Earnings Call Transcript - KN Q3 2020

Operator, Moderator

Good afternoon and welcome to the Knowles Corporation Fourth Quarter 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. With that said, here with opening remarks is Knowles' Vice President of Investor Relations, Mike Knapp. Please go ahead.

Mike Knapp, Vice President of Investor Relations

Thanks, Elaine and welcome to our earnings call. I am Mike Knapp and presenting with me on the call today are Jeffrey Niew, our President and Chief Executive Officer; and John Anderson, our Senior Vice President and Chief Financial Officer. Our call today will include remarks about future expectations, plans and prospects for Knowles, which constitute forward-looking statements for purposes of the Safe Harbor provisions under applicable federal securities laws. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses and profits and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings included, but not limited to the annual report on Form 10-K for the fiscal year ended December 31, 2019, 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 at our website at knowles.com and in our current report on Form 8-K filed with the SEC today, 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 have made selected financial information available on webcast slides which can be found on 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?

Jeffrey Niew, CEO

Thanks, Mike, and thanks to all of you for joining us today. For Q4, we reported revenue of $243 million, up 18% sequentially and up 4% from a year ago period. As we mentioned in our pre-announcement release, stronger-than-expected MEMS microphone demand in multiple end markets and improving trends in Hearing Health solutions drove the upside. Gross margins improved 130 basis points to 38% and our earnings per share was above the high end of our guidance range at $0.41. Overall, a very solid quarter where we saw improving demand in audio in combination with solid operational execution across our businesses. Now let me update you on the current customer demand across our end markets. In audio, sales were up 22% from the prior quarter versus our expectations of more than 7%. In the second half of 2020, we saw broad-based sequential improvement in MEMS mic sales across mobile and non-mobile end markets. In mobile, stronger sales to North American and Chinese OEMs drove the majority of the increase as 5G functions accelerated. Non-mobile applications also increased with sales in the year, IoT and computing markets driven by work-from-home and remote schooling trends. We expect these trends in non-mobile applications to continue to be favorable for MEMS microphones in the first half of 2021. For Hearing Health, shipments were higher-than-expected going into the quarter, but remained lower than the year-ago period as COVID challenges persist. Data from the Hearing Industry Association shows that unit sales of hearing aids in the U.S declined by 7.5% year-over-year in Q4, with only modest improvement in the VA sales during the quarter. Under the umbrella of our Hearing Health business, we also sell high-performance microphones and speakers to premium audio companies, as well as many smaller customers for a diverse set of niche applications unrelated to Hearing Health. One example is in-ear headset monitors used by musicians in live music performances. These types of customers have been severely impacted by COVID and account for the majority of the shortfall relative to pre-pandemic sales. We remain confident that the Hearing Health business will fully recover in the near future as the COVID vaccine becomes more widely available. In Precision Devices, Q4 sales were flat sequentially as expected, as COVID continued to impact our medtech and defense end markets. Shipments of high-performance capacitors into the medtech market continue to be negatively impacted by COVID-related delays in elective surgeries. We are confident that this market will recover as the vaccine becomes more widely distributed. In Defense, COVID-related program delays were a drag on growth in 2020. But we are beginning to see a recovery as bookings in this market have improved in the last two months. These products have longer lead times and we expect these shipments to begin to positively impact Q2. Overall, I was pleased we're able to grow Precision Device revenue in 2020 despite headwinds from the pandemic, with growth coming from electric vehicles, defense, and industrial, partially offset by medtech. I anticipate we will return to more robust growth in PD as medtech and defense markets recover. I'm very proud of our team's execution during these challenging times. We not only weathered an extremely difficult first half of 2020, but we also took significant actions to improve our business. As our MEMS microphone business fully recovered in the second half of 2020, we saw the strong operating leverage and cash flow potential inherent in our business model even while COVID is still having a negative impact on a number of our end markets. I believe the leadership position across the markets we serve and our strategy to deliver high-value differentiated solutions to a diverse set of growing end markets will enable us to come out of this pandemic well-positioned to take advantage of future growth. In addition, we have several opportunities to improve our gross margins which I expect will drive additional earnings in 2021 and beyond. With that, I'll turn it over to John to expand on our financial results and provide guidance for the first quarter.

