Mike Knapp - IR Jeffrey Niew - President and CEO John Anderson - SVP and CFO.

Alex Gauna - JMP Securities Harsh Kumar - Stephens, Inc. Robert Labick - CJS Securities Jaeson Schmidt - Lake Street Capital Tristan Gerra - Robert W. Baird Robert Sassoon - R F Lafferty and Company Christopher Rolland - FBR Capital Markets.

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Knowles Corporation First Quarter 2015 Financial Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions].

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

Thanks, Kevin and welcome to our first 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, included, but not limited to, the annual report on Form 10-K for the fiscal year ended December 31, 2013, periodic reports filed from time to time with the SEC and the risks and uncertainties identified in today’s earnings release.

All forward-looking statements are made as of the date of this call and Knowles disclaims any duty to update such statements, except as required by law.

In addition, pursuant to Regulation G, any non-GAAP financial measures referenced during today’s conference call can be found in our press release posted on our website at knowles.com, including a reconciliation to the most directly comparable GAAP measures.

Except for revenue, all financial references on this call will be non-GAAP, unless otherwise indicated. Also we’ve made selected financial information available in webcast slides, which can be found in the Investor Relations section of our website.

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

Jeff?.

Thanks Mike. Thanks to all of you for joining us today. For Q1, we reported revenue of $239 million, gross margins and operating margins were approximately 25% and 4% respectively.

Revenue in our mobile consumer segment was down 21% sequentially, better than anticipated in a seasonally weak Q1, as we resumed shipments of microphones to a key customer platform earlier than expected. We also experience stronger than expected demand during the quarter for speaker and receiver products.

Revenue from MCE comprised 56% of total sales in the first quarter. As I just noted I was very pleased that we began shipping microphones on our current platform at a North American OEM that had been on hold since September 2014.

While units shipped were still relatively low in Q1, I expect that microphone volumes for this platform will pick up in Q2 as we continue to regain share. Our goal is to get back to historical share levels with this customer and we are engaged across our next generation platforms for mics, speakers and receivers.

Revenue from Chinese OEMs declined sequentially in Q1 as expected due to timing of product launches and Chinese New Year, but were up 9% from the year-ago period. As projected by industry analysts, the rate of growth of Chinese OEMs is expected to moderate in 2015.

With that said we continue to believe that these OEMs will deliver significant growth for us this year as they expand beyond their domestic market. In many emerging markets outside of China 2G phones still constitute the majority of units shipped.

These devices normally have lower acoustic content, we will benefit from unit growth as well as the conversion to 4G devices and the associated increase in audio content per device. These benefits come from MEMS microphone share gains against older ECM technology, multi-mic adoption trends and increased traction with higher value solutions.

On a global basis this year we project multi-mic adoption to drive more than 5% growth in the number of mics per device and expect sales of integrated modules to double versus 2014, driven by several product launches over the next few quarters.

In Q2 the mobile consumer segment is expected to have sequential revenue growth driven by share recovery at a major North American customer and growth at Chinese OEMs. This growth will be partially offset by an adjustment of speaker inventories at one major customer ahead of new operating system launch.

Lastly, we are cautiously optimistic about the recent reviews of handsets introduced by a Korean OEM, where we continue to maintain strong market share. In the specialty component segment Q1 sales were down 10% quarter-over-quarter and represented about 44% of the total company revenue.

Revenues were down more than projected, primarily due to lower timing sales into the wireless infrastructure market and slightly softer demand in our hearing health business.

For Q2 we expect significant sequential revenue growth, in especially components driven by broad-based strength in hearing health partially offset by weaker timing sales into the wireless infrastructure market. With that I will turn it over to John to expand our financial results and provide our guidance for the June quarter.

John?.

Thanks Jeff. As Jeff mentioned earlier, we reported first quarter revenues of $239 million which was above the mid-point of our guidance. Mobile consumer electronic revenues of $135 million were down 21% sequentially, primarily due to normal seasonality.

This was better than expected driven by resumed microphone shipments to a North American OEM late in the quarter, which was originally forecasted for Q2. We also benefited from higher than expected demand for speaker and receiver products.

