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


FORM 10-K

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

For the fiscal year ended December 31, 2019.

or

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


Commission File Number: 001-36102

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

Delaware
90-1002689
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

1511 Maplewood Drive, Itasca, IL
(Address of Principal Executive Offices)

 
60143
(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading symbol
 
Name of each exchange on which registered
Common stock, $0.01 par value per share
 
KN
 
New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  
Yes  No 
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes      No 

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

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

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

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

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

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of the close of business on June 28, 2019 was approximately $1,645,000,000. The number of outstanding shares of the registrant’s common stock as of February 7, 2020 was 91,708,799.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the registrant's 2020 Annual Meeting of Stockholders have been incorporated by reference into Part III of this Annual Report on Form 10-K.





Table of Contents

 
 
Page
 
 
 
 
 
 
 
 
 
 




2

Table of Contents


PART I
ITEM 1. BUSINESS

Unless the context otherwise requires, references in this Annual Report on Form 10-K to “Knowles,” the “Company,” “we,” “our,” or “us” refer to Knowles Corporation and its consolidated subsidiaries.

Our Company

We are a market leader and global provider of advanced micro-acoustic, audio processing, and precision device solutions, serving the mobile consumer electronics, communications, medtech, defense, automotive, and industrial markets. We use our leading position in micro-electro-mechanical systems ("MEMS") microphones and strong capabilities in audio processing technologies to optimize audio systems and improve the user experience in mobile, ear, and Internet of Things ("IoT") applications. We are also a leader in acoustic components, high-end capacitors, and mmWave radio frequency ("RF") solutions for a diverse set of markets. Our focus on the customer, combined with our unique technology, proprietary manufacturing techniques, rigorous testing, and global scale, enables us to deliver innovative solutions that optimize the user experience. Knowles, founded in 1946 and headquartered in Itasca, Illinois, has approximately 8,500 employees in 12 countries around the world.

Our Strategy
The Company is focused on investing in high value solutions to diversify its revenue and increase exposure to high-growth markets.

In our Audio segment, our primary focus has been to position the Company to benefit from the positive trends we are seeing in Audio across consumer devices. With products ranging from mobile phones to headsets, and from smart speakers to household appliances, improved audio quality and voice-powered interactions are emerging as critical and necessary features. Consumers want better audio performance and to engage with technology through natural, spoken commands, across the mobile, ear, and IoT markets, and original equipment manufacturers (“OEMs") are racing to develop and deploy the technology to enable it. Our unique capabilities in acoustics, digital signal processing, and algorithms place us in a competitive position to enhance audio and enable voice input.

Our focus on strategically positioning the business to support these broader trends around audio input includes the acquisition of Audience, Inc. ("Audience") in 2015, which brought us essential digital signal processing and algorithm capabilities, and the divestiture of our low-margin speaker and receiver product line ("Speaker and Receiver Product Line") in 2016. During this time, we have also invested significantly in MEMS microphones and balanced armature speakers to maintain our leadership positions and optimize our manufacturing footprint across our business units.

In our Precision Devices segment, we continue to drive higher sales growth and improved operating margins through both organic initiatives and acquisitions. In 2017, we reshaped our portfolio by divesting our timing device business ("Timing Device Business") to increase our focus on growth platforms in Precision Devices where we have strong market positions and attractive margin profiles, including telecom, medtech, defense, automotive, and industrial applications.

Our Business Segments

Our reportable segments are as follows:

Audio Segment
Our Audio group designs and manufactures innovative audio products, including microphones and balanced armature speakers, audio processors, and software and algorithms used in applications that serve the mobile, ear, and IoT markets. Locations include the sales, support, and engineering facilities in North America, Europe, and Asia, as well as manufacturing facilities in Asia.


3

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Precision Devices ("PD") Segment
Our PD group specializes in the design and delivery of high performance capacitor products and mmWave RF solutions for technically demanding applications. Our high performance capacitor products are used in applications such as power supplies and medical implants, which sell to a diverse set of customers for mission critical applications across the communications, medtech, defense, automotive, and industrial markets. Our mmWave RF solutions primarily solve high frequency filtering challenges for our military customers, who use them in their satellite communication and radar systems, as well as our telecommunications infrastructure customers deploying mmWave 5G base stations. Locations include the sales, support, engineering, and manufacturing facilities in North America, Europe, and Asia.

We sell our products directly to OEMs and to their contract manufacturers and suppliers and to a lesser extent through distributors worldwide.

Market Trends

In our Audio segment, voice is being embraced as a primary user interface across consumer electronic devices. Voice assistants are proliferating throughout a variety of applications from mobile phones to headsets, and from smart speakers to household appliances. Consumers want to engage with technology through natural, spoken commands, across the mobile, ear, and IoT markets, and OEMs are racing to develop and deploy the technology to enable it. Our core capabilities in acoustics, digital signal processing, and algorithms place us in an ideal position to enhance audio and enable voice input.

Within the hearing aid market, sales are largely driven by aging demographics, healthcare spending, increasing affluence in emerging markets, and government subsidies.

Our Precision Devices segment sells high reliability, high voltage and high temperature ceramic capacitors, and electromagnetic interference filters across diverse end markets, including telecom, defense, medtech, and industrial markets. Portions of this segment face much greater exposure to capital investment cycles and government spending, both direct and indirect, as some of these end markets are largely dependent on project upgrades, expansion, and government contracts.

Geographic Trends

We strive to maintain our manufacturing facilities in close proximity to our direct customers. In Audio, we currently operate 4 facilities in Asia to serve the contract manufacturers who build OEM equipment on behalf of our end-customers. These contract manufacturers are largely based in China, Taiwan, India, Singapore, Indonesia, and Vietnam. Although end-user demand for consumer electronics and hearing aids is global and marketing activities occur globally, the majority of our manufacturing is located in Asia, primarily in China, Malaysia, and the Philippines.

In PD, we operate 5 facilities in North America and 1 facility in Asia for the manufacturing of capacitors that support our global customers, as well as their suppliers and contract manufacturers.

Competitive Landscape

Success in the electronic components industry is primarily driven by innovation and flexibility as customers compete to gain a share of the growing consumer device market. We compete across consumer platforms to deliver superior acoustic performance through customized products. Our investments in research and development enable us to capture new design wins across consumer OEMs. Our ability to balance and shift between full and semi-automation is key to our ability to optimize our operations and operating expenses. Additionally, it is important for suppliers to have flexibility and quick time-to-market to meet clients’ needs. Notably, according to industry estimates, the product cycle for mobile handsets has shortened over recent years. Key competitors include:

Audio - AAC Technologies, Goertek, Sonion, and Synaptics; and
PD - AVX Corporation, Kemet, and Murata.

In the Audio segment, our investments in research and development enable us to continually introduce new products with higher performance. Our customers are adopting these higher value microphones to improve the overall audio performance of their devices which in turn improves the end user experience. Typically our new products have higher average selling prices than the products they are replacing. Once introduced, the pricing for these products trend lower, as is typical in the consumer electronics market.

4

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For products that were introduced more than 18 months ago, we strive to offset anticipated price erosion through bill of material cost reductions, yield improvements, equipment efficiency, and movement to lower-cost manufacturing locations.

In the PD segment, the end markets tend to be more stable. We see a fragmented set of competitors across high end capacitor products for a diverse set of end markets including telecom, defense, medtech, and industrial.

Customers, Sales, and Distribution

We serve customers in the mobile consumer electronics, industrial, defense, automotive, medtech, and telecommunications markets. Our customers include some of the largest OEMs and operators in these markets. In addition, many of our OEM customers outsource their manufacturing to Electronic Manufacturing Services (“EMS”) companies. Other customers include global mobile phone manufacturers, hearing aid manufacturers, and many of the largest global EMS companies, particularly in China.

The Company's customers that accounted for 10% or more of total revenues were as follows:
 
Revenues
 
Years Ended December 31,
 
2019
 
2018
 
2017
Apple Inc.
22
%
 
19
%
 
19
%
Samsung Electronics Co., Ltd.
*

 
*

 
10
%
* Less than 10% of total revenues.

We manufacture and develop our products as well as maintain sales and technical customer support offices in North America, Europe, and Asia. In our PD segment, we supplement our direct sales force with external sales representatives and distributors. Our global distribution center is located in Penang, Malaysia. Our worldwide sales force provides geographically specific support to our customers and specialized selling of product lines to various customer bases. For further detail and for additional disclosures regarding sales and long-lived assets by geographic location, see Note 18. Segment Information to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

Raw Materials

We use a wide variety of raw materials, primarily metals, and semi-processed or finished components. Commodity pricing for various metals, such as palladium, gold, brass, stainless steel, and copper, fluctuates. As a result, our operating results are exposed to such fluctuations. Although some cost increases may be recovered through increased prices to customers, if commodity prices trend upward, we attempt to control such costs through fixed-price contracts with suppliers and various other programs.

We rely on highly specialized suppliers or foundries for critical materials, components, or subassemblies that are used in our products which, in some cases, may be sole sourced from such suppliers or foundries or, such suppliers or foundries may also be a strategic supplier to one of our competitors or a customer. The loss of any single supplier has not had a material impact on operating profits. However, should an event occur which affects the ability or willingness of any supplier or foundry to continue to deliver materials or components to us in a timely manner, we may not be able to identify or qualify an alternative supplier in a timely manner which, in any such period and future periods, could have a material adverse impact on our results of operations. See Item 1A. Risk Factors for additional information regarding risks related to our business.

Research and Development

We concentrate our research and development efforts on the design and development of new products for each of our principal markets. We also fund certain other emerging product and technology opportunities. Our future success is highly dependent upon our ability to develop complex new products, transfer new products to volume production, introduce them into the marketplace in a timely fashion, and have them selected for design into our customers’ products at competitive prices. Our future success may also depend on increasing acoustic content in our customers’ products including assisting our customers with integration of our products and software into their new products and providing support from the concept stage through design, launch, and production ramp.


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Intellectual Property and Intangible Assets

We rely on patent, copyright, trademark, and trade secret laws to protect our intellectual property, products, and technology. Our U.S. patents expire in calendar years 2020 through 2038. While our patents are an important element of our success, our business as a whole is not dependent on any one patent or group of patents. We do not anticipate any material effect on our business due to any patents expiring in 2020, and we continue to obtain new patents through our ongoing research and development. We have maintained U.S. federal trademark registrations for KNOWLES and Knowles logo designs, along with various other trademarks. These U.S. registrations may be renewed as long as the marks continue to be used in interstate commerce. We have also filed or obtained foreign registration for these marks in other countries or jurisdictions where we conduct, or anticipate conducting, international business. To complement our own research and development efforts, we have also licensed and expect to continue to license, a variety of intellectual property and technologies important to our business from third parties. See Item 1A. Risk Factors for additional information regarding risks related to our business.

Seasonality

In general, our businesses tend to have higher revenues in the third and fourth quarters of each fiscal year. This is particularly true of those businesses that serve the consumer electronics market. Our businesses tend to have short product cycles due to the highly technical nature of the industries they serve which can result in new OEM product launches that can impact quarterly revenues, earnings, and cash flow.

Employees

We currently employ approximately 8,500 persons across our facilities in 12 countries. Approximately 75% of our employees are located in Asia. We are subject to various local, national, and multi-national laws and regulations relating to our relationships with our employees. Our workforce in the United States is not unionized. We believe we generally have good relationships with employees and their representative organizations.

Other Information

Knowles was incorporated in Delaware on June 12, 2013 and was spun-off from Dover Corporation ("Dover" or "Former Parent") in 2014 (the "Separation"). The address of our principal executive offices is 1151 Maplewood Drive, Itasca, Illinois 60143. Our telephone number is 630-250-5100.

We post our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports on the "Financial Information - SEC Filings” link on the Investor Relations section of our website, www.knowles.com. We post each of these reports on the website as soon as reasonably practicable after the report is filed with or furnished to the Securities and Exchange Commission ("SEC"). The information on our website is not incorporated into this Form 10-K.

ITEM 1A. RISK FACTORS

Cautionary Statement Concerning Forward-Looking Statements

This Annual Report on Form 10-K contains certain statements regarding business strategies, market potential, future financial performance, future action, results, and any other statements that do not directly relate to any historical or current fact which are “forward-looking” statements within the meaning of the Securities Act of 1933, as amended (the "Securities Act"), the Exchange Act, and the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “anticipate,” “project,” “estimate,” “budget,” “continue,” “could,” “intend,” “may,” “plan,” “potential,” “predict,” “seek,” “should,” “will,” “would,” “expect,” “objective,” “forecast,” “goal,” “guidance,” “outlook,” “effort,” “target,” and similar expressions, among others, generally identify forward-looking statements, which speak only as of the date the statements were made.

