Knowles Corp (KN) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the Knowles Corporation Third Quarter 2017 Financial Results conference call. All lines have been placed on mute to prevent any background noise. (Operator Instructions.]

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

Please go ahead.

Thanks Mike and welcome to our Q3 2017 earnings call. I'm Mike Knapp, and presenting with me on the call today are Jeff Niew, our President and Chief Executive Officer; and John Anderson, our Senior Vice President and Chief Financial Officer.

Our call today will include remarks about future expectations, plans and prospects for Knowles, which constitute forward-looking statements for purposes of the Safe Harbor provisions under applicable federal securities laws. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses and profits, and involve 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, 2016, periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today's earnings release.

All forward-looking statements are made as of the date of this call, and Knowles disclaims any duty to update such statements, except as required by law. In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today's call can be found in our press release posted on our Website at knowles.com, including a reconciliation to the most directly comparable GAAP measures.

All references on this call will be on a non-GAAP continuing operations basis unless otherwise indicated. Also, we've made selected financial information available 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 results. Jeff?

Thanks Mike and thanks to all of you for joining us today. For Q3 we reported revenue of $222 million, up 17% sequentially and above the midpoint of our guidance. Gross margins of 38.3% were within our guidance range with lower than expected operating expenses resulting in EPS of $0.28 above the midpoint of our guidance. In our audio segment, sales were up 22% sequentially and came in largely as expected. MEM's microphone revenue was up over 30% sequentially as our largest customer began the ramp of its new handsets. Overall, revenue from audio comprised 76% of total sales in the third quarter. In the precision device segment, sales grew 4% sequentially and over 8% from the year-ago period through the stronger demand for capacitor devices.

We continue to see improving order trends in our defense, medical and auto markets driving demand for these products. Precision devices represented about 24% of total company revenue in Q3. As we look at the trends benefiting our audio segment over the next several years, we continue to see strong demand for voice enabled devices; from mobile phones to headsets and from smart speakers to TV and appliances, voice powered interactions are emerging as a critical and necessary feature. Consumers want to engage with technologies through natural spoken commands across the mobile, ear, and IoT markets and OEM's are racing to develop and deploy the technology to enable it. Our core capabilities in acoustics, digital signal processing and algorithms are unparalleled and place us in an idea position to enable voice technology.

In mobile, OEM customers continue to move to more microphones per handset. Vivo went from one microphone to two in its latest V-series handsets to improve audio input and the essential phone recently launched leveraging four of our microphones to enable better noise cancellation and beamforming.

In China, demand has remained soft for most of 2017 but I recently visited with customers there and feel very good about our position with the key players in this market. We continue to demonstrate the advantages of additional microphones as well as DSP-based smart mics to improve performance and enable use cases which increases our audio content per device. I anticipate sequential growth in China in Q4 as demand recovers. With our largest customer, we expect shipments to increase from Q3 levels as new flagship handsets continue to ramp. Our share remains strong and we expect this product cycle will carry over in the next year and drive strong year-over-year revenue growth in audio in Q1 of 2018.

For the ear market, we were pleased to see Samsung announce a new active noise cancelling headset that leverages five Knowles microphones. The microphones in this device detect external noise on both the right and left side providing users with exceptional noise reduction. The headsets compact in-ear design makes it highly portal relative to today's over-the-ear solutions and we expect ANC headsets to hit the market soon.

Active noise cancellation is becoming a key feature in many headsets and we recently announced our new [70 DB] signal noise ratio microphone to address the needs of our headset customers. We continue to expand our leadership in audio input technology and broaden our worldly product portfolio with this high [SNR] mic to enable better audio capture, remove unwanted noise and deliver a better user experience in headset applications.

In the IoT market, I believe we at an inflection point for voice enabled smart speakers. Over the past several weeks there's been a flurry of new smart speaker announcements including the Sonos 1, the Google Home Max and the Apple HomePod. All of these devices leverage an array of high performance microphones to enhance far field audio capture.

