Knowles (KN) Jeffrey S. Niew on Q4 2015 Results - Earnings Call Transcript

| About: Knowles Corporation (KN)

Knowles Corp. (NYSE:KN)

Q4 2015 Earnings Call

February 11, 2016 4:30 pm ET

Executives

Michael J. Knapp - Vice President-Investor Relations

Jeffrey S. Niew - President & Chief Executive Officer

John S. Anderson - Chief Financial Officer & Senior Vice President

Analysts

Harsh V. Kumar - Stephens, Inc.

Jaeson A. M. Schmidt - Lake Street Capital Markets LLC

Robert Labick - CJS Securities, Inc.

Tristan Gerra - Robert W. Baird & Co., Inc. (Broker)

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

Operator

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Knowles Corporation Fourth Quarter and Year-End 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. 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.

Michael J. Knapp - Vice President-Investor Relations

Thanks, Latoya, and welcome to our fourth quarter and year-end 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'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, 2014, periodic reports filed from time-to-time with the SEC, and 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, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at knowles.com, including a reconciliation to the most directly comparable GAAP measures. Except for revenue, all financial references on this call will be non-GAAP, unless otherwise indicated. Also, we've made webcast slides available in the Investor Relations section of the website, which we will refer to during this call.

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

Jeffrey S. Niew - President & Chief Executive Officer

Thanks, Mike. Thanks to all of you for joining us here today.

For Q4, we reported revenue of $310 million, up 5% quarter-over-quarter, and at the high end of the guidance we provided on our Q3 call. Gross margins were 32.8% and EBIT margins were 8.5%. Both metrics came in above the midpoint of our original guidance.

Mobile Consumer sales improved sequentially, driven by strong demand from our largest customer early in the quarter and improving trends at the Chinese OEMs. Sales from intelligent audio product lines were consistent with our original expectations. Overall, revenue for MCE comprised 65% of the total sales in the fourth quarter.

In 2015, we executed extremely well, supporting our largest customer with the introduction of their latest handsets, which drove second half results. Note that microphone sales were up more than 40% in the second half of 2015 versus the first half of the year, driven by share gains and normal seasonal patterns.

I'm very proud of our team and our success in regaining share in 2015. While we successfully delivered for this ramp, demand for our North American OEMs softened through the fourth quarter. Because we control our manufacturing, we can mitigate excess inventory risk and ship production on a real-time basis. With our manufacturing occurring much closer to the final device builds, we can quickly adjust output based on our customers' changes in demand.

Our large Korean OEM was down quarter-over-quarter as we expected, following the launch of two new handsets in the third quarter. We continued to maintain strong microphone share at this customer, but sales remained weak due to mix shifts to lower-end handsets within their portfolio, as well as continued share loss experienced by this customer.

China remains an important driver of our long-term growth. Recent report suggests that Chinese brands made up 40% of global phone sales in 2015 and they are expected to grow share again this year at the expense of other Android players.

In fact, seven of the top 10 handset vendors in 2015 were Chinese OEMs. Huawei and Oppo Vivo are two examples of strong performers in China. And they've demonstrated their ability to capture market share by delivering premium features, including superior acoustics. Xiaomi also remained a top 5 global handset supplier and we look forward to the launch of their new Mi 5 platform to improve their position in the market.

While we are currently seeing mixed trends from Chinese OEM-to-OEM, we have broad based exposure to these companies. We expect growth from these customers in 2016 as they grow their share and we benefit from multi-mic adoption and higher value audio solutions.

We are also pleased to see most of our OEM partners focused on the idea that sound matters. Last month at CES, we spoke with a number of our partners where we highlighted some of the important long-term growth drivers for our business, including improved voice and audio quality, as well as the trend towards voice as a user interface.

Smartphone manufacturers have been moving in this direction for the last few years to enhance call quality, improve voice detect accuracy and enable other audio features like, always on and always listening. We are now seeing headsets in hearable devices implementing similar features as customers demand improved audio performance.

One example is Earin, a Swedish partner of ours focused on high-fidelity audio devices, who recently began selling its latest generation wireless earphones at major U.S. retailers. These devices are built with high precision balanced armature speakers supplied by Knowles that deliver premium sound with minimal distortion. If you buy these headphones, you'll notice that the Knowles logo is printed on the box, highlighting our differentiated audio inside.

Another partner making headlines at CES was Bragi, with their new Dash smart earphones which use several of our microphones and balanced armature speakers. Again, the Knowles logo is displayed on the box, so consumers know they're getting the highest quality acoustics in the marketplace.

As I've mentioned in other calls, intelligent audio remains an important driver for our business over the next several years across a wide breadth of applications, customers and geographies. Last quarter, I told you about the Qualcomm Bluetooth headset reference design we won with our Always On, Always Listening mic solution.

