Knowles (KN) Q3 2026 earnings call transcript

Thank you, and to our third quarter, 2020 to the next meeting call. I'm Sarah Cook, Vice President of Investor Relations, and presenting with me today are Jeffrey New, our President and CEO, and John Anderson, our Senior Vice President and CFO. Our call today will include remarks about future expectations, plans, and prospects for Knowles, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal security 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 results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings, including but not limited to, the annual report on Form 10K for the fiscal year ended December 31st, 2025. Periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today's earnings released. All forward-looking statements are made as of the date of this call, and Knowles disclaims any duty to update such statements except as required by law. In addition, pursuant to RegG, any non-GAP 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 8K filed today with the SEC. This will include a reconciliation to the most directly comparable GAP measure. All financial references on this call will be on a non-GAP continuing operations basis with the exception of cash from operations or unless otherwise indicated. We've made selected financial information available on 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?

Thanks, Sarah, and thanks to all of you for joining us today. To start out, I'd like to take a moment to thank the Knowles team for delivering an outstanding third quarter. We had strong performance across our business as demonstrated by our key financial metrics. Revenant was 184 million, up 20% year over year and above the high end of our guided range. EPS was 38 cents, and cash generated from operations was 45 million, both at the high end of our guided range. These results reflect the strength of our execution and the positive momentum across. I believe our results continue to demonstrate that our focus on markets and products, where we have significant advantages, is paying dividends and positions as well for future growth.

In Q3, MedTech and specialty audio revenue was 67 million, up 4% year over year. Hearing how OEM customers new products, which are implementing AI features, throw demand slightly further than usual. While this change in the seasonality at seasonality accelerated sales to earlier in the year, we continued to expect the hearing help market to grow at historical rates in 2026. Precision devices delivered Q3 revenue of $117 million, up 33% year over year, with strong demand across every major product line and end market we serve. MedTech, defense, industrial, and in left of electrification. Our close collaboration with customers continues to drive a robust pipeline of design wins, as customers continue to choose our innovative and differentiated solutions.

I believe our year over year growth demonstrated the strength of our strategy and the momentum across the business. On a base of strong revenue growth, orders remain robust. Precision devices had a book to build of 1.5 in Q3, with broad-based order strength across our key in markets, both among OEMs and with our distribution partners. Q3 orders and PD segments were nearly $180 million, well above Q2 orders reinforcing my confidence and continued growth. As noted on the Q2 earnings call, there was a $15 million order early in Q3 for our filters for a defense customer that will be delivered over the next 36 months. I will now provide a little more color on the revenue and order strength across our PD and markets.

In MedTech, our post-power film capacitors continue to win and defibrillator and radio therapy applications, while our ceramic capacitors are securing strong design wins and next generation medical, imaging, and implantables. In defense, demand remains strong across all our product categories. Our RF filters film and ceramic capacitors are to high demand in munitions and communications applications.

We also serve a broad rate of application in industrial markets. As an example, our ceramic capacitors and capacitor assemblies are growing in use for plasma generators and semiconductor equipment. With strong borders at healthy backlog and continued design wins, we are in the process of adding capacity across most of our precision devices' product lines to support the demand. I expect this additional capacity to begin to come online in late Q1 with it being fully available in the second half of 2027. Our ability to continue to expand and meet increasing demand for our products is supported by our strong cash generation from operations.

We have the ability to invest in growth while returning capital to shareholders and reducing that. In the third quarter, we've repurchased $25 million from shares and reduced outstanding bank firing by $15 million in addition to funding organic growth initiatives. Our strong balance sheet positions as well support organic growth through disciplined capital investment and still pursue strategic, creative acquisitions. Before turning the call over to John to cover our financial results and provide our Q4 guidance, I would like to share my initial perspectives on 2027.

Our strategy of combining unique technologies to create cost of engineered solutions and then quickly ramping them at scale with a world-class operational capability is driving revenue growth in our core products and markets, margin expansion and strong cash flow. In 2027, as we add capacity, new design wins ramp and we fulfill our healthy backlog within our PD segment and our MSA segment continues to perform at historical growth levels, we expect organic growth to continue to exceed the revenue targets presented at our May 2025 investor day. I also believe we'll be entering the next phase of revenue growth beyond our core where we expect to have meaningful expansion of our SAM through the growth and issues we outlined at our investor day.

