Knowles Corp (KN) 2015 Q2 法說會逐字稿

Good afternoon and welcome to the Knowles Corporation second-quarter 2015 financial results conference call. (Operator Instructions)

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

Thanks, Latoya, and welcome to our second-quarter 2015 earnings call. I'm Mike Knapp, Vice 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 in Company sales, expenses and profits, and involve a number of risks and uncertain 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, included, but not limited to, the annual report on Form 10-K for the fiscal year ended December 31, 2014, 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 have 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 second-quarter results. Jeff?

Thanks, Mike. Thanks to all of you for joining us today. For Q2, we reported revenue of $241 million. Gross margins and operating margins were approximately 27% and 5%, respectively.

Revenue in our mobile consumer segment was down 2% from Q1, below our prior projections. Microphone shipments to a Korean OEM were weaker than expected, as this customer continued to struggle in both high- and low-end handsets.

That said, we were pleased to see strong sequential growth at a North American OEM and continued microphone share gains, as well as a rebound in growth from Chinese OEMs. This quarter highlights the benefits of our broad-based exposure to mobile consumer customers. This allows us to remain focused on investing and delivering best-in-class solutions.

Revenue from MCE comprised 55% of total sales in the second quarter. As I mentioned earlier, we continue to make excellent progress regaining microphone share at a North American OEM, and this success is translating to increased revenues from new products and improved operating leverage. We expect these trends to accelerate in Q3 as we are well positioned with solutions on next-generation platforms that will launch later this year.

Chinese OEMs shipped a total 237 million handsets in the first half of 2015, rising 7% from the prior year. Within those handsets shipped, 4G miles increased to 195 million units, according to data from the China Academy of Information and Communications Technology. Typically, we see better acoustic content per device on these 4G platforms.

Collectively, our revenue from Chinese OEMs was up 40% quarter over quarter on robust sales of microphones, speakers, and integrated modules. We still anticipate that China will outgrow the broader market this year, but this growth will moderate going forward.

MEMS microphone share gains, against older ECM technology, multi-mic adoption trends, and increased traction with higher-value solutions, is expected to continue with these customers as we move through 2015.

In the specialty components segment, Q2 sales were up 5% quarter over quarter and represented about 45% of total Company revenue. Revenues were up primarily due to higher acoustic and capacitor sales and were partially offset by continued weakness in timing device sales into the wireless infrastructure market.

In hearing health, we saw broad-based improvement across all OEMs. We continue to grow MEMS mic shipments in Q2 for hearing health devices and we remain the leading supplier of these solutions for this market. We also experienced strong performance from our capacitor business, driven by increased medical sales.

Additionally, I would like to highlight a few important announcements. First, we successfully completed our acquisition of Audience. I will talk more about this shortly, but I am very excited about how this acquisition expands our expertise in intelligent audio and signal processing solutions. This opens up new opportunities to improve audio performance and enable new applications for our customers.

Second, we introduced our I2S interface MEMS microphone for wearables and other voice-enabled applications. This intelligent solution is extremely small in size, with very low power consumption and allows our customers to connect directly to their application's processor.

This results in a more efficient architecture due to decreased complexity of design, increased battery performance, and lower billed material cost. We expect organic intelligent audio revenue in the second half of this year, driven by wearable design wins secured in the second quarter.

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

Thanks, Jeff. As Jeff mentioned earlier, we reported second-quarter revenues of $241 million, just above the low end of our previously projected range. Mobile consumer electronics revenues of $132 million were down 2% sequentially, primarily due to lower-than-expected sales to a Korean OEM as they continue to lose share in the handset record.

As expected, in the quarter, we continue to recover microphone share at a North American OEM, resulting in a sequential increase in microphone shipments. We anticipate further microphone share gains in the third quarter. Our speaker and receiver revenues in the quarter were in line with expectations.

Specialty component revenues of $109 million were up 5% sequentially. Increased demand for acoustic and capacitor products was partially offset by lower shipments of timing devices into the wireless infrastructure market.

Second-quarter gross margins were up 270 basis points sequentially to 27.3%, slightly above the high end of our prior expectations. Margin improvements were realized in both the specialty component and mobile consumer electronics segment due to improved capacity utilization, productivity gains, favorable foreign currency impacts, and product mix.

Operating expense in the second quarter was approximately $54 million and lower than expected due primarily to the timing of R&D hires and tight control over selling and administrative spending. Adjusted EBIT margin was 5% and non-GAAP diluted EPS was $0.08 for the quarter, with both metrics coming in at the high end of our guidance.