And I'm pleased to announce that Voice iQ is now on reference design for Mediatek's latest Helio X version mobile processor. Again, this solution is the world's first smart mic with acoustic activity detection to allow voice wait (7:02) features that reduce power consumption. Overall, we expect continued design win success around intelligent audio and anticipate revenue to begin to accelerate in the back half of 2016.

In the Specialty Components segment, Q4 sales were up 4% quarter-over-quarter, in line with prior expectations and represented about 35% of total company revenue. Sales in our acoustic business were up 10% sequentially and reached near record highs in Q4, driven by strong hearing health sales. Modest improvement in timing sales was offset by slightly lower capacity revenue.

With that, I'll turn it over to John to expand on our financial results. And then I'll come back to talk more about the speaker and receiver announcement we made today as well as what to expect in 2016. Slides have been posted in the Investor Relations section of the website, which I'll refer to a bit later in the call.

John?

John S. Anderson - Chief Financial Officer & Senior Vice President

Thanks, Jeff. As Jeff mentioned earlier, we reported fourth quarter revenues of $310 million, at the high end of the guidance provided on our Q3 earnings call. Mobile Consumer Electronic revenues of $201 million were up 6% sequentially, slightly better than expected, primarily driven by significant growth at our North American OEM, as we continue to support the launch of their new headsets. This increase was partially offset by lower sales to a Korean OEM. Shipments to Chinese OEMs were up modestly on a sequential basis.

Specialty Component revenues of $110 million were up 4% sequentially, in line with our expectations. Sales in our acoustic business were up 10% sequentially, and reached near record highs in Q4, driven by strong hearing health sales. Fourth quarter gross margins were up 70 basis points sequentially to 32.8%, in line with our expectations.

Margin improvement was driven across both segments. Within MCE, margin expansion related to increased capacity utilization and productivity gains, which was partially offset by unfavorable product mix, specifically higher speaker shipments.

Specialty Component margin improvements were aided by both favorable foreign currency impacts and a benefit from the production transfer of the hearing health business to our low-cost facility in the Philippines. Total company gross margins have now expanded 820 basis points since Q1 of 2015, driven by higher volumes and related capacity utilization, the ongoing implementation of our cost reduction initiatives, product mix and foreign currency impacts.

Operating expense in the fourth quarter was approximately $74 million. The sequential increase in expense was related to slightly higher R&D spending and a $1 million increase in our bad debt reserve. Our cost takeout initiative related to the integration of Audience remains on track, and we expect to achieve $25 million in annualized cost savings by the end of Q1 2016.

Adjusted EBIT margin was 8.5%, near the high end of the guidance range. Non-GAAP diluted EPS was $0.34, $0.13 above the midpoint of our projected range, with $0.02 of the favorable variance driven by operations and $0.11 from a lower effective tax rate. The reduction in our effective tax rate in the quarter was due to a change in the geographic mix of earnings, and the benefits of the recently enacted R&D tax credit which was retroactive to the beginning of 2015.

For full-year 2015, revenues were $1.08 billion, gross margins were 29.6%, EBIT margins were 6% and EPS was $0.65. 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 $63 million at December 31st. For the quarter, cash generated by operating activities was $66 million, significantly above our projections due to stronger than expected sales earlier in the quarter and related cash collections. In addition, year-end inventory levels were reduced below our estimates. Cash from operations included restructuring and production transfer cost of $7 million and capital expenditures of $15 million.

Our bank debt balance was $430 million at the end of the quarter, down $45 million from Q3. Interest expense was approximately $4 million in the quarter. I'll talk more about our expectations for Q1 and full-year 2016 shortly, but first I'll turn the call back to Jeff and he will outline some key strategic actions that are expected to drive improved financial performance in 2016. Jeff?

Jeffrey S. Niew - President & Chief Executive Officer

Thanks, John. Let's turn to the slide embedded in the webcast link I referred to earlier in today's call, which can be found in the Investor Relations section of our website. If you'll please turn to slide number two. I want to leave you with three important takeaways today. First, we announced the decision to sell our low-margin MCE speaker/receiver product line. I'll explain more about the rationale and impact from this decision in just a moment.

Second, in our remaining core business lines, microphones, hearing health and precision devices, we are leaders in each of these respective businesses and expect to maintain or expand this leadership. These businesses also generate strong gross and operating margins and drive healthy cash flow.

Lastly, the investment we are making in intelligent audio are necessary to achieve long-term growth and improve margins through dollar content increases per device and expansion into new markets.

Turning to slide number three. So, when we look at 2016, we plan to focus on two key priorities. We want to optimize our portfolio and drive long-term growth. I'll dive deeper into each of these bullets in the next few slides.

On slide number four, let's start with optimizing our portfolio. I want to explain the rationale behind the decision to sell our MCE speaker/receiver product line. As the number three supplier, Knowles is confronted with volatility and capacity utilization, and does not have the scale to improve gross margins and profitability in line with the rest of our businesses.

