Knowles Corp: Form 10-Q for the period ended Sep 30, 2024

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 high performance electronics for demanding applications, including ceramic capacitors and radio frequency ("RF") filters, advanced medtech microphones, balanced armature speakers, advanced micro-acoustic microphones, and audio solutions, serving the medtech, defense, electric vehicle, industrial, communications, and consumer electronics 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.

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

Recent Developments

On September 18, 2024, we entered into a definitive agreement to sell and assign certain assets and liabilities of the Company’s Consumer MEMS Microphones (“CMM”) business to Syntiant Corp. ("Syntiant") for approximately $150.0 million in total consideration, consisting of $70.0 million in cash, subject to customary working capital and inventory adjustments, and $80.0 million in Syntiant Series D-2 preferred stock, to be issued upon the closing of this transaction. The Company will also share in certain separation costs pursuant to a credit for up to $13.5 million, which Syntiant may apply to specified separation costs post-closing. In addition, the Company has committed to provide, under certain circumstances, up to $15.0 million in financing in connection with Syntiant's obligation to have $40.0 million of cash on the balance sheet, which financing would be junior to Syntiant's debt financing. The consummation of the transaction is not subject to a financing condition, but is subject to customary closing conditions. The transaction is expected to close in the fourth quarter of 2024. For additional information, refer to Note 3. Discontinued Operations to our Consolidated Financial Statements under Part I, Item 1, "Financial Statements."

The CMM divestiture represents a strategic shift that will have a major effect on our operations and financial results. As a result, we have reclassified the results of operations and financial position of CMM to discontinued operations for all periods presented. Unless otherwise noted, discussion within this Quarterly Report to the consolidated financial statements relates to our continuing operations.

This divestiture supports Knowles' continued transformation into an industrial technology company, consisting of its Precision Devices ("PD") and MedTech & Specialty Audio ("MSA") segments, primarily serving the defense, medtech, industrial, and electrification markets. We may incur some amount of dis-synergies following the sale of the CMM business due to the reduced size of our company and, as a result, we may undertake actions to help ensure that our cost structure is appropriate to support our remaining businesses.

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 September 30, 2024 compared with the Three Months Ended September 30, 2023

(in millions, except per share amounts)

Revenues

Revenues for the third quarter of 2024 were $142.5 million, compared with $108.1 million for the third quarter of 2023, an increase of $34.4 million or 31.8%. PD revenues increased $28.6 million due to our acquisition of the CD business. However, our legacy PD business experienced lower demand from the industrial and communication markets as a result of continued demand weakness associated with excess customer and channel inventory, partially offset by higher demand from the defense and medtech markets. MSA revenues increased $5.8 million, primarily due to higher shipping volumes of hearing health products driven by stronger end market demand and higher shipping volumes into the specialty audio market, partially offset by lower average pricing on mature products.

Cost of Goods Sold

Cost of goods sold ("COGS") for the third quarter of 2024 was $79.5 million, compared with $57.5 million for the third quarter of 2023, an increase of $22.0 million or 38.3%. This increase was primarily due to our acquisition of CD and lower factory capacity utilization in our legacy PD business, partially offset by product cost reductions and factory productivity improvements in the legacy PD business.

Restructuring Charges

During the third quarter of 2024, we recorded restructuring charges of $0.1 million within Gross profit for costs associated with transferring certain capacitors manufacturing to existing facilities to further optimize operations, and $0.1 million within Operating expenses related to headcount reductions within the PD segment. For additional information, refer to Note 8. Restructuring and Related Activities to our Consolidated Financial Statements.

During the third quarter of 2023, we recorded restructuring charges of $1.3 million for severance pay and benefits related to headcount reductions within our PD segment and $0.4 million in other charges, primarily in Operating expenses. 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 third quarter of 2024 was $62.9 million, compared with $50.4 million for the third quarter of 2023, an increase of $12.5 million or 24.8%. Gross profit margin (gross profit as a percentage of revenues) for the third quarter of 2024 was 44.1%, compared with 46.6% for the third quarter of 2023. The increase in gross profit was primarily due to our acquisition of CD. The decrease in gross profit margin was primarily due to the impacts of the acquisition of CD. Excluding the impacts of CD, gross profit margins increased primarily due to product cost reductions and factory productivity improvements in our legacy PD business, partially offset by lower factory capacity utilization in our legacy PD business and lower average pricing on mature products in our MSA business.

