Knowles Corp (KN) 2014 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Knowles Corporation fourth-quarter and year-end 2014 financial results conference call.

(Operator Instructions)

As a reminder, today's call is being recorded. With that said, here with opening remarks is Knowles' Vice President of Investor Relations, Mike Knapp. Please go ahead.

Thanks, Shannon. And welcome to our fourth-quarter and year-end 2014 earnings call. I am Mike Knapp, President of Investor Relations. 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 and Company sales, expenses and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from our 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, 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 Regulation 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. Except for revenue, all financial references on this call will be non-GAAP unless otherwise indicated. Also, we've made selected financial information available in webcast slides which can be found in the investor relations section of our website.

With that, let me turn the call over to Jeff who will provide some details on our fourth-quarter and year-end results. Jeff?

Thanks, Mike. Thanks to all of you for joining us today. For Q4, we reported revenue of $286 million. Gross margins and operating margins were approximately 32% and 13%, respectively, and exclude charges associated with the microphone issue discussed last quarter.

I would like to begin with an update on the microphone situation. We are pleased to report that our product has been requalified on this customer's smartphone platform. We expect shipments to resume in the second quarter of 2015. John will go into greater detail on the financial impact in just a moment.

The resumption of shipments to our customers highlights a few important points. First, it reflects our ability to quickly diagnose an issue, develop a new design, and ramp up a new product. Secondly, it demonstrates that Knowles is a critical supplier to the MEMS microphone market. Finally, it reflects customer confidence in our ability to effectively apply our expertise and solve difficult problems.

I would like to thank all of our employees for their tireless efforts over the last four months and commitment to resolving the situation.

Moving onto our results, revenue in our Mobile Consumer segment was down 6% sequentially, and microphone shipments on a specific platform remained on hold for the entire fourth quarter. Strong quarter-over-quarter sales of our speaker and receiver products helped offset the declines in microphones.

Based on public shipment volume we believe our revenue for microphones was unfavorably impacted by more than $50 million in Q4 and approximately $70 million for all of 2014. Revenue from MCE comprised 60% of total sales in Q4.

While shipments to Chinese OEMs were up significantly from the period a year ago, revenue from these customers declined sequentially in Q4 due to timing of product launches. For the full year of 2014, growth remained very strong, up 75% from 2013. As noted in previous calls, OEMs throughout China have been and will continue to be a growth driver for us.

We are benefiting from the conversion of at MEMS microphones, multi-mic adoption and increased traction with higher-value solutions. Sales from integrated audio modules more than doubled in 2014 versus 2013 and we expect growth again in 2015. We continue to win new designs across these customers by delivering superior performance, and reducing customers' time to market.

As we enter 2015, it is also important to note the progress we have made in the area of intelligent audio. We recently attended CES and met with many customers to demonstrate Knowles' ability to optimize the audio signal path in the next generation of mobile devices. Given the positive response from customers, we're confident in our approach to intelligent audio solutions.

We expect to continue to increase our investment in this area. For example, we recently hired a CTO to lead our long-term technology strategy. We also opened a design center in Sunnyvale in November which will focus on enabling the Company's intelligent audio solutions.

We are excited that some of these next-generation solutions are being implemented in new devices entering the market today. Last month, HP introduced the Pro Slate 12 tablet with ultrasonic technology, allowing the user to write on any paper or type of paper and the content immediately appear on the display.

This advancement is powered by one of our latest introductions, a digital microphone that supports ultrasonic bandwidth. This particular device uses seven microphones and drives content growth per device by enabling new applications.

In the Specialty Components segment, Q4 sales were down slightly quarter over quarter, and represented about 40% of the total Company revenue. Revenue from acoustics was up sequentially. This was offset by softer sales in precision devices as wireless infrastructure customers consumed inventory built earlier in the year.

Note that even with this minor pullback in Q4, precision device revenue was still up 3% over the year-ago period and at the high end of our Specialty Components growth rate targets. In both of our segments, we remain focused on optimizing our manufacturing footprint.

As expected, we saw the full benefits from our restructuring of our Vienna facility in the fourth quarter. We remain on track to deliver our annual savings target of $50 million by the end of 2015.

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

Thanks, Jeff. As Jeff mentioned earlier, we reported fourth-quarter revenues of $286 million. Mobile Consumer Electronics revenues of $171 million were down about 6% sequentially. As expected, microphone shipments remained on hold for the entire fourth quarter for the specific customer platform we discussed during our Q3 call.

Strong quarter-over-quarter sales of our speaker and receiver products helped offset the shipment declines in microphones. As Jeff mentioned, we believe our Q4 revenues were unfavorably impacted by more than $50 million.

Specialty Component revenues of $115 million were down 3% sequentially, driven by lower sales to wireless infrastructure customers as they reduced inventories that were built up earlier in the year. These declines were partially offset by continued broad-based demand among our hearing health customers.