Additionally, I don't believe this electromechanical product line can leverage our long-term investment in semiconductor and software design capability. By exiting this product line, we make meaningful improvements to our gross margins, while reducing our CapEx intensity and improving free cash flow. We intend to sell this business by the end of Q2 2016.

Turning to our growth initiatives on slide number five. As I mentioned earlier, our customers are focused on improving audio and voice quality and embracing voice as a user interface in our existing markets. For example, our largest customer moved to four microphones in their latest handsets to improve voice capture and the performance of their voice-activated applications. We've also seen many Chinese OEMs increase the number of microphones per handset for better call quality, improved audio capture and reduced background noise.

More and more customers are also supporting voice as a user interface as consumers become more comfortable with voice personal assistants like Cortana and Google Now. These trends are driving customers to Knowles in order to solve their audio hardware and software challenges, and we are extremely well positioned to benefit from this increased audio content per device, which is needed to enable high performance and new features.

Industry analysts believe that the MEMS microphone market will grow by more than 60% between 2015 and 2019. As the leader in this market, with the broadest portfolio of solutions and the most innovative technology roadmap, with unmatched scale with 8 billion MEMS microphones shipped to-date, we are uniquely positioned to capture this growth.

The capabilities we've added in our intelligent audio business are opening up multiple opportunities to increase the value we add by providing solutions that leverage our software and hardware competencies. Smart microphones as well as voice processing software and algorithms are examples of these types of value-add solutions. These new categories are already generating revenue and should start to contribute more to our top line in the second half of the year and beyond.

On slide number six, beyond smartphones, we are at the early stages of seeing voice redefining the relationship between consumers and technology. New applications like hearables and earphones and connected devices are adopting voice as the most natural and intuitive way to control the world around us. Devices like the Amazon Echo and Apple TV's remote control are examples of voice-enabled devices.

I recently purchased an Echo because I knew it levers seven Knowles microphones, and I've been very impressed with its capability to respond to my commands. It makes me think more about how other devices in my home should be voice-controlled.

These broader trends in the market are undeniable, and new customers are coming to us from industries like automotive, household appliances, and smart TVs to solve audio challenges they are facing. We are extremely well positioned to take advantage of these trends.

Now I'll turn it over to John to discuss our Q1 guidance and the outlook for 2016. John?

John S. Anderson - Chief Financial Officer & Senior Vice President

Thanks, Jeff. On slide seven, we've included our financial guidance for Q1 of 2016. It's important to note that our guidance relates to our continuing operations and excludes the financial results of our MCE speaker/receiver product line, which we intend to sell in 2016.

We expect revenue for the first quarter to be between $170 million and $190 million. $87 million of the sequential decline is driven by the reclassification of the speaker/receiver product line into discontinued operations. MCE revenue on a continuing basis is expected to be down $34 million or 30% sequentially, due to normal seasonality and lower shipments to a North American OEM as they adjust their inventory levels to reflect current market demand. Sales from Specialty Components are expected to be down $9 million or 8% sequentially, following a strong fourth quarter sales in hearing health.

We project non-GAAP gross margin to be approximately 36% to 38%, up 420 basis points sequentially at the midpoint, due primarily to the reclassification of our speaker/receiver product line into discontinued operations. On a continuing operations basis, gross margins are expected to be down approximately 500 basis points quarter-over-quarter. This decline is due to lower production volumes and capacity utilization, as previously mentioned, and lower ASP on mature products.

R&D spending in the quarter is expected to be between $25 million and $27 million, down $7 million from Q4 levels with $4 million of the decrease in spending directly associated with the speaker/receiver business and $3 million from the reduction of non-core R&D expenses in the continuing business.

Selling and administrative expense is expected to be $35 million to $37 million, down $5.5 million at the midpoint from Q4 levels with $4 million of the reduction due to the speaker/receiver impact and the remainder associated with lower spending in the continuing business.

We are projecting adjusted EBIT margin for the quarter to be between 3% and 5%. We expect non-GAAP diluted EPS for the quarter to be within a range of $0.01 to $0.07 per share. This assumes weighted average shares outstanding during the quarter of 90.1 million on a fully diluted basis. We expect our effective Q1 tax rate to be between 0% and 5%, as we continue to record a benefit from Audience losses.

For the first quarter, we expect cash from continuing operating activities to be within a range of $20 million to $30 million. This includes restructuring and production transfer payments of $3 million and capital expenditures of approximately $12 million.

Cash flow used in discontinued operations is expected to be approximately $6 million to $10 million. As previously stated, we are on track to achieve our projected cost synergy goal of $25 million annualized related to the integration of Audience by the end of Q1.

Moving to slide eight. Given the announced changes in our product portfolio, I wanted to highlight our expectations for our continuing operations in 2016. We're projecting a modest full-year revenue increase, driven by market growth, multi-mic adoption, share gains and new products, partially offset by price erosion on mature product. We expect about 50% of our 2016 revenue to come from the Mobile Consumer segment, compared to 60% in 2015 due to reduced exposure to the handset market.

