Knowles Corporation

Again, press the star and 1. I would now like to turn the call over to Vice President of Investor Relations, Patton Hofer.

Thank you, Kayla, and welcome to our Q3 2023 earnings call. I'm Patton Hofer, Vice President of Investor Relations, and presenting with me on the call today are Jeffrey New, our President and CEO, and John Anderson, our Senior Vice President and CFO. Our call today will include remarks about future expectations, plans, and prospects for NOLS, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal securities law. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses, and profits, and involve a number of risks and uncertainties that can cause actual results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings, including but not limited to a report on Form 10-K for the fiscal year ended December 31, 2022, periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today's earnings release. All forward-looking statements are made as of the date of this call, and NOLS disclaims any duty to update such statements except as required by law. In addition, pursuant to Reg. G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at NOLS.com. and in our current report on Form 8-K filed today with the SEC, including a reconciliation to the most directly comparable GAAP measures. All financial references on this call will be on a non-GAAP continuing operations basis unless otherwise indicated. Also, we've made selected financial information available in webcast slides, which can be found in the investor relations section of our website. With that, let me turn the call over to Jeff, who will provide some details on our results. Jeff? Thanks, Patton, and thanks to all of you for joining us today.

Those delivered solid third quarter results with earnings and cash flow above our expectations. Revenue of $175 million was in line with guidance, while adjusted EBIT margins of 21%, EPS of $0.31, and cash from operations of $40 million finished above the high end of our guidance ranges. In Q3, we took strategic actions to advance our transformation into an industrial technology company by announcing the acquisition of a Cornell Doublier and the exploration of strategic alternatives for our consumer MEMS microphone business. These actions reflect our ongoing efforts to increase exposure to high-growth markets and higher-value opportunities. The Cornell W8 acquisition, which was successfully completed yesterday, bolsters our precision device segment and is a testament to our commitment to growth, innovation, and delivering greater value to shareholders. This transaction significantly expands our serviceable available market through CDs capacitor offerings and will enable us to deliver a wider portfolio of products and solutions to both existing and new customers. CDs and markets are aligned with key growth tailwinds, including increasing defense budgets, med tech, and critical care application growth. They're also well positioned in industrial electrification, clean energy, and the implementation of next generation fast charging architectures. We are thrilled to welcome Cornell AA's talented employees to NOLS and look forward to realizing the tremendous benefits of this transaction for our customers and our shareholders. The acquisition is expected to be accretive to our EPS in 2024. Importantly, we continue to have a strong balance sheet allowing us to focus on balancing organic investment in R&D and CapEx with accretive M&A while continuing to return cash to shareholders through share repurchases. While we won't be getting into the specifics today relative to the exploration of strategic alternatives of the Consumer Mems My Business, what I will say is the process is progressing. Turning to segment results, Precision Advice's Q3 revenue improved sequentially and was down 22% from the prior year. Demand weakness associated with XX channel inventory continued in Q3, leading to low manufacturing capacity utilization. Demand has improved since Q2, and we are encouraged by the positive ordering trends in PD as book-to-bill finished above 1 for the first time in six quarters. We expect orders to continue to rebound in Q4, which gives us confidence in a return to growth in 2024. In MedTech and specialty audio, revenue was up 20% versus the prior year, and market demand remains resilient. Based on our projected sequential growth and strong execution over the quarter, we believe we are past the inventory correction we experienced in the first half of 23. We remain confident in our ability to grow MSA in 2024. In the consumer MEMS microphone business, revenue was up 2% from last year and earnings were slightly better than expected as consumer electronics markets have stabilized and demand for non-mobile products grew year over year. We expect Q4 will be the strongest quarter for CMM this year, including the highest quarter for mobile shipments driven by timing of customer product launches and improved share of position. To summarize briefly, MSA continues to perform well and we expect another strong quarter in Q4 with solid momentum heading into 2024. In PD, ordering trends have improved, but due to timing of the recovery, margins continue to be impacted by low-capacity dualization. With the robust secular trends in defense, medtech, and EV markets, complemented by the Cornell AA acquisition, we believe we are well-positioned for return to growth in PD. For CMM, consumer electronics markets have stabilized, and we expect second-half revenues to be up year-over-year. Q4 is expected to be the peak quarter for the year, driven by strong shipments of to mobile. We expect 2024 to benefit from the improving market trends and for CMM to return to full year revenue growth. While 2023 has been a challenging year, we are performing well in the second half. On the last earnings call, we laid out a target of 19% adjusted EBIT margins for the second half. Excluding Cornell Doublier, we expect to achieve that target. Although there has been some shift in earnings between Q3 and Q4, our second half EPS is expected to be in line with our previous expectations. As we enter the next phase of our transformation into an industrial technology company, I am confident the strategic actions we've taken will drive long-term shareholder value. Before I turn it over to John, I want to highlight the change in our guidance metrics starting in the fourth quarter. We will be providing revenue, EPS, and cash from operations guidance which is inclusive of the Cornell WBA acquisition. We believe these metrics are the best measure for our business and are aligned to the company's focus. Now let me turn the call over to John to detail our quarterly results and guidance.

