Executive Summary / Key Takeaways

• Strategic Transformation Complete: Knowles has successfully pivoted from consumer electronics to a pure-play industrial technology company focused on high-margin precision components for defense, medtech, and electrification markets, divesting its Consumer MEMS Microphones business for $142 million while integrating the Cornell Dubilier acquisition.
• Margin Inflection at Hand: Production challenges in the specialty film capacitor line are resolving, with a new prototype line improving yields. A $75+ million energy sector order (with substantial prepayment) will begin shipping in 2026, driving revenue from $25-30 million in 2025 to $55-60 million in 2026 and expanding gross margins beyond the current 44-45% range.
• Defense & Electrification Tailwinds: The Precision Devices segment is accelerating to the high end of its 6-8% growth target, fueled by robust defense spending on electronic warfare and specialized design wins in EV markets, with book-to-bill ratios above 1.0 for four consecutive quarters indicating sustained demand.
• Tariff-Insulated Manufacturing: Less than 5% of revenue and 3% of cost of goods sold are exposed to current tariffs, with U.S.-based production providing a competitive advantage as industrial customers seek secure domestic supply chains.
• Capital Allocation Discipline: Strong cash generation (16-20% of revenues) funds a $400 million share repurchase program while maintaining net leverage at just 0.6x EBITDA, providing flexibility for organic growth investments and selective acquisitions.

Setting the Scene: From Consumer Components to Mission-Critical Systems

Founded in 1946 and headquartered in Itasca, Illinois, Knowles Corporation spent decades building a reputation for components that perform unique, critical functions where failure is not an option. This legacy explains the company's current positioning: while most electronic component manufacturers chase high-volume consumer markets, Knowles deliberately serves applications requiring extreme reliability, custom engineering, and scalable manufacturing for niche but growing end markets.

The company's recent strategic moves have crystallized this focus. In December 2024, Knowles completed the $142 million sale of its Consumer MEMS Microphones segment to Syntiant Corp., eliminating the cyclical, price-sensitive consumer business. This divestiture followed the November 2023 acquisition of Cornell Dubilier, which added high-performance film, mica, and electrolytic capacitors to the portfolio. The result is a transformed business consisting of two core segments: Precision Devices (PD), manufacturing capacitors and RF/microwave filters, and MedTech Specialty Audio (MSA), producing advanced microphones and balanced armature speakers for medical and specialty audio applications.

This matters because it fundamentally alters Knowles' earnings power and risk profile. The divested consumer business competed on price in commoditized markets with short product cycles. The remaining businesses compete on performance in regulated, mission-critical markets with decade-long product lifecycles. Defense programs, medical devices, and industrial electrification systems require qualification processes that create switching costs and pricing power. This shift from volume to value is the foundation of the investment thesis.

Technology, Products, and Strategic Differentiation

Knowles' competitive moat rests on proprietary technologies that solve problems commodity components cannot. In the MSA segment, balanced armature speakers deliver superior sound quality in miniaturized form factors essential for hearing aids and premium in-ear monitors. These aren't off-the-shelf speakers; they're custom-engineered transducers that command gross margins in the low-50% range, well above consumer audio components.

The PD segment's technology advantage is more nuanced and more valuable. The company's ceramic capacitors and RF filters serve applications like radar systems, satellite communications, and medical implants where standard components fail. The specialty film capacitor line, acquired through Cornell Dubilier, addresses "pulse power" applications—devices that must store and rapidly release massive energy bursts. These include defibrillators, railgun systems, radiotherapy equipment, and emerging downhole oil & gas tools for fracking and drill bit cleaning.

Why does this matter? Pulse power applications represent new demand, not share gains from existing markets. The $75+ million energy sector order validates that Knowles' technology enables capabilities competitors cannot match. The company isn't competing on price; it's creating new solutions for customers' most challenging technical problems. This translates to pricing power, sticky relationships, and margins that expand as production scales.

The July 2025 launch of High-Q Ceramic Core Inductors extends this moat further. By leveraging existing ceramic materials expertise, Knowles enters an adjacent $500 million market for mission-critical RF inductors used in medical implants, defense systems, and industrial equipment. Management expects meaningful revenue in 24 months, but the strategic value is immediate: customers can now source capacitors and inductors from a single qualified supplier, deepening Knowles' penetration in existing accounts and raising switching costs.

