areas where the liabilities of Dover may become Knowles’ obligations. For example, under the Code and the related rules and regulations, each corporation that was a member of the Dover U.S. consolidated group during a taxable period or portion of a taxable period ending on or before the effective time of the distribution is jointly and severally liable for the U.S. federal income tax liability of the entire Dover U.S. consolidated group for that taxable period. Consequently, if Dover is unable to pay the consolidated U.S. federal income tax liability for a prior period, Knowles could be required to pay the entire amount of such tax which could be substantial and in excess of the amount allocated to it under the tax matters agreement between it and Dover. For a discussion of the tax matters agreement, see the section entitled “Certain Relationships and Related Person Transactions—Agreements with Dover—Tax Matters Agreement.” Other provisions of federal law establish similar liability for other matters, including laws governing tax-qualified pension plans as well as other contingent liabilities.

 

34


Table of Contents

If the distribution, together with certain related transactions, does not qualify as a transaction that is generally tax-free for U.S. federal income tax purposes, you and Dover could be subject to significant tax liability and, in certain circumstances, Knowles could be required to indemnify Dover for material taxes pursuant to indemnification obligations under the tax matters agreement.

A condition to the distribution is the receipt by Dover of either (i) a private letter ruling from the IRS together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. Even if the private letter ruling from the IRS is obtained, Dover does not currently intend to complete the transaction if it has not also obtained a tax opinion because such opinion will address, among other things, certain conditions that the private letter ruling does not address but are relevant to determining whether the distribution will qualify for tax-free treatment. The private letter ruling, if obtained, as well as any opinion of tax counsel, will rely on certain facts, assumptions, representations and undertakings from Dover and Knowles, including those regarding the past and future conduct of the companies’ respective businesses and other matters. If any of these facts, assumptions, representations or undertakings are incorrect or not satisfied, Dover and its stockholders may not be able to rely on the private letter ruling (if obtained) or the opinion, and could be subject to significant tax liabilities. Notwithstanding the private letter ruling, if obtained, or the opinion of tax counsel, the IRS could determine on audit that the distribution is taxable if it determines that any of these facts, assumptions, representations or undertakings are not correct or have been violated or if it disagrees with the conclusions in the opinion. For more information regarding the private letter ruling or opinion, see the section entitled “Material U.S. Federal Income Tax Consequences.” In addition, Dover and Knowles intend for certain related transactions to qualify for tax-free treatment under federal, state and local tax law and/or foreign tax law.

If the distribution is determined to be taxable for U.S. federal income tax purposes, Dover and its stockholders that are subject to U.S. federal income tax could incur significant U.S. federal income tax liabilities. For example, if the distribution fails to qualify for tax-free treatment, Dover would for U.S. federal income tax purposes be treated as if it had sold the Knowles common stock in a taxable sale for its fair market value, and Dover’s stockholders, who are subject to U.S. federal income tax, would be treated as receiving a taxable distribution in an amount equal to the fair market value of the Knowles common stock received in the distribution. In addition, if certain related transactions fail to qualify for tax-free treatment under federal, state and local tax law and/or foreign tax law, Dover (and, under the tax matters agreement described below, Knowles) could incur significant tax liabilities under U.S. federal, state, local and/or foreign tax law.

Under the tax matters agreement between Dover and Knowles, Knowles would generally be required to indemnify Dover against taxes incurred by Dover that arise as a result of Knowles’ taking or failing to take, as the case may be, certain actions that result in the distribution failing to meet the requirements of a tax-free distribution under Section 355 of the Code or of such related transactions failing to qualify for tax-free treatment. Also, under the tax matters agreement, Knowles would generally be required to indemnify Dover for one-half of the taxes and other liabilities incurred by Dover if the distribution fails to meet the requirements of a tax-free distribution under Section 355 of the Code for reasons other than an act or failure to act on the part of Knowles or Dover, and therefore Knowles might be required to indemnify Dover for such taxes and liabilities due to circumstances and events not within the control of Knowles. Under the tax matters agreement, Knowles is also required to indemnify Dover for one-half of certain taxes incurred as a result of the restructuring activities undertaken to effectuate the distribution or as a result of the application of certain rules relating to consolidated federal income tax returns, whether payable upon filing tax returns related to the restructuring and distribution or upon a subsequent audit of those returns. Knowles’ indemnification obligations to Dover under the tax matters agreement are not limited by a maximum amount. If Knowles is required to indemnify Dover under the circumstances set forth in the tax matters agreement, Knowles may be subject to substantial liabilities, which could materially adversely affect its financial position.

 

35


Table of Contents

Knowles may not be able to engage in certain corporate transactions after the separation.

To preserve the tax-free treatment to Dover and its stockholders of the contribution and the distribution and certain related transactions, under the tax matters agreement that Knowles will enter into with Dover, Knowles is restricted from taking any action following the distribution that prevents the distribution and related transactions from being tax-free for U.S. federal income tax purposes. Under the tax matters agreement, for the two-year period following the distribution, Knowles will be prohibited, except in certain circumstances, from:

 

    entering into any transaction resulting in the acquisition of 40% or more of its stock or substantially all of its assets, whether by merger or otherwise;

 

    merging, consolidating or liquidating;

 

    issuing equity securities beyond certain thresholds;

 

    repurchasing its capital stock; and

 

    ceasing to actively conduct its business.

These restrictions may limit Knowles’ ability to pursue certain strategic transactions or other transactions that it may believe to be in the best interests of its stockholders or that might increase the value of its business. In addition, under the tax matters agreement, Knowles is required to indemnify Dover against any such tax liabilities as a result of the acquisition of Knowles’ stock or assets, even if it did not participate in or otherwise facilitate the acquisition. For more information, see the section entitled “Certain Relationships and Related Person Transactions—Agreements with Dover—Tax Matters Agreement.”

The spin-off and related internal restructuring transactions may expose Knowles to potential liabilities arising out of state and federal fraudulent conveyance laws and legal dividend requirements.

If Dover files for bankruptcy or is otherwise determined or deemed to be insolvent under federal bankruptcy laws, a court could deem the spin-off or certain internal restructuring transactions undertaken by Dover in connection with the separation to be a fraudulent conveyance or transfer. Fraudulent conveyances or transfers are defined to include transfers made or obligations incurred with the actual intent to hinder, delay or defraud current or future creditors or transfers made or obligations incurred for less than reasonably equivalent value when the debtor was insolvent, or that rendered the debtor insolvent, inadequately capitalized or unable to pay its debts as they become due. A court could void the transactions or impose substantial liabilities upon Knowles, which could adversely affect Knowles’ financial condition and its results of operations. Among other things, the court could require Knowles’ stockholders to return to Dover some or all of the shares of its common stock issued in the spin-off, or require Knowles to fund liabilities of other companies involved in the restructuring transactions for the benefit of creditors.

The distribution of Knowles’ common stock is also subject to review under state corporate distribution statutes. Under the Delaware General Corporation Law (“DGCL”), a corporation may only pay dividends to its stockholders either (i) out of its surplus (net assets minus capital) or (ii) if there is no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Although Dover intends to make the distribution of Knowles’ common stock entirely out of surplus, Knowles cannot assure you that a court will not later determine that some or all of the distribution to Dover stockholders was unlawful.

After the separation, certain of Knowles’ executive officers and directors may have actual or potential conflicts of interest because of their previous or continuing positions at Dover.

Because of their current or former positions with Dover, certain of Knowles’ expected executive officers and directors own equity interests in Dover. Following the separation, even though Knowles’ Board of Directors will consist of a majority of directors who are independent, and Knowles’ expected executive officers who are currently employees of Dover will cease to be employees of Dover upon the separation, some of Knowles’

 

36


Table of Contents

executive officers and directors will continue to have a financial interest in shares of Dover’s common stock. In addition, certain of Knowles’ directors will continue serving on the Board of Directors of Dover. Continuing ownership of shares of Dover’s common stock and equity awards, or service as a director at both companies could create, or appear to create, potential conflicts of interest if Knowles and Dover pursue the same corporate opportunities or face decisions that could have different implications for Dover and Knowles.

Knowles may have received better terms from unaffiliated third parties than the terms it will receive in its agreements with Dover.

The agreements Knowles will enter into with Dover in connection with the separation, including the separation and distribution agreement, transition services agreement, tax matters agreement and employee matters agreement were prepared in the context of Knowles’ separation from Dover while Knowles was still a wholly owned subsidiary of Dover. Accordingly, during the period in which the terms of those agreements were prepared, Knowles did not have an independent Board of Directors or a management team that was independent of Dover. As a result, the terms of those agreements may not reflect terms that would have resulted from arm’s-length negotiations between unaffiliated third parties. Arm’s-length negotiations between Dover and an unaffiliated third party in another form of transaction, such as a buyer in a sale of a business transaction, may have resulted in more favorable terms to the unaffiliated third party. For more information, see the section entitled “Certain Relationships and Related Person Transactions—Agreements with Dover.”

Some contracts and other assets which will need to be transferred or assigned from Dover or its affiliates to Knowles in connection with Knowles’ separation from Dover may require the consent or involvement of a third party. If such consent is not given, Knowles may not be entitled to the benefit of such contracts and other assets in the future, which could negatively impact Knowles’ financial condition and future results of operations.

The separation and distribution agreement and various local transfer agreements provide that in connection with Knowles’ separation from Dover, a number of contracts with third-parties and other assets are to be transferred or assigned from Dover or its affiliates to Knowles. However, the transfer or assignment of certain of these contracts or assets require providing guarantees or the consent of a third party to such a transfer or assignment. Similarly, in some circumstances, Knowles and another business unit of Dover are joint beneficiaries of contracts, and Knowles will need to enter into a new agreement with the third-party to replicate the existing contract or assign the portion of the existing contract related to the Knowles business. It is possible that some parties may use the requirement of a guarantee or consent or the fact that the separation is occurring to seek more favorable contractual terms from Knowles or to seek to terminate the contract. If Knowles is unable to provide a guarantee or obtain such consents on commercially reasonable and satisfactory terms or if the contracts are terminated, Knowles may be unable to obtain some of the benefits, assets and contractual commitments which are intended to be allocated to Knowles as part of Knowles’ separation from Dover. The failure to timely complete the assignment of existing contracts or assets, or the negotiation of new arrangements, or a termination of any of those arrangements, could negatively impact Knowles’ financial condition and future results of operations. In addition, where Knowles does not intend to provide a guarantee or obtain consent from third party counterparties based on Knowles’ belief that no guarantee or consent is required, the third party counterparties may challenge a transfer of assets on the basis that the terms of the applicable commercial arrangements require that a guarantee be provided or the third party counterparty’s consent. Knowles may incur substantial litigation and other costs in connection with any such claims and, if Knowles does not prevail, Knowles’ ability to use these assets could be adversely impacted.

Knowles expects to incur new indebtedness at or prior to the distribution, and the degree to which Knowles will be leveraged following completion of the distribution may have a material adverse effect on Knowles’ business, financial condition or results of operations and cash flows.

Knowles has historically relied upon Dover for working capital requirements and other cash requirements, including in connection with Knowles’ previous acquisitions. After the distribution, Knowles will not be able to

 

37


Table of Contents

rely on the earnings, assets or cash flow of Dover and Dover will not provide funds to finance Knowles’ working capital or other cash requirements. As a result, after the distribution, Knowles will be responsible for servicing its own debt, and obtaining and maintaining sufficient working capital and other funds to satisfy its cash requirements. In connection with the distribution, Knowles expects to incur borrowings of $             million and distribute $             million of the proceeds of such indebtedness to Dover. After the separation, Knowles’ access to and cost of debt financing may be different from the historical access to and cost of debt financing under Dover. Differences in access to and cost of debt financing may result in differences in the interest rate charged to Knowles on financings, as well as the amounts of indebtedness, types of financing structures and debt markets that may be available to Knowles.

Knowles’ ability to make payments on and to refinance its indebtedness, including the debt incurred pursuant to the distribution, as well as any future debt that Knowles may incur, will depend on Knowles’ ability to generate cash in the future from operations, financings or asset sales and the tax consequences of Knowles’ repatriation of overseas cash. Knowles’ ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond Knowles’ control. If Knowles is not able to repay or refinance its debt as it becomes due, Knowles may be forced to sell assets or take other disadvantageous actions, including (i) reducing financing in the future for working capital, capital expenditures and general corporate purposes or (ii) dedicating an unsustainable level of Knowles’ cash flow from operations to the payment of principal and interest on Knowles’ indebtedness. In addition, Knowles’ ability to withstand competitive pressures and to react to changes in Knowles’ industry could be impaired. The lenders who hold such debt could also potentially accelerate amounts due, which could potentially trigger a default or acceleration of any of Knowles’ other debt.

In addition, Knowles may increase its debt or raise additional capital following the distribution, subject to restrictions in Knowles’ debt agreements. If Knowles’ cash flow from operations is less than it anticipates, or if Knowles’ cash requirements are more than it expects, Knowles may require more financing. However, debt or equity financing may not be available to Knowles on terms acceptable to Knowles, if at all. If Knowles incurs additional debt or raises equity through the issuance of preferred stock, the terms of the debt or preferred stock issued may give the holders rights, preferences and privileges senior to those of holders of Knowles’ common stock, particularly in the event of liquidation. The terms of the debt may also impose additional and more stringent restrictions on Knowles’ operations than it currently has. If Knowles raises funds through the issuance of additional equity, your percentage ownership in Knowles would be diluted. If Knowles is unable to raise additional capital when needed, it could affect Knowles’ financial condition, which could negatively affect your investment in Knowles. Also, regardless of the terms of Knowles’ debt or equity financing, the amount of Knowles’ stock that it can issue may be limited because the issuance of Knowles’ stock may cause the distribution to be a taxable event for Dover under Section 355(e) of the Code, and under the tax matters agreement, Knowles could be required to indemnify Dover for the resulting tax. See the section entitled “Risk Factors—Risks Relating to the Separation—Knowles may not be able to engage in certain corporate transactions after the separation.”

Until the distribution occurs, Dover has the sole discretion to change the terms of the distribution in ways which may be unfavorable to Knowles.

Until the distribution occurs, Dover will have the sole and absolute discretion to determine and change the terms of the distribution, including the establishment of the record date and distribution date. These changes could be unfavorable to Knowles. In addition, Dover may decide at any time not to proceed with the separation.

Risks Related to Knowles’ Common Stock

Knowles cannot be certain that an active trading market for its common stock will develop or be sustained after the separation, and following the separation, Knowles’ stock price may fluctuate significantly.

A public market for Knowles’ common stock does not currently exist. Knowles anticipates that on or prior to the record date for the distribution, trading of shares of its common stock will begin on a “when-issued” basis

 

38


Table of Contents

and will continue through the distribution date. However, Knowles cannot guarantee that an active trading market will develop or be sustained for its common stock after the separation. Nor can Knowles predict the prices at which shares of its common stock may trade after the separation.

Similarly, Knowles cannot predict the effect of the separation on the trading prices of its common stock. After the separation, Dover’s common stock will continue to be listed and traded on the New York Stock Exchange (“NYSE”) under the symbol “DOV.” Subject to the consummation of the separation, Knowles expects the Knowles common stock to be listed and traded on the NYSE under the symbol “KN.” The combined trading prices of Dover’s common stock and Knowles’ common stock after the separation, as adjusted for any changes in the combined capitalization of these companies, may not be equal to or greater than the trading price of Dover’s common stock prior to the separation. Until the market has fully evaluated the business of Dover without the Knowles businesses, or fully evaluated Knowles, the price at which Dover or Knowles’ common stock trade may fluctuate significantly.

The market price of Knowles’ common stock may fluctuate significantly due to a number of factors, some of which may be beyond Knowles’ control, including:

 

    Knowles’ business profile and market capitalization may not fit the investment objectives of Dover’s current stockholders, causing a shift in Knowles’ investor base, and Knowles’ common stock may not be included in some indices in which Dover’s common stock is included, causing certain holders to sell their shares;

 

    Knowles’ quarterly or annual earnings, or those of other companies in its industry;

 

    the failure of securities analysts to cover Knowles’ common stock after the separation;

 

    actual or anticipated fluctuations in Knowles’ operating results;

 

    changes in earnings estimates by securities analysts or Knowles’ ability to meet those estimates or its earnings guidance;

 

    the operating and stock price performance of other comparable companies;

 

    overall market fluctuations and domestic and worldwide economic conditions; and

 

    other factors described in these “Risk Factors” and elsewhere in this information statement.

Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the trading price of Knowles’ common stock.

In addition, investors may have difficulty accurately valuing Knowles’ common stock. Investors often value companies based on the stock prices and results of operations of other comparable companies. Currently, no public communication technologies company exists in the United States that is directly comparable to Knowles’ size, scale and product offerings. As such, investors may find it difficult to accurately value Knowles’ common stock, which may cause the trading price of Knowles’ common stock to be below its true value.

A number of shares of Knowles’ common stock are or will be eligible for future sale, which may cause Knowles’ stock price to decline.

Any sales of substantial amounts of shares of Knowles’ common stock in the public market or the perception that such sales might occur, in connection with the distribution or otherwise, may cause the market price of Knowles’ common stock to decline. Upon completion of the distribution, Knowles expects that it will have an aggregate of approximately              shares of its common stock issued and outstanding. These shares will be freely tradeable without restriction or further registration under the U.S. Securities Act of 1933, as amended (the “Securities Act”), unless the shares are owned by one of Knowles’ “affiliates,” as that term is defined in Rule 405 under the Securities Act.

 

39


Table of Contents

Knowles is unable to predict whether large amounts of its common stock will be sold in the open market following the distribution. Knowles is also unable to predict whether a sufficient number of buyers would be in the market at that time. A portion of Dover’s common stock is held by index funds tied to stock indices. If Knowles is not included in these indices at the time of distribution, these index funds may be required to sell Knowles’ common stock.

Knowles cannot guarantee the timing, amount, or payment of dividends on its common stock.

The timing, declaration, amount and payment of future dividends to Knowles’ stockholders will fall within the discretion of Knowles’ Board of Directors. The Board of Directors’ decisions regarding the payment of dividends will depend on many factors, such as Knowles’ financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints, and other factors that the Board of Directors deems relevant. For more information, see the section entitled “Dividend Policy.” Knowles’ ability to pay dividends will depend on its ongoing ability to generate cash from operations and access to the capital markets. Knowles cannot guarantee that it will pay a dividend in the future or continue to pay any dividend if Knowles commences paying dividends.

Your percentage of ownership in Knowles may be diluted in the future.

Your percentage ownership in Knowles may be diluted because of equity issuances for acquisitions, capital market transactions or otherwise, including, without limitation, equity awards that Knowles will be granting to its directors, officers and employees. Knowles’ employees will have options to purchase shares of its common stock after the distribution as a result of conversion of their Dover stock options (in whole or in part) to Knowles stock options.

In addition, Knowles’ amended and restated certificate of incorporation will authorize Knowles to issue, without the approval of Knowles’ stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over Knowles’ common stock respecting dividends and distributions, as Knowles’ Board of Directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of Knowles’ common stock. For example, Knowles could grant the holders of preferred stock the right to elect some number of Knowles’ directors in all events or on the happening of specified events or to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences Knowles could assign to holders of preferred stock could affect the residual value of Knowles’ common stock. See the section entitled “Description of Knowles’ Capital Stock.”

Certain provisions in Knowles’ amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of Knowles, which could decrease the trading price of the common stock.

Knowles’ amended and restated certificate of incorporation and amended and restated by-laws will contain, and Delaware law contains, 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 Knowles’ Board of Directors rather than to attempt a hostile takeover. These provisions include, among others:

 

    the inability of Knowles’ 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 Knowles’ Board of Directors to issue preferred stock without stockholder approval;

 

    the division of Knowles’ Board of Directors into three approximately equal classes of directors, with each class serving a staggered three-year term;

 

40


Table of Contents
    a provision that stockholders may only remove directors for cause;

 

    the ability of Knowles’ directors, and not stockholders, to fill vacancies (including those resulting from an enlargement of the Board of Directors) on Knowles’ Board of Directors; and

 

    the requirement that stockholders holding at least 80% of Knowles’ voting stock are required to amend certain provisions in Knowles’ amended and restated certificate of incorporation and Knowles’ amended and restated by-laws.

In addition, following the distribution, Knowles will be subject to Section 203 of the DGCL. Section 203 provides that, subject to limited exceptions, persons that (without prior board approval) acquire, or are affiliated with a person that acquires, more than 15 percent of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliate becomes the holder of more than 15 percent of the corporation’s outstanding voting stock.

Knowles believes these provisions will protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with Knowles’ Board of Directors and by providing Knowles’ Board of Directors with more time to assess any acquisition proposal. These provisions are not intended to make Knowles immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that Knowles’ Board of Directors determines is not in the best interests of Knowles and its stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.

In addition, an acquisition or further issuance of Knowles’ stock could trigger the application of Section 355(e) of the Code. For a discussion of Section 355(e), see the section entitled “Material U.S. Federal Income Tax Consequences.” Under the tax matters agreement, Knowles would be required to indemnify Dover for the tax imposed under Section 355(e) of the Code resulting from an acquisition or issuance of its stock, even if it did not participate in or otherwise facilitate the acquisition, and this indemnity obligation might discourage, delay or prevent a change of control that you may consider favorable.

 

41


Table of Contents

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

This information statement and other materials Dover and Knowles have filed or will file with the SEC contain, or will contain, certain statements regarding business strategies, market potential, future financial performance, future action, results and other matters which are “forward-looking” statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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. Additionally, forward-looking statements include, but are not limited to:

 

    Knowles’ expectations as to future sales of products;

 

    Knowles’ ability to protect its intellectual property in the United States and abroad;

 

    Knowles’ estimates regarding its capital requirements and its needs for additional financing;

 

    Knowles’ estimates of its expenses, future revenues and profitability;

 

    Knowles’ estimates of the size of the markets for its products and services;

 

    Knowles’ expectations related to the rate and degree of market acceptance of its products; and

 

    Knowles’ estimates of the success of other competing technologies that may become available.

In particular, information included under the sections entitled “Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business,” and “The Separation and Distribution” contain 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 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 result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Neither Dover nor Knowles undertakes any obligation to update any forward-looking statement, except as required by applicable law.

 

42


Table of Contents

DIVIDEND POLICY

The timing, declaration, amount, and payment of any dividends following the separation by Knowles is within the discretion of its Board of Directors and will depend upon many factors, including Knowles’ financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of Knowles’ debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets, and other factors deemed relevant by its Board of Directors. Moreover, if Knowles determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends.

 

43


Table of Contents

SELECTED HISTORICAL COMBINED FINANCIAL DATA

The following table presents Knowles’ selected historical combined financial data. Knowles derived the selected historical combined financial data as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 from Knowles’ audited combined financial statements included elsewhere in this information statement. Knowles derived the selected historical combined financial data as of September 30, 2013 and for the nine months ended September 30, 2013 and 2012 from Knowles’ unaudited combined financial statements included elsewhere in this information statement. In the opinion of management, the unaudited combined financial statements as of September 30, 2013 and for the nine months ended September 30, 2013 and 2012 have been prepared on the same basis as the audited combined financial statements and include all adjustments, consisting only of ordinary recurring adjustments, necessary for a fair statement of the information for the periods presented. Knowles derived the selected historical combined financial data as of December 31, 2010, and as of and for the fiscal years ended December 31, 2009 and 2008 from Knowles’ unaudited combined financial statements that are not included in this information statement. In Knowles’ management’s opinion, the unaudited combined financial statements for these periods have been prepared on the same basis as the audited combined financial statements and include all adjustments, consisting only of normal recurring adjustments and allocations, necessary for a fair statement of the information for the periods presented. This section should be read in conjunction with the discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the unaudited pro forma combined financial statements and corresponding notes, the audited combined financial statements and corresponding notes, and the unaudited interim combined financial statements and corresponding notes included elsewhere in this information statement.

The historical financial data includes costs of Knowles’ businesses, which include the allocation of certain corporate expenses from Dover. Knowles believes these allocations were made on a reasonable basis. The selected financial information may not be indicative of Knowles’ future performance as an independent company. To ensure better understanding, you should read the selected combined financial data presented below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the combined financial statements and accompanying notes included elsewhere in this information statement.

 

44


Table of Contents

SELECTED HISTORICAL COMBINED FINANCIAL DATA

(Dollars in thousands)

 

    For the nine months
ended September 30,
    For the years ended December 31,  
    2013     2012     2012     2011 (1)     2010     2009     2008  

Statement of Earnings data:

             

Revenue

  $ 884,468      $ 821,441      $ 1,117,992      $ 983,318      $ 730,444      $ 587,006      $ 630,443   

Operating earnings

    101,809        95,253        136,064        146,404        141,527        78,571        83,577   

Operating margin

    11.5     11.6     12.2     14.9     19.4     13.4     13.3

Net earnings

    72,826        50,670        79,097        98,457        109,272        37,295        33,059   

Adjusted for:

             

Depreciation and amortization

  $ 98,372      $ 83,449      $ 114,878      $ 84,773      $ 54,385      $ 50,678      $ 49,507   

Interest expense, net

    36,184        44,764        56,470        39,892        20,253        21,154        37,510   

Provision for income taxes

    (6,615     47        (181     7,099        7,535        18,478        13,030   

EBITDA (2)

  $ 200,767      $ 178,930      $ 250,264      $ 230,221      $ 191,445      $ 127,605      $ 133,106   

EBITDA margin (2)

    22.7     21.8     22.4     23.4     26.2     21.7     21.1
    As of
September 30,
          As of December 31,  
    2013           2012     2011 (1)     2010     2009     2008  

Balance Sheet Data:

             

Total assets

  $ 2,124,691        $ 2,044,529      $ 2,000,713      $ 1,034,257      $ 1,051,138      $ 1,075,070   

Total third party debt

    —            —          —          —          —          —     

Notes payable to Parent, net

    542,519          528,812        1,419,422        440,486        573,308        611,313   

Total Parent Company equity

    1,297,452          1,188,107        286,650        443,860        330,710        330,874   
    For the nine months
ended September 30,
    For the years ended December 31,  
    2013     2012     2012     2011 (1)     2010     2009     2008  

Other Data:

             

Research and development

  $ 61,955      $ 57,571      $ 77,321      $ 65,895      $ 49,286      $ 45,014      $ 44,769   

Capital expenditures

    59,488        97,339        145,647        96,314        32,920        19,323        27,279   

 

(1) On July 4, 2011, Knowles completed the stock acquisition of the Sound Solutions business line from NXP Semiconductors N.V (“NXP”). The combined statements of earnings and combined balance sheets include the results of operations, net assets acquired and depreciation and amortization expense related to Sound Solutions since the date of acquisition. See Note 4 of the notes to the combined financial statements for additional information related to this acquisition.
(2)

Knowles uses the term “EBITDA” throughout this information statement, defined as net earnings plus (i) depreciation and amortization expense, (ii) interest expense and (iii) income taxes. EBITDA and EBITDA margin (defined as EBITDA as a percentage of revenue) are not presented in accordance with GAAP and may not be comparable to similarly titled measures. Knowles uses EBITDA and EBITDA margin as supplements to its GAAP results of operations in evaluating certain aspects of its business, and its Board of Directors and executive management team focus on EBITDA and EBITDA margin as key measures of Knowles’ performance for business planning purposes. These measures assist Knowles in comparing its performance between various reporting periods on a consistent basis, as these measures remove from operating results the impact of items that, in

 

45


Table of Contents
  Knowles’ opinion, do not reflect its core operating performance. Knowles believes that its presentation of EBITDA and EBITDA margin 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. For a reconciliation of EBITDA to net earnings, the most directly related GAAP measure, please see the table above.

 

46


Table of Contents

UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

The unaudited pro forma combined financial statements of Knowles consist of unaudited pro forma combined statements of earnings for the nine months ended September 30, 2013 and for the fiscal year ended December 31, 2012, and an unaudited pro forma combined balance sheet as of September 30, 2013. The unaudited pro forma combined financial statements reported below should be read in conjunction with Knowles’ “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the historical annual and interim combined financial statements and the corresponding notes included elsewhere in this information statement.

The following unaudited pro forma combined financial statements are subject to assumptions and adjustments described in the accompanying notes. Knowles’ management believes these assumptions and adjustments are reasonable under the circumstances and given the information available at this time. However, these adjustments are subject to change as Dover and Knowles finalize the terms of the separation, including the separation and distribution agreement, related transaction agreements and the debt/equity structure of Knowles. The unaudited pro forma combined financial statements do not purport to represent what Knowles’ financial position and results of operations actually would have been had the separation and distribution occurred on the dates indicated, or to project Knowles’ financial performance for any future period.

The pro forma balance sheet adjustments assume that Knowles’ separation from Dover occurred as of September 30, 2013. The pro forma adjustments to the unaudited pro forma combined statements of income assume that the separation occurred as of January 1, 2012.

The unaudited pro forma combined financial statements give effect to the following:

 

    the contribution by Dover to Knowles, pursuant to the separation and distribution agreement, of all the assets and liabilities that comprise the Knowles business;

 

    the expected transfer to Knowles, upon the spin-off, of certain assets and liabilities that were not included in Knowles’ historical combined financial statements;

 

    for purposes of preparing the unaudited pro forma combined financial information (i) new third party debt incurred by Knowles as of the distribution date is estimated to total $400.0 million at an annual interest rate of LIBOR plus 1.50%, comprised of a $300.0 million five-year senior secured term loan facility and a $200.0 million five-year senior secured revolving credit facility, of which $100.0 million is drawn as of the distribution date and (ii) the amount of the payment from Knowles to Dover prior to the distribution is estimated to be $400 million;

 

    the settlement of $542.5 million of intercompany net notes payable due from Knowles to Dover;

 

    the reclassification of Dover’s remaining net investment in Knowles to additional paid-in capital, and the distribution of approximately 85.2 million shares of Knowles’ common stock at a par value of $0.01 per share; and

 

    the impact of the separation and distribution agreement, tax matters agreement, employee matters agreement and transition services agreement and the provisions contained therein.

