Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the Knowles Corporation Third Quarter 2017 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] With that said, here with opening remarks is Knowles' Vice President of Investor Relations, Mike Knapp. Please go ahead.

Thanks, Mike, and welcome to our Q3 2017 earnings call. I'm Mike Knapp, and presenting with me on the call today are Jeff Niew, 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's 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, 2016, periodic reports filed from time to time with the SEC and the risks and uncertainties identified in today's earnings release. All forward-looking statements are made as of the date of this call, and Knowles disclaims any duty to update such statements, except as required by law. In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at knowles.com, including a reconciliation to the most directly comparable GAAP measures. All 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 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, Mike, and thanks to all of you for joining us today. For Q3, we reported revenue of $222 million, up 17% sequentially, and above the mid point of our guidance. Gross margins of 38.3% or within our guidance range with more than expected operating expenses resulting in EPS of $0.28, above the mid point of our guidance. In our Audio segment, sales were up 22% sequentially and came in largely as expected. MEMS microphone revenue was up over 30% sequentially as our largest customer began to ramp of its new handsets. Overall, revenue from Audio comprised 76% of total sales in the third quarter. In the Precision Device segment, sales grew 4% sequentially and over 8% from the year ago period due to stronger demand for capacitor devices. We continue to see improving order trends in our defense, medical and auto markets driving demand for these products. Precision Devices represented about 24% of total company revenue in Q3. As we look at the trends benefiting our Audio segment over the next several years, we continue to see strong demand for voice-enabled devices. From mobile phones to headsets and from smart speakers to TV and appliances voice powered interactions are emerging as a critical and necessary feature. Consumers want to engage with technology through natural spoken commands across the mobile, ear and IoT markets and OEMs are racing to develop and deploy the technology to enable it. Our core capabilities in acoustics, digital signal processing and algorithms are unparallel to parallel and placed us in an ideal position to enable voice technology. In mobile, OEM customers continue to move to more microphones for handset. Vivo went from one microphone to two in its latest V series handsets to improve audio input and the Essential Phone recently launched leveraging four of…

Thanks, Jeff. As Jeff Mentioned, we reported third quarter revenues of $222 million, up 17% sequentially and slightly above the midpoint of our projected range. On a year-over-year basis third quarter revenue was down 9% as declines in the Audio segment were partially offset by an 8% revenue increase in precision devices. As expected audio revenues of $168 million were down 13% from the year ago period primarily due to lower MEMS’ microphone sales resulting from a later than normal launch of new handsets at our largest customer and a decrease in shipments to Chinese handset OEMs. Hearing health sales were also lower on a year-over-year basis driven by reduced market share as we continue to be disciplined in our pricing practices. In the Precision Device segment, revenues of $54 million were up 8% year-over-year as a result of increased capacitor shipments to the defense, medical and automotive markets. Third quarter gross margins were 38.3% below the midpoint of our guidance and prior year levels as margins were negatively impacted by costs associated with the settlement of a warranty claim and unfavorable fixed overhead absorption in our MEMS microphone business in connection with the later than expected launch of a customer's new handset. Operating expenses in the quarter were $53.2 million better than the midpoint of our guidance and down more than $2 million from the year ago period as a result of lower incentive compensation costs and our ongoing efforts to reduce general and administrative expense. For the quarter adjusted EBIT margin and non-GAAP diluted EPS was 14% and $0.28 respectively. 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…

Thanks, John. As we look to 2018, I anticipate that we will benefit from the timing of the product cycle at our largest customer, recovery in the China handset market, driving [ph] sales into IoT and headset devices as well as stable trends in hearing health and precision devices. I also expect shipments of our new string [ph] family of single and multi-core DSP solutions to accelerate as customer products are introduced to the market. I am optimistic about these growth opportunities and our ability to capitalize on these audio trends. I believe our focus in investment in acoustics is enabling our broader audio strategy, which combines leading edge microphones with digital signal processing and algorithms to solve our customers’ most difficult challenges in the mobile, ear and IoT markets. We remain uniquely positioned to cross these end markets and well aligned with our customers roadmaps to deliver best-in-class audio input solutions for their next generation platforms. Operator, we can now take questions.

[Operator Instructions] Your first question is from Bill Peterson from JPMorgan.

Yeah, hi. Thanks for taking the question. I have a few. I guess if we start off with IoT, I believe in the last call you said you couldn’t have an exit run rate this year somewhere like upper single digits of audio. We think of these connected home based of the announcements you have, when should we expect this to achieve at least 10% of revenue and then have a few follow-ups.

