Knowles Q2 2023 Earnings Call Transcript

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Provided by Quartr
August 2, 2023

There are 7 speakers on the call.

Operator

Good afternoon and thank you for attending today's Knowles Second Quarter 2023 Earnings Conference Call. My name is Kayla Baker, and I will be your conference operator today. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. I will now pass the conference over to your host, Patton Hoefer, Vice President of Investor Relations with Knowles.

Operator

Thank you, and you may proceed.

Speaker 1

Thanks, Kayla, and welcome to our Q2 2023 earnings call. I'm Patton Hoefer, 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 for Knowles, which constitute forward looking statements for Forward looking statements in this call will include comments about demand for company products, Anticipated trends in company sales, expenses and profits 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 that 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, the risks and uncertainties identified in today's earnings release.

Speaker 1

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 ks 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 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.

Speaker 1

Jeff?

Speaker 2

Thanks, Pat, and thanks to all of you for joining us today. Knowles delivered solid results for the 2nd quarter with revenues of $173,000,000 adjusted EBIT margins of 16% And EPS of $0.23 all finishing above the midpoint of our guided range. Gross margins of 42% finished above the high end of the guided range As our teams around the globe continue to improve efficiency, reduce fixed costs and improve mix in light of the macro challenges in certain end markets. In Precision Devices, Q2 revenue was down 20% from the prior year. Inventory challenges in the industrial, distribution and telecom markets continued as we have experienced further revenue weakness in Q2.

Speaker 2

Defense was down versus the prior year as delays in project awards impacted Q2 bookings and revenue. Finally, the electric vehicle market remains exciting for Knowles, growing again in Q2 versus the prior year as from the prior year, but up more than 30% sequentially as customer inventory levels declined faster than we originally anticipated. We are definitely past the inventory correction we experienced in the Q1 of 2023. I'd also like to take a moment to commend our MSA team They delivered outstanding margins in the quarter, a true testament to our differentiated products and operational excellence in our factories. In consumer MEMS microphones, revenue is down 3% from last year.

Speaker 2

Non mobile was up versus the prior year, As channel inventory sell through has improved and upgrade cycles are returning earlier than previously expected. While the smartphone market continues to be very difficult, especially in China, the shift of mix toward ear, IoT and Compute is positively impacting gross margins in this segment. Now I'll spend a few minutes discussing the current customer and market conditions for each segment before turning the call over to John to provide the Q3 guidance. Starting with Precision Device segment. In the industrial and telecom markets, which currently make up approximately 10% of total company revenue, We are seeing continued weakness as inventory levels remain elevated.

Speaker 2

We previously expected the inventory situation to improve in the second half, Based on the current outlook, we are now expecting these markets to be down the remainder of the year. For our 3 key end markets, defense, medtech and EV, The long term outlook is unchanged from our previous expectations. Knowles continues to expand its design wins in these growth markets with a broad range of customers. Demand for components in the medtech space has been relatively flat in the first half of the year with some excess inventory. And based on current demand, we expect to return to year over year growth starting in Q3.

Speaker 2

For defense, our previous revenue projections For the year, factored a number of bookings in Q2 for communications, radar and electronic warfare programs, which have been delayed. While we believe our position in our core markets for PD along with the secular trends within these markets are unchanged, Continued weakness in industrial and the delayed bookings in defense are reducing our expectations for revenue in the second half of twenty twenty three. To mitigate the impact of these delays, we have implemented several measures to reduce costs in Precision Devices to improve profitability. John will provide more detail on these actions during his portion of the call. Moving to MedTech and Specialty Audio.

Speaker 2

The hearing health market Demand has stabilized as hearing aid inventories around the globe have returned to more normal levels. Our Q3 guide reflects a more than 20% revenue growth versus The prior year turned by the improved inventory situation and increases in demand in the traditional hearing aid market, particularly in the U. S. It is a very positive sign that we are returning to growth in the second half of twenty twenty three, which provides confidence for growth in 2024. Lastly, on to our Consumer MEMS Microphone segment.

