Knowles Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Knowles became an independent, publicly traded company on February 28, 2014, following its spin-off from Dover Corporation. Prior-period results were prepared on a stand-alone basis from Dover’s records and include allocated corporate costs; they may not reflect the costs of operating independently. Unless otherwise indicated, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Revenue | $273.4 | $276.1 |
| Gross profit / margin | $83.1 / 30.4% | $94.6 / 34.2% |
| Operating earnings | $11.2 | $22.1 |
| Net earnings | $7.6 | $11.9 |
| Diluted earnings per share | $0.09 | $0.14 |
| Operating cash flow | $43.2 | $21.7 |
| Capital expenditures | $23.9 | $29.4 |
- Revenue declined 1.0%. Mobile Consumer Electronics (MCE) revenue fell 3.4% to $164.0 million, while Specialty Components (SC) revenue rose 2.9% to $109.4 million.
- GAAP gross margin fell 3.8 percentage points. Management attributed the decline principally to pricing and product mix on mature products, lower fixed-cost absorption in MCE, and production-transfer costs. Non-GAAP gross margin was 32.5%, versus 35.3%.
- Adjusted EBIT was $32.1 million, down from $41.0 million; adjusted EBIT margin was 11.7%, versus 14.8%. These non-GAAP measures exclude specified items, including amortization, stock compensation, restructuring, production-transfer costs and other adjustments.
- Net earnings fell 35.7%. Net interest expense declined to $0.7 million from $11.9 million, as the prior-year amount mainly reflected debt owed to Dover. The 2014 effective tax rate was 24.6%, versus 1.7%, affected by discrete tax items; excluding those items, the reported rates were negative 4.9% and negative 2.7%, respectively.
Financial position and liquidity
- At March 31, 2014, cash and cash equivalents were $51.4 million, down from $105.6 million at year-end. Cash held by non-U.S. operations was $46.4 million.
- Total debt was $400.0 million: a $300.0 million term loan and $100.0 million drawn on a $200.0 million revolving facility. The facilities mature in five years; the reported borrowing rate was 1.66%. The company was in compliance with its financial covenants and expected to remain compliant over the next 12 months.
- Current assets were $422.2 million and current liabilities were $197.6 million. Management said operating cash flow and access to capital markets should provide adequate resources for at least the next 12 months.
- Operating cash flow increased, principally reflecting working-capital timing and collections. Investing cash outflow was $28.3 million, including $23.9 million of capital expenditures and $4.4 million of capitalized patent-defense costs. Cash used in financing was $68.8 million, primarily reflecting a $465.9 million net transfer to Dover, partially offset by $400.0 million of new debt proceeds.
Material changes and operating drivers
- MCE earnings were pressured by lower sales to two key smartphone OEM customers, unfavorable mature-product pricing and mix, and increased intellectual-property legal costs. MCE revenue was $164.0 million versus $169.8 million; adjusted EBIT was $17.1 million versus $31.5 million.
- SC benefited from stronger demand for precision devices, particularly in Chinese wireless infrastructure markets. SC adjusted EBIT increased to $23.3 million from $20.3 million.
- Production-transfer costs were $5.8 million, compared with $0.8 million in Q1 2013. The company was moving manufacturing to existing lower-cost Asian facilities. Stand-alone public-company support costs may exceed the 2013 Dover allocation by approximately $5 million to $10 million in 2014.
- Management reported a $1.42 million pre-tax benefit from correcting the 2013 incentive-compensation accrual and a $1.10 million reduction in net earnings from foreign taxes on 2012 royalty income; it said these corrections were not material to any affected period.
Outlook, risks and contingencies
- On April 1, 2014, the board authorized cessation of manufacturing at the Vienna, Austria facility, with completion expected by mid-year. Production is to move to Asia while research and development remains in Vienna. The action is expected to contribute to the previously announced $40 million to $50 million annualized cost-savings target.
- Estimated pre-tax closure charges are $72 million to $77 million, including $40 million to $45 million of non-cash asset impairment and approximately $20 million of employee redundancy costs. Most charges were expected in Q2 2014. Management forecast 2014 capital expenditures of 6% to 8% of revenue.
- Knowles identified risks including customer concentration and demand changes, pricing and competition, product qualification and new-product ramps, foreign-exchange and input-cost fluctuations, restructuring execution, and intellectual-property litigation. It reported no material change to the risk factors in its 2013 Form 10-K.
- In multi-forum litigation with GoerTek, Chinese courts reportedly issued two judgments against Knowles Suzhou in April 2014, each specifying an injunction and damages of RMB 37 million (approximately $5.9 million). Knowles intended to appeal and had not accrued amounts for the judgments based on its assessment. U.S. ITC proceedings and patent challenges in China and the United States remained pending. The company stated that legal costs may be material, while its overall assessment was that these matters were not expected to materially adversely affect results or financial condition.
Important facts for investors to verify
- How quickly the Vienna closure and broader manufacturing transfers deliver savings, and whether estimated charges or transfer costs change.
- Whether smartphone customer market-share losses, product pricing and MCE margins stabilize or worsen.
- The status and potential financial or operational impact of the GoerTek litigation, including the Chinese judgments and appeals.
- Post-spin-off standalone operating costs, cash availability across jurisdictions, debt-service capacity and continued covenant compliance.
- The sustainability of tax benefits, including the Malaysian tax holiday, which the filing said expires December 31, 2021 unless extended or renegotiated.