Knowles Q1 2023 Earnings Call Transcript

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April 27, 2023

There are 8 speakers on the call.

Operator

Afternoon. Thank you for attending today's Knowles First Quarter 2023 Earnings

Speaker 1

I would now like to pass the

Operator

conference over to your host, Pat Hoefer, Vice President of Investor Relations with Knowles. Thank you. You may proceed.

Speaker 2

Thank you, Joel, and welcome to our Q1 2023 earnings call. I'm Pat Hofer, Vice President of Investor Relations and presenting with me on the call today are Jeffrey New, 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 renewals, which constitute forward looking statements for purposes of the Safe Harbor provisions under applicable federal securities Forward looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses and profits 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 ks 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 knolled.com and in our current report on Form 8 ks filed today with SEC, including a reconciliation to the most directly comparable GAAP measures.

Speaker 2

All financial measures on this call will be on a non GAAP continuing operations basis unless otherwise indicated. Also, we've made selected Financial information available in webcast form, 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

Speaker 3

Thanks, Pat, and thanks to all of you for joining us today. Our Q1 results were largely in line with our expectations. Revenue finished slightly below the midpoint of our guidance, but due to strong operational performance and the benefits of mix, we were able to deliver gross margins, Adjusted EBIT margins, EPS and cash from operations all above the midpoint of the guided ranges. Looking at Q1 in more detail, Knoll generated $144,000,000 of revenue, slightly below the midpoint, driven by weak consumer electronics demand in the market and access customer and channel inventory across all three segments. In Precision Devices, revenue was down 4% from the prior year.

Speaker 3

EV, MedTech and Defense all grew year over year, while our industrial market faced inventory challenges, which are now expected to continue through Q2. In Medtech and Specialty Audio, revenue was down 24% versus prior year levels due to customer inventory adjustments and softer end market demand in the hearing health market. I would note MSA was better than expected as inventory moved faster than we anticipated, driving revenue higher in Q1. In Consumer MEMS Microphones, revenue was down 48% from Q1 of 2022 as all end markets were down versus prior year. Before I turn the call over to John, I'll spend some time discussing the current customer and market conditions for each segment with some insights into what we are seeing for Q2 and the rest of the year.

Speaker 3

For our Precision Device segment, we continue to have strong demand and growth in our 3 key end markets: defense, medtech and EV. In defense, the demand for communications and electronic warfare systems continued to amplify the need for our RF filtering and high performance capacitor products. Despite awards and shipments in this market being lumpy at times, we grew year over year again For MedTech, our high performance and high reliably capacitor price grew again in Q1, and we continue to see demand growth throughout 2023. We believe this market continues to show resilience similar to our MSA segment in the face of economic or macroeconomic challenges. In the EV market, we grew 50% year over year in the Q1.

Speaker 3

Knowles continues to expand its design wins in this exciting market with a broad range of new customers. We expect continued growth throughout 2023 with the EV market being our fastest growing market for Knowles. In the industrial market, which currently makes up less than 15% of company revenue, we are seeing continued weakness as distribution Customer inventory levels remain elevated. We expect the inventory challenges market to continue in the Q2, but we see signs that lead us to believe of recoveries coming in the second half. Overall for PD, we expect strong bookings in Q2 For our 3 key markets and depending on the inventory consumption at our distributors, we can see a return to growth in the second half for this segment.

Speaker 3

In MedTech and Specialty Audio, as we stated on the Q4 call, we started seeing signs early in Q1 that the inventory situation was improving, which gave us increasing confidence on strong sequential revenue improvement in Q2. Our guide reflects a more than 27% presentation. We have a sequential improvement in MSA driven by major hearing aid retailers around the globe starting to see a return to growth. This demonstrates resilience of this end market and provides confidence in a return to growth starting in Q3 of this year. Lastly, our consumer MEMS microphone segment.

Speaker 3

Demand across all our end markets were down in Q1 versus prior year levels, But as we look ahead, we are starting to see recovery in some end markets. Specifically, non mobile shipments are expected to be up over 30% sequentially presentation as channel inventory has improved and replacement cycles are expected to start in Q3. These markets are still down from prior year levels, but definitely showing signs the presentation. Finally, while the smartphone market has not degraded further, we are not yet seeing a recovery. Presentation.