John Anderson, CFO

Thanks, Jeff. We reported fourth quarter revenues of $243 million, up 18% sequentially and 4% from the year-ago period, driven by increased shipments in the audio segment. Audio revenues of $202 million were up 22% sequentially, due to increased shipments of MEMS microphones across multiple end markets and continued recovery in the Hearing Health market. The Precision Device segment delivered revenues of $41 million, flat sequentially and in line with our expectations. Fourth quarter gross profit margins were 38% at the high end of our guidance range and up 130 basis points sequentially. Audio segment gross margins improved 260 basis points driven by higher factory capacity utilization and lower costs as well as favorable product mix related to increased shipments into the hearing health market. In the Precision Devices segment, gross margins were lower sequentially due to lower factory capacity utilization and unfavorable product mix. R&D expense in the quarter was $20 million, up $1 million sequentially as higher incentive compensation costs and a nonrecurring supplier payment was partially offset by reduced spending in intelligent audio. SG&A expenses were $27 million, flat sequentially and $2 million above our guidance due to higher incentive compensation costs. For the quarter, adjusted EBIT margin was 18% at the high end of our guidance range and up 430 basis points sequentially, driven by increased shipment volumes, higher gross profit margins, and improved operating leverage. EPS was $0.41 above our guidance range due to higher revenue and gross margins and a $0.03 discrete tax benefit, partially offset by higher incentive compensation costs. 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 $148 million at the end of Q4. For the fourth quarter of 2020, cash generated by operations of $76 million was a record high and well above our guidance range due to higher EBITDA and lower-than-expected net working capital. Capital spending was $12 million in the quarter. For full year 2020, cash generated from operations was $128 million and free cash flow was $96 million, representing more than 12% of revenues. We exited the year with net debt of less than $25 million and repurchased 1.1 million shares in 2020. Moving to the first quarter of 2021, we expect total company revenue to be between $190 million and $210 million, up 23% at the midpoint versus the same period a year ago. Revenue from the Audio segment is expected to be up approximately 35% from Q1 2020 due to increased MEMS microphone shipments into non-mobile applications as work-from-home and remote learning trends continue. In addition, we expect higher mobile microphone demand at both our largest customer and Chinese OEMs. Precision Device revenue is expected to be down approximately 12% over prior levels, driven by defense project push outs and the continued impacts of COVID-19 on elective medical procedures, specifically for implantable devices. As Jeff noted, defense bookings have strengthened over the last two months, and we're optimistic about growth in this market in 2021. We estimate gross margins for the first quarter to be approximately 37% to 39%, up 230 basis points from the year-ago period, driven by increased audio demand and improved factory capacity utilization in our MEMS microphone business, partially offset by price erosion and unfavorable FX impacts. R&D expense is expected to be between $19 million and $21 million, down $2 million from prior year levels due to a reduction in spending related to intelligent audio products, partially offset by increases in MEMS microphone and Precision Device spending. We're projecting selling and administrative expense to be between $24 million and $26 million, down $9 million from the year-ago period due to a $4 million reduction in legal expense and the impact of restructuring actions taken in the second quarter of 2020. We're projecting adjusted EBIT margin for the quarter to be in the range of 13% to 17% and expect EPS to be within a range of $0.23 to $0.27 per share. This assumes weighted average shares outstanding during the quarter of 95.1 million on a fully diluted basis. We're forecasting an effective tax rate of 14% to 18% for the quarter. Please refer to our press release and to our Form 8-K filed today with the SEC for a GAAP and non-GAAP reconciliation. For the quarter, we expect cash generated by operations to be between $25 million and $35 million and capital spending to be approximately $10 million. 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.

