Knowles Corporation — Q3 2019 Form 10-Q
Business context and period: Knowles supplies micro-acoustic and audio-processing products and precision devices, including capacitors and mmWave RF solutions. This unaudited report covers the three and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Amounts are in U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $235.9m | $236.2m | $620.9m | $603.1m |
| Gross profit / margin | $93.5m / 39.6% | $89.8m / 38.0% | $238.4m / 38.4% | $228.3m / 37.9% |
| Operating earnings | $33.6m | $29.6m | $50.4m | $44.1m |
| Continuing-operations earnings (loss) | $25.4m | $(17.8)m | $28.6m | $(13.8)m |
| Diluted continuing-operations EPS | $0.27 | $(0.20) | $0.31 | $(0.15) |
| Operating cash flow | — | $50.6m | $39.3m |
Q3 revenue was essentially unchanged year over year, while nine-month revenue rose 3.0%. For the quarter, Audio revenue fell $5.3m (2.7%) to $193.7m, while Precision Devices (PD) rose $5.0m (13.4%) to $42.2m. Nine-month Audio revenue declined $4.5m; PD revenue increased $22.3m. PD growth reflected DITF acquisition contribution and higher shipments, particularly in defense, telecommunications and medtech.
Q3 gross margin improved 1.6 percentage points, mainly from cost reductions and favorable product mix, partly offset by lower pricing on mature products and higher PD production costs. Q3 GAAP operating earnings rose; nine-month operating earnings were $50.4m. Management’s MD&A reports nine-month EBIT of $50.5m, a small difference from the statements’ $50.4m operating earnings. Non-GAAP adjusted EBIT was $44.3m for Q3 and $87.1m for the nine months, versus $38.6m and $74.7m, respectively; these measures exclude specified items and should be considered alongside GAAP results.
The sharply improved reported earnings versus 2018 were substantially affected by taxes: 2018 included a large discrete tax expense associated primarily with Tax Reform Act-related uncertain tax positions, later released in Q4 2018. Q3 2019’s tax provision was $5.0m versus $43.1m in Q3 2018. The 2019 nine-month provision was $11.0m versus $45.3m in 2018.
Cash, debt and liquidity
- Cash and cash equivalents were $69.7m at September 30, 2019, down from $73.5m at year-end 2018; $63.2m was held by non-U.S. operations.
- Nine-month cash flow: $50.6m provided by operations, $44.0m used in investing and $10.3m used in financing; cash declined $3.8m. Capital expenditures were $32.6m.
- Debt carrying value was $154.8m, consisting of $172.5m principal of 3.25% convertible senior notes due November 2021, net of unamortized discount and issuance costs. Revolver borrowings were zero; the facility provides up to $400m. The company reported compliance with debt covenants and expected continued compliance over the next 12 months.
- Current assets were $394.3m and current liabilities $139.3m. The balance sheet also recognized $36.3m of operating lease liabilities following adoption of the lease standard in 2019.
Outlook, commentary and risks
- No specific revenue or earnings guidance is provided in the supplied filing text. Management expects operating cash generation and access to capital markets to provide adequate resources for working capital, capital expenditures and strategic investments.
- For 2019, management expected capital expenditures of 5%–6% of revenue. The company was expanding manufacturing capacity, particularly in PD.
- Management cited lower handset demand for MEMS microphones and Intelligent Audio, mature-product price erosion, and continuing Audio workforce rationalization. Ear and IoT demand partly offset handset weakness. PD growth required added personnel and factory overhead.
- Key stated risks include reliance on a limited number of large OEM customers; customer demand and product-launch timing; pricing pressure and competition; China’s economic slowdown and trade tensions/tariffs; product quality and warranty claims; supply availability and costs; and execution of product ramps and diversification.
- Malaysia tax holidays benefit earnings but depend on meeting annual conditions and, unless extended or renegotiated, a significant holiday expires December 31, 2021. Repatriating foreign cash may incur state and foreign withholding taxes.
- Ordinary-course legal matters include commercial, warranty, employment and intellectual-property claims. Management did not expect their disposition, after accruals and insurance, to materially adversely affect the company; legal accruals were not significant. The filing also cites shareholder-activism-related expenses.
Most important facts for investors to verify
- Whether Audio demand, especially handset microphone and Intelligent Audio demand, stabilizes and whether Ear/IoT growth can offset weakness and mature-product pricing pressure.
- How much PD growth is organic versus acquisition-related, and whether manufacturing expansion can sustain margins as staffing and capacity costs rise.
- The quality and sustainability of earnings improvement, separating operating performance from the unusually high 2018 tax provision and reviewing non-GAAP adjustments.
- Cash conversion and working-capital trends: receivables increased to $162.4m and inventories to $151.2m from year-end 2018.
- Funding and potential dilution associated with the 2021 convertible notes, including the company’s stated intent to settle principal in cash, and continued covenant compliance.
- Conditions supporting Malaysia tax holidays, their 2021 expiration, and any future tax or repatriation effects.