Knowles Corporation (NYSE:KN) Q4 2022 Earnings Call Transcript

Knowles Corporation (NYSE:KN) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Good afternoon, and welcome to the Knowles Corporation Fourth Quarter and Full Year 2022 Financial Results Conference Call. My name is Tamiya and I’ll be your Operator for today. With that said, here with opening remarks is Knowles Vice President of Investor Relations, Patton Hofer. Please, go ahead.

Patton Hofer: Thank you, Tamiya, and welcome to our Q4 2022 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 and company sales, expenses and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations.

The company urges 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, 2021, periodic reports filed from time-to-time with the SEC and the risks and uncertainties identified in today’s earnings. 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 to pursuant 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 measure.

All financial references on this call will be on a non GAAP continuing operation basis, unless otherwise indicated. Also, we’ve made selective financial information available in webcast slides, which can be found in 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. Before we dive into the Q4 results, I wanted to refresh everyone on the new segmentation that we introduced during our investor update call in November, as this is how we will be discussing the company in the prepared remarks. We separate our audio into two — in segments in two. The first segment is called MedTech & Specialty Audio, or MSA, which primarily includes acoustic solutions sold into the Hearing Health market. The second is our consumer MEMS Microphones segment, or CMM, which is focused on microphones sold into the ear, IoT, compute and smartphone markets. Knowles now operates and reports under their three segments, Precision Devices, MedTech & Specialty Audio and consumer MEMS Microphones.

With that, let me begin with a summary of our Q4 results. We were pleased to report; we delivered results at or above the high end of our guided ranges for gross margins, adjusted EBIT margins and free cash flow, despite a challenging backdrop in consumer electronics market and the COVID related issues in China. In the quarter Knowles generated $197 million of revenue, which was down 16% versus the prior year, driven primarily by weak consumer electronics and market demand and customers inventory adjustments in consumer MEMS and MedTech & Specialty Audio. Consumer MEMS mics was down 31% versus prior year levels, and MedTech & Specialty Audio was down 13%. In contrast, Precision Devices delivered revenue growth of 9% versus prior year levels, as we continue to see robust demand in defense, medtech, EV and industrial end markets.

We deliver gross margins of 40.4%, above the high end of our guided range; earnings per share of $0.33, in line with the guidance — with our guidance; and we generate just shy of $40 million in free cash flow, which was at the high end of our expectation. I believe these results demonstrate that our focus on the markets and price where we have significant competitive advantages is paying dividends, particularly our profit margins and cash flow. For full year 2022, I would like to take a minute to highlight each segments performance individually and their current market dynamics. First in Precision Devices, we delivered record revenue, gross margins and adjusted EBIT margins. Revenue grew 21%, gross margins finished at 47%, an increased to 140 basis points versus prior year levels.

Adjusted EBIT finished at $68 million and grew 29% versus the prior year. We continue to see strong organic growth in the mid to high-single-digits going forward driven by defense, medtech, and EV market. Both of our product categories, high performance capacitors, and our filters continue to demonstrate our superior technical capabilities, providing a competitive advantage for Knowles in markets we serve. Second, our MedTech & Specialty Audio delivered record gross margins and adjusted EBIT in the year. Revenue was flat with prior year levels and strong growth in Hearing Health market in the first half was offset by customer inventory adjustments and a softer end market demand in the second half. Gross margins finished at 50%, 270 basis points increase over prior levels.

Adjusted EBIT finished at $88 million, a 10% increase versus 2021. Although market condition deteriorated slightly for the segment, we’re able to deliver double-digit earnings growth and flat revenues. In the near term, we continue to see customer inventory adjustments and software end market demand. We have confidence in the resilience of this market and day time bookings trends, we expect to see strong sequential growth for revenue and profitability in Q2 2023 as customers inventories normalized. Now onto our consumer MEMS microphone business. Revenue in this segment was down $144 million versus prior levels. 2022 was a difficult year for consumer electronics around the globe as end market demand, customer inventory adjustments, and the impact of COVID lockdowns in China severely impacted the segment top line.

Photo by Mark Paton on Unsplash

In August, we announced our restructuring actions to address current market conditions and dynamics to accelerate our strategy to diversify away from commodity microphones. Today, I’m pleased to confirm all the actions have been put in place delivering greater than $28 million of annualized savings. In Q1, we continue to see weak end market demand in inventory adjustments by our customers. These headwinds are across most end markets and geographies, including PCs and smartphones. Because of the weak demand, we will continue to operate in less than 50% capacity utilization in Q1, negatively impacting gross margins. Despite these near term headwinds, we expect sequential improvement in Q2 for revenues and profitability, and on the beginning of China market recovery and our customers’ new products.