Speaker 3

Due to excess capacity in the market, we are seeing further pricing pressure. While our strategy has not changed, in the short term, we will continue to fill our capacity with smart For CMM, due to normal seasonality of this business and improving market conditions, we are expecting Strong sequential improvement for revenue and earnings starting in Q2. We expect sequential improvement to continue for the remaining quarters in 2023. Overall for Knowles, the outlook for improvement in revenue, margins and earnings as the year progresses remains unchanged from our last call. Presentation.

Speaker 3

In Precision Devices, the defense, medtech and EV markets remain robust, while inventory challenges further dampen the industrial market in the near term. Lastly, for CMM, we are seeing improving trends in computing and ear and IoT, while smartphone demand shows a slower return to recovery. In summary, we are now expecting 2% to 3% reduction off of last year's full year revenue. Now let me turn the call over to John

Speaker 4

Thanks, Jeff. We reported 1st quarter revenues of 144,000,000 down 28% from the year ago period, driven primarily by lower shipment volumes in consumer MEMS mics and medtech and specialty audio. The Precision Device segment delivered revenues of $54,000,000 down 4% from the prior year, driven by excess channel inventory in the industrial market, partially offset by increased shipments in EV, Defense and Medtech end markets. In the Medtech and Specialty Audio segment, revenue was 46,000,000 As the first half of twenty twenty two, demand benefited from strong COVID recovery. Consumer MEMS Mic revenue of $45,000,000 was down forty eight presentation.

Speaker 4

We are pleased with

Speaker 3

the progress we made in the quarter,

Speaker 4

driven by weak global demand for consumer electronics and channel inventory adjustments across all end markets. 1st quarter gross margins were 37.7 percent, 270 basis points above the high end of our guidance range and down 3.90 basis points from the same period a year ago. Precision Devices segment gross margins were 46.9%, up 130 basis points from the prior year due to factory productivity gains and lower raw material cost. Medtech and Specialty Audio segment gross margins were 43.5%, down 6 80 basis points versus the prior year, driven primarily by lower factory capacity utilization, partially offset by foreign currency benefits. Consumer MEMS microphone gross margins for the Q1 was 21.7%, down more than 11 percentage points versus the prior year, partially offset by benefits of the restructuring actions announced in August of 2022.

Speaker 4

R and D expense in the quarter was $17,000,000 Down $3,000,000 from the prior year with the reduction driven entirely by the benefits of the restructuring actions taken in the Consumer MEMS microphone segment. SG and A expenses were $27,000,000 $2,000,000 higher than prior year levels, driven primarily by higher incentive compensation cost, partially offset by restructuring actions in the Consumer MEMS Microphone segment. For the quarter, adjusted EBIT margin was 5.6%, Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $52,000,000 at the end of the quarter. We generated cash from operations of $22,000,000 above the midpoint of our guidance range driven by lower net working capital.

Speaker 4

Capital spending was $4,000,000 in the quarter and we repurchased approximately 430,000 shares at a total cost of $7,500,000 We ended the quarter with cash net of outstanding borrowings of $7,000,000 Moving to guidance for the 2nd quarter. We expect total company revenue to be between $165,000,000 $180,000,000 up 20% sequentially and down 8% versus the same period a year ago. We estimate gross margins for the Q2 to be approximately 39% to 41%, R and D expense is expected to be between $15,000,000 $17,000,000 down $2,000,000 from prior year levels, driven primarily by prior year restructuring actions in the consumer MEMS Mike segment. We're projecting selling and administrative expense to be between 26 and $28,000,000 up $3,000,000 from the year ago period, driven primarily by higher incentive compensation cost, to be in the range of 14% to 16% and expect EPS to be within a range of $0.20 to $0.24 per share. This assumes weighted average shares outstanding during the quarter of 95,100,000 on a fully diluted basis.

Speaker 4

We're forecasting an effective tax rate of 17% to 19% for both the quarter and full year 2023, which reflects a change in jurisdictional income and the potential impact of the unmet conditions for our tax holiday in Malaysia. For the quarter, we expect cash from operations to range from $5,000,000 to negative $5,000,000 Capital spending is expected to be approximately We'll now turn the call back over to the operator for the question and answers portion of our call. Operator?

Operator

The first question is from the line of Bob Labick with CJS Securities. You may proceed.

