Good afternoon and welcome to the Knowles Corporation Third Quarter 2019 Financial Results Conference Call. [Operator Instructions]. Here with opening remarks is Knowles' Vice President of Investor Relations, Mike Knapp. Please go ahead.

Thanks, Christine, and welcome to our Q3 2019 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 sales, expenses and profits, and involve the 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, 2018; 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 call can be found in our press release, posted on our website, at Knowles.com, including 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 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. In Q3 we continued to make solid progress against our strategy to deliver high value, differentiated solutions to a diverse set of growing end markets. For the quarter, we reported revenue of $236 million, above the midpoint of our guidance range, and flat from the year-ago period as strong sales into the ear and IoT markets, and solid demand for precision devices were offset by continued soft trends in mobile. EPS of $0.38 was in line with our expectations. In our audio segment, Q3 revenue was down 3% from the year-ago period due to softer demand for high-end handsets in China that leverage our MEMS microphones and intelligent audio solutions, largely offset by record sales of microphones and increasing shipments of balanced armature speakers into the ear and IoT markets. In the precision device segment, sales were up 13% from the year-ago period due to continued demand for our differentiated products across multiple end markets and a tuck-in acquisition. Q3 sales in audio continues to highlight the benefit of our diversified portfolio of solutions for the mobile, ear, and IoT markets. In mobile, worldwide shipments of smartphones served as a headwind for our audio business in Q3. DiDi now estimates the smartphone shipments in North America will be down 5% in 2019 versus the prior year and down 9% in China. We see these downward trends to be even more pronounced for high-end smartphones. That said, at our largest customer we experienced stable mobile trends in Q3 and are seeing year-over-year growth in this OEM's non-mobile platforms. Though this OEM's mobile business is expected to be down year-over-year we anticipate full-year revenue growth from this customer in 2019 given our increasing sales to their ear, IoT and computing…

Thanks, Jeff. We reported third quarter revenues of $236 million, above the midpoint of our guidance range and flat from the year-ago period. Record microphone shipments in the ear and IoT markets and continued growth in precision devices was offset by lower shipments of microphone and intelligent audio solutions into the smartphone market. Audio revenues of $194 million were down 3% from the year-ago period, due to weaker demand for high-end smartphones in China that use our MEMS microphones and intelligent audio solutions. These declines were largely offset by increased shipments of microphones and balanced armature speakers into the ear and IoT markets. Hearing health sales were up slightly from the year-ago period. The precision device segment delivered revenues of $42 million, up 13% from the third quarter of 2018 which was the result of 8% organic growth driven by strong demand for high performance capacitors in the defense and med tech end markets, and an acquisition completed early in the first quarter of 2019. Third quarter gross profit margins were 40.1%, within our guidance range and up 170 basis points from the year-ago period, driven by favorable product mix within audio, specifically higher microphone sales to the ear and IoT markets. Precision device segment margins were flat year-over-year as improved pricing on high-performance capacitors was offset by higher raw material costs and increased manufacturing capacity to support future growth in our mmWave filtering solutions. Operating expenses in the quarter were $51 million, down 2% from the year-ago period due to reductions in R&D spending within the audio segment. For the quarter, adjusted EBIT margin was 19%, at the midpoint of our guidance range, up 250 basis points from the year-ago period on higher gross profit margins and reduced operating expense. EPS was $0.38, at the midpoint of our guidance…

Thanks, John. Our Q3 results and our Q4 guidance reaffirms our strategy to invest in high value, differentiated solutions and diversify our end markets to deliver shareholder value. I'm pleased with the continued progress we've made to increase our exposure to growth markets like ear, IoT, 5G infrastructure and edge processing. We expect that revenues from non-mobile markets will represent over 70% of our total company revenue in 2019, growing at greater than 10% from the prior year with above corporate average gross margins. For 2019 we expect our full-year company revenue to increase by approximately 4% and EPS to increase by 12%. As we look towards 2020, our company remains uniquely positioned across the markets we serve. In audio, macro trends around better acoustic performance and edge processing remain positive and are enabling us to increase our content per device. In precision devices, we continue to deliver strong revenue and earnings growth, both organically and through tuck-in acquisitions. With our strong positions in core markets, coupled with the investments we are making in growth products, I am increasingly confident that we can drive continued revenue growth with strong operating leverage in 2020. Operator, we can now take questions.