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 will turn to our balance sheet and cash flow. Cash and cash equivalents totaled $37 million at the end of June. For the quarter, cash flow from operating activities was $17 million and included payments related to restructuring and production transfer costs of $7 million. Capital spending in the quarter was $21 million.

Our bank debt balance was $398 million at the end of the quarter, up slightly from March 31 levels. Interest expense was approximately $3 million in the quarter.

Now I will turn to our third-quarter guidance. I will start with our expectations for Knowles ex-Audience and then present guidance related to the Audience acquisition, which we closed on at the beginning of Q3.

We expect Knowles ex-Audience revenue for the third quarter to be between $275 million and $295 million. MCE revenue is expected to be up approximately 33% sequentially at the midpoint, with significant increases in microphone and speaker shipments. This will be driven by shipments to a North American OEM on their new platforms, continued improvement in sales to Chinese OEMs, and stable quarter-to-quarter sales to a Korean OEM.

Specialty component revenue is expected to be up slightly on a sequential basis, coming off a strong Q2 for both hearing health and capacitors.

We project non-GAAP gross margin to be approximately 30% to 32%, up 370 basis points sequentially at the midpoint. This margin improvement is driven primarily by new product introductions, productivity gains, microphone share recovery, and related higher capacity utilization. Assuming the midpoint of our Q3 guidance, gross margins are expected to improve 640 basis points from Q1 levels.

R&D spending in the quarter is expected to be nearly $25 million, up $2 million or 9% from Q2 levels, driven by higher new product development activity. Selling and administrative expense is expected to be approximately $33 million, up $1.5 million from Q2 as we return to more normalized levels of spending.

We are projecting adjusted EBIT margin ex-Audience to be between 11% and 13%. We expect non-GAAP diluted EPS for the quarter to be within a range of $0.25 to $0.33 per share. This assumes weighted average shares outstanding during the quarter to be 86.5 million on a fully diluted basis and excludes the additional shares issued in connection with the acquisition of Audience. Please refer to our press release for a GAAP to non-GAAP reconciliation.

For the third quarter, we expect cash flow from operating activities to be approximately $5 million and include restructuring and production transfer payments of $10 million. Cash from operations during the quarter is expected to be negatively impacted by a $30 million to $40 million increase in net working capital as we increase both production and shipping level to support new product introductions.

Now let's move on to Audience. We anticipate third-quarter revenue to be approximately $10 million due to lower shipments to a Korean OEM as they continue to lose share in the handset market. Non-GAAP gross margin is expected to be approximately 45%, resulting in an adjusted loss of approximately $0.18 per share on a fully diluted basis.

As of the acquisition date, Audience had cash and cash equivalents of approximately $31 million. During the quarter, we expect Audience to utilize $25 million of cash, which includes $11 million in one-time payments directly related to the acquisition and $14 million used in operations.

We've taken several cost reduction actions in the quarter and expect to achieve more than half of the $25 million in estimated cost synergies by the end of the fourth quarter of this year, with the bulk of the remaining synergies expected to be realized by the end of Q1 of 2016. We continue to believe that the acquisition will be accretive by the fourth quarter of 2016.

I will turn the call back over to Jeff to discuss more about Audience and some closing remarks. Then we will move to the Q&A portion of the call. Jeff?

Thanks, John. I wanted to close with some additional commentary on our recent Audience acquisition. As we discussed before, we are executing on our strategy to move from an acoustics company to an audio solutions provider.

We believe this acquisition uniquely positions us to optimize the audio signal path for our customers, which will enhance performance and enable new applications for their devices. It will also expand our available market and improve our ability to capitalize on mid- and long-term trends in the mobile market.

Our first priority, now that we have closed this transaction, is to execute on the $25 million in annualized cost synergies. In parallel, we have defined a roadmap to realize intelligent audio revenue synergy that includes smart mics, unbundling of software, and leveraging of our existing customer relationships.

Customers are already beginning to embrace our intelligent audio solutions. I believe the combination of Audience's proven R&D capabilities and IP and Knowles's focus on improving the audio experience, coupled with the cost synergies we have outlined, will enable the acquisition to be accretive by Q4 of 2016. The combination of the Companies should also result in higher long-term growth rates and improved gross margins over the years to come.

