Knowles Corporation

Good afternoon and thank you for attending today's Knowles Second Quarter 2023 Earnings Conference Call. My name is Kayla Baker and I will be your conference operator today. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again press the star and one. I will now pass the conference over to your host, Patton Hofer, Vice President of Investor Relations with Knowles. Thank you, and you may proceed.

Thanks, Kayla, and welcome to our Q2 2023 earnings call. I'm Patton Hofer, Vice President of Investor Relations, 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 Knowles, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal securities law. 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 that the company's SEC filings, including but not limited to, The annual report on Form 10-K for the fiscal year ended December 31, 2022. 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 our current report on Form 8K filed today with the SEC, including a reconciliation to the most directly comparable GAAP measure. All financial references on this call will be on a non-GAAP continuing operation basis unless otherwise indicated. Also, we've made selected financial information available in webcast slides, which can be found on the investor relations section of our website. With that, let me turn the call over to Jeff, who will provide some details on our results. Jeff?

Thanks, Patton, and thanks to all of you for joining us today. Knowles delivered solid results for the second quarter with revenues of $173 million, adjusted EBIT margins of 16%, and EPS of 23 cents, all finishing above the midpoint of our guided range. Gross margins of 42% finished above the high end of the guided range, and our teams around the globe continue to improve efficiency, reduce fixed costs, and improve mix in light of the macro challenges in certain end markets. In precision devices, Q2 revenue was down 20% from the prior year. Inventory challenges in the industrial, distribution, and telecom markets have continued as we've experienced further revenue weakness in Q2. Defense was down versus the prior year as delays in project awards impacted Q2 bookings and revenue. Finally, the electric vehicle market remains exciting for Knowles, growing again in Q2 versus the prior year as we continue to secure additional design wins for onboard and fixed infrastructure charging. In MedTech and specialty audio, revenue was down 2% from the prior year, but up more than 30% sequentially as customer inventory levels declined faster than we originally anticipated. We are definitely past the inventory correction we experienced in the first quarter of 2023. I'd also like to take a moment to commend our MSA team as they delivered outstanding margins in the quarter, a true testament to our differentiated products and operational excellence in our factories. In consumer MEMS microphones, revenues down 3% from last year. Non-mobile was up versus the prior year, driven by new product launches and improved demand in ear and IoT. Computing was also a bright spot in the quarter, finishing better than expected as channel inventory sell-through has improved and upgrade cycles are returning earlier than previously expected. While the smartphone market continues to be very difficult, especially in China, the shift of mix toward ear, IoT, and compute is positively impacting gross margins in this segment. Now I'll spend a few minutes discussing the current customer and market conditions for each segment before turning the call over to John to provide the third quarter guidance. Starting with precision device segments, in the industrial and telecom markets, which currently make up approximately 10% of total company revenue, we are seeing continued weakness as inventory levels remain elevated. We previously expected the inventory situation to improve in the second half, but based on the current outlook, we are now expecting these markets to be down the remainder of the year. For our three key end markets, defense, MedTech, and the EV, the long-term outlook is unchanged from our previous expectations. NOLS continues to expand its design wins in these growth markets with a broad range of customers. Demand for components in the MedTech phase has been relatively flat in the first half of the year with some excess inventory, and based on current demand, we expect to return to year-over-year growth starting in Q3. For defense, our previous revenue projections for the year factored a number of bookings in Q2 for communications, radar, and electronic warfare programs which have been delayed. While we believe our position in our core markets for PD along with the secular trends within these markets are unchanged, continued weakness in industrial and in delayed bookings and defense are reducing our expectations for revenue in the second half of 2023. To mitigate the impact of these delays, we've implemented several measures to reduce costs in precision devices to improve profitability. John will provide more detail on these actions during his portion of the call. Moving to MedTech and specialty audio, the hearing health market demand has stabilized as hearing aid inventories around the globe have returned to more normal levels. Our Q3 guide reflects a more than 20% revenue growth versus the prior year turned by the improved inventory situation and increases in demand in the traditional hearing aid market, particularly in the U.S. It is a very positive sign that we are returning to growth in the second half of 23, which provides confidence for growth in 24th. Lastly, onto our consumer MEMS microphone segment. Due to the normal seasonality of this business and improving market conditions in non-mobile, we are expecting sequential improvement for revenue throughout the remainder of the year. The second half recovery is now expected to be less pronounced than we previously discussed, driven primarily by the smartphone market. In non-mobile applications, second half