Fourth-quarter gross margins declined sequentially to 24.6%, due primarily to charges associated with the microphone issue and the related lower capacity utilization.

As stated during our Q3 call, there were potential exposures related to the impacted microphone which were not reflected in our Q4 projections. During the quarter, we incurred approximately $21 million in charges related to the microphone issue. Excluding the impact of these charges, gross margins would have been approximately 32%, at the low end of our prior projected range.

Operating expense in the fourth quarter was approximately $54 million, consistent with Q3 levels. Adjusted EBIT margin for the quarter was 6.2%, down sequentially, driven by the impact of the microphone issue, partially offset by benefits of prior restructuring actions. Without a the microphone charges incurred in the quarter, adjusted EBIT margin would have been 13%, in line with our prior projections.

Non-GAAP diluted EPS was $0.14 for the quarter. Excluding the impact of the microphone charges mentioned, non-GAAP EPS would have been $0.38. This includes $0.01 of benefit related to favorable foreign currency fluctuations.

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 $55 million at the end of December. For the quarter, cash flow from operating activities was $26 million, and includes payments related to restructuring and production transfer costs of $9 million. Capital spending in the quarter was approximately $16 million.

Since the spinoff from Dover, we have increased our cash position from $41 million to $55 million, while funding $45 million of restructuring and production transfer costs and $84 million in CapEx. Our bank debt balance was unchanged for the quarter at $400 million, comprised of $300 million of borrowings outstanding under the term loan facility and $100 million under the revolving credit facility.

On December 31, 2004 Knowles entered into an amended credit agreement to increase the amount of the revolver from $200 million to $350 million. The facility increase provides Knowles with increased flexibility to execute our corporate growth strategy, and aligns our liquidity with our peer group. In total, we exited 2014 with more than $300 million of liquidity.

Interest expense was $2.1 million in the fourth quarter. For full-year 2014, we recorded revenue of $1.14 billion, gross margins of 29.4%, and EBIT margins of 9.9%. Excluding the direct microphone charges incurred, full-year gross margins were 31% and EBIT margins 12%. Note that while these margins exclude of the direct microphone charges, they do not reflected the negative EBIT impact of lower shipments and lower production volumes.

Now, let me turn to our first-quarter guidance. We expect first-quarter revenue of $225 million to $245 million. MCE revenue is expected to be down approximately 25% quarter over quarter due to seasonal trends. As previously mentioned, our microphone with a major North American OEM has been requalified but we have not included any shipments in our Q1 projections.

Specialty Component revenue is expected to be approximately 9% lower quarter over quarter, driven by seasonal patterns of customer product introductions in acoustics and continued burn off of inventory from telecom customers. We projected non-GAAP gross margin to be approximately 25% to 27% in connection with lower capacity utilization rates resulting from the impacted microphone and Chinese new year.

R&D spending in the quarter is expected to be approximately $23 million, up from Q4 driven by a higher level of activity related to our integrated audio modules and intelligent audio solutions. Selling and administrative expense is expected to be approximately $34 million. We are projecting adjusted EBIT margin to be between 1% and 4%, with the first-quarter effective tax rate in the range of 13% to 15%.

We expect non-GAAP diluted EPS for the first quarter to be within a range of $0.01 to $0.07 per share. This assumes weighted average shares outstanding during the quarter to be 85.7 million on a fully diluted basis. Please refer to our press release for a GAAP to non-GAAP reconciliation.

For the first quarter, we expect cash flow from operating activities to be between $5 million and $15 million.

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

In summary, we made excellent progress in a number of different areas despite the challenges from the microphone situation. We made advancement in new product development and optimized our manufacturing footprint across both business segments. For 2015, we are pleased that our microphone has been requalified and shipments are expected to resume in the second quarter.

We also look forward to a stronger second half of the year driven by normal seasonal trends and new product growth. Overall, I'm confident that the improvements we've made will translate into revenue growth and improved profitability in the years to come.

Operator, we can take questions.

(Operator Instructions)

Harsh Kumar, Stephens.

Yes, hi, guys. First all, congratulations on getting that requalification. I had a bunch of questions on that issue as I try to jiggle the model to find out how that ramp will be.

But maybe you could start off with the June quarter. As you start shipments, will it be a slow ramp building up to the year? Or are you all done and you're going to start from day one at a pretty steady clip? How should we think about the ramp for June-September with that particular customer and that recall?

First of all our system takes stuff back. We're referring that the shipments will restart in Q2, which will be the April quarter. And we're not really giving guidance on that. We're still working through the details of the supply chain and ramp up and things like that.

But I would expect it to be not overly slow. And we expect to sit there and see -- we should get a nice share, we think a nice share in Q2 based on where we were three months ago. As we go into the back half of year, we are engaged on all next-generation products. So, we'd expect it to be more of a typical type year that we started to see last year in Q3 before we ran into the situation.

