Q1 2020 Earnings Call
At this time, all participants are in listen only mode.
After the speakers presentation there'll be a question answer session ask a question during the session you'll need to press star one on your telephone if you acquire any further assistance. Please press star zero with that said here with opening remarks is known as Vice President of Investor Relations. Mike Ma'am. Please go ahead.
Thanks, Christine and welcome to our Q1 2020 earnings call.
Mike now from presenting with me on that day on the call today or Jeff you, our President and Chief Executive Officer, John Anderson, or senior Vice President and Chief Financial Officer.
Our call today will include remarks about future expectations plans and prospects for knows 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 FCC filings, including but not limited to the annual.
Port on form 10-K for the fiscal year ended December 31st 2019 periodic reports filed from time to time with the FCC and the risks and uncertainties identified in today's earnings release.
All forward looking statements are made and some of the did up this call and Nols disclaims any duty to update such statements except as required by law. In addition, pursuant to Reg G. Any non-GAAP financial measures reference during today's call can be found in our press release posted on our website at <unk> Dot com, including a reconciliation to the most directly comparable GAAP measures.
All financial references on this call will be on a non-GAAP continuing operations basis, unless otherwise indicated.
Also we made selected financial information available on webcast slides, which can be found in the Irish section of our website with that let me turn the call over to Jeff will provide some details on the results Jeff.
Thanks, Mike Thanks to all of you for joining us today.
Hope all of you and your families are healthy and save.
This is no doubt an unprecedented in challenging times and we continue to focus on the health and safety of our employees customers and partners worldwide.
I'm very proud of our employees around the globe for stepping up to help solve the challenge is currently pacing I appreciate the referenced as we continue to execute our strategy.
I believe our strong balance sheet and diversified customer base in end markets will enable us to whether it is difficult period and allow us to continue to invest to support future growth when the markets were turned to a more normalized level.
In my prepared remarks, I will briefly discuss the Q1 financial results and then talk about what we're seeing in terms of demand across our end markets and products.
After that I'll discuss the operational challenges, we are encountering as well as the actions, we're taking to mitigate near term impact on our business.
I'll, then turn it over to John for more details on the actions we have taken a we'll be taking to ensure we remain maintain liquidity will still investing in our core business and growth opportunities.
For Q1, we reported revenue of 163 million inline with our updated guidance down 9% from the year ago period.
Audio sales were down partially offset by stronger precision device sales.
Gross margins were 35.7%.
EPS was three cents as cobot 19 caused significant disruption within our manufacturing operations across Asia, which negatively negatively impacted labor productivity in factory utilization.
As I move into demand and operational portion of my prepared remarks, I want to note that the ultimate impact Kobin 19 will help our business in Q2 is very difficult to estimate this time.
I will try to provide as much detail as possible to help investors understand how I see things today, knowing that the situation remains very dynamic.
Let me begin with an update on our on our customer demand across our end markets.
And our audio segment Q1 revenue was down 14% from the year ago period, driven by weaker demand for hearing health products and softer sales into mobile here and I O T markets.
Well Q1 audio demand was weaker than original original projections much of the weakness hit later in the quarter and we are anticipating continued softer demand trends throughout Q2.
In hearing help we began to see a significant slowdown in orders late in the quarter based on end market demand in Europe, and the U.S., which represents approximately 85% of the global hearing aid market.
This was sort of corresponds to countries that adopted cobot 90 little bit restrictions later than Asia with the U.S. lagging Europe by several weeks.
Given many audiologist office remain close coupled with hearing health heavy reliance on demand from people over the age of 65 at higher risk from Cobot 19, we anticipate our hearing health business in Q2 will be down significantly from the year ago period.
Despite this near term weakness, we know from prior downturns. The hearing health demand is reasonably insulated from economic declines.
Since your Gulf customers are older and generally less exposed to equity markets older homes and how the income to purchase hearing aid, we expect a man to improve as people feel comfortable that cobot 19 is under control.
Based on discussions our customers were assuming improving trends related to virus moving restrictions, we expect to second quarter to mark the bottom end demand for this market with sequential improvement in the second half of 2020.
However, it may take until 2021 to get back to 2019 run rates.
Moving onto the mobile you are now T. markets. The mobile market represented less than 30% of total company sales in Q1 as smartphone demand trends weakened throughout the quarter.
