Knowles Corporation

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

Thanks, Helene, and welcome to our earnings call. I'm Mike Knapp, and presenting with me on the call today are Jeffrey 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, included but not limited to the annual report on Form 10-K for the fiscal year into December 31st, 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 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 with the FCC today, including a reconciliation to the most directly comparable GAAP measures. All 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 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. Thanks to all of you for joining us today. For Q4, we reported revenue of $243 million, up 18% sequentially, and up 4% from the year-ago period. As we mentioned in our pre-announcement release, stronger than expected MEMS microphone demand in multiple end markets and improving trends in hearing health solutions drove the upside. Gross margins improved 130 basis points to 38%, and our earnings per share was above the high end of our guidance range at $0.41. Overall, a very solid quarter where we saw improving demand in audio in combination with solid operational execution across our businesses. Now let me update you on current customer demand across our end markets. In audio, sales were up 22% from the prior quarter versus our expectations of more than 7%. In the second half of 2020, we saw broad-based sequential improvement in MEMS mic sales across mobile and non-mobile end markets. In mobile, stronger sales to North American and Chinese OEMs drove the majority of the increase as 5G phone shipments accelerated. Non-mobile applications also increased with sales into ear, IoT, and computing markets driven by work from home and remote schooling trends. We expect these trends in non-mobile applications to continue to be favorable for MEMS microphones in the first half of 2021. For hearing health, shipments were higher than expected going into the quarter, but remained lower than the year-ago period as COVID challenges persist. Data from the Hearing Industry Association shows that unit sales of hearing aids in the U.S. declined by 7.5% year-over-year in Q4, with only modest improvement in the V8 channels during the quarter. Under the umbrella of our hearing health business, we also sell high-performance microphones and speakers to premium audio companies as well as many smaller customers for a diverse set of niche applications unrelated to hearing health. One example is in-ear headset monitors used by musicians in live music performances. These type of customers have been severely impacted by COVID and account for the majority of the shortfall relative to pre-pandemic sales. We remain confident that the hearing health business will fully recover in the near future as the COVID vaccine becomes more widely available. In precision devices, Q4 sales were flat sequentially, as expected, as COVID continued to impact our med tech and defense end markets. Shipments of high-performance capacitors into the med tech market continue to be negatively impacted by COVID-related delays in elective surgeries. We are confident this market will recover as the vaccine becomes more widely distributed. In defense, COVID-related program blades were a drag on growth in 2020, but we are beginning to see a recovery as bookings in this market have improved in the last two months. These products have longer lead times, and we expect these shipments to begin to positively impact Q2. Overall, I was pleased we were able to grow precision device revenue in 2020 despite headwinds from the pandemic, with growth coming from electric vehicles, defense, and industrial, partially offset by MedTech. I anticipate we will return to more robust growth in PD as MedTech and defense markets recover. I'm very proud of our team's execution during these challenging times. We not only weathered an extremely difficult first half of 2020, we also took significant actions to improve our business. As our MEMS microphone business fully recovered in the second half of 2020, We saw the strong operating leverage and cash flow potential inherent in our business model, even while COVID is still having a negative impact on a number of our end markets. I believe the leadership position across the markets we serve and 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. In addition, we have several opportunities to improve our gross margin that I expect will drive additional earnings in 2021 and beyond. With that, I'll turn it over to John to expand on our financial results and provide guidance for the first quarter. Thanks, Jeff. We reported fourth quarter revenues of $243 million, up 18% sequentially and 4% from the year-ago period, driven by increased shipments in the audio segment. Audio revenues of $202 million were up 22% sequentially, due to increased shipments of MEMS microphones across multiple end markets and continued recovery in the hearing health market. The precision device segment delivered revenues of $41 million, flat