Specialty component revenues of $104 million were down 10% sequentially, lower than expected driven by primarily by weaker timing device sales in connection with the continued pause in China LTE infrastructure build-outs.

We also saw slightly softer demand in the quarter with a major hearing health OEM due to a work stoppage at their facility, which has since been resolved. We expect to resume normal shipping levels with this customer in Q2. First quarter gross margins were flat sequentially at 24.6% which was below our prior expectations.

The variance in margins was primarily due to lower fixed overhead absorption in the specialty components segment and unfavorable product mix within mobile consumer. Specifically we sold a higher proportion of speakers and receivers during the quarter. Operating expense in the first quarter was approximately $52 million and lower than expected.

This lower spending level was driven largely by the timing of new engineer hires, lower than expected legal costs, due to the Gore-Tex settlement and tight control over non-R&D spending. Adjusted EBIT margin was 3.6% and non-GAAP diluted EPS was $0.06 for the quarter, with both metrics coming in close to 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 $39 million at the end of March.

For the quarter, cash flow from operating activities was $7 million that includes payments related to restructuring and production transfer cost of $10 million. Capital spending in the quarter was $18 million.

Our bank debt balance was $396 million at the end of the quarter with the reduction from the prior year end due to scheduled principal payments on our bank term loan. Interest expense was $2.4 million in the quarter. Now I will turn to our second quarter guidance. We expect second quarter revenue of $240 million to $260 million.

MCE revenue is expected to be up sequentially 4% with increases in microphone shipments at a North American OEM. This will be partially offset by lower speaker shipments at a major customer in connection with their transition to a new operating system.

Specialty components revenue is expected to be up 5% sequentially driven by increased volumes from hearing health and capacitor customers. We expect incremental softness in China LTE infrastructure build outs to impact second quarter shipments.

We project non-GAAP gross margin to be approximately 25% to 27% up a 140 basis points sequentially at the mid-point. This margin improvement is driven by higher capacity utilization in our microphone business as we continue to regain share at a major North American OEM.

We also expect favorable product mix as demand and sales increase in our hearing health business. This improvement is partially offset by lower capacity utilization in our speaker business.

We expect customer product launches later this year, along with optimization of our manufacturing footprint to drive sequential revenue growth and improved operating margins in the second half of the year.

R&D spending in the quarter is expected to be nearly $24 million, up $4 million or 20% from Q1, driven by a higher level of activity related to our intelligent audio solutions and other new product development activities. Selling and administrative expense is expected to be approximately $33 million, essentially flat with Q1 levels.

For the full year we expect R&D to be in the range of 8% to 8.5% of sales. We are projecting adjusted EBIT margin to be between 3% and 5% in the second quarter. We expect non-GAAP diluted EPS for the quarter to be within a range of $0.03 to $0.09 per share.

This assumes weighted average shares outstanding during the quarter to be $86.1 million on a fully dilutive basis. Please refer to our press release for a GAAP to non-GAAP reconciliation.

For the second quarter we expect cash flow from operating activities to be between $10 million and $20 million and include restructuring and production transfer payments of $9 million. I will 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. In summary, I am increasingly confident that we will experience strong revenue growth in the second half of 2015, driven by customer platform launches and adoption of our new products.

The trends around multi-mic adoption and higher value audio solutions remains strong and we expect our first intelligent audio sales to materialize in the second half of the year.

This growth should drive improved capacity utilization and coupled with the optimization of our manufacturing footprint, improved operating margins in the back half of the year. Operator, we can now take questions. .

[Operator Instructions]. Our first question comes from Alex Gauna of JMP Securities. .

Good afternoon, guys. Thanks for taking my question.

I was wondering, Jeff if you could give us some color around something you’ve said in the past in terms of the gross margin effect of resumed shipments into that large North American OEM, as well as just more broadly would depend on how aggressively you were pricing your products in order to regain share.

What are you doing on that front, the new pricing structure for some of these products, what kind of headwind to gross margins is that? Thanks..