John? Thanks, Jeff. We reported third quarter revenues of $175 million in line with guidance and down 2% from the year-ago period driven by lower shipments and precision devices. The precision device segment delivered revenues of $50 million, down 22% from the prior year, driven by continued weak demand associated with excess channel inventory in industrial and distribution end markets and timing of shipments into the defense market. Bookings in the quarter were $58 million, resulting in a book-to-bill ratio of 1.2 for Q3. In the MedTech and specialty audio segment, revenue was $57 million, up 20% versus the prior year, as demand has returned to more normalized levels. Consumer MEMS microphone revenues of $68 million were up 2% versus the prior year, driven by higher shipments into non-mobile applications. Third quarter gross margins were 44.6%, 110 basis points above the high end of our guidance range and up 610 basis points from the same period a year ago. Precision devices segment gross margins were 40.4%, down 710 basis points from the prior year due to lower factory capacity utilization. MedTech and specialty audio segment gross margins were 54.9%, up 700 basis points versus the prior year, driven by factory productivity improvements, favorable product mix, and the favorable impact of foreign exchange rate changes. Consumer MEMS microphones delivered gross margins of 39.9%, up nearly 16 percentage points versus the prior year, driven by a gain on the sale of assets, lower factory costs, favorable product mix, and higher factory capacity utilization, partially offset by price reductions in the smartphone market. R&D expense in the quarter was $17 million, up $1 million from the prior year, driven by higher incentive compensation costs and timing of materials spent, partially offset by reduced spending in our CMM segment, driven by the benefits of prior year restructuring actions, as we continue to shift our focus and spending to our higher margin businesses. SG&A expenses were $25 million, $1 million lower than prior year levels, driven by lower sales commissions and incentive compensation costs in precision devices, partially offset by higher professional and legal fees associated with the exploration of strategic alternatives for CMM. For the quarter, adjusted even margin was 21%, 520 basis points above prior year levels, and 100 basis points above the high end of our guidance range. BPFs was 31 cents in the quarter, 6 cents above prior year levels, and 1 cent above the high end of our guidance range. Now, I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $75 million at the end of the third quarter. We generated cash from operations of $40 million above the high end of our guidance range, driven by higher adjusted EBITDA and lower net working capital. Capital spending was $4 million in the quarter and we repurchased approximately 900,000 shares at a total cost of $15 million. We ended the quarter with cash, net of outstanding bank borrowings of $30 million. As Jeff mentioned, future guidance will be provided for revenue, EPFs, and cash from operations. We believe these financial metrics align best with our long-term strategic focus and are the best measure for our business as we transition to an industrial technology company. We expect to hold a virtual investor day to provide updates to our mid-term financial targets, capital allocation, addressable markets, and long-term strategy shortly after the completion of our evaluation of strategic alternatives relating to the CMM segment. Moving to our guidance for the fourth quarter, which includes the Cornell Dublier acquisition, which closed yesterday. Revenues are expected to be between $210 and $220 million, up 9% versus the same period a year ago. We're projecting EPS to be within a range of $0.27 to $0.31 per share. This assumes weighted average shares outstanding during the quarter of $93 million on a fully diluted basis. We're projecting cash from operations to range from $40 to $50 million, and capital spending is expected to be $5 million. We expect to exit 2023 with approximately $80 million of cash and $286 million of debt, which includes $175 million of borrowings under a revolving credit facility and an interest-free seller note, which was issued in connection with the Cornell Dublier acquisition. We expect to have a net leverage ratio of approximately 1.4 as we exit 2023. I'll now turn the call back over to the operator for questions and answers portion of the call. Operator?