Jeffrey Niew, CEO

Thanks, John. Our company remains uniquely positioned across a diverse set of end markets poised to grow over the next several years. We remain the leader in Hearing Health Solutions and expect recovery to 2019 levels in the next few months. In MEMS mics, we expect non-mobile applications to drive future growth, and the mobile market stabilized as more 5G phones are introduced. For Precision Devices, we expect revenue to grow in 2021, driven by continued momentum in defense and electric vehicles and recovery in the medtech market. As we look further into 2021, and our markets continue to recover. I believe we can drive shareholder value by delivering earnings and cash flow above pre-COVID levels. Operator, we can now take questions.

Operator, Moderator

And your first question comes from Harsh Kumar with Piper Sandler.

Harsh Kumar, Analyst

Yes. Hey, guys. First of all, let me just say congratulations. This has been a phenomenal turnaround that you guys have executed across all measures controlling OpEx and now I think you guys are really seeing the results of it. So really appreciate what you guys are doing from the side of investors. Jeff, I had a quick question. If I was to try and ask you, what do you think the handset growth is for the year, we're hearing 10%. But I want to hear you talk a little bit about what you're expecting in-ear and IoT growth for the year, or call it mid-term? And then also what do you think would be the PD growth rate? In other words, I'm trying to get an idea of your growth rate for the mid-term 2 to 3 years out.

Jeffrey Niew, CEO

First, let's discuss mobile first. We've been focusing on this for a while now. Overall, in the past three years, mobile unit sales have not been strong, and we've been reflecting on that. Looking back to 2017, around 36% of our company revenue came from mobile. We expect this to drop to under 25% in 2021. Our current expectations for mobile indicate that there are predictions it might return to pre-pandemic levels in 2022. However, we’re not abandoning the mobile market; we are simply experiencing faster growth in other areas.

John Anderson, CFO

You can get better gross margin.

Jeffrey Niew, CEO

You can achieve better gross margins. This is an area we will continue to focus on. However, I do not think we have very high expectations for mobile. When we look at non-mobile applications, the situation is quite different. About 19% of the company's total revenue in 2017 came from non-mobile applications in MEMS microphones, and this figure is expected to rise to around 30% in 2021. We still see growth in this area. We have discussed IoT here, and more recently, we've also been talking about computing. The shift to working and studying from home has significantly increased demand in the laptop PC market. While this level of demand may not be sustainable indefinitely, it is certainly expected to be higher than in the 2017-2018 period. We are still very optimistic about non-mobile applications. Regarding the handheld PD market, we have two distinct businesses with several markets, which is a lot to cover in a brief call. Generally speaking, the RF business, mainly driven by defense, is expected to grow moving forward. We did see growth in that business in 2020, but it was not as strong as we anticipated due to delays in defense contracts. We expect it to strengthen again in 2021 and continue to grow. As for the high-performance capacitor business, starting from a small base, we have seen good growth and expect more in 2021, 2022, and beyond, particularly in the high-voltage segment of the electric vehicle market. We are focusing on areas like onboard chargers and battery management in the EV sector. Additionally, we anticipate a recovery in the medtech market in 2021. It's difficult to predict exactly when that will occur, but as elective surgeries begin to resume, we have been monitoring what major customers in that space, like Abbott, are saying. Longer term, we believe medtech will be a growth area for us.

Harsh Kumar, Analyst

Hey, thanks, Jeff. I think you've addressed many of my questions. The only other quick one I have is about the timing of hearing health. I understand it’s a shifting situation with everything happening due to COVID. But do you want to venture a guess on when you might return to levels similar to a year ago or full capacity?

Jeffrey Niew, CEO

Yes, I would say that as we look into the first quarter, the traditional hearing aid market is nearing a return to normal. However, one aspect that we're missing, which we haven't discussed much, is that about 10% of sales in this division are related to other applications. When I refer to other applications, I'm not talking about the balanced armature for true wireless. I'm referring to audio professionals, like performers on stage who use our headsets and speakers. We also supply to the aviation sector and other non-hearing health medical markets, which constitutes about 10% of the market. Unfortunately, that segment is still significantly down. We are optimistic that as the vaccine rollout continues, performers will return, and concerts will resume, resulting in a recovery for this business. In conclusion, hearing health is approaching normal levels in the first quarter, but the 10% from other categories is still substantially impacted.

