Michael J. Knapp - Knowles Corp. Jeffrey S. Niew - Knowles Corp. John S. Anderson - Knowles Corp..

Charlie Lowell Anderson - Dougherty & Co. LLC Bill Peterson - JPMorgan Securities LLC Harsh V. Kumar - Stephens, Inc. Bob J. Labick - CJS Securities, Inc. Jaeson A. M. Schmidt - Lake Street Capital Markets LLC Anthony Joseph Stoss - Craig-Hallum Capital Group LLC Gary Mobley - The Benchmark Co. LLC Maggie McNally - Robert W. Baird & Co., Inc..

Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the Knowles Corporation Second Quarter 2017 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.

As a reminder, this conference call is being recorded. With that said, here with opening remarks is Knowles' Vice President of Investor Relations, Mike Knapp. Please go ahead.

Thanks, Andrew, and welcome to our Q2 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's sales, expenses and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations.

The company urges investors to review the risks and uncertainties in the company's SEC filings, including but not limited to the Annual Report on Form 10-K for the fiscal year ended December 31, 2016, periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today's earnings release.

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

In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today's 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.

All references on this call will be on a non-GAAP continuing operations basis unless otherwise indicated. Also, we've made selected financial information available in webcast slides, which can be found in the IR section of our website. With that, let me turn the call over to Jeff, who will provide some details on our results.

Jeff?.

Thanks, Mike, and thanks to all of you for joining us today. For Q2, we reported revenue of $190 million, in line with the midpoint of guidance. Gross margins of 39.4% and EPS of $0.13 were both at the high end of our guidance range.

In our Audio segment, sales were down 2% and came in largely as expected, as strong year-over-year microphone growth in IoT was partially offset by the Chinese handset inventory correction we called out last quarter. Sales in our hearing health business were also lower, as expected, driven by our decision to be more disciplined with our pricing.

Overall, revenue from Audio comprised 73% of total sales in the second quarter. In the Precision Device segment, Q2 sales grew about 4% year-over-year due to stronger demand for timing and capacitor devices. We continue to see improving trends in our defense, industrial, and medical markets driving demand for these products.

Precision Devices represented about 27% of total company revenue in Q2. As we look across the end markets we serve, we are seeing robust and broad-based demand trends in our MEMS microphone business. In the IoT market, we see accelerating mic sales due to voice-enabled smart speakers.

Amazon noted after its 2017 Prime Day that the Dot was the best selling product in any category across Amazon globally. Prime members also purchased seven times more Echo devices than they did on Prime Day of 2016. The microphone array used by these devices has been an enabler of their success in the market.

Advanced echo cancellation and beamforming technologies restrain noise, strengthen voice pickup, and improve voice recognition in noisy environments. All this is enabled by high performance MEMS microphones.

Sales from our large IoT customer were up more than 4X from the year-ago period, and we see the potential for significant growth continuing into 2018 as Apple, Google, Chinese OEMs and others focus on this market.

With the successful launches like Amazon's Echo and Google's Home and the upcoming Apple's HomePod release, we are seeing a move towards voice-enabled user interfaces across a variety of markets and products.

To better adjust the needs of this diverse set of customers, Knowles sponsors its first audio conference in May named The Future of Voice and Audio for Connected Devices.

It was held in conjunction with IoT World Conference in Santa Clara with more than 150 customers and software partners joining Knowles to discuss the challenges and solutions for developing, selecting and integrating the next generation of audio products in the connected devices.

The setup place of this new event was our new open DSP smart microphone, the first intelligent microphone from Knowles built on the company's internally developed microphone and DSP technology platforms, enabling features like voice wake, command recognition and acoustic event detection.

Multiple software companies have committed to or have already ported their software to this smart microphone, and this solution had been sampled and is currently being evaluated by dozens of companies in the U.S., China, Korea and Europe. We are pleased with the initial traction and excitement around this solution.

We are also expecting to announce details around our first multi-core DSP audio solution next quarter, which utilizes the same software development framework as the single-core smart mic architecture we've already introduced.

With multiple open-course, extremely high compute performance that is tuned for audio efficiency and expanded memory, this solution has the ability to manage all audio functions in both IoT and your applications.