And at this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. Our first question comes from the line of Bob Labick with CJS Securities. Your line is open.

Good afternoon. Thanks for taking our questions. Wanted to start, I guess, just with guidance, since you just kind of ended there. Could you give us a sense of what's included in that guidance from CD? I guess it's two months, given that it closed yesterday. We just want to confirm that and maybe give us a sense of what the revenue contribution is there.

Yeah, Bob. Obviously, our intent is not to guide by the segment going forward, but I think Obviously, with the period, we don't own it the whole quarter. It's about two months. We're expecting roughly about $20 million in revenue from Cordell Dublier.

Okay, great. And then, I mean, it just closed, obviously. Give us a sense of kind of the integration process and timing. And I know when you purchased it, you mentioned that their margins are lower than your PD, but there's that opportunity potentially to bring those up. So give us Talk about that opportunity to raise CD margins up to or closer to PD's historic average, please.

Just to reconfirm, Bob, kind of what we said was that we expect probably roughly about $140 million of revenue next year with EBITDA $25 to $27 million, somewhere in that range, for EBITDA next year. And there is some pretty significant cost synergies that will take some time to get I think we looked at probably $3 million to $4 million of cost synergies that we think that we're getting. What we didn't detail too much about was revenue synergies. I think there are going to be some revenue synergies with Cornell. We'll probably go into a little bit more detail of that at the investor day. But I think we would expect some of these revenue synergies to start showing up in the back half of 2024. Got it.

Okay, great. And then last one for me. I'll jump back in queue. You mentioned the analyst day. Just to be clear, when you conclude the CMM process or have they concluded? How is it? Will you have sold it? Will you have decided?

Yeah, I think that's a question we anticipate getting. We kind of put that in John's script, but I think the best way to put this is I think we need to have some clarity on the outcome of the strategic alternative process. I don't have a firm date on when that's going to be complete, but I think it probably is really, we kind of view it from a perspective is we got to have a kind of a clarity around the outcomes of that process. Now, what that means in clarity, you know, there's a lot of different outcomes here. I don't want to speculate on what the outcomes could be, but I think, you know, in order to start giving, you know, new midterm targets, we've really got to know, you know, kind of what the situation is relative to strategic alternatives with the microphone business. But we are progressing. But we are, but it is progressing.

I mean, we are making progress.

Okay, super. Thanks so much.

And our next question comes from the line of Christopher Roland with Susquehanna. Your line is open.

Hey, guys. Thanks for the question. Perhaps you can talk about PD, how you see inventory there. Are we... Are we almost done with the clear out there? Also, anything else you, you know, want to talk about, you know, pricing, you know, order trends, et cetera, would love to know.

