Knowles Corporation

And welcome to the NOS Corporation First Quarter 2021 Financial Results Conference Call. At this time, all participants are in Arizona 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 keypad. If you require any further assistance, please press star 0. With that said, here with opening remarks is Knowles, the Vice President of Investor Relations. Mike Knapp, please go ahead.

Thanks, Sunidra, and welcome to our Q1 21 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 Knowles, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal securities laws. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings, including but not limited to the annual report on Form 10-K for the fiscal year ended December 31, 2020, 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 need 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 on our press release posted on our website at NOLS.com and in our current report on Quorum 8K filed today with the SEC. 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 here today. For Q1, we reported revenue of $201 million above the midpoint of our guidance and up 23% from the year-ago period on strong MEMS microphone demand in multiple end markets and improving trends to hearing health. Precision device revenues were in line with our expectations. Gross margins improved 330 basis points to 39%, and our earnings per share was above the high end of our guidance range at $0.29. Overall, another solid quarter highlighting our operating leverage as demand improves across a broad range of our end markets, coupled with our focus on high-value products to improve gross margins. Let me now provide some detail on the trends we are seeing by end market. In audio, sales were up 36% from the year-ago quarter, better than our expectations going into the quarter. We saw broad-based improvement year-over-year in the MEMS microphone sales across non-mobile and mobile end markets. sales to non-mobile applications were driven by work from home and remote schooling, as well as the ongoing trend towards applications requiring high-performance audio solutions. We expect these favorable trends to continue throughout 2021 and in the years to come. Since our last call, we made two new product announcements which support our focus on non-mobile applications. First, we announced AISonic Bluetooth Standard Solution, a new, complete development solution that enables fast and easy voice integration into Bluetooth devices. The development kit includes a null CSP coupled with multiple microphones to enable OEMs to build voice-activated calling, control, and far-field speech recognition capabilities into Bluetooth devices. We also announced earlier this month the availability of two new MEMS microphones for automotive applications. The new microphones are engineered to a higher standard of quality to support the increasing demands of the automotive market for hands-free calling, advanced voice assistance, and in-cabin noise cancellation. In mobile, stronger sales to Chinese OEMs and North American OEMs drove the majority of the year-over-year increase. Trends in Q1 were better than normal given the timing of product launches last year and improved demand from Chinese OEMs. In Q2, we expect demand in mold to decrease sequentially due to product cycle timing from last year's launches. While we expect sequential improvement in mobile for Q3, third-party data enhanced expectations for the second half of 2021 indicate that year-over-year rate of growth will moderate and be more aligned to what we have seen over the last few years. This validates our focus on faster growing non-mobile applications, which reduces our reliance on growth from the mobile market. For hearing health, shipments were slightly higher than expectations for the quarter. March data showed improved momentum in the VA hearing aid channel, indicating continued gradual improvement in the hearing aid market as vaccinations roll out and private practice audiologists remain open. While demand from the audiophile portion of this market remains soft versus pre-pandemic levels, we have seen some improvement and are optimistic we will see demand accelerate in the second half of the year. In precision devices, Q1 sales were down about 12%, as expected, as COVID continued to impact our med tech and defense end markets. At the same time, we saw record bookings in PD during the quarter, driven by improved demand in our defense and med tech and markets and sustained strength in demand from electric vehicles and industrial customers. This gives me increased confidence that we can grow precision devices revenue again this year as the med tech and defense end markets recover throughout the rest of 2021. We were off to a great start in 2021, and I believe our leadership positions across the markets we serve and our strategy to deliver high-value, differentiated solutions to a diverse set of growing end markets, positions as well for future growth. With that, I'll turn it over to John to expand on our financial results and provide the guidance for the second quarter. John? Thanks, Jeff. We reported first quarter revenues of $201 million, up 23% from the year-ago period, driven by increased shipments in the audio segments. Audio revenues of $163 million were up 36% due to increased shipments of MEMS microphones across multiple end markets and a recovery in the hearing health market to pre-pandemic levels. The precision device segment delivered revenues of $38 million in line with our expectations and down 12% from Q1 2020 levels as shipments into the med tech and defense markets were negatively impacted by COVID-19. First quarter gross profit margins were 39% at the high end of our guidance range and up 330 basis points versus the same period a year ago. Audio segment gross margins improved 470 basis points driven by favorable product and customer mix, higher factory capacity utilization, and lower factory spending. In the precision devices segment, gross margins were 150 basis points below the prior year capacity utilization. R&D expense in the quarter was $20 million, in line with expectations and audio, partially offset by higher incentive compensation costs and increased spending in MEMS microphones. SG&A expenses were $25 million, in line with our guidance. and down almost $9 million from prior year, driven by a $4 million reduction of legal expenses, reduced spending in intelligent audio, and the impacts of restructuring actions taken in the second quarter of 2020. For the quarter, adjusted EBIT margin was 17%. At the high end of our guidance range and up more than a year ago, driven by increased shipment volume, higher gross margins, and operating expense reductions.