Yes, let me start with the ASP question first. There is the I would say, on the ASPs, we stated all along we are going to have to be a little bit more aggressive to get the share back and we have had to, but it wasn’t out of the line with what we expected. So I think that’s pretty in line with what we expected.

I think the bigger impact, as we look at the gross margins in Q1 and Q2 and John tried to expand a little bit upon this is the fact that we still have the sales and the absorption, because it was still an issue, because we are not back to the share that we were prior to September of 2014.

Now John will expand a little bit on that?.

Sure, just to add a little bit granularity to that Alex. As Jeff indicated we resumed shipments and production of the impacted microphone late in Q1.

We expect to continue to recover share in Q2 but we do not expect to be fully back to the pre-September 2014 share levels in the second quarter and this really negatively impacts our capacity utilization and our product mix as we are producing and selling less new product, which typically carries a higher ASP.

Just to kind of quantify I would estimate the impact of the mic issue on our gross profit margins in Q2 to be roughly 200 to 300 basis points. So again we were back to that pre-September share level, we would have an up lift in gross profit margin between call it 250 basis points..

Okay, that’s fair enough. Thank you, and very helpful.

If I look into the back half of the year, when we start talking about the impact of Intelligent Audio Voice IQ as well as the next generation products that are out there, is it still your belief that the pricing structure of the industry hasn’t changed and can you give us an idea of the tailwind from the new products that you think there might be either in a gross margin sense or an ASP sense exiting the year and if you could in that answer talk about what you might think as a result of all of this, your overall industry share loss might be for the year because of this effect? Thanks..

There’s a lot of question there, let me try to take these one at a time. First on intelligent audio, we don’t expect that the sales that we get an intelligent audio in the back half of the year to be large enough to have a significant positive impact on gross margin.

We are just rolling these products out and I would say that as we are rolling these intelligent audio products out a lot of the target is, I would say is a little bit more nichier applications, we are spending a little bit more time with the Internet of things, wearables and there is a lot of great opportunities there but I would say in general there are lower volume, and so we see that intelligent audio really start to have an impact on gross margin as we go into 2016.

As far as the share loss that we took, I think it is a little too early to tell how we exit the year but what I would definitely say is I feel strongly that we will have higher share in the back half of the year than we did in the front half of the year. We started off, although we shipped product to the North America customer in Q1 it wasn’t a lot.

In Q2 it increases significantly over Q1 but again as John stated we won’t back to the share level. We do anticipate the share will be higher in the back half than in the front half.

So it’s a little early because there is a lot -- a number of -- again launches of products that are going to come in the back half of the year, to say what the share level will be but it’s definitely going to be higher than it was in the front half..

Okay, thank you. Congratulations on the requalification..

Thank you. Thank you very much..

Our next question comes from the line of Harsh Kumar with Stephens..

Can I ask you, once you get pass this current model that you just got back into with your North American customer and as you back in with a basically a brand new microphone, and even going forward and once you start shipping let’s just say voice IQ broadly, is it possible for you to go back to that 55%-60% level in the future based on technology and just this model rolling off?.

Well as I said in previous calls that’s our goal Harsh. We are really trying to get back to that previous level.

We have got some great new products, and you are seeing a lot of demos and what we are working on, and we think that it’s possible we got to work real hard, we got to get the new products out, it’s really the key thing, get them out and make sure they are all accepted in the marketplace, but that’s our stated goal.

We got to get back to the share that we work pre the problem that we had in September of last year..

Got it. And then I wanted to ask about the ASP decline, you mentioned earlier, John gave some numbers about 200-250 bps.

As you get back on full bore, would then engage with this new customer, can you just talk about how that impacts as this model rolls off and the newer model comes on do you get an ASP benefit or is this ASP decline sort of permanent thing in the industry?.

I think we will get some ASP benefit, Every time we introduce a new model we get some ASP benefit, so I would expect there would be some, as again kind what we were saying, there will be a new microphone designed in and it will have different features and different performance and different things.

So we do anticipate there will be some ASP improvement based on the new products that we introduce in the back half of the year. .

Fair enough. Thanks guys I will get back….