Non-GAAP gross profit for the third quarter of 2024 was $64.8 million, compared with $50.9 million for the third quarter of 2023, an increase of $13.9 million or 27.3%. Non-GAAP gross profit margin (non-GAAP gross profit as a percentage of revenues) for the third quarter of 2024 was 45.5%, compared with 47.1% for the third quarter of 2023. The increase in non-GAAP gross profit was primarily due to our acquisition of CD. The decrease in non-GAAP gross profit margin was primarily due to the impacts of the acquisition of CD. Excluding the impacts of CD, non-GAAP gross profit margins increased primarily due to product cost reductions and factory productivity improvements in our legacy PD business, partially offset by lower factory capacity utilization in our legacy PD business and lower average pricing on mature products in our MSA business.

Research and Development Expenses

Research and development expenses for the third quarter of 2024 were $10.2 million, compared with $8.1 million for the third quarter of 2023, an increase of $2.1 million or 25.9%. Research and development expenses as a percentage of revenues for the third quarter of 2024 and 2023 were 7.2% and 7.5%, respectively. The increase in expenses was primarily driven by our acquisition of the CD business that increased expenses in our PD segment. The decrease in expenses as a percentage of revenues was driven by our acquisition of the CD business.

Selling and Administrative Expenses

Selling and administrative expenses for the third quarter of 2024 were $33.9 million, compared with $29.4 million for the third quarter of 2023, an increase of $4.5 million or 15.3%. Selling and administrative expenses as a percentage of revenues for the third quarter of 2024 and 2023 were 23.8% and 27.2%, respectively. The increase in expenses was primarily driven by our acquisition of CD, partially offset by lower professional fees and the benefits of PD restructuring actions taken in the prior year. The decrease in expenses as a percentage of revenues was driven by higher revenues.

Interest Expense, net

Interest expense for the third quarter of 2024 was $3.9 million, compared with $0.6 million for the third quarter of 2023, an increase of $3.3 million. The increase is primarily due to imputed interest expense on our Seller Note from the CD acquisition and a higher outstanding revolving credit facility balance during the third quarter of 2024. For additional information on borrowings and interest expense, refer to Note 9. Borrowings to our Consolidated Financial Statements.

Other Expense (Income), net

Other expense for the third quarter of 2024 was $2.6 million, compared with income of $0.5 million for the third quarter of 2023, a change of $3.1 million. Expense in 2024 primarily represents unfavorable foreign currency changes. Income in the third quarter of 2023 represents favorable foreign currency changes.

Provision for (Benefit from) Income Taxes and Non-GAAP Provision for Income Taxes

The effective tax rate ("ETR") from continuing operations for the third quarter of 2024 and 2023 was 24.6% and (34.5)%, respectively. The ETR from continuing operations for the third quarter of 2024 includes discrete items totaling $0.7 million of tax benefit primarily attributable to stock-based compensation and the deferred tax impact of a tax rate change. The ETR from continuing operations for the third quarter of 2023 includes discrete items totaling $0.3 million of tax benefit primarily attributable to stock-based compensation and the recognition of foreign tax credits resulting from the release of IRS Notice 2023-55. Absent the discrete items, the ETR from continuing operations for the third quarter of 2024 and 2023 was 30.3% and (31.9)%, 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 and benefit for the third quarter of 2024 and 2023, respectively. The change in the ETR was mainly due to the impact of intangible property transfers in 2023, the mix of earnings and losses by taxing jurisdictions, and net discrete items.

The non-GAAP ETR from continuing operations for the third quarter of 2024 and 2023 was 7.3% and 21.7%, respectively. The non-GAAP ETR from continuing operations includes discrete items totaling $0.9 million of tax benefit and no discrete impact for the three months ended September 30, 2024 and 2023, respectively. Absent the discrete items, the non-GAAP ETR from continuing operations for the third quarter of 2024 and 2023 was 10.7% and 21.7%, respectively. The change in the non-GAAP ETR was primarily due to increased utilization of foreign tax credits compared to the prior year.

Earnings from Continuing Operations

Earnings from continuing operations for the third quarter of 2024 was $9.2 million, compared with $15.2 million for the third quarter of 2023, a decrease of $6.0 million. As described above, the decrease is primarily due to income tax expense in the third quarter of 2024 compared to a benefit for the third quarter of 2023, along with higher operating expenses, interest expense, and unfavorable foreign currency changes, partially offset by higher gross profit.

Earnings from continuing operations before interest and income taxes ("EBIT") for the third quarter of 2024 was $16.1 million, compared with $11.9 million for the third quarter of 2023, an increase of $4.2 million. EBIT margin (EBIT as a percentage of revenues) for the third quarter of 2024 was 11.3%, compared with 11.0% for the third quarter of 2023. The increase in EBIT was primarily due to higher gross profit, partially offset by higher operating expenses and unfavorable foreign currency changes. The increase in EBIT margin was primarily due to higher gross profit, partially offset by higher operating expenses, the impacts of the acquisition of CD on gross margins, and unfavorable foreign currency changes.