Lastly, I wanted to thank our employees for all their hard work supporting the Audience acquisition and the excellent execution in our core business. Our strong Q3 expectations highlight that we are back on solid operational footing and well positioned for future growth.

With that, operator, we can move to the Q&A session.

(Operator Instructions) Bob Labick of CJS Securities.

First question I just wanted to ask -- congratulations on getting back. You said you were improving your share at a large OEM, US OEM. Could you tell us, implied in your guidance for the next-generation product, are you getting close to your historical levels? Or do you still think you can get back to those? What's the time frame in that regard?

It's hard, Bob, to put a timeline on when we would get back to the share. But we don't anticipate we will be back to the share in the third quarter. But as we've talked about in the previous quarter and the quarter before that, our goal is to get back to the share that we are at.

And I think we've taken a big step here in Q1, Q2, and now with our guidance in Q3 to get there. A lot of products have been made. Just to give you an example, we talked a lot about the charges that we had taken in previous quarters relative to the returned product.

All the products have been screened. It is all been returned to the customer, so we believe that's all behind us. And the relationship with the customer is quite positive.

So I wouldn't want to put a timeline on it. But I keep stating our goal is to get back to the share we are at. And every successive quarter -- Q1, Q2, and now embedded in our guidance for Q3 -- are we are regaining share.

Okay, great. And then just switching gears over to the Audience acquisition, what are some of the Knowles customers that weren't customers of Audience saying to you about the acquisition and opportunities to sell to that group of customers? Have you had those discussions yet or even prior to making your bid on Audience?

Well, we had a number of discussions with some of the larger customers of Audience prior to the acquisition. Plus, if you think about it, we had been working on our intelligent audio strategy organically for a while.

And what we have gone out now to customers and said, look, we have this organic plan. We want to accelerate this in terms of new products and the things that we can do.

And the reaction has been very, very positive. I think customers see what we see is is there's still a tremendous opportunity as we look forward to either improve the performance of the -- the audio performance of the devices that you have today. And there's lots of opportunities to enable new applications that don't exist today. So I think it was viewed very positively.

I think the thing that we have to focus on now is you think about the design cycles that take place within mobile consumer. Typically, they are 6 to 12 months. We have owned the business now for 26 days or 27 days, whatever today's date is.

So we're just getting going into this cross-selling opportunity, the unbundling of the software, selling their products into our existing customers that they weren't doing a lot of business with, coupled with a lot of the work that we have been doing pioneering the smart microphone market. So we see a lot of positives from the customers that have embracing the thought of intelligent audio.

Okay, great. Thank you very much.

Tristan Gerra of Baird.

How much of the $10 million in restructuring is included in your Q3 gross margin guidance, ex-Audience? And is there any restructuring left for your Q4 gross margin?

With respect to restructuring, we non-GAAP out the restructuring costs. So there aren't any implied in the non-GAAP results that I talked about with respect to the guide. Your second question?

In terms of your target for Audience to breakeven in Q4, could you give us a little bit more details in terms of what your expectations are? Do you expect cross-selling opportunities, meaning that you expect your quarterly revenue run rates by the end of next year to be higher than what you are guiding for Q3? And if you could talk about gross margin improvement opportunity in the Audience business?

So we are not going to speak specifically to the revenue numbers in Q4 or Q1. But I think the key thing, Tristan, here is that we got to get going on first, selling the existing product that Audience has to our larger existing customer base. We have significantly more reach, Knowles does, than Audience does.

I think we've talked a little about this. We see the voice processor market as being an opportunity. We see unbundling of both these world-class noise suppression algorithms from hardware and being willing to license these algorithms. We started that process. We think that's a relatively large opportunity.

And of course, we think that we are pioneering here in the smart mic market, but Audience definitely brings capability to hopefully bring more smart mic products out in the years to come, especially as we go into 2016.

So --but I would anticipate, again, just talking back to how I was talking about on the first question is think of a design cycle on these products as 6 to 12 months. So we start seeing some of this revenue synergy probably towards Q1, Q2 of next year is when you start to see that.

Great, thank you.

Jaeson Schmidt of Lake Street Capital.

Thanks for taking my questions. Jeff, just a quick clarification on one of the previous questions. When you talk about getting to back historical share at the North American OEM, are you speaking about the current platform or future generation platforms?

We were referring to the future generation platforms. We still have a fair -- we have done pretty well in the existing platform. But our focus really is about the future.