So just to reiterate what I said, or repeat, we'll see a ramp in Q2. It's hard to say the exact date in Q2 of when it's going to happen, but once it gets going, it should get going. And then we'll start getting into the season of next-generation products being introduced, which our goal here, Harsh, is to regain the share that we've lost associated with the microphone issue.

Got it. That's actually very helpful, Jeff. And I'm going to ask this question -- this particular customer is very relentless about quality and unforgiving to people who make mistakes. It's actually great that you guys got back in. I just wanted to get a better handle on what is it about your relationship with them that allows you to get back in? Is it just that you're a big player in mics, you have to manufacture? What is that critical function that allows you to get back in?

Harsh, that's a pretty good question. I would say it's a couple things. First, we are a supplier across multiple platforms. So, when we talk about customers, whether it be this customer or other customers, we sell into headsets, and tablets, and the handsets, and across multiple platforms of course on the microphone.

And then the second thing that I think is pretty critical for us is that we supply other things besides microphones. We are a supplier on speakers and receivers. And increasingly some of our high-end audio components we're starting to provide into headsets.

So, I think what we see is it's a real partnership that we have with these customers and it's long term. It's not short-term. Most of these customers that we're talking about, whether it be here in North America or over in Asia, we've been doing business with them for many years.

And while this has no doubt been a difficult situation -- and, believe me, the team here has lived it -- we get a real good feeling with these customers that they want to work with us because the new products we're coming out with, the breadth of our product line, which allows us to be across all of their different products.

And thanks again for that color. That was also really helpful. My last question and I'll get back in line, guys, is, that the 25% decline -- we cover a couple of handset guys, and I think, in general, March wasn't quite as bad for most of the handset guys. Still, there is a pretty strong product ramp happening for phones. I'm curious, is there anything else that's going on besides normal seasonality with respect to March over December?

When we look back over the last few years, Harsh, I think this is pretty much in line with what we would expect seasonally. There's always questions around these next launches. When I say -- questions around them -- how well they're going to do in the marketplace.

A lot of it's inventory build, as you sit there towards the end of the first quarter. It's hard for us to predict exactly what Q2 -- and if you remember, if you went back to Q2 last year, we talked about Samsung, once they build all the inventory we had a pullback in Q2 on inventory. It's hard to say what's going to happen this year but we are well positioned. So the 25% down, I don't put that in a category of being out of the normal, what we'd normally see.

The other thing I just would say on the Specialty Components side, we are seeing some sequential downward a little bit. A majority of that is between two things. One is our acoustics business, which, if you go back over the last four or five years, Q1 is traditionally much slower than before.

Most of our customers on the hearing aid side introduce products in the fourth quarter and they get all the inventory out. So we typically see again seasonally a Q1 that's slow.

The other thing that we have is we are working through inventory issue that we had with our telecom customers on the precision devices side. We saw that start to show up in Q4 and it's continuing as we go into Q1.

Jeff, thanks again for that clarity. And congratulations again on getting back in.

Alex Gauna, JMP Securities.

Thanks for taking my question. Jeff, I'm wondering as it pertains to the Q2 resumption, are we talking about the parts that were recalled and rescreened or your product fix or a combination? And if it's not the products that were recalled and screened, is that still inventory that might be useful to you at some point here down the road? Thank you.

I think what I would say is, on the first question, relative to rescreened or new parts, our expectation it would be both. It's a combination of working through, again, some of the screened parts that we have, but also new products, the new design. So I think it's both.

Refresh me on the second question?

So, if you're using some of your screened parts, I'm guessing that you have inventory then that could be consumed by the single customer. It doesn't necessarily need to find a new home?

There may be some extra inventory. I don't think at this point anything that we would have said were scrapped is scrapped. And I don't think we think that necessarily it's going to be able to be resold to anybody else because these are custom parts, Alex. So, I don't see that being the case.

I think, as you look at the charge -- and John can go into detail more about it -- that we took in the fourth quarter, that was to cover a lot of scrap and the inventory and the material associated with this. John can go into more detail on that but that was really to reserve for all that material.

Okay. I got it. And then a quick question -- can you talk to maybe the industry dynamics? As you resume shipments, presumably others in Southeast Asia were able to pick up some of the slack from you, the largest player in the industry. But when you resume production, we are no longer going to be in the sweet spot of seasonal demand. What does that mean to how that customer thinks about allocating its demand among the different players? Is there going to be a situation where there's all of a sudden a lot of excess supply in the industry?

I don't necessarily see that exactly that way, Alex. What we see is that, first of all, you do have the ramp up of the Korean model that will come towards the end of Q1 into Q2. There's a fair number of Chinese OEM introductions that are planned in Q1 and Q2. Coupled with that is, as we get into late Q2, into early Q3, we'll start to see us getting prepared for the ramp to the next generation of the North American OEMs.