Adjusted earnings before interest and income taxes ("Adjusted EBIT") from continuing operations for the third quarter of 2024 was $30.0 million, compared with $24.6 million for the third quarter of 2023, an increase of $5.4 million. Adjusted EBIT margin (Adjusted EBIT from continuing operations as a percentage of revenues) for the third quarter of 2024 was 21.1%, compared with 22.8% for the third quarter of 2023. The increase in Adjusted EBIT was primarily due to higher non-GAAP gross profit, partially offset by higher non-GAAP operating expenses, and unfavorable foreign currency changes. The decrease in Adjusted EBIT margin was primarily due to higher non-GAAP operating expenses, the impacts of the acquisition of CD on gross margins, and unfavorable foreign currency changes, partially offset by higher gross profit.

(Loss) Earnings from Discontinued Operations, net

Loss from discontinued operations for the third quarter of 2024 was $8.7 million, compared with earnings of $1.4 million for the third quarter of 2023, a decrease of $10.1 million. The change in discontinued operations was primarily driven by our goodwill impairment and loss on disposal of business related to the pending divestiture of CMM, partially offset by favorable income tax changes. For additional information, refer to Note 3. Discontinued Operations to our Consolidated Financial Statements.

Diluted Earnings per Share from Continuing Operations and Non-GAAP Diluted Earnings per Share from Continuing Operations

Diluted earnings per share from continuing operations was $0.10 for the third quarter of 2024, compared with $0.17 for the third quarter of 2023, a decrease of $0.07. As described above, the decrease is primarily due to income tax expense in the third quarter of 2024 compared to a benefit for the third quarter of 2023, along with higher operating expenses, interest expense, and unfavorable foreign currency changes, partially offset by higher gross profit.

Non-GAAP diluted earnings per share from continuing operations was $0.26 for the third quarter of 2024, compared with $0.20 for the third quarter of 2023, an increase of $0.06. As described above, the increase was due to higher non-GAAP gross profit and lower non-GAAP income tax expense, partially offset by higher non-GAAP operating expenses, interest expense, and unfavorable foreign currency changes.

Results of Operations for the Nine Months Ended September 30, 2024 compared with the Nine Months Ended September 30, 2023

(in millions, except per share amounts)

30

Revenues

Revenues for the nine months ended September 30, 2024 were $411.0 million, compared with $317.6 million for the nine months ended September 30, 2023, an increase of $93.4 million or 29.4%. PD revenues increased $75.5 million due to our acquisition of the CD business, partially offset by lower demand from the industrial and communication markets in our legacy PD business as a result of continued demand weakness associated with excess customer and channel inventory. MSA revenues increased $17.9 million, primarily due to higher shipping volumes of hearing health products driven by stronger end market demand, partially offset by lower shipping volumes into the specialty audio market and lower average pricing on mature products. In addition, revenues in the nine months ended September 30, 2023 were unfavorably impacted by financial incentives offered to customers in the fourth quarter of 2022, which resulted in higher shipping volumes in the fourth quarter of 2022 and lower revenues in the first quarter of 2023.

Cost of Goods Sold

COGS for the nine months ended September 30, 2024 was $235.7 million, compared with $172.2 million for the nine months ended September 30, 2023, an increase of $63.5 million or 36.9%. This increase was primarily due to our acquisition of CD, lower factory capacity utilization in our legacy PD business, partially offset by product cost reductions and favorable MSA product mix.

Restructuring Charges

During the nine months ended September 30, 2024, we recorded restructuring charges of $1.8 million related to headcount reductions and $1.1 million for costs associated with transferring certain capacitors manufacturing to existing facilities to further optimize operations within our PD segment. These actions resulted in restructuring charges of $1.4 million within Gross profit and $1.5 million within Operating expenses. For additional information, refer to Note 8. Restructuring and Related Activities to our Consolidated Financial Statements.

During the nine months ended September 30, 2023, we recorded restructuring charges of $0.2 million within Gross profit and $1.1 million within Operating expenses for severance pay and benefits related to headcount reductions within our PD segment, and $0.7 million for other costs. 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 nine months ended September 30, 2024 was $173.9 million, compared with $145.2 million for the nine months ended September 30, 2023, an increase of $28.7 million or 19.8%. Gross profit margin for the nine months ended September 30, 2024 was 42.3%, compared with 45.7% for the nine months ended September 30, 2023. The increase in gross profit was primarily due to our acquisition of CD, product cost reductions, higher shipping volumes, and favorable MSA product mix, partially offset by lower factory capacity utilization in our legacy PD business, production transfer costs, the amortization of fair value adjustments to inventory for the CD acquisition, and lower average pricing on mature products in our MSA business. The decrease in gross profit margin was primarily due to impacts of the acquisition of CD. Excluding the impacts of CD, gross profit margins increased primarily due to product cost reductions and favorable MSA product mix, partially offset by lower factory capacity utilization in our legacy PD business, production transfer costs, the amortization of fair value adjustments to inventory for the CD acquisition, and lower average pricing on mature products in our MSA business.