In particular, information included under the sections entitled “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contain forward-looking statements.


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Readers are cautioned that the matters discussed in these forward-looking statements are subject to risks, uncertainties, assumptions, and other factors that are difficult to predict and which could cause actual results to differ materially from those projected, anticipated, or implied in the forward-looking statements. Where, in any forward-looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will be achieved or accomplished. Many factors that could cause actual results or events to differ materially from those anticipated include those risks and uncertainties described below and elsewhere in this Annual Report on Form 10-K, including under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K and Knowles does not assume any obligation to update any forward-looking statement as a result of new information, future events, or otherwise, except as required by applicable law. All forward-looking statements, expressed or implied, included in this Annual Report on Form 10-K are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that we may make or persons acting on our behalf may issue.

You should consider each of the following factors as well as the other information in this Annual Report on Form 10-K, including our financial statements and the related notes, in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. In general, we are subject to the same general risks and uncertainties that impact many other companies such as general economic, industry, and/or market conditions and growth rates; possible future terrorist threats or armed conflicts and their effect on the worldwide economy; and changes in laws or accounting rules. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of these risks occur, our business and financial results could be harmed. In that case, the trading price of our common stock could decline.

Risks Related To Our Business

Our largest segment, Audio, derives a significant portion of its revenues from a limited number of OEM customers. If revenues derived from these customers decrease or the timing of such revenues fluctuates, our operating results could be adversely affected.

Our Audio segment accounted for 80% of our consolidated revenues for fiscal 2019. Our Audio segment derives a significant portion of revenues from a small number of OEM customers. For 2019, Audio top five customers accounted for approximately 49% of Audio’s revenues. For the year ended December 31, 2019, Apple Inc. accounted for approximately 27% of Audio’s revenues and 22% of consolidated company revenues. The mobile handset industry is also subject to intense competition that could result in decreased demand and/or declining average selling prices for our products and those of our OEM customers. The loss of any one of Audio’s top customers or a reduction in the purchases of Audio’s products by such customers would reduce our total revenues and may have a material adverse effect on our operating results, and any delay of a significant volume of purchases by any one of our top customers, even if only temporary, would reduce our revenues in the period of the delay and may have a material adverse effect on our operating results. Further, concentration of market share among a few companies and the corresponding increase in purchasing power of these companies may result in lower prices for our products which, if not offset by a sufficient increase in the volume, or favorable changes in the mix, of purchases of our products, could have a material adverse effect on our revenues and margins. In addition, the timing, volume, and mix of purchases by our significant customers may be impacted by the timing of such customers’ new or next generation product introductions, and the timing of such introductions may have a material adverse effect on our operating results. Accordingly, if current market and industry dynamics continue, our Audio segment’s revenues will continue to depend largely upon, and be impacted by the timing, volume, and mix of future purchases by a limited number of our OEM customers.

We derive the majority of our Audio revenues from MEMS microphones and a significant reduction in our sales of MEMS microphones could significantly reduce our revenues and adversely impact our operating results.

Within our Audio segment, revenues are generated primarily from the sales of our MEMS microphones. Sales of MEMS microphones accounted for approximately 57% of our consolidated revenues for fiscal 2019. We expect that a substantial portion of our revenues will continue to be attributable to sales of MEMS microphones and any weakening of demand, loss of market share, or other factors adversely affecting our levels and the timing of our sales of MEMS microphones, including our customers’ product release cycles, market acceptance, product competition, the performance and reliability of our MEMS microphones, and economic and market conditions could cause our Audio revenues to substantially decline, which may have a material adverse effect on our operating results.

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We depend on the mobile handset market for a significant portion of our revenues, and any downturn or slower than expected growth in this market could significantly reduce our revenues and adversely impact our operating results.

The mobile handset market accounted for approximately 27% of our consolidated revenues for fiscal 2019. While other markets such as mobile headsets, wearables, and IoT are gaining in significance, we expect that a substantial portion of our consolidated revenues will continue to be attributable to the mobile handset market, which is cyclical and characterized by continuous and rapid technological change, product obsolescence, price erosion, evolving standards, short product life cycles, and significant fluctuations in product supply and demand. Moreover, the mobile handset market may not continue to grow at the rate experienced in recent years or may decline for reasons outside of our control including competition among market participants, market saturation, and global economic conditions. The mobile handset market has experienced and may experience periodic downturns which may be characterized by diminished product demand, production overcapacity, high inventory levels, and accelerated erosion of average selling prices. Given that the strength of the mobile handset market is a primary driver of revenues for our Audio segment, any downturn in the mobile handset market could have a material adverse effect on our business and operating results. In addition, a decline in global economic conditions, particularly in China and other geographic regions with high concentrations of mobile handset users, could have adverse, wide-ranging effects on demand for our products or technologies, the products and services of our customers or licensees, particularly OEM handset manufacturers, the solvency of key suppliers, failures by counterparties, and negative effects on mobile handset inventories. In addition, our customers’ ability to purchase or pay for our products and services and their customers’ ability to upgrade their mobile handsets could be adversely affected by economic conditions, leading to a reduction, cancellation, or delay of orders for our products or services.

If we are unable to continue to offset erosion of average selling prices in our Audio segment our gross margins may be adversely affected.

Like most technology sectors, the mobile handset industry has traditionally experienced an erosion of average selling prices due to a number of factors, including intense competition, component pricing trends, changes in demand mix, excess inventories, and rapid obsolescence resulting from technology advances. Within our Audio segment, while average selling prices vary significantly on a product to product basis, we have generally been successful with largely offsetting price erosion by shifting our product mix to new, higher end or higher performance microphones and gradually shifting customers from analog microphones to higher value digital microphones. To offset average selling price erosion, we must either continue to be successful with these initiatives or increase our selling prices. If we are unable to continue to offset average selling price erosion, the average selling prices of our products may decrease and our future operating results may be materially adversely affected.

We rely on highly specialized suppliers for a variety of highly engineered or specialized components, and other inputs for which we may not be able to readily identify alternatives or substitutes in the event of a supply disruption or capacity constraint at or by any of these suppliers, which could have a material adverse impact on our results of operations.

Certain of our businesses rely on highly specialized suppliers or foundries for critical materials, components, or subassemblies that are used in our products. In some cases, such suppliers or foundries may be our sole source of supply or, such suppliers or foundries may also be a strategic supplier to one of our competitors or a customer. In either of these cases, should an event occur which affects the ability or willingness of any of such supplier or foundry to continue to deliver materials or components to us in a timely manner, we may not be able to identify or qualify an alternative supplier in a timely manner which, in any such period and future periods, could have a material adverse effect on our results of operations. Potential events or occurrences which could cause business or supply disruptions or affect the ability or willingness of a supplier or foundry to continue to supply us include changes in market strategy, the acquisition of, sale, or other change in control or ownership structure of a supplier or foundry, strategic divestiture, bankruptcy, insolvency or other financial difficulties, business disruptions, operational issues, or capacity constraints at a supplier or foundry.

Global markets for our products are highly competitive and subject to rapid technological change. If we are unable to develop new products and compete effectively in these markets, our financial condition and operating results could be materially adversely affected.

We compete in highly competitive, technology-based, industries that are highly dynamic as new technologies are developed and introduced. Our competitors may introduce products that are as or more technologically advanced than our products or launch new products faster than we can, which may result in a loss of market share or revenue by us. If we are unable to anticipate or match our competitors’ development or launch of new products, identify customer needs and preferences on a timely basis, or successfully launch or ramp production of our new products, our business and operating results may be materially adversely affected.

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We operate in the highly competitive mobile handset industry, which requires us to invest significant capital in developing, qualifying, and ramping production of new products without any assurance of product sales. If our new products are not designed into a customer's product or qualified by a customer our operating results could be negatively impacted.

A significant portion of our consolidated revenues are derived from acoustic components and audio solutions, including software, that are required to go through extensive customer qualification processes before being selected by customers for inclusion in their end products. In order to meet the product launch schedules of our top customers, we may invest capital and devote substantial resources, including design, engineering, sales, marketing, and programming efforts, based on non-binding forecasts provided by these customers, without any assurance that our products will be designed into a customer’s product or qualified by the customer. In such cases, if our product is not designed into or qualified by the customer, we may not recover or realize any return on the capital that we invested and our operating results may be materially adversely affected.

In addition, the time required and costs incurred by us to ramp-up production for new products can be significant. Certain non-recurring costs and expenditures for tooling and other equipment may not be reusable in manufacturing products for other customers or different products for the same customer. Product ramps typically involve greater volumes of scrap and risks to execution such as higher costs due to inefficiencies and delays in production, all of which can have a material adverse effect on our operating results.

Our foreign operations and supply chain are each subject to various risks that could materially adversely impact our results of operations and financial condition.

Many of our manufacturing operations, research and development operations, vendors, and suppliers are located outside the United States and if we are unable to successfully manage the risks associated with our global operations, our results of operations and financial condition could be negatively impacted. These risks include:
o  
labor unrest and strikes, particularly in Asia, where the majority of our manufacturing operations are located;
o  
earthquakes, floods, and other natural disasters, epidemics (such as the coronavirus currently impacting China), or catastrophic events, particularly in Asia, where the majority of our manufacturing operations are located;
o  
acts of terrorism or armed conflicts;
o  
political or economic instability;
o  
government embargoes, trade restrictions, and import and export controls; and
o  
transportation delays and interruptions.

Global economic conditions and changes in U.S. and International Trade Policy could materially adversely impact our business, results of operations, and financial position.

In the past, the Company's business and operating results have been adversely affected by these global economic conditions and remain vulnerable to future adverse impacts. In particular, our sales to customers in China continue to be impacted by the recent economic slowdown in China. Any continued or prolonged economic deceleration in China may have a material adverse effect on our sales to customers in China, our operating results, and our financial condition.


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Further, rising international trade tensions, new or increased tariffs, and trade wars among countries have and may continue to impact the global economy and the trade policies of the United States. The U.S. government has taken certain actions and demonstrated its intent to alter its approach to international trade policy using many tactics at its disposal including the renegotiation, termination or threatened termination, or renegotiation of certain existing bilateral or multi-lateral trade agreements and treaties with, the imposition of tariffs on a wide range of products and other goods manufactured in, China, countries in Europe, and other countries and the imposition of sanctions on countries and companies that it has concluded are directly or indirectly avoiding United States’ trade sanctions. Given that the majority of our largest manufacturing facilities are located in China and Southeast Asia, trade policy changes in the United States, China, or other countries, such as the tariffs and sanctions currently proposed, implemented, and threatened by the U.S. government, present particular risks for us that could adversely impact our results of operations and financial condition. New or increased tariffs implemented in China are having an adverse effect on a small percentage of our capacitor products, tariffs announced but not yet implemented could have an adverse effect on our other products, and threatened tariffs could adversely affect all of our products. We cannot predict future foreign trade policy in the United States or other countries, the terms of any new or renegotiated trade agreements or treaties, or tariffs or the impact of such matters on our business. A trade war involving the United States is likely to negatively impact world trade and the world economy in various ways and, consequently, have a material adverse effect on our results of operations and financial condition. To the extent that tariffs, trade restrictions, or sanctions imposed by the United States or other countries increase the price of, affect customer demand for, affect our ability to supply our products, or create adverse tax consequences, in the United States or other countries, our business and our operating results may be adversely affected. As a result, changes in international trade policy, changes in trade agreements, the imposition of tariffs or sanctions by the United States or other countries could materially adversely affect our results of operations and our financial condition.

Changes to export restrictions and economic sanction laws may adversely affect our operating results.

As a global company headquartered in the U.S., we are subject to U.S. laws and regulations, including import, export, and economic sanction laws. These laws may include prohibitions on the sale or supply of certain products to embargoed or sanctioned countries, regions, governments, persons, and entities, may require an export license prior to the export of the controlled item, or may otherwise limit and restrict the export of certain products and technologies. Many of our customers and suppliers are foreign companies or have significant foreign operations. The imposition of new or additional economic and trade sanctions against our major customers or suppliers could result in our inability to sell to, and generate revenue from such customers or purchase materials from such suppliers. Although these restrictions and laws have not significantly restricted our operations in the past, there is a risk that they could do so in the future.