EPS was 29 cents in Q1, above our guidance range and up 26 cents from the prior year.

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 $182 million at the end of Q1. Cash generated by operations in the quarter was $40 million, well above the high end of our guidance due to higher EBITDA and lower than expected net working capital. Capital spending was $5 million in the quarter. Given our existing cash position and our expectations that we will continue to generate free cash flow in the future, the company intends to mature in Q4 of this year in cash. Moving to the second quarter of 2021, we expect total company revenue to be between $185 and $205 million, up 28% at the midpoint versus the same period a year ago. Revenue from the audio segment is expected to be up approximately 41% from Q2 2020 due to increased shipments into non-mobile and hearing health applications. Precision device revenue is expected to be flat versus prior year levels, but up more than 20% sequentially as defense and med tech demand improves. We estimate total company gross margins for the second quarter to be 39% to 41%, up 770 basis points from the year-ago period, driven by improved capacity utilization, favorable mix within the MEMS microphone business, and continued recovery in the hearing health market. Our Q2 gross margin guidance reflects favorable mix, and we have increasing confidence that total company gross profit margins will approach 40% for full year 2021. R&D expense is expected to be between $20 and $22 million, up $1 million from prior year levels due to higher incentive compensation and increases in MEMS.

We're projecting selling and administrative expense to be between $25 and $27 million, down $1 million from the year-ago period.

The reduction is due to a decrease in legal expense, and the impact of restructuring actions taken in the second quarter of 2020, partially offset by higher incentive compensation costs and merit increases. We're projecting adjusted EBIT margin for the quarter to be in the range of 14% to 18%, and expect EPS to be within a range of $0.23 to $0.29 per share. This assumes weighted average shares outstanding during the quarter of $96.5 million on a fully diluted basis. We're forecasting an effective tax rate of 13% to 17% for the quarter. For the quarter, we expect cash generated by operations to be between $10 and $20 million and capital spending to be approximately $10 million. Please refer to non-GAAP reconciliation. I'll now turn the call back over to Jeff for closing remarks. Jeff? Thanks, John.

Before we move to the Q&A, from our Q1 results and our Q2 guide.

First, the diversity of our revenue across a range of growing in markets is a significant factor. In addition to participating in a number of compelling growth opportunities in markets that demand high-value solutions, we have recently seen a growth in one specific market and are lowering volatility in our business. These results demonstrate that we are off to a good start, but there is more improvement to come as we expect a recovery of demand in PDs. from the MedTech and defense end markets. Third, we have increased our across the company. We have seen this gross margin improvement in Q1 results and the guidance for Q2, and this focus will continue to be a priority for us as we move forward. In closing, our strategy to deliver high-value, differentiated solutions to a diverse set of end markets is paying off, and I am confident we can drive shareholder value by delivering strong price growth and cash flow in 2021 and beyond. Operator, we can now take questions.

