Knowles Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 31, 2024

There are 8 speakers on the call.

Operator

Thank you for standing by. My name is Caelin. I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2024 Knowles Corporation Earnings Conference Call. All lines have been placed on mute to prevent any background noise.

Operator

After the speakers' remarks, there will be a question and answer session. I would now like to turn the call over to Sarah Cook. You may begin.

Speaker 1

Thank you, and welcome to our Q2 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 securities 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. The Company urges investors to review the risks and uncertainties in the Company's SEC filings, including but not limited to, the Annual Report 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.

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 knolls.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 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 website.

Speaker 1

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

Speaker 2

Thanks, Sarah, and thank you all for joining us today. Let me start by saying, I'm pleased with the performance of our business in the Q2. We continue to execute on our plan of focusing on high growth end markets where we have differentiated solutions and in Q2 the business performed as we expected. We delivered 205,000,000 in revenue which is at the midpoint of our guided range and represents 18% growth on a year over year basis. EPS of $0.24 and cash from operations of 25,000,000 were both in line with our expectation and at the midpoint of our guided range.

Speaker 2

From a segment perspective, medtech and specialty quality revenue grew 4% sequentially as the end market for our hearing health products remained strong. The market dynamic of the aging population, expansion of the middle class globally and improved hearing aid penetration all remain favorable. We reported adjusted EBITDA margins of over 45%, driven by continued operational execution and our sustained success of new product adoption. We expect the strength to remain throughout the year within 2024 and for 2024 to be a year of growth for the MedTech and Specialty Audio segment. Despite the continued headwinds from normalization of inventory levels in our industrial and distribution end markets, Precision Devices delivered solid results in the 2nd quarter.

Speaker 2

Driven by the acquisition of Cornell, revenue was up 55% on a year over year basis. Adjusted EBITDA margins increased nearly 260 basis points sequentially on flat revenue, driven by strong operational execution and improvements in gross margin within Cornell. We have begun to see signs of inventory reduction in our distribution channel in industrial end markets and we are ready to capitalize on growth as demand improves. I would also add our design activity remains robust and we are well positioned to grow as the market recovers. On our consumer MEMS microphone business, we continue to progress to a conclusion on the strategic alternatives process taking into consideration all stakeholders from customers to suppliers and shareholders to employees.

Speaker 2

From an operational standpoint, CMM Financial results in the quarter were solid. Revenue was up 3 was up 9% from the prior quarter and adjusted EBITDA margins grew by 3.30 basis points. Before I conclude, I would like to touch on our capital allocation activities. In the Q2, based on our continued robust cash generation, we repurchased $25,000,000 of shares, while also reducing our debt by $34,000,000 We expect sustained cash generation for the remainder of 2024. The first half of twenty twenty four produced solid financial results.

Speaker 2

I continue to be pleased with the performance of the business and I'm excited about the opportunities we have ahead of us. My confidence in our ability to deliver shareholder value remains strong as our teams continue to demonstrate operational excellence, execution in innovative products and expanding our market share across our core businesses. Now, let me turn the call over to John to go into the details of our quarterly results and provide the Q3 guidance.

Speaker 3

Thanks, Jeff. We reported 2nd quarter revenues of $205,000,000 at

Speaker 2

the midpoint of guidance and

Speaker 3

up 18% from the year ago period, driven by organic growth of 2% and the acquisition of Cornell in the Q4 of 2023. EPS was $0.24 in the quarter at the midpoint of our guidance range and up $0.01 or 4 percent from the Q2 of 2023. In the Medtech and Specialty Audio segment, revenue was 60,000,000 dollars down 2% versus the prior year. Our Hearing Health business was up 5% offset by lower demand in the specialty audio market. Gross margins were 54.6 percent, up more than 100 basis points versus the year ago period, driven by favorable product mix and benefits from foreign currency.

Speaker 3

The Precision Devices segment delivered revenues of $74,000,000 up 55% from the year ago period, driven by the acquisition of Cornell, partially offset by lower shipments of high performance capacitors into distribution and OEMs in the industrial end market as customer and channel inventories remain elevated. Gross margins were 37.2%, down 250 basis points from the Q2 of 2023 due to the acquisition of Cornell. While the gross margins at Cornell remain lower than that of the legacy Precision Devices business, we saw sequential margin improvement at Cornell of 3.40 basis points and we expect margins to continue to improve throughout 2024. Excluding Cornell, year over year gross margins within the PD segment were flat. Consumer MEMS microphone revenues of $71,000,000 were up 9% versus the year ago period due to share gains and increased consumer demand primarily in ear and IoT end markets.