Non-GAAP gross profit for the nine months ended September 30, 2024 was $182.5 million, compared with $146.7 million for the nine months ended September 30, 2023, an increase of $35.8 million or 24.4%. Non-GAAP gross profit margin for the nine months ended September 30, 2024 was 44.4%, compared with 46.2% for the nine months ended September 30, 2023. The increase in non-GAAP gross profit was primarily due to our acquisition of CD, product cost reductions, higher shipping volumes, and favorable MSA product mix, partially offset by lower factory capacity utilization in our legacy PD business and lower average pricing on mature products in our MSA business. The decrease in non-GAAP gross profit margin was primarily due to impacts of the acquisition of CD. Excluding the impacts of CD, non-GAAP gross profit margins increased primarily due to product cost reductions and favorable MSA product mix, partially offset by lower factory capacity utilization in our legacy PD business and lower average pricing on mature products in our MSA business.

Research and Development Expenses

Research and development expenses for the nine months ended September 30, 2024 were $29.2 million, compared with $24.0 million for the nine months ended September 30, 2023, an increase of $5.2 million or 21.7%. Research and development expenses as a percentage of revenues for the nine months ended September 30, 2024 and 2023 were 7.1% and 7.6%, respectively. The increase in expenses was primarily driven by our acquisition of the CD business, which increased expenses in our PD segment. The decrease in expenses as a percentage of revenues was driven by our acquisition of the CD business.

Selling and Administrative Expenses

Selling and administrative expenses for the nine months ended September 30, 2024 were $106.8 million, compared with $87.3 million for the nine months ended September 30, 2023, an increase of $19.5 million or 22.3%. Selling and administrative expenses as a percentage of revenues for the nine months ended September 30, 2024 and 2023 were 26.0% and 27.5%, respectively. The increase in expenses was primarily driven by our acquisition of CD, partially offset by lower professional fees and the benefits of PD restructuring actions taken in the prior year. The decrease in expenses as a percentage of revenues was driven by higher revenues.

Interest Expense, net

Interest expense for the nine months ended September 30, 2024 was $12.9 million, compared with $2.2 million for the nine months ended September 30, 2023, an increase of $10.7 million. The increase is primarily due to imputed interest expense on our Seller Note from the CD acquisition and a higher outstanding revolving credit facility balance during the nine months ended September 30, 2024. For additional information on borrowings and interest expense, refer to Note 9. Borrowings to our Consolidated Financial Statements.

Other Expense, net

Other expense for the nine months ended September 30, 2024 was $2.5 million, compared with $0.5 million for the nine months ended September 30, 2023, a change of $2.0 million. The change is primarily due to unfavorable foreign currency exchange rate changes.

Provision for (Benefit from) Income Taxes and Non-GAAP Provision for Income Taxes

The ETR from continuing operations for the nine months ended September 30, 2024 and 2023 was 38.1% and (32.7)%, respectively. The ETR from continuing operations for the nine months ended September 30, 2024 and 2023 includes discrete items totaling $0.3 million of tax benefit and $0.3 million of tax expense, respectively. The discrete items impacting the tax provision for the nine months ended September 30, 2024 are primarily attributable to stock-based compensation and the deferred tax impact of a tax rate change. The ETR from continuing operations for the nine months ended September 30, 2023 includes discrete items totaling $0.3 million of tax expense primarily attributable to stock-based compensation and the recognition of foreign tax credits resulting from the release of IRS Notice 2023-55 Absent the discrete items, the ETR from continuing operations for the nine months ended September 30, 2024 and 2023 was 39.5% and (33.7)%, 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 and benefit for the nine months ended September 30, 2024 and 2023, respectively. The change in the ETR was mainly due to the impact of intangible property transfers in 2023, the mix of earnings and losses by taxing jurisdictions, and net discrete items.

The non-GAAP ETR from continuing operations for the nine months ended September 30, 2024 and 2023 was 9.1% and 23.0%, respectively. The non-GAAP ETR from continuing operations includes discrete items totaling $0.9 million of a tax benefit and $0.9 million of tax expense for the nine months ended September 30, 2024 and 2023, respectively. Absent the discrete items, the non-GAAP ETR from continuing operations for the nine months ended September 30, 2024 and 2023 was 10.5% and 21.5%, respectively. The change in the non-GAAP ETR was primarily due to increased utilization of foreign tax credits compared to the prior year.

