Knowles Corporation

Good afternoon and welcome to the Knowles Corporation first quarter 2020 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. With that said, here with opening remarks, is NOLS Vice President of Investor Relations, Mike Knapp. Please go ahead.

Thanks, Christine, and welcome to our Q1 2020 earnings call. I'm Mike Knapp, and presenting with me on the call today are Jeff New, our President and Chief Executive Officer, and John Anderson, our Senior Vice President and Chief Financial Officer. 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 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 on Form 10-K for the fiscal year ended December 31, 2019, 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 Knowles 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 call can be found in our press release posted on our website at knowles.com, 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 on webcast slides, which can be found in the IR section of our website. With that, let me turn the call over to Jeff, who will provide some details on our results. Jeff.

Thanks, Mike, and thanks to all of you for joining us today. I hope all of you and your families are healthy and safe. This is no doubt an unprecedented and challenging time, and we continue to focus on the health and safety of our employees, customers, and partners worldwide. I'm very proud of our employees around the globe for stepping up to help solve the challenges we are currently facing, and I appreciate the efforts as we continue to execute our strategy. I believe that our strong balance sheet and diversified customer base and end markets will enable us to weather this difficult period and allow us to continue to invest to support future growth when the markets return to a more normalized level. In my prepared remarks, I will briefly discuss the Q1 financial results and then talk about what we are seeing in terms of demand across our end markets and products. After that, I'll discuss the operational challenges we are encountering, as well as the actions we are taking to mitigate near-term impacts on our business. I will then turn it over to John for more details on the actions we have taken or will be taking to ensure we maintain liquidity while still investing in our core business and growth opportunities. For Q1, we reported revenue of $163 million in line with our updated guidance and down 9% from the year-ago period. Audio sales were down, partially offset by stronger precision device sales. Gross margins were 35.7%, and EPS was 3 cents as COVID-19 caused significant disruptions within our manufacturing operations across Asia, which negatively impacted labor productivity and factory utilization. As I move into the demand and operational portion of my prepared remarks, I want to note that that the ultimate impact COVID-19 will have our business in Q2 is very difficult to estimate this time. I will try to provide as much detail as possible to help investors understand how I see things today, knowing that the situation remains very dynamic. Let me begin with an update on our customer demand across our end markets. In our audio segment, Q1 revenue was down 14% from the year-ago period driven by weaker demand for hearing health products and softer sales into mobile ear and IoT markets. While Q1 audio demand was weaker than our original projections, much of the weakness hit later in the quarter, and we are anticipating continued softer demand trends throughout Q2. In hearing health, we began to see a significant slowdown in orders late in the quarter based on end market demand in Europe and the U.S., which represents approximately 85% of the global hearing aid market. This slowdown corresponds to countries that adopted COVID-19 movement restrictions later than Asia, with the U.S. lagging Europe by several weeks. Given many audiologists' offices remain closed, coupled with hearing health's heavy reliance on demand from people over the age of 65 who are at higher risk from COVID-19, we anticipate our hearing health business in Q2 will be down significantly from the year-ago period. Despite this near-term weakness, we know from prior downturns that hearing health demand is reasonably insulated from economic declines. Since hearing health customers are older and generally less exposed to equity markets, own their homes, and have the income to purchase hearing aids, we expect demand to improve as people feel comfortable that COVID-19 is under control. Based on discussion with our customers who are assuming improving trends related to virus movement restrictions, We expect the second quarter to mark the bottom in demand for this market, with sequential improvement in the second half of 2020. However, it may take until 2021 to get back to 2019 run rates. Moving on to the mobile ear and IoT markets, the mobile market represented less than 30% of total company sales in Q1 as smartphone demand trends weakened throughout the quarter. Sales to our largest U.S. and Korean customers were higher than the year ago period, while sales to Chinese volumes were down significantly. Demand has begun to stabilize in China, and we currently expect sales into the mobile market to remain lower than the year ago period. We are talking to all of our mobile customers and industry experts. At this point, many are expecting smartphone units worldwide in 2020 to be down as much as 15% from 2019. Revenue from ear and IoT also declined year over year, but represented greater than 30% of sales in Q1. As growth rates reset across consumer electronics, we expect true wireless will remain the best-performing segment within the ear market. We continue to invest in MEMS microphones and balanced armature solutions to support this market. In early April, IDC said that it expects demand for smart home products to decline year over year in the second quarter, and we expect similar trends in our business. We expect to remain the leader in the MEMS microphone business. As we have previously discussed, improved voice communication and speech recognition are driving the need for more microphones with increased performance, lower power, higher robustness, and smaller size. Our new products and programs across ear, IoT, and mobile are expected to extend our differentiation and competitive position to drive long-term sales growth with higher gross margins as we continue to increase investment in this business. Overall, our microphone revenue in Q2 is expected to be flat with sales in Q1. Moving to precision devices segment, in Q1, sales were up 6% from the year-ago period, driven by continued demand for our differentiated products across defense, medtech, and the electric vehicle end markets. We also made good progress fixing the operational issues we experienced in Q4 of 2019. We anticipate sales in precision devices to grow more than 5% sequentially in Q2 and expect gross margins to increase as operational improvements continue to take hold despite increases in palladium prices. Now let me discuss where we stand from an operations perspective. For our manufacturing facilities, we remain focused on aligning output with our customers' demand as we continue to protect our employees. Most of our non-manufacturing employees now work from home and travel throughout the company has been restricted. In China, where our manufacturing supports MEMS and microphones and high-performance capacitor products, Q1 was extremely challenging with the extended Chinese New Year followed by a slow ramp back to normal production levels as travel restrictions were lifted and our employees were allowed to return to work. Our China operations are now running without production constraints. In the Philippines, Where most of our hearing health solutions are produced, the government has implemented enhanced community quarantine until mid-May. Due to the government restrictions and significant demand weakness in the hearing aid market, we anticipate very low capacity utilization as we align our output with the demand in the quarter. In Malaysia, where we make microphones for both the consumer and the hearing health market, the government has implemented a movement control order until mid-May. As with our Philippines operation, because of the government restrictions and significant demand weakness in hearing aid market, we expect very low utilization in Q2 to align output with demand. In the U.S. and Dominican Republic, where the bulk of our precision device solutions are produced, we have seen limited impact to date and we continue to monitor the situation daily. Lastly, in response to these market conditions, we are taking significant actions to reduce operating expenses, control CapEx, and manage working capital. We are re-evaluating all the projects across the company, identifying those projects with the best potential given the adjusted market conditions. Where appropriate, we are taking steps to reduce costs this year. The goal is to make sure we maintain a strong balance sheet with ample liquidity while meeting our short-term commitments and supporting the long-term potential of the business. All these actions As these actions are ongoing, we will provide additional details as they are completed, but I wanted to specifically address one area. In intelligent audio, demand has been below expectation, and we are further reducing the allocation of resources to this product line to align with the growth potential and the challenging market conditions. We will continue to support existing products and customer programs. John will provide additional details on how we expect these and other changes will impact operating expense for the balance of the year. Overall, the primary short-term issue we face today is related to demand rather than supply, especially in our hearing health market. Our company remains uniquely positioned across the markets we serve, and I believe our strategy to deliver high-value, differentiated solutions to a diverse set of growing end markets will enable us to come out of this pandemic well-positioned to take advantage of future growth. With that, I'll turn it over to John to expand on our financial results and provide our details for the second quarter. John?