[Operator Instructions]. Your first question comes from the line of Sujeeva Desilva from Roth Capital.

Just a couple of questions on the end markets. Do you still expect in the ear and IoT part of the business that IoT would be stable relatively, and ear would be the growth driver? Is that still the expectation?

Yes, good question. I would say generally speaking, I think IoT will still be up but nowhere near the rate of ear this year. You know, that's kind of been flipping and flopping from year-to-year. I would just make the comment, I think we've talked about this in past calls, that in 2016, the year when IoT revenue in our mic business was about 7% of the revenue in mics. This year, it's going to come in over 30% of the revenue this year, we'll actually -- in mics will be in ear and IoT. Yes, I would say the majority of growth is coming from ear but there still is growth in IoT.

Okay. And then congratulations on the win at Amazon. The wins, content-wise. Should we think the content you described for Amazon there is a typical headset going forward? Is that a premium headset? How can we compare the Amazon content to what may be the typical true wireless headset content for you guys?

Yes. I mean, I think that's a little bit of a tougher question to answer entirely, to this day, so let me just take it in pieces. I would say on the balanced armature side, I would say this is probably premium. Two balanced armatures per ear, we're probably talking premium. On the microphones, when you have three per ear, I would say it's premium today. But I think if you look at the design pipeline and what people are talking about, having three microphones per ear is probably going to become pretty standard in the longer term. And that's -- you know, mainly the third mic is being added inside the ear for active noise cancellation. With the two microphones on the outside, primarily to improve voice communication, improve anything you're doing in terms of with voice recognition.

Okay. And then one quick question on the IA. I didn't hear if there was an update on the 20 million, 25 million expectation for '19 [indiscernible] still the range you're expecting?

Yes. I would say it's going to be tough for us to get to the low end of that range, but with that said, we're pretty excited about the products, the handsets, that were introduced in the last week that are using our quad-core DSP. I think this is like, a pretty important moment for us from the perspective of all the things that you can do with our quad-core DSP. Some of it's audio and actually now some of it's non-audio. So we're pretty excited about this opportunity and we're pretty excited about 2020.

Your next question comes from the line of Christopher Rolland from Susquehanna. Your line is open.

To the balanced armature speaker market, perhaps you can talk about what those revenues were in 3Q and your expectation for 4Q. Also perhaps if you can discuss, I know you said you'd talk about them when they were released. But just generally what that pipeline looks like for you guys, and how it sizes up to that roughly I guess, call it $90 million extra ear opportunity that you guys highlighted in your analyst day? Thanks so much.

Yes. So let me start by just breaking out. We have a pretty robust balanced armature business overall to begin with and that's divided up between our hearing health market, which you know, we do very well in, and then there's balanced armature, what I would call to the premium -- the really premium headphone market. You know, the guys that are in the $300, $400, $500 range. That's a pretty robust business for us. Now, as we start talking about the true wireless opportunity, as I said in the past, if you look at these true wireless headsets, they are looking more and more like a hearing aid. I mean, they are looking more and more like that. Now that being said, we are kind of limited in terms of I would say the capacity now and probably until into mid -- into late Q2 is when all that capacity will be going online. And that's when we would really expect to see the revenue from balanced armature in the true wireless market, start to accelerate. So we're not going to break out the exact number at this moment for true wireless. It's relatively small. I'm not going to say it's very large. But what I would say is we have a lot of interest. We have a lot of customers are interested in moving forward. And I think we're preparing for the back half of next year is when we really see the growth is going to come.

Great. Thank you for that. And then on precision devices, was it maybe a tad bit softer than I expected? I think you guys talked about pricing on high performance capacitors there. Obviously the MLCC market has moved through a super bubble, obviously lower end products there. But maybe pricing starting to firm there. Is this just a lag there on this side? Do you expect any more changes in pricing? And then within precision devices, I don't know if you said it or not. Your 5G filters. What's the timing on when you might ship your first? Thank you.