Earnings from Continuing Operations

Earnings from continuing operations for the nine months ended September 30, 2024 was $13.0 million, compared with $39.0 million for the nine months ended September 30, 2023, a decrease of $26.0 million. As described above, the decrease is primarily due to higher operating expenses, income tax expense in 2024 compared to a benefit in 2023, higher interest expense, and unfavorable foreign currency exchange rate changes, partially offset by higher gross profit.

EBIT from continuing operations for the nine months ended September 30, 2024 was $33.9 million, compared with $31.6 million for the nine months ended September 30, 2023, an increase of $2.3 million. EBIT margin for the nine months ended September 30, 2024 was 8.2%, compared with 9.9% for the nine months ended September 30, 2023. The increase in EBIT is primarily due to higher gross profit, partially offset by higher operating expenses and unfavorable foreign currency exchange rate changes. The decrease in EBIT margin is primarily due to higher operating expenses, impacts of the acquisition of CD on gross margins, and unfavorable foreign currency exchange rate changes, partially offset by higher gross profit.

Adjusted EBIT from continuing operations for the nine months ended September 30, 2024 was $78.5 million, compared with $59.5 million for the nine months ended September 30, 2023, an increase of $19.0 million. Adjusted EBIT margin for the nine months ended September 30, 2024 was 19.1%, compared with 18.7% for the nine months ended September 30, 2023. The increase in Adjusted EBIT is primarily due to higher non-GAAP gross profit, partially offset by higher non-GAAP operating expenses and unfavorable foreign currency exchange rate changes. The increase in Adjusted EBIT margin was primarily due to higher non-GAAP gross profit, partially offset by higher non-GAAP operating expenses, impacts of the acquisition of CD on gross margins, and unfavorable foreign currency changes.

(Loss) Earnings from Discontinued Operations, net

Loss from discontinued operations for the nine months ended September 30, 2024 was $269.3 million, compared with a loss of $14.0 million for the nine months ended September 30, 2023. The change in discontinued operations was primarily driven by our goodwill impairment and loss on disposal of business related to the pending divestiture of CMM, partially offset by favorable income tax changes. For additional information, refer to Note 3. Discontinued Operations to our Consolidated Financial Statements.

Diluted Earnings per Share from Continuing Operations and Non-GAAP Diluted Earnings per Share from Continuing Operations

Diluted earnings per share was $0.14 for the nine months ended September 30, 2024, compared with $0.42 for the nine months ended September 30, 2023, a decrease of $0.28. As described above, the decrease is primarily due to higher operating expenses, income tax expense in 2024 compared to a benefit in 2023, higher interest expense, and unfavorable foreign currency exchange rate changes, partially offset by higher gross profit.

Non-GAAP diluted earnings per share was $0.64 for the nine months ended September 30, 2024, compared with $0.47 for the nine months ended September 30, 2023, an increase of $0.17. As described above, the increase was primarily due to higher non-GAAP gross profit, partially offset by higher non-GAAP operating expenses, interest expense, and unfavorable foreign currency exchange rate changes.

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

(in millions, except per share amounts)

34

(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) Production transfer costs represent duplicate costs incurred to migrate manufacturing to facilities primarily within the United States. These amounts are included in the corresponding Gross profit and Earnings from continuing operations before interest and income taxes for each period presented.

(3) These expenses are related to the acquisition of CD by the PD segment. These expenses include ongoing costs to facilitate integration, the amortization of fair value adjustments to inventory, and costs incurred by the Company to carry out this transaction.

(4) Other expenses include non-recurring professional service fees related to an execution of various reorganization projects, foreign currency exchange rate impacts on restructuring balances, and the ongoing net lease cost (income) related to facilities not used in operations.

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

(6) The non-GAAP reconciling adjustments are those adjustments made to reconcile Earnings from continuing operations before interest and income taxes to Adjusted earnings from continuing operations before interest and income taxes.

(7) 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 September 30, 2024 compared with the Three Months Ended September 30, 2023

The following is a summary of the results of operations of our two reportable segments: Precision Devices and Medtech & Specialty Audio.

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 from continuing operations before interest and income taxes to our consolidated earnings from continuing operations.

Precision Devices

(in millions)

Revenues

PD revenues were $78.8 million for the third quarter of 2024, compared with $50.2 million for the third quarter of 2023, an increase of $28.6 million or 57.0%. Revenues increased due to our acquisition of the CD business. In addition, our legacy PD business experienced lower demand from the industrial and communication markets as a result of continued demand weakness associated with excess customer and channel inventory, partially offset by higher demand from the defense and medtech markets.

