Knowles Corp

NYSE:KN

Earnings Call Transcript 2018-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Knowles Corporation Fourth Quarter and Year-End 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]. Thank you.

With that said, here with opening remarks is Knowles' Vice President of Investor Relations, Mike Knapp. Please go ahead.

[Michael Knapp, Vice President of Investor Relations]

Great. Thanks, Simon. And welcome to our Q4 and year-end 2018 earnings call. I'm Mike Knapp. And presenting with me on 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 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 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 financial references on this call will be on a non-GAAP continuing operations basis unless otherwise indicated.

It's important to note that the fourth quarter of 2017 included a royalty settlement related to a license agreement that increased revenue in the quarter by $11 million and reduced operating expenses by $6 million. Comparisons to the fourth quarter of 2017 amounts have been adjusted to exclude the impact of this settlement.

Also, we've made selected financial information available in webcast slides which can be found in the IR section of our website.

With that, let me turn the call over to Jeff who will provide some details on our results. Jeff?

[Jeffrey Niew, President and Chief Executive Officer]

Thanks, Mike. And thanks to all of you for joining us today. For Q4, we reported revenue of $224 million, up 10% from the year-ago period, and earnings per share of $0.37 which was at the high end of the guidance we provided last quarter.

For full-year 2018, we were pleased to deliver 11% top line growth with strong operating leverage, ahead of the expectations we had in the beginning of the year and well above the growth rates we saw in most of the end markets we serve.

Migrating our product portfolio to higher value solutions has enabled us to increase our content per device and capitalize on the positive macro trends around audio and edge processing across Mobile, Ear and IoT applications.

We also saw robust demand for our Precision Device solutions. Sales grew across every Knowles business unit in 2018, which highlights our successful efforts to increase exposure to growth markets and diversify our product portfolio.

In our Audio segment, Q4 revenue was up 5% from the year-ago period. Sales to Chinese OEMs more than doubled year-over-year in Q4 on greater dollar content from MEMS mics and Intelligent Audio solutions. Sales into Hearing Health were also higher than the year-ago period.

Overall, revenue from Audio comprised 83% of total sales in the fourth quarter.

In the Precision Device segment, sales were up 35% from the year-ago period, hitting record levels for the fourth consecutive quarter due to demand for our differentiated products across multiple end markets and a tuck-in acquisition.

Precision Devices represented about 17% of total company revenue in the quarter.

In 2018, our Audio segment capitalized on the trends that we have been discussing over the past 12 months – improved audio input performance and processing being moved to the edge of the network driving more microphones per device, adoption of higher performance mics, and implementation of new Intelligent Audio solutions.

In addition to these trends, our continued focus on ear and IoT markets resulted in solid MEMS microphone growth and stronger-than-anticipated demand for our Intelligent Audio solutions.

We were also pleased to see our Hearing Health business return to growth in 2018. In the mobile market, sales to Chinese OEMs reached all-time record levels, up 70% from 2017. This growth was driven by robust demand for higher performance microphones and new Intelligent Audio design wins ramping, which led to share gains and higher ASPs.

At our largest customer, we grew sales in 2018 from the prior year as we saw significant increases in microphone sales to non-handset products.

As we exited 2018, demand trends in mobile have been weaker than anticipated, and elevated smartphone inventory levels are expected to impact our results in the current quarter.

That said, I believe continued multi mic adoption and additional Intelligent Audio design wins will help us outgrow the mobile market in 2019.

Now, let me move on to the ear market. Our growth in ear for 2018 was driven by higher volumes of wireless headsets, the increasing number of microphones per headset and the implementation of higher performance microphones.

I continue to be very optimistic about the growth prospects in this market, given our long and successful history of solving challenges in hearing aids and our broad range of solutions including microphones, balanced armature speakers, smart mics and audio processors.

We see continued convergence in technology requirements between consumer headsets and hearing aid devices for high-performance audio solutions that are extremely low power with very small footprints.

We are uniquely positioned to address the needs of this market and see a potential of $10 of content per device as we focus on enabling feature-rich consumer products.

In the IoT market, we continue to see countless new product launches of voice-enabled devices. At CES last month, Amazon and Google voice assistants dominated discussions as the two companies battled to gain voice control of consumers' connected homes, appliances and cars.