For example, on May 16, 2019, the U.S. Department of Commerce published a final rule in the Federal Register that amended the Export Administration Regulations by adding Huawei Technologies Co., Ltd. ("Huawei") and 68 of its affiliates to the “Entity List” for actions contrary to the national security or foreign policy interests of the U.S. This rule imposed new export licensing requirements on exports, re-exports, and in-country transfers of all U.S.-regulated products, software, and technology to the designated Huawei entities, which initially prevented sales of all Knowles’ U.S. regulated products to Huawei. The U.S. Department of Commerce subsequently issued licenses to the Company enabling us to pursue sales of certain audio products to Huawei, but indicated its intent to deny the Company's license application related to the export of certain telecommunication products to Huawei. We do not expect this event to have a material impact on our results of operations. However, if more restrictions are placed on sales of our products to our existing or potential customers, this could adversely affect our business and results of operations in the future.

As a result of restrictive export laws, our customers may also develop their own solutions to replace our products or seek to obtain a greater supply of similar or substitute products from our competitors that are not subject to these restrictions, which could materially and adversely affect our business and results of operations.

In addition, our association with customers that are or become subject to U.S. regulatory scrutiny or export restrictions could subject us to actual or perceived reputational harm among current or prospective investors, suppliers or customers, customers of our customers, other parties doing business with us, or the general public. Any such reputational harm could result in the loss of investors, suppliers, or customers, which could harm our business, financial condition, operating results, or prospects.

Our success depends on our ability to attract and retain key employees, and if we are unable to attract and retain such qualified employees, our business and our ability to execute our business strategies may be materially impaired.

Our future success depends largely on the continued service and efforts of our executive officers and other key management and technical personnel and on our ability to continue to identify, attract, retain, and motivate them, particularly in an environment of cost reductions and a general move toward more performance-based compensation for executives and key management.


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Implementing our business strategy also requires specialized engineering and other talent, as our revenues are highly dependent on technological and product innovations. Competition for such experienced technical personnel in our industry and where we are located is intense, and we cannot assure that we can continue to recruit and retain such personnel. For example, there is substantial competition in China for experienced engineers and technical personnel where most of our operations are located and for machine learning and software engineers in California and India where we primarily conduct research and development for our software and intelligent audio products, which may make it difficult for us to recruit and retain key employees. If we are unable to attract and retain such qualified employees, our business and our ability to execute our business strategies may be materially impaired.

Our revenues and operating results could be materially adversely affected if we are unable to protect or obtain patent and other intellectual property rights or if intellectual property litigation is successful against us.

We employ various measures to maintain, protect, and defend our intellectual property, including enforcing our intellectual property rights in various jurisdictions and forums throughout the world. However, policing unauthorized use of our products, technologies, and proprietary information is difficult and time consuming and these measures may not prevent our intellectual property from being challenged, invalidated, copied, disclosed, stolen, or circumvented. If we fail to protect our proprietary rights, our competitors might gain access to our technology, which could adversely affect our ability to compete successfully in our markets and harm our operating results. We also may not be successful in litigation or other actions to enforce our intellectual property rights, particularly in countries where intellectual property rights are not highly developed or protected, particularly in Asia, where the majority of our manufacturing operations are located. Litigation, if necessary, may result in retaliatory legal proceedings alleging infringement by us of intellectual property owned by others. We have had and may in the future have difficulty in certain circumstances in protecting or enforcing our intellectual property rights, including collecting royalties for use of certain patents included in our patent portfolio in certain foreign jurisdictions due to, among other things: policies of foreign governments; challenges to our licensing practices under such jurisdictions’ competition laws; failure of foreign courts to recognize and enforce judgments of contract breach and damages issued by courts in the United States; and/or challenges pending before foreign patent authorities as to the validity of our patents and those owned by competitors and other parties.

Our competitors or other third parties may also assert infringement or invalidity claims against us in the future. If one of our products is found to infringe on a third party’s rights, we may have liability for damages arising out of past infringement and may need to seek a license to use such intellectual property going forward. If a license is not available or if we are unable to obtain a license on terms acceptable to us, we would either have to change our product so that it does not infringe or cease selling the product. Any of these events may have a material adverse effect on our business, operating results, and financial condition.

The expense of protecting, defending, and enforcing our intellectual property, or defending claims that our products, technology, or manufacturing processes infringe the intellectual property rights of others, can vary significantly period to period and, in any given period, could have a material adverse effect on our operating results.

We have invested and continue to make strategic investments and acquisitions that, if not successful, could have a material adverse effect on our business and financial results.

We engage in strategic transactions and make strategic investments including investments in emerging technology companies and intellectual property which are focused on growth by positioning the Company for expansion into new markets, territories or technologies, exploiting new or growing customer or market opportunities, and developing new technologies and products. Such acquisitions and strategic investments naturally entail significant risks and uncertainties, some of which are beyond our control. We may not, for example, be able to retain key employees, customers, or suppliers of acquired companies, derive value from acquired technology or assets and we may experience delays in achieving cost synergies or higher than expected costs in implementing them. In addition, due to our inexperience with certain adjacent or complimentary technologies and doing business in certain geographic regions that may be served by acquired businesses, we may underestimate the costs or overestimate the benefits that we expect to realize from such acquisitions or investments, and we may not achieve them. We cannot, therefore, provide assurance that each of our acquisitions or strategic investments will be accretive or generate anticipated financial returns. If, for any of these or for unforeseen reasons, our strategic acquisitions or investments fail to meet our expectations or forecasts, our business and results of operations may be materially adversely affected.

Our effective tax rate may fluctuate which will impact our future financial results.

Our effective tax rate is highly dependent upon the geographic composition of our worldwide earnings as we are subject to income taxes in both the U.S. and various foreign jurisdictions. Tax regulations governing each region, changes to those regulations, differing statutory tax rates, changes in the valuation of deferred tax assets, tax law, or rate changes could adversely affect our effective tax rate, and ultimately actual taxes payable.

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The estimated effects of applicable tax laws, including current interpretation of the Tax Cuts and Jobs Act ("Tax Reform Act"), have been incorporated into our financial results. The U.S. Treasury Department, Internal Revenue Service ("IRS"), and other standard-setting bodies could interpret or issue future legislation or guidance which impact how provisions of the Tax Reform Act will be applied or otherwise administered that is different from our interpretation, which could have a material adverse impact on our effective tax rate as well as our future financial results and tax payments.

Further, our tax returns are subject to periodic reviews or audits by domestic and international authorities, and these audits may result in adjustments to our provision for taxes or allocations of income or deductions that result in tax assessments different from amounts that we have estimated. We regularly assess the likelihood of an adverse outcome resulting from these audits to determine the adequacy of our provision for taxes. There can be no assurance as to the outcome of these audits or that our tax provisions will not change materially or be adequate to satisfy any associated tax liability. If our effective tax rates were to increase or if our tax liabilities exceed our estimates and provisions for such taxes, our financial results could be adversely affected.

Our effective tax rate is favorably impacted by tax holidays granted to us by certain foreign jurisdictions, which lowers the tax rates we are subject to for a period of time as compared to the countries' statutory tax rates. These tax holidays are subject to the satisfaction of certain conditions, including exceeding certain annual thresholds of operating expenses and gross sales. If we fail to satisfy such conditions, our effective tax rate may be materially adversely impacted. For additional detail, see Note 13. Income Taxes to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data." Moreover, tax rates and laws in the countries where we operate may change, or tax reforms may be enacted domestically or in foreign jurisdictions which adversely affect our liquidity, cash flows, and future reported financial results or our ability to continue to structure and conduct our business as is done currently.

We are subject to potentially material liability for breaches of confidentiality agreements with certain of our top customers.

We have entered into non-disclosure agreements with several of our top customers which require us not to disclose and to protect certain information regarding, among other things, aspects of those customers’ businesses plans, products, and technology. These confidentiality agreements, in some cases, impose strict liability on us in the event of any breach of these agreements by us or our employees or agents and, should such a breach occur, any resulting damage award or settlement could have a material adverse effect on our operating results and financial condition.

Our business and operations could suffer in the event of security breaches, cybersecurity incident, other unauthorized disclosures, or network disruptions.

While we have taken and continue to actively take measures to protect the various proprietary information, algorithms, source code, and confidential data relating to both our and our customers’ business and products that is stored on our computer networks, servers, and peripheral devices, as well as on servers owned or managed by third party vendors whom we leverage, such data and information remains vulnerable to cyber attacks, cyber breaches, theft, or other unauthorized access. These attacks are increasing in their frequency, sophistication, and intensity and are costly to protect against. In addition, many of the techniques used to obtain unauthorized access, including viruses, worms, and other malicious software programs, are difficult to anticipate until launched against a target and we may be unable to implement adequate preventative measures. If successful, such unauthorized access could result in loss of valuable intellectual property, disclosure of confidential customer or commercial data, disclosure of government classified information, or system disruptions and subject us to civil liability and fines or penalties, damage our brand and reputation or otherwise harm our business, any of which could be material.

Should any security breach result in the disclosure of certain of our customers’ or business partners’ confidential information, we may incur liability to such customers or business partners under confidentiality agreements that we are party to with such parties. In addition, delayed sales, lower margins, or lost customers resulting from security breaches or network disruptions could materially reduce our revenues, materially increase our expenses, damage our reputation, and have a material adverse effect on our stock price.

There is also a danger of industrial espionage, unauthorized disclosures, theft of information or assets (including source code), or damage to assets by people who have gained unauthorized access to the Company's facilities, systems, or information. Such breaches, misuse, or other disruptions could lead to unauthorized disclosure of confidential or proprietary information or improper usage or sale of the Company's products or intellectual property without compensation and theft, manipulation, and destruction of private and proprietary data, which could result in defective products, production downtimes, lost revenue, or damage to our reputation, and have a material adverse effect on our stock price.


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Additionally, any disruption, termination, or substandard provision of our communication networks and IT systems, whether as a result of computer or telecommunication issues (including operational failures, computer viruses, or security breaches), localized conditions (such as power outage, fire, or explosion) or events or circumstances of broader geographic impact (such as earthquake, storm, flood, other natural disaster, epidemic, strike, act of war, civil unrest, or terrorist act), could materially affect our business by disrupting normal operations.

Global privacy legislation, enforcement, and policy activity are rapidly expanding and creating a complex data privacy environment. We are subject to many data privacy, data protection, and data breach notification laws and regulations in the United States and around the world, including the European General Data Protection Act ("GDPR"), which became effective as of May 25, 2018. While we have taken measures to assess the requirements of, and to comply with data privacy legislation, there is the potential for fines and penalties, litigation, and reputational harm in the event of a data breach.

Fluctuations in foreign currency rates and commodity prices could have a material adverse effect on our operating results and financial condition.

We conduct a significant amount of business outside the United States and adverse movements in currency exchange rates, particularly the Malaysian ringgit, the Chinese renminbi (yuan), and the Philippine peso, in any period or periods, could have a material adverse effect on our business and our operating results due to a number of factors, including, among others:
o
our products are manufactured and sold outside the United States which increases our net exposure to changes in foreign exchange rates;
o
our products, which are typically sold in U.S. dollars, may become less price-competitive outside the United States as a result of unfavorable foreign exchange rates;
o
certain of our revenues that are derived from customer sales denominated in foreign currencies could decrease;
o
our foreign suppliers may raise their prices if they are impacted by currency fluctuations, resulting in higher than expected costs and lower margins;
o
the cost of materials, products, services, and other expenses outside the United States could be materially impacted by a weakening of the U.S. dollar; and
o
a sustained weakening of the U.S. dollar for an extended period could have a material adverse impact on our operating results and financial position.

While we have entered and may in the future enter into derivative financial instruments in an effort to hedge our foreign currency exposure, we remain exposed to the economic risks of foreign currency fluctuations.

In addition, we use a wide variety of raw materials in our manufacturing operation and are exposed to market risks associated with changes in commodity prices. Changes in commodity prices (from tariffs or otherwise) cannot always be predicted, hedged, or offset with price increases to eliminate earnings volatility. As a result, significant changes in commodity prices, particularly for various precious metals, could have a substantial adverse effect on our financial condition and results of operations. See the “Risk Management” section of Item 7 for additional discussion of foreign currency and commodity price risks.


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Our products are complex and could contain defects, which could result in material costs to us and harm our business, results of operations, and financial condition.