PD EBIT was $8.4 million for the third quarter of 2024, compared with $6.1 million for the third quarter of 2023, an increase of $2.3 million. EBIT margin for the third quarter of 2024 was 10.7%, compared to 12.2% for the third quarter of 2023. The increase in EBIT is primarily due to higher gross profit, partially offset by higher operating expenses. The increase in operating expenses was primarily driven by the acquisition of the CD business, which includes higher intangible amortization expenses of $2.7 million. The gross profit increase was primarily driven by our acquisition of CD, partially offset by lower gross profit margins. The lower gross profit margins were primarily impacted by the acquisition of CD. Excluding the impacts of CD, gross profit margins increased primarily due to product cost reductions and factory productivity improvements, partially offset by lower factory capacity utilization.

PD Adjusted EBIT was $16.1 million for the third quarter of 2024, compared with $9.7 million for the third quarter of 2023, an increase of $6.4 million. Adjusted EBIT margin for the third quarter of 2024 was 20.4%, compared with 19.3% for the third quarter of 2023. The increases were primarily due to higher non-GAAP gross profit, partially offset by increased non-GAAP operating expenses. The non-GAAP gross profit increase was primarily driven by our acquisition of CD, partially offset by lower non-GAAP gross profit margins. The lower non-GAAP gross profit margins were primarily impacted by the acquisition of CD. Excluding the impacts of CD, non-GAAP gross profit margins increased primarily due to product cost reductions and factory productivity improvements, partially offset by lower factory capacity utilization.

MedTech & Specialty Audio

(in millions)

Revenues

MSA revenues were $63.7 million for the third quarter of 2024, compared with $57.9 million for the third quarter of 2023, an increase of $5.8 million or 10.0%. Revenues increased primarily higher due to higher shipping volumes of hearing health products driven by stronger end market demand and higher shipping volumes into the specialty audio market, partially offset by lower average pricing on mature products.

MSA EBIT was $25.0 million for the third quarter of 2024, compared with $22.3 million for the third quarter of 2023, an increase of $2.7 million or 12.1%. EBIT margin for the third quarter of 2024 was 39.2%, compared with 38.5% for the third quarter of 2023. The increase in EBIT is primarily due to higher gross profit, driven by higher shipping volumes. The increase in EBIT margin is primarily due to improved operating leverage, partially offset by lower gross profit margins driven by lower average pricing on mature products and unfavorable product mix.

MSA Adjusted EBIT was $26.1 million for the third quarter of 2024, compared with $23.2 million for the third quarter of 2023, an increase of $2.9 million. Adjusted EBIT margin for the third quarter of 2024 was 41.0%, compared to 40.1% for the third quarter of 2023. The increase in Adjusted EBIT is primarily due to higher non-GAAP gross profit, driven by higher shipping volumes. The higher adjusted EBIT margin is primarily due to improved operating leverage, partially offset by lower non-GAAP gross profit margins driven by lower average pricing on mature products and unfavorable product mix.

Segment Results of Operations for the Nine Months Ended September 30, 2024 compared with the Nine Months Ended September 30, 2023

Precision Devices

(in millions)

Revenues

PD revenues were $227.2 million for the nine months ended September 30, 2024, compared with $151.7 million for the nine months ended September 30, 2023, an increase of $75.5 million or 49.8%. Revenues increased due to our acquisition of the CD business, partially offset by lower demand from the industrial and communication markets in our legacy PD business as a result of continued demand weakness associated with excess customer and channel inventory.

PD EBIT was $10.5 million for the nine months ended September 30, 2024, compared with $21.6 million for the nine months ended September 30, 2023, a decrease of $11.1 million. EBIT margin for the nine months ended September 30, 2024 was 4.6%, compared to 14.2% for the nine months ended September 30, 2023. The decreases were primarily due to increased operating expenses, partially offset by higher gross profit. The increase in operating expenses was primarily driven by the acquisition of the CD business, which includes higher intangible amortization expenses of $8.5 million. The gross profit increase was primarily driven by our acquisition of CD, partially offset by lower gross profit margins. The lower gross profit margins were impacted by lower factory capacity utilization in our legacy PD business, the acquisition of CD, production transfer costs, and the amortization of fair value adjustments to inventory for the CD acquisition, partially offset by product cost reductions and factory productivity improvements in our legacy PD business.