Today, the bulk of our IoT revenue has come from Amazon who continued to deliver new products last quarter like the new Echo, the Echo Plus and the Echo Sport products. Now we are starting to see our IoT customer base begin to expand. In addition to a broader customer base, we are also seeing new geographies developing voice enabled IoT devices. Amazon recently announced it will open the Alexa platform to allow developers to service Indian and Japanese consumers and in China, Xiaomi recently launched its smart speaker which uses six of our smart microphones.

I believe we are still in the very early days of smart speaker and voice enabled IoT penetration and I expect that Knowles will be the premier supplier of audio input technology across these platforms. Let me discuss a little bit more about the progress we are making with our intelligent audio solutions. Design activity has been high for our open single core DSP smart mics across all our end markets and we have design wins with several customers in the mobile and ear markets. The first of which we expect to begin shipping in 2018. Beyond smart mics we recently launched the industries first complete audio system solution and improves audio input through a highly optimized multi-core audio DSP. This solution built upon our open DSP smart mic architecture is designed for the complex performance requirements of far field voice applications as well as the low powered needs for battery powered devices. We are seeing that machine learning is an important trend that is leading to breakthroughs in human voice interaction across our end markets to improve accuracy.

As more voice usage data becomes available, speech recognition will continue to improve through the use of more microphones with intelligent audio process and algorithms. Our new product allows us to capitalize on this trend. It addresses the limitation of today's most popular voice enabled devices by managing the environmental factors such as background noise, improving power consumption and enhancing voice recognition during moments of limited connectivity.

By moving processing to the edge of the network and embedding intelligence into the device, the solution is closer to the user and their environment. This enables a better user experience by being more aware of the source and context of the audio, reducing the need for unnatural pauses and keeping more of the user sounds local thus enhancing privacy. Over the last few months, we have engaged with several companies in the early stages of product development and secured our first IoT design wins which we expect to begin shipping in the first half of next year. Overall, the complexity of voice input application continues to grow driving high levels of interest in design activity for our new family of audio DSP's.

There's a wide diversity of interest across mobile, ear and IoT markets and we looked forward to communicating our progress. With that I'll turn it over to John to explain our financial results and provide our guidance for the fourth quarter. John?

Thanks Jeff. As Jeff mentioned, we reported third quarter revenues of $222 million, up 17% sequentially and slightly above the midpoint of our projected range. On a year-over-year basis, third quarter revenue was down 9% as declines in the audio segment were partially offset by an 8% revenue increase in precision devices. As expected, audio revenues of $168 million were down 13% from the year ago period primarily due to lower MEM's microphone sales resulting from a later than normal launch of new handsets at our largest customer and a decrease in shipments to Chinese handset OEM's.

Hearing health sales were also lower on a year-over-year basis driven by reduced market share as we continue to be disciplined in our pricing practices. In the precision device segment, revenues of $54 million were up 8% year-over-year as a result of increased capacitor shipments to the defense, medical and automotive markets.

Third quarter gross margins were 38.3% below the midpoint of our guidance and prior year levels as margins were negatively impacted by cost associated with the settlement of a warranty claim and unfavorable fixed overhead absorption in our MEM's microphone business in connection with the later than expected launch of a customers new handset. Operating expenses in the quarter were $53.2 million, better than the midpoint of our guidance and down more than $2 million over -- from the year ago period as a result of lower incentive compensation cost and our ongoing efforts to reduce general and administrative expense.

For the quarter, adjusted EBIT margin and non-GAAP diluted EPS was 14% and $0.28 respectively. Further information including a detailed reconciliation of GAAP, the 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 equivalence totaled $58 million at September 30. For the quarter, cash flow from operations was $10 million and capital spending was $12 million. Bank borrowings increased by $11 million in the quarter. Earlier this month we executed a five-year $400 million senior secured revolving credit facility. The new facility replaces the term loan and revolving credit facility which was in place since the spinoff from Dover and provides Knowles with greater financial flexibility and moves the maturity date on outstanding bank borrowings from Q1 2019 to the fourth quarter of 2022.

Moving to our fourth quarter guidance; we expect total company revenue for the quarter to be between $225 million and $260 million with the midpoint up 9% sequentially and 1% from the year ago period. Our Q4 revenue guidance reflects both a sequential and year-over-year increase in shipments of microphones for new flagship handsets at our largest customer as well as a sequential increase in shipments in Chinese OEM's driven by increased mobile handset volumes.

