Knowles Q4 2023 Earnings Call Transcript

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February 7, 2024

There are 8 speakers on the call.

Operator

Good afternoon. My name is Audra, and I will be your conference operator today.

Speaker 1

At this time, I

Operator

would like to welcome everyone to the Knowles Fourth Quarter and Full Year 2023 Earnings Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Speaker 1

At this time, I would like

Operator

to turn the conference over to Sarah Cook. Please go ahead.

Speaker 2

Thank you, Audra, and welcome to our Q4 and full year 2023 earnings call. I'm Sarah Cook, Vice President of Investor Relations. 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 Safe Harbor provisions, please bear applicable federal securities laws. Forward looking statements in this call will include comments about demand for company products, anticipated trends in company's sales, expenses and profits and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations.

Speaker 2

The Company urges investors to review the risks 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 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 atknolls.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. We've made selected financial information available in webcast slides, which can be found in the Investor Relations section of our webcast.

Speaker 2

With that, please let me turn the call over to Jeff who will provide details on our results. Jeff?

Speaker 3

Thanks, Sarah, and thanks to all of you for joining us today. Before I get into the Q4 results and my remarks on the status of our markets and what we are seeing for Q1, I would like to start off with some highlights from the previous year. We again made significant progress in transforming our business to higher value products, which we believe will drive increased shareholder value in the years to come. In our medtech and specialty audio business, after a large inventory correction in the first half, we delivered 17% sequential revenue growth in the second half of twenty twenty three with strong operating margins. Our operational performance coupled with the success of our new products gives us great momentum as we enter 2024.

Speaker 3

In our Precision Device segment, We successfully completed the acquisition of Cornell Dubilier, which significantly expands our total available market for capacitors in key markets and drives opportunities for future growth. Since closing in Q4, we now believe The synergies will be higher than our initial expectations. Lastly, the company closed out 2023 with another strong year of free cash flow of $106,000,000 or 15 percent of revenues. This has allowed us to continue to fund organic growth and look at additional acquisition opportunities in our target markets, all while continuing to buy back shares and keeping our debt at very manageable levels. We are very excited about the direction we are heading and believe we will continue to drive shareholder value in 2024 and beyond.

Speaker 3

Now on to our Q4 results. We delivered revenue of $215,000,000 and EPS of $0.28 within our guidance range with cash from operations of $60,000,000 which was above the high end of our guided range. Turning to segment results. MedTech and Specialty Audio revenue was up 9% versus same period a year ago. The hearing health market continues to perform well and we are expecting strong year over year growth in the first half of twenty twenty four.

Speaker 3

The dynamics of aging populations in Western economies, expansion of the middle class globally and increasing penetration of people with mild to moderate hearing loss all point to positive market dynamics in the mid to long term. Precision Device revenue was up 10% year over year, including the acquisition of Cornell. While inventory in the channel remains high, Specifically in industrial and distribution and with a number of OEM customers, underlying demand appears to be stable and design activity across our core markets remains high. With this backdrop, we expect increased earnings per PD in 2024 As we focus on cost controls and capacity utilization and optimization, earnings growth will be driven by organic gross margin improvement and the Cornell acquisition and its associates synergies. Shale inventory normalization expected in the second half of twenty twenty four will complement our expected earnings growth.

Speaker 3

Turning to the consumer MEMS microphone business, we continue to move forward with the exploration of strategic alternatives. In the quarter, revenue was up 8% from the same period a year ago. We have now seen 3 quarters of sequential growth driven by growing demand in non mobile products, expanded mobile share and the ongoing recovery in the PC market. We expect to see strong year over year revenue and earnings growth in the Q1 of 2024. To summarize, MSA continues to perform well and the momentum shown in Q4 gives us confidence in 2024 revenue and earnings growth.