So, I don't necessarily see it rolling out exactly that way. But one thing I just will add, which I think I mentioned on the last call, which is, we do expect some pricing pressure here on this requalified product. That was one of the things I think we called out and I still think that holds true. And we do see some pricing pressure as we go into Q2 on these products that are requalified.

Okay. One last quick one because you mentioned the ramp of Chinese platforms. Here now as we are entering 2015, I know you've got some really nice positioning in some of the key brand OEMs and speakers in China. Based on what you're seeing right now with some of the upcoming refreshes, do you feel like you might be in a position to take some speaker share in 2015 or is that still a TBD? Thanks.

Yes. I'm going to lay that as a TBD. I think we're better positioned this year in terms of speakers than we have in any year since we've owned Sound Solutions; the business that we bought from NXP. But I think, do we want to take share or not. But I think we are well positioned.

The Chinese OEMs, clearly our product portfolio and a roadmap on speakers and receivers looks really good. And we're real happy where we are, how we're positioned right now.

Okay. Thank you. Good luck.

Jaeson Schmidt, Lake Street Capital.

Hi, guys. Thanks for taking my questions. I wanted to talk to you about gross margins. Obviously some near-term headwinds due to capacity but once you start reshipping, and as we progress throughout this year, would it be fair to expect gross margins to resume to their more historical levels?

Yes. Let me start out with a bridge for you. I think it's important to bridge Q4 2014. As you know, we reported adjusted gross margins of 24.6%. That includes the direct charge of $21 million related to the microphone issue. If you add that back, our gross margins would be at 32%.

It's important to note that in addition to the direct charges we incurred, our product lines for this platform were idled in the quarter. So, if you take into effect the total impact, the lost EBIT on that volume, the gross margins for Q4 would be north of 35%. I'm not going to comment on future margins into 2015 but we do see improvement as we go throughout the year in margins.

Okay. And then, Jeff, you mentioned seeing some pricing pressure in the requalified part but can you talk a bit more about the pricing environment overall?

Yes. I think the things that we talked about in the past are still holding true. We're seeing, specifically the Chinese OEMs, multi-mic adoption really coming to fruition, where if you see the platforms that are being introduced by the major OEMs in China are going from one mic to two mics, in some cases two mics to three mics. That goes against pricing pressure.

The second thing is we continue to see them moving towards higher performance microphones. I think that really fits well. And I think, we talk a little bit about now, and again we don't think it's going to have a big impact on 2015. But as we look out into 2016 and beyond, intelligent audio really has some real opportunities here to change the game and the marketplace from the standpoint of enabling new applications, taking performance to a new level that we haven't seen yet.

The things that we talked about a year ago on the spin -- when we said people want better audio, they're willing to pay for it, and they want new applications involving audio -- still hold true. We still see that.

Okay. And the last one for me, wondering how much of your revenue came from China in Q4.

I don't know if I have that in front of me right at the tip of my hand. Mike can follow up with you. But I would say, as I said in the discussion, sequentially we would have liked to have seen it a little higher, but it was mainly due, from what we see, some delays of new product introductions.

And as we go into 2015, I think the market is defining that the Chinese OEM growth will start to slow. And that's factored into how we look at Q1, and as we go forward it's starting to slow.

But luckily for us, we have these offsetting factors, that we're pretty well positioned in speakers and receivers. You've got multi-mic adoption, conversion from the old ECM technology into MEMS microphones.

So, there's a lot of things that are going the right direction that lead us to believe that we'll grow faster in the China market than the market has grown. Similar that we've done this year or 2014, sorry, last year.

All right. Great. Thanks, guys.

Jason, it's Mike. Just a touch over 10% on Chinese OEMs.

Okay. Thanks, Mike.

Anthony Stoss, Craig-Hallum.

Hi, guys. I just have a question related to the requalification. I'm just curious as to why you're not perhaps starting to ship to Apple in Q1. And why is there a delay until Q2.

Second question, do you think you've got the systems in place now to make sure that this doesn't happen again?

Then, lastly, your view in the past of having 60% to 70% share of this market for mics. With this issue has your quality been tarnished with other customers? Do you still think you can hold in that 60% to 70% longer term? Thanks.

Let me take the last question first and then I'll go back. The question of whether our quality has been tarnished with other customers -- and I would say the answer is absolutely not. In fact, what I would say is even with the customer we had the problem with, I think the relationship comes out stronger.

They understand more about what we do, how we do it. We're much closer to them. I really feel good about -- as good as you can feel about a situation like this happening.

As far as -- I'm sorry, the first question?

The delay in shipment until Q2.

Yes. Our qualification or requalification, the approval, didn't happen that long ago. So, I wouldn't say it happened early in the or late in the fourth quarter. It happened more recently.

And if you think about what happens once that goes forward, then there's got to be filling the supply chain, discussing pricing, as we've discussed earlier in the call. There's a lot of things that have got to happen around it.

