Q2 2022 Knowles Corp Earnings Call
An audio hearing health also grew 19% year over year as those continues to increase market share, which was further aided by new product introductions.
In contrast, the Mems microphone business was negatively impacted by the headwinds I've already mentioned.
We are taking advantage of this weaker demand environment to right size, our factory capacity in this business and drive the company towards the financial goals I've summarized.
As inventory in the channel is reduced and demand in consumer electronics returns, our Mems microphone business business will be well positioned for improved profit margins and cash flows.
Turning to our overall profitability again, we're very pleased to hit our guidance for gross margins. Despite a very challenging backdrop for revenue growth.
Our adjusted EBIT margins of 20% in Q2 was above the high end of our guidance and EPS of <unk> 33.
It was above the mid time mid point of our expectation.
Lastly, our free cash flow exceeded our expectation and we remain committed to our goal to return at least 50% of our free cash flow to shareholders.
I continue to believe our strategic focus on higher margin products and markets positions <unk> well to continue to create value for shareholders for the years to come.
With that let me turn the call over to John to review, our Q2 financials, and our Q3 guidance John .
Thanks, Jeff we reported second quarter revenues of $188 million down $12 million from the same period, a year ago, driven by weak demand for Mems microphones, partially offset by increased demand in hearing health and our precision device segment.
Audio revenues of $129 million were down 14% from the same period, a year ago due to weak global microphone demand for consumer electronics, Covid Lockdowns in China, and excess PC and smartphone channel inventory.
The decline in Mems microphone revenue was partially offset by increased shipments in hearing health on market growth share gains and new products.
The precision device segment delivered revenues of $60 million up 19% from prior year driven by growth across most end markets with the highest growth coming from defense industrial and Med Tech markets.
Second quarter gross profit margins were 41, 5% at the midpoint of our guidance range and down 90 basis points from the same period a year ago.
Audio segment gross margins finished 300 basis points below 2021 levels, driven by lower factory capacity utilization in our Mems microphone business, partially offset by lower factory spending and favorable mix in our hearing health business.
Precision devices segment gross margins were 46, 7% up 350 basis points from the prior year, driven by favorable mix productivity gains and higher factory capacity utilization.
R&D expense in the quarter was $18 million down more than $3 million from the prior year driven by lower incentive compensation costs.
SG&A expenses were $24 million 4 million lower than the prior year, driven by lower incentive compensation cost.
For the quarter adjusted EBIT margin was 20% up 210 basis points from the prior year driven by a reduction in operating expenses.
EPS was <unk> 33.
Which was <unk> <unk> above the midpoint of guidance and <unk> <unk> above the prior year with the increase driven by lower operating expenses reduced interest cost and a lower share count partially offset by the impact of lower shipment volume.
Now I'll turn to our balance sheet and cash flow cash and cash equivalents totaled $48 million at the end of the quarter cash from operations was $20 million near the high end of our expectations, primarily due to lower net working capital.
Capital spending was $7 million in the quarter and we repurchased approximately 940000 shares at a total cost of $18 6 million.
Before moving to the third quarter guidance as Jeff stated earlier, we are accelerating our strategy to reduce our exposure to lower margin commodity microphones were taking actions beginning in the third quarter to rightsize, our manufacturing capacity and operating expenses in our Mems microphone business.
This restructuring is expected to yield $25 million to $30 million of annualized savings with roughly half of the savings coming from lower factory overhead and half related to lower operating expenses.
We expect Knowles to exit 2022, with a quarterly operating expense run rate of approximately $45 million, which reflects both the impact of our restructuring actions and normalized levels of incentive compensation.
We expect to incur cash charges associated with the restructuring of approximately $23 million to $28 million related to severance and the settlement of vendor obligations.
Lastly, the cost reduction actions, we're taking today support our strategy of focusing on higher value solutions, which should enable us to deliver on our midterm financial targets of 22% to 24% adjusted EBIT margin and 15% to 17% free cash flow margin earlier, then we communicate.
<unk> last November .
Moving to the guidance for the third quarter.
We expect total company revenue to be between 170 and $185 million down approximately 24% from the same period, a year ago, driven by lower shipments of Mems microphones in connection with weak consumer electronic demand and excess compute and smartphone channel inventory.
Revenue from the audio segment is expected to be down more than 30% from Q3 2021, primarily due to lower demand for Mems microphones, driven by the macro economic headwinds we've discussed.