Speaker 3

In PD, we are expecting channel inventory to correct and demand recovery to begin in the back half of twenty twenty four. Synergies identified in association with Cornell acquisition are projected to be higher than initially expected beginning to materialize in the second half 2024. For CMN, we expect to achieve modest full year revenue growth in 2024. While 2023 was a challenging year, we performed well in the second half. Heading into 2024, I'm optimistic we have growth across all three of our business units in revenue and total company earnings along with continued robust cash flow.

Speaker 3

We continue to transform our company to higher value products and markets and I'm confident the strategic actions we've taken will drive long term shareholder value. Before I turn it over to John, as a member, we will be providing revenue, EPS and cash from operations guidance. As I said in Q3, we believe these metrics are the best measures for our business and are aligned to the company's focus. Now, let me turn the call over to John to detail our quarterly and annual results and guidance. John?

Speaker 4

Thanks, Jeff. We reported 4th quarter revenues of 215,000,000 in line with guidance and up 9% from the year ago period driven by the acquisition of Cornell, which we completed on November 1. EPS was $0.28 in the quarter within our guidance range and $0.05 below prior year levels. In the Medtech and Specialty Audio segment, Revenue was $67,000,000 up 9% versus the Q4 of 2022 and increased demand in the hearing health market. Gross margins were 54.2%, up 260 basis points versus the prior year, driven by factory productivity improvements, Favorable product mix and foreign currency impacts.

Speaker 4

The Precision Device segment delivered revenues of 70,000,000 up 10% from the prior year, driven by the acquisition of Cornell, partially offset by lower shipments into the distribution and industrial end markets As we continue to see excess channel inventory, gross margins were 35.4%, down 13 percentage points versus the prior year due to lower factory capacity utilization and the acquisition of Cornell. Consumer MEMS microphone revenues of $78,000,000 were up 8% versus the prior year, driven by higher shipments into the mobile and compute markets. Although full year revenues were down 12% In 2023, driven by an extremely weak Q1, we delivered sequential revenue growth over the remainder of the year through a combination of market growth and share gains. Gross margins were 24.7%, 70 basis points above the same period a year ago on higher factory capacity utilization. On a total company basis, R and D expense in the quarter was $16,000,000 up slightly compared to the prior year.

Speaker 4

SG and A expenses were $31,000,000 $4,000,000 higher than prior year levels, driven by the acquisition of Cornell and an increase in professional and legal fees associated with the exploration of strategic alternatives for CML. Now, I'll turn to our balance sheet and cash flow. We generated $60,000,000 in cash from operating activities in the quarter and capital spending was $5,000,000 We also repurchased approximately 1,200,000 shares at a total cost of 20,000,000 and ended the year with cash and cash equivalents of $87,000,000 On a full year basis, free cash flow was 106,000,000 or 15% of revenues and we repurchased approximately 2,900,000 shares at a cost of 48,000,000 We exited 2023 with $271,000,000 of debt, which includes $160,000,000 of borrowings under our revolving credit facility and a seller note, which was issued in connection with the Cornell acquisition. Lastly, our net leverage ratio was 1.3 times 2023 EBITDA. Now moving to our guidance.

Speaker 4

For the Q1 of 2024, revenues are expected to be between 190 $200,000,000 up 35% versus the year ago period, driven by both organic growth and the acquisition of Cornell. R and D expenses are expected to be between $17,000,000 $18,000,000 and selling and administrative expenses are expected to be within the range of 30 to $32,000,000 up from prior year due to the Cornell acquisition. We're projecting adjusted EBIT margin for the quarter To be within a range of 12% to 14%, we're forecasting interest expense in Q1 to be between $5,000,000 $7,000,000 which includes approximately $2,000,000 of non cash imputed interest. For full year 2024, we expect interest expense of $22,000,000 and we expect an effective tax rate of 14% to 16% for both the quarter and full year 2024. We're projecting EPS to be within a range of $0.16 to $0.20 per share, up $0.13 from the year ago period.