But what I feel is, without coming out and saying exactly what we get, because we don't have the exact numbers of what we get in Q2, we're not giving guidance on Q2, I feel comfortable that we're going to get share. So, I think we feel real comfortable where we are.

As far as what our systems -- I think one of the things that's come out of this for us is we have taken a look back at ourselves and said -- what do we need to do to make sure this doesn't happen again. And I'm not going to go into all the details but, clearly, we have made some structural changes internally to make sure things like this don't happen again.

Obviously this was very traumatic for us, it was traumatic for our shareholders but it was traumatic for the employees. But, in the end, I think it made us stronger. It's going to make us stronger in the long term, especially as we move -- our products are not becoming less complex as we go forward. Our products are getting more and more complex as people are demanding better performance, new applications.

Thanks, Jeff.

Tristan Gerra, Baird.

Hi. Good afternoon. Just a quick follow-up question on the pricing that you said would expect to erode a little bit more in Q2, probably beyond what normally has been a declining trend on a year-over-year basis. Could you talk a little bit about the declining production costs that you expect to realize this year? And is a 20% adjustment in ASP a good assumption starting in Q2?

Tristan, first let me take the second question first. We're not expecting overall for our business a 20% decline in ASPs. It's nothing to that extent.

On the second question relative to cost -- and John can expand on this -- but we have a very robust cost take-out plan that goes even beyond the $50 million that we're talking about here in our normal cost of business, what we call value creation, working on to bring costs out.

And as we've always talked about, and what we expect, is that we introduce a product, and if it's higher performance we expect to get better ASP, and then over time during the product lifecycle, we expect that it was going to come down in price over time. What we're just saying is, on this specific product, it's coming down significantly faster than we would've expected if we hadn't had this problem.

So John, do want to expand on that?

Yes. Tristan, just to expand a little bit, first of all, with respect to the value creation that Jeff mentioned, we target 3% to 4% productivity improvement over the course of the year. And that's really driven by material cost reductions, labor productivity, application of lean principles in both our plants and in our back office.

In addition to that, we have the initiatives that we talked about at our investor day where we were targeting $50 million in annualized savings. As we previously stated, we're slightly ahead of schedule in terms of those cost savings targets. We're going to exit Q4 of 2014 at just under a $40 million run rate and annualized savings.

A big portion of that was the closure of our Vienna production facility which was $28 million to $30 million. In addition, we've had some footprint capacity rationalization in our precision device business. And we're in the initial phases of our transfer from our hearing health business from China to our low-cost facility in the Philippines.

So, think of exiting Q4 at $40 million. We expect another $10 million in 2015 as we complete the transfer of our hearing health business to the Philippines, and have some further facility rationalization within our precision devices. So, hopefully the combination of the productivity and value creation that we have, and these initiatives, gives you a feel of what we're doing on our cost structure.

Okay. That's useful. And then what was the mix approximately of your integrated module business in the quarter on your consumer side?

You said mix between speaker, receiver and microphone?

Of the integrated module that combines the microphone and the speaker. I'm assuming it's still a fairly small percentage of your mix.

It's a small percentage but growing pretty fast. That's what I would say. We don't publicly give that detail. It's becoming increasingly difficult because partially, if you think about it, when we get a module sale it actually takes away from speaker sales. So it's really hard.

Less than 10% of the total MCE business.

Great. Thanks again.

Bob Labick, CJS Securities.

Good afternoon. Thank you. Could you tell us, have you been able to find out or glean from the industry where the capacity was made up exactly when you were not shipping this particular mic? And has that, in your opinion, had any impact on your future capacity going forward? Was there more added? Was there more shipped? Or how will that impact the landscape on a go-forward basis?

It's hard for us to ascertain exactly but from our market intelligence we'd say it wasn't one person, it was multiple. And there was just not one person who could pick up that slack.

I think the second thing I would just -- and we think that's positive, that you don't see one guy coming in and adding all the capacity and saying that we're going to move forward with this.

You asked a second question, Bob?

Just any implication from that, the fact that there was at least this initial surge to make up for your being out in the short term, any implication on that on the long term.

I think what you see is potentially maybe some capacity got ahead of itself. But if you look at between multi-mic adoption, if you look at we're still getting a fair amount of conversion from the old technology ECMs, plus you have the normal growth rate of the smartphone market itself, I think what you see is that there's going to be a need for more capacity in the marketplace as these dynamics continue to play out.

Okay, great. And then on that specific platform, I think on the October call you had mentioned you thought the impact would be $40 million in Q4 and $60 million to $70 million in 2015. It was obviously a bigger launch than anticipated back then so it was a bigger impact Q4. Can you give us a sense of the impact in 2015, at least through Q1, of what you are expecting now? And particularly as it relates to the guidance because you're guiding down $40 million, I think, year over year, and that seems -- help us reconcile that Q1.