Harsh Kumar, Analyst

Thanks, Jeff. Thank you, John, and congrats again, guys.

John Anderson, CFO

Thanks, Harsh.

Jeffrey Niew, CEO

Thank you. Thanks, Harsh.

Operator, Moderator

And your next question comes from the line of Anthony Stoss from Craig-Hallum.

Anthony Stoss, Analyst

Hey, Jeff, John, and Mike. Jeff, in your prepared remarks, you talked about gross margins and that you have some more improvements to be made or some more programs to improve them. Just if you could offer, I guess maybe a range as to where you think you exit the December quarter this year, what you need to do to get there. And then, secondly, maybe more for John, are you done with all OpEx cuts? Is there still more to go? And then, Jeff, also last question. Are you seeing any component shortages? Every chip company is talking about it on wafers, et cetera. I'm just curious what you guys are seeing.

Jeffrey Niew, CEO

Yes, let me address your last question first. Regarding wafer shortages, we have not experienced any shortage of wafers. Instead, we have seen extended lead times, which poses a challenge as we try to predict product mix further in advance. However, the lack of sufficient wafers has not been an issue for us. We have a solid group of partners who have performed well for us. On the gross margin front, I will pass it over to John shortly, but I want to provide a couple of comments first. We began discussing gross margin improvements at the end of 2019, and 2020 was certainly a challenging year, particularly in the first two quarters. Much of the good work we have been doing is overshadowed by two factors: our product mix, as our Hearing Health and medtech businesses are currently down, and the impact of not utilizing our factories fully. Now, I'll let John discuss some of the actions we are taking and what that means for 2021.

John Anderson, CFO

Sure. First of all, I'm pleased with the progress in our gross margin, which increased by more than 130 basis points sequentially. We had gross margins of about 36.7% in Q3, and they rose to 38% in Q4. Considering the potential for further margin improvement, Jeff mentioned that specific parts of our business are still facing challenges, particularly in the audio file sector, PD, the medtech market, and defense. All three of these end markets usually have above-average gross margins, so once we fully recover in these areas, we should see some positive momentum. Additionally, in the fourth quarter, despite achieving 38%, we experienced some workforce disruptions in our North American manufacturing facilities due to COVID. If these disruptions do not persist, it will also benefit us moving forward. Given the current market conditions, I believe there's no reason we can't achieve full-year 2021 gross margins above 2019 levels. We finished at around 39.1% in 2019. I hope this provides some insight.

Anthony Stoss, Analyst

Got it. If I could sneak in one more, Jeff. Any update on when you can get the automated VA equipment in, and then up and running?

Jeffrey Niew, CEO

Yes, I will give you a quick update on that. The line is shipped, it's actually on the ground in the Philippines in the facility. We have not yet been able to get the installation team there in order to install the machine. But we're hopeful with the distribution of the vaccine that we're not too far off from being able to send a team there, and that any restrictions relative to travel to the Philippines will be fully cleared. Once we get it there, I'm anticipating it's about 8 to 10 weeks to get it fully installed. And so, we have a pretty good pipeline of opportunities for the back half of the year, which I hope we don't have to push out. I don't think we will, I think we're going to get this line up and going. But I think the pipelines in the back half of the year is looking pretty good. And so we got to get this thing installed, but I think it should happen sometime in late Q2.

Anthony Stoss, Analyst

Thanks for the details, Jeff.

John Anderson, CFO

Hey, Tony, did we address your OpEx question?

Anthony Stoss, Analyst

No, I was going to save that for the follow-up call tonight. But go ahead. I assume you can be pretty close to the end of it.

