Knowles Corp

NYSE:KN

Earnings Call Analysis

Strong Q2 Performance and Promising Guidance

In Q2 2024, Knowles Corporation achieved $205 million in revenue, marking an 18% year-over-year growth. The company's Medtech and Specialty Audio segments benefited from a strong hearing health market, while the acquisition of Cornell boosted the Precision Devices segment's revenue by 55%. Adjusted EBITDA margins were impressive, exceeding 45%. Looking ahead, Knowles projects Q3 revenue between $210 million and $220 million, with an EPS range of $0.29 to $0.33. The company is also maintaining robust cash flow, enabling share repurchases and debt reduction.

Solid Growth Amidst Challenges

In the second quarter of 2024, Knowles Corporation reported revenue of $205 million, marking an 18% increase year-over-year. This growth is largely attributed to their strategic focus on high-growth end markets and solid performance in their Medtech and Specialty Audio segments. Despite fluctuations in inventory levels particularly within industrial markets, the company has managed to keep its earnings per share (EPS) at $0.24, aligning well with expectations.

Segment Performance Highlights

The company's Medtech and Specialty Audio sectors saw a 4% sequential revenue growth, driven primarily by strong demand for Hearing Health products facilitated by an aging population and improved market access. On the other hand, the acquisition of Cornell positively influenced the Precision Devices segment, with a notable 55% year-over-year revenue increase, thanks to strong execution and operational improvements.

Positive Outlook and Continued Investment

Knowles has expressed confidence that 2024 will be a strong year for the Medtech and Specialty Audio segments. The adjusted EBITDA margin reported was over 45%, stemming from operational efficiency and increased adoption of new products. Moving forward, the company expects overall revenue in Q3 2024 to range between $210 million and $220 million, translating to a projected year-over-year growth of 23%. EPS is anticipated to fall between $0.29 to $0.33.

Capital Allocation Strategy

In addition to operational successes, Knowles is actively managing its capital allocation. In Q2, the company repurchased $25 million worth of shares while simultaneously reducing debt by $34 million, culminating in a net debt leverage ratio of 1.1. This prudent management indicates healthy cash flow, estimated to continue in the range of $35 million to $45 million in the upcoming quarters.

Strategic Alternatives and Future Expansion

The company is in the process of finding strategic alternatives for its Consumer MEMS Microphone (CMM) business, with indications of a nearing conclusion. Although this segment has not shown substantial growth recently, Knowles remains open to acquisitions that align with its operational goals, emphasizing a commitment to remain below a debt leverage ratio of 2.75.

Conclusion: A Steady Path Forward

In summary, Knowles Corporation continues to demonstrate resilience and growth potential across its segments, particularly within Medtech and Specialty Audio. Their strategic acquisitions and proactive management of cash flow position them well for sustained growth. Investors should keep an eye on the upcoming quarter's performance, particularly in the context of operational execution and strategic planning around the CMM business.

Earnings Call Transcript 2024-Q2

[Operator]

Thank you for standing by. My name is Calin. I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2024 Knowles Corporation Earnings Conference Call. [Operator Instructions].

I would now like to turn the call over to Sarah Cook. You may begin.

[Sarah Cook, executive]

Thank you, and welcome to our second quarter 2024 earnings call. I'm Sarah Cook, Vice President of Investor Relations, and presenting with me today are Jeffrey Niew, our President and CEO; and John Anderson, our Senior Vice President and CFO.

Our call today will include remarks about future expectations, plans and prospects for Knowles, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal securities laws. 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 could cause actual results to differ materially from current expectations.

The company urges investors to review the risks and uncertainties in the company's SEC filings, including, but not limited to, the annual report Form 10-K for the fiscal year ended December 31, 2023, 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 any duty to update such statements, except as required by law. In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at knowles.com, and in our current report on Form 8-K filed today with the SEC.

This will include 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. 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 details on our results. Jeff?

[Jeffrey Niew, executive]

Thanks, Sarah, and thank you all for joining us today. Let me start by saying I'm pleased with the performance of our business in the second quarter. We continue to execute on our plan of focusing on high-growth end markets where we have differentiated solutions. And in Q2, the business performed as we expected.

We delivered $205 million in revenue, which is at the midpoint of our guided range and represents 18% growth on a year-over-year basis. EPS of $0.24 and cash from operations of $25 million were both in line with our expectations and at the midpoint of our guided range. From a segment perspective, Medtech and Specialty Audio revenue grew 4% sequentially as the end market for our Hearing Health products remain strong.

