Mike Knapp - Vice President, Investor Relations Jeff Niew - President and Chief Executive Officer John Anderson - Senior Vice President and Chief Financial Officer.

Suji De Silva - ROTH Capital Bill Peterson - JPMorgan Harsh Kumar - Stephens Bob Labick - CJS Securities Jaeson Schmidt - Lake Street Capital Markets Christopher Rolland - Susquehanna.

Good afternoon and welcome to the Knowles Corporation First Quarter 2017 financial results conference call. At this time, all participants are in a listen-only mode. And later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

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

Thanks, Amanda, and welcome to our Q1 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 our 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 this call can be found in our press release posted on our Web site at knowles.com, including a reconciliation to the most directly comparable GAAP measures.

All financial references on this call will be on a non-GAAP continuing operations basis unless otherwise indicated. Also, we've made selected financial information available on webcast slides, which can be found on the Investor Relation section of our Web site. 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 Q1, we reported revenue of $194 million, up 5% from the year ago period with gross margins of 38% and earnings per share of $0.12. All metrics came in above the midpoint of our guidance range.

In our audio segment, sales came in slightly stronger than expected driven by better than anticipated MEMS microphone demand from two of our largest North American customers as well as from Chinese OEMs. Overall, revenue from audio comprised 74% of total sales in the first quarter.

In the precision device segment Q1 sales were also better than expected due to stronger demand for our timing and capacitor devices. We are seeing improved order trends in our defense, industrial and medical markets with a stable telecom infrastructure market driving demand for our products.

Precision devices represented about 26% of total company revenue in Q1. We continue to see strong demand trend in our MEMS microphone business, voice as a user interface and improved audio quality are driving the need for higher performance microphones, multi-mic adoption and smart microphones across our mobile, ear and IoT markets.

Revenue in our microphone business grew in Q1 versus the year ago period and we expect sales in this business to be up for the full year 2017 versus 2016 as customers remain focused on improving audio input for their devices.

Last month, we were pleased to see Samsung highlight the importance of enhanced audio capture with latest flagship phone, the Galaxy S8 and S8+.

These handsets come equipped with new high performance microphones that help minimize distortion in noisy environments and optimize performance for activities like concept recording or improved voice capture to enable new features like Bixby, it's new smart voice assistant.

I mentioned last quarter that our capabilities in acoustics, signal processing and software have enabled us to benchmark the performance of our customers' product across many different used cases.

These data has provided us with a foundation to clearly demonstrate the benefits from additional mic content for our customers and drive multi-mic adoption. We continue to see evidence that we are successfully demonstrating the advantages of adding more microphones to improve or enable important news cases.

Recently smartphone OEMs like VIVO have embraced higher quality microphones and doubled the number of mics in their latest X series handsets or device. In addition HTC is now leveraging four microphones in their new flagship phone versus three mics in their prior phone for better noise cancellations and multi-media capture.

This improves the consumer experience and enables OEMs to differentiate its product in the market. In our hearing health business, customers continue to leverage multiple MEMS microphones to improve performance due to the advantages over electric mics particularly around automated assembly and performance robustness across temperature and moisture.

High-end hearables from companies like Doppler and [NewHero] [ph] are also implementing multiple mics and balanced our mics to deliver new solution that combine the features of a commercial ear bud and assisted listing device.

Some of this service can amplify speech, intelligently cancel noise and enable customers to blend music and the sounds around them to enhance situational awareness.

Just two weeks ago, our largest IoT customer Amazon announced that for the first time, it was making the high performance powerfield microphone array and voice processing technology Echo available to hardware makers who want to build the Alexa experience into their products.

With the Alexa 7-Mic Far-Field Development Kit, the company is enabling developers to build and launch voice activated products by reducing development time and cost. In addition to driving more mics per device, we are also excited about our growing portfolio of smart microphones.

Last week, we introduced the world's first smart microphone with an embedded digital signal processor. This new smart microphone combines a world-leading MEMS device with a best in class open digital signal processor into a single subminiature package.