If I could just add, I mean the margin improvement that we expect in the back half of the year is really driven by new product launches, which create improved factory utilization in our facilities and that’s really driven sequentially in Q3 and Q4..

Yes, it’s worth highlighting again, as we look at the price reductions we had to give in order to get share back, I mean that although there is some of this, a small amount of this has brought the margins down probably a little lower than people have expected but it's in line with what we expected.

But the primary driver to getting the margins back up is getting the sales back and filling the factory. Those are much larger impact on the margins than the ASP decline. .

Got it, guys..

So the last major driver too is we do have additional plant consolidation in our hearing health business. We will have the production transfer into our Philippines facility completed in Q3 and so that will add some additional margin expansion. .

Got it. Thanks. Thank you. .

Our next question comes from Bob Labick with CJS Securities..

Thank you.

I just want to follow up on that last answer you gave, could you elaborate a little more on the trends in the specialty components, both hearing health and you mentioned the telecom infrastructure and other, both on the revenue side, but also just remind us where we stand on the cost savings initiatives in hearing health and also in other components?.

So you want to talk a little bit more about -- okay let me talk about the trends first. I don’t think the trends have changed dramatically in the hearing health business. There was a little bit of I would say, a slight slowdown in Q1. We had one customer who was dealing with a works stoppage at one of his major manufacturing plants.

So they didn’t take as much product as we would have expected. But I think as we look to Q2 the trends in the marketplace still are positive and so on the hearing health side I feel pretty good about the business.

When we think about the wireless infrastructure business there I would just say is, I think you probably see it, there has been fair number of people who have already been talking about the fact that there is this weakness in China, the roll out of LTE is kind of taking a pause. I would say this is not altogether unexpected.

It's always hard to predict the timing of this, when it slows down and when it ticks back up. And what we are saying is, at this point in Q2 we just don’t see a pick up back.

We believe it will come back, it may take a couple more quarters but we believe it will come back and if you think back to 2014 the business was pretty strong, the wireless infrastructure business was pretty strong in last year and this year it looks like some of our customers that are rolling out the LTE infrastructure they may have got a little ahead of themselves and it's taken a pause and again it will come back, it's just a question of when.

Now just a little bit more on the financials with the….

Yes, Bob just in terms of updating where we are relative to the $50 million annualized savings target, as you’ll recall we exited 2014 with roughly $40 million in annualized savings and that was primarily driven by the closure of our Vienna facility, that was 30 of the 40.

We are expecting an additional $10 million to $12 million in cost savings in 2015 to get that $50 million target at the end of the year.

And that’s again, that is really driven by the move of our hearing health business from China to our existing facility in the Philippines, that will be completed in Q3 of this year, and that will drive another $10 million to $12 million..

Great. Thanks very much..

Our next question comes from Jaeson Schmidt with Lake Street Capital..

Hey guys, thanks for taking my questions.

Jeff I am wondering if you could just talk generally about what you are seeing in the competitive landscape, if you are seeing any new entrants into the market and how you guys think you are currently positioned overall?.

We divide this probably into -- first of all the mobile consumer -- I assume you are talking about the mobile consumer, correct?.

Correct..

Yes, okay, let me divide it in to speakers and receivers and mics. I think that’s the easiest way to talk about it. In the speakers and receiver market we are not really seeing any real entrants in this, it’s AC, Gore-Tex and Knowles.

I think we’ve talked about in the past there are some other competitors in this marketplace but there’s a dramatic difference in capability and technology between the top three and anyone below that. So it’s really not a big difference.

In the microphone market it’s really the same players, but I think what we may see as we go forward is that as we move towards things like intelligent audio and more advanced solutions we may be competing with different players that are already in market for those different sockets.

So as we look it up, basic analog mic, we were primarily dealing with ACs and Gore-Tex of the world but as we move towards much more significantly advanced microphones it may change a little bit in terms of who we’re competing against.

I think the positive story about this is as the leader we’re prepared to compete in both these areas are very well, positioned very well.