Amazon recently announced that more than 100 million Alexa devices have been sold to-date.

In China, we are also benefiting from strong growth in ear and IoT demand. All of these devices need microphones and many highlight the important trend of processing being moved from the cloud to the edge of the network to improve data privacy, security, contextual awareness, latency and to reduce total cost.

Customers recognize that our audio solutions are optimized to deliver the best performance for these types of tasks, and this is resulting in strong design activity across all types of IoT devices for our microphones as well as our audio processors.

As expected, sales into the ear and IoT markets represented over 20% of total microphone sales in 2018, up from 6% in 2016.

We made a conscious effort over the past several years to diversify our microphone revenues, and in 2019 we expect this trend to continue with greater than 25% of our microphone sales to be into these markets.

Our Precision Devices business had an outstanding 2018 with record revenues and operating profits. Strong demand for our differentiated products across multiple end markets drove higher sales and a tuck-in acquisition supported both top and bottom line results.

The defense, industrial and automotive end markets provided a strong backdrop for us in 2018 and we continue to anticipate that our Precision Device solutions for electric vehicles and 5G will provide additional growth for us over the next several years.

With that, I'll turn it over to John to expand on our financial results and provide our guidance for the first quarter. John?

[John Anderson]

Thanks, Jeff. Before I provide commentary on our financial results for the fourth quarter of 2018, it's important to note the fourth quarter of 2017 included a royalty settlement related to a license agreement that increased revenue in the quarter by $11 million and reduced operating expenses by $6 million. My comparisons to fourth quarter 2017 amounts have been adjusted to exclude the impact of the settlement.

As Jeff mentioned, we reported fourth quarter revenues of $224 million, slightly below the midpoint of our guidance range and up 10% from the year-ago period, driven by increased shipments in both the Audio and Precision Device segments.

Audio revenues of $185 million were up 5% from the year-ago period, driven by higher revenues from Intelligent Audio solutions and increased shipments of MEMS microphones to the ear and IoT markets.

Sales of Hearing Health products also increased over the fourth quarter of 2017.

Precision Device revenues of $39 million were up more than 35% year-over-year as a result of 26% organic growth, driven by strong demand in defense, industrial and automotive end markets and an acquisition completed in the first quarter of 2018.

Fourth quarter gross margins were 42.6%, above the midpoint of our guidance range due to favorable product mix, settlement of a supplier warranty claim and factory productivity gains in the Precision Device segment.

Operating expenses in the quarter were $53 million, below the midpoint of our guidance range, but up $5 million from the year-ago period due to higher incentive compensation expense and increased R&D spending.

For the quarter, adjusted EBIT margin was 19%, above the midpoint of our guidance range and up 200 basis points from the fourth quarter of 2017, demonstrating our ability to deliver solid operating leverage on revenue growth.

Non-GAAP diluted EPS was $0.37, at the high end of our guidance range.

For full-year 2018, we delivered 11% revenue growth, 39.5% gross margins, 14.2% adjusted EBIT margins and EPS of $1.01.

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 $74 million at the end of 2018. For the fourth quarter, cash generated from operations was $59 million and capital spending was $22 million.

Bank debt was reduced by $32 million as we repaid borrowings outstanding under our revolving credit facility.

Moving to the first quarter of 2019, we expect total company revenue to be between $165 million and $185 million.

Revenue from the Audio segment is expected to be down 6% year-over-year related to a smartphone inventory correction and weak conditions in the handset market.

Precision Device revenue is expected to be up 18% over prior year levels, driven by continued strong organic growth across defense, industrial and automotive markets, and the impact of a capacitor acquisition which closed earlier in the quarter.

We expect the smartphone inventory correction to be largely completed by the end of the first quarter. We anticipate returning to revenue and earnings growth in the second quarter as we benefit from increased microphone sales into ear and IoT markets and expect continued strong demand for Precision Device products across most end markets.

Additionally, we expect total company revenue growth for full year 2019 driving operating margin improvement.

We project non-GAAP gross margin for the first quarter to be approximately 37% to 39%, 60 basis points better than the prior year due to favorable product mix, factory productivity gains and the impact of foreign currency.

