Knowles Corporation — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual report, not a standalone Q4 filing; quarterly figures below are unaudited. Knowles makes audio components and processing solutions, including MEMS microphones, and precision devices such as high-performance capacitors and mmWave RF products. Its reportable segments are Audio and Precision Devices (PD).
Financial results and position
| Metric | 2019 | 2018 |
|---|---|---|
| Revenue | $854.8 million | $826.9 million |
| Gross profit / margin | $328.0 million / 38.4% | $322.6 million / 39.0% |
| Operating earnings | $81.2 million | $77.8 million |
| Continuing-operations earnings | $49.7 million | $65.6 million |
| Net earnings | $49.1 million | $67.7 million |
| Diluted continuing-operations EPS | $0.53 | $0.72 |
| Operating cash flow | $123.9 million | $98.5 million |
| Capital expenditures | $41.2 million | $80.1 million |
| Free cash flow (non-GAAP) | $82.7 million | $18.4 million |
- Revenue increased 3.4%. PD revenue rose 18.9% to $172.0 million, while Audio revenue was essentially flat at $682.8 million.
- GAAP gross margin fell 0.6 percentage points. EBIT was $80.8 million, or 9.5% of revenue, versus $77.1 million, or 9.3%, in 2018. Adjusted EBIT, a non-GAAP measure, was $126.9 million (14.8% margin), up from $117.2 million (14.2%).
- Net earnings and continuing-operations EPS declined chiefly because the effective tax result shifted from a 2018 benefit of $4.5 million to 2019 tax expense of $16.6 million. The 2018 tax benefit included a $17.8 million reduction to the transition-tax liability. Non-GAAP diluted EPS increased to $1.07 from $1.01.
- Cash and equivalents were $78.4 million at year-end, compared with $73.5 million. Current assets were $388.4 million and current liabilities $151.5 million. Total assets were $1.655 billion and stockholders’ equity $1.289 billion.
- Year-end debt carrying value was $156.8 million, consisting of convertible notes; the notes’ principal is $172.5 million and they mature in November 2021. There were no revolving-credit borrowings at year-end. The company reported compliance with its credit-facility covenants.
Quarterly context
Fourth-quarter 2019 revenue was $233.9 million, gross profit $89.6 million, continuing-operations earnings $21.1 million, and diluted continuing-operations EPS $0.22. For Q4 2018, the corresponding figures were $223.8 million, $94.3 million, $79.4 million, and $0.87. The sharp earnings comparison reflects, in part, the unusually favorable 2018 tax result.
Changes, outlook, and material matters
- Segment performance: Audio, about 80% of 2019 revenue, had nearly unchanged sales; higher Ear and IoT demand was offset by weaker handset demand and lower pricing on mature products. PD growth reflected higher defense, telecom, and medtech shipments, acquisitions, and pricing; its EBIT margin declined to 17.7% from 19.0% as staffing and precious-metal costs rose.
- Acquisitions: Knowles acquired DITF for $11.1 million in January 2019 and the MEMS microphone ASIC Design Business from ams AG for $57.9 million in December. The ASIC business had no revenue at acquisition; its assets included developed technology valued at $33.3 million. Acquisition-related purchase-price allocations and technology valuations involve estimates.
- Cash investment and outlook: 2019 free cash flow improved with lower capital spending and favorable working-capital movements. Management expected 2020 capital expenditures of 5%–7% of revenue; the filing provides no specific revenue or earnings guidance. Knowles does not anticipate near-term cash dividends.
- Restructuring and expenses: 2019 restructuring charges were $6.0 million, mainly related to PD manufacturing transfers and Audio workforce actions. Management’s non-GAAP reconciliation also excluded $4.4 million of shareholder-activism expenses, along with acquisition-related items and other adjustments.
- Customer and product concentration: Apple represented 22% of consolidated revenue, 27% of Audio revenue, and the top five Audio customers together represented about 49% of Audio revenue. MEMS microphones were about 57% of consolidated revenue; mobile handsets about 27%.
- Principal risks: Customer concentration, handset-cycle volatility and price erosion, competition and product qualification risk, specialized supplier dependence, Asia-centered manufacturing exposure, trade restrictions and tariffs, currency and commodity volatility, and cybersecurity, product-quality, intellectual-property, and impairment risks. The filing cited coronavirus impacts in China as a potential operating disruption. A sustained 10% weakening of the U.S. dollar was estimated to reduce annual pretax operating results by approximately $17.4 million.
- Taxes, debt, and assets: Malaysian tax holidays reduced taxes on eligible earnings and were scheduled to expire in 2021, subject to conditions. The company had a U.S. cumulative-loss position and recorded valuation allowances against deferred tax assets. Notes are due in 2021; the credit facility has covenant requirements and could mature earlier if the notes are not addressed by April 30, 2021.
- Contingencies and audit: Management did not expect ordinary-course legal matters to have a material adverse financial effect. The auditor issued unqualified opinions on the financial statements and internal controls. Critical audit matters included MCE goodwill impairment and valuation of developed technology acquired with the ASIC Design Business; no goodwill impairment was recorded, and reporting-unit fair values exceeded carrying values by at least 30%.
Investor verification priorities
- Assess Apple and other major-customer exposure, handset demand, MEMS microphone dependence, and the pace of diversification into Ear, IoT, and PD markets.
- Reconcile GAAP and adjusted earnings, especially tax effects, non-GAAP exclusions, restructuring, and the 2018 transition-tax benefit.
- Review the 2021 convertible-note repayment or refinancing plan, note-conversion dilution and hedge arrangements, and ongoing covenant headroom.
- Track gross-margin pressures from mature-product pricing, precious metals, warranty costs, and capacity-related overhead, alongside the sustainability of stronger free cash flow.
- Monitor 2020 capital spending, acquisition integration and ASIC technology assumptions, goodwill valuation sensitivities, Malaysian tax-holiday conditions, and China/trade-related supply risks.