We’re really excited about intelligent audio, we’ve got products out there in the market, people want to buy them and we’re first to market again with these products./ So I think we’re pretty well positioned no matter who it is or what segment of the market that we’re competing in. .

Okay and John how should we look at your tax rate for this year and next?.

The tax rate in Q1 was a little -- the effective tax rate on our non-GAAP earnings is right around 19%, a little higher. That’s really a result of having lower than expected income in a zero tax rate jurisdiction. I wouldn’t change your model of 12% to 14% on a long term basis for an effective tax rate. .

All right, thanks a lot guys. .

Thanks, Jaeson. .

Our next question comes from Tristan Gerra with Baird. .

Good afternoon. You said it today that Q2 gross margin ex the impact of the microphone issue will be 28% to 29% of [indiscernible], you mentioned a 200 to 300 basis points impact on Q2 gross margin. Last quarter you mentioned that Q4 gross margin will have been above 35% excluding the microphone issue.

Is the difference between that, in the 28%, 29% range and the 35% driven by lower pricing alone? And if you could also talk about the mix of the screening process that enabled you to come back in that leading customer in the U.S.

versus the re-spin [ph] and whether that screening process is basically resulting in lower gross margin than if you were just shipping the recent product?.

Yes, so we were able to get back into the customer sooner than we expected and I think that the positive they work with us pretty closely in order to do that. I think I don’t have the exact date here, Tristan but at some point we’ll be through all the re-screen products and using the re-spinned product that has the fix in it.

I would anticipate that sometime probably in Q2 when that happens. I’ll [indiscernible] a little bit more but the impact is not really about lower pricing.

The margins first of all are typically higher in the back half of the year than the front half of the year and it’s driven by two things, one is sales are higher in the back half of the year which drives capacity utilization and so I'm not going to say the pricing that we’ve had to give had no impact on the gross margin but by far the loss of capacity utilization has a significantly higher impact on the margins.

.

Yes and Tristan just to add to that, you mentioned in Q4 your reference margins of 35% versus the adjusted margin today that I mentioned of, call it 28% to 29%. The difference is really two things. As Jeff mentioned the back half of the year our capacity utilization is historically much higher.

That typically can account for 300 to 400 basis points between first half of the year and second half of the year and also our ASPs are typically higher in that Q4 timeframe versus the Q1, Q2 just because of the normal adjustment in prices as the product is rolled out. .

Yes, and I think those are the two facts. And the other thing, just remember Q4 was, I’d say the last quarter of our infrastructure business. We’re still -- we see weakness in Q1, Q2. That had some impact on the difference in the gross margin as well; our sales are down significantly in the wireless infrastructure business. .

Okay, that’s very useful. And then as a follow-up I think in the past you have mentioned your expectation to exit this year at a 35% gross margin run rate and that by end of next year you could be at 39%.

Is it fair to assume that if you are looking at a 400 basis points in gross margin improvement next year assuming that you are reiterating that expectation, does that imply some additional restructuring or is that on the basis of higher top line alone and mix?.

As far as your first question, as far as exiting 2015 I don’t see any major obstacle to exiting the year in the mid 30% gross margin range. It does include though the execution of our -- the completion of our production transfer in our hearing health business. But I don’t see any obstacles there. You also referenced a 2016 number.

I don’t think we ever gave guidance. We pushed out our mid-term target to 2017 and there again I don’t see any obstacles to prevent us from achieving that 2017 mid-term target of 39..

Great. Thank you very much..

Our next question comes from Robert Sassoon with R F Lafferty..

One of your major Korean customers recently launched a new platform.

Looks like [ph] it contains two microphones instead of three, so is this something that we should be concerned about in terms of the multi-microphone platform growth story or is it -- is there a specific case of this particular customer that they have chosen to choose two instead of three microphones?.

Everybody [ph] says they have a number of platforms that they ship on and if you look at the Note 4 that was introduced late last fall, it had three microphones. The S6 has stayed with two microphones like S5 was. And I think a little of this is, there is some competition that Samsung is facing relative to Chinese OEMs and they are looking at cost.

