Knowles Corporation

Good afternoon and welcome to the Knowles Corporation second quarter 2021 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker's remarks, 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 would like to withdraw the question, just press the band key. Please be advised that today's conference is being recorded. With that said, here with opening remarks is Knowles Vice President of Investor Relations, Mike Knapp. Please go ahead.

Thanks, Bloom, and welcome to our Q221 earnings call. I'm Mike Knapp, and presenting with me on the call today are Jeffrey New, our president and CEO, and John Anderson, our senior vice president and CFO. Our call today will include remarks about future expectations, plans, and prospects for NOLs, which constitute forward-looking statements for purposes of the safe harbor provision 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 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 at our website at NOLS.com and in our current report on Form 8-K 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, and thanks to all of you for joining us today. For Q2, we reported revenue of $200 million above the midpoint of our guidance and up 31% from the year-ago period driven by strong demand across our audio and precision device segments. Gross margins improved to 42.4% and our earnings per share were $0.31, both above the high end of our guidance range. In audio, revenue was up 43% from the year-ago period as hearing health sales doubled and we saw continued robust MEMS microphone demand in multiple end markets. Precision Devices delivered record revenues in Q2, up 5% from the year-ago period, underscored by a recovery in the MedTech market and an acquisition we completed in the quarter. Overall, a great quarter for the company that emphasized our leading position across a broad range of growing end markets, our focus on high-value products to improve gross margins, and our strong operating leverage. Let me provide some detail on the trends we are seeing by end markets. In audio, we saw broad-based improvement year-over-year in MEMS microphone sales across non-mobile and markets, particularly in ear, IoT, and computing devices, as work-from-anywhere and remote schooling trends continue. We anticipate non-mobile to represent more than 50% of microphone sales in 2021, as new true wireless and IoT devices are launched in the second half of the year. In addition, we are beginning to see emergence of new markets we can serve in the non-mobile category that may provide additional growth opportunities over the next several years. First, we are seeing increased design activity around the virtual reality market. IDC forecasts VR headset shipments to grow to over 28 million units in 2025 with a five-year CAGR of 41%. VR has the potential to revolutionize a number of industries, and high-performance audio is a critical piece of this equation to enable the best user experience. The second is LightGoods, where we recently introduced a complete development platform consisting of microphones and a digital signal processor that enables fast and easy voice integration for smart appliances. This solution was selected by Samsung in its Family Hub portfolio of smart appliances, and the first product launched, the correct product introduced, was a smart refrigerator. Finally, we see the automotive market becoming a potential opportunity for our MEMS microphone business as our customers focus on reducing unwanted road or engine noise in the cabin and enabling voice input to control the vehicle systems. We are seeing an accelerated transition from electric to MEMS microphones in automotive and have launched a new product portfolio for this market as customers are beginning to recognize the importance of higher quality and the supply assurance that Knowles offers. In mobile, Q2 mic sales came in as expected, and we expect a strong seasonal uptick in sales in Q3 as multiple OEMs around the world launch new handsets. For hearing health, shipments have recovered to pre-COVID levels, and we see improved demand in the audio file segment as U.S. concerts resume. In addition, the White House issued an executive order earlier this month, which could help accelerate the issuance of over-the-counter hearing aid regulations and products in the U.S. While this is not new news for the sector, it does highlight there is a potential upside for us to benefit from the large addressable market of people suffering from mild hearing loss. Overall, we expect continued strength in traditional hearing aid channels with momentum building in the over-the-counter market. We also expect continued rapid growth in the TWS segment with premium devices offering advanced features like active noise cancellation and assisted listening functionality. All this represents positive trends for ear-worn device acoustics over the next several years. In precision devices, Q2 sales reached record levels, with significantly improved gross margins, and demand in defense, medtech, industrial, and electric vehicle markets drove strong sequential improvement. We also acquired Integrated Microwave Corporation, a leader in the design and manufacturing of custom, high-performance RF filters for the aerospace, defense, and communications industries. By expanding our product portfolio, we grow our serviceable, available market while providing our customers a one-stop shop for their high-performance R solutions. John will discuss the financial impact from this transaction in just a moment. For the second quarter, we also saw record bookings again in PD, giving me confidence that we can grow precision device revenue again this year. We get a strong first half and expect the momentum to continue in Q3. I believe our leadership positions across the markets we serve and our strategies to deliver high-value, differentiated solutions to a diverse set of growing end markets positions us well for future growth. With that, I'll turn it over to John to expand on our financial results and provide guidance for the third quarter. John? Thanks, Jeff. We