Knowles Corp (KN) 2015 Q3 法說會逐字稿

Good afternoon and welcome to the Knowles Corporation third-quarter 2015 financial results conference call. (Operator Instructions) As a reminder, this conference is being recorded.

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

Thanks, Shanice, and welcome to our third-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 uncertainties that could cause actual results to differ materially from current expectations.

The Company urges investors to review the risks and uncertainties in the Company's SEC filings, including, but not limited to, the annual report on Form 10-K for the fiscal year ended December 31, 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 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 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 third-quarter results. Jeff?

Thanks, Mike. Thanks to all of you for joining us today. For Q3, we reported revenue of $295 million, up over 20% sequentially at the midpoint of our guidance -- and at the midpoint of our guidance. Gross margins were 32.1% and EPS was $0.16. Both metrics came in at the high end of the range we provided on our Q2 call.

Organic revenue in our mobile consumer segment was up over 30% from Q2, in line with our projections. Microphone sales were up over 50% quarter over quarter, driven by significant growth at a North American OEM as we supported the launch of their new handsets, new product launches from a Korean OEM, and normal seasonality.

Speaker sales were slightly below expectations due to the timing of the launch of our customer's new handsets. Sales to the Chinese OEMs declined sequentially due to timing of product launches at a specific customer. Revenue from Audience-related products came in as expected. Revenue from MCE comprised 64% of total sales in the third quarter.

There were several important highlights surrounding the launch of our largest customer's new handsets that I wanted to point out. First, teardowns of the new products revealed that four MEMS microphones were implemented in the device versus three in the prior generation. This provides additional evidence of multi-mic adoption trend we have talked about over the past several quarters. The move to more mics per device can be seen across customers and platforms to improve performance and enable features like voice to text.

We continue to benefit from multi-mic adoption, as it expands the available market for MEMS microphones. We believe that our technological leadership and scale is unmatched in this market and makes us an important partner when designing next-generation mobile devices.

In August, IDC lowered its global smartphone growth forecast for 2015 to 10.4% from 11.3%, citing a slowdown in China as the country joins North America and Western Europe in a more mature growth pattern. We see moderating growth from Chinese customers, but we still anticipate year-over-year growth from Chinese OEMs as we increase content per device through multi-mic adoption and high-value acoustics, including intelligent audio solutions.

Intelligent audio remains an important driver of our business over the next several years across a wide breadth of geographies and customers. I wanted to focus on two important intelligent audio solutions that are already gaining traction.

Our Voice iQ solution is the world's first always on smart microphone that repartitions the audio path to significantly reduce power consumption and improve battery life relative to other architectures. Many customers are focused on improving always-on capabilities and we believe our solutions optimizes power use, enables flexible design across multiple architectures, and has the potential to reduce billed material costs.

For consumers, this solution expands how they use and experience voice-enabled digital interfaces on devices, including handsets, wearables, and headsets. Rather than touching a smartphone button to activate a voice interface or digital assistant, consumers can simply speak to the devices for seamless hands-free control.

I'm excited to report that Voice iQ has been adopted by several ecosystem partners, including Qualcomm's Bluetooth audio headset solutions. I expect more reference designs and design wins for Voice iQ in the quarters to come and believe it is an important first step in expanding our intelligent audio business.

The second intelligent audio solution that is starting to generate revenue is our I2S solution. Using the I2S interface, manufacturers can connect MEMS microphones directly to the application's processor, which is ideal for the wearables market. The result is a more efficient architecture to decrease complexity, increase battery proponents, and lower billed material costs. We recently began shipping our I2S microphone to several platforms, including the Moto 360 smartwatch.

Audience's expertise in software and digital signal processing remains critical to our intelligent audio roadmap. The combination of software, signal processing, and acoustics will enable us to optimize the audio signal path with new architectures that can dramatically improve performance and bring new features to the market. We believe this will result in next-generation products and applications like smart mics, ultrasonics, and wind noise reduction for hearables.

I believe we are still at the very early stages of what can be possible when building an audio system versus individual components. Overall, we expect continued design win success around intelligent audio with our organic and Audience-related solutions and anticipate revenue will begin to accelerate in Q3 2016, with earnings accretion by Q4 2016.