Yeah. I mean, I think, you know, from our perspective in the PD business and also within the MSA business, the pricing's been very, very stable. I mean, we don't think there's any issues relative to pricing in these markets. What I would say first on the MSA side is the market continues to be very resilient and strong in the hearing health market. And we're very excited about 2024, our position for new products with our customers, the growth of the end market. We feel pretty good. We don't see any inventory issues in this market today. And in fact, I just make the comment, Chris, that there's kind of like this, although we've been kind of tamping down what the belief is about over-the-counter, well, we're not seeing great pickup in over-the-counter demand. They're starting to be kind of like with our customers and the market, a belief that the marketing of over-the-counter hearing aids is actually drawing more people into the traditional channels than would have normally come in. And so we feel pretty positive about the MSA business. On the PD side, I would say it's a little bit more of a mixed bag, but here's what I would say, is that we had a book-to-bill above one for the first time in six quarters. And I bring that up. I mean, that's a pretty big step. Now, I will say, you know, a significant amount of the orders that we saw in Q3 were from defense, which typically are, you know, not short orders. Like, they're typically longer-term orders that we deliver over, you know, sometimes a year, year and a half. Now, all this being said, you know, I'd say, you know, if we look at a 24, I think, you know, defense looks pretty good. The med business and EV look pretty good. You would think, you know, the long-term of those businesses or markets looks pretty good. But what I think is probably the least clarity on yet is industrial distribution. And it does remain weak. The bookings remain weak in this portion of the business, and the shipments remain weak. Now, we're listening to a lot of what a lot of other people are saying. You know, we are seeing the work down in our distribution channel. We see the inventory of what they've got. We're starting to see it work down. But I think, you know, overall, we feel, you know, pretty good about growth for 2024 in the PD business. And I think the other side of this is, you know, once we get back to growth, the capacity utilization will improve and the margins will return back to a more, like, normalized level that we saw when the business was growing. Okay.

Yeah, the industrial weakness, I would say, is going around, no surprise there. It's a very solid December guide, and without guiding March, perhaps you can just kind of give us the broad puts and takes, given you're kind of de-emphasizing consumer, and so I don't think kind of seasonal trends will hold there. If you could talk about it more broadly and what to kind of expect there, it would be good.

Yeah, so let me start with the consumer business. You know, seasonally, Q1 is typically down after launches in mobile. So, you know, I think we'll continue to see a trend like that, that in Q1 mobile will be certain, CMF will be down. I would also say that, you know, that we're having a very, very strong quarter in Q4 for MSA. It will be down sequentially, but I think the theme around the CMM business and the MSA business is year over year there will be significant growth because if you remember, Chris, we had a very weak Q1 of 23, so there should be some pretty significant growth year over year. The PD business, here's how I kind of would frame it is I would sit there and say we're probably going to be flattish year over year in Q1 for PD, excluding Cornell. So obviously the Cornell will add, just think of it, we said about $140 million, it's probably a little bit more back-end loaded than front-end loaded, but you can get to a number there to see what Cornell will be generating. But overall, I think, Chris, what we kind of feel is Q3, Without Cornell, we're flattish year over year. So we feel pretty good about that, considering everything that's going on in the marketplaces. And then Q1, with having some easy comps in Q1 of 23, we should see some significant growth. And then on top of it, add in the Cornell number as well.

Very helpful. Thank you, guys.

And your next question comes from the line of Anthony Stoss with Craig Hallam Capital. Your line is open.

Good afternoon, guys. Maybe more for John. In terms of total op-ex and gross margins for the December quarter, could you give us kind of your thoughts?

You said for Q4, Tony? Yes.

Yeah, so, you know, again, we're kind of moving away from gross margin, really focusing on operating margin with this transformation to industrial tech. You know, what I'll say is, you know, Q3 had some one-time benefits that were in both gross margin and operating margins that were, you know, fixed assets sale. We had roughly $5 million. We also had, I'll call it an NRE recovery of a couple million dollars. That is not going to recur in Q4, so you'll see margins going down sequentially.

Okay, but just on OpEx, I know it's only two months.

Yeah, from an OpEx standpoint, Tony, we've ran, you know, I think a couple times I've talked about kind of 43 to 45 million run rate. We've been a little lower than that. We will jump up with the Cornell Dublier acquisition. slightly, but I would say for the core business, that 43 to 45 million or under, we're right there. Could be a touch lower than that. And then on top of that, adding in the CD, CD is roughly 20 to 25 million annually in operating expenses.

Okay, got it. And if you guys were to, it seems like things are picking up bookings on PD. If you were just to look at nulls prior to CD, would you expect total revenue growth in 2024 over 2023, Jeff?

Well, I mean, I'm not going to predict the full year at this moment, but I would just sit there and say is Q1 will definitely be up year over year, not counting CD. I would say that's kind of what the thing I'd step out and do. It's a little early to start projecting the full year, but I think we're going to start out very well in Q1. Going back to kind of what I answered in one of the other questions, which is in the microphone business as well as the MSA business, we expect some pretty strong year-over-year growth in Q1. I would say the PD business is still, I would say, flattish, and then add on top of it the CD revenue.

