Knowles Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. Knowles supplies micro-acoustic, audio-processing and precision-device products. Its reportable segments are Audio and Precision Devices (PD). The Timing Device Business, sold in November 2017, is presented as discontinued operations.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $178.5 million | $168.3 million |
| Gross profit / margin | $65.3 million / 36.6% | $59.3 million / 35.2% |
| Operating earnings | $4.3 million | $1.3 million |
| Continuing-operations loss | $0.4 million | $5.0 million |
| Net loss | $0.3 million | $3.2 million |
| Adjusted EBIT (non-GAAP) | $14.7 million | $14.4 million |
| Non-GAAP diluted EPS from continuing operations | $0.11 | $0.11 |
| Operating cash flow | $(5.5) million | $17.9 million |
| Capital expenditures | $23.5 million | $17.7 million |
Revenue increased 6.1%. Gross margin improved year over year, while non-GAAP gross margin declined to 37.4% from 38.7%; management cited foreign-exchange headwinds and lower microphone capacity utilization. Reported net loss improved, but the company remained slightly loss-making from continuing operations. The 2018 effective tax rate was a 200% provision, reflecting the small pretax-income base and earnings mix across tax jurisdictions.
Audio revenue was $146.4 million, up 1.5%; PD revenue was $32.1 million, up 33.2%. PD growth reflected higher capacitor shipments and Compex. Segment adjusted EBIT was $17.9 million for Audio, down from $19.9 million, and $7.4 million for PD, up from $4.7 million.
Cash and cash equivalents were $62.7 million at March 31, 2018, down from $111.7 million at year-end. Current assets were $356.2 million and current liabilities $139.2 million. Debt carrying value was $194.3 million, comprising $143.6 million of 3.25% convertible notes and $50.7 million drawn on a $400 million revolving facility. No principal payments are scheduled before the notes’ 2021 and facility’s 2022 maturities. The company reported compliance with debt covenants and expected to remain compliant over the next 12 months.
Material changes and management commentary
- Revenue growth came from PD and higher MEMS microphone shipments to certain North American and Korean customers; lower shipments to key Chinese OEMs and mature-product price declines partly offset Audio growth.
- Gross profit benefited from volume, material savings, productivity and lower restructuring costs. Higher costs from volume and mix, unfavorable foreign exchange, mature-product pricing and lower microphone utilization were offsets.
- Operating cash flow fell by $23.4 million year over year. Management attributed the change primarily to an $11.0 million greater investment in adjusted working capital and increased payments of accrued liabilities. Inventory increased to $144.0 million from $125.6 million at year-end.
- Investing cash outflow was $40.4 million, including $23.5 million of capital expenditures and the Compex acquisition. Management expects 2018 capital expenditures of 7%–10% of revenue and believes operating cash flow and capital-market access will provide adequate resources for working capital, capital spending and strategic investments.
- Knowles acquired substantially all Compex assets in January for $18.7 million, including adjustments; Compex contributed $2.6 million of revenue and $0.2 million of pretax earnings after acquisition. The purchase-price allocation remained preliminary.
- Q1 2018 included a $0.7 million correcting entry for inventory reserves that increased pretax earnings; management said it was not material to the originating period or expected to be material for 2018.
Outlook, risks and contingencies
The filing provides no specific revenue or earnings guidance. Management’s capital-spending outlook is 7%–10% of revenue for 2018. It identified risks including customer concentration and demand changes, OEM launch timing, price erosion, microphone capacity utilization, foreign-exchange movements, input costs and availability, product quality, competition, and execution and integration of acquisitions and restructuring. The company’s Malaysian tax holidays run through December 31, 2021, subject to conditions; failure to meet them could adversely affect the tax rate. Accounting for certain Tax Cuts and Jobs Act effects remained incomplete, with completion expected by Q4 2018; management did not expect recently issued IRS guidance to materially change the provisional liability. Legal proceedings arise in the ordinary course; management did not expect them, individually or collectively, to materially adversely affect cash flow, results or financial condition.
Important facts for investors to verify
- Whether Audio demand, mature-product pricing and microphone capacity utilization improve, particularly given exposure to a limited number of large OEM customers.
- Whether working-capital investment and elevated inventory convert into cash; Q1 operating cash flow was negative despite higher revenue.
- Whether PD growth and Compex integration sustain performance, and whether the acquisition’s preliminary purchase-price allocation changes.
- Whether capital spending remains within the stated 7%–10% of revenue range and debt covenants remain comfortably met.
- Final tax-reform accounting and continued eligibility for Malaysian tax holidays; also note that $55.2 million of cash was held outside the United States at quarter-end.