Knowles Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 24, 2024

There are 7 speakers on the call.

Operator

My name is Brianna, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Knowles Corporation Third Quarter 2024 Earnings Conference Call. Please note that this call is being recorded. At this time, all participants are in a listen only mode. After the speakers' remarks, there will be a question and answer session.

Operator

I will now turn the call over to Sarah Cook.

Speaker 1

Thank you, and welcome to our Q3 2024 earnings call. I'm Sarah Cook, Vice President of Investor Relations. And presenting with me 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 purposes of the Safe Harbor provisions under applicable federal security 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 could cause actual results to differ materially from current expectations.

Speaker 1

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, 2023, 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 ks filed today with the SEC. This will include a reconciliation to the most directly comparable GAAP measure. All financial references on this call will be in a non GAAP continuing operations basis unless otherwise indicated.

Speaker 1

We've made selected 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 details on our results. Jeff?

Speaker 2

Thanks, Sarah, and thanks to all of you for joining us today. Before I move on to the results in detail, I would like to remind you that all financial metrics given on today's call are on a continuing operations basis unless otherwise noted as we signed a definitive agreement in Q3 to sell the consumer MEMS microphone business. The sale will further our strategy of transitioning the company's portfolio to higher growth markets and products where we have differentiated solutions that drive value for both our customers and shareholders. This positions Knowles for strong growth in both revenue and earnings in the future. As demonstrated by our 3rd quarter results, our total company adjusted EBITDA margins were 24.6 percent and as market conditions improved in the PD segment and we realized the full benefit of synergies from the Cornell acquisition, I expect additional margin expansion.

Speaker 2

Now turning to our results. We continue to deliver on expectations in the Q3. Revenue of $143,000,000 was at the high end of our guided range, which represents 32% growth on a year over year basis driven by the Cornell acquisition along with 4% organic growth. EPS of $0.26 was at the midpoint of our guided range while cash from operations was $53,000,000 inclusive of CMM exceeding the high end of our guided range. Onto our segment, in Q3, medtech and specialty audio revenue grew 4% sequentially and 10% on a year over year basis.

Speaker 2

Our continued operational excellence, sustained success of new product adoption and cutting edge technology is evidenced by our growth and strong margins. The end market for our caring health products remains strong and we are optimistic about our future. In Q3, Apple announced software updates that add over the counter hearing aid features to the AirPod Pro 2. Over the counter hearing aids address mild hearing loss, which is the least penetrated portion of the hearing health market. We believe these features will continue to drive hearing loss awareness as users will now have a hearing test readily available that could help them in understanding and recognizing hearing loss sooner.

Speaker 2

This coupled with the potential of eliminating the stigma of using hearing help device could drive earlier adoption of traditional hearing aids. Similar to previous years, we are expecting the medtech and specialty audio segment to finish 2024 strong with Q4 revenue being the highest of the year driven by normal seasonality from new product launches within the hearing health market. Looking at our Precision Device segment, in spite of continued headwinds in inventory levels in the industrial markets and with our distribution partners, revenue grew 6% sequentially driven by defense and electrification end markets. On a year over year basis, revenues grew 57% due to the acquisition of Cornell. I am also pleased with the progress we are making on expanding margins as we improve capacity utilization, productivity and pricing.

Speaker 2

Reflecting our ownership of Cornell this past year, I continue to be excited by this acquisition. We have improved our adjusted EBITDA margins 700 basis points throughout the year by accelerating cost synergies, continued operational improvements and increased pricing. We have also instilled a disciplined approach to cash deployment leading to increased net operating cash flow. Despite continued challenges in our end markets, Cornell is expected to be accretive to its 1st year of ownership, a significant milestone and a critical pillar in our acquisition strategy. As I look forward for the full Precision Device segment, we expect to see modest sequential revenue growth in Q4.

