Good afternoon and welcome to the Knowles Corporation Second Quarter 2018 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 Chantel and welcome to our Q2 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 under 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 31st, 2017; 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 this call can be found on our press release posted on our website at knowles.com, including a reconciliation to the most directly comparable GAAP measures. All financial references on this call will be on a non-GAAP continuing operations basis, unless otherwise indicated. Also we've made selected financial information available on 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 $188 million at the high end of the guidance range we provided on last quarter's call. Gross margins of 39.4% and EPS of $0.18 were both above the guidance range. In our Audio segments, revenue was up 10% from a year-ago period, which was better than expected. Sales of MEMS microphones were higher, driven by strength in sales to Chinese OEMs and growth at our largest customer across their entire product portfolio. Sales in the hearing health were stable from a year-ago period. Overall, revenue from Audio comprised 81% of total sales in the second quarter. In the Precision Device segment, sales were up 39% from a year-ago period, hitting record levels due to strong demand for capacitor and film devices across most end markets and an acquisition completed in the first quarter. Precision Devices represented about 19% of company revenue in the quarter. In Q2, macro trends around voice-in-voice and audio input as well as share gains drove MEMS microphone sales higher from the year-ago period. In China, we expected MEMS microphone revenue to more than double on a sequential basis. In Q2, the business with these customers were stronger than expected and almost tripled sequentially. This improvement is being driven by several factors, including demand for higher performance microphones, multi-mic and intelligent audio adoption, and share gains. At our largest customer, microphone shipments increased significantly from a year-ago period. Our share across all product that this customer remain strong and we respect -- expect full year 2018 growth from this customer versus the prior year, with peak shipments anticipated in Q3. In Korea, while our share remained stable, sales were lower than a year-ago period, reflecting subdued demand for this…

Thanks Jeff. As Jeff mentioned, we reported second quarter revenues of $188 million, near the high end of our projected range and up 15% from the year ago period, driven by increased shipments in both the Audio and Precision Device segments. Audio revenues of $152 million were up 10% from the year-ago period. Within the Audio segment, MEMS microphone shipments increased by more than 15%, driven by strong demand at Chinese OEMs and growth at our largest customer across their entire product portfolio. This growth was partially offset by lower shipments to Samsung. Sales into the hearing health market were stable from a year-ago period. Precision Device revenues of $37 million were up 39% year-over-year as a result of 27% organic growth, driven by strong demand in defense and industrial end markets and an acquisition completed earlier this year. Second quarter gross margins were 39.4%, above the high end of our guidance due to better-than-expected pricing, favorable product and customer mix, and a benefit from onetime items. Operating expenses in the quarter were $54 million, up $3 million from the year ago period due to the impact of the Capacitor acquisition made earlier this year and higher incentive compensation expense. For the quarter, adjusted EBIT margin was 11.4% and non-GAAP diluted EPS was $0.18, with both metrics above our guidance range. 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 $51 million at June 30. For the quarter, cash generated from operations was $14 million and capital spending was $25 million. Bank borrowings were unchanged from March 31, 2018, levels. Moving to our…

Thanks John. As we enter the second half of the year, we're seeing positive momentum in both of our business segments and expect 9% revenue growth in 2018. Our Microphone business continues to grow in Mobile, Ear, and IoT. We expect increasing sales of intelligent audio solutions across all of our end markets. In addition, I expect continued strength in capacitor demand and our hearing health business to remain stable throughout the rest of the year. As we transition from an acoustic component supplier to an audio solutions provider, we're expanding our available market and enabling macro audio trends, including processing at the edge of the network and voice as user interface. I continue to believe that our core capabilities in acoustics, digital signal processing, and algorithms are unique and unrivaled and we are ideally positioned to grow across all of our end markets. Operator, we can now take questions.

[Operator Instructions] Your first question comes from Suji Desilva with ROTH Capital. Your line is open.

Hi Jeff, hi John. Congrats on the results here. In the SmartMic business guys, the customers you have, OPPO, Vivo, how does the pipeline look behind them? Have you focused your efforts on the first two customers? Or are there many more kind of followers that want to do what they've done?