Speaker 5

So I wanted to start, obviously, you guys are operating, I think, very well in a difficult and volatile market. And so I wanted to I want to kind of take a step back and just get like a big picture view. And you've given medium term targets Previously, I think it's 43% gross margin and the 22% to 24% adjusted EBIT margin. And a lot of the growth to getting there was mix shift to higher margin business plus utilization and then the recovery in CMM. So maybe give us a sense of what the hurdles are, where we are in that timeline And where you stand, I guess, on CMM, you've done the restructuring.

Speaker 5

Is there more to come? Or is it now just utilization to catch up? And Kind of level set us back to the medium term targets and where we stand given all of the volatility in the market.

Speaker 3

Yes. Bob, that's a good question. So let me just take back a step back like you said and kind of give you on the bigger kind of picture here. But I kind of what we sit there and say is, I think we're making great progress on mix. I think I'll take you back to Some of our 3 key markets that we talk a lot about is Medtech, which includes MSA in the decks that we put together for investors.

Speaker 3

And then defense and EV, if you go back, as I kind of said, in 2018, that was about 32% of our total company revenue. Last year, it was 47%. I would say it would probably be over 55% of our business now is in between medtech, EV and Defense. So we're making good progress there. Those businesses continue to perform extremely well for us.

Speaker 3

I highlight, first, even in the short term, our MSA business, which is the Hearing Health business, It's recovering faster than we had expected a quarter ago, and it continues to demonstrate the resilience of the medtech markets On PD, just a little bit more. We are expecting to have extremely strong bookings, which possibly could be record bookings in Q2 based on our forecast this This is kind of playing exactly the place we want to go. Now if you go to the TMM business, as I kind of said in the prepared remarks, We are starting to see recovery in the non mobile portions of the market. I would say that my recent Discussions like on Taiwan, which is primary laptop, is that this is coming up a little faster than we probably expected a quarter ago. But I will sit there and say that the mobile portion of this business, we are not really seeing a lot of improvement here.

Speaker 3

And we're still hopeful with seasonality I don't think we're backing off our midterm targets that we've talked about at all. In fact, I would sit there and say is, If the rest of the year kind of plays out the way we're expecting, which I'll just say this, about 2% to 3% down is what I kind of said in the prepared remarks, We'll be exiting the year probably at like the gross margins that we're expecting around 43%. And so I think Obviously, we got to do that for a full year, but you can see the power that we're getting to with mix, capacity utilization to get to that 43% plus. I would just caution, I think the Q3 and Q2 are still going to be a little volatile here. We are expecting sequential growth in Q3 again.

Speaker 3

Right now, I projected about 8% to 10% sequential growth off of the Q2 finish is where I'd say. But overall, I don't think we're changing any of what we're talking about for the midterm.

Speaker 5

Okay, super. Thank you for all that color. And then just kind of I guess shifting over to your balance sheet, obviously, you've done a fantastic job. You've paid down your net You've done some restructuring. Is it still an area of focus right now?

Speaker 5

Or are you more focused internally? How should we think about M and A opportunities for you?

Speaker 3

And I think we'll continue to buy back shares, but we are still interested in M and A, and I would say specifically in the PD space. And I think Over the last couple of years up till maybe 6 months ago, some of the valuations were getting kind of a little crazy and we kind of just backed away from that and said we'd rather keep that strong balance And I think we're going to benefit from that, whether it be this year or next through some of the M and A opportunities that we have. So I would sit there and say that It's likely we're going to do some M and A over the next 18 months or so, and hopefully at prices that are Thanks, Bob.

Operator

Thank you. The next question is from the line of Christopher Rolland with Susquehanna.

Speaker 6

Hey, guys. Thanks for my question. You guys touched kind of on the inventory dynamic. Maybe you could break this up kind of by end markets, if they stick out, if the inventory dynamic sticks out. Thank you.

Speaker 3

Yes. Here's what I'd say is, I think we kind of talked on the last call about that inventory for us Would not be a headwind this year. We didn't see necessarily our inventory going down for the full year, but it wouldn't be a headwind again like it was last year. But I think if you're referring maybe to the inventory in the channel, and I would sit there and say is Most of our end markets, I would say, are in pretty decent shape right now. And so let me start with a few of them.

Speaker 3

I would sit there and say, After a year of a lot of challenges, the compute market is doing as much better in terms of the channel inventory than it was 6 months ago, so we feel pretty good about that. Our hearing health customers in MSA, I visited all these customers in the last quarter. I was with a number of the CEOs of these companies, and I would sit there and say they are optimistic about the full year for growth for that market. And I would sit there and say, we're going to obviously benefit from that. It doesn't appear The inventory we got was in Q1 is going to continue the rest of the year.