The market dynamic of the aging population, expansion of the middle class globally and improved hearing need penetration, all remain favorable. We reported adjusted EBITDA margins of over 45% driven by continued operational execution and our sustained success of new product adoption. We expect the strength throughout the year within 2024, and for 2024 to be a year of growth for the med tech and specialty Audio segment.

Despite the continued headwinds from normalization of inventory levels in our industrial and distribution end markets, Precision Devices delivered solid results in the second quarter. Driven by the acquisition of Cornell, revenue was up 55% on a year-over-year basis. Adjusted EBITDA margins increased nearly 260 basis points sequentially on flat revenue, driven by strong operational execution and improvements in gross margin within Cornell.

We have begun to see signs of inventory reduction in our distribution channel in industrial end markets, and we are ready to capitalize on growth as demand improves. I would also add, our design activity remains robust, and we are well positioned to grow as the market recovers. On our Consumer MEMS Microphone business, we continue to progress to a conclusion on the strategic alternatives process, taking into consideration all stakeholders from customers to suppliers and shareholders to employees. From an operational standpoint, CMM financial results in the quarter were solid. Revenue was up -- was up 9% from the prior quarter, and adjusted EBITDA margins grew by 330 basis points.

Before I conclude, I would like to touch on our capital allocation activities. In the second quarter, based on our continued robust cash generation, we repurchased $25 million of shares while also reducing our debt by $34 million. We expect sustained cash generation for the remainder of 2024.

The first half of 2024 produced solid financial results. I continue to be pleased with the performance of the business, and I'm excited about the opportunities we have ahead of us. My confidence in our ability to deliver shareholder value remains strong as our teams continue to demonstrate operational excellence execution in innovative products and expanding our market share across our businesses.

Now let me turn over to John to go into the details of our quarterly results and provide the Q3 guidance. John?

[John Anderson, executive]

Thanks, Jeff. We reported second quarter revenues of $205 million at the midpoint of guidance and up 18% from the year ago period, driven by organic growth of 2% and the acquisition of Cornell in the fourth quarter of 2023. .

EPS was $0.24 in the quarter at the midpoint of our guidance range and up $0.01 or 4% from the second quarter of 2023. In the Medtech and Specialty Audio segment, revenue was $60 million, down 2% versus the prior year. Our Hearing Health business was up 5%, offset by lower demand in the specialty audio market. Gross margins were 54.6%, up more than 100 basis points versus the year ago period, driven by favorable product mix and benefits from foreign currency.

The Precision Device segment delivered revenues of $74 million, up 55% from the year ago period, driven by the acquisition of Cornell, partially offset by lower shipments of high-performance capacitors into distribution and OEMs in the industrial end market as customer and channel inventories remain elevated.

Gross margins were 37.2%, down 250 basis points from the second quarter of 2023 due to the acquisition of Cornell. While the gross margins at Cornell remain lower than that of the legacy Precision Devices business, we saw sequential margin improvement at Cornell of 340 basis points, and we expect margins to continue to improve throughout 2024.

Excluding Cornell, year-over-year gross margins within the PD segment were flat. Consumer MEMS microphone revenues of $71 million, were up 9% versus the year ago period due to share gains and increased consumer demand primarily in ear and IoT end markets. Gross margins were 28.1%, a 550 basis point decrease from the prior year due to the absence of a $4 million benefit related to the sale of fixed assets, which was recorded in the second quarter of 2023.

On a total company basis, R&D expense in the quarter was $17 million, up 6% from Q2 2023 due to the acquisition of Cornell. SG&A expenses were $32 million, $2 million higher than prior year levels, driven by the acquisition of Cornell partially offset by restructuring actions taken in the second half of 2023 in the Precision Device segment. Interest expense was up $4 million versus the prior year due to higher bank borrowings associated with the acquisition of Cornell in the fourth quarter of 2023. Now I'll turn to our balance sheet and cash flow.

In the second quarter, we generated $25 million in cash from operating activities at the midpoint of our guidance. For the first 6 months of 2024, we generated $42 million in operating cash flow, representing a $20 million increase over the first 6 months of 2023. Capital spending was $3 million in Q2 and we ended the quarter with cash and cash equivalents of $84 million. During the second quarter, we repurchased 1.4 million shares at a total cost of $25 million, and we reduced outstanding borrowings under our revolving credit facility by $34 million.