Our products are complex and could contain defects, which could result in material costs to us. Product development in the markets we serve is becoming more focused on audio signal processing for improved audio performance and to enable intelligent and more sophisticated audio solutions. The increasing complexity of our products increases the risk that we or our customers or end users could discover latent defects or subtle faults after significant volumes of product have been shipped. This could result in material costs and other adverse consequences to us including, but not limited to: loss of customers, reduced margins, damage to our reputation, a material product recall, replacement costs for product warranty and support, payments to our customers related to recall claims as a result of various industry or business practices, a delay in recognition or loss of revenues, loss of market share, or failure to achieve market acceptance, and a diversion of the attention of our engineering personnel from our product development efforts. In addition, any defects or other problems with our products could result in financial losses or other damages to our customers who could seek damages from us for their losses. A product liability or warranty claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend. In particular, the sale of systems and components that are incorporated into mobile handsets for the global mobile phone industry involves a high degree of risk that such claims may be made. Due to the complex nature of our products, quality and reliability issues may be identified after significant volumes of a product have been shipped to a large customer. A warranty or product liability claim against us in excess of our available insurance coverage and established reserves, or a determination that we have liability or an obligation to cover the costs of a customer product recall, could have a material adverse effect on our business, results of operations, and financial condition.

In addition, our products are typically sold to customers at prices that are significantly lower than the cost of the customer’s products in which they are incorporated. Given that a defect in one of our products could give rise to failures in the products that incorporate them, we may face claims for damages that are disproportionate to the revenues we receive from the products involved and because we are self-insured for matters relating to product quality a significant claim could have a material adverse effect on our financial condition. Moreover, to the extent a defect in one of our products is caused by a defective component supplied to us by a third party, we may, nonetheless, be liable to the customer and be unsuccessful in seeking indemnification from that third party.

Our goodwill, other intangible assets, or long-lived assets may become impaired, which could result in a significant charge to earnings.

We hold significant amounts of goodwill, other intangible assets, and long-lived assets, and the balances of these assets could increase in the future if we acquire other businesses. At December 31, 2019, the balance of our goodwill, other intangible assets, and long-lived assets was $1.2 billion and the total market value of the Company’s outstanding shares was $1.9 billion. Under generally accepted accounting principles in the United States ("U.S. GAAP"), we review our goodwill, other intangible assets, and long-lived assets for impairment when events or changes in circumstances indicate the carrying value of such goodwill, other intangible assets, or long-lived assets may not be recoverable. In addition, we test goodwill and other indefinite-lived intangible assets for impairment annually. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill, other intangible assets, or long-lived assets may not be recoverable, include, but are not limited to, a sustained decline in stock price and market capitalization, significant negative variances between actual and expected financial results, reduced future cash flow estimates, adverse changes in legal factors, failure to realize anticipated synergies from acquisitions, and slower growth rates in our industry. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill, other intangible assets, or long-lived assets is determined to exist, negatively impacting our results of operations. If our market capitalization was to fall below the book value of our total stockholders’ equity for a sustained period, we may conclude that the fair value of certain of our intangible or long-lived assets is materially impaired. In this case, we would be required under U.S. GAAP to record a non-cash charge to our earnings which could have a material adverse effect on our business, results of operations, and financial condition.

Risks Related to Our Indebtedness

Our credit agreement requires us to comply with certain financial covenants and our failure to comply could have a material adverse effect on our business, financial condition, and results of operations.

The credit agreement governing our revolving credit facility contains covenants requiring us to, among other things, maintain a minimum ratio of consolidated EBITDA to consolidated interest expense and a maximum ratio of consolidated total indebtedness to consolidated EBITDA. In the past, we have obtained amendments from the lenders under the credit agreement which have allowed us to comply with the financial covenants, but there can be no assurance that in the future the lenders will agree to such amendments, and our inability to comply with the covenants could result in an event of default which, if not cured or waived, could have a material adverse effect on our business, financial condition, and operating results.


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We are subject to counterparty risk with respect to the convertible note hedge transactions.
 
As discussed in Note 12. Borrowings to our audited Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data", we issued convertible senior notes (the "Notes") and concurrently entered into convertible note hedge transactions and separate warrants. The option counterparties are financial institutions, and we are subject to the risk that one or more of the option counterparties may default under the convertible note hedge transactions. Our exposure to the credit risk of the option counterparties will not be secured by any collateral. If any of the option counterparties become subject to insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at that time under our transactions with such counterparties. Our exposure will depend on many factors but, generally, the increase in our exposure will be correlated to the increase in the market price and in the volatility of our common stock. In addition, upon a default by the option counterparties, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.

There are risks associated with our indebtedness, which could have a material adverse effect on our financial condition.

Our outstanding indebtedness and any additional indebtedness we incur may have negative consequences, including:
o
requiring us to use cash to pay the principal of and interest on our indebtedness, thereby reducing the amount of cash flow available for other purposes;
o
limiting our ability to obtain additional financing for working capital, capital expenditures, acquisitions, stock repurchases, dividends, or other general corporate and other purposes;
o
limiting our flexibility in planning for, or reacting to, changes in our business and our industry; and
o
increasing our vulnerability to interest rate fluctuations to the extent a portion of our debt has variable interest rates.

Our ability to make payments of principal and interest on our indebtedness depends upon our future performance, which is subject to general economic conditions, industry cycles, and financial, business, and other factors, many of which are beyond our control. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to, among other things: refinance or restructure all or a portion of our indebtedness; reduce or delay planned capital or operating expenditures; or sell selected assets. Such measures might not be sufficient to enable us to service our debt. In addition, any such financing, refinancing, or sale of assets might not be available on economically favorable terms or at all, and if prevailing interest rates at the time of any such financing and/or refinancing are higher than our current rates, interest expense related to such financing and/or refinancing would increase. Furthermore, our variable rate indebtedness may use LIBOR as a benchmark for establishing the rate. LIBOR is the subject of recent national, international, and other regulatory guidance and proposals for reform. These reforms and other pressures may cause LIBOR to disappear entirely or to perform differently than in the past. The consequences of these developments cannot be entirely predicted, but could include an increase in the cost of our variable rate indebtedness. If there are adverse changes in the ratings assigned to our debt securities by credit rating agencies, our borrowing costs, our ability to access debt in the future, and/or the terms of the financing could be adversely affected.

Transactions relating to our Convertible Notes may dilute the ownership interest of our stockholders, or may otherwise depress the price of our common stock.

The conversion of some or all of our outstanding Notes would dilute the ownership interests of existing stockholders to the extent we deliver shares upon conversion of any such Notes. If the Notes become convertible under the terms of the indenture, and if holders subsequently elect to convert their notes, we could be required to deliver to them a significant number of shares of our common stock. Any sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the Notes may encourage short selling by market participants because the conversion of such notes could be used to satisfy short positions. Additionally, anticipated conversion of such notes into shares of our common stock could depress the price of our common stock. For additional detail, see Note 12. Borrowings to our Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data.”


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The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material effect on our reported financial results.

Accounting Standards Codification ("ASC") 470-20, Debt with Conversion and Other Options requires an entity to separately account for the liability and equity components of convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet, and the value of the equity component is treated as an original issue discount for purposes of accounting for the debt component of the Notes. As a result, we are required to record a greater amount of non-cash interest expense in current periods presented as a result of the amortization of the discounted carrying value of the Notes to their face amount over the term of the Notes. ASC 470-20 requires interest to include both the current period’s amortization of the debt discount and the instrument’s coupon interest, which could adversely affect our reported or future financial results, the trading price of our common stock, and the trading price of the Notes. In addition, under certain circumstances, the convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash are currently accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of the Notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of the Notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes, then our diluted earnings per share would be adversely affected.

Risks Related to Our Corporate Governance and Common Stock

Our business could be negatively affected as a result of the actions of activist or hostile stockholders.

Our business could be negatively affected as a result of stockholder activism, which could cause us to incur significant expense, hinder execution of our business strategy, and impact the trading value of our securities. In the past, the Company has been the subject of shareholder activism, and we are subject to the risks associated with any future such activism. Stockholder activism, including potential proxy contests, requires significant time and attention by management and the Board of Directors, potentially interfering with our ability to execute our strategic plan. Additionally, such stockholder activism could give rise to perceived uncertainties as to our future direction, adversely affect our relationships with key executives and business partners, and make it more difficult to attract and retain qualified personnel. Also, we may be required to incur significant legal fees and other expenses related to activist stockholder matters. Any of these impacts could materially and adversely affect our business and operating results. Further, the market price of our common stock could be subject to significant fluctuation or otherwise be adversely affected by stockholder activism.

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

Each of our certificate of incorporation, our by-laws, and Delaware law, as currently in effect, contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirers to negotiate with our Board of Directors rather than to attempt a hostile takeover. These provisions include, among others:
o
the inability of our stockholders to call a special meeting or act by written consent;
o
rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings;
o
the right of our Board of Directors to issue preferred stock without stockholder approval;
o
the classification of our Board of Directors and a provision that stockholders may only remove directors for cause, in each case until our 2021 annual meeting of stockholders; and
o
the ability of our directors, without a stockholder vote, to fill vacancies on our Board of Directors (including those resulting from an enlargement of the Board of Directors).

In addition, current Delaware law includes provisions which limit the ability of persons that, without prior board approval, acquire more than 15% of the outstanding voting stock of a Delaware corporation from engaging in any business combination with that corporation, including by merger, consolidation, or purchases of additional shares, for a three-year period following the acquisition by such persons of more than 15% of the corporation’s outstanding voting stock.


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In light of present circumstances, we believe these provisions taken as a whole protect our stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with our Board of Directors and by providing our Board of Directors with more time to assess any acquisition proposal. These provisions are not intended to make us immune from takeovers or prevent changes in the composition of our Board of Directors. However, these provisions could delay or prevent an acquisition that our Board of Directors determines is not in the best interests of the Company and all of our stockholders.

Our stock price has been and may continue to be volatile and may fluctuate significantly which may adversely impact investor confidence and increase the likelihood of securities class action litigation.

Our common stock price has experienced substantial volatility in the past and may remain volatile in the future. During 2019, our closing stock price ranged from a high of $22.74 per share to a low of $12.38 per share. Volatility in our stock price can be driven by many factors including divergence between our actual or anticipated financial results and published expectations of analysts or the expectations of the market, market conditions in our industry, announcements that we, our competitors, our vendors, or our customers may make regarding their operating results, technological innovations, and the gain or loss of customers, or key opportunities. Our common stock is also included in certain market indices, and any change in the composition of these indices to exclude our company may adversely affect our stock price. Increased volatility in the financial markets and/or overall economic conditions may reduce the amounts that we realize in the future on our cash equivalents and/or marketable securities and may reduce our earnings as a result of any impairment charges that we record to reduce recorded values of marketable securities to their fair values.

Further, securities class action litigation is often brought against a public company following periods of volatility in the market price of its securities. Due to changes in our stock price, we may be the target of securities litigation in the future. Securities litigation could result in substantial uninsured costs and divert management’s attention and our resources.


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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our corporate headquarters is located in Itasca, Illinois. Our material properties used in connection with manufacturing, sales, research and development, and corporate administrative operations, and the segments served at that facility, are as follows:
Location
 
Principal Function(s)
 
Owned or Leased
 
Segment
 
Square Footage (in thousands)
Suzhou, China
 
Manufacturing and administrative
 
Leased
 
Audio, PD
 
495
Cebu, the Philippines
 
Manufacturing and administrative
 
Owned
 
Audio
 
215
Penang, Malaysia
 
Manufacturing and administrative
 
Owned
 
Audio
 
187
Cazenovia, New York
 
Manufacturing, research and development, sales, and administrative
 
Owned
 
PD
 
133
Itasca, Illinois
 
Corporate headquarters, research and development, sales, and administrative
 
Owned
 
Audio
 
95
Mountain View, California
 
Research and development and administrative
 
Leased
 
Audio
 
88

We believe that our owned and leased facilities are well-maintained and suitable for our operations.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we are involved in various legal proceedings and claims arising in the ordinary course of our business. The majority of these claims and proceedings relate to commercial, warranty, employment, and intellectual property matters. Although the ultimate outcome of any legal proceeding or claim cannot be predicted with certainty, based on present information, including management’s assessment of the merits of the particular claim, we do not believe that the disposition of these legal proceedings or claims, individually or in the aggregate, after taking into account recorded accruals and the availability and limits of insurance coverage, will have a material adverse effect on our cash flow, results of operations, or financial condition.

We own many patents and other intellectual property pertaining to our products, technology, and manufacturing processes. Some of our patents have been and may continue to be infringed upon or challenged by others. In appropriate cases, we have taken and will take steps to protect and defend our patents and other intellectual property, including through the use of legal proceedings in various jurisdictions around the world. Such steps have resulted in and may continue to result in retaliatory legal proceedings, including litigation or other legal proceedings in various jurisdictions and forums around the world alleging that we infringe on patents owned by others. The costs of investigations and legal proceedings relating to the enforcement and defense of our intellectual property may be substantial. Additionally, in multi-forum disputes, we may incur adverse judgments with regard to certain claims in certain jurisdictions and forums while still contesting other related claims against the same opposing party in other jurisdictions and forums.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.