Yes. So, obviously, there is a -- of the two handset guys that we've already announced, we've kind of alluded to somebody in the IoT market will be introducing a product that we think later this year. But the pipeline is pretty full. We now have more opportunities within Mobile, we have a fair number of opportunities within IoT, and we have opportunities within the Ear, specifically in the wireless area. And so how I kind of view this is we kind of go into end of 2018. It's not yet a significant number in 2018. But as we go into 2019 with the pipeline where we are, we're pretty excited about the potential for 2019 and beyond.

Great. And maybe a follow-up there on intelligent audio. Can you tell us -- can you remind us the kind of pricing you see there versus the traditional mics? And is it coming in the way you expect or you're seeing competition for that socket?

Yes, let me just make one point here. I think there's a couple of vectors of growth with us -- with the SmartMic that we probably don't measure directly in the intelligent audio as we see in the traditional product. First of all, it's -- of course, there's intelligent audio product. And depending if you're going from an analog mic to a SmartMic or you're going from a digital mic to SmartMic, that right there, that one upgrade to that mic can be in the neighborhood of three to five times the pricing. The second piece, which we're seeing is, is that when people move to a SmartMic, they also start to move towards higher-performance mics for the other mics, and in some cases, digital microphones, which drives content growth. And then the last piece, I think, which we're in a very unique position when we get these design wins with SmartMics, is that we can get higher share of these products. Of course, on the SmartMic, we are the only supplier at this point, but it also allows us to leverage ourselves into the rest of the slots within the device that we're in. So, overall, I just would say is we're kind of talking the neighborhood of three to five times, maybe even in some cases could be higher in terms of revenue per device compared to was in the past.

Okay, great. Thanks guys.

Your next question comes from Anthony Stoss with Craig-Hallum. Your line is open.

Hey guys. Congrats on your China revenue tripling, that's great. Jeff, can you just confirm, since there was a lot of moving parts last year, the sale of the timing division and the losing of revenue on an organic-to-organic basis or maybe just share your thoughts what total revenue number you were using to get to that 9% year-over-year growth? And then secondly, any thoughts or what you can share on your biggest North American customer going into this fall kind of generation-over-regeneration either content or share? And then lastly, if you think China is going to be up, down, flat sequentially in Q4?

Yes. Let me take the first question on the growth. What we've done is we pro formaed all the taking the timing business out. So, if you just do it on an organic basis with the small acquisition -- there was a small acquisition we did in capacitors, but it's 9% year-over-year.

It's off -- if you go back to 2017, it's off the continuing -- revenue from continuing operations, which was $744 million, Tony.

Correct. Your second question, I'm not going to make too many comments about our largest customer going forward and share. We potentially don't talk about share-specific customers, especially on products that aren't even released. But here is what I would say is, is I think we're very well-positioned across a lot of products within their portfolio. I think some other peers that some people get compared to or that we compare to, they're primarily focused on handsets. And this is not just with this customer, but overall, there is IoT devices, there is ear-worn devices, there is tablets, there is laptops, there is wearables like watches. So, we have a pretty broad portfolio of product. And I think it kind of showed up in our Q2, right? I mean, I think a lot of the people in the space, the handset business was maybe not what people expected, but we had a lot of growth in other places as well. The last thing I just -- would just keep continuing to highlight, even beyond this customer, we do have a lot of business down in Ear and IoT. It will be about 20% of our sales within the microphone business. So, we feel pretty good. The last question that you asked was about China. Our expectations for Q3 is that we are going to see still double-digit sequential growth in China, even after that tripling -- almost tripling in Q2. So, we still see a lot of strength in China for us. And it's not really been driven by the macro trends within China, it's being driven by our position in China. Where you sit there and say, they're using more microphones, they're using more high-performance mics, including there's AI adoption starting to have some impact on China, specifically Vivo and OPPO as well as share gains within those customers.

And then lastly, Jeff, China for December, if you think that's up or down or flat sequentially?

I'm not going to make a call on that yet, Tony. I think it's a little early to do that. I think we feel really good about Q3 right now. I'm going to -- not that I don't know like what we're thinking, but it's just -- I want to pounce on that to say [Indiscernible] is going to go.

We understand. Nice job again. Thanks.

Thanks Tony.

Your next question comes from Bob Labick with CJS Securities. Your line is open.

Yes, hi. It's Pete Lucas for Bob. Jeff, you talked about SmartMics a bit in the prepared remarks there and you've had some nice wins of late. You talked about one of the advantages you have is being able to operate across the architecture. In those cases, would you be the sole source for those mics?