They are struggling at a cost basis. But I don’t think this is a trend overall that we see. In fact I would say that as we look to last year we had about 6% growth in units in microphones, based on multi-mic adoption above the normal market rate growth. And this year we are projecting it's going to be 5% again.

So I keep thinking and I am seeing this, we are not seeing anybody else who is making moves towards less microphones. In fact, as we go towards the back half of the year we continue seeing more people that are actually adding microphones, not taking them out. So in no way do we see that as a trend. .

Right, and I know noticed, because I know you can’t speak on -- I noticed that one of your competitors has been diversifying out of acoustics into non-acoustics last year.

So I was wondering, whether that was a sign also that the market for acoustics was not as exuberant going forward as you might have originally thought?.

No, I don’t think that, I think -- I can't speak to what they said or they see they are looking at, things like haptics.

I can't speak to what made them decide to get into the haptics market but as we look forward, if you think about our competitive differentiation we talked about it a fair amount and if you remember the three circles of acoustics, mechanical integration and intelligence, we kind of talked about the fact that the ACs and the Gore-Tex of the world are not as strong in the area of intelligence where we're really employing a big focus.

And we see a lot of these new applications coming forward. We talked a lot about VoiceIQ, we talked about ultrasonics. We think there is a strong demand in the marketplace for higher value acoustic solutions and that the growth rates are going to continue.

We're going to be the agent of change, we're going to be engine of bringing these new products out. But we are comfortable that when we talk to the customers that they are hungry for better performance and new applications enabled by acoustics. .

All right. Okay.

And just one more question, Jeff, do you have the D&A, depreciation and amortization figure for the first quarter?.

Robert, this is Mike. I can post that on the IR site..

Yes if you can send me it by email. That will be great..

Okay..

Thank you very much..

Thank you..

Our next question comes from Christopher Rolland with FBR Capital Markets..

Hey, guys. I wanted to dig in for a second on packaging for a moment here.

So I guess my first question is where were you guys on back end Q1 utilizations? And then my second question is, assuming you guys have a normal utilization level, let’s just say like 80% or something like that, what is the cost of packaging as a percentage of the total cost of demand? And then finally how many extra gross margin points do you think you get from doing the packaging yourself versus your competitors who are paying foundry, is it 100 basis points or 300 or 600, how do you guys view that as an advantage?.

Let me just take the first. We are not going to share our cost structure on this call and we on a regular basis do, do to an assessment of whether we should be sourcing the packaging outside or doing ourselves.

There is the gross margin improvement, there is some and I don’t have it quantified right here to be able to answer that, but there is also the time to market, the ability to innovate in the area of packaging that allows us to do it, -- we have own manufacturing, our own test structure that we set up.

So we think it is pretty important, if you look at, compared to the competitors that are in the marketplace, some have their own packaging, some don’t, some have their own design on their MEMS and ASICs and others don’t.

If you go back to kind of the competitive analysis we are very unique in the fact that we control the designs for the ASICs and the MEMS as well as the packaging.

We do the whole thing and if you go back to our larger competitors in mics like AAC and Gore-Tex you can go through their reports and they talk about how much lower their gross margin is at microphones compared to speakers and a lot of it comes from the fact that we control the supply chain. So we think it’s pretty important to do that.

As far as the capacity utilization I don’t have the exact figure but normally Q1 is a very low capacity utilization quarter.

We have the changed New Year and having experience of been there a number of times it’s kind of like Christmas in the United States, where nobody works like three or four days before it starts and nobody really works three or four days after.

So you end up with roughly two and half weeks of no production but on top of that we didn’t have as a high demand because of the North American platform that we are shipping a minimal out to. So I don’t have the exact figure but I would say the connection is probably less than 50% in the first quarter..

Yes, it’s very low just to add a little bit of granularity there, typically the second half of the year, I mean we are running 90% plus capacity utilization. Sometimes in Q3 full out. In a typically year, Q1 or the first-half of the year we can kind of be in that 70%-65% range.

So on a full year basis we are kind of doing our capacity planning based on like an 85% utilization. This is a real thumb..