Speaker 4

This assumes weighted average shares outstanding during the quarter of 94,000,000 on a fully diluted basis. Lastly, we're projecting cash from operations to be within a range of $0,000,000 to $10,000,000 and capital spending is expected to be $5,000,000 I'll now turn the call back over to the operator for the questions and answers portion of our call. Operator?

Operator

Thank you. We'll go first to Christopher Rolland at Susquehanna.

Speaker 5

Hey guys, thanks so much for the question. So I guess You talked about some excess channel inventory in some of your end markets. I was wondering if you could perhaps flesh that out for us and maybe discuss how this might affect kind of future revenues as we or areas as we look through 2024? Thank you.

Speaker 3

Yes. Thanks, Chris, for the question. So what I would say is the primary area that we see lot of inventories, what we call it in the industrialanddistribution channels. And we've listened to some of the big distributors calls and they're seeing a fair amount of channel inventory and it is impacting our business, no doubt, specifically in the PD segment, both in the Cornell portion as well as the traditional PD portion. Now we're hearing a lot that there may be again, people are projecting a recovery in the back half of the year.

Speaker 3

But I think what we're focused on in the first half is number 1, we do have strong organic growth in the Q1 and it's being driven primarily by our MSA business as well as our CMM business and of course the additional revenue we get from Cornell the acquisition, that's the inorganic portion. And to that end, again, I think we're really focusing on cost here in the short term, Making sure we're optimizing our factory utilization, getting value creation in our factories, as well as cost control and OpEx. So those are things that we're going to be focused on until we see the recovery. And but in the meantime, in a number of our businesses, we are seeing Very little channel inventory problem at this point, but primarily industrial and distribution.

Speaker 5

Excellent. And sorry for this all encompassing question, but would love to know for March, you guys gave top line and bottom line, But we kind of love to know the moving parts on the kind of sequential changes By segment and then also to get to your EPS guidance and any clues on the balance between gross margin and OpEx, how those trend? And then lastly, John, I had a little bit Of a question mark getting to your cash from operations, I assume there's some working capital adjustments, but would love to know what those were. Thanks. Sorry.

Speaker 3

Okay. So just I'll handle the revenue portion by segment. I think, as I kind of said, in the microphone business, We do expect strong year over year growth in the CMM business year over year. It is down sequentially, but probably a little less Significantly than we normally see. We're still seeing quite good demand in Q1.

Speaker 3

So it's not as seasonally down as we would normally expect in a normal year. And then in our MSA business, it is Seasonally down, Q4 typically is our strongest quarter in our hearing health market where they we have a big hearing aid show where products are launched In early Q4, a lot of building goes on in Q4. So seasonally Q1 is usually lower. But again, Our hearing health business is up pretty significantly year over year. And then if you go to the Precision Device segment, You would sit there and you look in total, it's up pretty significantly sequentially, But it's being or sorry, it's up marginally sequentially, a lot being driven by the Cornell acquisition.

Speaker 3

I'll turn it over to John to talk more about on the EPS and the cash numbers?

Speaker 4

Yes, sure. So Chris, in my prepared remarks, I provided for Q1 revenue guidance, I provided OpEx both R and D and SG and A as well as EBIT margins. The only thing I really didn't specifically talk about is gross margins, but you can kind of think of the gross margins being very similar to Q4 levels in Q1. And then we expect sequential increases over the remainder of 2024. I think that was the first piece.

Speaker 4

I also provided the interest expense and taxes. So I think you have all the mechanics to get to that EPS guidance we have. I think your other question was on free cash flow.

Speaker 6

Yes, it

Speaker 5

was cash from operations specifically and I apologize, I joined the call a little late.

Speaker 4

Yes. So cash from operations, very strong in both Q4 and for the full year. And I would say A lot of this is sustainable. We did have a benefit in 2023 for of inventory about $14,000,000 When you look at the balance sheet, it's a little camouflaged because you have the inventory related to the Cornell acquisition. But if you strip that out, the inventory, I'll call a legacy business down about $15,000,000 which created some tailwind.