John Anderson, CFO

Yes, I mean, in Q4 we incurred about $47 million of OpEx. A couple of items that I want to pull out is, we had abnormally high incentive compensation costs about $2 million higher than normal. We really finished strong and on the higher EBIT, we had higher incentive comp costs. We also had some engineering costs which is a little more than a $1 million. So if you take those out, call it a $44 million to $45 million run rate, I would say very modest increases from there going into 2021. There's nothing line of sight where we see this big opportunity to reduce further, but I think we can get great operating leverage if we can grow the top line and really just we shouldn't have much more than 2% to 3% increases in 2021 in OpEx.

Anthony Stoss, Analyst

Thanks. Best of luck guys.

Jeffrey Niew, CEO

Thank you.

Operator, Moderator

And your next question comes from the line of Bob Labick from CJS.

Bob Labick, Analyst

Good afternoon and also congratulations on some very strong results.

Jeffrey Niew, CEO

Thanks, Bob.

Bob Labick, Analyst

I wanted to stick with the gross margin question. And obviously you just spoke about the opportunity to have very strong gross margins this year. Looking out further, can you talk a little bit about the opportunity to perhaps get above 40%? And what would be the drivers there? And maybe is your mix changing even within mobile, or what are the current drivers right now of the improved gross margins, despite having some of the higher margin businesses being suffered? So I guess there's two questions there, sorry.

John Anderson, CFO

That's okay. I would say that we briefly discussed 2020 being somewhat challenging in terms of pricing. We made some pricing decisions in February, March, and April for the second half of the year, though it was difficult to predict what the demand would be. However, it's clear that pricing and demand are now much better aligned, especially as we move into 2021. A few years ago, we were experiencing price erosion of around 7% to 8% on mature products, but by 2019, that had decreased to less than 4%. We encountered some challenges in Q1 and Q2, which led us to make decisions about pricing for the latter half of the year, but I don't expect that trend to continue. As we introduce new products in MEMS microphones, we're seeing higher gross margins, and we are also seeing growth in non-mobile applications, which have higher gross margins. Within the MEMS microphones, the product mix is certainly benefiting us in 2021. In other areas, such as Hearing Health, we discussed balanced armature receivers, which will have higher gross margins on average. There is still a transition in the Hearing Health market from traditional microphones to MEMS microphones, which, while not directly increasing our sales, does impact gross margins. In PD, we are focusing on defense and medtech sectors within electric vehicles, where gross margins are higher. The R&D investments for new products are being directed towards markets with higher gross margins, and you will start to see the impact of this in 2021.

Bob Labick, Analyst

Great. And then I think you started to touch on this a little bit too, but I wonder you could talk about your thoughts on kind of the longer-term consequences of COVID. You'd mentioned that in the computing market, work-from-home and remote school and stuff should increase that over pre-COVID levels. Are there any other like changes in your end markets? Or your thoughts about the future that have changed as a result of COVID?

Jeffrey Niew, CEO

No, I have a couple comments about the hearing health market, which is kind of interesting, which is if you go back when we are talking about this in February, March last year, we were saying that there's two things that had to happen. One was, people had to feel comfortable, we had to have a solution to COVID. And number two is people had to feel comfortable coming out. As I talked to the hearing health customers, if the audiologists are open, the consumers are coming. We're not seeing people staying home, right? And so I think the recovery once the vaccine is out, should be pretty good for us in these markets. I do think there is, especially in our PD side, medtech, it would appear to me that there's some pent-up demand in medtech. And I think the other thing I would say is, and this is not COVID related, but I think we're very well-positioned in defense with PD. I think we've worked in the areas where investments being made relative to electronic warfare, right. We've got some very unique products there and I think that's going to be a nice growth market. But I see that recovering again, as COVID starts to dissipate.

Bob Labick, Analyst

Okay, super, Thank you.

Operator, Moderator

And our next question comes from the line of Christopher Rolland from Susquehanna.

Christopher Rolland, Analyst

Thanks, guys. I guess my first question is a follow-up. Can you talk about and I didn't totally understand, Jeff, what you were talking about with pricing. Were you saying that pricing has improved from down 3% to 4% that you talked about? Could we even see pricing up in this kind of environment? And then secondly, is capacity utilization nearly 100% for the full year here as lead times are stretched and you have visibility into perhaps some tightness in the back half? How hard are we going to be running this year? Thanks.