At this time, I would like to remind everyone, in order to ask a question, press star number one on your telephone keypad. And your first question comes from Harsh Kumar. with Piper Simmer.

Congratulations on very solid performance, very solid results, Jeff, John, and the team. Quick question for you guys. Jeff, you mentioned that you expect the rate of audio or color I was hoping the rate of growth, at least, I was hoping you could maybe clarify how you're seeing the rest of the year. I don't want exact numbers. I know you're not in a position to give it, but just some color would be helpful based on whatever you've seen so far. And I've got one more follow-up.

Yeah. So, you know, I think, you know, if we look at, you know, our non-mobile applications, and I'll talk about it that way, you know, I still think, you know, we expect the non-mobile applications to be pretty strong throughout the year, harshly. I think whether it be you look at the laptop PC market, we think that's going to continue to be strong. Our IoT business continues to be very strong. There are a number of new products that are launching in the ear market that should help us. So I think from our perspective, the non-mobile portion of the business is pretty good. I think what we're just kind of looking at in terms of mobile is that it's third-party data. We had a very strong Q1. in mobile. But Q2, based on the timing of product launches from last year, is weaker in mobile than Q2. And I wouldn't say we're pessimistic about mobile in the back half. I just think the rate of growth obviously will moderate as The back half of the year for mobile was pretty good. So that's kind of more, I would say, we're a little bit more cautious about mobile. But overall, you know, for the microphone business, we still feel very good for the full year as a whole business.

Got it. Hey, very helpful, Jeff. And then maybe I'll link these two questions together. I was sort of surprised. I think John mentioned the $10 million CapEx. I believe that might have been for the second quarter.

And maybe with that, the line for VA, if I'm not mistaken, maybe.

I'll let John kind of talk about the $10 million in a second. But let me talk just briefly about the VA line. Generally speaking, you know, we have a nice funnel of opportunity still, but I think we're seeing additional COVID-related delays. You know, I think we're coming from a perspective here in the U.S. where, you know, that, you know, I don't know what the exact numbers are, but 20 to 25 percent of the population has been vaccinated.

You know, hopefully we're installing this equipment. We're seeing somewhat of problems for us. You know, I think we had said we hoped it would be installed in Q2.

I think we're pushing that into Q3 now based on still COVID-related delays. And, you know, I think it's a tough situation, no doubt on this. But on the reverse side is, you know, we're going to get there. The machine's there. It's powered up. It's actually running some stuff.

But there have been other, you know, in the factory that have has slowed down the installation.

Harsh, with respect to the 10 million cap, the automated DA line, but the majority of it relates to our MEMS microphone business and really new products.

Got you. Thank you, guys. Congratulations.

Again, solid results. Thank you. Sorry, sorry.

And your next question comes from Bob Cleavitt. with CJS Securities.

I wanted to ask, you know, a year plus, kind of new normal, and you've talked a fair bit, so I wanted to kind of tie it into the non-mobile market that you're selling into. How have the sizes of the various end markets for MEMS mics changed, you know, post-pandemic, if at all? And what's the next, you know, growth area for MEMS mics for you?

I mean, it's an interesting question. I mean, I think, you know, I got to be honest, I still think we see a fair amount of opportunity in the markets that we've seen, which, you know, is... You know, ear, IoT, and, you know, increasingly notebook and tablet are great opportunities for us. So I think, you know, those still have to play out. A little color on those. You know, I think on ear, I think we've kind of talked about this over the last, you know, maybe two, three quarters, the fact that, you know, that increasingly, you know, that there will be more, a larger group of customers that will be doing business with us on the ear. And I think that's going to be a growth opportunity this year in the back half. front half and into next year. IoT, I think, you know, we've had two things going on in IoT. One is upgrade to higher performance mics, which has been helpful to our revenue in terms of higher ASP. But I think the other thing that we're starting to see is this idea of the long tail that, you know, that we can see this start to be growing.