Knowles’ historical combined financial statements include expense allocations for certain support functions that are provided on a centralized basis within Dover, such as expenses for business shared services, and other related costs that benefit Knowles. Upon completion of the separation, pursuant to agreements with Dover, Knowles expects that Dover will continue to provide it with some of the services related to these functions on a transitional basis in exchange for agreed-upon fees, and Knowles expects to incur other costs to replace the services and resources that will not be provided by Dover. Knowles will also incur additional costs related to being a stand-alone public company. As a stand-alone public company, Knowles’ total costs related to such support functions may differ from the costs that were historically allocated to it from Dover. Knowles estimates that these costs may exceed the allocated amount for full year 2012 of $26.1 million by a range of approximately

 

47


Table of Contents

$5.0 million to $10.0 million in 2014. Knowles has not adjusted the accompanying unaudited pro forma combined statements of earnings for any of these estimated costs as they are projected amounts based on estimates and, therefore, are not factually supportable.

Additionally, Knowles expects to incur non-recurring spin-off transaction, transition, financing and related costs. The accompanying unaudited pro forma combined statements of earnings have not been adjusted for these estimated expenses as they are not expected to have an ongoing impact on Knowles’ operating results. Knowles anticipates that substantially all of these expenses will be incurred prior to or shortly after the distribution. Due to the scope and complexity of these activities, the amount of these costs could increase or decrease materially and the timing of when they are incurred could change.

 

48


Table of Contents

KNOWLES CORPORATION

UNAUDITED PRO FORMA COMBINED STATEMENT OF EARNINGS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013

(dollars and shares in thousands, except per share amounts)

 

     Historical     Pro Forma
Adjustments
         Pro
Forma
 

Revenue

     884,468      $ —           $ 884,468   

Cost of goods and services

     571,528        —             571,528   
  

 

 

   

 

 

      

 

 

 

Gross profit

     312,940        —             312,940   
         

Selling and administrative expenses

     211,131        —             211,131   
  

 

 

   

 

 

      

 

 

 

Operating earnings

     101,809        —             101,809   
         

Interest expense (income), net and debt expense

     36,184        (30,178   (A)      6,006   

Other expense, net

     (586     —             (586
  

 

 

   

 

 

      

 

 

 

Earnings before provision for income taxes

     66,211        30,178           96,389   

(Benefit from) provision for income taxes

     (6,615     5,702      (B)      (913
  

 

 

   

 

 

      

 

 

 

Net earnings

     72,826        24,476         $ 97,302   
  

 

 

   

 

 

      

 

 

 

Unaudited Pro Forma Earnings Per Share

         

Basic

       (C)    $ 1.13   

Diluted

       (D)    $ 1.12   

Average Number of Shares Used in Calculating Earnings Per Share

         

Basic

       (C)      85,845   

Diluted

       (D)      86,935   

See Notes to Unaudited Pro Forma Combined Financial Statements

 

49


Table of Contents

KNOWLES CORPORATION

UNAUDITED PRO FORMA COMBINED STATEMENT OF EARNINGS

FOR THE YEAR ENDED DECEMBER 31, 2012

(dollars and shares in thousands, except per share amounts)

 

     Historical     Pro Forma
Adjustments
        Pro
Forma
 

Revenue

   $ 1,117,992      $ —          $ 1,117,992   

Cost of goods and services

     711,000        —            711,000   
  

 

 

   

 

 

     

 

 

 

Gross profit

     406,992        —            406,992   

Selling and administrative expenses

     270,928        —            270,928   
  

 

 

   

 

 

     

 

 

 

Operating earnings

     136,064        —            136,064   

Interest expense (income), net and debt expense

     56,470        (47,925   (A)     8,545   

Other expense, net

     678        —            678   
  

 

 

   

 

 

     

 

 

 

Earnings before provision for income taxes

     78,916        47,925          126,841   

(Benefit from) provision for income taxes

     (181     6,989      (B)     6,808   
  

 

 

   

 

 

     

 

 

 

Net earnings

   $ 79,097      $ 40,936        $ 120,033   
  

 

 

   

 

 

     

 

 

 

Unaudited Pro Forma Earnings Per Share

        

Basic

       (C)   $ 1.32   

Diluted

       (D)   $ 1.30   

Average Number of Shares Used in Calculating Earnings Per Share

        

Basic

       (C)     90,775   

Diluted

       (D)     91,996   

See Notes to Unaudited Pro Forma Combined Financial Statements

 

50


Table of Contents

KNOWLES CORPORATION

UNAUDITED PRO FORMA COMBINED BALANCE SHEET

AS OF SEPTEMBER 30, 2013

(dollars in thousands)

 

     Historical      Pro Forma
Adjustments
         Pro Forma  

Current assets:

          

Cash and cash equivalents

   $ 88,590       $ (3,000   (G)    $ 85,590   

Receivables, net of allowances of $1,603

     225,483         —             225,483   

Inventories, net

     149,467         —             149,467   

Prepaid and other current assets

     10,804         —             10,804   

Deferred tax assets

     5,846         —             5,846   
  

 

 

    

 

 

      

 

 

 

Total current assets

     480,190         (3,000        477,190   
  

 

 

    

 

 

      

 

 

 

Property, plant and equipment, net

     354,811         —             354,811   

Goodwill

     955,183         —             955,183   

Intangible assets, net

     319,505         —             319,505   

Other assets and deferred charges

     15,002         3,000      (G)      18,002   
  

 

 

    

 

 

      

 

 

 

Total assets

   $ 2,124,691       $ —           $ 2,124,691   
  

 

 

    

 

 

      

 

 

 

Current liabilities:

     

Accounts payable

   $ 141,330       $ —           $ 141,330   

Accrued compensation and employee benefits

     38,138         —             38,138   

Short-term debt

     —           100,000      (G)      100,000   

Other accrued expenses

     29,942         4,500      (I)      34,442   
  

 

 

    

 

 

      

 

 

 

Total current liabilities

     209,410         104,500           313,910   
  

 

 

    

 

 

      

 

 

 

Notes payable to Parent, net

     542,519         (542,519   (H)      —     

Deferred income taxes

     46,097              46,097   

Long-term debt

     —           300,000      (G)      300,000   

Other liabilities

     29,213         14,698      (E)      43,911   

Net investment/Stockholders’

     

Common stock

     —           852      (F)      852   

Additional paid-in capital

     —           1,403,109      (E)(F)(G)(H)(I)      1,403,109   

Parent Company investment in Knowles Corporation

     1,279,990         (1,279,990 )  

(H)

     —     

Accumulated other comprehensive loss

     17,462         (650   (E)      16,812   
  

 

 

    

 

 

      

 

 

 

Total net investment/Stockholders’ equity

     1,297,452         123,321           1,420,773   
  

 

 

    

 

 

      

 

 

 

Total liabilities and Parent Company equity

   $ 2,124,691       $ —           $ 2,124,691   
  

 

 

    

 

 

      

 

 

 

See Notes to Unaudited Pro Forma Combined Financial Statements

 

51


Table of Contents

KNOWLES CORPORATION

NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS

(Amount in thousands, except where otherwise indicated)

 

(A) The pro forma adjustment to interest expense (income), net and debt expense includes the removal of interest expense of $36.2 million and $56.6 million, for the nine months ended September 30, 2013 and the year ended December 31, 2012, respectively, related to the intercompany net notes payable with Dover that will be settled prior to the distribution date.

In addition, for purposes of preparing the unaudited pro forma combined financial information, Knowles has assumed it will incur new third party indebtedness in the U.S. totaling approximately $400.0 million in conjunction with the separation from Dover. The debt is expected to consist of a senior secured five-year term loan facility in an aggregate principal amount of $300.0 million and a senior secured five-year revolving credit facility in an aggregate principal amount of $200.0 million, of which $100.0 million is drawn as of the distribution date. Interest expense related to the term loan and revolving credit facilities is assumed to be an annual rate of LIBOR plus 1.50% before debt costs and fees, or, approximately $5.3 million or 1.3% and $7.8 million or 2.0% for the nine months ended September 30, 2013 and the year ended December 31, 2012, respectively. Furthermore, Knowles will pay a commitment fee on the average daily unused portion of the revolving facility of approximately 0.25%.

A 1/8% change to the annual interest rate would change interest expense by approximately $0.5 million on an annual basis. Assumed debt costs and initial fees totaling approximately $3.0 million are expected to be amortized over the terms of the associated debt, which is expected to be five years. Actual amounts of debt outstanding, interest expense and other terms of debt may differ from the pro forma adjustments depending on fluctuations in interest rates and/or other variables.

Pro forma interest expense, net for the nine months ended September 30, 2013 and the year ended December 31, 2012 are estimated as follows:

Nine months ended September 30, 2013:

Removal of interest expense related to net notes payable with Dover

   $ (36,176

Addition of nine months of interest expense related to incurrence of $400.0 million at LIBOR plus 1.50%

     5,348   

Addition of amortization of deferred financing costs and commitment fees related to the new indebtedness

     650   

Total pro forma adjustment to Interest expense, net

   $ (30,178

Year ended December 31, 2012:

Removal of interest expense related to net notes payable with Dover

   $ (56,592

Addition of annual interest expense related to incurrence of $400.0 million at LIBOR plus 1.50%

     7,817   

Addition of amortization of deferred financing costs and commitment fees related to the new indebtedness

     850   

Total pro forma adjustment to Interest expense, net

   $ (47,925

 

(B) Adjustments to the statements of earnings for the nine months ended September 30, 2013 and the year ended December 31, 2012 reflect the tax expense computed by applying the statutory income tax rates of the relevant jurisdictions to the pro forma adjustments in Note (A) above in effect at September 30, 2013 and December 31, 2012, respectively, offset by a non-recurring benefit related to the corresponding release of valuation allowance. A zero tax rate has been applied to pro forma adjustments related to the U.S., since Knowles has historically recorded a full valuation allowance in that jurisdiction. The impact of pro forma adjustments on non-current deferred tax assets, adjusted for any related valuation allowances, and liabilities are reflected in Knowles’ historical September 30, 2013 balance sheet based on the tax jurisdiction.

 

52


Table of Contents
(C) The number of Knowles shares used to compute basic earnings per share is based on the number of shares of Knowles’ common stock assumed to be outstanding on the distribution date, based on the number of shares of Dover’s common stock outstanding, assuming a distribution ratio of one share of Knowles common stock for every two shares of Dover common stock outstanding.

 

(D) The number of shares used to compute diluted earnings per share is based on the number of basic shares of Knowles’ common stock and assuming the same distribution ratio, as described in Note (C) above, plus incremental shares assuming exercise of dilutive outstanding options and restricted stock awards. This calculation may not be indicative of the dilutive effect that will actually result from Knowles’ stock-based awards issued in connection with the adjustment of outstanding Dover stock-based awards or the grant of new stock-based awards. The number of dilutive shares of common stock underlying Knowles’ stock-based awards issued in connection with the adjustment of outstanding Dover stock-based awards will not be determined until the distribution date or shortly thereafter.

 

(E) Dover provides to certain management employees a deferred compensation plan, and through a non-qualified plan, supplemental retirement benefits in excess of qualified plan limits imposed by federal tax law. The benefit obligation attributed to Knowles employees upon spin for these plans will be reflected in Knowles’ combined balance sheet as of the distribution date. The benefit plan expense associated with the non-qualified, supplemental plan is included in Knowles’ historical combined statements of operations and is not material.

The pro forma adjustment reflects the addition of the net benefit plan liabilities for the aforementioned deferred compensation plan and the non-qualified, supplemental plan that will be transferred to Knowles by Dover as part of the completion of the separation.

 

Assumed deferred compensation plan and non-qualified, supplemental retirement plan-Impact to 9/30/2013 pro forma balance sheet:

  

Liability assumed by Knowles upon spin

   $ (14,698

Additional paid-in capital

     14,048   

Accumulated other comprehensive loss, net of tax effect

     650   

 

(F) Represents the distribution of approximately 85.2 million shares of Knowles’ common stock at a par value of $0.01 per share, totaling approximately $0.9 million to holders of Dover common stock. The offset to this is recorded in the pro forma adjustment to Additional paid-in capital.

 

(G) Reflects the inclusion of $400.0 million in new indebtedness expected to be incurred by Knowles, as summarized in Note (A) above. The pro forma adjustment also reflects the amortization of deferred financing costs of $3.0 million over a five-year period, as well as the expected distribution of $400.0 million from Knowles to Dover upon separation.

Loans outstanding under the five-year term facility will mature on the fifth anniversary of the debt execution date and, beginning on the first anniversary of the debt execution date, will amortize in equal quarterly installments in annual amounts (expressed as percentages of the loans made under the term facility on the initial funding date of the term facility which will occur immediately prior to the distribution) as set forth below, with the remaining balance due on the final maturity date for the term facility. For purposes of preparing the unaudited pro forma combined financial information, it is assumed that the term loan facility estimated at $300.0 million is a long-term obligation at September 30, 2013 per the amortization schedule below, and the revolving facility estimated at $100.0 million is a short-term obligation.

 

Year after debt execution date

  

Per Annum Amount

1    0.0%
2    5.0%
3    10.0%
4    10.0%
5    10.0%

 

53


Table of Contents
(H) The two equity accounts of additional paid-in capital and Parent Company investment in Knowles Corporation include the following pro forma adjustments to the September 30, 2013 balance sheet:

 

    the settlement of intercompany net notes payable due from Knowles to Dover at September 30, 2013 that will be executed prior to the distribution date;

 

    the distribution of Knowles’ common stock;

 

    the distribution of cash from Knowles to Dover upon separation;

 

    the reclassification of Dover’s remaining net investment in Knowles to additional paid-in capital; and

 

    the adjustment related to the net benefit plans liabilities assumed as noted in note (E) above.

 

Additional paid-in capital pro forma adjustments to 9/30/2013 balance sheet:

  

Settlement of intercompany net notes payable to Dover

   $ (542,519

Distribution of approximately 85.2 million shares of Knowles’ common stock, par value $0.01 per share

     852   

Distribution from Knowles to Dover upon separation

     400,000   

Reclassification of Parent Company remaining net investment in Knowles Corporation

             to additional paid-in capital

     (1,279,990

Net benefit plan liabilities assumed by Knowles (see note (E) above)

     14,048   

Tax liability payable to Dover per tax matters agreement

   $ 4,500   
  

 

 

 

Total, additional paid-in capital pro forma adjustment

   $ (1,403,109
  

 

 

 

 

(I) In connection with the separation, Dover and Knowles will enter into a tax matters agreement which will govern Dover’s and Knowles’ respective rights, responsibilities and obligations after the distribution with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and other matters regarding taxes. In general, each party is responsible for its own taxes after the separation (except that, under certain circumstances, Knowles will be responsible for certain taxes imposed on Dover arising out of the separation and related transactions). For purposes of preparing the unaudited pro forma combined financial information, Knowles has currently estimated that it will have a liability due to Dover for reimbursement for certain tax-related items, as outlined in the tax matters agreement, of approximately $4.5 million, payable within one year from distribution date. This amount, as well as the timing of payment could change.

 

54


Table of Contents

CAPITALIZATION

The following table sets forth Knowles’ capitalization as of September 30, 2013 on a historical basis and on a pro forma basis to give effect to the pro forma adjustments included in Knowles’ unaudited pro forma financial information. See the section entitled “Unaudited Pro Forma Combined Financial Statements” and the related notes thereto. The information below is not necessarily indicative of what Knowles’ capitalization would have been had the separation, distribution and related financing transactions been completed as of September 30, 2013. In addition, it is not indicative of Knowles’ future capitalization. This table should be read in conjunction with the sections entitled “Unaudited Pro Forma Combined Financial Statements,” “Selected Historical Combined Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Knowles’ combined financial statements and notes included elsewhere in this information statement.

 

     As of September 30, 2013  
     (dollars in millions)  
     Actual      Pro Forma  

Cash and cash equivalents:

   $ 88.6       $ 85.6   
  

 

 

    

 

 

 

Debt, including current and long-term:

     

Current debt

   $ —        $ 100.0   

Long-term debt

     —          300.0   

Notes payable to Parent, net

     542.5         —    
  

 

 

    

 

 

 

Total debt

   $ 542.5       $ 400.0   
  

 

 

    

 

 

 

Equity:

     

Common stock, par value $0.01

   $ —        $ 0.9   

Additional paid-in capital

     —          1,403.1   

Parent Company investment in Knowles Corporation

     1,280.0         —    

Accumulated other comprehensive earnings

     17.5         16.8   
  

 

 

    

 

 

 

Total Equity

   $ 1,297.5       $ 1,420.8   
  

 

 

    

 

 

 

Total Capitalization

   $ 1,840.0       $ 1,820.8   
  

 

 

    

 

 

 

Knowles has not yet finalized its post-distribution capitalization. Pro forma financial information reflecting Knowles’ final post-distribution capitalization will be included in subsequent amendments to this information statement.

 

55


Table of Contents

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 the audited combined financial statements and related notes, the unaudited interim combined financial statements and related notes, and the unaudited pro forma combined financial statements and related notes, each included elsewhere in this information statement. 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 information statement, particularly in “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements.” Knowles believes the assumptions underlying the combined financial statements are reasonable. However, the combined financial statements included herein may not necessarily reflect Knowles’ results of operations, financial position and cash flows in the future or what they would have been had Knowles been a separate, stand-alone company during the periods presented.

As explained above, except as otherwise indicated or unless the context otherwise requires, the information included in this discussion and analysis assumes the completion of all the transactions referred to in this information statement in connection with the separation and distribution. Unless the context otherwise requires, references in this information statement to “Knowles Corporation” “Knowles,” “we,” “us,” “our” and “our company” refer to Knowles Corporation and its combined subsidiaries. References in this information statement to “Dover” or “parent” refers to Dover and its combined subsidiaries (excluding Knowles), unless the context otherwise requires.

Management’s discussion and analysis, which Knowles refers to in this information statement as “MD&A,” of Knowles’ results of operations, financial condition and cash flows is provided as a supplement to the audited financial statements and unaudited interim financial statements and footnotes thereto included elsewhere herein to help provide an understanding of Knowles’ financial condition, changes in financial condition and results of Knowles’ operations.

Overview and Outlook

Background

On May 23, 2013, Dover announced its plan to spin-off certain of its communication technologies businesses into a stand-alone, publicly-traded company known as Knowles. Upon completion of the spin-off, Knowles will have an independent technology presence in the communication technologies industry. Knowles will have significant product breadth in acoustic components, including MicroElectroMechanical Systems (“MEMs”) microphones, speakers, receivers and transducers, as well as a competitive position in communication infrastructure components. Knowles will be based in Itasca, Illinois.

The spin-off will be in the form of a distribution of 100% of the shares of common stock of Knowles, which will become an independent, publicly-traded company. The distribution is intended to be tax-free to Knowles, Dover, and its U.S. stockholders. Dover currently expects that the distribution will be completed in the first quarter of 2014. Completion of the transaction is subject to certain conditions, including that (A) Dover will have received either (i) a private letter ruling from the IRS together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, (B) Dover will have received final approval of Dover’s Board of Directors, (C) the NYSE will have approved the listing of Knowles’ common stock, subject to official notice of issuance and (D) that the SEC will have declared

 

56


Table of Contents

effective the registration statement of which this information statement forms a part, and that no stop order relating to such registration statement will be in effect. For a complete discussion of all of the conditions to the distribution, see the section entitled “The Separation and Distribution—Conditions to the Distribution.”

Business Segments

Knowles is 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 FASB ASC Topic 280—Segment Reporting and include i) Mobile Consumer Electronics (“MCE”) and ii) Specialty Components (“SC”). The segments are aligned around similar product applications serving Knowles’ key end markets, to enhance focus on end market growth strategies.

 

    MCE designs and manufactures innovative acoustic products, including microphones, speakers and receivers, used in several applications that serve the handset, tablet and other consumer electronic markets. Locations include the corporate office in Itasca, Illinois; sales, support and engineering facilities in North America, Europe and Asia; and manufacturing facilities in Europe and Asia.

 

    SC specializes in the design and manufacture of specialized electronic components used in medical and life science applications, as well as high-performance solutions and components used in communications infrastructure and a wide variety of other markets. SC’s transducer products are used principally in hearing aid applications within the commercial audiology markets, while its oscillator products predominantly serve the telecom infrastructure market and capacitor products are used in applications including radio, radar, satellite, power supplies, transceivers and medical implants serving the defense, aerospace, telecommunication and life sciences markets. Operating facilities and sales, support and engineering facilities are located in North America, Europe and Asia.

Knowles sells its products directly to original equipment manufacturers (“OEMs”) and to their contract manufacturers and suppliers, and to a lesser extent through distributors worldwide.

Knowles’ Markets and Market Trends

Knowles’ products serve a variety of end markets, notably, consumer mobile devices, medical technology, aerospace and defense and telecom, and can generally be divided into two categories: Acoustic Components and Specialty Components, as described below.

 

    Acoustic Components. Includes analog and digital microphones, MEMs microphones, surface mounted device microphones, receivers, speakers, speaker modules, multi-functional devices, ultrasonic sensors and integrated audio sub-systems.

 

    Specialty Components. Includes transducers, oscillators and capacitors.

The markets served by Acoustic Components continue to be driven by trends in smartphone and tablet innovation and demand. Today, mobile device OEMs are facing ever-rising challenges to differentiate their products in the global marketplace while managing growing cost pressures and time-to-market expectations. However, mobile consumers and mobile carriers alike are expecting better quality voice calls, audio and video conferencing, capturing and playback, media content consumption and gaming, as well as extended battery life. To enable smart mobile devices to handle ever more demanding audio use cases, OEMs are increasingly adopting more intelligent active audio components (audio chipset) and higher performance passive acoustic components. Trends impacting the smartphone market today include:

 

   

Smartphone growth from feature phone substitution. The smartphones segment within the handset device market has exhibited consistently strong unit growth over the past five years (>40% unit volume compound annual growth rate). There continues to be a positive mix shift from the proliferation of lower-end smartphone devices and the further cannibalization of feature phones (i.e., non-smartphones). The average smartphone continues to drive higher audio content including more

 

57


Table of Contents
 

microphones and higher value speakers than its feature phone counterpart, compounding the growth of acoustic content as mobile phone sales rise. As consumers’ demand at the high end of the smartphone market continues, the average selling price (“ASP”) of handset devices is expected to remain constant, supporting the price of superior electronic components.

 

    Smartphone OEM market share shifts are likely to remain volatile for some time. Recently, Nokia and Blackberry have lost significant market share to other U.S. and Asian-based OEMs who have released smartphones that have been more readily accepted due to, among other factors, perceived feature sets and price points. Knowles expects the OEM market to continue to be dynamic over time, characterized by rapid market share shifts driven by new product introductions, price points and feature sets.

 

    New OEM product line rollouts. Smartphones continue to shift to Long Term Evolution (“LTE”), a standard for 4G wireless technology, and the shift is expected to buoy unit growth in developed markets and drive the competitive landscape in high-end chipsets through 2014. Aggressive LTE deployments are expected in China, in addition to a build-out of deeper coverage profiles in the U.S., Japan, Korea and Northern Europe. This will drive an increase in LTE smartphone units over the next five years, which should help maintain some level of high-end smartphone volume growth despite high market penetration.

 

    Shortened smartphone upgrade plans at U.S. carriers. Several U.S. carriers have recently introduced new smartphone plans which offer consumers the option of paying for their phone in monthly installments with no upfront lump sum payment, and the ability to upgrade again in 12 months. Plans such as these could drive greater-than-expected unit growth (turnover) at the high end, as they are most likely to appeal to high-income consumers seeking to upgrade their phone more frequently.

 

    High-end consumer elasticity. Consumers are reluctant to downgrade from a high-end smartphone to a low-end smartphone in most circumstances. This is especially true as high-end smartphones will likely continue to offer significant performance advantages and new functionality compared to low-end smartphones.

 

    Proliferation of premium acoustics with speaker protection. The adoption of boosted audio amplifier with speaker damage protection is increasingly pervasive, driving further speaker-box enhancement and higher dollar content. Also, the widespread adoption of the high definition voice standard by telecom carriers will drive improved quality in audio components. Recently, a key OEM migrated to higher performance audio chipsets, indicating a desire for speaker-box design upgrades (from 3 transducers to 5 transducers) and the adoption of high-definition receivers. Knowles believes other OEMs will follow this trend and adopt improved technology to remain competitive, thus expanding the addressable market.

Specialty Components products are sold across diverse end markets, and relative to the Acoustic Components end markets, portions of this business 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 and expansion, and government contracts. These products can be divided into the following categories:

 

    Medical and life sciences products (i.e., transducers, hearing aids). Product sales are largely driven by aging demographics, healthcare spending, insurance policies, the rise of a middle class in emerging markets and government subsidies.

 

    Aerospace and defense communications (i.e., capacitors). Aerospace and defense spending and automation (largest end market), telecom regional coverage and bandwidth expansion, and growing industrial power supply requirements are a few of the end-market trends driving the product sales in this sector.

 

58


Table of Contents
    Telecom infrastructure (i.e., oscillators). Sales are typically levered to the expansion of large telecom companies, looking to increase wireless signal in new or existing territories, although these products are also sold to aerospace and defense companies (i.e., airplane radio frequencies).

Geographic Trends

Knowles strives to maintain its manufacturing facilities in close proximity to its direct customers. In the case of MCE, Knowles operates four facilities in Asia to serve the contract manufacturers who build OEM equipment on behalf of its end-customers. These contract manufacturers are largely based in China, Taiwan and India. Although end-user demand for consumer electronics is global, and marketing activities occur globally, critical mass for manufacturing is located in Asia, and as a result, a large majority of MCE’s manufacturing capacity is based in Asia, primarily China, Malaysia and the Philippines.

In the case of SC, Knowles operates three facilities in Asia to serve the manufacturing sites of both hearing aid OEMs and the contract manufacturers who build OEM headsets on behalf of earphone makers. These manufacturing sites are based in China, Singapore, Indonesia and Vietnam. Although marketing activities and end-user demand for hearing aid and specialty consumer components is global, critical mass for manufacturing is located in Asia for the purposes of being close to the point of assembly. Knowles also operates three facilities in the United States, one in Mexico, and three in Europe for the manufacturing of capacitors and oscillators that support its global telecom and military customers, as well as their suppliers and contract manufacturers.

While no significant statutory limitation exists, a repatriation of profits from foreign markets to the United States is inherently inefficient, as business expansion opportunities and capital expenditure requirements are expected to be consistent with the needs of Knowles’ direct customer and manufacturing locations.

Competitive Landscape

Success in the electronic components industry is primarily driven by innovation and flexibility as customers compete to gain share of the fast growing handset market. Capturing growth opportunities usually results from competition across both platform and component designs, which supports position, pricing and margins.

Continuous research and development investment allows for the capture of all emerging new brands with early mover advantage. Flexibility in balancing full and semi-automation is a key to achieving a superior cost structure. Additionally, it is important for component vendors to have flexibility and quick time-to-market to meet clients’ needs. Notably, according to industry estimates, the product cycle for handsets has shortened to eight months from two years. Key competitors include:

 

    MCE: AAC Technologies and Goertek

 

    SC: Sonion for hearing health and a highly fragmented set of competitors across capacitor and oscillator products for each end market

In the mobile consumer electronics segment, Knowles’ investments in R&D enable it continually to introduce new products that are higher performance. Knowles’ customers are quickly adopting these higher value microphones, speakers and receivers in their new products as they improve the overall audio performance in the end application, which in turn improves the end user experience. With each successive generation, Knowles’ new products generally have higher average selling prices than the products they are replacing. Once introduced, the pricing for these products follows a normal downward trend as typically seen in the consumer electronics market. To get additional performance gains, OEMs are moving to Knowles’ even higher value integrated audio solutions with microphones and an antenna in a plastic module.

For products that were introduced more than 18 months ago, Knowles has consistently achieved productivity gains through a robust value creation program. Bill of material cost reductions, yield improvements, equipment efficiency and labor reductions are significant drivers in offsetting projected price erosion.

 

59


Table of Contents

In the specialty components segment, the end markets are more stable, and mix of products and customers are drivers of average selling prices and margin.

Expected Growth Dynamics

Acoustic component unit growth is expected to outgrow the underlying handset device industry. Knowles’ management believes that the total addressable market for acoustic components will be $4.7 billion in 2013 and $5.6 billion in 2014. In all, management expects a 14% to 18% compound annual growth rate for acoustic component units for the period from 2013 through 2017. This is higher than the outlook for smartphone and tablet unit growth, reflecting upgraded and additional requirements for acoustic components in smartphone devices, resulting in higher acoustic component content value per device.

Although a view exists that smartphones are being commoditized, implying hardware specifications may be plateauing, management believes there remains significant potential to enhance the user experience through advanced acoustics, whereby the new generation of acoustic components can create a meaningful differentiation without significant incremental cost for handset OEMs. For example, a very popular new OEM product release is equipped with three microphones, up from only two in the previous version, delivering superior noise cancellation with minimal incremental cost to the OEM. In another example, a newly released and well-accepted tablet from an OEM uses four speaker boxes to create a stereo effect and improved bass frequency response, and offers a larger display with better resolution for multimedia functionality. Three primary growth trends are currently driving the smartphone market:

 

    Continued shift in consumer preference from feature phones to smartphones and computers to tablets as consumers’ primary source of media consumption.