We exited the second quarter with $261 million of total debt that includes $146 million of borrowings under our revolving credit facility and an interest-free seller note issued in connection with the Cornell acquisition. Lastly, our net debt leverage ratio based on trailing 12 months adjusted EBITDA was 1.1x.

Moving to our guidance. For the third quarter of 2024, revenues are expected to be between $210 million and $220 million, up 23% versus the year-ago period, driven by organic growth of 3% and the acquisition of Cornell. R&D expenses are expected to be between $16 million and $18 million, and selling and administrative expenses are expected to be within the range of $29 million to $31 million, up $5 million from the prior year due to increases associated with the Cornell acquisition.

We're projecting adjusted EBIT margin for the quarter to be within a range of 16% to 18%. We're forecasting interest expense in Q3 to be approximately $4 million, which includes $2 million of noncash imputed interest. We expect an effective tax rate of 9% to 13% for the quarter, which is lower than normal due to the utilization of foreign tax credits. And we're projecting EPS to be within the range of $0.29 to $0.33 per share. This assumes weighted average shares outstanding during the quarter of $92.2 million on a fully diluted basis. Projecting cash from operations to be within a range of $35 million to $45 million, and capital spending is expected to be $5 million.

I'll now turn the call back over to the operator for the questions-and-answers portion of our call. Operator?

[Operator]

[Operator Instructions] Our first question comes from the line of Christopher Rolland with Susquehanna.

[Christopher Rolland, analyst]

I know you guided for sequential and year-over-year growth in med tech and Specialty Audio and Precision Devices. I assume that's also going to include consumer. And if you could just kind of force rank or give us some idea of what that sequential strength might be for those different segments? That would be great.

[Jeffrey Niew, executive]

Yes. So Chris, thanks for the question. So first, I think it's been very deliberate about this, the sequential growth is coming from the non-CMM portion of the business. So I think -- and what we're starting to see, particularly in the Precision Device business, we think we're starting to see sequential improvement on our way at some point and hopefully in the near future, a return to year-over-year growth on a pro forma basis when you include Cornell.

And we're seeing that being relatively broad-based. So I think we're pretty pleased. We are seeing some sequential growth in the Medtech and Specialty Audio. I think it's going to be quite honestly, a little bit more pronounced the sequential growth in Q4 versus Q3. But we do expect in Precision Devices to again have sequential growth in Q4 from Q3. As far as the CMM business, we are not in Q3, seeing a lot of sequential growth. I'd say it's flattish. But it is coming off, I'd say, a pretty strong Q2 on a year-over-year basis. We had a pretty strong Q2. I think the CMM business was up about 8% or 9% year-over-year in Q2. So it's coming off a pretty strong Q2.

[Christopher Rolland, analyst]

Great. And then I guess maybe following up there because September for CMM typically is pretty strong for you guys. Are you -- is it -- are you seeing something different in content? Or is it just purely timing? And then lastly, any update on potentially selling that business. And yes -- we'll just stop that.

[Jeffrey Niew, executive]

Yes. So let me take the second question first. I would say not a huge update from the last quarter, but I would say we're inching closer towards a conclusion. And so I think that's about what we can say at this point. We're inching closer towards a conclusion.

I would say, overall, for the full year, the CMM business is actually going to be up pretty significantly year-over-year. And so I think it appears -- I would say we're not going to comment by quarter, but I think it's up about 8% or so, that's what we're seeing for the full year.

[Operator]

And your next question comes from the line of Anthony Stoss with Craig-Hallum.

[Anthony Stoss, analyst]

I have a couple of questions. On the CD acquisition, I think the past quarter, you were kind of ballparking at -- to equate to about $135 million to $140 million for the full year 2024. Is that change? Or is that still kind of the right number to think about?

[Jeffrey Niew, executive]

I'd say it's a little lower than that. Although here's what I would say, I think when we announced the deal, we talked about $26 million in EBITDA for this year. We're still sticking. We're going to hit the $26 million of EBITDA even on the lower number. And the way we're doing that, quite frankly, is the synergies are larger than we had expected.

I think we've talked about that probably in the past. I think a couple of quarters ago, we were talking about maybe a couple of million dollars of kind of price opportunity. Last quarter, we talked maybe 3% to 4%. I would say, it's probably closer to 5 now in terms of price in that business. So we're feeling pretty good about where we are. And I think -- what I'd say, talking about CD acquisition is, the margins are coming up like probably a little faster than we would have expected even on lower revenue, which is, I think, a really good sign.

Because as the market starts to recover, we can see that the margins are going to expand, and we're going to get to the target margins that we've kind of talked about early on faster than we probably would have said.

