Q3 2021 Knowles Corp Earnings Call
Good afternoon, and welcome to the Q3 2021 Knowles Corporation earnings Conference call My.
My name is Emma and I will be your conference operator today.
This time I would like to welcome everyone to the conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
Would like to ask a question. During this time simply press star followed by one on your telephone keypad. If you would like to withdraw your question again press Star one with that said here with opening remarks is Knowles Vice President of Investor Relations, Mike Knapp. Please go ahead.
Thanks, Emma and welcome to our Q3 2021 earnings call I'm, Mike Knapp 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 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 on Form 10-K for the fiscal year ended December 31, 2020 periodic reports filed from time to time with the SEC and the risks and uncertainties identified in today's earnings release.
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 Dot Com and in our current report on form 8-K filed with the SEC.
Including a reconciliation to the most directly comparable GAAP measures.
All 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 IR section of our website.
With that let me turn the call over to Jeff who will provide some details on our results. Thanks, Mike and thanks to all of you for joining US today for Q3, we reported revenue of $233 million above the midpoint of our guidance and up 13% from a year ago period, driven by strong demand across our audio and precision device segments.
Gross margins improved to 41, 8% near the high end of our guidance range and our earnings per share was <unk> 45 above the high end of our expectations.
In audio revenue was up 8% from the year ago period as hearing health sales increased on strong end market demand and Mems microphone sales group driven primarily by Iot.
Precision device delivered record revenues again in Q3 up 35% from the year ago period, driven by improved demand across a broad range of end markets, we serve and in acquisition we completed in Q2.
We also delivered cash from operations of $56 million overall, another strong quarter that demonstrates the benefit of our investment in differentiated products to increase revenue across a diverse set of growing end markets driving gross margins higher and delivering strong earnings and cash flow.
Let me now spend some time.
Some time detailing the trends, we're seeing by the end markets and each one of our business segments.
In audio we saw broad based improvement year over year, and Mems microphone sales despite experiencing supply constraints here.
<unk> also increased from the year ago period on strong end market demand.
As we look forward. We believe recently proposed rules from the FDA on over the counter hearing AIDS if adopted will make it easier for people with mild hearing loss to have access to technology to improve quality of life. We expect this new channel to bolster bolster our growth in hearing help over the years to come.
We are increasing our capacity to service, our traditional hearing aid market and the opportunities for the over the counter and true wireless markets.
Moving on to precision devices sales reached record levels again in Q3 with significant will improve gross margins as demand for med Tech industrial defense and electric vehicle markets drove strong year over year improvement.
We continue to develop advanced solutions for mission critical applications that rely on our high performance capacitors and RF filters, which is yielding solid results.
In high performance capacitors, the med tech market drove a significant portion of the year over year growth as demand for our demand improve for our high reliability products used in implantable devices and MRI machines.
We're also beginning to see a broadening of our customer base in Asia, and Europe and high voltage EV platforms begin to go to production.
In our filters are probably continue to see strong demand from defense customers in North America, and Europe for communications and radar systems solutions.
We are also beginning to see a number of new design opportunities and five millimeter wave telecom and we secured several prototype orders for small cells and repeater equipment.
For the third consecutive quarter, we saw record bookings in PD across a wider array of products, giving me confidence we can grow precision device revenue by greater than 15%. This year with the bulk of the growth being driven by organic initiatives.
In a moment John will discuss the Q3 results and the Q4 guide in more detail, but our revenue growth is currently being held back by a number of short term issues that have recently been in the headlines which include extended lead times and capacity constraints on semiconductors and more release recently power disruptions in China as well as some lingering COVID-19 uncertainty.
For the past several years, our strategy has been to focus our R&D investment capacity expansions and acquisitions can products for growing markets that value our differentiated solutions.
This is paying dividends today as gross margin continues to expand driving increased operating income and cash flows.
As these headwinds start to dissipate, we expect the impact of our strategy to be even more pronounced on our financial results.
Our team has delivered three strong quarters. So far this year I believe our leadership positions across the markets, we serve and our strategy to deliver high value solutions to a diverse set of growing end markets positions us well for the rest of 2020, 'twenty one and beyond.
With that I'll turn it over to John to expand on our financial results and provide the guidance for the fourth quarter John Thanks.
Thanks, Jeff we reported third quarter revenues of $233 million up 13% from the year ago period, driven by increased shipments in both the audio and precision device segments audio revenues of $178 million were up 8% due to higher demand for Mems microphones across mobile and non mobile end markets and stronger hearing AIDS.