Full-year gross margins are expected to be approximately 38% to 40% with sequential improvement throughout the year. The margin expansion will be driven by both new product introductions in the second half of the year and improved operating leverage related to our normal seasonal patterns.

R&D spending is expected to increase modestly from Q1 levels for the remainder of 2016. We expect to rationalize SG&A throughout 2016 as we right-size operating expenses to support our continuing operations. We anticipate SG&A reductions will be realized in the back half of 2016 and expect to exit the year at a $140 million annualized run rate. This compares to more than a $160 million run rate in Q4 of 2015.

We expect our 2016 tax rate to be approximately 5%, as we benefit from Audience losses in the first half of the year. Our long-term effective tax rate is expected to be between 10% and 15%.

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?

Jeffrey S. Niew - President & Chief Executive Officer

Thanks, John. To conclude on slide number nine, the actions we've already taken in our core business will greatly improve our gross and operating margins, and we expect additional improvement as we move through the year, driven by stronger sales of higher margin solutions.

In addition, we are taking action to right-size our OpEx, rationalizing SG&A while investing in R&D that will support our future growth. With the marketplace in greater value on audio quality and voice as a user interface, I believe our leading position in hearing health, microphones and intelligent audio combined with stable sales of precision devices will drive top-line growth and strong operating margins in the future.

Operator, we can now take questions.

Question-and-Answer Session

Operator

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

Harsh V. Kumar - Stephens, Inc.

Yeah. Hey, guys. Lots of stuff going on; have a lot of questions. But let me first say that it looks like your largest customer is stabilizing. So congratulations on that, guys. Let me start off with your largest customer. So what should we expect that to be as a percentage of sales after you exit this discontinued business?

Jeffrey S. Niew - President & Chief Executive Officer

I don't know if I have the exact number in front of me, Harsh, but what I would just say is, we only have one customer as a company that's over 10% of sales in 2016. And I don't know, John...

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. Harsh, I can – when you look at the 2015 10-K, which will be filed shortly...

Harsh V. Kumar - Stephens, Inc.

Okay.

John S. Anderson - Chief Financial Officer & Senior Vice President

...you'll see our largest customer represents about 25% of our sales in 2015. That will go to less than 20% – we expect that to go to less than 20% in 2016.

Harsh V. Kumar - Stephens, Inc.

Okay. So your largest customer will be less than 20% in 2016 and this is of course – okay, got it. And then, curious, your margins are jumping up nicely in March quarter from a variety of reasons. You're cutting costs in Audience, you're taking out stuff. I was wondering if, John, you could take us through – I think you gave us how much of the OpEx reduction will be from the sale of the existing business. But I was wondering if you could also give us an idea how much Audience are getting – or the acquisition of Audience, how much of that is built-in in terms of continued cost reduction in the March quarter?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. I mean, Harsh, a couple of things. First of all, as I said, we are on track with our goal of getting $25 million in annualized cost reductions by the end of Q1. I also talked about our overall decline in operating expenses being roughly $4 million a quarter due to the reclassification of speakers/receivers into discontinued operations. And then, on top of that, we have other cost takeout in our, I'll call, continuing business.

Jeffrey S. Niew - President & Chief Executive Officer

And just to make one other comment, we did talk about a reduction in R&D that – we've talked about this on previous calls, the possibility of taking out some non-core R&D as we look for projects that were very speculative and long term. And we've done some of that already in Q4, which starts taking effect in Q1.

Harsh V. Kumar - Stephens, Inc.

Okay. And then, just one more and I promise I'll get back in queue after this. Your acoustics business, your hearing health business jumped up quite a bit. Is there any specific reason, Jeff, that drove that?

Jeffrey S. Niew - President & Chief Executive Officer

There is normal seasonal trends. I think we talked about – it's one of the best quarters we've ever had in our acoustics business. I think the longer-term trends here, Harsh, are still very positive in terms of demographics. Emerging markets starting to buy hearing aids.

I also think that we've done pretty well in terms of MEMS microphones in this space. That's relatively new. We've been in the MEMS microphone business for more than 10 years, but the hearing health market has been recently adopting it and that's been a real help to our business.

Harsh V. Kumar - Stephens, Inc.

Hey, congratulations, guys. Looks like you're making progress on your long-term plans. Thanks again.

Jeffrey S. Niew - President & Chief Executive Officer

Thanks, Harsh.

Operator

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

Jaeson A. M. Schmidt - Lake Street Capital Markets LLC

Hey, guys. Thanks for taking my questions. I know in the release you said the speaker and the receiver product line was about $235 million in 2015. How much of – first of all, was that down in 2015? And if so, by how much?

John S. Anderson - Chief Financial Officer & Senior Vice President

It was up modestly in 2015.

Jeffrey S. Niew - President & Chief Executive Officer

Yeah. Up modestly.