R&D spending in Q1 is expected to be between $21 million and $25 million, flat compared to prior-year levels.

Selling and administrative expense is expected to be $27 million to $31 million, also consistent with prior-year levels.

We're projecting adjusted EBIT margin for the quarter to be in the range of 7% to 9% and expect non-GAAP diluted EPS to be within the range of $0.09 to $0.13 per share. This assumes weighted average shares outstanding during the quarter of 94 million on a fully diluted basis.

We are forecasting an effective non-GAAP tax rate of 13% to 17% for the quarter.

Please refer to our press release for a GAAP to non-GAAP reconciliation.

For the first quarter, we expect cash utilized in operations to be between $10 million and $20 million. Capital spending in the quarter is expected to be $20 million to $25 million. Full-year capital spending is expected to be between 6% and 8% of revenues.

I'll now turn the call back over to Jeff for closing remarks and then we'll move to the Q&A portion of the call. Jeff?

[Jeffrey Niew, President and Chief Executive Officer]

Thanks, John. For 2018, we drove 11% top line growth with every Knowles business unit contributing. This highlights our successful efforts to diversify revenue as we focus on growth markets like ear and IoT and we continue to invest in high-value solutions.

I want to thank all of our employees who contributed to this performance in the face of a challenging second half of the year in the smartphone market.

As we enter 2019, all of our businesses are well positioned. In Audio, the macro trends are on better performance and edge processing remains favorable, and are enabling us to expand our total available market and grow our business.

In Precision Devices, we continue to execute our playbook and drive strong revenue growth and operating margin improvement, both organically and through tuck-in acquisitions.

While our first quarter is being impacted by an inventory correction in smartphones, we expect this to largely be behind us by the end of the quarter and anticipate the company returning to year-over-year growth in Q2.

We will benefit from increasing sales into our ear and IoT markets, robust demand from Intelligent Audio solutions, growth in Hearing Health and Precision Devices, which I expect will enable us to grow the total company revenue with strong operating leverage in 2019.

Operator, we can now take questions.

[Operator]

Certainly. [Operator Instructions]. And your first question comes from the line of Charlie Anderson with Dougherty & Co. Your line is open.

[Charles Anderson, Dougherty & Co.]

Yeah. Thanks for taking my questions and congrats on a strong double-digit growth here in 2018. I want to start, Jeff, with maybe just if you can offer maybe a little bit more framework on 2019. You're calling for growth here. I wonder how much of that is coming off of IA? How much are we thinking Precision Devices contributes? And then, maybe any commentary too on the market share you're expecting in mics and some of the pricing trends you're seeing there? Thanks.

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. So, on previous calls, Charlie, we had kind of talked about that PD had a potential, we think, to grow at 5% to 10% per year. Based on where we are today, we think PD can probably get to the higher end of that range.

In our Hearing Health business, we had growth in 2018 and we are expecting growth again at the GDP type number for 2019.

In IA, we have said, for a couple of quarters in a row, that we expect 2% to 4% top line growth in 2019 from IA. And we think that forecast is still good.

So I think what that kind of leaves here is the microphone business. And there's no doubt that, if you look at Q1, there is an inventory correction in the end market, in the handset market. We think that will largely be behind us by the end of Q1. And we are getting increasingly more bullish in the microphone market about IoT and ear, and we think that will help us throughout the year.

So, overall, I think we see that we can have growth in 2019 despite us being just about flat in Q1.

[Charles Anderson, Dougherty & Co.]

Great. And then just as a follow-up, I wonder kind of what you're seeing real-time in terms of visibility, have the order patterns changed in the last few weeks compared to where they were five, six weeks ago? What's giving you some of that optimism going into Q2 that this is sort of the bottom here? Thanks.

[Jeffrey Niew, President and Chief Executive Officer]

Well, I would preface this, Charlie, that Chinese New Year is going on right now and we want to see what happens when we get back from Chinese New Year. But I think that there's still demand in the market for smartphones, albeit it's probably not as strong as people had expected. And that based on what we see going into Q2, we see that inventory largely being out, but we also see that, starting in Q2, that there is number of IoT and ear products that will be going to production.