Yes. I would say that if you look at, there's published reports where people are estimating on the number of phones that are going to be built. If you work backwards in the numbers, I would say the impact in Q1, considering we're not having any real shipments in Q1, I would say it's $30 million to 35 million.

And as we go towards the second quarter, hopefully, as we said, we expect to be shipping. The impact will be less because of that but we'll also start ramping hopefully toward the next generation stuff as we exit Q2.

Okay, great. Helpful. And then, obviously you spoke a little bit on the Vienna and the decision and reaching that goal already, which is great. But there was obviously the $21 million impact in this quarter. Is there an impact in Q1, as well? Is there a way to get -- or could you just remind us again your mid-term margin assumptions, and if those have changed materially from this.

Yes, let me hit Q1 first. Q1 gross margins are impacted by a couple things. First, they're impacted by the microphone issue. Second, Q1 is seasonally our lowest margin because of Chinese new year. And, so, you've got a combination here of Chinese new year and the impact in mic creating fairly low capacity utilization. So, that's the first question.

The second question with respect to our mid-term operating model, as we stated on our Q3 earnings call, our mid-term operating model targets are unchanged. We're looking towards achieving them by the end of 2017. And for reference it was 39% on gross profit margin.

Great. That's fantastic. Then the last one for me, you touched on it a little bit in terms of the ultrasonic, but can you just give a sense of some of the new technology that you have been developing? Another example, ultrasonic or Voice iQ or N'Bass, where those stand now or when we may expect other new technologies coming out of here?

We're really highly focused on productizing some of the things we've talked about already. I'll point you back to our intelligent audio. The response we're getting from the marketplace about enabling new applications is really positive.

What I would say though is what we're faced with as we introduce these products, is the integration and the introduction is significantly more complicated than previous models that we've worked with. And what we really have done over the last six months -- and I think this is one of the positives people talk about, one of the positives of not being part of Dover -- we're investing a fair amount of money more in R&D. We continue to step forward in R&D.

And the latest I think I talked about on my script was we opened this facility in Sunnyvale. We already had a facility in California relative to our large OEM up there that's supporting that. But now we've got a facility that's really tasked with working on the integration issues of intelligent audio.

And, so, if you were to sit there and say, the thing that I'm pretty bullish on as we go into 2016 and 2017, is intelligent audio. There'll be more products that we're going to talk about as time goes on, but we are highly focused on getting the first products launched and getting them integrated in our customer solutions at this point.

Okay. Great. Congratulations, too, on the requalification.

Christopher Roland, FBR Capital Markets.

Hi, guys, thanks for squeezing me in. And I also echo my congrats on your requal there. Switching gears to another customer, can you guys talk about your expected contribution from a Korean customer that typically replenishes inventory in Q1 and also ramps their flagship phone bills at the end of the quarter? Thanks.

First, I'd say we're well-positioned there for this launch. We obviously are getting ready for this. I think you guys understand the market dynamics as well as I do in the end market of what's happening here.

I come back to it. The Knowles position here is that we are very well-positioned across the board at all OEMs, whether it be the Chinese OEMs or the North American or the Korean customers, or even we talk about Microsoft now, we're well-positioned with Microsoft. And, so, to the extent of that case, we're ready for the ramp.

How it's going to go and whether it's going to be successful, it's hard for us to say. Your guess is as good as ours as how they're going to do in the end market. Obviously it's dependent on how the phone is received. But what I'd say is we're well-positioned in order to take advantage of that.

Okay. Great. And as I look at the market, and it's probably a gross oversimplification here, but it seems like a function of ASPs, unit volumes, and then Knowles' share. So, I just wanted to get your idea how you see those three things playing out.

ASPs overall year over year, particularly on these price discounts that you mentioned, how do you see that playing out? How do you see unit growth playing out? And then, ultimately, what's your share, in your minds, in 2015?

I'd start off by saying, these products, if you look at them, whether they're microphones, speakers, or receivers, they are not commodities. A lot of the stuff we're doing is custom for specific customers, and we work with them very, very closely. I go back to what I talked about earlier in the call, which is just that we expect that the ASPs are higher at the beginning of a product launch and then start to decline.

I do think, obviously, when one of our larger customers, there's going to be more than expected price erosion because of this issue, it does have an impact overall on our overall business. But if you go outside of this customer, I don't think we're seeing abnormally different ASP erosion than that normal path where we introduce a product. It comes down in price, and then we introduce the next one.

We also see, obviously, and it helps offset it, is this, again, move towards these high-value products. Whether it be better performance, things like new applications like ultrasonics or intelligent audio, as we get towards the back half of this year and into 2016. As well as audio modules which, in general, are higher ASPs. So, we see a lot of positives on the ASP side.