 

    Increasing number of microphones and speakers required as well as quality of acoustics demanded in order to sell tablets and smartphones as potential replacements to other mediums for media; recent trends in new OEM product sales indicate that consumers continue to demand more, not fewer, microphones and speakers in their electronic devices.

 

    Combination of new OEM products and potentially shortened contract upgrade plans motivate consumers to more frequently consider the purchase of a new phone, increasing turnover in smartphones and thus additional sales for acoustic component suppliers.

 

    Higher performing content unlocked by audio integration. OEM smartphone and tablet evolution are converging on dynamics for thinner industrial designs, higher performing audio applications, and faster time-to-market product cycles to maintain market leadership. It is anticipated that a deeper collaboration of audio as an optimized subsystem will continue by leveraging acoustic and industrial design together, including integration of electro-mechanical connectivity, into modules for with audio content.

Research and Development

Knowles spends on average 6.5% to 7.5% of revenue on an annual basis on projects intended to preserve and extend Knowles’ technological advantage. Recent research and development investments have been focused on providing better sound quality and increased integration of Knowles’ audio components. Research and development expenses are classified within selling and administrative expense. Knowles spent $77.3 million, $65.9 million and $49.3 million on research and development, or 6.9%, 6.7% and 6.7% as a percentage of revenue, for the years ended December 31, 2012, 2011 and 2010, respectively.

Results

Knowles’ revenue for the first nine months of 2013 increased $63.0 million, or 7.7%, compared to the same period of 2012, primarily due to increased demand for components serving primarily the smartphone market,

 

60


Table of Contents

including an increase in multiple microphone applications and new smartphone models introduced by major OEM customers. This was offset by reduced demand for acoustic components used in specialty headset applications and flat demand for products serving the telecommunication infrastructure market.

Knowles’ 2012 revenue increased $134.7 million, or 13.7%, to $1.1 billion from $983.3 million in 2011. The overall increase in revenue resulted primarily from increased MEMs microphone volumes due to new product introductions and overall smartphone market growth, combined with a full year of revenue for Sound Solutions in 2012 compared to six months of revenue in 2011. Revenue increased 34.6% for 2011 from $730.4 million in 2010, with the majority of the growth attributable primarily to the 2011 acquisition of Sound Solutions, which supplemented its product offerings in the growing handset market.

Other

Knowles is expected to have capital structure, balance sheet and other financial policies consistent with investment-grade credit metrics. The spin-off will allow Knowles to pursue a more aggressive growth strategy, invest to expand technology and manufacturing leadership and continue its commitment to innovation.

Knowles’ combined financial statements have been prepared on a stand-alone basis and are derived from Dover’s consolidated financial statements and accounting records. The combined financial statements represent Knowles’ financial position, results of operations and cash flows as its business was operated as part of Dover prior to the distribution, in conformity with U.S. generally accepted accounting principles. All intercompany transactions between the Knowles entities have been eliminated. Transactions between Knowles and Dover, with the exception of sales transactions and intercompany net notes payable, are reflected in equity in the combined balance sheet as “Parent Company investment in Knowles Corporation” and in the combined statement of cash flows as a financing activity “Net transfers (to) from Parent Company.”

Combined Results of Operations

 

     Nine Months Ended
September 30,
    % / Point
Change
 
     2013     2012     2013 vs.
2012
 

Revenue

   $ 884,468      $ 821,441        7.7

Cost of goods and services

     571,528        528,426        8.2
  

 

 

   

 

 

   

Gross profit

     312,940        293,015        6.8

Gross profit margin

     35.4     35.7     (0.3

Selling and administrative expenses

   $ 211,131      $ 197,762        6.8

Selling and administrative as a percent of revenue

     23.9     24.1     (0.2

Operating earnings

   $ 101,809      $ 95,253        6.9

Operating margin

     11.5     11.6     (0.1

Depreciation and amortization

   $ 98,372      $ 83,449        17.9

Research and development

     61,955        57,571        7.6

Provision for income taxes

   $ (6,615   $ 47        nm   

Effective tax rate

     (10.0 )%      0.1     (10.1

Net earnings

   $ 72,826      $ 50,670        43.7

 

61


Table of Contents
     Years Ended December 31,     % / Point Change  
     2012     2011 (1)     2010     2012 vs.
2011 (1)
    2011 (1)
vs. 2010
 

Revenue

   $ 1,117,992      $ 983,318      $ 730,444        13.7     34.6

Cost of goods and services

     711,000        605,298        395,803        17.5     52.9
  

 

 

   

 

 

   

 

 

     

Gross profit

     406,992        378,020        334,641        7.7     13.0

Gross profit margin

     36.4     38.4     45.8     (2.0     (7.4

Selling and administrative expenses

   $ 270,928      $ 231,616      $ 193,114        17.0     19.9

Selling and administrative as a percent of revenue

     24.2     23.6     26.4     0.6        (2.8

Operating earnings

   $ 136,064      $ 146,404      $ 141,527        (7.1 )%      3.4

Operating margin

     12.2     14.9     19.4     (2.7     (4.5

Depreciation and amortization

   $ 114,878      $ 84,773      $ 54,385        35.5     55.9

Research and development

   $ 77,321      $ 65,895      $ 49,286        17.3     33.7

Provision for income taxes

   $ (181   $ 7,099      $ 7,535        (102.5 )%      (5.8 )% 

Effective tax rate

     (0.2 )%      6.7     6.5     (6.9     0.2   

Net earnings

   $ 79,097      $ 98,457      $ 109,272        (19.7 )%      (9.9 )% 

 

(1) On July 4, 2011, Knowles completed the stock acquisition of the Sound Solutions business line from NXP Semiconductors N.V. (“NXP”). The combined statements of earnings and combined balance sheets include the results of operations, net assets acquired and depreciation and amortization expense related to Sound Solutions since the date of acquisition. See Note 4 of the notes to the combined financial statements for additional information related to this acquisition.

Revenue

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

Knowles’ revenue for the first nine months of 2013 increased $63.0 million, or 7.7%, compared to the same period of 2012, due to an increase in volume of $91.8 million, partially offset by a decrease of $30.1 million related to pricing concessions. Increased demand for components serving primarily the smartphone market, including an increase in multiple microphone applications drove a $30.9 million increase, and new smartphone models introduced by major OEM customers resulted in a $91.8 million increase. The volume increase was partially offset by $27.0 million due to various delays related to OEM smartphone releases in the third quarter, as well as the impact of market share losses by two key smartphone OEM customers, and $4.2 million as a result of reduced demand for acoustic components used in specialty headset applications and flat demand for products serving the telecommunication infrastructure market. Foreign currency translation positively impacted revenue by a negligible amount.

2012 Versus 2011

Knowles’ 2012 revenue increased $134.7 million, or 13.7%, to $1.1 billion from $983.3 million in 2011. The overall increase in revenue resulted primarily from increased MEMs microphone volumes, due to new product introductions and overall smartphone market growth which resulted in an increase in revenue of $89.6 million. In addition, Sound Solutions contributed an increase of $134.0 million in acquisition-related revenue in the first half of 2012 as compared to the first half of 2011. The increase in 2012 revenue was partially offset by $30.8 million as a result of OEM market share shifts for the speaker and receiver product lines, $26.4 million related to pricing concessions for components serving the mobile consumer electronics and medical technology markets corresponding to normal product life cycle maturities within these markets and $25.0 million due to reduced demand within the telecommunications infrastructure market.

 

62


Table of Contents

2011 Versus 2010

Revenue increased $252.9 million, or 34.6%, for 2011 from $730.4 million in 2010, with $190.2 million of the increase in revenue attributable to the 2011 acquisition of Sound Solutions, whose speaker and receiver product lines supplemented Knowles’ existing product offerings in the growing handset market. Organic revenue growth of approximately 9% was largely due to continued strong demand for MEMs microphones for use in the smartphone market, which grew $110.2 million year over year. The increase in 2011 revenue was partially offset by $25.6 million due to strategic pricing initiatives for components serving the mobile consumer electronics and medical technology markets, corresponding to normal product life cycle maturities, as well as $23.6 million due to weak demand for products serving the medical technology and telecommunication infrastructure markets.

Costs of Goods and Services

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

Costs of goods and services for the nine months ended September 30, 2013 increased $43.1 million, or 8.2%, as compared to the comparable prior year period, of which $57.6 million was driven by the higher sales volume and $6.8 million was due to higher restructuring costs. Partially offsetting this increase was a $33.0 million impact of productivity initiatives, primarily due to $24.0 million in lower conversion costs within MCE for MEMs. As a percentage of revenue, costs of goods and services remained consistent across periods at 64.6% and 64.3% for the nine months ended September 30, 2013 and 2012, respectively.

2012 Versus 2011

Costs of goods and services for the year ended December 31, 2012 increased $105.7 million as compared to 2011, or 17.5%, primarily due to the integration of Sound Solutions, reflecting a $116.9 million increase, since 2012 included a full year of costs as compared to a half year in 2011. In addition, increases of $9.5 million and $9.3 million due to the increase in sales volume within MCE and an increase in labor costs resulting from labor inflation in China and Malaysia, respectively, were offset by a $31.6 million decrease as a result of strategic pricing initiatives and lower conversion costs within MCE.

2011 Versus 2010

Costs of goods and services for the year ended December 31, 2011 increased $209.5 million as compared to 2010, or 52.9%, as the integration of the July 2011 Sound Solutions acquisition drove an increase of $154.9 million. The increase in sale volume from the prior year within the MCE segment and labor inflation costs in China and Malaysia resulted in increases of $42.4 million and $2.9 million, respectively. Furthermore, foreign currency translation negatively impacted costs of goods and services by $5.6 million. Partially offsetting the overall increase was a decrease of $9.6 million due to productivity initiatives within MCE.

Gross Profit

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

Gross profit generated in the first nine months of 2013 increased $19.9 million, or 6.8%, compared to the same period of 2012, driven principally by the increase MEMs sales volumes. Gross profit margin remained relatively consistent at 35.4% and 35.7% for the nine months of 2013 and 2012, respectively, as operating leverage from the higher MEMs volumes was offset by additional restructuring costs of $6.8 million and new product ramp up inefficiencies.

2012 Versus 2011

Gross profit in 2012 increased $29.0 million, or 7.7%, as compared to 2011, reflecting the benefit of increased sales volume, while gross profit margin decreased 200 basis points from 38.4% in 2011 to 36.4% in

 

63


Table of Contents

2012. The decline in gross profit margin was attributed to new product ramp up costs and the integration of Sound Solutions, which more than offset the operating leverage achieved by Knowles’ other product lines.

2011 Versus 2010

Gross profit in 2011 increased $43.4 million, or 13.0%, as compared to 2010, resulting from increased sales volume. Gross profit margin decreased 740 basis points compared to 2010, reflecting the impact of aforementioned integration of the Sound Solutions acquisition in 2011 and related increase in depreciation and amortization expense.

Selling and Administrative Expenses

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

Selling and administrative expenses increased $13.4 million in the first nine months of 2013 as compared to the same period of 2012, due principally to higher restructuring charges of $5.6 million incurred in connection with various cost savings initiatives, higher labor costs of $4.0 million due to inflation and an overall increase to support the higher sales volume. As a percentage of revenue, selling and administrative expenses decreased 20 basis points as compared to the prior year period. Included in selling and administrative expenses were corporate allocations of $16.9 million and $19.7 million for the nine months ended September 30, 2013 and 2012, respectively, which represent administration of treasury, employee compensation and benefits, public and investor relations, internal audit, corporate income tax, supply chain and legal services.

2012 Versus 2011

Selling and administrative expenses increased $39.3 million, or 17.0%, in 2012 from $231.6 million in 2011 in order to support higher sales volume. Year over year, selling and administrative expenses as a percentage of revenue increased 60 basis points, as Knowles experienced higher acquisition-related amortization and restructuring charges in 2012 compared to 2011, partially offset by one-time transaction costs of approximately $13.0 million incurred in 2011, in connection with the Sound Solutions acquisition. Included in selling and administrative expenses were corporate allocations of $26.1 million and $21.8 million for the years ended December 31, 2012 and 2011, respectively.

2011 Versus 2010

Selling and administrative expenses increased $38.5 million, or 19.9%, in 2011 compared to 2010 in order to support higher sales volume. As a percentage of revenue, selling and administrative expense decreased 280 basis points, despite higher acquisition amortization and other nonrecurring expenses of approximately $13.0 million in 2011 compared to 2010 related to the Sound Solutions acquisition, reflecting the leverage from higher sales volume. Corporate expense allocations increased $0.5 million from $21.3 million in 2010 to $21.8 in 2011.

Research and Development

Research and development costs are a component of selling and administrative expense. For each of the nine months ended September 30, 2013 and 2012, research and development, as a percentage of revenue, was 7.0%. For the years ended December 31, 2012, 2011 and 2010, research and development, as a percentage of revenue, was 6.9%, 6.7% and 6.7%, respectively. Shorter product life cycles due to the technological nature of Knowles’ business, as well as continued design efforts for new customers, drove continuous product innovation and improvement over these periods as evidenced by several new product introductions by Knowles’ customers and the continued growth in the handset market, particularly in 2012.

 

64


Table of Contents

Operating Earnings

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

Operating earnings increased $6.6 million, or 6.9%, for the first nine months of 2013 as compared to the same period of 2012, as the increase in sales volume more than offset higher restructuring charges of $12.4 million. Operating margin decreased 10 basis points, as operating leverage from the higher MEMs volume was offset by increased costs associated with new product lines.

2012 Versus 2011

Operating earnings in 2012 decreased $10.3 million, or 7.1%, when compared to 2011, and operating margin declined 270 basis points to 12.2% in 2012 from 14.9% in 2011. Higher restructuring costs, the integration of Sound Solutions, including higher acquisition-related amortization expense, and new product ramp up costs drove the decline in operating results. These costs were partially offset by operating leverage of Knowles’ other product lines, as well as the 2011 incurrence of one-time transaction costs of $13.0 million related to the Sound Solutions acquisition.

2011 Versus 2010

Operating earnings in 2011 increased $4.9 million, or 3.4%, when compared to 2010, mainly due to increased sales volume. Operating margin decreased 450 basis points to 14.9% in 2011 from 19.4% in 2010, due to a variety of factors, including higher depreciation and amortization expense of $22.0 million, higher raw material costs and other nonrecurring and integration-related expenses due to the 2011 acquisition of Sound Solutions, including one-time transaction costs of approximately $13.0 million recorded at the Corporate level.

Income Taxes

Knowles is subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining the provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws.

In Knowles’ historical combined financial statements, income tax expense and deferred tax balances have been calculated on a stand-alone basis although Knowles’ operations have historically been included in the tax returns filed by Dover. In the future, as a stand-alone entity, Knowles will file tax returns on its own behalf and its deferred taxes and effective tax rate may differ from those in historical periods.

The effective tax rate for operations was (10.0)% for the nine months ended September 30, 2013 and 0.1% for the nine months ended September 30, 2012. Unfavorable discrete items recognized during the 2012 nine months period totaled $0.4 million. The combined effective tax rate is also impacted by a valuation allowance of $1.2 million and $5.6 million for the nine months ended September 30, 2013 and 2012, respectively, applied against U.S. losses. Excluding discrete items, the comparable effective tax rate was (10.0)% for the nine months ended September 30, 2013 and (0.6)% for the comparable 2012 period.

The effective tax rates for the years ended December 31, 2012, 2011 and 2010 were (0.2)%, 6.7% and 6.5%, respectively. The 2010 rate was favorably impacted by net discrete items of $8.4 million, principally related to non-U.S. items. For the years ended December 31, 2012, 2011 and 2010, the non-U.S. income tax rates were (1.2)%, 3.9% and 11.2% respectively.

Knowles reflects a low or negative effective tax rate due to a non-U.S. operation where income is taxed at a low rate due to a significant tax holiday granted to Knowles by Malaysia effective through December 31, 2021 subject to Knowles’ satisfaction of certain conditions that Knowles expects to continue to satisfy, and where the tax benefit of losses that are expected to be realized accrue in higher tax rate jurisdictions. The benefit of this

 

65


Table of Contents

incentive in Malaysia for the nine months ended September 30, 2013 and 2012 is estimated to be approximately $22.0 million and $23.0 million, respectively, and $45.0 million, $25.5 million and $20.4 million, for the years ended December 31, 2012, 2011 and 2010, respectively. Knowles also has tax incentives in other jurisdictions that are not material to its overall tax rate. The combined effective tax rate is also impacted by the valuation allowance applied against U.S. losses.

Restructuring Charges

Knowles undertakes restructuring programs from time to time to better align its operations with current market conditions. Such activities include targeted facility consolidations, headcount reductions and other measures to further optimize operations. Details regarding restructuring programs undertaken during the reporting period are as follows:

Nine Months Ended September 30, 2013

During the nine months ended September 30, 2013, Knowles had restructuring programs underway to reduce headcount in connection with integration activities within its consumer electronics business, to reduce headcount within its German and North American operations that serve the telecom infrastructure market in order to better align the business with current market dynamics and to continue the migration of its U.K.-based capacitor production into existing Asian manufacturing facilities. Knowles expects to incur full-year 2013 restructuring expenses of approximately $17.0 million related to these programs, of which approximately $14.8 million was incurred during the nine months ended September 30, 2013.

2012

In 2012, Knowles incurred charges totaling $5.9 million, relating to the integration of its dynamic speaker and receiver businesses, continuation of the consolidation of the oscillator facility, and the initiation of a new program to migrate its U.K.-based capacitor production to lower-cost existing facilities in Asia.

2011

In 2011, in response to the slow global economic environment, and in particular, the weakened telecommunications market, Knowles’ incurred charges totaling $1.8 million in connection with two U.S. facility consolidations in the capacitor and oscillator business.

2010

In 2010, Knowles’ incurred restructuring charges totaling $0.2 million relating to the closure of a European facility within MCE, in connection with a customer phase out of a product line. The closure commenced in 2009 and was finalized in 2010.

Segment Results of Operations

The summary that follows provides a discussion of the results of operations of both reportable segments (Mobile Consumer Electronics (“MCE”) and Specialty Components (“SC”)). See Note 16 to the Combined Financial Statements for the years ended December 31, 2012, 2011 and 2010, and Note 13 for the nine months ended September 30, 2013 and 2012, for a reconciliation of segment revenue, segment earnings before interest, taxes, depreciation and amortization (EBITDA), and operating margin to Knowles’ combined results.

Knowles evaluates business segment performance on EBITDA (Segment EBITDA) and EBITDA margin, defined as net earnings plus (i) depreciation and amortization expense, (ii) interest expense and (iii) income taxes, and EBITDA as a percentage of revenue, respectively. The costs of certain shared resources are allocated between segments based on each segment’s estimated usage of the shared resources. Other indirect items that are maintained at the corporate level and are not allocated to the segments include executive and functional compensation costs and other administrative expenses relating to the corporate headquarters.

 

66


Table of Contents

Certain non-GAAP measures used by Knowles to measure performance include bookings and book to bill ratio. Bookings represent the number of customer orders for a particular period. The book to bill ratio is used as an indicator of demand versus supply, and it compares the total amount of orders received relative to revenues for the corresponding period. Knowles believes that both of these non-GAAP measures provide Knowles and its investors an indication of its performance and outlook. A ratio of above 1.0 implies that more orders were received than filled, indicating strong customer demand, while a ratio below 1.0 implies weaker customer demand.

Mobile Consumer Electronics

 

     Nine Months Ended
September 30,
       
     2013     2012     2013 vs. 2012  

Revenue

   $ 559,234      $ 489,396        14.3

Operating earnings

   $ 86,425      $ 67,355        28.3

Other expense

     (805     (1,561     (48.4 )% 

Depreciation and amortization

     75,301        58,170        29.4
  

 

 

   

 

 

   

EBITDA

   $ 160,921      $ 123,964        29.8
  

 

 

   

 

 

   

Operating margin

     15.5     13.8  

EBITDA margin

     28.8     25.3  

Other measures:

      

Research and development

   $ 39,544      $ 34,503        14.6

Bookings

     601,611        515,341        16.7

Book to bill ratio

     1.08        1.05     

 

     Years Ended December 31,     % Change  
     2012     2011     2010     2012 vs. 2011     2011 vs. 2010  

Revenue

   $ 670,358      $ 509,916      $ 226,201        31.5     125.4

Operating earnings

   $ 102,742      $ 106,224      $ 70,506        (3.3 )%      50.7

Other expense

     (2,334     (477     (632     389.3     (24.5 )% 

Depreciation and amortization

     79,668        49,076        18,721        62.3     162.1
  

 

 

   

 

 

   

 

 

     

EBITDA

   $ 180,076      $ 154,823      $ 88,595        16.3     74.8
  

 

 

   

 

 

   

 

 

     

Operating margin

     15.3     20.8     31.2    

EBITDA margin

     26.9     30.4     39.2    

Other measures:

          

Research and development

   $ 46,243      $ 36,021      $ 17,198        28.4     109.4

Bookings

     673,406        503,344        247,362        33.8     103.5

Book to bill ratio

     1.00        0.99        1.09       

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

MCE’s revenue for the nine months ended September 30, 2013 increased by $69.8 million, or 14.3%, compared to the same period of 2012. Revenue increased approximately $96.0 million on higher volumes, partially offset by a $27.4 million unfavorable impact from pricing. Foreign currency translation had a negligible favorable impact in the current year period. The volume increase resulted primarily from strong demand for components serving the smartphone market, resulting in a $30.9 million increase, including the continued trend for multi-microphone product offerings, with key OEM customers incorporating up to three microphones per device. New smartphone product launches continued to drive a significant portion of the MCE volume growth, driving an increase of $91.8 million. The volume increase was partially offset by various delays related to OEM smartphone releases in the third quarter, as well as the impact of market share losses by two key smartphone OEM customers, causing a decrease of $27.0 million.

 

67


Table of Contents

Operating earnings increased $19.1 million, or 28.3%. The increase in earnings and margin was primarily driven by higher volumes, attributing $42.0 million of the increase as compared to the prior year period, as well as benefits from productivity initiatives and recent restructuring actions, attributing approximately $27.8 million of the increase. These improvements more than offset the impacts of: pricing concessions, that resulted in an earnings decline of $27.4 million, higher restructuring charges of $7.3 million relating to cost reduction actions in the speaker and receiver facilities, higher investment in research and development of $5.0 million and higher labor costs due to inflation in China and Malaysia of $4.5 million.

EBITDA for the nine months ended September 30, 2013 increased $36.9 million, or 29.8%, compared to the same period of 2012, while EBITDA margin increased 350 basis points, driven by the same factors that drove the increase in operating earnings.

Bookings for the nine months ended September 30, 2013 increased 16.7% reflecting strong demand for components serving the smartphone market in response to OEM new product introductions in the third quarter.

2012 Versus 2011

MCE’s 2012 revenue increased $160.4 million, or 31.5%, when compared to 2011, as increased demand for MEMs microphone volumes due to new OEM product introductions and overall smartphone market growth increased volume by $68.0 million and $21.6 million, respectively. In addition, Sound Solutions contributed an increase of $134.0 million in acquisition-related revenue in the first half of 2012 as compared to the first half of 2011. Knowles’ revenue growth was tempered in part by OEM market share shifts for the speaker and receiver product lines, which partially offset the increase in revenue by $30.8 million. The 2012 revenue increase was also partially offset by $19.9 million due to pricing concessions corresponding to normal product life cycle maturities, as well as a $6.0 million unfavorable foreign currency impact.

Operating earnings decreased $3.5 million, as the higher sales volume of $39.6 million due to the aforementioned drivers, as well as productivity initiatives that resulted in efficiencies of $29.3 million as compared to 2011, were offset by pricing concessions of $19.9 million, higher depreciation and amortization expense of approximately $10.6 million related to the acquisition of Sound Solutions, coupled with one-time costs related to new product ramp up and higher labor costs due to inflation and China and Malaysia of $6.0 million. Operating margin decreased as the increase in new OEM product introductions and overall smartphone growth drove a decline of 550 basis points.

EBITDA increased $25.3 million, or 16.3%, in 2012, and EBITDA margin decreased, as the impact of the pricing concessions, new product ramp-up costs and higher labor costs as previously noted drove a decline of 350 basis points.

The 33.8% increase in 2012 bookings from the prior year reflects inclusion of a full year of Sound Solutions bookings, as well as continued strength for acoustic products serving the smartphone market. Overall, Knowles’ MEMs microphones remain well-positioned to capitalize on this market’s growth as Knowles has continued to invest in capacity to meet the growing market demands.

2011 Versus 2010

MCE’s 2011 revenue increased $283.7 million, or 125.4%, when compared to 2010, with $190.2 million of the increase attributed to the July 2011 acquisition of Sound Solutions, which supplemented its product offerings in the growing handset market.

In addition, multi-microphone product offerings drove the increase in revenue by approximately $110.2 million. The 2011 revenue increase was partially offset by $16.3 million for pricing concessions corresponding to normal product life cycle maturities. Excluding Sound Solutions, segment revenue increased $93.5 million, or approximately 41.0%. The organic revenue growth resulted primarily from increased MEMs microphone volumes due to new product introductions and overall smartphone market growth.

 

68


Table of Contents

Operating earnings increased $35.7 million, or 50.7%, as the increase in sales volume due to the aforementioned drivers and the acquisition of Sound Solutions increased operating earnings by $63.6 million and $18.0 million, respectfully. Partially offsetting the increase to operating earnings was the impact of pricing concessions of $16.3 million and lower margins resulting from the integration of the acquired speaker and receiver product lines, as well as higher depreciation and amortization expense of $21.1 million primarily related to the acquisition of Sound Solutions.

EBITDA increased $66.2 million, or 74.8%, and EBITDA margin decreased 880 basis points due to the aforementioned drivers.

Bookings in 2011 reflect the continued strength for acoustic products serving the smartphone market, coupled with the incremental bookings generated by Sound Solutions.

Specialty Components

 

     Nine Months Ended
September 30,
       
     2013     2012     2013 vs. 2012  

Revenue

   $ 325,273      $ 332,088        (2.1 )% 

Operating earnings

   $ 45,763      $ 60,322        (24.1 )% 

Other income

     1,860        677        174.7

Depreciation and amortization

     21,325        23,944        (10.9 )% 
  

 

 

   

 

 

   

EBITDA

   $ 68,948      $ 84,943        (18.8 )% 
  

 

 

   

 

 

   

Operating margin

     14.1     18.2  

EBITDA margin

     21.2     25.6  

Other measures:

      

Research and development

   $ 22,411      $ 23,068        (2.8 )% 

Bookings

     331,563        336,290        (1.4 )% 

Book to bill ratio

     1.02        1.01     

 

     Years Ended December 31,     % Change  
     2012     2011     2010     2012 vs. 2011     2011 vs. 2010  

Revenue

   $ 447,691      $ 473,472      $ 504,309        (5.4 )%      (6.1 )% 

Operating earnings

   $ 77,156      $ 95,732      $ 111,830        (19.4 )%      (14.4 )% 

Other income (expense)

     (106     643        (4,605     (116.5 )%      (114.0 )% 

Depreciation and amortization

     33,399        33,262        33,322        0.4     (0.2 )% 
  

 

 

   

 

 

   

 

 

     

EBITDA

   $ 110,449      $ 129,637      $ 140,547        (14.8 )%      (7.8 )% 
  

 

 

   

 

 

   

 

 

     

Operating margin

     17.2     20.2     22.2    

EBITDA margin

     24.7     27.4     27.9    

Other measures:

          

Research and development

   $ 31,078      $ 29,874      $ 32,088        4.0     (6.9 )% 

Bookings

     447,370        470,032        511,609        (4.8 )%      (8.1 )% 

Book to bill ratio

     1.00        0.99        1.01       

Nine Months Ended September 30, 2013 Versus Nine Months Ended September 30, 2012

SC’s revenue for the nine months ended September 30, 2013 decreased by $6.8 million, or 2.1%, compared to the same period of 2012, due to a $4.2 million decrease in volume, primarily due to weakness in the domestic military markets resulting from governmental funding uncertainties and reduced demand for Knowles’ acoustic components used in specialty headset applications due to overstock and inventory corrections by the OEM customers, offset in part by modest demand for acoustic components serving the hearing technologies market.

 

69


Table of Contents

The telecom markets were sluggish through the first half of 2013, but improved in the third quarter due to higher demand from telecom customers serving the anticipated build-out of wireless infrastructure in China. In addition, pricing concessions drove a decline in revenue as compared to the prior year period of $2.8 million.

Operating earnings for the nine months ended September 30, 2013 decreased $14.6 million, or 24.1%, compared to the same period of 2012, and operating margin decreased 410 basis points. The decrease in earnings and margin was driven by lower volumes of $7.8 million, wage inflation in Knowles’ Asian workforce of $6.9 million, $2.8 million in pricing concessions and $5.1 million in higher restructuring charges relating to the continued migration of the segment’s U.K.-based capacitor production into existing Asian manufacturing facilities and headcount reductions within the segment’s German and North American operations that serve the telecom infrastructure market to better align the operations with current market dynamics. The decrease in operating earnings was partially offset by productivity initiatives, as the benefits of the aforementioned restructuring programs and other strategic initiatives resulted in an increase to operating earnings of $8.6 million.

EBITDA decreased $16.0 million as compared to the prior year period, or 440 basis points, due to the drivers impacting operating earnings.