PD Adjusted EBIT was $37.7 million for the nine months ended September 30, 2024, compared with $30.0 million for the nine months ended September 30, 2023, an increase of $7.7 million. Adjusted EBIT margin for the nine months ended September 30, 2024 was 16.6%, compared with 19.8% for the nine months ended September 30, 2023. The increase in Adjusted EBIT was primarily due to higher non-GAAP gross profit, partially offset by higher non-GAAP operating expenses and lower non-GAAP gross profit margins. The decrease in adjusted EBIT margin was primarily due to higher non-GAAP operating expenses and lower non-GAAP gross profit margins. The increase in operating expenses was primarily driven by the acquisition of the CD business. The lower non-GAAP gross profit margins were impacted by the acquisition of CD and lower factory capacity utilization in our legacy PD business, partially offset by product cost reductions and factory productivity improvements in our legacy PD business.

MedTech & Specialty Audio

(in millions)

Revenues

MSA revenues were $183.8 million for the nine months ended September 30, 2024, compared with $165.9 million for the nine months ended September 30, 2023, an increase of $17.9 million or 10.8%. Revenues increased primarily due to higher shipping volumes of hearing health products driven by stronger end market demand, partially offset by lower shipping volumes into the specialty audio market and lower average pricing on mature products. In addition, revenues in the nine months ended September 30, 2023 were unfavorably impacted by financial incentives offered to customers in the fourth quarter of 2022, which resulted in higher shipping volumes in the fourth quarter of 2022 and lower revenues in the first quarter of 2023.

MSA EBIT was $71.9 million for the nine months ended September 30, 2024, compared with $57.4 million for the nine months ended September 30, 2023, an increase of $14.5 million or 25.3%. EBIT margin for the nine months ended September 30, 2024 was 39.1%, compared with 34.6% for the nine months ended September 30, 2023. The increases were primarily due to due to improved operating leverage, including the impacts of higher gross profit margins driven by favorable product mix, foreign currency changes, and product cost reductions, partially offset by lower average pricing on mature products.

MSA Adjusted EBIT was $75.0 million for the nine months ended September 30, 2024, compared with $60.0 million for the nine months ended September 30, 2023, an increase of $15.0 million. Adjusted EBIT margin for the nine months ended September 30, 2024 was 40.8%, compared to 36.2% for the nine months ended September 30, 2023. The increases were primarily due to improved operating leverage, including the impacts of higher non-GAAP gross profit margin driven by favorable product mix, favorable foreign currency changes, and product cost reductions, partially offset by lower average pricing on mature products.

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 portion of our cash is generated and typically held outside the United States. Our cash and cash equivalents totaled $92.6 million and $87.3 million at September 30, 2024 and December 31, 2023, respectively. Of these amounts, cash held by our non-U.S. operations totaled $32.7 million and $71.8 million as of September 30, 2024 and December 31, 2023, 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. We expect to reduce our cash balance in the second half of the year, primarily driven by the payment of the Seller Note related to the CD acquisition and debt reduction, partially offset by cash generated from operations.

On September 18, 2024, we entered into a definitive agreement to sell our CMM business for $150.0 million. For additional information, refer to Note 3. Discontinued Operations to our Consolidated Financial Statements. On June 17, 2024 in anticipation of the CMM transaction, we entered into a Consent Memorandum with the administrative agent and our lenders under the A&R Credit Agreement (as defined below) regarding consents to certain conditions applicable to disposition of assets. For additional information refer to Note 9. Borrowings.

On November 1, 2023, we acquired (i) all the issued and outstanding shares of Kaplan Electronics, Inc. and (ii) certain assets of Cornell Dubilier Electronics, Inc. and CD Aero, LLC (collectively, "Cornell Dubilier" or "CD") for aggregate consideration of $259.8 million, which equated to a total fair value of consideration transferred of $246.8 million. This acquisition's operations are included in the PD segment. For additional information, refer to Note 4. Acquisition to our Consolidated Financial Statements.

On September 25, 2023, the Company amended its Amended and Restated Credit Agreement (the "A&R Credit Agreement") to, among other things, (a) permit the Company in connection with the acquisition of Cornell Dubilier, to incur senior priority seller financing indebtedness (the “Seller Note”) in an aggregate principal amount of $122.9 million secured by certain assets (including equity interests) acquired in connection with such acquisition and the capital stock of Cornell Dubilier, LLC (the “Acquisition Assets”), which shall mature two years after the effective date of such Seller Note (the “Seller Note Maturity Date”), (b) extends the requirement to pledge the Acquisition Assets that would otherwise constitute collateral under the Credit Agreement to the date that is 90 days after the Seller Note Maturity Date, and (c) restricts, until the Seller Note Maturity Date, the amount of dispositions and investments from the Company and certain of its subsidiaries into Cornell Dubilier, LLC and the acquired subsidiaries that constitute Acquisition Assets from exceeding $80.0 million the aggregate. All other terms remain the same as the A&R Credit Agreement dated February 8, 2023.