Right now, as far as we can see, there is nobody else in the marketplace that has a microphone that has a digital signal processor built into it as well as we provide a fair number of the algorithms that go inside of that microphone. So, I think we're in a pretty unique position on these products right now.

And then just last one from me. You talked a little bit also about wireless earbud adoption, which has been a better slower, but it sounds like you've got some good things in the pipeline there. Can you talk about any other or expand on any changes coming that would improve the earbuds for better adoption rates?

Well, I mean, I think we do have a quite a bit of business, I would say first of all, in wired headsets. So, let's just start with that. The second thing is there is the -- that we call the true wireless, which is a new category and we're expecting there's a lot of customers who are going to be introducing products in this space, I would say, over the next six to nine months. The last piece, which I alluded to on the SmartMic, we do think there are some greater opportunities for us in the Bluetooth headset market to embrace SmartMic in terms of -- to really change the dynamic in how you interface with your headset.

Great. Thank you very much.

Your next question comes from Charlie Anderson with Dougherty & Co. Your line is open.

Yes, thanks for taking my questions and my congrats as well. So, I'm curious about pricing runs. Jeff, you've sort of addressed this in the last couple of calls about what you're seeing on the microphone side and sounds like it's been getting more positive. Just if you could update us there. But then I'm also curious on Precision Devices. We're seeing pretty decent lift in gross margin there. I wonder if pricing trends are helping you. Is there a tightness in supply out there that's benefiting you in the market as well? Thanks.

Yes, let me talk about the ASPs first and then let John a couple of comments on gross margin on Precision Devices. In ASPs, I think we've kind of always alluded back to this, 6% to 10% on mature products price erosion. We as industry, we talk to people; we were at the higher end of the range in 2016. We were at around 6% to 7% in 2017. We expect now to be in 2018 price erosion on mature products below the 6% to 10% range. So, it's been trending positively in the competitive environment as well as the products that we're introducing are differentiated. I'd say just one more comment about the ASPs overall, which includes new products. The ASP will probably be just down slightly year-over-year for the total business, but that's a little bit driven by the mix. We have a lot of higher share this year in China, which they tend in some of their lower-end phones to use lower-end mics. So, -- but overall, I mean, I think the competitive environment, I still think, continues to be quite positive for us. And as we've looked towards 2019, when we start talking about the new products we have on their microphone business with transitions from analog to digital as well as smart microphones coming into the space and higher volumes, I think we're -- we feel pretty good about 2019 in terms of ASPs.

In terms of Precision Device gross margins, really three drivers here. First of all, there's operational performance. We've seen some pretty good lean activity there. Second is we made an acquisition earlier this year in the first quarter. The margins in that business are above the corporate average or I should say the average for PD. So that brought it up. And we are seeing some favorable pricing.

If I could just circle back on the microphone business. And so it's great that we see pricing trends improve for you. When do we see that translate into gross margin left? I think if I just look at the Audio segment, I know we don't see the microphone margins. But in the Audio segment, they're down a little bit and I think pretty flat quarter-over-quarter.

Yes, I mean -- again, I will sit there and continue to sit there and say is, is that our expectation is not that the gross margin on the core microphone business, you're going to see big shifts upward in gross margin. I think one of the things we think about is, in the past when we had a fair amount of price erosion, we were able to offset it with a lot more cost reductions internally. I would just say it has become more of a challenge on the cost reduction side and it's kind of lining up with the price erosion side. So, again, I would say our opportunity really to see gross margins expand is going to be really around intelligent audio in 2019 and beyond.

Got it. Thanks so much.

Thanks Charlie.

Your next question comes from Harsh Kumar with Piper Jaffray. Your line is open.

Yes, hey guys. First of all, congratulations. Awesome numbers, awesome guide, awesome commentary. Jeff, I had a couple of questions. First of all, China share, your numbers are just massive. I -- usually, you provide some kind of commentary on the competitive landscape there. I'm curious if there's something specific happening, perhaps some dislocation with the local players that's also helping? Or is it just performance and share gains, is that basically driving everything here?