Bookings for the nine months ended September 30, 2013 decreased 1.4% reflecting reduced demand for audio components serving the commercial headset market and soft demand for specialty components serving the telecommunication and defense markets. Bookings for audio components serving the medical technology market remained steady year-over-year.

2012 Versus 2011

SC’s 2012 revenue decreased $25.8 million, or 5.4%, when compared to 2011, due mainly to lower sales volumes of components serving the telecommunication infrastructure market, resulting in a decrease of approximately $25.0 million driven in part by continued deferral of investment in upgrades to telecom networks by the major telecom equipment providers, as well as pricing concessions on components used in older OEM models, resulting in a decrease in revenue of approximately $6.5 million. The volume decline in components serving the telecom markets was offset in part by volume growth in components serving the medical technology market, including growth from new products and modest market growth, driving an increase in revenue as compared to the prior year of $10.3 million.

Operating earnings decreased $18.6 million as compared to 2011, and operating margin declined 300 basis points. The decline in revenue and pricing concessions drove decreases of $6.6 million and $6.5 million, respectively. Additionally, $2.8 million in higher restructuring costs relating to the consolidation of U.S. oscillator production facilities, coupled with $3.6 million higher labor costs due to labor inflation in Asia, contributed to the decline in earnings and the reduction in operating margin. A favorable foreign currency impact slightly offset the decreases in earnings.

EBITDA decreased $19.2 million, or 14.8%, reflecting the factors that drove the decline in operating earnings.

The decrease in bookings reflects moderate industry growth for medical technology components, which was more than offset by reduced demand for products serving the telecommunications market.

2011 Versus 2010

SC’s 2011 revenue decreased $30.8 million, or 6.1%, when compared to 2010, attributed mainly to weak market demand for telecommunication infrastructure products due to delays brought about by potential mergers of telecom equipment providers and slower than expected adoption of 3G and 4G in China, coupled with weak demand for products serving the medical technology market due to customer inventory issues early in 2011,

 

70


Table of Contents

which drove a decrease in volume of $23.6 million. In addition, pricing concessions on acoustic and oscillator components used in older OEM models resulted in a decrease in revenue of $9.3 million. A favorable foreign currency impact of $2.5 million partially offset the decline in revenue as compared to the prior year.

Operating earnings decreased $16.1 million, or 14.4%, reflecting the impacts of lower sales volumes and pricing concessions as previously noted. Operating margin decreased 200 basis points reflecting under absorption of overhead within Knowles’ business lines serving the telecom market, as well as higher material costs and unfavorable mix within Knowles’ capacitor businesses.

EBITDA declined $10.9 million, or 7.8% when compared to the prior year, due to the impact of the same factors that drove the decrease in operating earnings.

SC’s 2011 bookings reflect the impact of customer inventory corrections, which contributed to lower medical technology orders, as well as reduced demand for products serving the telecommunications market.

Financial Condition

Historically, Knowles has generated and expects to continue to generate positive cash flow from operations. Cash flows related to financing activities reflect changes in Dover’s investment in Knowles. Transfers of cash to and from Dover are reflected as a component of “Parent Company investment in Knowles Corporation” in the combined balance sheets.

Subsequent to the separation, Knowles will no longer participate in cash management and funding arrangements with Dover. Historically, Knowles has utilized these arrangements to fund significant expenditures, such as manufacturing capacity expansion and acquisitions. Knowles’s ability to fund its operations and capital needs will depend on its ongoing ability to generate cash from operations and access to capital markets. Knowles believes that its future cash from operations and access to capital markets will provide adequate resources to fund its working capital needs, dividends (if any), capital expenditures, and strategic investments. It is anticipated that Knowles will secure a revolving line of credit in the U.S. from a syndicate of commercial banks to provide additional liquidity. Furthermore, if Knowles were to require additional cash in the U.S. above and beyond its domestic cash on the balance sheet, the free cash flow generated by the domestic businesses and availability under its anticipated revolver, Knowles would most likely raise long-term financing through the U.S. debt or bank markets.

Knowles’ ability to make payments on and to refinance its indebtedness, including any third party debt incurred pursuant to the distribution, as well as any debt that Knowles may incur after the distribution, will depend on its ability in the future to generate cash from operations, financings or asset sales and the tax consequences of Knowles’ repatriation of overseas cash. Due to the global nature of Knowles’ operations, a significant portion of its cash is held outside the Unites States. Knowles’ cash and cash equivalents totaled $88.6 million and $10.3 million at September 30, 2013 and December 31, 2012, respectively. Of these amounts, cash held by Knowles’ non-U.S. operations totaled $74.8 million and $10.3 million as of September 30, 2013 and December 31, 2012, respectively.

Knowles holds the vast majority of its cash and operating cash flows outside the U.S., since this cash is needed by its foreign subsidiaries to fund its capital expenditures and growth plans, as Knowles’ manufacturing locations are based outside of the United States. Knowles has not provided income taxes on $1.6 billion of undistributed earnings of foreign subsidiaries, because it intends to permanently reinvest these earnings outside the U.S.

Knowles generates cash flow in the U.S. primarily through ongoing product sales, management fees and royalty income, and Knowles utilizes cash in the U.S. primarily for expenses relating to operations and corporate functions, including management, administration and research and development. Knowles has generated approximately $27 million, $16 million and $23 million of cash flow in the U.S. during the years ended

 

71


Table of Contents

December 31, 2012, 2011 and 2010, respectively, which has been sufficient to meet its domestic cash needs in each such year, as most of its capital expenditures and expenses occurred outside of the United States during those years. U.S. cash flow is not presented in accordance with GAAP and is defined as operating cash flow, generated within the U.S. which includes corporate expense allocations, but excludes net U.S. interest expense related to intercompany notes payable with Dover of $22.1 million, $21.6 million and $22.1 million as of December 31, 2012, 2011 and 2010, respectively. U.S. cash flow amounts exclude U.S. interest expense related to intercompany net notes payable to Dover, as it is management’s intention to settle these notes prior to the distribution date, and these amounts are not necessarily representative of interest payments related to the future debt of Knowles. Knowles projects that its cash generation within the U.S. for the foreseeable future will be self-sustaining to meet all estimated U.S. expenditures and, as such, Knowles does not anticipate the need to repatriate the earnings of its foreign subsidiaries in order to satisfy its domestic cash needs, including the service of any third party debt incurred in the United States.

Knowles management will continue to reassess its need to repatriate the earnings of its foreign subsidiaries.

Cash Flow Summary

 

     Nine Months Ended
September 30,
    Years Ended December 31,  

(dollars in thousands)

   2013     2012     2012     2011     2010  

Net Cash Flows Provided By (Used In):

          

Operating activities

   $ 95,560      $ 79,169      $ 189,556      $ 182,926      $ 154,645   

Investing activities

     (59,661     (63,567     (115,603     (917,033     (29,243

Financing activities

     41,953        (32,807     (90,037     759,693        (134,700

Operating Activities

Cash provided by operating activities for the nine months ended September 30, 2013 increased $16.4 million from the comparable prior year period, primarily attributable to an increase in net earnings of $22.2 million driven by the higher sales volume due to increased demand for components serving primarily the smartphone market and new product introductions by OEMs, as well as a $14.9 million increase in depreciation and amortization due to capital investments in property, plant and equipment related to the ramp up for new product introductions. The increase in operating cash flows as compared to the prior year period was partially offset by higher investments in adjusted working capital of $23.6 million (calculated as accounts receivable, plus inventory, less accounts payable), primarily due to the timing of vendor payments for the electronics and acoustics markets, causing a $36.0 million decrease in accounts payable.

Cash provided by operating activities in 2012 increased $6.6 million compared to 2011, largely driven by higher depreciation and amortization of $30.1 million for the current year period due to higher acquisition-related amortization expense and investments to support growth and new product introductions. Partially offsetting this increase was the increased investment in adjusted working capital of $5.7 million due to timing of customer payments, and lower net earnings resulting from higher restructuring costs and the integration of Sound Solutions.

Cash provided by operating activities in 2011 increased $28.3 million from the prior year period, primarily due to higher net earnings before depreciation and amortization of $19.6 million, primarily as a result of the integration of Sound Solutions in 2011.

Knowles has outstanding intercompany net notes payable with Dover and its affiliates of $542.5 million, $528.8 million and $1,419.4 million at September 30, 2013, December 31, 2012 and December 31, 2011, respectively, which were put in place to fund the business over a defined period of time. The change in 2012 as compared to 2011 represents the repayment of the loan between Dover and Knowles related to an intercompany

 

72


Table of Contents

agreement whereby Dover loaned Knowles funds for the 2011 acquisition of Sound Solutions. The loan was established in July 2011 and repaid to Dover in September 2012; therefore, Knowles recognized interest expense on the note in 2012 until the time of repayment. Net interest expense on these notes, as reflected in operating activities as a reduction in net earnings, totaled $36.2 million and $44.8 million for the nine months ended September 30, 2013 and 2012, respectively, and is included in “Interest expense, net” in the combined statement of earnings. Net interest expense on these notes totaled $56.6 million, $39.9 million and $20.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. It is management’s intention to settle these notes prior to the distribution date, and these amounts are not necessarily representative of interest payments related to the future debt of Knowles.

Investing Activities

Cash used in investing activities results primarily from cash outflows for capital expenditures and the Sound Solutions acquisition, partially offset by a related purchase price adjustment, proceeds from the sale of property, plant and equipment and the capitalization of patent defense costs.

Acquisition of Sound Solutions. On July 4, 2011, Knowles completed the stock acquisition of the Sound Solutions business line from NXP Semiconductors N.V. The purchase price of $855.0 million was funded through an intercompany loan agreement and was subject to working capital and other contractual adjustments. Knowles received approximately $22.0 million from NXP in 2011 as settlement for working capital and other contractual adjustments and an additional $45.0 million in 2012, reflecting purchase price adjustments for post-acquisition contingencies. These amounts resulted in cash inflows of approximately $45.0 million for the nine months ended September 30, 2012 and the year ended December 31, 2012, and net cash outflows of $824.3 million for the year ended December 31, 2011, net of cash acquired.

Capital spending. Capital expenditures, primarily to support capacity expansion, innovation and cost savings, were $59.5 million and $97.3 million, or 6.7% and 11.8% as a percentage of revenue, for the nine months ended September 30, 2013 and 2012, respectively. Expenditures for the years ended December 31, 2012, 2011 and 2010 were $145.6 million, $96.3 million and $32.9 million, or 13.0%, 9.8% and 4.5% as a percentage of revenue, respectively. The higher capital expenditures in 2012 reflected Knowles’ continued investment in capacity expansion to support growth in the handset market with significant investments to increase MEMs manufacturing capacity in its domestic and Asian facilities. A large driver of the 2013 capital expenditures has been the construction and customization of a new manufacturing facility in Cebu, Philippines. When operational in 2014, this 215,000 square foot facility will support several growth and productivity initiatives for Knowles. Knowles expects full-year 2013 capital expenditures to approximate 8.0% of revenues.

Capitalization of patent defense costs. Knowles capitalizes external legal costs incurred in the defense of its patents when it is believed 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 seven to ten years. During the nine months ended September 30, 2013 and 2012, Knowles capitalized $5.1 million and $10.9 million, respectively, in gross legal costs related to the defense of its patents. During the year ended December 31, 2012, Knowles capitalized approximately $13.9 million in gross legal costs related to the defense of its patents.

Financing Activities

Change in borrowings, net. The change in Knowles’ outstanding notes payable with Dover and its affiliates is reflected in the combined statement of cash flows as a financing activity in “Change in borrowings, net.” Management intends to settle these notes prior to the distribution date. The change in 2011 as compared to 2010 primarily relates to an intercompany agreement whereby Dover loaned Knowles funds for the 2011 acquisition of Sound Solutions. The change in 2012 as compared to 2011 represents the repayment of the aforementioned loan between Dover and Knowles.

 

73


Table of Contents

Since there are no securities being sold in the distribution, Knowles will not receive any proceeds in connection with the distribution. To the extent Knowles sells any common stock after the distribution date, Knowles will classify the net proceeds received from such offering as cash received from financing activities. In addition, if and to the extent that employees exercise Knowles stock options or other Knowles equity-based awards following the distribution date, the proceeds, if any, received by Knowles from those exercises will be classified as cash received from financing activities. Near term, cash generated from the exercise of stock options is not expected to be material to Knowles’ combined cash flows.

Knowles intends to enter into certain financing arrangements prior to or in connection with the separation. For purposes of preparing the unaudited pro forma combined financial information as included elsewhere in this information statement, Knowles has currently assumed that new indebtedness in the U.S. with lending institutions totals approximately $370.0 million to $420.0 million. Knowles expects the new indebtedness to be in the form of a five-year senior secured term loan facility totaling $300.0 million, and a five-year senior secured revolving facility totaling $200.0 million, of which $100.0 million will be drawn.

Liquidity and Capital Resources

Free Cash Flow

In addition to measuring Knowles’ cash flow generation and usage based upon the operating, investing and financing classifications included in the combined statements of cash flows, Knowles also measures free cash flow and free cash flow as a percentage of revenue. Free cash flow is calculated as cash flow provided by operating activities less capital expenditures. Knowles’ management believes these measures are useful in measuring its cash generated from operations, and cash generated from operations as a percentage of revenue, 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 revenue are not presented in accordance with GAAP and may not be comparable to similarly titled measures used by other companies in Knowles’ industry. As such, free cash flow and free cash flow as a percentage of revenue should not be considered in isolation from, or as an alternative to, any other performance measures determined in accordance with GAAP.

Knowles’ businesses, while not having significant seasonality, tend to have stronger revenue in the third and fourth quarters of each fiscal year. This is particularly true of those businesses that serve the consumer electronics market. Knowles’ 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 Knowles’ free cash flow to cash flow provided by operating activities:

 

     Nine Months Ended September 30,  
     2013        2012  

Free Cash Flow (dollars in thousands)

  

Cash flow provided by operating activities

   $     95,560         $     79,169   

Less: Capital expenditures

     (59,488        (97,339
  

 

 

      

 

 

 

Free cash flow

   $ 36,072         $ (18,170
  

 

 

      

 

 

 

Free cash flow as a percentage of revenue

     4.1        (2.2 )% 
  

 

 

      

 

 

 

 

     Years Ended December 31,  
     2012     2011     2010  

Free Cash Flow (dollars in thousands)

      

Cash flow provided by operating activities

   $ 189,556      $ 182,926      $ 154,645   
      

Less: Capital expenditures

     (145,647     (96,314     (32,920
      
  

 

 

   

 

 

   

 

 

 

Free cash flow

   $ 43,909      $ 86,612      $ 121,725   
  

 

 

   

 

 

   

 

 

 

Free cash flow as a percentage of revenue

     3.9     8.8     16.7
  

 

 

   

 

 

   

 

 

 

 

74


Table of Contents

Knowles generated positive free cash flow for the nine months ended September 30, 2013 of $36.1 million, as compared to negative free cash flow of $18.2 million for the same period of 2012. This increase in free cash flow is primarily the result of higher net earnings and lower capital investments in 2013 as compared to 2012.

In 2012, Knowles generated free cash flow of $43.9 million, representing 3.9% of revenue and 55.5% of net earnings. Free cash flow in 2011 was $86.6 million, or 8.8% of revenue, compared to $121.7 million, or 16.7% of revenue, for 2010. The decrease in free cash flow in 2011 and 2012 is primarily due to higher capital expenditures in both periods. The higher level of capital expenditures, particularly for 2012 and the first half of 2013, was primarily due to increased capacity at Knowles’ Cebu, Philippines facility, as well as investment to expand capacity to meet the demands in the acoustics market.

On a go-forward basis, Knowles expects capital expenditures to decrease to approximately 6.0% to 8.0% as a percentage of revenue. Additionally, the interest expense related to Knowles’ net notes payable with Dover and its affiliates that will be settled prior to distribution date is reflected in historical net earnings, but is not necessarily representative of future debt-related interest for Knowles.

Contractual Obligations

A summary of Knowles’ combined contractual obligations and commitments as of December 31, 2012 and the years when these obligations are expected to be due is as follows:

 

(in thousands)

   Total      Less than 1
Year
     1 - 3 Years      3 - 5 Years      More than
5 Years
 

Short-term and long-term debt (1)

   $ 400,000       $ —         $ 145,000       $ 255,000       $ —     

Notes payable to Parent, net (2)

     528,812         528,812         —           —           —     

Interest expense (1) (2)

     63,692         56,592         7,100         —           —     

Rental commitments (3)

     24,050         12,087         10,025         1,362         576   

Purchase obligations (3)

     1,478         1,478         —           —           —     

Capital leases

     396         106         222         68         —     

Post-retirement benefits (4)

     4,300         1,533         248         392         2,127   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations

   $ 1,022,728       $ 600,608       $ 162,595       $ 256,822       $ 2,703   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents Knowles’ current estimate of new indebtedness of $370.0 million to $420.0 million at an annual interest rate of LIBOR plus 1.50%. For purposes of preparing the contractual obligations related to this new indebtedness, Knowles has estimated total new indebtedness of $400.0 million, of which $300.0 million represents a five-year senior secured term loan facility and $100.0 million represents a five-year senior secured revolving credit facility, with estimated interest expense totaling approximately $7.1 million for the year ended December 31, 2013. Interest expense has not been estimated beyond December 31, 2013, since actual amounts of debt outstanding, interest expense and other terms of debt have not yet been finalized.
(2) Represents outstanding intercompany net notes payable and related interest expense to Dover that will be settled prior to the distribution date. Interest expense has been derived from the combined financial statements, and the ultimate amount of intercompany interest to be settled may differ from what has been presented. See Note 3 to the Combined Financial Statements for additional information.
(3) Represents off-balance sheet commitments and obligations for rental commitments related to operating leases and purchase obligations related to open purchase orders with Knowles’ vendors.
(4) Amounts represent estimated benefit payments under Knowles’ unfunded defined benefit plans. See Note 14 to the Combined Financial Statements for additional information.

 

75


Table of Contents

Risk Management

Knowles is exposed to certain market risks which exist as part of its ongoing business operations, including changes in currency exchange rates, the dependence on key customers, and price volatility for certain commodities. Knowles does not engage in speculative or leveraged transactions and does not hold or issue financial instruments for trading purposes.

Foreign Currency Exposure

Knowles conducts business through its 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 Knowles’ products are manufactured in lower-cost locations and sold in various countries. Cross-border transactions, both with external parties and intercompany relationships, result in increased exposure to foreign exchange effects. Accordingly, significant changes in currency exchange rates, particularly the Malaysian Ringgit, the Euro, the Chinese Renminbi (Yuan) and the Philippine Peso, could cause fluctuations in the reported results of Knowles’ businesses’ operations that could negatively affect Knowles’ results of operations. Decreased strength of the U.S. dollar could adversely impact the cost of materials, products and services purchased overseas. A 10% weakening of the U.S. dollar would reduce Knowles’ operating results by approximately $32.0 million pre-tax.

In addition, sales and expenses of Knowles’ non-U.S. businesses are also translated into U.S. dollars for reporting purposes and the strengthening or weakening of the U.S. dollar could result in unfavorable translation effects.

Dependence on Key Customers; Concentration of Credit

The loss of any key customer and Knowles’ inability to replace revenues provided by a key customer may have a material adverse effect on Knowles’ business and financial condition. For the years ended December 31, 2012, and 2011, one customer, Apple, accounted for approximately 18% and 12%, respectively, of total revenues. No other customers accounted for more than 10% of total revenues during these periods. No customer accounted for more than 10% of total revenues for the year ended December 31, 2010. If a key customer fails to meet payment obligations, Knowles’ operating results and financial condition could be adversely affected.

Commodity Pricing

Knowles uses 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 and silver, and “rare earth” materials (dysprosium and neodymium) fluctuates. As a result, Knowles’ operating results are exposed to such fluctuations. Although some cost increases may be recovered through increased prices to customers if commodity prices trend upward, Knowles attempts to control such costs through fixed-price contracts with suppliers and various other programs, such as Knowles’ global supply chain activities.

Critical Accounting Policies

Knowles’ combined financial statements are based on the application of generally accepted accounting principles in the United States of America (“GAAP”). GAAP requires the use of estimates, assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue and expense amounts Knowles reports. These estimates can also affect supplemental information contained in Knowles’ public disclosures, including information regarding contingencies, risk and Knowles’ financial condition. The significant accounting policies used in the preparation of Knowles’ combined financial statements are discussed in Note 2 to the Combined Financial Statements included elsewhere in this information statement. The accounting assumptions and estimates discussed in the section below are those that Knowles

 

76


Table of Contents

considers most critical to an understanding of its financial statements because they inherently involve significant judgments and estimates. Knowles believes its use of estimates and underlying accounting assumptions conforms to GAAP and is consistently applied. Knowles reviews valuations based on estimates for reasonableness on a consistent basis.

Revenue Recognition: Revenue is recognized when all of the following circumstances are satisfied: a) persuasive evidence of an arrangement exists, b) price is fixed or determinable, c) collectability is reasonably assured, and d) delivery has occurred or services have been rendered. The majority of Knowles’ revenue is generated through the manufacture and sale of a broad range of specialized products and components, with revenue recognized upon transfer of title and risk of loss, which is generally upon shipment. Knowles does not have significant service revenue, licensing, income or multiple service arrangements. Knowles recognizes third-party licensing or royalty income as revenue over the related contract term. Revenue is recognized net of customer discounts, rebates and returns. Rebates are recognized over the contract period based on expected revenue levels. Sales discounts and rebates totaled $14.2 million, $14.2 million and $15.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. Returns and allowances totaled $4.6 million, $4.2 million, and $4.3 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Inventories: Inventories, including all international subsidiaries, are stated at the lower of cost or market, determined on the first-in, first-out (FIFO) basis. The value of Knowles’ inventory may decline as a result of surplus inventory, price reductions or technological obsolescence. It is Knowles’ 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 Knowles’ policy to carry reserves against the carrying value of at-risk inventory items after considering the nature of the risk and any mitigating factors.

Goodwill and Indefinite-Lived Assets: Knowles has significant tangible and intangible assets on its balance sheet that include goodwill and other intangibles related to acquisitions. The valuation and classification of these assets and the assignment of useful depreciation and amortization lives involve significant judgments and the use of estimates. Goodwill and certain other intangible assets deemed to have indefinite lives (primarily trademarks) are not amortized. Instead, Knowles’ assets and reporting units are tested and reviewed for impairment on an annual basis during the fourth quarter of each fiscal year or, when indicators of impairment exist, such as a significant sustained change in the business climate, or, when a significant portion of a reporting unit is to be reclassified to discontinued operations, during the interim periods. Knowles estimates fair value using discounted cash flow analyses (i.e., an income approach) which incorporate management assumptions relating to future growth and profitability. Changes in business or market conditions could impact the future cash flows used in such analyses. The testing of these intangibles under established accounting guidelines for impairment requires significant use of judgment and assumptions, particularly as it relates to the identification of reporting units and the determination of fair market value. Knowles believes that its use of estimates and assumptions are reasonable and comply with generally accepted accounting principles.

Goodwill balances at December 31, 2012 and 2011 totaled $946.1 million and $946.9 million, respectively, and other indefinite-lived intangible assets totaled $32.0 million at December 31, 2012 and 2011. There were no impairments of goodwill or other indefinite-lived intangible assets as of December 31, 2012, 2011 and 2010. Knowles performed impairment testing of its four identified reporting units for the years ended December 31, 2012, 2011 and 2010, and the fair value of these four reporting units exceeded their carrying value and no impairment was recognized. If the fair value of each of these reporting units was decreased by 10%, the resulting fair value would still have exceeded the carrying value and no impairment would have been recognized.

Other Intangible and Long-Lived Assets: Knowles’ other intangible assets with determinable lives consist primarily of customer relationships, unpatented technology, patents, trademarks and drawings and manuals, and these assets are amortized over their estimated useful lives. Other intangible assets with determinable lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an

 

77


Table of Contents

asset may not be recoverable, such as a significant sustained changed in the business climate. If an impairment indicator exists, 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. Other intangible assets with determinable lives at December 31, 2012 and 2011 totaled $312.8 million and $341.7 million, respectively.

Knowles’ business relies on patents and proprietary technology and seeks patent protection for products and methods. Knowles capitalizes external legal costs incurred in the defense of its patents when it is believed 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 seven to ten years. Knowles’ 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. During the years ended December 31, 2012, 2011 and 2010, Knowles capitalized $13.9 million, $0.2 million and zero, respectively, in legal costs related to the defense of its patents. Amounts capitalized are supported by the discernible value of future royalty income supported by court-ordered or otherwise agreed-upon settlements and similar expected outcomes in the future.

Pension and Other Post-Retirement Plans: Dover provides a defined benefit pension plan for its eligible U.S. employees and retirees. As such, the portion of Knowles’ liability associated with this U.S. plan is not reflected in Knowles’ combined balance sheets and will not be recorded at the distribution date as this obligation will be maintained and serviced by Dover. Effective December 31, 2013, Knowles participants in this plan will no longer accrue benefits. Dover also provides to certain management employees, through non-qualified plans, supplemental retirement benefits in excess of qualified plan limits imposed by federal tax law. On the distribution date, Knowles will assume the benefit obligation attributed to Knowles’ employees for this non-qualified plan, and it will be reflected in Knowles’ combined balance sheet as of the distribution date. Effective December 31, 2013, Knowles participants in this plan will no longer accrue benefits. Dover provides a defined contribution plan to its eligible U.S. employees and retirees in which Knowles employees participated. Knowles’ expense relating to defined contribution plans was $3.3 million, $2.8 million, and $3.7 million for the years ended December 31, 2012, 2011, and 2010. In addition, Knowles sponsors four defined benefit pension plans to certain non-U.S. employees. Knowles’ expense related to these plans for the years ended December 31, 2012, 2011 and 2010 were $1.2 million, $0.6 million and $0.4 million, respectively. These plans are considered direct obligations of Knowles and have been recorded within Knowles’ historical combined financial statements in accordance with GAAP.

The valuation of Knowles’ pension plans requires the use of assumptions and estimates that are used to develop actuarial valuations of expenses and assets/liabilities. Inherent in these valuations are key assumptions, including discount rates, investment returns, projected salary increases and benefits, and mortality rates. Annually, Knowles reviews the actuarial assumptions used in its pension reporting and compares them with external benchmarks to ensure that they accurately account for future pension obligations. Changes in assumptions and future investment returns could potentially have a material impact on Knowles’ pension expense and related funding requirements. Knowles’ expected long-term rate of return on plan assets is reviewed annually based on actual returns, economic trends and portfolio allocation. Knowles’ 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. See Note 14 to the Combined Financial Statements included elsewhere in this information statement for additional information related to Knowles’ employee benefit plans, including the actuarial assumptions used.

Income Taxes and Deferred Tax Balances: For purposes of the historical combined financial statements, Knowles’ income tax expense and deferred tax balances have been estimated as if Knowles filed income tax returns on a stand-alone basis separate from Dover. As a stand-alone entity, Knowles’ deferred taxes and effective tax rate may differ from those of Dover in the historical periods.

 

78


Table of Contents

Knowles 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, Knowles 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. A valuation allowance is recorded to reduce deferred tax assets to the net amount that is more likely than not to be realized.

Knowles 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.

Knowles has evaluated its deferred tax assets for each of the reporting periods, including an assessment of cumulative income over the prior three-year period. Since Knowles is 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 full valuation allowance was required for the 2012 and 2011 periods.

Knowles 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 Knowles’ 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 for 2012, 2011 and 2010 were (0.2)%, 6.7% and 6.5%, respectively. The 2010 rate was favorably impacted by net discrete items of $8.4 million, principally related to non-U.S. items.

Knowles has not provided for any residual U.S. income taxes on the unremitted earnings of non-U.S. subsidiaries as such earnings are currently intended to be indefinitely reinvested outside the United States. It is not practicable to estimate the amount of tax that might be payable if some or all of such earnings were to be repatriated, or the amount of foreign tax credits that would be available to reduce or eliminate the resulting U.S. income tax liability.

Accruals and Reserves: Knowles has accruals and reserves that require the use of estimates and judgment with regard to risk exposure and ultimate liability. Knowles estimates losses under these programs using certain factors, which include but are not limited to, actuarial assumptions, its experience and relevant industry data. Knowles reviews these factors quarterly and considers the current level of accruals and reserves adequate relative to current market conditions and experience.

 

    Knowles is involved in various lawsuits, claims and investigations arising in the normal course of its business, including those related to intellectual property. In the opinion of management, the ultimate disposition of these matters is not expected to have a material adverse effect on Knowles’ combined financial position, liquidity or results of operations. Management and legal counsel will periodically review the probable outcome of such proceedings, the costs and expenses reasonably expected to be incurred and currently accrued to date and the availability and extent of insurance coverage. In addition, Knowles may provide indemnities for losses that result from the breach of general warranties contained in certain commercial agreements. Historically, Knowles has not made significant payments under these indemnifications. At December 31, 2012, 2011 and 2010, Knowles’ legal reserves were not significant.

 

79


Table of Contents
    Most recently, Knowles has 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 Knowles believes that these estimates accurately reflect the anticipated costs, actual results may be different than the estimated amounts.

Derivatives: Knowles periodically uses derivative financial instruments to hedge its exposures to various risks, including interest rate and foreign currency exchange rate risk. Knowles does not enter into derivative financial instruments for speculative purposes. Derivative financial instruments used for hedging purposes must be designated an effective hedge of the identified risk exposure at inception and throughout the life of the contract. Knowles recognizes all derivatives as either assets or liabilities on the combined balance sheet and measures those instruments at fair value. For derivatives designated as hedges of the fair value of assets or liabilities, the changes in fair value of both the derivatives and of the hedged items are recorded in current earnings. 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.