Speaker 3

Gross margins were 28.1%, a 5 50 basis point decrease from the prior year due to the absence of a $4,000,000 benefit related to the sale of fixed assets, which was recorded in the Q2 of 2023. On a total company basis, R and D expense in the quarter was $17,000,000 up 6% from Q2 2023 due to the acquisition of Cornell. SG and A expenses were $32,000,000 $2,000,000 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 Precision Device segment. Interest expense was up $4,000,000 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.

Speaker 3

In the Q2, we generated $25,000,000 in cash from operating activities at the midpoint of our guidance. For the 1st 6 months of 2024, we generated $42,000,000 in operating cash flow, representing a $20,000,000 increase over the 1st 6 months of 2023. Capital spending was $3,000,000 in Q2 and we ended the quarter with cash and cash equivalents of $84,000,000 During the Q2, we repurchased 1,400,000 shares at a total cost of $25,000,000 and we reduced outstanding borrowings under our revolving credit facility by $34,000,000 dollars We exited the 2nd quarter with $261,000,000 of total debt that includes $146,000,000 of borrowings under our revolving credit facility and an interest free seller note issued in connection with the Cornell acquisition. Lastly, our net debt leverage ratio based on trailing 12 months adjusted EBITDA was 1.1 times. Moving to our guidance.

Speaker 3

For the Q3 of 2024, revenues are expected to be between $210,000,000 $220,000,000 up 23% versus the year ago period, driven by organic growth of 3% and the acquisition of Cornell. R and D expenses are expected to be between $16,000,000 $18,000,000 and selling and administrative expenses are expected to be within the range of $29,000,000 to $31,000,000 up $5,000,000 from the prior year due to increases associated with the Cornell acquisition. We're projecting adjusted EBIT margin for the quarter to be within a range of 16% to 18%. We're forecasting interest expense in Q3 to be approximately $4,000,000 which includes $2,000,000 of 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

And we're projecting EPS to be within the range of $0.29 to $0.33 per share. This assumes weighted average shares outstanding during the quarter of 92,200,000 fully diluted basis. We're projecting cash from operations to be within a range of $35,000,000 to $45,000,000 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

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

Speaker 4

Hey, guys. Thanks for the question. I know you guided for sequential and year over year growth in medtech and specialty audio and precision devices. I assume that's also going to include consumer. And if you could just kind of force rank or give

Speaker 2

us some idea of what

Speaker 4

that sequential strength might be for those different segments, that would be great.

Speaker 2

Yes. So Chris, thanks for the question. So first, I think for being very deliberate about this, the sequential growth is coming from the non CMM portion of the business. So I think what we're starting to see, particularly in the Precision Device business, we think we're starting to see sequential improvement on our way at some point and hopefully in the near future, a return to year over year growth on a pro form a basis when you include Cornell. And we're seeing that being relatively broad based.

Speaker 2

So I think we're pretty pleased. We are seeing some sequential growth in the medtech and specialty audio. I think it's going to be quite honestly a little bit more pronounced the sequential growth in Q4 versus Q3. But we do expect in Precision Devices to again have sequential growth in Q4 from Q3. As far as the CMM business, we are not in Q3 seeing a lot of sequential growth.

Speaker 2

I'd say it's flattish, but it is coming off, I'd say a pretty strong Q2 on a year over year basis. We had a pretty strong Q2. I think the CMM business was up about 8% or 9% year over year in Q2. So it's coming off a pretty strong Q2.

Speaker 4

Great. And then I guess maybe following up there because September for C and M typically is pretty strong for you guys. Are you seeing something different in content or is it just purely timing? And then lastly, any update on potentially selling that business and yes, we'll just stop

Speaker 2

there. Okay. So let me take up the second question first. I would say not a huge update from the last quarter, but I would say we're inching closer towards a conclusion. And so I think that's about what we can say at this point where it's inching closer towards a conclusion.

Speaker 2

I would say overall for the full year, the CMM business is actually going to be up pretty significantly year over year. And so I think it appears I would say we're not going to comment by quarter, but I think it's up about 8% or so that's we're seeing for the full year.

Speaker 4

Okay, great. Well, great results in the parts that matter. Thanks, guys.

Operator

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

Speaker 4

Good afternoon, guys. I have

Speaker 5

a couple of questions. On the CD acquisition, I think the past quarter you were kind of ballparking it to equate to about $135,000,000 to $140,000,000 for the full year 2024. Is that changed or is that still kind of the right number to think about?

Speaker 2

I'd say it's a little lower than that. Although here's what I would say, I think when we announced the deal, we talked about $26,000,000 in EBITDA for this year. We're still sticking. We're going to hit the $26,000,000 of EBITDA even on the lower number. And the way we're doing that, quite frankly, is the synergies are larger than we had expected.