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INFORMATION ABOUT OUR EXECUTIVE OFFICERS

The following sets forth information regarding our executive officers, as of February 12, 2020.
Name
Age
Position
 
 
 
Jeffrey S. Niew
53
President & Chief Executive Officer
 
 
 
John S. Anderson
56
Senior Vice President & Chief Financial Officer
 
 
 
Christian U. Scherp
54
President, Performance Audio
 
 
 
Raymond D. Cabrera
53
Senior Vice President, Human Resources & Chief Administrative Officer
 
 
 
Daniel J. Giesecke
52
Senior Vice President & Chief Operating Officer
 
 
 
Robert J. Perna
56
Senior Vice President, General Counsel & Secretary
 
 
 
Michael S. Polacek
56
President, Intelligent Audio
 
 
 
Air A. Bastarrica, Jr.
40
Vice President, Controller

Jeffrey S. Niew has served as President & Chief Executive Officer since September 2013 and as a member of our Board of Directors since February 2014. From November 2011 until the Separation in February 2014, Mr. Niew served as a Vice President of Dover Corporation and as President and Chief Executive Officer of Dover Communication Technologies. Mr. Niew joined Knowles Electronics LLC (“Knowles Electronics”) in May 2000 and became Chief Operating Officer in January 2007, President in January 2008, and President and Chief Executive Officer in February 2010. Prior to joining Knowles Electronics, Mr. Niew was employed by Littelfuse, Inc., from 1995 to 2000, where he held various positions in product management, sales, and engineering in the Electronic Products group and by Hewlett-Packard Company, from 1988 to 1994, where he served in various engineering and product management roles in the Optoelectronics Group in California.

John S. Anderson has served as Senior Vice President & Chief Financial Officer since December 2013. From January 2013 until the Separation in February 2014, Mr. Anderson served as Vice President and Chief Financial Officer of Dover Communication Technologies. Previously, Mr. Anderson served as Vice President and Chief Financial Officer of Dover Energy (August 2010 to January 2013) and Vice President and Chief Financial Officer of Dover Fluid Management (October 2009 to August 2010). Previous experience includes the roles of Corporate Controller and Director Financial Planning & Analysis for Sauer-Danfoss Inc. (October 2004 to October 2009) and Director of Finance and Controller for Borg Warner Turbo Systems GmbH (August 2002 to October 2004).

Christian U. Scherp has served as President, Performance Audio since July 2015 and prior thereto he was Co-President, Mobile Consumer Electronics - Speakers and Receivers (September 2012 to June 2015). Prior to joining Knowles Electronics, Mr. Scherp served as the Global Head of Sales for the Consumer Devices business of TE Connectivity, a manufacturer of connectivity and sensor platforms (November 2011 to August 2012). Additional previous experience includes the following roles at Conexant Systems: Executive Vice President of Sales (January 2011 to June 2011), Co-President, WW Sales, Marketing, Program Management (July 2009 to December 2010), and President (2008 to 2009).

Raymond D. Cabrera has served as Senior Vice President, Human Resources & Chief Administrative Officer since February 2014. From November 2011 until the Separation in February 2014, Mr. Cabrera served as Vice President, Human Resources of Dover Communication Technologies. Previously, Mr. Cabrera served in the following capacities at Knowles: as Vice President, Human Resources and Chief Administrative Officer (January 2004 to November 2011), Vice President, Human Resources (March 2000 to January 2004), and Director, Human Resources (June 1997 to March 2000) of Knowles Electronics.

Daniel J. Giesecke has served as Senior Vice President & Chief Operating Officer since February 2014. From January 2012 until the Separation in February 2014, Mr. Giesecke served as Vice President, Global Operations of Dover Communication Technologies. Previously, Mr. Giesecke served as Vice President, Advanced Manufacturing Engineering, Knowles Electronics (February 2009 to January 2012), Senior Director, Advanced Manufacturing Engineering, Knowles Electronics (January 2008 to February 2009), Director of Engineering Operations, Knowles Electronics (November 2003 to January 2008), and various operations, supply chain, and engineering positions since he joined Knowles Electronics in 1995.


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Robert J. Perna has served as Senior Vice President, General Counsel & Secretary since May 2019. Prior to joining Knowles, Mr. Perna served as Senior Vice President, General Counsel and Secretary of The AZEK Company, a manufacturer of commercial and residential building products (November 2018 to April 2019) and as Senior Vice President, General Counsel and Secretary of Rockwell Collins, Inc., a leading producer of cabin interior, communications and aviation systems for the aerospace and defense industry (January 2014 to November 2018). In addition, he served as Vice President, General Counsel and Secretary at A. M. Castle & Co., a specialty metals and plastics distributor and value-added processor (November 2008 to January 2014) and held various in-house legal positions at CNH Global, Navistar International and GE Capital Rail Services.

Michael S. Polacek has served as President, Intelligent Audio since February 2017. Prior to joining Knowles, Mr. Polacek was a partner with Eachwin Capital, L.P., a management investment firm, from December 2012 to January 2017 and served as a strategic adviser for KKR Private Equity during 2012. In addition, he held numerous management and other senior positions, including Senior Vice President, Corporate Development and Key Market Segments at National Semiconductor, a semiconductor manufacturer, from 1992 to 2011.

Air A. Bastarrica, Jr. has served as Vice President, Controller since July 2018. Mr. Bastarrica has been with the Company since 2012 and has held numerous financial leadership roles including Director, Finance-Performance Audio (MCE and HHT) (September 2016 to June 2018), Director, Finance-Hearing Health Technologies (July 2015 to August 2016), and Manager, Corporate Financial Planning and Analysis (December 2012 to June 2015). Previously, Mr. Bastarrica held several financial positions at Navistar Inc. (April 2000 to November 2012) in Brazil and the United States.


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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is listed on the New York Stock Exchange ("NYSE") under the ticker symbol “KN”.

Dividends

Since our common stock began trading on the NYSE, we have not paid cash dividends and we do not anticipate paying a cash dividend on our common stock in the immediate future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend on many factors, such as our financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints, and other factors that the Board of Directors deems relevant. Our ability to pay dividends will depend on our ongoing ability to generate cash from operations and access to the capital markets.

Holders

The number of holders of record of our common stock as of February 7, 2020 was approximately 914.

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

None.


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Performance Graph
This performance graph does not constitute soliciting material, is not deemed filed with the SEC, and is not incorporated by reference in any of our filings under the Securities Act or the Exchange Act, whether made before or after the date of this Annual Report on Form 10-K and irrespective of any general incorporation language in any such filing, except to the extent we specifically incorporate this performance graph by reference therein.

chart-0606ca65228856388b0a17.jpg
Data Source: NYSE
*Total return assumes reinvestment of dividends.
The graph assumes $100 invested on December 31, 2014 in Knowles Corporation common stock, the PHLX / Semiconductor Sector Index, and the S&P Small Cap 600 Index.







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ITEM 6. SELECTED FINANCIAL DATA

The following table presents selected financial data on a continuing operations basis as derived from our audited Consolidated Financial Statements. The selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included under Item 7 and the Consolidated Financial Statements and accompanying notes included under Item 8, "Financial Statements and Supplementary Data."
 
 
Years Ended December 31,
Statement of Earnings Data (1)
(in millions, except share and per share amounts)
 
2019

2018

2017

2016

2015 (2)
Revenues
 
$
854.8

 
$
826.9

 
$
744.2

 
$
755.7

 
$
753.6

Gross profit
 
328.0

 
322.6

 
286.0

 
295.7

 
281.6

Interest expense, net (3)
 
14.5

 
16.0

 
20.6

 
20.4

 
12.7

Provision for (benefit from) income taxes
 
16.6

 
(4.5
)
 
12.9

 
8.3

 
3.2

Earnings from continuing operations
 
$
49.7

 
$
65.6

 
$
6.5

 
$
19.8

 
$
17.4

 
 
 
 
 
 
 
 
 
 
 
Basic earnings per share from continuing operations
 
$
0.55

 
$
0.73

 
$
0.07

 
$
0.22

 
$
0.20

Diluted earnings per share from continuing operations
 
$
0.53

 
$
0.72

 
$
0.07

 
$
0.22

 
$
0.20

Basic shares outstanding (4)
 
91,156,124

 
90,050,051

 
89,329,794

 
88,667,098

 
86,802,828

Diluted shares outstanding (4)
 
93,439,023

 
91,194,747

 
90,490,007

 
89,182,967

 
86,992,254

 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31,
Balance Sheet Data
(in millions)
 
2019
 
2018
 
2017
 
2016
 
2015 (2)
Total assets
 
$
1,654.6

 
$
1,547.9

 
$
1,549.8

 
$
1,515.0

 
$
1,696.4

Total third party debt and finance lease obligations (3)(5)
 
$
166.1

 
$
170.6

 
$
207.4

 
$
313.8

 
$
447.5

 
 
Years Ended December 31,
Other Data (1)
(in millions)
 
2019
 
2018
 
2017
 
2016
 
2015 (2)
EBIT (6)
 
$
80.8

 
$
77.1

 
$
40.0


$
48.5


$
33.3

Depreciation and amortization
 
$
54.4

 
$
52.4

 
$
53.8

 
$
69.0

 
$
72.4

Capital expenditures
 
$
41.2

 
$
80.1

 
$
49.5

 
$
32.2

 
$
36.8


(1) 
On July 7, 2016, the Company completed the sale of its Speaker and Receiver Product Line. On November 28, 2017, the Company completed the sale of its Timing Device Business. All amounts presented are on a continuing operations basis. For additional information, refer to Note 2. Disposed and Discontinued Operations to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

(2) 
On July 1, 2015, the Company completed its acquisition of all of the outstanding shares of common stock of Audience. The Consolidated Statements of Earnings and Consolidated Balance Sheets include the results of operations, net assets acquired, and depreciation and amortization expense related to Audience since the date of acquisition.

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(3) 
On January 27, 2014, we entered into a $200.0 million five-year senior secured revolving credit facility with a group of lenders, as well as a $300.0 million five-year senior secured term loan facility pursuant to a Credit Agreement ("Original Credit Agreement"), which are referred to collectively as the “Prior Credit Facilities.” In connection with the Separation, we incurred $100.0 million of borrowings under the revolving credit facility and $300.0 million of borrowings under the term loan facility, in each case to finance a cash payment to our Former Parent immediately prior to the Separation. On December 31, 2014, we amended our Prior Credit Facilities to increase the amount of the revolving credit facility in the Original Credit Agreement to $350.0 million but incurred no additional borrowings. On July 1, 2015, we amended our Prior Credit Facilities to facilitate our ability to consummate the Audience acquisition. We funded the cash portion of the consideration through a drawdown of our existing revolving credit facility and cash on hand. On February 9, 2016, the Company entered into a third amendment to its Prior Credit Facilities in connection with the Company’s decision to sell the Speaker and Receiver Product Line, which also included permanent reduction by the Company of the aggregate revolving commitment under the Original Credit Agreement from $350.0 million to $300.0 million. On April 27, 2016, the Company entered into a fourth amendment to its Prior Credit Facilities in connection with the Company's offering of the 3.25% Convertible Senior Notes due November 1, 2021 (the "Notes"). On October 11, 2017, the Company entered into a Revolving Credit Facility Agreement (the "New Credit Facility"). The new agreement is being used for working capital and other general corporate purposes of the Company, including refinancing of indebtedness under the Company’s Prior Credit Facilities. The New Credit Facility contains a five-year senior secured revolving credit facility providing for borrowings in aggregate principal amount of up to $400.0 million. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations—Borrowings" section for additional information related to our debt.

(4) 
On July 1, 2015, the Company issued 3.2 million shares to former stockholders of Audience and for the conversion of vested in-the-money Audience stock options. The Company also converted unvested in-the-money Audience stock options and restricted stock units for an aggregate of 461,371 shares of its common stock. See Note 19. Earnings per Share to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data" for information regarding earnings per common share.

(5) 
Also includes current portion of long-term debt and finance lease obligations.

(6) 
We use the term “EBIT” throughout this Annual Report on Form 10-K, defined as earnings from continuing operations plus (i) interest expense, net and (ii) income taxes. EBIT is not presented in accordance with accounting principles generally accepted in the United States of America ("GAAP" or "U.S. GAAP") and may not be comparable to similarly titled measures used by other companies. We use EBIT as a supplement to our GAAP results of operations in evaluating certain aspects of our business, and our Board of Directors and executive management team focus on EBIT as a key measure of our performance for business planning purposes. This measure assists us in comparing performance between various reporting periods on a consistent basis, as this measure removes from operating results the impact of items that, in our opinion, do not reflect our core operating performance. We believe that our presentation of EBIT is useful because it provides investors and securities analysts with the same information that we use internally for purposes of assessing our core operating performance. For a reconciliation of EBIT to earnings from continuing operations, the most directly related GAAP measure, please see the Statement of Earnings Data table above. The Company does not consider EBIT to be a substitute for the information provided by GAAP financial results.