sequentially and in line with our expectations. Fourth quarter gross profit margins were 38%. At the high end of our guidance range and up 130 basis points sequentially, audio segment gross margins improved 260 basis points, driven by higher factory capacity utilization and lower cost, as well as favorable product mix related to increased shipments into the hearing health market. In the precision devices segment, gross margins were lower sequentially due to lower factory capacity utilization and unfavorable product mix. R&D expense in the quarter was $20 million, up $1 million sequentially, as higher incentive compensation costs and a non-recurring supplier payment was partially offset by reduced spending in intelligent audio. SG&A expenses were $27 million flat sequentially and $2 million above our guidance due to higher incentive compensation costs. For the quarter, adjusted EBIT margin was 18% at the high end of our guidance range and up 430 basis points sequentially, driven by increased shipment volumes, higher gross profit margins, and improved operating leverage. EPS was $0.41 above our guidance range due to higher revenue and gross margins and a $0.03 discrete tax benefit, partially offset by higher incentive compensation costs. Further information, including a detailed reconciliation of GAAP to non-GAAP results, is provided in the financial tables of today's press release and can also be found on our website at Knowles.com. Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $148 million at the end of Q4. For the fourth quarter of 2020, cash generated by operations of $76 million was a record high and well above our guidance range due to higher EBITDA and lower than expected net working capital. Capital spending was $12 million in the quarter. For full year 2020, cash generated from operations was $128 million and free cash flow was 96 million, representing more than 12% of revenues. We exited the year with net debt of less than 25 million and repurchased 1.1 million shares in 2020. Moving to the first quarter of 2021, we expect total company revenue to be between 190 and 210 million, up 23% at the midpoint versus the same period a year ago. Revenue from the audio segment is expected to be up approximately 35% from Q1 2020 due to increased MEMS microphone shipments into non-mobile applications as work from home and remote learning trends continue. In addition, we expect higher mobile microphone demand at both our largest customer and Chinese OEMs. Precision device revenue is expected to be down approximately 12% over prior year levels driven by defense project pushouts and the continued impacts of COVID-19 on elected medical procedures, specifically for implantable devices. As Jeff noted, defense bookings have strengthened over the last two months, and we're optimistic about growth in this market in 2021. We estimate gross margins for the first quarter to be approximately 37% to 39%, up 230 basis points from the year-ago period. driven by increased audio demand and improved factory capacity utilization in our MEMS microphone business, partially offset by price erosion and unfavorable FX impacts. R&D expense is expected to be between $19 and $21 million, down $2 million from prior year levels due to a reduction in spending related to intelligent audio products, partially offset by increases in MEMS microphone and precision device spending. We're projecting selling and administrative expense to be between $24 and $26 million, down $9 million from the year-ago period due to a $4 million reduction in legal expense and the impact of restructuring actions taken in the second quarter of 2020. We're projecting adjusted EBIT margin for the quarter to be in the range of 13% to 17% and expect EPS to be within a range of $0.23 to $0.27 per share. This assumes weighted average shares outstanding during the quarter of $95.1 million on a fully diluted basis. We're forecasting an effective tax rate of 14% to 18% for the quarter. Please refer to our press release and to our Form 8K filed today with the FCC for a GAAP and non-GAAP reconciliation. For the quarter, we expect cash generated by operations to be between $25 and $35 million and capital spending to be approximately $10 million. I'll now turn the call back over to Jeff for closing remarks, and then we'll move to the Q&A portion of the call. Jeff? Thanks, John. Our company remains uniquely positioned across a diverse set of end markets poised to grow over the next several years. We remain the leader in hearing health solutions and expect recovery to 2019 levels in the next few months. In MEMS likes, we expect non-mobile applications to drive future growth and the mobile market stabilized as more 5G phones introduced. For precision devices, we expect revenue to grow in 2021, driven by continued momentum in defense and electric vehicles and recovery in the medtech market. As we look further into 2021 and our markets continue to recover, I believe we can drive shareholder value by delivering earnings and cash flow above pre-COVID levels. Operator, we can now take questions.