I wouldn't say it's any displacement of the local players. I would say it's displacement of its secondary players. I think we've talked about this in the past that we're seeing less of the secondary players like -- we talk about the past that Bosch had exited the market. We're seeing less of people like ST in the market. So, I think that's part of where the share gains are coming from. The second thing is, is our product portfolio for China that we worked on last year for introduction, which includes the IA stuff, is really starting to come through and it's not just on, of course, the SmartMics, but it's also on our digital microphones, it's also on our analog microphones. We've got a great product portfolio. But one of the things that's in here that is starting to provide some growth in China and I know this is probably like specific things that's a little bit different, but it's not the majority of the growth, it's still handset. We are seeing more Ear and IoT opportunities that we're shipping to in China. Now, I wouldn't say that they're the number one driver of this, but we're definitely starting to see some of the players in China, both Ear and IoT, they have similar products in North America already. So, that's what's driving it.

Got it. Thank you. That was great. And then I would assume your margins or the mix, if you will, of margin on the intelligent audio stuff is better than your traditional business. Is that generally speaking an accurate statement? And then could you give us some color on perhaps not exact numbers, but how much better is it?

Well, I won't give the exact numbers, because we aren't selling that much yet, but it definitely is going to be above the corporate gross margin. And it's not going to be like one or two points better than the corporate gross margin. So, I think there's a couple of things that are really important to think about on this SmartMic or/and the multi-core DSP. First of all, because we're providing in a lot of cases the algorithms, we're providing this architecture that is very unique. And what we expect is, is that we will not see as much price erosion on mature products once they're designed in. Now, there are people who are thinking about features all the time and what they cost and we've got to be competitive on price and how they implement it. There's other ways to implement this. But overall, the -- it will be significantly higher than the corporate gross margins.

Harsh, just to add a little bit, I think scale is really important in this IA business. Right now, we're relatively modest volumes and we have a set amount of fixed overhead. When we start scaling this up, there's going to be pretty strong leverage to that. So, if you look at the margins today, they're a little north of maybe our average. But as that business scales up, gross margin should really improve.

Understood. And my last one, guys, is that usually, you see uptick in gross margins in 2Q versus 1Q, let's just say, sequentially. But this 2Q, you guys really came to on the gross margin side, they really kind of went up a lot. What's playing out there outside of just the normal stuff that you typically do?

Yes, it's a little unusual, Harsh. I mean, Q2 was favorable. Keep in mind that our capacity utilization was pretty high in Q2, maybe higher than normalized. We're building inventory in anticipation of a strong second half. So, our capacity utilization was pretty good, maybe a little higher than normal seasonal Q2. I think that's--

There were some one-time items in Q2, but we still would have been above the midpoint of the guidance.

We had two one-time items about 80 basis points in total. So, you can take that 39.3, on a normalized basis 38.5. But to Jeff's point, that was still above the midpoint.

Hey, congratulations guys. I'll get back in line here.

Thanks Harsh.

Your next question comes from Tristan Gerra with Baird. Your line is open.

Hi, good afternoon. So, trying to get a sense of the contribution from the higher ASP stuff. So, you reiterated the assumption that IoT would be about 20% of microphone, assuming revenue for this year. Any sense if where that number could go for next year? And also, is the DSP-based stuff really ramping next year? I'm assuming with your ramping in China this year is more of the noise cancellation type of stuff. And what potential contribution could we see from the DSP-based stuff next year and what type of application the volume is going to be? Is that smart speakers or is that smartphone as well?

Yes. So, we think that, second question first, which is more around the intelligent audio, I think we said in the last call, we're reiterating in this call that intelligent audio will contribute 2% to 4% growth over the finish of this year in terms of beyond the core. We still feel very comfortable at that number, Tristan. And what I think we're pretty excited about, it is pretty broad-based when we think about 2019 across Mobile, Ear, and IoT. Now, there are some nuances here. Some people are more interested in SmartMics; others are more interested in the multi-core DSP. We are not expecting a lot of multi-core DSP shipment this year. It will be primarily coming in 2019. As far as 2019 for IoT, I don't think we're in a position yet to really call out the exact number in terms of percentage of sales. But here's what I would say, I don't think there is any reason why in North America we still shouldn't see growth in the IoT market. It probably won't be as fast it has been in previous years as more and more of these devices start coming out. Now, what I would say is, is there is a tremendous amount of activity in China around IoT devices, and that could be a real nice growth driver for us in 2019. And on top of that, when you think about 2019, there will be more than just mics; it will be SmartMics and potentially multi-core DSP.