We continue to see Precision Devices being strong and we actually are potentially thinking that, in Q2, we are also going to start to see a reasonably strong hearing aid market as well. So, I guess, the way I'd frame this is, even with a flat to slightly down mobile market for the full year, we still can see growth for the whole company.

[Charles Anderson, Dougherty & Co.]

Great. Thank you so much.

[Jeffrey Niew, President and Chief Executive Officer]

Thanks, Charlie.

[Operator]

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

[Harsh Kumar, Piper Jaffray]

Yeah. Hey, guys. Congratulations on managing your business well through these turbulent times and sort of positioning the company well with the future products.

Jeff, I had a question on your 1Q. Would you expect both your China – I'm sorry, 2Q beyond that. Would you expect both your China and your large customer to come back for you and start growing in 2Q or would it be just that you expect the IoT business to start ramping and maybe there are parts and pieces of the mobile business that come out?

[Jeffrey Niew, President and Chief Executive Officer]

Well, let me just start with one comment about China first. I think if you look at our Q1, we are still expecting China will be up still year-over-year in Q1. So, we'll start with that framework that there's a lot of good things going on across in China. We still have multi-mic adoption in the mobile market. We have Intelligent Audio opportunities. We have higher performance mics. And I think when a lot of people look at China, I think the other thing is, we have ear and IoT opportunities as well. So, forget about Q2 on China, we'll be growing year-over-year in Q1.

As far as our largest customer, I think the one thing I would kind of frame out is, if you think about for us in 2018 – and I mentioned this in the scripted remarks – we actually grew in our largest customer in 2018, but it wasn't on mobile. It was on all the other products.

And I think as we start going in – and I took a look at this, Harsh – when I look back over time, I think, you're starting to see that other products with this customer are starting to drive a fair amount of demand for us. So, I still think that, as we go into Q2 and the full year, we still have an opportunity to grow with that customer for the full year.

[Harsh Kumar, Piper Jaffray]

Understood. And thank you for the color. As my follow-up, Jeff, if I can ask you, you talked about little over 20% for IoT and ear exiting 2018. And I think you said something along the lines of 25% for 2019. Would I not think just looking at the trajectory of how things are going and where the world is going that that's a very achievable and sort of easy goal and that maybe we should expect a bigger number than 25%? Is that a good way to think about it?

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. I would say this with just one kind of thought process here is that we're still modeling out a flat to down market in mobile. But mobile still being one of our larger businesses, it's still relatively wide range. Here's what I'd say – I said it's greater than 25%. I don't know what the exact number is going to be, but I would say greater than 25%.

[Harsh Kumar, Piper Jaffray]

Got it. Thank you. Thank you, Jeff. Thanks for the clarity. Appreciate it.

[Operator]

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

[Bill Peterson, JP Morgan]

Yeah. Hi, guys. Thanks for letting me ask a question. First, I guess, in your Intelligent Audio, you’re reiterating an additional 2% to 4% on top line growth for 2019. I guess, the question is, I believe that's why smartphone has kind of been the lead market with the SmartMics. What kind of traction are you achieving in the other edge and IoT devices? I guess, if you can quantify or help us with the breadth and depth of design wins and engagements you're having, marquee customers as well as lot of more IoT-type products. It's hard to understand what the pipeline looks like for this year as we think about growth even beyond. Thank you.

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. That's a good question, Bill. Thanks for the question. So, let me just start with mobile. I think we have been quite successful so far with Intelligent Audio and mobile. We expect that to continue in 2019.

If you start looking at the ear market, I would say there is quite a few opportunities. What I would just say though about them is this – we’re not seeing like one opportunity is going to drive all the revenue.

I think the last time I looked at the funnel with the team, there was more than 10 ear opportunities for Intelligent Audio right now. And so, I think ear is a little bit more challenging from the standpoint of that it’s a little bit more fragmented of a market, but we have a lot of opportunities in the ear market.

The IoT market, again we have a lot of opportunities, Bill. I guess, what always concerns me on the IoT market is which products are successful and which are not. Obviously, the product that's in the market that we talked about last year has been done reasonably well. I think on the Facebook call, they said it's done better than they expected. But we have, I would say, a fair number of new design wins across multiple customers, but we're going to have to see how successful those products are. So, I would say, overall, the breadth is pretty good, the pipeline is full and that 2% to 4% stands.