Speaker 2

While we have a very healthy pipeline of new opportunities in multiple end markets, which positions us well for growth as the market recovers in 2025, bookings continue to be inconsistent as we have yet to see a sustained recovery in the industrial end market and with our distribution partners. As I noted in the beginning of our call, I am pleased with the signing of the definitive agreement to sell the consumer MEMS microphone business. As Ori discussed, our quarterly results demonstrate our expanded margin profile as we continue to focus on more attractive growing end markets in the medtech, defense, electrification and industrial spaces. I am confident in our ability to deliver shareholder value as we complete this important step in our evolution to a leading industrial technology company. We expect the closing by the end of the Q4 and anticipate holding an investor forum in Q1 2025 where we will discuss our growth strategy and plans for the future in more detail.

Speaker 2

Now let me turn the call over to John to detail our quarter results and provide Q4 guidance.

Speaker 3

Thanks, Jeff. Please keep in mind all measures that I'll be referencing today are on a continuing operations basis and exclude the consumer MEMS microphone business unless specifically stated. We reported 3rd quarter revenues of $143,000,000 at the high end of the guidance range and up 32% from the year ago period driven by the acquisition of Cornell in the Q4 of 2023 and organic growth of 4%. EPS was $0.26 in the quarter at the midpoint of our guidance range and up $0.06 or 30% from the Q3 of 2023. In the MedTech and Specialty Audio segment, revenue was $64,000,000 up 10% versus the prior year on higher demand in both hearing health and specialty audio.

Speaker 3

Gross margins were 53.1%, down 60 basis points versus the year ago period driven by unfavorable product mix and slightly lower production yields. The Precision Devices segment delivered revenues of 79,000,000 dollars up 57% from the year ago period, driven by the acquisition of Cornell, partially offset by lower shipments of high performance capacitors into the distribution channel and to OEMs in the industrial end market as customer and channel inventories remain elevated. Shipments into the medical, defense and electrification markets were up slightly and in line with expectations. Gross margins were 40%, down 40 basis points from the Q3 of 2023 due to the acquisition of Cornell, partially offset by a 230 basis point improvement in legacy PD margins, driven by factory productivity gains. While gross margins at Cornell are below our legacy Precision Device business, we saw 500 basis point gross margin improvement since Q1 of this year driven by improved factory capacity utilization, supply chain savings and higher pricing.

Speaker 3

On a total company basis, R and D expense in the quarter was $8,900,000 up $1,000,000 from Q3 2023 due to the acquisition of Cornell. SG and A expenses were $24,000,000 $5,000,000 higher than prior year levels driven by the acquisition of Cornell partially offset by restructuring actions taken in the second half of twenty twenty three in the PD segment. Interest expense was up $3,300,000 versus the prior year due to higher bank borrowings associated with the acquisition of Cornell in the Q4 of 2023. Now, I'll turn to our balance sheet and cash flow. In the Q3, we generated $53,000,000 in cash from operating activities, above the high end of our guidance range on lower than expected net working capital and higher cash received from settlement of foreign exchange forward contracts.

Speaker 3

For the 1st 9 months of 2024, we generated $95,000,000 in operating cash flow, representing a $30,000,000 increase over the 1st 9 months of 2023. Please note that cash from operations for the

Speaker 4

3

Speaker 3

9 months ended September 30 is inclusive of the consumer MEMS microphone business. Capital spending was $4,000,000 in the quarter. During the Q3, we repurchased 250,000 shares at a total cost of $4,500,000 and reduced outstanding bank borrowings under our revolving credit facility by 38,000,000 dollars We exited the quarter with cash of $93,000,000 $225,000,000 of debt that includes borrowings under our revolving credit facility and an interest free seller note issued in connection with the Cornell acquisition. Lastly, our net leverage ratio based on trailing 12 months adjusted EBITDA was one times. Moving to our guidance.

Speaker 3

For the Q4 of 2024, revenues are expected to be between $141,000,000 $151,000,000 up 5% versus the year ago period driven by the acquisition of Cornell. R and D expenses are expected to be between $8,000,000 $9,000,000 and selling and administrative expenses are expected to be within a range of $23,000,000 to $25,000,000 flat with the prior year. We're projecting adjusted EBIT margin for the quarter to be within a range of 21% to 23%. Interest expense in Q4 is estimated to be $3,000,000 and includes non cash imputed interest. We expect an effective tax rate of 9% to 13% for the quarter, which is lower than normal due to the utilization of foreign tax credits.

