Knowles Corporation

Good afternoon, and welcome to the Knowles Corporation fourth quarter and full year 2022 financial results conference call. My name is Tamia, and I'll be your operator for today. With that said, here with opening remarks is Knowles Vice President of Investor Relations, Patton Hofer. Please go ahead.

Thank you, Tamia, and welcome to our Q4 2022 earnings call. I'm Patton Hofer, Vice President of Investor Relations, And presenting with me on the call today are Jeffrey New, our President and CEO, and John Anderson, our Senior Vice President and CFO. Our call today will include remarks about future expectations, plans and prospects for NOLS, 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, including but not limited to the annual report on Form 10-K for the fiscal year ended December 31, 2021. Periodic reports filed from time to time with the SEC and the risks and uncertainties identified in today's earnings. All forward-looking statements are made as of the date of this call, and NOLS disclaims any duty to update such statements, except as required by law. In addition to pursuant Reg G, any non-GAAP financial measures referenced during today's conference call can be found in our press release posted on our website at NOLS.com and in our current report on Form 8K filed today with the SEC, including a reconciliation to the most directly comparable GAAP measure. All financial references on this call will be on a non-GAAP, continuing operation basis unless otherwise indicated. Also, we've made selected financial information available in webcast slides, which can be found in the investor relations section of our website. With that, let me turn the call over to Jeff, who will provide some details on our results.