Speaker 2

Due to the normal seasonality of this business and improving market conditions in non mobile, We are expecting sequential improvement for revenue throughout the remainder of the year. The second half recovery is now expected to be less pronounced than we previously discussed, driven primarily by the smartphone market. In non mobile applications, second half demand in computing and ear in IoT are expected to be up significantly versus the prior year, driven by improved channel inventory levels and replacement cycles in computing. In the smartphone market, demand expectations for new products and further weakness in China are driving additional pressure on the recovery Overall for Knowles, although the outlook for improvements in revenue in the second half has softened, we are still expecting margin expansion and earnings growth versus The prior year, in MSA's inventory situation in the hearing health market is behind us as forecasted, and we are increasingly confident of second half revenue growth. In Precision Devices' continued weakness in the industrial market coupled with delays in defense orders have impacted revenue expectations for the remainder of 2023.

Speaker 2

We believe, however, the secular trends in defense, medtech and EV markets remain robust. Lastly, for CMM, We are seeing a slow recovery in consumer electronics, primarily due to the smartphone market and softer demand in China. In summary, we are now expecting total company revenues in the second half of the year to be near prior year levels. And with the cost efficiencies and actions we've implemented along with favorable mix, we expect our second half adjusted EBIT margins to be greater than 19%. Now let me turn the call over to John to detail our quarterly results and guidance.

Speaker 3

Thanks, Jeff. We reported 2nd quarter revenues of $173,000,000 down 8% from the year ago period, driven primarily by lower shipment volumes in Precision Devices and The Precision Device segment delivered revenues of $48,000,000 down 20% from the prior year, driven by continued weak demand associated with the excess channel inventory in the industrial and distribution markets and timing of shipments into the defense market. In the Medtech and Specialty Audio segment, revenue was $61,000,000 down 2% versus the prior year As we faced tough year over year comparables as the first half of twenty twenty two demand benefited from strong COVID recovery. Consumer MEMS Mic revenue of $65,000,000 was down 3% versus the prior year, driven by weak global demand for smartphones, partially offset by growth in non mobile applications. 2nd quarter gross margins were 42%, 100 basis points above the high end of our guidance range and up 50 basis points from the same period a year ago.

Speaker 3

Precision Devices segment gross margins were 39.7 percent, down 700 basis points from the prior year Due to unfavorable capacity utilization, Medtech and Specialty Audio segment gross margins were 53.5%, Up 4 10 basis points versus the prior year, driven by productivity gains, lower factory cost and foreign currency benefits. Consumer MEMS microphones delivered gross margins of 33.6%, up 3 40 basis points versus the prior year, Driven by benefits of the restructuring actions announced in August 2022, improved product mix and a gain on the sale of assets, partially offset by pricing pressure in the mobile market. R and D expense in the quarter was $16,000,000 down $2,000,000 from the prior year With the reduction driven by the benefits of the restructuring actions taken in the Consumer MEMS Microphone segment. SG and A expenses were $30,000,000 $6,000,000 higher than prior year levels, driven primarily by higher incentive compensation costs and higher professional and legal fees, partially offset by restructuring actions in the Consumer MEMS Microphone segment. For the quarter, adjusted EBIT margin was 16% At the high end of the guidance range, EPS was $0.23 in the quarter, slightly above the midpoint of our guidance range.

Speaker 3

Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $54,000,000 at the end of the quarter. We generated cash from operations of $1,000,000 above the midpoint of our guidance range driven by timing of customer collections. Capital spending was $4,000,000 in the quarter and we repurchased approximately 300,000 shares at a total cost of 5,000,000 We ended the quarter with cash net of outstanding bank borrowings of $9,000,000 Before moving to guidance for the Q3, I want to comment briefly on some of the specific cost reduction actions we're taking within the Precision Device segment to mitigate the impacts of our reduced revenue outlook. In Q3, we expect to incur a charge of roughly $2,000,000 which is expected to result in Annualized cost savings of more than $5,000,000 These actions will be in place by the end of this year and when implementation is complete, We expect PD operating margins to return near 2022 levels.

