Mike Knapp - Vice President of Investor Relations Jeffrey Niew - President and Chief Executive Officer John Anderson - SVP and Chief Financial Officer.

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

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Knowles Corporation Second 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, [indiscernible] and welcome to our second quarter 2015 earnings call. I’m Mike Knapp, Vice President of Investor Relations, and presenting with me on the call today are Jeff Niew, our President and Chief Executive Officer; and John Anderson, our Senior Vice President and Chief Financial Officer.

Our call today will include remarks about future expectations, plans and prospects for Knowles, which constitute forward-looking statements for purposes of the Safe Harbor provisions under applicable federal securities laws.

Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses and profits, and involve a number of risks and 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, 2014, periodic reports filed from time to time with the SEC and the risks and uncertainties identified in today’s earnings release.

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

In addition, pursuant to Regulation G, any non-GAAP financial measures referenced during today’s conference call can be found in our press release posted on our website at knowles.com, including 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 second quarter results.

Jeff?.

Thanks Mike and thanks to all of you for joining us today. For Q2 we reported revenue of $241 million. Gross margins and operating margins were approximately 27% and 5% respectively. Revenue in our mobile consumer segment was down 2% from Q1 below our prior projections.

Microphone shipments to a Korean OEM were weaker than expected as this customer continued to struggle to hold high and low handsets. That said we were pleased to see strong sequential growth in at a North America OEM and continued microphone share gains as well as a rebound in growth from Chinese OEMs.

This quarter highlights the benefits of our broad based exposure to mobile consumer customers. This allows us to remain focused on investing and delivering best in class solutions. Revenue from MCE comprised 55% of total sales in the second quarter.

As I mentioned earlier, we continue to make excellent progress regaining microphone share at a North American OEM and this success has translated to increased revenues from new products and improved operating leverage.

We expect these trends to accelerate in Q3 and we are well-positioned with solutions our next-generation platforms that will launch later this year. Chinese OEMs shipped a total of 237 million handsets in the first half of 2015 rising 7% from the prior year.

Within those handsets shipped 4G models increased to 195 million units according to data from the China Academy of Information and Communications Technology. Typically, we see better acoustic content per device on these 4G platforms.

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

MEMS microphone share gains against older ECM technology, multi-mic adoption trends and increased traction with higher value solutions is expected to continue at these customers as we move through 2015. In the specialty component segment Q2 sales were up 5% quarter-over-quarter and represented about 45% of total company revenue.

Revenues were up primarily due to higher acoustic and capacitor sales and were partially offset by continued weakness in timing device sales into the wireless infrastructure market. In hearing health we saw broad based improvement across all OEMs.

We continue to grow MEMS mic shipments in Q2 by hearing health devices and we remain the leading supplier of these solutions for this market. We also experienced strong performance from our capacitor business driven by increased medical sales. Additionally, I'd like to highlight a few important announcements.

First, we successfully completed our acquisition of Audience. I'll talk more about this shortly. I am very excited about how this acquisition expands our expertise in intelligent audio and signal processing solutions. This opens up new opportunities to improve audio performance and enable new applications for our customers.

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

This results in a more efficient architecture to decrease complexity design, increase battery performance and lower build material cost. We expect organic intelligent audio revenue in the second half of this year driven by relative design wins secured in the second quarter.

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

John?.

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

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

Specialty component revenues of $109 million were up 5% sequentially. Increased demand for acoustic and capacitor products was partially offset by lower shipments of timing devices into the wireless infrastructure market. Second quarter gross margins were up 270 basis points sequentially to 27.3% slightly above the high end of our prior expectations.

Margin improvements were realized in both, the specialty component and mobile consumer electronics segment due to improved capacity utilization, productivity gains, favorable foreign currency impacts and product mix.

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

Further information including a detailed reconciliation of GAAP to non-GAAP results is provided in the financial tables of today's press release. It can also be found on our website at knowles.com. Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $37 million at the end of June.

For the quarter cash flow from operating activities was $17 million and included payments related to restructuring and production transfer cost of $7 million. Capital spending in the quarter was $21 million. Our bank debt balance was $398 million at the end of the quarter up slightly from March 31 levels.