Jeff? Thanks, Patton, and thanks to all of you for joining us today. Before we dive into the Q4 results, I wanted to refresh everyone on the new segmentation that we introduced during our investor update call in November, as this is how we will be discussing the company in the prepared remarks. We separate our audio segment in two. The first segment is called MedTech and Specialty Audio, or MSA, which primarily includes acoustic solutions sold into the hearing health market. The second is our consumer MEMS microphone segment, or CMM, which is focused on microphones sold into the ear, IoT, compute, and smartphone markets. Knowles now operates and reports on their three segments, precision devices, med tech and specialty audio, and consumer MEMS microphones. With that, let me begin with a summary of our Q4 results. We were pleased to report we delivered results at or above the high end of our guided ranges for gross margins, adjusted EBIT margins, and free cash flow, despite a challenging backdrop in consumer electronics market and the COVID related issues in China. In the quarter, Knowles generated $197 million of revenue, which was down 16% versus the prior year, driven primarily by weak consumer electronics and market demand and customers' inventory adjustments in consumer MEMS and MedTech and specialty audio. Consumer MEMS mics was down 31% versus prior year levels, and MedTech and specialty audio was down 13%. In contrast, precision devices delivered revenue growth of 9% versus prior year levels as we continue to see robust demand in defense, med tech, EV, and industrial end markets. We delivered gross margins of 40.4% above the high end of our guarded range, earnings per share of 33 cents in line with our guidance, and we generate just shy of $40 million of free cash flow, which was at the high end of our expectations. I believe these results demonstrate that our focus on the markets and products where we have significant competitive advantages is paying dividends, particularly in our profit margins and cash flow. For full year 2022, I would like to take a minute to highlight each segment's performance individually and their current market dynamics. First, in precision devices, we delivered record revenue, gross margins, and adjusted EBIT margins. Revenue grew 21%. Gross margins finished at 47% and increased 240 basis points versus prior year levels. Adjusted EBIT finished at 68 million and grew 29% versus the prior year. We continue to see strong organic growth in the mid to high single digits going forward driven by defense, med tech, and EV markets. Both of our product categories, high performance capacitors and our filters, continue to demonstrate our superior technical capabilities providing a competitive advantage for Knowles in the markets we serve. Second, our MedTech and specialty audio segment delivered record gross margins and adjusted EBIT in the year. Revenue was flat with prior year levels and strong growth in the hearing aid market in the first half was offset by customer inventory adjustments and a softer end market demand in the second half. Gross margins finished at 50%. 270 basis points increased over prior year levels, adjusted even to finish at $88 million, a 10% increase versus 2021. Although market conditions deteriorated slightly for the second year, we were able to deliver double-digit earnings growth on flat revenues. In the near term, we continue to see customer inventory adjustments and softer end-market demands. We have confidence in the resilience of this market, and based on bookings trends, we expect to see strong sequential growth for revenue and profitability in Q223 as customers' inventories normalize. Now on to our consumer VEMS microphone business. Revenue in this segment was down $144 million versus prior year levels. 2022 was a difficult year for consumer electronics around the globe as end market demand, customer inventory adjustments, and the impact of COVID lockdowns in China severely impacted the segment's top line. In August, we announced our restructuring actions to address current market conditions and dynamics to accelerate our strategy to diversify away from commodity microphones. Today, I'm pleased to confirm all the actions have been put in place, delivering greater than $28 million of annualized savings. In Q1, we continue to see weak end market demand and inventory adjustments by our customers. These headwinds are across most end markets and geographies, including PCs and smartphones. Because of the weak demands, we will continue to operate at less than 50% capacity utilization in Q1, negatively impacting gross margins. Despite these near-term headwinds, we expect sequential improvement in Q2 for revenues and profitability on the beginning of China market recovery and our customers' new products. In summary, For the company, Q1 is normally sequentially lower due to seasonality, but it's being further impacted by weak consumer demand, inventory in the channel, and COVID-related challenges in China as they reopen their economy. I am proud of the execution by our employees, which has allowed us to continue to generate cash in the face of substantial headwinds. As we look beyond Q1 into Q2, we are anticipating 15% to 20% sequential revenue growth with all three segments contributing. Lastly, I would like to highlight we have secured an extension of our $400 million revolving private facility until 2028. This reflects the strength of our balance sheet and the expectations to generate significant free cash flow. It also provides a substantial liquidity to supplement internal growth with acquisitions. With that, let me turn the call over to John to detail our quarter. John? Thanks, Jeff. We reported fourth quarter revenues of $197 million, down 16% from the year-ago period, driven by lower shipment volumes in consumer MEMS mics and MedTech and specialty audio, partially offset by higher revenues in precision devices. The precision device segment delivered revenues of $63 million, up 9% from the prior year, driven by growth in MedTech, EV, defense, and industrial end markets. For the full year, PD revenues increased 21%, including 18% organic growth and 3% from an acquisition, which was completed in 2021. Full year 2022 revenues were at record levels and driven by strong demand across all of our end markets. In MedTech and specialty audio, fourth quarter segment revenue was 62 million, down 13% versus the prior year as our customers reduced inventory levels and we faced difficult year-over-year comparables as the second half of 2021 benefited from strong COVID recovery. For the full year, MSA revenue was flat with prior year levels. Consumer MEMS MIC revenues of $72 million was down 31% versus the prior year, driven by weak global demand for consumer electronics, channel inventory adjustments, and COVID-related issues in China. For the full year, revenue was down 33%, driven by weak consumer demand and inventory adjustments in most end markets and geographies. Fourth quarter gross profit margins were 40.4%, 190 basis points above the high end of our guidance range and down 290 basis points from the same period a year ago. Precision devices segment gross margins were 48.6%, down slightly from the prior year due to favorable inventory adjustments in Q4 2021 that did not repeat. For the full year, gross margins finished at a record high of 47.2% and up 250 basis points over prior year levels driven by favorable product and customer mix, factory productivity improvements, and the acquisition we completed in the first half of 2021. MedTech and specialty audio segment gross margins were 51.6%, up 120 basis points versus the prior year, driven by favorable product mix and foreign currency benefits. For the full year, MSA delivered record gross margins of 49.9%, up 270 basis points over prior year levels, driven by favorable product mix productivity improvements, and benefits related to foreign exchange. Consumer MEMS microphone gross margins for the fourth quarter were 23.9%, down more than 11 percentage points versus the prior year, driven by significantly lower factory capacity utilization, pricing, and unfavorable mix, partially offset by benefits of the restructuring actions implemented in the second half of the year. For the full year, gross margins were 28.2%, down 960 basis points from the prior year, driven by unfavorable capacity utilization and product mix, partially offset by benefits of the restructuring actions announced in August. For full year 2022, total company gross margins were 40.6%, down 110 basis points from 2021, with record annual gross margins in both the PD and MSA segments, more than offset by significant year-over-year margin declines in the consumer MEMS mic segment. R&D expense in the quarter was $15 million, down more than $4 million from the prior year, with the reduction driven entirely by lower incentive compensation costs and the benefits of the restructuring actions taken in the consumer MEMS microphone segment. SG&A expenses were $27 million, $3 million lower than prior year levels driven by lower incentive compensation costs. For the quarter, adjusted EBIT margin was 18.9% and 190 basis points above our expectations. For the full year, EBIT margins were 18.6%. EPS was $0.33 in the quarter at the midpoint of our guidance range. Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled 48 million at the end of the quarter. We generated cash from operations of 47 million, slightly above the midpoint of our guidance range. Capital spending was 7 million in the quarter. For full year 2022, free cash flow was 54 million, representing just over 7% of revenue. We repurchased 2.3 million shares at a total cost of 44 million and exited the year with cash net of debt of $3 million. This marks the first time since the spinoff we've ended the year in a net cash position. Moving to guidance for the first quarter of 2023, we expect total company revenue to be between $140 and $155 million, down 27% versus the same period a year ago, with the decline in revenues driven by weak demand in consumer members like Inventory corrections in med tech and specialty audio partially offset by year-over-year growth in precision devices.