[John Anderson, executive]

Tony, just to give a little color to that, when we acquired CD Q4 of last year, margins were right around 30%. Same thing in Q1 of this year, and we're seeing sequential -- pretty significant sequential improvement. We expect to be kind of in the high 30s as we exit 2024.

[Jeffrey Niew, executive]

Yes. And so -- and that's a combination, obviously, of some capacity utilization, but it's also getting the synergies.

[Anthony Stoss, analyst]

Got it. Perfect. Second question, I just want to confirm something. So on the September guide, are you assuming anything from your prior biggest handset customer in terms of content in a handset?

[Jeffrey Niew, executive]

So again, what I would kind of say is actually, we're not going to make comments on specific customers. I think overall, I would just make the comment, again, the growth sequentially is coming from the non-CMM portion of the business.

And I think -- we keep continuing to focus on overall reducing our exposure to mobile which is our -- one of our lowest gross margin markets. And -- but overall, if you look at for the full year, the CMM business will be up 8% based on what we're seeing for this year for the full year.

[Anthony Stoss, analyst]

Got it. Okay. And then lastly, Jeff, I think in the past quarters, you're sitting with about 5 months' worth of inventory in PD, and you wanted to bring it down to 2 months. Are we still in that kind of same 5 months? Or is it starting to come in?

[Jeffrey Niew, executive]

So you're referring to inventory in the channel, correct? That's what you're referring to?

[Anthony Stoss, analyst]

Yes.

[Jeffrey Niew, executive]

Yes. So we're definitely seeing -- so again, I kind of brought this up, we expect PD both in the classic PD as well as Cornell to be sequentially improving in Q3, and we expect it to improve in Q4. We are seeing the inventory in the channel starting to come down, but it's probably coming down a little bit slower than we expected.

So the steepness of the sequential improvement, it's probably a little less than we would have expected, but we're definitely seeing it. And when I look at the numbers, we had some nice even sequential growth we're going to have from in Cornell, but again, in classic PD from Q2 to Q3. So the inventory is definitely coming down in the channel. And there are still pockets where there's still probably too much inventory.

But overall, we're starting to kind of see the light at the end of the tunnel in the PD markets. So last test would kind of make a comment on, Tony, is passive versus semiconductors because I think we sometimes get these things mixed. What we're seeing is the semiconductor channel, which we're not obviously involved with as much. There is a lot of inventory still in semiconductors, but the passive inventory in the channel, the passive inventory has been reducing at a faster rate than we've been semiconductor in the channel.

[Operator]

And your next question comes from the line of Tristan Gerra with Baird.

[Tyler Bomba, analyst]

This is Tyler on for Tristan. I know you talked about some of the pricing opportunities you have on the Cornell side, but can you speak to pricing across the rest of your businesses?

[Jeffrey Niew, executive]

Yes, sure. I can talk about it. I would sit there and say, first, in the Medtech especially Audio pricing stable. I wouldn't say we've gotten big price increases for reductions. It's very, very stable. Again, a lot of things we have with these customers are longer-term contracts, very stable.

I think we're a very valuable valued supplier. In the Precision Device segment, outside of Cornell, we're seeing some modest price increases. I think again -- I think I've talked about this before, Tyler, where when we first started doing pricing in the classic PD section, we had some larger increases.

Now it's kind of smaller but continual. And then I think lastly, the CMM business, I'd say outside of mobile, pricing has been pretty stable in our CMM business. Mobile is still challenged. I would sit there and say mobile is still challenged. And so that's probably our biggest challenge in the mobile area. And again, as we try to, over time, reduce our exposure in mobile, we would probably see less and less price decreases in that business.

[Tyler Bomba, analyst]

Great. And then just looking at the Hearing Health business, have you seen anything notable to call out on the OTC market? Any sense that there's upside relative to your expectations for that business?

[Jeffrey Niew, executive]

Yes. We've been on the call, like many times talking about OTC. And I've always kind of like tried to hold back expectations in terms of how big this could be. it still is not really like becoming a significant piece of business for us. And what I can sit there and say pretty confidently, there's no sockets. I can point to that we've really lost as of any significant volume. And so it's just not developing with the way people had hoped, but more -- it's kind of in line what we -- what I would say I still think the OTC market is helping with the traditional hearing aid market where people are hearing more about hearing aids.