<unk>.
Precision devices delivered record revenues of $55 million up 35% year over year as a result of organic growth of 21% and an acquisition completed in the second quarter of 2021.
Third quarter gross profit margins were 41, 8% near the high end of our guidance range and up more than 500 basis points versus the same period a year ago.
Audio segment gross margins improved more than 450 basis points, driven by productivity gains higher factory capacity utilization and favorable product and customer mix.
In the precision device segment gross margins were more than 600 basis points above prior year levels due to productivity gains improved factory utilization favorable inventory reserve adjustments and an acquisition, partially offset by higher precious metals cost are.
R&D expense in the quarter was $20 million up slightly from the year ago period, the lower than expected due to the timing of new hires.
SG&A expenses were $27 million in line with our guidance range and up $1 million from the prior year, driven primarily by higher incentive compensation cost and an acquisition, partially offset by lower legal expense.
For the quarter adjusted EBIT margin was 22, 6% above the high end of our guidance range and up more than eight percentage points from the same period, a year ago, driven by higher gross profit margins improved operating leverage and favorable FX impacts.
EPS was <unk> 45.
Above the high end of our guidance range and up 21 from the prior year.
Further information, including a detailed reconciliation of GAAP to non-GAAP results is provided in the financial tables of today's press release and can also be found on our website at Knowles Dot com.
Now I'll turn to our balance sheet and cash flow.
Cash and cash equivalents totaled $140 million at the end of Q3 cash generated by operations in the quarter was $56 million above the high end of our guidance due to higher EBITDA and lower than expected net working capital.
Capital spending was $12 million in the quarter.
Given our existing cash position and our expectations that we will continue to generate significant free cash flow in the future. We will settle the principal amount of the convertible notes, which mature next month in cash.
Moving to the fourth quarter, we expect total company revenue to be between $230 and $235 million down 4% at the midpoint versus the same period a year ago.
Revenue from the audio segment is expected to be down approximately 14% from Q4, 2020, driven by timing of customer product launches and supply chain constraints, resulting in reduced mems microphone shipments, partially offset by higher hearing health revenues.
Sure.
Precision device revenue is expected to be up more than 40% versus the prior year driven by strong organic growth in the defense Med Tech and industrial end markets and the acquisition completed in the second quarter of this year.
We estimate total company gross margins for the fourth quarter of <unk>, 40% to 42% up 300 basis points from the year ago period, driven by higher capacity utilization favorable product mix and the acquisition completed in Q2.
Our gross margin expansion through the first three quarters of 2021 demonstrates the execution of our strategy to deliver high value differentiated solutions to our end markets.
We expect total company gross profit margins will reach approximately 41% for full year 2021, a record high and approximately 200 basis points above 2019 levels.
R&D expense in Q4 is expected to be between 19% and $21 million flat with prior year levels.
We're projecting selling and administrative expense to be between 27 and $29 million up $1 million from the year ago period, driven by higher incentive compensation cost and the impact of the acquisition completed earlier this year.
Okay.
Adjusted EBIT margin for the quarter is expected to be approximately 21%.
<unk> is expected to be within a range of 43 to <unk> 45 per share.
This assumes weighted average outstanding shares during the quarter of $95 6 million on a fully diluted basis.
Okay.
Despite the near term supply chain challenges, which are impacting revenue our actions to improve gross margins coupled with our discipline over operating expense spending is resulting in an expected increase in full year EPS of nearly 40%.
About 2019 levels.
We're forecasting an effective tax rate of 8% to 12% for the quarter. This range includes a discrete tax benefit related to the filing of our 2020 federal tax return.
Going forward due to the potential expiration of a tax holiday at the end of 2021.
Our future expected effective tax rate may increase to 14% to 18%.
We're expecting cash generated by operations in Q4 to be between 45, and $55 million and capital spending to be approximately $20 million.
Please refer to our press release and to our form 8-K filed today with the SEC for a GAAP to non-GAAP reconciliation.
I'll now turn the call back over to Jeff for closing remarks, and then we'll move to Q&A portion of the call Jeff. Thanks, John.
We're increasingly confident about our near and longer term prospects as our strategy to deliver high value differentiated solutions to a diverse set of growing end markets is allowing us to expand gross margins, while driving operating income and producing strong cash flow. We will continue to drive shareholder value through investment in high gross margin products accretive.