Speaker 3

In the PD segment, I would sit there and say, Medtech, EV, Defense, a lot of custom products that we're building. I wouldn't say our customers have a lot of inventory. I wouldn't say that's the issue. I would say to that industrialdistribution segment where we still see and we're hearing there is inventory in the channel that needs to be burned down. Last quarter, I thought we would probably start to see an uptick in Q2 in that portion of the business.

Speaker 3

It hasn't materialized. It now appears to us that it's been pushed out a quarter that we might see the inventory rundown in the industrial portion of Precision Devices Starting to dissipate in Q3.

Speaker 6

That's great. And I was talking about distribution. So thank you for that. You also have some kind of interesting options, I would say, for your business model, around EVs, RF, whether for defense or 5 gs, and balanced armature speakers. And I guess I would ask, what are you most optimistic about and when could these be meaningful drivers of your business.

Speaker 3

Yes. So I mean, again, as I kind of stated like a little earlier, this is starting to become a pretty significant portion of our business. When I look at Defense, this is if I go back a few years ago, this was less than and I know some of this is through acquisition. If I go back to the 2020 timeframe, this was like a $30,000,000 $40,000,000 business. And through acquisitions and growth, it's going to be over $100,000,000 Again, we've grown our defense business on the back mainly of our filtering by a significant amount over the last 4 years.

Speaker 3

So we're still very excited about this market, Chris. We see a lot of opportunities both in terms of M and A, but also in terms of just organic growth with the product portfolio that So I think we're pretty happy with that. I would say generally speaking, our MedTech business, it's not growing at like breakneck pace, But I would sit there and say it is extremely stable and extremely strong gross margins and that goes for both MSA and PV. Presentation. I would sit there and say, we're now looking at our MedTech business being well over $250,000,000 right?

Speaker 3

It's a big business. Now again, it doesn't grow at 10% per year, but it's extremely strong, good gross margin with great cash flow. And we're going to continue to look for opportunities to continue to grow that business. And then lastly, EV, like you mentioned, it started from a small base, I mean, it was up 50% in the Q1 and bookings were extremely strong here. We're expanding our customer base.

Speaker 3

If I go back 2 years ago, the majority of our business came from a couple of customers. Now we've got many customers. And so We're pretty confident about our position in EV. And if I'll remind you, this is all on high voltage charging systems, right? And so it's not like that are being put both in cars and we're actually seeing some design wins in business in the charging stations now as well.

Speaker 3

So I'd say those three markets

Operator

Thank you, Mr. Roland. The next question is from the line of Tristan Gerra with Baird. You may proceed.

Speaker 1

Hi, this is Tyler on for Tristan. Thanks for taking the questions. First, building off of the previous question, Could you provide an update on the balanced armature speaker line? And then also how has the over the counter hearing aid market been trending?

Speaker 3

Yes. I think those are 2 good questions. I appreciate those questions. First on the over the counter market, I would say I'm Incrementally more optimistic than I was a quarter ago. I would say we've seen more orders coming in, in the over the counter market than I would have said a quarter ago for this year.

Speaker 3

One of the reasons that the MSA business has been doing a little bit better, But I would just say, there's still concern it could be channel filling and how that's actually going to sell in the end market. So I'm still holding my breath here, But I'd say I'm incrementally more optimistic about the over the counter market. As far as the BA align, I think I mentioned this last quarter. We have not filled this line yet. I would say part of it is the reason is a lot of the designs that we've been working on with Customers in China have been slower to come to production.

Speaker 3

Now with China reopening, we are starting to see more activity. But I think what we are surprised at and happy about is The ASPs are significantly higher than we would have expected a year and a half ago, to the tune of 30%, 40% higher than we were expecting. So the revenue coming off this line is approaching what we would have expected a year and a half ago at the lower ASPs. I think there's 3 ways that we're going to fill this line, which is probably a little different than we would have talked about 2 years ago. 1 is This high definition audio, which is expanding the range of what you can listen to in the high frequency band where you can only use a VA really to get that really great high definition at high frequency.