Sales to our largest U.S. in Korean customers were higher than year ago period will sales to trading volumes were down significantly.
Demand has begun to stabilize in China. We currently expect sales into the middle market to remain lower than a year ago period.
We are talking to all of our mobile customers in industry experts at this point many are expecting smartphone units worldwide in 2020 to be it's down as much as 15% from 2019.
Revenue from year end LT also declined year over year, but represented greater than 30% of sales in Q1.
As growth rate, our risk reset across consumer electronics, we expect true wireless will remain the best performing segment within the year market.
We continue to invest in Mems microphones and bells arbitrage solutions to support this marker.
In early April IVC. This said it expects demand for smart home products to decline year over year on the second quarter, and we expect similar trends in our business.
We expect to remain the leader in the Mems microphone business as we have previously discussed improves voice communication and speech recognition are driving the need for more microphones with increased performance more pyro power hi, robustness in smaller size.
Our new products and programs across your Aiotv and mobile are expected to extend our differentiation and competitive position to drive long term sales growth with higher gross margins as we continue to increase investment in this business.
Overall, our microphone revenue in Q2 is expected to be flat with sales in Q1.
Moving to precision devices segment in Q1 sales were up 6% from the year ago period, driven by continued demand for our differentiated products across defense Med Tech and the electric vehicle end markets.
We also made good progress fixing the operational issues, we experienced in Q4 2019.
We anticipate sales in precision devices to grow more than 5% sequentially in Q2, and expect gross margins to increase as operational improvements continued take hold despite increases in palladium prices.
Now, let me discuss where we stand from an operations perspective.
For our manufacturing facilities remain focused on aligning the output lighting output with our customers demand as we continue to protect our employees.
Most of our non manufacturing place. Please now work from home and travel up throughout the company had been restricted.
In China, where our manufacturing supports Mems microphones and high performance capacitor products Q1 was extremely challenging with the extended Chinese new year, followed by a slow ramp back to normal production levels as travel restrictions were lifted and our employees were allowed to return to work.
Our China operations are now running without production constraints.
In the Philippines, where most of our hearing health solutions are produced the government has implemented enhance community quarantine until mid may.
Due to the government restrictions and significant demand weakness in the hearing aid market, we anticipate very low capacity utilization as we aligned our output with the demand in the quarter.
In Malaysia, where we make microphones for both the consumer and the hearing health market. The government has implement a movie control order until midnight.
As with our Philippines operation because of the government restrictions and the significant demand weakness in hearing aid market. We expect very low utilization in Q2, two a line output with demand.
In the us in Dominican Republic, where the bulk of our precision device solutions are produced.
Limited impact to date, and we continue to monitor the situation daily.
Lastly in response to these market conditions, we are taking significant actions to reduce operating expenses control capex and manage working capital.
We are real value to all the projects across the company identifying those projects with the best potential given the adjusted market conditions.
Where appropriate we are taking steps to reduce costs this year.
The goal is to make sure we maintain strong balance sheet with ample liquidity, while meeting our short term commitments and supporting the long term potential the business.
All these action as these actions are ongoing we will provide additional details as they're completed but I wanted to specifically address one area.
In intelligent audio demand has been below expectation and we further we are further reducing the allocation of resources to this product line to align with the growth potential and the challenging market conditions, we will continue to support existing products and customer programs.
John will provide additional details and how we expect these and other changes will impact operating expense for the balance of the year.
Overall, the primary short term issue, we face today is related to demand rather than supply, especially in our hearing health market.
Our company remains uniquely position across the markets, we serve and I believe 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 position to take advantage of future growth.
With that I'll turn it over to John to expand on our financial results and provide our details for the second quarter John.
Thanks, Jeff.
We reported first quarter revenues of 163 million down 9% from a year ago period as lower shipments in audio were partially offset by increased sales and precision devices.
Audio revenues of 120 million were down 14% from a year ago period with lower shipments a balanced armature speakers and Mems microphones associated with weaker than expected demand and hearing health and mobile consumer markets due to the cobot 19 pandemic.
The precision device segment delivered revenues of $43 million up 6% from a year ago period, driven by continued robust demand in the defense Med Tech and electric vehicle markets.
First quarter gross margins were 35.7% down 320 basis points from the year ago period.
In the audio segment gross margins were 350 basis points lower due to production related disruptions associated with the cobot 19 pandemic, specifically Q1 2020 gross profit margins were negatively impacted by more than 500 basis points due to lower productivity due to lower labor productivity.
