Knowles Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Knowles supplies micro-acoustic, audio-processing and specialty components through Mobile Consumer Electronics (MCE) and Specialty Components (SC). Audience, Inc. was acquired on July 1, 2015; its results are included from that date.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $294.6m | $300.8m | $774.1m | $855.3m |
| Gross profit / margin | $88.7m / 30.1% | $52.2m / 17.4% | $199.1m / 25.7% | $169.0m / 19.8% |
| Operating loss | ($12.4m) | ($16.4m) | ($37.1m) | ($49.4m) |
| Net loss | ($14.9m) | ($14.6m) | ($46.8m) | ($85.9m) |
| Diluted loss per share | ($0.17) | ($0.17) | ($0.54) | ($1.01) |
| Operating cash flow | — | $12.4m | $89.2m |
Q3 adjusted EBIT, a non-GAAP measure, was $19.6m versus $42.2m; adjusted EBIT margin was 6.7% versus 14.0%. For the nine months, adjusted EBIT was $40.2m versus $95.9m, and margin was 5.2% versus 11.2%. Non-GAAP diluted EPS was $0.16 in Q3 ($0.38 prior year) and $0.30 year to date ($0.96 prior year).
At September 30, cash was $57.9m (including $52.3m held outside the U.S.); total debt was $474.8m, including $186.0m drawn on a $350m revolver. Current maturities were $26.3m. Current assets were $471.6m and current liabilities $245.2m. Cash increased $2.7m over the nine-month period; investing used $80.6m and financing provided $71.7m. Capital expenditures were $48.5m year to date.
Material changes and management commentary
- Q3 revenue declined 2.1%; MCE grew 3.7% to $189.2m, while SC fell 10.9% to $105.4m. Nine-month revenue declined 9.5%, with MCE down 11.1% and SC down 7.0%.
- Management attributed pressure to lower selling prices, weaker shipments to certain handset customers, a major OEM operating-system transition, and continued softness in China LTE infrastructure build-outs. MCE benefited from MEMS microphone share gains, multiple-microphone adoption, and $12.1m of Audience revenue in Q3.
- GAAP gross margin improved substantially against the prior-year period, which included customer-claim charges and accelerated depreciation and inventory charges. However, year-to-date non-GAAP gross profit fell 17.5%, reflecting lower prices, reduced shipments and weaker fixed-overhead absorption.
- Audience added costs as well as revenue: its Q3 operations generated $12.1m revenue and a $23.3m net loss. Audience-related restructuring charges were $8.0m; total Q3 restructuring charges were $9.4m. The acquisition’s purchase-price allocation remains provisional.
- Interest expense rose to $3.7m in Q3 and $9.2m year to date, primarily due to higher debt following the acquisition and higher rates. Debt increased from $400.0m at year-end 2014 to $474.8m.
Outlook, risks and unusual items
- No revenue or earnings guidance is provided in the supplied filing text. Management expects 2015 capital expenditures of $65m–$75m and believes operating cash flow and available financing will meet needs for at least 12 months.
- Knowles was in compliance with its debt covenants and expected to remain compliant for the next 12 months. The facilities have variable rates; an interest-rate swap covering $100m of debt is scheduled to begin in January 2016.
- Key disclosed risks include customer concentration and demand volatility, pricing and product-launch execution, customer qualification and product quality, acquisition integration and synergy delivery, restructuring savings, foreign exchange, indebtedness, tax-rate changes, and intellectual-property litigation.
- Malaysia tax holidays provided an estimated $7.9m tax benefit year to date and run through 2021, subject to conditions. Knowles said it does not expect to benefit from future U.S. losses or U.S. deferred tax assets.
- Audience-related IPO litigation had a proposed $6.0m settlement payable by insurance carriers, subject to court approval; Knowles recorded a matching receivable and reserve. Acquisition-related litigation had a $0.5m reserve and remained subject to final settlement and court approval.
- Cash-flow pressure reflected lower operating cash generation, including unfavorable changes in payables and accrued expenses. Foreign-currency translation reduced other comprehensive income by $60.1m year to date.
Investor verification priorities
- Assess underlying MCE and SC demand, pricing, customer concentration, and the durability of microphone share gains.
- Review Audience’s ongoing losses, integration costs, provisional valuation, and whether expected strategic benefits materialize.
- Reconcile GAAP improvements with the sharp declines in adjusted EBIT and non-GAAP EPS, including the exclusions used in those measures.
- Monitor operating cash flow, capital spending, debt balances, variable-rate exposure, and covenant headroom.
- Check the court outcomes for both Audience-related matters and continued qualification for Malaysia tax incentives.