We've received positive feedback from several audio experts and customers, and we have sampled the solution to a large Bay Area alpha customer for an IoT device expected to launch next year. We're planning to share more details on the solution when it's formally launched in Q4.

In China, we are anticipating 10% sequential growth in Q3 from our handset customers from a low Q2 level. Despite this more muted Q3 recovery, we have increased confidence that Q4 sequential growth will accelerate due to strong multi-mic adoption trends, launches of new handset products, and the completion of the region's inventory rebalancing.

Chinese handset customers are continuing to add more microphones in new handsets than in prior generation models. Models like the latest high-end Oppo, OnePlus handset went from two to three microphones, and several additional platforms will double the mic count from one to two microphones when they hit the market later this year.

We continue to demonstrate the advantages of additional microphones to improve performance and enable new use cases, which increases our audio content per device. We are also ready to support our largest North American customer, as the company ramps its next generation handsets later this year.

While there has been speculation around the timing of this launch, we are expecting that this product cycle will be positive one for Knowles.

As the largest provider of MEMS microphones in the – to this customer and to the world, our ability to deliver millions of high performance microphones in a matter of weeks is unmatched in the industry, and we expect significant sequential increases in revenue in Q3 and Q4.

John will provide some additional details on our expectations for growth in the second half of 2017 in just a moment. Overall, the industry trends around audio input and improved performance continue to provide a favorable backdrop for us, as we enter the second half of the year.

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

John?.

Thanks, Jeff. As Jeff mentioned, we reported second quarter revenues of $190 million, in line with our projected range.

Audio revenues of $138 million were down 2% from the year-ago period, as solid growth in MEMS microphones was offset by lower sales into the hearing health market, primarily as a result of reduced market share of receivers as we continue to be disciplined in our pricing practices.

Precision Device revenues of $52 million were up 4% year-over-year as a result of increased shipments in defense, industrial and medical markets. Second quarter gross margins were 39.4%, near the high end of our guidance, driven primarily by pricing discipline, favorable product mix, as well as productivity improvements within the Audio segment.

Operating expenses in the quarter were $57.1 million, better than the midpoint of our guidance and down $2.8 million from the year-ago period, as we continue to realize the benefits from cost reduction actions taken in prior periods as well as further actions taken in the second quarter.

For the quarter, adjusted EBIT margin and non-GAAP diluted EPS was 8.6% and $0.13 respectively, with both metrics near the high end 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 website at knowles.com. Now, I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $48.6 million at June 30.

For the quarter, cash flow from operations was $3.5 million and capital spending was $13.7 million. Notes and bank borrowings were reduced $3.6 million in the quarter. Moving to our third quarter guidance, we expect total company revenue for the quarter to be between $205 million and $235 million with the midpoint up sequentially by 16%.

Our Q3 guidance reflects the potential for a later-than-normal launch of new flagship handsets at a North American customer and a more modest recovery in microphone demand from Chinese handset OEMs. Further, we anticipate the sequential growth in Q3 to accelerate in Q4 at both North American and Chinese handset customers.

Precision Device revenue is expected to increase 2% sequentially and up 6% from the year-ago period, driven by increased capacitor demand across several end markets. We project non-GAAP gross margin for the quarter to be approximately 38% to 41%.

We are projecting operating expenses for Q3 to be between $55 million and $59 million, up slightly from the year-ago period at the midpoint, as a result of increased R&D spending. R&D spending in Q3 is expected to be between $24 million and $26 million. Selling and administrative expense is expected to be approximately $31 million to $33 million.

We are projecting adjusted EBIT margin for the quarter to be in the range of 13% to 15% and expect non-GAAP diluted EPS to be within a range of $0.23 to $0.29 per share. This assumes weighted average shares outstanding during the quarter of just over $92.8 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 third quarter, we expect cash generated from operations to be approximately $10 million to $20 million.

CapEx in the third 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 this year. We expect CapEx for full year 2017 to be within the range of 6% to 8% of total revenue.

For the full year, a slower recovery in demand from Chinese handset OEMs could reduce our year-over-year revenue growth by 1 percentage points to 2 percentage points versus our prior expectations of mid-single-digit revenue growth.