And, of course, we like this because it's long tail as well. And so this is more of like, people enable voice in this long tail. And then lastly, the tablet market, you know, I think, again, we've talked about this over the last few quarters, but just to reiterate, work from home, homeschooling, people, and, you know, if I go back three, four years ago, you know, that microphones on laptops and tablets

Now they're being used on a daily basis. We don't see this going away. In fact, we see this hopefully accelerating into higher performance mics and more microphones per device. I think it's pretty good.

I think another market, hard to say, getting a little bit more focus on automotive.

I don't know where this goes yet, but, I mean, it's here. It seems to me these things continue to crop up, these new applications that always require microphones.

Got it. That's great. And then switching gears a little bit, congratulations on the net cash position that you're in now, and appreciate that you're going to settle the converse with cash. So kind of two questions there. Pete? Talk about what's the right capital structure for the long term for you, and then also, you know, are you looking at any M&A, and if so, what's the market like out there right now?

Yeah, so... ...multi-M&A opportunities within PD. I think, you know, that is an area of focus of ours.

We had done... You know, I think four deals between 17 and the beginning of 20 that, you know, were all accreted very quickly after the deal was done. I think that's kind of what we're looking for is acquisitions that are pretty immediately accreted. And I think, you know, we have a, you know, we put this obviously on pause with everything that happened during the pandemic last year, but we're definitely, you know, moving that process forward and looking for things in that space. As far as the capital structure, I'll let John comment a little bit about that. Yeah, Bob, I would say our intent is definitely to maintain investment-grade-like credit metrics. So think of maximum leverage of 275, again, if we saw some acquisition out there. But we're going to be fairly disciplined with respect to anything we do there and maintaining debt at that level or below.

Got it. Great. Thank you so much.

And your next question comes from Sushi De Silva with World Capital.

Hi, Jeff. Hi, John. So you spoke about gross margin drivers and mixed opportunity. Can you be more specific as to what some of the elements there are in the gross margin expansion opportunity specifically?

I'll let John start this, and then I'll put some color on it at the end. Yeah, sure. Suji, I mean, we're very pleased with the overall trajectory, you know, in our gross margins, which were 39% in Q1. We guided to 40% at the midpoint for Q2. And really the drivers there are, you know, kind of what Jeff talked about is growth and a higher proportion of revenues and business coming from non-mobile applications and MEMS mics. And then we're running at, you know, consistently running at 90% plus in terms of capacity utilization across most of our businesses. We expect that to continue through 2021. Those are the big drivers. And then also in the back half, we have some new products coming on that typically carry above average gross margins. Those are the three biggest drivers. So it's that mix, new products, and capacity utilizations. Can I just make one other comment about this? If you think about where we've been, where we've come to, and where we're going, mobile is a very important market to us. We're not going to say it's not an important market, but the reality is that mobile, as an end market, is just not growing at the rate it was, say, five, six years ago, in terms of the number of units that are available. Some of these other markets, we've talked about here, IoT, the tablet market, the defense market, PD, EV, there's still the BA opportunity out there, they're growing much faster. And to the extent that this becomes a larger portion of our business, the mix kind of helps us drive growth margins.

Okay. And maybe related to that somewhat, my follow-up question, on the AI Sonic Bluetooth solution, I'm trying to understand if this is sort of an approach or something that you've had, you know, for years with different solutions. And if so, you know, what's the revenue and market penetration impact of something like that? And are there more solutions like AI Sonic coming down the pipeline? Hello? Hello?

Hello?

Excuse me. This is the conference operator. I apologize, but there will be a slight delay in today's conference. Please hold, and the conference will resume shortly. Thank you for your patience. I apologize, but there will be a slight delay in today's conference. Please hold, and the conference will resume shortly. Yes.

We're back. Okay.