Jaeson A. M. Schmidt - Lake Street Capital Markets LLC

Oh, okay. And then, how much was China as a percentage of Q4 revenue?

Jeffrey S. Niew - President & Chief Executive Officer

I think we have that written down here somewhere. I can give you just...

John S. Anderson - Chief Financial Officer & Senior Vice President

Maybe go to the next one. We'll pull this up and we'll have it for you in a second.

Jaeson A. M. Schmidt - Lake Street Capital Markets LLC

Okay. Just wondering if you could comment on what you're seeing from the infrastructure market and sort of your outlook for the rest of this year?

Jeffrey S. Niew - President & Chief Executive Officer

Yeah. It's hard for me to predict the full year of how we sit there and say infrastructure going, but I would just say this is – 2015 was a pretty tough year in terms of infrastructure. I think, as we said in the last call, I'll say it again, the business has stabilized. We do see, I would say, some modest improvement in the business, but we're yet to see any, like, what I would say wholesale large improvement in the business over the 2015 levels. So I would say it's been very stable now for a couple of quarters.

John S. Anderson - Chief Financial Officer & Senior Vice President

Just to follow-up to your question with Chinese OEMs, it was roughly 15% of our Mobile Consumer sales in Q4.

Jaeson A. M. Schmidt - Lake Street Capital Markets LLC

All right. I'll jump back in the queue. Thanks a lot, guys.

Jeffrey S. Niew - President & Chief Executive Officer

Thanks, Jaeson.

Operator

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

Robert Labick - CJS Securities, Inc.

Good afternoon. Thanks. Wanted to start – you've said in the past you had mid-term financial targets of gross margins of 39%. And then, the free cash flow is 12% of sales. You also mentioned that this divestiture should improve your free cash flow profile. Can you give us a sense of where those numbers may go?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. I mean, based on the full-year guidance I provided today, you can see we're at our mid-term model in terms of gross profit margin. We're currently investing heavily in R&D. And as we get leverage in the intelligent audio space and grow the top line, we'd expect our operating margins to go up with it.

Robert Labick - CJS Securities, Inc.

And is it safe to say that the free cash flow though in the future is expected to be higher than that 12% prior target?

John S. Anderson - Chief Financial Officer & Senior Vice President

You know what, at this point, we aren't changing our mid-term model targets, Bob.

Robert Labick - CJS Securities, Inc.

Okay. And then, one other obvious outcome from this divestiture is the Specialty Components become a much larger percentage of your overall business. It's hard to tease out in particular the contribution from hearing health, given the changes in the composition of specialty components since you were spun.

Is there a way you can help investors see the earnings contribution or the EBITDA or whatever you'd like to for hearing health to maybe value that on its own? It seems like it's a undervalued asset as part of your portfolio if it were a standalone business, but it's hard to tell what they actually contribute. Can you shine some light on that?

Jeffrey S. Niew - President & Chief Executive Officer

Well, let me just make a couple of comments. First of all, we've kind of given pretty good guidance on the revenue side, that roughly of specialty or precision devices, roughly – or Specialty Components, sorry, it's about 50%. So we've kind of given the area.

Generally speaking, I would say it's very tightly coupled though from an R&D standpoint as we go forward, especially with MEMS microphones into the Mobile Consumer with the MEMS microphone business, as we're seeing quite a bit of uptake on MEMS microphones in the hearing health business.

As far as the earnings, we haven't really disclosed that in much detail. I would say the hearing health business is slightly better in terms of margins than the timing and the capacitor business.

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. Where it really comes in is the gross margins are fairly correlated with the precision device business. Operating margins are a bit better just because of operating leverage...

Jeffrey S. Niew - President & Chief Executive Officer

So, you're leveraging spreads.

John S. Anderson - Chief Financial Officer & Senior Vice President

...and less operating leverage.

Jeffrey S. Niew - President & Chief Executive Officer

We don't – in the hearing health business, we only have about 10 customers that makes up the majority of the sales. So, if you think about from that perspective, you have two separate businesses, capacitors and timing, which each require their own sales teams and R&D and it's very separate, so.

Robert Labick - CJS Securities, Inc.

Okay. Fair enough. And then, last one. With the divestiture, are there any loss of microphone sales, any bundled sales in that regard? And what happens with N'Bass? Is that – do you still control that or what goes on with that?

Jeffrey S. Niew - President & Chief Executive Officer

Let me start on the question of N'Bass. We are selling N'Bass as part of the speaker/receiver business. And when we sell the business, that technology and product will go with the sale. So, that will be expected. As far as bundling, I would just sit there and say, our focus, as we go forward, if we think about where we were, we were selling more products to the customers.

But I think what we're starting to feel very strongly about is, we'd rather sell more advanced products in the areas that we have significant competitive advantage, specifically microphones. So, where we see really the bundling opportunity, where it's much more closely tied, is to sell a system level solution on the voice input side, which includes acoustics, signal processing and software. So, that's where we really see the real bundling opportunity.