In capacity utilization in our China manufacturing facility.
In addition, during the quarter, we realize greater than 400 basis points in material savings associated with the basic design business acquisition completed late in Q4.
This was partially offset by its shape a charge of 2.8 million related to the final settlement of a customer warranty claim.
Precision device gross margins finished slightly ahead of our forecast, which was 240 basis points lower than the prior year as increased palladium costs negatively impacted margins by more than 500 basis points.
Partially offset by operational improvements.
Proved pricing and favorable product mix.
R&D expense in the quarter was 22 million down 3% from a year ago period with lower spending in intelligent audio partially offset by increased spending in our core mems microphone and precision device businesses.
SGN a expenses were 34 million up 13% from the year ago period, driven by up 4 million increase in legal cost as we aggressively defend our intellectual property.
This increase was partially offset by reduced spending intelligent audio.
For the quarter adjusted EBIT margin was 3.4% down 590 basis points from the year ago period on lower revenue and gross profit margins as well as higher higher legal cost.
EPS for the quarter was three cents.
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 that Nols dotcom.
Now I'll turn to our balance sheet and cash flow.
We continue to maintain a strong financial position with liquidity of nearly 450 million at the end of the first quarter, including 148 million in cash and borrowing capacity of 300 million.
During the quarter, we increased our cash balance by drawing 100 million on our revolving credit facility, leaving 300 million in availability.
Cash used by operations was 2 million in capital spending was 8 million.
First quarter is typically our seasonal low in terms of cash generation and I'm confident in our ability to generate free cash flow for the full year 2020.
During the quarter, we repurchased roughly 1 million shares of our common stock at an average price of $15.06.
In the spirit of proactive and prudent liquidity management, we are temporarily suspending our share repurchase program.
Given the relatively short cycle nature of our business and recent global events.
His ability in the second quarter is challenging, especially as it relates to our hearing health business. In addition, there is a significant amount of uncertainty related to the duration of government workforce restrictions currently affecting our manufacturing operations in both the Philippines and Malaysia.
Based on the current circumstances will be providing limited guidance for Q2.
Our objective is to reinstate revenue gross profit and EPS guidance for the third quarter, along with our Q2 2020 earnings announcement.
I would now like to provide some insight into actions, we're taking which will help mitigate the financial impacts of the cobot 19 pandemic.
In April we implemented a temporary 10% pay reduction for all salaried employees, and a 15% reduction to CEO and board cash compensation.
In addition, we're further reducing operating expenses related to the intelligent audio business and we expect to have completed these actions as we exit the second quarter.
These actions along with other cost reduction measures, we're taking across the company are expected to result in cost savings of more than 20 million in 2020.
Well some of these savings will be reinvested our core businesses. We now estimate operating expenses to be 50 million in Q2, which is down more than 5 million sequentially and we expect to exit 2020 at a quarterly run rate of $40 million to $44 million.
Finally, we're reducing our capital expenditure plan and expect 2020 capital investments to the in the range of 35 to 45 million.
I'm confident that our strong financial position combined with the cost actions. We're taking in response to current market conditions will position the company well to serve our customers needs generate free cash flow and deliver strong operating leverage over the long term.
I'll now current turn the call back over to Jeff for closing remarks, and then we'll move to the Q and a portion of the call Jeff. Thanks, John.
Our company remains uniquely positioned across the markets. We serve the diversification of end markets that we've put in place is enabling us to weather. The storm will still investing in new growth categories, we expect to maintain or extend our leadership across the end markets we serve.
We remain the leader in hearing health solutions and expect recover recovery in two to 2029 2090 levels in the next nine to 12 months.
We expect your loyalty to drive growth in the future and mobile market to stabilize as Fiveg phones are introduced.
Precision device growth is expected to continue and we anticipate 2020 to be another good year for this segment.
With that we'll open it up for questions.
Thank you as a reminder, ask a question you meet the press Star then one on your telephone to withdraw your question press the pound or hash key. Please standby, we can past Q and a roster.
Your first question comes from the line of Anthony Stoss from Craig Hallum. Your line is open.
Hi, guys a couple of quick ones here.
Maybe can you give us the percent of revenues that hearing health was in 2019.
Obviously, we can size up.