Yeah, I mean – I mean I don't know if you're asking that by a quarter, but I would say that we're pretty confident that that next year for sure we should be achieving 10% because what we're seeing Bill is this is you know first of all we're seeing the continued growth in the leader in the space to expand beyond the U.S. and to put one of these devices in every home. But the second thing that – what I think which has really changed from the last call that we kind of alluded to, but we weren’t prepared to talk about that this is the floury of announcements of other people getting into the smart speaker business. And what we feel really good about in this space is that everybody is leveraging a lot of microphones per smart speaker. And so, I think what we're hopeful is that Xiaomi is the first, but that will probably see more announcements as we go into Q1 and Q2 next year of other people in China, who will be addressing this market. So I feel pretty comfortable saying that next year more than 10% of our sales will come from IoT.

Okay. I guess switching over to intelligent audio, I guess first if you can level set us on your revenue sort of run rate, that’d be great. But then if we think about the opportunity you described with mic plus DSP as well as your multi-core DSP solution. Which of those opportunities should we expect to be let’s say a better growth opportunity in 2018? It sounds like the DSP is sooner, but if you can kind of frame the growth rates or what we can expect in terms of growth for these products into next year.

Yeah, let me tell – I think the more immediate opportunities are around smart mic than around standalone multi-core DSP only because it was introduced sooner. And if you remember we had a first generation smart mic that were not DSP based, so we've kind of already been working with customers in this area. I think it's a little early to talk about what the revenue is going to be in 2018 because a lot of it has hinges on the success of the products. But let me just kind of tell you a little bit about how we view the smart mic. First of all, when a customer decides to use a smart mic, it usually drives an increase in the microphone count in order to take advantage of algorithms that would run on the device. That's the first thing it does, which is probably not being included because only be one smart mic, say if you have three in every one smart mic, but they are going to be digital. So now you get people to move from analog to digital add more microphones and likely now we are sole source across all three microphones that are in that space. So to kind of give you a frame here if you think about a customer that maybe buying, and I will make this up, a million phones, maybe we get 50% share of two analog microphones. Now, we're going to get a 100% share of a smart mic and likely a 100% share of two digital microphones. So you could see the power of this taking what would be probably a relatively small opportunity in making it large. And that's the power that we want to make sure that we get across all three our markets: mobile, ear and the IoT market.

Okay, if I could just sneak one more. It sounds like you’re driving further multi-mic adoption, you mentioned mention Oppo last quarter and Vivo and few others this quarter. So if we think about how we exit the year? I think last year you did 10% growth. How should we think about the multi-mic adoption of your conventional microphones? Thank you.

Yeah, I would say high single digits probably next year. I wouldn't say that’s going to be increases as much but probably high single digits going into next year, it’s probably not quite as high as it was this year, but still increasing.

Okay, thanks. I'll jump back. Congrats on the results and guide. Thank you.

Thank you.

The next question is from Bob Labick from CJS Securities.

Good afternoon. Thank you.

Hi, Bob.

Hi, Bob.

Hi. I wanted to just talk a little bit more about the new audio processor that you've started to discuss. Could you just help us to understand how is it different than what's out there on the market? What end markets will it be addressing? And I think you said you already have a customer signed up, but is that the case or is this a build it and hope we find customers? Just expand on the opportunity and more specifically what you do?

Yeah, so I’ll answer the second question first. Well, the product was introduced, but we've been working with a number of customers pre-launch alpha customers. And we do have one customer signed up to start shipping to in the first half of next year. And so, we're pretty excited that very quickly we've been able to move this into – and it’s for an IoT customer, but the way we're positioning this product I think we've done a fair amount of – we have a new web page and we have to do a lot of promotion. I’d say we're primarily focused on the IoT and ear markets. That's the primary focus. There are maybe some opportunities in mobile, but I’d say the primary focus is IoT and ear. What differentiates this product is the high level of performance relative to what's in the marketplace today coupled with extremely low power especially for portable applications. And lastly, what we are getting the feedback, which is a very important piece, is we've designed an STK and tools that, allows not only us to program this with our own software, but our customers and third parties to write software to this DSP. And so, you know, one thing we have been talking about is we already have I think close to now ten people signed up software companies that are actually porting their software to this DSP and the actually the smart mic, the same architecture and we have a number of customers now starting to write software to this DSP. And I think one of the things piece we've got raise low power, really great performance, you're at the right time with the right product at the right time, but they're also saying it's really hard to program with a lot of the DSPs that are out there. And this is a big advantage that this product has.