Robert Labick - CJS Securities, Inc.

Okay. Great. Thank you very much.

Jeffrey S. Niew - President & Chief Executive Officer

Thanks, Bob.

Operator

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

Tristan Gerra - Robert W. Baird & Co., Inc. (Broker)

Hi. Good afternoon. How much cash do you expect to have in your balance sheet exiting Q1? And also, if you could give us a sense of your utilization rates currently?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. Tristan, first of all, at the end of 2015, we had roughly $66 million in cash on hand and I'm sure you probably saw we did file an 8-K with an amendment to our credit facility. If you reflect that amendment and the adjustment to the credit facility, we have roughly $150 million of borrowing available. So, total liquidity, a little north of $210 million.

From a cash burn rate in Q1, we would expect roughly – let me come back to you with the exact rate, including the discontinued operations, that's the one that I want to pull up. I mentioned on the call, we'll have cash generated from operations in the continuing business. Maybe we'll go to the next question, I'll pull this up.

Jeffrey S. Niew - President & Chief Executive Officer

Your second question is around capacity utilization. Correct, Tristan?

Tristan Gerra - Robert W. Baird & Co., Inc. (Broker)

Oh, yes.

Jeffrey S. Niew - President & Chief Executive Officer

Yeah. So let me just take a step. This is probably a good point I want to bring up at this point. If you think about Q4 last year with our largest customer, remember we deliver microphones much earlier in the process. And I would just sit there and say is, the inventory correction that we're seeing now in Q1 is probably larger than some of the other people of the market because of the fact that we delivered lot of microphones earlier in the quarter. That would lead to produce capacity utilization in Q1.

But, just generally speaking, remember Chinese New Year is going on right now. We're in week one and a fair number of people are taking week two off as well. So you have two weeks in the quarter where essentially the capacity is sitting unutilized at all. Couple that with, I would say, a larger than expected inventory correction relative to our largest customer, and our capacity utilization is probably for the quarter somewhere – I don't hold this number, but probably close to 60% within the quarter.

Tristan Gerra - Robert W. Baird & Co., Inc. (Broker)

Okay. And then, just a quick follow-up...

John S. Anderson - Chief Financial Officer & Senior Vice President

Tristan, this is John coming back to you on...oh, sorry.

Jeffrey S. Niew - President & Chief Executive Officer

Go ahead, Tristan.

Tristan Gerra - Robert W. Baird & Co., Inc. (Broker)

I was going to ask about Audience, and what's the revenue outlook in terms of the second half? Do you expect the significant revenue win that I think you were talking about a few quarters ago? And how do we get to break-even by Q4?

Jeffrey S. Niew - President & Chief Executive Officer

Yeah. So let me cover that. First, we've delivered on the $25 million or we will be delivering on the $25 million of cost reductions that we committed to when we did the deal, for sure. In addition, we've talked about, we're taking out additional R&D costs in the non-core area, which I've referred to we did that in Q4. I will say though, and just to be – that was not the expectation, Samsung – or sorry, our Korean OEM, I'm sorry, is challenged in the marketplace.

And it's worthwhile just making a comment here, that our mix has been switching from, I would say, higher-end flagship phones, more to mid-range and low-end phones. And that not only impacts the Audience sales, but it also impacts the Knowles sales as they are using, what I would say, lower-end devices. So, the first half, I would say there are, especially with the Korean OEM, there are definitely some challenges there.

But, as we look to the back half of the year, I have to say I'm very encouraged to see design wins coming in that will drive revenue in the back half of the year. Now, I don't expect this is going to be – I don't think we've referred to in the past, Tristan, is a significant revenue contributor in the back half. We've basically said it would start to accelerate in the back half.

And my hope is, over the next quarter or so, start to make – give you guys a more feel on more design wins beyond what we've talked about in the area of intelligent audio that will drive that beginning, that acceleration of revenue in the back half of the year.

Now, John, why don't you answer us on the cash flow for...

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah, just to follow up on your cash flow question, Tristan. We expect to generate free cash flow of roughly $10 million in Q1. And that would include $10 million of cash burn from our discontinued operation. So, $20 million positive from the continuing business, $10 million burn in the discontinued business, a net free cash flow of $10 million.

Tristan Gerra - Robert W. Baird & Co., Inc. (Broker)

Great. Thank you very much.

Jeffrey S. Niew - President & Chief Executive Officer

Thank you.

Operator

Thank you. The next question is from Chris Rolland of FBR & Company. Your line is open.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Hey, guys. Thanks for the question. So you guys paid I think a little more than $850 million for the speaker/receiver asset from NXP. How much of that has been written down now? And then, if you can't sell it, how much do you expect to realize in cash restructuring charges?