In the specialty components segment, Q3 sales were down 3% quarter over quarter, slightly lower than expectation, representing about 36% of the total Company revenue. Despite lower sales, gross margins for the segment increased 170 basis points sequentially from 39.5% to 41.2%, helped by improvements in our cost structure. Weaker-than-expected demand for timing devices used in wireless infrastructure market and lower hearing health revenue following a very strong Q2 were primarily responsible for the decline. Capacity to revenue remained stable during the quarter, with strength in medical sales offsetting declines in telecom infrastructure.

In Q4, we expect hearing health sales to improve to the highest levels of the year. Additionally, the transfer of hearing health production to our Philippines facility was completed in Q3 and we expect continued margin improvement in Q4. Sales and capacitors and in timing are expected to remain consistent with Q3 levels.

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

Thanks, Jeff. As Jeff mentioned earlier, we reported third-quarter revenues of $295 million, at the midpoint of our projected range. Mobile consumer electronic revenues of $189 million were up over 40% sequentially, 34% organic, primarily due to higher microphone shipments to support our largest customer's launch of a next-generation handset.

Revenue growth was slightly offset by weaker-than-expected sales to Chinese OEMs due to both soft market demand and customer delays in new product introductions. Audience revenues were in line with our guidance.

Specialty component revenues of $105 million were down 3% sequentially, slightly below expectations. Softer-than-expected demand of timing devices for LTE infrastructure and larger-than-expected customer inventory rebalancing within hearing health drove the revenue shortfall.

Third-quarter gross margins were up 480 basis points sequentially to 32.1%, at the high end of our expectations. Margin improvement was driven across both segments. In MCE, margin expansion related to increased volume, improved capacity utilization, productivity gains, and favorable product mix, specifically a higher proportion of microphone shipments. Specialty component margin improvements were aided by the transfer of the hearing health business to our low-cost facility in the Philippines, which was completed in the quarter.

Total Company gross margins have expanded 750 basis points since Q1 of this year, driven by higher volume and related capacity utilization, the ongoing implementation of our cost reduction initiatives, product mix, and foreign currency impacts.

Operating expense in the third quarter was approximately $73 million. The sequential increase in expense was directly related to the acquisition of Audience and slightly lower than expected, as cost synergies related to integration have been realized earlier than expected. We remain on track to achieve the $25 million in annual cost savings associated with the integration of Audience by the end of Q1 2016.

Adjusted EBIT margin was 6.7%, near the high end of our guidance range. Non-GAAP diluted EPS was $0.16, $0.05 above the midpoint of our projected range, with $0.02 of the favorable variance driven by operations and $0.03 from a lower effective tax rate. 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 $58 million at September 30. For the quarter, cash used for operating activities was $12 million and included nonrecurring payments related to the acquisition and integration of Audience of $10 million and restructuring and production transfer costs of $9 million. Capital spending in the quarter was $10 million.

Our bank debt balance was $475 million at the end of the quarter, with the sequential increase primarily due to the acquisition of Audience, which closed on July 1. Interest expense was approximately $4 million in the quarter.

Now I will turn to our fourth-quarter guidance. We expect revenue for the fourth quarter to be between $290 million and $310 million. MCE revenue is expected to be up slightly at the midpoint. This is expected to be driven by continued sequential growth at a key North American OEM, partially offset by decreasing shipments to a Korean OEM in connection with the timing of their new product introductions. Revenue to Chinese OEMs is expected to increase modestly in Q4 from Q3 levels.

Specialty component revenue is expected to be up about 5% on a sequential basis, driven by seasonal strength in the hearing health business. We are projecting non-GAAP gross margin to be approximately 31% to 34%, up 40 basis points sequentially at the midpoint due primarily to favorable foreign currency impacts, partially offset by unfavorable product mix in our MCE business.

R&D spending in the quarter is expected to be $33 million, or 11% of sales, up slightly from Q3 levels. Selling and administrative expense is expected to be approximately $40 million, down slightly from Q3 levels. We are projecting adjusted EBIT margin to be between 7% and 9%.

We expect non-GAAP diluted EPS for the quarter to be within a range of $0.18 to $0.24 per share. This assumes weighted average shares outstanding during the quarter of 90 million on a fully diluted basis. We expect our long-term effective tax rate to be between 13% and 15%. Please refer to our press release for a GAAP to non-GAAP reconciliation.

