Knowles Corporation (NYSE:KN) Q3 2023 Earnings Call Transcript

Knowles Corporation (NYSE:KN) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Thank you for standing by. My name is Kayla Baker, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Knowles Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Vice President of Investor Relations, Patton Hofer.

Patton Hofer: Thank you, Kayla, and welcome to our Q3 2023 earnings call. I’m Patton Hofer, Vice President of Investor Relations. And presenting with me on the call today are Jeffrey Niew, our President and CEO; and John Anderson, our Senior Vice President and CFO. Our call today will include remarks about future expectations, plans and prospects for Knowles, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal securities laws. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses and profits, and involve a number of risks and uncertainties that can cause actual results to differ materially from current expectations.

The Company urges it investors to review the risks and uncertainties in the Company’s SEC filings, including, but not limited to, the annual report on Form 10-K for the fiscal year ended December 31, 2022, periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today’s earnings release. All forward-looking statements are made as of the date of this call and Knowles disclaims any duty to update such statements, except as required by law. In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today’s conference call can be found in our press release posted on our website at knowles.com and in our current report on Form 8-K filed today with the SEC, including a reconciliation to the most directly comparable GAAP measures.

All financial references on this call will be on a non-GAAP continuing operations basis unless otherwise indicated. Also, we’ve made selected financial information available on webcast slides, which can be found on the Investor Relations section of our website. With that, let me turn the call over to Jeff, who will provide some details on our results. Jeff?

Jeffrey Niew: Thanks, Patton, and thanks to all of you for joining us today. Knowles delivered solid third quarter results with earnings and cash flow above our expectations. Revenue of $175 million was in line with guidance, while adjusted EBIT margins of 21%, EPS of $0.31 and cash from operations of $40 million finished above the high end of our guidance ranges. In Q3, we took strategic actions to advance our transformation into an industrial technology company by announcing the acquisition of Cornell Dubilier and the exploration of strategic alternatives for our Consumer MEMS Microphone business. These actions reflect our ongoing efforts to increase exposure to high-growth markets and higher value opportunities. The Cornell Dubilier acquisition, which was successfully completed yesterday, bolsters our Precision Devices segment and is a testament to our commitment to growth, innovation and delivering greater value to shareholders.

This transaction significantly expands our serviceable available market through CD’s capacitor offerings, that will enable us to deliver a wider portfolio of products and solutions to both existing and new customers. CD’s end markets are aligned with growth — key growth tailwinds, including increasing defense budgets, medtech and critical care application growth. They are also well positioned in industrial electrification, clean energy and the implementation of next-generation fast-charging architectures. We are thrilled to welcome Cornell Dubilier’s talented employees to Knowles and look forward to realizing the tremendous benefits of this transaction for our customers and our shareholders. The acquisition is expected to be accretive to our EPS in 2024.

Importantly, we continue to have a strong balance sheet, allowing us to focus on balancing organic investment in R&D and CapEx with accretive M&A. We’ll continue to return cash to shareholders through share repurchases. While we won’t be getting into the specifics today relative to the exploration of strategic alternatives of the Consumer MEMS Mic business, what I will say is the process is progressing. Turning to segment results. Precision Devices’ Q3 revenue improved sequentially and was down 22% from the prior year. Demand weakness associated with excess channel inventory continued in Q3, leading to low manufacturing capacity utilization. Demand has improved since Q2, and we are encouraged by the positive ordering trends in PD as book-to-bill finished above one for the first time in six quarters.

We expect orders to continue to rebound in Q4, which gives us confidence in a return to growth in 2024. In Medtech & Specialty Audio, revenue was up 20% versus the prior year as market demand remains resilient. Based on our projected sequential growth and strong execution over the quarter, we believe we are past the inventory correction we experienced in the first half of ’23. We remain confident in our ability to grow MSA in 2024. In the Consumer MEMS Microphone business, revenue was up 2% from last year and earnings were slightly better than expected as consumer electronics markets have stabilized and demand for nonmobile products grew year-over-year. We expect Q4 will be the strongest quarter for CMM this year, including the highest quarter for mobile shipments driven by timing of customer product launches and improved share position.