Interest expense was approximately $3 million in the quarter. Now, I will turn to our third quarter guidance. I'll start with our expectations for Knowles ex-Audience and then present guidance related to the Audience acquisition which we closed on at the beginning of Q3.

We expect Knowles' ex-Audience revenue for the third quarter to be between $275 million and $295 million. MCE revenue is expected to be up approximately 33% sequentially at the midpoint with significant increases in microphone and speaker shipments.

This will be driven by shipments to a North American OEM on their new platforms, continued improvement in sales to Chinese OEMs and stable quarter-to-quarter sales to a Korean OEM. Specialty component revenue is expected to be up slightly on a sequential basis coming off a strong Q2 for both hearing health and capacitors.

We project non-GAAP gross margin to be approximately 30 to 32% up 370 basis points sequentially at the midpoint. This margin improvement is driven primarily by new product introductions, productivity gains, microphone share recovery and related higher capacity utilization.

Assuming the midpoint of our Q3 guidance, gross margins are expected to improve 640 basis points from Q1 levels. R&D spending in the quarter is expected to be nearly $25 million up $2 million or 9% from Q2 levels driven by higher new product development activity.

Selling and administrative expense is expected to be approximately $33 million up $1.5 million from Q2 as we returned a more normalized levels of spending. We are projecting adjusted EBIT margin ex-Audience to be between 11 and 13%. We expect non-GAAP diluted EPS for the quarter to be within a range of $0.25 to $0.33 per share.

This assumes weighted average shares outstanding during the quarter to be $86.5 million on a fully diluted basis and excludes the additional shares issued in connection with the acquisition of Audience. Please refer to our press release for a GAAP to non-GAAP reconciliation.

For the third quarter we expect cash flow from operating activities to be approximately $5 million and include restructuring and production transfer payments of $10 million.

Cash from operations during the quarter is expected to be negatively impacted by a $30 million to $40 million increase in net working capital as we increase both production and shipping levels to support new product introductions. Now let's move on to Audience.

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

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

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

We continue to believe that the acquisition will be accretive by the fourth quarter of 2016. I'll turn the call back over to Jeff to discuss more about Audience and some closing remarks, then we'll move to the Q&A portion of the call.

Jeff?.

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

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

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

Customers are already beginning to embrace our intelligent audio solutions. I believe the combination of Audience's proven R&D capabilities and IP and Knowles focus on improving the audience experience coupled with the cost synergies we've outlined will enable the acquisition to be creative by Q4 2016.

The combination of the companies should also result in higher long-term growth rates and improved gross margins over the years to come. Lastly, I want to thank our employees for all their hard work supporting the Audience acquisition and the excellent execution in our core business.

Our strong Q3 expectations highlight that we are back on sound operational footing and well positioned for future growth. With that operator, we can move to the Q&A session..

Thank you. [Operator Instructions] And the first question is from Bob Labick of CJS Securities. Your line is open..

Good afternoon..

Hi Bob..

Hi Bob..

First question I just want to ask congratulations getting back, you said you are improving your share at a large OEM, U.S.

OEM, could you tell us implied in your guidance for the next generation product are you getting closer to your historical levels or do you still think you can get back to those, what's the timeframe in that regard?.

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

And I think we've taken a big step here in Q1, Q2, and now with our guidance in Q3 to get there. A lot of progress has been made just to kind of give you an example, we talk a lot about the charge that we had taken in previous quarters relative to the returned product, all the product has been screened. It has all been returned to the customer.

So we believe that's all behind us and the relationship from the customer is quite positive. So I wouldn’t want to put a timeline on it, but I keep saying our goal is to get back to the share we're at and every successive quarter, Q1, Q2 and now embedded in our guidance Q3 is where we're gaining share..

Okay, great.

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

Well, we had a number of discussions with some of the larger customers of Audience prior to the acquisition.

Plus if you think about it we have been working on our intelligent audio strategy organically for a while and kind of what we’ve gone out on to customers and said, look we have this organic plan, we want to accelerate this in terms of new products and the things that we can do and the reaction has been very, very positive.

I think customers see what we see is, is there's still a tremendous opportunity as we look forward to either improve the performance, of the audio performance or the devices that you have today and there's lots of opportunities that enable new applications that don’t exist today.