Speaker 3

This will also put total company operating expenses at the low end of our previous range of $43,000,000 to $45,000,000 per quarter. Moving to guidance for the Q3. We expect total company revenue to be between $170,000,000 $180,000,000 down 2% versus the same period a year ago. We estimate gross margins for the Q3 to be approximately 41.5% to 43.5%, up 400 basis points from the year ago period. R and D expense is expected to be between $15,000,000 $17,000,000 down slightly from prior year levels, Driven by restructuring actions in the Consumer MEMS Mic segment.

Speaker 3

We're projecting selling and administrative expense to be between $24,000,000 $26,000,000 down $1,000,000 from the year ago period, primarily driven by restructuring actions in the Consumer MEMS and Precision Device segments. We're projecting adjusted EBIT margin for the quarter to be in the range of 18% to 20% and expect EPS to be within a range of $0.26 to $0.30 per share. This assumes weighted average shares outstanding during the quarter of $94,800,000 on a fully diluted basis. We're forecasting an effective tax rate of 18% to 19% for the quarter And we expect cash from operations to range from $20,000,000 to $30,000,000 Capital expending is expected to be 7,000,000 I'll now turn the call back over to the operator for the question and answer portion of the call. Operator?

Operator

And our first question comes from the line of Christopher Rolland with Susquehanna. Your line is open.

Speaker 4

Hey, guys. Thanks so much for the question here. Just talking about maybe your Largest customer, what we can kind of expect for the back half? I know you've been deemphasizing them over time. Seems like strength came from other areas of the market as well.

Speaker 4

But how does this affect seasonality? And in particular for your whole company, you're expecting to have really a strong seasonal December, Like 20% plus sequential, I think was where the Street was. Does this come into play here at all? Or is this Still just PD related that might dampen that. Thank you.

Speaker 2

Yes. So I would sit there and say, generally speaking, Without going to the customer specifics, I think we're pretty close to where we thought the CMM business would be in the back half. It's Not altogether. It's slightly down, but driven primarily by smartphone in China. So I think ear, IoT and Compute continue to look relatively strong for us, but smartphone is definitely coming in weaker.

Speaker 2

And I would say even more specific, China is coming in weaker. So our overall expectations for CMM It's probably slightly less than we would have said 3 months ago. I think the primary driver of what we kind of talked about here would probably be more on the PD side Versus the prior expectations.

Speaker 4

Yes. And then on the PD side of things as well, I get The push outs, defense related and other, it sounds like maybe there's some Inventory as well. Maybe go through where you think there's some inventory build, Where you think it is in terms of weeks or however you want to define it and when you think That inventory is finally going to work through here and what kind of caught you guys by surprise on the inventory side as well? Thanks.

Speaker 2

Well, I think in the original projections for PD, we were kind of starting to see recovery in the industrialdistribution portion of the business The back half and right now we're not seeing that recovery at all quite frankly. So I think it's going to be delayed into 'twenty four, the recovery industrial and Distribution. To make a few more comments, MedTech was stable in the first half, I'd call it. We do expect a return to growth in the back half for And then I'll just make a comment on the Fed. There's been a number of larger programs That have been delayed, which we haven't changed our position, but it's been delayed.

Speaker 2

And the one I can kind of call out, Chris, It's more specific. Lockheed just announced about a week ago or little over a week ago They were going to deliver 150 Joint Strike Fighters this year. That was the original projection. And now they're projecting to deliver only 110 Due to a number of issues on their side, so that's the kind of delays we're talking about here in defense. There's a couple of other larger programs like that.

Speaker 2

Our position in defense really hasn't changed. And the long term prognosis for defense still looks very good, but some of these orders are delayed. And We expected to get some of these orders in Q2. They didn't materialize and they're probably going to materialize in the back half, but it really draws into question whether we could deliver them Within the calendar year 'twenty three.