Okay, very useful. Thank you guys. In terms of total mobile mic industry growth, you mentioned a 5% boost from the sort of microphone phenomenon.

What are your views for total industry mic growth and if you could break it up into sort of the contribution from just general handset growth, does mic per phone phenomenon that you talked about, which was 5% and then the growth contribution from the movement from ECM mics to MEMS?.

Yes, I have to look at this in a little more detail. I don’t think I have those exact figures by the market but the market itself is expected to grow about 5% in total unit growth and then you add in a 5% for multi-mic adoption and there is some amount again of conversion from ECMs, although the number is not, I would say the primary driver.

The bigger driver is really the multi-mic adoption and the industry growth. So if I were to look at I’d probably say, again this is off the top of my head, I won’t be held to this, it’s some more north of 10%..

Okay, great. One last one, getting back to cost structure. So your largest Asian competitor has started a joint venture on the front end MEMs manufacturing side and they actually believe that they can get another five or maybe even 10 additional gross margin points by capturing that foundry margin themselves.

So first of all I guess does that sound right to you? And secondly do you have any inclination at all to get into front end manufacturing yourself?.

Well, let me just make sure what you are saying, I'm assuming you’re referring to AAC?.

Yes. .

Yes the things I’ve seen is, is they are trying to design their own MEMs and then they are going to source their wafers themselves as opposed to rely on the third party for the design. And they’ve been working on that now for about four years. They’ve been trying to bring that to market and we have yet to see them sell one device using that.

There’s definitely, clearly a margin issue that they’re struggling with, that they talked about. I mean I can only speak to what they’ve talked about. And there’s clear value in owning your own design but I think it’s not a simple task.

So as far as I know they’ve been working on that for about three or four years and we are yet to see that come to market. .

Hey, great guys, thanks. .

Our next question comes from Suzie Desult [ph] with Topeka. .

Thanks for taking the question.

So first of all having gone through the requalification process, can you talk about some of the changes you made perhaps that would reduce the risk of it recurring, just to understand some of that?.

Yes, I think we talked a little about this I think on the last call, but I think one of the primary things that we’ve done are our products have proliferated and so have handsets proliferated.

We’ve really gone back and looked at how we test our microphones in terms to the qualification process in real world use environment, as opposed to thinking of it as here’s a suite of test that we just do what we’ve always done and so we started to adjust how we test microphones in terms of the qualification process to ensure that this doesn’t happen.

The second thing is we had a little bit of what I call thinking about how we’re structured as an engineering organization and what we realize as we thought about this little bit more is we have great MEMs and great ASIC developers and great packaging guys and we have great test guys and that was kind of like how you put a microphone together.

But as the systems are becoming more complex we’ve added on to and start talking about more of the system level design as opposed to bring individual components together and we’re starting to see that this has been really helpful also potentially making us a fair bit more better at getting more products out hopefully over the long term.

So those are two things that we’re really focused on. .

Very helpful answer, and then also on the Intelligence Audio I know it’s more of a 2016 opportunity but want to get a sense of how long the design cycles are versus typical products, when that process might have started visibility for ’16 and what’s the financial impact of that ramping when it does ramp, in terms of revenue and pricing and margins?.

Yes the margins will be higher and the price is higher for sure, I mean the initial stop, the initial product that were coming out was I would say there are somewhere between 20% and 50% higher in ASP. They are much more expensive. But the volumes are very low at the beginning and the design cycles are longer.

And the reason the design cycles are longer than our typical products is in some cases, as we look at some of these products, we’re talking about changing the structure of the device itself and where the processing is being done. And so take a little bit more thoughtfulness on the side of the customer.

So what we’re seeing is the design cycle and this is not unexpected. I think I’ve been pretty clear that we would probably wouldn’t see intelligent audio having a big impact on 2015 but really it’s starting to show up results in 2016 and we still think that the case.

It’s a little too early to start projecting exactly what the sales and margins impact they’ll have because it will be highly dependent on which designs we win and where we win.

Again our targets have been, in the short term have really around wearables and internet of things, where there’s a lot of great opportunities in some of our products bring real fit to them. .

Great, thanks guys. .