Speaker 4

I'd also say from a free cash flow standpoint, CapEx were lower than normal. They were extremely low for full year 'twenty three. I think we've pushed out some projects and really focused on investments with highest ROI. So I would say that could tick up a little bit going in 2024, more to like a 3% to 5% of revenue range.

Speaker 5

Okay. I was specifically talking about the guide for cash from operations at 1 to 10. I was wondering if there was some working capital adjustments in there To get there,

Speaker 4

For Q1, Q1 is seasonally our lowest Free cash flow and cash from ops quarter, you can go back to Q1 of 2022 or 2023 And you'll see that we have bonus payouts in Q1, that's a big outflow. But from other components of net working capital, There's not a huge swing. There'll be some increases in inventory as we're building, taking in raw materials and building for ramp ups later in the year. So there may be a little headwind in the quarter. But again, Q1 is historically

Speaker 3

Even though Q1 is historically low, we're still expecting for the full year to have a very robust year again in terms

Speaker 4

of free cash flows. Similar, maybe a touch lower than 2023, but again, pretty strong cash flow for the full year. So you're I caution just looking at 1 quarter.

Speaker 5

Awesome. Thank you, guys.

Speaker 3

Yes. Thanks, Chris.

Operator

We'll move next to Bob Labick at CJS Securities.

Speaker 7

Hi, it's actually Lee Jagoda for Bob today. How are you?

Speaker 4

Good, Keith.

Speaker 7

Just starting with the CMM business and the strategic alternatives process, can you give us any kind of timeframe for a Cision one way or the other, whether it be first half, second half? Is it a 2025 event? And then I've got some follow ups.

Speaker 3

Obviously, we're trying to move this process along as quickly as we can, but there's

Operator

no definitive timeline at all to complete this. So that's what

Speaker 3

I'd say for now. It's and the process is progressing.

Speaker 7

And then I guess in your prepared remarks, it sounds like the business is faring Relatively well at the moment. What do you see as sort of the key drivers or variables to 2024 results? And how that might impact the process that's going on?

Speaker 3

Well, I mean, what I would say, you're right. 2023, especially the back half, After a very difficult front half, specifically Q1 of 2023, the back half shaped up pretty well And Q1 is looking very, very well as well. And so the dynamics here really are we got a number of new product introductions on our side that are Some of our customers do products, coupled with some share gains that we've seen. So we think we feel pretty and some market recovery. So, I think overall, I mean, we're expecting modest growth on revenue side year over year.

Speaker 3

I wouldn't expect some kind of crazy growth number this year, But we expect modest growth. And I think it's in line with our expectations that we had 3 months ago.

Speaker 7

And then just one last one for me. So, had you not had such strong free cash flow in Q4, It sounds like you would have hit your goal of sort of returning 50% of free cash flow to shareholders through repo Yes.

Speaker 4

Good catch. We came in at just under 50% and it's because December free cash flow is really the stronger than we anticipated. But I think It's close. It's probably 45% versus a 50% return.

Speaker 7

And as we look out to 2024, even if we don't have a sale To pay back some of the loan, is that how we should think about cash deployment?

Speaker 4

Yes, I think there's not a huge change in our capital allocation given where interest rates are and given the fact we do have Debt borrowings under a revolver. Now we are evaluating is it more advantageous to pay down debt versus repurchasing shares, I think it will be a combination of some combination of that, but we are evaluating it given when we set that 50 percent of free cash flow return, interest rates were significantly lower. So we're evaluating.

Speaker 7

That's fair. Thanks very much.

Operator

We'll move next to Tristan Gerra at Baird.

