Knowles Corporation — FY2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing; the filing’s Q4 figures are unaudited quarterly data, not a standalone quarterly report. Unless noted, financial results below are from continuing operations.
Business context
Knowles supplies MEMS microphones and audio-processing solutions, hearing-health transducers, oscillators and capacitors. In 2016 it reported Mobile Consumer Electronics (MCE) and Specialty Components (SC). In July, it completed the sale of its speaker and receiver product line and exited that business. Beginning in Q1 2017, it planned to report Audio and Precision Devices segments, with historical segment information to be recast.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Revenue | $859.3 million | $849.6 million |
| Gross profit / margin | $328.6 million / 38.2% | $312.3 million / 36.8% |
| Continuing-operations earnings | $19.1 million | $16.5 million |
| Continuing diluted EPS | $0.21 | $0.19 |
| Adjusted EBIT / margin (non-GAAP) | $106.1 million / 12.3% | $115.5 million / 13.6% |
| Net cash from operating activities | $107.5 million | $78.4 million |
| Free cash flow (non-GAAP) | $68.8 million | $15.3 million |
| Cash and cash equivalents at year-end | $66.2 million | $63.3 million |
| Debt carrying value at year-end | $298.2 million | $428.8 million |
Revenue rose 1.1%, as MCE growth of $18.1 million more than offset an $8.4 million SC decline. MCE revenue increased 4.3% on microphone shipments, market growth and share gains, partly offset by lower prices and unfavorable mix. SC revenue fell 2.0%, primarily due to pricing. GAAP gross margin improved, but adjusted gross profit declined 0.7% and adjusted EBIT declined 8.1%, reflecting pricing, mix, lower first-half fixed-cost absorption and higher Audience and product-development expenses.
Knowles reported a total net loss of $42.3 million, versus a $233.8 million loss in 2015, mainly due to discontinued operations. The discontinued speaker/receiver business generated a $61.4 million after-tax loss in 2016, including a $25.6 million loss on sale; 2015 included substantial impairment charges. FY2016 operating cash flow and free cash flow improved, while consolidated investing cash flow was $5.9 million and financing cash flow was a $109.9 million outflow. Capital expenditures were $38.7 million on a consolidated cash-flow basis; continuing-operations segment capital expenditures were $34.2 million.
Year-end current assets were $330.1 million and current liabilities $149.0 million. The company held $58.4 million of its $66.2 million cash balance outside the United States. It had $1.6 billion of undistributed foreign-subsidiary earnings intended to remain permanently reinvested. Debt included $163.1 million under the term loan and revolving facility and $135.1 million carrying value for $172.5 million principal of 3.25% convertible notes due 2021. The company reported compliance with debt covenants at year-end and expected to remain compliant over the next 12 months.
Material changes, outlook and risks
- Debt and capital allocation: Knowles issued $172.5 million of convertible notes in May 2016 and used proceeds primarily to reduce term-loan borrowings. It also paid $44.5 million for note hedges and received $39.1 million from warrants. Net sale proceeds of $40.6 million from the speaker/receiver business were used to reduce revolving-credit borrowings.
- Restructuring and investment: FY2016 restructuring charges were $11.8 million, primarily related to Audience integration, operating-cost reductions and manufacturing transfers. R&D expense increased to $100.5 million from $92.8 million. Management expects further restructuring as it optimizes manufacturing.
- Outlook: The filing gives no specific revenue or earnings guidance. Management expected 2017 capital expenditures of 6%–8% of revenue and stated it believed operating cash flow and capital-market access would provide adequate resources for needs. It highlighted growth opportunities in higher acoustic content, wearables and connected devices, alongside cost and operational-efficiency priorities.
- Key risks: Mobile handsets and MEMS microphones are significant revenue exposures; MCE’s top five customers represented 69.4% of segment revenue. Apple and Samsung represented about 17% and 11% of total company revenue, respectively. The company also cited price erosion, product-cycle volatility, competition, customer concentration, specialized supplier dependency, Asian manufacturing concentration, foreign exchange exposure, and covenant and refinancing risks. A sustained 10% weakening of the U.S. dollar was estimated to reduce operating results by about $20.9 million pre-tax.
- Tax and contingencies: The effective tax rate was 38.0%, affected by jurisdictional earnings mix and valuation allowances, partly offset by Malaysian tax holidays. The main Malaysian holiday rate was approved at 7.2% through 2021, subject to conditions. Knowles disclosed ordinary-course legal and IP matters but did not expect them, individually or collectively, to materially affect cash flow, results or financial condition. Separation-related tax and indemnification obligations remain potential exposures.
Most important facts for investors to verify
- Whether MCE volume and design wins can offset continuing pricing pressure, customer concentration and handset-market cyclicality.
- Whether adjusted EBIT and margins stabilize after 2016 declines, and how the 2017 Audio/Precision Devices segment recast changes comparisons.
- Debt repayment capacity, revolving-facility availability, covenant headroom and potential dilution or cash obligations from the convertible notes and warrants.
- The sustainability of cash generation and planned capital spending, including the distinction between continuing-operations and consolidated capex.
- Whether Malaysian tax-holiday conditions remain satisfied and whether foreign cash can remain overseas without constraining U.S. liquidity.
- Completion of sale-related obligations and whether the remaining discontinued-operation assets, liabilities, warranty and restructuring accruals settle as expected.