You're welcome that for Q2 also given your Chinese facility is now often that affected gross margins in Q1, while I know you're not guiding for Q2 do you think your gross margins will be up sequentially in Q2, and then lastly for Jeff.
The BA opportunity the funnel the automated production process, maybe you can just.
Bring us through where you're at right now what you think will happen for the second half this year.
Sure I'll, let John in critical care, Tony in respect to the first question I think the question was what percentage of total company revenues is hearing health, it's roughly 25% in 2019.
And then gross margins up from Q2 John.
Yes in terms of gross margins I mean as I as I mentioned in Q1, we had gross margins of.
Roughly 35%, 35.7%, we were really impacted in our specifically in our audio segment.
In a legal due to elongated Chinese new year, we had several workforce.
Restrictions in both our Malaysia Philippine facility ended the quarter, especially especially at the end of the quarter, we while our China facility is backed up and running at close to full capacity. There are still currently restrictions in both Philippines, and Malaysia, it's very difficult to quantify it's a very.
A question how long those will last.
In addition, I think it's important we did have I'll call. It an unusually high warranty claim in the first quarter, which was about 170 basis point impact. So I would say as we look into Q2.
We probably see sequentially similar gross margins, but remember the utilization as Jeff mentioned in our hearing health business very likely to be lower than it was in Q1 efficiently and then the offset is we won't have this this charge and warranty that we had in in Q1, So I think.
Sequentially.
Similar margins and I would just had one more piece of color to that Tony is that our goal here is not to build inventory through the quarter right. So I mean, we are keeping the specialty in the hearing health business the utilization at a very low level until the market starts to return, but I will say, though this is the gross margins in Q2.
And looking out this is probably one of the hardest things for us to have real clear visibility on both the demand in though in the hearing health market as well as the duration of workforce workforce restrictions at two of our more significant plant is very dynamic.
All right, let me give you a little color on the BA and the automation line I would slate that there has been some impact from global 19, especially with the travel restrictions and working at the automation supplier.
But I would say it hasn't been overly burdensome the delays and right now I think we've said in the past we said it would be ramping with full production in Q3, I would say, it's now more ramping in Q3, So I would say we're probably.
One to two months behind what what I said before it will have some impact on this year, but on the long term you, obviously thats doesn't have much impact at all as far as the opportunities.
I review with the team every other week the funnel of opportunities I'd say the funnel of opportunities look very good Tony as we.
We'll exit 2020 and into 2021, we still feel very comfortable with the reasons. We invested in this automation line and where we're headed with it.
Okay and you can just one more of the bulk of the Opex cost cuts would you say that primarily the intelligent audio group.
Tony at this point I guess would say, we'll we'll get will go through more detail as we others go through this but there's a lot of moving parts. You know there's some of this is temporary which obviously will not be what we're talking about the end the year like the seller, Rick the salary reductions, which we hope to eventually get back to people. So there's a lot of moving parts.
Here and what would I would just say is as we get through this and we implement everything we're going to do will go into more detail about how we got there.
Thanks, Jeff.
Your next question comes from the line of Bobsled the Heck from CJ Securities. Your line is open.
Good afternoon, thanks for taking the questions.
Just wanted to follow up on the BA.
Automation.
I don't know that this is possible at all but I figure that ask is it possible to re purpose some of the hearing health fee a and.
Hold that for more consumer product or or or configure it slightly differently. So that can go into the consumer your market or could you describe how the two might be different.
Yes, I think it's good question, Bob and thanks for the question date, I guess, what I'd say, it's remember when we did the Bellevue belts. Our merger automation. We also redesign receivers from the ground up third totally different designs and so and that was in order to reduce.
Cost of make them as well as for purposes of automation.
We do have some mannville capacity put in place.
For these new designs.
I'd say, a limited amount and thats, mainly just to.
To prove out the designs and maybe you have a little bit of startup sampling, but they're not really interchangeable remember the hearing health how I describe it always is it's lower volume high mix. So it's very manual intensive versus the automated has been designed to be.
Low mix, but very high volumes.
Okay got it great and then just one other for me can you talk about I think you alluded to a little bit, but the new product areas for your future investment and then also.
As it relates to new products, you talk about your customer new product Roadmaps, if theres been any significant changes and timelines that might impact this year.
I'll answer that first I mean, I would sit there and say theres no doubt across the globe that there has been impact on new products. I mean, I think it to think that wouldn't take place how that ultimately affect what's introduced this year I think.