Great. That helps a lot. And then utilization rates, should we assume that they peak in Q3 as opposed to Q4? And have you said what the percentage would be in Q3? I'm assuming in the 90s?

Yes, that's right, Tristan. I mean, we kind of have been running in the first half of this year, as I mentioned, a little higher than normal, maybe just a touch above 90% in the first half of this year. We expect to be close to full capacity in the second half of the year, call it, 95%. You always have to have a touch of a buffer. But--

Great. Very useful. Thank you.

Thank you, Tristan.

Your next question comes from the line of Jaeson Schmidt with Lake Street Capital. Your line is open.

Hey guys. Thanks for taking my questions. Jeff, wondering if you can comment where you think the average number of mics are for handset in China today and where we could see that going by the end of 2019?

I don't know if I have for China specifically. But the overall market in the handset space, we think it's now approaching two on average per phone. And I guess what I would say is, is not having looked at this in detail, but I think there's no reason why we shouldn't be able to grow this another 5% just on multi-mic adoption coming in into 2019. But I would add just one other thing to this when I think about -- start thinking about the intelligent audio is helping drive multi-mic adoption, because a lot of the things that we're doing with the SmartMic, we need more microphones in order to optimize these new -- performance of these applications. So, what I'm hoping is we're going to play a more active role in helping to drive that multi-mic adoption in the future in the handset space.

Okay. And then you mentioned that Samsung was down year-over-year in Q2. How should we think about revenue ramping at that OEM in the second half?

Well, I think there's going to be some normal seasonality in this -- in their business, which usually means, sequentially, it will be up from the front half to the back half. But I think we're in. We talk about 9% growth; we're still expecting this customer to be down year-over-year for the full year. We're expecting them to be down for the full year.

Okay. Thanks a lot.

Your next question comes from Christopher Rolland with Susquehanna International Group. Your line is open.

Hey guys. Solid quarter. Congrats. I wanted to talk a little bit about capacitors. Seems like that was pretty decent for you. While I was in Asia, I heard stories of 300% and 400% price increases. This is mostly for commodity capacitors. I know you guys don't play there; you guys are far more high end. But maybe talk about that market, whether there's some unexploited pricing power there and your market position and what we could see there going forward. I think you alluded to some positive trends for the rest of the year too.

Yes. So, first of all, it's been driven across a number of the markets. But for sure, we're seeing in defense and industrial very strong and I think we're going to see that continuing. Here is what I'd say, with some of these guys; these are larger, longer term customers. We have longer term contracts with a lot of these guys. And so I'm sure there will be opportunities toward -- at the end of these contracts. But I -- it's not -- like you said, it's not the commodity market where we're pricing these day-to-day. I mean, we have, in some of the cases I know on the defense side, in the medical side, we have two, three-year, four-year contracts with these people. So, I don't think that we're going to be able to see, I would say, a tremendous amount of pricing. It's mainly growth in the market. I would add one other thing is -- I mean, the numbers are quite high year-over-year. I think we're up about 40% in Q2 year-over-year. About two-thirds of it, I want to say, is coming from organic. About one-third is coming from the acquisition that was done in -- earlier in the year. And I just would say, we're not expecting as we think about 2019 that this kind of growth rate is sustainable on an organic basis. Our goal is to grow this at a greater than 5% number ex any acquisition that we do. But the market has been extremely strong for us this year.

Yes, very helpful. And then, CapEx, just timing of new capacity, I think you alluded to some -- supporting some MEMS wafer production. And then what kind of capacity are you looking for this year in 2019 before, how much -- and beyond? How much revenue can you support with this?

Yes, Chris, I'll start with, we've invested -- if you look at the Q, we've invested about $50 million in the first half of this year and that's primarily to increase capacity in MEMS for test and assembly, also MEMS wafer capacity expansion. And then we have made some capacity adds in our capacitor business. The MEMS and test assembly; that comes on fairly quick. We'll have that in place kind of back -- some of it is in place today, and we'll continue to ramp up in the back half of -- to support business in the back half of this year. The wafer capacity, that's really for 2019 and beyond. And that's -- of our full year CapEx this year, which we expect to be right around 9% to 10% of revenues, about $20 million of that is related to wafer capacity for 2019 and beyond.