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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion and analysis presented below refer to and should be read in conjunction with our audited Consolidated Financial Statements and related notes under Item 8. "Financial Statements and Supplementary Data." The following discussion contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those made, projected, or implied in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Form 10-K, particularly in “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements.”

Management’s discussion and analysis, which we refer to as “MD&A,” of our results of operations, financial condition, and cash flows should be read together with the audited Consolidated Financial Statements and accompanying notes included under Item 8. "Financial Statements and Supplementary Data," to provide an understanding of our financial condition, changes in financial condition, and results of our operations. We believe the assumptions underlying the Consolidated Financial Statements are reasonable. However, the Consolidated Financial Statements included herein may not necessarily reflect our results of operations, financial position, and cash flows in the future.

As discussed in Note 2. Disposed and Discontinued Operations to our audited Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data", we completed the sale of our high-end oscillators business ("Timing Device Business") in the fourth quarter of 2017 and the sale of our speaker and receiver product line ("Speaker and Receiver Product Line") in the third quarter of 2016. Accordingly, the results of operations and related assets and liabilities for the Timing Device Business and the Speaker and Receiver Product Line have been reclassified as discontinued operations for all periods presented. Unless otherwise indicated, discussion within this MD&A and elsewhere within this Annual Report on Form 10-K refers to results from continuing operations.

Our Business

We are a market leader and global provider of advanced micro-acoustic, audio processing, and precision device solutions, serving the mobile consumer electronics, communications, medtech, defense, automotive, and industrial markets. We use our leading position in micro-electro-mechanical systems ("MEMS") microphones and strong capabilities in audio processing technologies to optimize audio systems and improve the user experience in mobile, ear, and Internet of Things ("IoT") applications. We are also a leader in acoustic components, high-end capacitors, and mmWave radio frequency ("RF") solutions for a diverse set of markets. Our focus on the customer, combined with unique technology, proprietary manufacturing techniques, rigorous testing, and global scale, enables us to deliver innovative solutions that optimize the user experience. References to "Knowles," the "Company," "we," "our," or "us" refer to Knowles Corporation and its consolidated subsidiaries, unless the context otherwise requires.

Our Business Segments

We are organized into two reportable segments based on how management analyzes performance, allocates capital, and makes strategic and operational decisions. These segments were determined in accordance with ASC 280 - Segment Reporting and are comprised of (i) Audio and (ii) Precision Devices ("PD"). The segments are aligned around similar product applications serving our key end markets, to enhance focus on end market growth strategies.

Audio Segment
Our Audio group designs and manufactures innovative audio products, including microphones and balanced armature speakers, audio processors, and software and algorithms used in applications that serve the mobile, ear, and IoT markets. Locations include the sales, support, and engineering facilities in North America, Europe, and Asia, as well as manufacturing facilities in Asia.


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PD Segment
Our PD group specializes in the design and delivery of high performance capacitor products and mmWave RF solutions for technically demanding applications. Our high performance capacitor products are used in applications such as power supplies and medical implants, which sell to a diverse set of customers for mission critical applications across the communications, medtech, defense, automotive, and industrial markets. Our mmWave RF solutions primarily solve high frequency filtering challenges for our military customers, who use them in their satellite communication and radar systems, as well as our telecommunications infrastructure customers deploying mmWave 5G base stations. Locations include the sales, support, engineering, and manufacturing facilities in North America, Europe, and Asia.

We sell our products directly to original equipment manufacturers ("OEMs") and to their contract manufacturers and suppliers and to a lesser extent through distributors worldwide.

On December 20, 2019, we acquired substantially all of the assets of the MEMS Microphone Application-specific integrated circuit Design Business (“ASIC Design Business”) from ams AG for $57.9 million. The acquired business, which does not generate revenues, includes intellectual property and an assembled workforce. The acquisition’s operations are included in the Audio segment. For additional information, refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data.”

On January 3, 2019, we acquired substantially all of the assets of DITF Interconnect Technology, Inc. ("DITF") for $11.1 million. The acquired business provides thin film components to the defense, telecommunication, industrial, and medtech markets. This acquisition's operations are included in the PD segment. For additional information, refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On January 19, 2018, we acquired substantially all of the assets of Compex Corporation ("Compex") for $18.7 million. The acquired business provides single layer electronic components to the telecommunicaton, fiber optics, and defense markets. This acquisition's operations are included in the PD segment. For additional information, refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On November 28, 2017, we completed the sale of the Timing Device Business, part of the PD segment, for $130.0 million, plus purchase price adjustments for a net amount of $135.1 million. For additional information, refer to Note 2. Disposed and Discontinued Operations to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On January 11, 2017, we completed an acquisition of certain assets of a capacitors manufacturer for cash consideration of $3.7 million, of which $2.5 million was paid during the first quarter of 2017. An additional $1.0 million was paid during 2018, with the remaining $0.2 million paid in the first quarter of 2019. This acquisition's operations are included in the PD segment.

For discussion related to the results of operations and changes in financial condition for the year ended December 31, 2018 compared to the year ended December 31, 2017, refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 19, 2019 and is incorporated by reference herein.

Non-GAAP Financial Measures

In addition to the GAAP financial measures included in this item, we have presented certain non-GAAP financial measures. We use non-GAAP measures as supplements to our GAAP results of operations in evaluating certain aspects of our business, and our executive management team and Board of Directors focus on non-GAAP items as key measures of our performance for business planning purposes. These measures assist us in comparing our performance between various reporting periods on a consistent basis, as these measures remove from operating results the impact of items that, in our opinion, do not reflect our core operating performance. We believe that our presentation of non-GAAP financial measures is useful because it provides investors and securities analysts with the same information that we use internally for purposes of assessing our core operating performance. The Company does not consider these non-GAAP financial measures to be a substitute for the information provided by GAAP financial results. For a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, see the reconciliation included herein.


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Results of Operations for the Year Ended December 31, 2019 compared with the Year Ended December 31, 2018

 
 
Years Ended December 31,
(in millions, except per share amounts)
 
2019
 
2018
 
2017
Revenues
 
$
854.8

 
$
826.9

 
$
744.2

 
 
 
 
 
 
 
Gross profit
 
$
328.0

 
$
322.6

 
$
286.0

Non-GAAP gross profit
 
$
333.6

 
$
327.0

 
$
299.9

 
 
 
 
 
 
 
Earnings from continuing operations before interest and income taxes
 
$
80.8

 
$
77.1

 
$
40.0

Adjusted earnings from continuing operations before interest and income taxes
 
$
126.9

 
$
117.2

 
$
110.6

 
 
 
 
 
 
 
Provision for (benefit from) income taxes
 
$
16.6

 
$
(4.5
)
 
$
12.9

Non-GAAP provision for income taxes
 
$
17.6

 
$
13.0

 
$
14.9

 
 
 
 
 
 
 
Earnings from continuing operations
 
$
49.7

 
$
65.6

 
$
6.5

Non-GAAP net earnings from continuing operations
 
$
101.6

 
$
94.5

 
$
81.2

 
 
 
 
 
 
 
Earnings per share from continuing operations - diluted
 
$
0.53

 
$
0.72

 
$
0.07

Non-GAAP diluted earnings per share from continuing operations
 
$
1.07

 
$
1.01

 
$
0.88


Revenues

Revenues for the year ended December 31, 2019 were $854.8 million, compared with $826.9 million for the year ended December 31, 2018, an increase of $27.9 million or 3.4%. This change was due to an increase in PD revenues of $27.3 million primarily due to higher shipments to the defense, telecommunications, and medtech markets, our acquisition of DITF, and higher pricing. Audio revenues had an increase of $0.6 million primarily due to higher demand for MEMS microphones and balanced armature speakers in Ear and IoT applications, partially offset by lower demand for MEMS microphones and Intelligent Audio solutions in handset applications. Audio revenues were also impacted by lower average pricing on mature products.

Cost of Goods Sold

Cost of goods sold ("COGS") for the year ended December 31, 2019 was $525.1 million, compared with $503.9 million for the year ended December 31, 2018, an increase of $21.2 million or 4.2%. This increase was primarily the result of higher shipping volume, personnel and factory overhead increases in PD to support higher production volumes and manufacturing capacity, warranty claims (net of supplier recoveries), and higher precious metal pricing, partially offset by product cost reductions and favorable foreign currency exchange rate changes.


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Restructuring Charges

We undertake restructuring programs from time to time to better align our operations with current market conditions. Such activities include facility consolidations, headcount reductions, and other measures to further optimize operations. It is likely that we will have restructuring charges in the future as we continue to consolidate our manufacturing footprint. Details regarding restructuring programs undertaken during the reporting period are as follows:

During the year ended December 31, 2019, we recorded total restructuring charges of $6.0 million. We recorded $1.7 million within Gross profit, primarily for actions associated with transferring certain operations of capacitors manufacturing to other existing facilities in order to further optimize operations in the PD segment. We also recorded restructuring charges of $4.3 million within Operating expenses, primarily for actions associated with rationalizing the Audio segment workforce.

During the year ended December 31, 2018, we recorded total restructuring charges of $2.1 million. We recorded $0.4 million within Gross profit, primarily for actions associated with transferring certain operations of capacitors manufacturing to other existing facilities in order to further optimize operations in the PD segment. We also recorded restructuring charges of $1.7 million within Operating expenses, primarily for actions associated with rationalizing the Audio segment workforce.

Gross Profit and Non-GAAP Gross Profit

Gross profit for the year ended December 31, 2019 was $328.0 million, compared with $322.6 million for the year ended December 31, 2018, an increase of $5.4 million or 1.7%. Gross profit margin (gross profit as a percentage of revenues) for the year ended December 31, 2019 was 38.4%, compared with 39.0% for the year ended December 31, 2018. The gross profit increase was primarily due to product cost reductions, higher shipping volumes, and favorable foreign currency exchange rate changes, partially offset by lower average pricing on mature products, personnel and factory overhead increases in PD to support higher production volumes and manufacturing capacity, warranty claims, and higher precious metal pricing. The gross profit margin decrease was primarily due to lower average pricing on mature products, personnel and factory overhead increases in PD to support higher production volumes and manufacturing capacity, warranty claims (net of supplier recoveries), and higher precious metal pricing, partially offset by product cost reductions and favorable foreign currency exchange rate changes.

Non-GAAP gross profit for the year ended December 31, 2019 was $333.6 million, compared with $327.0 million for the year ended December 31, 2018, an increase of $6.6 million or 2.0%. Non-GAAP gross profit margin (non-GAAP gross profit as a percentage of revenues) for the year ended December 31, 2019 was 39.0%, as compared with 39.5% for the year ended December 31, 2018. The non-GAAP gross profit increase was primarily due to product cost reductions, higher shipping volumes, and favorable foreign currency exchange rate changes, partially offset by lower average pricing on mature products, personnel and factory overhead increases in PD to support higher production volumes and manufacturing capacity, warranty claims, and higher precious metal pricing. The gross profit margin decrease was primarily due to lower average pricing on mature products, personnel and factory overhead increases in PD to support higher production volumes and manufacturing capacity, warranty claims (net of supplier recoveries), and higher precious metal pricing, partially offset by product cost reductions and favorable foreign currency exchange rate changes.

Research and Development Expenses

Research and development expenses for the years ended December 31, 2019 and 2018 were $96.8 million and $100.6 million, respectively, a decrease of $3.8 million or 3.8%. Research and development expenses as a percentage of revenues for the years ended December 31, 2019 and 2018 were 11.3% and 12.2%, respectively. The decreases were primarily driven by lower incentive compensation and lower salary compensation as a result of headcount reductions within the Audio segment workforce.

Selling and Administrative Expenses

Selling and administrative expenses for the year ended December 31, 2019 were $145.7 million, compared with $142.5 million for the year ended December 31, 2018, an increase of $3.2 million or 2.2%. Selling and administrative expenses as a percentage of revenues for the year ended December 31, 2019 were 17.0%, compared with 17.2% for the year ended December 31, 2018. The increase in expenses was primarily driven by shareholder activism, higher legal expense related to protecting our intellectual property, and our acquisition of DITF, partially offset by lower incentive and stock-based compensation. Selling and administrative expenses as a percentage of revenues decreased due to the increase in revenues from the prior year.


