Knowles Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Knowles supplies audio and precision-device components. Its reportable segments are Audio and Precision Devices (PD); segment reporting was reorganized in 2017, with prior periods recast.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $221.7m | $243.1m | $605.6m | $618.7m |
| Gross profit / margin | $82.5m / 37.2% | $94.9m / 39.0% | $221.8m / 36.6% | $234.6m / 37.9% |
| Operating earnings | $20.9m | $26.5m | $7.1m | $18.8m |
| Continuing-operations earnings (loss) | $15.4m | $20.9m | $(19.6)m | $1.6m |
| Net earnings (loss), including discontinued operations | $15.7m | $(7.6)m | $(17.2)m | $(61.6)m |
| Diluted EPS from continuing operations | $0.17 | $0.24 | $(0.22) | $0.02 |
Q3 non-GAAP adjusted EBIT was $31.7m (14.3% margin), versus $39.9m (16.4%); nine-month adjusted EBIT was $63.9m (10.6%), versus $66.0m (10.7%). These company-defined non-GAAP measures exclude specified items and are not substitutes for GAAP results.
- Cash flow: Nine-month operating cash flow was $31.1m, down from $37.8m. Capital expenditures were $43.4m; investing cash flow was $(45.4)m. Cash fell $8.5m to $57.7m.
- Liquidity and debt: Current assets were $371.1m and current liabilities $155.4m. Debt carrying value was $311.2m, including $13.3m current maturities; cash was $57.7m. The company reported compliance with credit-facility covenants at quarter-end.
- Segments, Q3: Audio revenue fell 13.2% to $167.8m; segment EBIT was $28.1m versus $36.5m. PD revenue rose 8.5% to $53.9m; EBIT increased to $6.6m from $5.3m.
Material changes and unusual items
- Consolidated Q3 revenue declined 8.8%, primarily from lower Audio shipments to a North American customer amid later handset launches, weakness at key Chinese handset OEMs, and lower average selling prices. IoT microphone shipments partly offset the decline. PD benefited from capacitor shipments and the January 2017 capacitor-asset acquisition.
- Q3 gross margin declined 1.8 percentage points year over year. Management cited pricing, lower microphone shipments, lower fixed-overhead absorption, and production-transfer costs; productivity initiatives and lower selling and administrative costs partly offset the pressure.
- Nine-month results included $21.6m of impairment charges, principally a $21.3m charge for Audio product-line assets following a revised outlook for future demand. Restructuring charges were $8.3m, net of a $0.9m reversal.
- The Q3 net-income comparison was affected by the 2016 speaker-and-receiver product-line sale, which generated a $25.6m loss. That business had no revenue in 2017 periods shown; its 2017 discontinued-operations earnings included tax effects.
- Inventory rose to $148.3m from $108.2m, and management attributed weaker operating cash flow partly to working-capital investment, including inventory built for handset launches and a manufacturing transfer.
- Taxes were affected by discrete tax items and Malaysian tax holidays. The company said the holidays are conditional and currently expire December 31, 2021 unless extended or renegotiated.
Outlook, risks, and contingencies
- Management said operating cash flow and access to capital should fund working capital and capital expenditures for at least the next 12 months. It expected 2017 capital expenditures of 6%–8% of revenue. No quantified revenue or earnings guidance is provided in the filing.
- After quarter-end, Knowles entered a new five-year revolving credit facility of up to $400m, replacing the prior facility. Also after quarter-end, it agreed to sell its oscillator timing-device business to Microsemi for $130m, subject to working-capital adjustments, regulatory approval, and customary conditions. The company expected a Q4 2017 close and slight future earnings dilution; the business had nine-month revenue of $77.0m.
- Key disclosed risks include handset launch timing and demand, customer concentration, microphone price erosion, Audio capacity utilization, product quality and qualification, competition, foreign-exchange exposure, raw-material availability and cost, execution of restructuring and divestitures, and potential loss of Malaysian tax benefits.
- Knowles reported ordinary-course legal proceedings, including intellectual-property matters, but did not expect them, individually or together, to materially affect cash flow, results, or financial condition. Legal accruals were not significant.
Important facts for investors to verify
- Whether Audio demand, customer handset ramps, and average selling prices recover, and whether IoT growth can offset weakness in mobile and hearing-health products.
- Whether the timing-device sale closes on expected terms and how proceeds, lost earnings, and the stated dilution affect future results and debt.
- Whether elevated inventory converts to sales and cash, and whether planned capital spending and restructuring deliver expected productivity and cost savings.
- Progress on the new credit facility, debt maturities, covenant headroom, and the effect of variable rates and convertible notes.
- The quantitative effect of adopting the new revenue-recognition standard in 2018; the filing says the impact was still being assessed.