For the fourth quarter, we expect cash flow from operating activities to be within a range of $30 million to $40 million. This includes restructuring and production transfer payments of $6 million. CapEx in the fourth quarter is expected to be approximately $20 million.

As I mentioned previously, our estimated cost reductions in connection with the integration of Audience are ahead of schedule. We expect to be more than halfway to the projected cost synergy goal of $25 million annually by the end of Q4, with the remaining synergies being realized by the end of Q1 2016. We continue to believe that the acquisition will be accretive by the fourth quarter of next year.

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

Thanks, John. We were pleased to see strong sequential growth in our core mobile consumer business in Q3, driven by multi-mic adoption, recovery of share at a major OEM, and normal seasonal trends. We are continuing to see the benefits that restructuring is having on our specialty component business.

We now look forward to 2016 to drive adoption of our intelligent audio solutions as we optimize the audio signal path to enhance performance and enable new applications for our customers. I am pleased with the initial progress we have made is we transform from a leading acoustics provider to a world-class audio solutions partner. This journey as far from over, but we are confident in our growth plans and our ability to expand our margins over the long term.

Operator, we can now take questions.

(Operator Instructions) Harsh Kumar, Stephens.

Thanks for the opportunity to ask a question. Jeff, if I can just ask the question that's on mind of everybody. Your December implied guidance is up about $15 million. You've got one pretty large significant, call it, US-based customer that's ramping. You talked about a couple of parts and pieces that are moving China, Samsung, etc.

Can you talk about that one particular customer, if they are driving the bulk of the uptake? And I know that they are ramping pretty high in the December quarter. Why are you not seeing more than just $14 million, $15 million in the December quarter?

Harsh, that's a good question. First, let me just take you back a little bit to the story about how we -- our business operates. We have two pieces: we have the microphones and we have speakers.

The microphones tend to come earlier in the process. They are taken upstream; they have to put in a flex circuit, which gets delivered to a manufacturer to put in a phone. When the speakers are inserted directly into the phone, I guess what I would say is that a couple weeks of timing here can have big impacts on quarters. And remember, our speakers share has typically been lower.

So I guess the way we're kind of looking at it is that if you look at the back half of the year as a total, we are pretty much in line with the expectation, knowing that mics come earlier, speakers come later. And to be quite frank, the speaker -- the phone production probably started just a week or two later than we expected. So it kind of had some impact on these two businesses.

Very hopeful, Jeff. If I can ask a couple more. So you mentioned Audience cost cuts. This may be a question for John more. So when we look at the March quarter, as you take out more costs, should we expect therefore a pretty nice sequential drop in straight-up absolute dollar OpEx expenses as we finish the March quarter?

So the question you are really asking is are we going to see the OpEx reduction for quarter over quarter from --

From December to March, yes.

For December to March. Yes, I think that's correct, Harsh. As I said, we expect -- when we came out, we estimated $25 million in cost take out. We obviously realized some of those in Q3. We expect to get another layer in Q4 and be at our goal or halfway through our goal of $25 million annualized by the end of Q4. And then the remainder will come out by the end of Q1 of next year.

Great. And then last one and I will get back in line. We've heard from a couple of semiconductor guys that sell to Samsung that there is some timing stuff -- timing movement going on and timing of shipment. They are all talking about a weak December followed by a pretty big uptick in March. Are you guys seeing that as well or do you have anything to comment regards to that statement?

I guess just to comment on Korean OEM, we have obviously very good share there. We are extremely well positioned with them. And while we're not going to go into a great amount of detail about the Q1 quarter, our expectation is that just like there is every year, there's a big product launch by that company in the Q1 quarter. And that will drive strong sequential improvement in the Korean OEM's business from this quarter that we are in to the next quarter.

Great, guys. I will get back in line. Thanks.

Jaeson Schmidt, Lake Street Capital.

Thanks for taking my question. Just wanted to dig into China a bit. Wondering if you could comment about your visibility there and your thoughts surrounding channel inventory over it.

Yes, so here's how I kind of put it. I think we saw kind of a slowdown in Q3, but we expect an uptick back in Q4. And I just would kind of highlight two things.

Number one is we've been projecting a slowdown in the growth all along, so I don't think the slowdown in the growth is surprising. But additionally, I think what we've been looking at is a kind of delay or -- in product timing of a lot of their products -- the launching of their products.