This complete and customizable solution is similar in size to a MEMS microphone found in today's leading mobile electronic devices and provides an open platform that enables OEMs and third-party software developers to create and customize advanced features or leverage Knowles industry leading software and algorithms for a turnkey solution.

This is the first intelligent microphone from Knowles built on the company's entirely developed microphone and DSP technology platforms and enables features like voice wake with voice demand, spatial recordings and event detection such as breaking glass or infant crime.

With voice rapidly emerging as the primary user interface, this smart mic simplifies audio design and can reduce total system costs.

Overall, we continue to lead the MEMS microphone market, our diverse customer base, our scale, our breadth of product and our controlled over the MEMS basic packaging, signal processing and software designs uniquely positions us to improve audio input for our customers.

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

Thanks Jeff. As Jeff mentioned, we reported first quarter revenues of $194 million above the midpoint of our projected range and up 5% from the year ago period driven by slightly higher demand in both audio and precision devices. Audio revenues of $144 million were down 24% sequentially due to typical seasonality and up 5% from the year ago period.

Revenue from Chinese OEMs and two of our largest North American customers were up from year ago levels, while revenue from a Korean customer was down due to a later launch of its flagship handset.

Precision device revenues of $50 million were down 2% sequentially and up 4% year-over-year as a result of increased shipments in defense, industrial and medical markets.

First quarter, gross margins were 38%, 50 basis points above the midpoint of our guidance and 30 basis points better than prior year driven primarily by productivity improvements within our precision device segment.

Operating expenses in the quarter were $55.6 million in line with expectations and down $3 million from the year ago period as we continue to realize the benefits from cost reduction actions taken in the second half of 2016.

For the quarter, adjusted EBIT margin and non-GAAP diluted EPS was 8.2% and $0.12 respectively with both metrics above the midpoint of our guidance range.

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 Web site at knowles.com. Now, I will turn to our balance sheet and cash flow. Cash and cash equivalents totaled $63 million at March 31.

For the quarter, cash flow from operations was $18 million and capital spending was also $18 million. Bank borrowings were unchanged from December 31, 2016 levels. Moving to our second quarter guidance.

We expect total company revenue for the quarter to be between $180 million and $200 million flat with prior year at the mid-point with increases in MEMS microphone revenues driven by multi-mic adoption, the launch of our Korean customers' new flagship handset and growth in IoT.

We expect these microphone increases will be partially offset by a decline in microphone shipments to Chinese customers in connection with their realignment of inventory levels, which we expect to largely correct by the end of the June quarter.

And a decline in our hearing health business primarily as a result of lower market share receivers as we become more disciplined in our pricing practices. Precision device revenue is expected to be consistent with prior year levels.

We are projecting non-GAAP gross margin for the quarter to be approximately 37.5% to 39.5% down slightly versus prior year levels.

The year-over-year decline at the midpoint is expected to be driven by increased costs in connection with planned capacity increases to support microphone growth in the back half of the year and the absence of one-time favorable items that were recognized in the second quarter of 2016.

R&D spending in Q2 is expected to be between $24 million and $27 million up 4.5% from prior year levels due to increased project spending related to new products.

Selling and administrative expense is expected to be approximately $31 million to $34 million down 8% from year ago levels as a result of cost reduction actions taken in the second half of 2016 partially offset by higher incentive comp cost.

We are projecting adjusted EBIT margin for the quarter to be in the range of 7% to 9% and expect non-GAAP diluted EPS to be within a range of $0.08 to $0.14 per share. This assumes weighted average shares outstanding during the quarter of just over $92 million on a fully diluted basis.

We are forecasting an effective non-GAAP tax rate of 8% to 12% for the quarter. Please refer to our press release for a GAAP to non-GAAP reconciliation. For the second quarter, we expect cash generated by operations to be approximately $5 million to $10 million.

CapEx in the second quarter is expected to be approximately $20 million as we continue to expand capacity and introduce new products in our MEMS microphone business to support growth in the back half of the year. We expect CapEx for full year 2017 to be within the range of 6% to 8% of total revenue.