Precision device revenue is expected to be up more than 10% over prior year levels driven by continued broad based strength in defense Med Tech and industrial markets.
We estimate gross margins for the third quarter to be approximately 37% to 39% down 390 basis points from the year ago period, driven by lower factory capacity utilization in our Mems microphone business and unfavorable mix due to lower shipments to the high margin compute market.
These negative impacts are partially offset by productivity gains and improved capacity utilization and precision devices.
R&D expense is expected to be between 18% and $20 million in selling and administrative expense is expected to be between 26% and $28 million down from the year ago period, driven by lower incentive compensation cost.
We're projecting adjusted EBIT margin for the quarter to be in the range of 11% to 13% and EPS to be within a range of 17 to 21 per share. This assumes weighted average shares outstanding during the quarter of $94 8 million on a fully diluted basis.
We're forecasting an effective tax rate of 12% to 16% for the quarter and full year 2022.
For the third quarter, we expect cash generated from operations to be between $20 and $30 million and capital spending to be approximately $10 million.
While we don't typically provide guidance beyond the current quarter I'd like to provide some commentary as it relates to our expectations for the fourth quarter of 2022.
We're expecting 15% to 25% sequential growth for the Cup for the total company drill.
Driven by precision devices in hearing health and a modest increase in microphone shipments as channel inventory is expected to improve.
We also expect significant sequential improvement in gross margins adjusted EBIT margins and cash flow as we benefit from higher shipment volumes and begin to realize the benefits of our of our restructuring program.
We are estimating Q4 gross profit margins to be between 40% and 42% and adjusted EBIT margins to be above 20%.
For the full year, we expect free cash flow as a percentage of revenue to finish above 10%.
While demand and inventory levels in the consumer electronics market are challenging our strategy, coupled with our optimized cost structure positions us well to grow profitably when demand returns.
This along with expected continued growth in our precision device and hearing health businesses will enable us to accelerate achievement of the midterm adjusted EBIT margin and free cash flow margin targets introduced last November .
I'll now turn the call back to our operator to open the line for questions.
Certainly if you'd like to ask a question. Please press star followed by one on your telephone keypad.
Any reason you would like to remove that question. Please press star followed by two again to ask a question. Please press star one as a reminder, if youre using a speakerphone. Please pick up your handset before asking your question.
We will pause briefly as questions are registered.
The first question comes from Bob <unk> of CJS Securities.
Please proceed.
Thanks, Good afternoon.
I just wanted to pick up on what you just hey, how are you guys trying to pick up on what you just said there John in terms of the.
No discussion about guidance for Q4.
Can you give us a sense of.
Just.
Inventory adjustments and corrections will they be fully done through Q3, and Q4 of next year like more normalized Q4, reflecting end market demand and what are the biggest puts and takes and when will you have more more clarity into.
Yes.
Getting through the inventory in the channel and stuff.
Yes, so Bob this is Jeff So just a couple of commentary first I will just say is.
Most of the sequential growth that John referred to the 15% to 25% is coming from hearing health in PD.
We are expecting I would just say a very modest sequential improvement in the microphone business.
And I think we're starting to see some signs of the inventory channel.
Inventory as kind of being worked down.
It doesn't appear to be happening in Q3, and it is still my extend the Q4, but I think from our perspective as we look into 'twenty three.
We think the inventory should be out of the system and then we kind of think about what the growth is going to be in that business going forward, but.
Oh I kind of view it it's again most of the growth we're expecting in Q4 is coming from hearing health in PD, which is got longer lead times and a lot of the businesses already booked.
Okay, Great. That's helpful and then when you get through and let's just say it's 2023.
Done by the end of Q4, just for argument's sake for this question.
What's the expected impact on on your top line from <unk>.
<unk> are walking away from some of the more commoditized sales lower margin sales, how much kind of year over year would you be walking away.
Gross margins normalize.
PON.
As we said once the once you get through the correction and you'll have your new cost structure.
Rice.
I'm going to let Johnny on the gross margin in the second but let's just start from the premise of our mobile business and what percentage of the total company is mobile.
And I think.
In 2021.
We were little over 20% was mobile.
And if you go back.
Back to 2019.
<unk> talked to you look at mobile was probably 27%, 26% and this year I think we will end up well below 20% in terms of mobile and it is going to be mid teens next year.