We anticipate the EBIT impact associated with lower revenue to be offset by expanded gross margins and lower operating expenses. I'll now turn the call back over to Jeff for closing remarks, and then we'll move to the Q&A portion of the call.

Jeff?.

Thanks, John. We expect revenue growth for full year 2017 to be driven by both of our segments. We are uniquely positioned across our end markets and are well aligned with our customers' roadmaps to deliver best-in-class audio input solutions for their next-generation platforms in 2017 and beyond.

Longer term, we continue to invest in higher value differentiated solutions, from performance microphones to smart mics to digital single processors. We remain the only supplier in the industry with a broad-based audio portfolio as well as design and manufacturing control over the MEMS, ASIC, packaging, signal processing and software.

In addition, design activity around our new smart mic and DSP solutions is strong, and we're expecting design wins this year that will drive revenue in 2018. Operator, we can now take questions..

Thank you. And our first question comes from Charlie Anderson with Dougherty & Company. Your line is now open..

Yes. Thanks for taking my questions. Maybe just to drill on IoT opportunities, Jeff, you mentioned some of the activity in China. I think we've seen Alibaba and Baidu and now I think Xiaomi recently announce Echo-like products.

I wonder how you see the opportunities there or the competition there, when you think the timing happens in terms of your ability to take advantage of those opportunities in China.

And then just if I think about Prime Day and then the – how sort of the cadence of builds went, how I should think about the IoT business, the seasonality of it Q2 versus Q3 versus Q4? Thanks..

Yes. Well, first let me take the first question. I think there is a lot of activity around IoT in China. I think it's still a little early and unclear yet who the winners or losers are going to be in that market.

But I think kind of the way how we frame this out is, is that in the U.S., Amazon has clearly taken a very strong position, Google is in the market, there are other players in North America coming in, and we feel pretty good about being positioned there.

But our – our goal really and thought is, is that first everybody's got to get one of these smart speakers in their house. The next, they got to get one in every room. And then I think, third, which is a little longer term is, this has got to happen outside the U.S., this phenomenon.

And I would say it's a little unclear yet who the winners or the losers are going to be in China. But as usual, I feel very good about that we're positioned well with a lot of these people in terms of the microphone content. And so I feel pretty good about that.

As far as the seasonality around our largest IoT customer, I would just say that the – that what we see typically last year and I think we'll see this year is, it's a – it's definitely very strong in the Q3, Q4 timeframe versus some of our things in the handset space tend to ramp up a little earlier.

We have Samsung in the front half of the year, but it's really a Q3, Q4 phenomena. And so we're expecting, again, in the back half of the year to have strong growth in the back half of the year over the front half..

Great. And then just one quick one for me. I – you mentioned that the dozen or so companies evaluating – or over a dozen companies evaluating the smart mic.

I wonder if you'd give us any thoughts on which types of applications you are seeing that in and where do you think some of the earliest design wins can come, be it smartphone here, IoT, et cetera? Thanks..

Yes. That's a very good question. I think the great thing that we're seeing about this microphone, and we just introduced this, is the open nature of the platform. And what it'll allow us to do is – think of it as the platform that allows for innovation across numerous markets.

And so, well, I would say that clearly we've got some opportunities in our core handset space. We are seeing great opportunities in IoT and in the ear. And to the extent that we're seeing this, we kind of starting to view this as – could be a very broad-based product with the flexibility in design and what software runs on this device.

So we feel very, very good that in a very short period of time, whether it'd be through the IoT World Conference, whether it'd be through the customer we sample, there's a tremendous amount of design activity across mobile phones, handsets, IoT and the ear..

Great. Thanks so much..

Thank you. And our next question comes from Bill Peterson of JPMorgan. Your line is now open..

Yes. Hi, guys. Thanks for taking the questions. Actually I'd like to expand on both IoT as well as the smart mics, I guess first with IoT. You discussed overall sort of MEMS microphone share in 50%, 60% range. Obviously your share at Amazon has been higher.

I guess the question I have is, as we think about exiting this year, what type of share should we expect for these – I guess, these IoT opportunities as you see it? And I guess, how big can the connected home, IoT opportunity be in 2017 as a percentage of revenue based off your trajectory?.