On February 8, 2023, we entered into 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 September 30, 2024, outstanding borrowings under the Credit Facility were $108.0 million. At any time during the term of the Credit Facility, we will be permitted to request an increase to the commitments under the Credit Facility to establish one or more incremental term loans or revolving credit facilities 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 $100.0 million of our common stock. On April 28, 2022, we announced that our Board of Directors had increased the authorization by up to $150.0 million in additional aggregate value. At September 30, 2024, we have $68.2 million remaining that may yet be repurchased under our share repurchase program. 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 nine months ended September 30, 2024 and 2023, the Company repurchased 1,686,253 and 1,630,161 shares of common stock, respectively, for a total of $29.5 million and of $27.5 million, respectively.

Cash flows from operating, investing, and financing activities as reflected in our Consolidated Statements of Cash Flows and are presented on a consolidated basis, including discontinued operations. Cash flows are summarized in the following table:

(in millions)

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. Excluding non-cash items, the increase in cash provided by operating activities in 2024 is primarily due to an increase in net earnings driven by higher revenues and gross profit. The increase was partially offset by higher restructuring and incentive compensation payments in 2024.

Investing Activities

The cash used in investing activities during 2024 was primarily driven by capital expenditures, which were lower in 2024 as compared to 2023, offset by proceeds from the sale of intellectual property. The cash provided by investing activities during 2023 was primarily driven by proceeds from the sale of certain machinery and equipment, partially offset by capital expenditures to support product innovation and cost savings.

In 2024, we expect capital expenditures to be in the range of 2.0% to 3.0% of revenues.

Financing Activities

Cash used in financing activities during 2024 was primarily related to the $29.5 million of repurchases of common stock, the $52.0 million net payments on the revolving credit facility, the $6.4 million payment of taxes related to net share settlement of equity awards, and partially offset by proceeds of $2.1 million from the exercise of options. Cash used in financing activities during 2023 was primarily related to the $27.5 million of repurchases of common stock, the $6.2 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.

Adjusted Free Cash Flow

In addition to measuring cash flow generation based on the operating, investing, and financing classifications included in the Consolidated Statement of Cash Flows (including discontinued operations), Knowles also measures adjusted free cash flow and adjusted free cash flow as a percentage of revenues. Adjusted free cash flow is defined as non-GAAP net cash attributable to continuing operations less non-GAAP capital expenditures attributable to continuing operations. Non-GAAP net cash attributable to continuing operations is defined as net cash provided by operating activities less amounts attributable to discontinued operations. Non-GAAP capital expenditures attributable to continuing operations is defined as capital expenditures less amounts attributable to discontinued operations. Knowles believes these measures are helpful in measuring its cash generated from its continuing operations that is available to repay debt, fund acquisitions, and repurchase Knowles common stock. Adjusted free cash flow and adjusted free cash flow as a percentage of revenues are not presented in accordance with GAAP and may not be comparable to similarly titled measures used by other companies in our industry. As such, adjusted free cash flow and adjusted free cash flow as a percentage of revenues should not be considered in isolation from, or as an alternative to, any other liquidity measures determined in accordance with GAAP.

The following table reconciles our adjusted free cash flow to cash flow provided by operating activities:

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, 2023 filed with the Securities and Exchange Commission on February 21, 2024. There are no material changes in our previously reported critical accounting estimates.

Recent Accounting Standards

The issuance of recent accounting standards, as included in Note 2. Recent Accounting Standards to our Consolidated Financial Statements, is not expected to have a significant impact on our revenue, earnings, or liquidity.

During the nine months ended September 30, 2024, 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, 2023. For a discussion of our exposure to market risk as of December 31, 2023, 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, 2023.

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 third quarter of 2024 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The Company is in the process of reviewing the internal control structure of an acquired business and, if necessary, will make appropriate changes as we incorporate our controls and procedures into the recently acquired business.

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, 2023, other than as set forth below.

If we are unsuccessful in implementing our divestment strategy for the CMM business our business and financial results may be adversely affected.

The planned strategic divestiture of our CMM business involves significant risks and uncertainties, some of which are beyond our control. The occurrence of an event, change, or other circumstance, such as various closing conditions associated with the transaction not being satisfied or waived, could give rise to the transaction terminating or a delay in consummation. Similarly, failure to obtain, delays in obtaining, or adverse conditions contained in, regulatory or other required approvals, could impact the timing and certainty of consummation. Further, we may encounter unanticipated difficulties or expenditures relating to the transaction, such as legal proceedings that may be instituted against the Company and others. The divestiture of CMM may also result in disruptions to our ongoing business due to, for example, challenges associated with the separation of business infrastructure, difficulties in employee retention, and the response of customers, distributors, suppliers and competitors.