Speaker 4

Great. Thanks so much, Jeff.

Operator

And the next question comes from the line of Bob Labick with CJS Securities. Your line is open.

Speaker 5

Hi. It's Lee Jagoda for Bob tonight. How are you? Okay. So just to start with just to clarify your guidance, I think I heard you say in the back half in total, you expect flat revenues And EBITDA margins north of 19%, is that correct?

Speaker 3

That is correct.

Speaker 5

Okay. So I guess that would also imply around flat revenue for Q4. And I guess the question or the first question is, How much of that is conservatism without visibility versus you have visibility to What looks to be flat revenue consolidated?

Speaker 2

Well, I would sit there and say is, let me go through by business unit. I think we're very comfortable with the projections within the MSA, the MedTech and Specialty Audio. We do it is they do have growth year over year in the back half. As we kind of talked about in the Consumer Beams Microphone Business, I would say that is flattish year over year And so maybe slightly up. And then the Precision Device business obviously is down.

Speaker 2

Now within the Precision Device area, I would just sit there and say, on the defense side, I think we are going to get these orders. I can't predict the exact month we're going to get it. So there could be a little bit of conservatism in the fact that the orders come sooner rather than later, we'll be able to deliver it within calendar year 'twenty three. But right now, I wouldn't I can't count on that yet because I don't have the orders in hand yet and we're already in August. The second piece is this industrial and distribution portion.

Speaker 2

And quite frankly, we're not seeing a lot of recovery in this market. Could it change? Yes. But right now, we're kind of saying don't expect the kind of trajectory in that market to shift till sometime in 2024.

Speaker 5

Got it. And then, I guess along the lines of your balance sheet, balance sheet keeps getting stronger. You've talked about allocating 50% of your free cash flow towards share repurchase. Can you give us any update there? And then with regard to acquisitions, Has anything changed related to either size or areas of focus versus the last couple of years?

Speaker 2

Well, I think first, let me cover the acquisition I think if we look at the acquisitions we've done in the past since 2017, the largest one was about 80,000,000 I think with our balance sheet, there is the opportunity to probably look at some things that are larger than that on a purchase price basis With the discipline around that we don't want to overpay for something. And I think we kind of talked a lot about this that in previous years, The multiples were kind of like high. And so we're going to be very disappointed about what we do in terms of acquisitions, but they could be larger. And again, I'm optimistic that we're looking a lot of different things and we'll see how this all plays out over the next 6 months to a year. As far as the stock buyback, I think we've committed not 50%, but more than 50% of our free cash flow To go towards share repurchase, I think year to date for the full year, we've actually spent more than 50% of the cash flow year to date Through Q2 on share repurchases and we'll continue to buy back shares in line with what we've talked about in the past.

Speaker 5

Great. And then just one more for me and I'll hop back in queue. Any update on the OTC hearing aid market? Are you seeing any new entrants, more demand, anything along those lines?

Speaker 2

Yes. The short answer is we continue to see That it's actually doing better than we originally expected so far, but We're not seeing a lot of sell through data. I would sit there and say, our traditional hearing aid market is doing better than expected than we would have said 6 months ago. So I would say 2 things. Number 1, I think it's a little too early till we see sell through data on the over the counter market that to say that this is sustainable.

Speaker 2

And again, it's not a super meaningful number in the first half of the year, but it is better than expected. In the meantime, Maybe what we could be seeing here is that the over the counter market is actually getting people interested in looking at hearing aids And that they're opting for the traditional hearing aid market when they see that there's only a marginal difference in price And you get full service with a traditional hearing aid because the traditional hearing aid market is doing quite well right now.

Speaker 5

Great. Appreciate it.

Operator

And our next question comes from the line of Anthony Stoss with Craig Hallum. Your line is open.