So first, let me take the first question. I would say it was a little softer than we expected going into the quarter, and as I kind of said in my script, the industrial market -- we have seen a little bit of a slowdown. But that, with that being said, we still had, I want to say it was a 13% growth overall year-over-year. So not too shabby still. So we were expecting a little bit more. As I looked at Q4, I think it's a little bit better than what we had in Q3 in terms of the year-over-year growth as well as it's a pretty good step up in terms of sequential as well. So I would say that we're seeing some weakness in industrial and that's -- I would say that general marketplace that you kind of referred to. But still, when I say weakness, this is not like it's down significantly. It's still growing, just modestly versus it was growing pretty quickly in the past. Now you asked, your second question was related to the 5G mmWave base stations. We are already shipping into 5G mmWave base stations for production units. So we started shipping for that. And we expect that will continue. I think what we've kind of said, and we'll continue to say this, is the military demand continues to be very strong in this space. And the design activity around the 5G mmWave base stations still is strong. Although I think we're seeing a small push-out to the right in terms of the actual demand for the 5 mmWave base stations. But we are shipping into production units right now.

Your next question comes from the line of Anthony Stoss from Craig Hallum.

Two-part question. If you were to strip away just the IoT and ear segment, what kind of growth rate do you think you could see in 2020 or even in the immediate term? And then now that iFixit has got the Google Pixel 4 teardown showing your DSP, love to hear your thoughts. And I know, Jeff, you mention you've got design traction for 2020. Can you quantify that at all? Thanks.

Yes. So let me take the first question. I'm not really sure I understand the first question. Are you asking me about the mobile market for microphones versus the ear and IoT for microphones? Is that what you're asking me about?

Non-mobile ear and IoT.

Non-mobile ear and IoT, we would expect to grow again in 2020. I would say what's changed is, I'm cautiously optimistic about the mobile market. I mean, it's been a pretty big headwind for us for the full year 2019, from the perspective, you know, we know what happened at the largest customer earlier in the year. There's been weakness, a fair amount of weakness in China. But I think what we're starting to see is that as 5G starts to roll out in a bigger way next year, there's some 5G this year but realistically it's more next year. Even if we can get this, which we're hopeful of, to a flat market year-over-year, it no longer becomes a headwind to our business. And that's why I think we highlighted, Tony, is that about -- we have over 70% of our business is non-mobile now. And that 30% was a headwind in 2019. But we think it could be flattish in 2020, which would be really great for us to see that part being flat. Second question you asked me about the quad-core DSP, let me just make a couple more comments on this. You know, just generally speaking. We're pretty excited about this and I want to just kind of lay this out for a moment. It just may take a moment, Tony. But think about what they're doing with this device. First, where you need real time processing, like actually like, no latency in processing, where you need the device to be always-on, right. And then there's a combination of what I would call pre-processing before it goes -- keeping the AP off before it -- the AP or the application processor gets turned on. But there's also pieces where the full application is running on our chip now. And so let me give you a couple applications. One you've heard of, is the keyword detection. You've heard of that. That's running on this device. Another one is like, echo cancellation and barge-in, running on this device. So if you have music on, and you want to barge into the device, it can do that, right. The third thing which is kind of interesting is there are other sensors in this platform that need real-time -- need always-on power that are now being processed through our device as well. And this just has to do with the gesture recognition. So what you're starting to see is, is that customers are starting to say to themselves is, yes, audio has to be real-time. Yes, audio has to be always-on. But there's other sensors that need it to, and this device is pretty valuable for this device. As far as the design pipeline, we're working really, really hard here, Tony, for next year to continue this momentum we're having in the back half of the year on the design side. And I think that's kind of where I'd leave it for right now.

Can I follow up on that? Is there any quantification on the amount you're saving the device maker from handling everything in the handset itself versus hitting the cloud? Is there a cost savings, have you quantified any of that and do they recognize that?