Stock-Based Compensation: Knowles’ employees have historically participated in Dover’s stock-based compensation plans. Stock-based compensation has been allocated to Knowles based on the awards and terms previously granted to Knowles’ employees. The principal awards issued under the stock-based compensation plans include non-qualified stock options, stock-settled stock appreciation rights (“SARs”), and performance share awards. 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 recognized as expense on a straight-line basis, generally over the explicit service period of three years (except for retirement-eligible employees and retirees) and is included in selling and administrative expenses in the combined statements of earnings. Expense for awards granted to retirement-eligible employees is recorded over the period from the date of grant through the date the employee first becomes eligible to retire and is no longer required to provide service.

Knowles uses the Black-Scholes valuation model to estimate the fair value of SARs and stock options granted to employees. The model requires that Knowles estimate the expected life of the SAR or option, expected forfeitures and the volatility of Dover’s stock using historical data. Knowles uses the Monte Carlo simulation model to estimate fair value of performance share awards which also requires Knowles to estimate the volatility of Dover’s stock and the volatility of returns on the stock of Dover’s peer group as well as the correlation of the returns between the companies in the peer group. At the time of grant, Knowles estimates forfeitures, based on historical experience, in order to estimate the portion of the award that will ultimately vest. See Note 12 for additional information related to Knowles’ stock-based compensation.

 

80


Table of Contents

BUSINESS

Overview and History

Knowles engages in the design and manufacture of innovative products and components which serve the mobile consumer electronics, medical technology, telecommunications infrastructure, military/space and other industrial end markets. Knowles is currently owned by Dover, a global, diversified industrial manufacturer. Knowles is part of Dover’s Communication Technologies segment, and was built through a series of acquisitions (including Knowles Electronics, Vectron International, Novacap, Syfer, Dielectric, Voltronics and Sound Solutions) and internal growth initiatives spanning the last 20 years. Dover recently announced the spin-off of Knowles into a separate, publicly-traded company. Knowles has a leading position in MEMs microphones, speakers and receivers which are used in mobile handsets, smartphones and tablets within the consumer electronics market. Knowles is also a leading manufacturer of transducers used in the hearing health segment of the medical technology market and has a strong position in oscillator (timing devices) and capacitor components which serve the telecommunication infrastructure, military/space and other industrial markets.

The spin-off will be in the form of a distribution of 100% of the shares of common stock of Knowles, which will become an independent, publicly-traded company. The distribution is intended to be tax-free to Knowles, Dover, and its U.S. stockholders. Dover currently expects that the distribution will be completed in the first quarter of 2014. Completion of the transaction is subject to certain conditions, including that (A) Dover will have received either (i) a private letter ruling from the IRS together with an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code or (ii) an opinion of Baker & McKenzie LLP, tax counsel to Dover, substantially to the effect that, among other things, the distribution will qualify as tax-free for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, (B) Dover will have received final approval of Dover’s Board of Directors, (C) the NYSE will have approved the listing of Knowles’ common stock, subject to official notice of issuance and (D) that the SEC will have declared effective the registration statement of which this information statement forms a part, and that no stop order relating to such registration statement will be in effect. For a complete discussion of all of the conditions to the distribution, see the section entitled “The Separation and Distribution—Conditions to the Distribution.”

Management Philosophy

Knowles’ leadership guides the continued progress of its research and development, the expansion of its technology platforms, and the efficacy of its businesses. This guidance is achieved through an understanding of end-user needs and by anticipating the opportunities Knowles can bring to its product design and manufacturing. Knowles is an application-based technology company, and its businesses are committed to operational excellence and to being market leaders as measured by market share, customer service, innovation, profitability and return on invested capital. In addition, Knowles is committed to creating value for its customers, employees, and stockholders through sustainable business practices that protect the environment, and developing products that help Knowles’ customers meet their sustainability goals.

Knowles’ Strengths

Knowles believes that the following competitive strengths will enable it to continue to expand on its industry leading position serving the communication technologies industry:

Leader in the communication technologies industry. Knowles has built an industry-leading enterprise in terms of brand recognition, technology and market presence in communication technologies. Based on market share, Knowles is a leading supplier of acoustic components to all major handset OEMs and hearing aid OEMs. Knowles also has a strong position in supplying oscillators and capacitors to customers in the telecommunications infrastructure, military/space and other industrial markets. Dynamic research and fast product development cycles, and high-volume, scalable manufacturing capabilities are characteristics that Knowles has developed and intends to continue to build upon.

 

81


Table of Contents

Market leading product innovation. Knowles invests significant resources in research and development and brings significant application expertise with capabilities to quickly and effectively design, develop and manufacture new products to meet its customers’ needs. Knowles maintains design centers in multiple locations in North America, Europe and Asia, which enables Knowles to attract the best talent in every region of the world. Knowles has increased its spending by over 50% to support its research and development functions over the last three years and spends an average of 6.5% to 7.5% of revenue on an annual basis on projects intended to preserve and extend its technological advantage.

Operational excellence. Knowles has a proven track record of executing operational improvements, through cost reductions, increased yields and improving capacity utilization. Knowles’ diversified operations include high-volume scalable production capabilities, fully automated production lines and labor-intensive assembly processes. Knowles maintains major manufacturing facilities in three countries which are integrated through a centralized operating and supply chain.

Well-established, collaborative relationships with leading customers. Knowles’ close relationship with its customers enables it to develop critical expertise regarding its customers’ requirements and needs. Knowles uses that expertise and application knowledge, coupled with its research and development to design differentiated products that are used to enhance the end users’ acoustic interface with their mobile devices or ensure performance in mission critical applications. Knowles’ products have been designed into multiple generations of its customers’ products.

Executive management team with proven history of success. Knowles’ CEO and his direct reports and the core operational team have worked together for a significant number of years. The executive management team has driven Knowles’ strong history of profitability and cash flow generation, and demonstrated a proven ability to execute under multiple ownership structures, including private equity and as part of the segment company structure within Dover. In addition to Jeffrey Niew, who will be Knowles’ President and Chief Executive Officer after the separation, Knowles’ named executive officers include John Anderson, Michael Adell, Raymond Cabrera and Gordon Walker, who have all held senior positions of responsibility at Dover prior to the separation. For more information regarding the named executive officers and other members of the management team of Knowles, see “Management.”

Strong financial performance allows Knowles to exceed customer demands. The Knowles business model has evolved as its end markets have developed and grown over the years. Its strong history of profitability and cash flow generation, supported by a strong and flexible balance sheet, will enable Knowles to continue to invest in new products and technology at a rapid pace in order to meet and exceed customer demands.

Business Segments

Knowles is 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 FASB ASC Topic 280—Segment Reporting and include i) Mobile Consumer Electronics (“MCE”) and ii) Specialty Components (“SC”). The segments are aligned around similar product applications serving Knowles’ key end markets, to enhance focus on end market growth strategies.

 

    MCE designs and manufactures innovative acoustic products, including microphones, speakers and receivers, used in several applications that serve the handset, tablet and other consumer electronic markets. Locations include the corporate office in Itasca, Illinois; sales, support and engineering facilities in North America, Europe and Asia; and manufacturing facilities in Europe and Asia.

 

   

SC specializes in the design and manufacture of specialized electronic components used in medical and life science applications, as well as high-performance solutions and components used in communications infrastructure and a wide variety of other markets. SC’s transducer products are used principally in hearing aid applications within the commercial audiology markets, while its oscillator

 

82


Table of Contents
 

products predominantly serve the telecom infrastructure market and capacitor products are used in applications including radio, radar, satellite, power supplies, transceivers and medical implants serving the defense, aerospace, telecommunication, and life sciences markets. Operating facilities and sales, support and engineering facilities are located in North America, Europe and Asia.

Knowles sells its products directly to original equipment manufacturers (“OEMs”) and to their contract manufacturers and suppliers, and to a lesser extent through distributors worldwide.

The following table shows the percentage of total revenue and segment earnings generated by each of Knowles’ segments for the years ended December 31, 2012, 2011 and 2010:

 

       Revenue     Segment Earnings  
       2012     2011     2010     2012     2011     2010  

Mobile Consumer Electronics

       60.0     51.9     31.0     62.0     54.4     38.7

Specialty Components

       40.0     48.1     69.0     38.0     45.6     61.3

The following table shows total assets by segment for the years ended December 31, 2012 and 2011:

 

     2012      2011  

Mobile Consumer Electronics

   $ 1,558,701       $ 1,456,434   

Specialty Components

     483,783         495,155   

Corporate / eliminations

     2,045         49,124   
  

 

 

    

 

 

 
   $ 2,044,529       $ 2,000,713   
  

 

 

    

 

 

 

Knowles’ Markets and Market Trends

Knowles’ products serve a variety of end markets, notably, consumer mobile devices, medical technology, aerospace and defense and telecom, and can generally be divided into two categories: Acoustic Components and Specialty Components, as described below.

 

    Acoustic Components. Includes analog and digital microphones, MEMs microphones, surface mounted device microphones, receivers, speakers, speaker modules, multi-functional devices, ultrasonic sensors and integrated audio sub-systems.

 

    Specialty Components. Includes transducers, oscillators and capacitors.

The markets served by Acoustic Components continue to be driven by trends in smartphone and tablet innovation and demand. Today, mobile device OEMs are facing ever-rising challenges to differentiate their products in the global marketplace while managing growing cost pressures and time-to-market expectations. However, mobile consumers and mobile carriers alike are expecting better quality voice calls, audio and video conferencing, capturing and playback, media content consumption and gaming, as well as extended battery life. To enable smart mobile devices to handle ever more demanding audio use cases, OEMs are increasingly adopting more intelligent active audio components (audio chipset) and higher performance passive acoustic components. Trends impacting the smartphone market today include:

 

    Smartphone growth from feature phone substitution. The smartphones segment within the handset device market has exhibited consistently strong unit growth over the past five years (>40% unit volume compound annual growth rate). There continues to be a positive mix shift from the proliferation of lower-end smartphone devices and the further cannibalization of feature phones (i.e., non-smartphones). The average smartphone continues to drive higher audio content including more microphones and higher value speakers than its feature phone counterpart, compounding the growth of acoustic content as mobile phone sales rise. As consumers’ demand at the high end of the smartphone market continues, the average selling price (“ASP”) of handset devices is expected to remain constant, supporting the price of superior electronic components.

 

83


Table of Contents
    Smartphone OEM market share shifts are likely to remain volatile for some time. Recently, Nokia and Blackberry have lost significant market share to other U.S. and Asian-based OEMs who have released smartphones that have been more readily accepted due to, among other factors, perceived feature sets and price points. Knowles expects the OEM market to continue to be dynamic over time, characterized by rapid market share shifts driven by new product introductions, price points and feature sets.

 

    New OEM product line rollouts. Smartphones continue to shift to Long Term Evolution (“LTE”), a standard for 4G wireless technology, and the shift is expected to buoy unit growth in developed markets and drive the competitive landscape in high-end chipsets through 2014. Aggressive LTE deployments are expected in China, in addition to a build-out of deeper coverage profiles in the U.S., Japan, Korea and Northern Europe. This will drive an increase in LTE smartphone units over the next five years, which should help maintain some level of high-end smartphone volume growth despite high market penetration.

 

    Shortened smartphone upgrade plans at U.S. carriers. Several U.S. carriers have recently introduced new smartphone plans which offer consumers the option of paying for their phone in monthly installments with no upfront lump sum payment, and the ability to upgrade again in 12 months. Plans such as these could drive greater-than-expected unit growth (turnover) at the high end, as they are most likely to appeal to high-income consumers seeking to upgrade their phone more frequently.

 

    High-end consumer elasticity. Consumers are reluctant to downgrade from a high-end smartphone to a low-end smartphone in most circumstances. This is especially true as high-end smartphones will likely continue to offer significant performance advantages and new functionality compared to low-end smartphones.

 

    Proliferation of premium acoustics with speaker protection. The adoption of boosted audio amplifier with speaker damage protection is increasingly pervasive, driving further speaker-box enhancement and higher dollar content. Also, the widespread adoption of the high definition voice standard by telecom carriers will drive improved quality in audio components. Recently, a key OEM migrated to higher performance audio chipsets, indicating a desire for speaker-box design upgrades (from 3 transducers to 5 transducers) and the adoption of high-definition receivers. Knowles believes other OEMs will follow this trend and adopt improved technology to remain competitive, thus expanding the addressable market.

Specialty Components products are sold across diverse end markets, and relative to the Acoustic Components end markets, portions of this business 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 and expansion, and government contracts. These products can be divided into the following categories:

 

    Medical and life sciences products (i.e., transducers, hearing aids). Product sales are largely driven by aging demographics, healthcare spending, insurance policies, the rise of a middle class in emerging markets and government subsidies.

 

    Aerospace and defense communications (i.e., capacitors). Aerospace and defense spending and automation (largest end market), telecom regional coverage and bandwidth expansion, and growing industrial power supply requirements are a few of the end market trends driving the product sales in this sector.

 

    Telecom infrastructure (i.e., oscillators). Sales are typically levered to the expansion of large telecom companies, looking to increase wireless signal in new or existing territories, although these products are also sold to aerospace and defense companies (i.e., airplane radio frequencies).

 

84


Table of Contents

Geographic Trends

Knowles strives to maintain its manufacturing facilities in close proximity to its direct customers. In the case of MCE, Knowles operates four facilities in Asia to serve the contract manufacturers who build OEM equipment on behalf of its end-customers. These contract manufacturers are largely based in China, Taiwan and India. Although end-user demand for consumer electronics is global, and marketing activities occur globally, critical mass for manufacturing is located in Asia, and as a result, a large majority of MCE’s manufacturing capacity is based in Asia, primarily China, Malaysia and the Philippines.

In the case of SC, Knowles operates three facilities in Asia to serve the manufacturing sites of both hearing aid OEMs and the contract manufacturers who build OEM headsets on behalf of earphone makers. These manufacturing sites are based in China, Singapore, Indonesia, and Vietnam. Although marketing activities and end-user demand for hearing aid and specialty consumer components is global, critical mass for manufacturing is located in Asia for the purposes of being close to the point of assembly. Knowles also operates three facilities in the United States, one in Mexico, and three in Europe for the manufacturing of capacitors and oscillators that support its global telecom and military customers, as well as their suppliers and contract manufacturers.

While no significant statutory limitation exists, a repatriation of profits from foreign markets to the United States is inherently inefficient, as business expansion opportunities and capital expenditure requirements are expected to be consistent with the needs of Knowles’ direct customer and manufacturing locations.

Competitive Landscape

Success in the electronic components industry is primarily driven by innovation and flexibility as customers compete to gain share of the fast growing handset market. Capturing growth opportunities usually results from competition across both platform and component designs, which supports position, pricing and margins. Continuous research and development investment allows for the capture of all emerging new brands with early mover advantage. Flexibility in balancing full and semi-automation is a key to achieving a superior cost structure. Additionally, it is important for component vendors to have flexibility and quick time-to-market to meet clients’ needs. Notably, according to industry estimates, the product cycle for handsets has shortened to eight months from two years. Key competitors include:

 

    MCE: AAC Technologies and Goertek

 

    SC: Sonion for hearing health and a highly fragmented set of competitors across capacitor and oscillator products for each end market

In the mobile consumer electronics segment, Knowles’ investments in R&D enable Knowles continually to introduce new products that are higher performance. Knowles’ customers are quickly adopting these higher value microphones, speakers and receivers in their new products as they improve the overall audio performance in the end application, which in turn improves the end user experience. With each successive generation, Knowles’ new products generally have higher average selling prices than the products they are replacing. Once introduced, the pricing for these products follows a normal downward trend as typically seen in the consumer electronics market. To get additional performance gains, OEMs are moving to Knowles’ even higher value integrated audio solutions with microphones and an antenna in a plastic module.

For products that were introduced more than 18 months ago, Knowles has consistently achieved productivity gains through a robust value creation program. Bill of material cost reductions, yield improvements, equipment efficiency, and labor reductions are significant drivers in offsetting projected price erosion.

In the specialty components segment, the end markets are more stable, and mix of products and customers are drivers of average selling prices and margin.

 

85


Table of Contents

Expected Growth Dynamics

Acoustic component unit growth is expected to outgrow the underlying handset device industry. Knowles’ management believes that the total addressable market for acoustic components will be $4.7 billion in 2013 and $5.6 billion in 2014. In all, management expects a 14% to 18% compound annual growth rate for acoustic component units for the period from 2013 through 2017. This is higher than the outlook for smartphone and tablet unit growth, reflecting upgraded and additional requirements for acoustic components in smartphone devices, resulting in higher acoustic component content value per device.

Although a view exists that smartphones are being commoditized, implying hardware specifications may be plateauing, management believes there remains significant potential to enhance the user experience through advanced acoustics, whereby the new generation of acoustic components can create a meaningful differentiation without significant incremental cost for handset OEMs. For example, a very popular new OEM product release is equipped with three microphones, up from only two in the previous version, delivering superior noise cancellation with minimal incremental cost to the OEM. In another example, a newly released and well-accepted tablet from an OEM uses four speaker boxes to create a stereo effect and improved bass frequency response, and offers a larger display with better resolution for multimedia functionality. Three primary growth trends are currently driving the smartphone market:

 

    Continued shift in consumer preference from feature phones to smartphones and computers to tablets as consumers’ primary source of media consumption.

 

    Increasing number of microphones and speakers required as well as quality of acoustics demanded in order to sell tablets and smartphones as potential replacements to other mediums for media; recent trends in new OEM product sales indicate that consumers continue to demand more, not fewer, microphones and speakers in their electronic devices.

 

    Combination of new OEM products and potentially shortened contract upgrade plans motivate consumers to more frequently consider the purchase of a new phone, increasing turnover in smartphones and thus additional sales for acoustic component suppliers.

 

    Higher performing content unlocked by audio integration. OEM smartphone and tablet evolution are converging on dynamics for thinner industrial designs, higher performing audio applications, and faster time-to-market product cycles to maintain market leadership. It is anticipated that a deeper collaboration of audio as an optimized subsystem will continue by leveraging acoustic and industrial design together, including integration of electro-mechanical connectivity, into modules for with audio content.

Customers, Sales and Distribution

Knowles serves customers in the mobile consumer electronics, medical technology, defense/aerospace, telecommunication infrastructure and other industrial markets. Knowles’ customers include some of the largest operators in these markets. In addition, many of Knowles’ OEM customers outsource their manufacturing to Electronic Manufacturing Services (“EMS”) companies. Other customers include global cell phone and hearing aid manufacturers and many of the largest global EMS companies, particularly in China. For the years ended December 31, 2012, and 2011, one customer, Apple, accounted for approximately 18% and 12%, respectively, of total Knowles revenue. No other customers accounted for more than 10% of total revenues during these periods. No customer accounted for more than 10% of total revenue for the year ended December 31, 2010.

 

86


Table of Contents

The following table details the sales of Knowles by geographic location for the years ended 2012, 2011 and 2010. These results do not necessarily indicate the geographies where Knowles’ products are deployed or where end-customer demand is originated.

 

     Years Ended December 31,  
     2012      2011      2010  

Asia

   $ 855,450       $ 681,740       $ 436,923   

Europe

     110,559         139,207         134,075   

Other Americas

     15,182         14,849         12,546   

Other

     6,901         9,404         5,525   
  

 

 

    

 

 

    

 

 

 

Subtotal non-U.S.

   $ 988,092       $ 845,200       $ 589,069   

United States

     129,900         138,118         141,375   
  

 

 

    

 

 

    

 

 

 

Combined total

   $ 1,117,992       $ 983,318       $ 730,444   
  

 

 

    

 

 

    

 

 

 

Knowles owns and conducts manufacturing operations through a network of facilities throughout the world. Knowles also maintains quality assurance, manufacturing technology, supply chain and distribution departments. Knowles’ global distribution center is located in Penang, Malaysia. See Note 16 to the Combined Financial Statements included elsewhere in this information statement for Knowles’ long-lived assets by geographic region.

Raw Materials

Knowles uses a wide variety of raw materials, primarily metals and semi-processed or finished components, which are generally available from a number of sources. As a result, shortages or the loss of any single supplier have not had, and are not likely to have, a material impact on operating profits. While the required raw materials are generally available, commodity pricing for various precious metals, such as palladium, gold and silver, and “rare earth” materials (dysprosium and neodymium) fluctuates. As a result, Knowles’ operating results are exposed to such fluctuations. Although some cost increases may be recovered through increased prices to customers if commodity prices trend upward, Knowles attempts to control such costs through fixed-price contracts with suppliers and various other programs, such as Knowles’ global supply chain activities.

Knowles has established a Green Materials Policy. The products offered are in compliance with the EU RoHS/WEEE regulations. This standard is based on the list of substances identified in the JIG-101 Standard which is endorsed by the EIA, the JEDEC and the JGPSSI associations as well as the Sony Standard SS-00259. To meet this requirement, supplier data for all purchased materials is reviewed to ensure compliance with applicable standards and performs analytical testing when deemed necessary.

Research and Development

Knowles conducts research worldwide to discover and develop new acoustic and related products around the world and refine its existing products. Knowles’ research is primarily conducted internally. Knowles employs approximately 400 employees worldwide in research and development. Knowles’ research and development efforts continue to expand the technology platforms that support its customers’ product and business development. By applying interrelated technologies to the design processes, Knowles strives to enhance and accelerate its customers’ initial concepts and design work, as well as provide for cost-effective component customization, manufacturing and subassembly. Research and development expenses are classified within selling and administrative expense. Knowles spent $77.3 million, $65.9 million and $49.3 million on research and development, or 6.9%, 6.7% and 6.7% as a percentage of revenue, for the years ended December 31, 2012, 2011 and 2010, respectively.

 

87


Table of Contents

Intellectual Property and Intangible Assets

Knowles owns many patents, trademarks, licenses and other forms of intellectual property, which have been acquired over a number of years and, to the extent relevant, expire at various times over a number of years. A large portion of Knowles’ intellectual property consists of patents, unpatented technology and proprietary information constituting trade secrets that Knowles seeks to protect in various ways, including confidentiality agreements with employees and suppliers, where appropriate. In addition, a significant portion of Knowles’ intangible assets relate to customer relationships. While Knowles’ intellectual property and customer relationships are important to its success, the loss or expiration of any of these rights or relationships, or any group of related rights or relationships, is not likely to materially affect Knowles’ results on a combined basis. Knowles believes that its commitment to continuous engineering improvements, new product development and improved manufacturing techniques, as well as strong sales, marketing and service efforts, are significant to its general leadership positions in the niche markets that it serves.

Seasonality

In general, Knowles’ businesses, while not having significant seasonality, tend to have stronger revenue in the third and fourth quarters of each fiscal year. This is particularly true of those businesses that serve the consumer electronics market. Knowles’ 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.

Properties

Knowles’ corporate headquarters is located in Itasca, Illinois. Knowles maintains technical customer support offices and operating facilities in North America, Europe and Asia.

The number, type, location and size of the properties used by Knowles’ continuing operations as of December 31, 2012 are shown in the following charts:

 

Number and nature of facilities:

  

Manufacturing

     17   

Warehouse

     3   

Sales / Service

     11   

Square footage (in 000s):

  

Owned

     727   

Leased (1)

     991   

Locations:

  

Asia

     9   

North America

     8   

Europe

     7   

 

(1) Expiration dates on leased facilities range from 1 to 15 years.

Knowles believes that its owned and leased facilities are well-maintained and suitable for its operations.

Environmental Matters

Knowles’ operations are governed by a variety of international, national, state and local environmental laws. Knowles is committed to continued compliance and believes its operations generally are in substantial compliance with these laws. Knowles is dedicated to the preservation and improvement of Knowles’ global environment. To help achieve this, Knowles has established a Green Materials Policy pursuant to which it has established a Green Materials Standard. The products Knowles offers are in compliance with the EU RoHS/WEEE regulations. Additionally, many products will be compliant with the Knowles Green Materials Standard.

 

88


Table of Contents

Employees

Knowles employs approximately 8,500 persons across 30 facilities in 14 countries. Approximately 76% of these employees are located in facilities across Asia. Knowles maintains strong labor relations throughout all of its facilities.

Regulation

It has been the long-standing policy of Knowles to maintain the highest ethical standards in the conduct of its affairs and in its relationship with customers, suppliers, employees and the communities in which Knowles’ operations are located. Knowles maintains standards that are consistent with the Electronic Industry Code of Conduct (the “EICC”). The EICC provides guidelines to ensure worker safety and fairness, environmental responsibility, and business efficiency.

Legal Proceedings

Knowles is involved in various lawsuits, claims and investigations arising in the normal course of its business, including those related to intellectual property. In the opinion of management, the ultimate disposition of these matters is not expected to have a material adverse effect on Knowles’ combined financial position, liquidity or results of operations. Management and legal counsel will periodically review the probable outcome of such proceedings, the costs and expenses reasonably expected to be incurred and currently accrued to date and the availability and extent of insurance coverage. In addition, Knowles may provide indemnities for losses that result from the breach of general warranties contained in certain commercial agreements. Historically, Knowles has not made significant payments under these indemnifications. At September 30, 2013, Knowles’ legal reserves were not significant.

 

89


Table of Contents

MANAGEMENT

Executive Officers Following the Separation

While some of Knowles’ executive officers are currently officers and employees of Dover, upon the separation, none of these individuals will continue to be employees or executive officers of Dover. The following table sets forth information regarding individuals who are expected to serve as Knowles’ executive officers, including their positions after the separation, and is followed by biographies of each such executive officer.

 

Name

 

Age

    

Position

Jeffrey S. Niew

    47       President & Chief Executive Officer

John S. Anderson

    50       Senior Vice President & Chief Financial Officer

Michael A. Adell

    43       Co-President, Mobile Consumer Electronics—Microphone Products

Christian U. Scherp

    48       Co-President, Mobile Consumer Electronics—Speaker and Receiver Products

Gordon A. Walker

    37       Co-President, Specialty Components—Acoustic Products

David W. Wightman

    59       Co-President, Specialty Components—Precision Devices

Raymond D. Cabrera

    46       Senior Vice President, Human Resources & Chief Administrative Officer

Paul M. Dickinson

    42       Senior Vice President, Corporate Development and Treasurer

Daniel J. Giesecke

    45       Senior Vice President, Global Operations and Chief Operating Officer

Joseph W. Schmidt

    67       Senior Vice President, General Counsel and Secretary

James F. Wynn

    53       Senior Vice President, Global Supply Chain

Bryan E. Mittelman

    43       Vice President, Controller

Jeffrey S. Niew serves as President and Chief Executive Officer of Knowles and will be a member of its Board of Directors upon the separation. Mr. Niew also currently serves as a Vice President of Dover Corporation and as President and Chief Executive Officer of Dover Communication Technologies, in which capacity he has acted since November 2011. 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 will serve as Knowles’ Senior Vice President and Chief Financial Officer. Mr. Anderson currently serves as Vice President and Chief Financial Officer of Dover Communication Technologies, in which capacity he has acted since January 2013. 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).

Michael A. Adell will serve as Co-President, Mobile Consumer Electronics—Microphone Products, a position he has held since July 2011. Previously, Mr. Adell served as Vice President and General Manager in the Knowles Acoustics division of Knowles Electronics (“Knowles Acoustics”) (from January 2009 to July 2011), General Manager, Knowles Acoustics (from December 2006 to January 2009), Director, Product Management, Knowles Acoustics (from July 2004 to November 2006) and Product Manager for silicon microphone products, Knowles Acoustics (from November 2002 to July 2004).

Christian U. Scherp will serve as Co-President, Mobile Consumer Electronics—Speaker and Receiver Products, a position he has held since September 2012. Prior to joining Knowles Electronics, Mr. Scherp served

 

90


Table of Contents

as the Global Head of Sales for the Consumer Devices business of TE Connectivity 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).

Gordon A. Walker will serve as Co-President, Specialty Components—Acoustic Products, a position he has held since July 2011. Previously, Mr. Walker served in the following roles in the Knowles Electronics division of Knowles Electronics: Vice President and General Manager (from December 2007 to July 2011), General Manager (from January 2006 to December 2007), and Director, Product Management (from September 2004 to December 2005). Prior to such positions, he held marketing, finance and operations roles after he joined Knowles Electronics in 1997.

David W. Wightman will serve as Co-President, Specialty Components – Precision Devices, a position he has held since April 2013. Previously, Mr. Wightman held the position of President of Ceramic & Microwave Products (from August 2004 to April 2013) and President of Dow-Key Microwave Corporation (from February 2000 to August 2004). Mr. Wightman’s experience also includes leadership roles at Danaher from February 1995 to February 2000.

Raymond D. Cabrera will serve as Knowles’ Senior Vice President, Human Resources and Chief Administrative Officer. Mr. Cabrera currently serves as Vice President, Human Resources of Dover Communication Technologies, in which capacity he has acted since November 2011. Previously, Mr. Cabrera served 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.

Paul M. Dickinson will serve as Knowles’ Senior Vice President, Corporate Development and Treasurer. Mr. Dickinson started his career with Knowles in October 2013. Previously, Mr. Dickinson was the Chief Financial Officer for EPAY Systems, Inc., from 2012 until moving to Knowles. Additional previous experience includes the following roles at Littelfuse, Inc.: Vice President and General Manager, Semiconductor Business (from 2008 to 2012), Vice President, Corporate Development & Treasurer (from 2005 to 2008), Treasurer (from 2003 to 2005), Director of Accounting and International Finance (from 2000 to 2003) and other finance leadership roles since he joined Littelfuse in 1993.