We estimate gross margins for the first quarter to be approximately 32% to 35%. Down 8 percentage points from the year-over-year

period driven by low factory capacity utilization and unfavorable mix in our consumer MEMS mic and MedTech and specialty audio segments. R&D expense is expected to be between $16 and $18 million, down $3 million from prior year levels driven primarily by prior year restructuring actions in the consumer MEMS mic segment. We're projecting selling at administrative expense to be between $25 and $27 million up $2 million from the year-ago period, driven primarily by higher incentive compensation costs, partially offset by restructuring actions we've taken in the consumer MEMS microphone segment. We're projecting adjusted EBIT margin for the quarter to be in the range of 2% to 6%, and expect EPS to be within a range of 1 to 7 cents per share. This assumes weighted average shares outstanding during a quarter of $94.8 million on a fully diluted basis. We're forecasting an effective tax rate of 16% to 18% for the quarter and full year 23, which reflects an expected change in jurisdictional income and the impact of the unmet conditions for a tax holiday in Malaysia. For the quarter, we expect cash generated from operations to range between $15 and $25 million. Capital spending is expected to be approximately $5 million. Given the current macro headwinds and uncertainty in the market, we'd like to provide some select commentary as it relates to our expectations for the second quarter of 23. As Jeff mentioned, we're expecting sequential revenue growth of 15% to 20%, with all three segments expected to drive the increase. We also expect gross margins in the second quarter will return to 40% or more, driven by improved capacity utilization and favorable mix. I'll now turn the call back over to Jeff for closing remarks. Jeff? Thank you, John. Well, there's no doubt we are dealing with some significant challenges in the global markets. Our Q4 and 2022 results continue to demonstrate our strategy to focus on high-value markets and products is allowing us to achieve strong EBIT margins and continuing to generate cash. Looking at 2023, we are expecting significant sequential improvement from Q1 to Q2 in both revenue and profitability. and I remain confident in our ability to achieve our midterm targets of 22% to 24% EBIT margins and 15% to 17% free cash flow margins. With that, we can open it up for questions.

Absolutely. We will now begin the question and answer session. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason at all you would like to remove that question, please press star followed by two. Again, to ask a question, please press star 1. As a quick reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. Our first question comes from Bob Levick with CJS Securities. Please proceed.

Good afternoon. Thanks for taking our questions.

Hey, Bob.