John S. Anderson - Chief Financial Officer & Senior Vice President

So our intention at this point is to sell the business. Let me follow up with you on book value after the $200 million write-down that we had in Q4.

Jeffrey S. Niew - President & Chief Executive Officer

We'll have to follow up on that. I don't think we have that right in front of us.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Okay. Also, for 2015, it seems like the loss in that business was pretty big. I get the argument that you guys are sub-scale there, but do you think there really is a good chance that there's somebody big enough with enough scale to get a lot of profitability from this business? What do you guys think the odds are of selling the business and how much do you want for it?

Jeffrey S. Niew - President & Chief Executive Officer

Well, we're in the process. We're starting the process kind of as we speak. So I think it's a little early or premature to make any comments on that. But let me just take a step back from how I view the business.

I think what we look at overall is that there are people who are making money in this business, but what we have – the struggle is, is that we don't have that kind of scale on the electromechanical side of a speaker business, in terms of plastics, things that we're trying to invest in. And that's – we've done a fair amount of analysis. We didn't take lightly the idea that whether we should be in this business. And I think, in the end, what we thought was there are other people out there who have a lot of the capabilities that we would have to build already in-house. They already have facilities that are large enough to house it.

And what we would be giving them is a couple of things. Number one is, we'll be giving them a relationship on this specific product category with a broad base of customers within the space, coupled with the manufacturing technology it took to manufacture it and they would be bringing the scale, and maybe even a stronger relationship on electromechanical devices that we could have.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

If I could, one more. I mean, I thought you were perhaps dual-sourced with this guy anyway, so I don't know if the relationship would be exclusive. Maybe I'm wrong there. And then also ex this business, how do you guys view gross margins for the remaining Mobile business for 2016?

Jeffrey S. Niew - President & Chief Executive Officer

I didn't understand the first question. I guess – can you repeat the first question?

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Yeah. I mean...

Jeffrey S. Niew - President & Chief Executive Officer

John will (41:08)

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

No, I mean you said that they're essentially buying a relationship with a large handset vendor. But from my understanding, I thought you were dual-sourced or maybe even triple-sourced on the speaker/receiver business. I just wanted some clarification there.

Jeffrey S. Niew - President & Chief Executive Officer

What I would say is we're buying the relationship on this specific product category, right? There are only three people supplying this market. So, in this specific product category, we have the relationships with all the people at these different – all the different OEMs and they would have that relationship at the level that we're dealing with, on specifically speakers and receivers.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Okay.

Jeffrey S. Niew - President & Chief Executive Officer

You asked about 2016...

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. A couple of questions.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Yeah. How do we view gross margins now for the remainder of Mobile?

John S. Anderson - Chief Financial Officer & Senior Vice President

We'll talk about it just for Q1. In Q1, the gross margin on the Mobile Consumer is going to be in the low-30% range, and then in the Specialty it will be in the high-30%s to low-40%s.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Okay. Great. Thanks.

John S. Anderson - Chief Financial Officer & Senior Vice President

Combined basis of – I gave the guidance. In terms of one other follow-up item you had, the book value of the speaker/receiver product line after the write-down is just under $400 million. It's actually in the press release.

Christopher Adam Jackson Rolland - FBR Capital Markets & Co.

Okay. Great. Thank you very much.

Operator

Thank you. The next question is from Robert Sassoon of Lafferty. Your line is open.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

Hi. Thank you. You mentioned in your full-year 2016 outlook, modest full-year revenue increase. Assuming that – is that on a like-for-like basis taking out the speaker and receiver's business in 2016?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. That's for the continuing business.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

And what is the pro forma for 2015 in terms of revenue?

John S. Anderson - Chief Financial Officer & Senior Vice President

It's in the investor deck and the supplemental; back in the appendix you'll see quarterly revenue for the continuing business.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

Right. And I think there was a question about Audience, and is your target still to break-even in the fourth quarter for Audience?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. So I think what we've said is, we're going to deliver the $25 million in the annualized savings which the majority have actually came last year, all right? And we have a little bit more coming this year. We have done some work to reduce, I would say, R&D as a total in terms of what we call non-core R&D that really doesn't have an impact on the long-term growth prospects for Knowles as a company.

Short-term, there are some challenges relative to the Korean OEM with mix and what they're buying, but that's more of not just an Audience issue, that's an overall Knowles issue. And I think, the second thing is – the last thing I would say is that we're becoming more confident as we enter Q1 and hopefully continue to be more confident in Q2 that we're going to be able to start increasing the revenue based on these, what I would call, products that are developed utilizing technology both from microphones, software, as well as signal processing.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

Just one more thing...

John S. Anderson - Chief Financial Officer & Senior Vice President

(44:36) profitability at the back half of the year.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

Right. Your guidance for the first quarter in terms of adjusted EBIT margin is 3% to 5%. And if I remember, a year ago it was about in that sort of range when you weren't actually on the iPhone 6 platform. So why there is not much of an improvement in terms – is it because of Audience, because it's – all the good progress have to keeping...