Daniel J. Giesecke will serve as Knowles’ Senior Vice President, Global Operations and Chief Operating Officer. Mr. Giesecke currently serves as Vice President, Global Operations of Dover Communication Technologies, in which capacity he has acted since January 2012. 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 engineering positions since he joined Knowles Electronics in 1995.

Joseph W. Schmidt is the Senior Vice President, General Counsel and Secretary of Knowles. Mr. Schmidt assumed this role on December 1, 2013 pursuant to a short-term independent contractor arrangement. Pursuant to the terms of this arrangement, Mr. Schmidt will serve in such capacity until March 31, 2014. Knowles has the right, exercisable by February 28, 2014, to extend the term of Mr. Schmidt’s arrangement until May 30, 2014. Mr. Schmidt served as Dover’s Senior Vice President, General Counsel and Secretary from May 2011 until his retirement on December 31, 2012; prior thereto Mr. Schmidt served as Vice President, General Counsel and Secretary of Dover from January 2003 to May 2011. Mr. Schmidt will be a valuable resource to Knowles as it prepares to be and becomes a public company given his 10 years of experience as General Counsel of Dover and his knowledge of Knowles’ business and will help the management team and the Board identify and transition to a new general counsel upon the expiration of his short-term arrangement.

 

91


Table of Contents

James F. Wynn will serve as Knowles’ Senior Vice President Global Supply Chain. Mr. Wynn currently serves as Vice President, Global Supply Chain of Dover Communication Technologies, in which capacity he has acted since January 2013. Previously, Mr. Wynn served as Vice President, Global Supply Chain (from February 2009 to January 2013), Senior Director, Global Supply Chain (from March 2004 to February 2009) and Director, Global Supply Chain (from March 2002 to March 2004) of Knowles Electronics.

Bryan E. Mittelman will serve as Knowles’ Vice President, Controller. Mr. Mittelman started his career at Knowles in September 2013. Previously, Mr. Mittelman served as the Controller for Morningstar, Inc. from December 2011 to September 2013. Additional prior experience includes operating his consulting business from June 2010 to December 2011 and the following roles at Siemens Healthcare Diagnostics and Dade Behring (which was acquired by Siemens in 2007): Vice President, Finance, North America (from January 2008 to May 2010), Vice President, Finance, Americas (from January 2007 to December 2007), Vice President, Corporate Audit and Advisory Services (from March 2006 to December 2006), Assistant Corporate Controller (from April 2005 to February 2006) and Director of Financial Reporting (from July 2002 to April 2005).

Board of Directors Following the Separation

The following table sets forth information with respect to those persons who are expected to serve on Knowles’ Board of Directors following the completion of the separation, and is followed by biographies of each such individual (except that Mr. Niew’s biographical information is set forth above under “—Executive Officers Following the Separation”). The nominees will be presented to Knowles’ sole stockholder, Dover, for formal election prior to the separation. Knowles may name and present additional nominees for election prior to the separation.

 

Name

  

Age

    

Title

Jean-Pierre M. Ergas

     74       Chairman of the Board of Directors

Jeffrey S. Niew

     47       Director, President & Chief Executive Officer

Keith L. Barnes

     62       Director

Robert W. Cremin

     72       Director

Ronald Jankov

     55       Director

Richard K. Lochridge

     70       Director

Donald Macleod

     65       Director

Jean-Pierre M. Ergas will serve as Chairman of Knowles’ Board of Directors. Mr. Ergas is a private investor. Since 2010, he has been the Managing Partner of Ergas Ventures, LLC. He is also a Director (since 1995), former Chairman of the Board of Directors (from 2000 to 2010), and Chief Executive Officer (from 2000 to 2007) of BWAY Corporation, a steel and plastic container manufacturer. Mr. Ergas is a Director of Dover (since 1994), and is chair of Dover’s Governance and Nominating Committee. Mr. Ergas also serves as a Director and member of the Audit Committee of Plastic Omnium, a manufacturer of automotive components and plastic products. Mr. Ergas will bring to the Board substantial international management experience as a former Chief Executive Officer and Chairman of five companies in the U.S. and Europe (namely, BWAY Corporation, American National Can Company, Cedegur Pechiney, Cebal S.A. and Alcan Europe), and senior executive at Pechiney S.A. and Alcan Aluminum Limited. Mr. Ergas holds an MBA from Harvard University. Drawing on his background, knowledge and experience managing all aspects of international businesses, including privatizations, acquisitions, cross-border transactions, post-merger integrations, productivity and performance initiatives, Mr. Ergas will provide important advice to Knowles’ President & Chief Executive Officer and contribute to the Board’s oversight of matters involving Knowles’ operation in international markets, business development and corporate strategies, as well as acquisition and divestiture activities.

Keith L. Barnes has been self-employed as a private investor since June 2011 and is Chairman and CEO of Barnes Capital Management, a family office investment company. From 2006 through December 2010, Mr. Barnes served as a member of the Board of Directors and President and Chief Executive Officer of Verigy Ltd. (a provider

 

92


Table of Contents

of advanced semiconductor test solutions that was spun-off from Agilent in 2006). He continued to serve as Verigy’s Chairman of the Board until its acquisition in June 2011 by Advantest. Prior to that he was Chairman and Chief Executive Officer (from 2003 to 2006) of Electroglas, Inc., an integrated circuit probe manufacturer. Mr. Barnes was Vice Chairman of the Board of Directors (from August 2002 to October 2003) of Oregon Growth Account and a management consultant. Mr. Barnes served as Chief Executive Officer (from 1995 to 2001) and Chairman of the Board of Directors (from 1998 to 2001) of Integrated Measurement Systems, Inc. (IMS), a manufacturer of engineering test stations and test software. Prior to becoming CEO of IMS, Mr. Barnes was a Division President at Valid Logic Systems and later Cadence Design Systems. Mr. Barnes is currently a member of the Board of Directors of Spansion, Inc. (a semiconductor manufacturer), Mentor Graphics Corporation (a provider of electronic design automation software) and JDS Uniphase Corporation (a provider of communications test and measurement solutions and optical products). He also serves on the boards of The Classic Wines Auction, and San Jose State University Tower Foundation. His previous board experience includes Intermec Inc. (a provider of data capture and mobile computing system solutions), Verigy Ltd., Cascade Microtech, Inc. (a developer of wafer probe solutions), Electroglas Inc. and DATAIO Corporation. Mr. Barnes graduated from San Jose State University with a Bachelor of Science degree in Environmental Science. Mr. Barnes brings to the Knowles’ Board his extensive management experience as chairman and chief executive officer of several technology companies and international sales and marketing knowledge, along with his manufacturing experience in China, Malaysia, Singapore, Europe and the United States and his experience as a board member for several public technology companies.

Robert W. Cremin is the Chairman (since May 2009) of the Board of Directors of Dover and is a Director of Dover (since 2005); a Director of Premera Blue Cross (since May 2010); a Director of the Pacific Northwest Ballet and Archilles International; and a former Chairman (from 2001 to 2011), Director (from 2001 to 2013), member of the Strategy & Technology Committee, President (from 1997 to 2009) and Chief Executive Officer (from 1999 to 2009) of Esterline Technologies Corporation, a manufacturer of aerospace and defense products. Mr. Cremin holds an MBA from Harvard University. Mr. Cremin’s experience will make him a valuable contributor to the Board and advisor to Knowles’ President & Chief Executive Officer on matters involving business strategy, capital allocation and acquisition and divestiture opportunities. His experience as Chairman, President and CEO of Esterline and as Chairman of Dover allowed him to develop many skills that will contribute to the effective functioning of Knowles’ Board. Under Mr. Cremin’s leadership, Esterline pursued a strategy that enabled it to grow its sales more than tenfold, in part by focusing on the markets it knew best, significantly expanding its investments in research and development, and cultivating a culture focused on lean manufacturing and velocity. In addition, his technical expertise and background in engineering will contribute to the Board’s understanding and consideration of opportunities involving Knowles and the markets it serves.

Ronald Jankov leads the Processors and Wireless Infrastructure division of Broadcom Corp., a provider of semiconductor solutions for wired and wireless communications. He joined Broadcom in 2012 following its acquisition of NetLogic Microsystems Inc., a fabless semiconductor company that went public in 2004, where Mr. Jankov served as President, Chief Executive Officer and as a member of its Board of Directors (from 2000 to 2012). Previously, Mr. Jankov served as Vice President of Sales and then Vice President and General Manager for the Multimedia Division (from 1995 to 1999) of NeoMagic Corporation, as Vice President (from 1994 to 1995) of Cyrix Corporation and as founder (from 1990 to 1994) of Accell Corp., an advanced semiconductor engineering support and technical sales firm. Mr. Jankov has a Bachelor of Science degree from Arizona State University. Mr. Jankov brings unique insight into the product, the technology and the market, and will contribute to the strategic vision for Knowles. He brings extensive hands-on deal-making experience and deep knowledge as a public technology company chief executive officer.

Richard K. Lochridge is a Director of Dover (since 1999); the retired President of Lochridge & Company, Inc., a management consulting firm; a Director of The Lowe’s Company, Inc., a home improvement retailer and PETsMART, a pet supplies retailer; and a former Director of the John Harland Company, a printed products supplier. Mr. Lochridge’s experience in management consulting makes him a valuable contributor to the Board and advisor to Knowles’ President & Chief Executive Officer as an expert on strategic planning, management styles, succession planning and similar matters. He worked many years with a major consulting company where a

 

93


Table of Contents

majority of his experience was with non-U.S. companies or covering international or global markets, and where he was for a time in charge of all international offices. His consulting work has enabled him to work closely with the boards and senior management of many public companies on complex and important transactions and projects in global arenas, giving him experience and insight that will be beneficial to Knowles. In addition, over a period of 28 years, Mr. Lochridge has served on the boards of seven public companies, including the three on which he currently serves (excluding Knowles). On these boards, he has at various times served as non-executive chair and chair of the audit, finance and compensation committees.

Donald Macleod served as Chief Executive Officer (from 2009 to 2011) of National Semiconductor Corporation, an analog semiconductor company, until National Semiconductor was acquired by Texas Instruments Incorporated. Mr. Macleod joined National Semiconductor in 1978 and served in a variety of executive positions prior to becoming Chief Executive Officer, including Chief Operating Officer (from 2001 to 2009), and Chief Financial Officer (from 1991 to 2001). He also served as the Chairman of the Board (from 2010 to 2011) of National Semiconductor. Mr. Macleod currently serves as Chairman of the Board (since 2012) of Intersil Corporation, a manufacturer and marketer of analog, mixed-signal and power management integrated circuits, and as a Director (since 2007) of Avago Technologies Limited, a global manufacturer of optoelectronics and analog interface components. Mr. Macleod also serves on the Board of Directors of a privately-held company, and also serves as a Trustee of The Saltire Foundation, a registered, independent Scottish charity whose mission is to advance business education and leadership through the provision of worldwide internships for Scottish students and fellows. Mr. Macleod holds a Bachelor of Science degree in economics and an Honorary Doctor of the University degree from the University of Stirling in Scotland. He is a member of the Institute of Chartered Accountants of Scotland. Mr. Macleod’s qualifications to serve as a Director include his more than 30 years of experience in senior management and executive positions in the semiconductor industry (both in Europe and the United States), and his accounting and finance qualifications and experience.

Upon completion of the separation, Knowles’ Board of Directors will be divided into three approximately equal classes. The directors designated as Class I directors will have terms expiring at the first annual meeting of stockholders following the distribution. The directors designated as Class II directors will have terms expiring at the second annual meeting of stockholders following the distribution, and the directors designated as Class III directors will have terms expiring at the third annual meeting of stockholders following the distribution. Commencing with the first annual meeting of stockholders following the separation, directors for each class will be elected at the annual meeting of stockholders held in the year in which the term for that class expires and thereafter will serve for a term of three years. Members of the Board of Directors will be elected by a plurality of the votes cast at each annual meeting of stockholders.

Director Independence

Knowles currently expects that, upon the consummation of the separation, Knowles’ Board of Directors will consist of members, a substantial majority of whom Knowles expects to satisfy the independence standards established by the Sarbanes-Oxley Act and the applicable rules of the SEC and the NYSE.

Knowles expects to make a determination of the independence of each nominee for director prior to his or her nomination for (re)election. No director may be deemed independent unless the Board determines that he or she has no material relationship with Knowles, directly or as an officer, stockholder or partner of an organization that has a material relationship with Knowles.

Committees of the Board of Directors

Effective upon the completion of the separation, Knowles’ Board of Directors will have the following standing committees: an Audit Committee, a Governance and Nominating Committee and a Compensation Committee.

 

94


Table of Contents

Audit Committee

Keith L. Barnes, Robert W. Cremin and Jean-Pierre M. Ergas are expected to be the members of the Board’s Audit Committee. Keith L. Barnes is expected to be the Chairman of the Audit Committee. The Board of Directors is expected to determine that at least one member of the Audit Committee is an “audit committee financial expert” for purposes of the rules of the SEC. In addition, Knowles expects that the Board of Directors will determine that each of the members of the Audit Committee will be independent, as defined by the rules of the NYSE, Section 10A(m)(3) of the Exchange Act, and in accordance with Knowles’ Corporate Governance Guidelines. The Audit Committee will meet at least quarterly and will assist the Board of Directors in fulfilling its oversight responsibilities. The primary functions of the Audit Committee will consist of:

 

    selecting and engaging an independent registered public accounting firm (“independent auditors”);

 

    overseeing the work of the independent auditors and Knowles’ internal audit function;

 

    approving in advance all services to be provided by, and all fees to be paid to, the independent auditors, who report directly to the committee;

 

    reviewing with management and the independent auditors the audit plan and results of the auditing engagement; and

 

    reviewing with management and the independent auditors the quality and adequacy of Knowles’ internal control over financial reporting.

The Board of Directors is expected to adopt a written charter for the Audit Committee that will describe its responsibilities, authority and resources in greater detail. The charter of the Audit Committee will be posted on Knowles’ website at www.knowles.com.

Governance and Nominating Committee

Keith L. Barnes, Robert W. Cremin, Jean-Pierre M. Ergas, Ronald Jankov, Richard K. Lochridge and Donald Macleod are expected to be the members of the Board’s Governance and Nominating Committee. Donald Macleod is expected to be the Chairman of the Governance and Nominating Committee. The Board of Directors is expected to determine that each of the members of the Governance and Nominating Committee will be independent, as defined by the rules of the NYSE and in accordance with Knowles’ Corporate Governance Guidelines. The primary functions of the Governance and Nominating Committee will consist of:

 

    developing and recommending corporate governance principles to the Knowles Board of Directors;

 

    identifying and recommending to Knowles’ Board of Directors candidates for election as directors and any changes it believes desirable in the size and composition of the Board of Directors; and

 

    making recommendations to Knowles’ Board of Directors concerning the structure and membership of the Board committees.

The Board of Directors is expected to adopt a written charter for the Governance and Nominating Committee that will describe its responsibilities, authority and resources in greater detail. The charter of the Governance and Nominating Committee will be posted on Knowles’ website at www.knowles.com.

Compensation Committee

Ronald Jankov, Richard K. Lochridge and Donald Macleod are expected to be the members of the Board’s Compensation Committee. Richard K. Lochridge is expected to be the Chairman of the Compensation Committee. The Board of Directors is expected to determine that each member of the Compensation Committee will be independent, as defined by the rules of the NYSE and in accordance with Knowles’ Corporate Governance Guidelines. In addition, Knowles expects that the members of the Compensation Committee will

 

95


Table of Contents

qualify as “non-employee directors” for purposes of Rule 16b-3 under the Exchange Act and as “outside directors” for purposes of Section 162(m) of the Code. The Compensation Committee, together with the independent directors on Knowles’ Board of Directors, will approve the compensation of Knowles’ Chief Executive Officer. The other primary functions of the Compensation Committee will consist of:

 

    approving compensation for executive officers who report directly to the CEO (together with the CEO, “senior executive officers”);

 

    granting awards and approving payouts under Knowles’ equity plans and its annual executive incentive plan;

 

    approving changes to Knowles’ compensation plans;

 

    reviewing and recommending compensation for the Knowles Board of Directors;

 

    overseeing the succession planning and management development programs; and

 

    supervising the administration of the compensation plans.

The Board of Directors is expected to adopt a written charter for the Compensation Committee that will describe its responsibilities, authority and resources in greater detail. The charter of the Compensation Committee will be posted on Knowles’ website at www.knowles.com.

Compensation Committee Interlocks and Insider Participation

During Knowles’ fiscal year ended            , Knowles was not an independent company, and did not have a compensation committee or any other committee serving a similar function. Decisions as to the compensation of those who currently serve as Knowles executive officers were made by Dover, as described in the section of this information statement entitled “Compensation Discussion and Analysis.”

Corporate Governance

Knowles is committed to conducting its business in accordance with the highest level of ethical and corporate governance standards. The Board of Directors of Knowles expects to periodically review its corporate governance practices and take other actions to address changes in regulatory requirements, developments in governance best practices and matters raised by stockholders. The following describes some of the actions Knowles expects to take to help ensure that Knowles’ conduct earns the respect and trust of stockholders, customers, business partners, employees and the communities in which we live and work.

Governance Guidelines and Codes

In connection with the separation, the Board of Directors of Knowles is expected to adopt written corporate governance guidelines that set forth the responsibilities of the Board and the qualifications and independence of its members and the members of its standing committees. In addition, in connection with the separation, the Board of Directors of Knowles is expected to adopt, among other codes and policies, a code of business conduct and ethics setting forth standards applicable to all of Knowles’ companies and their employees, a code of ethics for Knowles’ Chief Executive Officer and senior financial officers, policies prohibiting Knowles’ employees from buying or selling instruments to hedge against decreases in the market value of Knowles’ equity securities, and charters for each of its standing committees. All of these documents (referred to collectively as “governance materials”) will be available on Knowles’ website at www.knowles.com.

Board Leadership Structure and Risk Oversight

The Knowles Board of Directors is expected to adopt a structure in connection with the separation whereby the Chairman of the Board of Directors is an independent director. Knowles believes that having a chairman

 

96


Table of Contents

independent of management provides strong leadership for the Board of Directors and helps ensure critical and independent thinking with respect to Knowles’ strategy and performance. Knowles’ Chief Executive Officer is also expected to be a member of the Board of Directors as the management representative on the Board of Directors. Knowles believes this is important to make information and insight directly available to the directors in their deliberations. This structure gives Knowles an appropriate, well-functioning balance between non-management and management directors that combines experience, accountability and effective risk oversight.

Knowles believes that risk oversight is the responsibility of the Board of Directors as a whole and not of any one of its committees. The Board of Directors will periodically review the processes established by management to identify and manage risks and communicates with management about these processes. Knowles expects to establish a risk assessment team consisting of senior executives, which annually, with the assistance of a consultant, will oversee an assessment made at the operating companies and the segments of the risk at those levels and, with that information in mind, will perform an assessment of the overall risks Knowles may face. This team is expected to reassess on a quarterly basis the list at the Knowles level, the severity of these risks and the status of efforts to mitigate them and report to the Board of Directors on that reassessment.

Audit Committee Procedures; Disclosure Controls and Procedures Committee

The Audit Committee expects to hold regular quarterly meetings at which it will meet separately with each of Knowles’ independent registered public accounting firm, Knowles’ head of internal audit, financial management and Knowles’ general counsel to assess certain matters including the status of the independent audit process, management’s assessment of the effectiveness of internal control over financial reporting and the operation and effectiveness of Knowles’ compliance program. In addition, the Audit Committee, as a whole, will review and meet to discuss the contents of each Form 10-Q and review and approve the Form 10-K (including the financial statements) prior to its filing with the SEC. Management is expected to have a Disclosure Controls and Procedures Committee, which is expected to include among its members the chief financial officer, the controller, the treasurer, the head of investor relations, the head of tax, the head of internal audit and the general counsel. This management committee is expected to meet at least quarterly to review Knowles’ earnings release and quarterly or annual report, as the case may be, for the prior quarter and Knowles’ disclosure controls and procedures.

Complaints “Hotline”; Communication with Directors

In accordance with the Sarbanes-Oxley Act of 2002, upon the separation, Knowles expects that the Audit Committee will establish procedures for (i) the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters (“accounting matters”), and (ii) the confidential, anonymous submission by employees of concerns regarding questionable accounting matters. Such complaints or concerns are expected to be able to be submitted to Knowles, care of its Corporate Secretary or through the communications coordinator, an external service provider, by mail, fax, telephone or via the internet as published on Knowles website in connection with the separation. The communications coordinator will forward such communications to Knowles’ general counsel without disclosing the identity of the sender if anonymity is requested. Stockholders and other interested persons may also communicate with Knowles’ Board of Directors and the non-management directors in any of these same manners. Such communications will be forwarded to the chair of the Governance and Nominating Committee and Knowles’ general counsel.

Anti-hedging and Anti-pledging Policy

Knowles expects Knowles’ Board of Directors to adopt anti-hedging and anti-pledging policies which would prohibit its employees who receive an award under its long-term incentive plan from hedging or pledging their position in Knowles stock.

 

97


Table of Contents

Procedures for Approval of Related Person Transactions

While Knowles generally does not expect to engage in transactions with related persons, including its senior executive officers or directors, Knowles’ Board of Directors is expected to adopt policies and procedures regarding transactions with related persons. It is expected that such policies and procedures would provide that such transactions would be subject to review and approval by the Governance and Nominating Committee in accordance with a written policy and the procedures adopted by Knowles’ Board of Directors, which will be posted on Knowles’ website at www.knowles.com.

Compensation Consultant Independence

It is expected that Knowles’ Compensation Committee will adopt a policy to ensure the continuing independence and accountability to the committee of any advisor hired to assist the committee in the discharge of its duties. It is expected that under the policy, the committee will annually review and pre-approve the services that may be provided by the independent advisor without further committee approval. It is expected that, in order to ensure independence of the compensation consultant, the consultant will report directly to the chair of the Compensation Committee and work specifically for the committee solely on compensation and benefits.

Qualification and Nominations of Directors

The Governance and Nominating Committee charter that is expected to be adopted in connection with the separation will provide that the Governance and Nominating Committee considers and recommends to the Board of Directors nominees for election to, or for filling any vacancy on, Knowles’ Board of Directors in accordance with its by-laws, its governance guidelines, and the committee’s charter. The committee is expected to periodically review the requisite skills and characteristics of Board members as well as the size, composition, functioning and needs of Knowles’ Board of Directors as a whole. To be considered for Board membership, a nominee for director must be an individual who has the highest personal and professional integrity, who has demonstrated exceptional ability and judgment, and who will be most effective, in conjunction with the other nominees to Knowles’ Board of Directors, in collectively serving the long-term interests of all Knowles stockholders. The committee also considers members’ qualifications as independent, the financial literacy of members of the Audit Committee, the qualification of Audit Committee members as “audit committee financial experts,” and the diversity, skills, background and experiences of members of the Board of Directors in the context of the needs of the Board of Directors. The Governance and Nominating Committee may also consider such other factors as it may deem to be in the best interests of Knowles and its stockholders. Knowles believes it appropriate and important that at least one key member of Knowles’ management participate as a member of Knowles’ Board of Directors. In appropriate circumstances this number may be increased to two.

Whenever the committee concludes, based on the reviews or considerations described above or due to a vacancy, that a new nominee to Knowles’ Board of Directors is required or advisable, it will consider recommendations from directors, management, stockholders and, if it deems appropriate, consultants retained for that purpose. In such circumstances, it will evaluate individuals recommended by stockholders in the same manner as nominees recommended from other sources. Stockholders who wish to recommend an individual for nomination should send that person’s name and supporting information to the committee, care of the Corporate Secretary or through Knowles’ communications coordinator. Stockholders who wish to directly nominate an individual for election as a director, without going through the Governance and Nominating Committee or using Knowles’ proxy material, must comply with the procedures in Knowles’ amended and restated by-laws.

 

98


Table of Contents

COMPENSATION DISCUSSION AND ANALYSIS

Introduction & Executive Summary

Knowles is currently a wholly owned subsidiary of Dover and Dover’s senior management and the Compensation Committee of Dover’s Board of Directors (the “Dover Committee”) have determined Knowles’ past compensation. This Compensation Discussion and Analysis focuses primarily on Dover’s compensation policies and decisions for 2012 and the process for determining 2012 compensation while Knowles was part of Dover. It also attempts to outline certain aspects of Knowles’ anticipated post-distribution executive compensation policies. After the distribution, Knowles’ Compensation Committee and Board of Directors will be responsible for Knowles’ executive compensation strategy.

Historically

Dover’s executive compensation programs are designed to support the attraction, retention and development of Dover’s senior management by providing market competitive compensation opportunities, utilizing median compensation for each position as the benchmark. The programs reward management for the achievement of financial and operational results, while aligning the executives’ financial interests with those of Dover’s shareholders. Dover’s executive compensation is highly leveraged, with eighty-nine percent (89%) of the Dover CEO’s compensation at risk. The at-risk portion of a Dover executive’s compensation consists of an annual cash incentive, as well as long-term cash and equity incentives. Executive perquisites are very limited, and benefits offered to executives are generally consistent with those offered to non-executive employees.

Going Forward

Knowles’ executive compensation programs will be designed to ensure a strong linkage between pay and performance while enabling Knowles to attract and retain the top talent needed to drive Knowles’ long-term success. Executive compensation will be aligned with Company, business unit and individual performance objectives. Total compensation will be targeted to the median of the relevant external market with the opportunity to earn above-median pay for achieving exceptional results.

Knowles anticipates that its executive compensation will be highly leveraged, with a large majority of the total compensation at risk. Knowles’ compensation programs will reward executives for the achievement of financial and operational results and align their long-term personal financial objectives with the interests of Knowles’ stockholders. The three primary components of Knowles’ executive compensation program are expected to be: 1) base salary, 2) “at risk” annual cash incentive, and 3) “at risk” long term equity awards. Knowles’ executives will receive benefits and perquisites generally consistent with those offered to similarly situated employees at Knowles. The annual cash incentive payout will be based on predetermined financial and strategic objectives. The long-term compensation will consist solely of equity with a mixture of stock options and restricted stock units (RSUs). Consistent with recent spin-offs from large public companies, Knowles expects to offer select executives one-time Founder’s equity grants, consisting of both stock options and RSUs. Knowles expects current Dover Equity grants will be converted to Knowles equity grants at the time of the spin. Knowles also anticipates that Executive Stock Ownership Guidelines will be implemented.

This Compensation Discussion and Analysis presents historical compensation information for the following individuals, whom Knowles refers to as its Named Executive Officers (“NEOs”) and who will hold the positions below:

 

    Jeffrey S. Niew, Knowles President & Chief Executive Officer

 

    John S. Anderson, Knowles Senior Vice President & Chief Financial Officer

 

    Michael A. Adell, Co-President, Mobile Consumer Electronics—Microphone Products

 

    Raymond D. Cabrera, Knowles Senior Vice President, Human Resources & Chief Administrative Officer

 

    Gordon A. Walker, Co-President, Specialty Components—Acoustic Products

 

99


Table of Contents

The contents of this Compensation Discussion and Analysis are organized into five sections:

Section 1—Dover Compensation Decision Making for 2012

Section 2—2012 NEO Compensation Decisions

Section 3—Compensation Components

Section 4—Other Compensation Programs and Policies

Section 5—Anticipated New Knowles Plans

Decisions regarding the variable compensation of Knowles’ NEOs for 2012 were made by the Dover Committee and Dover’s senior management, utilizing the full-year financial results that included the businesses placed in discontinued operations in 2012.

Section 1—Dover Compensation Decision Making for 2012

Process

The process for making variable executive compensation decisions at Dover for 2012 began with goal setting at the beginning of the year and concluded with the actual incentive compensation payout decisions in early 2013. The process is designed to allow the Dover Committee, the Dover Board and Dover management time to reflect on and discuss information before being asked to approve a proposal or make decisions. The process for 2012 compensation decisions for Knowles’ NEOs involved the following parties: the Dover Committee, Dover’s CEO, Dover Communication Technologies’ CEO (Mr. Niew), Dover Energy’s CEO with respect to Mr. Anderson and the independent consultant advising the Dover Committee. The roles of each in making the 2012 compensation decisions were as follows:

The Dover Committee. The Dover Committee is responsible to Dover’s Board for overseeing the development and administration of Dover’s compensation and benefits policies and programs. In addition to making recommendations to the independent directors of Dover’s Board as to the compensation of Dover’s CEO, the Dover Committee, which consists of five independent directors, is responsible for reviewing and approving all compensation recommendations for direct reports to Dover’s CEO, including Mr. Niew. The Dover Committee is supported in its work by the Dover Human Resources department and by its independent compensation consultant, Semler Brossy.

Dover’s Chief Executive Officer. Each year, within the guidelines approved by the Dover Committee and based on Dover management’s review of competitive market data, Dover’s Chief Executive Officer recommends to the Dover Committee the salaries, annual incentive awards and long-term incentive awards for his direct reports, including Mr. Niew. In addition to market data and trends, these recommendations are based upon his assessment of each officer’s performance, the performance of the individual’s respective segment or function and employee retention considerations. The Dover Committee reviews these recommendations and approves any compensation changes involving the CEO’s direct reports. In addition to making recommendations concerning the compensation of his direct reports, Dover’s CEO also reviews and approves recommendations made by his direct reports.