Speaker 3

We're projecting EPS to be within a range of $0.26 to $0.30 per share. This assumes weighted average shares outstanding during the quarter of 91,200,000 on a fully diluted basis. We're projecting cash from operating activities to be within a range of $30,000,000 to $40,000,000 and capital spending is expected to be $6,000,000 Cash from operating activities includes $5,000,000 to $10,000,000 used by discontinued operations and capital spending includes $2,000,000 related to discontinued operations. In summary, our 3rd quarter results and 4th quarter guidance highlight the margin profile of our continuing operations. In addition, our increased exposure to attractive end markets, which include medtech, defense, electrification and industrials is expected to drive higher organic revenue growth rates, which we will cover in more detail at our Investor Forum, which is planned for Q1 of 2025.

Speaker 3

I'll now turn the call back over to the operator for the Q and A portion of our call. Operator?

Operator

Thank Our first question comes from the line of Bob Labick with CJS. Please go ahead.

Speaker 5

Good afternoon. Thanks for taking our questions and congratulations on the further transformation of the company.

Speaker 2

Thanks, Bob.

Speaker 5

So I wanted to start with kind of the underlying demand in PD. And I know I think John in your remarks you talked a little bit about the end markets, but I wasn't typing fast enough. So maybe you could kind of remind us what you said and then tell us the drivers. So what end markets in PD are the strongest right now? And what's driving that?

Speaker 5

And where is the weakness that you're seeing? And when do you see that kind of recovering?

Speaker 2

Okay. I'll let Bob get it. Let me just first give some color. This is Jeff. So I would sit there and say, generally speaking, the defense market still looks pretty okay.

Speaker 2

I think obviously, obviously with defense there has been and can be a time to time lumpiness relative to timing of orders, but the underlying demand is still there. And I think that's been the strength. I think we've definitely seen, especially when you think about our medtech business in PD, but if you take it overall with the MSA business, our medtech business continues to remain strong, I would say, specifically in the PD area. We're starting to see the turn back to growth in med tech in the PD section. I think MSA has still been doing very well, but med tech is still growing.

Speaker 2

I think what I would sit there and say from my perspective is electrification in Q3, Q4 overall is probably flattish year over year. But the real weakness still remains in the industrial and I would call with our distribution partners, which is a lot of industrial business. And so that's kind of like the real weakness that we see yet. I'd say, I was with a number of our distributors who are actually visiting Knowles yesterday. And then their commentary is kind of what we're seeing, which is 1 month bookings are good, next month they're a little weaker, then they come back.

Speaker 2

We're just not seeing yet in that portion of the market the consistency of bookings that we need to really see consistent year over year growth. Now what I would say is, I think we're still hopeful as we get into Q late Q1 to Q2, we should start seeing some recovery, at least that's what some of our distribution partners are talking about. But I think the great thing is in spite of all these things, the PD gross margin expanded through the year and we expect there's opportunity for further expansion. First with the synergies and the things we're doing on the Cornell side, but also on capacity utilization relative to the traditional PE business that does not not Cornell.

Speaker 5

Okay, great. I appreciate that very much. And obviously with the transformation, you're going to probably be a little more asset light and you may have told us this previously, but could you remind us the kind of go forward level of CapEx for kind of Remainco or?

Speaker 3

Yes, sure, Bob. I would say over a cycle kind of 3% of revenue range, 3%.

Speaker 2

Yes, I mean I think like if you look at

Speaker 3

So, it could get if we had some expansion in that area, you could have a period where it's a little above that. But I think overall over a cycle, 3% of revenue.

Speaker 2

Over a cycle and there could be a year where slightly lower and then the years where we're slightly over, but probably 2% to 4%, 2% to 4.5% depending on where we are in

Speaker 3

the cycle. 2024 will probably likely be

Speaker 2

a little under the 3% That's what I'm saying, correct.

Speaker 5

Okay. Got it. Great. And then last one, I'll jump back in queue here. But obviously, this is kind of just the beginning, so to speak.