In summary, for the company, Q1 is normally sequentially lowered due to seasonality, but it’s been further impacted by weak consumer demand, inventory in the channel and COVID-related challenges in China as they reopen their economy. I’m proud of the execution by our employees, which has allowed us to continue to generate cash in the face of substantial headwinds. As we look beyond Q1 and Q2, we are anticipating 15% to 20% sequential revenue growth with all three segments contributing. Lastly, I would like to highlight we have secured an extension of our $4 million revolving credit facility until 2028. This reflects the strength of our balance sheet and the expectations to generate significant free cash flow. It also provides a substantial liquidity to supplement internal growth with acquisitions.

With that, let me turn the call over to John to detail our quarter. John?

John Anderson: Thanks, Jeff. We reported fourth quarter revenues of $197 million, down 16% From the year ago period, driven by lower shipment volumes and consumer MEMS mics and medtech and specialty audio, partially offset by higher revenues and precision devices. The precision device segment delivered revenues of $63 million, up 9% from the prior year, driven by growth in medtech, EV, defence and industrial end markets. For the full year, PD revenues increased 21% including 18% organic growth and 3%. from an acquisition which was completed in 2021. Full year 2022 revenues were at record levels and driven by strong demand across all of our end markets. In medtech and specialty audio, fourth quarter segment revenue was $2 million, down 13% versus the prior year as our customers reduced inventory levels and we faced difficult year-over-year comparables as the second half of 2021 benefited from strong COVID recovery.

For the full year, MSA revenue was flat with prior year levels. Consumer MEMS mic revenues of $72 million was down 31% versus the prior year, driven by weak global demand for consumer electronics, channel inventory adjustments and COVID related issues in China. For the full year, revenue was down 33%, driven by weak consumer demand and inventory adjustments in most end markets and geographies. Fourth quarter gross profit margins were 40.4%, a 190 basis points above the high end of our guidance range and down 290 basis points from the same period a year ago. Precision devices segment gross margins were 48.6%, down slightly from the prior year due to favorable inventory adjustments in Q4 2021 that did not repeat. For the full year, gross margins finished at a record high of 47.2% and up 250 basis points over prior year levels, driven by favorable product and customer mix, factory productivity improvements and the acquisition we completed in the first half of 2021.

Medtech and specialty audio segment gross margins were 51.6%, up 120 basis points versus the prior year, driven by favorable product mix and foreign currency benefits. For the full year, MSA delivered record gross margins of 49.9%, up 270 basis points over prior year levels, driven by favorable product mix, productivity improvements and benefits related to foreign exchange. Consumer MEMS microphone gross margins for the fourth quarter were 23.9%, down more than 11 percentage points versus the prior year, driven by significantly lower factory capacity utilization, pricing and unfavorable mix, partially offset by benefits to the restructuring actions implemented in the second half of the year. For the full year, gross margins were 28.2%, down 960 basis points from the prior year, driven by unfavorable capacity utilization and product mix, partially offset by benefits of the restructuring actions announced in August.

For full year 2022, total company gross margins were 40.6%, down 110 basis points from 2021 with record annual gross margins in both the PD and MSA segments, more than offset by significant year-over-year margin declines in the consumer MEMS mic segment. R&D expense in the quarter was $15 million, down more than $4 million from the prior year, with the reduction driven entirely by lower incentive compensation costs and the benefits of the restructuring actions taken in the consumer MEMS microphones. SG&A expenses were $27 million, $3 million lower than prior year levels, driven by lower incentive compensation cost. For the quarter, adjusted EBIT margin was 18.9%, 190 basis points above our expectations. For the full year, EBIT margins were 18.6%.

EPS was $0.33 in the quarter at the midpoint of our guidance range. Now, I’ll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $48 million at the end of the quarter. We generated cash from operations of $47 million, slightly above the midpoint of our guidance range. Capital spending was $7 million in the quarter. For full year 2022, free cash flow was $54 million, representing just over 7% of revenue. We repurchase 2.3 million shares at a total cost of 44 million and exited the year with cash net of debt of $3 million. This marks the first time since the spin off, we’ve ended the year in a net cash position. Moving to guidance for the first quarter of 2023. We expect total company revenue to be between $140 million and $155 million, down 27% versus the same period a year ago.