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Interest Expense, net

Interest expense, net for the year ended December 31, 2019 was $14.5 million, compared with $16.0 million for the year ended December 31, 2018, a decrease of $1.5 million or 9.4%. The decrease in interest expense is primarily due to lower outstanding borrowings. For additional information on borrowings and interest expense, refer to Note 12. Borrowings to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

Provision for (Benefit from) Income Taxes and Non-GAAP Provision for Income Taxes

The effective tax rate ("ETR") for the year ended December 31, 2019 was a 25.0% provision, compared with a 7.4% benefit for the year ended December 31, 2018. The change in the ETR is primarily due to the mix of earnings by taxing jurisdictions and the Tax Reform Act. As a result of the IRS approval for an entity classification election received during the fourth quarter of 2018, we recorded a $17.8 million reduction to our transition tax liability.

The ETR for the years ended December 31, 2019 and 2018 was favorably impacted by two tax holidays granted to us by Malaysia. For additional information on these tax holidays, see Note 13. Income Taxes to our Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data."

The non-GAAP ETR for the year ended December 31, 2019 was a 14.8% provision, compared with a 12.1% provision for the year ended December 31, 2018. The change in the non-GAAP ETR was due to the mix of earnings by taxing jurisdictions and the Tax Reform Act.

The ETR and non-GAAP ETR deviate from the statutory U.S. federal income tax rate, mainly due to the taxing jurisdictions in which we generate taxable income or loss, the favorable impact of our tax holidays in Malaysia, and judgments as to the realizability of our deferred tax assets. A significant portion of our pre-tax income is subject to reduced tax rates as a result of our tax holidays in Malaysia, subject to our satisfaction of certain conditions that we expect to continue to satisfy. Unless extended or otherwise renegotiated, our existing tax holidays in Malaysia will expire in 2021. The U.S. operations were in a cumulative loss position as of December 31, 2019 and 2018. Based on this, and other relevant information, the Company concluded that tax losses and deferred tax assets generated in the U.S. would not be benefited currently or in the future.

Earnings from Continuing Operations

Earnings from continuing operations for the year ended December 31, 2019 was $49.7 million, compared with $65.6 million for the year ended December 31, 2018, a decrease of $15.9 million. The decrease is primarily due to a higher provision for income taxes, partially offset by higher gross profit.

Earnings and Adjusted Earnings from Continuing Operations Before Interest and Income Taxes

Earnings before interest and income taxes ("EBIT") from continuing operations for the year ended December 31, 2019 was $80.8 million, compared with $77.1 million for the year ended December 31, 2018, an increase of $3.7 million or 4.8%. EBIT margin (EBIT from continuing operations as a percentage of revenues) for the year ended December 31, 2019 was 9.5%, as compared with 9.3% for the year ended December 31, 2018. The increases in EBIT and EBIT margin were primarily due to higher gross profit.

Adjusted earnings before interest and income taxes ("Adjusted EBIT") from continuing operations for the year ended December 31, 2019 was $126.9 million, compared with $117.2 million for the year ended December 31, 2018, an increase of $9.7 million or 8.3%. Adjusted EBIT margin (adjusted EBIT from continuing operations as a percentage of revenues) for the year ended December 31, 2019 was 14.8%, as compared with 14.2% for the year ended December 31, 2018. The increases in Adjusted EBIT and Adjusted EBIT margin were primarily due to higher non-GAAP gross profit and lower non-GAAP operating expenses.

(Loss) Earnings from Discontinued Operations, net

The loss from discontinued operations was $0.6 million for the year ended December 31, 2019, compared with earnings of $2.1 million for the year ended December 31, 2018. The change in discontinued operations was primarily driven by an unrecognized tax benefit recognized in 2019 related to the Speaker and Receiver Product Line and a favorable purchase price adjustment in 2018 related to the Timing Device Business.


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Diluted Earnings per Share from Continuing Operations and Non-GAAP Diluted Earnings per Share from Continuing Operations

Diluted earnings per share from continuing operations was $0.53 for the year ended December 31, 2019, compared with $0.72 for the year ended December 31, 2018. The change was mainly driven by a higher provision for income taxes, partially offset by higher EBIT.

Non-GAAP diluted earnings per share from continuing operations for the year ended December 31, 2019 was $1.07, compared with $1.01 for the year ended December 31, 2018. The increase in non-GAAP diluted earnings per share was mainly driven by higher adjusted EBIT, partially offset by a higher non-GAAP provision for income taxes and the impact of higher non-GAAP diluted average shares outstanding.


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Reconciliation of GAAP Financial Measures to Non-GAAP Financial Measures (1) 
 
 
Years Ended December 31,
(in millions, except share and per share amounts)
 
2019
 
2018
 
2017
Gross profit
 
$
328.0

 
$
322.6

 
$
286.0

Stock-based compensation expense
 
1.6

 
1.6

 
1.8

Impairment charges
 

 

 
1.4

Restructuring charges
 
1.7

 
0.4

 
4.0

Production transfer costs (2)
 
2.3

 
2.2

 
6.7

Other (3)
 

 
0.2

 

Non-GAAP gross profit
 
$
333.6

 
$
327.0

 
$
299.9


 
 
 
 
 
 
Earnings from continuing operations
 
$
49.7

 
$
65.6

 
$
6.5

Interest expense, net
 
14.5

 
16.0

 
20.6

Provision for (benefit from) income taxes
 
16.6

 
(4.5
)
 
12.9

Earnings from continuing operations before interest and income taxes
 
80.8

 
77.1

 
40.0

Stock-based compensation expense
 
25.2

 
27.0

 
24.7

Intangibles amortization expense
 
7.0

 
6.5

 
7.3

Impairment charges
 

 

 
21.3

Restructuring charges
 
6.0

 
2.1

 
10.2

Production transfer costs (2)
 
2.3

 
2.6

 
6.8

Other (3)
 
5.6

 
1.9

 
0.3

Adjusted earnings from continuing operations before interest and income taxes
 
$
126.9

 
$
117.2


$
110.6


 
 
 
 
 
 
Interest expense, net
 
$
14.5

 
$
16.0

 
$
20.6

Interest expense, net non-GAAP reconciling adjustments (4)
 
6.8

 
6.3

 
6.1

Non-GAAP interest expense
 
$
7.7

 
$
9.7

 
$
14.5

 
 
 
 
 
 
 
Provision for (benefit from) income taxes
 
$
16.6

 
$
(4.5
)
 
$
12.9

Income tax effects of non-GAAP reconciling adjustments (5)
 
1.0

 
17.5

 
2.0

Non-GAAP provision for income taxes
 
$
17.6

 
$
13.0


$
14.9

 
 
 
 
 
 
 
Earnings from continuing operations
 
$
49.7

 
$
65.6

 
$
6.5

Non-GAAP reconciling adjustments (6)
 
46.1

 
40.1

 
70.6

Interest expense, net non-GAAP reconciling adjustments (4)
 
6.8

 
6.3

 
6.1

Income tax effects of non-GAAP reconciling adjustments (5)
 
1.0

 
17.5

 
2.0

Non-GAAP net earnings from continuing operations
 
$
101.6

 
$
94.5


$
81.2

 
 
 
 
 
 
 
Diluted earnings per share from continuing operations
 
$
0.53

 
$
0.72

 
$
0.07

Earnings per share non-GAAP reconciling adjustment
 
0.54

 
0.29

 
0.81

Non-GAAP diluted earnings per share from continuing operations
 
$
1.07

 
$
1.01

 
$
0.88

 
 
 
 
 
 
 
Diluted average shares outstanding
 
93,439,023

 
91,194,747

 
90,490,007

Non-GAAP adjustment (7)
 
1,449,627

 
2,046,989

 
1,959,801

Non-GAAP diluted average shares outstanding (7)
 
94,888,650

 
93,241,736

 
92,449,808



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Table of Contents


(1) In addition to the GAAP financial measures included herein, Knowles has presented certain non-GAAP financial measures that exclude certain amounts that are included in the most directly comparable GAAP measures. Knowles believes that non-GAAP measures are useful as supplements to its GAAP results of operations to evaluate certain aspects of its operations and financial performance, and its management team primarily focuses on non-GAAP items in evaluating Knowles' performance for business planning purposes. Knowles also believes that these measures assist it with comparing its performance between various reporting periods on a consistent basis, as these measures remove from operating results the impact of items that, in Knowles' opinion, do not reflect its core operating performance. Knowles believes that its presentation of non-GAAP financial measures is useful because it provides investors and securities analysts with the same information that Knowles uses internally for purposes of assessing its core operating performance.
(2) Production transfer costs represent duplicate costs incurred to migrate manufacturing to facilities primarily in Asia. These amounts are included in the corresponding Gross profit and Earnings from continuing operations before interest and income taxes for each period presented.
(3) 
In 2019, Other expenses of $4.4 million represent expenses related to shareholder activism and the remaining Other expenses relate to the acquisition of the ASIC Design Business by the Audio segment and the acquisition of DITF by the PD segment. In 2018, Other expenses in Gross profit and Operating expenses represent expenses related to acquisitions and the remaining Other expenses represent an adjustment to pre-spin-off pension obligations.
(4) 
Under GAAP, certain convertible debt instruments that may be settled in cash (or other assets) upon conversion are required to be separately accounted for as liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. Accordingly, for GAAP purposes we are required to recognize imputed interest expense on the Company’s $172.5 million of convertible senior notes due 2021 that were issued in a private placement in May 2016. The imputed interest rate is 8.12% for the convertible notes due 2021, while the actual coupon interest rate of the notes was 3.25%. The difference between the imputed interest expense and the coupon interest expense is excluded from management’s assessment of the Company’s operating performance because management believes that this non-cash expense is not indicative of its core, ongoing operating performance.
(5) 
Income tax effects of non-GAAP reconciling adjustments are calculated using the applicable tax rates in the jurisdictions of the underlying adjustments. Adjustments are also made to exclude certain impacts of the Tax Reform Act and the resulting consequences that were accounted for as uncertain tax positions.
(6) 
The non-GAAP reconciling adjustments are those adjustments made to reconcile Earnings from continuing operations before interest and income taxes to Adjusted earnings from continuing operations before interest and income taxes.
(7) 
The number of shares used in the diluted per share calculations on a non-GAAP basis excludes the impact of stock-based compensation expense expected to be incurred in future periods and not yet recognized in the financial statements, which would otherwise be assumed to be used to repurchase shares under the GAAP treasury stock method. In addition, the Company entered into convertible note hedge transactions to offset any potential dilution from the convertible notes. Although the anti-dilutive impact of the convertible note hedges is not reflected under GAAP, the Company includes the anti-dilutive impact of the convertible note hedges in non-GAAP diluted average shares outstanding, if applicable.


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Table of Contents


Segment Results of Operations for the Year Ended December 31, 2019 Compared with the Year Ended December 31, 2018

Audio
 
 
Years Ended December 31,
(in millions)
 
2019
 
Percent of Revenues
 
2018
 
Percent of Revenues
 
2017
 
Percent of Revenues
Revenues
 
$
682.8

 
 
 
$
682.2

 
 
 
$
637.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating earnings
 
$
107.2

 
15.7%
 
$
105.1

 
15.4%
 
$
75.8

 
11.9%
Other income, net
 
(0.1
)
 
 
 
(0.6
)
 
 
 
(0.3
)
 
 
Earnings from continuing operations before interest and income taxes
 
$
107.3

 
15.7%
 
$
105.7

 
15.5%
 
$
76.1

 
11.9%
Stock-based compensation expense
 
13.1

 
 
 
13.4

 
 
 
11.5

 
 
Intangibles amortization expense
 
4.7

 
 
 
4.7

 
 
 
6.5

 
 
Impairment charges
 

 
 
 

 
 
 
21.3

 
 
Restructuring charges
 
4.8

 
 
 
1.4

 
 
 
8.1

 
 
Production transfer costs (1)
 

 
 
 
1.0

 
 
 
6.3

 
 
Other (2)
 
0.4

 
 
 

 
 
 

 
 
Adjusted earnings from continuing operations before interest and income taxes
 
$
130.3

 
19.1%
 
$
126.2

 
18.5%
 
$
129.8

 
20.4%
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)  Production transfer costs represent duplicate costs incurred to migrate manufacturing to existing facilities in Asia. These amounts are included in earnings from continuing operations before interest and income taxes for each period presented.
(2)  In 2019, Other represents expenses related to the acquisition of the ASIC Design Business.

