Knowles Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Knowles became an independent public company on February 28, 2014 after its spin-off from Dover. Pre-spin-off periods were derived from Dover’s records and included allocated costs, so historical comparisons may not reflect the costs of operating independently.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $300.8 million | $311.6 million | $855.3 million | $884.5 million |
| Gross profit / margin | $52.2 million / 17.3% | $118.0 million / 37.9% | $169.0 million / 19.8% | $313.8 million / 35.5% |
| Operating income (loss) | $(16.4) million | $51.8 million | $(49.4) million | $102.6 million |
| Net income (loss) | $(14.6) million | $44.3 million | $(85.9) million | $72.8 million |
| Diluted EPS | $(0.17) | $0.52 | $(1.01) | $0.86 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $89.2 million | $109.3 million |
Q3 adjusted EBIT was $42.2 million (14.0% margin), versus $67.5 million (21.7%); nine-month adjusted EBIT was $95.9 million (11.2%), versus $159.0 million (18.0%). These are non-GAAP measures; the company’s reconciliations exclude items including restructuring, amortization, production-transfer costs and other charges.
At September 30, cash was $34.3 million, current assets $435.2 million and current liabilities $268.1 million. Debt totaled $400.0 million, comprising a $300.0 million term loan and $100.0 million revolver; $11.3 million was current. The variable borrowing rate was 1.66%, and the company reported compliance with its debt covenants. Nine-month capital expenditures were $68.0 million; capitalized patent-defense costs were $14.7 million. Cash declined $71.3 million during the nine months.
Material changes and business drivers
- Revenue declined 3.5% in Q3 and 3.3% for the nine months. Mobile Consumer Electronics (MCE) revenue fell 8.7% in Q3 and 8.2% year to date; Specialty Components revenue rose 5.8% and 5.2%, respectively.
- MCE was affected by lower pricing on mature products, reduced shipments to certain handset OEMs, a customer design change and a production and shipment hold on a new MEMS microphone version after a low-level defect. Management expected the issue to pressure MCE revenue and margins in the near term.
- Specialty Components benefited from hearing-health demand and strength in precision devices, particularly wireless infrastructure in China. Its Q3 adjusted EBIT rose to $30.0 million from $28.2 million.
- Gross profit deterioration reflected pricing pressure, the microphone production hold, a $15.0 million charge resolving customer claims for discontinued products, accelerated depreciation and inventory charges, and production-transfer costs.
Outlook, risks and unusual items
- No formal company-wide revenue or earnings guidance is provided. Management expects capital expenditures to equal 7%–9% of 2014 revenue.
- The Vienna facility closure was substantially complete by June 30. Knowles expects annual savings of $25–$30 million beginning in Q3 2014, and estimated total pre-tax costs of $47–$49 million, including $2–$4 million of additional costs primarily in Q4. It expected approximately $26–$28 million of those costs to be cash expenditures, mostly during 2014.
- Nine-month results included a $36.8 million valuation allowance on certain foreign deferred tax assets, primarily tax-loss carryforwards; this contributed to a $34.1 million tax provision despite a pre-tax loss. Q3 tax expense also included $1.7 million of Chinese withholding taxes on 2013 royalty income. Malaysia tax-holiday benefits partly offset the year-to-date tax impact.
- Foreign-currency translation reduced nine-month other comprehensive income by $45.4 million. Accelerated depreciation at the Beijing facility and restructuring-related charges were significant non-cash or unusual costs.
- GoerTek patent disputes remain material areas to monitor. A U.S. ITC administrative law judge found infringement of Knowles patents and recommended an exclusion order, subject to ITC review. Separately, Chinese courts awarded GoerTek damages of RMB 37 million (approximately $5.9 million) in each of two cases; Knowles appealed. Other U.S. and China proceedings remained pending. The company stated that legal reserves were not significant and did not expect the ultimate disposition to materially affect results or financial condition.
- Management stated it believed operating cash flow and access to capital would provide adequate resources for at least twelve months. It identified restructuring execution, product quality, customer concentration, pricing, currency, litigation and market demand among forward-looking risks.
Most important facts for investors to verify
- Whether and when the MEMS microphone production hold is resolved, and its effect on MCE shipments, margins and customer relationships.
- Whether the announced Vienna savings are realized on schedule and whether remaining restructuring and transfer costs stay within estimates.
- The cash and earnings impact of GoerTek litigation, including ITC action and the appeals of Chinese judgments.
- Whether the foreign deferred tax assets remain subject to valuation allowances and how tax-holiday conditions affect future effective tax rates.
- Debt covenant headroom, cash availability and capital spending needs, particularly as cash declined and the company began operating independently.
- The effect of non-GAAP exclusions and spin-off-related comparability on assessments of underlying operating performance.