Knowles Corp: Form 10-Q for the period ended Jun 30, 2023

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q.

Overview

We are a market leader and global provider of advanced micro-acoustic microphones and balanced armature speakers, audio solutions, and high performance capacitors and radio frequency ("RF") filtering products, serving the medtech, defense, consumer electronics, electric vehicle, industrial, and communications markets. Our focus on the customer, combined with unique technology, proprietary manufacturing techniques, and global operational expertise, enables us to deliver innovative solutions across multiple applications. References to "Knowles," the "Company," "we," "our," or "us" refer to Knowles Corporation and its consolidated subsidiaries, unless the context otherwise requires.

During the fourth quarter of 2022, we determined each operating segment represents a single reportable segment; thus, we now report three segments. These segments were determined in accordance with Financial Accounting Standards Board Accounting Standards Codification 280 - Segment Reporting and are comprised of (i) Precision Devices ("PD"), (ii) MedTech & Specialty Audio ("MSA"), and (iii) Consumer MEMS Microphones ("CMM"). The segments are aligned around similar product applications serving our key end markets to enhance focus on end market growth strategies.

• PD Segment

Our PD segment specializes in the design and delivery of high performance capacitor products and RF solutions primarily serving the defense, medtech, industrial, communication, electric vehicle, and distribution markets. PD has sales, support, and engineering facilities in North America, Europe, and Asia as well as manufacturing facilities in North America and Asia.

• MSA Segment

Our MSA segment designs and manufactures microphones and balanced armature speakers used in applications that serve the hearing health and premium audio markets. MSA has sales, support, and engineering facilities in North America, Europe, and Asia, as well as manufacturing facilities in Asia.

• CMM Segment

Our CMM segment designs and manufactures micro-electro-mechanical systems ("MEMS") microphones and audio solutions used in applications that primarily serve the ear, Internet of Things ("IoT"), computing, and smartphone markets. CMM has sales, support, and engineering facilities in North America, Europe, and Asia, as well as manufacturing facilities in Asia.

We sell our products directly to original equipment manufacturers ("OEMs") and to their contract manufacturers and suppliers and through distributors worldwide.

Non-GAAP Financial Measures

In addition to the GAAP financial measures included in this item, we have presented certain non-GAAP financial measures. We use non-GAAP measures as supplements to our GAAP results of operations in evaluating certain aspects of our business, and our executive management team and Board of Directors focus on non-GAAP items as key measures of our performance for business planning purposes. These measures assist us in comparing our performance between various reporting periods on a consistent basis, as these measures remove from operating results the impact of items that, in our opinion, do not reflect our core operating performance. We believe that our presentation of non-GAAP financial measures is useful because it provides investors and securities analysts with the same information that we use internally for purposes of assessing our core operating performance. The Company does not consider these non-GAAP financial measures to be a substitute for the information provided by GAAP financial results. For a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures, see the reconciliation included herein.

Results of Operations for the Three Months Ended June 30, 2023 compared with the Three Months Ended June 30, 2022

(in millions, except per share amounts)

Revenues

Revenues for the second quarter of 2023 were $173.0 million, compared with $188.0 million for the second quarter of 2022, a decrease of $15.0 million or 8.0%. PD revenues decreased $11.7 million, primarily due to lower demand from the industrial, distribution, and communication markets. CMM revenues decreased $2.3 million, primarily due to lower average pricing on mature products, partially offset by higher demand in the ear and IoT markets. MSA revenues decreased $1.0 million, primarily due to lower shipping volumes into the hearing health market, partially offset by higher shipping volumes into the premium audio market.

Cost of Goods Sold

Cost of goods sold ("COGS") for the second quarter of 2023 was $105.8 million, compared with $110.3 million for the second quarter of 2022, a decrease of $4.5 million or 4.1%. This decrease was primarily due to product cost reductions, benefits of prior year restructuring actions, and lower shipping volumes, and favorable foreign currency exchange rate changes, partially offset by lower factory capacity utilization.

Gain on Sale of Fixed Assets

As a result of transitioning to our next generation of MEMS wafer manufacturing technology, we sold certain machinery and equipment related to the CMM segment in the second quarter of 2023 and recorded a gain of $4.8 million. In addition, CMM expects to recognize further gains on sale of fixed assets in the third quarter of 2023. For additional information, refer to Note 6. Property, Plant, and Equipment, net to our Consolidated Financial Statements.

Restructuring Charges

During the second quarter of 2023, we recorded a $0.9 million gain on the sale of certain machinery and equipment that was previously written off through restructuring charges and a $0.8 million reversal of restructuring charges related to a change in estimate, all within Gross profit and the CMM Segment. We also recorded restructuring charges of $0.6 million in Operating expenses for severance pay and benefits to rationalize our CMM segment. For additional information, refer to Note 8. Restructuring and Related Activities to our Consolidated Financial Statements.

During the second quarter of 2022, we recorded restructuring charges of $0.5 million within Operating expenses.