And I would just highlight that one specific customer -- which I'm not going to go into details -- that within China is probably more problematic than the rest in terms of bringing down the China growth number. It's more about timing of launch of products.

Okay, that's helpful. And can you remind how much China is currently contributing to the top line?

We're looking at the number here in terms of -- it's probably about 10% of the business as a total, maybe a little bit higher, growing still, obviously. But about 10% of the business.

Okay, perfect. And wondering if you could comment a bit about what you're seeing from a pricing standpoint in both mics and speakers.

Yes. I would say obviously, we are watching ASPs very closely. And our ASPs are highly dependent on making sure we get new products out. And I bring it to two things. And you can see in the mobile consumer space, now that we are back into the North American OEM, how that impacts the margins to the positive. You can just see it. And obviously, part of that is the newer products are higher ASP than the more mature products.

But I also would draw you to that -- the other thing that really comes into play here -- which again, ASPs are very important -- is about fixed overhead absorption. And you can see when we are running full how it impacts the margins to the positive.

So I think from our perspective, this is a big balancing act. We got to get the new products out, we got to get the higher ASPs, but we also want to make sure that we run our capacity at a high level.

All right. Thanks a lot, guys.

Bob Labick, CJS Securities.

You touched on it earlier in the call, but could you just elaborate on some of the uses for the fourth mic that's on the US OEM phone? And talk about the industry applications. Do you expect other OEMs to follow and continue to increase multi-mic adoption?

Well, let me take the second question first. The trend for multi-mic adoption is still strong. We see it on a regular basis that people are moving toward multi-mic.

I'm not going to make a comment how the North American OEMs bring a fourth mic impact for their people in the future, but I would just say generally speaking, it would be pretty obvious that would be a positive to see that they are adding more microphones in order to improve performance.

My understanding is the microphone has added -- a second microphone is added at a bottom of the phone. It's used in various different applications, again, to move the -- to improve the performance.

I just keep coming back to is a lot of people in the midrange and the low end are going from one to two, two to three, and so what you see is that the trend is not stopping, that people are continuing to look at multi-mic adoption. And we are hopeful that at some point in the future, people will look even more mics. Because there are other applications that we see people starting to think about that may be requiring more microphones.

Okay, great. Thank you. And then you touched on a couple of new products that we should expect to see maybe 2016 and beyond. There's some we've talked about in the past. I was wondering if you give us an update specifically on where you stand with any traction with ultrasonics or N'Bass or the wind noise cancellation. And if any of that -- sales from those products might be coming in 2016?

I would sit there and say it's first on N'Bass. We have N'Bass sales and we will continue to have N'Bass sales. They are typically integrated into the speaker sales, so they are not like an independent product. They are part of another product. I would say that it's significant in the fact that it adds some value, but it's really part of the speaker business.

What I'd say is what I'm more excited and interested about is ultrasonics and our hearables technology, which I think a number of you on the call probably heard. I think it's a little early days both on these to go -- to project exactly when this will result in revenue, but I would say that our expectations is both these products would generate revenue in 2016. They're probably, I would say, 6 to 9 months behind where we are in some of the other products, like smart mics.

Okay. Thank you very much.

Chris Rolland, FBR & Company.

Thanks for the question. Can you guys talk about the stumbles at one of your major competitors? How do you think about your share in the absence and their absence?

And then when building your 4Q assumption, how are you addressing that? Are you assuming that they are coming online early in the quarter, late in the quarter? What was your timing around that timing assumption?

I'm assuming you are referring to STM, correct?

Correct.

Okay. Well, kind of how I view it is STM really hasn't been a significant supplier overall in the marketplace. If you take them in terms of what they're -- we believe they're supplying relative to the size of the market, it really hasn't been that significant. So I would sit there and say it really hasn't been a big factor either to the positive or the negative as we go through the quarter, I wouldn't sit there and say.

I think this is a story of -- I think we talked about this before. If you go back to some of the other competitors' businesses there in the semiconductor space, it's one platform in, one platform out. And I can't project when they can get back in or if they get back in. I'm not really in a position to make that comment.

But when I am in a position to say the comment is is that we took back significant share in Q3, and we're not exactly where we want to be yet. We still would like to get some our share back, but -- and we expect that going forward, we're going to be a major supplier into this market, as we have always been, and with our goal of getting to 60% share or higher.