Okay, great. That's very helpful and then just one other question. You discussed this I think – John at the end of your remarks too. Could you just give us an update on the capacity build out for the MEMS microphones and how much you've added as 10%, where that's going? How that's worked out for you so far? And obviously, there's the shift out of your largest customer, but the expectation is will you have enough capacity for next year. You're going to be adding more capacity next year et cetera.

Yeah, you know, good question, Bob. Yeah, we feel good about the MEMS microphone end markets. It should grow at greater than 10% unit growth in 2018 as it's easier where we've invested our cost higher than normal CapEx this year and that's really to put in capacity starting kind of midpoint of 2017, but if you listen to the script today, I said we’re going to invest another $20 million in Q4. That's primarily for additional capacity to be put in place in 2018 because again we feel pretty good about the unit growth carrying forward.

Let me add a little color to that on the competitive front. I think what we've seen – I think we’ve eluded this on previous calls that the competitive environment seems to be coming more favorable for us. We've seen a few people who have exited the microphone market. We've seen a few people who have kind of reduced their focus on this space. Couple that with, as John said, the end markets you know especially IoT and increasingly ear are very strong. And so, we're feeling pretty good of going into 2018 that we've got to be prepared. And so I think we'll probably be ending up to adding capacity in 2018 as well.

Yes, Bob, if you think about it, we mentioned this year we'd be in a range of 6% to 8% of revenues given you know what I mentioned about Q4 and our year-to-date spending will still be in that range, but it will be much closer to the high end than the low end of the range. I would expect it to be kind of at that high point again in 2018.

Great, thanks very much.

The next question is from Charlie Anderson from Dougherty & Company.

Yeah, thanks for taking my questions. A lot of good questions about the new products, so maybe I will just ask about the guide real quick. Other than the sort of product cycle timing with the largest customer were there any – are there any callouts elsewhere in the business in terms of revisions to the forecasts from earlier?

No, that's – that's really I would say as I noted our Q3 gross margins were probably a bit of a disappointment versus our forecast. We had a couple of things. We had a resolution of a subcontractor warranty claim that had roughly 50 basis points of impact to margin. And then again because we scaled back a little bit on our production plan in Q3 due to the later than normal launch of the handsets at our major customer that had roughly 100 basis points of impact. But as noted in Q4, we expect gross margins, the midpoint is 40%. So…

Let me extend a little more color on the revenue side. I mean I think the one disappointment probably in Q3 was still China was weaker than we had expected. And we're looking at the numbers quite a bit and I think the one thing that we continue to see is, is that in spite of the struggle that we've had for sure in 2017 with the end market in China, China is still up dramatically from 2015. So, in other words our China sales are up significantly from 2015. And we’re starting to think that maybe the Chinese market got kind of ahead of itself a little bit here and – but I was recently with all the customers the last few weeks and I feel good about our position there. And I think a lot of our IE activity especially around smart mics is focused in China market. So, we feel pretty good that Q4 hopefully is going to be a recovery quarter and that it will lead into a strong 2018.

Great and that’s just a question for me on the new products. If you guys win the multi-core DSP and then IOT device or hearable and then also some of the mics, I wonder if you could maybe just bracket out some of the content opportunity per device for us and then also in fact that gross margin section that becomes a larger portion of the business. Thanks.

Yeah, I mean just figure you know that we're talking – microphones are still in the range that we speak about, somewhere at the low end probably in the $0.25 range up to $0.40 for the standard microphone. A smart mic obviously can be 30%, 40%, 50% higher than that in terms of what – a smart mic would have. And then as we start to think about the multi-core DSP, I would caution to just think about this from a perspective of how much of the software activity that we actually do. We've got a wide breadth of customers that we're working with on the multi-core DSP, some of them are saying to us look we're going to do all the software ourselves. We've got all the capability in house. We’d love the fact that’s open. We're going to do everything versus some other customers that are saying we want you to do a lot of the software for us. And so there is a pretty wide breathe of what our expectation is relative to the ASP, but I would say it is definitely north of $3 on the DSP. And from our perspective, it’s all going to be very high gross margin. That's why I would say above the corporate average.

Great, thanks so much.

Your next question is from Anthony Stoss from Craig-Hallum.

Hey, guys, a couple part if you wouldn’t mine and I'm not sure if you’ll have this available. But if you – Jeff, if you looked at your average ASP per mic kind of where you’re at now versus say a year ago. I'm curious what you've seen overall. And then secondly maybe you can compare and contrast your number of smart speaker customers if it was one year ago maybe if you would mind sharing number of customers on the roster. And what you're seeing? Is it generally six or seven mics per smart speaker? Thanks.