Just as a reminder, if you would like to ask a question, press star one on your telephone keypad. And your first question comes from the line of Harsh Kumar with Piper Sandler.

Yeah. Hey, guys. First of all, let me just say congratulations. You know, this has been a phenomenal turnaround that you guys have executed, you know, across all measures, controlling OPEX. And now I think you guys are really seeing the results of it. So really appreciate what you guys are doing from the side of investors. Jeff, I had a quick question. If I was to try and ask you, you know, what do you think the handset growth is for the year? We're hearing 10%. But I want to hear you talk a little bit about what you're expecting in year and IoT growth for the year or call it midterm. And then also, what do you think would be the PD growth rate? In other words, I'm trying to get an idea of your growth rate for the midterm two to three years out.

Yeah. So first, let's talk about mobile first. You know, I think we've talked about this for a while, and I think, you know, that, you know, overall, you know, that, you know, obviously the last three years, when you talk about full-year mobile, you know, the unit sales have not been, like, great. You know, we've kind of been thinking about that, and we kind of looked at the numbers harsh, and I would sit there and say is, you know, I went back to 17. About 36% of the company revenue came from mobile in 17 years. You know, we're expecting in 21, it's going to be less than 25%. Um, you know, and so, you know, our expectations for mobile art is that, you know, that, you know, right now people are saying it'll probably get back to pre pandemic levels in 2022. And I think, you know, but again, it's not that we're leaving the mobile market, but we have other places where we're growing much faster. And I think it can get better gross margins. And so, you know, I think this is an area that, you know, that we'll continue to work in. But, you know, I don't think we have super high expectations for mobile. Now, if I go to the non-mobile applications, I would say, obviously, that's a little different. And if I look at the same numbers... About 19% of the company's total revenue in 2017 came from non-mobile applications and MEMS mics. It'll probably be close to 30% in 2021. And so, you know, this is an area where we still see growth, right? We've talked about beer. We've talked about IoT. I think the other one that, you know, we've been talking about more recently is computing. The whole work from home and the idea of school from home is driving a lot of demand in the laptop PC market. And I would say it may not stay sustained at this level indefinitely, but I think it's definitely going to be larger than it was in the 17, 18 timeframe. And so I think we're still very bullish on the non-mobile applications. I think the last question went kind of on to like PD. You know, I think, you know, this is, again, we have two separate businesses here with a number of markets, and this is probably a lot to digest in a quick call here, but just generally speaking, you know, the RF business, which, you know, has been primarily driven by defense, we still think that's going to grow, you know, going forward. You know, we still have growth in that business in 2020, But it wasn't as great as we thought it was going to be based on the delays in defense. We think it's going to get stronger again in 2021, and we expect that it's going to continue to grow. As far as the high-performance capacitor business, EV starting from a small base, but we've had nice growth. We expect to have growth again in 2021, 2022, and beyond. And this will be a lot in the high-voltage portion of the all-electric vehicle market. And we're specifically targeting, like, on-bar chargers and battery management. That's kind of where we're really focused in, in the EV market. And then, you know, we're expecting a recovery in the MedTech market, you know, in 21. And, you know, it's hard to say exactly when that comes, but as elective surgeries start to come, and we listen kind of a lot to our big customers in that market, like the Abbots of the world and what they're talking about. But, you know, longer term, we think MedTech will be a growth business for us.

Hey, thanks, Jeff. I think you answered a lot of my other questions. The only other quick one that I have, you know, to back in line was, you know, timing of hearing health. Is there, I mean, I know it's a moving target with all the COVID stuff going on, but do you want to even try to guess when you might be back to kind of year ago or full levels as you might think about it?

Yeah, I would say, you know, as we look into one, hearing health getting, hearing health as in the traditional hearing aid market, is getting pretty close to normal. I think the one piece that we're missing, and I know we haven't talked a lot about this, but about 10% of the sales in this division go to these other applications. And when I talk about other applications, I'm not talking about, you know, the balanced armature or true wireless. I'm talking about, like, audio style, like performers on stage that are wearing headsets, they have our speakers in them. We sell to the aviation market. We sell to other non-hearing health med markets. And it's about 10% of the market. That business is still significantly down. We're hoping as the vaccine, you know, obviously gets out, performers are going to start coming. And there's going to be concerts again. This business is going to pick up. So I would say, again, hearing health is pretty close back to normal in Q1. very close with this kind of other category, which is about 10% of business, still being significantly impacted.

Thanks, Jeff. Thank you, John, and congrats again, guys.

Thanks, Art.

And your next question comes from the line of Anthony Stoss from Craig Hallam.