Okay. I think they've previously talked about maybe 250 million mics a year. If you look at the last generation of the iPhone, it was -- probably, if I were to guess, maybe 20%, 25% share. So there is -- if they are not in this generation thus far and are coming back online in Q4, that could impact your share in 4Q.

So as I think about your 4Q guide, am I assuming that the sequential increase is not as great as it could have been, given STM coming on partially in the quarter? Or are you not including that at all?

Again, what I would say is they have not been significant supplier, and I can't speak to where they are in the process. I don't know where they are in the process. But what I would say is remember, we don't just sell one mic to one platform. We sell it to the Chinese OEMs; we sell to all the OEMs. We sell across tablets, headsets, handsets, go right down the list. And overall, they are not a significant share of the total.

The second thing is we also have other products that we sell, like speakers and receivers to the OEM. And one thing that this continues to be is we have a seat at the table with all of our customers as a strategic, strategic acoustic supplier. That can't be said for all the players in this marketplace.

Okay, great. And maybe if you guys can talk about specialty electronics and the components there. First of all, is there any seasonality for that business, particularly if we were to break it up in between hearing health and some of the passives business? And secondly, if there is no seasonality, is there anything we should kind of think about that could either be accelerating or decelerating in that business in the coming quarter or two?

Let me just break it down into two of the precision devices, which we consider capacitors and the timing business. I don't think we see a lot of seasonality in that -- in those businesses. I would say we call it more, especially in the timing business, it's more lumpy than I would say seasonal. And we've been suffering through this year on the timing business after a very strong 2014, a very weak 2015.

I'm not prepared to sit there and say that as we enter into 2016 that there is any type of significant improvement in the timing business at this point. So if -- what you would say in the timing business is if telecom infrastructure starts to resume, we will be in a good position to take advantage of that. And we will see growth sequentially and year over year.

On the hearing health side, there is a little bit of seasonality. It's nowhere near the type of seasonality we see in the mobile consumer, but typically, Q4 is a very strong quarter for the hearing aid business or the hearing health business.

We still -- we really like this business, obviously, the hearing health business. We've been a supplier to that market for 40, 50 years. It is extremely stable for us, and we're very well positioned with 60%-plus share of the overall acoustics business.

So we really like this business, and we think over the long term, this has got some growth potential as Baby Boomers good old, as emerging markets become more wealthy, and the middle class expands. So this is a business we continue to invest in and believe in for the future.

Great, thanks, guys. Really appreciate the time.

Tristan Gerra, Baird.

You talked a little bit about Samsung beyond Q4. Could you talk at a higher level what typical seasonality you see for Q1 at the top line? And do you see any factors that will lead those to trend differently from that typical seasonality?

Yes. Typically, Q1 is our weakest quarter in terms of sales. And there is a couple things that drive that. Number one is the market in China is closed down. It's kind of like the Christmas holiday is in the Western world, which is for about two weeks, productivity goes down the tubes and they stop building.

So we do have some things that -- challenges always in the fourth quarter relative to capacity utilization. And usually I would say at the end of after Chinese New Year, everybody comes back -- and we're talking about not our inventory, but our customers come back and see where their inventory is in the mobile consumer.

The other thing that usually happens in Q1 over the last few years has been the Korean OEM launches. And that typically drives a fair amount of sales, partially offsetting what's going on with Chinese New Year.

I would say at this point, we don't see a lot different from what we normally would see for Q1 this time. Obviously, it's a little early days to project how things turn out in Q1. But right now, I don't think we see things dramatically different than we normally do would for Q1.

Okay, that's useful. And then as a follow-up, in your specialty business and your exposure in wireless infrastructure -- some companies have noted a stabilization in Q3. Do you feel that there is any market share shift that could potentially impact you? And also how strategic do you see this business for Knowles going forward?

Well, here's what I would say is in Q3, we did see business slightly below what we expected. I would sit there and say there's a glimmer of hope in Q4. I wouldn't sit there and say it's translating into shipments yet, but we're starting to see just a glimmer that things may be turning. I'm not prepared to make the call to say that this is going to result in significant improvement at this point, but we are starting to see some glimmers that things are improving.

From an order intake standpoint.

From an order intake standpoint. But I wouldn't hold my breath around this yet. It's a little too early to be able to project. We know the business will come back, Tristan. We don't believe share has shifted. We believe the business will come back.