So I think it was very positively, I think the thing that we have to – we're focused on now is if you think about the design cycle that takes place within the mobile consumer typically they are six to twelve months.

We've owned the business now for I think 26 days or 27 days where we say is dated and so we’re just getting going into, this cross selling opportunity.

The unbundling of the software, selling their products into our existing customers that they want to do a lot of business with, coupled with, a lot of the work that we've been doing pioneering the smart microphone market. So we see a lot of positives and the customers have been embracing the part of the intelligent audio..

Okay, great. Thank you very much. .

Thank you. And the next question is from Tristan Gerra of Baird. Your line is open..

Hi, good afternoon, how much of the $10 million in restructuring is included in your Q3 gross margin guidance ex-Audience and is there any restructuring left for your Q4 gross margin?.

Tristan, this is John. With respect to restructuring, we non-GAAP out the restructuring costs, so there aren’t any implied in the non-GAAP results that I talked about with respect to the guidance.

Your second question?.

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

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

I mean I think we talked a little about this, the voice processor market as being an opportunity, we see unbundling of these roles past noise suppression algorithms from hardware, and we want to license these algorithms, we started that process. We think that is relatively large opportunity.

And of course we think that we are pioneering here in the smart mic market, but Audience definitely brings capability to hopefully bring more smart mic products out in the years to come, especially as we go into 2016, but I would anticipate again, just talking back to – was and on the first question, think of the design cycle of these products is six to twelve months.

So we start seeing some of this revenue synergy probably towards Q1, Q2 of next year is when you start to see that..

Great, thank you..

Thank you. And the next question is from Jaeson Schmidt of Lake Street Capital. Your line is open..

Hi guys. Thanks for taking my questions.

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

We refer to the future generation platforms. I mean we still have a fair – we've done pretty well on the existing platform, but our focus really is about the future.

Eventually, there will be another platform beyond the one that will be introduced later this year and our goal is as we move forward to get back to the share that we were before and it is going to be the goal going forward and so far again the progress we've made in Q1, Q2 and the Q3 guidance is pretty positive.

So we’re pretty happy about the progress we've made and again employees have also done a great job of making sure we got back in and I feel like the relationship with the customer is better than it was before based on they understand more about our capability.

We still have that very broad product portfolio on microphones, speakers, receivers, we sell a lot to these customers. So we're pretty I think strategy supplier to them..

Okay, great.

Thank you and then just wondering if you could talk about what you’re seeing as far as channel inventory?.

Are you referring to channel inventory as in end markets?.

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

I mean, I think the couple of things that we highlighted before that with the transition of one of our larger customers Microsoft now to Windows 10, there was an inventory overhang.

It's very hard for me to say, I would definitely say based on all the reports we’ve read coupled with our forecast, it’s clear that the Korean OEM has pulled back in terms of their builds because their sales are not as good as expected, but I don’t think we’re seeing a tremendous amount of inventory overhang on the end market at this point..

As I mentioned in the script, we are expecting basically flat sequential sales to the Korean OEM, so I think most of that inventory overhang is fine..

Yes, in fact if you remember we talked about it Q2 that it didn’t seem like the Korean OEM was really over building on the front end like they tended to do in previous years making sure they had product on the shelf.

They were a little bit more cautious on their build and to that extent we haven’t seen this much, the inventory issues are at least being total that they’re not going to buy from us because they have too much inventory..

Okay, thanks a lot guys..

Thank you. The next question is from Harsh Kumar of Stephens. Your line is open..

Yes, hi guys. Hey congratulations on getting back your large customer. Jeff may be a question for you.

Couple of the other companies that are selling to those kind of customers sometimes give us some metrics that the build is 60% in September, 40% in December of 55, 45 or may be if you don’t’ want to go to that detail could you tell us based on your history with Knowles, if September is a bigger quarter in revenues or December is a bigger quarter in revenues?.

Well, I mean it’s a little bit of a mixed bag. Harsh, here is why. When you think about how we deliver microphones, we actually have to deliver microphones to somebody who puts them on to a printed circuit board for flex circuit who then delivers it to the final assembler.