Eventually, there will be another platform beyond the once that will be introduced later this year. And our goal is, as we move forward, to get back to the share that we were before. It's going to be the goal going forward.

And so far, again, the progress we've made through Q1, Q2, and the Q3 guidance is pretty positive. So we are pretty happy about the progress we've made. And again, the employees at Knowles have done a great job of making sure we got back in.

And I feel like the relationship with the customer is better than it was before based on they understand more about our capabilities. We still have that very broad product portfolio, beyond microphones, speakers, receivers. We sell a lot to these customers. So we are a pretty, I think, strategic supplier to them.

Okay, great. Thank you. And then just wondering if you could talk about what you are seeing as far as channel inventory.

Are you referring to channel inventory as in end markets?

Yes, just across the landscape, if you are seeing anything out of the ordinary from an inventory standpoint.

I think the couple things that we've highlighted before, that with the transition of one of our larger customers, Microsoft, now to Windows 10, there was some inventory overhang. It's very hard for me to say. I would definitely say, based on all the reports we've read, coupled with our forecasts, it was clear that the Korean OEM has pulled back in terms of their builds because the sales are not as good as expected.

But I don't think we are seeing a tremendous amount of inventory overhang in the end market at this point.

As I mentioned in the script, we're expecting basically flat sequential sales to the Korean OEM. So I think most of that inventory overhang is behind us.

Yes. In fact, if you remember, we talked about it in Q2, that it didn't seem like the Korean OEM was really overbuilding on the front end like they tended to do in previous years, making sure they had product on the shelf. They were a little bit more cautious in their builds.

And to that extent, we haven't seen as much channel inventory issues. Or at least being told that they are not going to buy from us because they have too much inventory.

Okay. Thanks a lot, guys.

Harsh Kumar of Stephens.

Congratulations on getting back in at your large customer. Jeff, maybe a question for you. Couple of the other companies that sell into those kind of customers sometimes give us some metrics that the build is 60% in September or 40% in December or 55-45.

Or maybe, if you don't want to go to that detail, could you tell us, based on your history with Knowles, if September is a bigger quarter in revenues or December is a bigger quarter in revenues?

Well, it's a little bit of a mixed bag, Harsh. Here's why. When you think about how we deliver microphones, we actually have to deliver microphones to somebody who puts them onto a printed circuit board or a flex circuit, who then delivers it to the final assembler. Versus on the speakers and receivers, we actually deliver that directly to the final assembler and get assembled in the phone.

So in general, what I would say is that Q3, or I would say earlier on, microphones are tend to be stronger. And as we go into the later parts, speakers and receivers pick up little bit later than the microphones. So if you think about it is speakers and receivers for all of our customers get inserted at the final phone versus our microphones are sold upstream further in the supply chain.

Got it. That's actually very helpful. And then I know that you guys have been pretty vocal about it, that you had to take a little bit of an ASP haircut to get back and do some of the customers.

So if I said okay, let's just look a couple of years out. Without that hit, what do you think -- and without that distraction, where do you think your margins would have been? How much of a hit do you think you had to take because of that factor being involved?

So far, what I would say is the hit has been extremely short term. I don't view it being as that long term of a hit to ASPs. We are already pretty pleased at some of the ASPs on our new products that we have coming out in the back half of the year. I'd also say, as you think about why we invested in intelligent audio and why we bought Audience, it's about ASPs. It's about gross margins.

And so from our perspective is we believe the story that better performance, new applications, customers are willing to pay for that if it results in those things for the end consumer. As that be said, with intelligent audio coming over the next 12 to 18 months, what we see is that as that ASPs should begin to accelerate based on some of the things we're working on.

If I could just add a point to clarify, too, that the price concessions were really on I'll call it products in the market today versus new products coming out, call it, later this year. I think it's important to distinguish that. Because of the increasing specifications on new product, there's always a reset on ASPs.

As the products become more and more different -- two generations, three generations ahead -- there's a lot less impact on what happened to the ASPs two generations ago.

No, that's fair. And that's actually also consistent with what you guys have said. Jeff, as you guys get your arms around Audience, you sound a lot better about your ability to take costs out.

What are some of the easiest costs that you think you can take out? You don't have to give us a lot of detail, because I'm sure there's a lot of people listening in to this call. But if you just had to look at one or two of the easiest things you can do with Audience to cut costs, what would those be?

I'll let John speak to some of the exact things. But Knowles has got a history of being pretty good at taking cost out. So we feel pretty good about where we are today relative to the cost.