And from a perspective, I would sit there and say is we continue to operate with this business as another electronic component business amongst a number of other things. Clearly, we are investing a lot in acoustics. There's no doubt about it -- and in audio. But this business does generate cash, it doesn't require a ton of reinvestment, and they are very well positioned in the markets that they're in.

Great. Thank you.

Alex Gauna, JMP Securities.

Jeff, just moments ago, you said your goal is to get back to above 60% market share in MEMS mic. I'm wondering if you were to hazard a ballpark guess what type of share you might be exiting 2015 at, either on a run rate basis or the full year. Just to give us a sense of where you are in progressing towards your goal.

Yes, Alex, I think it's a little too early to make that call yet because what's really difficult for us to tell is how many phones are being built until after they are announced -- how many that are built. So we can look at what we are shipping, but it's really a challenge for us to project out exactly how that translates in the share.

I think what my take is we'll probably have a better understanding of what our share is on the Q1 call. We may be able to talk a little bit more about that for 2015. But for sure, for sure, we made a major step forward in Q3 from -- we talk about Q1. We had very minor share on the platform that was in volume. Of course, we have other business with that customer in terms of tablets and headsets and whatever. Speakers, receivers, everything.

But we saw another uptick in Q2 and as we talked about in the previous call, we felt we were pretty well positioned for the launch in Q3. And it's come through in terms of the sales number as well as the gross margin and the earnings numbers.

Okay. The way things are trending right now is you see the design win landscape and the strength of your products. Is that a reasonable goal for next year 2016 to be above 60% share? I know it's early to --.

Yes, I think it's a little early to say that. I guess what I would sit there and say is that our core business is really back on firm footing in Q3 -- growing from Q2 to Q3 and into Q4. We're really excited about some of the stuff we got going on in microphones that Audience capability allows us to execute on.

And if we're successful with Audience, I can for sure see a path to the 60%-plus. But we got a lot of work to do yet in the Audience area to bring in the new -- get new products out and start getting designed in -- although we are making progress -- and then begin to ship them.

Okay. And I know you said it was too early to draw firm conclusions, but on the timing uptake and the order intake, is that specific to any region or is it broadly speaking? Any color there would be appreciated.

You are speaking --

Primarily China.

Yes, wireless infrastructure.

Yes. I think -- we've seen a number of customers indicate that there may be some improvement coming. But from my perspective, it's like show me the money. Until it translates into actual orders and shipments, I am reluctant to sit there and say that we're going to see a significant improvement in that business in the short term.

Okay. And one last quick one. In terms of your guidance for Q4, and you've touched on some of the moving pieces already. But would you say this is a higher-than-average quarter of visibility as you guide, normal, less than average, with all the moving pieces? Can you characterize the challenges in guiding for Q4?

I would say pretty normal.

I would say pretty normal. I think what you see is barring the problem that we had with the North American OEM almost a year ago, what you see is first of all, let's start with the specialty component business. We got a pretty good handle on what's going on there. I don't think that there is a lot -- a super lot of variance there in that.

And then when it comes down to it is I think the mobile consumer. From the mobile consumer standpoint, by the time we're at this point in the quarter, we've got a pretty good idea of what's going on because when you are talking about the volumes you are talking about, it's very hard to slow down the supply chain if there's too many bought or it's very hard to shift share to the positive to us or to the negative.

So I think we feel pretty good about our ability to forecast within the quarter, barring some unforeseen circumstance, like we had last year with the North American OEM.

Okay, thanks very much and good luck.

(Operator Instructions) Robert Sassoon, RF Lafferty.

Thanks for taking my questions. On Audience, you guided for the third-quarter revenue of $10 million and a gross margin of 45%. Were those targets actually met?

Yes, we are very much in line with those targets on both revenue and gross margin.

And can I ask what you've baked in for Audience in your guidance for the fourth quarter?

Yes. So going toward, I think -- it's a small enough portion of the business when you look overall that we're not going to continue to forecast the Audience numbers. Needless to say, obviously, if we can get more Audience sales, the gross margins are higher, that will help us. There is no doubt.

But the other issue that we have is as time is going to go on, more and more of the products are going to be a combination of what Knowles does coupled with Audience does. And it's going to be hard to break it out. So I would say from a cost standpoint, we've talked about it. We are ahead of schedule to achieve the $25 million.