<unk> and stock buybacks.
Before we move to the Q&A I would like to announce we are planning on hosting an investor call in late November to provide an update on our growth opportunities and our capital allocation strategy as well as provide new midterm financial targets.
More details will follow new near future and we are excited about the opportunity to share our plans for revenue growth and gross margin expansion and what it means for operating margins and cash flow.
With that I'll turn it over to open for Q&A.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad well pause for just a moment to compile the Q&A roster.
Your first question comes from the line of Bob <unk> with CJS Securities. Your line is now open.
Good afternoon, congratulations on a nice quarter.
As Tom Thanks, Bob.
I wanted to dig into a few things you mentioned on.
Earlier as it relates to the supply chain can you give us kind of a sense of how much of it is international labor chip shortage and roughly how big <unk>.
Revenue hit it is and then going from there how long do you think this will impact you and your customers looking ahead.
So first I'd just make a comment I think we are being cautious in our guidance that we're providing.
I think yes.
Right now we're kind of in the midst of this.
Without going through a ton of detail I would probably estimate in 2021. This is probably 15 million plus in the back half in the back half of the year yeah. So some of it's in Q3.
The majority in Q4, but but but I think I think that's probably about a number 15 million plus.
It's hard to say again.
Obviously working with our suppliers I think it's mainly semiconductor I wouldnt call at this point that we are having major labor shortages or issues like that.
We have had some downtime on power in China, which had some impact for us.
In early Q4 late Q3.
Some of that seems to have passed.
Right now what the.
How that continues through the rest of the quarter, but again, we're being cautious.
And I would sit there and say right now I kind of use.
These things are going to linger around and into Q1 for sure maybe possibly into Q2 and that's when we start to see these things we start to see these things start to clear up.
I'm not going to call this exactly but but that's kind of what we see right now.
Got it okay great.
Helpful Color and then you mentioned the hearing health of the ear over the counter market could you maybe give us a sense of where the FDA is how long this could take two to be an opportunity for you and how big the market opportunity might be.
For you, yes, I'm not going to speculate on what the government is going to do I'm just going to talk about how we see this market, though Bob and how we see it as incremental.
And here's why we see it this way and I think I've talked about this on other calls, but but if you look at that pyramid that we would talk about is hearing loss profile of hearing loss.
Significant hearing last mile hearing loss. The most underserved portion of that is is mild hearing loss and Thats also the largest portion of people with hearing loss and this is where we think this is going to be targeted we have some customers who introduced over the counter products already in the marketplace and are being sold today.
And I think Theres, a couple of points I would make it number one is at least preliminarily.
Who are buying very early days over the counter hearing AIDS. The average age is much younger than the traditional hearing aid channel to the tune of 10 to 15 years younger and I think the positive of that is for US number one is it bring somebody into the idea of improvement of quality of life significantly earlier in their life and that allow.
<unk> for us to have to get multiple cycles of technology and buys of hearing AIDS overtime. So it increases the Tam it really increases the Tam both because youre, bringing new miles hearing loss people, but also at a younger age.
And so to speculate on how big this market is.
It'd be kind of I would probably say that the overall hearing aid market is roughly 15 million units a year, that's kind of the rough size of the market.
B.
Thinking El next two to three years this could be a couple million two 3 million hearing AIDS a year.
And and and and we're very encouraged last piece about the idea here that if you look at people have introduced products to the market. They are not focused on cost theyre focused on performance and that's a really important point for US right. We want people who are focused on performance right. Because first of all I don't want to turn people off with their first experience with hearing aid by some.
Buying something cheap, but also because of the value of our high value products, whether it be in microphones or in our speakers and receivers.
Okay, great. Thanks, and then one last one and I'll get back in queue, but obviously showing a lot of success in the precision device market.
Both organically, but through acquisitions, you've made in the past II can you just give us a sense of the M&A environment out there and if there's opportunities for you with your.
Pristine balance sheet now to continue to make.
Some acquisitions and precision device.
Yes.
I'd say that the.
The funnel is pretty active we're very active with an M&A area, but on the reverse side I would also say the valuations are quite high and I think from my perspective, it's really important, especially at the type of evaluations that were extremely disciplined about what we're going to do.
The acquisition that we did earlier this year has been very successful the three or four other ones that we did over 2017 at all been successful we want to keep up that that track record and I think the point I would just I would just say is.