We are well positioned with our major customers' new product introductions in the second half of the year and we continue to anticipate full year revenue growth in the mid-single digit range, expanding operating margins and increasing EPS for full year 2017 versus 2016 levels.

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

Jeff?.

Thanks John. As John said, I continue to expect mid-single digit revenue growth for full year 2017 driven by both growth in our audio and our precision device segments. In audio, we are leveraging our capabilities to acoustics, software and signal processing to improve audio quality enable consumers to control their device via voice.

We expect audio revenue in the second half of 2017 to be driven by multi-mic adoption in the mobile market, the launch of our customers' new handsets and adoption of new audio products across our end markets. I remain extremely excited about the revenue opportunities around voice today and then the years to come.

Operator, we could now take questions..

Hi, Jeff. Hi, John.

So, the China inventory correction, can you talk about the percent of revenues that was China this quarter and maybe [whether make it] [ph] down just to understand the peak and trough there?.

Yes. Let me describe, John, look at the numbers right now and as a percent of revenue. But, let me kind of just put some color on what we are seeing. First of all, I would start-off by saying the last six quarters. We have had a very strong growth year-over-year.

So, what we are kind of seeing that the dynamics we talked about in the market over the last, year and year-and-a-half relative to multi-mic adoption, using more high performance mics and their share gains in the marketplace continue. So we look at this kind of as a pause in Q2 and we do expect that growth will resume in Q3. John….

Yes. In terms of Q1, the revenue that Chinese OEMs are currently in the range of 11% and I would assume kind of 10% to 12% range for Q2. So….

Okay, great..

We kind of see it, it's being kind of a pause here after just six quarters in a row of very, very good growth..

Okay. Those numbers are from magnitude there.

And then, the inventory increase, was that driven by the China customers, inventory or is that building for the Korea customer's delayed launch or just some color there would be helpful?.

When we refer to the inventory, if you think about the cycles that happened, I don't know if this is what you are referring to, but typically what we have is, the front half of the year is obviously a lot less sales for us than the back half of the year. And there is three or four items; there is the holidays in the back half of the year.

There is the launch of our North American customer increasingly there is also -- we are seeing with our big IoT customer that there is a big push towards the back half of the year as well.

I think -- one of the things that we have been debating internally here in -- and we are starting to see maybe kind of a slight shift this year, which is slightly different than maybe previous years, which is Q4 could be stronger than Q3, primarily driven by some of the timing of some of these handset introductions coupled with our large IoT customer and how they are building and what the time of the year, when the sales become quite large..

Suji, I can also just add.

If you are looking at the balance sheet in our press release and looking at our inventory increase from 12.31 to 3.31, there was a bit of an increase and it really relates to a production transfer that it is taking place in our audio segment, we are building up inventory in connection with completing that transfer during the second and third quarter..

Okay. That helps.

And then, last question, on the new DSP based microphone, is that a significantly longer design cycle than the traditional microphone and is there an ASP uplift as you ramp those up?.

Let me start that first question, your second question first. Yes, we do expect a pretty significant price uplift from this product. Here is what I would say, the first generation of smart mic we have introduced, I would say probably lacks some flexibility, they were hard coated smart mics with specific -- for specific used cases.

I think what we kind of see this as a developing an open DSP, which for sure we are going to have some of our software products on it. But, it also allows our customers and third parties to write software to it for their own applications.

And so to the extent its more flexible, I would sit there and say the design cycle should not be as long and I would also say, it cuts across multiple markets this product. The smart microphones we have introduced at this point have been primarily targeted at the mobile market.

This cuts across IoT; there is opportunities in the ear, there is also opportunities for sure in mobile. So, we are really excited about the potential for this product..

That's helpful. Thanks guys. I will jump back in queue..

Thank you. Our next question is from the line of Bill Peterson of JPMorgan. Your line is open..

Yes. Hi, good afternoon, guys and solid job on the quarterly execution. Maybe piggybacking the last question, a few months ago one of your main competitors introduced also what appears to be a smart mic along with DSP Group and Sensory. Just kind of wanted to see what you have seen in the marketplace in terms of the interest in such products.

