Knowles Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. Knowles supplies micro-acoustic, audio-processing and specialty components through its Mobile Consumer Electronics (MCE) and Specialty Components (SC) segments. The filing presents the speaker and receiver product line as discontinued operations after its July 7, 2016 sale.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $243.1 million | $246.7 million | $618.7 million | $626.1 million |
| Gross profit / margin | $94.9 million / 39.0% | $97.3 million / 39.4% | $234.6 million / 37.9% | $231.2 million / 36.9% |
| Continuing-operations earnings | $20.9 million | $4.8 million | $1.6 million | $23.1 million |
| Net loss | $7.6 million | $14.9 million | $61.6 million | $46.8 million |
| Diluted EPS from continuing operations | $0.24 | $0.05 | $0.02 | $0.27 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $37.8 million | $12.4 million |
Q3 operating earnings were $26.5 million, versus $10.0 million a year earlier. For the first nine months, operating earnings were $18.8 million; management’s continuing-operations EBIT measure, which includes other income/expense, was $20.5 million versus $36.9 million. Nine-month cash flow included $31.0 million of capital expenditures. The company expects 2016 capital expenditures of 4%–5% of revenue.
Liquidity and debt
- Cash and cash equivalents were $60.0 million at September 30, 2016, down from $63.3 million at December 31, 2015; $49.5 million was held outside the United States.
- Reported borrowings, net of debt discounts and issuance costs, were $351.6 million, including $133.6 million carrying value of convertible notes and $218.0 million under the term loan and revolver. Long-term debt was $345.5 million.
- Net cash declined $3.3 million in the first nine months. Investing activities provided $13.6 million, including $40.6 million net sale proceeds; financing activities used $54.5 million.
- The company reported compliance with its debt covenants and expected to remain compliant over the next 12 months. Management said operating cash flow and access to capital markets should fund working capital and capital expenditures for at least that period.
Material changes and management commentary
- Quarterly revenue fell 1.5% year over year, with declines in both segments. MCE’s lower selling prices and unfavorable mix partly offset increased MEMS microphone shipments, including demand associated with multiple-microphone adoption at key Chinese OEMs. SC’s lower pricing was partly offset by higher timing-device demand.
- For Q3, MCE revenue was $140.4 million, down 0.6%, while segment EBIT increased to $22.0 million from $7.0 million, aided by lower restructuring expense, productivity and cost controls. SC revenue was $102.7 million, down 2.6%; EBIT increased to $19.8 million from $17.7 million, while adjusted EBIT declined to $23.2 million from $24.2 million.
- Nine-month reported gross profit increased, but continuing-operations earnings and diluted EPS fell substantially. Management attributed the earnings decline principally to higher expenses related to Audience, increased product-development spending and stock-based compensation, as well as lower selling prices and unfavorable mix. Nine-month SC earnings improved; MCE earnings declined.
- Company-reported non-GAAP results were Q3 adjusted EBIT of $39.9 million versus $35.8 million and non-GAAP diluted EPS of $0.37 versus $0.29. For nine months, adjusted EBIT was $66.0 million versus $90.3 million and non-GAAP diluted EPS was $0.59 versus $0.82. These measures exclude specified items and are not substitutes for GAAP results.
Outlook, risks and unusual items
- The speaker and receiver product line was sold for $45.0 million gross proceeds and $40.6 million net proceeds. Knowles recorded a $25.6 million sale loss, including $26.9 million of accumulated currency translation losses reclassified into earnings. Discontinued operations generated net losses of $28.5 million in Q3 and $63.2 million for the first nine months.
- Knowles issued $172.5 million of 3.25% convertible senior notes due 2021 and used proceeds primarily to repay term debt. The related accounting discount increased non-cash interest expense; quarterly net interest expense rose to $5.6 million from $3.6 million.
- The sale is expected to affect eligibility for one Malaysian tax holiday beginning January 1, 2017. Knowles was discussing possible modifications with Malaysian tax authorities. The filing notes that loss of tax-holiday benefits could materially increase its effective tax rate; the holidays benefited continuing-operations earnings by approximately $12.0 million in Q3 and $18.2 million year to date.
- Key stated risks include demand from large customers, mobile-product launch timing, pricing pressure, customer concentration, inventory built ahead of expected orders, manufacturing capacity and cost savings, product quality, foreign exchange, competition, litigation and tax-holiday conditions. Management reported no material developments in previously disclosed risk factors and no material expected adverse effect from ordinary-course legal proceedings.
- No full-year revenue or earnings guidance is provided in the supplied filing text; the stated quantitative outlook is the 2016 capital-expenditure range. Management described interim results as not necessarily indicative of full-year results.
Investor verification priorities
- Track MCE microphone shipments, customer concentration, average selling prices and product mix against the company’s cost-saving progress.
- Verify that the Malaysian tax-holiday conditions are modified or assess the potential tax-rate impact if they are not.
- Review post-sale warranty, restructuring and buyer-transition obligations, as well as any remaining discontinued-operation costs.
- Monitor debt repayment, variable-rate exposure, covenant headroom and potential dilution or cash settlement under the convertible notes and warrants.
- Reconcile reported GAAP performance with management’s adjusted measures and the excluded restructuring, acquisition, transfer and non-cash interest items.