I think youre going to continue to look at this but I think how we viewed it was Bob is that as we look forward to next year, we shouldnt have to deal with an inventory correction in the Mems microphone business and we intend to run the capacity that we have left over at 90% to 95% that would be the goal.
Our hearing health business should still grow a GDP plus type number and that 4% to 5% number and that we would expect high single digit growth from organically from from precision device business.
I think as we go forward, we're really focused on improving cash flow and improving EBIT margins and we think we'll be able to do that going into into Q4 and into next year.
Gross margin yeah, just in terms of gross margins Bob.
Q4, or Q3, our gross margins are down.
Close to 400 basis points year over year, that's almost entirely or it is entirely driven by a drop in capacity utilization for our Mems microphone business.
As Jeff mentioned and I mentioned, we're taking some pretty aggressive cost reduction actions about 50% of which are impacting in reducing factory overhead.
More normalized capacity utilization, our gross margin will be closer to 42%.
Got it okay Super Thank you very much.
Yeah.
Thank you.
The next question comes from.
<unk> de Silva of Roth capital.
Please proceed.
Hi, Jeff Hi, John So maybe continuing restructuring theme here.
The trough utilization youre seeing now versus kind of post restructuring might be John and what was the utilization just so you have some kind of.
Benchmark, what kind of what what gross margin might do in the future as you reduce the capacity.
Yes, I'm not going to go into specific gross margin and for capacity utilization in terms of what we're currently operating at but it's significantly below kind of our historical target, which is the kind of 90% to 95% run rate and let's be clear.
There's three factors that have gone into this current capacity utilization number one is globally demand in consumer electronics was down I think we all acknowledge that that's a lot like Pcs smartphone market, but even things like gaming, there's a lot of different products that are down.
There is excess inventory in the channel right. So.
Across many of our end markets. There is a lot of inventory in the channel and the third thing that's driven it is we did.
Did make decisions earlier in the year on pricing the whole pricing and take share.
So there are three things that add that up to now as far as the capacity utilization that we want to operate it. We've always said, it's 90% to 95% on an annualized basis and that's going to be the target for what we're going to be shooting for in 2023.
Yes, I think with <unk>.
Your other question with that we think clearly we have the opportunity if we're operating at close to 90% 95%.
<unk> within our men's business, we can get those margins up to the high <unk> and total company margins of 42% or more.
Okay.
And then just digging into the fourth quarter guidance, which you gave us 15% percent sequentially I believe 5% sequential I'm talking about mostly coming from hearing health in PD I didn't really think of hearing health as kind of a strong sequential business you talked about long term GDP ish growth. There. So I'm presuming a lot of <unk> is actually kind of competing just maybe correct me if I'm wrong, where maybe the OTC.
Any color there would be helpful.
But it is actually there is a fair amount from HFC or for hearing health.
Typically Q4 is a seasonally very strong quarter for the hearing health business Theres, a big hearing aid show that happens right to begin with the fourth quarter that drives a lot of demand from our customers as their audiologist leave the show and place their orders and they start building a new products. So there is a fair amount from HFC, but PD.
<unk> also contributed.
Okay, and maybe you could touch on my last question on the resilience of PD through but it seems to be kind of a weaker economic environment, obviously versus consumer oriented.
Thanks.
Yes, so I think we.
Obviously very pleased with the PD business.
Like you said show resilience I think they're very well positioned in a few markets that are doing extremely well defense aerospace doing very well for them.
Life Sciences or medical markets continue to be very strong for them.
I'd also add that again, we're still growing in our EV business.
From a small base.
It is growing so I think most of the markets that they have we're seeing strength in bookings continued to be strong. So so I always think of the PD business again like the hearing health business a lot of our orders and knowledge of what's going to happen over the next six months is kind of already baked in so that's why we.
Feel pretty comfortable about where the growth is going to come from in Q4. So did you just to add a little bit the defense and Med Tech business represents almost two thirds of the total PV business. So.
Well.
I was just kind of adding up the numbers hearing health business being med Tech plus.
Plus PD plus the defense business and BD about 45% of our business is now med Tech and defense and I would say that the <unk>.
Log in bookings continued to be very strong.
Okay, Great I appreciate all the color thanks, Jeff Thanks, John .
Thank you. The next question comes from Christopher Rolland of.