Early to tell Bob.
We're working very hard rock customers I would say our employees had been extremely productive working from home.
I've been very and process and I. Thank all the employees have been working from home in order to get things done a new products.
But some of our customers have been impacted too early to tell how that impacts this year, yet and then you're.
Oh, new products, Yes, I would say the one thing that we did mention intelligent audio, but maybe you didnt kind of catch this in the in my prepared remarks, which is we are increasing the amount of money, we're spending on R&D in the Mems microphone space.
First of all when we we had the acquisition last year from Amazon. We took on some R&D spend that was associated with that has obviously been a very successful acquisition even in the very short time, we've had to the design group in the product portfolio.
Even beyond that you were seeing more opportunities to invest in new products and Mems microphone into that and we have been increasing the amount of money spent on R&D and Mems mics.
And by the way there has been probably not as big also R&D spending increase in in precision devices.
Okay Super Thanks, very much.
Your next your next question comes from line of Christopher Rolland from Susquehanna. Your line is open.
Hey, guys.
Thanks for the question.
I believe in your remarks, you mentioned minus 15% year over year.
Set expectation for for Q2 and I guess.
Obviously, you guys aren't guiding but you know as we're thinking about this should that be a starting point for us for for next quarter and would you expect yourselves to be better or worse than that expectation.
So first I'll just to kind of thinking what I said was it could be as high as 15% and I was actually referring to the full year.
I didn't really saving specifically about Q2.
I think.
Our expectation right I think in the mobile market is this is that that China will be recovery you know.
We are definitely expecting some recovery in China in the mobile market Q1 was extremely weak for our China business within mobile.
And then I think.
Now I'm kind of like starting to go into discussions about stuff that's more public information, but you saw samsung's results. They were saying handsets are very very difficult going into Q2.
And I think the wildcard here, which I think I think you saw what our largest customer it made their announcement they didnt really give much guidance about about Q2, so im not trying to punt on this but I think.
Positioned in the market still remains the same I don't think we view that there's a big change in position, but there is a fair amount of volatility in terms of what's going to happen in Q2, but but again I think the number one thing. We see is you know is China will be a lot stronger in Q O Q twos in Q1.
I I guess, just more broadly I think the street was kind of looking for a large sequential increase would you still expect a sequential increase for Q2.
In terms of specifically mobile or would you mean.
Yes, you can do however, you want whole business, let me start with.
We have a very significant reduction in hearing health I mean that gets very significant this is not like down 5% or something like that sequentially, it's very significant.
I think it talked about it in the prepared remarks that most of the Audiologist in Europe, and North America had been closed.
Plus you add on the fact that covered has an outsized impact on older people. So we are concerned that when it will people really start going back out in terms of especially people who are the age range would buy a.
Hearing aid as far as our.
The specifically or microphone business like what we said is right now we expect it sequentially.
To be flat.
Okay, great and.
And then.
Maybe a few more details on this warranty claim is just one.
A one time issue.
And I don't know if its related or not but im sitting on I think I've mentioned this before.
James they're going to grow 50% in men's business.
We have any more clarity.
To what that Matt.
I think they previously talked about that business being 200 million growing 50%. So that's 100 million.
What could be into your market I'm just wondering if we have any other details there or any thoughts on what they were talking about so let let John hele. The warranty claim for a moment when do you want to talk about the warranty claim and this was a this was as much. This was a full settlement of a warranty claim with a customer in our Mems microphone.
On business.
It was roughly 2.2 point $8 million in the quarter, roughly a 170 basis point negative impact to gross margins and.
Expect that to be behind us, we always have some level of warranty claims, but the reason I called out Q1 is much higher than normal in Q1.
And then secondly regarding infinium.
I don't want to overly speculate here as to what they're talking about we do know I think the market knows that that in fitting has begun to sell finished mikes the full microphones versus bare die and there's a pretty significant difference in in revenue associated with selling a finished microphone versus a bare die.
So I think there definitely is both years, we are hearing and seeing in the market. They are starting to do that.
Great. Thanks for the clarity guys.
Sure.
Your next question comes from line of Bill Peterson from Jpmorgan. Your line is open.
Hi, this is.
Ken.
Hi Peterson.
The question in terms of the palladium cost.
Talked about.
Being impacts for gross margins for two to.
What's your outlook on palladium costs going forward is kinda continue to have an impact on gross.
Gross margins.