Hey, Jeff, John, and Mike. Jeff, in your prepared remarks, you talked about gross margins and that you have some more improvements to be made or some more programs to improve them. If you could offer a guess, maybe a range as to where you think it exits the December quarter this year, what you need to do to get there. And then secondly, maybe more for John, are you done with all OPEX cuts? Is there still more to go? And then, Jeff, also, last question, are you seeing any component shortages? Every chip company is talking about it on wafers, et cetera. I'm just curious what you guys are seeing. Yeah, so let me answer that last question first. In terms of waiver shortages, I would sit there and say we have not had any waiver shortages. What we have had is lead times go out, right? So, you know, the risk here with lead times going out is we're trying to predict mix further out, right? And so that's the challenge so far we've seen. But as far as, you know, not having enough waivers, that has not been an issue for us. You know, I think we've got a good group of partners that have done pretty well for us. On the gross margin side, I'm going to turn it over to John in a second. I just want to make a couple comments. You know, we started talking about gross margin at the end of 19 and wanting to improve it. And I would sit there and say, obviously, 2020 was, you know, obviously a tumultuous year, especially, you know, the first two quarters of the year. And I would say a lot of the work that we've been doing, the good work we've been doing, is being masked by two things. One is mix. Two of our highest gross margin businesses, our hearing health business, coupled with the med tech business and PD, are down. So MIX is not helping us even now. And then the second thing is obviously the absorption with all the factories that we have that we're running full and having impact as well. Now, I'm going to turn it over to John. He'll talk a little bit about some of the things that we're doing and how that translates and what it means for 2021. Sure. Yeah, just to add, Tony, I guess first of all, I have to say I'm pleased with the trajectory in our gross margin, you know, which was up more than 130 basis points sequentially. We had gross margins of about 36.7 in Q3. They're up to 38 in Q4. And then if you think about the potential to improve those margins, Jeff talked about, you know, selected portions of our business are still being impacted, the audiophile business, PD, the med tech business in defense. all three of those end markets typically carry above average gross margins so when we recover to fully recover in those markets i think there's clearly uh some tailwinds uh in addition we did in the in fourth quarter you know despite delivering 38 we had some workforce disruptions in our north american manufacturing facilities related to golden and so again if those uh You know, we don't expect those to continue. That will also be a tailwind for us moving forward. So I think, you know, if you take all that together, I think based on, you know, current end market conditions, there's no reason we can't have full year 2021 gross margins above 2019 levels. We finished right around just 39.1, I think, in 2019. So hopefully that gives them some color. Got it. If I could sneak in one more, Jeff, any update on when you can get the automated VA equipment in and then up and running? Yep. I'll give you a quick update on that. The line is shipped. It's actually on the ground in the Philippines in the facility. We have not yet been able to get the installation team there in order to install the machine. But we're hopeful with the distribution of the vaccine that we're not too far off from being able to send the team there and that any restrictions relative to travel to the Philippines will be fully cleared. Once we get it there, I'm anticipating it's about eight to ten weeks to get it fully installed. And so we have a pretty good pipeline of opportunities for the back half of the year. which, you know, I hope we don't have to push out. I don't think we will. I think we're going to get this line up and going. But I think the pipeline to the back after year is looking pretty good, you know, and so we've got to get this thing installed, but I think it should happen sometime in late Q2. Hey, Tony, did we address your optics question? No, I think, yeah, I was going to save that for a follow-up call tonight, but go ahead. I would assume you're getting pretty close to being at the tail end of it. Yeah, I mean, at Q4, we incurred about $47 million of OPEX. A couple items that I want to pull out is we had abnormally high incentive compensation costs, about $2 million higher than normal. We really finished strong, and on the higher EBIT, we had higher incentive comp costs. We also had some engineering NRE, which is a little more than $1 million, So if you take those out, call it a 44 to 45 million run rate, I would say very modest increases from there going into 2021. There's nothing line of sight where we see this big opportunity to reduce further, but I think we can get great operating leverage if we can grow the top line and really just we shouldn't have much more than 2% to 3% increases in 2021. Thanks. Best of luck, guys. Thank you.

And your next question comes from the line of Bob Laidick from CJS.

Good afternoon, and also congratulations on some very strong results. I wanted to stick with the gross margin question. And obviously, you just spoke about the opportunity to have very strong gross margins this year. Looking out further, can you talk a little bit about the opportunity to perhaps get above 40%? You know, what would be the drivers there? And maybe, you know, is your mix changing even within mobile? Or, you know, what are the current drivers right now of the improved gross margins despite having some of the higher margin businesses being suffered? So I guess that's two questions there. Sorry.