Speaker 3

Number 2, we are starting to see some of these over the counter hearing aid customers use Trying to see in the MSA margins, which is a lot of the learnings that we got off the automated line are have been have and are being applied to our manual lines, which is helping our gross margin in that business as well.

Speaker 1

Great. Yes, that's really helpful. And then just for my follow-up, can you just provide an outlook on what you're seeing in China in the smartphone market? And then There's anything you any signs you're seeing for

Speaker 3

a second half recovery there? I think There's going to be some recovery in China, the mobile market in the back half. I just don't know the size of it, but I would just sit there and say is it's not great right now the mobile I would say that's not just China. I would say that's the overall mobile market. I think it's a tough market.

Speaker 3

A lot of people Our customers don't make money in this market, coupled with there's very little growth. And so we still see this as a challenge. And I think it just continues to confirm What we've been talking about for 2 plus years about our desire and our now more than our desire, In terms of mobile, I think last year mobile was about 16% of our total company revenue. I would say this year we're probably looking at less than 15% this year. So I think we continue to execute on that strategy of diversifying away.

Speaker 3

And as our other markets recover, Make even a small percentage of the total business.

Speaker 1

Great. Thanks again for taking the questions.

Speaker 3

Presentation.

Operator

The next question is from the line of Anthony Stoss with Craig Hallum. You may proceed.

Speaker 7

Hey, Jeff and John. I'm curious if you've made any downshifts to your CapEx plans for the second half of the year. And Maybe Johnny can comment about your expected free cash flow in 2023 over 2022. Then I had a couple of follow ups.

Speaker 4

Yes, sure, Tony. In terms of CapEx, I'd say 2 things. 1, there's a shift more of our CapEx will be tilted toward The MSA segment and the PD segment, overall spend, it's coming down a bit. We're kind of in the 4% of revenue range What I would say for 'twenty three, if you think back a few years, we were higher. We were kind of in the 5% to 7% of revenue.

Speaker 4

And again, it's less It's important. We had a decent free cash flow above our guidance in Q1. Q2 is a bit more muted, but I think You really have to look at cash flow over a longer period than a quarter because it can really be influenced by timing, customer collections, payments at the end of the quarter, but for full year 'twenty three, we feel really good of free cash or I feel really good about free cash flow generation of 15% or more revenues in 2023.

Speaker 7

Got it. Thank you. And then Jeff, clearly you've upticked quite a bit your excitement related

Speaker 3

to the EV side of the business.

Speaker 7

I know it's got great gross margins. I'm curious if you want to share how big that business is Or how big do you think it could become over the next several years for Knowles?

Speaker 3

Yes. I think this year it will probably be roughly about 3% of our Company revenue this year, probably around $20,000,000 somewhere in that range, probably up probably 30% to 40% over last year. And I think what I guess what I would say my caution is with this business is, we've got a lot of design wins, But the content level with each customer is different. And we have some platforms where we have $20 worth of content per car, Who are going to be the big winners and losers in the end market, in the EV market? And to that extent, I guess, I would sit there and say, I would be disappointed In a couple of years, this business is at $40,000,000 to $50,000,000 But on the first side, we went with some of the winners, it could be $60,000,000 $70,000,000 in 2 to 3 years.

Speaker 3

So I think it's a little early to call like how big this is going to be, but I think what we like about this business is The macro of this market is, it's going to grow. The question is, how fast is it going to grow and what our content for vehicle is going to be.

Speaker 7

Got it. And the last question for John. I think I heard this correctly. You expect total revenues to be down 2% to 3% year over year. Can you maybe help us understand sometimes Q4, the December quarter is up, sometimes it's down.

Speaker 7

What do you think Q4 shakes out versus Q3?

Speaker 3

Well, let me just take that, Tony. So again, I just I kind of mentioned it. I would sit there and say right now we see kind of Q4 being the peak This year. And it varies from year to year, but I think what we kind of would add just the normal variance from year to year, But we'd also add the what do you call it, the recovery that we are seeing and how it's happening. As I said, last quarter we gave some, I would say, some soft guidance on the sequential improvement we were going to see in Q2, which We're right on kind of what we said we were going to do.

Speaker 3

Mostly on the

Speaker 4

high end of what we said, 15% to 20%, close to 20%.

Speaker 5

Correct, correct.

Speaker 3

And I would just start saying, right now, we see Q3 being up 8% to 10% sequentially from Q2. And then I think with seasonality and further recovery,

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