Jeffrey Niew, CEO

Yes, I believe the initial question about pricing relates to how 2020 was quite challenging, especially with decisions made during a poor market in the latter part of that year. However, as we move into 2021, pricing has stabilized, and we're introducing new products as we usually do, which is positively affecting numbers. Price erosion is less than 4%, possibly even below 3% for advanced microphones. Overall, we're experiencing a much improved pricing environment as we enter 2021. That addresses your first question. Regarding your second question about utilization…

Christopher Rolland, Analyst

Capacity utilization, yes.

Jeffrey Niew, CEO

Let me first comment briefly before handing it over to John to discuss utilization. Currently, the demand for Q1 is quite strong according to our guidance. We need to consider whether our largest customer will see another significant year for mobile phones in the latter half of the year. Additionally, we've experienced strong performance in non-mobile applications such as PCs, laptops, and tablets throughout COVID. I believe these will remain above 2019 levels, but the key question is whether they can maintain that performance through the second half of the year, which remains uncertain. Lastly, even if some markets weaken in the latter half of 2020, we anticipate a return of demand in sectors like medtech, defense, and audio/aviation/other medtech for HHT. This highlights the benefits of having a diversified business, where some areas are performing well while others may not. Overall, we are optimistic about 2021. John, please feel free to discuss capacity utilization.

John Anderson, CFO

Sure. In terms of capacity utilization, I’m focusing on the MEMS business. In Q4, we operated very close to 100%. Additionally, we sold and reduced our inventory. Looking ahead to Q1, capacity is higher than usual. We plan to work through the Chinese New Year, which will also be higher than normal. The first quarter typically sees lower demand.

Jeffrey Niew, CEO

Yes, I'd like to add another point. Typically, we anticipate that the first quarter will be seasonally low due to various dynamics in the mobile market. However, there could be a slight shift to the second quarter in the mobile sector because of the timing of product introductions. For the first quarter, we expect a utilization rate that is higher than usual as we work to meet demand. In the second quarter, while we'll continue to have strong utilization, we will also be focused on replenishing inventory. Right now, our supply conditions are stable with no significant constraints in the supply chain. Lead times for wafers have increased a bit, but it is not currently causing any bottleneck for us.

Christopher Rolland, Analyst

Okay, understood. Very helpful. Thank you guys. And I guess my second question is around 5G handsets. The kind of China handset complex in particular here, can you talk about some trends that you're seeing there, in terms of content for you guys, in terms of multi mic adoption, in terms of better mics? Is this a driver for you guys, as well? And then, people have begun to talk about an inventory of handsets building in China as people aggressively attack the last Huawei share that's out there. Are you seeing that as well? Thanks.

John Anderson, CFO

We experienced a very strong fourth quarter compared to the third quarter in China. The numbers show significant strength, but we expect a decline from the fourth quarter to the first quarter. However, there is a notable increase compared to the first quarter of 2020. Overall, the Android market has shown mixed results, with China being a major factor. Personally, I don't see a significant inventory issue at this moment. Looking ahead to our forecast for the second quarter, we expect China to show sequential growth as well, though we need to wait until after the Chinese New Year for more clarity. Currently, our forecasts from the first quarter to the second quarter look promising.

Christopher Rolland, Analyst

Understood. Thanks, guys. Appreciate and congrats on the solid quarter.

Jeffrey Niew, CEO

Thanks, Chris.

Operator, Moderator

And your next question comes from the line of Tristan Gerra from Baird.

Tristan Gerra, Analyst

Hi, good afternoon. Given your commentary that you were almost at a 100% utilization rate in Q4, and you're going to be higher than normal in Q1. If we assume 10% growth in smartphone this year, would you have to build capacity for the second half of this year? And also wanted to go back to the commentary that you expect Q1 shipments in smartphones to be higher than normal. And in Q2, you expect that there's going to be some inventory replenishment, given that some investors have been concerned about the shipping in Q1, is that something that you believe could impact the second half of the year where there is some point just excess inventories in the channel? I'm just trying to put this together and what it means for your utilization rates gross margin and shipments relative to demand.