Yeah, that's okay. Yeah, so I would say, you know, I think we talked a little bit about – 2020 being kind of like a little bit more challenged in terms of pricing. You know, we made some decisions on pricing, I would say, in the, you know, the February, March, April timeframe for the back half of the year that, you know, without, you know, it's hard to tell what the demand was going to be. But it's clear, Bob, that the pricing and the demand are much better aligned now. And even as we're in 2021, they're much better aligned. And so I think we talked about this before, which was if you go back a few years, we were averaging on mature products like 7%, 8% price erosion on mature products. By the time we got to 19%, it was less than 4%. And, you know, we kind of fell off the rail here with the demand, how it kind of came in, you know, in Q1 and Q2, and we're making decisions about pricing for the back half a year. I don't see that being sustained. So, you know, I think as we're introducing new products in MEMS mics, They're coming in at higher gross margins, and as also we have less mobile. I covered this kind of in an earlier question that the non-mobile applications continue to grow where the gross margin is higher. And so I think within MEMS, Mike, it's mixed. It's for sure mixed. It's helping us in 2021. As we look into the other businesses, you know, I think about where we think our growth is going to come from. You know, in hearing health, we talk about balanced armature receivers. I think that is going to be, as that grows, that's going to be higher gross margin than our corporate average. There is, you know, still ongoing within the hearing health market, a shift from the old style microphones to MEMS microphones. And while that doesn't add to our sales level, it changes the gross margin. And then, of course, in PD, you know, defense and med tech are areas in EV where we're focused, where gross margin is higher. So what you see is the R&D dollars for new products are being focused towards the markets that have higher gross margin. And you're going to start to see some of that come through in 2020-21.

Okay, great. And then I think you started to touch on this a little bit too, but I was wondering if you could talk about your thoughts on kind of the longer-term consequences of COVID. You had mentioned that in the computing market, work from home and remote school and stuff should increase that over pre-COVID levels. Are there any other changes in your end markets or your thoughts about the future that have changed as a result of COVID?

No, I'll make a couple comments about the hearing health market, which is kind of interesting, which is, you know, if you go back when we were talking about this in February, March last year, we were saying that there was two things that had to happen. One was people had to feel comfortable. We had to have a solution to COVID. And number two is people had to feel comfortable coming out. You know, because I talked to the hearing health customers. If the audiologists are open, the consumers are coming. We're not seeing people staying home, right? And so I think the recovery, once the vaccine is out, should be pretty good for us in these markets. I do think there is, especially on our PD side, MedTech, it would appear to me that there's some pent-up demand in MedTech. You know, and, you know, I think the other thing I would say is, and this is not COVID-related, but, you know, I think we're very well positioned in defense with PD. You know, I think we've worked in the areas where investments being made relative to, you know, electronic warfare, right? We've got some very new products there, and I think that's going to be a nice growth market. But I see that recovering again, you know, as COVID starts to dissipate.

Okay, super. Thank you.

And our next question comes from the line of Christopher Rowland from Susquehanna.

Thanks, guys. I guess my first question is a follow-up. Can you talk about, and I didn't totally understand Jeff, what you were talking about with pricing, were you saying that pricing has improved from down 3% to 4% that you talked about? Could we even see pricing up in this kind of environment? And then secondly, is capacity utilization nearly 100% for the full year here as lead times are stretched and you have visibility into perhaps some tightness in the back half? Um, how hot are we going to be running this year?