Hey. So I just wanted to kind of dig in a little more on what you just gave us, you know, in terms of guidance and a look into it. the first half in general. If I do the quick math on the sequential growth in Q2, it looks like you're still looking for about 10% revenue declines there. So 25 and plus or minus in Q1, 10 and Q2. The question is, can you talk more about the first half end market demand versus inventory corrections? And really talk about the end market demand for that first half by segment, if you could, in a new segment orientation that you've laid out for us.

Yeah, Bob, I'd be happy to do that, provide some additional color on Q2. And also, just like maybe first start with Q2, but then maybe delve in a little bit about what we see right now for a full year. But let me start with Q2. Let me break this up by the business units. As I said in the prepared remarks, we expect about 15% to 20% sequential revenue growth in Q2 over Q1. So first, in the MedTech and specialty audio, What I'd say here is we're fully booked for Q1 already. And I think we're probably a little ahead of normally where we'd be at this time. So we're feeling pretty good that what's included in our guidance for Q1 is very, very achievable. And the trend generally is that as we move through the quarter, the bookings are getting better. Even in Q2, we're already seeing strong bookings in Q2. So, you know, I think when we think about the sequential growth improvement in Q2, I think, you know, we're pretty happy about where we are with that. In the PD space, I would say it's kind of a similar story. You know, the current bookings, you know, which are even longer than out then where we would be in the MedTech and specialty audio, you know, are pretty good. And the expectations to see growth in defense, EV, MedTech, you know, are quite good. So I think we feel pretty good about that as well. Lastly, in the consumer events market, I would say I'm cautiously optimistic for modest improvements in Q2, and I think the majority of that will be in China improvements. Right now, if I were to sit there and look at my forecast or how I look at China, China's at a really low point in Q1 still, and we do see some pretty nice growth sequentially, not year over year yet, but sequentially. But there's still inventory clearly in some of these places. And I would point out specifically compute. We're not seeing a real recovery or move out of the inventory until probably the back half a year. So, you know, overall, again, 15 to 20% sequential growth. Now, I'd like to just make a comment, a few comments about 23. I'll preface this. This is a very fluid situation. This is not guidance. This is more just kind of what I'm thinking about. And I'll go through it by segment again. First, for precision devices, very strong defense markets we're expecting in 23. I'd say steady growth in the MedTech portion of precision devices. And then the last piece in terms of growth is EV. And I would say since the last earning call, our visibility into growth, to nice growth in this space for 23, looks pretty good. The bookings have been strong, and we expect them to continue to be strong. That's being driven by the abatement of the global shortage of chips first for automotive, but also more of our designs are now entering production and we have more confidence that they're entering production and that that's going to drive growth. We are experiencing some softening in the industrial markets with inventory starting to come up a little bit more elevated than normal in the distribution channel. But overall, I would sit there and say we still expect mid-single-digit growth for PD in 2023. In the MedTech space for the full year, I would say based on what's going to happen in the first quarter, which is there is this inventory correction, I would say we're expecting the full year to be flattish for this segment. All of our data points and discussions with our customers lead us to believe that we'll return to growth in this business in the second half of the year. But with a tough first quarter already being down versus prior year, it's probably going to be tough to get more than a flat-ish business for the full year. Now, lastly, probably the one that I probably have the most, I would say, wide variety of outcomes would be the consumer microphone business. I mean, there's a lot of people who are predicting, I would sit there and say, a big upswing in the back half. I mean, that could happen, but I'm not calling the bottom here. But right now, yet again, you know the first half continues to be impacted by demand in China, inventory clearing. I would say we'll definitely see sequential improvement from the first half based on normal seasonality in the back half of 23. And there's cautious optimism on return to growth in the second half for this segment, driven by normal seasonality, inventory being out of China, and a recovery in China. So I know that's a long answer. But all in all, I guess what I would say, given the PDF mid-single digit, MFA relatively flat, and given the first half challenges with CMM, I would say an upside-downside right here, kind of middle of the road, we see revenue being flat full year in 23. I mean, I hope that kind of gives you some color on all the markets. It's a lot of markets, but I wanted to make sure we covered that.