Gross Profit and Non-GAAP Gross Profit

Gross profit for the second quarter of 2023 was $73.7 million, compared with $77.7 million for the second quarter of 2022, a decrease of $4.0 million or 5.1%. Gross profit margin (gross profit as a percentage of revenues) for the second quarter of 2023 was 42.6%, compared with 41.3% for the second quarter of 2022. The decrease in gross profit was primarily due to lower shipping volumes, lower average pricing on mature products shipped into the mobile market and lower factory capacity utilization, partially offset by product cost reductions, the gain on sale of fixed assets, benefits of prior year restructuring actions, and favorable foreign currency exchange rate changes. The increase in gross profit margin was primarily driven by product cost reductions, the gain on sale of fixed assets, benefits of prior year restructuring actions, and favorable foreign currency exchange rate changes, partially offset by lower average pricing and lower factory capacity utilization.

Non-GAAP gross profit for the second quarter of 2023 was $72.7 million, compared with $78.1 million for the second quarter of 2022, a decrease of $5.4 million or 6.9%. Non-GAAP gross profit margin (non-GAAP gross profit as a percentage of revenues) for the second quarter of 2023 was 42.0%, compared with 41.5% for the second quarter of 2022. The decrease in non-GAAP gross profit was primarily due to lower shipping volumes, lower average pricing on mature products shipped into the mobile market and lower factory capacity utilization, partially offset by product cost reductions, the gain on sale of fixed assets, benefits of prior year restructuring actions, and favorable foreign currency exchange rate changes. The increase in gross profit margin was primarily driven by product cost reductions, the gain on sale of fixed assets, benefits of prior year restructuring actions, and favorable foreign currency exchange rate changes, partially offset by lower average pricing and lower factory capacity utilization.

Research and Development Expenses

Research and development expenses for the second quarter of 2023 were $19.7 million, compared with $21.3 million for the second quarter of 2022, a decrease of $1.6 million or 7.5%. Research and development expenses as a percentage of revenues for the second quarter of 2023 and 2022 were 11.4% and 11.3%, respectively. The decrease in expenses was primarily driven by reduced spending in our CMM segment driven by the benefits of prior year restructuring actions, partially offset by increased development activities in our MSA and PD segments. The increase in expenses as a percentage of revenues was driven by our lower revenues.

Selling and Administrative Expenses

Selling and administrative expenses for the second quarter of 2023 were $36.5 million, compared with $30.7 million for the second quarter of 2022, an increase of $5.8 million or 18.9%. Selling and administrative expenses as a percentage of revenues for the second quarter of 2023 and 2022 were 21.1% and 16.3%, respectively. The increase in expenses was primarily driven by higher professional service fees, higher incentive compensation, and a change in our deferred compensation liability. The increase in expenses as a percentage of revenues was driven by our increase in expenses and lower revenues.

Impairment Charges

No impairment charges were recorded during the second quarter of 2023. Impairment charges for the second quarter of 2022 were $239.8 million related to a goodwill impairment charge for the CMM segment. For additional information related to these impairment charges, refer to Note 4. Impairment Charges to our Consolidated Financial Statements.

Interest Expense, net

Interest expense for the second quarter of 2023 and 2022 was $0.8 million. We had a lower outstanding revolving credit facility balance during the second quarter of 2023 compared to the second quarter of 2022, offset by higher interest rates. For additional information on borrowings and interest expense, refer to Note 9. Borrowings to our Consolidated Financial Statements.

Other (Income) Expense, net

Other income for the second quarter of 2023 was $1.3 million, compared with expense of $1.7 million for the second quarter of 2022, a change of $3.0 million. Income in the second quarter of 2023 represents favorable foreign currency exchange rate impacts and the unrealized gains in our investment balances. Expense in the second quarter of 2022 represents an adjustment to pre-spin-off pension obligations and the unrealized losses in our investment balances, partially offset by favorable foreign currency exchange rate impacts.

Provision for Income Taxes and Non-GAAP Provision for Income Taxes

The effective tax rate ("ETR") for the second quarter of 2023 and 2022 was 21.8% and (11.9)%, respectively. The ETR for the second quarter of 2023 and 2022 includes discrete items totaling $0.1 million of tax expense and $0.6 million of benefit, respectively, primarily attributable to stock-based compensation. Absent the discrete items, the ETR for the second quarter of 2023 and 2022 was 21.3% and (12.2)%, respectively. The Company accrues taxes in various countries where it generates income and applies a valuation allowance in other jurisdictions, which resulted in the provision for both the second quarter of 2023 and 2022. The change in the ETR was mainly due to the book goodwill impairment recorded in the second quarter of 2022, as well as the mix of earnings and losses by taxing jurisdictions and net discrete items.

The non-GAAP ETR for the second quarter of 2023 and 2022 was 18.6% and 13.9%, respectively. The non-GAAP ETR for the second quarter of 2022 was impacted by a net discrete benefit totaling $0.4 million. Absent the discrete items, the non-GAAP ETR for the second quarter of 2023 and 2022 was 18.6% and 14.9%, respectively. The change in the non-GAAP ETR was primarily due to lower pre-tax earnings and the loss of our Malaysian tax holiday.