I am hopeful that we can get some more acquisitions done over the next 18 months, but I'd just keep that in mind is that we are trying to be very disciplined about valuation.
Got it Super Alright, thanks very much.
Thanks, Bob.
Okay.
Your next question comes from the line of Davita Silva with Roth Capital. Your line is now open Hi, Jeff Hi, John Congrats on the cash generation in the margin execution here.
<unk>.
Yeah. So first thing maybe on the gross margin since we're there.
What are some of the key factors that are driving the strength I know you have a event coming up to talk about it but you know.
How sustainable is some of the improvement that you've seen.
Yes, no good question.
In terms of the audio segment year over year, our gross profit margin improvement is really driven by two a greater to a greater extent as mix, specifically a higher proportion of Mems microphones shipped for non mobile applications also growth in the hearing health business.
Those are those are both probably the key drivers. Obviously, we're also running our factories at pretty high levels, 90% plus in terms of <unk>.
Capacity utilization I would say those are probably the main.
Things, we've also been really successful and we're paying a higher price per chips, we've been pretty successful at passing those costs on to our customers.
With PD I think it's a similar mix is really helping.
Higher proportion of sales going into <unk>.
Higher margin medical and defense applications, and then they really made.
A lot of progress on productivity gains within the factories and really optimal lot sizes, reducing scrap and excess inventory. So it is some blocking and tackling but it's also a really favorable mix yet. So let me just make me a little bit broader topline ive given you the detail like what's going on right now, but again I think as we talked.
About this due to you over the last couple of quarters to three four quarters about where we're investing our R&D resources, where we're investing our capex.
Trying to focus is it on.
Non commoditized products right and then and what's happening is as we get more of these products into the marketplace. We spend more money in these areas youre seeing that in terms of the mix just to finish up Tuesday.
With respect to I noted in my script that we're I'm confident that we'll be at or maybe even slightly above 41% for full year 2021.
If this investor call. We have later in the quarter, we'll talk about opportunities to expand gross margins further.
Okay look forward to that John and then a couple questions on the supply constraint.
In terms of the lead customer and then Mike.
I'm wondering if the ordering patterns would kind of have some of the ordering that might have happened in the fourth quarter push out to the first quarter. If that's not the way. This would play out given the constraints any color there would be helpful. Yes, I am not going to comment specific to one customer, but here's what I'd say relative to that we all know that the timing of the launch.
Is slightly off from last year.
It was delayed.
Related issues. This year. It was earlier I think it was more like a traditional pattern, but I think let me just speak generally and again not to a specific customer but.
I would say first the $15 million.
I kind of said earlier that we could have shipped more is is what we are being constrained by I'm not trying to I'm not trying to quantify here, what our customers are being constrained by and there's clearly.
Some constraints out there in certain applications with certain products across the customer base, but thats not even quantified it in the $15 million to $15 million for the back half is really what we think we could have shipped more if we could have gotten.
Our built more more microphones. Okay. That's helpful clarification, and then lastly on PD the bookings visibility very strong there I'm wondering if any component of that is related to supply constraints.
So just trying to cover their supply needs or how much of that versus the growth and the bookings thats really driving that.
I would say the vast majority of the growth, we don't see it that way and.
And let me just kind of frame this out here, we kind of have a.
Real distribution kind of piece of business that one piece was MPD there could be some more.
More ordering than we normally would see but when you start thinking about defence. Our aerospace. The majority of this is all custom product theyre ordering for.
We don't really have a supply constraint in that area, but life Sciences stopper.
We see that I don't think Thats a lot of cost in there.
Automotive again custom I don't really see this at.
At least in our minds that the vast majority of the growth and again I would say this industrial slash distribution business, which ends up being about.
15% of the business that area could be expanding at a faster rate. Maybe then is actually the demand is there, but so but the rest of the business I think is pretty solid.
Thanks for the color Jeff.
Okay.
Your next question comes from the line of Tristan <unk> with Baird. Your line is open.
Hi, Good afternoon, you talked about.
Seeing a higher cost to customers and could that provide a.
Clearly different pricing outlook for next year in other words.
<unk> be up next year as a result, and should we view this as a top line contributor.
Well I guess, what I would say is is that I.
I think it's a little too early to make that call yet.
I think we're going to see after we get through and I always pick this point in time, we've got to get through the holiday season here in the U S. And then Chinese new year, and then see things where things stand in spite of everything is going on.