Yeah, I think, what we see is – let me take the – the first question was I think the roster first, I will go to the roster first. What we've probably seen last year at this time we had really one customer that was buying from us. I would say we're probably up to seven or eight now that are buying from us in terms of smart speakers. Generally speaking the majority of these products have somewhere between four and seven microphones. I think there are some exceptions in the marketplace and we'll see how this all plays out. I mean I think there's been discussion on the Google many. There's only a couple microphones in that, but that's an extremely, aggressively priced device. So, you know, I think – but I think our expectation is probably that voice capture may not be good with – is good with two microphones. So I think there's a wide breathe of different opportunities here. I think there’ll be some opportunities from smart mics on the space. We already got a nice win. We’ll not super high volume with Xiaomi with some smart microphones. So I think there's a wide breathe. I think our focus here going into next year. I think we recapture – what we think are the players in North America on the IoT smart speakers. I think the next phase of this is, is really about China because I don't anticipate, it could be wring, but I don't dissipate the good North American people that are in the space to be really strong in China, but this is definitely coming into China and there's a lot of design activity in China around smart speakers. So that’s going to be the next phase to expand the roster. Your question on ASPs, I think we talked a little bit about the last call, we wish to reiterate what we said last call in 2016 – or first we typically said 6% to 10% down on matured products and at 2016 we said we’re at the high end of that range. I think we’ve projected in 2017. I think that still holds. We’ll probably be at above the middle of that range in 2017. And right now – and I mean it's very hard to predict how things going to 2018, but again I think I mentioned earlier in earlier question the competitive environment I think is turning more positive for us based on number of factors. And I think that – that as we go in 2018, we think the price erosion couple the competitive nature of the market with the new products that we're introducing and the higher end that the price erosion probably will be towards the lower end of that 6% to 10% on matured products. Maybe even below possibly even below, but I think it's a little too early to call that.

Great, thank you guys.

The next question is from Jason Smith from Lake Street Capital.

Hey, guys. Thanks for you to take my questions. Really quickly wondering how much China represented as far as Q3 revenue.

Q3 revenue…

Little bit of numbers here…

We’re calculating it right now, calculating. We have a slow processor.

No worries.

Roughly just a little under 20% of the mobile business.

Okay that's helpful. And then looking at operating expenses, I know you've guided $56 for Q4. How should we think about OpEx ramping in 2018?

I’m not really going to give guidance on 2018, but what I can say is I'm not aware of any major operating expense increases above current levels other than you're always going to have the normal market wage rate inflation and our incentive comp costs are likely to go up a little bit because they're below target levels for 2017. Other than that I wouldn't really expect any major increases.

Okay, thanks a lot.

The next question is from Suji Desilva from ROTH Capital.

Hi guys. Hi Jeff, hi John. In terms of the hearing health for the business, can you talk about the dynamics there, whether you think that's going to be stable going forward or just growing the GDP, any thoughts there would be helpful?

Yes I mean I think we’ve talked a lot about this on previous call about that we've been more disciplined on pricing a certain piece of business that we thought that we're not good margin. I would say that from our perspective we think the business is on a trajectory to stabilize at the current levels. And the remaining businesses is profitable and we think we're in a good position to defend and maintain that share. We still see also just what I would say is there’s still a lot of activity around the conversions with the year. We're seeing a little bit more activity around these assisted listening devices. And so we're hopeful that that next year will be a stable year and we won’t see the headwinds that we faced in 2017 based on walking away from some lower margin business.

Okay great. And my other questions around some of these intelligent mic systems that you're getting designed into. It seems like when you compete it for phone mic so it’s kind of socket by socket you try to get qualified for some versus others. With the intelligent mic systems if there's two or three mics there, do you automatically kind of get your mic swept in along with the main intelligent mic? Is that how these play out or whether still be competition for those micro end sockets, even where you have the intelligent mic?

I think it's been – it's early days of a number of these designs, right but I think generally speaking we're feeling like what we're doing is we're elevating ourselves above the rest of the competition relative to solving a specific problem in a used case, as opposed to just walking is in the cellular microphone. And so well I'm sure these customers consider, they consider for a couple the normal microphones considered another source. I think in the end we have really optimized these things to work as a system and we're talking to a different level within these customers now about how to make that happen. So I think there's a very good chance that we can garner a hundred percent of the share where we get start microphone as I do.

Well that was the color that I was looking forward to. Great, thanks guys.

The next question comes from Tristan Gerra with Baird.

Hi this is Maggie Mcnally on for Tristan. I'm just wondering what is driving the 40% gross margin profile, given the growth for 4Q. And with that how meaningful is the mix improvement coming from smart speakers?

