Knowles Corporation — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Knowles became an independent publicly traded company on February 28, 2014, following its spin-off from Dover. Prior-period figures include allocations from Dover and may not be fully comparable with standalone results.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $281.0 million | $296.7 million | $554.4 million | $572.8 million |
| GAAP gross margin | 12.0% | 34.1% | 21.1% | 34.2% |
| Operating income (loss) | $(44.2) million | $28.7 million | $(33.0) million | $50.8 million |
| Net income (loss) | $(78.9) million | $16.7 million | $(71.3) million | $28.6 million |
| Diluted EPS | $(0.93) | $0.20 | $(0.84) | $0.34 |
| Non-GAAP adjusted EBIT | $21.5 million | $50.5 million | $53.7 million | $91.5 million |
| Non-GAAP diluted EPS | $0.26 | $0.42 | $0.58 | $0.73 |
Q2 revenue declined 5.3%; first-half revenue declined 3.2%. Mobile Consumer Electronics (MCE) revenue fell 12.1% in Q2 and 8.0% year to date, while Specialty Components revenue rose 6.8% and 4.8%, respectively. MCE weakness reflected mature-product pricing, a smartphone customer design change and lower shipments to three OEMs. Specialty Components benefited from stronger precision-device demand, particularly in Chinese wireless infrastructure markets.
Reported profitability was burdened by the Vienna manufacturing closure and related costs, including restructuring, accelerated depreciation, inventory charges and production transfers. Adjusted EBIT also declined substantially, reflecting mature-product pricing, new-product ramp costs, weaker MCE fixed-cost absorption and higher legal spending. Q2 tax expense was $33.1 million despite a pretax loss, chiefly due to a $36.8 million valuation allowance on certain foreign deferred tax assets; a $4.4 million Malaysian tax-holiday benefit partly offset it.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $64.8 million, versus $57.5 million a year earlier. Investing cash outflow was $57.1 million; financing cash outflow was $68.6 million.
- Cash was $44.6 million at June 30, down from $105.6 million at year-end. $35.4 million was held by non-U.S. operations.
- Capital expenditures were $41.1 million for the first half. Management expects 2014 capital expenditures of 7%–9% of revenue.
- Debt totaled $400 million: a $300 million term loan and $100 million revolver borrowing; $7.5 million was current maturities. The credit facilities are five-year, secured facilities, with a $200 million revolving commitment. The reported borrowing rate was 1.65% and the company was in covenant compliance at June 30.
- Management said operating cash flow and access to capital markets should provide adequate resources for at least the next twelve months.
Outlook, unusual items and risks
- The Vienna action was substantially complete by June 30. Knowles reported $38.8 million of related costs and estimated total pretax costs of $45–$49 million, with $6–$10 million of additional restructuring and related charges expected, primarily in the second half of 2014. It expects annual savings of $25–$30 million beginning in Q3 2014.
- Management expected $5–$10 million of restructuring charges in Q3 2014 from the Vienna and other actions. Other programs include moving hearing-health and capacitor production to lower-cost Asian facilities and reducing consumer-electronics headcount.
- Knowles estimated standalone support-function costs could exceed 2013 Dover allocations by approximately $3–$5 million in 2014. Q3 selling and administrative expense was expected to decline sequentially, mainly due to legal-spending timing.
- GoerTek-related intellectual-property litigation spans U.S. and Chinese proceedings. Two Chinese judgments awarded GoerTek RMB 37 million (approximately $5.9 million) each and included injunctions; Knowles appealed, with appeals scheduled for September 2, 2014. Other claims, appeals and patent reviews remained pending. Management assessed overall legal matters as not expected to materially adversely affect results or financial condition; legal reserves were not significant.
- Key disclosed risks include customer concentration and handset-market changes, pricing pressure, product ramps and technology shifts, restructuring execution, foreign exchange, litigation and intellectual-property protection, raw-material availability, and post-spin-off obligations. Management reported no material change to the prior annual report’s risk factors.
Investor verification priorities
- Track MCE revenue, customer and product concentration, pricing, and whether new-product ramps restore margins.
- Compare realized Vienna and other restructuring costs and savings with management’s estimates and timing.
- Review the tax valuation allowance, deferred-tax-asset recoverability, and conditions and duration of the Malaysian tax holiday.
- Monitor the GoerTek litigation, especially the Chinese appealed judgments and the status and potential effects of U.S. proceedings.
- Assess cash generation, cash location and accessibility, capital spending, debt covenant headroom, and financing needs.