Knowles Corporation — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Knowles supplies microphones, audio products, capacitors and RF products across consumer electronics, medtech, defense, industrial, communications and other markets. Its three reportable segments are Precision Devices (PD), MedTech & Specialty Audio (MSA), and Consumer MEMS Microphones (CMM). Unless otherwise noted, amounts are in U.S. dollars.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $173.0 million | $188.0 million | $317.3 million | $389.4 million |
| Gross profit / margin | $73.7 million / 42.6% | $77.7 million / 41.3% | $127.5 million / 40.2% | $161.0 million / 41.3% |
| Net earnings (loss) | $13.6 million | $(242.9) million | $8.4 million | $(224.8) million |
| Diluted EPS | $0.15 | $(2.64) | $0.09 | $(2.44) |
| Adjusted EBIT / margin | $27.7 million / 16.0% | $37.6 million / 20.0% | $35.8 million / 11.3% | $77.0 million / 19.8% |
Q2 GAAP operating earnings were $16.9 million, versus an operating loss of $214.6 million in Q2 2022; the prior-year quarter included a $239.8 million CMM goodwill impairment. The company reported EBIT of $18.2 million for Q2 and $14.9 million for the first half under its MD&A presentation. Non-GAAP diluted EPS was $0.23 in Q2 and $0.28 for the first half, down from $0.33 and $0.68, respectively, in the comparable periods.
Cash, debt and liquidity: Cash and cash equivalents were $54.4 million at June 30, 2023, up from $48.2 million at year-end 2022. Current assets were $375.9 million and current liabilities $108.4 million. Long-term debt was $45.0 million, leaving cash above reported debt by $9.4 million. The revolving facility has a $400 million maximum commitment and matures in February 2028; Knowles reported compliance with its financial covenants and expected to remain compliant over the next 12 months. The weighted-average borrowing rate was 6.24% for the first half, versus 2.18% a year earlier.
For the first six months, operating cash flow was $22.4 million, investing cash flow was positive $4.2 million, and financing cash flow was negative $20.1 million. Capital expenditures were $7.9 million. Cash increased by $6.2 million. The company expects 2023 capital expenditures of 3%–4% of revenue.
Changes and drivers
- Q2 revenue declined 8.0% year over year; first-half revenue fell 18.5%. For the first half, CMM revenue declined $43.4 million, MSA declined $15.0 million and PD declined $13.7 million.
- Management attributed weaker first-half sales to weak consumer-electronics demand, excess supply-chain inventory and reduced customer shipments after incentives had pulled shipments into Q4 2022. MSA also faced customer inventory reductions in hearing health; PD cited weaker industrial, distribution and communications demand.
- Despite lower Q2 gross profit dollars, Q2 gross margin increased to 42.6%, supported by cost reductions, prior restructuring benefits, favorable currency and a fixed-asset sale gain. First-half gross margin declined to 40.2%, reflecting lower utilization and pricing pressure.
- Selling and administrative expense rose 18.9% in Q2 and 11.6% for the first half, including higher professional fees and incentive compensation. Adjusted EBIT and adjusted EPS declined in both comparison periods, reflecting weaker underlying operating performance.
- Q2 segment revenue and EBIT: PD $47.8 million and $4.8 million; MSA $60.6 million and $23.6 million; CMM $64.6 million and $6.3 million. MSA EBIT improved slightly year over year, while PD revenue and EBIT declined. CMM’s comparison benefited from the absence of the prior-year impairment.
Outlook, risks and unusual items
- The filing provides no specific revenue or earnings guidance. Management said it historically generated, and expected to continue generating, positive operating cash flow and considered cash generation and capital-market access adequate to fund working capital, investment and share repurchases.
- Knowles recognized a $4.8 million gain on CMM machinery sold during the quarter as it transitions to next-generation MEMS wafer manufacturing technology. It expects further fixed-asset sale gains in Q3 2023; about $5.7 million of sale proceeds remained deferred pending transfer of the remaining assets, expected primarily in Q3.
- Q2 gross profit included $1.7 million of restructuring credits, including a gain on equipment previously written off and a reversal related to an estimate change. The company also recorded $0.6 million of Q2 operating-expense restructuring charges; first-half operating-expense charges were $1.6 million.
- Consumer-electronics weakness led to CMM goodwill impairment charges of $239.8 million in Q2 2022 and $231.1 million in Q4 2022. Management cautioned that lower-than-forecast growth or margins and changes in discount-rate assumptions could cause future impairment.
- Risks highlighted include dependence on large customers, particularly the top five CMM customers; demand and inventory swings; price erosion; product quality and launch timing; supply availability and costs; competition; foreign exchange; cybersecurity; geopolitical and trade conditions; and tax changes. The Malaysian tax holiday ended after conditions were not met; management believed an approximately $11.6 million U.S. valuation allowance release related to foreign tax credits was reasonably possible within 12 months.
- Routine legal claims and proceedings were not expected, individually or collectively, to materially adversely affect cash flow, results or financial condition based on information available. The filing reported no material changes to previously disclosed risk factors and no material developments in legal proceedings.
Important facts for investors to verify
- Whether consumer-electronics demand and customer inventory levels improved after the weak first half, and how that affected CMM shipments and utilization.
- How much of Q2 gross-margin support came from the $4.8 million asset-sale gain and restructuring credits, and whether expected Q3 gains are realized.
- Whether adjusted EBIT, margins and cash generation stabilize despite lower revenue and higher selling and administrative costs.
- Facility covenant headroom and borrowing costs under the amended credit agreement, especially given the higher weighted-average interest rate.
- Customer concentration, continuing price pressure, and the potential for further CMM goodwill or other asset impairment.
- Remaining authorization and pace of repurchases: Knowles bought back 733,438 shares for $12.5 million during the first half; $132.7 million remained under the program at the end of May.