Speaker 2

I think we've talked about that probably in the past. I think a couple of quarters ago, we were talking maybe a couple of $1,000,000 of kind of price opportunity. Last quarter, we talked maybe 3 to 4. I would say it's probably closer to 5 now in terms of price in that business. So we're feeling pretty good about where we are.

Speaker 2

And I think what I'd say, Tony, about CD acquisition is the margins are coming up like probably a little faster than we would have expected, even on lower revenue, which is I think a really good sign because as the market starts to recover, we can see that the margins are going to expand and we're going to get to the target margins that we've kind of talked about early on faster than we probably would

Speaker 3

have said. Tony, just to give a little color to that, when we acquired CD Q4 of last year, margins were right around 30%. Same thing in Q1 of this year and we're seeing sequential pretty significant sequential improvement, we expect to be kind of in the high 30s as we exit 2024.

Speaker 2

Yes. And so and that's a combination obviously of some of this capacity utilization, but it's also getting the synergies.

Speaker 5

Got it. Perfect. Second question, just want to confirm something. So the September guide, are you assuming anything from your prior biggest handset customer in terms of content in a handset?

Speaker 2

So, again, what I'm trying to say is, actually, we're not going to make comments on specific customers. I think, overall, I would just make the comment again, the growth sequentially is coming from the non CMM portion of the business. And I think we keep continuing to focus on overall reducing our exposure to mobile, which is our one of our lowest gross margin markets. And but overall, if you look at for the full year, the CMM business will be up 8% based on what we're seeing for this year for the full year.

Speaker 5

Got it. Okay. And then lastly, Jeff, I think in past quarters you're sitting with about 5 months worth of in PD and you wanted to bring it down to 2 months. Are we still in that kind of same 5 months or is it starting to come in?

Speaker 2

So you're referring to inventory in the channel, correct? That's what you're referring to? Yes. Okay. Yes.

Speaker 2

So we're definitely seeing so here's like again, I kind of brought this up. We expect PD both in the classic PD as well as Cornell to be sequentially improving in Q3 and we expect it to improving in Q4. We are seeing the inventory in the channel starting to come down, but it's probably coming down a little bit slower than we expected. So the steepness of the sequential improvement is probably a little less than we would have expected, but we're definitely seeing it. When I look at the numbers, we had some nice even sequential growth going to have from in Cornell, but again in classic PD from Q2 to Q3.

Speaker 2

So the inventory definitely coming down in the channel. And there are still pockets where there's still probably too much inventory. But overall, we're starting to kind of see the light at the end of the tunnel in the PD markets. So, the last thing I just would kind of make a comment on, Tony, is passives versus semiconductors because I think we sometimes get these things mixed. What we're seeing is the semiconductor channel, which we're not obviously involved with as much.

Speaker 2

There is a lot of inventory still in semiconductors, but the passive inventory in the channel, the passive inventory has been reducing at a faster rate than semiconductor in the channel.

Speaker 5

Very good. Thanks, Jeff, for all the color.

Speaker 2

Yes.

Operator

And your next question comes from the line of Tristan Gerra with Baird. Your line is open.

Speaker 6

Hi, this is Tyler on for Tristan. Thanks for taking the questions. I know you talked about some of the pricing opportunities you have on the Cornell side, but can you speak to pricing across the rest of your businesses?

Speaker 2

Yes, sure. I can talk about it. I would sit there and say first in the med tech especially audio pricing stable. I wouldn't say we've gotten big price increases or reductions. It's very, very stable.

Speaker 2

Again, a lot of things we have with these customers are longer term contracts, very stable. I think we're a very valued supplier. In the Precision Device segment outside of Cornell, we're seeing some modest price increases. I think again, I think I've talked about this before, Tyler, where when we first started doing pricing in the classic PD section, we had some larger increases. Now it's kind of smaller, but continual.

Speaker 2

And then I think lastly, the CMM business, I'd say outside of mobile, pricing has been pretty stable in our CMM business. Mobile is still challenged. I would sit there and say mobile is still challenged. And so that's probably our biggest challenge is the mobile area. And again, as we try to over time reduce our exposure to mobile, we would probably see less and less price decreases in that business.

Speaker 6

Great. And then just looking at the hearing health business, have you seen anything notable to call out on the OTC market? Any sense that there's upside relative to your expectations for that business?

Speaker 2

Yes. We've been on the call like many times talking about OTC and I've always kind of like tried to hold back expectations in terms of how big this could be. It still is not really like becoming a significant piece of business for us. And what I could sit there and say pretty confidently, there's no sockets I can point to that we've really lost of any significant volume. And so it's just not developing the way people had hoped, but more it's kind of in line what we'd hoped.