There's a lot of work that has to be done in these things. When you take costs out, we know there's a fair amount of work here. But we have an organization that's pretty good at doing it. And I'll let John comment a little bit on what type of cost takeouts.

The big areas are consistent with what we talked about when we announced the acquisition. It's really the public company costs -- executive officers. There are some selective finance, admin, corporate function areas. There's some occupancy costs.

And we've started on that trek to realize that $25 million in Q3. Again, we expect to see 50% of the savings by the end of Q4, with the remainder being realized by the end of Q1 of 2016.

And I would just add probably the biggest challenge is is we got to get Audience on to our business processes. Right? And that allows us to take the cost out once they are on our business processes. And we are in that process right now of migrating over to our business process and system.

Great. And then last one for me and then I'll move on. Jeff, if I had asked you what would be one or two of the most exciting things you could do with the Audience product in terms of an actual example, what would you say that would be?

It's an interesting question. Here's what I would just say is I could use a couple of these things, a couple examples. First of all, let me use the smart mic. Let's get out in front of that right now.

We have been talking about smart mics now for probably 6 to 9 months. We've got our first products out there; secured design wins in Q2 with sales in Q3. What I think -- we have a lot of ideas what to do with smart mics. But doing it organically, we can only do so much at a time. Audience has all the capabilities to be able to accelerate the number of products that we introduce over time in the smart mic area.

The other one that I am pretty excited about short term is the noise suppression software. Every customer we talk with acknowledges that Audience has the best-in-class noise suppression algorithms in the marketplace.

We talked a lot about that. As a public company, Audience was trying to sell a piece of hardware with software in order to have higher sales.

We don't really need to do that. We think of it more as if we can get our noise suppression software and eventually optimize the noise suppression with our smart mics, what you can see is a really great opportunity for us to improve our margins, grow our sales, at the same time, giving the customers a better solution.

So those are probably the two big ones that I would say that are on the forefront. Added with there are products that Audience has that we are going to leverage our sales capability, our relationships, to start selling those products. So those are the three things.

Hey, guys. Thank you so much for your time.

Robert Sassoon of RF Lafferty.

Thank you for taking my questions. On Audience, you say you are going to basically cut $25 million by the end of the first quarter. So to get to the earnings accretion level, does that mean from then on that it really is then largely reliant on getting the revenue synergies?

Yes. I would say that that would be where the majority of how we get there. I'm sure there will be potential other cost reduction opportunities. We always talk about cost. We are highly focused on it.

But for sure, what we see is this ability to really get these products that we have been working on or the Audience products out in front of the larger space of customers and start selling that with, again, the design cycle, 6 to 12 months design cycle. So we are just starting that off.

And so what we had anticipated that you would start to see the outcome of this starting some in Q1, into Q2, and then it would really start to accelerate as we get these products in the market, into our customers.

Right. Okay. Second question I had is on the iPhone 6 platform. The actual next update of iPhone 6, people say, is going to come through in September or October. So is that, from your perspective, seen as a new products? Or as a continuation of the existing platform in terms of how ASPs will be sent and the product you send?

I really can't comment specifically about that specific platform. I would just say in general, our goal is to have a new product on every successive generation with all our customers. And they are asking us for new products.

So if you think about it from our perspective, our R&D focus in the short term is very focused on delivering an incrementally better product, whether it be speaker, receiver, or microphone, for a next-generation platform. In the long term, we talk more about intelligent audio and really changing the landscape of what's bought.

Right. Yes. From the perspective of a product upgrade, it's obviously a completely new generation phone. Is that seen from your perspective as a continuation of an existing platform or a completely new product?

Typically, new product.

Okay. And my final question is that basically, you've been talking a lot about China and obviously the growth prospects there, even if the smartphone market there seems to be maturing, to some extent.

But one market that you haven't talked about, but maybe you can give us a perspective on how you see it, is India, which seems to be the next real growth market in smartphones. Where are you positioned at the moment with respect to India? And what is your strategy in approaching it? Is there a different approach to India than might have been the case that you've actually approached in with respect to China?

Well, what's not clear in India yet is who the winners and losers are going to be in China. I don't think it's just India. Think of India, think of Indonesia. Think there's all these other third-tier countries where smartphones are just starting to get going.

And I think this is one of the benefits of where Knowles is in terms of being very broad amongst a lot of customers. I always tell that story: three or four years ago, we did zero business with Xiaomi. Today, Xiaomi is one of our larger customers.