John Anderson, CFO

Right now, my feeling about the full year is that we will likely build close to full capacity throughout the year, with Q2 focused on inventory buildup. Our strategy involves having a diverse customer base, so we don’t need to have the capacity for peak demand in the second half of the year. We’re confident that we will have enough customers purchasing specific parts that we can produce them in the first half. My estimate is that we will be close to full production for the year. Regarding mobile, I anticipate that its contribution to our total revenue will continue to decline. We have an excellent product lineup and strong markets. While we still sell microphones in the higher end, we need to explore different ways to engage with the lower end of the mobile market. Long-term, we aim to shift away from the lower segments in mobile. What surprises me is the gross margin and the average selling prices we’re working with at my factory. Selling low-end microphones at prices between $0.10 to $0.15 yields a gross margin below our corporate average, whereas we could sell to areas like IoT computing or higher-end mobile at much better margins. This approach not only boosts our revenue but also enhances our gross margins. It's clear that demand for microphones is rising, allowing us to be less aggressive in pursuing the lower end of the market.

Tristan Gerra, Analyst

Great. That's very useful. And then, as a follow-up to that you've mentioned the new products that you're going to launch outside of smartphones that are presumably higher ASPs and driving mix. Is this going to be just a shift into higher ASPs, higher margin products outside of smartphone? Or do you think those products can also help you gain share outside of smartphone? Or are you just reliant on those non-smartphone end markets to just grow faster year-over-year?

John Anderson, CFO

I'm not sure if we've analyzed the results regarding share gains, but I want to emphasize that our primary focus is on achieving higher average selling prices and improved gross margins. In some instances, the results will be clear, while in others they may not be. We believe, as we've discussed before, that the microphone market is primarily a two-competitor landscape, and we don't see that changing. We are confident that our new products in the market will allow us to capture our fair share.

Tristan Gerra, Analyst

Great. Thank you.

Operator, Moderator

And your next question comes from the line of Suji Desilva from Roth Capital.

Suji Desilva, Analyst

Hi, Jeff. Hi, John. I understand you are focused on getting the equipment installed, and that travel is difficult. Regarding the demand side, for the programs that would utilize that capacity in the second quarter, are those programs waiting for your product or have they been delayed? I'm trying to grasp the demand aspect.

Jeffrey Niew, CEO

I meet with the team weekly to discuss the demand side of this, and we've been trying to supplement some lower volume opportunities with manual production. We want to limit this, as it isn't beneficial for gross margins, and we haven't engaged in much of it. However, we continually assess if we are ready to increase our output. Although there is demand for our product, we haven't been prepared to commit to producing it in high volume. I believe we are moving closer to that point. Remember that this lineup can produce about a million units a month, so if we can ramp this up by the end of Q2, we could potentially see an additional 4 to 6 million units in the latter half of the year, depending on yield.

Suji Desilva, Analyst

Okay, great. And then on the business, just trying to how close you’re pretending to make levels and whether they ... them.

Jeffrey Niew, CEO

Yes, what I would say is that in Q1, we're quite close to pre-pandemic levels. The one segment that hasn't returned is the other half of our patients who use the same technology, like live musicians. We sell a significant number of microphones in aviation and also in non-hearing health medical applications. These businesses have not yet recovered and typically involve smaller customers. These are among our highest gross margin customers, and they have yet to come back.

Suji Desilva, Analyst

Okay. And if we're going to take one quick question, you mentioned something about smartphones and the irregular timing of their launches. I was wondering if you could elaborate on whether things from 2020 were moved to 2021 or if anything from 2020 was brought forward to later 2021, or if the irregularity was simply due to COVID.

Jeffrey Niew, CEO

We already saw that normally, our peak quarter is Q3, it got pushed to Q4, which is kind of leading us into the path that the low quarter in mobile specifically, may be Q1. I think Q2, right. And so that's something we're saying is because of that delay, that the mobile specific portion, it will be probably less in Q2 than Q1.