You have any thoughts about the market right now.
So so I'll, let John go to the specific details, but I mean, I think how we look at palladium is what's the market price today, there are opportunities for us to pre buy some played in which depending on where we do it could have a positive impact, but overall I would say that for the full year Palladium, we'll have a impact.
A negative impact on gross margin for the full year, but looking junkets, but year over year, but the prices that as Jeff mentioned, we did enter into some pre buys and the prices that we realized in Q1 will be similar to the prices that we'll have over the rest of the year. So again, we don't expect further increases.
But we did have a year over year headwind, including cost.
Okay got it and then in terms of mobile market.
Hi Inn portion of the hence the markets being affected more relative to the mid range and low unsung some for like the China mobile market.
Can you talk about that.
Yeah, I think thats, a little hard to say right now because again I think there was such a dramatic reduction in demand in China in Q1, we're starting to see that come back.
I think it's a little too premature to say, how the high end versus the mid range versus the low end it was going because theres just so much noise in all these numbers down.
I wouldn't say innings changed that we sit there and we say all the sudden high enhanced that's our are much stronger by I honestly can't said that are much weaker either so I mean, there's a lot of volatility in these numbers bye bye like location, obviously was China first in Q1, most in Q1 as we've moved in Q2 now we're seeing more.
Volatility, where the demand is going to come from Europe, and North America. So I think we're going have to see how that plays out but I think it's good question, we're definitely monitoring to see where that goes.
Okay got it.
Thank you.
Your next question comes from line of Christian Gebara from Baird. Your line is open.
Hi, good afternoon.
Given your guidance for EOG My question has to be flat sequentially in Q2.
Is that lead to impact the supply disruption given that the.
Units, so expect it to actually increase sequentially Q2 worldwide and you've mentioned so China recovering.
Or is there a market share impact and then also have you seen such a largest smelter.
Customers changing their fall kaskida for Q2 or the second half.
You know just as I would sit there and say right now we see flat sequentially overall for the microphone business, but I mean to be truthful, it's moving around a lot I mean I. That's I would say is when I when I look at.
The markets that we here are our yearend aiotv business.
We we expect.
To be.
Slightly up be up sequentially.
And and you know it and then I would say.
The mobile more like flattish, but one thing that we are concerned about we had a reasonably strong which we didn't talk about that a reasonably strong tablet and notebook market in Q1 and.
We are starting to see that start to those to slow down somewhat.
I think people talked about this in terms of that with all work work at home orders tablets and notebooks were really moving very quickly in Q1, where we are concerned there is going to be some decline in Q2.
Okay.
Any quantification of the mix.
On tablets notebooks versus smelter in Q1, so youre, making business.
Yes, I mean.
Again, it's a little too early to say here, but I mean in Q1.
Tablets, and notebooks were about 15% of our toll business.
I can see that possibly declining some.
So when you look at our notebook tablet and I call, we called the other category. There is other stuff in here.
I could see that Dick declining to being.
I mean, these numbers, probably like 11, 12% of the total.
Okay, Great and then next question. So you mentioned, how you're going to keep your intently at current Standalone that trying to rebuild what do you see in the supply chain, notably it's not enough people.
Trying to rebuild at all.
Yes, and let him to enable just wanted to two which is historically.
Well I mean, I think what we're trying to do is it when I say this is really really applicable to the hearing health market with such a significant decline. We just didn't want to end up with a ton of inventory.
In our facility because right now there's a fair amount of of data out there from third parties that is talking about what's going on with our hearing help customers.
If you were just under three hearing help customers in Europe, where three of our largest hearing health customers that are publicly traded and.
We're struggling the people who have already spoken of not given any guidance has to far as to what they see in Q2.
And so I think that's really the area we are watching the inventory pretty closely on the microphones side, but I would say.
We're probably a little bit more optimistic and we have to be looking a little bit forward there because of normal seasonality in the back half the year. Jude Q2 would typically be a quarter, where we would build some inventory for the Q3 in Q4 ramp but as you know it's going be hard to say is it going to really happened in Q3 or Q4 with some of these seasonal ramps.
So it's really about hearing health, making sure we align the output to demand.
Great. Thank you.
Again, if he would like to ask a question. Please press star and the number one on your telephone keypad. Your next question comes from line of Charlie Anderson from Dougherty <unk> Co. Your line is open.