So I think if you think about where the market is going, the question we have to ask first is, is it going to be one of the existing brands that are going to be successful there? Or is it going to be a new brand that doesn't exist?

We are engaged with all these guys. So as they start to want better acoustics, better phones -- like we went through first in US, then it was in Korea, then it was in Japan and then it was in China. Eventually, people will sit there and say we want better acoustics.

And if Microsoft is successful there, then we will be okay. If the customers in China become successful in India, we will be okay. If it's the North American OEM, we will be okay, because of the fact that we have such a broad base of customers.

So we are watching this market very closely. I wouldn't say -- but right now, I would say still our focus is on a global basis with the North American OEM, the Korean OEM, and then the Chinese players, which are increasingly now what you are starting to see is winners and losers that are coming out of the China market.

All right. And it seems -- just one more thing now. It seems that one of the winners -- and they've actually is trying to expand into the India market -- is one of the Chinese OEMs, is Huawei. Are you involved with them at all?

Yes. Huawei is large customer of ours. We do a fair amount of business with them and we are well positioned with them. Again, that's the good example. If they are successful, Huawei, then we will be there. We are there.

Just to give you an example, at Huawei, it's one of our customers that we spend, install a fair amount of our integrated audio modules. We do a fair amount of work with them in that area. So it looks -- I think Huawei will be potentially one of the winners in the marketplace. I agree with you.

Okay. Thanks very much.

Chris Rolland of FBR Capital Markets.

Thanks for the question. On Audience, as I think about the linearity towards accretion here, if I got this right, it sounds like we're going to get an expense benefit over the next couple of quarters. And then perhaps there may be a gap until you have joint products together. Am I thinking about that right?

I would think of it a little bit differently. I would say you are right on the front part, which is about the expense. But then I think what you got to think about is the product that we started organically, our hope is to accelerate those. And then on top of that, then we will have the new products plus their products that we are cross-selling.

So I would sit there and say there's three categories of products. There's the stuff we are going to jointly develop. There's the stuff that we have already started organically. And then there's their products that we are going to take to other customers. There's three pieces to it.

Okay, excellent. That is helpful. Exiting 2016, in terms of the top-line accretion that you are thinking about or those extra revenues, how do you divide it up into those three buckets?

I don't think we've looked at it that closely yet. I think we are very early days with talking to all the customers. In general, I would just say is that the software licensing is probably a very high gross margin. We know it's very high gross margin. But the sales per unit are probably lower.

If you think of smart mics, the smart mics that we look to be selling today and hopefully accelerating in 2016, the ASPs are quite a bit higher than our standard ASPs for microphones. And then some the existing products, I think, that Audience has, like digital signal processors, we don't think the price will be that dramatically different than what they sell today. It's just the hope is to sell it to more people.

So if I were to say the buckets from a sale standpoint, I would say smart mics, followed by the Audience products, followed by probably software licensing.

Okay, thank you. And you were pretty helpful in providing us with some longer-term gross margin guidance beyond just a quarter to just help us through this transition that we have been going through over the past couple of quarters here. Maybe you could give us a little bit more color there; what we could see potentially into the fourth quarter, let's say.

And if you could force rank the drivers that you see for that gross margin expansion, whether it's price improvements or share gains at your large North American customer or Chinese or whether it's mix? What's going on there? What are the things to look at?

Sure, I can take this one. First, maybe we just recap what I mentioned in the script. For Q2, gross margins were up about 270 basis points, really driven across both segments. And it was driven by improved factory utilization, productivity, a little bit of currency, as well as product mix.

For Q3, in our guide, I also mentioned another 370 basis point improvement at the mid-point, and again, driven by new product introductions, productivity gains, and microphone share recovery.

As I mentioned on the last call, we believe there is further opportunity for sequential gross margin expansion beyond Q3. And it's really driven by the same things, the same themes from Q2 and Q3. We do expect a little better factory asset utilization in Q4. Jeff talked about this a little earlier in the call.

July, especially in our speaker receiver business, we don't have a lot of production going on versus in the fourth quarter, we will have, call it, three solid months. We also will be completing the hearing health transfer to our low-cost facility in the Philippines at the end of Q3. And so that should be a tailwind for us in Q4 and going forward.

And then the other is just the proportion of new product sales that we envision. So again, I think there's opportunity for sequential gross margin expansion beyond Q3.

