Knowles Corporation — FY 2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; it is not a standalone fourth-quarter filing. Knowles supplies micro-acoustic, audio-processing and precision-device products. It reported two segments: Audio, serving mobile, hearing, headset and IoT markets, and Precision Devices (PD), supplying capacitors and related products to industrial, defense, aerospace, medical and telecom markets. Segment reporting was reorganized in 2017, with prior-period segment figures recast.
Financial performance and liquidity
- Revenue: $744.2 million, down 1.5% from $755.7 million in 2016. Audio revenue fell 3.7% to $637.4 million; PD revenue rose 13.9% to $106.8 million.
- Profit and margins: Gross profit was $286.3 million, down 3.2%; gross margin declined to 38.5% from 39.2%. Continuing-operations earnings were $6.5 million versus $19.8 million, and diluted EPS was $0.07 versus $0.22. Net earnings were $68.3 million, including $61.8 million from discontinued operations, primarily the Timing Device Business sale gain. Adjusted EBIT, a non-GAAP measure, increased to $110.6 million from $99.7 million; adjusted EBIT margin was 14.9% versus 13.2%.
- Cash flow and investment: Operating cash flow was $92.9 million, down from $107.5 million. Capital expenditures were $51.6 million; free cash flow, a non-GAAP measure, was $41.3 million versus $68.8 million. Cash and cash equivalents at year-end were $111.7 million, up from $63.4 million.
- Debt and liquidity: Long-term debt carrying value was $192.6 million, including $141.9 million carrying value for the 3.25% convertible notes and $50.7 million drawn on the revolving facility. The new senior secured revolving facility provides up to $400 million and matures in 2022, subject to an earlier maturity condition tied to the notes. The company reported compliance with its debt covenants at year-end. Current assets were $394.9 million and current liabilities $151.6 million.
- Fourth-quarter context: Q4 2017 revenue was $215.5 million and continuing-operations earnings were $31.9 million; net earnings were $85.5 million, including discontinued operations.
Material changes versus 2016
- Audio revenue was pressured by lower selling prices on mature products and reduced hearing-health transducer shipments; higher IoT microphone shipments and $13.6 million of royalty-dispute settlement revenue partly offset the decline. Future royalty revenue is not expected to be material.
- PD benefited from higher capacitor shipments, including to defense, medical and automotive markets, and the 2017 capacitor-asset acquisition.
- GAAP EBIT from continuing operations declined to $40.0 million from $48.5 million. The company recorded $21.3 million of impairment charges on an Audio product line, compared with $0.5 million in 2016. Cost reductions and lower intangible amortization partly offset these pressures.
- The sale of the Timing Device Business to Microsemi closed on November 28, 2017. It generated $123.1 million net cash proceeds and a $62.3 million pre-tax gain; $10 million of sale proceeds was held in escrow. The 2016 sale of the Speaker and Receiver Product Line had produced a $25.6 million pre-tax loss.
- Cash flow from operations and free cash flow declined, with working-capital investment and higher capital spending contributing. Inventory increased to support a major customer handset launch and a hearing-health production transfer.
Outlook, commentary and risks
- Management expects 2018 capital expenditures of 7%–9% of revenue. The filing provides no specific revenue or earnings guidance. Management described voice-enabled mobile, headset and IoT products as growth opportunities and continued investment priorities.
- The Tax Cuts and Jobs Act created provisional tax accounting, including an $18.0 million net transition-tax liability, payable over nine years. The company said final tax-reform accounting could change materially and expected to complete it in Q4 2018; it also expected incremental tax from GILTI provisions beginning in 2018.
- Key exposures include dependence on mobile handsets and MEMS microphones (about 36% and 60% of total revenue, respectively), customer concentration (Apple and Samsung were 19% and 10% of company revenue), price erosion, rapid product cycles, and specialized suppliers. A sustained 10% weakening of the U.S. dollar was estimated to reduce pre-tax operating results by about $17.9 million annually.
- Other risks include execution of product launches and manufacturing transfers, impairment of significant goodwill and intangibles, foreign operations and currency movements, debt covenant compliance, and potential tax obligations related to the former parent. Management did not expect ordinary-course legal proceedings to have a material adverse effect. The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- How much of reported 2017 earnings and cash generation reflects ongoing operations versus the Timing Device Business disposal and other discontinued operations.
- Whether Audio pricing, customer concentration and handset exposure are offset by growth in IoT, hearing health and other markets.
- Whether the 2017 Audio impairment signals further demand deterioration, and whether restructuring and production-transfer savings are being realized.
- The final effect of tax reform, including the transition-tax estimate, GILTI, tax-holiday conditions and any subsequent adjustments.
- Debt repayment and refinancing capacity, covenant headroom, working-capital requirements, and the returns from planned capital spending.