Hi, Mike. It's Suzy.

Can you hear me? Yeah.

Okay. So let me repeat my follow-up question then. You know, on the fall into the gross margin question, the AI Sonic Bluetooth solution that you announced, I'm curious if that's sort of a new type of product or something you guys have always been doing, and what the revenue model impact or end market penetration impact or content impact, something like that is, and are there additional sort of reference design or solutions like this coming similar to AI Sonic in the future?

Yeah, so what I would say is this is a really targeted, Suji had the long tail solution, of customers, and we've got a number of these reference designs now in the works. There's four or five of them. What we're trying to do is design, like, one solution that can go to many end customers as opposed to a custom solution for each customer we deal with. You know, it's a little early to say, you know, what this means yet because it is a long tail, and I think we'll be talking about this more in the quarters to come. But I think what really the takeaway I would sit there and say for everyone is this, is that It's, you know, first for sure, you know, we have this line of DSPs, which we'd like to sell in long tail and give them a solution. But we're also open to working with third-party DSPs to provide solutions as well to drive more microphone sales. And, you know, and I think, you know, again, we're starting to see this in a number of different locations. And it's a little early to say how big this could be, but there's the IoT market for sure in the long tail. And increasingly, we kind of talked about the ear market for true wireless. There's a long tail there as well. Now, I'll kind of give you just one other kind of piece of something that we're working on right now, which we'll probably talk more about in the quarters to come, is what we've actually now started to build an entire headset reference design. And it's very interesting that we could go to customers and say, you know, here is the full design, microphones, VAs, all the software, usually algorithms with third parties, in order to provide a total solution on true wireless to smaller companies that really don't have the ability to put something like this together.

Okay. Very helpful. Thanks, guys.

Thanks, Sujit. Thanks, Sujit.

And your next question comes from Anthony Scalls with Craig Hallam.

Thanks. Close enough. Jeff, I wanted to follow up on your comments relating to a moderating mobile phone business. Can you comment on where you think content is right now? Is content, you know, number of mics per phone peaked? Is it flat? Is it going to be down, you think, year over year per device? And then also on the ear side of the business, you know, kind of XBA as you're waiting to get the automated lines up, what does content look like within the ear just related to mics? Thanks.

Yeah. So let me take your question first. I just would sit there and say the general trend right now is to move towards more microphones. I would sit there and say that there's a number of different applications that are driving that, but we're starting to see a larger and larger portion of what people are doing. thinking about three microphones per ear versus a couple years ago it was one to two per ear. So I think the content story on ears is pretty strong over the next year or two. Coupled with, again, obviously the ear has been dominated by a small group of customers. We're starting to see that diversify more into more customers. And I kind of attuned to some of the other markets that have been developed or pioneered by certain customers, and then it usually kind of fans out into new customers. So the year opportunity, I still think, the next couple of years still looks pretty good for us. I think it's pretty positive, both from content and still from growth in the market. As far as the mobile side, I would sit there and say the number of mics per has probably, I would say, moderated in terms of increases. We are seeing some increase, you know, obviously with Nix, more 5G phones are being sold. I think the next big leg up still that's out there is the move from analog to digital in terms of the mobile market. I would say it's a relatively small percentage of the market has moved towards digital microphones. But, you know, I think over time, you know, if you look at the other markets, whether it be the tablet market, the IoT market, the ear market, all these markets are eventually moving towards digital microphones. And I think mobile will come along with that as well.

Glenn, as a follow-up, your comments about record bookings from PD in the quarter – I presume that's through the remainder of this year. And is there any way of gauging whether or not you think some of this is tied up to component shortages, double ordering, or do you think you have visibility on designs?