From a revenue synergy standpoint, what we have is a bunch of TAM that's been opened up by Audience as well as ability to bring other products to market that we hadn't had the ability to do, like now with ultrasonics and hearables. We've talked about smart mics, increasing the amount of products that come out.

And all those things require a combination of software, requires signal processing, as well as expertise and acoustics to bring to market. So it will be increasingly difficult to breakout the Audience-specific numbers.

Okay. You previously mentioned that you could actually get Audience's gross margin on a stand-alone basis -- I know that's bearing in mind what you just said -- by selling the softwares on a stand-alone basis. Is that something that you are targeting to do and do you have a timeline for the sale of software?

Yes, so that for sure is one of our targets, to begin to sell software. Again, I think we talked about it in the previous quarter that under the Audience business model, as a stand-alone public company, it was very difficult just to sell software to this market. It wasn't really conducive to being a stand-alone public company.

For us, for sure, this is a target. I would anticipate in the first half of next year, you would start to see some revenue from the software side.

All right. And just one question on the -- I know it was a question asked earlier. I'm trying to get my head around why there is only a $5 million improvement in your revenue -- on your guided revenue at the midpoint from your third-quarter figure.

Bearing in mind that I would imagine the key driver would have been the North American OEM or new platform, the fact that they -- there are four microphones instead of three. And microphones are, as you mentioned, coming to the very early stage of the building process. So maybe are there other things that are missing that are sort of dragging down those -- that uplift to your revenue?

So yes, let me just cover back again. With the North American OEM, we ship early in the process. What I would say is we are ahead of their builds for phones because we are shipping microphones 6 to 8 weeks ahead of time to support their builds. So what you typically are seeing this quarter is more microphone sales in Q3 than in Q4.

That is offset by -- at the specifically North American OEM -- is the start of the production of the phone was just slightly later than expected. Again, big impact in the quarter that you are going to see. We see more speaker sales in Q4. Hence, why we are probably not seeing the margin improvement we would expect even on the improved sales.

Just to jump in, though, overall sequentially, sales to this North American OEM are up Q3 over Q4.

Correct. Well, I was going to get that. Sequentially, they are up. China, we expect to be up modestly, as we said. The other issue that we are facing here is at the Korean OEM, they had their launch quarter midyear in July for the Note and the Edge Plus. And now we see kind of a slowdown. We expect that to pick up again in Q1. But sequentially, Nokia is -- not Nokia -- Samsung, or the Korean OEM, is down.

And that's going to continue to the fourth quarter, you think?

Yes. I mean -- yes.

Okay.

Yes, down sequentially Q3 to Q4.

And does that actually also impact Audience's stand-alone numbers as [being in review]?

Yes, it does a bit.

It does a bit.

Okay. So going back to the original question then, you would expect Audience to be lower than the $10 million that you had guided for in the third quarter?

Yes.

Slightly, yes.

Okay. Okay, thanks.

Harsh Kumar, Stephens.

Yes. Hey, guys. Had one or two longer-term questions. Can I ask -- so you will start shipping joint products in the second quarter, I think, of next year, with some sort of intelligence in the mics. What kind of gross margin profile do you think these products will have?

That's a little far out. I would say for sure higher than the gross margin that -- the standard -- our overall average. It's going to be above (inaudible), Harsh. It's a little early to say the exact gross margin for that business, but what I would say is we had would hoped that that business would be overall greater than $40 million, approaching $50 million. Those are the type of numbers we are targeting. Kind of similar to Audience.

We've said before, Harsh: the ASPs are significantly higher on a smart mic versus a MEMS mic. Obviously, there's a little higher bond cost, but better -- clearly improved margins.

Got it. Thanks, guys; that's helpful. And then how is the process for separation and sale of the software piece going -- not piece, I should say. The licensing piece that you are trying to do with the phone guys? What's data show? Any colors you guys can provide? People like it, people don't like it, whatever.

Well, Audience has the best-in-class performance. There is no doubt about that. And we continue to hear that in terms of noise suppression software. And they've been asking -- a lot of our customers have been asking for a long time to be able to buy the software.

The implementation, it takes some time. We started that, I would say, three, four, five weeks after the deal closed because we have to essentially get the software in a format that they can actually use relative to using software only. So what I would say is we are where we expected to, be, and again, I said it earlier in one of the other questions: I would expect that we would see sales in the first half of the year.

