Q4 2023 Knowles Corp Earnings Call

Participants

Christopher Rolland; Analyst; Susquehanna Financial Group, LLLP

Bob Labick; Analyst; CJS Securities

Tristan Gerra; Analyst; Robert W. Baird & Co Inc

Presentation

Operator

Good afternoon. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Knowles Fourth Quarter and Full Year 2023 earnings call. Today's conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. At this time, I would like to turn the conference over to Sarah Cook.

Please go ahead.
Thank you, Audra, and welcome to our Q4 and full year 2023 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 Safe Harbor provisions under applicable federal securities laws. Forward-looking statements in this call will include comments about demand for company products and independent 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, 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 at knowles.com and in our current report on Form eight K 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.
With that, please let me turn the call over to Jeff, who will provide details on our results, thus foodservice and boost 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 2023 with strong operating margins. Our operational performance coupled with the success of our new products gives us great momentum as we enter 2024.
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 million or 15% 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.
Now onto our Q4 results. We delivered revenue of $215 million and EPS of $0.28 within our guidance range, with cash from operations of $60 million, which was above the high end of our guided range.
Turning to segment results, MedTech and specialty audio revenue was up 9% versus the 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 2024 for 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 for PD in 2024 as we focus on cost controls and capacity utilization and optimization, our growth will be driven by organic gross margin improvement and the Cornell acquisition and associated synergies. Channel inventory normalization expect in the second half of 2024 will complement our expected earnings growth turning to the consumer buys 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 three 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 first quarter of 2024.
To summarize, MSA continues to perform well and the momentum shown in Q4 gives us confidence in 2024 for revenue and earnings growth in PD., we are expecting channel inventory to correct and demand recovery to begin in the back half of 2024 for synergies identified in association with Cornell acquisition are projected to be higher than initially expected beginning to materialize in the second half of 2024 for CM, and we expect to achieve modest year-over-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. 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, remember, 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?

Thanks, Jeff. We reported fourth quarter revenues of $215 million in line with guidance and up 9% from the year ago period, driven by the acquisition of Cornell, which we completed on November first. 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 million, up 9% versus the fourth quarter of 2022 to an 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. The Precision Device segment delivered revenues of $70 million, 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 meant microphone revenues of $78 million 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 first quarter, 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&D expense in the quarter was $16 million, up slightly compared to the prior year. SG&A expenses were $31 million, $4 million 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 million in cash from operating activities in the quarter, and capital spending was $5 million. We also repurchased approximately 1.2 million shares at a total cost of $20 million and ended the year with cash and cash equivalents of $87 million. On a full year basis, free cash flow was $106 million or 15% of revenues, and we repurchased approximately 2.9 million shares at a cost of $48 million. We exited 2023 with $271 million of debt, which includes $160 million 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 for the first quarter of 2024, revenues are expected to be between $190 million and $200 million, up 35% versus the year ago period, driven by both organic growth and the acquisition of Cornell R&D expenses are expected to be between $17 million and $18 million. And selling and administrative expenses are expected to be within the range of $30 million to $32 million 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 million and $7 million, which includes approximately $2 million of non-cash imputed interest.
For full year 2024, we expect interest expense of $22 million, 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 $0.2 per share of $0.13 from the year ago period. This assumes weighted average shares outstanding during the quarter of $94 million on a fully diluted basis. Lastly, we're projecting cash from operations to be within a range of $0 to $10 million, and capital spending is expected to be $5 million.
I'll now turn the call back over to the operator for the questions and answers portion of our call operator in queue.

Question and Answer Session

Operator

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

Christopher Rolland

Hey, guys, thanks so much for the question. So I guess, Tom, 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.

Yes, thanks, Chris, for the question. So but I would say is the primary area that we see a lot of inventories when we call it in the industrial and flash distribution channels. And we've listened to some of the big distributors calls until they're seeing a fair amount of channel inventory and it is impacting our business. No doubt is specifically in the PDP segment, both in the field of Cornell portion as well as the traditional dot PD. portion. Now we're hearing a lot that there may be again that people are projecting the recovery in the back half of the year. But I think what we're focused on in the first half is number one. We do have strong organic growth in the first first quarter, 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 through through the acquisition. That's the inorganic portion into that. And we feel again, I think we're really focused in on 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. And 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.

Operator

Excellent. And sorry, for this all encompassing question, but we'd love to know for March, you guys gave top line and bottom line, but would 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 and how those trends? And then lastly, John, I had a little bit of a question, Mark, getting to your on your cash from operations. I assume there's some working capital adjustments, but would love to know what those were.
Thanks, Sara.
Okay. So to be able to book the revenue portion by segment, I think you always kind of said in the microphone business, we do expect strong year-over-year growth in the CFM 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. So it's that is seasonally down as we would normally expect in a normal year a minute in our MSA business, it is seasonally down in Q4 typically is our strongest quarter in our hearing health market where they 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 present, the Precision Device segment, I you would sit there and you look in total, it's up pretty significantly sequentially, but it's being up or sorry, it's up marginally sequentially. A lot being driven by the Cornell acquisition. I'll turn it over to John. Talk more about on the EPS and cash flow numbers.