On the speakers and receivers we actually deliver that directly to the final assembler and get assembled in the phone. So in general what I’d say is, is that Q3 or I would say earlier on around microphones are tend to be stronger, as we go into the layers parts speakers or receivers pick up a little bit later than the microphones.

So if you think about it is speakers or receivers get, or all of our customers get inserted at the final phone versus our microphones are still upstream further in the supply chain..

Got it.

That’s actually very helpful and then some I know that you guys on pretty vocal about it that you had to take a little bit of ASP – get back and do some other customer so if I said okay let’s just look a couple of years now without that hit, what do you think and without the distraction, where do you think your margins would have been? I mean how much of a hit did you, do you think you had to take because of that factor being involved?.

So far what I’d say is the hit has been extremely short-term. I don’t view it as being as that long term of a hit ASP’s. We’re already pretty pleased that some of the ASP’s in our new products that we have coming out in the back half of the year.

I also say as, as you think about why do we invested in intelligent audio and why we bought Audience, it's about ASP’s, it about gross margins and so from our perspective is we believe the story that, better performance, new applications, customers are willing to pay for results of those things for the end consumer.

And that to be said, with the intelligent audio on the coming over the next 12, 18 months, what we see as that ASP is should begin to accelerate based on some of things we're working on..

Harsh, if I could share a point there to clarify to that, the price concessions were really on our products in the market today versus new products coming out called later this year. I think it's important to kind of distinguish that, because of the increasing specifications our new product there is always a reset on ASPs..

And the products become more and more different, two generations, three generations ahead, is there lot less impact on, what happened in the ASPs, two generations ago..

That’s fair and that’s actually also consistent on what you guys have said.

Hey Jeff, as you guys get your arms around Audience, you sound a lot better about your ability to take costs out, what are some of the easiest costs that you think you can take out, you don’t have to give us a lot of detail because I’m sure there is a lot of people listening in into this call, but if you just tend to look at one or two of the easiest things you can do with Audience to cut costs, what would those be?.

I’ll let John speak to the some of the exact things, but I mean, Knowles has got a history of being pretty good at taking cost out. So we feel pretty good where we are today relative to the cost. I mean there is a lot of work that has to be done on these things.

When you take cost out, we know there is a fair amount of work here, but we have an organization that is pretty good at doing it.

Now I'll let John talk a little bit on what type of cost?.

Yes Harsh, I mean that is a big areas are consistent with what we talked out when we announced the acquisition, it’s really the public company cost, executive officers.

There are some selective finance, admin, corporate function areas, there is some occupancy cost and we started on that track to realize that $25 million in Q3, again we expect to see 50% of the savings by the end of Q4 with the remainder being realized by the end of Q1 of 2016..

And I just would add probably the biggest challenge is we've got to get Audience onto our business processes right that allows us to take the cost out once out once of our [indiscernible] business processes..

And we’re in that process right now of migrating over to our business process and system..

Great and then last one from me and then I will move on.

Hey Jeff, if I were to ask you what one or two of the most exciting things you could do with the Audience product in terms of an actual example, what would you say that would be?.

Interesting question. Here is what I would just say is, I tried to use a couple of these things, a couple of examples. First of all let me use a smart mic, let us get out in front of that right now. We’ve been talking about smart mic now for probably six to nine months. Their first products out there secured design wins in Q2 with sales in Q3.

What I think, we have lot of our ideas what to do with smart mics, but doing it organically we can only do so much at a time. Audience has all the capabilities to be able to accelerate the number of products that we introduce over time and the smart mic areas. The other one that I am pretty excited about short-term is the noise suppression software.

Every customer we talked with acknowledges that Audience has the best-in-class noise suppression algorithms in the marketplace. We talked a lot about that as a public company, Audience was trying to sell a piece of hardware with software in order to tap higher sales. We don’t really need to that.

We think of it more as if we can get our noise suppression software and eventually optimize noise suppression with our smart mic, which you can see as a really great opportunity for us to improve our margins, grow our sales and at the same time giving the customers a better solution.

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

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

Thank you. And the next question is from Robert Sassoon of R F Lafferty. Your line is open. .

Okay. Thank you for taking my questions.