The ETR and non-GAAP ETR deviate from the statutory U.S. federal income tax rate, mainly due to the taxing jurisdictions where we generate taxable income or loss. As a result of the rapid decline in demand for global consumer electronics during 2022, we did not satisfy all of the conditions of our tax holiday in Malaysia. As such, we are not including this tax holiday benefit in our 2023 GAAP ETR and non-GAAP ETR. For additional information on tax holidays refer to Note 11. Income Taxes to our Consolidated Financial Statements.

Net Earnings (Loss)

Net earnings for the second quarter of 2023 were $13.6 million, compared with a loss of $242.9 million for the second quarter of 2022, an increase of $256.5 million. As described above, the increase is primarily due to impairment charges in the second quarter of 2022 that did not recur in the second quarter of 2023 and lower income tax expense, partially offset by lower gross profit and higher operating expenses.

Earnings (Loss) and Adjusted Earnings Before Interest and Income Taxes

Earnings before interest and income taxes ("EBIT") for the second quarter of 2023 was $18.2 million, compared with a $216.3 million loss for the second quarter of 2022, an increase of $234.5 million. EBIT margin (EBIT as a percentage of revenues) for the second quarter of 2023 was 10.5%, compared with (115.1)% for the second quarter of 2022. The change is primarily due to impairment charges recorded in the second quarter of 2022 that did not recur in the second quarter of 2023, partially offset by lower gross profit and higher operating expenses.

Adjusted earnings before interest and income taxes ("Adjusted EBIT") for the second quarter of 2023 was $27.7 million, compared with $37.6 million for the second quarter of 2022, a decrease of $9.9 million. Adjusted EBIT margin (Adjusted EBIT as a percentage of revenues) for the second quarter of 2023 was 16.0%, compared with 20.0% for the second quarter of 2022. The decreases were primarily due to lower non-GAAP gross profit and higher non-GAAP operating expenses.

Diluted Earnings (Loss) per Share and Non-GAAP Diluted Earnings per Share

Diluted earnings per share was $0.15 for the second quarter of 2023, compared with loss per share of $2.64 for the second quarter of 2022, an increase of $2.79. As described above, the change is primarily due to impairment charges recorded in the second quarter of 2022 that did not recur in the second quarter of 2023, partially offset by lower gross profit and higher operating expenses.

Non-GAAP diluted earnings per share was $0.23 for the second quarter of 2023, compared with $0.33 for the second quarter of 2022, a decrease of $0.10. As described above, the decrease was primarily due to lower non-GAAP gross profit and higher non-GAAP operating expenses.

Results of Operations for the Six Months Ended June 30, 2023 compared with the Six Months Ended June 30, 2022

(in millions, except per share amounts)

Revenues

Revenues for the six months ended June 30, 2023 were $317.3 million, compared with $389.4 million for the six months ended June 30, 2022, a decrease of $72.1 million or 18.5%. PD revenues decreased $13.7 million, primarily due to lower demand from the industrial, distribution, and communication markets, partially offset by increased demand in the electric vehicle market. CMM revenues decreased $43.4 million, primarily due to lower demand for MEMS microphones in the mobile, IoT, and computing markets. The decreases in these markets were primarily driven by weak global demand for consumer electronics and excess inventory in the supply chain. In addition to lower end market demand, shipping volumes were unfavorably impacted this period by financial incentives offered to customers resulting in higher shipping volumes in the fourth quarter of 2022. CMM revenues were also impacted by lower average pricing on mature products shipped into the mobile market. MSA revenues decreased $15.0 million, primarily due to lower shipping volumes into the hearing health market as customers reduced their inventory levels, partially offset by higher shipping volumes into the premium audio market. In addition to lower end market demand, shipping volumes were unfavorably impacted this period by financial incentives offered to customers resulting in higher shipping volumes in the fourth quarter of 2022.

Cost of Goods Sold

COGS for the six months ended June 30, 2023 was $196.2 million, compared with $228.4 million for the six months ended June 30, 2022, a decrease of $32.2 million or 14.1%. This decrease was primarily due to lower shipping volumes, product cost reductions, benefits of prior year restructuring actions, and favorable foreign currency exchange rate changes, partially offset by lower factory capacity utilization.

Gain on Sale of Fixed Assets

As a result of transitioning to our next generation of MEMS wafer manufacturing technology, we sold certain machinery and equipment related to the CMM segment in the six months ended June 30, 2023 and recorded a gain of $4.8 million. In addition, CMM expects to recognize further gains on sale of fixed assets in the third quarter of 2023. For additional information, refer to Note 6. Property, Plant, and Equipment, net to our Consolidated Financial Statements.

Restructuring Charges

During the six months ended June 30, 2023, we recorded a $0.9 million gain on the sale of certain machinery and equipment that was previously written off through restructuring charges and a $0.8 million reversal of restructuring charges related to a change in estimate, all within Gross profit and the CMM Segment. We also recorded restructuring charges of $1.4 million in Operating expenses for severance pay and benefits to rationalize our CMM segment, and $0.3 million for other costs. For additional information, refer to Note 8. Restructuring and Related Activities to our Consolidated Financial Statements.

