Knowles Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Amounts are in millions of dollars except per-share data.
Business context and performance
Knowles supplies micro-acoustic and audio-processing products and precision devices, including capacitors and mmWave RF solutions. Its reportable segments are Audio and Precision Devices (PD). DITF, acquired in January 2019, is included in PD.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $205.2 | $188.4 | $385.0 | $366.9 |
| Gross profit | $76.4 | $73.2 | $144.9 | $138.5 |
| Gross margin | 37.2% | 38.9% | 37.6% | 37.7% |
| Operating earnings | $12.4 | $10.2 | $16.8 | $14.5 |
| Earnings from continuing operations | $5.9 | $4.4 | $3.2 | $4.0 |
| Diluted EPS from continuing operations | $0.06 | $0.05 | $0.03 | $0.04 |
- Q2: Revenue rose 8.9%. Audio revenue increased 5.3% to $159.9, driven by Ear and IoT demand and higher handset shipments to certain customers. PD revenue rose 23.8% to $45.3, reflecting medical and telecom shipments, higher pricing, and DITF. Gross margin declined, with mature-product price erosion, warranty claims, product mix, and PD capacity-related costs partly offset by volume, cost improvements, and favorable currency.
- First half: Revenue rose 4.9%; PD increased 25.2% to $86.0, while Audio was essentially flat at $299.0. Audio handset demand was affected by a major customer’s inventory correction and lower demand from Korean and Taiwanese OEMs. Gross margin was broadly stable year over year.
- Net earnings were $5.9 in Q2 versus $4.6; first-half net earnings were $3.2 versus $4.3. First-half continuing earnings were pressured by higher taxes and operating expenses despite improved gross profit and lower interest expense. Management also reported non-GAAP diluted EPS of $0.22 versus $0.18 in Q2 and $0.34 versus $0.30 for the first half; these are adjusted, non-GAAP measures.
Cash flow, balance sheet, and debt
- First-half operating cash flow was $10.9, compared with $9.3. Investing cash use was $35.9, including $24.5 of capital expenditures and $11.4 for acquisitions. Financing provided $5.0; cash decreased $19.9 to $53.6.
- At June 30, cash was $53.6, current assets $362.9, and current liabilities $127.5. Long-term debt was $171.9, versus $158.1 at year-end; cash less reported debt was approximately $118.3 net debt. The company had $19.0 drawn under its $400.0 revolving facility.
- The $172.5 principal amount of 3.25% convertible notes matures in November 2021; the revolver matures in October 2022. No principal payments were contractually due before those maturities. Knowles reported compliance with debt covenants and expected to remain compliant over the next 12 months.
- Operating lease right-of-use assets and liabilities were recognized following adoption of the new lease standard in 2019; adoption did not materially affect earnings or cash flows.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance is provided in the supplied filing text. Management expected 2019 capital expenditures of 6%–7% of revenue and stated that operating cash flow and capital-market access should provide adequate resources for working capital, capital expenditures, and strategic investments.
- Management identified risks including dependence on large OEM customers and handset demand, pricing pressure, China’s economic slowdown, trade tensions and tariffs, product quality and launch timing, inventory levels, competition, supply availability, and foreign exchange. Shareholder activism and associated costs also affected selling and administrative expenses.
- Malaysia tax holidays materially reduced the tax burden, subject to annual conditions, and are scheduled to expire December 31, 2021 unless extended or renegotiated. The filing reports a 65.2% first-half GAAP effective tax rate, affected by jurisdictional earnings mix.
- Q2 included a $0.5 inventory-reserve correcting entry that reduced pretax earnings; a $0.4 tax correcting entry in Q1 increased tax expense. The company said these prior-period errors were not material. First-half restructuring charges were $2.8, principally related to PD manufacturing transfers and Audio workforce actions.
- DITF was acquired for $11.1 and contributed $4.0 of revenue and a $0.2 pretax loss through June 30. Ordinary-course legal matters include commercial, warranty, employment, and intellectual-property claims; management did not expect them to have a material adverse effect, and legal accruals were not significant.
Important facts for investors to verify
- Whether Audio demand, particularly from major handset customers, stabilizes and offsets mature-product pricing pressure.
- Whether PD growth and DITF integration translate into sustained margins as capacity and personnel costs rise.
- Cash conversion, inventory growth, capital spending, and the rise in borrowings; also confirm revolver availability and covenant headroom.
- The durability of Malaysia tax incentives and the potential effect of their expiration or failure to meet required conditions.
- The composition and recurrence of non-GAAP adjustments, including shareholder-activism, restructuring, and production-transfer costs.