Lastly, we expect a later than normal launch of new flagship handsets at our largest customer to result in strong year-over-year audio revenue growth in Q1 2018. Precision device revenue is expected to be flat sequentially off a strong Q3 and up 7% from the year-ago period driven by increased capacitor demand across several markets. We are projecting non-GAAP gross margin for Q4 to be between 39% and 41% and expect operating expenses to be between $55 million and $57 million flat with the year-ago period at the midpoint as increased R&D spending is offset by lower selling and administrative expense.

We're projecting adjusted EBIT margin for the quarter to be in the range of 16% to 18% and expect non-GAAP diluted EPS to be within a range of $0.33 to $0.39 per share. This assumes weighted average shares outstanding during the quarter of just over $92 million on a fully diluted basis. We're forecasting an effective non-GAAP tax rate of 8% to 12% for the quarter. Please refer to our press release for our GAAP to non-GAAP reconciliation.

For the fourth quarter, we expect cash generated from operations to be approximately $50 million to $60 million. Capital spending in the quarter is expected to be approximately $20 million as we continue to expand capacity and introduce new products in our MEM's microphone business. I'll now turn the call back over to Jeff for closing remarks and then we'll move to the Q&A portion of the call. Jeff?

Thanks John. As we look to 2018, I anticipate that we will benefit from the timing of the product cycle at our largest customer, recovery in the China handset market, (inaudible) sales into IoT and headset devices as well as stable trends in hearing, health and precision devices. I also expect shipments of our family of single and multi-core DSP solutions to accelerate as customer products are introduced to the market. I am optimistic about these growth opportunities and our ability to capitalize on these audio trends. I believe our focus and investment in acoustics is enabling our broader audio strategy which combines leading edge microphones with digital signal processing and algorithms to solve our customers most difficult challenges in the mobile, ear and IoT markets.

We remain uniquely positioned across these end markets and well aligned with our customers roadmaps to deliver best in class audio input solutions for their next generation platforms. Operator, we can now take questions.

[Operator Instructions.] Your first question comes is from Bill Peterson from JPMorgan.

Yes, hi, thanks for taking the question. My -- I have a few. I guess if we start off with IoT, I believe on the last call you said you could have an exit run rate this year of somewhere like upper single digits of audio. When we think of these connected homes based (inaudible) since you have, when should we expect this to achieve at least 10% of revenue? And I have a few follow-ups.

Yes, I mean I don't know if you're asking that by quarter but I would say that, you know, we're pretty confident that next year for sure we should be achieving 10% because what we're seeing Bill is this, is first of all we're seeing the continued growth in the leader in this space to expand beyond the U.S. and to put one of these devices in every home. The second thing though, what I think which has really changed from the last call that we kind of alluded to but we weren't prepared to talk about that this flurry of announcements of other people getting into the smart speaker business.

And what we feel really good about in this space is that if everybody is leveraging a lot of microphones per smart speaker and so I think what we're hopeful is that Xiaomi is the first but that we'll probably see more announcements as we go into Q1 and Q2 of next year of other people in China who will be addressing this market. So, you know, I feel pretty comfortable saying that next year more than 10% of our sales will come from IoT.

Okay, I guess switching over to intelligent audio. I guess first, if you can level set us on your revenue sort of run rate that would be great but then if we think about the opportunities that you described with mic plus DSP as well as your multi-core DSP solution, which of those opportunities should we expect to be, let's say, a better growth opportunity in 2018? It sounds like the DSP is sooner but if you can kind of frame the growth rates of what we can expect in terms of growth for these products in the next year?

Yes, let me -- I think the more immediate opportunities are around smart mic than around the standalone multi-core DSP only because it was introduced sooner. And f you remember, we had a first generation of smart mics that were not DSP based so we kind of already have been working with customers in this area. I think it's a little early to talk about what's the revenue going to be in 2018 because a lot of it hinges on the success of the products. But let me just kind of tell you a little bit about how we view the smart mic. First of all, when a customer decides to use a smart mic, it usually drives an increase in the microphone count in order to take advantage of algorithms that would run on the device. That's the first thing it does which would probably not be included because there would only be one smart mic. Say if you have three, there would be one smart mic but they are going to be digital. So now you get people to move from analogue to digital, add more microphones and likely, now, we are sole source across all three microphones that are in that space.