So keeping in mind: design cycles are 6 to 12 months. So we got to be able to give them a product, and it will be small in the first half of the year. It's not going to be a big number in the first half of the year to software sales.

Got it. And then couple of the companies do this when they make acquisitions. John, I was wondering if you be able to point out for us exactly how much dilution was from Audience to the EPS number? Some companies do it and some don't. I don't know where you guys stand on your --.

Well, we did, Harsh. We did give in our guide in Q3. We did talk about $0.18 of dilution impact from Audience as both the increased shares outstanding, about $3.6 million, as well as the losses of Audience. As we said, our actual EBIT impact in the quarter was more favorable than the $0.18.

And it's just going to be -- honestly, Harsh, it's going to be a real challenge going forward to separate that out because we are fully integrating them in. In terms of they are working on products that are microphones; they may work on products in the future that are speakers. So there's a lot of product that they are going to work on and it will be integrated into the overall business.

And Harsh, just add a little more granularity to that. That tax benefit we had. When we gave that original guidance of $0.18, we weren't sure we were going to be able to benefit the losses of Audience in certain tax jurisdictions. In our actual results, we have realized and benefited that. So that was that $0.03 tax benefit that was included in the actual Q3 results and that was attributable to Audience.

Thanks, guys. And I apologize; I missed it. And then my last one is I think your longer term both gross margin as well as the other goals -- all the other goals are significantly higher from where you are at. How do you guys feel about achieving those? Just whatever longer term is: a year out, two years out, sort of the high 30%s gross margin level. Is that still a pretty good goal to think about?

Yes, I think so, Harsh. We're not changing our midterm operating model targets at this point. The themes we've talked about on the call today -- multi-mic adoption, higher value solutions -- they will bring us back to revenue growth, which we expect to start in the second half of 2016. They will also be favorable to margins.

The one thing you do have to keep in mind is R&D will be higher than what we set out in our original midterm model targets. But we still are committed to the targets that we announced back in February 2014.

Got it, guys. Thanks.

Suji Desilva, Topeka.

Clarification on the new products you're planning with Knowles and Audience in the -- I guess the mid-2016 time frame. Will those products be in a position to intercept designs and volume ramps of the new phones in the second half of 2016 or will that be too early for that product?

I would say we are hopeful it will intercept some design phones for that period because we want to have some launch customers. That's why we said we will start to see some acceleration of revenue in Q3 and we probably expect to see more revenue in Q4.

But I guess what I would say is it's not linear, like we're going to start today and you're going to see a linear to that Q4 of next year. I would say we're focused on cost reductions and then after the cost reductions are complete, we're focused on design wins that will start to show revenue in Q3 and Q4 next year.

Okay, great. And my other question is on Audience. They had a codec effort underway pre the merger. I'm wondering if that's something you're focused on or if you're deemphasizing going forward versus the intelligent mic effort.

There's a lot of things that Audience has in their portfolio; that being one of them. We continue to assess the viability of these products for sure. There's a possibility that this could be critical to our future, but I think it's a little too early days to say where the codec goes.

There's a lot of discussion in the marketplace about is -- where a codec would play and how it will play. I would say it's a great piece of technology today that we acquired as part of the Audience acquisition, and we're still working towards figuring out how to make or how that plays in the future of Knowles.

Okay, great. And then last question. You guys talk about China overall demand being a little bit weaker, but can you talk about your design momentum in China and how that looks to set you up for the next 6 to 12 months in China versus your design win today?

Yes, I would say we are very well positioned at the Chinese OEMs. I can't sit there and I can't -- I said this before and I hate to reiterate this but -- or restate it -- but I can't think of a Chinese OEM or a customer in the space that we don't participate in.

And if you look at where we were, if you go back 8 to 10 years ago when we got into this, we were a very limited player all the way now through the Audience acquisition. We are a very important player in the audio now and increasingly in acoustic space. So I feel pretty good about where we are in terms of design activity. There's a lot of design activity going on.

There's a few customers that are obviously doing more design than others. You know who the winners and losers are. You can read as well as I do, but we are very well positioned with all of them.

Great. Thanks, guys.

At this time, I'm showing no further questions. I would like to the call back over to Mike Knapp for closing remarks.

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

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.