Great. Thanks so much, guys.

Alex Gauna of JMP Securities.

Thanks for taking my question. John, I know you just touched on this. But I wanted to get into that improvement you saw in gross margins here in the June quarter. Kind of surprises me, the magnitude you are able to achieve with the softness out of your large Korean customer.

Were you taking capacity off-line? Was it part of your restructuring on part of this? I'm just wondering on how you got the better loading in that environment. And I would have assumed that, even though you are recovering a share at your North American OEM, that those -- my understanding with those were discounted parts because of the recall. So maybe some more color on how you achieved such good growth on the gross margin line.

Yes, Alex. To your first question, no, we didn't take out capacity, factory capacity in the quarter. It really is all about utilizing, a better utilization of capacity in our existing facilities. Again, on the mics, where we are building and it's going into a flex, we started that ramp up this month. So we are seeing some pretty sequential improvement in capacity utilization.

But yes, that's the biggest driver is volume on the top line as well as absorption from higher production levels. And I would say that's probably two-thirds of the 370 basis points improvement. Again, there are some other impacts that we are still getting the benefits of prior restructurings that we had done. But the big driver is really, again, volume and fixed-asset absorption.

And just to say the other thing, too, Alex, is in our specialty component, we don't talk too much about that. But the gross margin was better in that business. And I think what you see here is a fair amount of the restructuring activities have been taking place over the last year or so, going into effect. So you are starting to see some of the cost reductions we take going into effect as well.

Okay, fair enough.

Yes, just to add to that, Jeff brings up a good point about acoustics. We are seeing some margin improvement there. And it's really due to MEMS penetration as well as our hearing health or our transfer to our low-cost facility in the Philippines. But the MEMS portion of that business continues to grow, which helps us on margin.

And I know you are preparing us for some further uncertainty around your large Korean customer that has share issues in the marketplace. But there are also some refreshes coming the back part of the year. Are there any hidden gotchas in this in terms of maybe reduced mic counts or share that we should be cognizant of there rolling into this quarter?

I think we are pretty well positioned at that Korean OEM. If you think about the Audience acquisition, considering that is one of their largest customers, I think it only improves our position at that customer.

And I know there's -- again, there are a number of refreshes that are coming that we hear about in the marketplace. And right now, I would say that we think we are very well positioned to continue to be a significant player in those platforms.

Okay, great. Thank you. Congratulations on the improved outlook.

(Operator Instructions) Anthony Stoss of Craig-Hallum.

Outside of your American OEM, could you talk about what you're seeing on the ASP side, if you expect that to move up as well in the second half of the year?

And then also if you would venture a guess into Q4 in China? So China was strong in Q2; you expect it to be up in Q3. Any visibility into Q4 this point? And then lastly, I know you guys didn't own Audience in Q2. But I'm curious their revenue for the June quarter.

The first question there was about the ASP outside non-US. I wouldn't say I've looked in that level of detail. But what I would probably say is that the ASPs are probably down on the mature products in line with expectation. And there are some new products that will be coming out in the back half of the year, specifically for outside of -- into the Chinese OEMs. So we feel pretty good about some of the products that are coming out to the Chinese OEMs later this year.

The second question I think you asked was about revenue for China in Q4. Here's what I would say. We are expecting growth in Q3. It will be a little bit on a sequential basis a little bit more moderate compared to what it was from Q1 to Q2.

And I think we got to continue to watch this. They have a lot of new products coming out. But the market is slowing. I think the positive for us is we continue to see that we are growing faster than the market itself is growing.

And it's because we are still converting the old ECM technology over to MEMS microphones. It comes from a higher-value solutions as well as multi-mic adoption. We continue to see those trends in China playing out, that there are more microphones on average as every successive generation of phones is introduced.

The last question, on Audience -- I don't know. Do we have the Audience, the Q2 number that they are asking about are the sales for Q2? We didn't give any numbers on that.

Just curious if it's roughly in line or what your expectations are for [varieties] going forward.

It's a bit above our guidance for Q3, just a bit above that. So our guide for Q3 was $10 million. It's a little north of that.

Slightly north of that.

Okay. Thanks, guys.

There are no further questions in queue at this time. I will turn the call back over for closing remarks.

Great. Thanks, Latoya. And thanks for everybody for joining us today. We appreciate your interest in Knowles and look forward to speaking with you on our next earnings call. Thanks and goodbye.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.