Yeah. Thank you for taking my questions to partner and hearing health.
Sounded like you leave Q2 could potentially be a trough I wonder what gives you the covenants that we sort of troponin Q2 is it simply.
Some of those children placed being lifted or is the industry getting creative and how we diagnose and supply and then as it relates to gross margin impacts from hearing health I Wonder if you could maybe speak to the interplay between revenue and gross margin. There you know fixed cost anyway, you can quantify just to help us think about.
That will be in back to going forward not going to follow.
Let me take the first one first I would say is.
What is very different about us in the hearing health market Charlie is that unlike the mobile market, where we're reasonably small supplier and a much larger market.
We're one of the largest suppliers to the hearing health market and so we have I would say pretty good access to high level people within in the hearing aid market.
Secondly, we watch very diligently third parties that are looking at these markets you know as I mentioned, we have three customers in there in Europe that are publicly traded at there's a fair amount of data on and I think you're right. The first thing is the shelter in place orders have to come off and we're starting to see that.
We are starting to see that you I think I've read this morning, Italy is starting to reopen right you're starting to see states.
In the U.S. start to open obviously with restrictions, but I think the big wildcard here, so thats better right away, because audiologist will start to reopen their offices, but but but I think the bigger wildcard, where we're kind of like saying, okay, how much better as of yet and how how long the tag is when do older people feel more cars.
Vertebral, leaving their house and going out to get irrigate.
Obviously, there are some things that people are doing to try to mitigate that in terms of fitting at home and longer term, there's over the counter hearing aid, but but shorter term I think the primary method for getting hearing aid is still going to it audiologist office and getting fitted and so I think what we kind of here on the market.
Place and Thats kind of what we're modeling is that Q2 is the trough as Audiologist office opened and then as people become more.
I'd call. It confident is not getting sick there are more people Gaga and hearing aid.
I would add like one last thing to this is we've had a fair amount of obviously experience with the hearing it market. It's one of our core markets for 40 plus years.
Is that we don't think this is an economic issue.
Out of the markets, we're talking about in the consumer spaces like whatever you're going to get their jobs back and are they going to be willing to spend.
Our history tells us is that it's not economic in nature.
People, who are older typically are not highly invested in equity markets. They typically on their home, they're typically on some type of of fixed income. So they know how much money coming in whether it be from so security our pensions and so so so it's usually as we saw an eight or nine there was very minor impact.
On that recession on the hearing aid market. So it's really comes down to Audiologist reopening that number two people feel uncomfortable and that means either some type of treatment vaccine or a reduction in number of cases, and then I think the market will return to normal.
And then sure Charlie I mean, we don't typically give gross profit margins by product line, but I can talk a little bit too you know our fixed costs and capacity utilization from a segment standpoint, So our audio segment capacity utilization was lower than planned and.
Q1, we typically are in that kind of low 80% in Q1 due to Chinese new year that always occurs well because of the you long dated Chinese new year and the other workforce disruptions. We experienced we were probably closer to 70% capacity utilization and audio in Q1.
I expect is just as we mentioned earlier the microphone business will continue similar capacity utilization, but we are expecting a pretty significant downturn in capacity utilization for our hearing health business and that as we said earlier that comprises about 25% of the total.
And again, Charlie Luckily the way we view this as this is temporary I don't think we view the hearing health market is this is.
Permanently impaired market. We view this is that once people that are treatments or the curve started to change or vaccine. This will not be an economic issue and people will return to the market at 2019 levels.
Okay, Great and then for my follow up on the Opex reductions.
You have this doesn't normally high opex right now because of the legal expense that can vary from quarter to quarter. I'm curious those numbers you gave US does that include continued.
It will be the legal expenses or not thanks, no what we expect.
Fair amount with this quarter we had.
Foreign 5 million of legal expenses, we expect a similar amount in Q2, and then a pretty significant drop off again with cobot 19. The discovery process. There, we're going through its really difficult to nail that timing, but we have we do expect us to be behind us by the end of Q3 and.
So when I talk about that Q4 run rate of 42 to 44 million, we aren't envisioning any legal costs by the end of the year because we do expect this should get behind us.
Okay, great. Thanks, so much.
Sure.
There are no further questions at this time Mr., Mike now I turn the call back over to you.
Great. Thanks, very much for joining us today as always we appreciate your interest in knows and look forward to speaking with you on our next earnings call. Thanks, and good night.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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