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.