Yeah, that's super helpful. And then it doesn't sound like this is the case at all, but I just want to clarify that In terms of some of the changes, is there any market share shifts of any – no, it doesn't sound like there's any major – certainly like any major losses despite everything that's going on. But any market share shifts, potential wins, or how are you viewing the competitive landscape in this difficult macro environment?

Yeah, I mean, I would say for precision devices, again, we always kind of say it's kind of hard to identify the real competition here. I don't think there's any shift. I would sit there and say we're taking share in the defense portion of that market. And ED is a new market, so I don't know how you sit there and say we're taking share. We're just capitalizing on a new market in terms of ED. In MedTech and specialty audio, I would sit there and say we kind of took some share last year. I think those share gains are sustained. I don't think we see a lot of change in that either up or down in terms of share. We have relatively high share in that business. And then the consumer business, you know, I really can't point to and sit there and say we've lost this or we've won this at changing share significantly. You know, I would say in the consumer space, we're probably taking more lower margin business in the short term than we would want because we're trying to optimize our capacity utilization. But, you know, and really to get the improvement that we're hoping for in the back half from this business, we're going to have to get the full capacity utilization or near it in the back half of 23.

Got it. Okay, great color. And then last question for me, I promise I'll jump back in queue. But it just relates to what you just said in terms of you gave us the update on the restructuring, said it's complete. You know, I think you kind of planned a capacity drawdown, so to speak, you know, back in August or before that, probably the first half or middle of last year. Are you done with restructuring? Is there more, given the outlook now, that you need to do to take out? Or how do you feel about the level of capacity that you have after this restructuring?

Well, I mean, I feel pretty good about the level of capacity we have right now.

But there's a lot of background noise on your side. Hey, Bob, there's a lot of background noise on your side.

Okay. Sorry. This is my last question, so if you can just answer, I'll hit mute.

Yeah, I'll answer. So as far as the capacity utilization, our capacity we have, I think we feel pretty good about where we're at. We took out, again, a fair amount of capacity last year, and I think when the market recovers, we feel comfortable that we can fill that capacity with reasonably good gross margin business. As far as restructuring, I think, If there's one thing about it you can say, we're not shy about taking action when it's necessary, and we'll move forward with the structuring if it becomes necessary in any of our business if it makes sense. So that's how I would answer that question.

Great. Thank you so much.

Thank you. Our next question goes to Christopher Rollin with Susquehanna.

You may proceed.

Hey, guys, thanks for the question. And thanks for all that info. I don't know if I followed all of it. There was a lot there. I guess maybe asking a different way for March. Can you talk about I think I have you guys down roughly 25% sequential. Can you talk about the three segments and and you know, either force rank them or how they kind of apply to that 25. My next question will be about inventories, but I'm not quite sure how sell-in is affected here for each of these segments into March.

Yeah, so for the March quarter, you know, I would sit there and say, we're talking Q4 to Q1. Yeah, so I would sit there and say in precision devices, you know, we typically seasonally Q1, is down. We're expecting growth from this business again in Q1 year over year, but it is down sequentially. Just to describe what kind of goes on here, we typically give our price increases at the end of the year. That does sometimes drive people to want to order more in the previous quarter, especially in our distribution channel where they can get a lower price before the end of the year. It's very difficult to control that, but that's driving some sequential decline. in Q1. In the hearing health business, MSA, I would sit there and say, you know, we had a very strong first half of 22. It definitely has slowed down. And if you look at some of our hearing aid customers, they're starting to report, they're basically pointing to, you know, one to three, one to four percent full-year growth in the hearing health market. weighted heavily towards the back half, so they're expecting the first half to be down. So we're dealing with the first half being down in that business, the end market, but also inventory in the channel. But as I said, what I kind of see in this business is we are already fully booked for Q1. So the numbers that we're thinking in our guidance, we're already fully booked, which is probably a little earlier than we expected. We go into Q2, we're already starting to see bookings that are stronger probably than, or stronger than, and we're kind of talking 15% to 20% sequential growth in the Q2. So I feel pretty good about that business going into Q2 and into the back half of the year. I think the big wild card is the microphone business. We're not seeing, obviously, any recovery in Q1. Q1 is a very challenging quarter. We're running sub-50% capacity utilization. We are expecting some sequential improvement in Q2, but I would say it's not a reduction or inventory coming down. It's just some recovery in China from what I would say Q4 and Q1 being extremely low. As I said, I'm cautiously optimistic that this business can return to growth year over year in the back half of 2023.