Financial Performance: Evidence of a Working Strategy

Knowles' Q3 2025 results provide tangible proof that the transformation is working. Revenue from continuing operations grew 7% year-over-year to $153 million, while EPS jumped 22% to $0.33. More telling is the gross profit margin expansion from 44.1% to 45.7%, driven by higher shipping volumes, product cost reductions, and improved factory utilization in ceramic capacitors and RF filters. This margin improvement occurred despite the specialty film line still ramping and generating higher scrap costs.

The PD segment's performance is particularly compelling. Q3 revenue of $88.2 million grew 11.9% year-over-year, with gross margins expanding 150 basis points to 41.5%. Adjusted EBIT margins reached 22.9%, up from 20.4% a year ago. This acceleration reflects both volume leverage and mix shift toward higher-value defense and electrification applications. The segment's book-to-bill ratio was 1.0 in Q3, marking the second-largest order quarter in the past year, with defense bookings particularly strong.

The MSA segment, while growing more modestly at 1.6% in Q3, maintains exceptional profitability with 53% gross margins. The hearing health business, which represents a significant portion of MSA revenue, demonstrated resilience as essential medical devices historically show only modest short-term impacts from economic shocks. The specialty audio business is gaining traction, and the supply agreement to provide metal cans to Syntiant post-divestiture creates a stable, albeit lower-margin, revenue stream that utilizes existing capacity.

Cash flow generation underscores the strategy's durability. Q3 operating cash flow of $29 million was at the high end of guidance, driven by lower working capital needs. For the nine months ended September 2025, Knowles generated $130 million in operating cash flow—16-20% of revenues, consistent with management's full-year target. This conversion rate is exceptional for a manufacturing business and reflects the asset-light nature of custom engineering work relative to commodity component production.

Capital allocation demonstrates management's confidence. The company repurchased 940,000 shares for $20 million in Q3 and 3.2 million shares year-to-date, reducing share count and boosting EPS growth. With $139 million remaining on its $400 million authorization and net leverage at just 0.6x EBITDA, Knowles has ample firepower to fund organic growth, pursue acquisitions, or accelerate buybacks.

Segment Deep Dive: Precision Devices at an Inflection Point

The PD segment is where the margin inflection story plays out. The specialty film capacitor line, acquired through Cornell Dubilier, experienced production challenges in Q4 2024 and Q1 2025 as Knowles consolidated facilities and ramped new products. These issues caused shipment shortfalls exceeding $3 million and pressured margins as the company incurred fixed overhead and scrap costs while delivering few units.

Why does this matter? The challenges masked underlying demand strength and created a temporary margin drag that is now reversing. By Q1 2025, a new prototype production line improved flow and yields. Management expects incremental shipment improvements throughout the first half of 2025, with a larger ramp in the second half. The Q3 2025 gross margin of 41.5%—up 150 basis points year-over-year—already reflects this progress, and the full benefit is still ahead.

The $75+ million energy sector order crystallizes the opportunity. This multi-year contract for pulse power capacitors includes substantial prepayment, de-risking the ramp. Shipments begin in 2026, with at least $25 million expected that year. The order transforms the specialty film business from a drag to a driver: revenue will more than double from $25-30 million in 2025 to $55-60 million in 2026, with margins expanding as fixed costs are absorbed and yields improve.

Management guidance indicates gross margins will see sequential improvement from Q3 to Q4 2025, with a "bigger jump up in Q3 2026" once the energy order fully ramps. The drop-through on incremental revenue is estimated at 35-40% to the bottom line, well above the current 45% gross margin, suggesting significant operating leverage. This is the core of the investment case: a temporary production issue masking a permanent improvement in earnings power.

Defense market dynamics amplify this opportunity. Defense spending is increasing and shifting toward electronic warfare, where Knowles' RF filters and capacitors are essential for radar, jamming, communications, and munitions. The company is seeing "accelerating design wins" and "robust secular trends" across medtech, defense, industrial, and EV markets. These design wins create revenue streams that last for program lifecycles, providing visibility and reducing cyclicality.

Segment Deep Dive: MedTech Specialty Audio's Resilient Profitability

The MSA segment provides stability and cash generation while the PD segment ramps. Q3 2025 revenue of $64.7 million grew 1.6% year-over-year, with gross margins holding at 53%. This performance reflects the essential nature of hearing health products, which show remarkable resilience during economic uncertainty. Historically, hearing aid markets grow 2-3% annually with minimal cyclicality.

The segment's profitability is structural. Balanced armature speakers command premium pricing because they deliver superior performance in compact form factors that no other technology can match. This creates a defensible niche where Knowles is the preferred supplier for major hearing aid manufacturers. The specialty audio business, serving high-end in-ear monitors and professional audio equipment, provides additional growth exposure to the premium audio trend.