On Audience you say you are going to basically cut sort of [indiscernible] by the end of the first quarter, so to get to the earnings accretion level does that mean from then on that it really has been largely reliant on getting the revenue synergies?.

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

But for sure what we see is this ability to really get these products that we’ve been working on or the Audience products out in front of large base of customers and start selling that with again the design cycles six to twelve months design cycle.

So we're just starting that off and so what we do anticipated is that you start to see the outcome of this starting some in Q1, in the Q2 and then it really starts to accelerate as we get these products into market into our customers..

All right. Okay, second question I have is on the i76 platform, the actual next updates of i76 people say it’s going to come through in September, October.

Is that from your perspective seen as a new product, so is that continuation of the existing platform in terms of how ASPs are reset and the products that you send?.

So I really can’t comment specifically about that specific platform, but I would just say in general, our goal is to have a new product on every successful generation with all our customers and they’re asking us for a new product.

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

Now, just from the perspective of a product upgrade that offers a complete new generation phone, is that seen from your perspective as a continuation of the existing platform or completely new products?.

Typically new product..

Okay.

And my final question is, basically you’ve been talking a lot about China and obviously the growth prospects there, even if the smartphone market there seems to be maturing to some extent, but one of the market that you haven’t talked about and maybe you can give us a perspective of how you see it is India which seems to be the next growth - real growth market in smartphones.

Where are you positioned at the moment with respect to India and what is your sort of a strategy and sort of approach, is here a different approach to India than might have been, in the case that you've actually approached with respect to China?.

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

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

So I think, if you think about where the market is going, the question we have to ask first is, is it going to be one of the existing brands that are going to be successful there or is it going to be a new brand that doesn’t exist. So, we’re engaged with all these guys.

So as they start to want better acoustics, better phones, like we went through, first in the U.S. then it was in Korea, then it was in Japan, then it was in China eventually people will sit there and say we want better acoustics. And if Microsoft is successful there, then we're probably okay.

If the customers in China become successful in India, we'll be okay. If it is the North American OEM will be okay, because for the fact that we have such a broad base of customers, so we are watching this market very closely.

I wouldn’t say it, but right now I would say still our focus is on a global basis with the North American OEM, the Korean OEM and then the Chinese players which are increasingly, now we’re starting to see is winners or losers that are coming out of the China market..

All right.

Just one more thing now, I think they are one of the winners and they've actually been trying to get, expand into the India market is are the Chinese are able to just, Huawei are you involved with them at all?.

Yes, I mean Huawei is a large customer of ours. We do a fair amount of business with them and we’re well positioned with them, again that’s a good example. If they are successful and if they’re successful Huawei then we will be there, we’re there.

Just to give you an example, at Huawei it is one of our customers that we spent and sold a fair amount of our integrated audio modules. We do a fair amount of work with them in that area, so it looks, I think Huawei will be potentially one of the winners in the marketplace I agree with you..

Great, thanks very much..

Thank you. And the next question is from Chris Rolland of FBR Capital Markets. Your line is open..

Hey guys thanks for the question.

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

I would think about little bit differently. I would say you flaring the front part which is about the expense, but then I think what you have to think about is the product that we started organically, our hope is to accelerate those and then on top of that then we'll have the new products plus, their products that we’re cross-selling.

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

Okay, excellent that is helpful.

Exiting 2016, in terms of the topline accretion that you’re thinking about all those extra revenues, how do you sort of divide it up into those three buckets?.

I don’t think we've looked at it that closely yet. I think we’re very early days. We're talking to all the customers. I mean in general I would just say is that software licensing is probably a very high gross margin, though it is very high gross margin, but the sales per unit are probably lower.

If you think of smart mics the, the smart mics that we look to be selling today and hopefully accelerating in 2016 the ASP’s are quite a bit higher than our standard ASP’s for microphones and then some of the existing products, I think that Audience has like digital signal processors.

We don’t think the price will be that dramatically different than what they sell today, just the whole business sells to more people. So, if I would say is the buckets from a sales standpoint I would say smart mics followed by the Audience products followed by probably software licensing..

Okay, thank you. And you were pretty helpful in providing us with some longer-term gross margin guidance beyond just a quarter to just kind of help us through this transition that we’ve been going through over the past couple of quarters here.