[Bill Peterson, JP Morgan]

Okay. Thanks for that. With your full-year guidance of expecting growth in your commentary, it kind of implies a really strong – I guess that even looks like near double-digit growth in Audio sequentially. And we haven't really seen that in June typically. First, hopefully, my math is right, but is a big chunk of that Hearing Health as you discussed? Or is it just – I guess just given the inventory levels in Q1, it's replenishment in Q2, just if you can help us understand those dynamics, that would be helpful. Thank you.

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. Right now, based on what we see in the marketplace, we do see sequentially a strong Q2 over Q1. So, I think that is definitely the case. I think if there's a little bit of Hearing Health – but I wouldn't say it's the primary driver of it – I would say it's more ear and IoT products that are the driver of it in Q2.

[Bill Peterson, JP Morgan]

Okay. Thanks for that.

[Operator]

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

[Robert Labick, CJS Securities]

Good afternoon. Thank you. I wanted to stick with the Intelligent Audio and SmartMics. Can you talk about the customers that are adopting them? Is it broadly across all of your customers? Is it centered anywhere? And also, just the use cases again, I know we've talked about a few, but are those expanding and what are the biggest drivers of the adoption of these?

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. I think what we're finding with the SmartMic, Bob, is this – it's a very good gateway product. It's a very cost-efficient way to add features on mobile, ear, IoT products.

But I think what we're also seeing is that, after they are introduced to this product – we have our multi-core processors – as they start to expand in use cases, they are moving up to more powerful processors and into multi-core processors. We have the four-core processor. We'll be introducing another version of that this quarter as well. So, they're moving up in terms of content they want to put on.

As far as the applications, a lot of it centers initially around always-on voice wake. That's what it starts with. But then it becomes a lot of other things and it's a wide variety of things even within mobile, within ear. There’s a lot of different things people are thinking about with this device.

And I think I'll go back to what we said early on, which I haven't talked about maybe in the last quarter, which is the open nature of the platform which allows us to have third-parties develop to it, which allows our customers to develop their own algorithms and features and which allows us to do the algorithm development.

And why is it so powerful? Well, if you think about the Bluetooth market, if you think about the handset market, it's very, very difficult to run a lot of these applications, audio applications, either in the cloud or on the apps processor. And they are finding more and more applications that can fit in this processor.

So, as you go throughout the year and the products introduced, we'll talk more about the use cases, but they – for sure – are expanding.

[Robert Labick, CJS Securities]

Okay, great. And then just shifting over to the Hearing Health, you sound a little more upbeat about it than you have in a little while. Can you talk about kind of what drove the turnaround in growth and the expected growth going forward?

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. I think there is probably two things I would say shorter term and I would say there's a couple of things longer term, of course. So, the longer-term things are, obviously, the dynamics of the age of the population. We think that's always going to be our favor. More and more baby boomers are getting to the age when hearing aids are necessary.

The second thing I think which I think we are positive about in the longer term is that people are getting more accustomed to wearing things on their ears for an extended period of time, and the AirPods are the show of that.

And so, a hearing aid – I guess is the third piece, a hearing aid and a true wireless headset are starting to look more and more alike and there's this convergence between those. And so, what we're starting to see is that, yes, we have microphones and that we'll sell in the ear, but we also have these extremely small balanced armature receivers that we sell in the hearing aid market that are becoming more interesting to people who make wireless headsets. We have Intelligent Audio opportunities on the ear.

So, when I think about it is the hearing health market and our consumer market for ear are converging. And so, what you're seeing is a lot of the products that we sell to hearing aid guys are now starting to be sold not only there, but also into the commercial marketplace.

[Robert Labick, CJS Securities]

Got it. Okay, great. Thank you very much.

[Jeffrey Niew, President and Chief Executive Officer]

Thanks, Bob.

[Operator]

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

[Christopher Rolland, Susquehanna]

Hey, guys. Thanks for the question. Bringing up the multi-core DSP, how does that design win funnel look for you guys now? Do you think you have another design win or a close? And then, just perhaps talk about traction for single core DSP too and what percent of sales that might be?

[Jeffrey Niew, President and Chief Executive Officer]

I don't have the numbers on what percentage of sales the multi-core would be right here. But, yes, we do have more design wins for the multi-core. We definitely do. And we expect more as the year progresses that will be ramping in the back half of the year.