China is still weak for us I mean, it's still weak for us we'll see how this kind of develops as we get closer to.
Chinese new year, but it's still quite weak.
Sure.
I would say when we talk a lot about Mems mics in the pricing environment in passing on cost, but the pricing environment and my mic in both PD and hearing health has been reasonably favorable athene. So so I think overall.
As you know again and I guess this goes back to what we said a few questions ago is that the more we focus on non commoditized portions of our market.
The more positive the pricing low comp become.
And gross and gross margin will be better.
Okay, Great and then any update on the balance some extra speaker and where you stand in terms of finalizing that automated factory in the Philippines.
I'm glad I got that question Tristan.
Yeah. So the team is there.
Just saw actually a video with the first vial products coming off the line.
Obviously this is not fully quantified yet, but we're expecting to be shipping the customers this quarter.
That's the expectation right now is that in Q4, we will start shipping off the automated line.
And if you think about it as I said it before it's been touching goal for so long.
And I think the teams that have gone there by the way just the teams that maybe there is some of them are listening or in the Philippines. They had a quarantine for seven days when they got there before they could go into the factory, which I know is a tall pain in the neck and so I appreciate the team's willing to go there and do that but we expect that as design wins start to ramp.
We probably won't see full utilization of the capacity in the first half of next year. It will start ramping up to closer to four full utilization in the back half of 'twenty two.
Great areas for thank.
Thank you.
Yes.
Your next question comes from the line of.
Christopher Rolland with Susquehanna International Your line is now open.
Hi, Good afternoon. This is actually Dr. <unk> Chang on for Chris.
I just wanted to follow up on the gross margin question.
Obviously, a great progression here, but I'm curious how much more upside the utilization can bring to the table you already said 90 plus percent right now.
We're also.
Got it.
Yes.
The hearing health part as well it seems like it's already recovered quite a bit. So what are some of the other drivers that could help you to get to that 42% target.
Yes, as I mentioned, we're going to give a little more clarity and color on future gross margin expansion. There is there's a few levers that we will talk about mix is one of them higher higher growth in I'll call. It the hearing health the precision device the non mobile Mems mic business that's one.
But we will elaborate a little more on those drivers.
Let me make a couple of comments I think number one new products will obviously across all of our businesses will drive that number one or two as I think we've talked pretty extensively in our business. We're really not intent on adding capacity to maintain commoditized products are selling and so I think I think.
That keeps going back to obviously, there's mix within what products, we're selling but there's also the fact that you know that.
We kind of see is that lower gross margin.
Business kind of falls off the bottom and we've talked about things like dye sales to be able to like service those types of markets.
Do think there is some opportunity yet for gross margin expansion and as John said, we'll go through those details on the.
On the Investor call, we'll have it in late November.
Sounds great and then.
On the inventory side it seems like for the past couple of quarters, you've been building internal inventory, but this quarter. It was down by 24 days.
Would you say you are in a comfortable range right now and should we interpret this as strong demand overall or is it more supply constraints kicking in.
I think it's a little bit of both I think I mean, we do have definitely supply constraints on certain product categories, where if.
We could build more we would and we are I would say closer to hand to mouth on inventory on certain products.
On the reverse I think inventory being down.
There is beyond the supply constraints beyond the supply constraints. There's the issue of this normal seasonality, where I think we go through with in Q1 Q2, we bring raw materials in and Q.
Q2 into Q3, we build the product and then we have our strongest quarter typically.
Neither.
In Q3 or in Q4, which drives inventory down. So this is following kind of a normal path that we saw but we are having constraints does allow us not to build as much as we'd like one other point I'd add is to that kind of unique to this year as we're transitioning in our Mems microphone business transitioning to eight inch so we're carrying a little extra <unk>.
Inventory I would expect that to go down kind of mid 2022.
One other point I would sit there and say you know at this point.
I think we talked about utilization because of supply constraints, we are not running in our microphone business at full capacity right now and we're not but we are not running at full capacity right now.
Sounds great. Thank you very much.
At this time there are no further questions Mr. <unk> I turn the call back over to you.
Great. Thanks, Emma and thanks, everyone for joining us today as always we appreciate your interest in Knowles, we're also going to be participating in the Roth Conference on November 18th Nols Fargo Conference on December 2nd So we hope to speak with you then.
Our next earnings call. We'll also have more information out on our Investor update later in November so thanks and goodbye.
This concludes today's conference call you may now disconnect.
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