Thank you. So yeah, that I think the first question on pricing again 2020 was kind of a difficult year having made some decisions on pricing when the market was very poor, right about, you know, that, you know, about the back half. But as we go into 2021, pricing is stabilized. And what's happening is new products, of course, are being introduced like we normally do, which is, you know, resetting the numbers, you know, and price erosion is coming in, you know, but less than that 4%. It could be even less than 3%, you know, quite frankly, on them's mind. So we're seeing a lot better pricing environment as we go into 2021. So I think that would be the comment. And then your second question is, I'll let John talk about the utilization. Let me just make one quick comment. Right now, the demand, obviously, based on our guide, for Q1 is quite strong in Q1. I think the areas that we're talking about for the back half of the year are and getting prepared for is, you know, our largest customer, is it going to be another big year for mobile phones in the back half a year? That's a question that we have to think about, right? The second one, you know, is that, you know, within our non-mobile applications, PC and laptop and tablets, have been extremely strong, you know, through the COVID. And the question is, I do believe they'll be above 2019 levels, but the question is, will they sustain at this level all the way through the back half of the year? Yet to be seen, right? I think it's yet to be seen. And then the last piece, before we talk about cash pass utilization, I would just say is that, you know, kind of what we're saying, you know, how I see it is that even if some of these markets, you know, are a little bit weaker, you know, in the back half in, say, 2020s, We do have all these other stuff coming back, right, MedTech within PD. We have defense. We have, you know, this audio file slash aviation slash, you know, other MedTech for HHT. So this stuff should be coming back. So, you know, I kind of view it as this is the value of diversified business, right, that you have some things up, some things down. But overall, you know, again, we feel pretty good about 2021 right now. Just, Chris, in terms of capacity utilization, I'm really talking about the men's business, but Q4, you know, we ran very close to 100%. We actually, in addition to that 100%, we actually sold and took down our inventory as well. I would say as we look into Q1, you know, it's higher than normal. We're actually going to work through Chinese New Year, and it would be higher than the normal first quarter. It's seasonally low. Yeah, and let me make one more comment. You know, I think... Normally, we expect, you know, that Q1, you know, with some of the dynamics in the mobile market, it's the seasonally low quarter. It could shift slightly in the Q2 on mobile, right, because of the timeline of when things were introduced. That's kind of where I was going. Q1, we're going to have that normally high or higher than normal trend. utilization. Q2, we will, but it will be replenishing inventory in Q2. Q1, we're kind of all out to meet demand. And again, that's based on kind of the conditions that we see right now. No significant supply chain constraints today. You know, lead times for wafers have extended a little bit, but it's not a bottleneck for us today.

Okay, understood. Very helpful. Thank you, guys. And I guess my second question is around 5G handsets, you know, the kind of China handset complex in particular here. Can you talk about some trends that you're seeing there in terms of content for you guys, in terms of multi-mic adoption, in terms of better mics? Is this a driver for you guys as well? And then people have begun to talk about an inventory of handsets building in China as people aggressively attack the lost Huawei share that's out there. Are you seeing that as well? Thanks.

So we saw a very strong Q4 sequentially from Q3 in China. I'm looking at the numbers here. Yeah, we saw very strong. And so it's definitely going to be down sequentially from Q4 to Q1. We're already projecting that. But it is up significantly over Q1 of 2020. So, you know what? I would say, you know, just generally speaking, the Android market has been kind of a little bit of a mixed bag here, and Chuck obviously tried to drive a lot of this, and it My personal feeling right now is I'm not feeling like there's a big inventory issue. If I look at kind of the forecast we're starting to see for Q2, China still will be up sequentially in Q2. So although, again, I always preface that with we've got to wait until after Chinese New Year. But right now our forecast seems pretty good sequentially from Q1 to Q2.

Understood. Thanks, guys. Appreciate it, and congrats on the solid quarter.

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

Hi. Good afternoon. Given your commentary that you were almost at 100% utilization rates in Q4 and you're going to be higher than normal in Q1, if we assume 10% growth in smartphone this year, Would you have to build capacity for the second half of this year? And also, I wanted to go back to the commentary that you expect Q1 shipments in smartphones to be higher than normal, and in Q2, you expect that there's going to be some inventory replenishment. Given that some investors have been concerned about overshipping in Q1, is that something that you believe could impact the second half of the year where There is, at some point, just excess inventories in the channel. I'm just trying to put all of this together and what it means for utilization rates, cost margin, and shipments relative to real land demand.

