Knowles Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless noted. Knowles supplies micro-acoustic, audio-processing and specialty components through its Mobile Consumer Electronics (MCE) and Specialty Components (SC) segments. Audience, acquired in July 2015, is included in 2016 results but not in Q1 2015.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Revenue from continuing operations | $185.3 million | $186.6 million |
| Gross profit / gross margin | $66.8 million / 36.0% | $62.5 million / 33.5% |
| Operating income (loss) | $(5.9) million | $10.3 million |
| Continuing operations income (loss) | $(12.5) million | $5.0 million |
| Discontinued operations loss, net | $(16.9) million | $(20.8) million |
| Net loss / diluted loss per share | $(29.4) million / $(0.33) | $(15.8) million / $(0.19) |
| Operating cash flow | $19.8 million | $6.8 million |
| Capital expenditures | $9.8 million | $17.7 million |
Revenue declined 0.7%. Gross profit and margin improved, but higher operating costs drove a swing to an operating loss. Adjusted EBIT from continuing operations, a non-GAAP measure, was $10.7 million versus $23.3 million; adjusted EBIT margin was 5.8% versus 12.5%. Non-GAAP diluted EPS was $0.08 versus $0.20. These non-GAAP measures exclude items including stock compensation, amortization, restructuring and production-transfer costs.
At March 31, cash was $44.2 million, down from $63.3 million at year-end; $40.0 million was held outside the U.S. Total debt was $401.2 million ($29.5 million current and $371.7 million long-term), versus $428.8 million at year-end. Cash and cash equivalents less total debt imply net debt of approximately $357.0 million. Current assets were $313.9 million and current liabilities $169.9 million. Operating cash flow benefited from receivables collections; financing outflows included $20.0 million of revolving-credit repayments and $7.5 million of term-loan principal payments.
Debt facilities bear variable rates; the weighted-average rate was 2.68% in Q1 2016 versus 1.93% in Q1 2015. The company reported compliance with its covenants at March 31 and said it expected to remain compliant over the following 12 months.
Material changes and business drivers
- MCE revenue increased 0.7% to $83.3 million, reflecting microphone shipments and Audience revenue, partly offset by lower selling prices and unfavorable mix. MCE reported an $8.6 million segment loss before interest and taxes, versus $9.9 million income.
- SC revenue declined 1.8% to $102.0 million, mainly due to lower pricing. Segment EBIT increased to $15.6 million from $12.7 million, supported by productivity, production transfers and foreign exchange benefits.
- Research and development expense rose to $26.1 million from $16.3 million; selling and administrative expense rose to $43.1 million from $35.9 million. Management attributed increases primarily to Audience and increased product-development spending.
- Q1 2016 included $4.7 million of restructuring charges, primarily related to Audience integration and other cost-reduction actions; Q1 2015 included a $0.7 million restructuring credit.
Outlook, risks and unusual items
- Knowles intended to sell its speaker and receiver product line and expected a sale in 2016, but had no definitive buyer agreement and could not estimate proceeds. The business was classified as discontinued operations for all periods presented. Its revenue was $20.4 million in Q1 2016 versus $52.0 million in Q1 2015.
- Management expected 2016 capital expenditures of 5%–6% of revenue and believed operating cash flow and access to capital markets would provide adequate resources for at least 12 months. The filing provides no specific revenue or earnings guidance.
- On May 4, 2016, after quarter-end, Knowles issued $150 million of 3.25% convertible senior notes due 2021, receiving approximately $140 million net proceeds intended to reduce term-loan borrowings. The notes include conversion, hedge and warrant features that may affect dilution. A 30-day option allowed purchasers to buy up to an additional $22.5 million principal amount.
- A fourth credit-agreement amendment, dated April 27, 2016, raised the maximum leverage ratio covenant from 3.25 to 3.75 and added a senior secured leverage ratio limit of 3.25. The filing also identifies foreign-exchange, customer demand, pricing, product-launch, integration, execution and intellectual-property risks.
- Audience-related litigation includes a proposed $6.0 million insured settlement awaiting court approval, recorded with a corresponding receivable, and a separate acquisition-related matter with $0.5 million accrued. Management stated it did not expect legal proceedings, individually or collectively, to materially adversely affect the company, while noting outcomes cannot be assured.
- Malaysian tax holidays benefit results and remain subject to conditions; they are scheduled to expire December 31, 2021. Failure to meet conditions could adversely affect the effective tax rate.
Important facts for investors to verify
- Progress, timing, sale price and any remaining costs associated with the speaker and receiver divestiture.
- Whether MCE can restore profitability and whether Audience-related spending and integration deliver expected benefits.
- Debt repayment after the convertible-note issuance, covenant headroom and the potential effects of conversion and warrants on dilution.
- Whether stronger operating cash flow is sustainable, given the quarter’s substantial receivables-related cash benefit.
- Approval and final terms of the disclosed legal settlements, and continued eligibility for Malaysian tax holidays.