Speaker 6

Hey guys, nice gross margins in a tough environment. Jeff, I wanted to follow-up on Q4. So if Q4 is roughly flat with a year ago Q4 And up 12%. Are you expecting China smartphones etcetera to bounce back in the December quarter?

Speaker 3

Or what do you really need to come through, they

Speaker 6

hit kind of an up 12% sequentially for December.

Speaker 2

Yes. I mean, we do have some sequential improvement From Q2 to Q3 and Q3 to Q4. But I mean, if I go back to the numbers prior to 2022, I mean, we're nowhere near the numbers we were shipping per quarter in 'twenty one at the end of 'twenty one. And so, I mean, I would sit there and say, again, Our expectations have come down reasonable amounts since last quarter for China and it seems like this is Doable? I mean, looking at China, essentially for the full year being flat, flattish with 2022.

Speaker 2

I mean that's what we're talking about, which 2022 is not a

Speaker 3

great year for China. And the sequential improvement, Tony, from Q3 to Q4 is very modest that we have built in here. Correct.

Speaker 6

Got it. And then if you backed up the delays in defense on the PD side, I mean, how much of it can you tell is just business in general slowing down? Or is it closer to what you guys expected if you didn't see those delays on Defense side?

Speaker 2

I would say of the shortfall compared to what we would have thought a quarter ago, I would say probably about 30% to 35% of it is defense and the rest is the industrial distribution. We were expecting if I look back at a quarter ago, we were expecting for industrial distribution It kind of starts coming back in a stronger way. I mean, not quite back to 'twenty two levels, but starting to come back. And we're just not seeing that. We're just not seeing a rebound at this point.

Speaker 2

So say 60% industrial distribution not improving And about 35%, 40% of it delays in defense.

Speaker 4

Got it. And last question for me.

Speaker 6

You called out computer PC being stronger. That's definitely nice to see. I'm just curious if you looked at that business as a whole, do you think PCs are going to still be down year over year 2023 versus 2022 for you guys?

Speaker 2

I would sit there and say right now, our PC market is going to be flattish year over year, But definitely growth in the back half compared to what it was last year. So the first half was Really low, especially Q1 in the notebook tablet market. We had a really weak Q1 and We're expecting based on orders and demand in Q3, some nice growth year over year. So, but overall for the full year, it's going to be roughly flattish, our compute market. I guess what I'd say, Tony, in a lot of these markets, Ear, IoT, Compute, We're seeing a lot of it being, I would say, flattish year over year, right, in terms of your IoT compute, But definitely weaker in the first half and stronger in the back half.

Speaker 2

The one exception is in smartphone. We're just not seeing a recovery in that market.

Speaker 6

That's definitely better than your peers. My compliments on how you guys are performing in the compute side for sure. And then I guess Let me throw one to John. On the OpEx $43,000,000 to $45,000,000 is that a good number to use kind of on a go forward basis? Or are there still more levers that you think you might pull and drop that even further?

Speaker 3

Yes, Tony, I think I would go toward the low end of that number from a run rate. We did have in this quarter higher than normal OpEx. We had some professional fee spending that we pulled forward from the back half of the year into Q2, but you can see in my guide Yes. OpEx go back down to I think it's $41,000,000 is the midpoint of the guide for Q3. So I would keep it in that kind of $41,000,000 $43,000,000 for the remainder of 2023.

Speaker 2

Yes. I mean just to say, Tony, we've taken a number of actions based on We were at the beginning of the year, we were expecting some very nice growth from PD, which is not materializing. And so we've taken action on the cost side To make sure that we can maintain profitability, you can kind of see even with a shortfall on revenue, we're pretty close On the profitability and the operating margins are holding up. Yes.

Speaker 3

I would say both gross margins and operating margins are holding up fairly well given the challenges on the top line.

Speaker 6

Yes, exactly. All right. Thanks, guys. Appreciate it.

Operator

And there are no further questions at this time. This concludes today's conference call and you may now disconnect.

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