Okay, I guess first following up on that, I guess maybe I don't totally understand. If you're fully booked, I believe you're still implying a sequential drop into Q1 for MedTech. Why would that be the case if you were fully booked out?

Well, it's fully booked out to that lower expectation, but I would say it's It's skewed toward the end of the quarter that the shipments are going to happen.

Okay. Okay. And then my second question is around inventories. I mean, if we have this very large increase in June, I guess there's two things to that. First of all, I'd love to understand the full industry dynamic. Perhaps you can quantify that. even how this inventory dynamic looks, you know, maybe revenue out there in terms of inventory that needs to be burned through in March in order to get that strong seasonal June. I assume that that's why June is so strong here because of this inventory dynamic overall. And then just to add one more thing to that, I apologize, but for your largest customer, I think they're still your largest customer, a lot of people are guiding for a week or June that we would have expected. And do you anticipate that in your guidance, or is it now at the point where it's not meaningful?

So, I mean, they're still a meaningful customer, but we're not going to make any comments about our shipments specifically to them. But here's what I'd say is, If you look at the sequential growth that we expect from Q1 to Q2, it is the vast majority is between PD and MSA. So PD and the MedTech and specialty audio. I would say on an absolute basis, it's incremental that we're expecting sequential growth in Q2. So it's not a huge amount of sequential growth. Secondly, as far as inventory goes, I mean, we're following a lot of the same things you're following in terms of mobile phone shipments, in terms of PCs. And so let's give you one example. We just got the data for January sales on handsets in China. It was not good. I mean, it was not good. And so we're still not seeing the inventory come out of the channel that's there in terms of finished product. And I would sit there and say for PCs, we've talked to the customers, but we're also looking at what the industry is saying is, And most people are saying that the inventory won't be cleared out until the end of the second quarter.

Okay, great. Thank you very much. That's helpful, Jeff.

Thank you. Our next question comes from Anthony Stoss with Craig Hallam. Your line is open.

Hi, guys. Jeff, let me start with you. I wanted to really focus in more on the PD side, which is still doing quite well. Do you have a view on the inventory in the channel, particularly just for the PD side? Where do you think it is?

I would sit there and say that the majority of stuff we do with the custom stuff, which is med tech, defense, and EV, I would say that there isn't a lot of inventory in the channel at all. I think they order for specific builds. We deliver their custom products. We're not seeing people say, oh, I got too much inventory in that portion of the market. If you look at the PD business, I would say the industrial slash distribution business was somewhere in the neighborhood of $50 million, $60 million on an annualized basis. Because we watched that inventory, it definitely, especially in the distribution where we can see it, it has been starting to creep up some. So we are expecting a little bit of weakness here in the short term. But, you know, overall, we still expect mid-single-digit growth for this business in 2023. I mean, and driven by very strong defense growth, very strong EV growth, and steady MedTech growth.

Got it. And then just the nature of your competitors, and I know you guys are shied away from really the mobile market, but I'm curious. Generally, what you're seeing on ASPs, and maybe I guess I'm more interested on the PD side, is are your competitors acting fairly rational at this point?