Yes. So let me just talk a little bit overall share, how kind of we see 2017 build, and then maybe we could expand a little bit more into IoT. I guess, overall, I'd say our share we expect to be stable. And let me give you the positives and negatives. At our large Korean customer, our share is actually up.

We are in a very strong position with the new mic that was launched earlier this year. So our share is actually higher.

I would say our share in China is probably slightly lower, and I'd say that as we talked about walking away from some of our – the lower end business, but overall in the higher end of the market, especially as we go into the back half of the year into Q4, we feel pretty good about where our share is in China.

I would say we've kind of forecasted at our largest IoT customer that there would be another source. So our share is coming down, although we are by far the majority share player at that account. And then of course, the North American guy where we kind of think that the share is flattish to maybe slightly up at the largest customer in North America.

But overall, we kind of feel it's – our share is stable, 2016 to 2017. Now, specifically to IoT, it's very interesting because we're – everyone's focused on Amazon. Right? Because they are the largest player.

But I think the thing that Knowles is in a very strong position is that we are kind of the go-to guy, whether it be the other guys in North America, there's people working on things in Korea, in Japan, in China.

We've got a very robust set of design opportunities that some of which are we'll be talking about hopefully in next quarter or so, that go to production in Q3 and Q4. Now, the hard part here is, who is the winners and the losers. That's the real hard part yet for us to predict.

But I just – I can't find any significant opportunities where we sit there and go, oh, we're not well positioned with those customers..

Okay. Thanks for that. And again, I guess related to the smart mic, you had your first solution. I heard you discussing your multi-core solution. We've seen in the June timeframe some other larger players like Qualcomm and Synaptics who acquired some businesses. And they're highlighting voice as user interface, much the same way you guys do.

But they're obviously looking at from a different approach, more from the processor and codec side, and you guys are looking at it from the microphone up.

I guess the question is, is that how can we think about your advantages versus some competitors who may try to add more intelligence on the processor side and just require, let's call it, standard microphones versus some of the smart microphones? What can you guys bring that's different versus these well-funded competitors? Thank you..

That's a good question. I would start with the fact that we have developed, I would call, a open platform for innovation.

That's the number one thing that I would start with, which is – we've just kind of decided that we're not going to be the one that innovates every possible use case in the ear, IoT and the mobile phone and that we're working with third-parties that are thinking up how to use a smart microphone, which is very different than the approach of some of these other guys.

The second thing is, what you see is, is that and one of the reasons that we acquired Audience was that they had the capability to design extremely high compute, low power DSPs.

And this is kind of playing out as we kind of talk to customers that we seem to be at some very good sweet spots in terms of power, performance and cost, very, very, very unique. And then the third thing that we see is that we're at the very front end. We talked about the smart microphone, which is single core.

We're getting prepared to do some multi-core device. We're going to have an entire family of products, all based on the same core, the same open platform that's going to allow for innovation.

Our customers can write software to it, third-parties can write software, and so can we to innovate around this family of signal processors in smart microphones..

Okay. Thanks for that, and good luck in the future..

Thank you..

Thank you. And our next question comes from Harsh Kumar with Stephens. Your line is now open..

Hey, guys. I had a couple of question. First of all, I was curious, Jeff, I know you talked about China impact. There were some in, sounds like, 2Q. I'm curious, how much of an impact are you seeing or counting to see in the September quarter in your guide? And how does the ramp at your largest customer that interplay? I'm curious about that..

Just to make sure, repeat the second part of that question, Harsh?.

I'm sorry. Yeah.

How is the interplay between the ramp at your largest customer versus the expected declines in China?.

Yeah. So, first, I would just say is, as we look at the quarter, Q3 for China, it is going to be up sequentially 10%. That's our prediction at this point. But it's off some low numbers in Q2. And I would say, as I look at the forecast I'm receiving from the customers and what we're seeing is, it's ramping through the quarter.

And that gives us a lot of confidence that these new products that are being launched with more microphones are going to drive very strong sequential growth in Q4 in China.

Now, the interplay of this is – the other portion, so I would say that if you think about where we're looking at for Q3, I would say that North American customer is probably about 75% of moving into Q4 versus China about 25% of what we're facing in terms of Q3. So....

Versus what we might have thought three months ago..