Dover Communication Technologies’ Chief Executive Officer. As CEO of Dover Communication Technologies, Mr. Niew was responsible for making recommendations to Dover’s CEO concerning 2012 compensation decisions involving his direct reports, including Knowles’ other NEOs, except for Mr. Anderson. These recommendations were based upon his assessment of each individual’s performance, the performance of the individual’s respective business unit or function and employee retention considerations. Dover’s CEO reviewed these recommendations and approved the final compensation decisions for Mr. Niew’s direct reports.

Dover Energy’s Chief Executive Officer. In 2012 Mr. Anderson was the Chief Financial Officer for the Dover Energy segment. The Dover Energy CEO was responsible for making recommendations to Dover’s CEO concerning 2012 compensation decisions for Mr. Anderson. Dover’s CEO reviewed these recommendations and approved the final compensation decisions.

 

100


Table of Contents

Independent Compensation Consultant. The Dover Committee has retained Semler Brossy as its independent executive compensation consultant. This firm routinely provides the Dover Committee with an evaluation of the market competitiveness of Dover’s executive compensation packages, an assessment of pay in relation to performance, input into CEO and other executive pay decisions and input on other compensation-related matters at the request of the Dover Committee. The firm reports directly to the Dover Committee, and the Dover Committee may replace the firm or hire additional consultants at any time. A representative of the firm attends meetings of the Dover Committee, upon request, and communicates with the chair of the Dover Committee between meetings. While the Dover Committee values the advice of its consultant, the Dover Committee and the other independent directors of Dover’s Board are the sole decision-makers in regard to the compensation of executive officers.

For Dover, the 2012 compensation determination process with respect to Knowles’ NEOs was as follows:

February 2012—The Dover Committee and the independent directors of Dover’s Board reviewed and approved the financial performance targets for the annual incentive plan. Dover’s CEO approved the strategic goals for each of his direct reports, including Mr. Niew. Mr. Niew, in turn, approved the strategic goals for each of his direct reports, including Knowles’ NEOs, except for Mr. Anderson. The Dover Energy CEO approved Mr. Anderson’s strategic goals.

November 2012—The Dover Committee reviewed and considered market compensation data and executive compensation trend information from its independent consultant. The Dover Committee also reviewed tally sheets to understand the full cost of each executive, share ownership levels, realized pay and payouts under different termination scenarios.

February 2013—The Dover Committee reviewed with Dover’s CEO the financial and strategic performance of each of his direct reports in 2012, along with the proposed pay actions. After discussion, the Dover Committee approved pay actions for each direct report, including Mr. Niew. The Dover Committee certified the performance results for the incentive plans. Dover’s CEO reviewed with Mr. Niew the performance of each of Mr. Niew’s direct reports, including all of Knowles’ other NEOs, except for Mr. Anderson, and approved the compensation decisions made for those individuals. Dover’s CEO also reviewed with the Dover Energy CEO the performance of Mr. Anderson and approved the compensation decisions.

Going forward

Knowles expects it will follow a compensation determination process that will be similar to Dover’s. The Compensation Committee of Knowles’ Board of Directors (the “Knowles Committee”), consisting of independent directors, will oversee the development and administration of Knowles’ compensation and benefits policies and programs. In addition, the Knowles Committee will make recommendations to the Knowles Board on Knowles’ CEO compensation. The Knowles Committee will also approve compensation recommendations for Mr. Niew’s direct reports. The Knowles Committee intends to retain an independent compensation consultant.

Pay Mix

Dover’s executive compensation program for executive officers has been designed to emphasize performance-based compensation. Fixed compensation elements, such as salary, although essential to a competitive compensation program, are not the focal point of the program. The majority of Knowles’ NEOs’ compensation has been “at risk,” which means that it varies year to year depending on factors such as Dover’s earnings per share on a fully-diluted basis (“EPS”), earnings before interest and taxes (“EBIT”), revenue or the internal Total Shareholder Return (“iTSR”) of an NEO’s business unit, Dover’s actual stock price performance and relative Total Shareholder Return (“TSR”) versus that of Dover’s peers. Dover believes that its financial metrics are the drivers of shareholder value, while the market measures focus on actual shareholder value creation.

 

101


Table of Contents

Going forward

Knowles expects the emphasis on performance-based compensation to continue at Knowles. Knowles anticipates the majority of compensation to be “at risk” with annual incentive compensation to be paid upon achievement of financial and individual strategic goals. Knowles expects that the long-term incentives will be based 100% on equity with a mixture of stock options and RSUs, as described below under “Section 3—Compensation Components—Dover Equity Awards.”

Competitor Data—Peer Groups

In 2011, the Dover Committee launched an effort to identify peer companies that, taken together, more closely reflected Dover’s size and portfolio, and better represented Dover’s market for executive talent. At the request of the Dover Committee, Semler Brossy led the process to update the list of Dover’s peer companies.

The Dover Committee now references two overlapping peer groups in making executive compensation decisions: (1) a smaller, more tightly clustered group for assessing executive pay levels and practices and (2) a broader group for assessing Dover’s financial performance and total shareholder return.

For assessing executive pay programs and levels, the Dover Committee selected a group of companies that are similar to Dover in terms of end markets, complexity, revenue and market capitalization. The original 22 companies were reduced to 21 with the merger of Cooper Industries and Eaton. The Dover Committee believes that this group (listed below), in combination with survey-reported information, provides an appropriate representation of the market for executive talent.

Executive Pay Levels and Practices Peer Group (for 2012)

 

Cameron International      Illinois Tool Works      Roper Industries
Corning      Ingersoll-Rand      SPX Corp.
Danaher      Pall Corp.      Textron
Eaton Corp.      Parker-Hannifin      Timken Company
Emerson Electric      Pentair      Tyco International
Flowserve Corp.      Precision Castparts Corp.      Weatherford
FMC Technologies      Rockwell Automation      3M Company

For measuring TSR—the basis for Dover’s performance shares—the Dover Committee concluded that an expanded group of companies (building from the 21 above) would better represent the range of alternatives for Dover’s shareholders’ capital and help to mitigate the impact of any single-company events on relative performance measurements.

Company size was not explicitly considered in developing the expanded performance-benchmarking group, as it is less of a direct consideration when comparing shareholder returns. Other than size, each of the previously mentioned criteria was utilized in determining the performance benchmarking peer group.

 

102


Table of Contents

Performance Share TSR Peer Group (beginning with awards made in 2012)

 

Actuant      Honeywell International      Rockwell Automation
AMETEK Inc.      Hubbell Inc.      Roper Industries
Amphenol Corp      IDEX Corp.      Snap-on Inc.
Cameron International      Illinois Tool Works      SPX Corp.
Carlisle Companies      Ingersoll-Rand      Teledyne Technologies
Crane Co.      Lennox International      Textron
Corning      Nordson Corp.      Timken Company
Danaher      Pall Corp.      Tyco International
Eaton Corp.      Parker Hannifin      United Technologies
Emerson Electric      Pentair      Vishay Intertechnology
Flowserve Corp.      Precision Castparts Corp      Weatherford International
FMC Technologies      Regal Beloit Inc.      3M Company
Gardner Denver          

The Executive Pay Levels and Practices peer group was used to prepare the market data reviewed by the Dover Committee in November 2012. The Performance Share TSR peer group will be used by Dover to measure its relative performance over the next three years to determine payouts for the performance shares awarded beginning January 2012.

In addition to peer group information, Dover has historically referred to pay data for manufacturing companies from the Mercer US Global Premium Executive Remuneration Suite, Towers Watson Survey Report on Top Management Compensation, Hewitt Total Compensation Management surveys and databases, and Equilar Top 25 Survey. These surveys were selected because they include a broad range of manufacturing companies that are comparable to Dover in many ways, including geographic diversity, substantial U.S. operations, comparable revenues and operations in many of the same manufacturing sectors.

Going forward

Knowles anticipates that the process for setting its executive officer compensation levels will be similar to the process used by Dover. Knowles’ Compensation Committee will seek input from the independent directors on Knowles’ Board, Knowles’ CEO and its independent compensation consultant. Since Knowles will operate on the same fiscal calendar as Dover, Knowles expects the timeline used for making decisions surrounding compensation will be similar to that of Dover.

Dover has engaged Towers Watson, on Knowles’ behalf, to assist in designing Knowles’ anticipated executive compensation program. With the assistance of Towers Watson, an initial industry peer group was developed to benchmark compensation in the markets in which Knowles recruits for executive talent. The selected group of companies is similar to Knowles in terms of end markets, complexity and revenue. In addition, Knowles will use the following survey data to benchmark executive pay when peer group data is not available: Towers Watson General Industry Executive Database, Towers Watson Top Management Survey Report and Mercer Benchmark Database. Towers Watson will also review a sample of recent spin-offs to assess market compensation practices and make recommendations to the Dover Committee. Following the distribution, Knowles’ Compensation Committee is expected to retain its own consultant to advise it in its compensation planning decisions.

 

103


Table of Contents

Knowles Executive Pay Levels and Practices Peer Group

 

Atmel Corporation    Fairchild Semiconductor Int’l Inc.    Molex Inc.
AVX Corporation    Interdigital Inc.    RF Micro Devices Inc.
Ciena Corporation    Littlefuse Inc.    Silicon Laboratories Inc.
Cirrus Logic Inc.    LSI Corporation    Skyworks Solutions Inc.
Cree Inc.    Methode Electronics, Inc.    Vishay Intertechnology, Inc.
Cypress Semiconductor Corp    Microsemi Corporation   

The table below provides 2012 revenue statistics for the above peer group and Knowles.

 

Percentile

   2012 Revenue ($Million)  

75th Percentile

     1,689   

50th Percentile

     1,318   

Knowles

     1,118   

25th Percentile

     757   

Section 2—2012 NEO Pay Decisions

The compensation awarded to Knowles’ NEOs in 2012 reflected their respective business units’ financial performance and their individual performance against strategic goals.

Annual Incentive Awards—Financial Objectives

Mr. Niew participated in Dover’s Executive Officer Annual Incentive Plan or “AIP” in 2012. The AIP was designed to reward Dover’s executive officers with an annual bonus for the achievement of both financial and strategic objectives, which are linked to Dover achieving its longer-term goals. For Section 162(m) purposes, the amount available to be paid under the AIP each year is determined by the extent to which Dover achieves that year’s EPS goal established at the beginning of the year. Achievement of Dover’s EPS target allows maximum bonuses to be paid, subject to the negative discretion of the Dover Committee in determining the final bonus to be paid to each senior executive participating in the AIP. Achievement below the EPS target reduces bonus funding by 1% for every 1% below target; achievement above the EPS target does not increase the bonus funding. For purposes of the annual incentive plan, Dover’s 2012 EPS target was $4.83 which, as permitted by the plan, reflected adjustments that (x) included any businesses acquired during the year and full-year results for any business that was placed in discontinued operations during the year (excluding any related goodwill impairment charges) and (y) excluded the impact of any share repurchase programs during 2012. On this basis, Dover achieved EPS of $4.64, such that bonuses were available to be paid at 96.1% of maximum.

The bonuses actually paid under the AIP for 2012 were equal to or less than this 96.1% maximum funding amount. In determining the actual bonus to be paid to each AIP participant, fifty percent of each participant’s bonus was based upon the achievement of specific financial targets and 50% was based upon the achievement of specific individual strategic goals.

 

104


Table of Contents

Knowles’ other NEOs participated in Dover’s annual bonus program, with such Dover performance goals as set forth below.

For all of Knowles’ NEOs, the financial targets listed below were utilized to determine the 50% of their annual bonuses that were tied to financial results.

 

     2012 Targets      2012 Results  
   in $millions except for EPS  
   EPS (1)      Sales      EBIT      EPS (1)      Sales      EBIT  

Dover Communication Technologies, Inc. (Niew and Cabrera)

     4.83         1,758         325         4.64         1,517         219   

Dover Energy (Anderson)

     4.83         2,161         523         4.64         2,173         539   

Knowles Acoustics (Adell)

     n/a         378         126         n/a         406         152   

Knowles Electronics (Walker)

     n/a         226         68         n/a         232         69   

 

(1) As discussed above, EPS target and actual results for 2012 included any businesses placed in discontinued operations during 2012 (excluding any related goodwill impairment charges) and excluded any benefits of share repurchases during 2012. Accordingly, EPS target and “actual results” for 2012 did not represent EPS for 2012 as calculated and reported by Dover under general accepted accounting principles. Dover believed that including in the EPS full-year 2012 results any business placed in discontinued operations during 2012 but which were owned by Dover throughout the period was appropriate for determining overall operational performance of Dover as such businesses were continuing operations when the targets were established at the beginning of the year. Likewise, Dover believed that excluding the benefits of share repurchases was appropriate in considering EPS for incentive compensation purposes as the impact of share repurchases does not reflect operational performance of the Dover businesses.

The following table reconciles 2012 EPS as reported in Dover’s audited financial statements to Dover’s 2012 EPS for purposes of Dover’s annual incentive plan:

 

Dover 2012 fully diluted EPS from continuing operations

   $ 4.53   

Impact of businesses placed into discontinued operations during the year (excluding any related goodwill impairment charges)

     0.17   

Impact of shares repurchased under Dover’s share repurchase programs

     (0.06
  

 

 

 

Dover 2012 Annual Incentive Plan EPS Achieved

   $ 4.64   
  

 

 

 

Annual Incentive Awards—Strategic Objectives

As described above, each of Dover’s executive officers, including Mr. Niew, and each of Knowles’ other NEOs had unique strategic objectives that were utilized to determine the remaining 50% of their annual incentive. The individual NEO strategic goals, which are described below, were linked to the overall success of Dover, as it continued to move forward on its strategic pathway to achieve consistent long-term success.

Mr. Niew

 

    Mr. Niew’s 2012 strategic objectives under the AIP included the startup of a new manufacturing site in the Philippines, achieving growth in the MEMs microphone business and the results achieved by the Sound Solutions business acquired in 2011.

Other NEOs:

 

    Mr. Anderson’s 2012 strategic objectives were focused on the Dover Energy segment and included the successful integration of Dover Energy acquisitions, global expansion (outside of North America and Europe) and successful execution of operational improvements.

 

    Mr. Adell’s 2012 strategic objectives focused on the Knowles Acoustics business and included new product introductions, operational improvements and capacity expansion.

 

105


Table of Contents
    Mr. Cabrera’s 2012 strategic objectives were focused on the Dover Communication Technologies segment and included expanding global operations in Asia, integration of the Sound Solutions acquisition, recruitment of the leadership team in the new manufacturing site in the Philippines and strategic talent acquisition.

 

    Mr. Walker’s 2012 strategic objectives were focused on the development and execution of a robust Knowles Electronics new product pipeline, enterprise value creation through cost reductions, and development of a business strategy to expand revenue and earnings growth opportunities in non-core markets.

Annual Incentive Awards—Payments

Based on 2012 financial performance against the original goals, and the performance of Knowles’ NEOs against their strategic objectives, Knowles’ NEOs were paid the following amounts in the first quarter of 2013:

 

     AIP $
Payout 2012
     AIP Payout as %
of Target 2012
 

Jeffrey S. Niew

     260,000         50

John S. Anderson

     170,000         105

Michael A. Adell

     197,479         180

Raymond D. Cabrera

     92,000         84

Gordon A. Walker

     133,000         133

Going forward

Knowles expects that its NEOs will continue to receive a significant portion of their compensation in the form of “at-risk” pay. Knowles anticipates that it will have an annual cash incentive plan, as described in Section 5 below, that will reward Knowles’ NEOs based on the satisfaction of a combination of corporate financial metrics, business unit financial metrics and operational goals, as established by Knowles’ Compensation Committee. Each NEO will have a target annual incentive payment, expressed as a percentage of his base salary.

Changes in Salary

There was no salary increase for Mr. Niew in 2013. Knowles’ other NEOs received salary increases in 2013 ranging from 1.4% to 4.0%, based on their individual performance and the relative competitiveness of total compensation, based on survey data. These salary increases were recommended by Mr. Niew for all other NEOs except Mr. Anderson, and by the Dover Energy CEO for Mr. Anderson. The recommendations were approved by Dover’s CEO.

2013 Annual Bonus and Long-Term Incentive Award Target Amounts

In 2012 the Dover Committee reviewed a total compensation analysis for the company peer group recommended by Semler Brossy to assess the competitiveness of each of the Dover NEO’s total compensation, including Mr. Niew’s. Based on this review and upon the recommendation of Dover’s CEO, the Dover Committee left unchanged Mr. Niew’s target annual bonus and long-term incentive award amounts for 2013. Mr. Niew recommended 2012 target total compensation levels for each of his direct reports, including Knowles’ NEOs except for Mr. Anderson, based on the performance of each executive and the competitiveness of each executive’s total compensation. The Dover Energy CEO made such recommendation for Mr. Anderson. The recommendations were reviewed and approved by Dover’s management.

 

106


Table of Contents

A summary of the approved 2013 target compensation levels for each of Knowles’ NEOs is below:

 

     2013  
     Salary      Target Bonus     Target LTI  

Jeffrey S. Niew

   $ 525,000         100   $ 1,000,000   

John S. Anderson

   $ 335,000         50   $ 400,000   

Michael A. Adell

   $ 285,000         40   $ 300,000   

Raymond D. Cabrera

   $ 283,250         40   $ 300,000   

Gordon A. Walker

   $ 260,000         40   $ 250,000   

Realized Long-Term Performance Based Compensation

Cash Performance Program

Dover’s three-year cash performance program (“CPP”) rewards executives for improving the value of the entity through earnings growth and cash flow generation over a three-year period. During the three-year plan period ending December 31, 2012, Dover generated $4.1 billion in EBITDA and $2.3 billion of free cash. The payout methodology and details of the program can be found in the section entitled “Compensation Components” under the subheading “Cash Performance Program Awards.” The payouts to Knowles’ NEOs from the plan for the three-year period ending December 31, 2012 were:

 

     CPP $ Payout      CPP Payout as %
of Target
 

Jeffrey S. Niew

     1,639,532         547

John S. Anderson

     653,526         545

Michael A. Adell

     409,883         547

Raymond D. Cabrera

     409,883         547

Gordon A. Walker

     409,883         547

Performance Shares

In February 2010, Dover issued performance share awards that may be earned over three years based on the TSR of Dover’s stock relative to its peer group over that time period. Mr. Niew was then the president of one of Knowles’ operating companies and he did not receive a performance share award in 2010. Mr. Anderson received a target performance share grant on 1,049 shares in 2010. For the three-year period ending December 31, 2012, Dover had a TSR of 68.5%, placing it at the 64.5 percentile of its peer group. This results in a payout of 158% of the original grant. As a result, Mr. Anderson received 1,657 shares.

Going Forward

Knowles expects that its NEOs will continue to receive a significant portion of their compensation in the form of “at-risk” pay. Knowles expects to use annual grants of Knowles equity in the form of stock options and RSUs as part of Knowles’ NEOs compensation. Knowles does not expect to utilize a cash performance plan or performance shares as part of Knowles’ Long Term Compensation Program. Knowles anticipates converting outstanding performance shares to Knowles RSUs with the same terms and conditions as the outstanding performance shares, except that such RSUs will have time-based vesting.

Section 3—Compensation Components

Dover offers a compensation program that provides structure and commonality across all of its operating companies. The following chart represents the components of Dover’s compensation program, and is not to scale for any particular NEO.

 

107


Table of Contents

Executive Compensation Program

 

LOGO

Consistent with its pay for performance philosophy, Dover provided the following compensation and benefits components to its senior management team, including Knowles’ NEOs. After the distribution, Knowles’ NEOs will receive compensation and benefits under Knowles’ compensation program, as determined by Knowles’ Compensation Committee.

 

Compensation Element

  

Objective

  

Current Dover Approach

  

Anticipated Knowles

Approach Going Forward

Salary    To provide a reasonable fixed level of annual cash compensation.    Individual salaries were set based on the executive’s responsibilities, performance, skills and experience as compared with relevant and comparable market talent. The market median was the reference for salaries.    Knowles expects individual salaries will continue to be set based on the executive’s responsibilities, performance, skills and experience as compared with relevant and comparable market talent. The market median will be the reference for salaries.
Annual Incentive Plan Bonus    To encourage and reward the executive officer’s contribution toward producing strong financial and operating results and advancing Dover’s corporate strategy.    Awards were based 50% on financial performance (an assessment of Dover EPS, revenue and/or earnings for the executive’s relevant business unit) and 50% on contributions to strategic initiatives.    Knowles expects that awards will be based on a combination of both financial performance and strategic personal objectives. Financial objectives will be based on Knowles financial goals and an executive’s relevant business unit when applicable.

 

108


Table of Contents

Compensation Element

  

Objective

  

Current Dover Approach

  

Anticipated Knowles

Approach Going Forward

Long-term Cash Performance Program Award    To encourage and reward an executive officer’s contribution in producing strong financial and operating results over a three-year period and to retain talented executives    Payouts, if any, were based on each Dover business unit’s performance as measured by iTSR.    Knowles does not intend to offer the long-term cash performance program.
Equity Awards    To encourage executive officers to focus on long-term performance, to retain talented executives and to align their interests with those of Dover’s shareholders.   

SSAR awards created value only to the extent Dover’s stock price appreciates over the stock price at the time of grant of the award; time vesting only.

 

A portion of the equity award for each senior executive officer, including all NEOs, was in the form of performance shares. Performance shares vest based on Dover’s three-year total shareholder return compared to that of Dover’s peer group.

  

Knowles’ intention is to offer a combination of stock options and restricted stock units.

 

Stock options create value only to the extent Knowles’ stock price appreciates over the stock price at the time of grant of the award, time vesting only.

 

Restricted stock units that will reward executives for stock price appreciation, while providing more stable value to enhance executive retention.

401(k), Pension and Health & Wellness    To provide competitive benefits, including tax-efficient retirement benefits, to retain talented executives and to encourage them to focus on long-term performance.   

Dover executives, including all of Knowles’ NEOs, participate in retirement and benefit plans generally available to Dover employees on the same terms as other employees.

 

Some of Dover’s U.S.-based employees, including all of Knowles’ NEOs, also participate in a tax-qualified defined benefit pension plan. All U.S.-based Dover employees are offered a health and wellness plan (including health, term life and disability insurance). None of Knowles’ NEOs receive enhanced health and wellness benefits.

  

Knowles expects to provide health and welfare plans and qualified retirement plans that will be generally available to most employees.

 

Knowles also expects all U.S.-based Dover employees to be offered a health and wellness plan (including health, term life and disability insurance). Knowles expects that none of its NEOs will receive enhanced health and wellness benefits.

 

Knowles will not be offering a qualified defined benefit pension program, but Knowles will be offering a 401(k) plan.

 

109


Table of Contents

Compensation Element

  

Objective

  

Current Dover Approach

  

Anticipated Knowles

Approach Going Forward

Non-Qualified Retirement Plan    To provide competitive benefits, including tax-efficient retirement benefits, to retain talented executives.    Dover offers two non-qualified plans with participation generally limited to individuals whose annual salary and bonus earnings exceed the IRS limits applicable to Knowles’ qualified plans: a pension replacement plan (“Dover PRP”) and a deferred compensation plan. All of Knowles’ NEOs are eligible to participate in these plans.   

All Knowles executives who have participated in these Dover non-qualified plans will have their benefit accruals frozen on December 31, 2013.

 

Knowles does not anticipate developing a supplemental executive retirement plan. However, Knowles reserves the right to develop a deferred compensation plan for key executives in the coming years.

Severance    To provide fair and consistent severance benefits and avoid individual negotiations.    All of Dover’s NEOs are covered under this executive severance plan. If a covered executive’s employment is terminated without cause (as defined in the severance plan), the executive will generally be entitled to receive twelve months of salary and healthcare benefits continuation; a prorated bonus for time worked during the year; and the next payable CPP award.    Knowles expects to offer executive severance benefits similar to Dover’s executive severance benefits.
Change-in-Control    To retain talent in the event of a change-in-control. To provide consistent severance benefits in the event of termination following a change-in-control and avoid individual agreements.   

Dover has a senior executive change-in-control (“CIC”) severance plan. The CIC severance plan establishes the severance benefits payable to eligible executives if they are involuntarily terminated following a change-in-control.

 

Dover does not provide tax gross-ups in the senior executive change-in-control severance plan.

   Knowles anticipates that it will offer executive severance and CIC benefits similar to Dover, including a prohibition on tax gross-ups for excise taxes caused by change-in-control severance payments.

 

110


Table of Contents

Compensation Element

  

Objective

  

Current Dover Approach

  

Anticipated Knowles

Approach Going Forward

Perquisites    To provide competitive programs to retain talent.   

Dover has no formal executive perquisite program, nor does Dover own or operate any corporate aircraft.

 

Dover management and the Dover Committee believe that providing significant perquisites to executive officers would not be consistent with its overall compensation philosophy.

 

There have been limited legacy perquisite benefits provided to executives at the operating company level.

   Knowles does not anticipate having a formal executive perquisites program.
Clawback policy and Shareholding guidelines    To provide policies that protect shareholder interests.    Dover’s PRP and annual incentive plans include clawback provisions.    Knowles expects to adopt clawback policies and shareholding guidelines that are consistent with Dover’s policies and guidelines.

Salary

Dover set salaries of its executive officers at levels that were intended to motivate and reward annual achievements and continued service. The executive salary structure used the median as a reference for determining salaries, reflecting a philosophy that base compensation should range around the market median, with above-market compensation reflecting exceptional performance. This use of the median as a reference was also consistent with current market practice of Dover’s peer companies.

Going forward

Knowles expects individual salaries will continue to be set based on the executive’s responsibilities, performance, skills and experience as compared with relevant and comparable market talent. The market median will be the reference for salaries.

Performance-Based Compensation

Dover offers incentive compensation on an annual and longer-term basis.

Annual Incentive Plan Bonus (AIP)

Executive officers at Dover who participate in the AIP, including Mr. Niew, may earn a bonus each year based on their performance against both financial and individual strategic goals. The annual bonus is funded for Section 162(m) purposes and then reduced to the final award based on financial and strategic goal achievement. AIP targets are determined according to an executive’s business/function complexity, size and overall impact on Dover’s results, as well as strategic leadership and managerial responsibility.

 

111


Table of Contents

For 2012, 50% of a Dover NEO’s annual bonus was based on the achievement of financial performance criteria based on EPS, revenue and/or operating earnings for segment executives. The other 50% of the annual bonus was based on the achievement of individual strategic objectives related to long-term value creation for Dover shareholders. Executives could achieve up to 200% of their target bonus for performance that is significantly above the targeted performance. They could receive significantly less than the target bonus for performance below the targeted level. Dover believes that balancing the measurement of performance for the AIP between financial and strategic objectives is an important factor in mitigating risk and creating long-term value for Knowles’ shareholders.

Going forward

Knowles expects that its NEO’s annual bonuses will be based on a combination of financial metrics and strategic personal objectives. As under the Dover AIP, Knowles expects that its executive officers will have the potential to earn up to 200% of their target bonus for performance that is significantly above the targeted performance, and they may receive significantly less than the target bonus for performance below the targeted level. Knowles believes that balancing the measurement of performance for the AIP between financial and strategic objectives is an important factor in mitigating risk and creating long-term value for Knowles’ shareholders. The anticipated new annual incentive plan is described below in Section 5.

Long-Term Incentive Plan (LTIP)

Dover offers senior executive officers incentive compensation over periods of time longer than one year under its LTIP. Awards made to Dover executive officers through 2012, including CPP and performance share awards paid out in February 2013, were made under Dover’s 2005 Plan. Beginning with the awards made in 2013, long-term incentive awards to executive officers were made under Dover’s 2012 Plan, which was adopted by the Dover Board and Dover stockholders in 2012. The Dover Committee believes that compensation earned over a longer period helps retain highly qualified executive officers and motivates them toward longer-term goals that will benefit shareholders.

Long-term incentive awards are generally made only once each year during the Dover Committee meeting regularly held in the first quarter, after the announcement of earnings for the prior year. All SSAR grants, whenever made, have an exercise or base price equal to Dover stock’s closing price on the NYSE on the date of grant. Mid-year hires who participate in the Dover long-term incentive plan usually receive their first grant the following February.

The following table summarizes the components of Dover’s LTIP and the related performance criteria:

 

LTIP Component

  

Performance Criteria

  

Vesting or Exercise Period

CPP awards    iTSR    Awards vest and are paid in cash at the end of a three-year performance period.
     
SSARs    Market price of Dover common stock    SSARs are not exercisable until three years after grant; thereafter, they remain exercisable for another seven years.
     
Performance shares    TSR relative to performance peer group    Awards vest and are settled using shares at the end of a three-year performance period.
     

The 2012 present value grant amounts for Knowles’ NEOs were based on each NEO’s executive’s position and responsibility at the time of the grant. The resulting dollar value was allocated between cash performance

 

112


Table of Contents

program awards, stock-settled stock appreciation rights and performance shares with such allocation based on the executive’s responsibilities across the organization. Executives with comparable positions and responsibilities had similar long-term incentive compensation opportunities.

Cash Performance Program Awards. Dover makes cash performance awards annually for the three-year performance period commencing with the year of the award. Any payout of cash performance awards occurs three years later, conditional upon the calculated level of achievement relative to the preset iTSR targets by the participant’s business unit over the three-year period.

Payouts of Dover cash performance awards are made on a sliding scale using the following formula:

 

LOGO

No payouts are made unless iTSR equals or exceeds 6%. The payout to any individual may not exceed $5,000,000 and total payouts for all participants for a business unit may not exceed 1.75% of the value created at that business unit over the three-year performance period.

iTSR is a measure of the change in an entity value plus the free cash flow generated by the entity over the three-year time period. In the case of iTSR, entity value is determined by using a multiple of the entity’s EBITDA. Dover believes increasing the entity value as measured by iTSR creates long-term shareholder value.