During the six months ended June 30, 2022, we restructured our MEMS Microphones product line, which is included within the CMM segment. This action resulted in the termination of a research and development project and a reduction in workforce. We recorded restructuring charges of $5.4 million related to this action and $0.5 million for other costs. In addition, we recorded restructuring charges of $1.2 million to rationalize the Intelligent Audio product line workforce, which is also included within the CMM segment. For additional information, refer to Note 8. Restructuring and Related Activities to our Consolidated Financial Statements.

Gross Profit and Non-GAAP Gross Profit

Gross profit for the six months ended June 30, 2023 was $127.5 million, compared with $161.0 million for the six months ended June 30, 2022, a decrease of $33.5 million or 20.8%. Gross profit margin for the six months ended June 30, 2023 was 40.2%, compared with 41.3% for the six months ended June 30, 2022. The decrease in gross profit was primarily due to lower shipping volumes. The decrease in gross profit margin was primarily due to lower factory capacity utilization, and lower average pricing on mature products shipped into the mobile market, partially offset by product cost reductions, benefits of prior year restructuring actions, the gain on sale of fixed assets, and favorable foreign currency exchange rate changes.

Non-GAAP gross profit for the six months ended June 30, 2023 was $127.1 million, compared with $161.9 million for the six months ended June 30, 2022, a decrease of $34.8 million or 21.5%. Non-GAAP gross profit margin for the six months ended June 30, 2023 was 40.1%, compared with 41.6% for the six months ended June 30, 2022. The decrease in non-GAAP gross profit was primarily due to lower shipping volumes. The decrease in non-GAAP gross profit margin was primarily due to lower factory capacity utilization and lower average pricing on mature products shipped into the mobile market, partially offset by product cost reductions, benefits of prior year restructuring actions, the gain on sale of fixed assets, and favorable foreign currency exchange rate changes.

Research and Development Expenses

Research and development expenses for the six months ended June 30, 2023 were $39.7 million, compared with $44.4 million for the six months ended June 30, 2022, a decrease of $4.7 million or 10.6%. Research and development expenses as a percentage of revenues for the six months ended June 30, 2023 and 2022 were 12.5% and 11.4%, respectively. The decrease in expenses was primarily driven by reduced spending in our CMM segment driven by the benefits of prior year restructuring actions, partially offset by increased development activities in our PD and MSA segments. The increase in expenses as a percentage of revenues was driven by our lower revenues.

Selling and Administrative Expenses

Selling and administrative expenses for the six months ended June 30, 2023 were $70.3 million, compared with $63.0 million for the six months ended June 30, 2022, an increase of $7.3 million or 11.6%. Selling and administrative expenses as a percentage of revenues for the six months ended June 30, 2023 and 2022 were 22.2% and 16.2%, respectively. The increase in expenses was primarily driven by higher professional service fees and higher incentive compensation incurred in the second quarter of 2023 and a change in our deferred compensation liability. The increase in expenses as a percentage of revenues was driven by our lower revenues and an increase in expenses.

Impairment Charges

No impairment charges were recorded during the six months ended June 30, 2023. Impairment charges for the six months ended June 30, 2022 were $239.8 million related to a goodwill impairment charge for the MCE reporting unit. For additional information related to these impairment charges, refer to Note 4. Impairment Charges to our Consolidated Financial Statements.

Interest Expense, net

Interest expense for the six months ended June 30, 2023 and 2022 was $1.6 million. We had a lower outstanding revolving credit facility balance during the six months ended June 30, 2023 compared to the six months ended June 30, 2022, offset by higher interest rates. For additional information on borrowings and interest expense, refer to Note 9. Borrowings to our Consolidated Financial Statements.

Other (Income) Expense, net

Other expense for the six months ended June 30, 2023 was $1.0 million, compared with expense of $1.2 million for the six months ended June 30, 2022, a change of $0.2 million. Expense in 2023 represents unfavorable foreign currency exchange rate impacts, partially offset by the unrealized gains in our investment balances. Expense in 2022 represents an adjustment to pre-spin-off pension obligations and the unrealized losses in our investment balances, partially offset by favorable foreign currency exchange rate impacts.

Provision for Income Taxes and Non-GAAP Provision for Income Taxes

The ETR for the six months ended June 30, 2023 and 2022 was 36.8% and (14.6)%, respectively. The ETR for the six months ended June 30, 2023 and 2022 includes discrete items totaling $0.7 million of tax expense and $1.6 million of benefit, respectively. The discrete items impacting the tax provision for first quarter of 2023 and 2022 are primarily attributable to stock-based compensation. Absent the discrete items, the ETR for the six months ended June 30, 2023 and 2022 was 31.6% and (15.5)%, respectively. The Company accrues taxes in various countries where it generates income and applies a valuation allowance in other jurisdictions, which resulted in the provision for both the six months ended June 30, 2023 and 2022. The change in the ETR was mainly due to the book goodwill impairment recorded in the second quarter of 2022, as well as the mix of earnings and losses by taxing jurisdictions and net discrete items.

The non-GAAP ETR for the six months ended June 30, 2023 and 2022 was 21.1% and 13.4%, respectively. The non-GAAP ETR includes discrete items totaling $0.9 million of tax expense for the six months ended June 30, 2023 and a net discrete benefit totaling $0.4 million for the six months ended June 30, 2022. Absent the discrete items, the non-GAAP ETR for the six months ended June 30, 2023 and 2022 was 18.4% and 13.9%, respectively. The change in the non-GAAP ETR was primarily due to lower pre-tax earnings and the loss of our Malaysian tax holiday.