Suji Desilva, Analyst

Okay, great. Thanks, guys.

Operator, Moderator

And your next question comes from the line of Bill Peterson from JPMorgan.

Bill Peterson, Analyst

Yes, hi, thanks for taking the question and nice job and execution amid the pandemic here. My first question, and I know it's a smaller part of business, but the intelligent audio refocused on IoT, hoping that you can just give us an update. What type of IoT markets are you focusing on from here? What does the competition look like? Where's your best chances for success? Any updated products beyond the dual-core and quad-core processors you have? And you can just give us an update from this business?

Jeffrey Niew, CEO

We mentioned that we have a number of applications with relatively low volume. For instance, we're involved in several sound bars and have secured designs with well-known consumer brands for Bluetooth speakers. We're also making progress in the remote control market. Additionally, we've achieved a few design wins in stereo applications and appliances, and smart TVs are included as well. While these applications are all low volume, there are a few important points to consider. First, we're currently spending significantly less than we did a year ago, which is not only boosting DSP sales but also increasing microphone sales to customers in this long tail market, which we have not previously explored. Secondly, when we look at DSP sales through smaller customers, the gross margins exceed 50%. Therefore, we are approaching this with a different perspective than we did a year ago, and the IoT long tail may indeed provide opportunities with microphones, making the DSPs a potential growth area for us. However, it's worth noting that developing these long tail markets typically takes time due to the larger number of small customers involved. The positive trend we've seen includes design partnerships with some customers, many of whom are creating their own software for our DSPs and utilizing next-generation technologies. While I don't anticipate this becoming a $100 million business, I believe it could reach around $20 million to $30 million, particularly as sales shift towards more digital high-performance microphones to increase content.

Bill Peterson, Analyst

Okay. So $20 million, $30 million probably more long-term plus, Mike doesn't matter.

John Anderson, CFO

Yes, I just think I think well, let's comment. IoT is driving to new applications, where microphones weren't used before. And I think that's, like in a TV is a good example of that, right? If we're successful with TV, yet to be seen, microphones aren't a big portion of TVs. And we've talked about this before from the fact that there's no reason your TV can't act like your Amazon Echo, which sits in your room, your TV can do the exact same function. And so these are the type of things which, if we could start having every TV have four microphones, there's millions of TVs built every year, they don't have that today.

Bill Peterson, Analyst

Understood. In terms of use of cash, hoping to get an updated, maybe under your CapEx plans for this year? Maybe even above any sort of idea on cash flow from operation and working capital constraints are things going on related to COVID? And then, use of cash, debt pay down and things like that, if you can give us and feel free to the priorities.

John Anderson, CFO

Yes. Sure, Bill. I was hoping somebody was going to ask about cash flow and liquidity that's the metric and I'm pretty proud of the team's execution on. But as we exit 2020, we've got about $550 million of liquidity, as I mentioned, in the script, $150 million of cash, and then we've got a revolver that's on tap for $400 million. We do have converts $172 million of converts that'll mature in this November. So we've got a lot of optionality with how we retire those converts combination of either using existing cash on hand or borrowing from the revolver. And in terms of CapEx for the year, I mean, I will say 2020 was unusually low. We are right around $32 million in CapEx. I think, as you look out into 2020, will be closer to the 5% to 7% of revenue type of CapEx level, primarily on new products. And then I think your other question was capital allocation. I don't think there's a big change in priority. Our priorities will continue to be funding all this, or granted organic growth opportunities we have, we will kind of step up the pace of looking at accretive acquisitions and in precision devices. And then lastly, we'll always look at opportunistically at return of capital through share repurchases. We repurchased about a little over a million shares in 2020.

Bill Peterson, Analyst

Very clear. Thank you.

Jeffrey Niew, CEO

Thanks, Bill.

Operator, Moderator

And I have no further questions in the queue.

Jeffrey Niew, CEO

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

Operator, Moderator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.