The supply agreement to provide metal cans to Syntiant post-divestiture impacts margins modestly—nearly 200 basis points of drag in Q1 2025—but utilizes existing capacity and maintains customer relationships. As this agreement matures and mix shifts toward higher-value microphones and speakers, MSA margins should sustain in the low-50% range, providing a stable profit foundation while PD expands.

Competitive Context: Niche Depth vs. Scale Breadth

Knowles competes against industrial giants—TDK Corporation (TTDKY), Infineon Technologies (IFNNY), STMicroelectronics (STM), and Kyocera Corporation (KYOCY)—each with vastly larger scale but broader, more commoditized portfolios. This comparison reveals Knowles' strategic positioning and risk/reward profile.

TDK, with $30.5 billion market cap and $2.2 trillion yen in revenue, dominates passive components but targets high-volume markets with gross margins around 31%. Knowles' 44% gross margin reflects its focus on niche, high-performance applications where TDK's scale advantages are less relevant. TDK's strength in automotive and IoT sensors creates some overlap, but Knowles' specialization in balanced armature speakers for medtech and pulse power capacitors for defense carves out a defensible space where TDK's generalist approach cannot compete effectively.

Infineon, a $56.8 billion semiconductor leader, holds ~45% share in MEMS microphones but focuses on high-volume consumer and automotive applications. Its 39% gross margin and 11.5% operating margin trail Knowles' 43.9% and 17.2%, respectively. Infineon's scale enables faster iteration in consumer markets, but Knowles' custom engineering for mission-critical applications creates switching costs that volume competitors cannot easily overcome. The companies compete in RF filters, but Knowles' focus on defense and medtech provides insulation from the price pressures Infineon faces in consumer markets.

STMicroelectronics, with $22.9 billion market cap, excels in digital MEMS microphones for mobile devices but generates only 34.6% gross margins, reflecting commodity pressures. Its operating margin of 6.6% is less than half Knowles' 17.2%, illustrating the profitability advantage of Knowles' niche focus. STM's strength in the Apple ecosystem creates volume but limits pricing power, while Knowles' medtech and defense customers prioritize performance over cost.

Kyocera, a $19.0 billion diversified manufacturer, competes in ceramic capacitors but generates just 28.1% gross margins and 4.6% operating margins. Its cost-leadership strategy in volume markets contrasts sharply with Knowles' performance-leadership approach. Kyocera's low margins reflect intense competition in commoditized segments that Knowles deliberately avoids.

The key insight: Knowles trades scale for profitability and defensibility. While competitors chase $10 billion markets with 5-10% margins, Knowles dominates $100-500 million niches with 40-50% margins. This positioning creates a more predictable, higher-return business model, but it also means Knowles lacks the diversification to absorb shocks in its core markets. The company's U.S.-based manufacturing provides a further moat, as tariff concerns drive customers to seek domestic suppliers—a trend management notes is generating inquiries from industrial customers considering Knowles for security of supply.

Risks and Asymmetries: What Could Break the Thesis

The investment case hinges on execution of the specialty film ramp. While Q3 2025 showed progress, the Q4 2024 and Q1 2025 challenges demonstrate that consolidating production and scaling new technology carries real risk. If yield improvements stall or the energy order shipments are delayed beyond Q2 2026, the margin inflection could be pushed out, compressing earnings and testing investor patience. Management's guidance for "linear improvement" through Q2 2026 with a "bigger jump" in Q3 2026 sets a clear marker; any deviation would undermine credibility.

Customer concentration presents another risk. Defense and medtech customers represent large, concentrated revenue streams. While these relationships are sticky, program cancellations or delays could create revenue gaps that niche focus makes harder to fill. The hearing health market's 2-3% historical growth provides stability but limits upside, making PD's success critical for overall growth.

Palladium cost volatility could pressure margins, though management has mitigated this through pre-buys locked through H1 2026. If prices spike beyond current levels and pre-buying opportunities are limited, gross margins could face 100-200 basis points of headwind. Similarly, broader industrial market cyclicality could impact distribution demand, though normalized inventory levels (3-3.5 months) suggest limited near-term downside.

The tariff situation, while currently manageable, remains fluid. Though less than 5% of revenue is exposed, significant expansion of tariffs could impact costs or customer demand. Management's confidence in passing through costs is based on historical experience, but unprecedented trade tensions could test this assumption.