The ETR and non-GAAP ETR deviate from the statutory U.S. federal income tax rate, mainly due to the taxing jurisdictions where we generate taxable income or loss. As a result of the rapid decline in demand for global consumer electronics during 2022, we did not satisfy all of the conditions of our tax holiday in Malaysia. As such, we are not including this tax holiday benefit in our 2023 GAAP ETR and non-GAAP ETR. For additional information on tax holidays refer to Note 11. Income Taxes to our Consolidated Financial Statements.

Net Earnings (Loss)

Net earnings for the six months ended June 30, 2023 was $8.4 million, compared with a loss of $224.8 million for the six months ended June 30, 2022, an increase of $233.2 million. As described above, the increase is primarily due to impairment charges in the second quarter of 2022 that did not recur in the second quarter of 2023 and lower income tax expense, partially offset by lower gross profit.

Earnings (Loss) and Adjusted Earnings Before Interest and Income Taxes

EBIT for the six months ended June 30, 2023 was $14.9 million, compared with a loss of $194.5 million for the six months ended June 30, 2022, an increase of $209.4 million. EBIT margin for the six months ended June 30, 2023 was 4.7%, compared with (49.9)% for the six months ended June 30, 2022. The change is primarily due to impairment charges recorded in 2022 that did not recur in 2023, partially offset by lower gross profit.

Adjusted earnings before interest and income taxes for the six months ended June 30, 2023 was $35.8 million, compared with $77.0 million for the six months ended June 30, 2022, a decrease of $41.2 million. Adjusted EBIT margin for the six months ended June 30, 2023 was 11.3%, compared with 19.8% for the six months ended June 30, 2022. The decreases were primarily due to lower non-GAAP gross profit.

Diluted Earnings (Loss) per Share and Non-GAAP Diluted Earnings per Share

Diluted earnings per share was $0.09 for the six months ended June 30, 2023, compared with a loss per share of $2.44 for the six months ended June 30, 2022, an increase of $2.53. As described above, the change is primarily due to impairment charges recorded in 2022 that did not recur in 2023, partially offset by lower gross profit.

Non-GAAP diluted earnings per share was $0.28 for the six months ended June 30, 2023, compared with $0.68 for the six months ended June 30, 2022, a decrease of $0.40. As described above, the decrease was primarily due to lower non-GAAP gross profit.

Reconciliation of GAAP Financial Measures to Non-GAAP Financial Measures (1)

(in millions, except per share amounts)

28

(1) In addition to the GAAP financial measures included herein, Knowles has presented certain non-GAAP financial measures that exclude certain amounts that are included in the most directly comparable GAAP measures. Knowles believes that non-GAAP measures are useful as supplements to its GAAP results of operations to evaluate certain aspects of its operations and financial performance, and its management team primarily focuses on non-GAAP items in evaluating Knowles' performance for business planning purposes. Knowles also believes that these measures assist it with comparing its performance between various reporting periods on a consistent basis, as these measures remove from operating results the impact of items that, in Knowles' opinion, do not reflect its core operating performance. Knowles believes that its presentation of non-GAAP financial measures is useful because it provides investors and securities analysts with the same information that Knowles uses internally for purposes of assessing its core operating performance.

(2) In 2023, Other expenses relate to non-recurring professional service fees incurred primarily in the second quarter including an evaluation of restructuring actions. In addition, Other expenses include the ongoing net lease cost related to facilities not used in operations. In 2022, Other expenses represent an adjustment to pre-spin-off pension obligations of $3.4 million, which was recorded during the second quarter of 2022 in Other expense (income), net line on the Consolidated Statements of Earnings, and the ongoing net lease cost related to facilities not used in operations.

(3) Income tax effects of non-GAAP reconciling adjustments are calculated using the applicable tax rates in the jurisdictions of the underlying adjustments.

(4) The non-GAAP reconciling adjustments are those adjustments made to reconcile Earnings (loss) before interest and income taxes to Adjusted earnings before interest and income taxes.

(5) The number of shares used in the diluted per share calculations on a non-GAAP basis excludes the impact of stock-based compensation expense expected to be incurred in future periods and not yet recognized in the financial statements, which would otherwise be assumed to be used to repurchase shares under the GAAP treasury stock method.

Segment Results of Operations for the Three Months Ended June 30, 2023 compared with the Three Months Ended June 30, 2022

The following is a summary of the results of operations of our three reportable segments: Precision Devices, Medtech & Specialty Audio, and Consumer MEMS Microphones.

See Note 15. Segment Information to the Consolidated Financial Statements for (i) a reconciliation of segment revenues to our consolidated revenues and (ii) a reconciliation of segment earnings before interest and income taxes to our consolidated earnings.

Precision Devices

(in millions)

Revenues

PD revenues were $47.8 million for the second quarter of 2023, compared with $59.5 million for the second quarter of 2022, a decrease of $11.7 million or 19.7%. Revenues decreased primarily due to lower demand from the industrial, distribution, and communication markets.