By following the same playbook we used in our core of investing in innovative technologies using these technologies to develop customized solutions to solve our customer problems and then scaling into high-value production. We expect three fundamental paths to supplement our core growth.

First, we are developing new products such as attenuators and inductors for our existing markets. This is a great opportunity to provide a wider array of solutions to the markets and customers we already serve.

Second, we are utilizing existing technologies and capabilities for new customers and markets as we are doing with our micro-solutions group and with post-full power capacitors. The breadth of opportunities we are pursuing that leverage our core competencies continue to expand with limited expansion of effects to support this new business.

Lastly, we are seeing the opportunity to meaningfully grow content with existing products and technology at current customers as we have discussed ensuring health and with integrated capacitor solutions. All these initiatives are expected to meaningfully expand our SAM will complement our strong core and I look forward to providing a more detailed outlook and updates on these initiatives and others in 2027.

Now let me turn the call over to John for our financial results and our Q4 guidance.

Thanks Jeff. We reported third quarter revenues of 184 million of 20 percent from the year ago period and above the high end of our guidance range. EPS was 38 cents in a quarter, up five cents or 15 percent from the year ago period and at the high end of our guidance range. Tax provided by operating activities was 45 million, also at the high end of our guidance range.

In the med tech and specialty audio segment, Q3 revenue was 67 million, up 4 percent compared with the year ago period, gross margins were 51.9 percent. The precision devices segment delivered third quarter revenues of 117 million, up 33 percent from the year ago period. Increased demand from both OEM customers and our distribution channel partners resulted in strong growth in the four major markets we serve, med tech, defense, industrial and electrification.

Segment gross margins were 41.6 percent, up 10 basis points from the third quarter of 2025 on higher volume, partially offset by unfavorable inventory adjustments. On a total company basis, R&D expense in the quarter was 10 million, up 1 million compared to Q3 2025, on higher project spending in both MSA and PD segments. SG&A expenses were 30 million, up 4 million from prior year levels, driven primarily by higher sales commissions, higher incentive compensation expense, and increased head count as we pulled forward hiring, primarily to support increased customer demand and new product initiatives. Interest expense for the quarter was 1.6 million, down 700,000 from the third quarter of 2025 due to lower average death balances.

Now I'll turn to our balance sheet and cash flow. In the third quarter, we generated 45 million in cash from operating activities and capital spending with 7 million. During the third quarter, we repurchased 695,000 shares at a total cost of 25 million. We exited the quarter with cash of 47 million and 116 million of borrowings on the revolving credit facility.

Lastly, our net leverage ratio based on trailing 12 months adjusted EBITDA was 0.4 times and we have liquidity of more than 330 million as measured by cash, plus unused capacity under our revolving credit facility, moving to our Q4 guidance. For the fourth quarter of 2026, revenues are expected to be between 180 and 190 million, up 14 percent year or year at the midpoint. R&D expenses are expected to be between 10 and 12 million. Selling and administrative expenses are expected to be within the range of 29 to 31 million. We're projecting adjusted EBIT margin for the quarter to be within the range of 23 to 25 percent. Interest expense in Q4 is estimated at 1.5 million and we expect an effective tax rate of 15 to 90.

We're projecting EPS to be within the range of 39 to 43 cents per share, up 5 cents or 14 percent year or year at the midpoint, driven by a 20 percent increase in adjusted EBITDA, partially offset by the absence of a 3 cent discrete tax benefit, which was included in Q4 2025. This assumes weighted average shares outstanding during the quarter of 87 million on a fully diluted basis. We're projecting cash from operating activities to be within the range of 60 to 70 million. Capital spending is expected to be 8 million. We expect full year capital spending to be approximately 5 percent of revenues.

Looking ahead, we expect capital spending to be above our historic range of 3 to 5 percent, increasing to 5 to 7 percent of revenues in 2027 as we continue to make investments in capacity to support increased customer demand in the precision device segment. The strong growth and financial results we've achieved through the first three quarters of 26 combined with a robust backlog and increased order activity, giving confidence in our ability to deliver 2026 revenue growth of 16 percent at the midpoint of our guidance range and adjusted EBITDA growth of 24 percent over 2025 levels, with both metrics well above the high end of the target ranges that we provided at our May 2025 investor day.

I'll now turn the call back over to the operator for the Q&A portion of our call. Operated?