So, let me just comment on what kind of capacity like our revenue we're trying to support. It really is mix-dependent. We sell now microphones, which are SmartMics that are selling in the upper -- near $1, and then we're selling analog mics that are sub-$0.20. And so the only thing I would just say is when I think about this, it's entirely mix independent. There is a lot of talk in the marketplace from independent places or independent companies about what the kind of growth could be in the MEMS microphone market over the next couple of years. We're planning to support that. With 50%-plus share, we want to be -- participate in that. So, we're pretty optimistic going in 2019. But there is -- this is MEMS wafer capacity that we're putting in place for 2019, which is a kind of a one-time thing that we'll go back down to our normal range of about 6% to 8% of revenue in 2019.

Exactly, 6% to 8% is kind of our revenues for 2019 and beyond. That wafer capacity is kind of periodic, I'll call it. Every four to five years, we've got to put some step increases in MEMS wafers.

Thanks for the color guys and congrats.

Thanks.

Your next question comes from the line of Gary Mobley with Benchmark. Your line is open.

Hi guys. Thanks for taking my questions. Congrats on a strong start to the year. Jeff, I wanted to go do some numbers with you on the intelligent audio. You mentioned perhaps adding 300 basis points to 2019 revenue; presumably that's $25 million. And if I'm not mistaken, the ASPs on intelligent audio solution could be, what, roughly $1.25. So, we're talking 20 million units. First of all, am I doing the right math there? And then, of those 20 million units, if I'm doing the right math, how much of that is greenfield opportunities versus long-time customers and long-time platforms upgrading to these intelligent audio solutions?

Let me answer the second question first. Most -- almost every customer I can think of that we're talking to is somebody we do business with already that we sell mics to. So, it's talking to them about how we can add features or improve the performance through the implementation of the signal processing and the algorithms with the microphone. So, these are our existing customers. The second question you asked more about -- I think it's a little bit -- sorry, a little more complex than just taking the number for the SmartMics. I think you also have to realize that we're expecting to sell the multi-core DSP next year as well. And the ASPs of that are north of $3. So, there's going to be a mix here. And again, we're saying 2% to 4% over what this year is -- and there will be sales of intelligent audio here, albeit it's not going to be a huge number, but there will be sales this year. So, I think it's a little too early to talk about what the mix is going to be between SmartMic and multi-core DSP to kind of like really cone in on like how many units we're going to ship. But the pipeline is pretty full. And it's across Ear, IoT, and Mobile. It's pretty full. With -- we're starting with Mobile this quarter. We started shipping to Vivo and OPPO as well as we started shipping to the Bay Area customers, which we've referred to for IoT.

Okay. Just had a follow-up question about China. The China supply chain has been known as hot and cold. You've experienced that all too well. And so I'm just curious to get your opinion on inventory issues, whether or not there may be getting a little too hot as we progress through the balance of 2018 and whether that sets up the first half of 2019 as maybe some inventory depletion period.

Well -- I mean, that's a good -- I mean, I think we monitor that. We have extended our lead-times out because of demand in China. And we have firm orders already through end of Q3 for almost all of our customers in China. And I was asked the question of what you think about Q4. I think this is something to think about. But I would say that a lot of what we're seeing here is not really growth in the volume of China. Its share gains, it is adoption of higher ASP microphones or higher-performance microphones, both standard mics, analog, digital and SmartMics as well as multi-mic adoption. So, when we think about this, I'm not sure we're seeing a lot of this being anything macro in China where they're like ordering so much more than they were last year in terms of -- because they're billing so much more. It's just more our position in the market is quite good.

Thank you for that. That's it for me.

Your next question comes from the line of Bill Peterson with JP Morgan. Your line is open.

Hi, thanks for taking my questions. And good job on the quarter and the guide. I have a few questions. First in Precision Devices, it's somewhat of a near-term question as well as long term. But the near-term one, if you -- I think if you say that 25% year-on-year growth, that kind of assumes you're actually looking at it early sequentially down or flattish. And I'm wondering what's behind that, what's driving that. And then the longer term part of the question is somewhat related to the ASP question. But if you -- assuming you do have a lot of these long-term contracts, would you assume there should be an upward bias on this? Or in your answer earlier when you talk about at least 5% growth, I would assume that it would really try -- really kind of settle into a normal growth environment. But I'd love to get your thoughts on that. Thank you.