And I guess, secondarily, I suppose this new microphone you are talking about, will this replace the existing voice for IQ, I guess as far as only had a few customers try to adopt it?.

Bill, I will answer your second question first. That would be true. We were potentially over the longer term to replace some of the voice IQ type products that we have got in the marketplace today. I think what I would say there is a couple of key differences between what we see in the marketplace that people are talking.

First of all, we are sampling already, we are sampling customers and our expectation is that we would have revenue late this year from this product.

Secondly, I think what also is great about this product is it being open, which is -- and just a really important feature that we heard from the market that -- yes, in some cases we want to use your software, but we want to write our own software or we want to use this third-party, I think that's a very, very big plus.

I think the last thing -- I think that we continue to focus on, if we think about the reason we're being so successful in the MEMS microphone market. We talk about the broad product portfolio, just adds that; we talk about the scale just adds to it. We could talk about our ability to control the supply chain and design from the perspective of the DSP.

We owned the technology that goes in that DSP. We owned the microphone, the packaging the test, the assembly and so from our perspective, I think this is a much more flexible encompassing product that will have a lot of use across multiple markets..

Okay. Thanks for that color. I guess more broadly on intelligent audio, generally speak too much on that and things like Versant.

Can you give us any sort of guide post on how the design pipeline is, still looking more like a 2018 opportunity, what -- how should be thinking about the growth of this in later this year and into next year?.

Yes. Here what I will say is, I think we talked about this on previous calls, I said for the primary revenue that we see coming out of the intelligent audio capability in this year is driving the multi-mic adoption. I mean I see it when I visit the customers about how now we are having strong influence on convincing them to add additional microphones.

And in some cases, we've gotten some software sales. We get some smart mic sales. I think what we're learning as we get deeper and deeper into this, flexibility is important for our customers and we introduced the products that we talked about just last week.

This product priced the kind of flexibility the customers are looking for to use our total solution, but also develop their own solutions. So if I think about what I talked about in the last quarter and to say it again this quarter, primarily we're focused on this year on driving multi-mic adoption.

I would say that we're going to start to see more revenue from some of these products as we -- later this year and into 2018..

Okay. Last question for me as well, when you think about the IoT business, you are speaking more about it.

I was wondering if you can help us quantify how large it's now and how it's expected to grow this in the second half, I mean two weeks assume this can reach scale like, I guess 10% of revenues or how should we think about the growth of this throughout the year..

Yes. I would say it's probably not going to get to 10% of revenues this year. But, remember I would say this is starting from an extremely low point in 2015. So I would say it's going to be somewhere between 5% and 10%, probably closer to 10%.

But it's starting from a point of 0% 2.5 years ago, right? So, we're starting to see this be a significant contributor.

I would say the second piece of this is that we're very optimistic about the proliferation, right? I think primarily the revenue has come in the short-term around what we kind of call the hubs, right? But, I think in the longer term, if you look at like IoT world conference, which is going on in a couple of weeks, if you look at what happened at CES, what you kind of see is as we're being inundated with requests from other companies who want to voice enable their device beyond the hub.

And so what we're hopeful is, beyond the hubs, I think we're still going to have a lot of growth this year, next year, but I think after that you're going to start seeing more of these peripheral devices starting to drive growth..

Okay. Thanks a lot for the color guys..

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

Yes. Hi. Thanks, Jeff. Couple for you, sorry, I promise this is my last question on China and hopefully for everybody else.

But any color on how big the impact of inventory is, the China is only a 11% of revenue, I'm curious, is it possible that most of your $9 million or some missed relative to the street for the guide is China if that's the case, China is off 50%, is that -- am I thinking about it correctly or is it a lot less than that and there are other parts in it?.

Yes. So if you are kind of how -- I'm going to look at it. I mean, there is a couple of ways looking at this and we can talk about it sequentially or year-over-year, but here is kind of I view it.

First, I'm going to start saying that even with essentially flat revenues sequentially slightly down, slightly to down to flat revenue sequentially, we have strong growth in mics. We still have strong growth in mics.