On the volume side, I think we've talked about the dynamics but the dynamics still are pretty good. The multi-mic adoption continues. Conversion from older ECM technology continues. Moves from -- you are starting to see some people contemplate more speakers per device.

So, the market is growing. Our product category is growing faster than what's happening in the marketplace itself. So, overall we feel pretty good about where the market goes over the next few years.

Okay, great. Thank you for that color. And then, finally, if you could walk me through your gross margin expectations for expansion this year. So, 32% pro forma today. I would expect your big North American customer to have gross margins below corporate average maybe just because of their size and negotiating power. But perhaps I'm wrong there -- and feel free to correct me.

But why would margins improve through the year as this larger customers mixes in, and particularly with the pricing pressure that you mentioned? Is it just a function of higher utilization on your back end, for example? And perhaps maybe you could talk about where those utilizations are today.

A couple of questions there. First of all, with respect to margins, obviously we aren't going to comment on margins about a specific customer.

In terms of improvement going forward in 2015, a couple drivers here. First, as you said, it's factory utilization. Second, is, I'll call it product mix.

If you think about 2014, we had less sales of new products because of this microphone issue. Going forward into 2015, we think we'll have a higher proportion of new products which, as Jeff mentioned, each new platform comes out at a higher ASP.

We think those two factors, combined with the cost-saving initiatives that I mentioned on the call previously, will drive margins higher in the second half of the year.

Great. Thanks, guys, and congrats again on the requal.

Rob Stone, Cowen and Company.

Hi, guys. I know you can probably hardly wait to get one more gross margin question but here goes. I just wonder if you could pull apart what is the normal seasonal dip that you see from Q4 to Q1 on gross margins as a result of the typical seasonal reduction in utilization. That's my first question and I have a couple of others.

Yes. I would say 2014 obviously is an outlier so I'll go back to 2013. And if you think of gross margins there, there's typically a spread of 400 basis points between Q1, which is seasonally low and, I'll call it Q3-Q4 which is our higher margin quarters. So, think of it that way. Again, you can't really look at Q4 because of the issue we had this year.

Sure. A high level strategic question -- there a lot of different technologies and trends towards higher-quality audio, more mics, et cetera. Do you see any correlation between customers looking at those types of solutions and some other feature set on the smartphone?

For instance, does it correlate to higher resolution screens? Is it within a particular high-end, mid-range? Is it the segment, the price point? Help us understand how big a slice of the market may adopt these higher-end solutions.

I think what we've seen in general is that when a new product is introduced, or let's say a new level of performance is introduced, it starts at the high end, and then slowly it starts migrating to the mid range from and then eventually gets to the low end.

I think I'll use microphones as the example. The microphones that are used in mid-range phones are significantly better than the microphones that were used in mid-range phones two years ago.

I equate this to audio is not altogether different. If you think about, like, screen technology. If you go back 10 years ago, people had black-and-white screens, and they were small, then it went to color, then it went to larger, went to higher pixel count. We have all those types of, I would say, specs that we have on microphones, and similarly on speakers.

So, in general, and we've talked a fair amount about this at investor day, and when we get out we talk about this more, is people want better acoustic performance. You could think of all the applications where today you use a phone and you sit there and say -- well, the acoustic performance, while better than it was three years ago, there's still room for improvement. And to the extent that we can improve the performance, our customers are willing to pay for it in order to give it to the consumers.

I have a fair number of meetings with higher-level people that are customers and one of the reasons I think that I can get some of these meetings is because audio is important. They don't look at audio as a commodity. They look at audio as a differentiator. And even in the mid-range phones, they look at it as it's something you've got to have -- you've got to have that performance.

Can you characterize, perhaps, or at least roughly what the spread might be then between, let's say, a mid-range phone that's got a full HD screen and that type of spec versus a high-end phone that maybe has 2HD or support for 4K video, that type -- what type of a spread is there then on your revenue opportunity per unit?

It depends on the customer. Are you talking in terms of total content per phone or performance? There's a lot of different aspects here.

I'm trying to size the impact of, when you talk qualitatively about higher performance at the high end, how much of a spread that might give you on your revenue-per-system opportunity.

Okay, I understand, I understand. It's a little bit complicated because of the Chinese OEMs. And I'll tell you why in a moment.

But, first of all, a typical high-end phone has three microphones, a typical mid range has two, and a typical low-end has one. So, you see between a mid-range and a high-end. Now, one of the interesting things is, as people move to two microphones in the mid-range, it's a doubling of content on the microphone side.

Now, the Chinese OEMs bring a different thing into factor, I would say, because of the modules that are coming into effect, which we don't necessarily have across all customers. In general, I would say that the mid-range phones are less in terms of, probably by a factor maybe of 20%, 25% in terms of content than the high-end phones.

And the stuff that's being brought out in the high-end phones typically migrates down to the mid-range phones. So overall we see in all of our categories, whether it be low-end, mid-range or high-end, increasing content.