Our next question comes from Harsh Kumar with Stephen. .

Thanks for getting me a follow up. Hey John, I had a quick question, so during the course of the call I’ve had a few calls from my staff guys on modeling this. I think everybody is struggling with the same thing, you are at 26% now and I know you only gave one quarter guide but you’re asking us to get to 35%.

That’s almost a 900 basis point increase in two quarters. I think I just want to understand what gets you there, why should we build that number, the part that I picked up was there was something about 250 basis points improvement coming from, let’s say increased utilization.

Could you maybe kind of bridge that for us so that we can adequately model? And then I had another follow up..

Sure, Harsh. Again we got the guide for Q2 was 25 to 27. I also mentioned that we are still in Q2 being negatively impacted by capacity utilization, i.e. we still aren’t back to pre-September 2014 levels on the impacted mic. If we were back to those levels we would pick up another 250 basis points.

So that gets you to, I will call it, guide of 27.5 to 29.5.

If then you consider what we typically see seasonally, front half of the year to back half of the year, when the back half has much heavier product launches we can typically see in a swing, if you go back to 2013 you can see a swing of 300 to 400 basis points between first half and second half. So you have got that leg.

The last leg is, again we are completing the product transfer in our hearing health business which will be completed in Q3 which will give us another 10 million to 12 million in annualized savings. So it's really that kind of the bridge to get to -- as I said, I don’t see a reason why we couldn’t exit 2015 in the mid 30% gross margin..

Got it. So that was very helpful, I appreciate your letting me ask a follow up. Thanks guys..

Our next question comes from Alex Gauna with JMP Securities..

Just another point of clarification for me on what Harsh just asked you, John. My understanding had been, as we were heading into the June quarter, that, that was going to be, in your expectation one of the biggest legs up, because of some of the benefits from resumed shipments and from the manufacturing consolidation.

Am I wrong in that supposition and then also the hearing health manufacturing cost efficiencies that are coming on later in the year, is that been the last of it that we should expect until you announce any other new programs? Thanks..

Yeah, with respect to Q2, I will say our margin while it's improving a 140 basis points improvement, we did expect slightly better margin improvement there, and that’s really a result of, we had some headwind in both the speaker business, where we moved, roughly sales out of Q2 into Q3 due to their change to a new operating system.

And we also continue to be unfavorably impacted by softness in the wireless infrastructure business and our timing. So it is fair that we expected, if you think back three months ago, our view of Q2 margins would have been a little better than what we came in to. But we haven’t changed at all our view on the back half. .

Okay and then as far as the efforts that are in place for further cost savings that we get in the back half, that’s been the completion of everything you set out to do that we know about them right?.

Yeah and I mean, Alex what I will say is, we're going to continue to evaluate --we got a lot on our plates still, that we have to execute and make it seamless to the customer. Well once we get these initiatives done we're going to continually evaluate new opportunities for consolidation of our footprint and margin expansion. .

Okay. Fair enough. Thanks again..

Our next question comes from Harsh Kumar with Stephens..

Hi, we are tag teaming..

Hi, Harsh, how are you doing?.

Hey guys, back in line again. I just want to be really clear about understanding this dispersion [ph], so going back to some of what Alex asked and some of what I was asking earlier, the 300 to 400 basis points increase in the back half that you get from utilization, that’s assuming a much higher share that you previously had at your top tier U.S.

based customer because your shares on a flux can we make that assumption that you will get a similar effect in the second half of this year?.

First of all there is normal seasonality, right. I mean all things being equal the back half of the year will be significantly better margins than the front half of the year. We do expect from where we are today in terms of the share that we will have higher share in the back half of the year.

So we are expecting that, as I said in the script, we think we are pretty well positioned on new products with a number of new customers that will help drive the capacity utilization, that coupled with the restructuring activities that we’ve been doing over the last year, [indiscernible] do they get into the better margins in the back half of the year.

.

Very helpful, guys. Thank you..

Thanks Harsh..

And I’m not showing any further questions at this time. I’d like to turn the conference back over to our host for closing comments. .

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

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day..