With the decline in revenues driven by weak demand in consumer MEMS mic, inventory corrections and medtech and specialty audio, partially offset by year-over-year growth in precision devices. We estimate gross margins for the first quarter to be approximately 32% to 35%, down eight percentage points from the year ago period, driven by low factory capacity utilization and unfavourable mix in our consumer MEMS mic medtech and specialty audio segments. R&D expense is expected to be between $16 million and $18 million, down $3 million from prior year levels, driven primarily by prior year restructuring actions in the consumer MEMS mic segment. We’re projecting selling and administrative expense to be between $25 million and $27 million, up $2 million from the year ago period, driven primarily by higher incentive compensation cost, partially offset by restructuring actions we’ve taken in the consumer MEMS microphone segment.

We’re projecting adjusted EBIT margin for the quarter to be in the range of 2% to 6% and expect EPS to be within a range of $0.01 to $0.07 per share. This assumes weighted average shares outstanding during the quarter of $94.8 million on a fully diluted basis. We’re forecasting an effective tax rate of 16% to 18% for the quarter and full year ’23 which reflects an expected change in jurisdictional income and the impact of the unmet conditions or tax holiday in Malaysia. For the quarter, we expect cash generated from operations to range between $15 milloin and $25 million, capital spending is expected to be approximately $5 million. Given the current macro headwinds and uncertainty in the market, we’d like to provide some select commentary as it relates to our expectations for the second quarter of ’23.

As Jeff mentioned, we’re expecting sequential revenue growth of 15% to 20% with all three segments expected to drive the increase. We also expect gross margins in the second quarter will return to 40% or more, driven by improved capacity utilization and favorable mix. I’ll now turn the call back over to Jeff, for closing remarks. Jeff?

Jeffrey Niew: Thanks, John. But there’s no doubt, we are dealing with some significant challenges in the global markets. Our Q4 and 2022 results continue to demonstrate our strategy to focus on high value markets and products is allowing us to achieve strong EBIT margins and continuing to generate cash. Looking at 2023, we are expecting significant sequential improvement from Q1 to Q2 in both revenue and profitability and remain confident in our ability to achieve our midterm targets of 22% to 24% EBIT margins, and 15% to 17% free cash flow. With that, we can open up for questions.

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Q&A Session

Operator: Absolutely. We will now begin the question-and-answer session. Our first question comes from Bob Labick with CJS securities. Please proceed.

Bob Labick: Good afternoon. Thanks for taking our questions.

Jeffrey Niew: Hey, Bob.

Bob Labick: So, I just wanted to kind of dig in a little more on what you just gave us in terms of guidance and a look at two into the first half in general, if I do the quick math on the sequential growth in Q2, it looks like you’re still looking for about 10% revenue declines there. So, 25 and plus or minus in Q1, 10 in Q2. The question is, can you talk more about the first half end market demand versus inventory corrections, and really talking about the end market demand for that first buy segment if you because in a new segment, orientation that you’ve laid out for us?

Jeffrey Niew: Yes, Bob, happy to do that, provide some additional color on Q2, and also just like maybe first start with Q2, but then maybe delve in a little bit about what we see right now for full year. But let me start with the Q2, let me break this up by the business units. As I said in the prepared remarks, we expect about 15% to 20%, sequential revenue growth in Q2 over Q1. So, first in the MedTech, and Specialty Audio, what I’d say here is we’re fully booked for Q1 already. And I think we’re probably a little ahead of normal where we’d be at this time. So, we’re feeling pretty good that — what’s included in our guidance for Q1 is very, very achievable. And the trend generally, is that as we move through the quarter, the bookings are getting better.

Even in Q2, we’re already seeing strong bookings in Q2. So, I think — when we think about the sequential growth improvement in Q2, I think, we’re pretty happy about where we are with that. In the PD space, I would say, it’s kind of a similar story. The current bookings, which are even longer than out then where we would be in the MedTech and Specialty Audio are pretty good. And the expectations of pros and defense, EV, MedTech are quite good. So, I think we feel pretty good about that as well. And lastly, in the consumer MEMS market, I would say, I’m cautiously optimistic for modest improvements in Q2, and I think the majority of that will be in China improvements. Right now, if I were to sit there look at my forecasts or how I look at China, China’s at a really low point in Q1 still.

And we do see some pretty nice growth sequentially, not year-over-year yet, but sequentially. But there’s still inventory clearly in some of these places. And I would point out specifically compute, we’re not seeing a real recovery or move out of the inventory till probably the back half a year. So, overall, again, 15% to 20% sequential growth. Now, I’d like to just take make a comment — few comments about 2023. I’ll preface this, this is a very fluid situation. It’s not guidance, it’s more just kind of when I’m thinking about, and I’ll go through it by segment again. So, first for Precision Devices, very strong defense markets we’re expecting in 2023. I’d say steady growth in the MedTech portion of Precision Devices. And then the last piece in terms of growth is EV.