Got it. And speaking of CD, I'm curious if you could share some light on where they stand inventory-wise. Is it similar to Noel's position? There's still a little bit to be worked off, or what kind of commentary can you give us on CD's inventory?

Yeah, I think they're seeing a lot of the same thing in their distribution portion of the business. Just remember, this is quite a bit more distribution business. About 50% of their revenue goes through distribution, and they are still seeing the same thing. But here's what I would add. Their OEM business, their direct business, is actually holding up a little bit better than the PD business. The reason I say this is, remember, we've had these kind of push-outs on defense relative to things like Lockheed, which we've talked about in previous quarters. They have a fair amount of business in what I would call electrification, clean energy, med tech, and it seems to be holding up pretty well, their OEM business. So that's kind of like kind of a little bit offsetting. So we're not seeing overall quite the decline that we saw in the PD business. So I think in the distribution slash industrial portion of business, yeah, we're still seeing similar things.

Got it. And the last question for me, John, you made a comment about your CMM business is going to be pretty strong in Q4. Was there a different change in those? thinking on how much business you'll take for the December quarter within, say, smartphones or just in consumer in general?

Just repeat. We had some pickup in the CMM business. Yeah, I'm not going to go into detail by customer, but we have seen an increase, we think, in share in the mobile business in Q4. You know, to the extent, you know, I would sit there and say the positive is, you know, we get a lot better capacity utilization, we get more revenue. But, you know, incrementally in the CMF business, the margins are not as high in the mobile portion of the business.

Got it. Thanks, guys. Appreciate it.

And again, if you would like to ask a question, please press the star and number one on your telephone keypad. Our next question comes from the line of Tristan Jira with Baird. Your line is open.

Thank you. Quick questions again on the PD business. You mentioned that the bucket of weakness was still industrial and dusty. Is it fair to assume it's about one-third of your precision devices business? What do you see in some of the other segments, including automotive, which I think in the past was maybe about 10% of your PD business? Is that slowing any additional color on the the various end markets within that business?

Yeah, I would sit there and say, yeah, the industrial distribution portion of the business is probably a little bit less than a third of the business, but it is down pretty significantly year over year. That's the biggest weak point. You know, I think we talked a little bit about defense. You know, it will be down nowhere near kind of what we, what do you call it, have in industrial and distribution areas. But more on the timing of orders than anything else. Our automotive business still will be up. You know, it's obviously from a small base. You know, we had talked about $15 to $20 million in 23 of revenue. We'll be firmly in the middle of that range for automotive this year with some nice growth year over year.

Okay, great. And then... I know that you're holding commentary on your CMM business, pending the review. Just what is the willingness to reduce the top line as you potentially restructure that or take any other actions relative to what would be a gross margin, a creative event? And how do you mitigate, which is what some other companies have done, reducing production and, as such, incurring underutilization charges, but at the same time avoiding inventory bill. Just trying to look at, you know, at a high level how things could look like or how your willingness to change the business model in that regard in terms of how drastic that could be in terms of top line and gross margin impact.

Yeah, well, let me just make the first point. If you remember back middle of 2023, we took some pretty significant action relative of this. Sorry, middle of 2022, some pretty significant action in this business, taking out about $30 million worth of cost, combination of both OPEX and cost of goods sold, taking costs out, fixed overhead. And so I think, you know, for now, we're kind of where we want to be. until, and we're actually running pretty close to capacity in the back half of the year in this business right now. I think what we're kind of hopeful for that we see as the opportunity in this business, you know, obviously we're going through the strategic alternative processes, is that as the non-mobile portion of the business grows, which is significantly higher margin, the mix shift will help significantly over the next 12 months, 18 months, and we'll naturally be able to take less mobile business as we'll be filling our capacity with higher gross margin business. I really don't see us taking any further action in this business until we get to the conclusion of strategic alternatives and what's going to happen with the business.

Great. Very useful. Thank you very much.

And there are no further questions at this time. This concludes today's conference call. You may now disconnect.