Speaker 5

Can you talk about the M and A environment for you right now and the characteristics of targets and how long it will take you to kind of get back out and looking at things or what's out there now?

Speaker 2

Yes, I think it's a great question. Thanks, Fred. I think it's a core portion of our strategy going forward in terms of finding opportunities like Cornell where there's good synergies with what we do. I would say that we have a number of opportunities in front of us that we're assessing right now. I mean, it's always hard to say when that's going to come to fruition.

Speaker 2

We are going to be very selective in like what we do. We don't want to do something that we come out in the street with things which doesn't make sense. So we're being very careful what we do. I would just add one thing that we are very pleased about that I think helps really the M and A story, which is it's very clear for us with all the transformation we've done into a higher margin business, our multiple is expanding. And I think that gives us more options relative to acquisitions.

Speaker 2

EBITDA multiple. Our EBITDA multiple is expanding and so it gives us more options with M and A. And so to make things accretive much faster on a higher multiple of EBITDA basis. So I think this is very critical to our future and we have a lot of resource being put into this. So I well, I can't definitively say once something happens, we are on the hunt right now.

Speaker 2

I mean we are looking.

Speaker 5

Got it. Okay, super. Thanks so much.

Operator

Our next question comes from the line of Christopher Rolland with Susquehanna. Please go ahead.

Speaker 6

Hey, guys. Thanks for the question. I guess, my first one is Cornell, that's pretty amazing margin expansion that you have there. I was wondering, do you still have continued opportunities? I'd also love to focus a little bit on pricing there.

Speaker 6

Do you think you still have movement upwards in pricing? Is there something left here in terms of margin improvement that we could see for the CD business?

Speaker 2

Yes. Let me handle the pricing first and then I'll let John talk just generally to the margins overall. So if you remember when we went through this, I think I don't hold these exact numbers. When we first announced the deal, we didn't really talk too much about price. By the end of the Q1 of owner, we kind of talked about a couple of $1,000,000 of price.

Speaker 2

I think last quarter, I talked about $3,000,000 to $4,000,000 of price. I think we're going to be for the year above $5,000,000 of price that we're going to get this year. And if you look at the timing of price, we have longer term contracts with customers. We have there's a lot of inventory in the channel relative to the industrials. So there's going to be based on the pricing actions we've already taken, there's going to be more price in 2025.

Speaker 2

So I would say $5,000,000 this year, maybe another couple of million next. So a big portion of the margin improvement is coming from price. I'd say the second thing and John can kind of expand on this, but we really haven't done a tremendous amount yet on like what I call value creation in on the manufacturing floors with Cornell. That process will take start of next year, we'll start working on that and we'll start laying that out. But I think there's also opportunity to do the things that we do in the traditional Knoll business, whether it be PD or the MSA business, where we get a fair amount of value creation every single year.

Speaker 2

So I would say I'm reasonably confident that we're going to have more margin expansion. And we'll talk more about the Investor Day, your overall for the PD segment, what kind of margin expansion that we can get. But we should get more from Cornell. I don't know, John, do you have any other color?

Speaker 3

I think just to kind of reiterate what Jeff said, we had 500 basis points of improvement in Cornell and it was really driven by improved pricing. Also to a lesser extent, we're getting some supply chain savings, material savings. So that's there. I think that will continue into 2025. And then also we're planning on getting the major sites on our Oracle instance.

Speaker 3

Once we get that, there's some also, I'll call it, OpEx synergies to harvest from that. So there's room for increased margin in that quarter. Yes.

Speaker 2

I think what I just would kind of highlight here is the last thing on the price, because obviously this has been a relatively challenging year for the PPE segment as a whole in terms of revenue, especially the industrial market. And we're still getting $5,000,000 of price in the year. And I think that's bodes really well for as the market recovers what it means.

Speaker 6

Thank you, Jeff. And yes, I did as a lead in want to talk a little bit more about industrial. So it sounds like there might be some inventory there. Would love to know when you think that normalizes? How much inventory is there?