So to kind of a give you a frame here, if you think about a customer that may be buying, and I'll make this up, a million phones, maybe we get 50% share of two analogue microphones. Now we're going to get a 100% share of a smart mic and likely a 100% share of two digital microphones. So you can see the power of this taking what would be probably a relatively small opportunity and making it large. And that's the power that we want to make sure that we get across all three of our markets; mobile, ear and the IoT market.

Okay, if I could just sneak one more. You -- it sounds like you're driving further multi-mic adoption; you mentioned OPPO last quarter and Vivo and a few others this quarter. So if we think about how we exit the year, I think last year you did 10% growth. How should we think about the multi-mic adoption of your conventional microphones? Thank you.

Yes, I would say high single digits probably next year. I wouldn't say that's going to be increased as much but probably high single digits going into next year. It's probably not quite as high as it was this year but still increasing.

Okay, thanks. I'll jump back. Congrats on the results and guide -- thank you.

Thank you.

The next question is from Bob Labick from CJS Securities

Good afternoon, thank you. I wanted to just talk a little bit more about the new audio processor that you've started to discuss. Could you just help us understand, how is it different than what's out there on the market, what end markets will it be addressing and I think you said you already have a customer signed up but is that the case or is this a build it and hope that we find customers? Just expand on the opportunity and more specifically what can we do?

So I'll answer the second question first. The product was introduced but we've been working with a number of customers pre-launch, you know, alpha customers, and we do have one customer signed up to start shipping to in the first half of next year and so we're pretty excited that, very quickly we've been able to move this into -- and its for an IoT customer. But the way that we're positioning this product, and I think we've done a fair amount of -- we have a new Web page and we're doing a lot of promotion. I'd say we're primarily focused on the IoT and ear markets, that's the primary focus. There may be some opportunities in mobile but I'd say the primary focus is IoT and ear.

What differentiates this product is the high level of performance relative to what's in the marketplace today coupled with extremely low power, especially for portable applications and lastly what we are getting the feedback, which is a very important piece, we've designed an SDK and tools that allows not only us to program this with our own software but our customers and third parties to write software to this DSP. And so one of the things we've been talking about is we already have I think close to now ten people signed up, software companies that are actually porting their software to this DSP and actually the smart mic, it's the same architecture, and we have a number of customers now starting to write software to this DSP. And I think one of the things, piece of feed we've got, great low power, really great performance, you're at the right time with the right product at the right time, but they're also saying it's really hard to program a lot of DSP's that are out there and this is the big advantage that this product has.

That's very helpful. And then just one other question, you discussed this I think John at the end of your remarks too, could you just give us an update on the capacity build out for the MEM's microphones and how much you've added, is it 10%, where that's going, how that's worked out for you so far and obviously, you know there was the shift out of your largest customer but the expectation is will you have enough capacity for next year, are you going to be adding more capacity next year, etc.?

Good question Bob. Yes, we feel good about the MEM's microphone end markets, you know, those should grow at greater than 10% unit growth in 2018 as you're aware, we've invested, I'll call it, higher than normal capex this year and that's really to put in capacity starting kind of midpoint of 2017 but if you listen to the script today I said we're going to invest another $20 million in Q4, that's primarily for additional capacity to be put in place in 2018, because again, we feel pretty good about the unit growth carrying forward.

Let me add a little color to that on the competitive front. You know, I think what we've seen, and I think we've alluded to this on previous calls, that the competitive environment seems to becoming more favorable for us. We've seen a few people who have exited the microphone market. We've seen a few people who have kind of reduced their focus on this space; couple that with, as John said, the end markets, you know, especially IOT and increasingly ear are very strong and, you know, so we're feeling pretty good going into 2018 that we've got to be prepared and so I think we'll probably be ending up adding capacity in 2018 as well.

Yeah Bob, if you think about it, we mentioned this year we'd be in a range of 6% to 8% of revenues given what I mentioned about Q4 and our year-to-date spending, we'll still be in that range but it will be much closer to the high end than the low end of the range. I would expect it to be kind of at that high point again in 2018.