Versus what we might have been thought about three months ago. So, the majority of what we're seeing in Q3 – and I hate to say, but weekly our forecast change, and it's right on the quarter. So, it's very hard to predict how this all plays out at the end of Q3 to Q4.

But I just reiterate we feel very good this is going to be a positive cycle for us with the North American customer..

Understood, Jeff. And Jeff and John, thanks for that clarity. And then, you talked about in your press release and even in your earnings transcript you talked about new wins that are driving revenues in 2018. You talked about the DSP-based mic.

One of the other things that was supposed to happen, I think, was that the mic and speaker combo, I forget the name, Versant.

Has anything come out of that, or have you had any kind of progress with that particular product set at all?.

Yeah. So here's what I'd say is, think about the products that we first introduced that were really started, developed under Knowles as being single use-case solutions. Right? So, Versant was a single use-case solution. The original microphone, the ASIC-based smart mics were for a single purpose.

I think we still have opportunities with these devices, but they are single use case versus what I would tell you is that the platforms we're developing are for many use cases. They're open, they're flexible to allow that – for whether you want to do a voice wake, you want to do event detection.

These same devices – and they can be used across the ear, IoT or the handset market. And I think that's the kind of the changes that we knew this was coming, this flexible platform. And in the meantime, we had these single use cases that will still drive some revenue for us. There is no doubt. They'll still drive some revenue for us.

But to really amp this up and move in the right direction, we got to have a more flexible platform, which we're now starting to get in the marketplace..

Got it, Jeff. Thank you. And – and one more for me. I don't know how to ask this question, so I'll just ask it. The late ramp for the large U.S.

customer, is everything set with them date-wise or whatever information they give you in terms of -- for you to give you the green signal to go ahead, or are things still kind of, quote-unquote, "mucking around," sort of moving around?.

I think I'm just – I'm not going to comment to that level of detail about this customer. I would just say is I keep coming back to this. We're very well positioned. We think this is going to be a positive cycle for us..

Okay. Understood. Thanks, Jeff. I'll be back in the line..

Thank you. And our next question comes from Bob Labick with CJS Securities. Your line is now open..

Good afternoon. Thank you. Why don't you start – obviously you gave essentially full year guidance of growth in revenue and EPS as well. So there's some implications for Q4.

And seemingly, if you take the midpoint, maybe 10% revenue growth year-over-year in Q4, and also margin seemed to be sequentially stronger from Q3, can you just talk a little bit about the margins and the primary growth drivers that are necessary to get you to the full year growth in revenues?.

Let me take – let me take the revenue first. I think the two pieces that we see is that the recovery of the China market for sure, and again, like I think I said earlier, I think assuming Q3 comes in with a 10% growth with the sequentially month-by-month what we're seeing, I think we feel very good about where we are for China.

I think back to our largest customer, I think there is a lot of – again, we're well-positioned there. So, I mean, it could come in earlier, it could in later, but we're – we're definitely well-positioned there. And that has a lot to do with the margins. But I'll let John make a couple of comments about the margins..

Yes, Bob. Well, I mentioned in my script that while our expectations for revenue growth for the full year have been reduced from that mid-single digit range to potentially 1 or 2 percentage points lower, I'm confident that that impact from lower volume can be offset by better improved gross margins and lower operating expense.

So, really, we think from an EBIT standpoint, we're fairly unchanged from where we would have been three months ago. And just to elaborate a little bit on your gross margin question, it's really coming from a couple of things.

First of all, pricing discipline; second, productivity gains, really the day-to-day labor productivity, value creation; and then third is mix. We've got a higher percentage of new product. If you think about just historically our gross margins, they're typically better in the back half of the year versus the first half of the year.

First half this year, we were just a touch under 39%. And again, historically, our back half has been better than the first half. So, hopefully, that can provide you a little more granularity..

Okay. Great. Yes. And then, just jumping to – there's been a lot of discussion from your – I don't know, call it, your tees are on the multi-core DSP product, which we'll hear more about I guess potentially next call.

But that being said, can you just talk about the R&D process and where you're spending the bulk of the, call it, $100 million is? Did this multi-core idea come from within the – customers come and say, can you go bill this for us, or how did you come up with this as your next new product, and what's the primary thought process between – from the R&D spending going forward?.