Dover Equity Awards. Dover equity awards generally consist of SSARs and performance shares, and in limited circumstances, restricted shares.

SSARs. All SSARs are granted with ten-year terms and are not exercisable until three years after their grant. The exercise or base price of all SSARs is the closing price of Dover stock on the date of grant.

Performance Shares. Performance shares represent potential payments of common stock based on Dover’s TSR relative to that of its peer group over the three-year performance period. Dividends are not earned on performance shares during the performance period.

 

113


Table of Contents

Actual payments may range from 0% to 200% of target grant, as follows:

 

LOGO

Restricted Shares. Dover grants awards of restricted shares in limited circumstances, such as for retention or recognition of special achievements. Dividends are accrued during the vesting period and paid only when the shares vest.

Treatment of outstanding Dover equity awards: Effective as of the distribution, Knowles anticipates that the Dover equity awards previously granted to Knowles’ NEOs will be converted to Knowles equity awards under Knowles’ new long-term incentive plan. In general, Knowles anticipates that each award will be subject to the same terms and conditions as were in effect prior to the distribution, except that performance shares will convert to time-based RSUs. In addition, Knowles’ NEOs will receive new Knowles equity-based awards, as described below. For additional information, see “Certain Relationships and Related Person Transactions—Agreements with Dover—Employee Matters Agreement.”

Going Forward

As described in Section 5 below, Knowles anticipates that its Board will approve a new long-term incentive plan at the time of the spin-off. Awards made under that plan will be primarily equity-based. Knowles’ intention is to offer a combination of stock options and restricted stock units. Stock options create value only to the extent Knowles’ stock price appreciates over the stock price at the time of grant of the award, time vesting only. These stock options will have an exercise price set at the closing stock price on the grant date, with a three-year ratable vesting schedule. Restricted stock units will reward executives for stock price appreciation, while providing more stable value to enhance executive retention. The restricted stock units will also have a three-year ratable vesting schedule. Knowles does not anticipate introducing a performance cash or a performance share plan in the next year. In connection with the distribution, Knowles anticipates that outstanding Dover cash performance awards held by Knowles employees with a performance period extending beyond the distribution date will be cancelled.

Section 4—Other Compensation Programs and Policies

Executive Severance

Knowles’ NEOs have not had employment contracts. Dover has an executive severance plan that covers Knowles’ NEOs, which provides them severance benefits if they are terminated without cause. If a covered executive’s employment is terminated without cause (as defined in the severance plan), the executive will generally be entitled to receive twelve months of salary and healthcare benefits continuation; a prorated bonus for time worked during the year; and the next payable CPP award. See “Potential Payments Upon Termination or Change-in-Control.”

 

114


Table of Contents

Senior Executive Change-in-Control Severance Plan

Dover has a senior executive change-in-control (“CIC”) severance plan. The CIC severance plan establishes the severance benefits payable to eligible executives if they are involuntarily terminated following a change-in-control. Messrs. Niew and Anderson are eligible to participate in Dover’s CIC severance plan. Under the Dover CIC severance plan Messrs. Niew and Anderson are not eligible for any tax gross-up on the benefit. An eligible participant is entitled to receive severance payments under the plan if, within 18 months after the change-in-control, either the executive’s employment is terminated by the company without “cause” or he or she terminates employment for “good reason” (as such terms are defined in the plan). The severance payments and benefits will consist of: a lump sum payment equal to 2.99 times his or her annual salary and bonus, reduced to 2.0 for a termination date that occurs after December 31, 2015; and one year of health care benefit continuation. See “Potential Payments Upon Termination or Change-in-Control.”

Dover senior management, including all of Knowles’ NEOs, may not receive severance benefits under more than one plan or arrangement. Dover does not provide tax gross-ups in the senior executive change-in-control severance plan. Dover does use a “best net” approach, in which Dover pays the severance payment called for under the plan or the maximum severance payable before excise taxes are incurred, whichever results in a higher after-tax payment to the executive.

Going Forward

Knowles does not intend to offer employment contracts to any of Knowles’ NEOs. CIC benefit payments will consist of a lump sum payment equal to 2.0 times his or her annual salary and bonus and one year of health care benefits. Knowles anticipates that it will offer executive severance and CIC benefits similar to Dover, as described in Section 5 below, including a prohibition on tax gross-ups for excise taxes caused by change-in-control severance payments.

Benefits

401(k), Pension Plan and Health & Wellness Plans. Dover senior management, including all of Knowles’ NEOs, participate in retirement and benefit plans generally available to Dover employees on the same terms as other employees. Dover and most of its businesses, including Knowles, offer a 401(k) plan to substantially all U.S.-based employees and provide a company matching contribution denominated as a percentage of the amount of salary deferred into the plan by a participant during the course of the year. Some of Dover’s U.S.-based employees, including all of Knowles’ NEOs, also participate in a tax-qualified defined benefit pension plan. All U.S.-based Dover employees are offered a health and wellness plan (including health, term life and disability insurance). None of Knowles’ NEOs receive enhanced health and wellness benefits.

Non-Qualified Retirement Plans. Dover offers two non-qualified plans with participation generally limited to individuals whose annual salary and bonus earnings exceed the IRS limits applicable to Knowles’ qualified plans: a pension replacement plan (“Dover PRP”) and a deferred compensation plan. All of Knowles’ NEOs are eligible to participate in these plans.

Benefits under the Dover PRP are determined using the benefit calculation and eligibility criteria as under the pension plan, except that United States Internal Revenue Code limits on compensation and benefits do not apply. Prior to December 31, 2009, the participants in the Dover PRP accrued benefits greater than those offered in the pension plan. Effective January 1, 2010, Dover modified this plan so that executives subject to United States Internal Revenue Service compensation limits will accrue future benefits that are substantially the same as benefits under the pension plan. Individuals who participated in the Dover PRP prior to January 1, 2010 will receive benefits calculated under the prior benefit formula through December 31, 2009 and benefits calculated under the lower Dover PRP benefit formula on and after January 1, 2010. Amounts receivable by the executives under the Dover PRP are reduced by any amounts receivable by them under the pension plan and the amounts of the company match in the 401(k) plan.

 

115


Table of Contents

Dover offers a deferred compensation plan to allow participants to elect to defer their receipt of up to 50% of salary and 100% of bonus and any payout of a cash performance award. Dover does not consider the deferred compensation plan to play a major role in its compensation program, as it does not match any amounts deferred or guarantee any particular return on deferrals. The plan merely permits executive officers to defer receipt of part of their compensation to later periods and facilitates tax planning for the participants.

Going Forward

Knowles anticipates that its executive officers will participate in retirement and health and welfare plans generally available to other Knowles employees, on the same terms as other employees. Knowles will not offer a defined benefit pension or a pension replacement plan. There will be no accrued additional benefits under Dover’s pension plan nor pension replacement plan after December 31, 2013. Beyond 2013, there will be no new deferrals to the Dover Non-Qualified Deferred Compensation plan, and Knowles does not anticipate developing a Knowles deferred compensation plan in the coming year.

Clawback Policy

Dover’s PRP and annual incentive plans include clawback provisions.

Anti-hedging and Anti-pledging Policy

Currently, all Dover employees who receive an award under its long-term incentive plan, including all of Knowles’ NEOs, are prohibited from hedging or pledging their position in Dover stock.

Perquisites

Dover has no formal executive perquisite program, nor does Dover own or operate any corporate aircraft. Dover management and the Dover Committee believe that providing significant perquisites to executive officers would not be consistent with its overall compensation philosophy. None of Knowles’ NEOs received significant perquisites in 2012.

There have been limited legacy perquisite benefits provided to executives at the operating company level.

In 2012 Messrs. Adell, Cabrera and Walker participated in an Executive Medical Reimbursement Plan, which provided reimbursements for certain out-of-pocket medical expenses not covered under their health insurance plan. As of early 2013, Mr. Cabrera no longer participated in the Executive Medical Reimbursement Plan.

Going Forward

Knowles’ executives will receive benefits and perquisites generally available with those offered to other employees at Knowles. Knowles will not offer an Executive Medical Reimbursement Plan.

Shareholding Guidelines

Dover believes that its executives will most effectively pursue the long-term interests of its shareholders if they are shareholders themselves. In 2009, the Dover Committee adopted formal share ownership guidelines (subject to exceptions that may be granted by the Dover Committee for significant personal events or retirement planning).

The Dover Committee reserves the right to provide a portion of annual bonus and/or cash performance awards in stock for any Dover executive officer who fails to meet or make satisfactory progress toward satisfying the guidelines within the required time.

 

116


Table of Contents

Tax Deductibility; Section 162(m)

Dover’s AIP, cash performance awards and performance share awards covered under its 2005 Plan are designed to satisfy the requirements of Section 162(m) of the Internal Revenue Code which limits Dover’s ability to deduct, in calculating corporate income tax, compensation in excess of $1 million to specified executive officers unless the compensation is performance-based, among other requirements. The Dover Committee considers tax deductibility to be an important, but not the sole or primary, consideration in setting executive compensation. Accordingly, the Dover Committee has the authority to approve, and in specific situations has approved, the payment of compensation that may not be deductible when it believes such payments are in the best interests of Dover shareholders.

Going forward

Knowles expects it will adopt anti-hedging policies and an incentive clawback policy, in accordance with SEC rules and the rules of Knowles’ listing exchange. Knowles will institute an executive shareholding guideline policy to further align the executive interests with shareholder interests. Knowles does not anticipate introducing new perquisites for the executives, as Knowles does not feel it is aligned with Knowles’ philosophy of providing more pay at risk. Knowles will conduct its initial Say on Pay vote, as well as a vote on the frequency of future Say on Pay votes, at Knowles’ first Annual Meeting. Dover has engaged Towers Watson on Knowles’ behalf to assist in designing Knowles’ anticipated executive compensation program and, following the distribution, Knowles’ Compensation Committee will select its own independent compensation consultant, using criteria that it determines appropriate to do so, without input from Dover or Knowles’ management. Knowles intends to design plans that allow for awards that satisfy the tax deductibility provision in Section 162(m) of the Internal Revenue Code following the date these rules become applicable to Knowles.

Section 5—Anticipated New Knowles Plans

Executive Severance Plan and Senior Executive Change-in-Control Severance Plan

Knowles intends to adopt the Knowles Executive Severance Plan, under which eligible executives (including Presidents of a Knowles-business unit, Vice Presidents of Knowles and any U.S. officer senior to Vice Presidents) will be entitled to receive severance payments if the executive’s employment is terminated by Knowles without cause, as such term is defined in the plan. The severance payments will consist of base salary continuation for twelve months, plus an additional monthly amount equal to the then cost of COBRA health continuation coverage, based on the level of health care coverage in effect on the termination date, for the lesser of twelve months or the period that the executive receives COBRA benefits. An eligible executive will also receive an additional severance payment equal to a pro rata portion of the executive’s annual incentive bonus. The severance payments are subject to the executive executing and not revoking a release of claims against Knowles.

Knowles also intends to adopt the Knowles Corporation Senior Executive Change-in-Control Severance Plan (or, “Knowles’s CIC severance plan”). Under Knowles’s CIC severance plan, eligible executives (including the CEO and the CFO of Knowles, Presidents of a Knowles-business unit and those Vice Presidents of Knowles who are designated as eligible by the CEO of Knowles from time to time) will be entitled to receive severance payments if, within 18 months after the change-in-control, either his employment is terminated by Knowles without “cause” or the executive terminates employment for “good reason,” as such terms are defined in the plan. The severance payments will consist of:

A lump sum payment equal to 2.0 multiplied by the sum of the executive’s (i) annual salary on the termination date or the change-in-control date, whichever is higher, and (ii) target annual incentive bonus for the year in which the termination or the date of the change-in-control occurs, whichever is higher; and

A lump sum payment equal to the then cost of COBRA health continuation coverage, based on the level of health care coverage in effect on the termination date, if any, for one year.

 

117


Table of Contents

If Knowles determines that (i) any payment or distribution to an executive in connection with change-in-control, whether under the CIC severance plan or otherwise, would be subject to excise tax as an excess parachute payment under the Internal Revenue Code and (ii) the executive would receive a greater net-after-tax amount by reducing the amount of the severance payment, Knowles will reduce the severance payments made under the CIC severance plan to the maximum amount that might be paid (but not less than zero) without the executive becoming subject to the excise tax.

No executive may receive severance benefits under more than one plan or arrangement.

Long-term Incentive Plan

In connection with the distribution, Knowles expects to adopt the Knowles Corporation 2014 Equity and Cash Incentive Plan (the “2014 Plan”). The material features of the 2014 Plan are summarized below, but this summary is qualified in its entirety by reference to the full text of the 2014 Plan.

Knowles’ Compensation Committee intends grants and awards under the 2014 Plan to foster behavior that will produce the greatest increase in value for shareholders, reinforce key company goals and objectives that help drive shareholder value, and attract, motivate and retain officers, key employees and directors. Knowles’ Compensation Committee intends to grant incentive awards for Knowles’ NEOs under the 2014 Plan as discussed in “Section 3—Compensation Components—Dover Equity Awards.”

Duration and Amendment. The 2014 Plan has a predetermined term of 10 years, subject to approval by the shareholders, and will terminate in 2024. Knowles’ Compensation Committee may make grants and awards at any time or from time to time before the 2014 Plan terminates.

Knowles’ Board may amend or terminate the 2014 Plan as it deems advisable, except as provided for in the 2014 Plan. In addition, without shareholder approval, the Board cannot approve either the cancellation of outstanding options or SSARs and re-issue awards having a lower exercise price or base price, or amend outstanding options and SSARs to reduce the exercise price or base price thereof (including cash buyouts and the voluntary surrender of underwater options).

Administration. Knowles’ Compensation Committee will administer the 2014 Plan. Knowles’ Compensation Committee will consist of independent members of the Board each of whom is also a “non-employee director” for purposes of the rules under the Securities Exchange Act of 1934 and an “outside director” within the meaning of Section 162(m) of the Internal Revenue Code.

Knowles’ Compensation Committee will select employees who shall receive awards, determine the number of shares covered thereby, and establish the terms, conditions and other provisions of the awards. The Board of Directors will determine the form and amount of directors’ shares to be paid to directors from time to time, subject to the limits of the 2014 Plan. Knowles’ Compensation Committee will determine the procedures and terms under which a director may elect to defer receipt of his or her directors’ shares. Knowles’ Compensation Committee may interpret the 2014 Plan and establish, amend and rescind any rules relating to the 2014 Plan. Knowles’ Compensation Committee may delegate all or part of its responsibilities under the 2014 Plan to the CEO to the extent permitted by Delaware law, except for granting awards to executives subject to Section 16 of the Exchange Act or Section 162(m) of the Code. Only the Board may determine awards to members of the Board.

Eligibility. Officers and other key employees of Knowles’ and its subsidiaries, as selected by Knowles’ Compensation Committee, and non-employee directors of Knowles will be eligible to participate in the 2014 Plan.

Shares Reserved for Issuance; Share Counting. A total of                                  shares of common stock are reserved for issuance under the 2014 Plan. The maximum number of shares issuable under the 2014 Plan is subject to adjustments resulting from stock dividends, stock splits, recapitalizations, reorganizations and other similar changes.

 

118


Table of Contents

Shares subject to stock options and SSARs will reduce the shares available for awards under the 2014 Plan by one share for every one share granted. Performance share awards, restricted stock, restricted stock units that are settled in shares of common stock, directors’ shares and deferred stock units will reduce the shares available for awards under the 2014 Plan by three 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, vests 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 2014 Plan that is cancelled, terminated, or forfeited or that expires will be available for reissuance under the 2014 Plan.

Award Limits. The maximum number of shares of common stock subject to any award intended to comply with Section 162(m) of the Code that may be granted under the 2014 Plan during any fiscal year of Knowles to any employee shall be                                  options or SSARs,                                  shares of restricted stock and                                  restricted stock units. No employee may be granted any performance share award intended to comply with Section 162(m) of the Code that could result in an employee receiving more than                                  shares of common stock for any performance period. No employee shall be granted a cash performance award intended to comply with Section 162(m) of the Code that could result in an employee receiving a payment of more than                                  for any performance period. No non-employee director may be granted more than                                  shares of common stock in any fiscal year.

No more than 5% of the aggregate share reserve may be awarded as restricted stock awards or restricted stock units having a vesting period more rapid than annual pro rata vesting over a period of three years.

Types of Awards. The 2014 Plan provides for stock options and SSAR grants, restricted stock awards, restricted stock unit awards, performance share awards, cash performance awards, directors’ shares and deferred stock units. The 2014 Plan also permits the issuance of awards to Knowles employees in substitution for such employees’ outstanding Dover awards (see the section entitled “Management—Compensation Discussion and Analysis—Treatment of Outstanding Dover Equity Awards”).

Stock Options and Stock-Settled Stock Appreciation Rights. Knowles’ Compensation Committee may grant options and SSARs under the 2014 Plan. Grants of options under the plan permit the participant to acquire shares of common stock at an exercise price fixed on the date of grant during the life of the award. SSARs granted under the plan are “freestanding,” meaning they are granted separately from options and the exercise of SSARs is not linked in any way to the exercise of options. A SSAR allows the plan participant to receive the increase, if any, in the fair market value of the number of shares of common stock underlying the award during the life of the award over a base price set on the date of grant. The amount payable upon the exercise of the SSAR will be paid to the plan participant in shares of common stock. Knowles’ Compensation Committee determines the exercise price for options and the base price of SSARs, which may not be less than the fair market value of the common stock on the date of grant. Knowles’ Compensation Committee may provide for SSARs to be settled in cash to the extent the committee determines to be advisable under foreign laws or customs.

Knowles’ Compensation Committee determines any conditions to the exercisability of options and SSARs, including requirements of a period of continuous service by the participant (time vesting) or performance or other criteria. Options and SSARs may not generally be exercised prior to the first anniversary of the date of grant. The committee also determines the term of each award, provided that the maximum term of any option or SSAR is ten years from the date of grant.

Restricted Stock and Restricted Stock Units. Knowles’ Compensation Committee may award restricted stock or restricted stock units to participants under the 2014 Plan. Restricted stock is registered in the name of a participant on the date of grant subject to vesting requirements and restricted stock units are rights credited to a bookkeeping account that will be settled by the delivery of shares if certain vesting conditions are satisfied. Knowles’ Compensation Committee determines the vesting period, of not less than one year or more than five years, with respect to a restricted stock or restricted stock unit award and whether other restrictions, including the

 

119


Table of Contents

satisfaction of any performance targets, are applicable to the awards. A holder of unvested restricted stock may not exercise voting rights during the restriction period. No dividends or dividend equivalents will be paid on unvested restricted stock or restricted stock unit awards during the restriction period, but in the discretion of the committee, dividend equivalents may be credited to an account for distribution to a participant after vesting.

Performance Share Awards. Knowles’ Compensation Committee may grant performance share awards to employees that will become payable in shares of Knowles’ common stock upon the achievement of objective pre-established performance targets based on specified performance criteria over a performance period of not less than three years. Awards may set a specific number of performance shares that may be earned, or a range of performance shares that may be earned depending on the degree of achievement of the pre-established performance targets. Shares of common stock in payment of performance shares will be issued only if Knowles’ Compensation Committee has certified after the end of the performance period that the required performance targets have been met and the amount of the award.

Cash Performance Awards. Knowles’ Compensation Committee may grant a participant the opportunity to earn a cash performance award conditional upon the satisfaction, over a performance period of not less than three years, of certain pre-established objective performance targets based on specified performance criteria. Knowles’ Compensation Committee will establish a percentage of the value created at the relevant business unit (or Knowles as a whole) during the performance period that the maximum total payout for that business unit (or Knowles as a whole) may not exceed. Cash in payment of cash performance awards will be issued only if Knowles’ Compensation Committee has certified after the end of the performance period that the required performance targets have been met and the amount of the award.

Directors’ Shares and Deferred Stock Units. The Board may designate a percentage of the non-employee director’s compensation to be paid in directors’ shares or may in its discretion determine to pay a specified dollar amount or number of shares as part of the non-employee director’s annual compensation. Subject to procedures Knowles’ Compensation Committee may establish from time to time, a non-employee director may elect to defer receipt of directors’ shares. Should a director elect to defer receipt of directors’ shares, deferred stock units will be credited to a bookkeeping account on the basis of one deferred stock unit for each directors’ share, which deferred stock units will be settled by the delivery of common stock upon the termination of the director’s service as a director or, if earlier, upon a date specified by the director at the time of the deferral election. Dividend equivalents will be credited on deferred stock units and distributed at the same time the shares are delivered upon settlement of the units.

Performance Criteria. Cash performance awards and performance share awards will be, and other awards may be, made subject to performance criteria. Knowles’ Compensation Committee establishes performance targets based on the plan’s performance criteria that include objective formulas or standards for determining the amount of the performance award that may be payable to a participant when the targets are satisfied. The performance targets do not need to be the same for all participants.

The performance criteria under the 2014 Plan include: (i) the attainment of certain target levels of, or a specified percentage increase in, revenues, income before income taxes and extraordinary items, income or net income, earnings before income tax, earnings before interest, taxes, depreciation and amortization, or a combination of any or all of the foregoing; (ii) the attainment of certain target levels of, or a percentage increase in, after-tax or pre-tax profits including, without limitation, that attributable to continuing and/or other operations; (iii) the attainment of certain target levels of, or a specified increase in, operational cash flow; (iv) the achievement of a certain level of, reduction of, or other specified objectives with regard to limiting the level of increase in, all or a portion of Knowles’s or an affiliate’s bank debt or other long-term or short-term public or private debt or other similar financial obligations of Knowles or affiliate, which may be calculated net of such cash balances and/or other offsets and adjustments as may be established by the committee; (v) the attainment of a specified percentage increase in earnings per share or earnings per share from continuing operations; (vi) the attainment of certain target levels of, or a specified increase in, return on capital employed or return on invested

 

120


Table of Contents

capital or operating revenue; (vii) the attainment of certain target levels of, or a percentage increase in, after-tax or pre-tax return on stockholders’ equity; (viii) the attainment of certain target levels of, or a specified increase in, economic value added targets based on a cash flow return on investment formula; (ix) the attainment of certain target levels in the fair market value of the shares of Knowles’s common stock; (x) market segment share; (xi) product release schedules; (xii) new product innovation; (xiii) product or other cost reductions; (xiv) brand recognition or acceptance; (xv) product ship targets; (xvi) customer satisfaction; (xvii) total shareholder return; (xviii) return on assets or net assets; (xix) assets, operating margin or profit margin; and (xx) the growth in the value of an investment in Knowles’s common stock assuming the reinvestment of dividends.

Effect of Termination, Death, Disability or Change-in-Control on Awards. If a participant’s employment is voluntarily or involuntarily terminated other than for cause, vested stock options and SSARs will expire three months after the termination of the participant’s employment or the expiration of the original term, whichever is earlier. If a participant dies or becomes disabled while employed by Knowles, outstanding stock options and SSARs will fully vest and may be exercised by the person’s designated beneficiary, or in the absence of such designation, by the participant’s estate, for the balance of the original term or 60 months, whichever is shorter. If a participant retires on or after age 62, a participant may exercise options and SSARs that are, or within 60 months of the date of retirement become, exercisable, but not beyond the balance of the original term. The enhanced post-employment benefits for retirement on or after age 62 are conditioned upon a participant complying with certain non-competition restrictions that correspond to the period during which enhanced post-employment benefits are provided.

Subject to certain exceptions, cash performance awards, restricted stock, restricted stock units and performance shares will be forfeited if such awards are not vested when the participant terminates employment. If a participant dies, becomes disabled while employed by Knowles or is terminated by Knowles other than for cause, or in the event of any special circumstances as determined by the committee, time-vested restricted stock and restricted stock units will fully vest, subject to attainment of any performance criteria applicable to the award. In the event of retirement after age 62, restricted stock and restricted stock units will continue to vest, subject to compliance with certain non-competition restrictions.

In the case of cash performance awards and performance shares, if a participant dies or becomes disabled while employed by Knowles, a participant or his or her estate is entitled to a pro rata award for the period of service during the performance period, subject to attainment of applicable performance targets. In the case of retirement on or after age 62, a participant is entitled to the cash performance or performance share award that would have been earned had he or she remained in employment for the balance of the performance period, subject to attainment of applicable performance targets. Amounts payable to a participant who retires on or after age 62 are conditioned upon the participant complying with certain non-competition restrictions and any applicable performance criteria.

Vesting of outstanding awards to employees under the 2014 Plan accelerates upon the consummation of a change-in-control (as defined in the 2014 Plan) and one of the following double-trigger vesting requirements: (i) involuntary termination other than for cause, death or disability within 18 months of the change-in-control, (ii) a resignation for good reason within 18 months of the change-in-control, or (iii) outstanding awards are not replaced by a successor with awards that preserve existing value, the awards are not assumed by a successor, or the awards are impaired in value or rights. In addition, Knowles’ Compensation Committee has the right to take such other action with respect to awards in connection with a change-in-control as it determines to be appropriate. In the case of a change in the ownership of effective control of Knowles or in the ownership of a substantial portion of the assets of Knowles, any deferred stock units will settle on the date of such change of control or change in ownership by delivery of shares of common stock.

 

121


Table of Contents

Annual Incentive Plan

Knowles intends to grant annual cash bonuses to executive officers based upon satisfaction of performance targets under an Executive Officer Annual Incentive Plan (“annual bonus plan”).

Purpose of the Plan. Knowles intends to establish the annual bonus plan to make annual bonus amounts paid to certain senior executive officers fully deductible by Knowles for federal income tax purposes as qualified performance-based compensation under Section 162(m). The plan provides for the payment of annual bonuses to senior executive officers who are in a position to make material contributions to Knowles’ success and who are selected each year by Knowles’ Compensation Committee. These annual bonuses are intended to motivate participants and reward the achievement of annual performance targets established each year by the committee.

Duration and Modification. The annual bonus plan does not have a predetermined term. Knowles’ Board may at any time suspend or terminate the plan, or make modifications to it for future performance periods as it may deem advisable. However, the Board may not make any amendments which are expected to materially increase amounts payable under the plan unless appropriate measures have been taken to cause the increased benefits to meet the requirements for qualified performance-based compensation under Section 162(m).

Administration. As described above with respect to the 2014 Plan, Knowles’ Compensation Committee will administer this annual bonus plan.

Eligibility. Knowles’ Compensation Committee in its sole discretion will determine the executive officers eligible to participate in the annual bonus plan each year. For this purpose, executive officer means Knowles’ chief executive officer, Knowles’ chief operating officer, if any, each other executive who reports directly to either Knowles’ chief executive officer or Knowles’ chief operating officer, if any, any other of Knowles’ executives or executives of Knowles’ affiliates selected by Knowles’ Compensation Committee, or any person who is an executive officer of ours under applicable SEC definitions.

Performance Period and Performance Goals. An executive officer designated to participate in the annual bonus plan may earn an annual cash bonus conditioned upon the attainment of pre-established performance targets measured over each calendar year. The performance target must be established in writing by Knowles’ Compensation Committee within the first 90 days of each year on the basis of one or more of the performance criteria specified under the plan. The performance criteria under the plan consist of the following, as applied to Knowles as a whole, or to a subsidiary, a division or a business unit: (i) earnings before interest, taxes, depreciation and amortization, (ii) cash flow, (iii) earnings per share, (iv) operating earnings, (v) return on equity, (vi) return on investment, (vii) total shareholder return or internal total shareholder return, (viii) net earnings, (ix) sales or revenue, (x) expense targets, (xi) targets with respect to the value of common stock, (xii) margins, (xiii) pre-tax or after-tax net income, (xiv) market penetration, (xv) geographic goals, (xvi) business expansion goals or (xvii) goals based on operational efficiency.

Certain Adjustments. Knowles’ Compensation Committee has the discretion to reduce or eliminate any amounts otherwise payable under the annual bonus plan. The committee may not authorize payments under the plan in excess of the amounts determined in accordance with the plan’s provisions.

Payment of Incentive Compensation. Knowles’ Compensation Committee will make the determination of whether any amount is payable under the annual bonus plan. Knowles’ Compensation Committee will certify, in writing and before any amount under the plan is paid, the amount that is payable with respect to each participant for performance during the prior calendar year. All payments are made in cash within 2 12 months following the performance period. The maximum annual cash bonus payable under the plan to any covered individual with respect to any performance period may not in any circumstances exceed $5 million.

 

122


Table of Contents

Summary Compensation Table

The Summary Compensation Table and notes show all remuneration for 2012 provided to Knowles’ NEOs, consisting of the following executive officers:

 

    Knowles’ Chief Executive Officer;

 

    Knowles’ Chief Financial Officer; and

 

    Knowles’ next three most highly-compensated executive officers.

The determination of the most highly compensated executive officers is based on total compensation paid or accrued for 2012, excluding changes in the actuarial value of defined benefit plans and earnings on nonqualified deferred compensation balances.

 

Name and

Principal Position

  Year     Salary
($)
    Bonus
($) (1)
    Stock
Awards
($) (2)
    Option
Awards
($) (3)
    Non-Equity
Incentive Plan
Compensation
($) (4)
    Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings
($) (5)
    All Other
Compensation
($) (6)
    Total
($)
 

Jeffrey S. Niew

Chief Executive Officer

    2012        525,000        260,000        165,122        509,599        1,639,532        181,301        7,040        3,287,594   

John S. Anderson,

Chief Financial Officer

    2012        325,000        170,000        66,078        203,851        653,526        50,569        9,893        1,478,917