Outlook and Guidance: The Path to Higher Margins

Management's guidance frames the earnings power story. For Q4 2025, revenue is projected at $151-161 million (9% growth at midpoint), with adjusted EBIT margins of 22-24%. This implies meaningful margin expansion from Q3's 22.6% adjusted EBIT margin, driven by improved specialty film output and capacity utilization.

For full-year 2025, Knowles expects PD to grow at the high end of its 6-8% target, with total company organic growth at the high end of the 4-6% range. This represents an acceleration from historical levels, supported by new design wins and the specialty film expansion. MSA is expected to grow 2-4%, providing stable cash generation.

The 2026 outlook is where the story gets compelling. Specialty film revenue is projected to reach $55-60 million, up from $25-30 million in 2025, with the energy order delivering at least $25 million. Management expects gross margins to "go higher in 2026, really driven by the back half of '26, driven by that ramp-up in the specialty film line." This implies potential gross margin expansion to 46-48% by Q3 2026, with operating leverage driving EBIT margins toward the mid-20s.

Operating cash flow guidance of 16-20% of revenues for 2025, combined with capex at ~5% of revenues, suggests free cash flow margins in the 11-15% range—strong for a manufacturing business. The company expects to generate "robust cash from operations throughout 2025," providing continued funding for buybacks and capacity expansion.

Valuation Context: Pricing a Margin Inflection Story

At $23.02 per share, Knowles trades at a market capitalization of $1.98 billion and an enterprise value of $2.08 billion. The valuation multiples reflect a company in transition:

• EV/Revenue: 3.63x - Moderate for an industrial components company, but reasonable given the margin profile and growth outlook. Peers trade at 1.74x (STM) to 3.68x (Infineon), with Knowles' premium reflecting higher margins and niche positioning.
• P/Operating Cash Flow: 19.40x - Reasonable for a business generating 16-20% OCF margins, especially with improving working capital efficiency.
• P/Free Cash Flow: 24.17x - Reflects strong cash conversion and disciplined capex. The 11-15% FCF margin implied by guidance supports this multiple.
• Gross Margin: 43.87% - Substantially exceeds all named peers (TDK 31.25%, Infineon 39.24%, STM 34.60%, Kyocera 28.11%), justifying a premium valuation.
• Operating Margin: 17.20% - Nearly double STM's 6.62% and well above Infineon's 11.51%, demonstrating superior cost structure and pricing power.
• Debt/Equity: 0.26x - Conservative balance sheet with net leverage at 0.6x EBITDA provides financial flexibility and reduces risk.
• ROE: 4.68% - Modest but improving as margins expand and capital turns more efficiently.

The valuation appears to price in the current 4-6% growth and 44-45% gross margins but may not fully reflect the potential for 2026 margin expansion to 46-48% and specialty film revenue doubling. If management executes on the specialty film ramp, the combination of revenue growth, margin expansion, and continued buybacks could drive EPS growth of 20-25% in 2026, making the current multiples appear reasonable for a company with improving returns and defensive end markets.

Conclusion: A Transformed Company at an Inflection Point

Knowles Corporation has completed a strategic transformation that repositioned it as a pure-play industrial technology company serving mission-critical markets with high-margin, hard-to-replicate components. The divestiture of consumer MEMS eliminated cyclicality and price competition, while the Cornell Dubilier acquisition added specialty film capacitors that address new pulse power applications with substantial pricing power.

The investment thesis centers on a margin inflection driven by resolving specialty film production challenges and ramping a $75+ million energy order in 2026. This isn't a turnaround story—it's an execution story. The underlying demand is proven, the technology is qualified, and customers are prepaid. The Q3 2025 results, with PD segment margins expanding 150 basis points and book-to-bill remaining strong, demonstrate that execution is on track.

Defense spending tailwinds, electrification trends, and tariff-insulated U.S. manufacturing provide additional layers of growth and protection. While peers chase scale in commoditized markets, Knowles dominates niches where performance commands premium pricing. The company's 44% gross margins and 17% operating margins reflect this positioning, and the balance sheet's 0.6x net leverage provides strategic optionality.

The critical variables to monitor are specialty film yields and the timing of energy order shipments. If management delivers the promised "bigger jump" in margins by Q3 2026, the earnings power will materially exceed current expectations. If execution falters, the stock's moderate valuation multiples provide downside support, but the thesis would be delayed. For investors, Knowles offers a rare combination: exposure to secular growth trends in defense and electrification, margin expansion potential, and defensive characteristics—all at a valuation that doesn't require heroic assumptions.