Yes. So I'll start with the smart mic. I mean, when we did the acquisition of Audience, about six months to nine months after that, we really laid out a product roadmap. We kind of said is, is that the ASIC-based smart mics, which we started developing pre-Audience, were again single point of use or single use case devices that could do one function.

And so it limited the lot – the size and the number of opportunities. We started looking -we started saying, well, where is our strength? It comes from mics. So we developed the first single-core platform DSP, which we already introduced. We've sampled a lot of customers.

And on the roadmap, we right away said that the next step was, was that we wanted to go to a multi-core device that could, like, run the entire year in IoT audio functions. So we moved in that direction. And we started sampling customers, I would say, these pre-production samples. And so far, the feedback has been pretty positive.

And I think it just keeps coming back to is that all these devices leverage the Audience capability around low power, building an open platform with high compute performance specifically tuned for audio input applications.

And we layer on top of that all the tools to make this an open platform so that third parties can develop, including our customers, their own solutions for this platform..

Got it. Okay. Thank you very much..

Thank you. And our next question comes from Jaeson Schmidt with Lake Street Capital. Your line is now open..

Hey, guys. Thanks for taking my questions. Jeff, just curious if you could comment what are you seeing from the infrastructure market..

Yes. I would say that it's stable. I wouldn't see that we see a big up or down in the marketplace. I would call it stable. And our expectations going forward into the back half of the year is same thing. We're not seeing big ups or downs in this market. It's more just stable..

Okay.

And then, John, just to get a clarification on your comments surrounding margins, should we then expect OpEx to remain fairly flat in Q4 over Q3?.

Yes. I think that's a safe assumption. I mean, just going back, we've reduced in our SG&A – I'll take R&D out of the OpEx right now, but we've reduced SG&A throughout 2016. We exited 2016 below our run rate target of $140 million. We actually exited closer to $130 million run rate.

I expect 2017 full-year SG&A to be below 2016 levels, as we're going to get the full year benefit of those actions we took throughout 2016. And yes, to follow up on your specific question, I would expect the level of expenses in the second half of the year will be in line, if not a touch below, from an SG&A standpoint in the first half of 2017..

Okay. Thanks a lot, guys..

Thank you. And our next question comes from Anthony Stoss with Craig-Hallum. Your line is now open..

Hey, guys. So, Jeff, you talked about your share with your biggest North American customer being roughly flat to maybe up slightly. How about ASPs or total content? Are you still getting a similar price for each mic? Also, maybe more for John. You talked about walking away some of the low-end business.

Maybe remind us or update us where your ad capacity utilization lies? And then lastly, on the whole smart speaker market, are your mic ASPs roughly what they are in the smartphone side? Thanks..

So I'll take that first one – the last one first, which is the easy one. Yes, the ASPs are roughly in line with the rest of the market. I don't see dramatic differences in that. Your first question relative to ASPs at our largest customer. I'm not going to comment about specifically ASPs at the largest customer.

I can make some comments about ASPs, which last call we kind of talked about on our mature products that the erosion was looking to be at the lower end of the 6% to 10% range that we've projected before versus in 2016. It was at the higher end of the range. So I think that means our pricing discipline has been working.

The erosion on the older products is less. I would also just make a comment more generally speaking about ASPs, and you could kind of gather what this means, but we are seeing more of a stabilization of ASPs overall relative to the mix is more positive. Meaning, people are using the higher-end mics. So, I think that's a very big positive.

If you think about last year, we talked about China, selling more mid-range and low-end mics, which drove the overall ASPs down, not price erosion, but with just the mix. I think 2017 is looking relatively positive in terms of the mix, in terms of overall ASP..

And Tony, in terms of capacity utilization, you can think of – from, I'll call it, the last month of Q2 through the end of the year, we're going to be running close to full out in terms of capacity in our Audio segment. You'll see inventory crept up fairly significantly in Q2.

It could creep up again in Q3 based on – again, it's all timing of shipments kind of in that month of September. But from a capacity standpoint, yeah, the last seven months of the year, you can consider 95%-plus utilization..

Great. Thank you..

Thank you. And our next question comes from Gary Mobley with Benchmark. Your line is now open..

Hi, guys. Thanks for taking my question. I had a question about the competitive environment out there. You've already talked about the different roadmaps on the smart mic front and where you guys are colliding with some other players.