Yes.
<unk> <unk>.
Please proceed.
Okay.
Okay. Thank you.
Hi, guys.
Yes, I guess my questions are around the restructuring and.
I guess ongoing expenses that youre going to be able to cut.
Our expenses going up Q on Q and then how did these trail out as we as we move through it or is there any opex services.
Mostly on the manufacturing and Cogs side I know you mentioned it probably was but is there anything in opex and swap.
Yes, Chris in terms of the annualized $25 million to $30 million about half of it is the IDL. So factory overhead in our Mems microphone factories and then the other half is opex combination of R&D and SG&A.
Okay.
That certainly makes sense.
And then my second question is around second part around that can correlate.
I was trying to run rate, yes go for it.
So run rate were expecting opex to be right around $45 million. That's the quarterly run rate. Once once we've implemented these actions and we adjust for incentive comp kind of a normalized level of incentive comp. So if you are modeling 'twenty three that's kind of what you want to put in for a quarterly run rate.
Okay, I think it's that incentive comp.
That would explain why that's up from from here I guess.
And then.
Obviously way down this year.
Okay excellent and then.
Around inventories I want to understand.
Inventory dynamic a little bit.
I want to talk about customer inventories, but also your own inventories youre at a 157 days so would love to know internally, where you want to bring that and then secondly.
Can you talk a little bit more about the inventory dynamics that youre seeing I mean was this just a.
Classic semiconductor cycle, where there was over buying just at the component level or are these finished goods finished PC finished.
Mobile finished Iot et cetera devices that are that are waiting to be sold.
Maybe if you could just classify customer inventories and how you see it that'd be great too.
Yes, So let me I'll use the PC market is kind of the good examples of that.
Just wanted to track in terms of the number of units sold per year and would you could see us based on the number of units that were sold in the PC market in 2021.
We shipped significantly more units than the number of units that were shipped in the market.
Estimate is that right now in the market through a combination of there is some raw material of ours in the already out there. There is stuff that's work in progress and finished inventory.
There is probably in the PC market three months worth of inventory.
In the marketplace and with the lower demand you can kind of see when you sit there and see like the all the third party data kind of says the PC shipments will be down around 15% and if you take another quarter's worth of inventory you can see how that can very quickly have to be worked down.
And driving demand down.
We're again hopeful as we talk with customers that the inventory will start to come down I know theres been a lot of discounts in the marketplace to try to move some of that inventory.
When demand comes back I think that's a little harder to say, but I think inventory is definitely going to come down I'll, let John comment on the inventory internally, but yes number typically I'll make this comment typically towards the middle part of the year is when our inventory is at highest because we're usually building seasonally for the back half of the year.
<unk> right now I would say with demand down inventory is probably higher than we would like at this moment, but I think we're very active an active program to make sure that that inventory kind of gets like back in line by the end of the year.
Commentary, yes, I would just add in terms of in addition to what Jeff said, you're right, Chris at 157 days inventories well above what we're expecting it's really a couple of factors.
Pretty abrupt drop in.
Demand. It's also we're take we're keeping a higher safety stock just with the Covid related lockdowns that we've experienced in China.
We've made the conscious decision to keep more safety stock things are improving slightly and I would say, we expect inventory to come down fairly significantly between now and the end of the year. The other issue too is we had a conversion in our fab from six inch to eight inch so we.
Higher inventory.
Last time buys and things like that but we expect that to be coming down both in the second half of this year and in 'twenty three and again this will drive improved cash flow in the second half, particularly in the fourth quarter of this year.
Awesome. Thanks, guys.
Yeah.
Okay.
Thank you. The next question comes from Tristan <unk> of Baird.
Please proceed yes.
Hi, This is Tyler on for Christian Thanks for taking the question I just have one could you. Please provide us an update on the capacity ramp of that balanced armature line.
Yes, yes, so I don't know if you saw during the quarter, we did a fair amount of marketing about.
High definition audio and how balanced armatures can enable that.
But I would say is that obviously the capacity that fully utilized today.
We're expecting to see more of a ramp up in the back half of the year I think one of the challenges that we've seen is with China being on Lockdown a lot in the first half new design wins in China have been a little bit tougher to come by.
But I would just sit there and say is first of all number one is achieving all of its cost targets doing very well on that side number two is we've learned a lot from this on our balanced armature automation line and are applying a lot of the learnings back to our manual lines in order to improve gross margin bring costs down very.