Yeah, I mean, right now, kind of how I feel, Tristan, about the full year is that we will be probably building full out through the full year with Q2 being more of building inventory. We talked about this before. Our strategy here is because we have such diversity of customers and markets that we don't have to have capacity in place for the peak in the back half of the year. Because we have enough customers that we're very confident are going to buy and what part numbers that we can build those in the first half. So, you know, right now I would sit there and say I would think we're going to build pretty close to full out for the full year. That would be my guess. As far as mobile, you know, I think, you know, mobile is for us, you know, if I think about it, it's going to continue to decline the percentage of our total company revenue. And I think one of the things that we are thinking more about, Tristan, as we go into this year is that we've got a great product portfolio. We've got a lot of great end markets. Yes, at the higher end of the market, we still sell microphones. We like those sales. But when we start thinking about the lower end of the market, there may be other methods for us besides selling the full microphone to sell into the lower portion of the mobile market. And so... What I think about this is over the long term is we are trying to start moving away from the lower end of the markets in mobile. And what really drives me there, Tristan, is this. First of all, it's the gross margin, but it's also the absolute ASP that I'm filling my factory with. When we sit there and we see microphones in the low end being sold at $0.10 to $0.15 at a gross margin that is sub the corporate average versus we could sell that to ear, IoT, compute, or higher-end mobile at a higher gross margin, it's both a revenue driver and it's a gross margin driver. And I think we're getting to the point where, again, when I see it, the demand for microphones continues to rise. And so we're able to kind of like not go as aggressively after the low end of the market.

Great. That's very useful. And then as a follow-up, so you've mentioned the new products that you're going to launch outside of small firms that are presumably higher ASPs and driving mix products. Is this going to be just a shift into higher ASPs, higher margin products outside of smartphone, or do you think those products can also help you gain share outside of smartphone, or are you just reliant on those non-smartphone end markets to just grow faster year over year?

Well, I mean, I don't know if we've done the analysis of results in share gains, but I would just say the primary goal here is higher ASPs and higher gross margins. That's where we're focused. And in some of the cases, you know, these will be dual source. In others, they won't be. You know, I think what we feel, you know, Tristan, you know, I think we've talked about this. It's really a two – to competitor situation here within the microphone market. And I don't think anything's really changing with that. So, you know, I think we'll get our fair share with the new product that we have in the market that we're attacking. Great.

Thank you.

And your next question comes from the line of Sujad De Silva from Roth Capital.

Jeff, I just want to go back to the results here. The balanced armature, you talked about the supply side. You guys are trying to get the equipment installed. I understand travel is hard. But on the demand side, are the programs that would intercept that capacity in second half, are those programs waiting for your product? Have they been pushed out? I'm just trying to understand the demand aspect of the balanced armature.

I would say the way this is working is, like, I literally meet with the team about the demand side of this weekly. And we've been trying to supplement some of the lower volume opportunities with manual production. We don't want to do a lot of this because it's not good for gross margins, and we haven't done a lot of this. But what we keep talking about is, oh, we're not ready. Okay, how's the next one? And so I wouldn't say it's waiting, but what I would sit there and say is that people want to use the product, But we haven't been ready to say we're going to give this in high volume. And so, you know, I think we're getting much closer to being able to say that. And, you know, I think if you remember, the lineup produces about a million units a month. So, you know, if you think we can get this going by the end of Q2, that would say that, you know, there's probably somewhere, depending on yields when we first run it full out, somewhere in the neighborhood of, you know, four to six million units in the back half of the year incrementally. Okay, great.

And then on the, on the health business, just trying to understand, you know, back to why, how close you are to pandemic levels and whether there's any reason that we shouldn't get back to those levels or above them?

Yeah, I mean, again, What I would say is in Q1, we're pretty close back to pre-pandemic levels. The one piece that's still not come back is the other applications that we sell the same exact technology to, like the live musicians. We sell a fair amount of microphones in aviation. We sell a fair amount of, what do you call it, microphones into non-hearing health medical applications. And these businesses are still like not still down. And the interesting thing about this, these are all smaller customers. So if you imagine, these are some of our highest gross margin customers as well that have not come back.

One quick one. You made a comment about smartphones and the launches being kind of an irregular timing. I was curious if you could elaborate on that comment. Were things from 20 pushed out to 21 or things pulled in from later 21? Or is it just that there was no pattern because COVID we didn't know?

We already saw that normally our peak quarter is Q3. It got pushed to Q4. which is kind of leading us into the path that the low quarter in mobile specifically may be Q1. I said Q2. It's Q2, right? And so that's the only thing we're saying is because of that delay, that the mobile-specific portion will be probably less in Q2 than Q1. Okay, great. Thanks, guys.