May be you could give us a little bit more color there, what we could see potentially into the fourth quarter let’s say, and if you could force rank the drivers that you see for that gross margin expansion, whether its price improvements or share gains, that your large North American customer or Chinese or whether it’s a mix, what’s going on there, what are the things to look at?.

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

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

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

Jeff talked about this a little earlier in the call, July especially in our speaker receiver business. We don’t have a lot of production going on versus of the fourth quarter we'll have call it three solid months.

We also will be completing the hearing health transfer to our low cost facility in the Philippines at the end of Q3 and so that should be a tailwind for us in Q4 and going forward and then the other is just the proportion of new product sales that we envision. So again, I think there is opportunity for sequential gross margin expansion beyond Q3..

Great, thanks so much guys..

Thank you. And the next question is from Alex Gauna of JMP Securities. Your line is open..

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

Were you taking capacity offline was part of your restructuring a part of this? I’m just wondering on how you got the better loading in that environment and I would have assumed that even though you recovered in share your North American OEM that those, my understanding with those were discounted parts because of the recall.

So may be some more color on how you achieved such good growth on the gross margin line?.

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

But yes that's the biggest driver is volume on the top line as well as absorption from higher production levels. And I would say that’s probably two-thirds of the 370 basis points improvement.

Again there are some other impacts that we’re still getting the benefits of prior restructurings that we had done, but and the big driver is really again volume and fixed asset absorption..

And just to say you have two answers, in our specialty component we don’t talk too much about that, but the gross margin was better in the net business and I think what you see here is a fair amount of the restructuring activities that have been taking place over the last year or so going into effect.

So we’re starting to see some of the cost reductions we take going into effect as well..

Fair enough..

Jeff brings up a good point about acoustics. We are seeing some margin improvement there and it’s really due to MEMS penetration as well as our hearing health transfer to our low cost facility in the Philippines, but the MEMS portion of that business continues to grow which helps us..

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

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

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

Okay. Great, thank you. Congratulations on the improved outlook..

Thank you. Thank you, Alex..

Thank you. [Operator Instructions] The next question is from Anthony Stoss of Craig-Hallum. Your line is open..

Hi guys.

Outside of your American OEM, could you talk about what you’re seeing on the ASP side, if you expect that to move up as well in the second half of the year? And then also if you'd venture a guess into Q4 in China, so China was strong in Q2 and you expect it to be up in Q3 any visibility in Q4 at this point? And then lastly, I know you guys didn’t own Audience in Q2, but I’m curious of their revenue for the June quarter.

Thanks..

If we take the first question there was about the ASP outside - non-U.S., I haven’t I wouldn’t say I've looked in that level of detail, but what I would probably say is that the ASPs are probably down on the mature products in line with expectation and there are some new products that will be coming out in the back half of the year specifically for outside of, in the Chinese OEMs.

So we feel pretty good about some of the products that are coming out in the Chinese OEMs later this year. The second question I think you asked was about revenue for China in Q4, as I said we are expecting growth in Q3.

In Q3, it will be a little bit on a sequential basis a little bit more moderate compared to what it was from Q2 to Q3, sorry from Q1 to Q2 rather and I think we got to continue to watch this, they have a lot of new products coming out, but the market is slowing.

I think the positive for us is we continue to see that we’re growing faster than the market itself is growing and it’s because we’re still converting the old ECM technology over to MEMS microphones. It comes from the higher value solutions as well as multi-mic adoption.

We continue to see those trends in China playing out that there are more microphones on average as every successive generation of phones is introduced..

Last question on Audience, we have the Audience the Q2 number that you’re asking about the sales for Q2 we didn’t give any numbers on that..

Just curious if it is roughly in line or what your expectations are for Audience going forward?.

It is bit above our guidance for Q3. It is just a bit above that. Our guide for Q3 was $10 million it is slightly above that..

Okay, thanks guys..

Thank you and there are no further questions in queue at this time. I'll turn the call back over for closing remarks..

Great thanks [indiscernible] and thanks everybody for joining us today. We appreciate your interest in Knowles and look forward to speaking with you on our next earnings call. Thanks and good bye..