So it's still okay in Q2, but I would say we were expecting to be stronger in Q2 because of China and in China this is not just showing up in Q2 because this inventory situation which we think will correct itself by the end of Q2.

The second thing, there is some decline in the hearing health business, which John mentioned in his discussion, relative to -- we've taken kind of approach on our receivers of being a little bit more price discipline in the hearing health market, it costs us some share.

Now, what I would just say I would add one more thing about this is, we continue to be optimistic on our hearing health type products in some of the -- what we call commercial actual applications for assisted listing devices, pro-audio, ear buds, hearables, we continue to be see that being an area of growth, but in the short-term, in our hearing aide business, we have decided to kind of walk away from some share which is causing some of that..

Harsh, just to add a little more color to China if you think about we talked at last quarter about in 2016, China grew at 60%..

Yes..

We continue to see growth not at that rate, but do you think growth in Q1 slowing, but still growth. Now as we've said we're seeing kind of flat sequentially. If we would have continued to grow at that call it 60% growth that is close to $10 million..

I got you, okay. That's very helpful.

And then, are you with your largest customer, when -- I'm curious when do you actually see the ramp, do you see it in June or do you see all of that in 3Q calendar?.

Well, I'll say this, Harsh. I'm not going to share confidential information. I think you could read kind of what is in the marketplace just like we read in the marketplace. And so I'll just kind of quote from what we see in the marketplace, which is -- there is still a fair amount of speculation on what handsets and what's the timing of introduction.

And I kind of said it in earlier question, which is -- this maybe a little bit different this year than the previous years.

In a lot of years, Q3 is our biggest quarter, but what we kind of see here is first there could be some I would say later ramp in some of these things coupled with I -- we look at our IoT customer last year was much stronger for them in Q4 than Q3 and we're kind of expecting the similar type situation this year..

Fair enough, Jeff. I think you mentioned that earlier, thanks for clarifying.

And then how do you feel about your -- so once you get past this inventory issue, you sort of get back into China and such are being discussed again, how do you feel about share gains, maybe not the rate of last year, but still share gains in China with your MEMS microphone this year for 2017..

I would say Harsh, that this year our share will probably go up, but let me just explain it's going to be little different this year. I wouldn't expect significant share gains in China this year.

What I would expect is a stable share in China, still stable share at our largest customer coupled with the IoT market growing at a very rapid rate where we have high share. So I would say that is probably more how we gain some share, but I wouldn't say that this year's growth is going to be driven a lot by share gains.

I would say it's IoT, I would say it's introduction of new handsets by some of our larger customers in the back half of the year and there will be growth in China, but more driven by the multi-mic adoption that we kind of like driven..

But we don't expect full year growth in China to be anywhere near the 60% level of calls --.

We have said that in previous calls as well..

No, fair enough. Thanks guys. Thank you so much..

Thank you. Our next question is from the line of Bob Labick of CJS Securities. Your line is open..

Hi, thanks.

Just going over to the hearing health part, you just alluded to, could you talk a little bit about how big is the -- your receivers as a percent of sales per hearing health I guess you had $58 million last year Q2 in hearing health or 220 for the year, what percent is receivers and how much do you walk away from, just so we can kind of quantify this on an annual or quarterly basis?.

Yes. I mean, I guess what I would just say is, we're not going to go into that level of detail. I can give you a little more color about some of the things that we see. First of all, let's keep in mind here that in our receiver business, our hearing health business, I would say we kind of view it as three separate pieces that we look at.

There is the microphones that we sell to the hearing health, there is receivers that we sell to the hearing health and then what we call internally, we call our commercial business, which is what we take that same technology and sell it to other market at hearing health that likes the pro-audio, the hearables, the earphones.

So generally speaking I would say in microphones and receivers, the mics have a ASP that's about half of what a receiver is and into the extent that when we lose a receiver unit on a revenue basis it's less -- it's more than it would be on a MEMS device or a microphone.