Jordan.
Beyond the balanced armatures for but I would say the commercial market.
Starting to see some traction with some of our hearing health customers.
As also some demand for the over the counter market from the queue.
Customers that we have in that space.
Overall, I would sit there and say our expectation is that hopefully will be filling that line in 2023.
Okay. Thanks for all the insight.
Yeah.
Thank you. The next question comes from Anthony Stoss of Craig Hallum.
Please proceed.
Hey, guys.
John maybe for you I wanted to focus in on the September revenue Guide I'm curious if you'd care to comment on if you think you're losing share with your biggest north American.
Smartphone customer.
Maybe walking away due to Asps and then I had a couple of follow ups.
Okay.
Jeff we're not going to comment on any specific customer I think it will just keep going back to the comment here that you know that.
We're committed to not pursue lower margin business.
I think that's something that we've kind of said stated for the last year year and a half.
Tony and.
I'll leave it at that.
Again with the commentary that we expect in 'twenty three our smartphone business will be 15% roughly of the total company revenue.
Got it thanks for that and then.
John .
So you gave us Opex, where you think you'll be in Q4, where do you think you'll exit 2023, both on gross margins and opex per quarter.
Tony I'm not going to give guidance on 2023, but as I mentioned today earlier if we.
Once we've implemented the cost reduction actions that we.
Discussed today, we expect these all to be implemented by the end of Q4, we think gross margins going into assuming we're running at a reasonably high capacity kind of 90% in the Mems microphone business, we think gross margins would be 42% or above in 2023, Let me just take one of them.
Tony I think we kind of said here on this call here is with the actions that we're taking the shift in mix better capacity utilization lower capex spending right. I mean, you can go right from a resulting we've kind of talked about when we came out in November .
<unk>.
'twenty one with our call we kind of said, we can get to the 22% to 24% and EBIT margins and free cash flow of 15% to 17% in the three to four year timeframe.
Well, we're one we're going to be one year into that in November .
I would say that based on the actions, we're taking I think we can get to those numbers potentially a year earlier right. So.
We're two years away right. So so I would say that's just the commentary we would put in there is different ways to get there through opex do better capacity utilization and better mix right. It's a bunch of different ways to get there, but we're highly focused on hitting those EBIT margin adjusted EBIT margin targets and the free cash flow margins.
Got it and then.
Last question on the millimeter wave any update would be helpful in kind of your thoughts on.
That's going to grow in 2023 over 2022.
Yes so.
We continue to do extremely well in the RF business.
It's growing year over year.
Primarily defense.
Again, I would say, we do have a few customers that we.
We are starting production with in the millimeter wave space I, just would caution I very very cautious about how well. This is going to be accepted we get big forecasts from people, but but there's a lot of it.
These customers that we have are small and we're just not seeing the rollout of millimeter wave.
In the commercial marketplace in any big way in the end market, although some of our customers that we have are telling us they could be larger numbers. So I just I'm very cautious about saying this is going to be a big number for telecom.
But again the defense business continues to do very well the RF business continues to be.
Very good for us.
Okay. If I can sneak in one more just on the sure.
On the restructuring charges etcetera, I know you guys bought a fair amount.
Of stock back is that something that you will you think it will ease up on and pay down debt continually.
No Tony I don't think Theres a change of course, there we committed in black last November that we would return 50% of our free cash flow back to shareholders through share repurchases. We are on track for that in 2022, and I don't see any reason to change course, we're very comfortable with the cash flow generation looking for.
Forward.
Especially into the back half of or the last quarter of 'twenty two.
In 2023, so no really no change of course, and I think it is important even with that commitment to returning.
Cash to shareholders, we still have plenty of capacity for acquisitions, and we're going to be.
Pursuing and looking at those opportunities as well as repurchasing stock.
Perfect. Thanks, a lot guys. Thank you.
Yes.
Thank you that will conclude our time of questions I would now like to pass the conference back over to Jeffrey <unk> for closing remarks.
Yes again this is Jeff we do thank you for your time I think we look forward to the next few quarters in terms of taking action on this restructuring and are setting us up for a much stronger Q4 in 2023.
Thank you very much.
That concludes the conference call. Thank you for your participation you may now disconnect your lines.
Sure.
Okay.
Okay.