Yes. I think that's pretty hard to quantify. I think there's a couple things. I would say that that's kind of like I think a secondary from their perspective. They see the cloud as not being taxed as much. I think they're focused on this idea of real-time processing with no latency, having multiple sensors including microphones being one of them on all the time for contextual awareness and do a lot of different things. And then the third is, is that ultimately, I think you look at this, the real thought players, they want to have more things done locally from the perspective also of privacy.

Your next question comes from the line of Bob Labick from CJS Securities.

Just wanted to stick with BA for a minute here. Can you talk about your current manufacturing, and given the growth in ear that's just starting and the nice win with the Echo Buds and others? How are you managing the inventory for BA and towards the -- with this growth and the path towards the automation which I think you expect in the first half of next year, to have a new automated line. Just talk about the process of the inventory management and the expected growth for this category.

Sure. So I wouldn't expect in the short term that we'd have a significantly a lot more inventory to do this. I would say it's probably the opposite here is, if demand increases, we're trying to balance the demands that are out there against the fact that we don't really want to have to add a lot more manual assembly in order to do this knowing just at least that the automation is coming online. I was -- I viewed the automation this week. It's on track to be ready in the first half. And we're excited to get that installed because I think one thing that has come out of this, these Echo Buds for us, is it's getting a lot of, I would say, second-tier players to say hmm, this is kind of interesting. When can we start having more discussions? And so I think there's going to be a real balance here in the next six months of design wins and revenue relative to the fact that we don't really have the capacity in place to handle this yet until the back half of the year.

One thing to add, Bob, too, is as Jeff said, we'll have that first automated line in place at some point in Q2, and if we see demand increasing here, we'll kind of pull things forward on a second line and we could have that probably in place back late 2020.

Let me temper that. Let me temper that, though. Just saying is that the issue -- I'm just a little bit -- I want to make sure is, is that this is a brand-new design for our balanced armature, a brand-new production process. We've got to make sure it all works properly before we would order the second line.

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

Great job once again managing expectations and earnings in a tough environment. Jeff, I had one for you. I look at your guidance for the audio business. Compared to September numbers you're basically calling for flattish kind of trends. I know that we're going into the Christmas builds and then we have Chinese New Year a little bit early this year. I believe it's January 25. So I expect kind of like a double dive, if you will, in consumer stuff including handsets. How do I think of your guidance for December audio business versus the Chinese New Year being sort of earlier this year, on top of Christmas?

So I'm kind of looking at the numbers here. You know what I mean, we usually have seen a dip in Q4 versus Q3. Because of that large customer that has that big ramp and it kind of tempers in the third. I would say kind of look at the numbers. If I look at last year, we had a pretty large, sequential down in Q4 last year. And this year. And you know, and again, I would say is, ear and IoT are a much larger portion of the business than they were a year ago. And to the extent that that's the case, we're not seeing as much of this downward trend in Q4. Now, I think that you're starting to now move into Q1 and I'm not -- I can't -- it's really hard for me to give you a lot of guidance into Q1. But I will say this. We usually have a pretty strong build through Chinese New Year and then we have a drop off and then we see how it resumes at the end of Q1. I guess all I would say is, is that it's a little early. My biggest concern right now is in terms of you want to talk about the audio business overall. China has been weak overall. I mean, I said that in the call, that -- or in the remarks. It has been weak. And so I think we want to see how this goes up to Chinese New Year, but then I would say that's my one concern. Just overall, China's been weak, especially high-end handsets.

Can for my follow-up, I know you probably have seen the initial order runs or order book for the Amazon headset. Have you gotten an indication of how they're thinking about ramping that -- that particular piece? Or they want to evaluate how things go through Christmas and then come back to you guys?

I'm going to punt on that. I mean, I think you know, that -- you know, now we're talking about really specifically about a customer's product, and I think it's pretty confidential at this point, Harsh. I just really can't comment on that.

Your next question comes from the line of Charlie Anderson from Dougherty.