That said, we've walked away from some receiver business intentionally that was going to require us to make some CapEx investment that I just didn't have the return that made sense for us.

And I'm not going to go into that level of detail, exactly how much it was, but I think we are being pretty disciplined around price in this market and to the extent we want to make sure that we continue to generate strong cash flow out of this business, we will do that.

The last piece I would just say is, that we're still pretty positive about the future of sale receivers to non-hearing aide customers, there is pro-audio, hearables, earphones, assisted listing devices.

This seems to be a market that over the year, year-and-a-half has done very well and as we look towards the back half of 2017 and into 2018, we see opportunities in this space as well..

Okay, great. Maybe just following up on that, you gave us a range for the size of the IoT market for you.

How big is the hearables market, not hearing health, but the Bragi headphones and dash and those kind of opportunities, roughly how big is that now and how big can that be one, three, five years from now?.

I would say it's still relatively small, it's not a huge market today, but we can definitely see this market starting to emerge and not to say that it's similar in our thought process, but it is in terms of what's in mobile starting obviously from a much lower base here, is that we're seeing a lot of requests like IoT and mobile for multi-mic applications.

You're seeing more and more headphones, hearables, devices that all require more likes. I always use the example, there has been a ton of press about AMC in the marketplace. When we hear that that's music to our ears from the perspective of that anybody is using AMC, is going to need more mics.

And so, I would say and this is all being driven by the idea that Bluetooth is going ultra low power, is it driven by power USBC and lighting force and so we feel pretty optimistic about the long-term coming from a smaller base..

Got it. Okay. Thanks very much..

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

Hi guys. Thanks for taking my questions.

Most of my questions have already been asked, but just want to start with a clarification regarding your largest customer, so you guys feel confident about that relationship, the only thing that's uncertain this time around seems to be the timetable of launches, correct?.

Well, I mean, I think from our perspective what we said is, our goal is last year we had a very strong year with them, we felt pretty good. And we feel good about where we are today going forward. I mean, I don't think we have much more comment on that at this point.

There is -- every year, we go through this on timing, right? I mean, this is not an uncommon thing, do they announce in North America and ship in -- sorry, announce and ship in North America only, do they launch globally now you've ended the additional complexity that the rumor in the market, I think we are confirming is that there is going to be multiple phones.

And so that add some level of like which phone would sound more right. So from our perspective is -- it's more about, yes, more about timing..

Okay. That's helpful.

And then, just the last one regarding, how we should be thinking about OpEx going forward obviously picking up slightly in Q2, but do you guys anticipate needing to spend heavily in the back half of the year?.

Yes. I could take this. I mean, let me just go back to what we said last year. We had a target of reducing our OpEx and we did throughout 2016. We exited 2016 actually below our target which was an annualized run rate of $140 million. I really don't expect an increase above that $140 million rate in 2017.

So we should really see pretty strong operating leverage and favorable impact as a result of maintaining our operating expenses at -- that's $140 million or less run rate. And we'll always look at additional opportunities to reduce our operating expenses..

Okay. Thanks a lot..

Thank you. Our next question is from the line of Tristan Gerra from Robert W. Baird. Your line is open..

Hi. This is [indiscernible] on for Tristan Gerra of Baird.

You've talked about having the smart speaker turnkey solution later this year, how do you see smart speakers growth later this year and next year and what is the competitive landscape for intelligent audio in that area?.

Yes. Okay, all right. Here what I'd say is -- there is definitely going to be an area of where we're going to try to participate in this -- I would call it hopefully more of a turnkey type solution to some of the issues that the non-hub people are facing.

And I think I don't see us kind of like we look at some of them are very, very big mobile customers that there is going to be a big opportunity beyond multi-mic adoption maybe a little bit of software in those applications.

I think there is this peripheral group of people in the IoT space that are hungry for new solutions and I think there is going to be some opportunities and hopefully we'll start to talk more about this later this year.

But, here I'd just say is -- in spite of all as I said earlier in spite of all the great talk around IoT, I would say primarily the volume right today is driven around the hubs and the multi-mics around the hubs today, right, that's where the volume is today.