I would say, you know, in the PD space, you know, again, most of our stuff is custom, long-term contracts, you know, and I would sit there and say I haven't seen much pricing on pressure at all. in that portion. There's been a little bit more discussion in that distribution slash industrial side on pricing, but it's not big. Now, I'll make the comment on the CMM business. I'll be honest. I mean, the pricing has been challenged in Q4 and Q1. If you look at 2022 and 2021, 2020, we've really limited price erosion in that microphone business for the last three, four years. We've done a pretty good job of keeping that sub-four, even sub-3%. But as you look at the end of this year, as we started saying, okay, we've got to fill some of this capacity, the price erosion has become more, and we're expecting that to kind of persist in the first half of 2023, because there's a lot of excess capacity chasing less business. And so You know, we're hopeful with new products and things that will happen towards the back end for next year and into 2024 that, you know, that will reverse that trend again. But in the short term, it's kind of tough on pricing in that business. And I didn't ask, but on the hearing health, you know, I think a business or MSA business, I think, you know, the dynamics really haven't changed dramatically. You know, I think, you know, we're seeing essentially flattish pricing. Yeah, Tony, just to add on that. On PD, one of the big drivers or one of the drivers of gross margin expansion in 22 was pricing. We increased gross margins, you know, over 250 basis points. There's some mix. There's some productivity improvements. But we've also been really good at passing on our inflationary input cost to the customers through price increase.

Got it. Makes sense. And, John, since I have you, I'm wondering kind of your view on the full-year CapEx. I know you gave us for Q1 and Q2. on top of that, you guys have done a good job on free cash flow over the last 12 months. What are your thoughts now, given the reduced expectations for 2023, where your cash flow goes? I know in the past you were hoping that it nearly doubled, but I'm curious what your updated view is for free cash flow. I thought you led with CapEx.

Did you lead CapEx or free cash flow? From a CapEx standpoint, I think we're going to Yeah, we're going to be kind of in the 4% to 5% of revenue from a CapEx standpoint with more of it skewed to the PD and MSA segments. You know, we clearly aren't going to put in more CapEx for capacity and CMM, so I would say two-thirds of our CapEx in 23 will go to PD and MSA. And I think it's worth just mentioning on the CapEx side, you know, Tony, At one point, like 65%, 70% of our capex used to go where we were at 7%, 8% towards the microphone business. Now it's like 33% of 4% to 5%. And so you can see how we're shifting where we spend our dollars. In terms of cash flow, I mean, despite some pretty tough macro conditions, we still delivered 7% free cash flow as a percent of revenues in 22. And we had a big headwind, Tony, with networking capital. Inventory increased. Our payables, because we really started turning off the spigot, our payables were at a historic low as we exited 22. So it's a $40 million to $50 million working capital headwind in 22. We don't expect that to recur in 23. That's one of the metrics that I feel pretty good about is we have a very reasonable shot at getting back to that 15%, so kind of doubling that. the 22 rate as a percent of revenue in 23. And again, not having the headwind, being a little more disciplined on our CapEx, and then some operating expenses. So that kind of points to getting back to the free cash flow percent of sales back to where we were in 21.

One last question, if I could sneak it in, and maybe I misheard. When you talked about kind of second half growth, For Q3, the September quarter, are you calling for September 23 to be larger than September 22? Same thing with December.

In terms of revs. Yeah, I would say the answer to that is yes. You know, I think, you know, let me just break it down by segment. We're expecting growth, you know, in precision devices in the back half over the back half of 22. That's all the dynamics we've talked about. In MedTech, I think we started seeing this inventory correction in the back half of 22. I think we have a lot easier comps, and again, the market's expecting, the end market, our customers, and there's a lot of data out there, are expecting to return back to growth in the back half of the year. So we're expecting some nice growth year over year. But Wildcard is really around the microphone business. I think right now, if I were to sit here and say, Yeah, I would expect year-over-year growth in the back half, but I'm being very cautious in calling that out. And I would sit there and say if we really start seeing really nice growth in that business and there's a recovery, you know, I kind of said to Bob's question, when we'll end up flattish, when we really start seeing some strong growth in the microphone business in the back half, we'll do better than flattish for the full year.