reported second quarter revenues of $200 million, up 31% from the year-ago period, driven by increased shipments in both the audio and precision device segments. Audio revenues of $150 million were up 43% due to increased shipments of MEMS microphones across non-mobile end markets and the recovery of the hearing health market to pre-COVID-19 levels. Precision Devices delivered record revenues of $50 million, up 5% year-over-year, as a result of organic growth driven by increased demand for high-performance capacitors in medtech, industrial, and automotive markets, and an acquisition completed in the second quarter of 2021. Second quarter gross profit margins were 42.4%, well above the high end of our guidance range, and up more than 10 percentage points versus the same period a year ago. Audio segment gross margins improved more than 12 percentage points, driven by higher factory capacity utilization and favorable product and customer mix. In the precision device segment, gross margins were five percentage points above prior year levels due to favorable product mix, productivity gains, and increased pricing, partially offset by higher precious metals cost. R&D expense in the quarter was $22 million, in line with expectations, and up $2 million from the year-ago period as higher incentive compensation costs and increased spending in MEMS microphones, hearing health, and precision devices was partially offset by the impact of restructuring actions taken in the second quarter of 2020. SG&A expenses were $28 million, $1 million above our guidance range, driven by higher incentive compensation costs and increased legal expense related to the favorable ruling we received in the Belsing lawsuit. SG&A was up $1 million from the prior year due to higher incentive compensation costs, partially offset by the impact of restructuring actions taken in the second quarter of 2020. For the quarter, adjusted EBIT margin was approximately 18% at the high end of our guidance range and up more than 18 percentage points from the same period a year ago, driven by increased shipment volumes and higher gross margins. EPS was 31 cents above our guidance range and up 32 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 $94 million at the end of Q2. Cash generated by operations in the quarter was $21 million, above the high end of our guidance. due to higher EBITDA and lower than expected net working capital. Capital spending was $11 million in the quarter. During the quarter, we resumed buying under our share repurchase plan and acquired roughly 1 million shares. We also completed the acquisition of Integrated Microwave Corporation for $79 million, net of cash acquired. In 2022, we expect the acquisition to deliver more than $20 million in revenues at above-average gross margins and EPFs of 4 to 6 cents. Given our existing cash position and our expectations that we will continue to generate significant free cash flow, we intend to settle the principal amount of the convertible notes, which mature in Q4 of this year, in cash. Moving to the third quarter. We expect total company revenue to be between $227 and $237 million, up 13% at the midpoint versus the same period a year ago. Revenue from the audio segment is expected to be up approximately 6% from Q3 2020 due to increased shipments into non-mobile and hearing health applications. Precision device revenue is expected to be up more than 38% versus the prior year, driven primarily by organic growth in the defense, med tech, and EV markets, and the acquisition completed last quarter. We estimate total company gross margins for the third quarter to be 40 to 42%, up 430 basis points from the year-ago period, driven by both the audio and precision device segments on higher capacity utilization, favorable product and customer mix, and the acquisition completed in Q2. Our gross margin expansion in the first half of 2021 demonstrates the execution of our strategy to deliver high valued differentiated solutions to our end markets. We expect total company gross profit margins will exceed 40% for full year 2021. R&D expense in Q3 is expected to be between 21 and 23 million. up $3 million from prior year levels due to higher incentive compensation costs and increases in MEMS microphone and precision device spending. We're projecting selling at administrative expense to be between $26 and $29 million, up $1 million from the year-ago period, driven by higher incentive compensation costs and the impact of the acquisition completed in Q2, partially offset by lower legal expense. We're projecting adjusted EBIT margin for the quarter to be in the range of 19 to 21% and expect EPS to be within a range of 38 to 42 cents per share. This assumes weighted average shares outstanding during the quarter of 95.3 million on a fully diluted basis. We're forecasting an effective tax rate of 11 to 15% for the quarter. And we expect cash generated by operations in Q3 to be between $30 and $40 million, with capital spending of approximately $15 million. Please refer to our press release and to our Form 8-K filed today with the FCC for a GAAP to non-GAAP reconciliation. 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. Before we move to the Q&A, there are a few points I'd like to highlight from our Q2 results and our Q3 guidance. First, the diversity of our revenue across a range of growing end markets is a significant benefit. In addition to participating in a number of compelling growth opportunities in markets that demand high-value solutions, we are continuing to reduce risk of being exposed to any one specific market. Second, our Q2 results cap off a very positive first half for revenue and gross margins, which coupled with operating leverage is driving increased even margins. Lastly, our strategy to deliver high-value, differentiated solutions to a diverse set of end markets producing strong cash flow that allows us to drive shareholder value through debt reduction, investment in high-growth margin products, accretive acquisitions, and stock buybacks. Operator, we can now take questions.