Revenues

Audio revenues were $682.8 million for the year ended December 31, 2019, compared with $682.2 million for the year ended December 31, 2018, an increase of $0.6 million or 0.1%. Revenues increased primarily due to higher demand for MEMS microphones and balanced armature speakers in Ear and IoT applications, partially offset by lower demand for MEMS microphones and Intelligent Audio solutions in handset applications. Audio revenues were also impacted by lower average pricing on mature products.

Earnings and Adjusted Earnings from Continuing Operations Before Interest and Income Taxes

Audio EBIT from continuing operations was $107.3 million for the year ended December 31, 2019, compared with $105.7 million for the year ended December 31, 2018, an increase of $1.6 million or 1.5%. EBIT margin for the year ended December 31, 2019 was 15.7%, compared to 15.5% for the year ended December 31, 2018. The increases were primarily driven by lower incentive compensation, partially offset by increased restructuring charges.

Audio Adjusted EBIT was $130.3 million for the year ended December 31, 2019, compared with $126.2 million for the year ended December 31, 2018, an increase of $4.1 million or 3.2%. Adjusted EBIT margin for the year ended December 31, 2019 was 19.1%, compared with 18.5% for the year ended December 31, 2018. The increases were primarily driven by lower incentive compensation.


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Table of Contents


Precision Devices
 
 
Years Ended December 31,
(in millions)
 
2019
 
Percent of Revenues
 
2018
 
Percent of Revenues
 
2017
 
Percent of Revenues
Revenues
 
$
172.0

 
 
 
$
144.7

 
 
 
$
106.8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating earnings
 
$
30.3

 
17.6%
 
$
27.7

 
19.1%
 
$
18.4

 
17.2%
Other (income) expense, net
 
(0.1
)
 
 
 
0.2

 
 
 
(0.8
)
 
 
Earnings from continuing operations before interest and income taxes
 
$
30.4

 
17.7%
 
$
27.5

 
19.0%
 
$
19.2

 
18.0%
Stock-based compensation expense
 
1.4

 
 
 
0.8

 
 
 
0.4

 
 
Intangibles amortization expense
 
2.3

 
 
 
1.8

 
 
 
0.8

 
 
Restructuring charges
 
0.8

 
 
 
0.5

 
 
 
0.1

 
 
Production transfer costs (1)
 
2.3

 
 
 
1.6

 
 
 
0.5

 
 
Other (2)
 
0.5

 
 
 
1.7

 
 
 
0.1

 
 
Adjusted earnings from continuing operations before interest and income taxes
 
$
37.7

 
21.9%
 
$
33.9

 
23.4%
 
$
21.1

 
19.8%
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)  Production transfer costs represent duplicate costs incurred to migrate manufacturing to existing facilities. These amounts are included in earnings from continuing operations before interest and income taxes for each period presented.
(2)  In 2019, Other represents expenses related to the acquisition of DITF. In 2018, Other represents expenses related to the acquisition of Compex and an adjustment to pre-spin-off pension obligations.

Revenues

PD revenues were $172.0 million for the year ended December 31, 2019, compared with $144.7 million for the year ended December 31, 2018, an increase of $27.3 million or 18.9%. Revenues increased primarily due to higher shipments to the defense, telecommunications, and medtech markets, our acquisition of DITF, and higher pricing.

Earnings and Adjusted Earnings from Continuing Operations Before Interest and Income Taxes

PD EBIT from continuing operations was $30.4 million for the year ended December 31, 2019, compared with $27.5 million for the year ended December 31, 2018, an increase of $2.9 million or 10.5%. EBIT margin for the year ended December 31, 2019 was 17.7%, compared with 19.0% for the year ended December 31, 2018. The increase in EBIT was primarily driven by higher gross profit as a result of product cost reductions, increased shipments, and higher pricing, partially offset by personnel and factory overhead increases to support higher production volumes and manufacturing capacity. In addition, PD is experiencing higher precious metal pricing. Despite an increase in EBIT, our EBIT margin decreased driven by lower gross margins as a result of adding production personnel to support growth and experiencing higher precious metal pricing, partially offset by the benefits of product cost reductions and higher pricing.

PD Adjusted EBIT was $37.7 million for the year ended December 31, 2019, compared with $33.9 million for the year ended December 31, 2018, an increase of $3.8 million or 11.2%. Adjusted EBIT margin for the year ended December 31, 2019 was 21.9%, compared with 23.4% for the year ended December 31, 2018. The increase in adjusted EBIT was primarily driven by higher gross profit as a result of product cost reductions, increased shipments, and higher pricing, partially offset by personnel and factory overhead increases to support higher production volumes and manufacturing capacity. In addition, PD is experiencing higher precious metal pricing. Despite an increase in EBIT, our EBIT margin decreased driven by lower gross margins as a result of adding production personnel to support growth and experiencing higher precious metal pricing, partially offset by the benefits of product cost reductions and higher pricing.


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Financial Condition

Historically, we have generated and expect to continue to generate positive cash flow from operations. Our ability to fund our operations and capital needs will depend on our ongoing ability to generate cash from operations and access to capital markets. We believe that our future cash flow from operations and access to capital markets will provide adequate resources to fund our working capital needs, dividends (if any), capital expenditures, and strategic investments. We have secured a revolving line of credit in the United States from a syndicate of commercial banks to provide additional liquidity. Furthermore, if we were to require additional cash above and beyond our cash on the balance sheet, the free cash flow generated by the business, and availability under our revolving credit facility, we would most likely seek to raise long-term financing through the U.S. debt or bank markets.

In May 2016, we sold the Notes and concurrently entered into convertible note hedge transactions and separate warrants. The Notes will mature in November 2021, unless earlier repurchased by us or converted pursuant to their terms. The Notes are unsecured, senior obligations and interest is payable semiannually in arrears. The Notes will be convertible into cash, shares of our common stock, or a combination thereof, at our election. We have primarily used the net proceeds to reduce borrowings outstanding under our term loan facility. For additional information, refer to Note 12. Borrowings to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On January 11, 2017, we completed an acquisition of certain assets of a capacitors manufacturer for cash consideration of $3.7 million, of which $2.5 million was paid during 2017. An additional $1.0 million was paid during 2018, with the remaining $0.2 million paid during the first quarter of 2019. This acquisition's operations are included in the PD segment.

On October 11, 2017, we entered into the New Credit Facility. For additional information, refer to Note 12. Borrowings to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On November 28, 2017, we completed the sale of the Timing Device Business, part of the PD segment, for $130.0 million, plus purchase price adjustments for a net amount of $135.1 million. For additional information, refer to Note 2. Disposed and Discontinued Operations to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On January 19, 2018, we acquired substantially all of the assets of Compex for $18.7 million. The acquired business provides single layer electronic components to the telecommunicaton, fiber optics, and defense markets. This acquisition's operations are included in the PD segment. For additional information, refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

On January 3, 2019, the Company acquired substantially all of the assets of DITF for $11.1 million. The acquired business provides thin film components to the defense, telecommunication, industrial, and medtech markets. This acquisition's operations are included in the PD segment. For additional information, refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data.”

On December 20, 2019, the Company acquired substantially all of the assets of the ASIC Design Business for $57.9 million. The acquired business, which does not generate revenues, includes intellectual property and an assembled workforce. The acquisition’s operations are included in the Audio segment. For additional information, refer to Note 3. Acquisitions to our Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data.”

Our ability to make payments on and to refinance our indebtedness, as well as any debt that we may incur in the future, will depend on our ability in the future to generate cash from operations and financings. Due to the global nature of our operations, a significant portion of our cash is generated and held outside the United States. Our cash and cash equivalents totaled $78.4 million and $73.5 million at December 31, 2019 and 2018, respectively. Of these amounts, cash held by our non-U.S. operations totaled $74.6 million and $55.3 million as of December 31, 2019 and 2018, respectively.

To the extent we repatriate these funds to the U.S., we may be required to pay U.S. state income taxes and applicable foreign withholding taxes on those amounts during the period when such repatriation occurs. Management will continue to reassess our need to repatriate the earnings of our foreign subsidiaries.


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Cash Flow Summary

Cash flows from operating, investing, and financing activities as reflected in our Consolidated Statements of Cash Flows are presented on a consolidated basis (including discontinued operations). Cash flows are summarized in the following table:
 
 
Years Ended December 31,
(in millions)
 
2019
 
2018
 
2017
Net cash flows provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
123.9

 
$
98.5

 
$
92.9

Investing activities
 
(110.5
)
 
(88.0
)
 
69.5

Financing activities
 
(8.5
)
 
(48.6
)
 
(117.9
)
Effect of exchange rate changes on cash and cash equivalents
 

 
(0.1
)
 
1.0

Net increase (decrease) in cash and cash equivalents
 
$
4.9

 
$
(38.2
)
 
$
45.5


Operating Activities

Cash provided by operating activities in 2019 increased $25.4 million compared to 2018, primarily due to a net sum of favorable changes in accounts payable, inventories, and receivables. In addition, there was a decrease in income taxes paid and improved earnings before income taxes and discontinued operations, partially offset by the increased payment in 2019 to settle our annual incentive compensation obligation, which was accrued at a higher level in the previous year.

Investing Activities

Capital expenditures, primarily to support capacity expansion, innovation, and cost savings, were $41.2 million and $80.1 million for the years ended December 31, 2019 and 2018, respectively. The cash used in investing activities during 2019 was driven by capital expenditures and the acquisitions of the ASIC Design Business and DITF. The cash used in investing activities during 2018 was driven by capital expenditures and the acquisition of Compex, partially offset with escrow proceeds from the sale of our Timing Device Business in 2017.

Financing Activities

Cash used in financing activities during 2019 is primarily related to the net payments under our revolving credit facility of $9.0 million and the $6.4 million payment of taxes related to net share settlement of equity awards, partially offset by the net proceeds of $9.8 million from exercise of stock-based awards. The cash used in financing activities for 2018 was primarily related to the $41.7 million net payment on our revolving credit facility and the $4.7 million payment of taxes related to net share settlement of equity awards.

Liquidity and Capital Resources

Free Cash Flow

In addition to measuring our cash flow generation and usage based upon the operating, investing, and financing classifications included in the Consolidated Statements of Cash Flows, we also measure free cash flow and free cash flow as a percentage of revenues. Free cash flow is calculated as cash flow provided by operating activities less capital expenditures. Our management believes these measures are useful in measuring our cash generated from operations that is available to repay debt, pay dividends, fund acquisitions, and repurchase Knowles’ common stock. Free cash flow and free cash flow as a percentage of revenues are not presented in accordance with GAAP and may not be comparable to similarly titled measures used by other companies in our industry. As such, free cash flow and free cash flow as a percentage of revenues should not be considered in isolation from, or as an alternative to, any other liquidity measures determined in accordance with GAAP.

Our businesses tend to have stronger revenues in the third and fourth quarters of each fiscal year. This is particularly true of those businesses that serve the consumer electronics market. Our businesses tend to have short product cycles due to the highly technical nature of the industries they serve, which can result in new OEM product launches that can impact quarterly revenues, earnings, and cash flow.


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The following table reconciles our free cash flow to cash flow provided by operating activities:
 (in millions)
 
Years Ended December 31,
Free Cash Flow
 
2019
 
2018
 
2017
Cash flow provided by operating activities
 
$
123.9

 
$
98.5

 
$
92.9

Less: Capital expenditures
 
(41.2
)
 
(80.1
)
 
(51.6
)
Free cash flow
 
$
82.7

 
$
18.4

 
$
41.3

Free cash flow as a percentage of revenues
 
9.7
%
 
2.2
%
 
5.5
%

In 2019, we generated free cash flow of $82.7 million, representing 9.7% of revenues, compared to free cash flow in 2018 of $18.4 million, representing 2.2% of revenues. The increase in free cash flow in 2019 compared to 2018 was primarily due to decreased capital expenditures and a net sum of favorable changes in accounts payable, inventories, and receivables.

In 2020, we expect capital expenditures to be in the range of 5.0% to 7.0% of revenues.

Contingent Obligations

We are involved in various legal proceedings, claims, and investigations arising in the normal course of business. Legal contingencies are discussed in Note 15. Commitments and Contingent Liabilities to our Consolidated Financial Statements under Item 8, "Financial Statements and Supplementary Data."

Contractual Obligations and Off-Balance Sheet Arrangements

A summary of our contractual obligations and commitments as of December 31, 2019 and the years when these obligations are expected to be due is as follows:
 
 
 
 
Payments Due by Period
(in millions)
 
Total
 
Less than 1 Year
 
1-3 Years
 
3-5 Years
 
More than 5 Years
Debt (1)