Thanks very much.

The next question is from Charlie Anderson from Dougherty & Company.

Thanks for taking my questions, a lot of good questions about the new product so maybe I'll just ask about the guide real quick. Other than the sort of product cycle timing with the largest customer, were there any other callouts elsewhere in the business in terms of revisions to the forecast from earlier?

No, that's really it. I would say as I noted, our Q3 gross margins were probably a bit of a disappointment versus our forecast. We had a couple of things, we had a couple of things. We had a resolution of a subcontractor, warranty claim. That had roughly 50 basis points of impact to margin and then again because we scaled back a little bit on our production plan in Q3 due to the later than normal launch of the handsets to the major customer, that had roughly a hundred basis points of impact.

But as noted in Q4, we expect gross margins, the midpoint is 40%.

Let me just add a little more color on the revenue side. I mean, I think the one disappointment probably in Q3 was still China was weaker than we had expected. And we're looking at the numbers quite a bit and I think the one thing that we continue to see is that in spite of the struggles that we've had for sure in 2017 with the end market in China, China is still up dramatically from 15. So in other words, our China sales are up significantly from 15 and we're starting to think that maybe the Chinese market got kind of ahead of itself a little bit here and -- but I was recently at all of the customers the last few weeks and I feel good about our position there and I think a lot of our [IA] activities, especially around smart mics is focused in the China market so we feel pretty good that Q4 hopefully is going to be a recovery quarter and that it will lead into a strong 2018.

Great, and then just a question from me on the new products, if you guys win the multi-core DSP in an IoT device or a hearable and also some of the mics, I wonder if you could maybe just bracket out some of the content opportunity for device for us and then also back to gross margins to the extent that becomes a larger portion of the business, thanks.

Yes, I mean just figure that we're talking -- microphones are still in the range that we speak about, somewhere at the low end probably in the $0.25 range up to $0.40 for the standard microphone. You know, a smart mic obviously can be, you know, 30%, 40%, 50% higher than that in terms of what a smart mic would have. And I know as we start to think about the multi-core DSP, I would caution to just think about this from a perspective of how much of the software activity that we actually do. You know, we got a wide breadth of customers that we're working with on the multi-core DSP. Some of them are saying this, look, we're going to do all of the software ourselves. We've got all of the capability in-house, we love the fact that it's open we're going to do everything versus some other customer saying we want you to do a lot of the software for us and so there's a pretty wide breadth of what our expectation is relative to the ASP. But, I would say it's definitely north of $3.00 on the DSP. And you know, from our perspective it comes -- it's all going to be very high gross margin, that's what I say, above the corporate average.

Great, thanks so much.

Your next question is from Anthony Stoss from Craig-Hallum.

Hi guys, a couple part if you wouldn't mind and I'm not sure if you'll have this available. But if you -- Jeff, if you looked at your average ASP per mic kind of where you're at now versus say a year ago, I'm curious what you've seen overall. And then secondly, maybe you can compare and contrast your number of smart speaker customers if it was one a year ago, maybe if you wouldn't mind sharing a number of customers on the roster and what you were seeing, was it generally six or seven mics per smart speaker? Thanks.

Yes, I think what we see is -- and let me take I guess the first question was the roster. I'll go to the roster first. You know, what we've probably seen is last year at this time we had really one customer that was buying from us. I would say we're probably up to seven or eight now that are buying from us in terms of smart speakers. Generally speaking, the majority of these products have somewhere between four and seven microphones. I think there are some exceptions in the marketplace and we'll see how this all plays out. You know, I mean, I think there's been discussion on the Google Mini, there's only a couple of microphones in that but that's an extremely aggressively priced device. So, you know, I think -- but I think our expectation is probably that voice capture may not be as good with two microphones.

So I think there's a wide breadth of different opportunities here. I think they'll be some opportunities from some smart mics in this space. We've already got a nice win, while not super high volume with Xiaomi with some smart microphones. So I think there's a wide breath. I think our focus here going into next year, I think we capture who we think are the key players in North America on the IoT smart speakers. I think the next phase of this is, it's really about China because I don't anticipate, I could be wrong, but I don't anticipate the North American people that are in this space, to be really strong in China but this is definitely coming to China and there's a lot of design activity in China around smart speakers. So that's going to be the next phase to expand the roster.