Yes, sure. So Chris, in my prepared remarks, I provided for Q1 revenue guidance, I provided OpEx, both R&D and SG&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 I also provided the interest expense and taxes. So I think you have all of the mechanics to get to that EPS guidance we have. I think your other question was on free cash flow

Christopher Rolland

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

Yes. So cash from operations, very strong in both Q4 and for the full year. And I would say, you know, a lot of this is sustainable. We did have a benefit in 2023 for a reduction of inventory about $14 million. 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 the legacy business down about $15 million, which created some tailwind. I'd also say from a free cash flow standpoint, CapEx were lower than normal.
They were extremely low for full year 23, I think we pushed out some projects and really focused on investments with highest ROI. So I would say that could tick up a little bit going into 2024 more to like a 3% to 5% of revenue range.

Christopher Rolland

Okay. I was specifically talking about the guide for cash from operations at one to ten. I was wondering if if there was some working capital adjustments in there to go there for Q1?

Q1 is seasonally our IQ stream, our lowest free cash flow and cash from ops quarter. You can go back to Q1 of 22 or 23. And you'll see that we have bonus payouts in Q1. That's a big outflow. But from the other components of net working capital. There's not a huge swing. There will 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 and we'll handle it at what

I would add and Aiolos, because even though Q1 is historically low, we're still expecting for the full year to have a very robust year yet in terms of free cash flows.

Similar maybe a touch lower than 2023.But again, pretty strong cash flow for the full year. So your caution just looking at one quarter off.

Christopher Rolland

Thank you, guys.

Yes, thanks, Chris.

Operator

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

Bob Labick

Prior to actually we do go for Bob today for you. I think, Tom, just starting on with the CMM business and the strategic alternatives process, can you give us any kind of timeframe for a decision 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.

You know, obviously, we're trying to move this process along as quickly as we can, but there's no definitive time line at all to the completers. So that's what I'd say for now. It's probably in the process is progressing.

Bob Labick

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 on the and how that might impact the process that's going?

Well, I mean, what I would say you're right, 2023, especially the back half. You enter a very difficult front-half, specifically Q1 and 23. The back half shaped up pretty well in Q1 is looking very, very well as well. And so there's the dynamics here really are we've got a number of new product introductions on our side. There have been some of our customers to products, coupled with some share gains that we've seen. So and we think we've built brick and some market recovery. So I think overall, I mean, we're expecting modest growth on revenue side year over year. I wouldn't expect to have some kind of crazy growth number this year. But we expect modest growth and I think it's in line with our deal, our expectations that we had three months ago.

Bob Labick

And then just one last one for me. So I'm yes, had you not had such strong free cash flow in Q4, um, you it sounds like you would have hit your goal of sort of returning 50% of free cash flow to shareholders to regain.

Good cash, good cash yet we came in at just under 50%, and it's because December free cash flow is really stronger than we anticipated. But I think as we are if it closes, it's probably 45% versus a 50% return.

Bob Labick

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

Yes, I think I think we'll can 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 our 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% of free cash flow return, interest rates were significantly lower. So we'll have value we're evaluating.

Bob Labick

That's fair. Thanks very much.

Operator

We'll move next to Tristan Gerra at Baird.

Tristan Gerra

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

So you're asking about the revenue from specifically from Cornell in Q4?

Tristan Gerra

Correct? Q4 and Q1, if possible?

Yes, it was roughly in line with your expectations for Q4 and for two months, about $20 million in revenue and EPS neutral EPS neutral. 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 $10 million a month in Q1. I would say, if you remember on November first, when we announced the closing the deal, we kind of laid out some metrics. So I think you were on the revenue side, what we said is pretty aligned. I think the EBITDA is and it's pretty close in line, maybe a tad higher. But I think the biggest thing I would talk about here is on the synergies we had, I think committed to around $4 million of costs 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 other $4 million. 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 a product management or pricing to actually raise prices with this business, which I think you know that with the lead times with distribution inventory, it makes may take a little bit of time for this to kind of really come in and show up in our actual results. So we probably won't see a lot of start coming till the back half starting the back half of 24. But I think what I'd say is beyond the $4 million of cost savings we see now still, I would say, a reasonably significant, especially going into 25 improvement in margins from this business, just purely based on pricing,

It is down a little bit on the accretion. We expect it to be neutral again in Q1. We expect it to be accretive to our earnings kind of beginning in the back half of 2024. 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 million interest free loan in connection with that acquisition. So we calculate using a market rate of about 7.25%, we input impute interest. So that's included in that.

I mean, yes, I mean, I guess I'd say interest and overall, we feel pretty good about where we are three months into the three, four months into this, that acquisitions are really a nice fit for us and we have the opportunity to be a nice grower on the margin side in the and the EBITDA side, but starting really in the back half of the year.

Tristan Gerra

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 domestic telecom industrial, obviously 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, you know, for the capacitor, which is most of that business? And also if you can remind us whether you have pricing agreements and TAA type of agreements or is it all Alsop?

Yes. So first, on the pricing in Europe, I think we talk about pricing in the court outside for a 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 or 2023. I think the biggest thing that we see, you know, in terms of the markets is still this industrial slash distribution business still is very, very weak at this moment in O. and I., and we kind of see it in the corn belt that we see from the Cornell business as well. But that was factored into kind of what we said by the November very time line when we announced the closure or the closing on the business. So it's really about industrial and telecom. There are a few, I 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 industrial slash distribution business and when we believe that that's going to recover. But in the meantime where 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. And in this interim period, probably through the first half.

Tristan Gerra

Great thank you very much.

Operator

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

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 and goodbye.

Operator

This concludes today's conference call.
Thank you. For your participation. You may now connect.