Got it. Thanks, guys. Appreciate it. Best of luck.

Thanks, Don.

Thank you. As a quick reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question comes from Suji De Silva with Rocket Capital. You may proceed.

Hi, Jeff. Hi, John. Maybe hitting on a subsegment you haven't talked about much yet, the EV auto market. Can you talk about what the potential for that to ramp up is in terms of program visibility? I know it's longer visibility. And whether that can grow to be a material part of the revenues two to three years out?

Yeah, I think it's worth kind of mentioning that. So I think last year we had some reasonable growth last year, and I think we had set the expectation it was going to be around $15 million in sales at the EV business. It actually was slightly over that, so we exceeded that. I think we could have probably shipped more into that segment if it wasn't for the chip shortages that a lot of our customers were experiencing. Right now, I would sit there and say for this year, for 23, we would expect another 30% to 40% growth in terms of revenue so that it will be probably over $20 million in revenue. But I think the other part about this, Suji, that I just kind of would make a comment is the bookings are becoming very strong. And so I don't want to get into how the bookings exactly translate into when the revenue will come, but I'm hearing from the team that we could have in excess, obviously with more bookings in the back half, more than $30 million in bookings in this business. And that kind of starts to give you the indication of where that business could probably go in 2024. So all that said, design wins are strong. It depends on who are the winners three or four years from now. But I think we had said we hoped this business could be like $50 million, $60 million in three to four years. I think that's achievable. You know, and if we win with the winners, we'll see who those are, you know, in terms of how much content we have. It could be even more than that. So, you know, it's starting to become material, you know, later this year in the 24. Okay.

And then my other question is for John, perhaps. You know, you talked about a lot of the elements looking ahead to in revenue and gross margin and free cash flow intermediate term. But in terms of the cost, and you already did the restructuring here and had that question before in terms of more restructuring. Is the revenue, I'm sorry, is the cost OPEX in 1Q the way to think about a run rate going forward from here, John? Is there more flow through of the restructuring benefit? And is that the right baseline to start with as we move forward?

Yeah, if you look at Q4, and actually the numbers I gave in Q1, the benefits are full of the restructuring we announced last August are entirely baked into that. I've talked before about a $45 million run rate, which is about $180 million annualized. That's kind of what I would expect sitting here today. That is up over 22 levels, and it's really driven primarily by incentive comp. Bonuses were very low in the consumer MEMS segment as well as at corporate in 22, so we're going to have a pretty decent uptick. because we're planning to get back to normalized levels in terms of incentive comp. We also are adding some headcount in the PD to support the growth there. And then we also, you know, have conversely the benefits from the restructuring we took. So, again, I think kind of a 40% run rate is appropriate.

Okay. Thanks, John.

Thank you. Our next question comes from Christopher Rollin with Susquehanna. You may proceed.

Chris?

Oh, sorry about that mute button. This one's for John. and I might have heard this incorrectly, so I apologize, but did you guide Q2 to an EBIT margin of 22 to 24? I have gross margins. Hello? Yeah, Chris, I said gross margin.

Jeff mentioned sequential growth of 15 to 20%, and I said with that, gross margins will be back at 40% or above in Q2. Yep.

Okay, I thought I heard improved cap utilization and favorable mix 22 to 24 EBIT, or I made that up.

Yeah, I didn't say that. The gross margin getting back to 40% is dependent on increased capacity utilization, but we do... I mean, there's going to be a significant improvement in even margins in Q2, you know, but... But not to that level. Use the gross margins in Q1, use it in Q2, look at the revenue. That's going to go right to the bottom line. I kind of gave you a pretty good trail. If you think of sequential growth, gross margins at 40 above, and I just gave the run rate on OpEx, so you can...

Yeah, I must have had some bad notes. Apologize, guys. Thank you.

No worries. Thanks, Chris.

Thank you. There are no other questions waiting at this time. So as a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. There appear to be no further questions at this time. This concludes today's conference call. Thank you for your participation. You may now disconnect your line.