Yes can you, I think you said dragging the…

Driving…

The margin improvement from Q3 to Q4 is really the absence of again we had a couple, we had a one time warranty claim that was 50 basis points in Q3. That we don't expect to recur. We also scaled back our production plan slightly. That had about 100 basis points. So if you think that we were just north of 38% you add back 150 basis points for those two items, you're very close to 40%. We're running close to capacity or add capacity in Q4. So you get a slight uptick to in terms of capacity utilization versus, I mean we’re probably in the mid-90s in Q3. So that's really the drivers of that call it 150 basis point improvement sequentially.

Okay great, thank you. And then just a follow-up. Do you expect similar market share at your North American customer as in prior models?

Yes I think what we're projecting is stable share in the ramp quarters. I mean beyond that, I think, it's too far out to speak that, it can vary from quarter-to-quarter, but we don’t see anything dramatically shifting year-over-year.

Okay. Thank you.

[Operator Instructions] The next question is from Christopher Rolland from Susquehanna.

Hey guys, thanks for the question. So given the kind of delay or push out in models, that your North American customer, how much revenue actually pushes out of Q4? And in your opinion is that all then push into Q1?

Well I that, I think, I guess we're getting into specific number. I mean there's a lot of obviously moving parts we have that hearing health business, we have the Precision Devices business. And so there's a lot of moving parts here. But I would say it's not insignificant, right. So I mean it's not like we're talking about a couple million dollars here. There’s also a fair amount of uncertainty in the demand for that new flagship.

I mean the hard thing about this is look, you guys read all the press releases that are going out, and all the coverage that goes out, just like we do. And I only think I would just say is, is that there's still possibility of mortgage pulled in the Q4, more goes into Q1. It's really hard to say, but what I would say is, is that year-over-year that we feel like that we're going to get some nice growth this year over the full ramp, right. So fee; so we feel pretty good about that. I’d also just one other comment, relative to that customer increase. And I think we've had some good success this year in multi mics beyond the handset. I think everyone that we talk about little bit about the Home Pod, everyone’s heard about Air Pod. So there's more going on there, while it’s small relative to the phone, it's still a nice thing that’s coming in for us with this customer.

Chris I think I mean it’s listed in both my Group and Jeff’s Group. We said we expect strong revenue growth in the audio segment, on a year-over-year basis in Q1 of 2018.

Correct.

Got it got it. And then on the smart speaker side, maybe you can give the holiday season is important for that. Maybe you can give us your expectation for total unit growth year-on-year for that category? And then lastly, you have a lot of six mic and seven mics Kind of architectures out there, do you expect them to reduce the number of mics, or do you think that those numbers of mics are key to the quality, maintaining the quality of those devices? Thanks.

First question year-over-year for the holiday season I think our expectation is that our largest customer in the IoT space will be up. I think we discussed though in the past, last year we were sole source. We are still getting the vast majority of that volume, but there is a second source that shipping into that customers. So it’s little for us to exactly read, but needless to say the expectations are for the business to be up. I believe I can look at the numbers, I'm looking at year-over-year. I'm going to hold my breath yet and say, on the other stuff, the other products. They're not even shipping in the marketplace yet to say how well they're going to do. I mean I think we have a lot of nice forecast but to say how much they're actually going to sell at this point this is the struggle with IoT. We get a lot of customers who come in, design a lot of microphones and they say we got a lot of volume, but it's hard to say how they're going to sell. It's very difficult. I know we're going to get a fair number of microphones in the ramp because they’re going to build a certain number of units. But I think we got to wait and see which products are the winners and losers in the marketplace. As far as the number of mics per, I think there is – I’m not going to sit there and say all six mics. I mean there are products that are coming to market with less microphones, but our fundamental believe still, as we worked in mobile, as we see what's going out in ear, and in IoT still is that more mics results in better voice input. And so there are tradeoffs though. If you're going for a very low cost product, you're trying to strip cross out, maybe you say, I'm going to sacrifice quite simply. So I think it's still early so it goes, but I think if you think about it, the products I mentioned on the descript, the majority of those have somewhere between four and seven microphones. Now there's a couple of other products which I mentioned earlier like the Google Mini, that only have a couple of microphone. So it's a little early, too early to say, but generally speaking, we still have to believe more mics means better performance.

Chris I’m just going to add a little granularity to your question on IoT. I think Bill had it too. You think about it we shipped our first mic into the IoT market in Q4 of 2015, really low levels sales. It was roughly 20 million into IoT in terms of revenue in 2016, it's going to close to double in 2017. And we are confident on growth beyond that moving forward.

Yeah and doing a great category. Thanks guys.

There are no further questions at this time. I will turn the call back over to the presenters.

Great. 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 good bye.