And your next question comes from the line of Bill Peterson from JP Morgan.

Yeah. Hi, thanks for taking the question and a nice job in execution amid the pandemic here. My first question, and I know it's a smaller part of your business, but the Intelligent Audio refocused on IoT. Hopefully, if you can just give us an update, what type of IoT markets are you focusing on from here? What does the competition look like? Where is your best chances for success? Any updated products beyond the dual core and quad core processors you have? If you can just give us an update for this business.

Yeah. So, again, I think we talked about there's a fair amount of applications now that we're in. that are relatively low volume. To give you some examples, we're in a number of now sound bars. I think we've won designs on some consumer brands you would recognize for Bluetooth speakers. You know, I think another area that we seem to be doing well is remote controls. You know, we have a couple ear applications, appliances. We've got a few design wins that are more referenced at the beginning, but smart TVs. But they're all, like, lower volume applications. And I think there's a couple points I would make about this bill. First, you know, obviously we're not spending anywhere near as much money as we were, you know, a year ago. And I think we're at a position now where this is not only driving sales of the BSP, but it's also driving sales of microphones to customers in this long tail that we really haven't dealt with in the past. The third piece is that I would sit there and say, as I'm looking at the BSPs we're selling because of these smaller customers, You know, the gross margins are in excess of 50%. And so, you know, I think, you know, when we look at this, and I think we're looking at this a little bit differently than, say, we did, you know, obviously a year ago, that IoT long tail could actually be with microphones and, you know, these DSPs could be a growth market for us. Now, you know, I think my experience is with these long tails is it takes time to develop, right, because it's a lot of small customers. But I think the positive thing I've seen so far is we win a design with some of these customers. Sometimes it's with their own software, their writing software to our DSP. They use the next generation and the next generation. And so, you know, I think it – and I don't see it as being a $100 million business. But I do see this, you know, maybe being, you know, a $20, $30 million business possibly with microphone sales being driven toward more digital mics, toward more high-performance mics in order to get more content.

Okay, so $20, $30 million, probably more long-term plus, you know, mic as an adder.

Yeah, I just think one last comment. You know, what I see as driving these new applications is, where microphones weren't used before. And I think that's, you know, like, and a TV is a good example of that, right? If we're successful with TVs, you have to be seeing, you know, microphones aren't a big portion of TVs. And we've talked about this before from the fact that there's no reason your TV can't act like your Amazon Echo, which sits in your room. Your TV can do the exact same function. And so these are the type of things which, you know, if we could start having every TV have four microphones, there's millions of TVs built every year. They don't have that today.

I understand. In terms of use of cash, hoping to get an update maybe on your CapEx plans for this year, maybe even, you know, about that, any sort of idea on cash flow from operation and working capital constraints or things going on related to COVID. And then, you know, use of cash, debt pay down, things like that, if you can give us a feel for the priorities this year.

Yeah, sure, Bill. I was hoping somebody was going to ask about cash flow and liquidity. That's a metric I'm pretty proud of the team's execution on. But as we exit 2020, we've got about $550 million of liquidity, as I mentioned in my script, $150 million of cash, and then we've got a revolver. that's untapped for $400 million. We do have converts, $172 million of converts that will mature in this November. So we've got a lot of optionality with how we retire those converts, a combination of either using existing cash on hand or borrowing from the revolver. And in terms of CapEx for the year, I mean, I will say 2020 was unusually low. We were right around $32 million in CapEx. I think as you look out into 2020, we'll be closer to the 5% to 7% of revenue type of CapEx level, primarily on new products. And then I think your other question with capital allocation, I don't think there's a big difference change in priority. You know, our priorities will continue to be funding all the organic growth opportunities we have. We will, you know, kind of step up the pace at looking at accretive acquisitions and precision devices. And then lastly, we'll always look at opportunistically at, you know, return of capital through share repurchases. We repurchased about a little over a million shares in 2020.

Very clear. Thank you.

And I have no further questions in the queue.

Great. Well, thanks very much for joining us today. As always, we appreciate your interest in NOLS, and we look forward to speaking with you on our next earnings call. Thanks, and goodbye.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.