demand in computing and ERT are expected to be up significantly versus the prior year. driven by improved channel inventory levels and replacement cycles in computing. In the smartphone market, demand expectations for new products and further weakness in China are driving additional pressure on the recovery in this business, ultimately limiting the upside in the back half of 23 for CMS. Overall for Knowles, although the outlook for improvements in revenue in the second half have softened, We are still expecting margin expansion and earnings growth versus the prior year. In MSA's inventory situation, the hearing health market is behind us, as forecasted, and we are increasingly confident of second-half revenue growth. In precision devices, continued weakness in the industrial market, coupled with delays in defense orders, have impacted revenue expectations for the remainder of 2023. We believe, however, the secular trends in defense, medtech, and EV markets remain robust. Lastly, for CMM, we are seeing a slow recovery in consumer electronics, primarily due to the smartphone market and softer demand in China. In summary, we are now expecting total company revenues in the second half of the year to be near prior year levels. And with the cost efficiencies and actions we've implemented, along with favorable mix, we expect our second half adjusted EBIT margins to be greater than 19%. Now let me turn the call over to John to detail our quarterly results and guidance. Thanks, Jeff. We reported second quarter revenues of $173 million, down 8% from the year-ago period, driven primarily by lower shipment volumes in precision devices and consumer MEMS mics. The precision device segment delivered revenues of $48 million, down 20% from the prior year, driven by continued weak demand associated with excess channel inventory in the industrial and distribution markets and timing of shipments into the defense markets. In the med tech and specialty audio segment, revenue was $61 million, down 2% versus the prior year, as we faced tough year-over-year comparables as the first half of 22 demand benefited from strong COVID recovery. Consumer MEMS mic revenue of $65 million was down 3% versus the prior year, driven by weak global demand for smartphones, partially offset by growth in non-mobile applications. Second quarter gross margins were 42%, 100 basis points above the high end of our guidance range and up 50 basis points from the same period a year ago. Precision devices segment gross margins were 39.7%, down 700 basis points from the prior year due to unfavorable capacity utilization. MedTech and specialty audio segment gross margins were 53.5%, up 410 basis points versus the prior year, driven by productivity gains, lower factory cost, and foreign currency benefits. Consumer MEMS microphones delivered gross margins of 33.6%, up 340 basis points versus the prior year, driven by benefits of the restructuring actions announced in August 2022, improved product mix, and a gain on the sale of assets, partially offset by pricing pressure in the mobile market. R&D expense in the quarter was $16 million, down $2 million from the prior year, with the reduction driven by the benefits of the restructuring actions taken in the consumer MEMS microphone segment. SG&A expenses were $30 million, $6 million higher than prior year levels, driven primarily by higher incentive compensation costs and higher professional and legal fees, partially offset by restructuring actions in the consumer MEMS microphone segment. For the quarter, adjusted EBIT margin was 16%, at the high end of the guidance range. EPS was $0.23 in the quarter, slightly above the midpoint of our guidance range. Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $54 million at the end of the quarter. We generated cash from operations of $1 million above the midpoint of our guidance range, driven by timing of customer collections. Capital spending was $4 million in the quarter, and we repurchased approximately 300,000 shares at a total cost of $5 million. We ended the quarter with cash net of outstanding bank borrowings of $9 million. Before moving to guidance for the third quarter, I want to comment briefly on some of the specific cost reduction actions we're taking within the precision device segment to mitigate the impacts of our reduced revenue outlook. In Q3, we expect to incur a charge of roughly $2 million, which is expected to result in annualized cost savings of more than $5 million. These actions will be in place by the end of this year, and when implementation is complete, we expect PD operating margins to return near 2022 levels. This will also put total company operating expenses at the low end of our previous range of $43 to $45 million per quarter. Moving to guidance for the third quarter, we expect total company revenue to be between $170 and $180 million, down 2% versus the same period a year ago. We estimate gross margins for the third quarter to be approximately 41.5% to 43.5%, up 400 basis points from the year-ago period. R&D expense is expected to be between $15 and $17 million, down slightly from prior year levels, driven by restructuring actions in the consumer MEMS-like segment. We're projecting selling and administrative expense to be between $24 and $26 million, down $1 million from the year-ago period, primarily driven by restructuring actions in the consumer MEMS and precision device segments. We're projecting adjusted EBIT margin for the quarter to be in the range of 18 to 20 percent, and expect EPS to be within a range of 26 to 30 cents per share. This assumes weighted average shares outstanding during the quarter of $94.8 million on a fully diluted basis. We're forecasting an effective tax rate of 18% to 19% for the quarter, and we expect cash from operations to range from $20 to $30 million. Capital expending is expected to be $7 million. I'll now turn the call back over to the operator for the question and answer portion of the call. Operator?