Speaker 6

Hi, good afternoon. Could you break down the revenue contribution from Cornell in Q4 and what's embedded Q1 guidance. And then also if you could expand on the accretion higher than expected that you expect From Cornell, what's driving that now that you have some visibility on the business post the close of this purchase?

Speaker 3

So you're asking about the revenue from specifically from Cornell in Q4? Correct. Q4 and Q1, if possible, Yes. It was roughly in line with our expectations for Q4 for 2 months at about $20,000,000 In revenue and EPS neutral. EPS neutral.

Speaker 3

And I would say that the monthly run rate Probably slightly higher than that in Q1, starting to be a little bit higher in Q1 than the $10,000,000 a month in Q1. I would say, if you remember on November 1, when we announced the closing of the deal, we kind of laid out some metrics. I think we're on the revenue side, what we said is pretty aligned. I think the EBITDA is pretty close in line, maybe a tad higher. But I think the biggest thing we've talked about here is on the synergies.

Speaker 3

We had I think committed to around $4,000,000 On the cost side, at the closing date within 36 months of the close, I think we're on target maybe slightly ahead on that, the $4,000,000 But I think the biggest thing that we've come to bring to the table is that We think there's an opportunity for what I call product management or pricing to actually raise prices with this business, which I think if you know with the lead times with distribution inventory, it may take a little bit of time for this to kind of really come in and show up in our results. So we probably won't see a lot of start coming till the back half, starting in the back half of 'twenty four. But I think what I'd say is Beyond the $4,000,000 cost savings, we see now, I would say, a reasonably significant, especially going into 25, improvement in margins from this business just purely based on pricing.

Speaker 4

And Kristen, just to add a little bit on the accretion. We expect it to be neutral again in Q1. We expect it to be accretive to earnings kind of beginning in the back half of twenty twenty four. And I think one thing to point out is in the calculation of accretion, we do include both the cash interest And then I mentioned this in the script, there's what we call imputed interest. We had a $123,000,000 interest free loan In connection with that acquisition, so we calculate using a market rate of about 7.25%.

Speaker 4

We impute interest, so that's included in that.

Speaker 3

I mean, I guess, I'd say, interest in overall, we feel pretty good about where we are 3 months into this, 3, 4 months into this, that this acquisition is really a nice fit for us And it has the opportunity to be a nice grower on the margin side and the EBITDA side starting really in the back half of the year.

Speaker 6

Great. And then for my follow-up within the Precision Device business, if you could give us some Details on how the various segments are moving. I'm guessing, disti, telecom, industrial, see going to be the weakest given the inventory deleveraging that's going on. But any commentary as well on automotive, defense? And also, how is the pricing looking like for The capacitor, which is most of that business and also if you can remind us whether you have pricing agreements, LTA type of agreements or is it all spot?

Speaker 3

Yes. So first on the pricing, I think we talked about pricing in the Cornell side portion of the acquisition. I think we've gone through a lot of the pricing work, obviously in the traditional PD business over the years, But we expect modest price increases in 2024 over 2023. I think the biggest thing that we see in terms of the markets is still This industrialdistribution business still is very, very weak at this moment. And We kind of see this in the Cornell business as well.

Speaker 3

But that was factored into kind of what we said by The November 1st timeline when we announced the closure or the closing on the business. So it's really about industrial and telecom. There are a few, would say large OEMs, which shall remain nameless that you'll have some inventory of their own. But I think that should clear up relatively quickly. It's still really about this industrialdistribution business and when we believe that that's going to recover.

Speaker 3

But in the meantime, we are really working hard in the factories to optimize capacity utilization, get value creation in the factories and control OpEx, that's what we're focused on right now in this interim period probably through the first half.

Speaker 6

Great. Thank you very much.

Operator

And there are no further questions at this time. I would like to turn the conference over to Sarah for closing remarks.

Speaker 2

Thank you for joining us today. As always, we appreciate your interest in Knowles and look forward to speaking with you on our next earnings call. Thank you. Goodbye.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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