Speaker 6

And then if you could break this up into what you're seeing geographically like East versus West? I know there's

Speaker 2

a debate over EVs, for example, China EVs look good, West EVs look a little soft. And anything like that would be helpful. Yes. So I think our best indicator, quite frankly, of inventory, it's really hard with a little harder with OEMs or direct customers who really know the exact amount of inventory. But with our distribution partners, we have a pretty good view into the inventory that they have.

Speaker 2

We still believe based on the data they're reporting to us that our distribution has about 6 months worth of inventory on hand right now. In order to really get back to normal ordering patterns, that's still got to come down by about 3 months. Now when that happens, again, as I kind of said on the earlier question, when we meet our distributor partners, they say 1 month's good, 1 month's poor. It's been inconsistent, right? Hasn't been just totally horrible, but it's been inconsistent.

Speaker 2

And I would say is this primarily North America and Europe. There isn't as much business in our PD segment in the industrial markets in Asia. It's not as much. It's specific to electrification. Now that's really not China, but we do have Asian customers.

Speaker 2

We are not doing a tremendous amount of electrification in China. I would say we're doing and that again, right now in the back half of the year, looking at this, it's flattish year over year in terms of because what I say is, yes, the electrification market is weak as you kind of pointed out, but we also have new design wins going into production. We are garnering new opportunities that are starting production. So that's kind of offsetting being down in electrification even though we're not participating as heavily in China.

Speaker 3

Awesome. Thank you.

Operator

Our next question comes from the line of Tristan Gerra with Baird. Please go ahead.

Speaker 4

Hi, good afternoon. Looking at the macro environment and you highlighted the continued weakness in industrial. The first question is, have you seen in other end markets, including consumer, any changes in demand patterns over the past few months? Or is it stable? And also if you could talk about pricing excluding the impressive progress you're making at Cornell, are you seeing any unusual pricing changes in the high end capacitors?

Speaker 4

What are you hearing from your customers as you perhaps renegotiate some annual pricing contracts there?

Speaker 2

Yes. So first, I'll just make a comment. Obviously, we've moved the CMM business into discontinued ops. That's our exposure to consumer until obviously that is fully sold. That is in line with our expectation going into the quarter.

Speaker 2

And as I look even into Q4, it's running in line with expectation. I think it's doing fine. And so I think there aren't any big issues we see in consumer at this moment. Now, yes, about the pricing environment within 1st within MSA, I would say stable. That's what I would say.

Speaker 2

We're not seeing a tremendous amount of pricing increases, but we're not seeing pricing reductions either that are pointing to any issues. And then in PD, which is primarily ceramic capacitors and which is a lot of end markets and then RF, which is primarily defense. I would actually say in defense, there is we still think some opportunity in terms of price in the RF market going forward. And then in the traditional cap space, I would say it's stable. I think one of the benefits we have in our businesses is that a big portion of our businesses in PD is sole source positions.

Speaker 2

And so I think we don't we're in long term contracts with a lot of people and we don't see a tremendous amount of price pressure in these markets even at a down market.

Speaker 4

Great. That's great to hear. And then how should we be looking at this coming quarter as the sequential trends for the various end market within PD?

Speaker 2

Yes. Okay. Let me look at these. On a sequential basis, we're expecting but first of all, let me say for PD overall, I kind of said on the prepared remarks, we're expecting modest sequential growth, right? And so if I look at the end markets overall, defense is going to be up, medtech is going to be up, electrification is flat and industrial is flat, right?

Speaker 2

So again, back to my kind of my points about industrial and distribution, which is a lot of industrial customers. It's not like we're seeing a degradation sequentially. But obviously these numbers were running a lot higher if you go back a year and a half ago. So we're just not seeing the continued improvement that we kind of saw. We did see some improvement from Q2 to Q3 in the industrial market, but that's kind of like now back to flat sequentially from Q3 to Q4.

Speaker 4

Great. Thank you very much.

Operator

There are no further questions at this time. This will conclude today's conference call. Thank you all for your participation. You may now disconnect.

Remove Ads
Powered by Quartr
Earnings Conference Call
Knowles Q3 2024
00:00 / 00:00
Remove Ads