Yeah, so let me just say at the top level, if you look sector by sector or market by market that we're in, what we're seeing is just extremely high design activity. Whether it be for faster, more precision, getting more output, new innovative features, all the applications we're involved in, people are asking for more customized stuff. It's a trend that we're just clearly seeing now.

And our product portfolio is well positioned to take advantage of this. I mean, it's very well positioned. Now to take it to 27, let me break it down by the segments, right?

First, MSA. MSA, we expect next year the hearing health business is going to perform at historical levels again. We will have a little bit of a headwind, I'd say primarily in the first half. I think we mentioned before on stamping that we had this, when we sold a consumer business, we have a supplier where we're at the last time by, at the end of this year, there'll be no revenue. And that's about, a headwind of about two to three percent next year, especially more in the first half, I would say, in the back half. But the micro solutions business, as we talked about, should start accelerating the back half. So overall, we'll still probably be in that two to four percent for the full year, although it may be down a little bit in the first half.

Now, PD, let's say the book to bill, again, in the second quarter was very strong. But the orders we're taking now, it was 1.5 in Q3. The orders we're taking in Q3 are already being scheduled into the first half of next year. But we are at a point where we are pretty close to capacity constrained. So, well, we're in a very strong year-over-year growth in the first half with PD. I think sequentially, it's going to be relatively flat because of capacity constraints. And so, I think that's probably the one thing. And when I say I think I'm just a bit clear on the MSA thing, yes, it may be a little bit of a headwind of stamping.

But remember, that stamping was on a cost plus basis, it doesn't generate a lot of EBIT, so it won't affect the EBIT, the margin should be better.

Yeah, I think gross margins, Tony, this year we've talked about kind of for MSA in that low 50% range. It expects that maybe a little, you know, a percent or so higher in 27 over 26.

Yeah, so bottom line is on this, we expect strong year-over-year growth in the first half. But sequentially, it's probably going to be, especially in the first quarter, might be slightly down on, like PD being flat sequentially because of capacity constraints with MSA being slightly down.

I think that's a fair, I think that's a fair guess, you know, somewhere in that, you know, it's slightly down sequentially based on the guide that we have.

Tony, were you talking about the MSA, it's the regular total nulls?

But still, if you look at the year-over-year number, it's way up. And again, MSA being slightly down, right, because of the stamping business going away, PD being flat, capacity constrained, as we're pretty much running all out.

Yeah, I mean, the business fully ramped. We're outputting like as expected, you know, and so, you know, now we've got about 6, 7 more quarters of delivery of this order. You know, I think if I look at the numbers, you know, it's performing in terms of the margins and the output as expected, you know, I really put a really call out to the team. I mean, this was like a herculean effort to ramp this with this speed and this amount of volume, but it's going very well.

Thanks, Tony.

So let me just first say it based on the markets. If I think about the markets that we participated, and I think I've said this, in medical, I do not see that there's safety stock or that this is going to grow through a cycle. We got a lot of great new design wins. I think it's sustainable. We're not seeing in medical that there's a concern here. Then I go to defense. I would argue that there's probably an opportunity for an acceleration from even where we are in terms of defense in the next 12 to 18 months.

As budgets around the world are increasing for both the US as well as allies, the replacement of munitions. There's a lot of things going on here that says that this is going to continue to maybe even accelerate. That's about 60% of our business or so right there as a company. The electrification is what it is. It's private and I would say we still expect growth next year.

We have some EV business. We expect that to be up again next year. We got a lot of great design wins as well as the energy order. I don't see a lot of concerns there. So you really come back down to industrial. If you look at it, there are some pockets here where I would sit there and say, okay, maybe this isn't sustainable like semiconductor equipment. How long will that last?

But we are not really overly reliant on one market. I can tell you when I look at our distribution partners, they do not have a lot of inventory. They're not holding excess inventory like we saw happen in 2022. I think this goes back to the discussion of what's different between back then in 2022. In 2022, we had lead times of 15 weeks. Some of the competitors, like say, ceramic capacitor guys, had 60 weekly times. Our lead times are now long, not driven by AI.

They're driven by our demand in our core markets. So I think, generally speaking, we're going to be pretty good going forward through the cycle.

Chris, just to clarify too, and that Jeff mentioned, roughly 60% of our business is met in defense, and that includes the hearing health business.

Yeah. Okay. Perfect.