And maybe they go look at over-the-counter hearing aid and then they opt into the traditional hearing aid channel. These are complicated devices. And I think there's probably a little bit of a, I would say, an under appreciation for the value of the audiologists in the way this works in terms of a person getting a hearing aid. And I think people are starting to realize that. And again, having in the market for many years, we didn't factor in too much in for OTC. And it's probably meeting expectation, but at a very low level. But the traditional hearing aid channel will continue to do very well.

[Operator]

[Operator Instructions] Our next question comes from the line of Bob Labick with CJS Securities.

[Bob Labick, analyst]

So you talked obviously about in Precision Device in particular, you have the destock going on in the inventory in the channel and stuff. But can you maybe talk a little bit about the overall end market demand where the biggest drivers are where you see that? And how long it takes to kind of get back up to that growth rate?

[Jeffrey Niew, executive]

Yes. Yes. So let me kind of just try to divide up into a few different markets. We got defense, Medtech, industrial, other. We'll make some comments a little bit about electric as well. And again, Cornell as well as the traditional PD participate in all these areas.

And so what I would just start and say, let me start with defense. We're definitely seeing growth in defense. We are seeing some growth in defense. It's not probably as high as we would have expected. But for the full year, we will see growth in defense. Medtech, there has been a number of areas where we have seen inventory issues, not the hearing aid, but in some of our other Precision Device markets.

But we are expecting that some pretty strong year-over-year growth in Medtech in the back half of the year as the inventory has kind of wind it down, right? So we are starting to see that in the marketplace. I -- my guess what I would sit there and say is that the 1 market that's probably a little bit -- probably the more [indiscernible] of all is the industrial/other. And that market has been, I'd say, not fixed, still in decline, and there's some modest improvement that we're seeing going forward.

But it's not like an effort area when I kind of set up front that the steepness of the recovery is probably not as large as we thought probably really more in the industrial area. We're seeing some sequential improvement. Now let me kind of a different way. I can also cut it a different way, which is OEM versus distribution. We're expecting some pretty strong back half of the year sequential improvement at our OEM customers. A lot of that driven by Med, and our distribution, we're expecting modest sequential growth in the back half of the year.

[Bob Labick, analyst]

Okay. Got it. And then I haven't really had a chance to fully go through this. So at the risk of sounding a little silly. Could you talk about the goodwill impairment in CMM? And what, I guess, the process was, and what that kind of says to us about that segment?

[John Anderson, executive]

Sure, Bob. I can take that. So as you recall, in the third quarter of last year, we announced that we were reviewing strategic alternatives for the CMM business. that review included a range of possibilities, including a potential sale or restructuring of the business.

During the second quarter of 2024, we evaluated the potential outcomes of our review. And we concluded as a management team that it's more likely than not the fair value of the CMM reporting unit was below its carrying value. And as a result, we recorded a goodwill impairment charge of $249 million.

[Bob Labick, analyst]

Okay. Got it. And basically, you said you're inching towards a resolution there. Can you talk about M&A? I mean, you've talked about. It most likely in the PD segment. But can you still -- is M&A still doable with the kind of ongoing CMM strategic alternatives? Or are they going to be separate events finish CMM and then get back to potential M&A? Or how is that process playing?

[Jeffrey Niew, executive]

Let me start with the first statement, which is our cash flow continues to be very robust. We're very pleased with the cash flow in the first half. Normally seasonally, cash flow is usually weaker in the first half. We had a very strong first half cash flow. We're expecting that to continue in the back half.

And I would sit there and say, we are definitely looking at acquisitions. But I guess what I would just say is we want to make sure we don't do anything that our shareholders would look at and say, why are they doing that. There's a lot of opportunities out there. And I point to the Cornell acquisition, which we think is, from a synergy standpoint, from how it fits with what we do.

I mean this has been a really great acquisition for us. We're looking for that next Cornell. And so I don't think it's going to take for a conclusion of the CMM process to move forward the M&A. If we find the right thing, our balance sheet is in good shape, we are going to move forward with M&A.

[John Anderson, executive]

And Bob, we've always said we're going to maintain modest debt levels not going above, call it, 2.75 on a net leverage ratio.

[Jeffrey Niew, executive]

And that kind of leads just a little bit on the capital allocation. We're continuing to buy back shares as well because of the cash flow. .

[Operator]

And there are no further questions at this time. I will turn the call back over to Sarah Cook.

[Sarah Cook, executive]

Thank you for joining us today. As always, we appreciate your interest in Knowles, and look forward to speaking with you on the next earnings call. This concludes our call today.

[Operator]

And this concludes today's conference call. You may now disconnect.