Knowles Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Knowles supplies micro-acoustic, audio-processing, and precision-device products through its Audio and Precision Devices (PD) segments. The results include Compex, acquired January 19, 2018; the Timing Device Business sold in November 2017 is presented as discontinued operations.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $188.4 million | $164.4 million | $366.9 million | $332.7 million |
| Gross profit / margin | $73.2 million / 38.9% | $63.2 million / 38.4% | $138.5 million / 37.7% | $122.5 million / 36.8% |
| Operating earnings (loss) | $10.2 million | $(18.0) million | $14.5 million | $(16.7) million |
| Continuing-operations earnings (loss) | $4.4 million | $(30.9) million | $4.0 million | $(35.9) million |
| Net earnings (loss), including discontinued operations | $4.6 million | $(29.7) million | $4.3 million | $(32.9) million |
| Diluted EPS from continuing operations | $0.05 | $(0.35) | $0.04 | $(0.40) |
| Adjusted EBIT (non-GAAP) | $21.4 million | $14.5 million | $36.1 million | $28.9 million |
Q2 revenue rose 14.6% year over year; first-half revenue rose 10.3%. At June 30, cash and equivalents were $50.8 million, versus $111.7 million at year-end 2017. Current assets were $364.8 million and current liabilities $142.4 million. Long-term debt carrying value was $196.1 million, compared with $192.6 million at year-end; debt principal payments are not scheduled before maturities in 2021 and 2022. The company reported compliance with credit-facility covenants.
For the first half, operating cash flow was $9.3 million, down from $21.4 million. Investing used $65.5 million, including $48.0 million of capital expenditures and $17.5 million for acquisitions. Financing used $4.9 million, and cash declined by $60.9 million. Management expects 2018 capital expenditures of 9%–10% of revenue.
Changes versus the prior comparable period
- Audio revenue increased 9.9% in Q2 and 5.6% in the first half, mainly on higher MEMS microphone shipments to certain North American and Chinese OEMs; lower Korean OEM shipments and mature-product price erosion partly offset growth.
- PD revenue rose 39.2% in Q2 and 36.3% in the first half, reflecting stronger capacitor shipments for defense and industrial markets and Compex sales.
- GAAP profitability improved substantially, principally because 2018 had no comparable impairment charge. In Q2 2017, Knowles recorded $21.3 million of impairment charges related to an Audio product line. First-half 2017 also included higher restructuring charges.
- Underlying measures were mixed: Q2 adjusted EBIT margin increased to 11.4% from 8.8%, while Audio’s first-half adjusted EBIT margin declined to 13.6% from 14.6%. Management cited mature-product price declines, higher manufacturing costs, and unfavorable currency effects as offsets to volume, savings, and productivity gains.
- Interest expense declined to $4.1 million in Q2 from $5.1 million, and to $8.1 million for the first half from $10.3 million, which the company attributed to lower outstanding borrowings.
Outlook, risks, and unusual items
- Management stated that operating cash flow and capital-market access should provide adequate resources for working capital, capital expenditures, and strategic investment. No revenue or earnings guidance is stated in the provided filing text.
- Tariffs already implemented adversely affected a small portion of capacitor products. Management said the near-term impact was not expected to be material, but warned that further tariffs or an escalating trade conflict could raise costs, affect demand, or pressure margins across both segments.
- Other disclosed risks include reliance on a limited number of large OEM customers, customer launch timing and demand shifts, mature-product price erosion, manufacturing utilization, foreign-exchange movements, product quality, raw-material availability and costs, and competition. Malaysian tax holidays support earnings but depend on meeting conditions and are scheduled to expire December 31, 2021 unless extended or renegotiated.
- Knowles recorded a $1.3 million Q2 pretax correction related to pre-spin-off pension obligations and a $0.7 million Q1 pretax correction related to inventory reserves. The filing says these corrections were not material to the historical periods or expected to be material to 2018 financial statements.
- The company had not completed its accounting for all Tax Cuts and Jobs Act effects and expected to complete it by Q4 2018. It expects the January 1, 2019 lease-accounting adoption to materially increase balance-sheet lease assets and liabilities.
- Management said ordinary-course legal proceedings were not expected to have a material adverse effect, based on information then available. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether Audio growth and margins can withstand continued mature-product pricing pressure and customer concentration.
- How capital spending, inventory growth, and working-capital movements affect cash generation; first-half operating cash flow was notably below 2017.
- The actual exposure to proposed or retaliatory tariffs, including any effects on sourcing, customer demand, and gross margins.
- Debt covenant headroom, convertible-note dilution or settlement exposure, and liquidity needs ahead of 2021–2022 maturities.
- Compex’s contribution and integration progress, and the final purchase-price allocation, which was still preliminary.
- Completion of tax-reform accounting, continued eligibility for Malaysian tax holidays, and the balance-sheet impact of lease-accounting adoption.
- Non-GAAP reconciliations and adjustments when assessing the difference between adjusted and GAAP performance.