Knowles Corporation — Q2 2020 Form 10-Q Summary
Business context and reporting period
Knowles supplies micro-acoustic, audio-processing and precision-device products to consumer electronics, communications, medtech, defense, automotive and industrial markets. This unaudited filing covers the quarter and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods. The business reports Audio and Precision Devices (PD) segments.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $152.2m | $205.2m | $315.3m | $385.0m |
| Gross profit / margin | $47.8m / 31.4% | $76.4m / 37.2% | $104.0m / 33.0% | $144.9m / 37.6% |
| Operating earnings (loss) | $(12.4)m | $12.4m | $(22.0)m | $16.8m |
| Net earnings (loss) | $(19.5)m | $5.9m | $(28.6)m | $3.2m |
| Diluted EPS | $(0.21) | $0.06 | $(0.31) | $0.03 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $25.0m | $10.9m |
| Capital expenditures | Not stated for quarter | Not stated for quarter | $14.6m | $24.5m |
- Q2 Audio revenue fell 34.6% to $104.5m; PD revenue rose 5.3% to $47.7m. Six-month Audio revenue declined 24.9% to $224.6m, while PD rose 5.5% to $90.7m.
- Q2 adjusted EBIT was $0.6m, versus $26.1m a year earlier; adjusted EBIT margin was 0.4%, versus 12.7%. For the six months, adjusted EBIT was $6.1m versus $42.8m, with margins of 1.9% and 11.1%.
- Cash and cash equivalents were $168.3m at June 30, 2020, compared with $78.4m at year-end 2019. Current assets were $443.0m and current liabilities $231.8m.
- Reported debt was $260.9m, including $100.0m drawn on the revolving facility and $160.9m carrying value of convertible notes. The revolver draw is classified as current; the notes mature November 2021. Debt principal payments shown for 2021 are $272.5m.
- Six-month financing cash flow was $79.6m, mainly reflecting $100.0m of revolver borrowing, offset by $15.0m of share repurchases and $6.0m of taxes on equity-award vesting.
Material changes versus the prior comparable period
- Revenue contracted 25.8% in Q2 and 18.1% for the first half, primarily from lower Audio demand amid COVID-19 and lower pricing on mature products. Audio manufacturing disruptions in Asia also reduced productivity and capacity utilization.
- Q2 gross margin declined 5.8 percentage points. Management cited lower Audio volumes, pricing pressure, manufacturing disruption and an inventory reserve in Intelligent Audio, partly offset by product cost reductions.
- PD performed better, with higher Q2 shipments to defense, automotive and communications markets; medtech shipments were weaker as hospitals delayed elective procedures.
- Restructuring charges increased to $7.4m in Q2 and $12.7m in the first half, compared with $0.5m and $2.8m, respectively, in 2019. Actions included Intelligent Audio workforce reductions and refocused R&D, as well as broader Audio workforce rationalization.
- Six-month operating cash flow improved by $14.1m year over year, chiefly from a favorable receivables movement and collection timing, despite the net loss.
Outlook, risks and unusual items
- Management expects full-year 2020 revenue, net income and cash flow to be below 2019, but says the pandemic’s duration and full financial impact cannot be reasonably estimated. No specific full-year revenue or earnings guidance is provided.
- 2020 capital expenditures are expected to be 5%–6% of revenue. Management expects additional cost-reduction benefits in Q3 from restructuring substantially completed in June and said it did not expect further 2020 charges for the specified restructuring actions.
- COVID-19 risks include demand and supply-chain disruption, facility restrictions and reduced manufacturing productivity. Other disclosed risks include customer concentration, OEM launch timing, price erosion, inventory exposure, competition, trade tensions, raw-material availability and intellectual-property matters.
- The company temporarily suspended share repurchases amid the pandemic. It had repurchased 996,109 shares for $15.0m in the first half; no shares were repurchased in Q2. The $100m program had $85.0m remaining at June 30.
- At June 30, Knowles reported compliance with credit-facility covenants and expected continued compliance over the next 12 months. The facility’s maturity could accelerate to April 30, 2021 if the 2021 notes have not been repaid, refinanced or converted by then.
- A $3.7m discontinued-operations gain in the first half was a tax refund related to the former Timing Device Business, not operating revenue. A California wage-and-hour representative action was filed in June; the company said it could not predict or meaningfully quantify the outcome.
- Malaysia tax holidays benefit the effective tax rate and are subject to conditions; the significant existing holiday is due to expire December 31, 2021 unless extended or renegotiated.
Important facts for investors to verify
- Whether Audio demand, pricing and manufacturing utilization recover, and whether the company’s lower-2020 outlook changes.
- How the company plans to address the $272.5m of 2021 debt principal payments, including the convertible notes and the revolver’s conditional earlier maturity.
- Whether inventory reserves and elevated inventory balances require further adjustments as demand and customer orders evolve.
- Whether restructuring delivers the anticipated cost savings and whether additional actions or costs arise.
- The effect of the California litigation, Malaysia tax-holiday conditions and any future repatriation taxes on results and cash.