To summarize briefly, MSA continues to perform well and we expect another strong quarter in Q4 with solid momentum heading into 2024. In PD, ordering trends have improved, but due to timing of the recovery, margins continue to be impacted by low capacity utilization. With the robust secular trends in defense, medtech and EV markets, complemented by the Cornell Dubilier acquisition, we believe we are well positioned for a return to growth in PD. For CMM, consumer electronics markets have stabilized and we expect second half revenues to be up year-over-year. Q4 is expected to be the peak quarter for the year, driven by strong shipments to mobile. We expect 2024 to benefit from the improving market trend and for CMM to return to full year revenue growth.

While 2023 has been a challenging year, we are performing well in the second half. On the last earnings call, we laid out a target of 19% adjusted EBIT margin for the second half. Excluding Cornell Dubilier, we expect to achieve that target. Although there has been some shift in earnings between Q3 and Q4, our second half EPS is expected to be in line with our previous expectations. As we enter the next phase of our transformation into an industrial technology company, I am confident the strategic actions we’ve taken will drive long-term shareholder value. Before I turn it over to John, I want to highlight the change in our guidance metrics starting in the fourth quarter. We will be providing revenue, EPS and cash from operations guidance, which is inclusive of the Cornell Dubilier acquisition.

We believe these metrics are the best measure for our business and are aligned to the Company’s focus. Now let me turn the call over to John to detail our quarterly results and guidance. John?

John Anderson: Thanks, Jeff. We reported third quarter revenues of $175 million, in line with guidance and down 2% from the year ago period, driven by lower shipments in Precision Devices. The Precision Device segment delivered revenues of $50 million, down 22% from the prior year, driven by continued weak demand associated with the excess channel inventory in industrial and distribution end markets and timing of shipments into the defense market. Bookings in the quarter were $58 million, resulting in a book-to-bill ratio of 1.2 for Q3. In the Medtech and Specialty Audio segment, revenue was $57 million, up 20% versus the prior year as demand has returned to more normalized levels. Consumer MEMS Microphone revenues of $68 million were up 2% versus the prior year, driven by higher shipments into nonmobile applications.

Third quarter gross margins were 44.6%, 110 basis points above the high end of our guidance range and up 610 basis points from the same period a year ago. Precision Devices’ segment gross margins were 40.4%, down 710 basis points from the prior year due to lower factory capacity utilization. Medtech and Specialty Audio segment gross margins were 54.9%, up 700 basis points versus the prior year, driven by factory productivity improvements, favorable product mix and the favorable impact of foreign exchange rate changes. Consumer MEMS Microphones delivered gross margins of 39.9%, up nearly 16 percentage points versus the prior year, driven by a gain on the sale of assets, lower factory costs, favorable product mix and higher factory capacity utilization, partially offset by price reductions in the smartphone market.

R&D expense in the quarter was $17 million, up $1 million from the prior year, driven by higher incentive compensation costs and timing of material spend, partially offset by reduced spending in our CMM segment driven by the benefits of prior year restructuring actions as we continue to shift our focus and spending to our higher-margin businesses. SG&A expenses were $25 million, $1 million lower than prior year levels, driven by lower sales commissions and incentive compensation costs in Precision Devices, partially offset by higher professional and legal fees associated with the exploration of strategic alternatives for CMM. For the quarter, adjusted EBIT margin was 21%, 520 basis points above prior year levels and 100 basis points above the high end of our guidance range.

EPS was $0.31 in the quarter, $0.06 above prior year levels and $0.01 above the high end of our guidance range. Now I’ll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $75 million at the end of the third quarter. We generated cash from operations of $40 million, above the high end of our guidance range, driven by higher adjusted EBITDA and lower net working capital. Capital spending was $4 million in the quarter. And we repurchased approximately 900,000 shares at a total cost of $15 million. We ended the quarter with cash net of outstanding bank borrowings of $30 million. As Jeff mentioned, future guidance will be provided for revenue, EPS and cash from operations. We believe these financial metrics align best with our long-term strategic focus and are the best measure for our business as we transition to an industrial technology company.