Jeffrey S. Niew - President & Chief Executive Officer

Yeah. I mean, do this way. I mean, you'll see all the stuff in the investor deck. Our speaker/receiver business is definitely challenged always in the off quarters as the number three supplier. You'll see the numbers as Q1 is a very tough quarter. And what you see is that the Audience losses in Q1 come in and replace kind of the losses that we have with speaker/receivers.

Now, the other side of this is, I just want to make sure I cover this once I'm ready, but I'll repeat it one more time is that, what we believe was going out with the North American OEM is what we see is we shipped a lot of microphones early in the quarter, before the demand was reduced. So we think we've shipped a fair amount of inventory based on the reported number of bills and what was sold. And so our inventory correction in Q1 is pretty severe relative to this customer.

Second thing is, our Korean OEM, as I already said, I won't repeat it again, but the mix towards lower end is a challenge on the microphone side.

Robert Sassoon - R.F. Lafferty & Co., Inc. (Research)

Okay. Okay. Thanks very much.

Operator

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

Harsh V. Kumar - Stephens, Inc.

Yeah. Hey. John, I wanted to get back to some of the longer-term guidance. I tried to put my model out for this year. And I know you can't guide to it, but maybe you can help us think about this. Last year, I just totaled up. You did I think roughly $847 million in continuing operations.

First of all, is that a good number to think about where we should be for 2016 or maybe slightly above that? And the question really is, to get to that kind of a number, we have to do a pretty significant increase in the MCE business, like a significant, significant increase in the MCE business, or am I missing something and there is an increase in the SCE business, as you get back some of the $30 million or so you lost in the base station. Can you just help us think about that?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. Harsh, first of all, your $800 million – and I think you said $847 million, very close to what we added, actually $850 million, if you add up...

Harsh V. Kumar - Stephens, Inc.

Okay. That's fair.

John S. Anderson - Chief Financial Officer & Senior Vice President

...the supplemental schedules. And yeah, we are projecting a modest amount of growth on that business. And I would say it's spread across both segments. We are expecting growth in both Mobile Consumer, the continuing business as well as Specialty. Might be weighted a little more towards specialty as we see some recovery in the telecom and 4G infrastructure, but both segments, we do expect some growth.

Harsh V. Kumar - Stephens, Inc.

And again for you, John, I think you had a comment in your – a comment that you made something about 50-50 split. Is that a 50-50 split between the two segments exiting 2016 or is that 50-50 for the whole year as we total up the two businesses?

John S. Anderson - Chief Financial Officer & Senior Vice President

Full year.

Harsh V. Kumar - Stephens, Inc.

Full year. Okay. Wow, okay. So, pretty dramatic growth than in the MCE side of the business in the back half as usual.

John S. Anderson - Chief Financial Officer & Senior Vice President

In the back half of the year, that's correct.

Jeffrey S. Niew - President & Chief Executive Officer

And there's a number of things. You have the normal seasonality. We have also new products that will be coming out that we're pretty excited about in the microphone space as well as we should start seeing some acceleration of revenue from intelligent audio.

Harsh V. Kumar - Stephens, Inc.

That's actually correct. That's helpful. Thanks. Thanks, Jeff. And then, tax rate, I think you said 0% to 5% for this year. I want to make sure I'm right on this as I model out. And then 10% to 15% kind of past that?

Jeffrey S. Niew - President & Chief Executive Officer

Yeah. Past 2016. 2016, we're going to continue to benefit from Audience losses, and if you think about it, we're benefiting losses in the U.S. that have rate of 35%. Our income specifically in Malaysia is very close to 0%. So we're continuing to benefit from that. As Audience losses diminish, that rate will go up. But that 5% was a full-year rate for 2016, and then beyond 2016, it's going to go up to the 10% to 15% level.

Harsh V. Kumar - Stephens, Inc.

Awesome. And then, another one for you, either Jeff or John. So let's say last year was kind of you were getting back into your largest customer and this year again starting on funky manner. But in a typical normal year, if let's say 2016 turned out to be a normal year, your Mobile business, is that typically up sequentially from 3Q to 4Q or flat or slightly down?

Jeffrey S. Niew - President & Chief Executive Officer

No, typically the Mobile business actually from Q3 to Q4 is down, but the peak quarter for us is typically Q3.

Harsh V. Kumar - Stephens, Inc.

Understood. Thanks, guys. That's all I had. Thank you. Oh, one more – sorry. Interest expense for 1Q, would you have that handy?

John S. Anderson - Chief Financial Officer & Senior Vice President

Yeah. Just anywhere between $3 million and $4 million, Harsh. There's not going to be a significant deviation from what we saw in Q4.

Harsh V. Kumar - Stephens, Inc.

Got it. Thanks, guys.

Operator

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

Jeffrey S. Niew - President & Chief Executive Officer

Great. 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.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.

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