Earnings and Adjusted Earnings Before Interest and Income Taxes

PD EBIT was $4.8 million for the second quarter of 2023, compared with earnings of $11.0 million for the second quarter of 2022, a decrease of $6.2 million. EBIT margin for the second quarter of 2023 was 10.0%, compared to 18.5% for the second quarter of 2022. The decreases were primarily due to lower revenues and lower gross profit margin, partially offset by the absence of adjustments to pre-spin-off pension obligations in 2023. The gross profit margin decrease was primarily driven lower factory capacity utilization.

PD Adjusted EBIT was $7.3 million for the second quarter of 2023, compared with $16.5 million for the second quarter of 2022, a decrease of $9.2 million. Adjusted EBIT margin for the second quarter of 2023 was 15.3%, compared with 27.7% for the second quarter of 2022. The decreases were primarily due to lower revenues and lower non-GAAP gross profit margin. The non-GAAP gross profit margin decrease was primarily driven by lower factory capacity utilization.

MedTech & Specialty Audio

(in millions)

Revenues

MSA revenues were $60.6 million for the second quarter of 2023, compared with $61.6 million for the second quarter of 2022, a decrease of $1.0 million or 1.6%. Revenues decreased primarily due to lower shipping volumes into the hearing health market as customers reduced their inventory levels, partially offset by higher shipping volumes into the premium audio market.

Earnings and Adjusted Earnings Before Interest and Income Taxes

MSA EBIT was $23.6 million for the second quarter of 2023, compared with earnings of $23.1 million for the second quarter of 2022, an increase of $0.5 million or 2.2%. EBIT margin for the second quarter of 2023 was 38.9%, compared with 37.5% for the first quarter of 2022. The increases were primarily due to higher gross profit margins, partially offset by higher operating expenses. The higher gross profit margin was driven by product cost reductions, higher factory capacity utilization, and favorable foreign currency exchange rates.

MSA Adjusted EBIT was $24.4 million for the second quarter of 2023, compared with $23.8 million for the second quarter of 2022, an increase of $0.6 million. Adjusted EBIT margin for the second quarter of 2023 was 40.3%, compared to 38.6% for the second quarter of 2022. The increases were primarily due to higher non-GAAP gross profit margins, partially offset by higher operating expenses. The higher non-GAAP gross profit margin was driven by product cost reductions, higher factory capacity utilization, and favorable foreign currency exchange rates.

Consumer MEMS Microphones

(in millions)

Revenues

CMM revenues were $64.6 million for the second quarter of 2023, compared with $66.9 million for the second quarter of 2022, a decrease of $2.3 million or 3.4%. Revenues decreased primarily due to lower average pricing on mature products, partially offset by higher demand in the ear and IoT markets.

Earnings (Loss) and Adjusted Earnings Before Interest and Income Taxes

CMM EBIT was $6.3 million for the second quarter of 2023, compared with a loss of $239.3 million for the second quarter of 2022, an increase of $245.6 million. The increase was primarily due to impairment charges in the second quarter of 2022 that did not recur in the second quarter of 2023, higher gross profit margins, and lower operating expenses, partially offset by lower revenues. The higher gross profit margin was driven by the gain on sale of fixed assets, benefits of prior year restructuring actions, product cost reductions, and favorable foreign currency exchange rates, partially offset by decreased factory capacity utilization and lower average pricing on mature products shipped into the mobile market.

CMM Adjusted EBIT was $8.4 million for the second quarter of 2023, compared with earnings of $3.7 million for the second quarter of 2022, an increase of $4.7 million. Adjusted EBIT margin for the second quarter of 2023 was 13.0%, compared to 5.5% for the second quarter of 2022. The increases were primarily due to higher non-GAAP gross profit margins and lower non-GAAP operating expenses, partially offset by lower revenues. The higher non-GAAP gross profit margin was driven by the gain on sale of fixed assets, benefits of prior year restructuring actions, product cost reductions, and favorable foreign currency exchange rates, partially offset by decreased factory capacity utilization and lower average pricing on mature products shipped into the mobile market.

Segment Results of Operations for the Six Months Ended June 30, 2023 compared with the Six Months Ended June 30, 2022

Precision Devices

(in millions)

Revenues

PD revenues were $101.5 million for the six months ended June 30, 2023, compared with $115.2 million for the six months ended June 30, 2022, a decrease of $13.7 million or 11.9%. Revenues decreased primarily due to lower demand from the industrial, distribution, and communication markets, partially offset by increased demand in the electric vehicle market.

Earnings and Adjusted Earnings Before Interest and Income Taxes

PD EBIT was $15.5 million for the six months ended June 30, 2023, compared with earnings of $23.3 million for the six months ended June 30, 2022, a decrease of $7.8 million. EBIT margin for the six months ended June 30, 2023 was 15.3%, compared to 20.2% for the six months ended June 30, 2022. The decreases were primarily due to lower revenues, lower gross profit margin, and increased operating expenses, partially offset by the absence of adjustments to pre-spin-off pension obligations in 2023. The gross profit margin decrease was primarily driven by lower factory capacity utilization, partially offset by product cost reductions and a decrease in precious metal costs.