Your question on ASP's, I think we talked about it a little bit last call and I'll just reiterate what we said last call, in 2016 -- we typically said 6% to 10% down on mature products and at 2016 we said we were at the high end of that range in 2016. I think we projected in 2017, I think that still holds. We'll probably be at about the middle of that range in 2017 and right now, and I mean it's very hard to predict how things go in 2018, but again, I think I mentioned earlier in an earlier question, the competitive environment I think is turning more positive for us based on a number of factors and I think that as we go in 2018, we think the price erosion, coupled with the competitive nature of the market with the new products that we're introducing and the higher end, that the price erosion probably will be toward the lower end of that 6% to 10% on mature products. Maybe even below, possibly even below but I think it's a little too early to call that.

All right, thank you guys.

The next question is from Jaeson Schmidt from Lake Street Capital.

Thanks for taking my questions. Really quickly, wondering how much China represented as far as Q3 revenue?

Q3 revenue? We're looking a the numbers here. Hang on one second Jaeson. We're calculating it right now. Calculating, we have a slow process here.

No worries.

Roughly just a little under 20% of the mobile business.

That's helpful. And then looking at operating expenses, I know you guided [56] for Q4. How should we think about opex ramping in 2018?

Yeah, I'm not really going to give guidance on 2018 but what I can say is I'm not aware of any major operating expense increases above current levels other than you're always going to have the normal market wage rate inflation and our incentive comp costs are likely to go up a little bit because they're below target levels for 2017. Other than that, I wouldn't really expect any major increases.

Okay, thanks a lot.

The next question is from Sujeeva Desilva from Roth Capital.

In terms of the hearing health part of the business, can you talk about the dynamics there whether you think that's going to be stable going forward or just growing GDP, any thoughts there would be helpful.

Yeah, I mean I think we've talked a lot about this on previous calls that we've been more disciplined on pricing on certain pieces of the business that we thought that were not good margin. I would say that from our perspective, we think that the business is on a trajectory to stabilize at the current levels. You know, the remaining business is profitable and we think we're in a good position to defend and maintain that share.

You know we still see also, just would say, is there's still a lot of activity around the convergence with the year. We're seeing a little bit more activity around these assisted listening devices and so we're hopeful that next year will be a stable year and we won't see the headwinds that we faced in 2017 based on walking away from some lower margin business.

My other question is around some of these intelligent mic systems that you're getting designed into. It seems like when you competed for phone mics it was kind of socket by socket, you'd try to get qualified for some versus others. With the intelligent mic systems, if there's two or three mics there do you automatically kind of get your mics swept in along with the main intelligent mic, is that how these play out or will there still be competition for those microphone sockets even where you have the intelligent mic?

You know I think it's been -- it's early days on a number of these designs right, but I think generally speaking we're feeling like what we're doing is we're elevating ourselves above the rest of the competition relative to solving a specific problem in a use case as opposed to just walking in and selling a microphone.

And so while I'm sure these customers consider for a couple the normal microphones, consider another source, I think in the end we've really optimized these things to work as a system and we're talking to a different level within these customers now about how to make this happen. So I think there's a very good chance that we can garner 100% of the share where we get smart microphones [designed].

That was the color I was looking for.

The next question is from Tristan Gerra from Baird.

This is Margaret Mcnally on for Tristan. I'm just wondering, what is driving the 40% growth margin profile given the growth for 4Q and with that, how meaningful is the mixed improvement coming from the smart speakers?

I'm sorry, can you -- I didn't get -- you said dragging the --

Driving the fourth quarter margin.

Yes, the margin improvement from Q3 to Q4 is really the absence of, again, we had a couple -- we had a one-time warranty claim that was 50 basis points in Q3, that we don't expect to reoccur. We also scaled back our production plan slightly, that had about a hundred basis points so if you think that we were just north of 38%, you add back 150 basis points for those two items, you're very close to 40%. We're running close to capacity or at capacity in Q4. So you get a slight uptick too in terms of capacity utilization versus -- I mean, we're probably in the mid-90s in Q3. So that's really the drivers of that, call it, 150 basis point improvement sequentially.