Hey, Chris, you're right. I mean, in terms of gross margin, if you kind of take the guidance, the components of the guidance that I gave, you can back into gross margin. And it's just above 46% of the midpoint of the guidance that I gave. I think there's room to continue to expand gross margins. Our target is 100 basis points a year, but I kind of exiting this year. Again, the guidance I provided is just in touch about 46%, but there is room for that to increase that next year.

I would just have one more thing, Chris, on that, as I'm kind of looking at the numbers here. I think we're going to exit above well above 25% on EBITDA margins this year. And I think John said this before, but I mean, we clearly see the path over the midterm now to get to 30% EBITDA margins.

If you take what I said, the gross margin alone, we think there's 100 basis points of improving annually. And then we're going to get operating leverage of 50 to 100 basis points with the growth that we have. So yeah, you can see a path there within two to three years going from where we are just a little north of 25 this year to 30%.

Yeah. So here's what I'd say is I'll give you a little bit of color on this, but I think this is going to be a great topic for an investor day sometime next year as we kind of move forward. But let me kind of talk about it a little bit.

First, I'd say if you look at our micro solutions group from MSA, we really have now a list as long as my arm of opportunities. We're really starting to actually have to kind of push back on customers. We talked about this. We had about a million dollars with a revenue in 2025. We'll have two to three, probably going to push a poster to three this year. I see a clear path north of five next year.

And then if you look in 28, it should be north of 10 and maybe even more. And so I'd say that it's a matter now of our execution. There's so many new applications, whether it be down whole applications. There's all different types of things in terms of even beyond the energy that we've discussed a lot. And that's ready to go. It's a question of when the customers will start ordering in some of these new applications. I'm really encouraged. We have not talked about this at all. We introduced a line of attenuators. Now this is primarily for defense. Take some time. Super encouraged by the initial reaction we're getting from attenuators. I'm super encouraged by inductors.

So a lot of good stuff coming here. I think I would just say this. What we're seeing is a meaningful expansion of our SAM with all these things we're doing beyond the core that will supplement that growth. And that's why we're feeling more and more compelled to try to call that out. And people will lay some numbers around that probably sometime in the new years.

Let me give you the short answer. Yes. Let me give you a little more color, a little bit longer answer. I think we're still six to seven quarters off from completing this order.

I think there's a possibility that we get another quarter that follows right on, but there may be a small gap. I think from my perspective, we have so many growth opportunities that are even beyond this energy order. Not that I don't want to focus on this because this could be a big upside to our numbers in 28, 29 and beyond. But I mean, it's a great opportunity for us. And hopefully, as we get further along in delivering this order, we'll be able to talk more about what comes beyond. Great. Well, thanks again for that question.

I mean, that's a great question, Bob. I think what we've learned from the whole ramp up of this automation is that we have a lot of margin expansion opportunity within that factory. I think that's what we've learned. I think part of that John's kind of alluded to that within the Cornell, former Cornell business that we acquired, especially film business, we think there are great opportunities for margin expansion. I don't know if it applies as much because we really are applying these kind of learnings to every one of our facilities as we go along.

But for sure, in this area, we're going to be adding more automation in order to improve yields, lower our overhead and make the Cornell business more profitable. I think we alluded to this when we bought that business. It was in the 27-28% gross margin. It's exiting the year in the mid-30s now with a clear path above 40. We're seeing all the things that we expected from that. I think what we're hoping is we find another acquisition that is a one plus one equals three and be a real home run that is like another Cornell over the next year or two. That really makes sense for us. Okay, great. Then obviously, you gave a nice initial look to 2027.

In general, in the economy and the macro, there's obviously a lot of inflationary pressures right now. How is Noel's position based on that kind of current inflationary market and how would this project into 2027 for you, if at all? I think we're positioned very well. I think just to face first day off, we have an excellent operation team globally that focused on value creation every year. They're looking for ways to reduce costs, reduce improved yields. We have that going on. That's an ongoing thing. I think we've alluded to this. I think the pricing environment is positive in the direction we're heading with the customer to it. Generally speaking, we are a critical piece of the bill materials, but we're not an overly large portion of our bill materials are our customers.

So moderate pricing every year increases our pretty much what we do. I wouldn't say we do it with every customer across every single segment, but we are looking at this on a continual basis. I think generally speaking, we're in a very good position to be able to handle inflationary pressures.

I've just added to that. I mean, I talked about the potential to increase gross margins, 100 basis points. The levers are really price, capacity utilization and productivity on the factory floor. Those are the three components, and there's a piece of both of those that will benefit us in 2027.