Speaker 2

Now what I would say, I still think the OTC market is helping with the traditional hearing aid market where people hearing more about hearing aids and maybe they go look in over the counter hearing aid and then they opt into at the traditional hearing aid channel. And these are complicated devices. And I think there's probably a little bit of a, I would say, an under appreciation for the value of the audiologist in the way this works in terms of a person getting a hearing aid. And I think people are starting to realize that. And again, having been in the market for many years, we didn't factor in too much in for OTC and it's probably meeting expectation, but at a very low level.

Speaker 2

But the traditional hearing HCL continue to do very well.

Speaker 6

Great. Thanks again for taking the questions.

Operator

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

Speaker 7

Thanks. Good afternoon.

Speaker 2

Hey, Bob. Hi, Bob.

Speaker 7

Hi. So you talked obviously about in Precision Device in particular, you have the destock going on in inventory in the channel and stuff. But can you maybe talk a little bit about the overall end market demand, where the biggest drivers are, where you see that and how long it takes to kind of get back up to that growth rate?

Speaker 2

Yes. So let me kind of just try to divide it up into a few different markets. We got defense, medtech, industrial, other. We'll make some comments a little bit about electric as well. And again, Cornell as well as the traditional PD participate in all these areas.

Speaker 2

And so what I would just say, let me start with defense. We're definitely seeing growth in defense. We are seeing some growth in defense. It's not probably as high as we would have expected, but for the full year, we will see growth in defense. Medtech, there has been a number of areas where we have seen inventory issues, not the hearing aid, but in some of our other precision device markets.

Speaker 2

But we are expecting that some pretty strong year over year growth in medtech in the back half of the year as the inventory has kind of weighing it down, right? So we are starting to see that in the marketplace. I guess what I would sit there and say is that the one market that's probably a little bit probably the more murky of all is the industrialother. And that market has been, I'd say, not it's still in decline and there's some modest improvement that we're seeing going forward. But it's not like and that's probably the area when I kind of said upfront that we're the steepness of the recovery is probably not as large as we thought, probably really more in the industrial area.

Speaker 2

We're seeing some sequential improvement. Now let me just cut it a different way. I could also cut it a different way, which is OEM versus distribution. We're expecting some pretty strong back half of the year sequential improvement on our OEM customers, a lot of that driven by Med. And our distribution, we're expecting modest sequential growth in the back half of the year.

Speaker 7

Okay, got it. Thanks. And then, I haven't really had a chance to fully go through this, so at the risk of sounding a little silly, could you talk about the goodwill impairment in CMM and what I guess the process was and what that kind of says to us about that segment?

Speaker 3

Sure, Bob. I can take that. So as you recall, in the Q3 of last year, we announced that we were reviewing strategic alternatives for the CMM business. That review included a range of possibilities, including a potential sale or restructuring of the business. During the Q2 of 2024, we evaluated the potential outcomes of our review And we concluded as a management team that it's more likely than not the fair value of the CMM reporting unit was below its carrying value.

Speaker 3

And as a result, we recorded a goodwill impairment charge of 249,000,000

Speaker 7

dollars Okay, got it. And basically you said you're inching towards a resolution there. Can you talk about M and A? I mean, you've talked about most likely in the PB segment, but can you still is M and A still doable with the kind of ongoing CMM strategic alternatives? Or are they going to be separate events you'll finish CMM and then get back to potential M and A?

Speaker 7

Or how is that process playing out?

Speaker 2

Well, let me start with the first statement, which is our cash flow continues to be very robust. We're very pleased with the cash flow in the first half. Normally, seasonally, cash flow is usually weaker in the first half. We had a very strong first half cash flow. We're expecting that to continue in the back half.

Speaker 2

And I would sit there and say, we are definitely looking at acquisitions. But I guess what I would just say is we want to make sure we don't do anything that our shareholders would look at and say, why are they doing that? There's a lot of opportunities out there. And I point to the Cornell acquisition, which we think is from a synergy standpoint, from a how it fits with what we do. I mean this has been a really great acquisition for us.

Speaker 2

We're looking for that next Cornell. And so I don't think it's going to take for a conclusion of the CMM process to move forward with M and A. If we find the right thing, our balance sheet is in good shape, we are going to move forward with M and A.

Speaker 3

And Bob, we've always said we're going to maintain modest debt levels, not going above, call it, 2.75 on a net leverage ratio.

Speaker 2

And that kind of leads to just a little bit on the capital allocation. We are continuing to buy back shares as well because of the cash flow.

Speaker 7

Okay, super. Thank you very much.

Operator

And there are no further questions at this time. I will turn the call back over to Sarah Cook.

Speaker 1

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

Operator

And this concludes today's conference call. You may now disconnect.

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