But just wondering, on the standard product side, who has been aggressive out there in the marketplace, if at all? Who's getting out of the market and, perhaps, who's doubling down?.

Yeah. I mean, I don't think the competitive environment has changed dramatically this year from last. I would say that we still see that, generally speaking, we make better margins than our competitors. And that's because of the fact that we control the design of the MEMS, the ASIC, the packaging, the test, we do it all ourselves internally.

And I think we extend that with the smart microphones and the software development tools around that. So, I think we continue to see that. Other than that, I would just sit there and say is that, generally speaking, we're not seeing share shift. I mean – and so to the extent, I – it's hard to talk about shares quarter-to-quarter.

We really want to talk about year-over-year. And I think I laid out kind of the positives and negative. So, we're not seeing a lot in the market. I might say that one of the competitors, AAC, has kind of been a little less active, but generally speaking, I don't see a lot of change..

Okay.

With the over-the-counter hearing aid market, perhaps, evolving in particular North America, I'm curious to know, is that a market that Knowles can compete for, particularly in the price point?.

Yeah. I mean, I think, for sure, that's a market we could compete for. I think what we kind of see in the overall marketplace is that there is already an over-the-counter market today that we participate in. Quite frankly, it's quite small today. But I think what I see is in the market what's changing is that there is this convergence around the year.

When I say convergence, what you start seeing is more and more of these devices that are coming to marketplace, which we've referred to on previous calls, they are starting to look closer and closer to hearing aids and could be used potentially at some point as assisted listening devices, over-the-counter hearing aids.

So, overall, I think we feel pretty positive about our position here. And there is no reason why we shouldn't be able to compete and participate in this over-the-counter market if it becomes more successful than it's been in the past..

Okay. Just one last question.

John, what was that $19 million impairment charge? Is that relating to the exit of some low-end business?.

No. Actually, we took a non-cash impairment charge. It's actually $21 million in the second quarter, and the charge primarily relates to develop technology, which was acquired as part of Audience acquisition, as the legacy Audience products aren't really forecasted to generate positive net cash flow over the remaining asset life, which is three years.

So, the things that Jeff's talking about on the new products, these are products that have been developed subsequent to the – with the Audience team and the Knowles team, but they've been developed subsequent to the acquisition. So, this really relates to legacy products acquired as of the date of the acquisition..

Got you. Okay. Thank you, guys..

Our next question comes from Tristan Gerra with Robert W. Baird. Your line is open..

Hi, this is Maggie McNally on for Tristan. Thank you for taking the question. I'm wondering how we should look at potential revenue contribution of smart speakers in the medium-term and what percentage of revenue that would look like over the next two years..

So – so I guess what I would say is, it's really hard to predict the size of this market. I mean, if you want to look at IoT – if you want to look at IoT in terms of what people are projecting, it's really broad in terms of, like, what they're projecting. But I think the common theme is, it's all up into the right.

Now, clearly Amazon is driving a lot of our revenue in the IoT space. But I think what you'll start to see is that in China, as we kind of alluded to, with smart speakers and IoT devices, other people in North America that are introducing smart speakers and IoT devices, our expectation for 2018 is pretty high.

It's just very difficult at this point to predict who's going to be successful and by how much, and it really comes down to this. Again, first, we got to get a smart speaker in everybody's house. Then we got to get one in every room, and then it's got to be expanded beyond the U.S.

And when you start thinking about the numbers that these could be, it could be staggering, but it's a question of the timeline to make that happen. And so it's very hard to speculate and say exactly how that's going to all play out. I would just say Knowles is really well positioned with microphones.

And a lot of the new products that you'll see me introduce later this year, all have at least three, four, five microphones, at least..

Just to add a little detail, because I know that Charlie and Bill earlier asked the same thing. IoT today, if you think, again, based on our kind of full year projections, it's upper single digits in terms of a percentage of our Audio segment. Think of high-single digits..

Okay. Thank you very much..

Okay..

And I'm showing no further questions at this time. I would now like to turn the call back to Mike Knapp for any further remarks..

Great. Well, thanks very much 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 good-bye..

Ladies and gentlemen, thank you for your participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day..