Great. And, finally, a housekeeping question or two for John, if I may. Could you comment at all on your expected CapEx needs for 2015? And, also, you noted that you've got quite a bit of liquidity with the expanded revolver. Any other color you can provide on sources and uses of cash other than CapEx? Thanks.

Yes, sure. With respect to CapEx, this year we spent about $84 million in CapEx. I expect that to come down as we go into 2015. We aren't giving full-year guidance but expect it to be lower than 2014 levels.

With respect to the liquidity, again, we increased our facility in December by $150 million. And this was really to provide us flexibility for general corporate purposes and executing our growth strategy. And it really aligns our liquidity with our peer group. So, nothing more specific than that.

Great. Thank you.

Harsh Kumar, Stephens.

Yes, hi, guys. Thanks for squeezing me in. I had one or two questions. First of all, John, the guidance you gave for gross margin, I think it's 24% to 26% at the median. Are there any charges included in that or is that a number we can safely model?

Karsh, no specific charges. We think the direct costs associated with the impacted microphone are behind us. What I will say, though, is we've got idle capacity for a significant portion of the quarter.

As Jeff mentioned, we aren't envisioning shipments to take place until Q2. We recently were notified of the requalification. So, a good portion of this quarter has idle overhead, which is fairly significant to our margins.

Great. That's a great lead in to my second question. I'm looking at your margins. The one that you gave, ex the charge, margin you said would have been 32% minus of the impact of the issue. If I compare that to the margins you put out last year, call it 37%, versus the 32%, is it fair for me to assume that your idle charges are accounting to roughly 400, 500 bps?

I think I said, Harsh, when I bridged it in an earlier question, on an as reported basis in Q4 we had gross margins of 24.6%. If you add back the direct cost, the $21 million, our margins were 32%. If you then take into account the lost EBIT on that volume that we had in Q4, margins would be in excess of 35%.

Got it. Okay, that's very helpful. Thank you. And then last question from me is March OpEx -- is it up meaningfully from, call it, September-December because of payroll, and the ramp associated with getting back in and into requal? And should we take that as a base and build it up? Or should we think that's a high number relative to the rest of the quarters for OpEx?

Let me talk first about R&D because I think that's the area that we've talked about previously and we will see some increases in R&D, really driven by intelligent audio. With the rest of selling and admin expenses, we're pretty flat with where we were in Q4.

So, this is saying, Harsh, we've been signaling all along that we think it's important to continue to increase our spending on R&D. Our R&D is already up pretty significantly on an absolute basis over the last two years, but we continue to see that being the case, especially as we move towards more complicated solutions.

That's fair guys. Thanks. That's all I got. Thank you.

Robert Sassoon of RF Lafferty & Co.

Thank you. You actually covered a lot of the things that I was going to ask. But just a specific question for John in terms of the D&A, depreciation and amortization, what was that in the fourth quarter?

Let me dig that one out and maybe go to the next question. I'll come back to you.

I was going to just carry on and say, with the changes you made in terms of manufacturing capacity, is depreciation and amortization going to be in a downward trend in 2015?

Can you repeat that?

You've basically consolidated your capacity and you're reducing CapEx. Is there going to be a downward trend in depreciation and amortization in 2015 and beyond?

We're not taking out capacity. The majority of stuff that you talk about in terms of -- we're relocating facilities from one location to another. So, we don't view it as taking out capacity.

I think what you see relative to lower CapEx is just a function of the fact that we're moving, over time, to less reliance on the growth of the end market and more reliance on the growth of the value of the solution. So, it's not requiring as much CapEx in order to grow the business.

Okay. And I didn't quite catch what you said the medium-term targets were. They're set for the end of 2017 or the start?

2017.

They start in 2017?

End of 2017.

End of 2017. And just a quick question on the -- you say, on the $21 million charges that you made against microphones, you hadn't anticipated those. Is there a reason why those were missed in the guidance figures that you gave at the end of the third quarter?

And, secondly, is there a risk that you will have addressed related to these charges -- you obviously have still not resumed shipments in the first quarter.

Again, we've recognized a $21 million charge in Q4. And that charge really includes reserve for finished goods inventory that we've deemed unlikely to sell related to this platform, as well as subcontractor inventory that was impacted by the defect. It's the subcontractor one that was really tough for us to get our arms around back in the end of October.

And also with respect to our finished goods inventory, we were going through a testing process and a screening process. We didn't know how much of that would be able to be utilized. So, that's why we said there's additional exposure but we didn't reflect it in our Q4 guidance.

Right. And there's no chance of any of that unanticipated charge (multiple speakers)?

Based on the information we have today, we don't believe there's additional exposure for this product.

All right. Okay. That's all my questions.

I'm showing no further questions at this time. I'd like to turn the conference back over to Mike Knapp for closing remarks.

Great. Thank you 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. Thanks for your participation and have a wonderful day.