I think we've got pretty good visibility on designs. And so here's what I would say is You know, it's pretty broad-based, and I would say that, you know, the areas that really improved the most significantly since, you know, last year in terms of bookings and into this year are med, which is, you know, a lot of implantable devices. So MRI and implantables. There's also some new applications in implantables that we're going to dive into. So I don't really see that as, you know, some type of double ordering device. Then there's the defense market, which they had a lot of supply chain issues through the back half this year into the first quarter. I do not see that as double ordering either. These are mostly our custom products that are very specific for them. They're not like off-the-shelf products. And so I don't see that there. The area that we tend to see if we were to see double ordering would be typically in the distribution business. would probably be something that would be more double ordering in PD. And as I see that business, that portion of the business, you know, it is up, is up over the first half, but not a lot. It's not where the growth is coming from in the distributor business. So we're not really seeing that. We don't think there's a lot of double ordering. One thing about PD is that, they have pretty long lead times based on some of the products. And so we have a pretty reasonably high degree of confidence on the revenue numbers, at least within the quarter. What we're usually very fully booked is what we're going to shift within the quarter going into it. And, Tony, if you heard in my script, I mean, we're projecting at the midpoint 20% sequential growth in the PD business from Q1 to Q2.

Got it. Thanks for the detail. Nice quarter, guys.

Thanks, Tony.

And as a reminder, to ask a question, press star and the number one on your telephone keypad. And your next question comes from Chris Wallen with CIG.

Chris? Sorry about that, the dreaded mute button. If you guys could actually talk about the supply situation for you guys right now. Are there any constraints there? Have you guys seen your lead times go up? And then just maybe talk about that ratio of bookings, what's sort of coming in right now to the billings and what you can fulfill.

Yeah, so, you know, I don't think we have any constraints that I'm aware of today. that would impact PD or hearing health business. I think we're pretty okay there. I would say in the men's microphone business, as I said last quarter, the lead times for wafers have gone out. If you think about within a men's microphone, there's the men's guide and then there's the ASIC that goes along with it. The men's guide, we don't have any constraints on at all. I think we talked about this, but we have a very solid relationship with our supplier there. We have dedicated capacity to some of the stuff that's going on there. We have had, I would say, longer lead times on the ASIC that goes in. This has not so far been any type of issue that has held us back from shipping. Now, what I will say is We have had some price increases on wafers passed on to us in order to meet the demand. But so far we've been able to pass those price increases on into the marketplace. And so, you know, I think right now, you know, I think, for what our expectations are for the quarter and in the back half of the year for us, I think we're pretty well aligned. If there was another big rise in demand in MEMS, Mike, I think we'd have to obviously look at this again. But right now, I think we're in reasonably good shape relative to supply matching up with demand.

Thanks, Jeff. And just as a follow-up, you mentioned pricing and pushing. along some price increases there. Previously, you talked about kind of high single digit on the microphone side going to mid. Is there any chance that we could get to low single digit ASP declines or even flat for the audio side of your business, just considering how tight things are kind of across the industry? Does that give you some extra pricing power? Thanks.

Yeah, and so, you know, it's a good question, and I think it's worth mentioning, you know, that I think, you know, if you go back, let's just forget about 2020. 2020 was kind of this pandemic year with a lot of crazy stuff going on. But in 19, price erosion on mature products, you know, I think we're seeing, you know, it's going to be less than 4%.

I think you're absolutely right. I would also Obviously, it will be dependent on the back after year, but this is not including mature products. I believe they are going to be roughly flat with last year, all being to the point that you're right. We're kind of in a market here where demand is high, and I think I talked about this in the last call. The intent is not to add to capacity at this point in the men's microphone business.

So, you know, we're highly focused on, you know, I would say the high-value portions of the market and the new products that are coming out that are associated with it. And so, you know, we feel pretty good about, you know, where ASPs are relative to, you know, where they were, say, 16, 17. 19 was a pretty good year for us, and we think there's the opportunity to even best that in 2021. Thanks, Jeff.

Okay, and there are no further questions. I'll now turn the conference back over to you for closing remarks.

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

This concludes today's conference call. You may now disconnect.