PD Adjusted EBIT was $20.3 million for the six months ended June 30, 2023, compared with $31.0 million for the six months ended June 30, 2022, a decrease of $10.7 million. Adjusted EBIT margin for the six months ended June 30, 2023 was 20.0%, compared with 26.9% for the six months ended June 30, 2022. The decreases were primarily due to lower revenues, lower non-GAAP gross profit margin, and increased non-GAAP operating expenses. The non-GAAP gross profit margin decrease was primarily driven by lower factory capacity utilization, partially offset by product cost reductions and a decrease in precious metal costs.

MedTech & Specialty Audio

(in millions)

Revenues

MSA revenues were $106.1 million for the six months ended June 30, 2023, compared with $121.1 million for the six months ended June 30, 2022, a decrease of $15.0 million or 12.4%. Revenues decreased primarily due to lower shipping volumes into the hearing health market as customers reduced their inventory levels, partially offset by higher shipping volumes into the premium audio market. In addition to lower end market demand, shipping volumes were unfavorably impacted this period by financial incentives offered to customers resulting in higher shipping volumes in the fourth quarter of 2022.

Earnings and Adjusted Earnings Before Interest and Income Taxes

MSA EBIT was $35.0 million for the six months ended June 30, 2023, compared with earnings of $44.8 million for the six months ended June 30, 2022, a decrease of $9.8 million or 21.9%. EBIT margin for the six months ended June 30, 2023 was 33.0%, compared with 37.0% for the six months ended June 30, 2022. The decreases were primarily due to lower revenues, lower gross profit margin, and higher operating expenses. The gross profit margin decrease was primarily driven by unfavorable product mix.

MSA Adjusted EBIT was $36.7 million for the six months ended June 30, 2023, compared with $46.2 million for the six months ended June 30, 2022, a decrease of $9.5 million. Adjusted EBIT margin for the six months ended June 30, 2023 was 34.6%, compared to 38.2% for the six months ended June 30, 2022. The decreases were primarily due to lower revenues, lower gross profit margin, and higher operating expenses. The gross profit margin decrease was primarily driven by unfavorable product mix.

Consumer MEMS Microphones

(in millions)

Revenues

CMM revenues were $109.7 million for the six months ended June 30, 2023, compared with $153.1 million for the six months ended June 30, 2022, a decrease of $43.4 million or 28.3%. Revenues decreased primarily due to lower demand for MEMS microphones in the mobile, IoT, and computing markets. The decreases in these markets were primarily driven by weak global demand for consumer electronics and excess inventory in the supply chain. In addition to lower end market demand, shipping volumes were unfavorably impacted this period by financial incentives offered to customers resulting in higher shipping volumes in the fourth quarter of 2022. Revenues were also impacted by lower average pricing on mature products shipped into the mobile market.

Loss and Adjusted Earnings Before Interest and Income Taxes

CMM loss before interest and income taxes was $1.9 million for the six months ended June 30, 2023, compared with a loss of $238.8 million for the six months ended June 30, 2022, an improvement of $236.9 million. The increase was primarily due to impairment charges in the second quarter of 2022 that did not recur in the second quarter of 2023 and lower operating expenses, partially offset by lower revenues and lower gross profit margins. The lower gross profit margin was driven by decreased factory capacity utilization and lower average pricing on mature products shipped into the mobile market, partially offset by benefits of prior year restructuring actions, the gain on sale of fixed assets, product cost reductions, and favorable foreign currency exchange rates.

CMM Adjusted EBIT was $3.8 million for the six months ended June 30, 2023, compared with $14.6 million for the six months ended June 30, 2022, a decrease of $10.8 million. Adjusted EBIT margin for the six months ended June 30, 2023 was 3.5%, compared to 9.5% for the six months ended June 30, 2022. The decreases were primarily due to lower revenues and non-GAAP gross profit margins, partially offset by lower non-GAAP operating expenses. The lower non-GAAP gross profit margin was driven by decreased factory capacity utilization and lower average pricing on mature products shipped into the mobile market, partially offset by benefits of prior year restructuring actions, the gain on sale of fixed assets, product cost reductions, and favorable foreign currency exchange rates.

Liquidity and Capital Resources

Historically, we have generated and expect to continue to generate positive cash flow from operations. Our ability to fund our operations and capital needs will depend on our ongoing ability to generate cash from operations and access to capital markets. We believe that our future cash flow from operations and access to capital markets will provide adequate resources to fund our working capital needs, capital expenditures, strategic investments, and share repurchases. We have secured a revolving line of credit in the United States from a syndicate of commercial banks to provide additional liquidity. Furthermore, if we were to require additional cash above and beyond our cash on the balance sheet, the free cash flow generated by the business, and availability under our revolving credit facility, we would most likely seek to raise long-term financing through the U.S. debt or bank markets.