I mean I would hope, if the demand continues the way it is, there would be some upward bias on pricing. I mean, I would hope that, I mean. But again, we're not dealing with the pricing like every single day. We're pricing these -- these are long-term contracts with these guys. But yes, I would hope there should be some opportunity on the long-term basis. As far as the growth, let's be clear, in Q2, we had 40% growth. About 25% of it came from organically. 15% came from the acquisition that we did in Q1. As I'm trying to look at the numbers for Q3, I think we have some pretty healthy growth in Q3. I'm looking here -- right here --

The guide that I gave, Bill, was pretty flat sequentially in Precision Devices off a really strong Q2.

Yes.

Okay. That's helpful.

There could be some potential upside. But right now, we're kind of looking at this as flat sequentially, given the strength that we had in Q2.

Okay. One follow-up on Precision, then I have a question on intelligent audio. But are -- is any of your CapEx that you've discussed going towards this? Or are you starting to see stressed lead-times in these capacitor businesses? Or are you able to fulfill orders steadily as you go, it's based off the type of market segments?

I think now what we think is -- yes, we think our lead-times are lower than a lot of our competition at this point. We have some specific product categories where we are struggling with capacity installing it. But as far as CapEx, I'm looking at the numbers for this year, I would say roughly about 10% of the total capital spend this year will be put into the capacitor business focused highly on expanding capacity.

And that's a lot higher than we have had historically in this business.

Yes, a lot higher.

If you go back to 2017, we probably spent half--

But when you see these types of growth rates, which we have had in the past, we've always talked about this, is the GDP growth business in the pad. Well, that's changing with the dynamics of the products we're introducing coupled with the markets. And so we probably will be starting to put a little bit more CapEx on a regular basis mainly for capacity expansion.

And these kind of bolt-on acquisitions also increase our capacity as well.

Okay, great. Just coming back and there's been a lot of questions on intelligent audio. Mine is kind of more of a high-level strategic. You had these sort of two historic customers that are obviously really important, OPPO and Vivo. Is your -- is it your ambition to really proliferate that, let's say, well beyond to capture a significant portion of additional customers? Or I believe long-term, you've talked about -- you see this kind of more aggregating more to IoT and Ear. I'm just curious of where you're spending your resources and maybe also what -- in terms of the customer pool, where is the most interest coming from at this stage?

Yes, so that's a topic that we discuss like weekly here, because we do have a lot of opportunities. What I would just sit there and say is we still have a fair amount of opportunities in Mobile. I think we're a little bit surprised at the level of interest we're getting across a number of customers in the Mobile space for this product. But I also think that when we look at Mobile, when -- and we think about that $1 billion-plus TAM as we go out three years from now, we think IoT and Ear are going to be a significant portion of that TAM. I think we always are nervous about in the mobile areas is could this be integrated someplace else. And so we're really -- we'll continue to pursue Mobile. But I think longer term; we think Ear and IoT are going to be great opportunities both for mics, but also for intelligent audio.

Okay, great. Thanks and congrats again guys.

Thanks Bill.

Thanks Bill.

Your next question comes from the line of Harsh Kumar with Piper Jaffray. Your line is open.

Yes, hey. Thank you. Just one simple question. You sort of gave an implied full year guidance all the way through December based on the organic sort of apples-to-apples number. And if you back into it, you're effectively -- I guess, we can back into it. But my question really is that in the fourth quarter, should we be expecting the Audio business to be effectively flattish? In other words, how do you see your Audio business trending in the fourth quarter on a sequential basis? There has only been one other company that's reported in the cell phone space and they're talking up for the largest customer here in U.S.

Yes. I mean, I think -- again -- I think you're pretty accurate, what you said, is you guys can like back into this number from what we said about that 9%. I think I made a comment with our large customer; the peak we do think will be in Q3. But there are some other things going on relative to other customers. So, I think I can get back pretty easily into the numbers. We gave you -- for three quarters, we said 9%, and I think you back right into the number.

That's fair. Thanks guys. Thank you. Congrats again.

Thank you.

There are no further questions at this time. I would now turn the call back over to Mike Knapp.

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

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