Knowles Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Knowles supplies micro-acoustic and audio-processing products and precision devices, through its Audio and Precision Devices (PD) segments. Comparisons below are with the corresponding 2017 periods; amounts are U.S. dollars in millions except per-share data.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $236.2 | $196.0 | $603.1 | $528.7 |
| Gross profit / margin | $89.8 / 38.0% | $74.1 / 37.8% | $228.3 / 37.9% | $196.6 / 37.2% |
| Operating earnings | $29.6 | $19.3 | $44.1 | $2.6 |
| Continuing-operations earnings (loss) | $(17.8) | $10.5 | $(13.8) | $(25.4) |
| Net earnings (loss) | $(16.2) | $15.7 | $(11.9) | $(17.2) |
| Diluted continuing-operations EPS | $(0.20) | $0.12 | $(0.15) | $(0.28) |
| Operating cash flow | Not separately presented for the quarter | $39.3 | $31.1 |
Revenue rose 20.5% in Q3 and 14.1% year to date. Q3 Audio revenue increased 18.6% to $199.0; PD revenue increased 31.9% to $37.2. Growth reflected higher microphone, intelligent-audio and capacitor shipments, Compex acquisition contribution, and demand from Chinese OEMs. Mature-product pricing pressure and reduced shipments to a key Korean OEM partly offset growth.
Q3 GAAP continuing-operations results included a $43.1 income-tax provision on $25.3 of pretax earnings. The unusually high tax charge drove the reported loss; management attributed $39.7 of discrete tax expense primarily to a $36.0 increase in uncertain tax positions related to Tax Reform Act consequences and a $3.1 adjustment to provisional deemed-repatriation tax accounting. Q3 non-GAAP diluted continuing-operations EPS was $0.34, versus $0.26; nine-month non-GAAP EPS was $0.64, versus $0.48. These are company-defined non-GAAP measures and should be considered alongside GAAP results.
Q3 GAAP gross margin improved slightly year over year, while non-GAAP gross margin declined to 38.4% from 38.9%. For nine months, non-GAAP gross margin fell to 38.4% from 39.3%. Management cited mature-product pricing, lower fixed-overhead absorption, foreign exchange and new-product ramp costs as offsets to volume, savings and productivity benefits.
Liquidity, debt and cash flows
- Cash and equivalents were $68.6 at September 30, down from $111.7 at December 31, 2017; $63.7 was held outside the U.S. Current assets were $383.3 and current liabilities $147.5.
- Net cash from operations was $39.3 for nine months, compared with $31.1. Investing used $66.0, including $58.0 of capital expenditures and $18.0 for acquisitions, partly offset by $10.0 of sale-related escrow proceeds. Financing used $16.3, including a $10.0 revolving-credit repayment. Cash declined $43.1.
- Debt carrying value was $187.9, down from $192.6; it comprised $147.2 of 3.25% convertible notes and $40.7 drawn on a $400.0 revolving facility. Principal maturities are $172.5 in 2021 and $40.7 in 2022. The company reported compliance with debt covenants and expected to remain compliant for the next 12 months.
- Knowles expected 2018 capital expenditures to be 9%–10% of revenue. It reported no specific revenue or earnings guidance in this filing.
Changes, outlook and risks
- Operating earnings improved versus 2017, which included $21.3 of impairment charges and higher restructuring charges. Nine-month operating earnings also benefited from higher gross profit and the absence of those impairments.
- Compex was acquired in January 2018 for $18.7, with $9.5 of revenue and $2.6 of pretax earnings included from acquisition through September 30. The Timing Device Business sale was completed in November 2017; Q3 2018 discontinued-operations earnings of $1.6 included a sale-related adjustment.
- Management cited customer and product-launch timing, dependence on a limited number of large OEMs, mature-product price erosion, capacity utilization, quality, and foreign-exchange exposure as risks. Tariffs were already adversely affecting a small percentage of capacitor products; broader tariffs or a trade escalation could raise input costs or weaken demand.
- Tax accounting remained provisional: Knowles intended to complete its Tax Reform Act accounting by Q4 2018. It said some or all of the $36.0 increase in uncertain tax positions could reverse within 12 months. Malaysian tax holidays benefit earnings but depend on meeting conditions and are scheduled to expire December 31, 2021 unless extended or renegotiated.
- The company expected adoption of lease accounting in January 2019 to materially increase balance-sheet assets and liabilities. It said ordinary-course legal proceedings were not expected to have a material adverse effect. Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Investor facts to verify
- How much of reported earnings and future tax expense depends on resolution of the uncertain tax positions and provisional Tax Reform Act accounting.
- Whether revenue gains from Chinese OEMs and new product launches can offset mature-product price erosion and weaker demand from the Korean OEM.
- Whether non-GAAP margin pressure from ramp costs, overhead absorption, currency and tariffs persists, and how the company defines its non-GAAP adjustments.
- Cash conversion and funding needs given elevated capital expenditures, lower cash balances, working-capital investment and scheduled debt maturities.
- Compex’s ongoing contribution, and the balance-sheet and covenant effects of the 2019 lease-accounting adoption.