Due to the global nature of our operations, a significant portion of our cash is generated and typically held outside the United States. Our cash and cash equivalents totaled $54.4 million and $48.2 million at June 30, 2023 and December 31, 2022, respectively. Of these amounts, cash held by our non-U.S. operations totaled $45.2 million and $40.0 million as of June 30, 2023 and December 31, 2022, respectively. To the extent we repatriate these funds to the U.S., we may be required to pay U.S. state income taxes and applicable foreign withholding taxes on those amounts during the period when such repatriation occurs. Management will continue to reassess our need to repatriate the earnings of our foreign subsidiaries.

On February 8, 2023, we entered into an Amended and Restated Credit Agreement (the "A&R Credit Agreement") that amends and restates the prior Credit Agreement (the "2020 Credit Agreement"), which provides for a senior secured revolving credit facility with borrowings in an aggregate principal amount at any time outstanding not to exceed $400.0 million. As of June 30, 2023, outstanding borrowings under the Credit Facility were $45.0 million. At any time during the term of the Credit Facility, we will be permitted to increase the commitments under the Credit Facility or to establish one or more incremental term loan facilities under the New Credit Facility in an aggregate principal amount not to exceed $200.0 million for all such incremental facilities. Commitments under the Credit Facility will terminate, and loans outstanding thereunder will mature, on February 8, 2028. For additional information, refer to Note 9. Borrowings to our Consolidated Financial Statements.

On February 24, 2020, we announced that our Board of Directors had authorized a share repurchase program of up to $100 million of our common stock. On April 28, 2022, we announced that our Board of Directors had increased the authorization by up to $150 million in additional aggregate value. The timing and amount of any shares repurchased will be determined by us based on our evaluation of market conditions and other factors, and will be made in accordance with applicable securities laws in either the open market or in privately negotiated transactions. We are not obligated to purchase any shares under the program, and the program may be suspended or discontinued at any time. The actual timing, number, and share price of shares repurchased will depend on a number of factors, including the market price of our common stock, general market and economic conditions, and applicable legal requirements. Any shares repurchased will be held as treasury stock. During the six months ended June 30, 2023 and 2022, we repurchased 733,438 shares and 1,249,495 shares of common stock, respectively, for a total of $12.5 million and $25.4 million, respectively.

Cash flows from operating, investing, and financing activities as reflected in our Consolidated Statements of Cash Flows are summarized in the following table:

(in millions)

36

Operating Activities

Cash provided by operating activities adjusts net earnings for certain non-cash items, including impairment charges, depreciation expense, amortization of intangible assets, stock-based compensation, changes in deferred income taxes, and the effects of changes in operating assets and liabilities. The increase in cash provided by operating activities in 2023 as compared to 2022 is primarily due to an improvement in working capital and lower incentive compensation payments in 2023, partially offset by lower net earnings, after adjusting for non-cash expense items. The favorable changes in working capital in 2023 were primarily driven by an increase in accounts payable and a reduction in inventories.

Investing Activities

The cash provided by investing activities during 2023 was primarily driven by proceeds from the sale of certain machinery and equipment. The cash used in investing activities during 2023 and 2022 was primarily driven by cash used for capital expenditures to support product innovation and cost savings.

In 2023, we expect capital expenditures to be in the range of 3% to 4% of revenues.

Financing Activities

Cash used in financing activities during 2023 was primarily related to the $12.5 million of repurchases of common stock, the $6.1 million payment of taxes related to net share settlement of equity awards, and the $1.9 million payment of debt issuance costs, partially offset by proceeds of $1.6 million from the exercise of options. Cash used in financing activities during 2022 was primarily related to the $25.4 million of repurchases of common stock and the $6.2 million payment of taxes related to net share settlement of equity awards, partially offset by proceeds of $6.0 million from the exercise of options.

Contingent Obligations

We are involved in various legal proceedings, claims, and investigations arising in the ordinary course of business. Legal contingencies are discussed in Note 14. Commitments and Contingent Liabilities to our Consolidated Financial Statements.

Critical Accounting Estimates

This discussion and analysis of results of operations and financial condition is based on our Consolidated Financial Statements, which have been prepared in conformity with U.S. GAAP. The preparation of these financial statements requires the use of estimates and assumptions related to the reporting of assets, liabilities, revenues, expenses, and related disclosures. In preparing these financial statements, we have made our best estimates and judgments of certain amounts included in the financial statements. Estimates are revised periodically. Actual results could differ from these estimates.

The information concerning our critical accounting estimates can be found under Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the Securities and Exchange Commission on February 9, 2023. There are no material changes in our previously reported critical accounting estimates.

Recent Accounting Standards

As included in Note 2. Recent Accounting Standards to our Consolidated Financial Statements, there are no recently issued or adopted accounting standards that have had or are expected to have a significant impact on our revenue, earnings, or liquidity.

During the six months ended June 30, 2023, there were no material changes to the information on market risk exposure disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022. For a discussion of our exposure to market risk as of December 31, 2022, refer to Item 7A, Quantitative and Qualitative Disclosures about Market Risk, contained in our Annual Report on Form 10-K for the year ended December 31, 2022.

Evaluation of Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our chief executive officer ("CEO") and chief financial officer ("CFO"), the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the second quarter of 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including the CEO and CFO, do not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, will be detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by intentionally falsified documentation, by collusion of two or more individuals within Knowles or third parties, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

There have been no material changes from the risk factors previously disclosed under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022.