We expect to hold a virtual Investor Day to provide updates to our midterm financial targets, capital allocation, addressable markets and long-term strategy shortly after the completion of our evaluation of strategic alternatives relating to the CMM segment. Moving to our guidance for the fourth quarter, which includes the Cornell Dubilier acquisition which closed yesterday. Revenues are expected to be between $210 million and $220 million, up 9% versus the same period a year ago. We’re projecting EPS to be within a range of $0.27 to $0.31 per share. This assumes weighted average shares outstanding during the quarter of $93 million on a fully diluted basis. We’re projecting cash from operations to range from $40 million to $50 million, and capital spending is expected to be $5 million.

We expect to exit 2023 with approximately $80 million of cash and $286 million of debt, which includes $175 million of borrowings under our revolving credit facility and an interest-free seller note which was issued in connection with the Cornell Dubilier acquisition. We expect to have a net leverage ratio of approximately 1.4 as we exit 2023. I’ll now turn the call back over to the operator for questions and answers portion of the call. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Bob Labick with CJS Securities.

Bob Labick: I wanted to start, I guess, just with guidance since you just kind of ended there. Can you give us a sense of what’s included in that guidance from CD? I guess it’s two months given that it closed yesterday. We just want to confirm that. And maybe give us a sense of what the revenue contribution is there?

Jeffrey Niew: Yes, Bob. Obviously, our intent is not to guide by the segment going forward. But I think, obviously, with the period — we don’t own it the whole quarter. It’s about two months. We’re expecting roughly about $20 million in revenue from Cornell Dubilier.

Bob Labick: Okay. Great. And then — I mean it just closed, obviously. Give us a sense of kind of the integration process and timing? And I know when you purchased it, you mentioned that their margins are lower than your PD, but there’s that opportunity potentially to bring those up. So give us — talk about like that opportunity to raise CD margins up to or closer to PD’s historic average, please?

Jeffrey Niew: Yes. And just to reconfirm, Bob, kind of what we said was that we expect probably roughly about $140 million of revenue next year, with EBITDA $25 million to $27 million, somewhere in that range for EBITDA next year. And there is some pretty significant cost synergies. That will take some time to get. I think we looked at probably $3 million to $4 million of cost synergies that we think that we’ll get. What we didn’t detail too much about was revenue synergies. I think there are going to be some revenue synergies with Cornell. We’ll probably go into a little bit more detail in that at the Investor Day. But I think we would expect some of these revenue synergies to start showing up in the back half of 2024.

Bob Labick: Got it. Okay. Great. And then last one for me. I’ll jump back in queue. Just — you mentioned at the Analyst Day, just to be clear, when you conclude the CMM process? Or have they concluded — how is it — will you have sold — will you have decided to? Or what’s…

Jeffrey Niew: Yes. That’s a — I think that’s a question we anticipate getting. We kind of put that in John’s script. But I think the best way to put this is, I think we need to have some clarity on the outcome of the strategic alternatives process. I don’t have a firm date on when that’s going to be complete. And so — but I think it probably is really — we kind of view it from a perspective is we got to have a — like kind of some clarity around the outcome of that process. Now what that means in clarity — and there’s a lot of different outcomes here. I don’t want to speculate on what the outcomes could be. But I think in order to start giving new midterm targets, we really got to know kind of what the situation is relative to strategic alternatives with the Microphone business.

John Anderson: But we are progressing.

Jeffrey Niew: But we are completely progressing. I mean, we are making progress.

Operator: And your next question comes from the line of Christopher Rolland with Susquehanna.

Christopher Rolland: Perhaps you can talk about PD, how you see inventory there? Are we almost done with the clear out there? Also, anything else you want to talk about pricing, order trends, et cetera, would love to know. Yes.