The first one on BA, obviously a really strong product for your strong product cycle here and you do get the added volume next year with the automated line. I guess I'm curious, if you could maybe just speak to some of the competitive differentiation long-term. Do you expect to hold very high market share here? Do you have some -- in terms of whether manufacturing process or IP, kind of a moat. Do you expect stacking sources at some point, just any additional color there? And then I've got a follow-up.

I think it's a little too early to say. I mean, there is, we do have some competition in the hearing aid side today. And I think that there's no reason why that competition would be into this market if we develop it. But I also do think, is you know, we are pioneering this market. And the moat that we're building around this market is very different than the building we have in the hearing health side. The hearing health side generally speaking is a lower volume, high-mix business. And this is going to be what we think is going to be a higher volume, lower mix business. And that's why we decided we wanted to go after this market. We said, we're going to redesign these products specifically for this higher volume market. And so what does that do? It allows us, number one -- and there is IP around this -- it allows us, number one, to ramp it faster when we want to. It allows it to have less labor in order to do it. It targets a much more, I would say, aggressive cost structure than we typically have had in the hearing health side. So I think we're building a competitive moat for the commercial market, or the true wireless market, similar to what we have on the hearing health side, but with, quite frankly, similar technology but a different set of products.

Perfect. And then for my follow-up, on the precision devices, gross margin, I think there was a reference in the script to a few elevated costs there. I think one was putting in capacity, the other was maybe higher raw materials or something like that. I wonder if you maybe just kind of speak to the outlook for the next year or so, and [indiscernible] gross margin.

I'm going to let John -- all right. I'm going to let John speak.

Yes, Charlie, PD gross margins were -- they were lower than expected in Q3 and they were flat with Q3 of 2018 levels. It was really due to a little lower than anticipated production volume, so we had unfavorable fixed overhead absorption due to softening industrial end market. We also had some manufacturing inefficiencies at one of our facilities. We expect these manufacturing issues to be fully addressed early in the current quarter and expect a sequential improvement, pretty significant improvement in gross margins at PD in Q4. So I would kind of call this a one time in Q3 impact.

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

Hi. This is Alex Kim dialing on behalf of Bill Peterson. I want to ask about CapEx first. So last quarter you mentioned CapEx would be about 6% to 7% of revenue and 20% of that CapEx was going to your balanced armature business. Are you sticking to that 20% number, and do you anticipate that number going up potentially to more quickly ramp BAs and to also address potential supply issues to meet the demand for BAs? And also how should we think about CapEx for 2020 and the breakdown between microphones and balanced armatures?

Yes, in terms of the first question, I'd say that assumptions are still valid, what I provided earlier. We may be a little below 6% as a total company in 2019, but that amount related to the balanced armature business is unchanged at this point. It's a little early to give guidance for 2020 but I would expect as a percent of revenue, to be kind of very similar range in 2020 versus 2019, kind of around this 6% or so. But we'll provide more guidance later.

Okay, thank you. And also, how should we think about OpEx for 2020, the trajectory?

You know, in terms of OpEx it's too early to go into 2020. But if you look at what our trend has been in OpEx over the last I'll call it three years, we've been pretty good at holding OpEx very -- to very, very modest increases, and as a result with revenue growth in the 4% to 5%, or 3% to 4% this year, higher than that last year, we've gotten very good operating leverage. I would expect the same trends to continue moving forward.

I think what we generally said is, is that we're really trying to control SG&A on the R&D side. We've tried, said we're going to keep that in the 11% range of sales. I still think those things hold. That's what we've been kind of trying to do over the last two years.

One thing I think is important just to give a little granularity, in Q3 and Q4 of this year, we did have increased legal spend. If you take that, relating to a specific IP dispute that we're pursuing, if you take that out our year-over-year SG&A is flat if not slightly down year-over-year.

Okay. And just to clarify, you said R&D 11% of sales, and then SG&A being flat if you take legal spend?

R&D a little less than that. We originally early in the year, we're estimating 11%. It's coming down closer to 10% as we optimize R&D spending in the audio segment.

Okay. And then SG&A flat if you take out the legal spend?

Correct.

There are no further questions at this time. Mr. Mike Knapp, I turn the call back over to you.

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.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.