But I think in the future as we get into 2018 and beyond I think there is going to be more opportunities and -- just at the hubs.

The last point, I would just make is going back to our announcement of our smart microphone, I think this is key stuff to the direction we are trying to head, which is look -- we can do some of these things in order to enable solutions with this where we have our own software, our own capability to drive multi-mic adoption.

But, we really want to enable third parties and our customers to be able to -- enable new applications as well, hopefully all driving more microphone demand..

Okay. Thank you.

And then, just as a quick follow-up, given that more Bezel less smartphones are coming to the market notably from China, is this expected to drive demand for your ultrasonic mics?.

That's an interesting question. There has been a number of phones that have been introduced in the market that utilize our microphones relative to ultrasonics, you probably know a few of them that are in the marketplace. I would say there is an opportunity but so far as what we have seen is, these are primarily very high end flagship phones.

I think the one that you could probably refer and everyone is kind of aware was, I believe called the Mi Max, which is the phone from Xiaomi. That's a very high end phone for the China market. And so far, I would say is, what we are seeing is, these are very, very high end phones. But, I would just say that add to this.

I play with one of these phones, it's very interesting because the screen is allowed to become extremely large without that speaker sitting on the front of the phone, right? And so, I think there are some opportunities though, I wouldn't say it's going to have a huge impact on us in 2017..

Okay. Thank you very much..

Thank you. [Operator Instructions] Our next question is from the line of Christopher Rolland of Susquehanna. Your line is open..

Hey, guys.

Perhaps you can talk about utilizations, your packing -- packaging facility particularly, and how that might trend through the year, and then, also how your CapEx might play into that equation?.

Yes. We can do that. I think we talked about this a little bit last quarter, I mean, we exited last year running full out with essentially running down inventory, and you can kind of see it in our balance sheet, how it looked at the year end.

As we went to Q1, I would say is, the demand was as we said in the -- here it was slightly stronger than expected and I don't know if China have this, maybe we're adding a little bit of inventory, but I don't think we add a ton of inventory back in Q1. We are starting to install the capacity in Q2.

We are, I would say excited to get that online because we want to make sure we are prepared for a very, very strong back half of the year.

So, basically speaking is, I would say is, our expectation, we are going to have pretty high utilization, which is kind of a abnormal throughout the whole year this year versus our utilization is usually lower in the first half raising to the high utilization in the back half. So, we should have better utilization throughout the full year this year..

Yes, just to add, we increased our inventory by about $10 million as I mentioned part of that increase was due to a closure of one of the production facilities in our mic business. And then, we also rebuilt in our audio segment. The other was kind of replenishing inventory..

We had announced that for closing the facility is part of another -- it's not a major, major -- small facility, that we built inventory. It's not in our microphone business. And to that extent, we built some inventory. I know we have been trying to build some inventory in our mic business because we exited the year at a very low level..

Okay, great. And playing into that as well, do you guys think that the global kind of supply/demand equation for mic is just changing here at all.

I mean, I know some guys have left the market here, is it slowly changing in your favor to the point where you guys think you can get maybe firmer pricing?.

Well, again, we talked about that last quarter, and when I start thinking about it, John has always talked about 6% to 10% price erosion on mature products. In 2016, I would say, we are closer to the 10% than the 6%. But, as you look into 2017, right now we are seeing an improving price environment..

Less price erosion..

Less price erosion, right? Than we had at last year.

And I would say, there is a combination of things here, right? One is, we have been successful introducing some new microphones like we talked at Samsung which helps, right? The demand is quite strong in the marketplace with what we see is a number of competitors who are making very, very small margins on this product category, which makes it hard to justify CapEx or capacity increases coupled with I think we talked about it.

We are looking a lot closer and being more disciplined on some of the mature products and maybe walking away because the demand isn't high enough from some of the mature lower ASP products..

I see. Great. Thanks for that..

Thank you. And at this time, I'm showing no further questions. I'd like to turn the call back over to Mr. Mike Knapp for any closing remarks..

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

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