Knowles Corporation — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Knowles supplies micro-acoustic, audio-processing, and precision-device products across consumer, communications, medtech, defense, automotive, and industrial markets. Its reportable segments are Audio and Precision Devices.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $205.8 million | $235.9 million | $521.1 million | $620.9 million |
| Gross profit / margin | $75.2 million / 36.5% | $93.5 million / 39.6% | $179.2 million / 34.4% | $238.4 million / 38.4% |
| Operating earnings (loss) | $13.6 million | $33.6 million | $(8.4) million | $50.4 million |
| Continuing-operations earnings (loss) | $5.6 million | $25.4 million | $(26.7) million | $28.6 million |
| Net earnings (loss) | $5.6 million | $25.4 million | $(23.0) million | $28.6 million |
| Diluted EPS from continuing operations | $0.06 | $0.27 | $(0.29) | $0.31 |
- Cash flow: Nine-month operating cash flow was $52.6 million, versus $50.6 million. Investing used $20.3 million, including $20.4 million of capital expenditures; financing provided $28.2 million. Cash increased $60.7 million to $139.1 million. Operating cash flow less capital expenditures was approximately $32.2 million, calculated from reported figures.
- Liquidity and debt: Current assets were $434.9 million and current liabilities $138.0 million at quarter-end. Debt carrying value was $213.0 million, comprising $163.0 million of convertible notes and $50.0 million drawn on a $400 million revolving facility. Cash exceeded debt by approximately $73.9 million, calculated from reported balances. The $172.5 million principal amount of the 3.25% notes is due November 2021.
- Segments: Q3 Audio revenue fell 14.9% to $164.8 million; Precision Devices revenue declined 2.8% to $41.0 million. For the first nine months, Audio revenue fell 21.0% to $389.4 million, while Precision Devices revenue rose 2.7% to $131.7 million.
Material changes versus comparable periods
- Revenue declined 12.8% in Q3 and 16.1% for the nine months. The decline was concentrated in Audio, reflecting lower demand, lower average pricing on mature products, and COVID-related disruption. A key North American handset launch partly offset Q3 Audio weakness.
- Gross margin contracted year over year in both periods. Lower volumes and pricing, along with weaker productivity and capacity utilization in Asian Audio operations, outweighed product-cost reductions.
- Nine-month results shifted to a continuing-operations loss from prior-year earnings. Audio reported a $0.5 million nine-month segment EBIT loss, compared with $72.1 million of earnings; Precision Devices’ segment EBIT increased to $26.2 million from $23.3 million.
- Q3 impairment charges of $7.6 million related to Intelligent Audio facilities. Nine-month restructuring charges were $12.8 million, primarily related to workforce rationalization and the Intelligent Audio restructuring.
Outlook, commentary, risks, and unusual items
- Management said it could not reliably estimate the pandemic’s duration or full impact, but expected full-year 2020 revenue, net income, and cash flow to be below 2019. No specific quarterly revenue or earnings guidance is stated in the filing.
- Management expected 2020 capital expenditures of 4%–5% of revenue, said it expected to remain in compliance with debt covenants over the next 12 months, and anticipated resuming share repurchases in Q4 2020. The company had repurchased 996,109 shares for $15.0 million through September; repurchases were temporarily suspended during the pandemic.
- The new revolving-credit agreement matures January 2, 2024, but includes a springing maturity tied to the 2021 convertible notes. If those notes are not repaid, refinanced, or converted by August 2, 2021, the facility may mature earlier unless the specified liquidity condition is met. Knowles reported covenant compliance at September 30.
- COVID-19 affected customer demand and manufacturing operations, especially in Audio; management cited ongoing uncertainty around supply chain, customer demand, operating costs, and asset recoverability. The company recorded $5.4 million of impairment on a vacated Mountain View lease asset and a $2.2 million estimated loss related to a Santa Clara facility lease expected to commence in 2021.
- Other notable items include $3.7 million of discontinued-operations earnings from a tax refund related to the Timing Device Business, and an ongoing Malaysian tax holiday that expires December 31, 2021 unless extended or renegotiated. A California wage-and-hour representative action was pending; management did not expect it to have a material adverse effect.
- Key stated business risks include dependence on large OEM customers, pricing pressure, product quality and launch timing, customer concentration, competition, raw-material availability and costs, and ongoing pandemic effects.
Most important facts for investors to verify
- Whether Audio demand, pricing, and Asian manufacturing utilization recover, and whether any major customer or product-launch changes affect shipments.
- Whether management’s expectation of lower full-year 2020 results and its capital-spending and share-repurchase plans remain on track.
- How the company plans to repay or refinance the $172.5 million convertible-note principal due in November 2021 and satisfy the credit facility’s liquidity and covenant requirements.
- Whether further restructuring, lease-related losses, or asset impairments arise, particularly given management’s uncertainty about COVID-19 and sublease assumptions.
- Whether the Malaysian tax holiday is extended and whether the California employment action or other legal matters develop materially.