When we talk about the multi-core, again, just like kind of with the SmartMic, we're not going to highlight like very small customers when they go to production, but we're expecting some larger customers will be going to production with the multi-core that we have not mentioned before. So, we're pretty optimistic about the multi-core product.

[Christopher Rolland, Susquehanna]

Great. Congrats on those wins. And then, as a follow-up, if I'm doing the math right here, it seems like if you ex out the growth in the ear and IoT, the mics for traditional handset, the revenue contribution might have been down quite a bit. Can you talk us through kind of the moving pieces there in terms of units versus ASP versus share? I think you guys might have actually picked up some share this year?

[John Anderson]

Yeah. There is a lot of moving pieces here. First of all, you referred about 2018 or I'm assuming you're talking about 2018…

[Christopher Rolland, Susquehanna]

2018, for the full year. 2018, yes.

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. I'm trying to look at the numbers here. If you look at – just if I'm looking at – I would say, overall, in 2019, mobile, it looks like to me it was flattish 2018.

[John Anderson]

2018 over 2017 is flattish.

[Jeffrey Niew, President and Chief Executive Officer]

Flattish. Right. And then, you have Ear, IoT, Hearing outgrowing and Precision Devices growing. To make a little bit comment on ASPs, I think that's a great opportunity. I think, to mention, we've always talked about 2018 being about 4% down on mature products. I'd say we're probably looking at a similar type number on mature products. But I think one of the things that I would just mention is that ASPs, overall, with the new products in the mix that are coming are going to be flat overall, even with that 4% reduction in mature products. And what that's leading for the company as a whole, we're expecting improving gross margin for 2019. I don't know, John, if you want to make a comment on that.

[John Anderson]

Yeah, sure. Yeah, with respect to gross margins, we finished full-year 2018 with a gross margin of 39.5%. We expect gross margins in 2019 to be slightly above 40%. And it's really driven by product mix. It's more sales of Precision Device, more sales of Intelligent Audio, slightly more sales of higher performance microphones again into ear and IoT markets, less into the mobile space. But, again, we feel pretty good about gross margin improvement going into 2019.

[Christopher Rolland, Susquehanna]

Yeah, that's a key number. Thanks for that.

[Operator]

[Operator Instructions]. Your next question comes from the line of Tristan Gerra with Baird. Go ahead. Your line is open.

[Tristan Gerra, Robert W. Baird & Co]

Hi. Good afternoon. As a follow-up to the prior question and your commentary about slight gross margin expansion that you anticipate for 2019, is that assuming similar utilization rates in the second half of this year versus what you had in the second half of 2018? Or was there any assumption about changing volumes in your main smartphone business that could also be a moving part of the gross margin equation?

[John Anderson]

Yeah. Good question, Tristan. In 2018, our full-year capacity utilization – again, I'm talking about in our MEMS microphone business – was right around 95%. We were kind of in the low-90s, close to 90% in the first-half. And up until, call it, midway through Q4, we were kind of running full out. And then it fell off a little bit in November, December. When we look out at 2019, capacity utilization will be a bit lower. It will be closer to kind of – the plan we have right now is based on 90%. And we have made some manning and staffing reductions already to kind of align to this new level of output expected.

[Tristan Gerra, Robert W. Baird & Co]

Okay. That's very useful. And then, you've mentioned the number of design wins in your ear and IoT business, but difficult to know which one are going to be meaningful versus the one that will be smaller depending on the success of end products. With that in mind, how would you view the mix of your ear and IoT business between smart speakers, wireless ear buds? Which of those segments and others you think will gain the most within that segment in 2019 based on the design win visibility that you have?

[Jeffrey Niew, President and Chief Executive Officer]

Yeah. I would say that we're definitely expecting significant growth in the ear in 2019. We do expect growth in IoT for sure, but the growth in the ear market is quite good.

[Tristan Gerra, Robert W. Baird & Co]

Great. Thank you.

[Michael Knapp, Vice President of Investor Relations]

Thanks, Tristan.

[Operator]

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

[Michael Knapp, Vice President of Investor Relations]

Great. Well, 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.

[Operator]

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