Okay, great thank you. And then just to follow-up, do you expect similar market share at your North American customer as in prior models?

Yes, I think what we're projecting is stable share in the ramp quarters. I mean, beyond that I think it's too far out to speak to that. You know, it can vary from quarter to quarter but we don't see anything dramatically shifting year-over-year.

Okay, thank you.

As a reminder, to ask a question, press Star 1 on your telephone keypad. The next question is from Christopher Rolland from Susquehanna.

So given the kind of delay or push out in models at your North American customer, how much revenue actually pushes out of Q4 and in your opinion does that all then push into Q1?

Well, I mean I think -- I guess we're not going to give a specific number. I mean, there's a lot of obviously moving parts. We have the hearing health business, we have the precision devices business and so there's a lot of moving parts here. But I would say, it's not insignificant, right? So it's not like we're talking about a couple of million dollars here.

There's also a lot of, fair amount of, uncertainty on the demand for that new flagship.

I mean the hard thing about this is is, look, you guys read all of the press releases that are going out and all of the coverage that goes out just like we do and the only thing I would just say is, is that there's still a possibility that more gets pulled into Q4, more goes into Q1, it's really hard to say but what I would say is that year-over-year that we feel like we're going to get some nice growth this year over the full ramp, right? So we feel pretty good about that.

I'd also make just one other comment relative to that customer. You know, increasingly I think we've had some good success this year in multi-mics beyond the handset. I think everyone that we talk a little bit about the HomePod, everyone's heard about the AirPods, so there's more going on there. While it's small relative to the phones, it's still a nice thing that's coming in for us with this customer.

Chris I think -- I mean, both my script and Jeff's script, we said we expect strong revenue growth in the audio segment on a year-over-year basis in Q1 of 2018.

And then on the smart speaker side, maybe you can give -- you know, the holiday season is important for that. Maybe you can give us your expectation for total unit growth year-on-year for that category and then lastly, you know, you have a lot of six mics and seven mics kind of architectures out there. Do you expect them to reduce the number of mics or do you think that those numbers of mics are key to the quality, maintaining the quality of those devices? Thanks.

First question, year-over-year for the holiday season, I think our expectation is that our largest customer in the IoT space will be up. I think we've discussed though in the past, last year we were sole source. We are still getting the vast majority of that volume but there is some, there is a second source that's shipping into that customer. So it's a little hard for us to exactly read but needless too say, the expectations are for the business to be up, I believe I've got to look at the numbers I'm looking at year-over-year. I'm going to hold my breath yet and say on the other stuff, the other products, they're not even shipping in the marketplace yet to say how well they're going to do. I mean, I think we have a lot of nice forecasts but to say how much they're actually going to sell at this point, this is the struggle with IoT. You know, we get a lot of customers who come in, designing a lot of microphones and they say we've got a lot of volume but it's hard to say how they're going to sell. It's very difficult. I know we're going to get a fair number of microphones in the ramp because they've got to build a certain number of units but I think we've got to wait and see which products are the winners and losers in the marketplace.

As far as the number of mics per -- you know, I think there is -- I'm not going to sit there and say it's all six mics. I mean, there are coming to the market with less microphones. But our fundamental belief still as we worked in mobile, as we see what's going on in ear and in IoT still is that more mics results in better voice input. And so there are tradeoffs though. You know, if you're going for a very low cost product, you're trying to strip cost out, maybe you say I'm going to sacrifice voice input. So, I think it's still early to see how it goes but I think, you know, if you think about it the products I mentioned on the script, the majority of those have somewhere between four and seven microphones.

Now there's a couple other products which I mentioned a little bit earlier like the Google Mini that only have a couple of microphones. So, it's a little too early to say but generally speaking we still have the belief, more mics means better performance.

Chris, if I could just add a little granularity to your question on IoT, I think Bill had it too. If you think about it, we shift our first mic into the IoT market in Q4 of 2015 and really low level sales. It was roughly $20 million into IoT in terms of revenue in 2016. It's going to close to double in 2017 and we are confident on growth beyond that moving forward.

Indeed a great category. Thanks guys.

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

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 goodbye.

This concludes today's conference call. You may now disconnect.